On March 6, the Federal Reserve issued a final rule that will limit its use of the "qualitative objection" in its Comprehensive Capital Analysis and Review (CCAR) exercise beginning in the 2019 cycle. For the largest and most complex firms, CCAR includes both a quantitative evaluation of a firm's capital adequacy under stress and a qualitative evaluation of its abilities to determine its capital needs on a forward-looking basis. Until the final rule was issued, a firm was required to pass both the quantitative and qualitative evaluation or the Federal Reserve could object and restrict the firm's shareholder distributions. Pursuant to the final rule, effective immediately, firms that participate in four CCAR exercises and successfully pass the qualitative evaluation in the fourth year will not be subject to the qualitative evaluation going forward. A firm that does not pass the qualitative evaluation in the fourth year will continue to be subject to a possible qualitative objection until it passes the evaluation. In addition, except for certain firms that have received a qualitative objection in the immediately prior year, the Federal Reserve will no longer issue a qualitative objection to any firm effective January 1, 2021. According to the Federal Reserve, “while the qualitative objection will no longer apply to certain firms, all firms will continue to be subject to a rigorous evaluation of their capital planning processes as part of CCAR. Firms with weak practices may be subject to a deficient supervisory rating, and potentially an enforcement action, for failing to meet supervisory expectations. In addition, all firms remain subject to a potential objection on quantitative grounds.”
On March 6, the Federal Reserve announced that it had voted to maintain the Countercyclical Capital Buffer (CCyB) at the current level of 0%. The CCyB is an extension of the capital conservation buffer calculated in accordance with the Federal Reserve’s Regulation Q (12 CFR Part 217). The CCyB is intended to be a tool that can help reduce the risk that regulatory capital requirements will tighten credit and undermine the broader economy’s performance (thus contributing to additional bank credit losses) during a downturn. The Federal Reserve may adjust the CCyB amount for credit exposures in the United States based on a range of macroeconomic, financial, and supervisory information indicating an increase in systemic risk in accordance with the Federal Reserve’s policy statement establishing a framework for implementing the CCyB, which is available in Appendix A to 12 CFR Part 217.
On March 6, the Federal Reserve published advance notice of proposed rulemaking, requesting comment on whether it should propose amendments to Regulation D to lower the rate of interest on excess balances (IOER) maintained at Federal Reserve Banks by pass-through investment entities (PTIEs). Pursuant to Regulation D, Federal Reserve Banks may pay interest to eligible institutions on balances in excess of required reserves. PTIEs take deposits from institutional investors and invest all or substantially all proceeds in balances at Federal Reserve Banks. If a PTIE qualifies as an eligible institution, the PTIE would effectively pass through the interest obtained at the IOER rate from a Federal Reserve Bank to the depositors, less a small spread, while also avoiding costs borne by other eligible institutions. As PTIEs may potentially attract large quantities of deposits at a near-IOER rate, the FRB is concerned that PTIEs have the potential to complicate implementation of monetary policy (such as large demand for reserves) to disrupt financial intermediation, and to negatively affect financial stability. The FRB is seeking comments on all aspects of the advance notice of proposed rulemaking as well as responses to specific questions presented in Section III.B of the advance notice. Comments are due within 60 days after the date of publication of the advance notice in the Federal Register.
The FSOC issued a notice of proposed interpretive guidance on nonbank designations. As part of its responsibilities, the FSOC has the authority to designate nonbank financial institutions that pose risk to financial stability as institutions subject to oversight by the Federal Reserve. The proposed interpretive guidance introduces the FSOC’s new activities-based approach to identifying risk, which involves the FSOC consulting with various regulatory agencies to evaluate products, activities, or practices that could pose risk to financial stability. The FSOC has proposed working collaboratively with the primary regulator of an institution to try to address risks posed by the institution, and only proceeding with a designation as a nonbank subject to Federal Reserve supervision if an institution’s risks cannot be addressed through the institution’s primary regulator. The proposed guidance also requires the FSOC to undertake a cost-benefit analysis before designating an institution as subject to Federal Reserve oversight; requires the FSOC to assess potential financial distress resulting from designation as an institution subject to Federal Reserve supervision; streamlines the process of designating an institution as subject to Federal Reserve oversight; and creates an “off-ramp” for companies that have been designated as subject to Federal Reserve supervision, but have since addressed any stability concerns raised by the FSOC. Comments are due within 60 days after the date of publication of the interpretive guidance in the Federal Register.
On March 12, the CFPB released its 18th edition of Supervisory Highlights. The report covers CFPB supervision activities generally completed between June 2018 and November 2018, and includes examination findings in the areas of automobile loan servicing, deposits, mortgage servicing, and remittances.
On March 6, the Federal Financial Institutions Examination Council (FFIEC) issued the Federal Financial Institutions Examination Council Policy Statement on the Report of Examination (ROE Policy Statement). Among other things, the ROE Policy Statement contains a minimum set of report of examination principles, permits the Office of the Comptroller of the Currency (OCC) to determine the specific format of its reports of examination, and provides the OCC with flexibility to continue to adapt its reports of examination. The ROE Policy Statement rescinds the Interagency Policy Statement on the Uniform Core Report of Examination issued October 1, 1993.
On March 7, the U.S. Department of Labor released its highly anticipated proposed rule to update the Fair Labor Standards Act’s overtime exemptions for executive, administrative, professional, and computer employees, and to replace a currently enjoined rule that was finalized in 2016. If adopted, the proposed rule would raise the salary threshold required for workers to qualify for each of the so-called white-collar exemptions to $35,308 per year ($679 per week), up from the $23,660 that was last updated in 2004, but lower than the Obama administration’s cutoff of $47,476 proposed in 2016. The DOL did not include any provision that allows for the salary level to automatically increase after a defined period of time, as the Obama administration’s 2016 proposed rule did. Instead, the DOL’s proposed rule seeks public comments on a plan to increase the salary threshold every four years going forward, with each increase to be preceded by a period of public comments. For more information, read the client alert issued by Goodwin’s Labor & Employment practice.
Enforcement & Litigation
In its continuing efforts to encourage companies to self-report Foreign Corrupt Practices Act (FCPA) violations, the U.S. Department of Justice (DOJ) announced that it intends to formalize the application of the principles of its FCPA Corporate Enforcement Policy to successor companies that uncover wrongdoing in connection with mergers and acquisitions. The DOJ has made clear that the FCPA Corporate Enforcement Policy will apply to companies that uncover corrupt conduct through due diligence in advance of an acquisition as well as to companies that learn of such conduct subsequent to an acquisition. This past week, two senior DOJ officials made speeches intended to incentivize additional self-reporting of FCPA violations and provided recent examples of the benefits of such cooperation. For more information, read the client alert issued by Goodwin’s Securities, White Collar & Business Litigation group.
On February 8, the federal court in New Jersey entered judgment in favor of the investment adviser defendant following an August 2018 trial on whether the adviser had violated Section 36(b) of the Investment Company Act of 1940 by charging excessive investment advisory fees. The 72-page decision was initially provided only to the parties but was released to the public on February 26, 2019.
At trial, the plaintiffs’ primary theory was that the adviser charged an excessive advisory fee to its proprietary funds because it provided what the plaintiffs contended were substantially the same services for a lower fee as a subadviser to third-party funds. Other plaintiffs have brought similar “subadvisory fee comparison” complaints against a number of other investment advisers, but this was the first one to reach trial.
The court held first that the plaintiffs’ comparison of advisory fees to subadvisory fees was not probative because the services provided in the two roles were different and that the adviser faced different risks in the two roles. The court further held that the plaintiffs had failed to show that the adviser had realized economies of scale as fund assets increased. To prove economies of scale, a plaintiff must show that “costs per unit of production” have declined. The plaintiffs argued that the “units of production” were the dollars of AUM, and that therefore if the costs to advise the fund have declined on a per-dollar basis, then the adviser has benefited from economies of scale. The court rejected that argument and held that the plaintiffs hadn’t shown what the relevant units of production were, let alone that costs per unit had declined. Prior to trial, the court had ruled in favor of the adviser on the issue of board process, and after trial the court held that the plaintiffs had not met their burden with respect to any other Gartenberg factor.
The plaintiffs have appealed the trial court’s decision. Two complaints against another fund adviser premised on similar theories were dismissed before trial last year and are also currently on appeal. Section 36(b) cases against two other advisers premised on similar theories were tried in November and December respectively, but no decisions have yet been issued. Complaints premised on similar theories against two additional advisers have not yet reached trial.
On March 6, the DOJ announced that it had entered into a consent order with a California-based subprime auto lender and its affiliate. The order brings an end to a lawsuit filed by the DOJ in March 2018, previously covered by Enforcement Watch, alleging that the lender’s repossession practices violated the Servicemembers Civil Relief Act (SCRA). Read the Enforcement Watch blog post.
On March 7, the New Jersey Attorney General’s Office announced that it had filed a complaint against two so-called “Buy Here-Pay Here” auto dealerships, alleging that they targeted vulnerable consumers by selling them high-mileage, used autos at grossly inflated prices; financed the sales through in-house loans with high interest rates that created a high risk of default; and reclaimed and then resold the same vehicles to other consumers. Read the Enforcement Watch blog post.
Goodwin's Investment Management practice is hosting its 11th Annual Good Run in conjunction with the Investment Company Institute’s (ICI) 2019 Mutual Funds & Investment Management Conference. The conference, sponsored by ICI and the Federal Bar Association, is the fund industry’s premier legal conference. Goodwin's Boston partner, Jamie Fleckner, will be speaking on a litigation panel at the conference. In recognition of those who participate in the Good Run, Goodwin will make a donation to Expect Miracles, a leading advocate in the fight against cancer within the financial services industry. For additional details and to register for the Good Run, click here.