Commissioner Gallagher Discusses Global Regulatory Harmonization, FSOC and FSB

Commissioner Gallagher delivered a speech titled “An Agenda for Europe and the United States” at a Harvard Law School symposium. The speech focused on regulatory harmonization and where the SEC should concentrate its efforts.

Commissioner Gallagher criticized Dodd-Frank, calling it “partisan manifesto untethered to the causes of the financial crisis.” He compared Dodd-Frank’s regulatory efforts on a domestic level to those of the G-20 and the Financial Stability Board (“FSB”) on an international level. He pointed out that the FSB’s regulatory harmonization efforts have “morphed into a top-down, forcible imposition of one-size-fits-all regulatory standards on sovereign nations by opaque groups of global regulators” – a transformation that, in his view, neglects “national sovereignty or consent of the governed.”

He explained that the FSB “one-size-fits-all” regulatory approach is especially evident in a particular memo by FSB Chair Mark Carney, which states that the “true purpose of the FSB is to direct national authorities to implement the FSB’s own policies.” Commissioner Gallagher warned against such “regulatory hubris” shown by “coercive” and “unfettered, unaccountable supernational governance,” and recommended that international regulators work toward cooperation for cross-border regulatory harmonization. He suggested that they create a “high quality foreign regulatory regime to qualify as a substitute for compliance with our own domestic requirements.”

Additionally, Commissioner Gallagher encouraged regulators to zero in on “reducing red tape” instead of “de-risking” markets. He also recommended, in cases in which regulators must impose regulatory burdens, that the rule be tailored narrowly to address the identified problem clearly. This shift, according to Commissioner Gallagher, will improve cost-benefit analyses and reduce regulatory framework burdens for market participants overall.

Lofchie Comment: Commissioner Gallagher raises a number of questions that should be addressed in an open discussion: How much power should the Financial Stability Oversight Council (“FSOC”) assume over the U.S. financial system? If Congress intends for FSOC to assume control over the securities and insurance markets, does FSOC have sufficient expertise to do so, given that it seems dominated by banking regulators? What is the nature of the interaction, and what should the interaction be, between FSOC and the FSB?

FDIC Vice Chair Hoenig Discusses Regulatory Relief for Community Banks and Volcker Rule Exemptions

Federal Deposit Insurance Corporation Vice Chair Thomas Hoenig delivered remarks recommending criteria for regulatory relief for community banks. He argued that such regulatory relief should not be a reason to abandon the Volcker Rule.

Mr. Hoenig explained that while he is not a critic of systemically important banks engaging in non-bank activities, he is concerned with the “distortions to the financial system that follow when these activities are conducted by commercial banks.”

According to Mr. Hoenig, the Global Capital Index, which was constructed by him and another colleague at the FDIC, revealed that at the more than 6,500 commercial banks in the United States, capital levels “far exceed those of the largest firms.” He stated that from a capital perspective, there is a case to be made for regulatory relief for the vast majority of commercial banks.

Mr. Hoenig suggested focusing regulatory relief on activity and complexity, rather than size. He recommended defining eligibility for regulatory relief based on criteria such as (i) banks that hold zero trading assets or liabilities, (ii) banks that hold no derivative positions other than interest rate swaps and foreign exchange derivatives, and (iii) banks whose total notional value of all their derivative exposures is less than $3 billion. He stated that of the over 6,500 commercial banks, only 400 do not meet these three criteria.

Mr. Hoenig then turned to areas community banks consistently highlight as sources of regulatory burden, such as the new risk-based capital rules, elements of consumer compliance regulation, and an “ever-expanding Call Report.” Mr. Hoenig also suggested “meaningful regulatory relief for traditional banks,” such as exempting traditional banks from all Basel capital standards and associated capital amount calculations, or exempting such banks from several entire schedules on the Call Report.

Mr. Hoenig pointed out that he did not recommend exempting either traditional banks or community banks from the Volcker Rule. According to Mr. Hoenig, weakening the Volcker Rule would be “contrary to moving the largest financial firms toward self-sufficiency.” Additionally, he stated, the “vast majority of community banks have virtually no compliance burden associated with implementing the Volcker Rule.”

Mr. Hoenig suggested existing guidance be updated for banks under $10 billion in total assets that engage in traditional hedging activities to clarify that Volcker Rule compliance requirements can be met by having clear policies and procedures that place appropriate controls on the activities. He also pointed out that there are “less than 400” of the 6,500 banks under $10 billion engaging in less traditional activities that may be restricted. Mr. Hoenig explained that there would be some initial compliance requirements to determine their status, and most will find that their trading-like activities are already exempt from the Volcker Rule.

Lofchie Comment: Banks turning away cash deposits, a pattern now widespread in the market because holding cash adversely affects capital ratios, suggests that the ratios are encouraging counterintuitive behaviors.

U.S. House Financial Services Subcommittee Holds Hearing to Examine Regulatory Burdens on Non-Depository Financial Institutions

The U.S. House Financial Services Subcommittee on Financial Institutions and Consumer Credit held a hearing titled “Examining Regulatory Burdens on Non-Depository Financial Institutions.”

The hearing examined the “rising compliance costs” to consumers, non-depository financial institutions and the U.S. economy that were brought about by Dodd-Frank. Specifically, witnesses testified as to whether products or services were no longer being offered to consumers because of agency actions and the impact that not having access to specific products or services might have on consumers.

Witnesses at the hearing encouraged Congress to change the governance structure of the Consumer Finance Protection Bureau (“CFPB”) to a five-member commission rather than a single governing chair. Witnesses agreed that the CFPB should adopt a non-enforcement period extending through the end of 2015 as the new statutory deadline for integrated disclosure requirements.

Lofchie Comment: A five-member commission, split between two parties with the President’s party holding the majority, serves the interests of all who believe in governmental transparency and healthy debate. As a practical matter, the minority party would not be able to disrupt or stall the agency since the chair controls virtually all of the resources of the agency and the majority party would control the votes. The benefit of having a minority party is simply that it would create the potential for a public debate. Without the possibility of dissent, nothing prevents the chair of an agency from being overly enthusiastic when describing the work done by the agency, the rules to be adopted or the rules to be rescinded. Ideally, regulators should be subjected to discord in the form of a dissenting opinion or two.

SEC and FINRA Issue Report on National Senior Investor Initiative

The SEC and FINRA issued a report titled “The National Senior Investor Initiative.” The report is intended to help broker-dealers assess, craft and refine their policies for investors who are nearing or entering into retirement.

The report includes observations and practices identified in the agencies’ examinations of forty-four broker-dealers. The examinations focused on how firms conduct business with senior investors, particularly in the following areas:

  • the types of securities purchased by senior investors;
  • the suitability of recommended investments;
  • the training of brokerage firm representatives;
  • the use of designations such as “senior specialist”; and
  • disclosures.

Lofchie Comment: Although the Report focuses on senior investors, it is also a good resource to review general sales, communications, suitability and supervision practices. It is worthwhile reading for all sales supervisors and compliance professionals. Firms should compare their retail sales procedures against those in the document to see whether the comparison helps them to identify any gaps.

One current regulatory “hot item” raised in the Report is that a firm should consider filing a suspicious activity report (“SAR”) when its employees have reason to suspect elder abuse. Another small but interesting point: different firms used different ages to determine which investors’ transactions had to be specially reviewed because the investors were “old.”

U.S. Department of Labor Issues Proposed Rule Regarding Fiduciary Definition

The U.S. Department of Labor (“DOL”) issued a proposed rule relating to the definition of fiduciary under ERISA and Section 4975 of the Code. The proposed rule, if adopted, would replace certain long-standing regulations relating to the definition of fiduciary with respect to the provision of investment advice and would expand the number of persons who would be fiduciaries in connection with providing investment advice or recommendations. According to the DOL, under the proposed changes, “retirement advisors will be required to put their clients’ best interests before their own profits.”

In connection with the proposed rule, the DOL proposed certain new class exemptions and amendments to several existing class exemptions from the prohibited transaction rules of ERISA and Section 4975 of the Code (including PTEs 75-1, 86-128, 77-4 and 84-24). These class exemptions and amendments would permit certain brokers, insurance agents and others to continue to receive certain types of compensation that would otherwise be prohibited.

The DOL had proposed regulations relating to the same subject matter in 2010 that were subsequently withdrawn.

Associations Send Letter to Senate in Support of the Cybersecurity Information Sharing Act of 2015

SIFMA and fifteen other associations (the “Associations”) sent a letter to Senator Mitch McConnell (R-KY) and Senator Harry Reid (D-NV) in support of the Cybersecurity Information Sharing Act of 2015 (S. 754) (the “Act”). The main purpose of the Act is to facilitate information sharing about cyber threats and developments between (i) different agencies of the U.S. government, (ii) the U.S. government and various private and local government entities and (iii) private entities.

In the letter, the Associations urge the Senators to bring the Act, which was approved by the Select Committee on Intelligence, to the Senate Floor as soon as possible. The letter states that the threat of cyberattacks is a “real and omnipresent danger”. The Associations argue that the Act will strengthen the nation’s ability to defend against such danger quickly and effectively by encouraging the business community and the government to share critical information.

Lofchie Comment: The government should facilitate information sharing about technology problems in general – not only cyber threats, but also technology breakdowns and close calls.

SEC Commissioner Gallagher Asserts Serious Flaws in Systemic Risk Designation Process

At a symposium celebrating the 75th anniversary of the Investment Company and Investment Advisers Acts (the “1940 Acts”), SEC Commissioner Daniel Gallagher discussed the “misguided quest” of the U.S. Financial Stability Oversight Council (“FSOC”) and the “Basel-based” Financial Stability Board (“FSB”) to regulate asset managers.

Commissioner Gallagher stated that the 1940 Acts enabled the SEC to effectively oversee the asset management industry, though that success has been overlooked. According to Commissioner Gallagher, the attempts of prudential regulators, particularly the FSOC and the FSB, to characterize asset managers and their activities as systemically risky “is nothing more than a ploy to wrest control of a hugely important sector of the capital markets from the SEC.”

Commissioner Gallagher discussed the history of these regulators, including their subsequent attempt at “concocting fictions to justify systemic risk designations.” Commissioner Gallagher is concerned that the FSB has been attempting to expand its focus to non-bank, non-insurer entities. He noted that in 2013, FSOC commenced a review to determine whether certain asset management firms should be designated as systemically important financial institutions (“SIFIs”) subject to enhanced prudential standards and supervision. He stated that “it would be foolhardy to expect the FSOC and FSB to stand down” in these endeavors against the asset management industry.

Commissioner Gallagher pointed out that each time the FSB made a policy decision affecting non-bank financial institutions, “the FSOC has followed suit.” He stated that FSB’s designation of AIG, Prudential, and MetLife as SIFIs was closely followed by FSOC’s designation of AIG and Prudential as SIFIs, and a commencement of a review of MetLife. According to Commissioner Gallagher, “it is plain to see that FSOC has entered into an insidiously symbiotic relationship with the FSB, supporting its actions on the international stage while using those actions to justify regulation at home.” Commissioner Gallagher argued that it is time to acknowledge that “the systemic risk designation process itself is far more dangerous to our financial markets than the purported risk factors it was created to address.”

Lofchie Comment: There is nothing in the legislative history of Dodd Frank to suggest that Congress conceived that the FSOC would regulate investment managers and private investment funds as systemically significant. Nor are there even ex-post legislator statements to confirm that Congress anticipated such a result.

Leaving aside the question of written legislative intent or a history of relevant debate or discussion preceding the adoption of Dodd-Frank, there are any number of questions to be asked about the SIFI process. Here are three: (i) what is the expertise of the FSOC group in regulating private investment funds, as opposed to banks?; (ii) are there other factors besides systemic risk, such as economic growth, that FSOC should consider in determining whether private investment funds may be designated as SIFIs?; and (iii) does FSOC plan to assert authority over individual investment funds on the theory that in the aggregate, investment funds are systemically significant?

Given the boundless authority that FSOC possesses, or seems to want to possess, it is only reasonable for Congress to answer these questions, or at least pose them to FSOC representatives.

Rhodes on “Greece’s Achilles’ Heel” in The Wall Street Journal

This morning, The Wall Street Journal published an op-ed “Greece’s Achilles’ Heel” by William R. Rhodes.  Bill is the President and CEO of William R. Rhodes Global Advisors, LLC; Professor-at-Large at Brown University; and former Senior Vice Chairman of Citigroup Inc.  CFS was honored to have Bill serve as a member of the Honorary Committee at Bretton Woods 2014.

“Greece’s Achilles’ Heel” is excellent (see  It struck a chord on two levels.

1) The approach is clear and represents the best path for Greece.  Bill notes:

– “It has yet to start negotiating seriously about a long-term solution to its debt crisis. The government needs to understand that creditors have long memories and want assurances that it will live up to the terms of whatever deal is struck.”

– “Past crises have shown that there is never a white knight able to ride to the rescue – despite rumors that the Greeks may turn to Moscow and Beijing for aid.”

– “Sovereign-debt deals have the best chance of succeeding if they are not seen as being imposed by the creditors, but rather owned and authored by the debtor country’s government.”

In a paper “Solving the Greek Crisis,” CFS outlined the math supporting a similar strategy in 2011.  Although time has elapsed, the basic approach remains valid (See “Solving the Greek Crisis:

2)  On a personal note, I traveled with a fellow banker to Nicaragua in the late 1980s to help structure a buyback.  Nothing happened.  In the aftermath, the country remained stagnant through 1995 when a buyback was finally orchestrated and the country began to grow again. Now is the time for action in Greece.

Lastly, at Bretton Woods, Bill offered an Honorary Committee Address called “Critical Issues for the Bretton Woods Institutions” – see  Many of these issues and recommendations are essential reading in advance of the upcoming IMF / World Bank meetings.

Best regards,

NFA Issues Notice Regarding CPO Delegation (Notice I-15-13)

The NFA issued a notice to members requiring CPOs to answer a question concerning delegation of certain responsibilities to another registered CPO, when they file a pool’s annual financial statement in the NFA’s EasyFile system. Due to the self-executing relief in CFTC No-Action Letters 14-69 and 14-126, a commodity pool operator (“CPO”) does not notify the NFA when delegating certain responsibilities to another registered CPO. For that reason, the NFA is unable to provide this information on its BASIC system. The new requirement corrects that deficiency.

The new requirement will allow NFA Members conducting NFA Bylaw 1101 due diligence on a particular pool to be able to confirm through the NFA’s BASIC system that the CPO of a particular pool is an NFA Member or exempt from such requirement.

In order to notify the NFA that investment management authority over a particular pool was delegated to a CPO, and to ensure that the NFA’s systems reflect the delegation, CPOs are now required to answer a question concerning delegation when they file a pool’s annual financial statement in the NFA’s EasyFile system.

Lofchie Comment: The requirements of NFA Bylaw 1101 are worth reconsidering. There may be no other regulatory certification that demands so much effort and work to be done and redone year after year. From a cost/benefit perspective, it is questionable whether these requirements represent a good use of a firm’s compliance dollars.