SEC Rejects Another Nine Proposed Bitcoin ETFs

The SEC Division of Trading and Markets rejected applications for nine exchange-traded funds (“ETFs”) tied to bitcoin futures markets from three separate companies – ProShares, Direxion, and GraniteShares – on the grounds that they lacked adequate means of preventing “fraudulent and manipulative acts and practices.” In each case, the rejections were subsequently stayed pending review by the SEC Commissioners.

The SEC affirmed its position that bitcoin futures markets necessitate stringent market manipulation and fraud prevention procedures since they are reliant upon a single exchange to determine the value of the bitcoin ETF. According to the SEC, the companies stated in their applications that they would use the Chicago Board Options Exchange (“CBOE”) and Chicago Mercantile Exchange (“CME”) futures market to establish the value of their ETFs. However, the SEC determined that the CBOE and CME bitcoin futures markets are not “markets of significant size.” Furthermore, the SEC did not agree that the companies’ existing surveillance procedures and capacity to share surveillance information with U.S. futures exchanges were sufficient to prevent market manipulation and fraud.

Senator Warren Introduces Anti-Corruption Legislation

Senator Elizabeth A. Warren unveiled a wide-ranging bill that seeks to “eliminate the influence of money in our federal government.”

The Anti-Corruption and Public Integrity Act would, among other things:

  • ban “Members of Congress, cabinet secretaries, federal judges, and other senior government officials from owning and trading individual stocks”;
  • institute a lifetime ban on former Member of Congress, Presidents and agency heads from lobbying;
  • require conflicts of interest disclosures in rulemaking comments and studies;
  • prevent certain individuals from the private sector from taking certain government positions, including, in some cases, running for office;
  • livestream audio of federal appellate courts and promote diversity on the federal bench;
  • create a new, independent anti-corruption agency to enforce federal ethics laws; and
  • increase financial and tax information disclosures for elected officials and candidates for federal office.

Lofchie Comment: One effect of Senator Warren’s proposed prohibitions is that the government would be peopled by career government employees or academics. The unspoken theory behind this is that work for a private enterprise is corrupt, yet work for the government itself or in academics is not. This is a false premise. It is commonplace that those in government seek to use their power to bolster their ambitions of running for higher office. Their political or personal ambition does not disqualify them from office, nor should it disqualify them from having a voice. Likewise, those with experience working in private industry often have a good deal to contribute to the government, perhaps more in some cases than those who have worked only in government or academics.

Senator Warren’s bill would ban any individual who had worked for a company that had received any contract from a government agency for working for that agency for the next four years. She would also ban any senior officer of a company that has been the subject of any enforcement action (without regard to its severity) from serving in Congress (shouldn’t voters in each State get to decide whom they wish to elect?) or working in the Executive branch.

These and her other legislative proposals are, of course, political positioning ahead of a possible run for higher office. But they add to her record of discouraging the private sector from commenting on rules that concern them and discouraging those with industry experience from joining the government. See, e.g., Senator Warren Asks CFTC to Withdraw EEMAC Report on Position Limits; Senator Warren Questions ”Good Intentions” behind Study Challenging DOL’s Fiduciary Proposal; Senator Warren’s Study Finds “Dangerous Problem” with Non-Cash Compensations in Annuity Sales.

SEC Chair Reflects on Investor Comments regarding Proposed Standards of Conduct

SEC Chair Jay Clayton expressed support for several key concepts regarding the proposed standards of conduct for investment professionals. In a public statement, Mr. Clayton identified and expanded on points that “resonated” with him throughout the investor roundtable series on the proposed Standards of Conduct rules, particularly with regard to the relationship between broker-dealers and investment advisers and their retail customers. Thus far, the SEC has hosted six roundtable discussions.

Mr. Clayton asserted that:

  • the SEC should ensure that the core obligations of investment professions match investor expectations during the rulemaking process;
  • retail investors want to have the ability to select a brokerage account and/or an investment advisory relationship;
  • the proposed Standards of Conduct rules are intended to help retail investors distinguish between broker-dealers and investment advisers;
  • financial professionals should be able to provide clear answers for their clients regarding important investment considerations; and
  • sales practices in which an investment professional puts his or her interests before those of the customer should be eliminated.

The seventh roundtable discussion will take place in Baltimore, Maryland on September 20, 2018.

Lofchie Comment: The key question is as to bullet point 2: customers’ ability to select either a brokerage account or an advisory account. If the SEC determines to impose rules on brokerage accounts that make them inherently unprofitable for broker-dealers to offer, then investors will lose that choice. Making a product or service unprofitable to offer means that that market becomes unavailable, even if it remains legal.

CFS Monetary Measures for July 2018

Today we release CFS monetary and financial measures for July 2018. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.7% in July 2018 on a year-over-year basis versus 4.8% in June.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Jul18.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’

Federal Register: CFTC Proposes to Simplify Exemptive Process for Foreign Clearing Organizations

The CFTC proposed amendments to codify policies and procedures for a non-U.S. clearing organization to obtain an exemption from registration as a derivatives clearing organization (“DCO”). The amendments were published in the Federal Register. Comments must be received on or before October 12, 2018.

As previously covered, the proposal would amend CFTC Parts 39 and 140, which address procedures for registration as a DCO. The proposal would (i) establish a new rule, CFTC Rule 39.6, that would create a regulatory framework for exempting non-U.S. clearing organizations from DCO registration with the CFTC, (ii) mandate clearing organizations to “observe the principles for financial market infrastructures in all material respects and be in good regulatory standing in its home country” under proposed regulation 39.6(a)(1)(ii), and (iii) obligate that a memorandum of understanding satisfactory to the CFTC be in effect between the agency and the clearing organization’s home country regulator.

International Regulatory Groups Analyze “Interconnectedness” between CCPs and Clearing Members

In a new report on interconnectedness and systemic risk, IOSCO, the Financial Stability Board, the Committee on Payments and Market Infrastructures and the Basel Committee on Banking Supervision (collectively, “international standard-setting bodies”) mapped the network of relationships between central counterparties and their clearing members. This report is the second issued by the international standard-setting bodies on central clearing interdependencies. (The first is available here.)

The regulators found, among other things:

  • “prefunded financial resources are concentrated at a small number of CCPs” (e.g., the two largest cross-border central counterparties (“CCPs”) account for roughly 40% of total prefunded financial resources);
  • CCP exposure is concentrated, with the 11 largest clearing members connected to 16-25 CCPs;
  • the network of relationships between CCPs and other financial institutions is characterized “by a core of highly connected CCPs and entities and a periphery of less highly connected CCPs and entities”;
  • only a small number of entities control the provision of each of the critical services required by CCPs; and
  • clearing members and their affiliates are also providers of critical services required by CCPs, such as being custodians or liquidity providers, so that if a significant clearing member were to default, it is very possible that the same entity could also be a vital service provider to the CCP.

The regulators cautioned that they did not assess potential “feedback mechanisms” that could amplify any initial stress. Further, they noted, the study was not intended to address the risk of central clearing, but rather to evaluate levels of interconnectedness. The regulators noted that central clearing is “intended to reduce the risk of contagion in financial markets, but it does not eliminate it”.

Lofchie Comment: Has mandated central clearing exacerbated interconnected risk and too big to fail? If so, would further mandates make it worse? Are the results of mandated central clearing playing out the way in which the regulators expected, particularly in terms of the very great concentration of risk in a very small number of firms and the very small number of firms able to provide broad access to CCPs?

FinCEN Director Examines Virtual Currency Regulatory Obligations

Financial Crimes Enforcement Network (“FinCEN”) Director Kenneth A. Blanco outlined agency efforts to protect financial institutions from fraud relating to new uses of financial technology, and described “how FinCEN is approaching virtual currency.”

Mr. Blanco emphasized FinCEN’s jurisdiction over virtual currency stating: “individuals and entities engaged in the business of accepting and transmitting physical currency or convertible virtual currency from one person to another or to another location are money transmitters subject to the AML/CFT requirements of the BSA and its implementing regulations.”

In remarks delivered at the 2018 Chicago-Kent Block Tech Conference, Mr. Blanco argued that innovation in financial services is a double-edged sword: it provides customers with greater access to various services but it can create opportunities for criminals. Mr. Blanco declared that FinCEN is focused on (i) expanding its understanding in the rapidly developing technological landscape, (ii) identifying risks, (iii) closing gaps and (iv) fostering smart innovation. FinCEN is also working to establish information-sharing programs such as FinCEN Exchange, related cyber defense programs and increased suspicious activity reports (“SARs”) to help the financial services sector protect itself from threats.

Mr. Blanco recounted FinCEN’s efforts as to virtual currency and initial coin offerings, including a listing of each of the major FinCEN administrative rulings as to the treatment of such products. In particular, Mr. Blanco stated that FinCEN expects businesses involved in initial coin offerings to meet all of their obligations in regard to anti-money laundering (“AML”) and combating the financing of terrorism. Mr. Blanco noted that financial institutions have been more active in the past couple of years as demonstrated by the increase in filings of virtual currency SARs.

Lofchie Comment: Not that one more cautionary warning was needed, but here is another cautionary warning that all firms involved with virtual currency or initial coin offerings must be extremely diligent in their procedures as improper activities may result in violations of not only securities and commodities laws, but also in those regarding money laundering.

Attorneys General Urge SEC to Strengthen Proposed Regulation Best Interest

A coalition of 17 Attorneys General (“AGs”) urged the SEC to bolster the requirements set out in proposed Regulation Best Interest (the “Proposed Rule”).

In a comment letter to the SEC, the AGs criticized the Proposed Rule, asserting that it (i) sets out a weak “best interest” standard that falls short of a uniform fiduciary standard and fails to require broker-dealers to act as fiduciaries for their clients; (ii) fails to sufficiently resolve broker-dealer conflicts of interest by turning a blind eye to harmful practices and erroneously relying on the “good faith of broker-dealers to fashion effective policies”; (iii) relies too heavily on disclosures, which alone are not effectual in protecting investors; and (iv) is fraught with ambiguities, leaving key terms undefined and causing confusion for regulators and investors.

The AGs recommended the following:

  • the Proposed Rule should be altered to impose a uniform fiduciary standard on broker-dealers and investment advisers;
  • the SEC should enhance certain disclosure requirements;
  • protections against conflicts of interest should be adopted; and
  • the SEC should ensure that all key terms and provisions are clearly defined.

Lofchie Comment: It is a safe bet that any time a regulatory advocate describes its recommendations as being “common sense,” they are not. According to the state attorneys general, imposing additional burdens on broker-dealers can be done “without compromising investor access to financial professionals, the availability of diverse financial products, or choice in fee arrangements.” That seems a remarkable conclusion: how can it possibly be that one can impose material additional requirements as to the provision of a service, and yet there is no effect on the availability or cost of that service? If it is so obvious that this can be accomplished as to securities transactions, then surely the NYC subway service can be similarly enhanced without any increase in cost or other ill effect.

There are certainly arguments that can be made in favor of Regulation Best Interest. A reasonable starting point should be to ask whether the regulation is worth the increased costs and the diminished availability of certain services. This requires advocates of the proposed regulation to be at least willing to concede the existence of trade-offs, and (even better) to attempt to quantify them to the extent possible. If there are no trade-offs, and if everything is free, a subway train should have already arrived at the station.

International Regulators Launch “Global Financial Innovation Network”

Several international regulatory agencies collaborated in the creation of the “Global Financial Innovation Network” (“GFIN”). The new network will focus on regulatory issues related to emerging technologies. There are 11 regulatory agencies in the new network including the Consumer Financial Protection Bureau and the UK’s Financial Conduct Authority.

In a draft consultation document, the agencies explained three major functions of the initiative: (i) information- and knowledge-sharing among regulators, (ii) collaboration in exploring major policy questions and (iii) “cross-border trials” instituted to aid companies as they deal with multi-jurisdictional regulatory challenges. The network is intended to serve as a resource for FinTech companies navigating the complicated web of international regulation. The regulators anticipate that GFIN will increase the speed at which innovative products are able to reach international markets. They also argue that the GFIN will promote transparency and investor protection.

The GFIN proposed the following as its organizational mission statement:

“The GFIN is a collaborative policy and knowledge-sharing initiative aimed at advancing areas including financial integrity, consumer wellbeing and protection, financial inclusion, competition and financial stability through innovation in financial services, by sharing experiences, working jointly on emerging policy issues and facilitating responsible cross-border experimentation of new ideas.”

The GFIN is requesting feedback on its proposed objectives, functions and structure. Comments must be submitted by October 14, 2018.

President Trump Imposes Sanctions against Iran

The Trump administration issued a new Executive Order (the “New Iran E.O.”) imposing certain U.S. sanctions against Iran, effective August 7, 2018.

Consistent with President Trump’s May 8 announcement ending U.S. participation in the Joint Comprehensive Plan of Action (Iran nuclear deal), the New Iran E.O. restores sanctions related to, among other things: (i) the Iranian government’s purchase or acquisition of U.S. dollars; (ii) Iran’s trade in gold and precious metals; (iii) the sale, supply or transfer to or from Iran of graphite, raw or semi-finished metals, and software for integrating industrial processes; (iv) significant transactions related to Iran’s national currency, the rial, and the maintenance of significant funds or accounts outside the territory of Iran denominated in the Iranian rial; (v) the purchase, subscription to, or facilitation of the issuance of Iranian sovereign debt; and (vi) Iran’s automotive sector.

In addition, certain wind-down authorizations expired at 11:59 p.m., EDT, on August 6, 2018, namely, those related to (i) the importation into the United States of Iranian-origin carpets and foodstuffs; (ii) activities related to the export or reexport to Iran of commercial passenger aircraft and related parts and services; and (iii) activities undertaken pursuant to General License I that relating to contingent contracts for activities related to passenger aircraft-related licensing.

In connection with the above, the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”) issued FAQs regarding the New Iran E.O., and updated certain existing Iran sanctions-related FAQs.