SEC Enforcement Director Reports Progress in Financial Reporting and Disclosure

SEC Enforcement Division Director Andrew Ceresney provided an overview of the Division’s work on issuer reporting and disclosure. In a speech given at the 2016 Annual Corporate Director’s Forum Conference, he discussed the changing context and complexity of violations and enforcement actions over time. He described the ways in which the SEC evolved in order to pursue deficiencies in financial reporting – the accuracy and reliability of which, he said, comprise the “bedrock” of the financial markets.

Director Ceresney noted that the SEC focus on financial reporting is “nothing new.” It is a response to (i) significant pressure to meet earning and performance expectations, (ii) prioritized focus on short-term performance and not on long-term success, (iii) poor oversight in units and subsidiaries, (iv) growth that outpaces reporting and accounting infrastructure, and (v) management’s questionable “tone at the top” and overreliance on process.

Director Ceresney highlighted current areas of concern including: (i) revenue recognition, (ii) asset valuation, (iii) earning management, (iv) missing or incomplete disclosures and (v) weak accounting controls.

Director Ceresney reported progress in reliable financial reporting due to the changing regulatory landscape and to certain SEC enforcement cases. He explained that boards, management and auditors are now “much more focused on the risks involved in preparation of financial statements and of the mitigants necessary to control these risks.”

Director Ceresney discussed a number of the enforcement actions that the SEC brought against corporate board members and accountants who had failed to fulfill their obligations. He said that audit committee members must understand that any time they encounter information suggesting problems with company filings, they must “take concrete steps to learn all relevant facts and cease annual and quarterly filings” until they are satisfied with the accuracy of the filing.

Regarding audit firms, Director Ceresney stated that “engagement partners need to be actively monitored to ensure that they are fully capable of fulfilling their critical role as gatekeepers.” He suggested that overseeing audit engagement partners was not a task for audit firms alone. “Board members shall keep a close eye on the procedures that [audit] firms employ to monitor their partners’ work,” he said.

Director Ceresney outlined the ways in which the SEC will remain proactive, such as continuing its programs for cooperation with whistleblowers (whom he described as “indispensable”). Further, he noted ongoing internal coordination through the Corporate Issuer Risk Assessment program and the Financial Reporting and Audit Group, which help the SEC to “glean valuable information” regarding potential financial frauds from company insiders. Director Ceresney stressed the importance of “gatekeepers” (particularly external auditors and members of the audit committee) in ensuring that issuers make timely, comprehensive and accurate disclosures. He cautioned that gatekeepers’ status will not exempt violations of their own responsibilities from the SEC’s enforcement.

CFTC Chair Massad Details Progress in Reform of Derivatives Marketplace

CFTC Chair Timothy Massad updated key issues currently before the CFTC and detailed progress on updates on various current issues being addressed by the CFTC.

CCP EU Equivalence. Chair Massad said that the CFTC is “getting closer” to reaching a “consensus with the European Commission on the issue of ‘equivalence’ so that European firms can continue to do business with our clearinghouse without incurring higher capital charges.”

CCP Resilience. Chair Massad solicited feedback on the following issues:

  • Stress Testing: What standards should be utilized for CCP stress testing across borders?
  • Recovery Planning: What happens if the “so-called ‘waterfall’ of resources” that are available for default prove insufficient? (These include: (i) the initial margin of the defaulting members and their guarantee fund contributions, (ii) the clearinghouse’s capital, (iii) the other clearing members’ pre-funded contributions to the guarantee fund, and (iv) potential assessments on clearing members.) How should the use of recovery tools be governed?
  • Supplementary Leverage Ratio (“SLR”): Chair Massad asked whether the SLR’s “schedule-based approach” is flawed and could have a “significant, detrimental effect on clearing and, in turn, on clearinghouse resiliency.”

Improving Data Reporting. Chair Massad noted that the CFTC is taking “many steps” to ensure “accurate, consistent and timely” data.

De Minimis Threshold. Chair Massad highlighted the CFTC staff’s recent report and said that the CFTC will be “studying” the questions associated with the de minimis issue further in the “coming months” and invited further public input.

Enhancing Market Safety and Stability. Citing the CFTC’s recent proposed rules to address cybersecurity concerns, Chair Massad said that the CFTC hopes to finalize the rules “later this year.”

Enforcement. Chair Massad briefly touched on the issue of proving manipulation in an age of automated trading, noting that “[I]f your firm is entering a lot of orders without the intention to consummate, you should probably go talk to your lawyers.”

Benchmarks. Finally, Chair Massad noted the CFTC’s enforcement actions related to benchmarks and expressed support for reforms to ensure benchmarks are “transparent and administered with integrity.”  However, he also cautioned against imposing too many requirements on benchmark administrators so as to “stifle innovation” or “make it impractical to secure sufficient participation in the rate setting process.”

Chair Massad delivered his remarks before the P.R.I.M.E. Finance (“Panel of Recognized International Market Experts in Finance”) 2016 Annual Conference at the Peace Palace in The Hague, Netherlands.

Lofchie Comment: It is clear that regulators now concede the risks that arise from central clearing, and they have abandoned the myth that clearinghouses somehow eliminate it, but now the question to ask is this: Is the CFTC focusing on the right risk? It appears that the CFTC remains focused on the risk that a clearinghouse may fail, but the larger systemic risk might be that the clearinghouse may survive only to drag down the financial markets by raising collateral demands, which could trigger a sell-off and drain liquidity from the markets at a time when liquidity is lowest.

As to benchmarks, Chair Massad acknowledged the substantial regulatory risks involved in being an administrator of, or a participant in, setting financial benchmarks. It is hard to see why any firm would want to assist in setting financial benchmarks given the absence of compensation for the task, the supervisory difficulties, and the possibility of criminal, civil or regulatory litigation.



SEC Corporate Finance Director Discusses Cross-Border Regulation of Issuers and Offerings

SEC Director of the Division of Corporate Finance Keith Higgins gave a wide-ranging speech on United States regulation and the treatment of foreign issuers and offerings over the last thirty years. He spoke at the PLI Fifteenth Annual Conference on Securities Regulation in London.

The Director’s remarks focused on the impact of the SEC staff study conducted in the 1980s on the internationalization of the securities markets and the regulatory changes that resulted from that report. Those changes include the adoption of Regulation S, Rule 144A and the SEC’s collaborative effort with Canada to build the Multi-Jurisdictional Disclosure System.

Mr. Higgins challenged conference participants to consider broad questions with respect to foreign issuers in the registered U.S. capital markets. In particular, he asked if the SEC should explore current recommendations to create a system to address public offerings that could be made in several jurisdictions “especially when it would seem that the long-term trend is moving away from these [cross-border] offerings.”

Director Higgins concluded by discussing three global topics that he said were currently the object of some regulatory focus: crowdfunding platforms, disclosure reform (i.e., simplification and improvement), and the possible reduction or elimination of interim financial reporting, at least for smaller companies.

Lofchie Comment: While the Director certainly covered a lot of historical and regulatory ground in his speech, he actually gave very little sense of the direction, if any, toward which he believed the Division should proceed. For example, although he noted that the discussion on re-thinking interim financial reporting has been going on for some time now, and he likewise remarked that commenters have noted that “a focus on short-term performance is not conducive” to long-term growth, he did not indicate that he would give any personal support to a lessening of interim financial reporting requirements. His closing words on this topic were that “the debates and research in this subject area are likely to continue in the future.”


Global Financial System Committee Provides Analysis of Liquidity in the Fixed Income Market

The Committee on the Global Financial System (“CGFS”) provided a detailed analysis on the current state of liquidity in the fixed income market. Published by the Bank for International Settlements (“BIS”), the report acknowledges that liquidity has declined in some markets, but observed that this decline has been primarily reflected in the size of trades rather than in a widening of the bid-ask spread.

The report states that the demand for market-making liquidity (which the report refers to as “immediacy”) increased, while dealers continue to reduce their willingness to take on customer positions, either because they find it unprofitable to do so or because new regulatory capital requirements make it impossible for them to do so.

The report identifies a potential trade-off between increased capital requirements for market makers, which according to the report, makes them more resilient, and the expense of maintaining such capital, which makes market makers more reluctant to take on risk. Further, the report states that very high capital requirements may actually make the system less resilient; i.e., “fragile,” because any decline in market prices can very quickly force deleveraging, which, if it becomes widespread, results in market sell-off.

Lofchie Comment: This report is a significant step forward by the global regulators in at last acknowledging that very high and potentially punitive capital requirements may be counterproductive and a source of risk. This may seem counterintuitive. It may appear obvious that when a single institution has more capital than others, it is better placed to survive a downturn than are others. However, when all institutions carry more capital, because they are all subject to higher capital requirements, a new risk arises because there is no cushion between the amount of capital an institution must have and the amount it actually has. Further, the “punishment” (being forced to shut down) for a capital violation is severe. Accordingly, universally high capital requirements combined with severe sanctions for capital failure is likely to lead to the result that in a downturn, everyone is very fast to flee the market; i.e., the system then becomes more “fragile.”

SEC Awards Whistleblower for Original Analysis

A whistleblower who assisted the SEC in an investigation by furnishing it with a “detailed analysis” constituting “original information” was awarded more than $700,000. The SEC determined that the whistleblower provided the SEC with “unique and useful” information leading to a successful enforcement action.

Lofchie Comment: This case communicates that the SEC will award an “outsider,” for providing original information (here, presumably for analyzing market data) that leads to a successful enforcement action, rather than awarding only a corporate insider. It’s an award about which we may feel better than (in the worst case) one that was given to a company insider who did not attempt to correct the problem internally but went directly to the government in the hopes of collecting reward money.


CFS Monetary Measures highlight shift in liabilities for December 2015…

Today we release CFS monetary and financial measures for December 2015. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.0% in December 2015 on a year-over-year basis versus 4.6% in November.

Higher rates are leading to the migration of liabilities away from time deposits.  For instance, the largest positive contributor to CFS Divisia M4 growth was commercial banks’ savings deposits (sweeps adjusted), contributing an increase of 2.6% in the last 12 months ending December 2015.  In contrast, the largest negative contributor to CFS Divisia M4 growth was commercial banks’ small time deposits, contributing a decrease of 0.4% in the last 12 months ending December 2015.

CFS Divisia indices can be found on our website at Broad aggregates are available in spreadsheet, tabular and chart form. Narrow aggregates can be found in spreadsheet form.

For Monetary and Financial Data Release Report:

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’


U.S. Agencies Support Basel Committee Guidance on External Audits of Banks

The Board of Governors of the Federal Reserve System, the FDIC and the Office of the Comptroller of the Currency (“OCC” and, collectively, the “agencies”) expressed their support of the March 2014 guidance on the “external audits of banks” by the Basel Committee on Banking Supervision (“BCBS”). While recognizing that the existing practices in the United States are broadly consistent with the BCBS guidance, the agencies also acknowledged that “differences exist between the standards and practices followed in the United States and the principles and expectations” in the BCBS guidance. For that reason, the agencies outlined their supervision expectations for incorporating the differences between the BCBS guidance and existing standards and practices in the United States. Their suggestions include:

  • Audit committees should monitor and assess the independence of the external auditor by considering whether their policies address the criteria for tendering the audit contract explicitly and whether the contract should be put out for bid periodically.
  • Communication should be open and candid between an institution’s external auditor and supervisors.
  • Audit committees are encouraged to ask how external auditors factor regulatory ratios into their materiality assessments.
  • Audit committees should consider requesting that their external auditor provide written feedback about the audit engagement team’s relationship with the internal audit function, including the team’s observations on the adequacy of the internal audit work, as it relates to the audit of the financial statements or the audit of internal control over financial reporting.
  • Consistent with the March 2003 Interagency Policy Statement on the Internal Audit Function and Its Outsourcing, an institution’s audit committee should consider whether the institution’s internal audit activities are being conducted in accordance with professional standards such as the Institute of Internal Auditors’ International Professional Practices Framework. Audit committees may look to this framework for guidance for both internal and external assessments of the internal audit function.

OFR Reports on Bilateral Repo Market

The Office of Financial Research (“OFR”) published quantitative information on bilateral repurchase agreement (“repo”) activities in the U.S. securities financing market. In addition, the OFR identified the three principal challenges involved in collecting this type of market data: (i) the limited scope of pilot data collection, (ii) the lack of data standards and (iii) separate data systems.

The OFR highlighted the following “next steps” to be taken in the U.S. securities financing market:

  • the development of permanent granular data collection of bilateral securities financing trades, which will “build on the lessons learned from this pilot data collection” and utilize consistent reporting definitions, concepts and requirements with collections that cover the triparty repo segment;
  • the implementation of mandatory data standards in order to reduce reporting burdens and improve data quality; and
  • the harmonization of reporting definitions, concepts and requirements by U.S. regulators (such as the Financial Stability Board) and international regulatory bodies.

Lofchie Comment: It would be helpful if the OFR explained how it picks the categories of financial risk that it elects to investigate. While it might be true that the selected securities activities pose a material risk to the economy, they certainly are not the activities that pose the greatest risk. Here are a few examples that might pose greater risk to the economy: the near insolvency of Puerto Rico, as well as the insolvency of a number of cities like Detroit, indicates that municipal bankruptcy is a greater long-term (or even short-term) threat to the economy than those risks that comprise the OFR’s current focus. The current low-interest-rate environment presents significant risk for pension plans that must achieve higher returns in order to meet fixed pension obligations. And threats of widespread bankruptcies in the energy sector remain. Yet despite all that, OFR appears to be focused resolutely on fully collateralized securities lending, seemingly without much regard for the genuine real-world risks that threaten economic stability in the United States.

MSRB Publishes 2015 Annual Report

The MSRB published the organization’s 2015 Annual Report. The Report highlighted MSRB’s ongoing efforts on investor protection, improved disclosure and new regulatory standards for municipal advisors. The Annual Report also reviewed the organization’s finances for the fiscal year and outlined an agenda for 2016.

The MSRB stated that it will continue to improve on the progress made to date, and in 2016 will:

  • enhance the availability of more robust pricing information for municipal securities investors;
  • work toward better disclosures of bank loans and alternative financings by municipal securities issuers;
  • create the first professional qualifying examination for municipal advisors; and
  • add objective, noncommercial resources on municipal market topics to the online MSRB Education Center.

Future initiatives include (i) shortening the settlement cycle to T plus 2,(ii) minimizing technological vulnerabilities in its trade reporting system, (iii) improving issuer disclosure practices and (iv) implementing regulatory standards for municipal advisors.

SEC Identifies Areas of Heightened Risk in 2016 Examination Priorities

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) identified key areas of risk in its Examination Priorities for 2016. These include protecting retail investors, assessing market-wide risks and using data analytics to find illegal activity.

Specifically, the OCIE identified the following as areas of regulatory focus:

Retail Investors

  • Advice offered to investors with retirement accounts
  • Exchange-Traded Funds (“ETFs”) – including investor compliance with exemption terms, sales practices, trading and disclosures. (Staff indicated that it would focus on “niche” ETFs and those that use leverage.)
  • Branch Offices – including supervision of representatives through the use of “data analytics” to catch “inappropriate” trading
  • Fee Selection and Reverse Churning – including matters where clients may be charged fees inappropriately on the basis of assets rather than trading
  • Variable Annuities – including sales issues
  • Public Pension Advisers – including gifts and entertainment

Assessing Market-Wide Risks

  • Cybersecurity
  • Regulation Systems Compliance and Integrity
  • Liquidity Controls – the OCIE identifies this specifically as an issue for funds
  • Clearing Agencies – for systemic risk

Data Analytics

  • Recidivist Representatives and Their Employers
  • Anti-Money Laundering
  • Microcap Fraud
  • Excessive Trading
  • Product Promotion


  • Municipal Advisors
  • Private Placements – with a focus on the EB-5 program for immigrants
  • Never-before-Examined Advisers
  • Private Fund Advisers – with a focus on whether they favor accounts that are charged performance fees
  • Transfer Agents

Lotchie Comment: The OCIE indicates that one of its areas of priority is determining whether investors’ assets are being put into accounts that are charged on the basis of assets under management rather than trading volume. It should be clear that the effect of the regulators’ drive to impose a “fiduciary” obligation on broker-dealers providing recommendations will be to motivate broker-dealers to move clients into accounts charging asset-backed fees. After all, an account that pays only transactional fees might not cost-justify the risk of a broker-dealer taking on fiduciary obligations (since it is unclear what those obligations might entail). Or, to put it differently, (i) if a broker charges an asset-based fee but does not do a lot of trading, then the broker risks getting dinged for overcharging; and (ii) if the broker charges transaction fees but does not do a lot of trading, then the broker does not make any money while taking on fiduciary responsibilities. It will be interesting to see whether the imposed obligation affects the ability of small or medium clients to access broker-dealer services.