Regulatory Reform. The ABCs for CPAs

Transcription

1 Financial Regulatory Reform The ABCs for CPAs The views expressed by the presenters do not necessarily represent the views, positions, or opinions of the AICPA e e s e p essed by e pese esdo o ecessa y ep ese e e s, pos o s, o op o s o e C or the presenter s respective organization. These materials, and oral presentation accompanying them, are for educational purposes only and do not constitute accounting or legal advice or create an accountant-client or attorney-client relationship.

2 Today s Objectives Today s program is designed to help you better understand: The major provisions of the Dodd-Frank Wall Street Reform & Consumer Protection Act; Key changes affecting investment advisers, private fund managers and private funds; Title VII and the impact of Dodd-Frank on the regulation of the OTC derivatives markets; and Issues impacting broker dealers. Slide No. 2

3 Today s Presenters Edward Johnsen Partner, Winston & Strawn LLP New York (212) EJohnsen@winston.com Julius Jerry Loeser Of Counsel, Winston & Strawn LLP Chicago (312) JLoeser@winston.com Peter Y. Malyshev Of Counsel, Winston & Strawn LLP Washington (202) PMalyshev@winston.com Wesley Nissen Partner, Winston & Strawn LLP Chicago (312) WNissen@winston.com John F. Hudson, CPA (Moderator) President, Hudson Consulting Group, LLC Slide No. 3

4 Dodd-Frank Wall Street Reform and Consumer Protection Act: General Overview

5 Scope 2,319 Pages Expected to generate more than 300 regulations American Bankers Association anticipates more than 5,000 pages of regulations The President signed the bill July 21 (which determines the effective date of many of the bill s provisions). Slide No. 5

6 Financial Stability Oversight Council [Title I A] Council of regulators. [Section 111] Purpose Monitor and provide oversight to system stability. [Sections 112, 113] Additional important role of Oversight Council Review and comment on FASB proposals. [Section 112(a)(2)] Comments will carry considerable influence Consider current loan mark-to-market market proposal Slide No. 6

7 Systemic Resolution Authority (Title II) FDIC may unwind nonbank systemically important financial firms such as AIG. [Section 210(a)(1)] Slide No. 7

8 Limits Some Federal Reserve Authority (Title I C, XI) In the future, Secretary of Treasury approval will be necessary for emergency lending. [Section 1101] GAO will audit Federal Reserve. [Section 1109] However, preserves Federal Reserve regulation of banks and bank holding companies, and adds regulation of systemically important Non Bank Financial Companies (NBFC). [Sections ] Slide No. 8

9 Bank Derivatives Activity (Title VII) Banks may continue traditional hedging activity to limit their risks and to enter into interest rate swaps and FX swaps (and even total return swaps on loans). However, derivatives involving commodities, agriculture, and non-cleared, non-investment- grade derivatives activities may only be conducted in the bank s nonbank affiliate. Slide No. 9

10 The Volcker Rule and Trading (Section 619) Banking organizations would be prohibited from engaging in trading securities for their own account except for government and municipal securities. This does not apply to securitization of loans. Slide No. 10

11 The Volcker Rule and Investments (Section 619) Banking organizations will be permitted to invest in hedge funds and private equity funds they sponsor, but the investment will have to be limited to: 3% of the fund s total ownership interests; and When aggregated with other such investments by the organization, 3% of the organization s Tier 1 capital. Slide No. 11

12 The Collins Amendment (Section 171) Added on the Senate floor, advocated by the FDIC. Eliminates Tier 1 capital treatment of trust preferred stock (TRuPS) (which hmay be considered as debt). Eliminates $100 billion of bank capital. Banks under $15 billion in assets are grandfathered. Others have 5½ years to phase out, starting in 2½ years. Slide No. 12

13 Lending Limits Provision to extend national bank lending limits to state banks did not survive. Slide No. 13

14 Interstate Branching (Section 613) De novo interstate branching by banks would be permitted. Slide No. 14

15 Regulation Q Prohibition against paying interest on demand deposit accounts terminates one year after enactment. Slide No. 15

16 Over-the-Counter Derivatives (Title VII) Regulation by SEC and CFTC. Transparency through clearinghouses and exchange trading. Slide No. 16

17 Mortgage Foreclosure Reduction (Title XIV) Yield-spread premiums prohibited. [Section 1403] Prepayment penalties prohibited. [Section 1414] Applies to all lenders, bank and nonbank. Slide No. 17

18 Securitization (Title IX D, Section 941) Skin in the game originator/securitizer shall retain 5% of the risk (unhedged) requirements unless regulator-proposed lending standards (ability and willingness to repay) for mortgages met. This does not apply to securitizations of plain vanilla mortgages with maturities of 5 years or longer. Nor does it apply to securitizations of FHA and VA loans. Bank regulators and SEC are to issue regulations in 270 days. Slide No. 18

19 Bureau of Consumer Financial Protection (Title X) Housed within the Federal Reserve Board (FRB). [Sections 1011 and 1012] Independent of the FRB. [Section 1012] Authorized to examine and take enforcement actions against banks with assets of $10 billion or more. [Section 1025] Slide No. 19

20 Bureau of Consumer Financial Protection, continued RESPA moves from HUD. [Section 1032(f)] TILA and TISA move from FRB. [Section 1032(f)] Staffs transfer 180 days to 1 year after enactment, subject to extension if Secretary of Treasury reports to Congress. FRB will pay budget of BCFP of $500 million to $700 million annually. [Section 1017] Slide No. 20

21 Thrifts (Title III) Office of Thrift Supervision will merge into Office of the Comptroller of the Currency. [Sections ] However, the thrift charter will be preserved. [Section 316(b)] Slide No. 21

22 Debit Card Interchange Fees Federal Reserve will set rates to ensure they are reasonable and proportional. Small banks exempt, but effect of competition may make that t illusory. Fed will not be permitted to consider costs other than those of the individual transaction and general fraud prevention costs. Slide No. 22

23 Shareholder Provisions (Title IX) Shareholders may cast nonbinding votes on executive pay, including golden parachutes. [Section 951] SEC may set rules for proxy access by shareholders. [Section 971(b)] Board of director compensation committees are to have independent board members. [Section 952] Slide No. 23

24 Sarbanes-Oxley Exemption for firms with less than $75 million market capitalization. [Section 989G] Slide No. 24

25 Key Changes Affecting Investment Advisers, Private Fund Managers and Private Funds

26 Overview: Legislation Status A. Dodd-Frank Conference Report B. Reconciliation of House-Senate Bills C. Final Passage D. Impact on Investment Advisers, Financial Planners, Private Fund Managers and Broker- Dealers E. Impact on Private Fund Investors F. Overview G. Additional Rulemaking Slide No. 26

27 Used by permission All Rights Reserved Slide No. 27

28 Elimination of Private Adviser Exemption A. Private Adviser Exemption (Section 203(b)(3) of the Advisers Act) B. The Goldstein Decision C. Reliance on Private Adviser Exemption D. New Limited Exemptions E. Investment Adviser Registration F. SEC Rulemaking Authority Slide No. 28

29 Used by permission All Rights Reserved Slide No. 29

30 New Limited Exemptions from Registration ti 1. Foreign Private Adviser Exemption [Sec. 403] 2. Private Fund Adviser Exemption [Sec. 408] 3. Venture Capital Fund Adviser Exemption [Sec 407] 4. Family Office Exemption [Sec. 409] 5. Small Business Investment Company Adviser Exemption [Sec. 403] 6. Exemption for Intrastate Advisers with No Private Fund Clients [Sec. 403] 7. Limited Exemption for Registered Commodity Trading Advisors [Sec. 403] Slide No. 30

31 Investment Adviser Registration Current Law: State versus Federal Registration Advisers generally must register with applicable states t unless exempt. Advisers with $25 million of AUM may choose to register with the SEC instead of state. Advisers with $30 million or more of AUM must register with the SEC (unless an exemption is available). Advisers required to register in 30 or more states must register with the SEC (unless an exemption is available). Bill Further Limits SEC Registration [Sec. 410] Bill effectively increases the $30 million threshold to $100 million. May be required ed to register with one or more states. Query whether an investment adviser that is exempt from registration in the state in which its principal office is located and that has AUM of $25 million or more (but less than $100 million) can elect to register with the SEC. Slide No. 31

32 Used by permission All Rights Reserved Slide No. 32

33 AUM Appendix A: Summary Chart of SEC IA Registration Required to Register with SEC (current law) < $25 million No, unless an adviser to a RIC. Required to Register with SEC (new law) No, unless an adviser to a RIC. Eligible to Register with SEC (current law) Generally, no unless required to register in 30 states or another Rule 203A 2 exemption applies. Eligible to Register with SEC (new law) Generally, no unless required to register in 30 states or another Rule 203A 2 exemption applies. Between $25 million Yes, if AUM $ 30 No, unless an adviser Yes. Generally, no unless (i) and $100 million million (unless another exemption applies; e.g., under Section 203(b) or an to a RIC. an adviser to a RIC; or (ii) it would be required to register in 15 or more states; or adviser to a RIC. (iii) it is not required to be registered as an IA with the state of its principal office. $100 million Yes, unless an exemption is available under Section 203(b). Yes, unless a very limited exemption is available under Section 203(b) (as amended) or such other rule (e.g., family office; venture capital adviser) as shall be created by the Bill. Yes. Yes. Slide No. 33

34 Investor Suitability Standards Accredited Investor Standard (Rules 215 and 501(a) under the Securities Act) [Sec. 412] Currently, defined as persons with income in each of the two most recent years in excess of $200,000 (or $300,000 for a couple) or with a net worth of at least $1 million (either individually or jointly). Bill excludes value of a person s primary residence; maintains the current net worth threshold for the time being. SEC to review and revise standard in the future. Qualified Client Standard (Section 205 of the Advisers Act) [Sec. 418] Currently, persons with at least $750,000 in AUM or persons with a net worth of more than $1.5 million. Bill requires SEC to adjust for inflation. Slide No. 34

35 The Volcker Rule: Limitation of Investment by Banks in Private Funds General Prohibition [Sec. 619] Section 619 of the Bill (Volcker Rule) prohibits a banking entity from acquiring or retaining ownership interests in Private Funds or from sponsoring such entities. Exception A banking entity may organize and offer (including sponsor) a private equity or hedge fund to which it provides a bona fide trust, fiduciary or other advisory services. Timeline Effective date is the earlier of 12 months after the issuance of final rules or within two years after the date of enactment. Board of Governors of the Federal Reserve may extend up to three one-year periods. One-time five-year extension for the divestiture of illiquid funds. Slide No. 35

36 Data; Reports; Exams and Disclosures Recordkeeping [Sec. 404] Authorizes SEC to require registered advisers to maintain records and file reports. Required Records [Sec. 404] Amount of AUM; use of leverage; counterparty credit risk exposures; trading and investment positions; valuation policies and practices of the fund; types of assets held; side arrangements or side letters; trading practices; other information determined to be necessary and appropriate. Confidentiality y[ [Sec. 404] SEC must keep filed reports confidential; exempt from The Freedom of Information Act ( FOIA ) with respect to such information. Confidentiality does not apply to Congress or other agencies. Disclosure [Sec. 405] Restricts SEC s ability to make public any proprietary information of an investment adviser obtained from filed reports. Exceptions for necessary or appropriate p purposes p of assessing potential systematic risk. Slide No. 36

37 Regulation of Financial Planners Study on Financial Planners [Sec. 919C] Considerations Recommendations Reports Slide No. 37

38 Used by permission All Rights Reserved Slide No. 38

39 Self-Regulatory Oversight of Investment Advisers Study on Enhancing Investment Adviser Examinations [Sec. 914] Section 914 requires the SEC to review and analyze the need for enhanced examination and enforcement resources for investment advisers. Considerations The number and frequency of examinations of investment advisers five years before enactment. Extent to which authorizing the SEC to designate one or more selfregulatory organizations would improve frequency of examinations. Current and potential approaches to examining the investment advisory activities of dually registered broker-dealers and investment advisers or affiliated broker-dealers and investment advisers. Report SEC must submit a report to Congress within 180 days after enactment. Slide No. 39

40 Bureau of Consumer Financial Protection [Sec. 1012] A. Exclusion for Accountants and Tax Preparers [Sec. 1027(d)] B. Exclusion of Other Service Providers Slide No. 40

41 Obligations of Brokers, Dealers and Investment tadvisers Study of Standards [Sec. 913] Section 913 requires SEC to conduct study to evaluate (1) effectiveness of existing standards of care for brokers, dealers and investment advisers when providing advice to retail customers; (2) whether there are gaps, shortcomings or overlaps. Considerations SEC must consider whether retail customers understand that there are different standards of care applicable to brokers, dealers and investment advisers. Authority to Establish a Fiduciary Duty for Brokers and Dealers Section 913(g) authorizes the SEC to promulgate rules to impose the same standard of care on brokers or dealers. Slide No. 41

42 Used by permission All Rights Reserved Slide No. 42

43 Investment Adviser Custody Issues Safeguarding of Client Assets [Sec. 411] Section 411 requires registered investment advisers to take such steps to safeguard clients assets over which h such adviser has custody, including, without limitation, verification of such assets by an independent public accountant Current Custody Rules Directs SEC to define by rule and prescribe means reasonably designed to prevent such acts, practices and courses of business as are fraudulent, deceptive or manipulative. Slide No. 43

44 Dodd-Frank Title VII Regulating the OTC Derivatives Markets

45 Outline The Big Picture New regulatory framework for commodities and securities swaps/new authority for the CFTC and the SEC. Amendments to the Commodity Exchange Act (CEA) What products are regulated under the DFA? What participants are regulated now? What new requirements apply to derivatives OTC transactions? Several things you may want to do now. Slide No. 45

46 The Big Picture Title VII Commodities Provisions Securities Provisions Amends: Amends: Commodity Exchange Act Securities Act of 1933 Securities Exchange Act of 1934 Before DFA: Provisions applicable to futures Under DFA: Before DFA: Provisions Provisions + applicable to applicable to swaps securities Broad based security indices. Mirror Reflection + Under DFA: Provisions applicable to securitybased swaps Single names and narrow based security indices. Slide No. 46

47 Amendments to the CEA Commodity Exchange Act Futures-related Provisions Swaps-related Provisions -Registration of intermediaries -Business standards -Required minimum capital -Requirement to trade on exchanges -Product approval by CFTC -Clearing of products -Reporting of trades -Margining of trades -Position limits -Anti-Fraud/Anti-Manipulation -Bankruptcy/segregation provisions Mirror Reflection -Registration of intermediaries -Business standards -Required minimum capital -Requirement to trade on Exchanges/SEFs -Product approval by CFTC -Clearing of products -Reporting of trades -Margining of trades -Position limits -Anti-Fraud/Anti-Manipulation -Bankruptcy/segregation provisions Slide No. 47

48 Basic Rule Unchanged If you are not an eligible contract participant (ECP): You can only trade or enter into swaps on an exchange. If you are an ECP: You can trade and enter swaps OTC and under the DFA. Slide No. 48

49 Query.. Technically the CEA is now: The Commodity [Futures and Swaps] Exchange Act And the CFTC should be: The Commodity [Futures and Swaps] Trading Commission - This issue was discussed during the deliberations over the DFA. - The CFTC to add new divisions: - The Swaps Division and the Swaps Data Repository Division. Future Regulation: A regulated derivative contract comprising futures and swaps (since they are already regulated similarly); and Some very limited exemptions for structured products. Slide No. 49

50 Regulatory Focus Regulation of Swaps OTC Markets Products Participants Markets Swaps Swap dealers Major swap participants Swaps entities Amendments to existing ones Swap execution facilities Swap datarepositories Stated t Goal: To bi bring transparency and accountability to the derivatives market. kt Slide No. 50

51 Stated Goals for Regulatory Overhaul Conference report views goals as accomplished by: Providing SEC and CFTC with authority to regulate OTC derivatives and to enforce regulations. Requiring central clearing and centralized trading for derivatives that must be cleared. Requiring data collection, reporting and publication of trade data through clearing houses or swap repositories. Regulating foreign exchange swaps. Regulating security-based swaps. Establishing new and higher standard of conduct for participants. Slide No. 51

52 What Do You Need to Do Now? Identify if you: Enter into regulated products such as swaps. Have swaps that are grandfathered under the DFA. Would be a regulated entity under the DFA. Need to report swaps, and to whom. Need to modify your business practices. Slide No. 52

53 (1) Product Perspective What products are covered under the DFA? If you do not enter into swaps nothing in the DFA applies. Slide No. 53

54 What Is a Swap? Swap : Not a Swap : Broadly defined and generally is an Contracts of sale of a commodity agreement, option, cap, floor, or for future delivery (i.e., futures ). contract or transaction the subject Forwards and spots. of which is, the value of which is Transactions subject to securities based on, or the performance of acts. which is dependent on, a financial, economic or commercial interest or Options on foreign currency traded consequence. on exchanges. 22 enumerated categories of Notes, bonds, evidences of swaps and any transaction that is indebtedness that are securities. or becomes known as a swap such Identified banking products. as: Contracts with federal entities Interest rates, currencies, backed by full faith and credit of commodities, securities, indices, United States. credit default swaps, weather, Specifically excluded foreign metal, agricultural, emissions. exchange swaps and forwards. Swap master agreements FERC-regulated energy contracts. Slide No. 54

55 Foreign Exchange Products Foreign exchange swaps and foreign exchange forwards are specifically defined d under the DFA and are considered d swaps. However: Cross-currency swaps, currency swaps and foreign exchange swaps are specifically included in the swaps definition. Secretary of the Treasury can make determination that they should not be regulated as swaps under the DFA. Traditionally FX traders and dealers were exempt under the Treasury Exemption of the CEA since Specific procedures for determination involving submitting written determination to congressional committees. Regardless of determination, CEA s reporting, business conduct, antimanipulation and anti-fraud provisions (for trader swaps) apply. Slide No. 55

56 FERC-Regulated Products Some products may be subject to concurrent regulation of the CFTC and the FERC. Contracts specifically subject to FERC s or state jurisdiction under Federal Power Act: - Entered under a tariff or rate of FERC or state regulator; - Not traded or cleared on an exchange or SEF; or - Traded or cleared on a trading facility owned by an RTO or ISO. CFTC: - Retains otherwise statutory jurisdiction over above contracts and those not traded on RTOs or ISOs. - Can exempt contracts subject to FERC-approved tariffs and rates if consistent with public interest. FERC: - Retains otherwise jurisdiction under 222 of FPA and 4A of NGA. Slide No. 56

57 Security-based Swaps Security-based swaps are separately defined and are subject to the SEC jurisdiction. Includes: A swap based on a narrow-based security index (generally 9 or less securities) and any interest thereon; a single security or a loan, the occurrence, non-occurrence of an event relating to an issuer of a security or a narrow-based security index (e.g., credit default swap - CDS); master agreements. Do not include: Transactions in exempted securities unless they are puts, calls or other options. Security-based swap agreement is not a securitybased swap and is defined under GLBA. Slide No. 57

58 Forwards and Spots Forward is: Any sale of a non-financial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically y settled. - Also see the Bankruptcy Code Definition of a forward agreement. There is long line of cases that further differentiate forwards from futures. Also, the CEA expressly excludes forwards from the regulation under the CEA. Spots: are: Generally contracts that are settled within 2 business days (e.g., g Bankruptcy Code definition), but depending on a particular market may settle at a later time. Slide No. 58

59 Agricultural Products Swaps on agricultural commodities are included in the definition of swap. However: Swaps on agricultural commodities are treated differently than other swaps under DFA; and It is illegal to enter into swaps on agricultural commodities unless you rely on the CFTC rule. - Part 35 of CFTC regulations for swaps or Part 32 for options. This means that t trading and/or clearing of swaps on agricultural commodities is not allowed. CFTC to promulgate rules under DFA to regulate how these swaps can trade or clear. Slide No. 59

60 (2) Participant Perspective What new entities are regulated under the DFA? Be regulated or not be at all Slide No. 60

61 Participant Determination If you have determined that you trade or deal in swaps, you need to determine whether: You now will be a regulated entity under the DFA. Slide No. 61

62 New and Old Regulated Participants New regulated participants under the DFA specifically related to swaps: Swap Dealers Major Swap Participants Definitions of old regulated participants amended to include swaps provisions: Futures Commission merchants Introducing brokers Associated persons with the above Commodity pool operators and trading advisors Floor brokers and floor traders Eligible contract participants (ECPs) (tightened, harder to qualify) Consistent provisions relating to security-based swaps. Slide No. 62

63 Swap Dealer Swap Dealer means any person that: Holds itself out as dealer in swaps; Makes a market in swaps; Regularly enters into swaps with counterparties as an ordinary course of business for its own account; or Engages in any activity causing the person to commonly known in the trade as a dealer or market maker in swaps. Determined on class or category basis. Exclusions Insured depository institution to extent offered in connection with origination of loan. Own account not as part of a regular business. De minimis to be defined by the CFTC. Slide No. 63

64 Major Swap Participant Major Swap Participant means: Any person not a swap dealer: - That maintains substantial position in swaps for any of the major swap categories as determined by the CFTC,excluding: - Positions held for hedging or mitigating commercial risk and hedging of positions maintained by ERISA plans; - Whose positions create substantial counterparty exposure that could pose systemic risk; or - Is a highly leveraged financial entity, not subject to bank capital requirements and maintains substantial positions in outstanding swaps. CFTC to determine substantial position by: Considering clearing and uncleared positions, collateral, and counterparty exposures. Excludes captive finance companies. Slide No. 64

65 Captive Finance Companies Captive finance companies are expressly excluded from the dealer/major participant definitions. Among other requirements such a company uses derivatives to hedge interest rate and currency risk from financing the predominant portion (90%) of which facilitates the purchase or lease of products manufactured by a parent or a subsidiary of parent. CFTC/SEC to coordinate and further define terms. Slide No. 65

66 Push-Out Provisions for Banks If you are a bank, ascertain if you qualify as a swaps entity for push-out purposes. Slide No. 66

67 Consequences of Characterization as a Swap Dealer/Major Swap Participant Register with the CFTC/SEC Maintain minimum capital Minimum margin Initial and variation on all swaps not cleared Abide by business conduct standards Verify eligible contract participant Disclose material risks, conflicts Daily mark Special entities Special duties in dealing with munies and pension funds Report swap transactions for themselves and end users Slide No. 67

68 (3) Market Perspective If you enter into swaps and are a regulated entity, what do you need to do now? Slide No. 68

69 Consequences of Categorization as Swap/Security-based Swap Agreement Clearing Trading Reporting Slide No. 69

70 Clearing If required to be cleared, must be cleared on derivatives clearing organization or clearing agency, respectively. What is required to be cleared? To be determined by CFTC/SEC either on own initiative or after review of DCO/clearing agency proposal. Factors include: - Existence of significant outstanding notional exposures; - Trading liquidity; - Adequate pricing data; - Mitigation of systemic risk; and - Availability of infrastructure to clear on consistent terms. Slide No. 70

71 Clearing Exception to Clearing Requirement: If one of the counterparties is not a financial entity, is using swaps to hedge or mitigate commercial risk and notifies CFTC/SEC how it meets its financial obligations for non-cleared swaps, then not required to be cleared although h counterparty t may still elect to have it cleared. Clearing means: Submission of the swap to a derivatives clearing organization (DCO) or clearing agency that is inserted between the parties as the new counterparty. Each original party is required to post margin to DCO or clearing agency. If not required to be cleared: Counterparty to swap with swap dealer or major swap participant can require posted collateral to be segregated. Slide No. 71

72 Trading If a contract must clear, such contract must also trade on a swap execution facility (SEF) or an exchange. CFTC/SEC to further define what trading, execution, facilitation of trading and trade processing mean. CFTC/SEC to further issue regulations on what is a SEF. Slide No. 72

73 Reporting Whether required to be cleared or not, swap subject to reporting requirements. Commission to issue interim final rule within 90 days. Real-time public reporting as soon as technologically practicable. For swaps that are not cleared, reporting should not disclose business transactions or market positions of any person. Reporting obligation (in following order): - Dealer - Major participant - Selected counterparty New reporting entities to be established swap data repositories Slide No. 73

74 Consequences of DFA Effect on Existing Trades Report to rely on grandfathering provisions w/in 180 days. Determine how you margin or will need to margin. File for an exemption under 2(h) with CFTC for trades in exempt commodities w/in 60 days. Effect on Future Trades Determine if need to clear/trade. - If standardized, most likely will need to clear Report all trades. Register if required. Margin. Slide No. 74

75 Legal Certainty Legal Certainty No contract between ECPS shall be void, voidable, unenforceable or may be rescinded based solely l on failure to be a swap or to be cleared. Unless expressly reserved, no termination right as a result of enactment or requirement of Act. Slide No. 75

76 Effective Dates General Rule Unless otherwise provided, provisions take effect on later of 360 days after enactment. CFTC/SEC Rulemaking When rulemaking is required, at least 60 days after publication of final rule. Special Deadlines Some provisions take effect within a specific period of time (e.g., 90 days, 180 days). Slide No. 76

77 Miscellaneous CFTC/SEC to consider exempting small banks (total assets less than $10 billion) from clearing requirements. Stable Value Contracts CFTC/SEC to conduct study to determine whether SVCs are swaps and, if so, whether they should be exempt. Until study is completed and final regulations are effective, SVCs are not considered swaps and regulations cannot retroactively treat SVCs as swaps. Swaps expressly not considered to be insurance and may not be regulated as insurance by any state. Many other provisions i to be addressed d in the future. Slide No. 77

78 Broker-Dealer Issues The Volcker Rule, Section 913 and Other Relevant Provisions

79 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) PROHIBITIONS ON PROPRIETARY TRADING AND CERTAIN RELATIONSHIPS WITH HEDGE FUNDS AND PRIVATE EQUITY FUNDS Banking entities are not permitted to: Engage in proprietary trading; or Acquire or retain any equity, partnership, or other ownership interest in or sponsor a hedge fund or a private equity fund. Nonbank financial companies supervised by the Federal Reserve will be subject to additional capital requirements and quantitative limits with regard to: Proprietary trading; and/or Acquiring or retaining any equity, partnership, or other ownership interest in, or sponsoring, a hedge fund or private equity fund. Certain permitted activities will not be subject to additional capital and quantitative limits. Slide No. 79

80 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) DEFINITION OF PROPRIETARY TRADING Engaging as a principal for the trading account of the banking entity or nonbank financial company in any transaction to purchase or sell, or otherwise acquire or dispose of: Any security, Any derivative, Any contract of sale of a commodity for future delivery, Any option on any such security, derivative, or contract, or Any other security or financial instrument that the appropriate federal banking agencies, the SEC, and the CFTC may by rule determine. Slide No. 80

81 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) STUDY AND RULEMAKING STUDY Within six months of the bill s enactment, the Financial Stability Oversight Council must study and make recommendations on implementing this section. RULEMAKING Not later than nine months after completion of the study, the federal banking agencies, SEC, and CFTC must consider the findings and adopt rules to carry out this section. Rules will be issued by: Federal banking agencies, for insured depository institutions; The Federal Reserve, for any company that t controls an insured depository institution, or that is treated as a bank holding company for purposes of Section 8 of the International Banking Act; any nonbank financial company supervised by the Federal Reserve; and most subsidiaries of the foregoing; The CFTC, for entities for which it is the primary financial regulatory agency; The SEC, for entities for which it is the primary financial regulatory agency. Slide No. 81

82 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) RULEMAKING The appropriate federal banking agencies, SEC, and CFTC will consult and coordinate to assure that rules are comparable and provide for consistent application and implementation, and to protect the safety and soundness of banking entities and nonbank financial companies. The chairperson of the Financial Stability Oversight Council will be responsible for coordination of the regulations. EFFECTIVE DATE. The earlier of: 12 months after the date of the issuance of final rules; or Two years after the date of enactment of the bill. Slide No. 82

83 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) CONFORMANCE PERIOD FOR DIVESTITURE No later than two years after the date on which the requirements become effective; or Two years after the date on which the entity or company becomes a nonbank financial company supervised by the Board. The Board may extend the two-year period for not more than one year at a time, if consistent with the purposes of Section 619 and not detrimental to the public interest. Extensions may not exceed an aggregate of three years. The Board also may extend the period during which a banking entity may take or retain an interest in, or provide additional capital to, an illiquid fund, to the extent necessary to fulfill a contractual obligation in effect on May 1, Slide No. 83

84 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) PERMITTED ACTIVITIES The purchase, sale, acquisition, iti or disposition iti of: Obligations of the United States or any agency thereof; Obligations, participations, or other instruments of or issued by Ginnie Mae, Fannie Mae, Freddie Mac, Farmer Mac, a Federal Home Loan Bank, or a chartered Farm Credit System institution; and Obligations of any state or of any political subdivision thereof. Purchases, sales, acquisitions, or dispositions of securities and other instruments in connection with underwriting or market-making activities that do not exceed reasonably expected near-term demands of clients, customers, or counterparties. Purchases, sales, acquisitions, or dispositions of securities and other instruments on behalf of customers. Risk-mitigating hedging activities in connection with and related to individual or aggregate positions, contracts, or other holdings. Slide No. 84

85 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) PERMITTED ACTIVITIES Investments in small business investment companies. Investments designed primarily to promote the public welfare. Investments that are qualified rehabilitation expenditures with respect to a qualified rehabilitated building or certified historic structure. Certain purchases, sales, acquisitions, or dispositions of securities and other instruments described by a regulated insurance company directly engaged in the business of insurance for the general account of the company, and by any affiliate of such regulated insurance company, provided that such activities by any affiliate are solely for the general account of the regulated insurance company. Slide No. 85

86 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) PERMITTED ACTIVITIES Organizing i and offering a private equity or hedge fund, including serving as its general partner, managing member, or trustee, and in any manner selecting or controlling (or having employees, officers, directors, or agents who constitute) a majority of the directors, trustees, or management of the fund, including any necessary expenses for the foregoing, provided that: The banking entity provides bona fide trust, fiduciary, or investment advisory services; The fund is organized and offered only in connection with the provision of bona fide trust, fiduciary, or investment advisory services and only to customers of such services of the banking entity; The banking entity does not acquire or retain an equity interest, partnership interest, or other ownership interest in the fund, except for certain de minimis investments; The banking entity complies with certain restrictions; Slide No. 86

87 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) PERMITTED ACTIVITIES (Continued from previous slide) The banking entity does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the fund or of any fund in which such fund invests; The banking entity does not share with the fund, for corporate, marketing, promotional, or other purposes, the same name or a variation of the same name; No director or employee of the banking entity takes or retains an equity, partnership, or other ownership interest in the fund, except for any director or employee of the banking entity who is directly engaged in providing investment advisory or other services to the fund; and The banking entity discloses to prospective and actual investors, in writing, that any losses are borne solely by investors and not by the banking entity, and complies with any additional rules imposed by appropriate federal banking agencies, the SEC, or the CFTC. Slide No. 87

88 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) PERMITTED ACTIVITIES Certain proprietary trading that t occurs solely l outside of the U.S., where the banking entity is not directly or indirectly controlled by a banking entity organized under the laws of the U.S. or of one or more states. Certain acquisitions or retentions of equity, partnership, or other ownership interests in, or sponsorship of, hedge or private equity funds by a banking entity solely outside of the U.S., provided that no ownership interest tin such hfund dis offered dfor sale or sold ldto a U.S. US resident and that the banking entity is not directly or indirectly controlled by a banking entity organized under the laws of the U.S. or of one or more states. Other activities that the appropriate federal banking agencies, the SEC, and the CFTC determine by rule would promote and protect the safety and soundness of the banking entity and the financial stability of the U.S. Slide No. 88

89 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) LIMITATIONS ON PERMITTED ACTIVITIES GENERAL No transaction, class of transactions, or activity may be permitted if it would: Involve or result in a material conflict of interest between the banking entity and its clients, customers, or counterparties; Result, directly or indirectly, in a material exposure by the banking entity to high-risk assets or high-risk trading strategies; Pose a threat to the safety and soundness of the banking entity; or Pose a threat to the financial stability of the United States. RULEMAKING The appropriate federal banking agencies, SEC, and CFTC will issue regulations to implement the foregoing limitations. Slide No. 89

90 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) LIMITATIONS ON PERMITTED ACTIVITIES CAPITAL AND QUANTITATIVE LIMITATIONS The federal banking agencies, SEC, and CFTC will adopt rules imposing additional capital requirements and quantitative limitations, including diversification requirements, regarding g these permitted activities if they are appropriate to protect the safety and soundness of banking entities engaged in such activities. LIMITATION ON PERMITTED ACTIVITIES DE MINIMIS INVESTMENTS GENERAL A banking entity may make and retain an investment in a hedge fund or private equity fund that the banking entity organizes and offers, subject to the limitations and restrictions in subparagraph (B) for the purposes of: Establishing the fund and providing it with sufficient initial equity for investment to permit the fund to attract unaffiliated investors; or Making a de minimis investment. Slide No. 90

91 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) LIMITATION ON PERMITTED ACTIVITIES DE MINIMIS INVESTMENTS LIMITATIONS AND RESTRICTIONS ON INVESTMENTS Investments by a banking entity in a hedge fund or private equity fund must: - No later than one year after the fund s establishment, be reduced through redemption, sale, or dilution to not more than 3 percent of the fund's total ownership interests. - Be immaterial to the banking entity, as defined by rule, but in no case may the aggregate of all interests of the banking entity in all such funds exceed 3 percent of Tier 1 capital. - For determining compliance with applicable capital standards, the aggregate amount of the outstanding investments by a banking entity under this paragraph, including retained earnings, must be deducted from the assets and tangible equity of the banking entity, and the amount of the deduction will increase commensurate with the leverage of the fund. Slide No. 91

92 Volcker Rule Proprietary Trading Restrictions ti (Sec. 619) LIMITATION ON PERMITTED ACTIVITIES DE MINIMIS INVESTMENTS (Continued) LIMITATIONS AND RESTRICTIONS ON INVESTMENTS A banking entity must actively seek unaffiliated investors to reduce or dilute its investment to the permitted amount. The Board may extend the period for meeting the foregoing requirements for two additional years if consistent with safety and soundness and in the public interest. Slide No. 92

93 Volcker Rule Impact on Broker-Dealers Bank-affiliated broker-dealers can still take proprietary positions vs. customers (facilitation). ti Will this still result in large, risky positions? Bank-affiliated broker-dealers can still make markets and underwrite securities. How does the firm determine that proprietary trading in connection with underwriting or market-making activities does not exceed reasonably expected near term demands of clients, customers, or counterparties? Bank-affiliated broker-dealers can still take proprietary positions to hedge certain risks. Will regulators challenge whether hedging positions exceed the amount needed to reduce the specific risks in connection with and related to positions, contracts, or other holdings? Slide No. 93

94 Volcker Rule Impact on Broker-Dealers Broker-dealers not affiliated with banks are not restricted in their ability to do proprietary trades. Will they have a competitive advantage? Could there be a migration of trading talent t to non-bank- affiliated broker-dealers or to private, unregistered trading entities? Are overall systemic risks really eliminated if non-bank-affiliated broker-dealers can still trade proprietarily? Will business be driven off-shore? Slide No. 94

95 Volcker Rule Impact on Broker-Dealers How will the Volcker rule affect proprietary trading firms and hedge funds? Loss of one universe of potential investors. Reduced competition from bank-affiliated brokerdealers. Possible loss of liquidity provided by the proprietary trading activities of bank-affiliated broker dealers. How will the Volcker rule affect the profitability of banks and their affiliated broker-dealers? Slide No. 95

96 Other Sections Relevant to Broker-Dealers Changes to Securities Investor Protection Act Increases SIPC cash amount from $100,000 to $250,000, with possible inflation adjustments. [Sec. 929H] Permits establishment of a bridge financial company to succeed to certain assets and liabilities of a broker-dealer when there isn t sufficient time to facilitate a private transaction prior to receivership proceedings. [Sec. 205] Slide No. 96

97 Other Sections Relevant to Broker-Dealers CONFLICTS OF INTEREST IN SALE OF ASSET- BACKED SECURITIES [Sec. 621] Prohibits an underwriter, placement agent, initial purchaser, or sponsor of an asset-backed security, or any affiliate or subsidiary of any such entity, for one year after the date of the first closing of the sale of the asset-backed security, from engaging in any transaction that would involve or result in any material conflict of interest t with respect to any investor in a transaction arising out of such activity. Slide No. 97

98 Other Sections Relevant to Broker-Dealers DEADLINE FOR COMPLETING EXAMINATIONS, INSPECTIONS, AND ENFORCEMENT ACTIONS [Sec. 929U] Requires the SEC staff to file an action, or provide notice to the director of the Division of Enforcement, of its intent to not file an action, no later than 180 days after the date on which SEC staff provides a written Wells notification to any person. Requires the SEC staff to provide an entity being examined or inspected with written notification indicating either that the examination or inspection has concluded, d has concluded d without t findings, or that t the staff requests the entity to undertake corrective action, no later than 180 days after the date on which SEC staff completes the on-site portion o of its compliance ce examination at or inspection or receives es all records requested from the entity being examined or inspected, whichever is later. Both subsections provide exceptions for certain complex actions. Slide No. 98

99 Other Sections Relevant to Broker-Dealers SHORT SALE REFORMS [Sec. 929X] DISCLOSURE Requires the SEC to prescribe rules for public disclosure of the name of the issuer and the title, class, CUSIP number, aggregate amount of the number of short sales of each security, and any additional information determined by the SEC, following the end of the reporting period, at a minimum, occurring every month. ENFORCEMENT Amends Exchange Act Section 9 to make it unlawful to effect a manipulative short sale of any security, and requires the SEC to issue other rules as necessary or appropriate to ensure that the appropriate enforcement options and remedies are available for violations. INVESTOR NOTIFICATION Amends Exchange Act Section 15 to require every registered broker or dealer to give notice to its customers that they may elect not to allow their fully paid securities to be used in connection with short sales, and to provide that if a broker or dealer uses a customer s securities in connection with short sales, the broker or dealer must provide notice to its customer that the broker or dealer may receive compensation in connection with lending the customer s securities. Slide No. 99

100 Other Sections Relevant to Broker-Dealers SHORT SALE REFORMS LENDING OR BORROWING SECURITIES [Sec. 984] Amends Exchange Act Section 10, making it unlawful to effect, accept, or facilitate a transaction involving the lending or borrowing of securities in contravention of such rules and regulations as the SEC may prescribe, and allows the appropriate federal banking agency, the National Credit Union Administration, or any other federal department or agency with responsibility under federal law, to prescribe rules or regulations restricting transactions involving the lending or borrowing of securities in order to protect the safety and soundness of a financial institution or to protect the financial system from systemic risk. No later than two years after enactment e t of this section, the SEC must promulgate rules that are designed to increase the transparency of information available to brokers, dealers, and investors, with respect to the lending or borrowing of securities. Slide No. 100

101 Other Sections Relevant to Broker-Dealers AUTHORITY TO RESTRICT MANDATORY PRE-DISPUTE ARBITRATION [SEC. 921] Gives the SEC the authority to prohibit, or impose conditions or limitations on the use of agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any future dispute between them arising under the federal securities laws, the rules and regulations thereunder, or the rules of a selfregulatory organization, if the SEC finds it to be in the public interest and for the protection of investors. WHISTLEBLOWER PROTECTION [SEC. 922] Authorizes the SEC, in any covered judicial or administrative action, or related action, to pay an award or awards to one or more whistleblowers who voluntarily provided original information to the SEC that led to the successful enforcement of the action, in an aggregate amount equal to no less than (i) 10 percent, in total, of what is collected of the monetary sanctions imposed in the action; and (ii) 30 percent, in total, of what is collected of the monetary sanctions imposed in the action. Establishes a Securities and Exchange Commission Investor Protection Fund that will be available to the SEC, without further appropriation or fiscal-year limitation, for paying awards to whistleblowers and funding the activities of the SEC Inspector General. Slide No. 101

102 Office of the Investor Advocate The Act establishes of an Office of the Investor Advocate. The Advocate will be an overseer of the overseer. The Advocate will have the power to retain independent counsel research staff and others, and will be charged with assisting retail investors in solving problems they have with SEC staff or SROs, identify areas where investors would benefit from changes in regulations, and identify problems that investors have with financial services providers. The Advocate also will send an annual report to the senate Banking Committee and the House Financial Services Committee. The report will not be subject to prior review by the SEC. Slide No. 102

103 Study and Rulemaking on Broker-Dealers Fiduciary i Duty Sec. 913 is pro-investor legislation that provides a road map for harmonizing regulation of persons who provide personalized investment advice on securities for retail customers. Must be investment advice Must be personalized Must concern securities Slide No. 103

104 Background Adviser regulatory scheme is principle-based. Many broker-dealers are excluded under incidental exclusion. Imposition of fiduciary standard would undermine this exclusion. Advisers owe clients a fiduciary obligation to act in client s best interest and to refrain from engaging in self-dealing, conflicts of interest, or otherwise taking advantage of client. Neither Advisers Act nor rules specifically state there is a fiduciary duty, but courts have held that there is one under Section 206 of the Advisers Act. Slide No. 104

105 Background Broker-dealers are not subject to a fiduciary duty under Securities Exchange Act of 1934, or rules under that Act, but facts may give rise to fiduciary duty. Discretion over accounts generally subjects brokerdealers to a fiduciary standard. Some account relationships are not clearly discretionary but have aspects of both discretionary and non-discretionary accounts. Over the years, multifactor tests have evolved to determine whether a broker is a fiduciary. Slide No. 105

106 Background Emergence of fee-based accounts blurred line between broker-dealers and investment advisers. Rand study provided d data on ways in which h broker-dealers and investment advisers market, sell, and deliver financial products and services to retail customers. Rand report found investor confusion on differences between brokers and advisers. Disclosures were not clear and seldom were read by investors. Slide No. 106

107 What Having a Fiduciary Duty Means to Retail Brokers Principle-based regulatory approach; fiduciary is not defined in the Advisers Act concept is somewhat amorphous. Intent t of Congress is that t as a fiduciary, i broker will have duty to act in best interests of client without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice. Slide No. 107

108 What Having a Fiduciary Duty Means to Retail Brokers Disclosure Conflicts of interest and potential conflicts of interest will have to be disclosed. Brochure disclosure for brokers? Compensation Commissions should be reasonable and disclosed. Consent Client consent to fees and acknowledgement of disclosure and recommended practices. Slide No. 108

109 What Having a Fiduciary Duty Means to Retail Brokers Scope of duty-facts and circumstances determination. Ongoing account management vs. transaction advice. Principal trading Can continue provided that protections are in place. Not clear if this means that burdensome restriction on principal trades under Adviser Act will be applied to brokers. Regulation FINRA regulates brokers with respect to new standard, but how will they do this? Little experience or expertise in this area of law. State have greater experience regulating fiduciaries, but staff and resources to do so are sparse in many states, and state regulation is uneven as a result. Regulation by enforcement action likely will result. Best execution Most best execution cases are brought against advisers on a breach of fiduciary duty claim; brokers with a fiduciary duty will become more vulnerable to such actions. What will be the impact on a broker-dealer s trading if a fiduciary standard is imposed? Slide No. 109

110 The SEC Study Standards of care for covered persons providing personalized investment advice to retail customers. Covered Persons: - Broker-dealers and their associated persons; and - Investment advisers and their associated persons. Retail Customer: - Natural person; - Receives personalized investment advice about securities form a covered person; and - Uses advice primarily for personal, family, or household purposes. Slide No. 110

111 SEC to Report on Study to House and Senate Committees within Six Months Report is to describe findings, conclusions, and recommendations of SEC from study, including: Description of sources of information considered; Analysis of gaps, shortcomings, or overlap in legal or regulatory standards in protection of retail customers relating to the standards of care for covered persons for providing personalized investment advice to retail customers. SEC to consider public comment to prepare report. Slide No. 111

112 Summary & Questions Slide No. 112

113 Thanks For Participating! Slide No. 113

114 Upcoming AICPA Webcasts For a complete listing of all AICPA Webcasts, please look at our latest programming schedule at Slide No. 114