Investor Advocate Rick Fleming Describes Progress on SEC Disclosure Effectiveness Initiative

SEC Investor Advocate Rick Fleming described continuing progress on the SEC Disclosure Effectiveness Initiative, an effort intended to review and modernize public company reporting requirements in Regulation S-K and Regulation S-X. In an address given at a NASAA Corporation Finance Training event in Texas, Mr. Fleming emphasized that meeting the informational needs of investors should be the guiding principle of the Initiative moving forward. He added that the methods for determining those needs are “as outdated as some of the disclosure rules.”

Mr. Fleming noted that the initiative is responsive to congressional mandates found in the JOBS Act and the FAST Act, but is broader in its objectives and scope than the mandates require (as is outlined in an SEC concept release dated April 2016). To the degree to which the FAST Act addresses “duplicative, overlapping, or outdated” provisions, Mr. Fleming stated, it reflects the fair criticism that the SEC has not done a “very good job of updating or streamlining its rules.”

Even so, he argued, the disclosure requirements serve as a crucial foundation upon which businesses raise capital. He stated that the success of the requirements should be measured primarily in terms of the “enhanced utility of corporate disclosures for the investing public.” Mr. Fleming stressed the importance of maintaining fairness in the evolving markets:

“[W]e are in the midst of a generational shift that will change the securities marketplace. But one thing will not change – investors will still count on those markets being fair. The challenge, particularly for regulators, will be to simultaneously think bigger and more creatively while exercising an appropriate level of caution to protect investors in an evolving world.”

Lofchie Comment: It is notable that Mr. Fleming did not focus on disclosures of political and political-interest issues, such as those favored by Senator Elizabeth Warren (D-MA). Instead, Mr. Fleming concentrated on disclosures that facilitate investment decisions.

SEC Trading and Markets Director, Other SEC Leaders Ready to Depart

SEC Director of the Division of Trading and Markets Stephen Luparello will leave his position by January 1, 2015. News of his departure follows the recent announcement that SEC Chair Mary Jo White will step down by the end of the Obama Administration.

Under Mr. Luparello’s leadership, the SEC:

  • “adopted Regulation Systems Compliance and Integrity (Reg. SCI), which established new controls to strengthen crucial technological systems, providing greater transparency, accountability and resilience”;
  • “enhanced [the] operational transparency and regulatory oversight of alternate trading systems . . . that trade stocks listed on a national securities exchange, including dark pools”; and
  • “approved a plan to create a comprehensive database [(i.e., the consolidated audit trail)] that allows regulators to track trading activity in the U.S. equity and options markets.”

The SEC noted that Mr. Luparello was “instrumental” in the creation of the first Equity Market Structure Advisory Committee. He was the principal liaison for SEC staff in discussions concerning the U.S. Treasury market in the wake of the events of October 15, 2014. Under Mr. Luparello’s direction, the SEC approved a rule that requires FINRA members to report U.S. Treasury securities transactions and gives regulators enhanced oversight of the U.S. Treasury market. Chief Counsel for the Division of Trading and Markets Heather Seidel will become the acting director.

Enforcement Division Chief Litigation Counsel Matthew C. Solomon will leave the agency early next month. Enforcement Division Deputy Chief Litigation Counsel David Gottesman and Enforcement Division Supervisory Trial Counsel Bridget Fitzpatrick will serve as acting Co-Chief Litigation Counsels.

Chief Accountant James Schnurr intends to retire from the agency. Mr. Schnurr began his tenure as Chief Accountant in October 2014. Wesley R. Bricker will succeed him as Chief Accountant.

Lofchie Comment: Mr. Luparello has broad experience in financial market regulation and is highly respected. His departure will be a loss to the SEC.

House Agriculture Committee Tells CFTC to Halt “Controversial” Proposals

House Committee on Agriculture Chair Rep. K. Michael Conaway (R-TX) asked CFTC Chair Timothy Massad to “refrain from pushing through controversial regulations” for the remainder of his tenure.

In a recent letter, Rep. Conaway cited three ongoing CFTC rulemakings to curtail: (1) Regulation AT, the comment period for which he urged the CFTC to extend by 180 days, (2) the position limits rule proposal, which he said lacked sufficient time to be analyzed properly before the regime change; and (3) the proposed cross-border application of the registration threshold (i.e., the “arranged, negotiated, executed” proposal).

After emphasizing the importance of his request, Rep. Conaway commended Chair Massad for his work at the CFTC, and praised his leadership at an agency that had been “reeling from previous mismanagement.”

Lofchie Comment: If ever a rulemaking reflected the triumph of political ideology over economic reality, it is the position limits proposal. It should be obvious to all by now that the price of energy is not driven by “speculation” but by world events, such as potential war in the Middle East, developments in Iran, Russia and Venezuela, economic activity in China, and the development of fracking. CFTC Chair Massad should at least admit the possibility that the rulemaking was ill-conceived or, failing that, defer the issue to the next regime. Is there really a policy basis for pushing through an energy position limits proposal that even its most devoted advocates can justify only by suggesting that it might do some good (see Commissioner Bowen Supports Position Limits) during a time when the world is awash in energy suppliers?

House Republicans Warn Federal Agencies Not to Finalize Pending Rules

A letter from House Republican leaders to all federal executive and independent agencies “cautioned” the agencies against “finalizing pending rules or regulations in the Administration’s last days.” Citing White House Chief of Staff Dennis McDonough’s statement that the Administration will pursue “audacious executive action throughout the course of the rest of the year,” House Republican leaders asserted that “forbearance is necessary to afford the recently elected Administration and Congress the opportunity to review and give direction concerning pending rulemakings.”

If their counsel is ignored, House Republican leaders warned, they will “work with colleagues to ensure that Congress scrutinizes [the agencies’] actions – and, if appropriate, overturns them – pursuant to the Congressional Review Act.”

Lofchie Comment: Such “stop” directives are common during a change in administration,  particularly one that also involves a change in parties.

Minneapolis Fed Requests Comments on Plan to End “Too Big to Fail”

The Federal Reserve Bank of Minneapolis (“Minneapolis Fed”) requested comments on its proposed “Minneapolis Plan to End Too Big to Fail” (the “Plan”).

In the Plan, the Minneapolis Fed proposed:

  • requiring covered banks to issue common equity equal to 23.5 percent of risk-weighted assets, with a corresponding leverage ratio of 15 percent, in order to “dramatically increase common equity capital” and “substantially reduce the chance of bailouts”;
  • calling on the U.S. Treasury Secretary to either certify that covered banks are no longer systemically important or subject those banks to an additional 5 percent of risk-weighted assets per year until (i) the Treasury certifies them as no longer systemically important, or (ii) the banks’ capital reaches 38 percent, which the Minneapolis Fed reports is the “level of capital that reduces the 100-year chance of a crisis below 10 percent”;
  • levying a shadow bank tax in order to discourage banking activity from moving to the shadow banking sector, which would equalize funding costs between the two sectors; and
  • allowing the government to reform the current supervision and regulation of community banks by adopting a system that is “simpler and less burdensome while maintaining [the government’s] ability to identify and address bank risk-taking that threatens solvency.”

Because the Plan’s approach could result in “the migration of risky activity from the banking sector to nonbank financial firms, where capital requirements are lower, if they exist at all,” it explained, the Minneapolis Fed proposed to “address this unequal treatment across sectors by taxing the borrowings of large nonbank financial firms – also known as shadow banks.” Effectively, this tax would “make the cost of funds roughly equivalent between large banks and nonbanks.”

The Minneapolis Fed requested feedback on all aspects of the Plan by January 17, 2017.

Lofchie Comment: The Minneapolis Fed’s Plan would attempt to end the problem of too-big-to-fail by driving every large bank out of business through the imposition of massive capital charges. Since putting large banks out of business would cause borrowing activity to move from banks to non-banks, the plan would then impose a tax on large non-bank lenders that effectively would force every large non-bank lender to either become a bank (presumably a small bank, since large banks would be compelled to close) or cease operations.

Since the likely effect of the Plan on the economy of the United States would be significant, the Minnesota Fed might find it useful to project what it believes the Plan’s effects would be and why. It also might be useful for the Minnesota Fed to ask itself (i) if there would be any large banks left, (ii) if there would be any large non-bank lenders left, (iii) how many banks would remain overall, (iv) what effect the Plan would have on the U.S. economy, and (v) whether it is troubling that the Plan effectively would force all large moneylenders to become banks.

SEC Chair Mary Jo White to Step Down

SEC Chair Mary Jo White announced that she will leave her position at the end of the Obama Administration. In April 2013, she became the 31st Chair of the SEC. Since that time, she has become one of its longest-serving leaders.

Under her administration, the SEC:

  • “advanced more than 50 significant rulemaking initiatives”;
  • “implemented the SEC’s first-ever policy to require admissions of wrongdoing in cases where heightened accountability and acceptance of responsibility is appropriate,” resulting in “admissions from more than 70 defendants, including 44 entities and 29 individuals”;
  • “brought more than 2,850 enforcement actions.” This number was more than had been brought during “any other three-year period in the [SEC’s] history” and included many “first-of-their-kind” cases in asset management, market structure and public finance;
  • “obtained judgments and orders totaling more than $13.4 billion in monetary sanctions”;
  • “charged over 3,300 companies and over 2,700 individuals, including CEOs, CFOs, and other senior corporate officers”;
  • “devoted significant resources . . . on using cutting-edge data analytics to uncover and investigate misconduct, resulting in numerous enforcement actions involving insider trading, asset management and complex financial instruments”;
  • “awarded more than $100 million to whistleblowers who provided key original information that led to successful enforcement actions;”
  • “made significant enhancements to [the SEC] examination program, including increasing staff by about 20 percent by hiring new examiners where funding permitted, and redeploying staff from other program areas to heighten focus on the fast-growing investment management industry.”

The SEC noted that Chair White also serves as a member of the Financial Stability Oversight Council and on several other domestic and international organizations, including the International Organization of Securities Commissions, the Financial Stability Board, the International Financial Reporting Standards Foundation Monitoring Board, the Financial and Banking Information Infrastructure Committee, and the Federal Housing Finance Oversight Board.

Chair White stated:

My duty has been to ensure that the Commission implemented strong investor and market protections, and to establish an enduring foundation for future progress in the most critical areas – asset management regulation, equity market structure and disclosure effectiveness. Thanks to the hard work and dedication of the SEC’s staff, we have accomplished both.


Lofchie Comment: Chair White’s resignation was to be expected. Her departure will allow the incoming President to appoint three new SEC commissioners, two of whom will be Republicans. The new chair will be either standing Commissioner Michael S. Piwowar or one of the two new Republican appointees.

A number of significant proposed rulemakings have yet to be considered by the SEC. Leaving aside the security-based swaps rules, the most important incomplete measures, such as required disclosures of political contributions, have little to do with the historic mission of the SEC. When Chair White failed to act quickly on these politically motivated proposals, she was excoriated by Senator Elizabeth Ann Warren, who attacked her professional competence and ethics. The harshness of those attacks, and the questionable policy basis of the proposed rules, suggests that Chair White will not attempt to force the measures through by aggressive means on a two-to-one party-line vote. It is more likely that President-elect Trump’s appointment will pursue his own views on issues addressed by the current proposals.

Chair White stayed calm and maintained her dignity in the face of unwarranted personal attacks. That she managed to train the SEC’s focus on its most important goals at the same time – protecting investors and attempting to create a regulatory system that would generate economic growth – is doubly admirable.

Acceleration of Money Growth…

Today’s CFS Divisia M4 release highlights a meaningful acceleration of growth in monetary and financial aggregates.

A steady advance of CFS monetary data since the beginning of the year suggests either the economy is springing back to life, inflation is moving higher, or some combination of the two.

CFS Divisia M4 – the broadest and most important measure of money – grew by 5.8% in October 2016 on a year-over-year basis versus 5.4% in September and 4.0% at the beginning of the year.

Importantly, growth in the narrow aggregate CFS Divisia M2 advanced by a stunning 7.9% on a year-over-year basis in October.

Regulatory and global macro cross currents are reshaping the financial system. The impact of these broad changes readily explains the divergence between the broad and narrow aggregates.

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’

OFR Paper Questions Whether Higher Capital Standards Reduce Bank Risks

An Office of Financial Research (“OFR”) working paper examined how risk-taking in the repurchase agreement (“repo”) market changed after the introduction of the Basel III supplementary leverage ratio (“SLR”) regulation for banks. The working paper found that broker-dealers owned by U.S. bank holding companies (“BHCs”) now borrow less in the repo market overall after the change, but a larger percentage of the borrowing is backed by more risky collateral.

The working paper considered that:

  • in theory, the SLR could incentivize BHC-owned broker-dealers subject to the SLR to: (i) reduce their activity in the repo market; (ii) reduce their use of lower risk collateral, such as government securities, to back repo; and (iii) increase their use of more price volatile collateral, such as equities;
  • such a change of behavior may: (i) have the unintended effect of reducing liquidity in the agency mortgage-backed securities (“MBS”) market; (ii) reduce the stability of BHC-affiliated broker-dealers’ repo funding, by limiting the ability to migrate triparty financing to blind-brokered and centrally-cleared repo venues in times of stress from a greater use of repo funding backed by non-government securities collateral; and (iii) encourage non-affiliated broker-dealers to play a large role in the repo market even as their regulatory regime has changed little post-crisis;
  • the leverage ratio as a risk-insensitive capital standard may encourage firms to increase the risk profile of their remaining activities – the SLR-driven results are relevant to ongoing policy discussions internationally about potentially increasing leverage ratio requirements for global systemically important banks;
  • regardless of whether a U.S. BHC-owned broker-dealer parent is above or below the SLR requirement, the announcement of this rule has disincentivized those dealers affiliated with BHCs from borrowing in triparty repo, particularly using Treasuries and agency MBS as collateral, and incentivized them to use riskier equity collateral; and
  • nonbank-affiliated broker-dealers are entering the repo market following the announcement of the SLR.

The working paper concluded:

Thus, the activity and importance of nonbank-affiliated broker-dealers in the triparty repo market appears to be growing in response to more stringent BHC capital standards that affect bank-affiliated dealers through consolidation.

This finding is persistent and may suggest the need to revisit regulatory requirements for broker-dealers, which have been subject to little change since the 2007-09 crisis, to prevent a buildup of risks in nonbank-affiliated broker-dealers.


Lofchie Comment: This paper demonstrates one of the more obvious flaws of the bank regulators’ new capital liquidity rules: simplistic, crude regulations (that do not distinguish between assets on the basis of their risk) have the effect of disincentivizing banks from holding safe assets, as opposed to risky assets, because both receive the same regulatory treatment. More specifically, the bank regulators have imposed regulations that are doing significant damage to the repo market for U.S. government securities and agency MBS market.  (For a defense of these capital liquidity requirements, see FDIC Vice Chair Defends Higher Leverage Ratio.)

Having demonstrated that the liquidity requirements have done damage to bank-affiliated broker-dealers, however, the paper seems to suggest that the same type of regulations should be extended to broker-dealers not affiliated with banks. The basis for this leap in logic is not clear. If a regulation is not working as intended, wouldn’t it make more sense to roll back the regulation going forward after receiving this feedback, rather than to extend it?

NY Fed Issues New Policy on Counterparties for Market Operations

The Federal Reserve Bank of New York issued a comprehensive overview of its counterparty framework, which includes a new policy on counterparties for all domestic and foreign market operations. The new counterparty policy is the result of a multi-year review of the framework for counterparty relationships across the full range of the trading desk operations in domestic and foreign financial markets.

Highlights from the new policy include:

  • reducing the minimum net regulatory capital (“NRC”) threshold for broker-dealer counterparties from $150 million to $50 million, in order to broaden the pool of eligible firms;
  • raising the minimum Tier 1 capital threshold for the banks, branches, and agencies of foreign banking organizations from $150 million to $1 billion, to better align the Tier 1 threshold with the new NRC threshold (which is measured with respect to Tier 1 capital of the bank holding company); and
  • introducing a 0.25% minimum U.S. government market share threshold as a means to more directly quantify the business capabilities of firms that express interest in becoming a primary dealer.

Under the new policy, counterparties will be expected to:

  • operate in accordance with the Best Practices for Treasury, Agency Debt and Agency Mortgage-Backed Securities Markets (published by the New York Fed-sponsored Treasury Market Practices Group) and FX market best practices guidance (such as the Global Preamble, promulgated by the New York Fed-sponsored Foreign Exchange Committee);
  • provide insight to regulators on an ongoing basis into developments in the markets in which they transact;
  • meet any minimum capital thresholds or other standards that are set forth by their primary regulator;
  • provide information (as needed) for counterparty risk management and monitoring; and
  • establish a compliance program that is consistent with the sound practices observed in the industry, and support adherence to the terms of its counterparty relationship with the Federal Reserve Bank of New York.

The Federal Reserve Bank of New York also provided the following materials for firms interested in becoming a counterparty:

The new policy and eligibility criteria are immediately effective.

Lofchie Comment: It is notable that the New York Fed reduced the capital requirements for primary dealers, while at the same time increasing those requirements for counterparties to foreign exchange transactions. Further, one could question whether reduced capital requirements for primary dealers reflect diminished market interest in operating as a primary dealer.

SEC Director Cites Trends Affecting Investment Products Offered by Insurance Companies

SEC Division of Investment Management Director David W. Grim cited trends affecting investment products offered by life insurance companies. In remarks before the ALI CLE 2016 Conference on Life Insurance Products, Mr. Grim described recent regulatory developments and offered several observations on the current environment of investment products offered by insurance companies:

  • Buyout Offers. Mr. Grim stated that “insurers continue to move away from the offering of variable insurance contracts that feature the significant types of guaranteed income benefits and death benefits previously offered and sold.” He urged insurers to carefully monitor sales practices associated with these offers and emphasized that they will continue to be under scrutiny by SEC staff.
  • Risk Disclosure. Director Grim pointed out that the Division’s March 2016 guidance on basic practices outlines, among other things, what funds should do to address changing conditions, how to relay updates to investors, and how to react to market developments.
  • Filing Process/Rate Sheet Supplements. Mr. Grim stated that the Division intends to “be flexible and responsive in the filing review process” through the increased use of rate sheet supplements used by issuers of variable insurance products. He urged issuers to confirm that a prospectus clearly discloses, among other things, how the rate sheet works; how the fees and rates may change; how to obtain the current rates; and how existing contract owners can obtain the rate that is applicable to them. Moreover, he noted that the Division staff “believes that historic rates should be disclosed in an appendix to the issuer’s prospectus or statement of additional information.”