On September 13, the SEC issued a statement regarding a Roundtable it plans to host in November 2018 regarding the U.S. proxy system. At the Roundtable, investors, issuers and other market participants will be invited to engage the SEC in discussion on various topics, including the proxy voting process, retail shareholder participation and the role of proxy advisory firms. In preparation for the Roundtable, the SEC’s Division of Investment Management announced in an Information Update that it was withdrawing two interpretive letters issued in 2004 to Egan-Jones Proxy Services and Institutional Shareholder Services, Inc. The two letters set forth guidelines to ensure that proxy advisory firms provide voting recommendations in an impartial manner, and that potential conflicts of interest are properly addressed. The SEC withdrew the letters to facilitate discussions at the Roundtable. The SEC also is seeking feedback from participants regarding Staff Legal Bulletin No. 20, which addresses the responsibilities of investment advisers with regard to voting client proxies and the retention of proxy advisory firms.
Federal Agencies Reaffirm the Role of Supervisory Guidance
Five federal agencies issued a Joint Statement on September 11 explaining the role of supervisory guidance for regulated institutions. The Joint Statement was issued by the CFPB, the Board of Governors of the Federal Reserve System (Federal Reserve), the FDIC, the Office of the Comptroller of the Currency and the National Credit Union Administration. Notably, the Joint Statement explains that, unlike a law or regulation, supervisory guidance does not have the force and effect of law. As a result, the Joint Statement clarifies that examiners will not criticize a supervised financial institution for a “violation” of supervisory guidance. The Joint Statement also explains that supervisory guidance may provide examples of practices that the agencies believe are consistent with safety and soundness standards, but it indicates that the agencies intend to limit the use of “numerical thresholds” or other “bright-lines” in describing their expectations in supervisory guidance. The Joint Statement does not limit the agencies’ discretion to determine that particular practices or conduct are unsafe or unsound or otherwise violate law or regulation, and it remains to be seen how examiners will implement the Joint Statement in practice. The agencies did not explain their motivation for issuing the Joint Statement aside from indicating that they have recently received “inquiries suggesting that the differences between supervisory guidance and laws and regulations may be unclear.” There is a widespread perception among regulated financial institutions that examiners often enforce supervisory guidance as though it were equivalent to a law or regulation, and the Joint Statement may reflect the objective of President Trump, who has appointed officials to key agency posts, of reducing regulatory burden. Notably, shortly following the issuance of the Joint Statement, SEC Chairman Jay Clayton also issued a statement in which he reiterated the SEC’s “longstanding position . . . that all staff statements are nonbinding and create no enforceable legal rights or obligations of the [SEC] or other parties.”
On September 13, the FDIC issued a proposed rule to implement Section 202 of the Economic Growth, Regulatory Relief, and Consumer Protection Act, which, for some insured institutions, exempts certain reciprocal deposits from consideration as brokered deposits. The proposed rule would allow well-capitalized and well-rated institutions to not treat as brokered deposits an amount of reciprocal deposits up to the lesser of (1) 20 percent of an institution’s total liabilities or (2) $5 billion. Under certain circumstances, an institution that is neither well-capitalized nor well-rated may also exclude reciprocal deposits from its brokered deposit calculations. The proposed rule is the first part of a two-part plan of the FDIC to revisit brokered deposit rules. For the second part, later this year, the FDIC intends to solicit public comment on the FDIC’s brokered deposit and rate cap regulations, broadly speaking. Comments on the current proposed rule on reciprocal deposits are due within 30 days after publication in the Federal Register.
On September 12, as part of its ongoing effort to update Regulation CC to reflect the evolution of the nation’s check collection system from one that is largely paper-based to one that is virtually all electronic, the Federal Reserve approved final amendments to the liability provisions of Regulation CC, which governs availability of funds and collection of checks. In cases where the original paper check is not available, the amendments stipulate that, for purposes of determining the burden of proof, it will be assumed that the item has been altered rather than forged. The presumption applies only in disputes between banks when one bank has transferred an electronic or substitute check to the other bank. As with existing rules under Regulation CC, the parties may, by mutual agreement, vary the effect of the amendments’ provisions. In addition, the final amendments clarify that the presumption does not apply if it is contrary to another federal statute or regulation, such as the U.S. Department of the Treasury’s rules regarding U.S. Treasury checks. The amendments become effective January 1, 2019.
On September 10, the CFPB proposed creating a “Disclosure Sandbox” to allow companies to test new disclosures or delivery methods that may better serve consumers. This is the first action from the CFPB’s new Office of Innovation, which Acting Director Mulvaney established in mid-July. The proposal revises the CFPB’s existing trial disclosure waiver program, which was established in 2013 using its authority under subsection 1032(e) of the Dodd-Frank Act. The existing program has never approved any trial disclosures. The proposal would encourage companies to test new disclosures by reducing the application burden and review time frame; increasing guidance regarding the testing time frame; specifying procedures for extensions of successful trial disclosure programs; and providing coordination with existing or future programs offered by other regulators to facilitate innovation. Comments on the proposed rule are due by October 10, 2018.
The CFPB issued an interim rule updating the model disclosure forms for the Summary of Consumer Rights and Summary of Identity Theft Rights in Appendices I and K of Regulation V. The rule becomes effective September 21, 2018. The new forms add a notice of rights which notifies consumers of their ability to freeze their credit free of charge. In addition, the new model form has been amended to reflect a statutory change to extend the minimum duration of initial fraud alerts to one year and to update the contact information for certain Fair Credit Reporting Act enforcement agencies. Comments must be received on or before November 19, 2018.
On September 12, the CFPB published its final rule (Final Rule) amending the procedures used by the public to obtain information from the CFPB under the Freedom of Information Act, the Privacy Act of 1974 (FOIA), and in legal proceedings. In its August 24, 2016, notice of proposed rulemaking, the CFPB had proposed to amend its rules regarding the confidential treatment of information obtained from persons in connection with the exercise of its authorities under federal consumer financial law. However, the Final Rule only pertains to information sought under FOIA. Notably, the CFPB omitted from the Final Rule previously proposed changes that would have allowed the CFPB to disclose confidential supervisory information to any agency it deems “relevant to the exercise of the Agency’s statutory or regulatory authority” – including state attorneys general, foreign regulators and state bar associations. The Final Rule is effective October 12, 2018.
On September 14, on the heels of the OCC’s July 31 announcement that it would begin accepting applications for special purpose national bank charters (Fintech Charter) from Fintech companies engaged in the business of banking, the New York State Department of Financial Services (NYDFS) refiled a lawsuit to block the OCC from issuing such charters. The Conference of State Bank Supervisors (CSBS) also announced its intention to attempt to block the OCC from issuing Fintech Charters. Both the NYDFS and the CSBS had previously filed lawsuits objecting to the OCC’s proposed Fintech Charter, but the lawsuits were dismissed on the grounds that it was not clear that the OCC intended to offer such charters.
After several years and a number of studies and related actions, the SEC has adopted a series of amendments to its rules and forms that deal with requirements that have become “redundant, duplicative, overlapping, outdated, or superseded.” This focus means that relatively few of these amendments will significantly affect existing public company disclosure requirements. Among the more notable amendments affecting Regulation S-K disclosure in periodic reports and registration statements are the following:
- elimination of financial disclosure about segments, research and development expenses, and geographic breakdown of revenues and assets in the “Business” section;
- elimination of market price information, dividend information, and ratios of earnings to fixed charges and earnings to fixed charges and preferred stock dividends; and
- changes in disclosures about the SEC and company websites and elimination of references to the SEC Public Reference Room.
Although there is still significant uncertainty regarding any possible withdrawal agreement from the European Union in relation to financial services, the publication of the government’s draft financial services withdrawal Regulations is a sensible time to revisit where we are. For more information, read the client alert issued by Goodwin’s Private Investment Funds practice.
Enforcement & Litigation
On August 31, the SEC accepted an Offer of Settlement whereby it issued a Cease-and-Desist Order and imposed Remedial Sanctions (Order) against a registered investment adviser (Company). From approximately 2006 to 2015, the Company disseminated advertisements and marketing materials that relied on back-testing performance for periods in which the described strategies were not in use.
The Company included information that relied on the back-tested performance in marketing materials, requests for proposal and in a white paper directed at existing and prospective institutional clients, financial intermediaries (e.g., brokers-dealers and financial advisors) and institutions that offered the Company's strategy as a series in their own investment trusts or that retained the Company to sub-advise a portion of the institution’s mutual fund using the strategy.
However, the SEC found that the Company failed to disclose that the marketing materials contained back-tested performance, which made the annualized cumulative results significantly better than they otherwise would have been. The SEC found that the Company’s advertisements were misleading because they failed to disclose that some of the quantitative ratings used to create the hypothetical portfolio were determined using a retroactive, back-tested, application of the Company’s quantitative model. The SEC also found the Company had failed to adopt and implement policies and procedures designed to prevent false and misleading advertisements.
Through acceptance of Company’s Offer of Settlement, the SEC Order determined the Company violated Section 206(2) and Section 206(4) of the Investment Advisers Act of 1940, and Rule 206(4)-1(a)(5) and Rule 206(4)-7 thereunder. The Company was ordered to cease and desist from these and future violations, was censured, and was ordered to pay a civil penalty in the amount of $1.9 million.
On August 27, the SEC accepted an Offer of Settlement whereby it issued a Cease-and-Desist Order and imposed Remedial Sanctions (Order) against two registered investment advisers (Adviser A and Adviser B, and collectively, the Advisers) and certain of their affiliates (collectively, the Respondents) for misconduct involving faulty investment models. According to the Order, the Respondents managed, offered and sold numerous investment products, including quantitative-model-based mutual funds, variable life insurance and variable annuities (Products) and separately managed accounts strategies (Strategies) (collectively, Products and Strategies). The Respondents marketed the Products and Strategies as “managed using a proprietary quant model,” and described how the models were designed to operate. According to the Order, the Respondents launched the Products and Strategies without first confirming that the models worked as intended and without providing appropriate risk disclosure. According to the Order, Adviser A discovered that a model included errors and stopped using it, then failed to disclose the errors or the decision to stop using the defective model to the board of trustees of the mutual fund (the Board) or to the public. The Order states that the Advisers also failed to disclose to investors and the Board that a junior analyst was the day-to-day manager of certain funds, rather than a more senior manager as initially disclosed. The Order also states that the Advisers failed to send required notices to investors under Section 19(a) of the 1940 Act that certain dividend payments included return of capital. According to the Order, in 2011 the Advisers added volatility “guidelines” (the Volatility Overlays) to the some of the mutual funds with inadequate disclosure to investors or to the Board. According to the Order, the Advisers did not take reasonable steps to confirm the accuracy of the Volatility Overlays and, in 2013, after discovering errors in the Volatility Overlays, the Advisers failed to disclose the errors to investors or the Board. Lastly, the Order states that the broker-dealer affiliate of the Advisers negligently relied upon and distributed to its advisory clients marketing materials premised on the flawed models and another adviser’s hypothetical and back-tested performance track record.
As a result of their conduct, the SEC found that Adviser A and an affiliated broker-dealer violated Section 17(a) of the Securities Act for the offer and sale of securities by means of making untrue statements of material fact or omitted to state a material fact necessary in order to make statements not misleading and the Advisers violated (i) Section 15(c) of the 1940 Act for failure to furnish information to a board as may reasonably be necessary to evaluate the terms of their advisory contracts; (ii) Section 206(2) of the Advisers Act, which prohibits an adviser from engaging in any transaction, practice or course of business which operates as fraud or deceit upon any client or prospective client; and (iii) Section 206(4) of the Advisers Act and Rule 206(4)-1(a)(5) for engaging in deceptive practices, among other violations. Without admitting or denying the SEC’s findings, four Respondent entities agreed to settle the SEC’s charges and pay approximately $53.3 million in disgorgement, $8 million in interest, and a $36.3 million penalty, and will create and administer a fair fund to distribute the entire $97.6 million to affected investors.
The National Law Journal named Goodwin partners Grant Fondo and Mitzi Chang to its 2018 Cryptocurrency, Blockchain and Fintech Trailblazers list. This inaugural award recognizes lawyers who are making great strides as finance and technology grow more and more entwined. View the full article here.
As new technologies reshape the way business is conducted, the world becomes more interconnected. The advent of decentralised blockchain technology has created new opportunities to take advantage of the borderless nature of this technology. As with many new technologies, there has been a rush to obtain patent protection for innovations in this space. View the full WIPR article by Goodwin’s Frederick Rein here.
Fiduciary Investment Advisors 2018 Annual Conference – September 20-21
Goodwin partner Michael Isenman will be a panelist at the Fiduciary Investment Advisors (FIA) 2018 Annual Conference. Mike will be a speaker on the panel “401(k)/403(b) Mock Deposition: How to Protect Against & Prepare for Defined Contribution Litigation.” For more information, visit the event website.
Jamie Fleckner will be a panelist at The PLANADVISER National Conference (PANC), the premier networking and business strategy event for specialist retirement plan advisers. Annually, the top tier of retirement plan advisers from across the U.S., including the PLANADVISER Top 100 and the PLANSPONSOR Retirement Plan Advisers of the Year, gather in Orlando, Florida, for three days of discussion and debate about the cutting edge of the retirement plan industry, and how to confront the industry’s biggest challenges. For more information, visit the event website.
Goodwin is a co-sponsor with Reed Smith of this year’s Conference of Counsel. The Conference will kick off on Wednesday, September 26, with an opening reception and dinner featuring Karen Solomon from the OCC as our guest speaker. The Goodwin panel will take place 4:15-5:15pm on Thursday, September 27. Panelists will include Financial Industry partners Tony Alexis, and William Stern. For more information, visit the event website.