GAO Reports on FinTech

The Government Accountability Office (“GAO”) issued a report on four types of financial technology (“FinTech”): marketplace lending, mobile payments, digital wealth management (also known as “roboadvisor”), and distributed ledger technologies (“DLTs”) such as blockchain. The GAO addressed functionality, risks and benefits, industry trends, and regulatory oversight.

The GAO did not make specific recommendations concerning oversight, noting that very little commonality exists between the differing types of FinTech. However, the GAO acknowledged the challenges involved in regulating FinTech:

“With respect to virtual currencies, federal and state regulators have taken varied approaches to regulation and oversight. The existing regulatory complexity for virtual currencies indicates that regulatory approaches for future applications for DLT will also be complex.”

Lofchie Comment: The GAO report serves as a good introduction to each of the four FinTech subsectors, and to some of the more significant legal and compliance issues that each business raises.

SEC Acting Chair Piwowar Emphasizes Disclosure in Regulation of Capital Markets

Before an audience of foreign regulators at the SEC’s 27th Annual International Institute for Securities Market Growth and Development, SEC Acting Chair Michael Piwowar addressed best practices for the regulation of capital formation. He emphasized the importance of disclosure for lowering the cost of capital and for protecting investors, and asserted that a guiding principle for regulators must be to determine whether the government is facilitating or interfering with the progress of capital markets.

Acting Chair Piwowar focused on the value of the disclosure regime. He said that prudential regulation in capital markets is a “misplaced idea,” and added that “while banks are in the business of minimizing risk, the capital markets are in the business of allocating risk.” He argued that disclosure is the most effective tool for allocating capital to the most efficient industries, and suggested that a disclosure regime for banks (which he called “market-based prudential regulation”) could also benefit investors.

In addition, he stressed that a regulatory agency should not “substitute its judgment for that of the market.”

Acting Chair Piwowar also touched on the subjects of enforcement, international cooperation, and emerging issues in FinTech.

Lofchie Comment: During his interim tenure, Acting Chair Piwowar is making significant efforts to return the SEC to its historical mission of enabling investors to make investment decisions on the basis of good corporate disclosure regarding facts of economic significance. These are necessary corrections to the course of an agency that had been used since the adoption of Dodd-Frank as an instrumentality of political partisanship without regard to the economic costs or the benefits of its rulemakings.


Sargen on Healthcare, the Budget, and Tax Reform


  • Economic policies of the Trump Administration are key to assessing the economic and market outlook.  The Republican House tax bill drafted last summer and slated to be voted on later this year has been the focal point for investors. Meanwhile, they are assessing the Republican replacement plan for Obamacare and the 2018 budget proposal submitted by the Office of Management and Budget (OMB) this past week.
  • Both plans are highly controversial, and it remains to be seen what will ultimately be enacted. The proposed budget would fund a 9% increase in military and security spending via steep cutbacks in non-defense related programs that Congressional Democrats and some Republicans oppose.  The main worry for the Republican leadership, however, is that the replacement plan for Obamacare may not attract sufficient Republican support to ensure passage.
  • How these proposals play out could have important consequences for tax reform legislation.  The healthcare plan supported by Speaker Ryan will halt Medicaid expansion in 2020 and shift funding from open-ended entitlements to a per capita cap.  The Congressional Budget Office (CBO) estimates it will generate $1 trillion in savings over a decade, although it will also reduce the number of people receiving insurance substantially.
  • Prospects for enacting tax reform would be enhanced if the Congressional Republicans coalesced on a healthcare plan, whereas failure to reach agreement could jeopardize tax reform and lessen investor confidence.  The vote in the House this week will provide an early read.

Focusing on Economic Policies

One of our main messages for investors since the presidential election has been to focus on policies of the Trump Administration that will have an important bearing on the economy. They are the news that will drive financial markets, as opposed to comments and tweets by the President that many regard as noise.

Until recently, the only substantive policy proposal was the House tax reform bill drafted by the Republican leadership last summer.  It contains features that President Trump supports including: (i) a significant reduction in the corporate tax rate (albeit to 20% instead of the 15%); (ii) immediate expensing of capital outlays but no interest rate deductibility; and (iii) incentives for multinationals to repatriate profits earned abroad.

The most controversial element is the border adjustment tax (BAT) that effectively subsidizes exports and taxes imports of overseas affiliates.  The intent is to eliminate incentives for U.S.-based firms to shift production abroad, and the BAT is also estimated to create more than one trillion dollars in tax revenues over a decade.  The latter is deemed essential by the Republican leadership to ensure tax reform is neutral for the federal budget.

The prospect of significant tax reform combined with regulatory relief, in turn, has been a major driver of the stock market rally since the election.  Indeed, some surveys indicate that approximately 70% of those polled believe legislation will be passed later this year.  The principal uncertainty is whether the BAT provision will clear the final bill.  If not, prospects for the budget deficit expanding considerably are higher, as it will be difficult to make up the loss in revenues.

Beyond this, investors suspect the budget deficit is set to widen during the Trump Administration for the following reasons: (i) President Trump supports a large increase in military and security spending as well as a one trillion dollar infrastructure program; (ii) during the campaign he indicated he would not touch entitlement programs such as Social Security, Medicare, and Medicaid; and (iii)  the President has stated he would help pay for these programs by making large scale cuts in other discretionary spending; collectively, however, they account for only 15% of total federal spending.

With the House Republican leaders recently having drafted legislation to replace Obamacare and the Office of Management and Budget submitting its plan for discretionary spending in the coming fiscal year, investors are now examining details of both plans and assessing the prospects they will be enacted.

Linking OMB’s Budget Plan and the Republican Health Care Bill

The budget plan submitted by OMB and the Republican bill to replace Obamacare were submitted separately; consequently, they have each drawn considerable scrutiny.  To understand them better, however, it is important to recognize that both are key components of the FY2018 budget plan that will be enacted later this year.

The plan submitted by OMB last week, for example, applies only to discretionary federal spending, which represents about 30% of total federal spending.  Under the OMB proposal, military and security outlays would increase by 9% in FY2018, and would be funded entirely through cutbacks in other programs, of which the largest would be for social programs and the EPA.  However, because Democrats and some Republicans are staunchly opposed to large-scale cutbacks in non-defense spending, the OMB plan is widely perceived to be an opening move by the Trump Administration that lays out its priorities.

The main areas of spending that are not addressed in the OMB proposal are mandatory programs, which consist of entitlements (Social Security, Medicare and Medicaid) and net interest payments on the national debt.  Of these, the fastest growing segment is Medicaid, which was expanded as part of the Affordable Care Act (ACA) and resulted in the largest gain in insurance coverage, about 11 million people.  As currently constituted, it is an open-ended obligation of the federal government.

Robert Samuelson of The Washington Post observes (March 20, 2017) that Medicaid increasingly is another mechanism by which government skews spending toward the old and away from the young: “Although three-quarters of Medicaid recipients are either children or young adults, they account for only one third of costs.  The elderly and disabled constitute the other one-quarter of recipients, but they represent two-thirds of costs.”  Samuelson concludes that getting Medicaid costs under control is a much needed reform, considering the aging of the population, with the number of Americans 85 and older expected to increase by 50% by 2030.

This is where the Republican Health Care bill comes into play, as one of the key provisions is phasing out Medicaid expansion through 2020.  Under the Republican bill the program also transitions to a system of block grants to each state that is based on per-capita payments for the Medicaid population.  According to the Congressional Budget Office (CBO), the Republican bill cuts spending by $1.2 trillion net and it eliminates new taxes worth just shy of $900 billion through 2026, of which the vast saving is from reduced Medicare expense.

That’s the good news. The bad news is the cost saving is attributable to fewer people enrolling for medical insurance: CBO estimates there will be a decline of 14 million enrollees next year relative to the Obamacare tally and a cumulative decline of 24 million by 2026.  Even if the CBO estimates prove to be too high, they pose a political problem for the Republican leadership in Congress, who must bring the conservative wing of the Party that favors a quicker end to Medicaid expansion into the fold together with moderates in the Senate who are concerned about a voter backlash if coverage is diminished.

At this juncture, it is unclear whether the Republicans in Congress will be able to find an acceptable compromise.  The first clear indication will come this week when a voted is slated in the House of Representatives.  While conservatives favor an earlier end to Medicaid expansion or simply repealing the ACA, such action would still leave in place the expensive open-ended federal Medicaid commitment.

Thus far, President Trump has been supporting Speaker Ryan’s plan, but he could switch tactics if passage of the bill appears in trouble.  Also, if the President continues to back the plan, he will be criticized for breaking his campaign pledge of not touching entitlements and his assurance that no one will lose coverage under the Republican plan.

Implications for Tax Reform

The resolution of the Health Care bill not only matters for healthcare spending, which comprises 28% of total federal outlays, but also for the passage of tax reform.  If the Congressional Republicans are able to coalesce around a healthcare bill that can pass Congress, it bodes well for the passage of tax reform legislation that investors are counting on.

Conversely, should Republicans be unable to agree, it would damage the chances for meaningful tax reform and harm their chances for maintaining control of Congress in the 2018 elections.  Daniel Henninger of the Wall Street Journal (March 10, 2017) characterizes the Republican dilemma as follows:

            “The day the Republicans clutch on this (healthcare) reform, there will be six-column headlines across the Washington Post and New York Times: “Trump Abandons Promises on Health Care”

            “It will be a fast ride downhill from there. That is because the health-care reform bill is inextricably linked to the politics of tax reform, the second pillar of the Trump legislative agenda.”

The challenge of confronting entitlement program expansions is particularly formidable now, as the aging of the baby boomers implies a steady increase in the size of the federal budget deficit in coming decades absent any changes in current policies (see Figure 1).  Indeed, by 2025 people 65 years and older will comprise 20% of the total population.  Meanwhile, with the added pressure to increase military and infrastructure spending the inevitable question investors must ask is “who will pay the bills?”  Once market participants understand the nature of the fiscal predicament, investors may reassess the optimistic assumptions that are embedded in financial markets today.

Figure 1: CBO Projections of Federal Budget Deficit Assuming No Change in Policies  

Source: Congressional Budget Office.

SEC Commissioner Stein Offers a Vision for the Future

SEC Commissioner Kara M. Stein cautioned regulators to “look forward” not “backward” in order to take advantage of the “amazing opportunities” created by markets in a “continual state of change.” In a speech before the 2017 “SEC Speaks” Conference, Commissioner Stein described a vision based on the premise that: “the markets exist to connect the capital of people who have saved with people who will put that capital to good use building companies and creating jobs.” She stated that: “Our policies should reflect that purpose—they should facilitate economic activity in a way that is fair and efficient and that benefits Americans who are saving and investing.”

She urged regulators to consider the impact of several market changes, including increased growth and diversity in exchange-traded products (“ETPs”), electronic trading and capital raising. She asserted that the “changes in the markets – the rise of institutional investors, the move to private markets, and the evolution of electronic trading – are all closely intertwined.”

On issues of disclosure, Commissioner Stein recognized that the Consolidated Audit Trail and similar regulatory developments will enhance disclosure requirements, and emphasized that “much more needs to be done.” Commissioner Stein stated that regulators themselves must change:

“The landscape in which we operate is quickly and fundamentally shifting. We too need to change. We cannot address the new world by simply turning the clock backward. Instead, we must look to the future.”


Lofchie Comment: Commissioner Stein’s vision of the future is about more regulation. When she asks why companies stay private for longer periods of time, she does not consider the possible answer that the costs of regulation are not worth the benefits of going public. Her conclusion is never whether regulation is the answer, only which regulation is the answer, as in: “Should we apply enhanced disclosure laws to these private companies? Or perhaps they require a unique set of rules.”

It is possible that Commissioner Stein is right, and that more disclosure could be needed. However, better reasoning demands broader questions. Perhaps one might ask: “Should we reduce the burden on public companies so that growing companies are more willing to register with the SEC?” Both questions (i.e., whether we should have more regulation or less) are worth asking. Ideally, all of the SEC Commissioners would raise and address both types of questions. Certainly, Commissioner Stein should consider why, for the past eight years, issuers have trended toward being willing to forego the benefits of the public markets in order to avoid the costs.

Sargen on China – U.S. Tensions…Diminish for Now


  • Notwithstanding adverse political news at home, the Trump rally has continued amid favorable economic news and investor optimism about pending corporate and personal income tax cuts.  Diminished tensions between the Trump Administration and China have also lessened the risk of a trade war.
  • The key event was President Trump’s reaffirmation of the “One China” policy to President Xi in a telephone exchange earlier this month.  At the same time, Defense Secretary Mattis talked about the need for a diplomatic rather than military solution to the dispute in the South China Sea, which the Foreign Ministry in China welcomed.
  • With Steve Mnuchin assuming the helm as Treasury Secretary, market participants are awaiting the stance the Treasury will take on whether to declare China a “currency manipulator.”  Press reports suggest the Trump Administration may change tactics, so that China is not singled out.
  • The bottom line: The risk of an escalation in tensions between the U.S. and China has lessened, and it appears moderates in the Trump Administration are calling the shots.   Nonetheless, circumstances could change if the dispute in the South China Sea heats up or if China’s trade surplus with the U.S. were to increase.

President Trump Moderates His Stance on China

At a time when the Trump Administration has been engulfed with a series of adverse political developments, market participants appear oblivious to them, and the so-called Trump rally lives on.  The principal reasons are that news on the economic front has been favorable, consumer and business confidence readings remain high, and investors are focused on the prospect for significant cuts in both corporate and personal tax rates.

In addition, a potential negative factor –namely, the prospect for a trade war between the U.S. and China – has also diminished recently.  The key development was a sudden reversal in President Trump’s stance toward China.  Throughout the presidential campaign, Mr. Trump took a hard line on China, claiming that its trade policies were unfair, and on several occasions he called for imposing tariffs of 35% on Chinese imports into the U.S.  Immediately after assuming office, President Trump upped the ante by congratulating the leader of Taiwan and by indicating he was open to reviewing the One China policy that China’s leaders regard as non-negotiable.

During the past month, however, the Trump Administration has softened its stance considerably.  In a telephone conversation with China’s leader, Xi Jinping, the President retreated from his earlier statement, and he indicated the White House had agreed to honor the One China policy “at the request of President Xi.”

The timing of the call was significant, coming just before President Trump met with Japanese Prime Minister Shinzo Abe to discuss the commitment of the U.S. to East Asia. It also coincided with a trip to Japan and South Korea by Defense Secretary Mattis, during which he talked of the need for a diplomatic rather than military solution to the dispute over islands in the South China Sea. The Foreign Ministry in Beijing welcomed the remarks and the Chinese press called them a “mind-soothing pill” that “dispersed the clouds of war.”1

Looking behind the scenes, these developments suggest that moderates in the Administration such as Secretary of State Rex Tillerson, Defense Secretary James Mattis and National Economic Council Director Gary Cohn are calling shots on China policy for the time being.  This is reassuring to those who worried that Peter Navarro, Wilbur Ross, and Robert Lightziger, who have a more protectionist bent, could be in charge of trade policy.

Is China a Currency Manipulator?

With Steven Mnuchin now confirmed as Treasury Secretary, market participants will now be watching to see whether the Treasury declares China to be a “currency manipulator,” as Mr. Trump suggested during the presidential campaign.  Since 2015, the criteria that the Treasury has used for making such a designation has been three-fold: (i) the country has a large current account surplus, defined to be in excess of 3% of GDP; (ii) it has a large bilateral trade surplus with the U.S.; and (iii) it intervenes in the currency markets to weaken its currency versus the U.S. dollar.

Based on these criteria, China meets only one condition – namely, it has a large bilateral surplus with the U.S.  Its overall current account surplus, by comparison, has fallen steadily over the past decade, and is currently less than 3% of GDP.  And while the Chinese authorities intervene regularly in the foreign exchange markets, since 2014 they have been primarily sellers of U.S. dollars.  The reason: China has experienced massive capital flight that far exceeds its currency account surplus, and the authorities have been trying to limit the depreciation of the RMB versus the dollar.

Weighing these considerations, the Treasury in the past has refrained from declaring China to be a currency manipulator.  If it were to do so now, the rationale would be political rather than economic.  Even then, it is unlikely the Trump Administration would want to escalate the issue at this time when it already has moderated its stance.

A recent Wall Street Journal article (February 14, 2017) stated that the White House is exploring a new tactic to discourage China from undervaluing its currency.  Under the plan the Commerce Secretary would designate the practice of currency manipulation as an unfair subsidy, without singling out China, and U.S. companies could then bring complaints to the Commerce Department.  While this tactic is in keeping with the stance adopted by previous administrations, Chinese officials reportedly are bracing for an unprecedented number of trade disputes, and they are considering possible retaliatory actions.

Avoiding a Full Scale Trade War

Both the United States and China for the time being are seeking to avoid a full scale trade war that would produce a “lose-lose” situation.  Investors, nonetheless, must consider the possibility of such an outcome in the future, especially if China’s bilateral trade surplus with the U.S. were to widen, while the RMB would weaken further against the dollar.

The latter outcome remains a distinct possibility for two reasons.  First, U.S. import demand is likely to surge if the U.S. economy continues to gain traction, and imports from China would in turn be boosted. Second, a stronger economy is likely to bring the Fed into play, and a widening in interest differentials between the U.S. and China would place added pressure on the RMB. In these circumstances, the Trump Administration could very well come down on the side of those who contend China is manipulating its currency, even if the Chinese authorities intervene to limit the depreciation of the RMB.

In these circumstances, markets are likely to focus on whether any sanctions imposed by the U.S. are targeted to specific items or are broadly based and severe. In the former case, markets would likely take the news in stride, as there are numerous instances in which the U.S. has imposed sanctions on select items.  However, if the Trump Administration were to up the ante by imposing broad-based sanctions – including high tariffs across a wide range of goods – markets would likely sell off, as investors would anticipate retaliation by the Chinese authorities and other countries that are affected.

Our assessment is the risk of a full scale trade war has lessened for the time being.  However, political developments such as a widening in the dispute over islands in the South China Sea or adverse developments in the U.S. could result in an escalation of trade tensions at some point.  In this respect, the risk of a trade war cannot be ruled out entirely.

1See Goldman Sachs report “Top of Mind,” February 6, 2007.

NY Financial Services Department Adopts Final Revisions to Cybersecurity Requirements

The New York Department of Financial Services (“DFS”) adopted final revisions to its new cybersecurity regulations, which apply to a wide range of insurance, banking and financial services companies (“Covered Entities”) under its supervision (see previous coverage of the proposed revisions). The regulations will take effect on March 1, 2017 and, starting in 2018, will require a Covered Entity to prepare and submit a Certification of Compliance annually by February 15 to the DFS concerning the firm’s cybersecurity compliance program.

Required elements of the program include (i) the means to prevent and detect cyber events, (ii) the development of a cybersecurity policy, (iii) the appointment of a “qualified” chief information security officer, (iv) testing programs, (v) audit trails and (vi) access controls.

New York Governor Andrew M. Cuomo praised the new regulations:

“These strong, first-in-the-nation protections will help ensure [the financial services] industry has the necessary safeguards in place in order to protect themselves and the New Yorkers they serve from the serious economic harm caused by these devastating cyber-crimes.”


Lofchie Comment: New York State has been very aggressive in regulating and sanctioning firms engaged in financial activities. In their original form, the rules proposed by New York State to regulate “money laundering” set impossible-to-meet compliance standards. (Ultimately, the rules adopted by New York State were less draconian than those that were proposed originally, but that is saying very little.) The adopted Cybersecurity regulations are open-ended, complex and burdensome and will result in creating many new ways for the government to collect fines when something goes wrong. The fact that New York State rushed to declare itself “first in the nation” to adopt such a detailed set of rules suggests that its local government is too eager to place onerous requirements on the financial sector and, as a consequence, expand opportunities to collect fines.

That said, firms must abide by the new compliance obligations and do their best not to give New York State an opportunity to collect.

CFTC Commissioner Bowen Describes “Four Disruptive Elements” Driving Regulatory Activity

CFTC Commissioner Sharon Y. Bowen identified “four disruptive elements” that are “substantially responsible” for recent regulatory activity: technology, demographics, economics and institutions. In a speech at Northwestern University as part of the 2017 Brodsky Family Northwestern JD-MBA Lecture Series, Commissioner Bowen described these “disruptive elements.”

  • Institutions. Commissioner Bowen contended that the United States is experiencing a “crisis in our institutions, and that is a crisis for our markets, for our government, and for our society.” In order to “increase trust in institutions,” Commissioner Bowen stated, the CFTC must be “willing to be more aggressive in enforcing our rules fairly, including being willing to take individuals and institutions to court rather than just settle with them.” She asserted that the CFTC should fulfill the Dodd Frank Act requirement to “promulgate a regulation to improve governance” and “rebuild faith in institutions.”
  • Economics. Commissioner Bowen urged market regulators to be more aware of “how the overall economy is functioning and what effect market regulations are having on the economy.” She highlighted position limits rulemaking by the CFTC as an example of “democratizing . . . markets and making them more accessible and fair to consumers and investors.”
  • Technology. Commissioner Bowen identified technology and cybersecurity issues as key marketplace disruptors. She expressed optimism that the CFTC will complete its work on Regulation Automated Trading, and noted that the CFTC adopted enhanced cybersecurity safeguard requirements. She urged regulators to be “mindful of the human dimension of these changes and watch for ways to encourage technology while also supporting the people displaced by it.”
  • Demographics. Commissioner Bowen called on regulators to respond to demographic considerations and encourage companies, nonprofits and the government to increase diversity.

Lofchie Comment: Here are four other factors that greatly affect the financial industry in general, and CFTC-regulated entities in particular: (i) the costs of regulation, (ii) the pace of regulatory change, (iii) declines in liquidity and cross-border markets caused by regulation, and (iv) uncertainty about the imminence and outcome of regulatory enforcement actions based on ambiguous trading requirements. Those might not be the most impactful factors, but they certainly are worth Commissioner Bowen’s consideration.

Commissioner Bowen should consider why the number of registered futures commission merchants has dropped so precipitously in the last few years. It isn’t because of demographics or a loss of trust; it’s because firms can’t operate profitably. (Seee.g.this information from the CFTC. Note that the data is from year-end 2014 and the decline has since continued.) In the absence of any meaningful evidence that more expensive regulatory requirements are necessary, the notion that imposing more of them (e.g., more rules on position limits) in order to help sustain futures seems ill considered. Commissioner Bowen should acknowledge the problem that futures commission merchants have become too big to fail because all but a few have shut down. In that regard, it seems ironic that the story of Commissioner Bowen’s call for more regulation appears on the same day as a story about a major firm dropping out of the clearing business.

Click here to read other news stories regarding Commissioner Bowen.

CFTC Commissioner Bowen Contends That “Transitions Present Opportunities”

In a speech titled “Transitions Present Opportunities,” CFTC Commissioner Sharon Y. Bowen outlined her views on Regulation Automated Trading (“AT”), cybersecurity, position limits and diversity.

Appearing before the Commodity Markets Council “Global State of the Industry” Meeting, Commissioner Bowen addressed:

  • Regulation AT. Commissioner Bowen stated that the supplemental proposal was revised to establish that firms using Direct Electronic Access to connect to commodities markets will not be required to register automatically, subject to certain conditions and that the second major revision of the supplemental proposal “would require that all electronic trading, algorithmic as well as non-algorithmic, . . . have two separate layers of pre-trade risk controls on it.”
  • Cybersecurity. Commissioner Bowen asserted that recent CFTC rulemakings are a “great first step” because they establish a comprehensive testing regime, require heightened risk management measures, focus on governance and are based on “well-regarded, accepted best practices for cybersecurity.”
  • Position Limits. Commissioner Bowen stated that “having position limits is essential,” and urged industry groups to help regulators “make one last push to get rules finalized that will help prevent the negative impacts of excessive speculation while allowing commercial end users to manage their risks.”
  • Diversity. Commissioner Bowen urged companies to “get buy-in from all relevant stakeholders for the diversity initiative and foster an environment that lends itself to inclusion.”


Lofchie Comment: One benefit of transitions is that they allow us to let go of the past. A preference for holding onto a failed theory is not unique to those in government. Indeed, one of the most famous works on the theory of knowledge and the course of scientific progress, Thomas Kuhn’s “The Structure of Scientific Revolution,” deals with precisely this issue (see Emory University Professor Frank Pajares’ Study Guide). If, after eight years of dedication to the proposition, proponents of position limits regulation could find no evidence that it served any purpose, then it is time to move on.

FINRA Prioritizes Compliance, Supervision and Risk Management in 2017

In a 2017 Regulatory and Examination Priorities Letter (“Priorities Letter”), FINRA identified compliance, supervision and risk management as primary areas for review.

FINRA stated that it will be focusing on the following issues, among others:

  • High-Risk and Recidivist Brokers. FINRA will enhance its approach to high-risk and recidivist brokers by reviewing firms’ (i) supervisory procedures for hiring or retaining statutorily disqualified and recidivist brokers, (ii) supervisory plans to prevent future misconduct, and (iii) branch office inspection programs and supervisory systems for branch and non-branch office locations.
  • Sales Practices. FINRA will evaluate firms’ (i) compliance and supervisory controls that are intended to protect senior investors, especially against microcap fraud schemes, (ii) reviews of product suitability and concentration in customer accounts, (iii) capacity to monitor the short-term trading of long-term products, (iv) procedures regarding registered and associated persons, and (v) compliance with social media supervisory and record-retention obligations.
  • Financial Risks. FINRA will examine firms’ (i) funding and liquidity plans, (ii) financial risk management practices, and (iii) implementation of the first phase of the new FINRA Rule 4210 margin requirements for covered agency transactions, which became effective on December 15, 2016.
  • Operational Risks. FINRA will assess firms’ (i) cybersecurity programs, (ii) internal supervisory controls testing, (iii) controls and supervision intended to protect customers’ assets, (iv) compliance with SEC Regulation SHO, (v) anti-money laundering programs, and (vi) application of exemptions and exclusions to municipal advisor registration requirements.
  • Market Integrity. FINRA will (i) monitor firms’ compliance with amended Order Audit Trail System rules, (ii) expand surveillance for cross-product manipulation to include trading in exchange-traded products, and (iii) supplement firms’ supervisory systems and procedures with “Cross-Market Equity Supervision Report Cards.” In addition, FINRA will (i) expand its Audit Trail Reporting Early Remediation Initiative to include Regulation NMS trade-throughs and locked and crossed markets, (ii) review firms’ compliance with Tick Size Pilot data collection obligations, and (iii) ensure that firms improve their Market Access Rule compliance by incorporating recommended best practices. FINRA also intends to review alternative trading systems’ customer disclosures and develop a pilot trading examination program in order to help “determine the value of conducting targeted examinations of some smaller firms that have historically not been subject to trading examinations due to their relatively low trading volume.” Lastly, FINRA will continue to expand its “fixed income surveillance program to include additional manipulation-based surveillance patterns, such as wash sales and interpositioning.”

Lofchie Comment: The new Priorities Letter offers a lot to talk about, since FINRA has managed to cover virtually every aspect of a firm’s business. It is incumbent on each firm to go through the letter carefully and scrutinize every relevant priority. The following areas might be of particular interest: (i) custody, (ii) seniors, (iii) improving the automation of “suitability” reviews (e.g., the ability to search for concentrated positions, or positions with excessive turnover), and (iv) cybersecurity training. Anti-money laundering enforcement actions have proved to be a treasure trove for financial regulators, so firms should continue to devote their attention to this area. Liquidity seems to be the odd item on FINRA’s list, since there are no real rules governing it, but rulemaking advances in that area should be expected in the near future, so regulators will be exploring ways to refine their understanding of best practices.

CFTC Chair Timothy Massad Resigns

CFTC Chair Timothy G. Massad tendered his resignation to President Obama. He will leave the CFTC on January 20, 2017. In a statement, which was accompanied by a 16-page summary of the CFTC’s accomplishments during his two-and-a-half-year tenure, Chair Massad asserted that the Commission had realized his agenda:

“I came to the CFTC with a number of priorities, and I am proud we have made significant progress in every area.”

Chair Massad highlighted accomplishments during his tenure. The CFTC:

  • ensured that “commercial businesses [could] continue using the derivatives markets efficiently and effectively to hedge routine commercial risk and engage in price discovery”;
  • “worked to ensure clearinghouses are stronger and more resilient through enhanced risk surveillance, new supervisory stress testing, and the development and completion of recovery and wind down plans and rules”;
  • “largely finished implementing the regulatory framework for swaps”;
  • “improved international coordination”;
  • “engaged in robust enforcement efforts”; and
  • took action to “address the new challenges and opportunities in the derivatives markets, particularly cyber threats, clearinghouse resilience, and the increased use of automated trading.”

Chair Massad emphasized that he “worked to make sure the rules focus on where the greatest risk exists, in transactions between large financial institutions,” and to ensure they were “largely harmonized with other domestic and international requirements.” He also noted that the clearinghouses are “stronger and more resilient,” through enhanced risk surveillance, new supervisory stress testing, and the development and completion of recovery wind down plans and rules.