Financial Services Update______February 21, 2012
Volume 7, No. 8



IN THIS ISSUE

Insights from Winston & Strawn

In the News

Banking Agency Developments

Treasury Department Developments

Commodity Futures Trading Commission

Securities and Exchange Commission

Exchanges and Self-Regulatory Organizations

Judicial Opinions

Rules Effective Dates

Winston & Strawn Speaking Engagements and Publications


Insights from Winston & Strawn [Top]

The last few weeks have seen a number of regulatory changes affecting investment advisers. In particular, the Commodity Futures Trading Commission (the "CFTC") has rescinded a commonly-used exemption from registration as a commodity pool operator ("CPO") and the Securities and Exchange Commission ("SEC") adopted amendments revising the calculation used to determine whether investors are "qualified clients."
On February 9, 2012, the CFTC issued final rules (the "Final Rules") that, among other things, rescinded Rule 4.13(a)(4). Rule 4.13(a)(4) provided an exemption from CPO registration for operators of pools only offered to investors that meet certain provisions of the "qualified eligible person" test under CFTC Rule 4.7 (essentially, individuals who are "qualified purchasers" within the meaning of Section 3(c)(7) of the Investment Company Act and entities that are "accredited investors" under Regulation D). Rule 4.13(a)(4) was commonly used by hedge fund managers to avoid registration as a CPO. CPOs and investment managers currently claiming exemptive relief for an existing pool (or investment fund) may continue to rely on Rule 4.13(a)(4) until December 31, 2012. CPOs (and investment managers) will not be able to claim relief under Rule 4.13(a)(4) with respect to any new commodity pool (or new investment fund) once the Final Rules become effective. Our full client briefing on the matter is available here.
On February 15, 2012, the SEC adopted amendments (the "Amendments") revising the dollar amount thresholds and calculation used to determine whether an investor is a "qualified client." The amendments included increased thresholds previously imposed by a July 2011 order by the SEC that required qualified clients to have at least $1 million of assets under management with the adviser or a net worth of at least $2 million, which amounts will be adjusted every five (5) years to account for the effects of inflation. Further, the Amendments generally exclude the value of an individual's primary residence and the debt secured by that residence, up to the fair market value of the residence, from the net worth calculation. These revisions are consistent with changes the SEC has made to the "accredited investor" net worth calculation. Finally, the Amendments also provide several transition provisions that allow an investment adviser and its clients to maintain existing performance fee arrangements that were permissible at the time the advisory contract was executed. The Amendments will be effective 90 days following their publication in the Federal Register. A more detailed Client Briefing regarding the Amendments will be forthcoming.
Finally, the SEC's amendments to the net worth thresholds and calculations under the "accredited investor" standard are effective as of February 27, 2012. To view our Client Briefing on this topic, please click here.


In the News [Top]
  • Occupy's Volcker Rule Comments.
On February 17th, Corporate Counsel summarized the comments submitted by "Occupy the SEC" in response to federal regulators' proposal implementing the Volcker Rule, the Dodd-Frank Wall Street Reform and Consumer Protection Act's (the "Dodd-Frank Act") prohibition against proprietary trading. The authors, current and former corporate lawyers and financial analysts, discussed compliance and risk management issues, arguing that compliance personnel should be better compensated. Occupied.
  • House Committee Passes Four Bills.
On February 16th, Bloomberg reported that the House Financial Services Committee (the "Committee") approved a bill removing the "push-out" provision of the Dodd-Frank Act. The bill would allow over-the-counter swaps tied to high-quality credit transactions to remain on the books of insured banks. The Committee also passed (i) a bill that would insure that the production of documents to the Consumer Financial Protection Bureau (the "CFPB") by banks would not constitute a waiver of any attorney work product privilege, (ii) a bill on small business capital formation, and (iii) a bill requiring the Securities and Exchange Commission (the "SEC") to conduct cost-benefit analyses before adopting new regulations. Committee Actions. See also Committee Website (with links to bills that were passed).
  • Whistleblower Potential.
On February 16th, Business Week reported that the SEC's new whistleblower rules could potentially have a greater impact than the False Claims Act. Potential.
  • The Supreme Court Will Hear a Case Involving Investor Protection Versus Free Speech.
On February 14th, Forbes reported on a recently submitted Supreme Court petition for certiorari filed by Bulldog Investors and co-authored by constitutional law professor Laurence Tribe. The case stems from a Massachusetts regulatory action against a hedge fund which allegedly violated state investor protection laws. The petition frames the issue as one involving free speech and asks, "whether a state ban on speech by an issuer of unregistered securities to members of the public based upon their financial status violates the First Amendment, where the speech is concededly truthful and non-misleading, and where the state characterizes the speech ban as a 'disclosure rule' to further an objective that federal law does not permit the state to achieve directly." Petition.
  • A Modest Proposal.
On February 14th, Bloomberg summarized the comments submitted by former Citigroup CEO John S. Reed in response to federal regulators' proposed rule implementing the Dodd-Frank Act's prohibition against proprietary trading. Proposal. Reed suggests: "I propose that [the] chief executive officer, the senior officer responsible for trading, his equivalent responsible for risk management, and his equivalent responsible for accounting within the trading unit sign a statement each quarter stating, that to the best of their individual knowledge the operations of the trading unit were conducted within the letter and spirit of the Volcker Rule." Reed Comments.
  • Labor and Treasury Departments' Annuity Proposals.
On February 10th, CFO.com discussed the Treasury and Labor Departments' proposals that would make it easier for 401(k) plan sponsors to offer annuities to plan participants. After summarizing the proposals, CFO.com addresses the proposals' shortcomings. Annuity Proposals.

Banking Agency Developments [Top]
  • Regulators Extend Foreclosure Review Period.
On February 15th, the Federal Reserve Board and Office of the Comptroller of the Currency (the "OCC") extended to July 31, 2012 the period in which homeowners may seek a review of their mortgage foreclosures under the federal banking agencies' Independent Foreclosure Review. Joint Press Release.
  • OCC Issues December Cost of Funds Reports.
On February 15th, the OCC issued the monthly Cost of Funds reports (current and historical), which provide information about funding costs, as of December 31, 2011, for institutions formerly regulated by the Office of Thrift Supervision. OCC Press Release.

Treasury Department Developments [Top]
  • CFPB Proposes Rule for the Supervision of Larger Debt Collectors and Credit Reporters.
On February 17th, the CFPB published for comment a proposed rule defining larger participants in the markets for consumer debt collection and consumer reporting who will be subject to CFPB supervision. Comments should be submitted on or before April 17, 2012. 77 FR 9592. See also CFPB Press Release.
  • Treasury Department Announces the Designation of Iran's Intelligence Ministry.
On February 16th, the Treasury Department announced the designation of the Iranian Ministry of Intelligence and Security ("MOIS"), Iran's primary intelligence organization, for its support to terrorist groups as well as its central role in perpetrating human rights abuses against the citizens of Iran and its role in supporting the Syrian regime as it continues to commit human rights abuses against the people of Syria. Any property or property interests in the United States or in the possession or control of U.S. persons in which the MOIS has an interest are blocked, and U.S. persons are prohibited from engaging in transactions with it. Treasury Department Press Release.
  • Money Laundering and Terrorist Financing Recommendations Issued.
On February 16th, the Financial Action Task Force, the global standard-setting body addressing money laundering and terrorist financing, released new recommendations to combat money laundering, terrorist financing, and the financing of the proliferation of weapons of mass destructions. FATF Statement; Treasury Department Statement.
  • FinCEN Advisory on Foreign-Located Money Service Businesses.
On February 15th, the Financial Crimes Enforcement Network ("FinCEN") issued an Advisory concerning the obligations financial institutions hold under the Bank Secrecy Act when providing financial services to foreign-located money service businesses.
  • FBAR Deadline Extended for Some.
On February 14th, FinCEN extended to June 30, 2013, the Report of Foreign Bank and Financial Accounts ("FBAR") filing deadline for certain employees or officers of investment advisers registered with the SEC who have signature authority over but no financial interest in certain foreign financial accounts. All other U.S. persons required to file an FBAR this year are required to meet the June 30, 2012, filing date. FinCEN Notice.
  • CFPB Amends Home Mortgage Disclosure Exemption Threshold.
On February 15th, the CFPB published a final rule amending the official commentary that interprets the requirements of Regulation C (Home Mortgage Disclosure) to reflect a change in the asset-size exemption threshold for depository institutions based on the annual percentage change in the Consumer Price Index for Urban Wage Earners and Clerical Workers ("CPI-W"). The exemption threshold has been adjusted to increase to $41 million from $40 million. The adjustment is based on the 3.43 percent increase in the average of the CPI-W for the twelve-month period ending in November 2011. Therefore, depository institutions with assets of $41 million or less as of December 31, 2011 are exempt from collecting data in 2012. The amendments are effective immediately. 77 FR 8721.
  • CFPB Requests Comment on Prototype Mortgage Monthly Statement.
On February 13th, the CFPB requested comment on a draft monthly mortgage statement designed to make it easier for homeowners to understand their loans and avoid unnecessary costs and fees. CFPB Press Release.

Commodity Futures Trading Commission [Top]
  • Open Meeting.
The Commodity Futures Trading Commission (the "CFTC") will hold a public meeting on February 23, 2012 to:
  • Consider adopting a final rule defining "swap dealer," "security-based swap dealer," "major swap participant," "major security-based swap participant," and "eligible contract participant;"
  • Consider adopting a final rule on swap dealer and major swap participant recordkeeping and reporting, duties, and conflicts of interest policies and procedures; futures commission merchant and introducing broker conflicts of interest policies and procedures; and swap dealer, major swap participant, and futures commission merchant chief compliance officers; and
  • Consider proposing a rule on procedures to establish appropriate minimum block sizes for large notional off-facility swaps and block trades; and further measures to protect the identities of parties to swap transactions.
CFTC Press Release.
  • CFTC May Raise Threshold for Swap Dealer Designation.
On February 16th, the Financial Times reported the CFTC may raise to $2 billion the gross notional value of swaps a company may sell before being designated a swap dealer. Definition.
  • The CFTC's Proposed Budget is Increased.
On February 10th, Reuters reported the Obama Administration's proposed budget for the CFTC is $308 million, a $103 million increase over the current budget. CFTC Budget.

Securities and Exchange Commission [Top]
New Final Rules
  • SEC Raises "Qualified Client" Threshold for Investment Advisory Performance Fees.
On February 15th, the SEC published amendments to Rule 205-3 under the Investment Advisers Act of 1940, as amended, which permits investment advisers to charge performance based compensation to "qualified clients." The revised rule will require "qualified clients" to have at least $1 million of assets under management with the adviser, up from $750,000, or a net worth of at least $2 million, up from $1 million. In addition, the revised rule will exclude the value of a client's primary residence and certain property-related debts from the net worth calculation. A grandfather provision will permit registered investment advisers to continue to charge clients performance fees if the clients were considered "qualified clients" before the rule changes. In addition, the grandfather provision will permit newly registering investment advisers to continue charging performance fees to those clients already being charged performance fees. The amendments are effective 90 days after publication in the Federal Register, which is expected during the week of February 20. SEC Press Release.
Other Developments
  • Exemptive Relief Under Section 12(g) for Certain Equity Incentive Plans.
On February 13th, the Division of Corporation Finance issued a letter providing exemptive relief from the registration requirements of Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") with respect to restricted stock units granted and to be granted pursuant to a written compensatory equity incentive plan. Exemptive Relief.
  • Division of Corporation Finance Guidance on Executive Compensation Advisory Vote.
On February 13th, the Division of Corporation Finance added new question 169.07 to its compliance and disclosure interpretations for the Exchange Act. The new question addresses the advisory vote to approve executive compensation that is required by Exchange Act Rule 14a-21. New Question 169.07.
  • SEC's Current Focus on Smaller Private Equity Firms.
On February 12th, Bloomberg reported that the SEC's examination of private equity firms is principally concerned with smaller firms and how those firms value their portfolios and market themselves to investors. Private Equity.
  • Insider Trading Roadblocks on Capitol Hill.
On February 11th, the Washington Post reported on the structural and political roadblocks hindering the SEC's ability to monitor insider trading on Capitol Hill. Roadblocks.

Exchanges and Self-Regulatory Organizations [Top]
Chicago Board Options Exchange
  • Amendments to Electronic Complex Order Rules Proposed.
On February 14th, the SEC provided notice of C2 Options Exchange's and the Chicago Board Options Exchange's individual filing of proposed amendments to their respective electronic complex order rules to adopt procedures for processing stock-option orders. The amendments would (i) adopt a definition of a stock-option order (as well as include a definition of a complex order); (ii) include procedures for routing the stock leg of a stock-option order; (iii) provide that there will be no "legging" of stock-options, except in one limited context; (iv) describe the electronic allocation algorithm applicable for stock-option orders in the complex order book and the complex order RFR auction; and (v) incorporate certain price check parameter and re-COA features applicable to the electronic processing of stock-option orders. Comments should be submitted within 21 days after publication in the Federal Register, which is expected during the week of February 20th.
  • SEC Approves Amendment to Automated Improvement Mechanism.
On February 10th, the SEC approved the Chicago Board Options Exchange's proposed amendment of CBOE Rule 6.74A, which relates to the Exchange's Automated Improvement Mechanism ("AIM"). The amendment will permit a Trading Permit Holder, when submitting an agency order to AIM to initiate an auction, to elect to have last priority in the AIM auction's order allocation. SEC Release No. 34-66375.
Financial Industry Regulatory Authority
  • Amendments to FOCUS Reports Receive Accelerated Approval.
On February 9th, the SEC granted accelerated approval to the Financial Industry Regulatory Authority's ("FINRA") proposed amendment to FINRA Rule 4524 ("Supplemental FOCUS Information"), to require each member, as FINRA shall designate, to file such additional financial or operational schedules or reports as FINRA may deem necessary as a supplement to the FOCUS report. Comments should be submitted on or before March 7, 2012. SEC Release No. 34-66364.
National Securities Clearing Corporation
  • Amendment to Margining Methodology Proposed.
On February 15th, the SEC provided notice of the National Securities Clearing Corporation's ("NSCC") filing of a proposed rule change designed to enhance NSCC's margining methodology as it applies to municipal and corporate bonds. Comments should be submitted within 21 days after publication in the Federal Register, which is expected during the week of February 20th. SEC Release No. 34-66398.
NYSE Euronext
  • Disapproval Proceedings Instituted Regarding Designated Market Marker Proposals.
On February 15th, the SEC instituted proceedings to determine whether to disapprove proposed rule changes filed by the New York Stock Exchange and NYSE Amex that would codify certain traditional trading floor functions that may be performed by Designated Market Makers and to provide Designated Market Makers and floor brokers access to disaggregated order information. The SEC believes that questions remain as to whether the proposals would promote just and equitable principles of trade, perfect the mechanism of a free and open market and the national market system, protect investors and the public interest, and not permit unfair discrimination. Comments should be submitted within 21 days after publication in the Federal Register, which is expected during the week of February 20th. Rebuttals should be submitted within 35 days. SEC Release No. 34-66397.
  • SEC Approves Amendments to Unlisted Trading Privileges Pilot Program.
On February 10th, the SEC approved NYSE Amex's proposed amendment of NYSE Amex Equities Rules 504 and 509 to modify the quoting requirements applicable to Designated Market Maker units registered in Nasdaq Stock Market securities traded on the Exchange subject to the Unlisted Trading Privileges Pilot Program. SEC Release No. 34-66371.

Judicial Opinions [Top]
  • No Evidence of Gun Manufacturer's Scienter Presented in 10b-5 Claim.
On February 17th, the First Circuit affirmed the entry of summary judgment dismissing plaintiffs' Rule 10b-5 securities fraud claims. The court found that no evidence exists of defendants' subjective bad intent and the evidence of reckless misstatements or omissions is thin. And where, as here, it is questionable whether a fact is material or its materiality is marginal, the argument that defendants acted with the requisite intent or extreme recklessness is undercut. In re Smith & Wesson Holding Corp. Securities Litigation.
  • Reinvested Earnings Included in Ponzi Scheme Loss Calculation.
On February 17th, the Second Circuit affirmed the trial court's loss calculation and held that in the context of Ponzi schemes, intended loss can include reinvested earnings even when those "earnings" are the illusory predicate upon which the Ponzi scheme rests. Defendant pled guilty to charges stemming from a Ponzi scheme. On appeal, he claimed that the loss calculated for purposes of the Sentencing Guidelines improperly included promised returns on the victims' investments. U.S. v. Hsu.
  • Million Dollar Attorney Fee Award is Affirmed.
On February 16th, the Fourth Circuit affirmed the confirmation of an arbitration award and held that the arbitration panel did not manifestly disregard the law when it awarded $1.1 million in attorneys' fees and costs to the former employees in accordance with the South Carolina Frivolous Civil Proceedings Act. A FINRA arbitration panel found that Wachovia's claims against former employees were frivolous and the trial court confirmed the panel's findings. Wachovia Securities LLC v. Brand.
  • Homeowner's Insurance Does Not Cover Ponzi Scheme Losses.
On February 16th, the Second Circuit held that a homeowner's insurance policy does not cover losses suffered in a Ponzi scheme. Plaintiff, a victim of Bernard Madoff's, sought recovery under her homeowner's insurance. Affirming the entry of summary judgment dismissing the claims, the Second Circuit held that plaintiff's Madoff account did not suffer a direct physical loss as required for coverage under her insurance policy. Lissauer v. Fireman's Fund Insurance Cos. (Summary Order).

Rules Effective Dates [Top]
  • Covered Securities of BATS Exchange, Inc. - Effective February 24, 2012.
The SEC is adopting an amendment to Rule 146 under Section 18 of the Securities Act of 1933, as amended ("Securities Act") to designate certain securities listed, or authorized for listing, on BATS Exchange, Inc. as covered securities for purposes of Section 18 of the Securities Act. Covered securities under Section 18 of the Securities Act are exempt from state law registration requirements. The SEC also is making corrections to the rule text to reflect name changes. 77 FR 3590.
  • Net Worth Standard for Accredited Investors - Effective February 27, 2012.
The SEC adopted amendments to the accredited investor standards under the Securities Act to implement the requirements of Section 413(a) of the Dodd-Frank Act. Section 413(a) requires the definitions of "accredited investor" in the Securities Act rules to exclude the value of a person's primary residence for purposes of determining whether the person qualifies as an "accredited investor" on the basis of having a net worth in excess of $1 million. This change to the net worth standard was effective upon enactment by operation of the Dodd-Frank Act, but Section 413(a) also requires revision of the current Securities Act rules to conform to the new standard. The SEC is also adopting technical amendments to Form D and a number of other rules in order to conform them to the requirements of Section 413(a) and to correct cross-references to former Section 4(6) of the Securities Act, which was renumbered Section 4(5) by Section 944 of the Dodd-Frank Act. 76 FR 81793. To view our Client Briefing on this topic, please click here.

Winston & Strawn Speaking Engagements and Publications [Top]
  • CFTC Eliminates and Revises Rule 4.13 Registration Exemptions and Limits Rule 4.5 Exclusion.
On February 9, 2012, the CFTC issued final rules that, among other things, rescinded certain relief from registration as a CPO with the CFTC. Briefing.

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