OCC Revises “Background Investigations” Booklet

The Office of the Comptroller of the Currency (“OCC”) made technical changes to the “Background Investigations” booklet of the Comptroller’s Licensing Manual. The booklet was substantively revised in November 2017.

The booklet outlines requirements for banks (i) to notify the OCC when there is a change of directors or senior executive officers, and (ii) to submit documents required by the OCC to review the background of proposed directors and executive officers. The booklet also describes prerequisites for exceptions and waiving the submission of required documents.

Lofchie Comment: Firms not regulated by the OCC may find the process outlined by the OCC useful in reviewing their own procedures for conducting background checks.

SEC Commissioner Urges Caution When Selling Complex Financial Products to Retail Investors

SEC Commissioner Kara M. Stein warned regulators and industry professionals to carefully consider the costs and benefits of marketing and selling complex products to retail investors.

In remarks delivered at the “SEC Speaks” conference in Washington, D.C., Ms. Stein asserted that technological advancements have increased the complexity of derivatives products, strategies and structures. While acknowledging the potential benefits, she noted the accessibility of complex products such as VIX-based futures to retail investors, and observed that these investors may not be fully cognizant of the attendant risks. She further highlighted the rise of leveraged and complex passive investment strategies, and posited that retail investors may not fully understand the added complexities of index investing.

Despite efforts to provide more effective financial education and enforcement actions targeting institutions for misleading retail investors, Ms. Stein said that market abuses related to complex products continue to persist. As such, she provided three specific recommendations:

  • the SEC, FINRA, and the exchanges should finalize the Consolidated Audit Trail and use it to better understand how these products affect investors and markets;
  • an exchange should only list complex products if they can also monitor the products for problems; and
  • industry professionals should recognize their responsibility and use their knowledge of such products to protect investors.

OCC Revises “Background Investigations” Booklet

The Office of the Comptroller of the Currency (“OCC”) made technical changes to the “Background Investigations” booklet of the Comptroller’s Licensing Manual. The booklet was substantively revised in November 2017.

The booklet outlines requirements for banks (i) to notify the OCC when there is a change of directors or senior executive officers, and (ii) documents required by the OCC to review the background of proposed directors and executive officers. The booklet also describes prerequisites for exceptions and waiving submission of required documents.

Lofchie Comment: Firms not regulated by the OCC may find the process outlined by the OCC useful in reviewing their own procedures for conducting background checks.  

CFTC and UK Financial Conduct Authority Sign FinTech Collaboration Arrangement

The CFTC and the UK Financial Conduct Authority (“FCA”) signed an agreement to facilitate collaboration, share information and support each other’s FinTech initiatives. This is the first FinTech arrangement for the CFTC with a non-U.S. counterpart.

The “Cooperation Arrangement” is primarily focused on the agencies’ respective FinTech initiatives, specifically the CFTC’s “LabCFTC” and the FCA’s “Innovate” programs. The regulators agreed to a framework for the exchange of information on businesses who participate in the programs, trends and developments in FinTech, regulatory issues surrounding FinTech development, best practices for engaging with innovators, and the activities of organizations that promote innovation. The regulators further committed to referring FinTech businesses to each other when such businesses are interested in operating in the other regulator’s jurisdiction. They also agreed to a variety of other measures intended to foster their mutual understanding of technology. The FCA and CFTC will host a joint event in London to facilitate FinTech firms’ engagement with both regulators.

CFTC Chair J. Christopher Giancarlo spoke of the groundbreaking nature of the arrangement: “This is the first FinTech innovation arrangement for the CFTC with a non-U.S. counterpart. We believe that by collaborating with the best-in-class FCA FinTech team, the CFTC can contribute to the growing awareness of the critical role of regulators in 21st century digital markets.” FCA Chief Executive Andrew Bailey agreed, saying, “As our first agreement of this kind with a U.S. regulator, we look forward to working with LabCFTC in assisting firms, both here in the UK and in the U.S., who want to scale and expand internationally in our respective markets.”

Lofchie Comment: Regulators cooperating with each other to better understand markets and products and to prepare for change is a far better approach than fighting over jurisdiction or shutting down change.

CFS Monetary Measures for January 2018

Today we release CFS monetary and financial measures for January 2018. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.8% in January 2018 on a year-over-year basis, maintaining the same growth rate as in December.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Jan18.pdf

For more information about the CFS Divisia indices and the data in Excel:
http://www.centerforfinancialstability.org/amfm_data.php

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

1) {ALLX DIVM }
2) {ECST T DIVMM4IY}
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’

CFTC Advisory Committee Examines Emerging Technology

The CFTC Technology Advisory Committee (“TAC”) considered challenges posed by new technologies. Officials from both inside and outside the CFTC and non-government financial and technology executives discussed (i) blockchain and the potential application of distributed ledger technology to the derivatives markets; (ii) virtual currencies and related futures products; (iii) the future of machine learning, artificial intelligence and computing power; (iv) developments in automated trading technologies; and (v) cybersecurity developments and best practices.

CFTC Commissioner Brian Quintenz, the sponsor of TAC, commented that while there is a need to rationalize the current regulatory framework for virtual currencies, there should be further investigation before adopting any new regulation. He described the potential application of distributed ledger technology (“DLT”) in the derivatives markets and the benefits exhibited by a trial version. Noting the challenges posed by DLT – including scalability issues, the digitalization of derivatives contracts, and DLT’s compatibility with existing CFTC regulations – he urged further discussion before taking any action. He cautioned that the CFTC “should not attempt to make value judgments about which new products are worthwhile,” and urged the cryptocurrency sector to set up a self-regulatory organization to set standards for its activities.

CFTC Commissioner Rostin Behnam recommended the CFTC take more immediate steps. While applauding TAC’s plans to reintroduce some of the Regulation Automated Trading (“Reg. AT”), he urged the CFTC to take immediate action “before an automated trading system run amok causes harm to market participants.” He asserted that “the question of a market event, flash crash or otherwise, is not if, but when.” Mr. Quintenz, speaking separately on the matter, encouraged the Committee to discuss and identify the specific risks associated with automated trading, how those risks are being addressed through the market’s incentive structure, and then to determine if regulation can effectively alleviate those risks.

CFTC Chair J. Christopher Giancarlo stated the CFTC’s first duty was to learn everything about the emerging FinTech industry before adopting regulations. LabCFTC, according to Mr. Giancarlo, will lead their efforts to learn and communicate with those in the technology industries. Since its launch, LabCFTC has conducted over 150 meetings with relevant entities and plans to continue fostering open communication.

Lofchie Comment: Mr. Behnam is right, of course, in predicting that something bad will eventually happen. More difficult is predicting what specific bad thing might happen and proposing rules that are reasonably tailored to prevent or deal with it. The alternative is to propose rules that don’t prevent problems, to have problems in spite of those ineffectual rules, and then to “find” that government wasn’t “tough enough” and so to adopt more expensive and futile rules. Put differently, the question is not, should there be rules; the question is whether there are specific rules that can forestall reasonably likely specific problems at a reasonable expense.

New Fed Chair Vows Vigilance in Preserving Financial Stability

Chair of the Board of Governors of the Federal Reserve System (“FRB”) Jerome H. Powell pledged to preserve the “essential” financial regulatory gains made since the financial crisis and to remain vigilant to risks to financial stability. In remarks delivered at his ceremonial swearing in, Mr. Powell emphasized the importance of transparency in the FRB, and vowed a commitment to fulfilling the goals of stable prices and maximum employment. He said that the FRB is “in the process of gradually normalizing both interest rate policy and [the Federal Reserve] balance sheet,” with the intention of “extending the recovery.”

D.C. Court of Appeals Decides to Exempt CLOs from Dodd-Frank Risk Retention Rules

A three-judge panel of the U.S. Court of Appeals for the D.C. Circuit ruled in favor of the Loan Syndications and Trading Association (“LSTA”) in its litigation against the SEC and Board of Governors of the Federal Reserve System (“FRB”) over the application of risk retention rules to managers of collateralized loan obligations (“CLOs”).

The Court concluded that “open-market CLO managers” are not subject to the credit risk retention rules mandated under the Dodd-Frank Act, which require firms to hold 5% of their fund. The Court explained that because CLO managers are not “securitizers” under Dodd-Frank Section 941, managers have no requirement to retain any credit risk.

The LSTA, which represents participants in the syndicated corporate loan market, first sued the SEC and FRB in 2014. On December 22, 2016, the United States District Court for D.C. ruled against LSTA. In overturning that ruling, the Court of Appeals agreed with LSTA’s primary contention that “given the nature of the transactions performed by CLO managers, the language of the statute invoked by the agencies does not encompass their activities.”

If the decision stands, (i) managers of open market CLOs will no longer be required to comply with the U.S. Risk Retention Rules, (ii) there may be no “sponsor” of this type of securitization transaction needed, and (iii) no party may be required to acquire and retain an economic interest in the credit risk of the securitized assets of such a transaction.

Implementation of the decision reached by the Panel could be delayed, modified, or reversed if the SEC and FRB seek rehearing in the Appellate Court or petition the United States Supreme Court to accept the case.

 

Senate Banking Committee Approves Three Trump Nominees

In executive session, the Senate Committee on Banking, Housing, and Urban Affairs considered the following nominations: Ms. Jelena McWilliams to be Chairperson and a Member of the Board of Directors of the Federal Deposit Insurance Corporation, Dr. Marvin Goodfriend to be a Member of the Board of Governors of the Federal Reserve System, and Mr. Thomas E. Workman to be a Member of the Financial Stability Oversight Council. All three nominees were approved. The nominations will now be advanced to the Senate floor for confirmation.

FINRA Calls Attention to Customer Recovery Issues

In a newly published paper, FINRA examined the issue of unpaid arbitration awards in the financial services industry and explored ways to improve outcomes for the FINRA arbitration forum.

Historically, FINRA has addressed unpaid arbitration awards through, among other actions, the suspension of member firms and individuals for non-payment. In this paper, FINRA identified additional steps that could be taken that would require action by the SEC or Congress. Those steps include:

  • SEC rulemaking to require firms to maintain additional capital;
  • Congressional legislation that would expand the scope of the Securities Investor Protection Corporation (“SIPC”) to include unpaid customer arbitration awards;
  • Legislation or rulemaking that would obligate firms to carry insurance to cover unpaid awards;
  • Legislation or rulemaking that would establish a second brokerage industry fund (distinct from SIPC);
  • An amended SEC Form BD that would require firms to disclose unpaid awards;
  • Legislation to amend the statutory disqualification definition under the Securities Exchange Act; and
  • Legislation to amend the Bankruptcy Code to prevent arbitration awards from being discharged in bankruptcy.

FINRA also made public certain data on unpaid customer arbitration awards from the past five years, and discussed plans to collaborate with other regulators on alternative approaches.

Separately, FINRA proposed amendments to its Membership Application Program rules to improve the timely payment of arbitration awards (see related coverage).

Lofchie Comment: FINRA should not address the issue of unpaid arbitration awards through an expansion of SIPC insurance. That fund is intended solely to remediate custodial claims. If it is turned into a general antifraud insurance fund, not only will the costs of maintaining the fund balloon, but those costs will be borne by firms and their customers who have nothing to do with generating them and exert no control over them.