Financial Services Alert - June 26, 2012 June 26, 2012
In This Issue

SEC Adopts Final Rules for Dodd-Frank Exchange Listing Standards Governing Compensation Committees

The SEC issued a final rule (the “Final Rule”) and a final amendment to the proxy rules (the “Proxy Rules Amendment”) that are designed to implement provisions of Section 952 of the Dodd-Frank Act, which added new Section 10C to the Securities Exchange Act of 1934 (“1934 Act”).  Section 10C requires the SEC to adopt rules directing the national securities exchanges and national securities associations (collectively referred to in this article as “national securities exchanges”) to prohibit the initial or continued listing of any equity security of an issuer that is not in compliance with Section 10C’s requirements regarding compensation committees and compensation consultants, legal counsel and other advisers (“compensation advisers”).  The Final Rule directs national securities exchanges to establish listing standards that impose independence standards on a compensation committee’s members, require a compensation committee to have the authority to engage, oversee and compensate compensation advisers and require compensation committees to consider independence-related factors before selecting or obtaining advice from compensation advisers other than in-house legal counsel.  The Proxy Rules Amendment revises the disclosure requirements for proxy materials relating to the election of directors at an annual meeting to include additional disclosures regarding the use of compensation advisers and related conflicts of interest. 

Current SEC rules do not require, and the Final Rule does not mandate, that an issuer establish a compensation committee or a committee that performs functions typically assigned to a compensation committee.  However, current national securities exchange listing standards generally require listed issuers either to have a compensation committee or to have independent directors determine, recommend or oversee specified executive compensation matters. 

Principal provisions of the Final Rule and the Proxy Rules Amendment are summarized below.

Final Rule

“Compensation Committee”.  The SEC’s proposal did not define the “compensation committee” to which Section 10C’s mandated listing standards should apply.  In response to public comment on the proposal, the Final Rule defines “compensation committee” as (1) any formally designated compensation committee, (2) any committee of the board that performs functions typically performed by a compensation committee, including oversight of executive compensation, whether or not formally designated as a compensation committee, and (3) in the absence of any committee in either of the foregoing categories, those members of a listed company’s board who oversee executive compensation matters on behalf of the board.

Compensation Committee Independence.  The Final Rule requires national securities exchanges to establish listing standards that require each member of a listed issuer’s compensation committee to be a member of the board of directors and be “independent.”  Independence for this purpose is not defined by federal statute or by the Final Rule but is to be defined by the national securities exchanges after taking into consideration “relevant factors,” including (1) the source of compensation paid to a director including any consulting, advisory, or other compensatory fee paid by the issuer, and (2) whether a director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer. 

Compensation Advisers.  Under the Final Rule, a national securities exchange’s listing standards must include the following requirements: (1) a compensation committee must have the authority, in its sole discretion, to retain or obtain the advice of compensation advisers; (2) a compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser it retains; (3) a compensation committee must take into consideration specific factors relating to the adviser’s independence identified by the SEC and any additional factors identified by a national securities exchange as part of its listing standards before either selecting a compensation adviser or obtaining advice from any compensation adviser other than in-house legal counsel; and (4) a listed issuer must provide appropriate funding for the payment of reasonable compensation, as determined by its compensation committee, to compensation advisers retained by the compensation committee.  Requirements (1) and (4) do not apply to directors who oversee executive compensation matters outside a formal board committee structure.

Exemptions.  The Final Rule does not apply to (1) controlled companies; (2) smaller reporting companies; and (3) the listing of certain security futures products and certain standardized options.  A national securities exchange may also choose to exempt from its listing standards adopted pursuant to the Final Rule such categories of issuers as it deems appropriate, taking into account, among other relevant factors, the potential impact of the listing standards on smaller reporting issuers.  In addition, the following types of issuers are not subject to the Final Rule’s independence requirements for compensation committee members: (a) limited partnerships; (b) companies in bankruptcy proceedings; (c) registered open-end management investment companies (mutual funds); and (d) certain foreign private issuers. 

Effective and Compliance Dates.  The Final Rule will become effective 30 days following its publication in the Federal Register.  Each national securities exchange must submit to the SEC, no later than 90 days following publication of the Final Rule in the Federal Register, proposed rule changes that comply with the Final Rule.  Each national securities exchange must have final rules or rule amendments that comply with the Final Rule approved by the SEC no later than one year following publication of the Final Rule in the Federal Register.

Proxy Rules Amendment

Section 10C(c)(2) of the 1934 Act requires the SEC to adopt new proxy disclosure requirements concerning the use of compensation consultants and related conflicts of interest.  The Proxy Rules Amendment implements this mandate by adding to Item 407(e) of Regulation S-K a disclosure requirement regarding any conflicts of interest raised by the use of a compensation consultant.  Item 407 applies to issuers registered under the 1934 Act, other than registered investment companies, with respect to any proxy or information statement relating to an annual meeting of shareholders at which directors are to be elected (or special meeting in lieu of an annual meeting).  Issuers must comply with the Proxy Rules Amendment in any proxy or information statement for an annual meeting of shareholders (or a special meeting in lieu of an annual meeting) at which directors will be elected occurring on or after January 1, 2013.

OCC Issues Interim Final Rule on Lending Limit, Which Implements Section 610 of Dodd-Frank Act and Applies to Certain Exposures Related to Derivatives Transactions and Securities Financing Transactions

The OCC adopted an interim final rule (the “Interim Final Rule”) that implements Section 610 of the Dodd-Frank Act (“Section 610”) and expands the statutory definition of “loans and extensions of credit” for the consolidated lending limit rule which will be applicable to national banks and federal and state-chartered savings associations.  The Interim Final Rule eliminates the OCC’s separate lending limit regulation for savings associations.  In general, a national bank’s or savings association’s extensions of credit to a single borrower are limited to 15% of the institution’s unimpaired capital and surplus, if unsecured and 25% of unimpaired capital and surplus, if fully secured.  State-chartered banks (but not state-chartered savings associations) are subject to separate lending restrictions under Section 611 of the Dodd-Frank Act.

The definition of “loans and extensions of credit under Section 610 and the Interim Final Rule includes any exposure to a person arising from a derivative transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrower transaction.”  Section 610 and the Interim Final Rule also add a definition of “derivative transaction” that includes any transaction that is a contract, agreement, swap, warrant, note, or option that is based, in whole or in part, on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities, securities, currencies, interest or other rates, indices, or other assets.

The Interim Final Rule provides three methods for calculating credit exposure of derivative transactions other than credit derivatives.   A national bank or savings association, however, must use the same method for calculating credit exposure from all of its non-credit derivative transactions.  As outlined in the Explanatory Table provided in the Interim Final Rule, the three methods include: (1) an internal model method; (2) a conversion factor matrix method; and (3) a remaining maturity method.  National banks and savings associations are expected to use compliance methods that fit their size and risk management requirements and that do not raise safety and soundness concerns.  Although a national bank or savings association may choose its own method, federal banking agencies may require a national bank or savings association to use a particular method if it finds that such method is necessary to promote the safety and soundness of the bank or savings association. 

The Interim Final Rule is effective July 21, 2012, and comments on the Interim Final Rule will be accepted until August 6, 2012. The OCC recognized, however, that national banks and savings associations will need time to conform their operations to the amendments implementing Section 610.  Accordingly, the Interim Final Rule, includes a temporary exception from the lending limit rule until January 1, 2013 for extensions of credit arising from derivative transactions or securities financing transactions.

SEC Approves Five Proposals by FINRA to Increase Fees

On June 22, 2012, the SEC issued separate orders of approval for four proposals by FINRA to increase various fees.  On June 25, the SEC approved a fifth fee proposal.  Following is a summary of the fee increases:

  • In Release No. 34-67241, the SEC approved, effective upon receipt of the filing, FINRA’s proposal (filed June 8, 2012) to amend Section 7 of Schedule A to the FINRA By-Laws to increase the fees for filing documents pursuant to FINRA Rule 5110 (Corporate Financing Rule – Underwriting Terms and Arrangements).  The amendment will (1) increase the rate from .01% to .015% of the offering amount, (2) increase the maximum fee from $75,500 to $225,500 for such filings and (3) increase the fee for an offering of securities on an automatically effective Form S-3 or F-3 registration statement filed as a shelf pursuant to Rule 415 by Well-Known Seasoned Issuers from $75,500 to $225,500.  This change will be implemented for filings and amendments made on or after July 2, 2012.
  • In Release No. 34-67239, the SEC approved, effective upon receipt of the filing, FINRA’s proposal (filed June 8, 2012) to amend Section 13 of Schedule A to the FINRA By-Laws governing the review charges for advertisements, sales literature, and other such material filed with or submitted to FINRA’s Advertising Regulation Department.  The amendment will (1) raise the fee charged for the review of printed material and video or audio media from $100 to $125, (2) raise the fee for expedited review from $500 to $600 per item and (3) raise the fee for pages in excess of 10 to $50 per page from $25.  This change will be implemented for filings made on or after July 2, 2012.
  • In Release No. 34-67240, the SEC approved, effective upon receipt of the filing, FINRA’s proposal (filed June 13, 2012) to amend Section 4 of Schedule A to the FINRA By-Laws to increase fees for branch office registration and new member applications and assess a new fee for continuing membership applications, and make corresponding amendments to NASD Rules 1012, 1013 and 1017.  The annual fee for registration of branch offices will change from $75 per branch office to a sliding fee scale of $175 per branch office up to 250, $150 for the next 250 up to 500 branch offices, $125 for the next 500 up to 1,000 branch offices, $100 for branch offices over 1,001 up to 2,000 and $75 for every branch office thereafter.  The new member application fee, currently either $3,000 or $5,000 depending on the net capital requirements for the business of the new member applicant, will increase to an amount ranging from $7,500 to $55,000 depending on the size of the new member applicant, with an additional $5,000 surcharge for a new member applicant that intends to engage in any clearing and carrying activities.  The new fee for continuing membership applications pursuant to NASD Rule 1017 will vary depending on the size of the applicant (measured by the number of registered persons associated with the applicant) and the nature of the change.  The fee for approval of a merger will range from $7,500 for the smallest firms to $100,000 for the largest firms; for approval of a material change will range from $5,000 to $75,000; and for approval of an ownership change, transfer of assets or acquisition will range from $5,000 to $15,000.  The fee changes for new member applications and continuing membership applications will be implemented on July 23, 2012.  The implementation date for fee changes to annual branch office registrations will be announced by FINRA but will be on or after January 1, 2013.
  • In Release No. 34-67242, the SEC approved, effective upon receipt of the filing, FINRA’s proposal to amend Section 1 of Schedule A to the FINRA By-Laws to adjust the rate of FINRA’S Trading Activity Fee (“TAF”) rate fee for transactions in covered equity securities.  The current TAF rate is $0.000095 per share for each sale of covered equity securities, with a maximum charge of $4.75 per trade.  Under the amendment, the TAF rate will increase to $0.000119 per share, with a per-transaction cap of $5.95.  FINRA intends to make the proposal effective on July 1, 2012.
  • In Release No. 34-67247, dated June 25, 2012, the SEC approved, effective upon receipt of the filing, FINRA’s proposal (filed June 11, 2012) to amend Sections 4 and 6 of Schedule A to the FINRA By-Laws to implement changes to certain fees relating to the Central Registration Depository (“CRD”).  The amendment will (1) increase the fee for each initial or transfer Form U4 filed by a member in the CRD system to register an individual from $85 to $100, (2) increase the disclosure event filing fee for Forms U4 and U5 from $95 to $110, (3) establish a new disclosure filing fee for Form BD of $110, (4) increase the annual system processing fee from $30 per registered individual to $45 per registered individual, (5) increase the fee for processing fingerprints from $13 to either $15 for fingerprints submitted electronically or $30 for fingerprints submitted in hard copy and also increase the fee for processing and posting fingerprints submitted by a member that have been  processed through another SRO from $13 to $30, (6) eliminate the exception to the payment of re-registration fees for successor members involved in mass transfers of registered representatives, and (7) increase the fee for late disclosure of a new disclosure event or the change in status of a previously reported disclosure event from $10 per day, up to a maximum of $300, to $100 for the first day that the disclosure event is not timely filed and $25 for each subsequent day, up to a maximum of 60 days, for a maximum amount of $1,575.

The comment period for the TAF rate amendment approved in Release No. 34-67242 ended prior to SEC approval.  There is a comment period for the other four proposals ending 21 days after publication of the order in the Federal Register (expected to occur in the next week).  Although the proposals other than the TAF rate proposal were effective upon filing, the SEC may, within 60 days after filing, summarily and temporarily suspend the rule change if it appears that such action is necessary or appropriate in the public interest, in which case the SEC will institute proceedings to determine whether the proposed rule should be approved or disapproved.

CFTC Proposes Rule Prohibiting Aggregation of Orders to Satisfy Minimum Block Sizes

The CFTC issued a proposed rule that would prohibit the aggregation of orders for different trading accounts in order to satisfy minimum block size or cap size requirements.  Trades that qualify as “block trades” are subject to special rules, including time delays to permit the trading parties time to hedge the trade before it is publicly reported.  Similarly, cap sizes are trading amounts above which the exact value of a publicly reportable swap transaction need not be specified; aggregating accounts over the cap size, therefore, would allow traders to mask the exact amounts of the swap.  The proposed rule’s prohibition on aggregation of orders would not apply to orders aggregated by certain commodity trading advisors (“CTAs”), investment advisers and foreign persons that have more than $25 million in total assets under management.  The proposal would also require parties to a block trade to qualify as eligible contract participants (“ECPs”), except where a designated contract market allows certain CTAs, investment advisers and foreign persons, in each case with more than $25 million in total assets under management, to engage in block trades on behalf of customers who are not ECPs.  Finally, the proposal would require that persons engaging in block trades on behalf of customers receive prior written consent to do so.

The proposal stems originally from a rule proposal issued in December 2010, entitled “Real-Time Public Reporting of Swap Transaction Data.” In January 2012, the CFTC issued a final rule that included certain items from the December 2010 proposal.  Several elements from the proposal pertaining to block trading were intentionally omitted from the final rule to permit the CFTC to perform additional analysis it deemed necessary prior to finalizing those provisions.  On March 15, 2012, the CFTC re-proposed some of the rules omitted from the January 2012 final rule.  Unfortunately, the CFTC later determined that some items were inadvertently omitted from the March 2012 re-proposal.  The proposed rule re-proposes the omitted items.

Comments are due 30 days from the proposal’s forthcoming publication in the Federal Register.

CFTC Proposes Rule Regarding Associated Persons of Swap Dealers and Major Swap Participants

The CFTC proposed a new rule that would “make clear” that swap dealers, major swap participants and other entities registered with the CFTC are required to supervise such entity’s associated persons and are jointly and severally responsible for the activities of the associated person with respect to customers common to it and any other swap dealer, major swap participant or other CFTC registrant. 

The release acknowledges that, unlike associated persons of other CFTC registrants, associated persons of swap dealers and major swap participants are not required to register as such.  As a result, swap dealers and major swap participants are not covered by existing CFTC regulations that allow a registered associated person to be associated with two or more sponsors (essentially, CFTC registrants) and that require such sponsors to supervise their associated persons and to be jointly and severally responsible for the associated person’s activities with respect to any customers common to such multiple sponsors.  The release explains that the existing CFTC rule is intended to prevent sponsors from attempting to assign liability for the actions or omissions of an associated person to a different sponsor with which the associated person is associated.  The proposed rule essentially extends the pre-existing regulation to include swap dealers and major swap participants.

Comments must be received by August 14, 2012.