Financial Services Alert - January 21, 2014

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) announced the 2014 examination priorities (the “Announcement”) for its National Examination Program (the “NEP”).  The priorities are organized according to the NEP’s four distinct program areas: (a) investment advisers and investment companies, (b) broker‑dealers, (c) exchanges and self-regulatory organizations, and (d) clearing and transfer agents.  This article presents selected highlights of the examination priorities for investment advisers and investment companies.

Corporate Governance, Conflicts of Interest and Enterprise Risk Management.  The NEP examination priorities include a number of topics that apply broadly across SEC registrant categories.  Among these is an ongoing effort to meet with senior management and boards of entities registered with the SEC and their affiliates to discuss “how each firm identifies and mitigates conflicts of interest and legal, compliance, financial, and operational risks.”  As described in the Announcement, “[t]his initiative is designed to: (i) evaluate firms’ control environment and ‘tone at the top,’ (ii) understand firms’ approach to conflict and risk management, and (iii) initiate a dialogue on key risks and regulatory requirements.”

Presence Exams. The SEC staff will continue its initiative to examine a significant percentage of the advisers newly registered as a result of the Dodd-Frank Act, with a focus on the following key areas: (1) marketing, (2) portfolio management, (3) conflicts of interest, (4) safety of client assets and (5) valuation.  Indicia of broker-dealer status concerns, cited in 2013 speech by David W. Blass, Chief Counsel of the Division of Trading and Markets, is among the factors cited in the Announcement for prioritizing examinations of private fund advisers.  The Announcement notes that as of September 30, 2013, over 200 presence exams had been completed and the Presence Exam initiative was on pace to meet its goal of “touching” 25% of newly registered advisers within two years.

Never-Before Examined Advisers.  In a new initiative, the SEC staff will conduct “focused, risk-based examinations” of advisers that have been registered for more than three years but have not yet been examined by the NEP and are not part of the Presence Exam initiative.

General Solicitation Practices.  Designated as one of the most significant of the NEP-wide initiatives is the review of general solicitation practices and the verification of accredited investor status in conjunction with reliance on newly adopted Rule 506(c) under the Securities Act of 1933.  The staff “generally will review, monitor, and analyze the use of Rule 506(c); and will evaluate due diligence conducted by broker-dealers and investment advisers for such offerings.”   (See this article in the July 23, 2013 Financial Services Alert for a discussion of Rule 506(c) and this article in that issue for a discussion concerning a coordinated initiative on the part of various branches of the SEC, including the Division of Enforcement, to analyze the market impact of, and market practices that develop as result of, permitting general solicitation in connection with private offerings under Rule 506(c).)     

Marketing/Performance. The staff will review advisers’ claims about their investment objectives and performance.  “For example, the staff will review and test hypothetical and back-tested performance, the use and disclosure of composite performance figures, performance record keeping, and compliance oversight of marketing.” 

Adviser Conflicts of Interest.  The Announcement cites the following specific types of potential conflicts of interest as focus areas in adviser examinations: (a) compensation arrangements, “with a particular focus on undisclosed compensation arrangements and their effect on recommendations made to clients,” (b) allocation of investment opportunities, (c) side-by-side management of accounts with performance-based fees and accounts with purely asset-based fees, and (d) risk controls and disclosure, particularly for illiquid investments and leveraged investment products and strategies.

Quantitative Trading Models.  NEP staff will examine investment advisers that rely substantially on quantitative portfolio management and trading strategies and assess, among other things, whether these firms have adopted and implemented compliance policies and procedures tailored to the performance and maintenance of their proprietary models, including procedures that (i) evaluate if models are used to manipulate the markets, (ii) reasonably review models and their output over time, (iii) maintain required books and records, and (iv) maintain a current inventory of all firm-wide proprietary models.

Registered Funds.  NEP staff will target some examinations at money market funds, with a particular focus on (1) the management of any potential stress events and (2) money market funds that exhibit “outlier behavior in some respect.”  The staff will continue its review of payments made by advisers and funds to distributors and intermediaries, disclosures made to fund boards about these payments, and related board oversight.   In addition, the staff will monitor the risks associated with changing interest rates and how they may affect fixed income funds and related risk disclosures, a topic also addressed in a January 2014 IM Guidance Update discussed elsewhere in this issue.

The Staff of the SEC’s Division of Investment Management issued IM Guidance Update 2014-1 which suggests risk management measures and related communications with fund boards that fund advisers may want to consider in view of changing conditions in the fixed income markets.   Among the risk management measures discussed are the following: (1) assessing fund liquidity and conducting stress tests over varying time periods; (2) assessing other potential stress scenarios, such as interest rate hikes, widening spreads, price shocks to fixed income products, increased volatility and reduced liquidity; and (3) analyzing the foregoing assessments to develop appropriate risk management strategies at a fund or complex level, potentially involving portfolio composition, concentrations, diversification and liquidity. The Update also suggests that fixed income funds should assess the adequacy of their disclosures to shareholders in light of any additional risks due to recent events in the fixed income markets and the potential impact of tapering quantitative easing and/or rising interest rates, including the potential for periods of volatility and increased redemptions.

The SEC’s Office of Municipal Securities has released a list of frequently asked questions (the “FAQs”) that presents its views regarding various aspects of the SEC’s municipal advisor registration rules (the “Final Rules”) (discussed in the October 8, 2013 Financial Services Alert and in a Client Alert focused on banks and trust companies). 

The FAQs, which may be updated periodically, provide answers to eighteen questions divided into 9 categories. 

What Constitutes “Advice”

Several questions address the issue of what constitutes “advice” for purposes of the Final Rules.  The FAQs reiterate statements made in the rule release (the “Adopting Release”) that accompanied the Final Rules that the term “advice” is not subject to a bright-line definition and that a determination of whether or not a person provides advice must be based on a facts and circumstances analysis.  However, the FAQs list a number of examples of factual information that, if provided without subjective assumptions, opinions, or views, would allow a person providing such facts to rely on the “general information exclusion” that excludes “advice” to a municipal entity or obligated person that provides general information and does not involve a recommendation regarding municipal financial products or the issuance of municipal securities.  Examples of such general information listed in the FAQs include factual information describing and even comparing the “general characteristics, risks, advantages, and disadvantages” of various forms of debt financing structures.  Providing factual and educational information regarding government financing programs and incentives would also not be considered “advice” according to the FAQs. 

The FAQs add that information may be tailored “in limited respects” to the municipal entity or obligated person and still fall within the general information exclusion from advice.  The FAQs include an example of a person providing general market information pertaining to a municipal entity’s outstanding bonds.  However, the FAQs also state that more specifically tailored factual statements could “imply a recommendation that could constitute advice.” Presenting various debt financing structuring options crafted “to address the specific needs, objectives, or circumstances of a municipal entity or obligated person” would, according to the FAQs, “likely…suggest a preferred financing approach” that could constitute a recommendation outside the scope of the general information exclusion. 

The FAQs provide that certain “clearly and conspicuously stated” disclosures and disclaimers would weigh against considering the provision of certain information to be a recommendation that constitutes advice.  Examples of these disclosures and disclaimers include statements that the person providing the information is not recommending an action, that the person is not acting as an adviser to the municipal entity or obligated person, and that the municipal entity or obligated person should discuss the information provided with its own advisers and experts.  The FAQs add, however, that the use of such disclosures and disclaimers is not controlling and is instead just a factor in the analysis of whether or not given information constitutes advice.  Therefore, simply adding such disclosures and disclaimers to written materials that clearly contain recommendations and advice would not be sufficient to excuse the person providing the materials from the obligation to register under the Final Rules.

Investment Adviser Exception

The FAQs also clarify the exclusion of registered investment advisers providing investment advice in such capacity from the definition of “municipal advisor.” Noting that “investment advice” is defined to exclude, among other things, advice concerning municipal derivatives, the FAQs clarify the view of the SEC staff that “advice concerning municipal derivatives” was meant to refer to advice regarding municipal derivatives used by municipal entities or obligated persons in connection with issuing municipal securities.  That is, the term is not intended to cover investment advisory services regarding municipal derivatives in an investment portfolio.  As a result, registered investment advisers are permitted to advise municipal entities and obligated persons regarding municipal derivatives in an investment portfolio without registering as municipal advisors. 

Underwriter Exception

Two questions in the FAQs concern situations in which a broker-dealer, acting as an underwriter for an issuance of municipal securities, discovers an error or omission in the course of its work.  The first question asks whether a broker-dealer that realizes that there is a material omission in the offering document after the issuance has closed and the underwriting period has terminated may recommend that the municipal entity prepare an offering supplement.  The FAQs clarify that, although the Adopting Release states that providing advice after the end of the underwriting period would be outside the scope of the underwriter exclusion, the broker-dealer would be permitted to advise the municipal entity to prepare a supplement to rectify the omission without registering as a municipal advisor.  The FAQs explain that such advice is “integral to” the broker-dealer’s underwriting responsibility and promotes compliance with the anti-fraud provisions of the securities laws.  Similarly, the second question asks whether a broker-dealer engaged to serve as underwriter for an issuance of municipal securities that discovers that the municipal entity has failed, during the previous five years, to comply with a continuing disclosure agreement pertaining to an outstanding issuance of municipal securities may advise the municipal entity to take corrective actions.  Again, the FAQs state that the broker-dealer may rely on the underwriter exclusion to advise the municipal entity to take corrective actions, such as completing the missing filings, without having to register as a municipal advisor.  The FAQs explain that the broker-dealer providing such advice would be fulfilling its obligation to ensure that the offering document for the current offering is materially accurate and complete, and would also be promoting compliance with the anti-fraud provisions of the securities laws. 

The SEC has issued a temporary stay of its municipal advisor registration rules (the “Final Rules”).  The stay means that the rules, which were to become effective on January 13, 2014, will not apply until July 1, 2014.  Municipal advisors continue to be subject to the temporary registration regime and the related statutory and regulatory requirements.  However, the stay provides that compliance with the Final Rules will not be required until July 1.

The requirements in the Final Rules that municipal advisors register on Form MA and related forms on a staggered basis starting on July 1, 2014 is unaffected by the stay.  Municipal advisors must therefore file for permanent registration according to the timeframe provided in the Final Rules.

In a letter to all FINRA member firms (the “FINRA Priorities Letter”), FINRA set forth its regulatory and examination priorities for 2014, highlighting significant risks and issues that could adversely affect investors and market integrity in the coming year. 

FINRA’s 2014 examination priorities are as follows:

Business Conduct Priorities

Suitability.  FINRA remains concerned about the suitability of recommendations to retail investors for complex products whose risk-return profiles, including their sensitivity to interest rate changes, underlying product or index volatility, fee structures or complexity may be challenging for investors to understand.  In this regard, the FINRA Priorities Letter states that, among other things, FINRA will be focused on the sale and suitability of:

• Complex structured products
• Non-traded real estate investment trusts
• Frontier funds (often investing in politically unstable regions of the world)
• Interest Rate Sensitive Securities, including mortgage-backed securities, long duration bonds and bond funds, emerging market debt, municipal securities, and baby bonds.

Recidivist Brokers.  FINRA noted that a small number of brokers have a pattern of complaints or disclosures for sales practice abuses that could harm investors as well as the reputation of the securities industry and financial markets.  FINRA will be expanding the High Risk Broker initiative, which was commenced in 2013 to identify such individuals and expedite investigations, and will create an enforcement team to prosecute such cases.

Conflicts of Interest.  FINRA stated that its examiners will explore topics addressed in its October 2013 report on conflicts of interest including firms’ approaches to identifying and managing conflicts as well as the participation of senior management in this process.  FINRA will evaluate firms’ conflicts management practices to help further inform its view on industry practices by focusing primarily on actions taken by firms and the impact on their clients, rather than focusing strictly on regulatory requirements.

Cybersecurity.  FINRA stated that its primary focus will be the integrity of firms’ policies, procedures and controls to protect sensitive customer data, and that its evaluation of cybersecurity matters will take the form of examinations and targeted investigations. 

Qualified Plan Rollovers.  FINRA noted that it shares concerns, articulated by the U.S. Government Accountability Office (“GAO”) in its 2013 Report, that the financial industry generally encourages employees to roll over their assets into IRAs without fully explaining the options that are available to these investors or making a valid determination that a rollover into an IRA is in the investor’s best interest.  Reviewing firm rollover practices will be an examination priority, and staff will examine firms’ marketing materials and supervision in this area.  FINRA will also evaluate securities recommendations made in rollover scenarios to determine whether they comply with suitability standards in FINRA Rule 2111.

Initial Public Offering Market.  FINRA noted the increase in the initial public offering (“IPO”) market during recent periods, and stated that for firms engaged in the public underwriting business, FINRA will review the firm’s due diligence activities, monitor the completeness and accuracy of firms’ filings regarding public underwritings with FINRA’s Corporate Finance Department, and review compliance with rules concerning the sales and allocations of IPO securities, including whether firms are incenting associated persons to sell cold offerings with client allocations of hot offerings.

Private Placement of Securities.  The FINRA Priorities Letter identifies private placements of securities as a priority, including a focus on:

• General Solicitation and Advertising of Private Placements.  FINRA reiterated its longstanding concern about abuses in the sale and marketing of private placement of securities, noting that recent amendments to Rule 506 of Regulation D permit, subject to certain limitations, general solicitation and advertising when offering some private placements.
• Due Diligence and Suitability of Private Placements.  FINRA stated that it will examine firm private placement activity to determine whether firms are taking reasonable steps to validate that investors meet accredited investor standards prescribed by Rule 506.
• Offerings of Securities through Private Placements.  FINRA will verify that firms are making required filings under FINRA Rules 5122 and 5123.

Anti-Money Laundering.  FINRA stated that in 2014 it will focus on anti-money laundering issues associated with the institutional business, noting emerging trends related to the utilization of executing broker-dealers by certain DVP/RVP (Delivery versus Payment/Receipt versus Payment) customers to liquidate large volumes of low-priced securities.  FINRA also noted the misconception among some executing brokers that Customer Identification Program Requirements do not apply to DVP/RVP customers.  In this regard, FINRA stated that it is important that all firms, regardless of business model, develop a risk-based AML program designed to address the risk of money laundering specific to their firm.

Municipal Advisors.  FINRA noted recent rules regarding municipal advisors promulgated by the SEC and that FINRA has been designated as the examining authority for municipal advisors that are FINRA members. 

Crowdfunding Portals.  FINRA noted that under the Jumpstart our Business Startups Act (the “JOBS Act”) retail investors are permitted to purchase unregistered securities offered through crowdfunding websites, and that FINRA has proposed rules with the objective of ensuring that the capital-raising objectives of the JOBS Act are advanced in a manner consistent with investor protection.  FINRA stated that as funding portals become FINRA members, FINRA will implement a regulatory program designed to protect investors while recognizing the distinctions between funding portals and broker-dealers.

Senior Investors.  FINRA stated that in 2014 its examiners will continue to focus on how firms engage with investors who are approaching retirement and who control a substantial portion of investable assets.

Fraud Detection Priorities

Microcap Fraud.  FINRA stated that microcap and low-priced over-the-counter (“OTC”) securities continue to be an area of significant concern. 

Insider Trading.  FINRA stated that insider trading continues to be a top regulatory priority and reiterated its points made in its 2013 examination priorities letter (the “2013 Priorities Letter”).  Specifically, FINRA stated that firms must continue to be vigilant in safeguarding material, non-public information, and should periodically assess information barriers and risk controls to ensure they are adequate.

Financial and Operational Priorities

Funding and Liquidity Risk.  FINRA stated that it will continue to be focused on funding and liquidity risk in 2014, noting that in 2014 it will ask many larger firms to perform a liquidity stress test that incorporates factors FINRA believes are important to understanding the resiliency of the firm’s liquidity position.  Specifically, FINRA will require stress-testing in the following four basic areas of the firm’s business: (a) stressed funding of proprietary positions (loss of counterparties, loss of funding for less liquid assets, widening of haircuts); (b) stressing of repo book (loss of counterparties, loss of internally generated liquidity, widening of haircuts); (c) stressing settlement payments and clearing deposits with clearing banks, central counterparties (CCPs) and clearing organizations; and (d) funding loss of customer balances or increases in obligations to lend to customers.

Risk Control Documentation and Assessment.  FINRA noted recent amendments to Rule 17a-3 of the Securities Exchange Act of 1934 which will require firms that hold more than $1 million in aggregate customer credits or $20 million in capital, including subordinated debt, to document their credit, market and liquidity risk management controls, and stated that it will examine these risk controls in 2014.

Accuracy of Firm’s Financial Statements and Net Capital.  FINRA stated that firms must be in a position to prepare accurate financial statements throughout the year, noting that areas of continued concern include: (a) failure to apply Open Contractual Commitment Charges, haircuts, undue concentration or blockage charges; (b) failure to comply with the Net Capital Rule at all times and, as a related item, failure to cease operations when a firm is under required capital until the net capital deficiency is cured; (c) failure to prepare books and records on an accrual basis, or only making proper accruals at the end of a broker-dealer’s fiscal year; and (d) netting transactions in the absence of authoritative accounting guidance which permits such netting.

Auditor Independence.  FINRA noted recent findings by the Public Company Accounting Oversight Board regarding the lack of independence by auditors of small broker-dealers.

Market Regulation Priorities 

Algorithmic Trading and Trading Systems.  FINRA noted that there have been a number of algorithmic trading malfunctions in recent years that have caused substantial market disruptions and raise concerns about firms’ ability to develop, implement and effectively supervise these systems.  In this regard, FINRA reiterated a number of comments from the 2013 Priorities Letter, noting that it will continue to assess whether firms’ testing and controls related to high frequency trading (“HFT”) and other algorithmic strategies and trading systems are adequate in light of the Market Access Rule and firms’ other supervisory obligations.

High Frequency and Other Algorithmic Trading Abuses.  FINRA noted the growth of HFT strategies in recent years and noted that some HFT strategies may be used for manipulative purposes.  In this regard, FINRA stated that firms’ need to be vigilant and outlined certain specific areas of concern that will be a focus of FINRA’s 2014 examinations.

Audit Trail Integrity.  FINRA notes that it has perceived significant, prolonged and wide-scale deficiencies in Large Options Positions Reporting (“LOPR”) and in properly marking the capacity of firm option orders.  FINRA stated that firms should assess their supervisory controls in these areas and that in 2014 FINRA anticipates focusing on in-concert reporting deficiencies, improper position deletions, non-reporting of positions, and the process that firms use to internally determine whether an OTC position qualifies as a reportable options position.

Best Execution of Equities, Options and Fixed Income Securities.  FINRA noted that has introduced new surveillance patterns to monitor best execution in equities and fixed income securities, and new procedures to monitor for best execution with respect to options transactions.  Among other things, FINRA stated that it will focus more closely on firms’ practices to ensure compliance with their best execution obligations with respect to limit orders in equity securities, and will review situations where a firm potentially ignores a favorable price on one options market and executes a trade on another to the detriment of the Customer.

Conclusion

FINRA encouraged firms to use the FINRA Priorities Letter, along with its own analysis, to enhance their compliance programs, stating that FINRA will be examining for strong controls and robust compliance efforts in the areas identified in the FINRA Priorities Letter.

The Federal Reserve Board (the “FRB” or the “Board”)  issued an advance notice of proposed rulemaking (the “ANPR”) seeking public comment on issues related to activities concerning physical commodities conducted by financial holding companies (“FHCs,” and each a “FHC”) and the restrictions needed to make certain that those activities are conducted in a safe and sound manner that is consistent with applicable law.  The FRB said that the applicable activities are those: (1) found to be “complementary to a financial activity” under section 4(k)(1)(B) of the Bank Holding Company Act (the “BHC Act”); (2) investment activities under section 4(k)(1)(H) of the BHC Act; and (3) physical commodity activities grandfathered under section 4(o) of the BHC Act.  Specifically, the activities related to physical commodities in which the Board has currently authorized FHCs to engage are:

“(1) physical commodity trading involving the purchase and sale of commodities in the spot market, and taking and making delivery of physical commodities to settle commodity derivatives (Physical Commodity Trading); (2) paying power plant owners fixed periodic payments that compensate the owner for its fixed costs in exchange for the right to all or part of the plant’s power output (Energy Tolling); and (3) providing transactions and advisory services to power plant owners (Energy Management Services).”

(collectively, “Complementary Commodities Activities”).

In the ANPR, the FRB notes that in the past several years, banking organizations have increased their activities involving physical commodity trading and during the same period, certain events (including the recent, global financial crisis and various environmental catastrophes) occurred that “suggest that the risks of conducting these activities are changing and the steps that firms may take to limit these risks are more limited.”

The 24 questions regarding the activities related to physical commodities that are posed by the FRB in the ANPR are:

            Question 1.  What criteria should the Board look to when determining whether a physical commodity poses an undue risk to the safety and soundness of a FHC?

            Question 2.  What additional conditions, if any, should the Board impose on Complementary Commodities Activities?  For example, are the risks of these activities adequately addressed by imposing one or more of the following requirements: (i) enhanced capital requirements for Complementary Commodities Activities, (ii) increased insurance requirements for Complementary Commodities Activities, and (iii) reductions in the amount of assets and revenue attributable to Complementary Commodities Activities, including absolute dollar limits and caps based on a percentage of the FHC’s regulatory capital or revenue?

            Question 3.  What additional conditions on Complementary Commodities Activities should the Board impose to provide meaningful protections against the legal, reputational and environmental risks associated with physical commodities and how effective would such conditions be?

            Question 4.  To what extent does the commitment that a FHC will only hold physical commodities for which a futures contract has been approved by the CFTC or for which the Board has specifically authorized the FHC to hold adequately ensure that physical commodities positions of FHCs are sufficiently liquid? What modifications to this commitment, including additional conditions, should the Board consider to ensure that a FHC maintains adequate liquidity in its commodity positions?

            Question 5.  What additional commitments or restrictions are necessary to ensure FHCs engaging in Complementary Commodities Activities do not develop unsafe or unsound concentrations in physical commodities?

            Question 6.  Should the type and scope of limitations on Complementary Commodities Activities differ based on whether the underlying physical commodity may be associated with catastrophic risks?  If so, how should limitations differ, and what specific limitations could reduce liability from potential catastrophic events?

            Question 7.  Does the commitment not to own, operate or invest in facilities for the extraction, transportation, storage, or distribution of commodities adequately insulate a FHC from risks associated with such facilities, including financial risk, storage risk, transportation risk, reputation risk, and legal and environmental risks?  If not, what restrictions should the Board impose to ensure that such extraction, transportation, storage or distribution facilities do not pose safety and soundness risks?

            Question 8.  Do Complementary Commodities Activities pose risks or raise concerns other than those described in this ANPR, and if so, how should those risks or concerns be addressed?

            Question 9.   What negative effects, if any, would a FHC’s subsidiary depository institution experience if the parent FHC was not able to engage in Complementary Commodities Activities?

            Question 10.  How effective is the current value-at-risk capital framework in addressing the risk arising from holdings of physical commodities? Would additional or different capital requirements better address the potential risks associated with Complementary Commodities Activities?

            Question 11.  What are the similarities and differences between the risks posed to FHCs by physical commodities activities, as described in this ANPR, and the risks posed to nonbank financial companies supervised by the Board (“nonbank SIFIs”)?  How do the safety and soundness and financial stability risks posed by physical commodities activities differ, if at all, based on whether the nonbank SIFI controls an IDI?

            Question 12.  What are the similarities and differences between the risks posed to FHCs by physical commodities activities, as described in the ANPR, and the risks posed to savings and loan holding companies that may conduct such activities?  How do the safety and soundness and financial stability risks posed by physical commodities activities differ, if at all, based on whether the savings and loan holding company is or is not affiliated with an insurance company?

            Question 13.  In what ways are non-BHC participants in the physical commodities markets combining financial and nonfinancial products or services in such markets?

            Question 14.  What are the complementarities or synergies between Complementary Commodities Activities and the financial activities of FHCs? How have these complementarities or synergies changed over time?

            Question 15.  What are the competitive effects on commodities markets of FHC engagement in Complementary Commodities Activities?

            Question 16.  Does permitting FHCs to engage in Complementary Commodities Activities create material conflicts of interest that are not addressed by existing law?  If so, describe such material conflicts and how they may be addressed.

            Question 17.  What are the potential adverse effects and public benefits of FHCs engaging in Complementary Commodities Activities?  Do the potential adverse effects of FHCs engaging in Complementary Commodities Activities, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, unsound banking practices, or risk to the stability of the United States banking or financial system, outweigh the public benefits, such as greater convenience, increased competition, or gains in efficiency?

            Question 18.  In what ways would FHCs be disadvantaged if they did not have authority to engage in Complementary Commodities Activities?  How might elimination of the authority affect FHC customers and the relevant markets?

            Question 19.  Should the Board’s merchant banking rules regarding holding periods, routine management, or prudential requirements be more restrictive for investments in portfolio companies that pose significantly greater risks to the safety and soundness of the investing FHC or its subsidiary depository institution(s)?  How could the Board evaluate the types and degrees of risks posed by individual portfolio companies or commercial industries?

            Question 20.  Do the Board’s current routine management restrictions and risk management requirements sufficiently protect against a court piercing the corporate veil of a FHC’s portfolio company?  If not, what additional restrictions or requirements would better ensure against successful veil piercing actions?

            Question 21.  What are the advantages and disadvantages of the Board raising capital requirements on merchant banking investments or placing limits on the total amount of merchant banking investments made by a FHC?  How should the Board formulate any such capital requirements or limits?

            Question 22.  What are the similarities and differences between the risks described above regarding merchant banking investments and the risks regarding investments made under section 4(k)(4)(I) of the BHC Act, which allows insurance companies to make controlling investments in nonfinancial companies (subject to certain restrictions)?

            Question 23.  What are the advantages and disadvantages of the Board instituting additional safety and soundness, capital, liquidity, reporting, or disclosure requirements for BHCs engaging in activities or investments under section 4(o) of the BHC Act?  How should the Board formulate such requirements?

            Question 24.  Does section 4(o) of the BHC Act create competitive equity or other issues or authorize activities that cannot be conducted in a safe and sound manner by an FHC?  If so, describe such issues or activities.

Comments on the ANPR are due no later than March 15, 2014.