Weekly RoundUp September 23, 2015

Financial Services Weekly News

Editor's Note

SEC Proposes Liquidity Management Rules for Mutual Funds. On Sept. 22 the SEC announced that it had voted to propose a package of rule reforms to enhance effective liquidity risk management by open-end funds, including mutual funds and exchange-traded funds (ETFs) but not money market funds. The rule changes would require the implementation of liquidity risk management programs and enhance disclosure regarding fund liquidity and redemption practices. According to the SEC press release, which includes a fact sheet, “a fund’s liquidity risk management program would be required to contain multiple elements, including: classification of the liquidity of fund portfolio assets based on the amount of time an asset would be able to be converted to cash without a market impact; assessment, periodic review and management of a fund’s liquidity risk; establishment of a fund’s three-day liquid asset minimum; and board approval and review.” In addition, the proposal would codify the 15% limit on illiquid assets included in current Commission guidelines. The proposed reforms also would permit mutual funds to elect to use “swing pricing” to pass on the costs resulting from shareholder purchase or redemption activity to the shareholders responsible for that activity. The SEC fact sheet describes swing pricing as “the process of reflecting in a fund’s NAV the costs associated with shareholders’ trading activity in order to pass those costs on to the purchasing and redeeming shareholders. It is designed to protect existing shareholders from dilution associated with shareholder purchases and redemptions and would be another tool to help funds manage liquidity risks.” Statements by Commissioners Daniel Gallagher and Michael Piwowar were generally supportive of the proposals, but expressed reservations about whether the three-day liquid asset minimum used the right length of time, as opposed to seven days, the period of time by which Section 22(e) of the Investment Company Act requires a fund to make payment after securities are tendered for redemption. They also questioned whether swing pricing could have some negative consequences and be more likely to cause disproportionate harm to retail investors. Along with its proposal, the SEC made available a Division of Economic Risk Analysis White Paper on Liquidity and Flows of U.S. Mutual Funds. Comments on the proposal are due 90 days after publication in the Federal Register.
Editor's Note
Editor's Note
Editor's Note

Regulatory Developments

NYDFS Announces Approval of First BitLicense Application from a Virtual Currency Firm

The New York State Department of Financial Services (NYDFS) announced Sept. 22 that it has approved Circle Internet Financial’s BitLicense application – making it the first company to receive a BitLicense from NYDFS. The BitLicense – which NYDFS finalized in June 2015 – is the first comprehensive regulatory framework for firms dealing in virtual currency such as Bitcoin, and includes key consumer protection, anti-money laundering compliance, and cyber security guidelines.

SEC Amends Rule 2a-7 Credit Rating Requirements and Issuer Diversification Provisions

On Sept. 16, the SEC adopted amendments (the Amendments) to Rule 2a-7 under the Investment Company Act and Form N-MFP to remove credit-rating references for instruments held by money market funds (MMFs). The Amendments, initially proposed in 2011 and re-proposed in 2014, were prompted by Section 939A of the Dodd-Frank Act, which mandates that the SEC review and, where appropriate, modify rules referring to ratings by credit rating agencies as a test of the creditworthiness of a security or money market instrument. MMFs must comply with the Amendments by Oct. 14, 2016 — the same compliance date for the implementation of the amendments to Rule 2a-7 relating to liquidity fees and redemption gates and requiring a floating net asset value for institutional prime and municipal MMFs. The Amendments revise the definition of “eligible securities” under Rule 2a-7 by removing all references to Nationally Recognized Statistical Rating Organizations (NRSRO) ratings. In general, under the current rule, 97% of a MMF is required to be invested in securities with the top short-term credit quality category of a requisite NRSRO (or comparable unrated securities). Under the Amendments, “eligible securities” are instead defined as securities presenting “minimal credit risk,” and the SEC codified four general factors funds must consider, to the extent appropriate, in analyzing the capacity of a security’s issuer or guarantor to meet its financial obligations. The Amendments also revise Rule 2a-7’s requirements for MMF portfolio diversification. It should be noted that the Amendments do not prohibit MMFs from using NRSRO ratings as an aid in assessing whether securities qualify as “eligible securities.” If a MMF uses NRSRO ratings to evaluate securities, however, the Amendments require the MMF to disclose on Form N-MFP the NRSRO ratings used in the evaluation.

MSRB Proposal to Apply Gifts and Gratuities Rule to Municipal Advisors Published in Federal Register

In the Sept. 9 issue of the Roundup we reported that the MSRB had filed a proposal seeking SEC approval to (1) apply MSRB Rule G-20, which provides limitations on business-related gift-giving by municipal securities dealers, to municipal advisors, (2) add a new provision to specifically prohibit both dealers and municipal advisors from seeking reimbursement for certain entertainment expenses from the proceeds of an offering of municipal securities and (3) extend to municipal advisors related books and records requirements through proposed amendments to MSRB Rule G-8. On Sept. 22 the proposal was published in the Federal Register. The text of the proposed rule amendments can be found at the end of MSRB Notice 2014-18. Comments are due by Oct. 13.

Enrollment Opens for Pilot Series 50 Exam for Municipal Advisors

The MSRB announced on Sept. 21 that municipal advisors may now begin enrolling to take the pilot Municipal Advisor Representative Qualification Examination (Series 50). The registration window for the pilot examination begins on Sept. 21 and closes on Jan. 14, 2016. Municipal advisor firms will need to utilize FINRA Form U10 to enroll their municipal advisor professionals for the Series 50 pilot exam and to remit the exam fee of $265.

Treasury and Commerce Further Ease Cuba Sanctions Regulations

In a Sept.18 press release the Department of Treasury and Department of Commerce announced additional amendments to the Cuban Assets Control Regulations (CACR) and Export Administration Regulations (EAR), which took effect Sept. 21. The amendments are extensive, and include easing sanctions on commercial and financial transactions by Cubans who are outside Cuba, easing sanctions on remittances to Cuban nationals, and allowing depository institutions to maintain accounts for certain Cuban nationals present in the United States in a non-immigrant status; depository institutions will no longer be required to block such accounts if not closed before the Cuban national’s departure. For additional information, please see the press release, updated FAQsTreasury and Commerce regulations.

Client Alert: NYSE Amends Rules for Release of Material News

Goodwin Procter’s Capital Markets practice has issued a client alert detailing the New York Stock Exchange’s amendment to its Rule 202.06, which governs the procedures that listed companies must follow for the release of material information. The amendment will become operative on Sept. 28, 2015. Most importantly, the amendment extends to 7 a.m. Eastern Time the pre-market hours during which listed companies are required to notify the NYSE before releasing material news. The amendment also provides advisory guidance related to the release of material news after the close of trading on the NYSE, and makes changes and provides clarification to the suggested means for the public release of material news and the circumstances in which the NYSE may halt trading in listed securities (including American Depository Receipts (ADRs)). A copy of the rule, marked to show the amendment, is available as Exhibit 5 of NYSE File No. SR-2015-38 as filed with the Securities and Exchange Commission. Securities and Exchange Commission Release No. 34-75809 relating to the NYSE amendment is available on the SEC web site.

Enforcement & Litigation

SEC Sanctions Investment Adviser With Failing to Adopt Proper Cybersecurity Policies and Procedures Prior To Breach

The SEC announcedsettlement with a St. Louis-based registered investment adviser (the RIA) over charges that it failed to establish the required cybersecurity policies and procedures in advance of a breach that compromised the personally identifiable information (PII) of approximately 100,000 individuals, including thousands of the RIA’s clients. The RIA had been using a third-party web service to store client PII including Social Security numbers and dates of birth in an unencrypted form when that server was attacked by hackers. The federal securities laws require registered investment advisers to adopt written policies and procedures reasonably designed to protect customer records and information. An SEC investigation found that R.T. Jones Capital Equities Management violated this “safeguards rule” during a nearly four-year period when it failed to adopt any written policies and procedures to ensure the security and confidentiality of PII and protect it from anticipated threats or unauthorized access.

Client Alert: CFTC Takes First Action Against Virtual Currency Options Trading Platform

Goodwin Procter’s Securities Litigation & White Collar Defense and Fintech practices have issued a client alert regarding the CFTC’s recent order against Coinflip and its chief executive officer. In taking this action against a virtual currency options trading platform operator, the CFTC confirmed that bitcoin and digital currencies are commodities, and ordered the company to cease illegally offering bitcoin options and to cease operating a facility for trading or processing of swaps without registering.

FDIC Inspector General Releases Report on Operation Choke Point

The Inspector General of the FDIC has released a report of its investigation into the agency’s role in Operation Choke Point, a U.S. Department of Justice initiative conducted during 2012 and 2013 intended to protect consumers from fraud perpetrated by financial intermediaries such as third party payment processors. The FDIC’s participation in Operation Choke Point attracted attention from Members of Congress, who expressed concern that FDIC officials acted improperly to deny access to the financial system to certain lawful businesses in order to advance their personal political or moral agenda. The Inspector General’s report concludes that the FDIC’s involvement in Operation Choke Point was “inconsequential” and that the agency acted within its broad statutory authority to supervise financial institutions. The report also states that the Inspector General found no evidence that the agency used a “high risk” list to target specific institutions or to pressure institutions to decline banking services to merchants on the high risk list. However, the report did note that the FDIC discouraged financial institutions from providing services to payday lenders in accordance with longstanding FDIC concerns about reputational and legal risks related to payday lending, and it found that the FDIC also exerted pressure to cause three financial institutions to terminate their involvement in providing tax refund anticipation loans. The report makes several recommendations, which it notes that the FDIC intends to implement. These include reviewing and clarifying existing policy and guidance pertaining to termination of banking services and reviewing and clarifying the agency’s policy and guidance related to the use of moral suasion to encourage supervised institutions to take particular actions.