DOL Debate on Fiduciary Rule Continues

Controversy over the decision by U.S. Labor Secretary Alexander Acosta to go live with the Fiduciary Rule continues.

The Labor Secretary was quoted as having given testimony to the effect that the process by which the rule was adopted was materially flawed and indicating that he intended to reconsider the rule, after it has gone into effect.

In a recent editorial published by The Hill, former SEC Commissioner Paul Atkins urged Secretary Acosta to again consider delaying implementation of the Fiduciary Rule, which is scheduled to become applicable on June 9, 2017. Secretary Acosta had announced on May 22, 2017 that the DOL would not delay the rule’s effective date any further. Mr. Atkins argued that in its current form, the rule threatens to result in meaningfully adverse economic consequences.

Mr. Atkins urged Secretary Acosta to delay the implementation date, cooperate with the SEC in developing fiduciary standards, and conduct a thorough study of the rule’s potential impact that would take more recent data into account. He suggested that the SEC’s June 1, 2017 request for comments on developing standards of conduct affords the DOL a channel through which to legally delay the effective date.

Mr. Atkins criticized the procedural history and development of the rule. He asserted that Secretary Acosta should pay particular attention to the DOL’s lack of cooperation with the SEC, and cited a 2016 U.S. Senate report that he believes indicates that appointees during the Obama administration “actively undermined SEC participation in the rule’s design.” Mr. Atkins also challenged the DOL’s claim that the rule will save investors $17 billion, and referred to an article in which former SEC economist Craig Lewis accused the DOL of “significantly overestimat[ing]” those potential savings.

Lofchie Comment: As Mr. Atkins points out, there are many good reasons for the DOL to delay the implementation of the fiduciary rule, including the current legal challenge before the U.S Court of Appeals for the Fifth Circuit, and the debatable assertion of “$17 billion” in savings made in a 2015 Council of Economic Advisers’ Report supporting the adoption of the rule. Further, the existence of two regulators, the DOL and the SEC, that each have independent suitability rules applicable to the same set of relationships and transactions, is simply bad government from a structural standpoint.

Given that, and given the criticism of the rule voiced by Secretary Acosta himself, it is somewhat unclear why the Secretary is not choosing to delay the Rule’s effective date.  The Secretary appears to be underestimating the disruption that may be caused by allowing a rule to go effective and then subsequently rescinding it or modifying it, as opposed to getting it right the first time.

Supreme Court Rules that SEC Disgorgement Claims Are Time-Limited

In Kokesh v. Securities and Exchange Commission (“Kokesh”), the Supreme Court held that a five-year statute of limitations applies to claims for the disgorgement of ill-gotten gains obtained through violations of federal securities laws. Kokesh follows the holding of Gabelli v. SEC in which the Supreme Court determined that the statute of limitations period applies when the SEC seeks monetary penalties.

In Kokesh, Justice Sonia Sotomayor (writing for a unanimous Supreme Court) held that disgorgement “bears all the hallmarks of a penalty” under 28 U.S.C. § 2462. The Court’s analysis was shaped by two guiding principles for determining whether sanctions represent penalties: (i) such penalties typically exist where the wrong that is to be redressed was committed against the public, and (ii) the purpose of a penalty is to deter similar conduct rather than to compensate a victim for loss. In Kokesh, the Supreme Court held that SEC disgorgement constitutes such a penalty.

Fiscal Times: The National Debt is a Bigger Problem Than You Think…

Today, The Fiscal Times published my opinion piece on U.S. Treasury debt.  Key ideas include:

– The debt situation is worse than commonly realized – when evaluated back to 1946.
– Fortunately, a few debt management policy tweaks can yield great benefit with limited costs.
– It’s our debt.  It’s our problem.  Let’s fix it.

To view the full article:

SEC Chair Asks for Input on IA and BD Conduct Standards

SEC Chair Jay Clayton solicited comments on “standards of conduct for investment advisers and broker-dealers.” Chair Clayton argued that the implementation of the Department of Labor (“DOL”) fiduciary rule (beginning on June 9, 2017) might have significant effects on SEC-regulated entities. In addition, he argued that financial sector developments over the past several years necessitate a new evaluation of conduct standards for advisers and broker-dealers:

“Given the significance of these issues — in particular, for retail investors looking to save for the things that matter most to them, including homeownership, education, and retirement — I look forward to robust, substantive input that will advance and inform the SEC’s assessment of possible future actions.”

The Chair solicited comments on:

  • possible changes to investment adviser and broker-dealer disclosure requirements;
  • how technological advances have impacted the manner in which investment advice is provided;
  • the impact of early Fiduciary Rule compliance efforts on market participants and investors;
  • standards for classifying a “retail investor”; and
  • different potential SEC approaches to developing conduct standards.

Comments can be submitted via email or webform.

Lofchie Comment: Whatever one thinks of the appropriate standards of conduct that should apply to broker-dealers and investment advisers doing business with retail investors, it is simply an absurd notion that the Department of Labor should set one standard for conduct as to certain assets and the SEC should simultaneously set general standards of conduct. Congress should direct that standard-setting as to retail securities transactions is within the exclusive purview of the SEC.

Economists Say Fed Report Shows Improved Bank Loan Portfolio Performance

In an article posted on the Liberty Street Economics blog of the Federal Reserve Bank of New York (“NY Fed”), authors James Vickery and April Meehl concluded that the latest NY Fed Report Quarterly Trends for Consolidated U.S. Banking Organizations demonstrates significant improvement in the performance of bank loan portfolios over the past few years.

Foreign Exchange Working Group Outlines Standards for Forex Market Participants

A group of central bank representatives and private sector market participants known as the Foreign Exchange Working Group (“FXWG”) released a new version of the “FX Global Code,” a set of conduct standards and principles for foreign exchange (“forex”) market participants. The FXWG was formulated in 2015 in order to “promote a robust, fair, liquid, open, and appropriately transparent market.”

The new version of the FX Global Code expands the topics covered by Phase One of the Code (ethics, information sharing, certain aspects of trade execution, and trade confirmation and settlement) published on May 26, 2016 (see Cadwalader Clients & Friends Memorandum, June 1, 2016). The new version includes: aspects of execution on e-trading and platforms, prime brokerage, governance, and risk management and compliance. Other important topics covered in the new version of the FX Global Code include “pre-hedging” and last-look practices.

As a whole, the FX Global Code covers six broad areas:

  • ethics;
  • governance;
  • execution;
  • information sharing and confidentiality;
  • risk management and compliance; and
  • transaction confirmation and settlement.

Lofchie Comment: The appropriate standards of conduct in the forex market have long been ambiguous, given (1) the absence (until Dodd-Frank) of much of a statutory/regulatory framework, (2) the fact that it is largely a principal market, (3) the limited involvement of lawyers and compliance personnel who might have served as “gatekeepers,” and (4) limited trade reporting information that might have served as a check on misconduct. That period of ambiguity is ending. While the FX Global Code may not have the force of law, regulators and private litigants are likely to point to it as establishing the required standard of conduct.

Many of the principles established in the FX Global Code are basic; e.g., one should strive to do the right thing, firms should manage risk appropriately, and trade disputes should be promptly resolved. Other standards, particularly those related to executing and information walls, will need to be carefully considered as to how they are implemented. Firms should review (or establish) compliance procedures for their FX desks and should compare those procedures to those governing other similar but perhaps more regulated markets.

New Study Shows Post-Crisis Regulations Hurt Bond Liquidity

In an article posted on the Liberty Street Economics blog of the Federal Reserve Bank of New York, authors Tobias Adrian, Nina Boyarchenko and Or Shachar (collectively, the “authors”) explained the results of a recent study, which indicated that corporate bond liquidity has been adversely affected by post-crisis regulation.

The authors analyzed FINRA Trade Reporting and Compliance (“TRACE”) data in order to evaluate trade activity and measure corporate bond market liquidity. By utilizing the information provided by TRACE reports, the authors were able to determine which parent bank holding company (“BHC”) corresponded to a dealer in a particular trade. The authors then calculated bond liquidity by using common corporate bond liquidity metrics and incorporating constraints based on the balance sheet of the relevant BHC.

The economists stated that the results demonstrate the negative impact on bond liquidity of post-crisis regulation. Further, the authors argue that actual trading behavior data supports this conclusion.

Lofchie Comment: The results of this study are welcome and expected. For quite some time, the regulators seemed to deny there was any proof that the Dodd-Frank regulations damaged liquidity, notwithstanding both evidence to the contrary and common sense (how could regulations that heavily burden trading not impact liquidity?). That said, the fact that the regulations impair liquidity does not mean that the regulations are bad. All it means is that the regulations create trade-offs; one can reasonably argue that the diminished liquidity is worthwhile. It is important, however, that the regulators admit that the trade-offs exist (“it’s all good” is not the way the world works: regulations have both costs and benefits).

CFTC “Modernizes” Recordkeeping Requirements

The CFTC amended its rules to modify the methods by which records must be kept. Under Rule 1.31, firms will no longer be required to (i) retain electronic records in their original format, (ii) keep records in a “non-rewritable, non-erasable format,” or (iii) employ a third-party technical consultant for certain filing requirements. The adopted amendments, including corresponding technical changes regarding recordkeeping, will become effective 90 days after publication in the Federal Register (see also, previous coverage).

Lofchie Comment: Will the CFTC rule changes cause the SEC to revisit its own rules? It would seem to be the right thing to do.

Sargen: Time to Consider Europe


  • Emmanuel Macron’s election as President of France has buoyed European markets, as it is the third election this year in which populist candidates have been defeated.  Moreover, with Angela Merkel’s party scoring key wins in regional elections, her chances of being re-elected in the fall are high.
  • In addition to lessened political risks, investors have been attracted by better-than-expected economic performance in the European Union (EU) this year.  Germany’s economy has been the locomotive, and Macron’s election has raised hopes that France will finally embark on much-needed structural reforms and that a renewed Franco-German partnership will revive the EU, as well.
  • Weighing these considerations, this may be a good time to add exposure to European equity markets: Profit growth has surged recently and political risk has lessened, while the discount on European stocks relative to the U.S. is in line with long-term norms.  The main risks are that Macron may not be able to deliver reforms and a populist leader could become Italy’s next President.

Background: EU Political Risks Lessen, while European Economies Improve

At the start of this year, a key issue relating to Europe was the prospect that elections in several countries – notably, Austria, Holland, France, Germany and Italy – could result in populist victories that would threaten the EU’s viability in the wake of last year’s vote in the UK in favor of Brexit.  France’s election was perceived to be the most important, because Marine Le Pen, the far right candidate, advocated that France should leave the EU and the euro.  While the odds of this happening were low, investor concerns heightened leading up to the first round elections, when there was a possibility Le Pen and far-left candidate, Jean-Luc Mélenchon, could be the two finalists.  In the event, Emmanuel Macron, a centrist politician who campaigned as a reformer, emerged as the front runner and went on to defeat Le Pen handily in the run-off.

In the wake of these developments, European equity markets rallied at one point by 5%, led by an 8% advance for the CAC.  The rally not only reflects investor relief that France will remain a core member of the EU, but also that the tide of populism on the continent has been contained:  The French election is the third in a row in which populist candidates were defeated, and recent state elections in Germany indicate that Angela Merkel’s prospects for being re-elected Chancellor appear very good.

At the same time, the EU has experienced better-than-expected economic performance, led by Germany: The 2.5% annualized rise in German GDP in the first quarter was the biggest in four quarters, and was well above potential (1.8% according to European Commission estimates.)  Investment in machinery and equipment also picked up in the quarter, suggesting a broadening of the expansion, which had been led by personal consumption.  German GDP in real terms is now 8.5% above its pre-crisis peak in 1Q 2008, well above other EU members.  Meanwhile, unemployment in Germany has fallen below 4% from a peak of more than 10% during the crisis.

For the EU as a whole, real GDP growth was 2% annualized, the best showing in the past two years. The improvement in growth is linked to the European Central Bank’s policies to keep interest rates near zero while expanding its balance sheet via asset purchases.  In addition, the 10% depreciation of the euro against the dollar in the past three years helped boost exports.

As in the United States, so-called “soft data” such as purchasing managers’ indexes and sentiment readings show a marked pick-up since the latter part of 2016.  Indeed, according to Credit Suisse, the latest PMI readings are consistent with EU growth accelerating to 3% (see Figure 1).  We would note, however, that hard economic data does not yet indicate the improvement in business sentiment.  Nonetheless, the latest EC forecast calls for the EU to grow by 1.7% this year, which is a considerable improvement from the past few years.

Figure 1:  European PMI Surveys Point to Stronger Growth 

Source: Thomson Reuters, Markit, Credit Suisse.

Another positive development is headline CPI has accelerated this year and is approaching the ECB’s 2% target, after running close to zero in 2015-2016.  This suggests the threat of deflation is waning, and the ECB can consider normalizing interest rates if this pattern continues.  That said, we believe the ECB will be very cautious about tightening monetary policy.

Will Macron Transform France and the EU?

To some extent, the boost in European equities since the first round of the French elections can be attributed to a relief rally that Marine Le Pen was not elected.  Beyond this, in the wake of Macron’s very decisive victory, some observers have asked whether the election could represent a turning point for France and the EU: Macron is a reformer who also seeks closer ties between France and Germany, which constitute the core of the euro-zone.

Soon after his election, Macron visited German Chancellor Angela Merkel, and both pledged to work closely to draw up a “road map” of reforms for the EU, including the possibility of implementing treaty changes, if necessary.  Merkel noted that work first needed to be conducted on reforms that are needed before changes in the EU treaty would be implemented.  One of the most important is the need for greater fiscal sharing if the EU is to evolve from a monetary union to a fiscal union. To go down that route, however, Germany wants to be confident France is committed to structural reforms that will make its economy more dynamic.  The reason: Germany undertook a comprehensive set of labor market reforms in the previous decade that are credited for reviving its economy.

For his part, Macron has called for a “revolution” to simplify France’s Labor Code, which is a 3,600 page document that regulates nearly every aspect of employer-employee relations.  This will not be easy to pull off, however, as he will encounter strikers and protesters, as previous French Presidents have.  For example, Francois Hollande, Macron’s processor, backed away from embarking on labor reforms in the face of stiff opposition.  Other reforms being considered include cutting the corporate tax rate from 33% to 25%, and reducing the size of France’s bloated government.  The latter goal, however, is modest, as Macron seeks to slow the expansion of government rather than to reduce its size, which is the largest among the leading industrial countries.

Having formed a new political party, Macron must first build a coalition with existing parties, so that he can gain a legislative majority in the parliamentary elections in June.  Those he has recruited so far lean strongly to the left, with many coming from the reform faction of the Socialist Party.  To appeal to the right, Macron is credited with making a wise choice of Édouard Philippe as Prime Minister.  Still, it appears unlikely Macron will win an outright majority, and he therefore may have to rule with a coalition.  Consequently, it remains unclear how successful he will be in achieving reforms that France desperately needs.

The Case for European Equities

The principal reasons for considering European equities are that (i) earnings prospects have improved with the economic upturn, while (ii) Macron’s election and the rejection of populism in several key European countries have lessened political risk.

The improvement in European corporate profits is shown in Figure 2.  It illustrates how far they lagged the U.S. market when economic growth trailed that in the U.S., and how they have improved recently.  Among developed countries, European stock markets traditionally have been the most levered to economic performance, and this continues to be the case, as earnings growth in Europe has exceeded that in the U.S. recently.  Moreover, the percentage of European companies beating expectations is the highest in a decade.  An additional factor supporting corporate profitability has been the weak euro.  Although it has firmed against the dollar recently, it is still relatively cheap on a purchasing-power basis.

Figure 2:  European Corporate Profits Lag the U.S. Until Recently
12-month trailing EPS, Index, Jan 2006 = 100

Source: Datastream, JPMAM. April 28, 2017.

On the surface, it appears European equities may offer good relative value, as the discount of European multiples to the U.S. is about 15%.  The latter, however, is close to the average of the past decade or so, when one takes into account differences in the sector compositions.  Therefore, we consider European equities to be reasonably valued relative to the U.S.

The other major consideration is that political risk in Europe has diminished considerably with Macron’s election and the likelihood that Angela Merkel will be re-elected Chancellor of Germany.  This has contributed to inflows of funds into European markets recently.  The principal risk for investors is disappointment that Macron may not be able to deliver on his reform agenda.  Another risk is that populism could resurface in the Italian presidential elections that must be held no later than a year from now.

Weighing these considerations, I believe now may be a good time to add to European equities, after years of being cautious about European markets.

CFTC Amends Rules to Protect Whistleblowers

The CFTC adopted several rule amendments in order to better protect whistleblowers from retaliation or intimidation by their employers and to establish a new review process for whistleblower claims. The amendments are based on a reinterpretation of the CFTC’s anti-retaliation authority under the Commodity Exchange Act (“CEA”).

The amendments create a new rule – Rule 165.20 – that (i) prohibits retaliation against a whistleblower or anyone else assisting in an investigation, (ii) authorizes the CFTC to bring civil enforcement actions against employers who retaliate against whistleblowers, and (iii) makes explicit that the anti-retaliation protections apply whether or not an award is made. One effect of the amendments will be to allow both the CFTC and a whistleblower to bring legal actions against employers for retaliation.

The newly adopted amendments make the following changes:

  • Rule 165.19 prohibits employers from taking action to prevent potential whistleblowers from communicating directly with the CFTC;
  • Rule 165.5(b) rescinds the requirement that, in order for a whistleblower to receive an award, they must be the original source of the information provided;
  • Rules 165.2(i)(2) and 165.2(l)(2) expand the list of entities to which a whistleblower can report misconduct before reporting to the CFTC and still maintain award eligibility;
  • Rules 165.2(i)(3) and 165.2(l)(2) expand the timeframe in which a whistleblower must file a Form TCR (i.e., a Tip, Complaint or Referral Form) from 120 to 180 days;
  • Rules 165.5(a)(3) and 165.11(a) allow a whistleblower to receive an award in both a Related Action and a covered judicial or administrative action;
  • Rule 165.11(b) prevents a whistleblower from receiving an award for a Related Action if they have received an SEC award for the same action;
  • Rules 165.15(a)(2) and 165.7(f)-(l) replace the Whistleblower Award Determination Panel with a Claims Review Staff, and implement an enhanced review process mirroring that of the SEC.

In addition, the CFTC rule amendments make other changes related to form filing, recordkeeping and confidentiality. The amendments also harmonize rules concerning the CFTC and the SEC whistleblower programs. The amendments will become effective 60 days after their publication in the Federal Register.

Lofchie Comment: The mythic image of the “whistleblower” is that of a brave individual facing down a giant corporation (and preferably of the future subject of a movie). Sometimes whistleblowing does work like that. At other times, a whistleblower is just someone out for money (or revenge). What does a company do when it becomes aware of a whistleblower who has gone straight to the government with an accusation, without first attempting to remedy the matter internally, and the allegations turn out to be (legally) mistaken or factually untrue? Can an employee who is concerned about being dismissed raise an allegation strategically as a defense against being fired? These are difficult real-world questions. Big companies doubtless will try to live with the whistleblower rather than risk allegations of mistreatment. For smaller companies, it’s a harder situation.