House of Representatives Repeals CFPB Auto-Loan Financing Regulatory Guidance

The House of Representatives voted to withdraw the Consumer Financial Protection Bureau (“CFPB”) regulatory guidance on auto-loan financing using Congressional Review Act (“CRA”) authority. The Joint Resolution passed the House by a vote of 234 to 175 and was sent to the President for his signature.

As previously covered, this guidance, although not a formal rule, allowed the CFPB to pursue legal claims against car dealerships that allegedly charged minority consumers higher interest rates on their auto loans. The CFPB avoided the Administrative Procedures Act’s rulemaking process and related requirements by enforcing this regulatory guidance rather than developing a rule.

In remarks before the House of Representatives, House Financial Services Committee Chairman Jeb Hensarling (R-TX) supported the repeal, alleging that the CFPB’s application of the guidance violated (i) Dodd-Frank Section 1029, which prohibits the CFPB from regulating auto dealers, and (ii) the Administrative Procedures Act, by issuing guidance rather than adhering to the designated rulemaking process.

Representative Maxine Waters (D-CA) argued against the repeal and asserted that the guidance (i) served its intended purpose by providing “clarity to indirect auto lenders,” and (ii) regulated auto lenders, not dealers. Ms. Waters further claimed that using the CRA to repeal this guidance is a “clear overreach,” and that the CRA was not designed to serve this purpose.

Lofchie Comment: Notwithstanding Rep. Waters’ dramatic statement, if the guidance is less than a rule, then use of the CRA to withdraw the guidance should be less impactful than use of it to withdraw a rule. The power to do the greater implies the power to do the lesser.  

President Trump Ends U.S. Participation in JCPOA, Reinstitutes Sanctions against Iran

President Donald J. Trump declared that the U.S. would end its involvement in the Joint Comprehensive Plan of Action (“JCPOA”) and ordered the reinstitution of U.S. sanctions against Iran.

The President ordered the Secretary of State and the Secretary of the Treasury to “re-impose all United States sanctions lifted or waived in connection with the JCPOA.” The Department of the Treasury Office of Foreign Assets Control (“OFAC”) will (i) “revoke, or amend, as appropriate” all general and specific licenses that were issued in connection with the JCPOA, (ii) issue new authorizations to ensure the wind-down of transactions and activities that relate to the removed or amended general and specific licenses, and (iii) institute pre-JCPOA sanctions at the end of the 90-day and 180-day wind-down periods. OFAC provided additional FAQs to provide guidance on the re-imposition of sanctions.

SEC Commissioner Michael Piwowar Resigns

SEC Commissioner Michael S. Piwowar submitted his resignation letter to President Donald J. Trump. Dr. Piwowar’s resignation will go into effect on July 7, 2018 (or earlier upon the swearing in of a successor).

Dr. Piwowar was appointed to the Commission by President Obama in 2013 and briefly served as Acting SEC Chair under President Trump. Before that, he served as the Republican chief economist for the U.S. Senate Committee on Banking, Housing and Urban Affairs under Senators Mike Crapo (R-ID) and Richard Shelby (R-AL). He also served in the White House as a senior economist at the President’s Council of Economic Advisers from 2008 to 2009 under both President Bush and President Obama.

Prior to joining the White House, Dr. Piwowar worked as a Principal at the Securities Litigation and Consulting Group, and at the SEC Division of Economic and Risk Analysis (previously, the Office of Economic Analysis) as a visiting academic scholar and senior financial economist.

Lofchie Comment: Commissioner Piwowar’s departure is a significant loss to the Commission. He brought to the SEC the perspective of an economist. As such, he consistently championed the relationship between a strong securities market, sensible financial regulation and economic growth.

SEC Chief Accountant Recommends Improving the Quality of Financial Reporting

SEC Chief Accountant Wesley Bricker made recommendations to improve the quality of financial reporting for regulatory agencies and firms. He also reviewed developments in non-Generally Accepted Accounting Principles (“non-GAAP”) measures and other areas.

In remarks before the Baruch College Financial Reporting Conference, Mr. Bricker encouraged standard-setting bodies to maintain distinct financial reporting frameworks for general and specific purpose reporting. He explained that general purpose financial reporting should continue to provide crucial business and financial information to shareholders while specific purpose financial reports should remain limited to a “special purpose framework” in order to address more specific needs.

Mr. Bricker identified the means by which firms can improve the quality of interim reviews and annual audits. He stated that firms should implement an “effective firm-wide (enterprise) risk management system” to enhance audit firm governance. He encouraged “independent, diverse thinking” on audit committees in order to improve corporate governance. He emphasized the importance of improving the “tone and culture” of the company in enabling auditors to accomplish their work.

Mr. Bricker mentioned that the SEC is issuing a request for public comment to address compliance challenges related to auditor independence rules. Mr. Bricker promised that amendments to the accounting standards will significantly improve the quality of financial reporting for investors. The amendments include: (i) requiring calendar year-end public companies to report revenue from contracts with customers; (ii) standardized company reporting requirements to help investors compare financial statements across companies; (iii) improving reporting and disclosures of non-GAAP and GAAP to help investors identify how management monitors performance and analysis; and (iv) enhancing the quality of disclosures as to market risk.

CFTC Commissioners Have Different Wish Lists

In separate remarks at the FIA 40th Annual Law and Compliance Conference, CFTC Commissioners Brian Quintenz and Rostin Behnam described their respective regulatory priorities in contrasting terms.

Commissioner Quintenz advocated for concerted efforts to accomplish harmonization between SEC and CFTC swap regulation. According to Mr. Quintenz, firms that register as both swap dealers and securities-based swap dealers with the CFTC and the SEC, respectively, should be subject to different regulatory requirements only when there are “irreconcilable difference[s] between the securities and derivatives markets.” Further, Mr. Quintenz emphasized the importance of pushing for full harmonization where possible, noting that small differences often lead to a large cost for compliance. As to CPO/CTA registration for registered investment advisers, SEFs and data reporting, Mr. Quintenz argued that deference to the rules of the other agency may be appropriate. A firm engaged in trading and reporting swaps and security-based swaps should follow “one set of rules, instead of two,” he argued.

While Commissioner Behnam also spoke about SEC/CFTC harmonization, he emphasized more broadly that CFTC Chair J. Christopher Giancarlo’s agenda for regulatory change was overly ambitious. In Mr. Behnam’s words:

We’ve been waiting for deliverables in terms of Project KISS, Reg. Reform 2.0, and CFTC and SEC harmonization, and anticipating resolution of unfinished business in terms of the de Minimis exception, position limits, capital, and Regulation Automated Trading (Reg. AT). Since that time, we’ve received the Chairman’s white paper on “Swaps Regulation Version 2.0,” which purports to set the agenda for Reg. Reform 2.0. While I appreciate the Chairman’s transparency in setting forth his vision and, in his words, starting a dialogue, I can’t help but note that there is already a process for dialogue with market participants regarding potential rule changes – the notice and comment process for proposed rules under the Administrative Procedure Act. Adding another white paper just pushes back the timeline for getting to actual deliverables. It adds another step to the process. It also takes a lot of staff time when budgets are tight.

Commissioner Behnam went on to say: “If [CFTC] staff is directed to focus on reworking the broader framework for the swaps market in lieu of fine-tuning and building on the progress we’ve made since 2008, we risk creating greater uncertainty and impracticability at increased costs to market participants.”

Lofchie Comment: While one can be sympathetic to Commissioner Behnam’s skepticism of the need for regulatory change, and that such change itself can be costly, sufficient time has now passed since Dodd-Frank was adopted to evaluate many of the rule changes. Many of the rule changes have not only not produced the suggested benefits, but have had a negative impact on liquidity, have increased market fragmentation, and have materially increased costs to end users. Particularly given the tremendous speed with which the swap rules were adopted, and given that there is now sufficient data to evaluate at least some of the results that they have produced, there seems a great benefit in the rethinking suggested by Chair Giancarlo and CFTC Chief Economist Bruce Tuckman. It should also be noted that many of the observations made by Chair Giancarlo had also been raised by him when he was a Commissioner, but had not received the attention that they merited or the discussion that they deserved and now hopefully will receive.

SEC Director of Investment Management Answers Questions on Proposed “Best Interest” Standard

SEC Division of Investment Management Director Dalia Blass addressed general questions on the recently proposed “best interest” standard. (See here for a thorough review of the proposed rule.) In addition, Ms. Blass updated SEC activity since the adoption of the liquidity risk management rule.

At a PLI Investment Management Institute program, Ms. Blass explained that the Regulation Best Interest (“Reg. BI”) proposals “are intended to serve Main Street investors by bringing the legal requirements and mandated disclosures of investment professionals in line with investor expectations.” Ms. Blass described how Reg. BI “raises the standard of conduct for broker dealers” while “preserv[ing] the pay-as-you-go broker-dealer model by recognizing how it differs from the investment adviser model.”

Ms. Blass responded to the fact that the term “best interest” is not defined in the proposal, stating “although we have not defined the term in the proposed rule text, we have defined the contours of the obligation: a broker-dealer cannot put its interests ahead of the retail customer’s and must comply with specific disclosure, care and conflict of interest obligations.” In this way, she argued, “Reg. BI incorporates, but goes beyond suitability.” Further, she notes “Reg. BI draws from principles that apply to investment advice under other regulatory regimes, yet it reflects the structure and characteristics of a broker-dealer’s relationship with retail customers.” Ms. Blass drew further distinction between broker dealers and investment advisers, stating: “[t]he duties required under Reg. BI are tied to each recommendation a broker-dealer makes, whereas an adviser’s fiduciary duty applies to the ongoing relationship with a client.”

Finally, Ms. Blass explained that the new interpretive guidance for investment advisers would serve to clarify their fiduciary duty standards. She said the guidance reaffirms that investment advisers must act in the best interest of its client, but also owes a duty of care and a duty of loyalty. She said the “staff recommended proposing this interpretation in order to draw together a range of sources and provide advisers with a reference point for understanding their obligations to clients.”

Separately, Ms. Blass discussed three projects implemented by the SEC following the adoption of a liquidity risk management rule. The rule requires certain registered investment companies to create liquidity risk management programs. Ms. Blass stated that the agency responded to feedback concerning the rule by (i) issuing FAQs regarding “classification, sub-advisory relationships, ETFs and reporting,” (ii) providing affected parties with six additional months in which to comply with the “classification and related elements of the rule,” and (iii) reevaluating the public reporting requirement of the rule to stop subjective liquidity information from being misconstrued. Ms. Blass also announced that the SEC intends to issue a proposal to modify the public reporting requirements for liquidity risk management programs. She said the new amendment would replace the requirement to “disclose publicly aggregated liquidity buckets” and instead require funds to provide an evaluation of their liquidity risk management programs in their annual shareholder reports.

Lofchie Comment: Ms. Blass expresses support for both the concept of “full-service” brokerage, where broker-dealers are able to make recommendations to retail investors and be paid through trading commissions, and for the imposition of a higher duty on broker-dealers under newly proposed Regulation Best Interest. Two fundamental questions are: (i) how much time/money must a broker-dealer invest in learning about a client so that it would be in a position to satisfy its proposed best interest obligation, and (ii) how many trades would a broker-dealer have to execute for the client so that the investment would be worthwhile?

It seems very likely that it would take a substantial volume of trading by a retail investor for a broker-dealer to truly understand its retail investor’s circumstances to the extent mandated by the proposed Best Interest Requirement. If that is the case, a retail investor who might execute ten or twenty trades a year will not be able to “pay for” full-service brokerage.

Of course, the above is just an uninformed guess. It would be more meaningful if the SEC were to provide its own estimates of (i) the costs to broker-dealers of obtaining and understanding required suitability information, (ii) the revenues and profits to broker-dealers of executing trades for retail customers, and (iii) the volume level at which it will make sense for broker-dealers to offer full-service brokerage recommendations to retail investors.

NYDFS Proposes “Best Interest” Standard for Sellers of Life Insurance and Annuity Products

The New York Department of Financial Services (“DFS”) proposed amendments to New York’s existing suitability regulation in order to establish a “best interest” standard for the sellers of life insurance and annuity products.

DFS issued the proposal in order to protect New York State consumers from receiving conflicted advice from agents, brokers and/or insurers regarding life insurance and annuity product transactions. The proposal would require an agent or broker (or an insurer, if there is no agent or broker involved) to “act in the best interest of the consumer.” According to the proposal, this means that an agent, broker or insurer should make recommendations “based on an evaluation of the suitability information of the consumer that reflects the care, skill, prudence, and diligence that a person familiar with such matters would use under the circumstances without regard to the financial or other interests” of themselves or other parties.

The amendments would (i) require disclosure of all suitability considerations and product information that form the basis of any recommendation, (ii) permit agents or brokers to make a recommendation only if they have a “reasonable basis to believe that the consumer can meet the financial obligations under the policy,” and (iii) prohibit an agent or broker from telling a consumer that a recommendation is part of financial planning, investment advice or related services (unless the agent or broker is a certified professional in that area).

Additionally, the proposed regulation would require insurers to (i) “establish and maintain procedures to prevent financial exploitation and abuse,” (ii) disclose to customers all relevant policy information in order to evaluate a transaction, and (iii) provide to producers all relevant policy information in order to evaluate a replacement transaction.

The proposed amendments are open to public comment for 30 days after their publication in the New York State Register.

Lofchie Comment: The proposed NYDFS standard that a seller must understand fourteen different characteristics of the insurance buyer, and must take account of “all available, products, services and transactions,” seems to set an unreachable bar. Is NYDFS really requiring that an insurance broker have information as to all available products, including those she does not offer, and then evaluate all of those available products against the customer’s fourteen suitability information characteristics?

Further, a “recommendation” seems to be defined to include any communication with a customer of a non-clerical nature, as it would seem that a broker would expect that a communication with a customer or potential customer would result in either the customer transacting or not transacting (that seems to cover all the bases). Does this mean that a broker responding to any question from a customer is thereby subject to the “best interest standard”? If so, the broker would be wise to let the customer do her own research.

These standards are published immediately after the SEC issued its own Retail Best Interest standard. While those rules seemed as if they would set a difficult standard for firms to meet, and likely would discourage firms from making recommendations, the New York State proposal is harsher by far; can brokers really meet these standards in talking to customers? This is not the first time that the NYDFS has issued a proposal with which compliance appeared impossible on its face (see, e.g., the NYDFS proposed AML Rules).

If these rules go forward as proposed, firms selling annuities in New York may be at high risk.

CFTC Commissioner Reviews Current Regulation of Cryptocurrencies

CFTC Commissioner Brian Quintenz described deficiencies in U.S. regulation of cryptocurrencies and identified potential developments in the “broader tokenization revolution.”

In remarks before the Eurofi High Level Seminar, Mr. Quintenz encouraged international regulators to develop different regulations for (i) cryptocurrencies that serve only as a medium of exchange or store of value and (ii) for tokens that are intended to represent physical assets.

Mr. Quintenz asserted that, in the future, a cryptocurrency’s “volatility and transferability” could compare reasonably well even against a sovereign currency. In this “broader tokenization revolution,” Mr. Quintenz outlined three motivations that may further increase the use of tokens: (i) tokenizing a company’s product as a marketing ploy; (ii) creating a token to improve efficiency of the blockchain construct for assigning and tracking ownership, coined as “the back office tokenization revolution”; and (iii) harnessing the flexibility of tokens to create a secondary market for non-tangible items.

Domestically, Mr. Quintenz called for better regulatory oversight for cryptocurrencies, particularly in the area of spot trades. He explained that the CFTC has regulatory authority only over derivatives on commodity cryptocurrencies and cannot regulate the spot transactions in such currencies, although it does retain enforcement authority over these markets to the extent that there is fraudulent conduct. According to Mr. Quintenz, this means that “the CFTC can only police fraud and manipulation in the actual trading of cryptocurrencies, but has no ability to make platforms register with the Commission or set any customer protection policies.”

To strengthen regulatory oversight, Mr. Quintenz said that the CFTC is launching an initiative to educate customers on cryptocurrency and potential fraud, “aggressively target[ing]” incidents of fraud and manipulation, and collaborating with the SEC. He argued that the “patchwork” nature of state and federal regulation will not be enough. Mr. Quintenz recommends the cryptocurrency spot platforms form an “SRO-like entity” to regulate customer protection rules and legitimize the markets. Mr. Quintenz emphasized, however, that an SRO-like entity is not a sufficient replacement for federal oversight.

Lofchie Comment: This is at least the second time that Commissioner Quintenz has pushed for cryptocurrency exchanges to establish a self-regulatory organization. This is unlikely to happen. For self-regulation to be really effective, the firms or exchanges that deem themselves to be compliant have to be able to “punish” the non-compliant firms in some way. When several firms gang up against another, that raises significant antitrust issues. Broker-dealers can do this in the securities markets because the Supreme Court recognizes that Congress has given broker-dealers a limited exemption by providing for the establishment of SROs, as has been the case under the Commodity Exchange Act. There is nothing similar for cryptomarkets. In any case, this market is far too young and fast-moving for an SRO system to develop.