Financial Services Alert - July 10, 2012

Goodwin Procter’s Trusts & Estate Planning Practice issued an Alert discussing the key points of the newly enacted Massachusetts Uniform Trust Code (MUTC), which has a significant impact on the administration of trusts.  This new legislation became effective immediately upon signing by the Governor on July 8, 2012.

The European Commission’s package of measures dealing with short selling is nearly complete, and the scope of the restrictions that will apply from November 1, 2012 is now clear.  This article considers the restrictions as they will apply to non-European persons trading outside the EU either in securities listed on exchange in the EU and/or in European sovereign debt.  The restrictions will apply irrespective of whether the trades actually take place on that European exchange.

The obligations apply also to non-European investment managers on an net aggregated basis where their underlying funds or portfolio management clients have short positions.

The measures consist of the substantive Regulation (No. 236/2012) and four implementing regulations that can all be found on the European Commission’s webpage here.

Summary

Key features of the requirements are as follows:

• Holdings of any short position (ignoring any stock borrowing agreements in place) of more than 0.2% (and each 0.1% above that) in the issued share capital of a company listed in the EU must be disclosed to the regulatory authority of the state in which the share is listed.  Short positions of more than 0.5% must also be publicly disclosed.  Persons who have a net short position in sovereign debt issued by an EU sovereign issuer must disclose that holding to the relevant country’s competent authority, although the disclosure threshold will vary depending an on the amount of outstanding debt issued by the sovereign entity (0.1% if the amount outstanding is 500 billion euros or less; 0.5% otherwise).  Disclosure under these rules must be made in the standard form set out in the implementing regulation.
• A person may enter into a short position in listed shares or sovereign debt only where it has made provisions to borrow the relevant security.  In other words, naked short positions are prohibited.  For these purposes, “borrowing” would include derivative contracts leading to physical settlement.
• Transactions in sovereign credit default swaps are permitted only in circumstances where they do not lead to an uncovered position.  In other words transactions are permitted only to hedge existing exposures.  The definition of a credit default swap (CDS) in the Regulation is broad enough to capture other similar financial instruments such as, for example, credit-linked notes.  It is worth noting that the definition of a prohibited “uncovered position” is narrower than the concept of exposure, however.  A person may have an exposure to the risk of default of a sovereign issuer other than just holding the relevant debt securities.  For example, a person who has shares in banks that have lent heavily to indebted countries is exposed to the risk of default; the purchase of a CDS on the relevant debt may therefore be permitted notwithstanding that the purchaser held no government debt directly.
• The local regulatory authority has the power to prohibit or restrict any form of  short selling of any financial instrument if the price of that instrument has declined “significantly” during a trading day in order to prevent a “disorderly decline in the price” of that instrument.  For liquid shares and bonds, this figure shall be at least 10%.

There are two relevant exemptions to the above restrictions:

• Where the principal trading venue is located in a non-European third country.  This will be an important provision for non-EU traders since they are more likely to be dealing in securities that are duly listed both in and outside the EU than would be a European person.  Whether the security is listed on a principal trading venue outside the EU will be a question of fact since the relevant European regulatory authorities will publicly determine where the principal trading venue is located for each share traded on a European market.  It will then be a matter of checking this publicly available list to determine where the principal venue is located and, therefore, whether this exemption is available.
• The provisions do not apply to market makers or to authorised primary dealers. Such persons are subject, however, to a requirement to notify the competent authority of the main trading venue in the union in which it trades at least 30 days before using the exemption or it will not be available.

The FDIC and FRB made available the public sections of resolution plans submitted by certain large bank holding companies (as required by Title I of the Dodd-Frank Act) to the FDIC and the FRB.  The plans are required to describe the reporting company’s strategy for rapid and orderly resolution under the Bankruptcy Code in the event the company is in material financial distress or is failing.  The financial institutions that were required to submit their resolution plans by July 2, 2012 (and all of whom met the deadline) were the initial group of nine financial institutions required to submit resolution plans.  The initial group included U.S. bank holding companies with $250 billion or more in total nonbank assets and foreign bank holding companies with $250 billion or more in total U.S. nonbank assets.  As reported by the financial press, the companies that submitted resolution plans used a broad variety of approaches.  Approaches included, among others, proposals to sell units individually, to sell units to hedge funds and to split off banking operations.  The FDIC stated that the resolution plans, whose public sections were made available, have not been edited or reviewed by the FDIC and are unchanged from the versions provided by the  bank holding companies that provided the plans.

The CFTC unanimously approved proposed interpretive guidance on the cross-border application of the swaps provisions of the Dodd-Frank Act.  The proposed guidance would interpret Section 2(i) of the Commodity Exchange Act (as amended by the Dodd-Frank Act), which states that the swaps provisions enacted as part of the Dodd-Frank Act shall not apply to activities outside the United States unless those activities have a direct and significant connection with activities in, or effect on, United States commerce. 

The proposed guidance would interpret the term “U.S. person” to include (i) any natural person who is resident in the United States, (ii) any corporation, partnership, or similar entity either (A) organized or incorporated under the laws of the United States or having its principal place of business in the United States, or (B) whose owners are responsible for the liabilities of such entity and one or more of whom is a U.S. person; or (iii) individual accounts, commodity pools, and other vehicles majority owned by U.S. persons or whose operator would be required to register as a commodity pool operator.  The guidance notes that, generally, a foreign branch or agency of a U.S. person would itself meet the definition of “U.S. person,” while a foreign affiliate or subsidiary of a U.S. person would not.  

The proposal would offer guidance regarding swap dealers and major swap participants, noting that the statutory definitions of “swap dealer” and “major swap participant” neither contain geographic limitations nor distinguish between U.S. and non-U.S. swap dealers or major swap participants.  Building on the de minimis thresholds established in the entity definition rules, the guidance proposes that a non-U.S. person whose level of swap dealing with U.S persons as counterparties exceeds the de minimis threshold would be required to register with the CFTC as a swap dealer.  The value of transactions with foreign branches of registered U.S. swap dealers would not be included for purposes of this calculation.  However, the calculation would include the value of any swap dealing transaction between the non-U.S. person or any of its non-U.S. affiliates under common control, on the one hand, and a U.S. person (other than foreign branches of U.S. persons registered as swap dealers), on the other.  It would also include the value of any swap dealing transaction between the non-U.S. person or any of its non-U.S. affiliates under common control where its obligations or the obligations of a non-U.S. affiliate are guaranteed by U.S. persons.  A roughly similar analysis would apply to major swap participants. 

Once registered, non-U.S. swap dealers and non-U.S. major swap participants would become subject to the Dodd-Frank Act provisions applicable to registered swap dealers and major swap participants.  However, the CFTC indicated that it would apply its authority “in a manner consistent with principles of international comity.”  To accomplish this, the proposed guidance would divide the relevant Dodd-Frank Act provisions into two categories:  “entity-level requirements,” which would apply to the firm or entity as a whole, and “transaction-level requirements,” which would apply to an individual swap.  Entity-level requirements would include statutory provisions and CFTC regulations regarding capital adequacy, risk management, chief compliance officers, and various record-keeping and reporting rules, which apply across all of a registrant’s swaps regardless of the counterparty or location of individual swaps.  Transaction-level requirements would include (i) clearing and swap processing, (ii) margining and segregation for uncleared swaps, (iii) trade execution, (iv) swap trading relationship documentation, (v) portfolio reconciliation and compression, (vi) real-time public reporting, (vii) trade confirmation, (viii) daily trading records, and (ix) external business conduct standards.

The proposed guidance would require registered non-U.S. swap dealers and non-U.S. major swap participants to comply with the entity-level requirements, although “substituted compliance,” in which complying with foreign regulations would be deemed to satisfy this requirement, would be permitted in certain circumstances.  The proposed guidance would, however, require non-U.S. swap dealers and non-U.S. major swap participants to comply with the transaction-level requirements for all their swaps with U.S. persons, other than foreign branches of U.S. persons, as counterparties.  Substituted compliance would generally not be permitted for transaction-level requirements. 

Although the CFTC is not required to solicit comments on interpretive guidance, it has chosen to do so here.  Comments are due 45 days after the guidance’s forthcoming publication in the Federal Register.

FINRA issued Regulatory Notice 12-34 requesting comment concerning rule changes FINRA should consider for the regulation of crowdfunding intermediaries.  The crowdfunding provisions in Title III of the JOBS Act provide an exemption from registration under the Securities Act of 1933 for securities offered by issuers in amounts of up to $1 million over a 12-month period, provided that the conditions of the exemption are met.  An intermediary that seeks to engage in crowdfunding must be registered as a broker-dealer or a funding portal, a newly created type of entity.  The JOBS Act mandates that each registered funding portal be a member of an applicable SRO, but limits the examination and enforcement authority of the SRO over registered funding portals to rules “written specifically for registered funding portals.”

In response to a suggestion by the SEC staff that FINRA consider adopting its own crowdfunding rules, FINRA is requesting comment in advance of rulemaking.  FINRA notes that in writing rules for registered funding portals, it would seek to ensure that the capital-raising objectives of the JOBS Act are advanced in a manner consistent with investor protection.  Commenters are asked to identify the types of requirements that should apply to registered funding portals, with particular attention to possible rules concerning supervision, advertising, anti-money laundering, fraud and manipulation, and just and equitable principles of trade.

FINRA also seeks comment on how member firms that act as crowdfunding intermediaries should be regulated and whether rules currently applicable to member firms should be relaxed in connection with crowdfunding activities.  FINRA requests information about how crowdfunding activities are likely to be conducted organizationally – for example, whether they would be conducted by a department of the member firm or moved into a separate, unregistered entity.

Comments must be received by August 31, 2012.

The CFTC issued for public comment a proposed exemptive order that would grant temporary exemptive relief to allow non-U.S. swap dealers and non-U.S. major swap participants to delay compliance with most of the entity-level requirements (excluding certain reporting requirements for swaps with U.S. counterparties) under certain conditions.  It would also allow those parties, as well as foreign branches of U.S. swap dealers and U.S. major swap participants, to temporarily comply only with the transaction-level requirements in the applicable home jurisdiction or branch location for swaps with non-U.S. counterparties.  The temporary relief would expire 12 months following the publication of the proposed order in the Federal Register.

Under the proposal, U.S. swap dealers and U.S. major swap participants would be able to delay compliance with certain entity-level requirements until January 1, 2013. 

Entities seeking to avail themselves of the phased compliance periods would be required to register as a swap dealer or major swap participant with the National Futures Association, and to submit to the NFA a compliance plan explaining how it intends to comply with all applicable requirements under the Commodity Exchange Act.  

Comments on the proposal are due 30 days after its forthcoming publication in the Federal Register.

The FRB issued a Supervision and Regulation letter, SR 12-10, providing a set of questions and answers (“Q&As”) regarding the management of other real estate owned (“OREO”).  The FRB stated that the Q&As, which do not replace prior FRB guidance, are “intended to clarify existing policies and promote prudent practices for the management of an institution’s OREO assets, addressing both safety and soundness policies and consumer compliance issues.”  The Q&As cover six principal types of issues: (1) transferring an asset to OREO; (2) reporting treatment and classification of an OREO asset; (3) appraisals; (4) property management; (5) operational and legal issues; and (6) sale and transfer of OREO assets.