Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Friday, July 29, 2011

Financial Stability Oversight Council Issues Annual Report on Current State of U.S. Financial System

The Financial Stability Oversight Council released its 2011 Annual Report. Under the Dodd-Frank Act, the Council must report annually to Congress on a range of issues, including the activities of the Council; significant financial market and regulatory developments; and potential emerging threats to the financial stability of the United States. The report must also make recommendations for promoting market discipline; maintaining investor confidence; and enhancing the integrity, efficiency, competitiveness, and stability of U.S. financial markets.
In this first annual report, the Council describes the current state of the U.S. financial system and some of the major forces that will shape its development going forward. The report also includes recommendations for additional steps that should be taken to complement these efforts and further strengthen the financial system. Those recommendations include:
1)      Heightened risk management and supervisory attention
Construct robust capital, liquidity and resolution plans.
Bolster resilience to unexpected interest rate shifts.
Maintain discipline in credit underwriting standards.
Employ appropriate due diligence for emerging financial products.
Keep pace with competitive, technological, and regulatory market structure developments.

2)      Reforms to address structural vulnerabilities
Implement structural reforms to mitigate run risk in money market funds. 
Elimination of most intraday credit exposure and reform of collateral practices in the tri-party repo market to strengthen the market.
Improve the overall quality of mortgage servicing by establishing national mortgage servicing standards and servicer compensation reform.

3)      Continued progress on housing finance
To strengthen the housing finance system, the Council member agencies and the Department of Housing and Urban Development should set forth standards and guidelines for participants in the housing finance system, and other actions that strengthen mortgage underwriting.
To give further confidence to the market and provide long-term stability to the U.S. financial system, the Council believes Congress must pass responsible legislation to reform the housing finance system. The reform efforts should not further destabilize the fragile housing market.

July 29, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Arbitration Rule Would Broaden Arbitrators' Authority to Make Disciplinary Referrals

FINRA recently filed with the SEC a proposed rule change to amend Rule 12104 of the Code of Arbitration Procedure for Customer Disputes (“Customer Code”) and Rule 13104 of the Code of Arbitration Procedure for Industry Disputes (“Industry Code”) to broaden arbitrators’ authority to make referrals during an arbitration proceeding.  Currently, Rule 12104(b) of the Customer Code and Rule 13104(b) of the Industry Code state, in relevant part, that any arbitrator may refer to FINRA for disciplinary investigation any matter that has come to the arbitrator’s attention during and in connection with the arbitration only at the conclusion of an arbitration.  As FINRA explains, "in light of well publicized securities frauds that resulted in harm to investors, FINRA has reviewed the Customer and Industry Codes (together, Codes) and determined that its rules on arbitrator referrals should be amended to permit arbitrators to make referrals during an arbitration proceeding, rather than solely at the conclusion of a matter as is currently the case." 

July 29, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

SEC Re-Proposes Rules on Shelf-Eligibility Conditions for ABS

The SEC re-proposed for public comment proposed rules requiring greater accountability and enhanced quality around asset-backed securities (ABS) when issuers seek to use an expedited registration process known as shelf registration.  The SEC initially proposed rules in April 2010 to significantly revise the regulatory regime for ABS. Subsequent to that proposal, the Dodd-Frank Act was signed into law and addressed some of the same ABS concerns. In light of those Dodd-Frank Act provisions and comments received from the public, the SEC re-evaluated its initial proposals.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Adopts Rule Eliminating Use of Credit Ratings as Eligibility Criteria for S-3

The SEC unanimously adopted new rules to conform to Dodd-Frank's mandate to reduce reliance on credit ratings as eligibility criteria for companies seeking to use “short form” registration (S-3 and F-3) when registering securities for public sale.  Companies currently qualify to use these forms if they are registering an offering of non-convertible securities, such as debt securities, that have received an investment grade rating by at least one nationally recognized statistical rating organization (NRSRO).

The new rules eliminate the credit ratings criteria and replace it with four new tests, one of which must be satisfied for an issuer to use Form S-3 or Form F-3. In order to ease transition for companies, the rules include a temporary, three-year grandfather provision.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Adopts Rule Requiring Large Trader Reporting

The SEC unanimously adopted 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 rule has two primary components:

  • it requires large traders to register with the Commission through a new form, Form 13H.
  • it imposes recordkeeping, reporting, and limited monitoring requirements on certain registered broker-dealers through whom large traders execute their transactions.

The new rule will be effective 60 days after its publication in the Federal Register.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Staff Report Finds Lack of Supervision in Selling Structured Products to Retail Investors

The SEC released a staff report identifying common weaknesses seen in sales of structured securities products and describing measures by broker-dealers to better protect retail investors from fraud and abusive sales practices.  The report summarizes the results of a sweep examination of the retail structured securities products business of 11 broker-dealers, covering a cross-section of the industry.

Among other things, the staff observed that broker-dealers might have:

  • recommended unsuitable structured securities products to retail investors;
  • traded at prices disadvantageous to retail investors;
  • omitted material facts about structured securities products offered to retail investors;
  • engaged in questionable sales practices with customers.

The report notes that there appears to have been a lack of training requirements for supervisors and registered representatives that market structured products to their customers. The report contains recommendations for improved surveillance of sales practices and enhanced training for sales and supervisory personnel.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Diageo Settles FCPA Charges with SEC for $16 Million

The SEC recently charged London-based Diageo plc, one of the world’s largest producers of premium alcoholic beverages, with widespread violations of the Foreign Corrupt Practices Act (FCPA) stemming from more than six years of improper payments to government officials in India, Thailand, and South Korea.  The SEC found that Diageo paid more than $2.7 million to obtain lucrative sales and tax benefits relating to its Johnnie Walker and Windsor Scotch whiskeys, among other brands. Diageo agreed to pay more than $16 million to settle the SEC’s charges. The company also agreed to cease and desist from further violations of the FCPA’s books and records and internal controls provisions.

The SEC’s order found that Diageo violated Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934. Without admitting or denying the findings, Diageo agreed to cease and desist from further violations and pay $11,306,081 in disgorgement, prejudgment interest of $2,067,739, and a financial penalty of $3 million. Diageo cooperated with the SEC’s investigation and implemented certain remedial measures, including the termination of employees involved in the misconduct and significant enhancements to its FCPA compliance program.

July 29, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

FINRA Fines SunTrust $5 Million for ARS Practices

The FINRA recently announced that it fined SunTrust Robinson Humphrey, Inc. (SunTrust RH) and SunTrust Investment Services, Inc. (SunTrust IS) for violations related to the sale of auction rate securities (ARS). SunTrust RH, which underwrote the ARS, was fined $4.6 million for failing to adequately disclose the increased risk that auctions could fail, sharing material non-public information, using sales material that did not adequately disclose the risks associated with ARS, and having inadequate supervisory procedures and training concerning the sales and marketing of ARS. SunTrust IS was fined $400,000 for having deficient ARS sales material, procedures and training.

FINRA found that beginning in late summer 2007, SunTrust RH became aware of stresses in the ARS market that raised the risk that auctions might fail. At the same time, SunTrust RH was told by its parent, SunTrust Bank, to reduce its use of the bank's capital and began to examine whether it had the financial capability in the event of a major market disruption to support all ARS in which it acted as the sole or lead broker-dealer. As these stresses increased, the firm failed to adequately disclose the increased risk to its sales representatives while encouraging them to sell SunTrust RH-led ARS issues in order to reduce the firm's inventory. As a result, certain SunTrust RH sales representatives continued to sell these ARS as safe and liquid. In February 2008, SunTrust RH stopped supporting ARS auctions, knowing that those auctions would fail and the ARS would become illiquid.

 In addition, both SunTrust RH and SunTrust IS used advertising and marketing materials that were not fair and balanced, and did not provide a sound basis for evaluating all the facts about purchasing ARS. Specifically, the materials did not contain adequate disclosure of all the risks of ARS, including adequately disclosing the risk that ARS auctions could fail, rendering the investments illiquid for substantial periods of time. Both firms failed to maintain adequate supervisory procedures and training concerning their sales and marketing of ARS. 

This action concludes the agreements in principle with FINRA that were previously announced in Sept. 2008 and withdrawn in May 2009. SunTrust RH and SunTrust IS voluntarily repurchased approximately $381 million and $262 million of ARS, respectively, from their customers after FINRA began its investigation. In addition, as part of the settlements, the firms will participate in a special FINRA-administered arbitration program for eligible investors to resolve investor claims for consequential damages.



July 29, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

RBS Agrees to Fed Reserve Order to Improve Oversight of U.S. Operations

The Federal Reserve Board recently announced the issuance of a joint consent cease and desist order by and among The Royal Bank of Scotland Group plc, Edinburgh, Scotland (RBS Group), a registered bank holding company, and The Royal Bank of Scotland plc, Edinburgh, Scotland (RBS plc), a foreign bank, and its branches in New York and Connecticut.  In addition to the Federal Reserve Board, the order is being issued by the New York State Banking Department, the State of Connecticut Department of Banking, and the State of Illinois Department of Financial and Professional Regulation.

The order requires the RBS Group to improve its oversight of its U.S. operations and also requires RBS plc and RBS N.V. to improve risk-management practices and compliance with Bank Secrecy Act and anti-money laundering requirements at their U.S. branches.

July 29, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, July 26, 2011

Is There Proxy Access After Business Roundtable v. SEC?

On July 22, the D.C. Circuit, a court that has previously vacated SEC rules for inadequate cost-benefit analysis, issued its harshest criticism yet of the agency when it vacated the proxy access rule for failure to consider the rule's effect upon efficiency, competition and capital formation.  The opinion is only 10 pages long, and Judge Ginsburg devotes himself to heaping criticism and scorn on the agency's failure to consider adequately its economic effects.  Business Roundtable v. SEC (D.C. Cir. July 22, 2011). To paraphrase just a snippet of the opinion:  the agency "inconsistently and opportunistically" framed the costs and benefits; failed adequately to quantify certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself and failed to respond to substantial problems raised by commenters, etc.  You get the drift of the opinion.

What's next for proxy access?  The SEC has not previously sought an en banc hearing or certiorari in those instances where the D.C. Circuit vacated rules, so that option seems unlikely.  It could, as with the previous efforts (variable annuity contracts and investment company boards with majority of independent directors), simply give up.  Activist shareholder groups, however, fought hard for proxy access and are not likely to give up the fight.  The agency can go back to the drawing board and attempt to develop a record on cost-benefit analysis that will satisfy the D.C. Circuit, but that will be a difficult, time-consuming task, given the numerosity of the court's criticisms, which has made it clear that it will not give the agency any benefit of the doubt.  (Jay Brown has demonstrated that this is inconsistent with the APA's arbitrary and capricious standard.)  Alternatively, the SEC might consider adopting a weaker version to encourage, but not mandate, proxy access that might pass muster with the business community and the D.C. Circuit.

In any event, morale must be low today at the SEC, as this is yet another black mark on Mary Schapiro's administration.

July 26, 2011 in Judicial Opinions | Permalink | Comments (0) | TrackBack (0)