At the recent “SEC Speaks” conference in Washington, DC this year, Chairman Mary Schapiro and senior Enforcement officials vowed to increase investor protection through use of the SEC’s expanded authority under the Dodd-Frank Act and initiatives designed to help the SEC enforcement staff proactively detect and prevent securities law violations. In her speech, Schapiro pointed to numerous modernization initiatives as central to this effort, including better hiring, more training, more sophisticated IT systems, and better management structures. Schapiro noted that the Commission now has Wall Street traders, asset managers, and quantitative analysts on staff alongside attorneys, economists and accountants and has more than doubled its training budget since 2009. She also touted the SEC’s new TCR system (tips, complaints, and referrals) as allowing the SEC to better “triage” the information it receives and use that information more effectively in terms of opening new investigations, directing information to existing investigations, and uncovering and tracking emerging trends.

Schapiro pointed to the SEC’s record 735 enforcement actions, which returned more than $2 billion to investors, as evidence that these efforts to modernize the agency and bolster its knowledge base are already bearing fruit. Division of Enforcement Director Robert Khuzami echoed these remarks, saying that the agency’s risk-based initiatives are paying off and that the SEC is being more proactive, which has, in his view, resulted in more deterrence. Declaring a new “entrepreneurial” spirit and ethos, Schapiro and Khuzami made clear that the SEC intends to redouble its enforcement efforts across the board.

…continue reading: An “Entrepreneurial” and Restructured SEC Pledges Proactive Enforcement

On February 23, 2012, the Commodity Futures Trading Commission voted to adopt final rules that regulate the internal conduct of futures commission merchants, introducing brokers, swap dealers and major swap participants. These rules impose duties and restrictions on these categories of registered entities concerning internal conflicts of interest and recordkeeping. Swap dealers, major swap participants and futures commission merchants must also designate a chief compliance officer who is charged with establishing and enforcing policies and procedures reasonably designed to ensure compliance with the Commodity Exchange Act and the regulations promulgated thereunder. The four types of registered entities must erect firewalls between clearing personnel and trading business personnel as well as between research personnel and non-research personnel. The final rules relating to recordkeeping require swap dealers and major swap participants to keep sufficient records to show general and trade-specific compliance with the Commodity Exchange Act and its regulations. The Commodity Futures Trading Commission worked closely with commenters and other regulators in drafting these rules.

…continue reading: CFTC Adopts Internal Business Conduct Rules

The Volcker Rule has been only a skeleton in statutory form, but now is beginning to take shape as proposed regulations would flesh out its requirements. Now that the comment period on the proposed regulations has ended, a survey of the substantive suggestions for change displays a variety of approaches, but at least the financial institutions directly affected have made significant, and strident, criticisms of most of the proposal. Surprisingly, many foreign governments have also weighed in because of their concern about the effect on global markets generally and on their own sovereign debt specifically. Many of these topics merit serious consideration.

The financial services industry is closely watching the progress of the federal financial regulatory agencies in adopting rules to implement the Volcker Rule. [1] The rule is at Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act and was enacted primarily at the urging of Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System. [2] The Agencies have issued a proposed rule (“Proposal”), the comment period for which ended on February 13. The Agencies will review and analyze the comments, before adopting a final rule that provides guidance on how a banking entity may now conduct market-making and fund activities.

…continue reading: What’s Next for the Volcker Rule?

This posting, the March 2012 Davis Polk Dodd-Frank Progress Report, is the twelfth in a series of Davis Polk presentations that illustrate graphically the progress of the rulemaking work that has been done and is yet to occur under the Dodd-Frank Act. The Progress Report has been prepared using data from the Davis Polk Regulatory Tracker™, an online subscription service offered by Davis Polk to help market participants understand the Dodd-Frank Act and follow regulatory developments on a real-time basis.

In this report:

• As of March 1, 2012, a total of 225 Dodd-Frank rulemaking requirement deadlines have passed. Of these 225 passed deadlines, 158 (70.2%) have been missed and 67 (29.8%) have been met with finalized rules.
• Major rulemaking activity this month included CFTC final rules relating to swap dealer internal business conduct and a CFPB proposed a rule defining “larger participants” in certain consumer financial markets.

For a number of years, commentators have noted that securities “reform” legislation seems to be passed only in the wake of major stock market crashes, with this pattern dating back to the South Sea Bubble. Some have argued that this pattern demonstrates the undesirability of such legislation, arguing that laws passed after a market crash are invariably flawed, result in “quack corporate governance” and “bubble laws,” and should be discouraged. Recently, this criticism has been directed at both the Sarbanes-Oxley Act and the Dodd-Frank Act. The forthcoming Cornell Law Review article, The Political Economy of Dodd-Frank: Why Financial Reform Tends to be Frustrated and Systemic Risk Perpetuated, presents a rival perspective. Investors, it argues, are naturally dispersed and poorly organized and so constitute a classic “latent group” (in Mancur Olson’s terminology). Such latent groups tend to be dominated by smaller, but more cohesive and better funded special interest groups in the competition to shape legislation and influence regulatory policy. This domination is interrupted, however, by major crises, which encourage “political entrepreneurs” to bear the transaction costs of organizing latent interest groups to take effective action. But such republican triumphs prove temporary, because, after the crisis subsides, the hegemony of the better organized interest groups is restored.

…continue reading: The Political Economy of Dodd-Frank

In adopting final rules on the treatment of cleared swap customer collateral, the CFTC has taken a major step in defining the architecture of market-wide swap clearing, a key pillar of the Dodd-Frank Act’s derivatives reform. After receiving intense arguments for divergent types of collateral protection, the CFTC adopted the “legal segregation, operational commingling” (“LSOC”) model.

The LSOC model is designed to eliminate the “fellow customer risk” to which futures customers are exposed. Under the LSOC model, if a customer of a futures commission merchant (“FCM”) defaults on a cleared swap margin obligation and the FCM is not able to satisfy the defaulting customer’s obligations, the derivatives clearing organization (“DCO”) has no recourse to funds of the FCM’s non-defaulting customers. Therefore, LSOC is intended to provide additional protection, albeit at an additional cost, to cleared swap customers beyond the current futures DCO model. In contrast, under the futures DCO model, any FCM customers’ swap collateral is available to the DCO upon a default of both the FCM and one of its futures customers. The CFTC has not extended the LSOC model to futures at this time, but will consider doing so.

…continue reading: CFTC Rule on Protection of Swap Collateral

This posting, the February 2012 Davis Polk Dodd-Frank Progress Report, is the eleventh in a series of Davis Polk presentations that illustrate graphically the progress of the rulemaking work that has been done and is yet to occur under the Dodd-Frank Act. The Progress Report has been prepared using data from the Davis Polk Regulatory Tracker™, an online subscription service offered by Davis Polk to help market participants understand the Dodd-Frank Act and follow regulatory developments on a real-time basis.

In this report:

• As of February 1, 2012, a total of 225 Dodd-Frank rulemaking requirement deadlines have passed. Of these 225 passed deadlines, 164 (72.9%) have been missed and 61 (27.1%) have been met with finalized rules.
• Major rulemaking activity this month included CFTC final rules on business conduct standards and registration of swap dealers and major swap participants.
• The GAO published seven studies in January 2012.

It is generally accepted that the full board has overall responsibility for risk oversight, mirroring the board’s responsibility for overseeing strategy. In deciding how to organize itself to oversee risk and risk management, the question arises as to whether the board should establish a separate risk committee. This article explores that question and provides examples to clarify the role and responsibility of a separate risk committee in situations where the board decides to establish one.

Through the risk oversight process, the board of directors obtains an understanding of the critical risks inherent in the corporate strategy, accesses useful information from internal and external sources about the critical assumptions underlying that strategy, remains alert to organizational dysfunctional behavior that can lead to excessive risk taking, and provides input to executive management regarding critical risk issues on a timely basis. How the board views risk oversight as a process should dictate how it chooses to organize itself for purposes of executing that process. The risk oversight process enables the board and management to develop a mutual understanding regarding the risks the company faces over time as it executes its business model for creating enterprise value. In organizing itself for risk oversight, what are some of the factors for boards to consider and when should boards establish a separate risk committee?

…continue reading: Should Your Board Have a Separate Risk Committee?

In our paper, Cross Border Shareholder Class Actions Before and After Morrison, we conduct an empirical inquiry into the effect of the Supreme Court’s 2010 decision in Morrison v. National Australia Bank on the competitiveness of US markets as a venue for listings by foreign issuers and trading in cross-listed stocks. Passed in the wake of Morrison, the Dodd-Frank Act requires that the SEC inform Congress about the merits of creating a new extraterritorial private right of action. We provide input into the debate by using data on 329 shareholder class actions filed against foreign companies and discussing the effects of such a right on the competitiveness of U.S. capital markets.

We conclude that foreign companies’ expected litigation costs should fall after Morrison, because investors who purchased their shares on overseas exchanges will be excluded from classes. By reducing expected litigation costs, Morrison eases a deterrent to US listing by foreign issuers and thereby makes the US a more competitive venue for cross-listings, as well as for the volume in the cross-listed stocks. We submitted our paper to the SEC as part of its public comment process, and have posted it on SSRN.

…continue reading: Cross Border Shareholder Class Actions Before and After Morrison

A recent acquisition approval order of the Board of Governors of the Federal Reserve System (the “FRB”) provides the first analysis of the “financial stability” factor in Section 604(d) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). This section amended Section 3(c) of the Bank Holding Company Act of 1956 (“BHC Act”) to require the FRB, when evaluating a proposed bank acquisition, merger, or consolidation, to consider “the extent to which [the] proposed acquisition, merger, or consolidation would result in greater or more concentrated risks to the stability of the United States banking or financial system”. Section 604(e) of the Dodd-Frank Act similarly amended Section 4(j)(2) of the BHC Act to require the FRB to consider financial stability concerns when reviewing notices by bank holding companies to engage in nonbanking activities.

On December 23, 2011, the FRB issued an order (the “Order”) explaining its reasons for approving the acquisition of RBC Bank (USA) (“RBC Bank”) by The PNC Financial Services Group, Inc. (“PNC”). (The FRB announced its approval of the transaction on December 19, 2011 but, unusually, the Order was not released until several days later.) The Order constitutes the first articulation by the FRB of how it will analyze proposed transactions under the new financial stability factor. The FRB stated in the Order, however, that it expects to issue a notice of proposed rulemaking implementing this change to Section 3(c) of the BHC Act as well as other provisions of the Dodd-Frank Act that require the FRB to consider the effect on financial stability of other proposals by financial institutions, and that this will afford the public an opportunity to provide comments on how the FRB should take financial stability into account when reviewing applications and notices.

…continue reading: “Financial Stability” Analysis in Bank M&A