SEC Commissioner Piwowar Criticizes DOL Fiduciary Rule

SEC Commissioner Michael S. Piwowar criticized the Fiduciary Rule (the “Rule”) in a comment letter submitted to the Department of Labor. Commissioner Piwowar stated that the prohibitory scheme established by the Rule generally is inconsistent with “American traditions of self-reliance, pioneering spirit, and rugged individualism.”

Commissioner Piwowar raised three major concerns with the Rule.

First, Commissioner Piwowar argued that the DOL maintains an “excessively dour” view of the effectiveness of conflicts disclosures, and that the view is inconsistent with the SEC’s experience concerning the regulation of conflicts of interest. Commissioner Piwowar indicated that the SEC currently is engaged in a “state-of-the-art” study of rulemaking processes that “prominently” includes disclosure-oriented policies. Accordingly, Commissioner Piwowar urged the DOL to cooperate with SEC staff in exploring potential disclosure-based remedies.

Second, Commissioner Piwowar contended that the Rule does not distinguish adequately between “selling” and “advice” activities. This lack of distinction, Commissioner Piwowar wrote, is inconsistent with the discrete regulatory frameworks that govern investment advisers and broker-dealers. For example, an investment adviser is a fiduciary and for that reason owes a duty of loyalty and a duty of care to clients. By contrast, a broker-dealer typically is not considered a fiduciary, but is required to deal fairly with clients by SEC and self-regulatory organization (e.g., FINRA) rules. Commissioner Piwowar contended that distinctive regulatory frameworks for investment advisers and broker-dealers are an important aspect of the regulatory regime, and indicated that broker-dealers are subject to a suitable amount of scrutiny pursuant to SEC and FINRA rules. According to Commissioner Piwowar, the assertion that “a broker-dealer’s duties have less ‘bite’ than an investment adviser’s obligations” overlooks the scrutiny to which broker-dealers are subject.

Finally, Commissioner Piwowar expressed concern that the Rule could impact both retirement portfolios and non-retirement securities accounts. Commissioner Piwowar stated that even though the Rule ostensibly was developed to target the ERISA plan and IRA account markets, compliance burdens might cause broker-dealers to apply the same standard to non-retirement accounts. In turn, he warned, the Rule “will have a dramatic impact on the provision of financial services to retail clients throughout the financial services industry.”

Lofchie Comment: Although Commissioner Piwowar’s statement that the DOL Fiduciary Rule is in conflict with the notion of American individualism may seem a little over the top, it, in fact, raises a real big-picture question: can the government and regulators devise a system of disclosure that is sufficient to allow individuals to make decisions for themselves based on the information required to be provided to them, or are most individuals so ill-equipped to make decisions for themselves, at least financial decisions, that the government can best protect them by limiting the options available to them, and so prevent them from the possibility of making stupid decisions? The question itself is, unfortunately, not trivial.

SEC Determines Interests in Virtual Organizations Are Subject to U.S. Securities Laws

The SEC determined that tokens sold to investors by a “virtual” organization may be considered securities and, thus, are subject to applicable federal securities laws.

In an Investigative Report, the SEC explained that organizations using blockchain or other distributed ledger technology in capital-raising activities must ensure compliance with securities laws. In the report, the SEC scrutinized an incident involving a “Decentralized Autonomous Organization” (“DAO”). A DAO is described as “a ‘virtual’ organization embodied in computer code and executed on a distributed ledger or blockchain.” In this matter, the DAO offered tokens in exchange for initial cryptocurrency investments and eventually was victimized by a hacker who diverted significant cryptocurrency assets raised by the DAO. The SEC investigated whether the DAO had violated securities law by offering and selling unregistered securities.

The SEC decided not to pursue charges but sounded a warning to issuers:

“[Registration] requirements apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology.”

In an Investor Bulletin, the SEC cautioned investors about potential risks associated with initial coin offerings. The SEC explained the function of distributed ledger technologies, such as blockchain, as well as virtual currency and how it is traded via the exchanges. The SEC warned investors that virtual currency offerings may be particularly susceptible to fraud and theft, and that tracing these currencies is difficult. The SEC noted that virtual currency offerings are often unregistered and operate unlawfully or overseas. As a result, recovering stolen virtual currency can be particularly difficult. The SEC warned investors to be wary of several signs that may indicate investment fraud, including “guaranteed” high rates of return, unsolicited offers and unlicensed issuers.

Lofchie Comment: Notwithstanding the somewhat exotic nature of the relevant asset (i.e., the virtual currency), the SEC’s finding that an asset that represents an ownership interest in a profit-making venture (or that depends on the management expertise of others) is a completely unsurprising result and well within the bounds of existing law.

Regulatory Agencies to Review Volcker Rule Provisions for Foreign Funds

Five federal financial regulatory agencies will review the treatment of certain funds under section 13 of the Bank Holding Company Act (“BHCA”), as added by the Volcker Rule.

According to a joint statement, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the SEC, and the CFTC (collectively, the “agencies”) will undertake a coordinated review of how the Volcker Rule (codified at BHCA Section 13) applies to certain foreign funds that are excluded from the definition of “covered funds.” The purpose of the review is to examine “possible unintended consequences” and impacts of the Volcker Rule.

The agencies stated that market participants are concerned about potential competitive disadvantages that could arise as a result of certain foreign funds being subjected to the Volcker Rule’s requirements due to their affiliations with a foreign banking entity, while other foreign funds remain exempt from the Volcker Rule’s requirements because they are not affiliated with a banking entity. Such foreign funds often fall outside (or are excluded from) the Volcker Rule’s definition of “covered fund,” and thus foreign banking organizations are free to invest in or sponsor such funds without violating the Volcker Rule. Nonetheless, the act of sponsoring or investing in the so-called “foreign excluded funds” can create certain problems for the funds themselves.

A foreign banking entity’s investment in or sponsorship of such a foreign excluded fund can cause the fund to be viewed as “affiliated” with the foreign banking entity. If deemed to be affiliated, foreign excluded funds are themselves “banking entities” and the funds themselves must comply with the Volcker Rule’s requirements – in particular, such funds are prohibited from engaging in proprietary trading or investing in other covered funds, absent an exception in the Volcker Rule. In addition, such funds must maintain a Volcker compliance program.

In this regard, the agencies noted that the Volcker Rule incorporates the BHCA’s existing concept of “affiliation.” For example, a foreign excluded fund would be “affiliated” with a foreign banking entity if the foreign banking entity were the general partner of the foreign excluded fund, or if the foreign banking entity were to own more than 25% of the voting shares of the fund.

The agencies also are not willing to simply exempt all foreign excluded funds from the scope of the Volcker Rule. There is no clear definition of what is a “foreign excluded fund” – other than an entity that isn’t a Volcker Rule regulated “covered fund.” The agencies expressed concern that exempting all foreign excluded funds from the “banking entity” definition could enable foreign banking organizations to use structures self-described as foreign excluded funds to engage in proprietary trading or covered fund investing in a manner that the foreign banking organization could not do so directly.

The agencies stated that until July 21, 2018, the agencies will not treat as a “banking entity” any foreign excluded fund that meets the agencies’ definition of a “qualified foreign excluded fund.” A “qualified foreign excluded fund” is defined as an entity that:

(1) Is organized or established outside the United States and the ownership interests of which are offered and sold solely outside the United States;

(2) Would be a covered fund were the entity organized or established in the United States, or is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments;

(3) Would not otherwise be a banking entity except by virtue of the foreign banking entity’s acquisition or retention of an ownership interest in, or sponsorship of, the entity;

(4) Is established and operated as part of a bona fide asset management business; and

(5) Is not operated in a manner that enables the foreign banking entity to evade the requirements of the Volcker Rule or its implementing regulations.

The agencies further noted that ultimately any relief may require Congressional action to amend the Volcker Rule itself.

OCC Names New Chief Risk Officer

The Office of the Comptroller of the Currency (“OCC”) named William A. Rowe as Chief Risk Officer. Mr. Rowe will be in charge of the Office of Enterprise Risk Management, the Enterprise Risk Committee and will serve as Liaison to the Federal Deposit Insurance Corporation. Prior to his current appointment, Mr. Rowe served with the OCC as Deputy to the Chief of Staff.

Acting Comptroller of the Currency Keith Noreika Supports National Bank Charters for FinTech Companies

Acting Comptroller Keith A. Noreika described efforts by the Office of the Comptroller of the Currency (“OCC”) to support responsible innovation, particularly with regard to granting national bank charters to FinTech companies.

At the Exchequer Club in Washington, D.C., Mr. Noreika remarked that the federal banking system must be more “inclusive,” and voiced a commitment to removing barriers that prevent the establishment of new banks. Mr. Noreika said that granting national bank charters to banking-oriented FinTech companies is a “good idea” that warrants careful consideration by the OCC, and noted that the banking landscape has evolved. To keep pace with evolution, Mr. Noreika argued, the OCC must avoid defining banks in an overly restrictive manner. By creating an avenue for FinTech companies to receive national bank charters, Mr. Noreika said, the OCC would promote growth and potentially reduce regulatory burdens.

Mr. Noreika addressed two lawsuits filed against the OCC. The first was filed by the New York Department of Financial Services, and the second, by the Conference of State Bank Supervisors. Each lawsuit challenges the OCC’s authority to grant special-purpose charters to FinTech companies that do not take deposits. He asserted that the OCC does in fact have authority to grant the charters in “appropriate circumstances,” and added that the OCC plans to defend that authority “vigorously” in its litigation responses.

Mr. Noreika rejected the argument that established banks would be disadvantaged by allowing FinTech companies to receive national banking charters. Granting these charters might bring FinTech companies “out of the shadows,” he stated, and subject them to a more rigorous and structured regulatory regime, since they would be supervised as national banks.

Mr. Noreika also addressed the contention that granting national charters to FinTech companies could jeopardize consumer protection. Mr. Noreika said that (i) national banks also are subjected to state laws that are designed to protect consumers, and (ii) a multitude of regulations are tailored specifically to national banks and contain strong protections for consumers.

Mr. Noreika highlighted other efforts by the OCC Office of Innovation, such as “office hours,” which are meetings requested by companies with OCC staff to discuss the regulatory implications of financial technology.

Market Experts Criticize Sarbanes-Oxley, Urge Capital Formation Reforms

At a hearing before the House Financial Services Subcommittee on Capital Markets, Securities and Investment, market experts discussed the decline in public offerings, the effects of the Sarbanes-Oxley Act of 2002 (“SOX”) and other federal corporate governance requirements. The panelists made recommendations for promoting capital formation, particularly in the area of public offerings. (See Committee Memorandum and Written Testimonies.)

Most of the witnesses criticized SOX Section 404, which imposes internal control requirements. New York Stock Exchange President Thomas W. Farley asserted that “designing, implementing, and maintaining complex systems required to satisfy SOX’s internal controls over financial reporting requirements can command millions of dollars in outside consultant, legal, and auditing fees, in addition to other internal costs.” John Berlau of the Competitive Enterprise Institute argued that Section 404 “has done little to prevent massive mismanagement or outright fraud at troubled firms.”

By contrast, University of Denver Sturm College of Law Professor J. Robert Brown argued that SOX has been unfairly maligned, and said that its mechanisms raise investor confidence with higher quality disclosures. However, Professor Brown echoed the expressed sentiment that the current system of financial disclosure must be updated overall and that current disclosure requirements are excessive or unnecessarily complicated. U.S. Chamber of Commerce Center for Capital Markets Competitiveness Executive Vice President Thomas Quaadman said that compliance costs have risen as a result of the SEC’s “overly complex and confusing disclosure regime, which even institutional investors have a difficult time understanding.” Mr. Quaadman cited a 2011 IPO Task Force report finding that “92% of CEOs found that the administrative burden of SEC reporting requirements was a significant challenge to going public.”

Several panelists advocated for enhancements to the JOBS Act as a way to catalyze growth of the public markets. Mr. Quaadman and Mr. Farley lauded the recent extension of a JOBS Act provision that will allow all companies to submit confidential draft registration statements (see previous coverage). aTyr Pharma Vice President of Finance John Blake advocated for the extension of a JOBS Act provision that grants certain SOX compliance exemptions for former emerging growth companies (“EGCs”) that have surpassed the five-year window for classification as EGCs.

Lofchie Comment:  However Congress and the SEC may come out on the trade-off between corporate regulation and the expense of that regulation, this hearing makes plain that Congress and the regulators are focused on substantive issues such as capital formation and corporate disclosure (and not on questions such as conflict minerals disclosure, as if the SEC had the means to end civil conflicts in Africa). As a result, now that they are focusing on real questions, it seems possible for Congress and the SEC to reach reasonable answers on issues of importance to the U.S. economy. See also SEC Chair Jay Clayton Lays out Regulatory AgendaA Regulatory Philosophy at Last (Statement of Former SEC Commissioner Paul Atkins).

CFS Monetary Measures for June 2017

Today we release CFS monetary and financial measures for June 2017. CFS Divisia M4, which is the broadest and most important measure of money, grew by 3.7% in June 2017 on a year-over-year basis versus 4.4% in May.

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’

Senate Finance Committee to Discuss Tax Reform

The United States Senate Committee on Finance (the “Committee”) will hold hearings on July 18, 2017 to discuss options for overhauling the tax code and to consider the nomination of David J. Kautter as U.S. Treasury Assistant Secretary for Tax Policy.

The first hearing will focus on catalyzing economic growth, competitiveness and job creation. Senate Finance Committee Chair Orrin Hatch (R-UT) explained that the purpose of the hearing will be to give committee members the opportunity to explore how Congress can “act to implement a simpler, fairer tax system.”

Following the hearing on tax reform, the Committee will consider the nomination of David J. Kautter to serve as U.S. Treasury Assistant Secretary for Tax Policy. Currently, Mr. Kautter serves as Partner-in-Charge at RSM US, an audit, tax and consulting firm in Washington, D.C.

SEC Commissioner Kara Stein Addresses Capital Markets Issues

SEC Commissioner Kara Stein shared her views on the current state of U.S. capital markets and addressed several key issues.

In remarks before the Healthy Market Structure Conference held in Boston, Commissioner Stein asserted that the relationship between issuers and investors should not be viewed as a “zero-sum game”; that both sides of the market spectrum benefit from strong market structures that address the needs of all participants.

Focusing on the issue of the decline of initial public offerings, Commissioner Stein explained that private equity capital and capital available through private debt allow companies to fund operations without turning to the public market. In an era of low interest rates, she said, companies often view debt financing as a tenable method of funding growth. Commissioner Stein admitted, however, that the regulatory environment has made “going public” less attractive. As a consequence of the decline, there has been a reduced volume of information available to the public, making price discovery more difficult for both public and private companies. She questioned whether a system that is affected by perpetual price discovery difficulties will eventually cause significantly adverse liquidity effects.

Commissioner Stein noted the effect of emerging technologies and their contribution to information disparities. In particular, she expressed concern about the effects of “dark pools” on price discovery. Commissioner Stein expressed hope that the SEC would move forward on initiatives to improve access to information as well as market transparency. She highlighted a 2016 SEC proposal regarding order routing disclosures and a 2015 SEC proposal regarding dark pool disclosure requirements as ripe for finalization.

Lofchie Comment: Commissioner Stein’s remarks point out a core conundrum. “More” regulation may have some benefits, but as the cost of those benefits increases, more issuers and investors determine that the costs of regulation outweigh those benefits. Regulators must confront honestly the trade-offs between the regulatory burdens that they impose and the number of issuers that will elect to operate under those burdens. Finding the right trade-off point is difficult, but before the search can begin, regulators must concede that there is a trade-off.

CFS Special Counselor Steve H. Hanke Honored by the University of Liechtenstein…

CFS congratulates Steve H. Hanke, CFS Special Counselor and Professor of Applied Economics and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University in Baltimore, on receiving a Doctorate Honoris Causa from the University of Liechtenstein.

At the University of Leichtenstein, located in Vaduz, Hanke was conferred the Doctorate by Rector Jürgen Brücker during a University Day ceremony. The ceremony concluded with a dinner hosted by H.S.H. Prince Phillip von und zu Leichtenstein and H.S.H. Prince Michael von und zu Leichtenstein.

Professor Hanke’s honor was in recognition of his standing as “one of the world’s leading authorities on currencies and alternative currency regimes” and as “the world’s authority on measuring and stopping hyperinflations.” This is Professor Hanke’s sixth Doctorate Honoris Causa.

For further detail: