The Staff of the SEC Division of Trading and Markets, Investment Management, and Corporate Finance provided updated guidance on June 12, 2015 in response to frequently asked questions (“FAQs”) regarding the SEC’s final rule implementing section 13 of the Bank Holding Company Act of 1956, commonly referred to as the “Volcker Rule.” The responses to these FAQ’s address a broad range of issues arising under the restrictions imposed by the Volcker Rule on banking entities proprietary trading activities and the ownership, sponsorship and management of “covered funds.” FAQ Responses.
On June 4, the Commodity Futures Trading Commission’s (“CFTC”) Division of Swap Dealer and Intermediary Oversight (“DSIO”) issued a No-Action Letter stating that it will not recommend that the CFTC take action for failure to register as an introducing broker or commodity trading advisor against persons located outside the United States that facilitate swap transactions for International Financial Institutions (“IFIs”) that have offices in the United States.
The DSIO took the position that the relief is appropriate in light of the unique attributes and status of IFIs, and in consideration of international comity. In addition, the relief granted is consistent with the CFTC’s prior treatment of IFIs for purposes of foreign futures and options transactions, the swap dealer definition, and mandatory clearing.
DSIO has defined IFIs, for purposes of the no-action letter, in accordance with prior CFTC policy to be the following institutions and organizations: International Monetary Fund, International Bank for Reconstruction and Development, European Bank for Reconstruction and Development, International Development Association, International Finance Corp., Multilateral Investment Guarantee Agency, African Development Bank, African Development Fund, Asian Development Bank, Inter-American Development Bank, Bank for Economic Cooperation and Development in the Middle East and North Africa, Inter-American Investment Corp., Council of Europe Development Bank, Nordic Investment Bank, Caribbean Development Bank, European Investment Bank and European Investment Fund (International Bank for Reconstruction and Development, International Finance Corp. and Multilateral Investment Guarantee Agency are parts of the World Bank Group).
On May 6, 2015, the Securities and Exchange Commission approved a proposal by the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) for a two-year pilot program that would widen the minimum quoting and trading increments–or tick sizes–for stocks of some smaller companies. The SEC plans to use the pilot program to assess whether wider tick sizes enhance the market quality of these stocks for the benefit of issuers and investors.
The tick size pilot will begin by May 6, 2016. It will include stocks of companies with $3 billion or less in market capitalization, an average daily trading volume of one million shares or less, and a volume weighted average price of at least $2.00 for every trading day.
The pilot will consist of a control group of approximately 1,400 securities and three test groups with 400 securities in each selected by a stratified sampling. During the pilot:
- Pilot securities in the control group will be quoted at the current tick size increment of $0.01 per share and will trade at the currently permitted increments.
- Pilot securities in the first test group will be quoted in $0.05 minimum increments but will continue to trade at any price increment that is currently permitted.
- Pilot securities in the second test group will be quoted in $0.05 minimum increments and will trade at $0.05 minimum increments subject to a midpoint exception, a retail investor exception, and a negotiated trade exception.
- Pilot securities in the third test group will be subject to the same terms as the second test group and also will be subject to the “trade-at” requirement to prevent price matching by a person not displaying at a price of a trading center’s best “protected” bid or offer, unless an enumerated exception applies. In addition to the exceptions provided under the second test group, an exception for block size orders and exceptions that mirror those under Rule 611 of Regulation NMS will apply.
A variety of data generated during the tick size pilot will be released publicly on an aggregated basis to assist in analyzing the impact of wider tick sizes on smaller capitalization stocks. The exchanges and FINRA will submit their initial assessments on the tick size pilot’s impact 18 months after the pilot begins. Order.
Recently, the Staff of the Division of Investment Management of the Securities and Exchange Commission (the “Staff”) issued updated Guidance that highlights the importance of cybersecurity of registered investment funds and registered investment advisers. The Guidance discusses a number of measures that funds and advisers may wish to consider when addressing cybersecurity risks. In particular, the Staff identified a number of measures that funds and advisers may with to consider in addressing cybersecurity risk. It further advised that funds and advisers should identify their respective compliance obligations when assessing their ability to prevent, detect and respond to cyber attacks. Fund managers and advisers should anticipate that cybersecurity will be a focal point of the Staff’s examination program. Guidance Update.
FINRA Rule 2040 governs the payment of transaction-based compensation by member firms to unregistered persons.
Rule 2040(a) – General.
Rule 2040(a) directs persons to look to SEC rules to determine whether the activities in question require registration as a broker-dealer under SEA Section 15(a). The provision also prohibits payments to appropriately registered associated persons unless such payments comply with applicable federal securities laws, FINRA rules, and SEA rules and regulations.
Rule 2040(c) – Foreign Finders.
Rule 2040(c) replaces NASD Rule 1060(b) and NYSE Interpretation 345(a)(i)/03, and provides that a member firm and persons associated with a member firm may pay transaction related compensation to non-registered foreign finders where the finders’ sole involvement is the initial referral to the member firm of non-U.S. customers, and the member firm complies with all the conditions set forth in the rule.
Based solely on its activities in compliance with Rule 2040(c), a foreign finder would not be considered an associated person of the member firm. However, unless otherwise permitted by the federal securities laws or FINRA rules, a person who receives commissions or other transaction-based compensation in connection with securities transactions generally has to be a registered broker-dealer or an appropriately registered associated person of a broker-dealer who is supervised by a broker-dealer. Member firms that engage foreign finders would be required to have reasonable procedures that appropriately address the limited scope of activities permissible under such arrangements. Regulatory Notice.
The disqualification provisions of Rules 262 and 505 under the Securities Act make the exemptions from registration under Regulation A and Rule 505 of Regulation D unavailable for an offering if, among other things, an issuer, any of its predecessors, or any affiliated issuer is subject to certain administrative orders, industry bars, an injunction involving certain securities law violations or specified criminal convictions. Disqualification also occurs if any of the issuer’s directors, officers, general partners, 10 percent beneficial owners of any class of the issuer’s equity securities, or promoters, underwriters, persons compensated for soliciting purchasers, or any of the underwriters’ or paid solicitors’ partners, directors, or officers, is subject to administrative orders, injunctions, associational bars or specified convictions.
On March 13, the SEC clarified that it may waive Regulation A or Regulation D disqualifications upon a showing of good cause that it is not necessary under the circumstances that the exemptions be denied. A waiver could include conditions or limitations. The SEC has delegated authority to grant these waivers to the Director of its Division of Corporation Finance.
On February 27, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission and the Commodity Futures Trading Commission issued a new set of frequently asked questions and responses regarding the scope and implementation of Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as the “Volcker Rule.” Among the issues addressed are:
- Loan Securitization Servicing Assets: Are the “rights or other assets” described in § 44.10(c)(8)(i)(B) of the Volcker Rule (“servicing assets”) limited to “permitted securities,” or can other assets be servicing assets for purposes of the loan securitization exclusion?
- Mortgage-Backed Securities of Government-Sponsored Enterprise: How are certain mortgage-backed securities issuers sponsored by government-sponsored enterprises treated under the final rule’s covered funds provisions?
- Covered Fund Exemption; Marketing Restriction on Foreign Banking Organization: The Volcker Rule provides an exemption for certain covered fund activities conducted by foreign banking entities (known as the “SOTUS Covered Fund Exemption”) provided that, among other conditions, “no ownership interest in such hedge fund or private equity fund is offered for sale or sold to a resident of the United States” (the “marketing restriction”). Does the marketing restriction apply only to the activities of a foreign banking entity that is seeking to rely on the SOTUS covered fund exemption or does it apply more generally to the activities of any person offering for sale or selling ownership interests in the covered fund?
- Conformance Period: How do the requirements of the Volcker Rule apply to a banking entity during the conformance period? For instance, must a banking entity deduct its investment in a covered fund from its tier 1 capital prior to the end of the conformance period?
- Foreign Public Fund Seeding Vehicles: The Volcker Rule excludes from the definition of covered fund a registered investment company and business development company, including an entity that is formed and operated pursuant to a written plan to become one of these entities. Would an entity that is formed and operated pursuant to a written plan to become a foreign public fund receive the same treatment?
On February 3, the SEC’s Office of Compliance Inspections and Examinations (OCIE) published a Risk Alert that contains observations based on examinations of more than 100 broker-dealers and investment advisers. The examinations focused on how these firms:
- Identify cybersecurity risks
- Establish cybersecurity policies, procedures, and oversight processes
- Protect their networks and information
- Identify and address risks associated with remote access to client information, funds transfer requests, and third-party vendors
- Detect unauthorized activity
A second publication, an Investor Bulletin issued by the SEC’s Office of Investor Education and Advocacy (OIEA), provides core tips to help investors safeguard their online investment accounts, including:
- Pick a “strong” password
- Use two-step verification
- Exercise caution when using public networks and wireless connections
On August 19, the SEC Announced a Municipal Advisor Exam Initiative for newly registered municipal advisors. This “presence” exam initiative appears to be similar in scope and purpose to the “presence” examinations that the SEC has been conducting of investment advisers that were newly registered as a result of the implementation of the Dodd-Frank-Act.
SEC rules that took effect on July 1 generally require municipal advisors to register with the SEC under the final registration process during a four-month phase-in period by October 31. The examinations are designed to establish a presence with the newly regulated municipal advisors. Over the next two years, the SEC Staff plans to examine a significant percentage of these advisors using an approach that focuses on identified risks. Areas targeted for scrutiny may include the municipal advisor’s compliance with its fiduciary duty to its municipal entity clients, books and recordkeeping obligations, disclosure, fair dealing, supervision, and employee qualifications and training. Press Release.
On June 25, the SEC announced that it has ordered the national securities exchanges and the Financial Industry Regulatory Authority (FINRA) to act jointly to develop and file with the Commission a national market system plan to implement a targeted 12 month pilot program that will widen minimum quoting and trading increments (tick sizes) for certain small capitalization stocks. The Commission plans to use the program to assess whether these changes would enhance market quality to the benefit of U.S. investors, issuers and other market participants. Press Release.