CFTC Holds Open Meeting and Approves Final Rules Enhancing Customer Protections

The CFTC held an open meeting and approved final rules enhancing protections afforded customers and customer funds held by futures commission merchants (“FCM”) and derivatives clearing organizations (“DCOs”). 

Click here for a summary of the meeting and final rule by Delta Strategy Group.

See: Amendments to the Rule Text; Commissioner O’Malia’s Opening Statement; Commissioner Wetjen’s Statement; Chairman Gensler’s Statement of Support on Customer Protections; Commissioner O’Malia’s Statement of Dissent; Commissioner Chilton’s Statement of Support; Chairman Gensler’s Statement of Support on OCR Reports.

Related news: House Ag Hearing on CFTC Customer Protections (October 3, 2013); Managed Funds Association Submits Comment Letter to CFTC on Proposed Rules for Enhancing Customer Protections (February 20, 2013); National Futures Association Submits Comment Letter to CFTC on Proposed Rules for Enhancing Customer Protections (February 20, 2013); CFTC Roundtable on Enhancing Protections Afforded Futures Customers (February 6, 2013); and Enhancing Protections Afforded to Customers and Customer Funds Held by FCMs and Derivatives Clearing Organizations; Notice of Proposed Rulemaking (CFTC; Fed. Reg. Version) (November 15, 2012).

CFTC Chairman Gensler Delivers Speech

CFTC Chairman Gary Gensler spoke at the 2013 Annual Glauber Lecture at Harvard University, reiterating themes he has covered in past speeches regarding swaps market reform.  Chairman Gensler again described the major components of swaps market reform, including:

  • transparency;
  • clearing;
  • swap dealer oversight;
  • international coordination; and
  • benchmark interest rates.

He closed by stating that the CFTC is not sized to the task of overseeing the markets, calling for additions to the CFTC staff and budget. 

Lofchie Comment: For readers who want to take a fuller look at the Chairman’s speech, I note that Chairman Gensler cited economist Adam Smith in a way that I thought interesting, even if the connections that Chairman Gensler made were not clear to me.  First, he referred to Adam Smith’s treatise, The Wealth of Nations, as the book in which Smith wrote about the “benefits of lowering the price of information,” and went on to say that “if you make information free, the economy benefits.”  While  I don’t actually remember Smith writing about lowering the price of information, my failure of memory is not important.  More significantly, the problem with this aspect of Chairman Gensler’s economic theory is that information is not, in fact, free.  In fact, it costs tremendous amounts of money to discover, and even more to record and report to the government.  Likely hundreds of millions of dollars will be spent providing the CFTC with all of the information that it demands.  The fact that the government mandates the production of this information, which is produced at great expense to the market, and makes it available to the world does not make the information “free” in an economic sense.  More significantly, it does not make the information, or the cost of producing the information, worthwhile; i.e., that is why a cost-benefit analysis of regulatory rules is generally required and sometimes performed.

 As to the benefit side of the equation, for all of the CFTC’s claims as to the benefits of transparency through “free” information, there is no link of which I am aware between the transparency of information as to swaps pricing and the financial crisis.  The problem is not that swap prices were hidden; the problem is that prices of physical assets (houses) were (in retrospect) too high. 

     Further on the topic of “free,” Chairman Gensler goes on to say that “if access to the market is free, everybody gets to compete.”  Isn’t that an argument that runs against everything in Dodd-Frank?  That is, Dodd-Frank imposes very substantial regulatory costs on swap dealers and on users of swaps.  Whatever arguments may be made in defense of swaps regulation, the last thing in the world that it does is make access to the market “free.”  In fact, one obvious result of the costs imposed by Dodd-Frank is that midsized dealers and small customers would seem likely to exit the swaps market entirely.  (It would be sensible for the government to do a survey on this issue.)

      It is a tribute to the high place that Adam Smith holds as an economic theorist that Chairman Gensler chooses to cite to him in defense of Dodd-Frank.  Still, one thinks of Adam Smith as a “liberal” (in the 18th-19th century “invisible hand” meaning of that term), and thus it is surprising that he should be cited in defense of a statute that is perhaps the ultimate in big regulation: a law that runs 2000 pages with rules that will likely run to 200,000 before we are done, all of it in support of a very visible hand.

See: Chairman Gensler’s Speech.
See also: CFTC Chairman Gensler Speaks on Swaps Market Reform (October 23, 2013).


House to Vote on Financial Services Bill Regarding Swaps Regulation

The Swaps Regulatory Improvement Act (H.R. 992) will be voted on by the House later this week. The Bill addresses Dodd-Frank Section 716 (“Prohibition against Federal Government Bailouts of Swaps Entities”), which prohibits federally insured banks from conducting certain swaps trades.  According to the House Financial Services Committee, this compels banks to “push out” trades to separate non-bank affiliates, which the Committee believes are less regulated and more highly leveraged.  H.R. 992 would add amendments to ensure that federally insured financial institutions can continue to provide risk-mitigation efforts for clients that use swaps to insure against price fluctuations.

Lofchie Comment:  As battered as the financial markets have been in trying to keep up with new Dodd-Frank swap regulations, all that has happened in the past will seem minor if banks are really forced to exit the swaps dealing business.  Likely hundreds of thousands of contracts would have to be very substantively renegotiated.  It simply cannot be done except at massive cost.  Furthermore, the idea of pushing swaps transactions (which are fundamentally credit transactions) out of banks is not remotely good or safe, either for the financial system or for swap counterparties.

See: House Financial Services Committee Press Release.
See also: H.R. 992.
Related news: House Financial Services Committee Considers Various Proposed Amendments to Dodd-Frank and JOBS Act (May 8, 2013).


House to Vote on Financial Services Bill Regarding Broker-Dealer Fiduciary Responsibilities

The Retail Investor Protection Act (H.R. 2374) will be voted on by the House this week.  The Bill addresses Dodd-Frank Section 913 (“Study and Rulemaking Regarding Obligations of Brokers, Dealers and Investment Advisers”), which permits but does not require the SEC to issue rules that extend fiduciary responsibilities which currently apply to investment advisers to broker-dealers.  H.R. 2374 would require the SEC to consider all other options before moving forward on a fiduciary standard for broker-dealers.  The bill would further require the SEC to identify if expanded fiduciary standards would result in less access to financial products and services for retail investors.  Additionally, the bill would require that the DOL wait until the SEC completes its rulemaking before proposing any rules altering the definition of a fiduciary. 

See: House Financial Service Committee Press Release.
See also: H.R. 2374.
Related news: House Subcommittee Approves Four Financial Services Bills (June 21, 2013).


CFTC Seeks Public Comment on Certification from TW SEF LLC to Implement Available-to-Trade Determinations for CDS

The CFTC is requesting public comment on a certification from TW SEF LLC (“TW SEF”) to implement available-to-trade determinations for certain interest rate and credit default swap contracts. 

TW SEF submitted its available-to-trade determinations to the CFTC on a self-certified basis, pursuant to CFTC Rule 37.10 (“Process for a swap execution facility to make a swap available to trade”) and Rule 40.6 (“Self-certification of rules”).  If TW SEF’s submission is deemed certified by operation of CFTC Rule 40.6, such swap contracts, whether listed or offered by TW SEF or any other designated contract market (“DCM”) or SEF, will be subject to the trade execution requirement under Commodity Exchange Act Section 2(h)(8) (“Clearing Requirement for Swaps”).  All transactions involving swaps that are generally subject to the trade execution requirement must be executed on either a DCM or SEF, and those transactions executed on an SEF must be executed in accordance with the methods prescribed in CFTC Rule 37.9(a)(2) (“Methods of execution for required and permitted transactions”).

The comment period will close on November 29, 2013. 

Lofchie Comment:  The CFTC has set the bar for the mandatory trading of swaps on SEFs so low that it is impossible to say what one could comment on.  There are now 19 SEFs of which we are aware, and all of their rules are in flux, yet vast amounts of trading are to be forced onto these newly created markets by government fiat in a very short period of time.  It seems imprudent.

See: CFTC Press Release; Online Comment Filing Form


CFTC Votes to Dismiss Appeal of 2011 Position Limits Rule

The CFTC voted to dismiss its appeal of the federal district court decision to strike down the CFTC’s 2011 position limits rule.  CFTC Commissioner O’Malia released a statement regarding the dismissal of the appeal, saying that the CFTC “should never have pursued an appeal in the first place.”  According to O’Malia, it was clear that the original draft of the rule was not well prepared, and the CFTC should have worked to propose an entirely new rule rather than pursue the old rule while simultaneously drafting a new proposed rule.  Commissioner O’Malia stated, “Wasting valuable taxpayer dollars on this legal dead-end is especially troubling given today’s austere budget situation.” 

See: Commissioner O’Malia’s Statement
Related news: CFTC to Court: Position Limits Appeal Will Be Dropped if New Rule Reached on Nov. 5 (October 29, 2013); Blog Post Quotes Commissioner Wetjen on Position Limits (October 24, 2013); CFTC Commissioner O’Malia Blasts Cross-Border Guidance and Potential Position Limits Rule (September 27, 2013); ISDA and SIFMA v. CFTC Court Date Set for Oral Arguments on Position Limits (August 26, 2013).


SEC Commissioner Gallagher Speaks on the Priorities and Mispriorities of the SEC

SEC Commissioner Daniel M. Gallagher delivered a speech to the AICPA/SIFMA Financial Management Society Conference on the Securities Industry regarding the need for the SEC to re-prioritize its agenda to focus on subjects more relevant to the SEC mission. Commissioner Gallagher stated that this mission is comprised of three intertwined components: to facilitate capital formation, to maintain orderly and efficient capital markets, and to protect investors.  While the mission is fairly straightforward, Gallagher said that often becomes complicated due to “the thick overlay of recent congressional mandates that, given our necessarily limited capacity, compete for our attention.” 

Commissioner Gallagher also spoke about the SEC’s conflicting priorities, first describing instances in which the SEC has misprioritized its agenda.  Gallagher highlighted the Dodd-Frank disclosure mandates for conflict minerals and resource extraction payments as an example, stating that “they were certainly mandates, but should never have been priorities,” since they did nothing to further the SEC’s mission.  Along with those examples, Commissioner Gallagher noted the Pay Ratio Disclosure Rule proposal as an SEC misprioritization, stating that it did not “address any aspect of the financial crisis, and, unlike other non-germane mandates in Dodd-Frank, it did not even purport to address a humanitarian crisis.” 

As a result of this kind of misprioritization, Commissioner Gallagher stated, the SEC has suffered, having gone from one of the best places to work in the federal government to one of the worst.  According to Gallagher, this is due to “years of carrying out mandates unresponsive to the financial crisis under unrealistic, arbitrary deadlines.”  Commissioner Gallagher went on to outline his idea of how to determine what the SEC priorities should be, which focuses on the SEC’s threefold mission: the relevancy of the task to the causes of the financial crisis, the trade-offs of engaging in the task, its cost, and whether the SEC has the expertise to complete it. 

Gallagher then described what would be on his list of priorities, including:

  • credit agency reference removal as required by Dodd-Frank, Section 939A (“Review of Reliance on Ratings”);
  • the commencement of a comprehensive market structure review;
  • proxy advisory reform;
  • the responsible implementation of Title IV of the JOBS Act, or “Regulation A+”;
  • fixed income regulatory reform; and
  • general disclosure reform.

Commissioner Gallagher also provided “a couple of items that would certainly not make my list,” such as mandated disclosure by issuers of non-material “political” contributions, and rewriting the Section 1504 “extractive industries” payment rule.  He concluded by stating that it is critical for the SEC to avoid setting its priorities in a vacuum, and emphasized the need for help from other regulators to ensure that the SEC agenda is not mistargeted. 

Lofchie Comment:  Commissioner Gallagher’s lists of mispriorities and priorities is a valuable start. Regulators must, as a group and not merely as individuals, prioritize those rules that actually have something to do with financial regulation. There should not be so many priorities that the market is overwhelmed by them.

See:  Commissioner Gallagher’s Speech.
Related news:  SEC Chair White Delivers Speech on Equity Market Structure (October 3, 2013).


SEC “Enforcement Commissioner” Speaks on Enforcement Program Developments

SEC Commissioner Luis A. Aguilar delivered a speech at the 20th Annual Securities Litigation and Regulatory Enforcement Seminar regarding recent SEC initiatives to strengthen the enforcement program. 

Commissioner Aguilar began by pointing out that much of the reputation of the SEC is based on the performance of the Division of Enforcement.  Therefore, Aguilar said, ever since he first took office, he has focused on strengthening the enforcement program, leading to his nickname of “The Enforcement Commissioner.” 

Continuing to speak about his work on enforcement, Aguilar noted developments in four areas: the factors that should drive the imposition of corporate penalties, holding SROs accountable when they fail to meet regulatory obligations, requiring admissions of fault in settlements, and using data and risk-based analytics to combat fraud. 

Commissioner Aguilar called the SEC’s 2006 Statement Concerning Financial Penalties (“Penalty Statement”) “flawed” due to its focus on corporate benefit as the dominant factor in assessing penalties rather than the misconduct itself.  Aguilar stated that he is pleased, however, that it has recently been made clear the Penalty Statement is not binding. He proposes to publish a new Penalty Statement that “appropriately focuses on deterring misconduct” by concentrating on:

  • the nature of the misconduct and the violation, or the degree of harm to investors, markets, and innocent parties, and the level of intent of the wrongdoer;
  • the nature of the defendant, its governance and its other conduct prior to the violation; 
  • self-reporting, cooperation, and remediation; and
  • equitable concerns and effects on parties other than the corporation.

Aguilar stated further that he expects the SEC to take a tougher stance against SROs that have inherent conflicts of interest between their regulatory responsibilities and their business functions.  He highlighted recent penalties that the SEC has imposed against NASDAQ and the Chicago Board Options Exchange, and said he is supportive of holding SROs accountable for failing to fulfill regulatory obligations.  Aguilar also noted the need for the SEC to ensure that the technology running capital markets functions properly, and urged the SEC to adopt a stronger rule on technology than Regulation SCI. 

Commissioner Aguilar went on to state that, after years of settling cases on a “neither admit nor deny basis,” the SEC will now require public admissions of wrongdoing in certain settlements.  According to Aguilar, the SEC will require admissions when it is in the public interest to do so, where a large number of investors were harmed or put at risk, or where defendants engage in “egregious misconduct or unlawfully obstruct the Commission’s investigative process.”  Aguilar stated that he believes this policy will enhance the deterrence message of settlements.

Finally, Aguilar concluded by speaking about new SEC initiatives which focus on using available data to combat fraud, including risk-based initiatives to identify fraud, and an enhanced approach to detect financial fraud.  He stated that the Division of Economic Risk and Analysis (“DERA”) and the Office of Compliance Inspections and Examinations (“OCIE”), along with the Division of Enforcement, have been working to use data analytics to identify suspicious performance returns and other potential misconduct.  Aguilar also noted the Division of Enforcement’s initiative, the Financial Reporting and Audit Task Force, which is “a renewed effort to combat financial fraud.”

Lofchie Comment:  There is no doubt that Commissioner Aguilar is correct in his observation: “It is no exaggeration to say that the SEC’s reputation is largely based on how well, or poorly, the Division of Enforcement performs.”  That said, U.S. financial regulators should be focused on the mission of promulgating sensible and clear rules that can be readily understood. 

See:  Commissioner Aguilar’s Speech.



CFTC Commissioner Chilton Delivers Speech before International Regulators Conference

CFTC Commissioner Bart Chilton opened the International Regulators Conference with a short speech and a Kevin Costner paraphrasing, stating, “if we build global regulatory regimes, others will come.”  Commissioner Chilton said that he expects the decisions of regulators today to set the global regulatory rules for the financial sector for a generation, and highlighted the importance of these conferences in helping regulators to work together and learn from each other.

Lofchie Comment:  Commissioner Chilton’s assertion that global investors will find the U.S. regulatory system attractive is one that should be subject to empirical confirmation.  The CFTC should commission a survey of non-U.S. investors to learn how they view U.S. financial regulation.  Given the amount of money being spent on new regulations that are supposedly attractive to non-U.S. customers, a survey would help determine what they really think.

See:  Commissioner Chilton’s Speech, “Understood and Understanding”.


FINRA’s Rick Ketchum: Think Like Billy Beane and Unleash the Power of Data; A New Era of Regulation

In a speech at the SIFMA C&L New York Regional Seminar, FINRA Chairman and CEO Rick Ketchum discussed how technological advances in the areas of data, risk analytics and surveillance are changing the way FINRA approaches market regulation. Chairman Ketchum envisions a “new day in regulation” that will harness the power of big data and technology to protect investors.

In his remarks, Chairman Ketchum stated that, while FINRA is at the very early stages of a new era of big data and cloud computing, there is transformative potential for regulation. Observing that FINRA already collects vast amounts of data from firms and the markets, Chairman Ketchum declared that determining how best to apply FINRA resources and improve the effectiveness and efficiency of its regulatory programs is the “next logical step” in the evolution of FINRA’s regulatory program. He characterized this evolution in the following way: “to use emerging technologies to better analyze the data we’re already gathering, and to gather more – and different – data to identify and prioritize risk in order to better protect investors and monitor the markets.”

While recognizing that there are buy-side privacy concerns in these big data repositories, Chairman Ketchum suggested that the true transformation for FINRA will be the indexing of all of the data which FINRA collects from firms and exchanges into a single search or surveillance query, and the similar steps FINRA is taking to change the way FINRA collects and looks at market information. 

Chairman Ketchum went on to discuss the compliance challenges facing firms today. Citing FINRA’s recent conflicts report, Chairman Ketchum identified the progress that many firms have made as the reason the bar must continue to be raised. He noted that many firms are at the forefront of financial innovation and in “the best position to identify the conflicts of interest that may exist when a product or service is launched or that develop over time.”

The Chairman concluded by outlining a few of the effective practices which firms can adopt, including, among other practices, the following:

  1. Firms can establish new product review processes that include perspectives independent of the business unit proposing a product.
  2. Firms should disclose conflicts with the objective of helping to ensure that customers understand the conflicts that the firm or registered representative have in recommending the product.
  3. Firms should review products after they’re launched to identify potential problems with a product that may not have been readily apparent during the initial review – or that may have arisen as a result of economic events – and take remedial action.
  4. Firms’ private wealth businesses should operate with appropriate independence from other business lines within a firm.
  5. Firms with revenue sharing or other partnering arrangements with third parties should exercise the necessary diligence and independent judgment to protect their customers’ interests.
  6. Each firm should ensure that its compliance department plays a significant role as a partner with the business to understand where the interests of clients and those of the firm do not align and what exposures lie in that gap.

Lofchie Comment: A fundamental problem right now is that firms are simply overwhelmed with new Dodd-Frank regulations, many of which are largely useless (tell me how clearing interest rate swaps makes the economy safe), and some of which are affirmatively destructive (mandatory SEF trading), but all of which are expensive. The fragmentation of power between the various regulators, with each of them seemingly competing to add new rules, is simply overwhelming the ability of the regulated to keep up.

Some of the most challenging regulations are on the data collection side, with various regulators mandating the collection of information without any ability to use it (Query: how can the CFTC use historical swaps data or how can the SEC make sense of the leverage information in Form PF). 

See: Transcript of Rick Ketchum’s Speech.