Bondi on 10 Points for SEC Reform

The new leadership of the Securities and Exchange Commission (“SEC”) should seize the opportunity to review and improve the agency’s enforcement program.

CFS senior fellow Bradley J. Bondi offers a ten-point blueprint for the program.  Brad’s recommended measures would allocate resources more efficiently, strike a better balance between regulation and enforcement, and promote a closer adherence to the SEC’s mission.

The full report is available at

As always, CFS welcomes opinion.

Senator Warren Asks Bank CEOs to Publicly Take Positions on CFPB Arbitration Rule

Senator Elizabeth Warren (D-MA) sent letters to the CEOs of 16 major financial institutions asking for information related to the Consumer Financial Protection Bureau (“CFPB”) arbitration rule.

Both House and Senate Republicans have recently introduced resolutions to block the rule using the Congressional Review Act, and the House resolution was approved on July 25, 2017. In light of this effort, Senator Warren requested that the CEOs of the 16 banks publicly express whether they support or oppose the rule. Senator Warren pointed to the lobbying groups that represent these banks and questioned why the financial institutions themselves would not take a position publicly:

“These organizations represent your bank and your industry, but you – and other CEOs of large banks – have remained silent on the rule. If your lobbyists are taking such strong positions against the rule, is there a reason both you and your bank have been unwilling to take a public position?”

While asking the banks to take a public position, Senator Warren also maintained that the information would be used in order to contribute to a better understanding of potential effects that may come from a reversal of the rule:

“This rushed process leaves little time for public hearings and other traditional congressional fact-gathering. I am seeking this information so that the public, my colleagues, and I can better analyze the impact of reversing this CFPB rule.”

In addition to requesting information regarding the banks’ positions on the rule, Senator Warren solicited data on outcomes of customer arbitration cases against the banks. She also requested that the banks provide copies of internal or public documents that demonstrate the impact of the rule on customers or company profits, and asked that each of the banks respond to her letter by September 1, 2017.

Lofchie Comment: There is little mystery as to why banks might choose to “remain silent” at this stage. They do not want to subject themselves to overtly political attacks, or be used in an obvious political stunt by Senator Warren. Senator Warren’s requests for a mountain of information from these banks suggest that the information gathered to date by the CFPB is lacking and that the resolutions under the Congressional Review Act are warranted. The fact that the Senator feels it necessary to ask these questions, rather than being able to argue from evidence already gathered by the CFPB, seems like an admission that the rulemaking was insufficiently considered.

SEC Issues Report on Access to Capital and Market Liquidity

The SEC Division of Economic and Risk Analysis (“DERA”) issued a report on how Dodd-Frank and other financial regulations have impacted (i) access to capital and (ii) market liquidity.

The report contains analyses of recent academic work, as well as original DERA analyses of regulatory filings. The report is divided into two major parts: “Access to Capital – Primary Issuance” and “Market Liquidity.” Highlights of the DERA report include the following:

Access to Capital – Primary Issuance

  • Primary market security issuance has not decreased since the implementation of Dodd-Frank regulations.
  • Capital from initial public offerings has “ebb[ed] and flow[ed] over time,” and the post-crisis downturn is “broadly consistent with historical patterns of IPO waves.”
  • The introduction of the JOBS Act brought an increase in small-company IPOs, and “IPOs by [emerging growth companies] may be becoming the prevailing form of issuance in some sectors.”
  • Regulation A amendments, including an increase in the amount of capital allowed to be raised, resulted in an increase in Regulation A offerings.
  • JOBS Act crowdfunding provisions have allowed some firms to use crowdfunding to raise pre-revenue funds.
  • The private issuance of debt and equity increased significantly between 2012 and 2016, and amounts raised through exempt offerings were much higher than those raised through registered securities.

Market Liquidity

  • There is no evidence that the Volcker Rule has resulted in decreased liquidity, particularly with regard to U.S. Treasury Market liquidity.
  • Trading activity in the corporate bond trading markets has tended either to increase or to remain static.
  • The number of dealers participating in corporate bond markets has remained similar to pre-crisis numbers.
  • Dealers have reduced capital commitments, which is in line with regulatory changes, such as the Volcker Rule, that “potentially reduc[e] the liquidity position in corporate bonds.”
  • For small trades, transaction costs generally have decreased; DERA suggested that this might be due in part to the emergence of alternate trading systems as platforms for trading corporate bonds.
  • For certain larger or longer maturity corporate bonds, transaction costs have increased since post-crisis regulatory changes.

DERA noted that it is difficult to quantify the effects of particular regulatory reforms, and that a variety of factors may contribute to market conditions.

Lofchie Comment: The conclusion reached by the Division of Economic and Risk Analysis – that there is no clear link between the Volcker Rule and decreased liquidity – contrasts sharply with the recent U.S. Treasury Report, which concluded that the rule’s “implementation has hindered marketmaking functions necessary to ensure a healthy level of market liquidity.” Similarly, a September 2016 study by FRB staff found that the Volcker Rule has had a “deleterious effect” on corporate bond liquidity. According to that study, dealers that are subject to Volcker requirements become less likely to provide liquidity during times of market stress.

Notably, DERA found that intraday capital commitments by dealers have declined by 68%. It is difficult to understand how a reduction in dealer inventory of this scale has no effect on liquidity. If that is really the case, then DERA should do more to identify the countervailing reasons that would explain the constancy of liquidity.

House Republican Staff Say CFPB Director Cordray Could Be in Contempt of Congress

Republican staff of the U.S. House of Representatives Committee on Financial Services (the “Committee”) released a report that lays out a case for instituting contempt of Congress proceedings against Consumer Financial Protection Bureau (“CFPB”) Director Richard Cordray.

In the staff report, the Republicans accuse Mr. Cordray of failing to comply with the Committee’s oversight of the CFPB, particularly regarding the recently adopted CFPB arbitration rule that concerns pre-dispute arbitration agreements. According to the report, Mr. Cordray refused consistently to comply with requests for records and documents related to the rule. In response, the Committee issued a congressional subpoena in order to compel the CFPB to produce the relevant records. The staff alleged that Mr. Cordray was legally obligated to address the congressional subpoena but failed to respond adequately. As a result, the Republicans accused Mr. Cordray of defaulting on the subpoena and asserted there is ample basis to proceed against Mr. Cordray for contempt of Congress.

Lofchie Comment: Agree or disagree with the policies of Mr. Cordray, it is just impossible to figure out how the CFPB fits within the structure of the government as established by the U.S. Constitution. The government has three branches: the Legislative (Article 1), the Executive (Article 2) and the Judicial (Article 3). Where does the CFPB fit into that structure? It seems troubling that the CFPB is not responsible to any of the branches. That is not a good way to run a railroad or a government.

OCIE Cybersecurity Report Shows “Overall Improvement”

The SEC Office of Compliance Inspections and Examinations (“OCIE”) examined 75 broker-dealers, investment advisers and investment companies as part of its Cybersecurity 2 Initiative to assess industry practices concerning cybersecurity preparedness. OCIE National Examination Program staff reported an overall improvement in awareness of cyber-related risks and the implementation of certain cybersecurity practices since the OCIE’s Cybersecurity 1 Initiative.

According to the OCIE Risk Alert, the Cybersecurity 2 Initiative examinations focused on written policies and procedures, and included more testing of controls. Specifically, it addressed:

  1. governance and risk assessment;
  2. access rights and controls;
  3. data loss prevention;
  4. vendor management;
  5. training; and
  6. incident response.

Notably, the OCIE found that all broker-dealers, all funds, and nearly all advisers examined in the Cybersecurity 2 Initiative maintained written cybersecurity policies and procedures around the protection of customer/shareholder records. These findings contrasted with those of the Cybersecurity 1 examinations. The OCIE also found firms that were not “adhering to or enforcing” policies and procedures, and firms where guidance for employees was too general. The OCIE report included recommendations for improving controls in their respective cyber programs.

In a related white paper on cyber risk, the Bank for International Settlements Financial Stability Institute evaluated the regulatory and supervisory initiatives in a number of leading jurisdictions, including Hong Kong SAR, Singapore, the United Kingdom and the United States. The report reviewed supervisory approaches to assessing the cyber-risk vulnerability and resilience of banks. The paper also identified a trend toward “threat-informed” testing frameworks, which use threat intelligence to design simulated cyber attacks when testing the cybersecurity of an entity.

Federal Register: OCC Requests Comments on Volcker Reforms

The Office of the Comptroller of the Currency (“OCC”) requested public comment on the Volcker Rule. The request was published in the Federal Register and comments are due by September 21, 2017.

As reported previously, the OCC identified four areas of the rule for consideration: (1) the scope of the entities to which the final rule applies, (2) the proprietary trading restrictions, (3) the covered fund restrictions, and (4) the compliance program and metrics reporting requirements.

The OCC requested public input in order to improve and inform proposed changes that could be made to the rule (without requiring revisions to the underlying statute). The OCC also asked for comments on how regulators could implement the existing rule more effectively.

Senate Democrats Outline “Prerequisites” for Bipartisan Tax Reform

In a letter addressed to President Donald Trump, Senate Majority Leader Mitch McConnell (R-KY) and Senate Finance Committee Chair Orrin Hatch (R-UT), 45 Senate Democrats (collectively, the “Democrats”) expressed a willingness to work with Republicans on “bipartisan tax reform.”

The Democrats asserted three “prerequisites” for a successful bipartisan tax reform plan. First, a reform plan “should not increase the tax burden on the middle class,” and should not be advantageous for the wealthiest subset of Americans. The Democrats observed that wealthy Americans continue to enjoy “outsized benefits from recent economic gains” even though wages for working-class individuals have not increased. The Democrats vowed they would not back a tax reform plan that “includes tax cuts for the top one percent.”

Second, any tax reform legislation must “go through regular order rather than reconciliation.” The Democrats criticized the potential effects of fast-tracking legislation through reconciliation:

“Using a fast-track process like reconciliation would undoubtedly result in outsized political influence on the process and significantly hinder lawmakers’ ability to close loopholes and end special interest favoritism that plagues our current tax system. As such, reconciliation is just a tool to jam through partisan short-term tax cuts that would result in economic uncertainty and instability and significantly increase our budget deficit.”

Third, reform legislation should not include deficit-financed tax cuts. The Democrats stated that they would not support deficit-financed tax cuts that could jeopardize the continuation of “critical programs,” including Medicare, Medicaid and Social Security.

MSRB Cautions Issuers against Selecting Counsel for Underwriters

The MSRB advised municipal securities issuers against designating or influencing the selection of an underwriter’s counsel in the process of offering bonds.

In a Regulatory Notice (“notice”), the MSRB explained that conflicts of interest can arise from an issuer playing a role in the selection of an underwriter’s counsel. According to the MSRB, underwriters must maintain their independence in order to effectively perform due diligence responsibilities and make fair assessments. A key resource for an underwriter is the presence of an experienced, unbiased, expert counsel. The MSRB warned that “conflicted loyalties” could arise if an issuer-designated counsel is used, which could call into question the “integrity and thoroughness of the due diligence process as well as the quality of representation provided by such counsel.”

While the MSRB acknowledged that an issuer may want to ensure that a sufficiently qualified counsel is selected, the MSRB also noted the significance of protecting the integrity of the underwriting process. The MSRB advised that an underwriter is subjected to financial risk and legal liability by representing an issuer; as such, it is in the best interest of the underwriter to choose a suitable counsel.

The MSRB reiterated that issuers should “refrain from [involvement] in selection of counsel,” or limit involvement to “concerns regarding competency, conflicts of interest and the avoidance of excessive costs.”

Lofchie Comment: Without a means of enforcement, will this notice change conduct? Although the MSRB cautions underwriters that they may be at greater risk of missing required disclosure if they rely on an issuer-selected counsel, it is not clear that this risk is urgent enough to discourage the practice (if it were, the notice would likely not be necessary).

Republican Leaders Announce Priorities for Tax Reform

The White House released a joint statement (the “statement”) with congressional Republican leadership expressing a “shared vision” for comprehensive tax reform. The group of Republican leaders consisted of House Speaker Paul Ryan (R-WI), Senate Majority Leader Mitch McConnell (R-KY), Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn, Senate Finance Committee Chairman Orrin Hatch (R-UT), and House Ways and Means Committee Chairman Kevin Brady (R-TX).

The Republican leaders asserted a commitment to introduce a “simpler, fairer” tax system with lower rates for American families. As described, the shared framework would reduce taxes for “small businesses so that they can compete with larger ones” and “all [U.S.] businesses so they can compete with foreign ones.” The Republican leaders called for a permanent system allowing more capital expensing to facilitate economic growth. They also indicated the following priorities: (i) to create an environment where American companies are incentivized to keep jobs in America rather than outsource them overseas, (ii) to create a more “level playing field” between domestic and foreign companies,” and (iii) to protect the U.S. tax base.

The Republican leaders set aside the idea of adopting a border-adjustment tax (“BAT”).

“While we have debated the pro-growth benefits of border adjustability, we appreciate that there are many unknowns associated with it and have decided to set this policy aside in order to advance tax reform.”

The Republican leaders announced that they expect a tax reform plan to move through the Senate Finance Committee and House Ways and Means Committee by the fall of 2017.