Weekly RoundUp June 26, 2019

Financial Services Weekly News: SEC Amends Auditor Independence Rules

Editor's Note

In This Issue. The Securities and Exchange Commission (SEC): (i) adopted amendments clarifying auditor independence rules in light of lending relationships with shareholders of an audit client; (ii) adopted a set of new capital, margin and segregation requirements for security-based swap dealers, major security-based swap participants and broker-dealers in a move that represents the last piece of the margin regime for uncleared swap and security-based swap products in the U.S.; and (iii) issued a concept release requesting public comment on how to simplify, harmonize and improve the exempt securities offering framework to expand investment opportunities and promote capital formation while maintaining appropriate investor protections. The Consumer Financial Protection Bureau (CFPB) and the Board of Governors of the Federal Reserve System (Federal Reserve) jointly published amendments to Regulation CC that implement a statutory requirement to adjust for inflation the amount of funds depository institutions must make available to their customers; and the Office of the Comptroller of the Currency (OCC) replaced its 2017 guidance for banks on higher-loan-to-value lending activities with new “core principles.” These and other developments are discussed in more detail below.

Please note: The Roundup will be on hiatus next week due to the July 4 holiday. We will resume publication on July 10.

Editor's Note

Regulatory Developments

SEC Adopts Amendments to Improve the Application of the Auditor Independence Rules to Loan Provision

On June 18, the SEC announced that it adopted amendments to the “auditor independence rules” used to analyze whether or not an auditor is independent when the auditor has a lending relationship with a shareholder of an audit client. Rule 2-01 of Regulation S-X sets forth a non-exclusive list of arrangements that the SEC deems inconsistent with an auditor’s independence, including certain lender-creditor arrangements in the so-called “Loan Rule.” Prior to the effectiveness of the amendments, under the Loan Rule, an auditor is not independent if it has a loan from “record or beneficial owners of more than ten percent of the audit client’s equity securities.” Rule 2-01 broadly defined “audit client” in the fund context to include every entity within the audit client’s “investment company complex.” The breadth of the Loan Rule and the definition of “audit client” resulted in disclosure by several fund complexes that their auditor had advised of Loan Rule violations. In June 2016, the SEC staff granted no-action relief to Fidelity Management and Research Company (the Fidelity Letter), which provided temporary relief for funds issuing financial statements that were audited by firms that were not in compliance with the Loan Rule. Via a letter dated September 22, 2017, the SEC staff extended this relief until “the effectiveness of any amendment to the [Loan Rule] designed to address the concerns expressed in the [Fidelity Letter].” On May 2, 2018, the SEC proposed rule amendments to address the challenges presented by the Loan Rule, which were adopted on June 18.

The amendments: (1) focus the analysis on beneficial ownership of an audit client’s equity securities rather than on both record and beneficial ownership; (2) replace the 10% bright-line shareholder ownership test with a “significant influence” test, which, while not defined, focuses on, among other things, whether, in considering certain factors, the shareholder-lender has significant influence over a fund’s portfolio management processes; (3) add a “known through reasonable inquiry” standard for identifying beneficial owners; and (4) remove from the definition of an “audit client” funds that would normally be considered an “affiliate” of a fund under audit. In short, the amendments focus the analysis on debtor-creditor relationships that reasonably may bear on the auditor’s impartiality or objectivity and are intended to more effectively identify borrowing relationships that are important to investors. The amendments become effective 90 days after the release is published in the Federal Register.

SEC Adopts Capital, Margin and Segregation Requirements for Dealers in Security-Based Swaps

On June 21, the SEC adopted a final package of rules and rule amendments (Final Rules) under Title VII of the Dodd-Frank Act applicable to security-based swap dealers (SBSDs), major security-based swap participants (MSBSPs) and broker-dealers. The accompanying press release stated: “These and other rules previously adopted by the [SEC] are designed to enhance the risk mitigation practices of firms that stand at the center of our security-based swap market, thereby protecting their counterparties and reducing risk to the market as a whole.” The rules address four key areas:

  • Capital requirements for SBSDs, MSBSPs, broker-dealers that use the alternative method of computing net capital, and broker-dealers that are not SBSDs or MSBSPs to the extent they trade the instruments;
  • Margin requirements for nonbank SBSDs and MSBSPs with respect to non-cleared security-based swaps;
  • Segregation requirements for SBSDs and stand-alone broker-dealers for cleared and non-cleared security-based swaps; and
  • Amendments to the SEC’s existing cross-border rule to provide a means to request substituted compliance with respect to the capital and margin requirements for foreign SBSDs and MSBSPs, and guidance discussing how the SEC will evaluate requests for substituted compliance.

The SEC’s Final Rules governing security-based swap dealers represent the last piece of the margin regime for uncleared swap and security-based swap products in the U.S. Previously, the Commodity Futures Trading Commission (CFTC) adopted margin requirements for swap dealers engaging in swap transactions and the U.S. prudential authorities established margin requirements for swap dealers transacting in both uncleared security-based swaps and swaps. The SEC’s Final Rules are substantially consistent with capital, margin, and segregation requirements of the CFTC.

The alternative compliance mechanism in the Final Rules will allow dual registrants that predominantly deal in swaps, and do not have a significant amount of security-based swap positions, to elect to comply with the capital, margin, and segregation requirements of the CFTC in lieu of SEC requirements. The alternative compliance mechanism reduces compliance costs to dual registrants, while also ensuring that registrants are subject to appropriate regulatory oversight. The finalization of the SEC’s Final Rules for security-based swap dealers paves the way for the CFTC to initiate the process of completing swap dealer capital and financial reporting requirements.

SEC Seeks Comment on Ways to Harmonize Private Offering Exemptions

On June 18, the SEC issued a concept release (Release) requesting public comment on how to simplify, harmonize and improve the exempt securities offering framework to expand investment opportunities and promote capital formation while maintaining appropriate investor protections. The SEC is undertaking a comprehensive review of the design and scope of the exempt offering framework and seeks comment on, among other items: (1) the framework’s consistency, accessibility and effectiveness, (2) necessary revisions to improve or streamline the capital raising exemptions (i.e., the private placement exemption, Rules 504 and 506 of Regulation D and Regulation Crowdfunding), (3) potential gaps in the framework that make it challenging to rely on an exemption to raise capital at key stages in a company’s business cycle, (4) whether the investor limitations regarding exempt offering participation, including the “accredited investor” definition, are sufficient, appropriate, or excessive and whether such limitations impose an undue burden on capital formation or access to investment opportunities, (5) whether the SEC can and should help facilitate more seamless, timely transitions by companies from one exempt offering to another (including any eventual registered public offering), (6) whether the SEC should take steps to support capital formation in exempt offerings through pooled investment vehicles such as interval funds and other closed-end funds and whether retail investors should be granted increased access to growth-stage companies through these vehicles, and (7) whether the SEC should revamp its exemptive rules governing resales of securities to promote capital formation and protect investors with secondary market liquidity. The public comment period for the Release will remain open for 90 days following its publication in the Federal Register, which is scheduled for June 26, 2019.

CFPB and Federal Reserve Issue Final Amendments to Regulation CC Regarding Funds Availability

On June 24, the CFPB and Federal Reserve jointly published amendments to Regulation CC that implement a statutory requirement pursuant to the Expedited Funds Availability Act of 1987 (EFA Act) to adjust for inflation the amount of funds depository institutions must make available to their customers. The amendments apply in circumstances ranging from next business day withdrawal of certain check deposits to setting the threshold amount for determining whether an account has been repeatedly withdrawn. The Dodd-Frank Act amendments require that the EFA Act's dollar amounts be adjusted for inflation every five years by the annual percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers. The first set of adjustments are detailed in the amendments. To help ensure that institutions have sufficient time to implement the adjustments, the compliance date for the adjusted amounts is July 1, 2020. 

The CFPB and the Federal Reserve are also implementing in Regulation CC the EFA Act amendments made by the Economic Growth, Regulatory Relief, and Consumer Protection Act, which include extending coverage of the EFA Act to American Samoa, the Commonwealth of the Northern Mariana Islands, and Guam.

OCC Replaces Higher-LTV Lending Activities Guidance with New “Core Principles”

On June 19, the OCC issued OCC Bulletin 2019-28 (Bulletin) regarding Higher-Loan-to-Value Lending Activities in Communities Targeted for Revitalization. The Bulletin rescinded 2017 guidance for banks seeking to develop programs to offer home loans with loan-to-value ratios of over 90%, known as “higher-LTV” loans. In rescinding its previous guidance, the OCC acknowledged that “banks have engaged in responsible, innovative lending strategies that are different from that bulletin’s specific program parameters while being consistent with its goals.”  In the Bulletin, the OCC replaced the previous guidance with a set of “core lending principles” designed to provide more flexibility to banks’ higher-LTV programs and encouraged banks interested in making higher-LTV loans in communities targeted for revitalization by a federal, state, or municipal governmental entity or agency to:

  • refer to the core lending principles in the Bulletin when considering making higher-LTV loans; and
  • discuss plans to offer higher-LTV loans with their OCC supervisory office before implementation, particularly if the offerings constitute substantial deviations from the bank’s existing strategic or business plans.

Enforcement & Litigation

Goodwin Alert: The Caremark Chimera: Can Directors Be Liable When The Red Flag Is Hidden From Them?

On June 18, in Marchand v. Barnhill, the Delaware Supreme Court revived a stockholder derivative lawsuit against the directors of ice-cream manufacturer Blue Bell Creameries USA, Inc. The suit alleged breaches of the directors’ fiduciary duty to oversee and monitor the corporation’s operations, following an early-2015 listeria outbreak at its manufacturing plants that resulted in three deaths, a product recall, an operational shutdown, and a liquidity crisis. The board was alleged to be completely unaware of prior “red flags” on food safety compliance because management had failed to bring any of these matters to its attention. In overturning the Court of Chancery’s dismissal of the claims, the Supreme Court concluded that the plaintiffs had met the standard to avoid dismissal by pleading facts supporting a reasonable inference that the Blue Bell directors had acted with bad faith, despite the management team’s alleged shortfalls as to information flow, because no board-level system whatsoever was in place to monitor and report on food safety. While the result of a full trial remains to be seen, this decision serves as a cautionary tale for any board of directors operating in a regulated industry, and suggests careful thought should be given to procedures for ensuring information flow to the board on key areas of operational risk. For more information, read the client alert issued by Goodwin’s Public M&A and Corporate Governance practice.

CFPB and 45 State AGs Obtain $168 Million in Student Debt Relief

On June 14, the CFPB announced settlement with a private student loan provider that issued and managed student loans at the now-defunct for-profit ITT Technical Institute. Forty-five states including KansasFloridaNevadaNorth Carolina, IowaMissouriKentuckyOhioOregon, and New York also settled with the loan provider under the same terms. Read the Enforcement Watch blog post.

4th Circuit Upholds $61 Million TCPA Verdict, Finding Standing Under Spokeo

On May 30, the Fourth Circuit upheld a $61 million Telephone Consumer Protection Act (TCPA) judgment in Krakauer v. Dish Network, L.L.C., No. 1518. The plaintiff, Dr. Thomas Krakauer (Plaintiff), placed his name on the Do-Not-Call registry in 2003. In 2009, he received calls from Satellite Systems Network (SSN), which Dish Network (Dish) retained to market Dish’s services, and filed a class action against Dish in 2015 for violation of the TCPA’s do-not-call provision. Following a trial, the jury determined that Dish was liable for the calls placed by SSN, and awarded the class a $20 million verdict. The court then determined that Dish’s violation of the do-not-call provision was willful, and trebled the jury verdict to more than $60 million. Dish appealed the verdict to the Fourth Circuit. Read the LenderLaw Watch blog post.

“Blameless Ignorance” Should Not Prohibit Application of Discovery Rule in FDCPA Case, Petitioner Argues

On May 13, petitioner Kevin Rotkiske submitted his brief to the United States Supreme Court in Rotkiske v. Klemm, No 18-328. As noted in a previous post, the court accepted Rotkiske’s appeal back in February to resolve a circuit split between the Third Circuit and the Ninth and Fourth Circuits on the appropriate calculation of the statute of limitations in the Fair Debt Collection Practices Act (FDCPA). The brief’s submission brings the court one step closer to resolving “[w]hether the ‘discovery rule’ applies to the one-year statute of limitations under the [FDCPA].” Read the LenderLaw Watch blog post.

This week’s Roundup contributors: Ethan Green, Christopher Herbert, Viona Miller, Nico Ramos and George Schneider.