Financial Services Update______August 1, 2011
Volume 6, No. 28



IN THIS ISSUE

Insights from Winston & Strawn

In the News

Banking Agency Developments

Treasury Department Developments

Joint SEC-CFTC Action

Commodity Futures Trading Commission

Securities and Exchange Commission

Exchanges and Self-Regulatory Organizations

Judicial Opinions

Winston & Strawn Speaking Engagements and Publications


Insights from Winston & Strawn [Top]

With news that President Obama and Congressional leaders have struck a tentative agreement on a framework for a budget deal that includes an increase in the federal government's borrowing limit one day prior to the August 2 deadline, it would appear that the debt ceiling crisis may finally be averted (although Congress has yet to vote on the legislation, which is expected today).

While this is of course welcome news, it is apparent that this is just a short-term solution, and much hard work remains to get the nation's fiscal house in order. Beyond our difficult long-term debt issues, of more immediate concern to those of us in the financial services community is whether Congress will allocate sufficient financial resources to properly fund the federal regulatory agencies that are charged with implementing and enforcing the vast reforms required by the Dodd-Frank Act, such as the Securities and Exchange Commission and the Commodity Futures Trading Commission. As has been widely reported recently, at the one year anniversary of the signing of the Act, many agencies are behind schedule in drafting the panoply of intricate rules and studies that are mandated by the Act. Further, concerns have been expressed by regulators and observers that the agencies are moving too hastily, with too few qualified staff to devote sufficient attention to the required rulemakings. CFTC Chairman Gensler, for one, has publicly stated he doubts that his agency will be able to police the derivatives market properly under the new rules they are in the process of drafting without a significant increase in staff funding. Many conservatives in Congress have called for significant cuts in regulatory agency budgets, in what they view is a political position consistent with free market principles. And, it is reported that this weekend's apparent budget deal emphasizes spending cuts, leaving the issue of revenue increases for another day.

While one can certainly debate the proper mix of spending cuts and revenue increases as an economic and fiscal matter, one thing is for sure: Regardless of one's political views, it is in everyone's interest to give our regulators enough resources and support to allow them to fulfill their mandates of ensuring fair, transparent and efficient financial markets. If we do this, we will be one step closer to hopefully putting the nation on a sound long-term economic footing again.


In the News [Top]
  • Judicial Challenges to Dodd-Frank Rules Considered.
On July 29th, the Wall Street Journal reported that financial industry and business groups are considering judicial challenges to the rules implementing the Dodd-Frank Act. The groups find support in the D.C. Circuit's July 22, 2011 opinion vacating the SEC's proxy access rules for failure to comply with the Administrative Procedures Act. Challenges.
  • Federal District Court Limits Sarbanes-Oxley Whistleblower Suits.
On July 28th, the Legal Intelligencer summarized the Eastern District Court of Pennsylvania's opinion in Wiest v. Lynch, a Sarbanes-Oxley whistleblower lawsuit in which the Court held that a putative whistleblower must do more than point out financial improprieties. He must essentially allege securities fraud. Whistleblower Limits.
  • The SEC's Enhanced Anti-Fraud Measures.
On July 27th, Reuters reported on the SEC's new efforts to combat fraud. Those efforts include the TCR Database, which provides a centralized system for handling tips, complaints and referrals. An FBI agent embedded at the SEC also views all the securities fraud tips that the Commission receives and attends SEC working groups on small-cap fraud and China-based reverse mergers. Enhanced Efforts.
  • Litigation Trends.
On July 26th, the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research released their 2011 mid-year assessment of securities class action filings. The number of securities fraud cases filed in the first-half of 2011 decreased by 9.6 percent from the number filed in the second-half of 2010. The number of traditional securities fraud lawsuits alleging accounting improprieties or the inflation of stock prices also appears to be declining while cases involving Chinese reverse mergers and mergers and acquisitions more generally are on the rise. Press Release.
  • The CFPB and the Republicans' Vow.
On July 26th, the New York Times' DealBook discussed the Senate Republicans' vow to refuse to confirm any director to the Consumer Financial Protection Bureau until certain changes are made to the Bureau's structure. Republicans' Vow.
  • Massachusetts Attorney General Rejects Broad Settlement Release.
On July 25th, Bloomberg reported that the Massachusetts Attorney General said she will not support a global home foreclosure procedures settlement if it includes a release of claims for the banks' securitization practices or relationship with Mortgage Electronic Registration Systems ("MERS"). The attorneys general for Delaware and New York have made similar comments. Attorneys General.
  • Federal Reserve Board Reports on Credit Ratings Replacements.
On July 25th, Reuters reported that later this year, the Federal Reserve Board anticipates replacing credit ratings with alternatives as part of its establishment of new capital requirements for banks. Ratings Replacements.
  • Pushy Broads.
On July 24th, Boston Globe columnist Joan Vennochi asks whether former FDIC Chairman Sheila Bair and former Congressional Oversight Panel Chairman Elizabeth Warren were pushed out of Washington, D.C. for being "pushy broads." Pushy Broads.

Banking Agency Developments [Top]
  • Federal Reserve Board Proposes Retail Forex Rule.
On July 28th, the Federal Reserve Board requested comment on a proposal that sets standards for banking organizations regulated by the Federal Reserve that engage in certain types of foreign exchange transactions with retail customers. Comments should be submitted on or before October 11, 2011. Federal Reserve Board Press Release.
  • OCC Issues Bulletin on Retail Forex Rule.
On July 28th, the OCC issued a Bulletin on its final rule authorizing national banks, Federal branches and agencies of foreign banks, and their operating subsidiaries to engage in certain off-exchange transactions in foreign currency with retail customers. The rule establishes various requirements with which national banks must comply to conduct such transactions.
  • OCC Issues Bulletin on OTS Integration.
On July 28th, the OCC issued a Bulletin on its interim final rule and request for comments that republishes those Office of Thrift Supervision regulations that the OCC has authority to promulgate and enforce as of July 21, 2011.

Treasury Department Developments [Top]
  • Treasury Designates Al-Qa'ida Members.
On July 28th, the Treasury Department announced the designation of six members of an al-Qa'ida network headed by Ezedin Abdel Aziz Khalil, a prominent Iran-based al-Qa'ida facilitator, operating under an agreement between al-Qa'ida and the Iranian government. As a result of the action, U.S. persons are prohibited from engaging in commercial or financial transactions with the designees, and any assets they may hold under U.S. jurisdiction are frozen. Treasury Department Press Release.
  • New Executive Order Targets Significant Transnational Criminal Organizations.
On July 25th, the Treasury Department announced that President Obama has signed an Executive Order imposing sanctions against significant transnational criminal organizations ("TCOs"). As a result of the Order, any property in the United States or in the possession or control of U.S. persons in which the significant TCOs have an interest is blocked, and U.S. persons are prohibited from engaging in transactions with them. The Order also authorizes the Treasury Department, in consultation with the Departments of Justice and State, to identify for sanctions any individual or entity determined to have materially assisted, sponsored or provided financial, material or technological support for any person whose property and interests in property are blocked pursuant to this Order. The Order immediately designates the following groups: the Brothers' Circle, the Camorra, the Yakuza, and Los Zetas. Treasury Department Press Release.
  • FSOC Releases Annual Report.
On July 26th, the Financial Stability Oversight Council released its 2011 Annual Report. The report describes the current state of the U.S. financial system and recommends steps to further strengthen the financial system. Those recommendations include heightened risk management and supervisory attention, and reforms to address structural vulnerabilities. FSOC Press Release.
Consumer Financial Protection Bureau
  • New Final Rules.
On July 28th, the Consumer Financial Protection Bureau issued four new rules:
  • Disclosure of Records and Information, an interim final rule establishing FOIA procedures, effective immediately with a request that comments be submitted on or before September 26, 2011; and
  • State Official Notification Rules, an interim final rule establishing procedures that govern the process by which state officials notify the CFPB of actions or proceedings undertaken pursuant to the authority granted in Section 1042(a) of the Dodd-Frank Act, effective immediately with a request that comments by submitted on or before September 26, 2011.
Financial Crimes Enforcement Network
  • FinCEN Issues Prepaid Access Final Rule.
On July 29th, the Financial Crimes Enforcement Network issued a final rule that amends the definitions of its Bank Secrecy Act regulations applicable to money services businesses ("MSB"). The new rule also establishes a more comprehensive regulatory approach for prepaid access. The rule puts in place suspicious activity reporting, and customer and transactional information collection requirements on providers and sellers of certain types of prepaid access similar to other categories of MSBs. The new rule is effective September 27, 2011. The compliance date is January 29, 2012. FinCEN Press Release.
  • FinCEN Withdraws Section 311 Action against Latvian Bank.
On July 26th, the Financial Crimes Enforcement Network withdrew its April 2005 finding under Section 311 of the USA PATRIOT ACT, which determined VEF Banka to be a financial institution of primary money laundering concern. FinCEN also withdrew the final rule against VEF Banka that imposed a special measure that prohibited U.S. financial institutions from directly or indirectly opening or maintaining correspondent accounts in the U.S. for VEF Banka. The withdrawals are effective upon publication in the Federal Register, which is expected during the week of August 1. FinCEN Press Release.
  • FinCEN Webinar on BSA E-Filing for MSBs.
The Financial Crimes Enforcement Network will hold an informational Webinar on August 10, 2011, to highlight to money services businesses ("MSBs") the benefits of the Bank Secrecy Act Electronic Filing System and instruct MSBs on the simple process of signing up and using E-Filing. FinCEN Press Release.

Joint SEC-CFTC Action [Top]
  • CFTC and SEC Request Comments on Swap Regulation.
On July 25th, the CFTC and SEC requested comment on swap regulation and clearinghouse regulation in the United States, Asia, and Europe. The comments are requested in connection with the Dodd-Frank Act's requirement that the agencies report to Congress on areas of cross-national regulation that are similar and other areas of regulation that could be harmonized. In addition, the report must identify major swap contracts, dealers, exchanges, clearinghouses, and regulators in each geographic area, and must describe the methods for clearing swaps and systems used for setting margin in each area. Comments should be submitted on or before September 26, 2011. CFTC Press Release.

Commodity Futures Trading Commission [Top]
  • CFTC Commissioner Seeks Comments on Swaps.
On July 28th, CFTC Commissioner Scott D. O'Malia issued a letter seeking comment on the manner in which the CFTC should determine (i) which swaps would be subject to the clearing requirement and (ii) whether to grant a stay of a clearing requirement. Comments should be submitted on or before September 14, 2011. CFTC Press Release.
  • Open Meeting.
The CFTC will hold an Open Meeting on August 4, 2011 to consider three final rules under the Dodd-Frank Act concerning agricultural swaps; swap data registration: registration standards, duties and core principles; and implementing the whistleblower provisions of Section 23 of the Commodity Exchange Act. CFTC Press Release.
  • CFTC Subcommittee on Data Standardization to Meet.
The CFTC announced that on August 5, 2011, the Subcommittee on Data Standardization, a new Subcommittee of the CFTC's Technology Advisory Committee, will hold a public meeting. At least two other public meetings are tentatively scheduled for September 30, 2011, and November 4, 2011. CFTC Press Release.

Securities and Exchange Commission [Top]
New Final Rules
  • Large Trader Reporting.
On July 26th, the SEC voted unanimously to adopt a new rule establishing large trader reporting requirements to enhance the agency's ability to identify large market participants, collect information on their trading, and analyze their trading activity. The new rule requires large traders to identify themselves to the SEC, which will then assign each trader a unique identification number. Large traders will provide this number to their broker-dealers, who will be required to maintain transaction records for each large trader and report that information to the SEC upon request. The new requirement is part of the agency's response to the May 6, 2010 "flash crash." The new rule will be effective 60 days after publication in the Federal Register, which is expected during the week of August 1. SEC Press Release.
  • New Short Form Criteria Replace Credit Ratings.
On July 26th, the SEC voted unanimously to adopt new rules required by the Dodd-Frank Act. The rules remove credit ratings as eligibility criteria for companies seeking to use "short form" registration when registering securities for public sale. The new rules replace credit ratings with four new tests, one of which must be satisfied for an issuer to use Form S-3 or Form F-3, the short forms. In order to ease transition for companies, the rules include a temporary, three-year grandfather provision. The new rules will be effective 30 days after publication in the Federal Register, which is expected during the week of August 1, except the rescission of Form F-9 and amendments to remove references to Form F-9 in other rules and forms, which will be effective December 31, 2012. SEC Press Release. See also Paredes Open Meeting Remarks (noting that the revisions that have been made to mitigate the risk that the rule amendments would shrink the pool of eligible Form S-3 issuers).
Proposed Rules
  • Shelf Eligibility Requirements for Asset-Backed Securities.
On July 26th, the SEC voted unanimously to re-propose for public comment rules requiring greater accountability and enhanced quality around asset-backed securities ("ABS") using shelf registration. The SEC initially proposed the rules in April 2010; however, subsequent to that proposal, the Dodd-Frank Act was signed into law and addressed some of the same concerns about ABS. In light of those Dodd-Frank Act provisions and comments received from the public, the SEC re-evaluated its initial proposals and is republishing them for comment. Comments should be submitted within 60 days after publication in the Federal Register, which is expected during the week of August 1. SEC Release No. 33-9244. See also SEC Press Release; Aguilar Open Meeting Remarks; Schapiro Open Meeting Remarks.
Other Developments
  • Capital Buffers Considered for Money Market Mutual Funds.
On July 27th, Bloomberg reported that members of the SEC staff may recommend capital buffers for money market mutual funds. Funds failing to maintain the buffer would have to announce that fact and convert to a floating net asset value. A proposed rule could be released as early as October. Capital Buffers.
  • SEC Report on Structured Product Sales Practices.
On July 27th, the SEC issued a report identifying common weaknesses seen in sales of structured securities products and describing measures that broker-dealers should adopt to better protect retail investors from fraud and abusive sales practices. SEC Press Release.

Exchanges and Self-Regulatory Organizations [Top]
Financial Industry Regulatory Authority
  • FINRA Modifies Certain Options Exercise Processes.
On July 29th, the Financial Industry Regulatory Authority updated its procedures for firms to designate their method of allocating options exercise assignment notices. Effective August 8, 2011, firms initiating an options business, or changing their allocation method, must use a new application form. FINRA also updated the designated random selection allocation procedures. FINRA Regulatory Notice 11-35.
  • FINRA Reaffirms Guidance on Soliciting Business in Foreign Jurisdictions.
On July 27th, the Financial Industry Regulatory Authority reaffirmed its guidance set forth in Notice to Members 00-02 concerning the solicitation of business in foreign jurisdictions. FINRA also withdrew NTM 98-91 concerning cold calling and advertising to persons in the United Kingdom, in light of changes to the U.K.'s legal and regulatory framework. FINRA Regulatory Notice 11-34.
  • Exception Proposed for Customer Account Statement Distribution Requirement.
On July 26th, the SEC provided notice of the Financial Industry Regulatory Authority's amendment to its proposal to adopt NASD Rule 2340 ("Customer Account Statements") as FINRA Rule 2231 in the consolidated FINRA rulebook. As originally proposed, new FINRA Rule 2231 would have required each general securities member to send account statements at least once each calendar month to each customer whose account had activity during the period since the previous statement was sent to the customer. The amendment would exclude certain account activities from the proposed monthly account statement delivery requirement. Comments should be submitted within 21 days after publication in the Federal Register, which is expected during the week of August 1. SEC Release No. 34-64969.
  • FINRA Proposes Expanding Arbitrators' Ability to Make Referrals.
On July 25th, the SEC provided notice of the Financial Industry Regulatory Authority's filing of a proposed amendment to Rule 12104 of the Code of Arbitration Procedure for Customer Disputes ("Customer Code"), and to Rule 13104 of the Code of Arbitration Procedure for Industry Disputes ("Industry Code"), to broaden arbitrators' authority to make referrals during an arbitration proceeding, rather than solely at the conclusion of the matter. Comments should be submitted on or before August 19, 2011. SEC Release No. 34-64954.
  • FINRA Issues Investor Alert.
On July 25th, the Financial Industry Regulatory Authority issued an Investor Alert warning investors about putting their assets into riskier and sometimes complex products such as structured notes with principal protection, high-yield bonds, floating-rate loan funds and leveraged products. FINRA Press Release.
Fixed Income Clearing Corporation
  • Amendments to GCF Repo Service are Proposed.
On July 25th, the SEC provided notice of the Fixed Income Clearing Corporation's proposed rule change regarding the GCF Repo service to adopt changes recommended by the Tri-Party Repo Infrastructure Reform Task Force ("TPR"). Because the GCF Repo service operates as a tri-party mechanism, FICC has been requested to incorporate changes to the service to align it with other changes recommended by the TPR for the overall tri-party repo market. FICC is proposing to initially implement the changes in a pilot program to run for one year. If FICC decides to extend the Pilot Program or to implement the changes in the Pilot Program permanently, FICC shall submit a proposed rule change filing to the Commission for that purpose. Comments should be submitted on or before August 19, 2011. SEC Release No. 34-64955.
NASDAQ Stock Market
  • SEC Designates Longer Period to Consider Proposed Reverse Merger Listing Requirements.
On July 25th, the SEC designated September 12, 2011, as the date by which it will either approve or disapprove, or institute proceedings to determine whether to disapprove, NASDAQ Stock Market's proposal to adopt additional listing requirements for reverse mergers. SEC Release No. 34-64956.
NYSE Euronext
  • NYSE Euronext Issues a Reminder Regarding Trading Pauses.
On July 27th, NYSE Euronext reminded members that the SEC has approved amendments to Rule 80C extending volatility trading pauses to all NMS stocks and revising certain related DMM quoting obligations under Exchange Rule 104(a)(1)(B). These rule changes will be effective August 8, 2011. NYSE Euronext Information Memo 11-22.

Judicial Opinions [Top]
  • Ashland Goes 0-2 in ARS Cases.
On July 28th, both the Second and Sixth Circuits affirmed the dismissal of auction rate securities ("ARS") cases brought by Ashland Inc. and its special purpose vehicle. Ashland invested in ARS offered by Morgan Stanley and Oppenheimer. After the ARS market collapsed, Ashland filed securities fraud complaints against Morgan Stanley in the Southern District of New York, and Oppenheimer in the Eastern District of Kentucky. Both district courts dismissed their respective cases and both appellate courts affirmed the dismissals. The Second Circuit held that Ashland, a sophisticated investor, could not plead reasonable reliance on Morgan Stanley's alleged misrepresentations in light of Morgan Stanley's publicly-filed statement, required by the SEC, explicitly disclosing the very liquidity risks about which Ashland claims to have been misled. The Sixth Circuit held that Ashland failed to plead a strong inference of scienter. Apart from conclusory allegations, Ashland failed to provide any facts explaining why or how Oppenheimer possessed advance, non-public knowledge that underwriters would jointly exit the ARS market and cause its collapse.
  • Madoff Trustee Lacks Standing to Sue Third Parties.
On July 28th, the Southern District of New York held that the Securities Investor Protection Act ("SIPA") trustee liquidating Bernard L. Madoff Investment Securities ("Madoff Securities") lacks standing to pursue common law claims against third parties who allegedly violated a duty to Madoff Securities' customers by failing to detect Madoff's fraud. According to the court, the trustee stands in the shoes of the debtor, not the creditors, is not a bailee under the common law, is not a subrogee as to third parties under SIPA, and is not an assignee of customer claims. Moreover, the trustee's claims are subject to the in pari delicto doctrine. Picard v. HSBC Bank PLC. On July 29th, Bloomberg summarized some of the implications of the decision. Implications. In a related development, the New York Times reported that the Government Accountability Office will investigate the trustee's decision to file clawback suits against Madoff investors who redeemed more money than they invested with Madoff. Clawbacks.
  • Adding Insult to Injury.
On July 28th, the Eastern District Court for Wisconsin held that the Koss Corporation could be liable under Rule 10b-5 for securities fraud after its vice president for finance embezzled $30 million from it. Applying agency law, the Court held that the financial misstatements made by the vice president to conceal her fraud can be imputed to the company. The control person liability claim against the company's president also survived. The Rule 10b-5 claims against the president and the firm's auditor, however, were dismissed for failing to adequately plead scienter. Puskala v. Koss Corp.
  • Securities Fraud Lawsuit against Lehman Brothers Proceeds.
On July 27th, the Southern District Court of New York ruled that purchasers of Lehman Brothers' debt and equity securities stated claims under the Securities Act and Securities and Exchange Act against Lehman Brothers, its former officers and directors, and its underwriters. In a thorough and methodical 106-page opinion, the Court held that plaintiffs' allegations that defendants made misleading statements and omissions concerning Lehman Brothers' risk management, liquidity risk, credit risk, asset valuations, and use of "Repo 105" accounting transactions, were actionable. In re Lehman Brothers Securities and ERISA Litigation. On July 28th, New York Times columnist Floyd Norris discussed the opinion's implications for auditors. Ernst & Young, Lehman Brothers' auditor, was also sued but unlike its co-defendants, had much of its motion to dismiss granted. Auditors.
  • Federal Court has Mandatory Original Jurisdiction in Foreclosure Case.
On July 27th, the Fifth Circuit addressed federal court diversity jurisdiction. Plaintiffs filed a state court complaint alleging that defendants violated state consumer protection laws and the Truth in Lending Act in the servicing and foreclosure of plaintiffs' home mortgage. Defendants removed the matter to federal court, where the TILA claims were dismissed. Declining to exercise supplemental jurisdiction, the federal district court remanded the state law claims. Defendants appealed the remand. Because defendants established that a defendant had been improperly joined, the Fifth Circuit held the trial court had original, mandatory diversity jurisdiction over the state law claims and erred in remanding the case. Cuevas v. BAC Home Loans Servicing, L.P.
  • Dismissal of Securities Fraud Lawsuit is Affirmed.
On July 26th, the Second Circuit affirmed the dismissal of a securities fraud complaint alleging that a real estate financing company made material misstatements of fact in its offering materials concerning the impairment of two mezzanine loans. The Court found that the alleged misstatements were not material because the value of the loans composed an immaterial portion of the issuer's total assets. In so doing, the Court noted that in considering the materiality of statements, courts should weigh whether an issuer's particular product or product line, or division or segment, has independent significance for investors. If so, then even a matter material to less than all of the company's business may be material for purposes of the securities laws. Here, however, plaintiffs could not plausibly allege that mezzanine loans constitute a component of the issuer's business that is of distinct interest to investors. The Court therefore considered the two mezzanine loans in the context of the issuer's entire business and found them to be an immaterial part of that business. Sheet Metal Workers Local No. 33 v. CBRE Realty Finance, Inc.

Winston & Strawn Speaking Engagements and Publications [Top]
  • Winston to Speak and Sponsor Thomson Reuters' 17th Annual LPC Loan Conference.
Winston & Strawn corporate finance partners will speak at the 17th Annual Thomson Reuters LPC Loan Conference to be held Thursday, September 22, 2011 in New York. The theme of this year's conference is "Boom to Bust and Back: The Global Loan Market Moves Forward." Event.

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