CFTC Acting Chair Giancarlo Makes Staff Changes

CFTC Acting Chair J. Christopher Giancarlo appointed: (i) Amir Zaidi, formerly legal counsel and policy advisor to Mr. Giancarlo, to lead the Division of Market Oversight (“DMO”); (ii) Vincent McGonagle, formerly Director of DMO, to be Acting Director for the Division of Enforcement; and (iii) John Lawton, formerly Deputy Director of the Division of Clearing and Risk, to be Acting Director of the Enforcement Division. Mr. Lawton replaces Jeffrey Bandman, who will serve as an advisor on issues related to Financial Technology.

CFTC Division Grants Relief Permitting Withdrawal of Residual Interests

The CFTC Division of Swap Dealer and Intermediary Oversight (“DSIO”) granted no-action relief, subject to specified conditions, to FIA and member futures commission merchants (“FCMs”) from CFTC Rule 22.17(b) requirements with respect to certain withdrawals of FCM excess residual interest. In particular, the relief allows FCMs to withdraw such funds prior to the completion of a daily segregation calculation pursuant to Rule 22.17(b) interest, subject to strict conditions, where a previously undermargined customer meets the customer’s margin obligations.

As explained by the CFTC, the relief addresses a “timing gap” created by the Rule 22.17 requirement that results in “significant amounts of FCM liquid capital, above the Cleared Swaps targeted residual interest amount, being held in Cleared Swaps Customer Accounts for the duration of the day.”

Lofchie Comment: This relief may seem technical, but it is highly material to FCMs who otherwise would be required to tie up their proprietary cash needlessly during the business day. As noted previously, the number of FCMs has declined substantially in the past several years. The decline likely is driven by increased regulatory costs and burdens, and decreased revenue opportunities. This relief is a step toward righting that wrong direction.

Treasury Secretary Nominee Clarifies Positions on Volcker Rule, Carried Interest

In written responses to the Senate Finance Committee, Treasury Secretary nominee Steven Mnuchin provided his views on a number of topics, including the carried interest on hedge funds and the Volcker Rule. Mr. Mnuchin stated that the administration’s tax plan would “recommend repealing carried interest on hedge funds.”

As to the Volcker Rule, Mr. Mnuchin suggested that the “proprietary trading” restrictions could be narrowed and the Volcker Rule applied only to FDIC-insured banks, not necessarily their affiliates. If confirmed as Chair of the Financial Stability Oversight Council, Mr. Mnuchin said he would “address the issue of the definition of the Volcker Rule to make sure that banks can provide the necessary liquidity for customer markets and address the issues” contained in a recent Fed working paper. Mr. Mnuchin stated that:

“I am supportive of the Volcker Rule to mitigate the impact that proprietary risk taking may have on a bank that benefits from federal deposit insurance. However, …we need to provide a proper definition of proprietary trading, such that we do not limit liquidity in needed markets….”

CFTC Extends Comment Period for Reg. AT

The CFTC extended the comment period to May 1, 2017 for the Supplemental Notice of Proposed Rulemaking (“SNPRM”) for Regulation Automated Trading. Prior to the extension, the SNPRM was scheduled to expire on January 24, 2017. The SNPRM modifies certain aspects of the proposed rulemaking for Regulation AT, which was published in the Federal Register on December 17, 2015.

Lofchie Comment: Given CFTC Chair J. Christopher Giancarlo’s concern over the rights of market participants to protect their intellectual property, comments on Regulation AT should be read with an open mind.

Federal Register: CFTC Requests Comments on Proposal to “Modernize” Recordkeeping Requirements

The CFTC requested comment on a proposal to modernize certain recordkeeping obligations. The proposal would remove a requirement that electronic records be kept in their original format, and would allow recordkeepers to reduce costs associated with paper records through the utilization of “advances in information technology.” The request for comments was published in the Federal Register.

Comments on the proposed amendments must be submitted by March 20, 2017.

Lofchie Comment: The rule proposal would provide welcome updates to the requirements for the storage of electronic records under CFTC Rule 1.31. Significantly, the proposal would eliminate many of the prescriptive requirements of the current rule, including the need for firms to use outdated “write once, read many” (or “WORM”) storage media. Instead, the proposed new rule would adopt a technology-neutral requirement that electronic records be maintained in ways that preserved their “authenticity and reliability.” In addition, the proposal would eliminate the need for firms that store records electronically to (i) appoint a “technical consultant” that agrees to provide the records to the CFTC, and (ii) file a notice with the CFTC regarding compliance with Rule 1.31. However, the proposal also would require firms to implement written policies to assure compliance with the new requirements, including policies for training personnel, and for regular compliance monitoring.

The CFTC’s recent move to a more principles-based approach presents an interesting question: will the SEC follow the CFTC’s lead and modernize SEC Rule 17a-4 along similar lines?


Outgoing SEC Chair White Urges Successors to Maintain “Fierce Independence”

Outgoing SEC Chair Mary Jo White asserted that the SEC must be “ready to use the full array of tools available” if it is to remain a strong market regulator. She argued that the SEC should not rely “on disclosure and enforcement alone” and that the SEC must maintain a “fierce independence in applying our expert, best judgment to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate the formation of capital by the companies whose innovation and growth drives the American economy.”

In a speech before the Economic Club of New York, Chair White described progress in a number of areas during her tenure including developments in fund liquidity, equity market structure, financial responsibility for broker-dealers, and public disclosure. She asserted that regulators “must recognize and address the interrelationships between financial institution and market, appropriately calibrated to both protect investors and support the risk-taking that is at the heart of our capital markets,” and claimed that the Financial Stability Oversight Council is a “particularly important forum” for sustaining and strengthening those interrelationships.

Chair White stated:

“At the core of being a good steward of the mission of the SEC is acting independently from the executive and legislative branches of government, fighting for that independence whenever necessary, and withstanding the inevitable criticism and pressure to change that follows.”

Chair White concluded that the “agency’s independence has been critical in allowing it to use its expert judgment to do what is best for investors and the markets – a task that could otherwise be rendered impossible by the whims of political pressure or the public mood.” She observed “[p]erhaps a bit paradoxically,” that this independence depends on regular oversight from a wide range of constituents with vastly different perspectives. Chair White highlighted trends that she felt were pushing against it, such as “highly prescriptive mandates,” and “legislative proposals from Congress seeking to remake [the SEC’s] rulemaking process.”

Lofchie Comment: The substance of Chair White’s advice and commentary seems Delphic. Is she telling her successors to be independent of the new administration of the President-elect, or is she articulating her stance toward Senator Elizabeth Warren’s various attacks? (See SEC Chair Mary Jo White to Step DownSenator Urges President to Replace SEC ChairSenator Warren Calls on SEC to Justify Disclosure Effectiveness Initiative.)

House Approves Bill to Require the SEC to Conduct Cost-Benefit Analyses

By a vote of 243-184, the House of Representatives approved the SEC Regulatory Accountability Act (H.R. 78). The Act would require the SEC to conduct cost-benefit analyses of its regulations and orders.

The Act would require the SEC to do the following before issuing a regulation:

  • “clearly identify the nature and source of the problem that the proposed regulation is designed to address, as well as assess the significance of that problem, to enable assessment of whether any new regulation is warranted”;
  • “utilize the Chief Economist to assess the costs and benefits, both qualitative and quantitative, of the intended regulation and propose or adopt a regulation only on a reasoned determination that the benefits of the intended regulation justify the costs of the regulation”;
  • “identify and assess available alternatives to the regulation that were considered, including modification of an existing regulation, together with an explanation of why the regulation meets the regulatory objectives more effectively than the alternatives”; and
  • “ensure that any regulation is accessible, consistent, written in plain language, and easy to understand and shall measure, and seek to improve, the actual results of regulatory requirements.”

The Act also requires the SEC to review its regulations every five years and conduct a “post-adoption impact assessment of major rules.”

Lofchie Comment: That regulators should be required to take the costs and benefits of their rulemakings into account seems entirely reasonable. The questions that arise are these: (i) how quantifiable are these costs and benefits in reality, and (ii) how seriously will regulators take the cost-benefit analysis requirement? In his farewell remarks, outgoing Department of Labor Secretary Thomas Perez asserted that the DOL’s new fiduciary rule would save investors seventeen billion dollars a year. (See Outgoing Labor Secretary Highlights “Great Progress.”) That number seems remarkable, especially since it cannot be verified in any scientific manner. Yet despite the ambiguous origins of that number, the DOL uses it to determine that the “benefits” of the rulemaking are high enough to “prove” that they outweigh any possible costs. Similarly, in adopting its rules under Dodd-Frank, the CFTC emphasizes the costs of the financial crisis, as though that crisis would recur if all of the CFTC’s rules were not adopted.

Quantifying benefits is a difficult task. Perhaps one way to solve the problem is to require regulators to justify the predicted effects of their rulemakings. The DOL’s estimate is one example: how would one “prove” the seventeen billion dollar benefit? Clearly, the DOL has assumed that those accounts which are subject to the rule will have higher rates of return. Here is a practical suggestion for making more realistic assessments: take a random group of retail accounts (say, 10,000) and calculate how well they performed over the last three years relative to a market index (such as the S&P 500). Then monitor how well the same accounts perform over the next three years relative to the same index.

Cost-benefit analysis does have its critics. One example is Harvard Law School Professor John C. Coates IV, who examined the implications of case studies concerning the cost-benefit analysis of financial regulation, and recommended steps “towards better cost-benefit analysis.”

CFS Monetary Measures for December 2016

Today we release CFS monetary and financial measures for December 2016. CFS Divisia M4, which is the broadest and most important measure of money, grew by 5.4% in December 2016 on a year-over-year basis versus 5.5% in November.

For Monetary and Financial Data Release Report:

For more information about the CFS Divisia indices and the data in Excel:

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’

SEC OCIE Sets 2017 Examination Priorities

In its “Examination Priorities for 2017,” the SEC Office of Compliance Inspections and Examinations (“OCIE”) set forth priorities based on current issues that “present potentially heightened risk to investors and/or the integrity of the U.S. capital markets.” The OCIE will focus future examinations on (i) retail investors, (ii) senior investors, and (iii) market-wide risks. The OCIE’s examination priorities follow closely on the heels of FINRA’s announced examination priorities.

Specifically, the OCIE prioritized examination in the following areas:

  • Retail Investors: The OCIE highlighted: (i) the provision of electronic trading advice (given the DOL’s fiduciary rule that drives the market in that direction), (ii) wrap fee programs, including whether the level of trading quality offered is high enough and the programs are cost-efficient for investors, (iii) exchange-traded funds, particularly their suitability and the creation/redemption process, (iv) never-before-examined advisers, (v) recidivist firms and individuals, (vi) multi-branch advisers, particularly their design and implementation of supervisory systems, and (vii) share selection in multi-class mutual funds (i.e., whether investors are being sold the cheapest share class).
  • Senior Investors: The OCIE will devote increased attention to its multi-year ReTIRE initiative, investors’ use of public pension advisers, and risks posed to senior investors.
  • Market-Wide Risks: The OCIE will focus on: (i) money market funds, especially concerning systemic risk issues, (ii) payment for order flow (an increasingly significant issue due to the narrowness of spreads), (iii) systemic risk issues of clearing agencies, (iv) the quality of FINRA examinations, (v) compliance with Regulation SCI and cybersecurity, (vi) the securities exchanges, and (vii) anti-money laundering.

The OCIE noted that it expects to allocate examination resources to other priorities that include (i) municipal advisors, (ii) transfer agents, and (iii) private fund advisers.

OCIE Director Marc Wyatt explained the importance of the announcement:

“OCIE’s priorities identify where we see risk to investors so that registrants can evaluate their own compliance programs in these important areas and make necessary changes and enhancements.”

Lofchie Comment: OCIE’s intention to enhance oversight of FINRA is most interesting. FINRA has been aggressive in sanctioning firms in the past. Perhaps FINRA’s increasing significance is the reason, since it has taken over the regulatory examination role for virtually all of the securities exchanges.

House Passes Bill to Facilitate Solicitation by Angel Investor Groups

The House of Representatives passed the Helping Angels Lead Our Startups Act (“HALOS Act”) (H.R. 79). The Act purports to “clarify the definition of general solicitation under Federal securities law” as it relates to certain communications by “angel investor groups.”

The HALOS Act defines an “angel investor group” as any group that (i) is “composed of accredited investors interested in investing personal capital in early-stage companies,” (ii) meets regularly and has established processes for making investment decisions, and (iii) is neither associated nor affiliated with broker-dealers or investment advisers.

The HALOS Act requires the SEC to revise Regulation D to specify that the prohibition against general solicitation (CFR Title 17, Section 230.502(c)) does not apply to a presentation or other communication by an issuer or their representative at an event:

  • that is sponsored by the United States government, an institution of higher education, a nonprofit organization, an angel investor group, a venture forum or trade association, or any other entity determined to be applicable by the SEC;
  • where advertising does not specify any securities offerings by the issuer;
  • that is sponsored by entities that do not offer investment recommendations or advice to attendees, engage in investment negotiations between the issuers and investors at the event, or charge event attendees any fees and receive compensation for the event that would require broker-dealer or investment advisor registration; and
  • where no specific information concerning securities offerings by the issuer is relayed by or on behalf of the issuer, subject to certain conditions.

Lofchie Comment: It is to be expected that the new Congress will look for ways to facilitate private firms’ ability to raise capital. The HALOS Act seems a reasonable step. One reason that the JOBS Act has not been more successful is because many of its exemptive provisions (particularly regarding qualification as an “accredited investor”) have raised sufficient uncertainty, or imposed enough burdensome conditions, for market participants to be reluctant to rely on the exemptions. The HALOS Act may suffer from some of the same deficiencies. Here are a few examples:

Under the HALOS Act, an angel investor group must (i) invest “personal capital” (what about money held in a trust, LLC or family-owned fund?), (ii) hold “regular meetings” (does “regular” mean on a constant or frequent schedule?), (iii) have “defined processes and procedures” (how defined should they be? Is it enough to say that a group gets together and votes?), and (iv) not be affiliated with a broker-dealer or adviser (what if a group includes the employees of a broker-dealer or adviser?). How can an issuer possibly know whether an angel investor group meets these qualifications?

None of these or similar requirements under the HALOS Act seems material to protecting investors or germane to enabling firms to raise capital. If the Act is going to serve its intended purpose, then Congress must (i) revise the requirements to include only those that will serve to protect investors demonstrably, and (ii) draft those requirements clearly enough to allow issuers to know they are safe in relying on the exemption.