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Bridging the Week by Gary DeWaal: April 18 - 22 and 25, 2016 (SEF Claims Foul; Compensation Deferrals and Claw-Backs; Financial Stability)

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Published Date: April 24, 2016

A swap execution facility sued multiple interest rate swap dealers and other entities claiming they colluded to prevent its success. In addition, six federal agencies proposed compensation rules that might result in more of the largest financial institutions’ senior officers’ (including, potentially, chief compliance and chief legal officers’) and substantial risk takers’ incentive bonuses being subject to deferral for four years, as well as previously paid bonuses being subject to claw-back for up to seven years. As a result, the following matters are covered in this week’s edition of Bridging the Week:

Swap Execution Facility Alleges in Lawsuit That Banks Conspired to Prevent Its Success;
Deferrals and Claw-Backs Potentially Required in Newly Proposed Compensation Arrangements for Senior Officers of Certain Financial Institutions;
SEC Claims Broker-Dealer’s Attempt to Escape FINRA Disciplinary Action is Untimely;
FSOC Expresses Concerns That Pooled Investment Vehicles’ Liquidity and Redemption Risks May Pose Financial Stability Concerns;
Related Broker-Dealers Agree to Pay US $1 Million Penalty to FINRA for Allegedly Not Sending Certain Required Information to Private Bank Clients; and more.

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Swap Execution Facility Alleges in Lawsuit That Banks Conspired to Prevent Its Success: The TeraExchange, a swaps execution facility registered with the Commodity Futures Trading Commission, and related entities, brought a lawsuit in a federal court in New York against multiple interest rate swap dealers and some of their affiliates; an interdealer broker of IRSs; and an electronic trading facility for IRSs (that also operates a SEF). Plaintiffs alleged that the defendants “conspired” to undermine TeraExchange and other IRS exchanges by, among other things, inhibiting customers of the IRS dealers’ affiliated futures commission merchants from clearing transactions executed on TeraExchange and the other IRS exchanges. They did this, said plaintiffs, because the dealers’ objected to TeraExchange’s all-to-all central limit order book execution platform that might bypass the dealers. As a result of the defendant’s actions, claimed Plaintiffs, they sustained substantial lost profits. Plaintiffs said that defendant’s actions are a violation of federal and New York State anti-trust laws, as well as of various common law prohibitions. Plaintiffs did not allege any violations by defendants of any law expressly governing SEFs or exchange-traded swaps, or any CFTC rule. Plaintiffs seek treble damages for defendants’ action and a permanent injunction against defendants’ continuing their allegedly “unlawful conduct.” Plaintiffs’ lawsuit is very similar to a lawsuit filed late in 2015 by the Public School Teachers’ Pension and Retirement Fund of Chicago. There plaintiff, in a purported class action lawsuit against 12 swap dealers and, in some cases, certain of their affiliates, alleged that the defendants also conspired to prevent IRSs from being traded on exchanges. (Click here for details on the purported class action lawsuit in the article, “Multiple Swap Dealers Sued for Allegedly Impeding Roll-Out of Centrally Executed Interest Rate Swaps; EU Shuts Downs Inquiry Regarding Credit Default Swaps” in the December 6, 2015 edition of Bridging the Week.)
Deferrals and Claw-Backs Potentially Required in Newly Proposed Compensation Arrangements for Senior Officers of Certain Financial Institutions: Six federal agencies proposed bonus payment deferral and claw-back arrangements for certain large financial institutions and certain of their most senior officers (including, potentially, chief compliance and chief legal officers), as well as employees who expose their firms to large risk, if they receive incentive-based compensation. In general, the compensation rules would apply only to covered financial institutions that maintain consolidated assets in excess of US $1 billion, while the most onerous requirements, would apply solely to covered firms with consolidated assets in excess of US $250 billion. Impacted institutions could include certain banks, broker-dealers (but apparently not future commission merchants), credit unions and investment advisers. The rules were proposed jointly by the National Credit Union Administration, Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency and the Securities and Exchange Commission. Under the proposed rules issued by the NCUA (the only agency that formally published its proposed rules as of April 22, 2016; however, NCUA’s proposed rules should be similar to those of the other agencies) the biggest firms would be required to defer a substantial portion of the incentive-based bonuses of senior executives (60 percent) and significant risk takers (50 percent) for four years and require the claw-back of previously paid bonuses for up to seven years if it is later determined that the senior executive or significant risk taker engaged in misconduct that “resulted in significant financial or reputational harm to the covered institution, fraud, or intentional misrepresentation of information used to determine the [covered person’s] incentive-based compensation.” The compliance date for the proposed rule, if adopted, would not be until the first calendar quarter that begins at least 540 days after a final rule is published. The proposed rules would also impose compensation arrangements’ oversight and approval requirements on boards of directors of covered institutions, and record-keeping requirements. The six federal agencies previously proposed similar compensation rules in 2011. Comments will be accepted on the proposed rules through July 22, 2016.
SEC Claims Broker-Dealer’s Attempt to Escape FINRA Disciplinary Action is Untimely: The Securities and Exchange Commission expressed its intent to file a friend of the court brief in the lawsuit filed by Scottsdale Capital Advisors Corporation and certain of its senior officers against the Financial Industry Regulatory Association a few weeks ago, in which Scottsdale challenged FINRA’s authority to bring a disciplinary action against the plaintiffs alleging violations grounded in the Securities Act of 1933. Plaintiffs had contended that FINRA has no authority to prosecute claims under the Securities Act because its disciplinary authority is limited to matters that might constitute violations of the Exchange Act of 1934, a provision of US law that established the SEC, authorizes national securities associations such as FINRA, and generally governs the secondary trading of securities, financial markets and their participants, including broker-dealers. The Securities Act generally addresses solely the issuance of securities, including imposing registration and disclosure requirements. Among other things, the SEC indicated it will argue that plaintiff’s federal law case is untimely and that plaintiffs must first pursue their administrative remedies before asserting any challenges in a federal court. (Click here for details regarding Scottsdale’s lawsuit in the article, “Broker-Dealer Challenges FINRA’s Authority to Enforce Original Federal Securities Law” in the March 27, 2016 edition of Bridging the Week.)
FSOC Expresses Concerns That Pooled Investment Vehicles’ Liquidity and Redemption Risks May Pose Financial Stability Concerns: The Financial Stability Oversight Council issued an update on asset management products and activities that, it claimed, might pose threats to national financial stability, including liquidity, redemption and leverage risks. Although the FSOC report noted certain recent initiatives of the Securities and Exchange Commission to enhance liquidity risk management and disclosure at registered funds and to limit the amount of leverage that registered investment companies may obtain through the use of derivatives, FSOC still issued its own recommendations of steps that might be taken to reduce relevant risks. To help mitigate against liquidity and redemption risks, FSOC recommended among other things, that registered funds that invest in less-liquid assets should engage in “robust” risk management practices particularly in anticipating “stressed conditions;” that “clear regulatory guidelines” should be adopted addressing limits on the ability of mutual funds to hold illiquid assets that “might interfere with a fund’s ability to make orderly redemptions”; and that there be better reporting by mutual funds of their risk management practices and liquidity profiles. FSOC recommended further study of the use of leverage by hedge funds and “welcomed” the SEC’s proposal to limit the amount of leverage mutual funds and exchange-traded funds might obtain through the use of derivatives. FSOC also recommended further study on the potential risks to financial stability potentially caused by securities lending activities. In a statement issued in connection with the release of the FSOC report, SEC Chairperson Mary Jo White noted the “overlap” between FSOC’s update and certain of the SEC’s recent proposed reforms, but made clear that FSOC’s update “should not be read as an indication of the direction of the SEC’s final asset management rules may take.” Timothy Massad, chairman of the Commodity Futures Trading Commission, noted that, although FSOC in its report cited certain leverage metrics, “[w]e have not yet ‘connected the dots’ between [those metrics] and the amount of underlying risk it represents.” (Click here to access information on the SEC’s proposal related to the use of derivatives by registered investment companies in the article, “SEC Considers New Rule to Restrict Use of Derivatives by Investment Companies” in the December 13, 2015 edition of Bridging the Week.)
Related Broker-Dealers Agree to Pay US $1 Million Penalty to FINRA for Allegedly Not Sending Certain Required Information to Private Bank Clients: JP Morgan Securities LLC and JP Morgan Clearing Corp. agreed to pay an aggregate fine of US $1 Million to resolve charges brought by the Financial Industry Regulatory Authority that, at various times from 2006 through 2014, they failed to provide certain information to private banking clients and engaged in other related violative activity. Specifically, FINRA alleged that from December 1, 2006 through December 10, 2012, JPMS failed to send notices to 3,266 of its Global Wealth Management customers confirming changes to their investment objectives within 30 days, as required by Securities and Exchange Commission rules. FINRA also claimed that, from October 2012 through August 2012, JPMS (1) failed to collect and review certain outside brokerage statements of its employees; (2) from January 1, 2009 through September 19, 2013, did not send a copy of customers’ account information to 1,310 private bank account holders; (3) from September 2007 through September 2014, did not provide confirmations of transactions to more than 7,500 private bank accounts for in excess of 92,000 transactions; and (4) from January 1, 2011 through December 7, 2012, sent letters to customers confirming updated information, but failed to retain copies of such letters. FINRA also charged that, annually from 2011 through 2013, JPMCC failed to send required privacy notices to certain customers. The JP Morgan entities resolved FINRA’s disciplinary action without admitting or denying any finding.

And more briefly:

Futures Exchanges Conform Rules to Latest CFTC OCR No Action Relief: Two exchanges, CME Group and CBOE Futures, amended their rules to conform certain of their revised large trader reporting requirements' deadlines to those recently adopted by staff of the Commodity Futures Trading Commission through no action relief. A few weeks ago, staff of the Division of Market Oversight of the Commodity Futures Trading Commission again delayed the roll-out of certain new large trader reporting requirements that initially were adopted during November 2013 and, most recently, scheduled to go into effect in late April 2016.
ESMA Adds Certain Credit Derivatives to List of Swaps That Must Be Centrally Cleared: The European Securities and Markets Authority included iTraxx main and iTraxx crossover credit derivatives among the derivatives that are required to be centrally cleared under the European Markets Infrastructure Regulation. The requirement will go into effect following publication of the relevant technical standards in the Official Journal of the European Union.

For more information, see:

Deferrals and Claw-Backs Potentially Required in Newly Proposed Compensation Arrangements for Senior Officers of Certain Financial Institutions:
https://www.ncua.gov/About/Documents/Agenda%20Items/AG20160421Item2b.pdf

ESMA Adds Certain Credit Derivatives to List of Swaps That Must Be Centrally Cleared:
https://www.esma.europa.eu/press-news/esma-news/esma-adds-credit-derivatives-its-public-register-emir

FSOC Expresses Concerns That Pooled Investment Vehicles’ Liquidity and Redemption Risks May Pose Financial Stability Concerns:
https://www.treasury.gov/initiatives/fsoc/news/Documents/FSOC%20Update%20on%20Review%20of%20Asset%20Management%20Products%20and%20Activities.pdf

See also:
Statement of Timothy Massad:
http://www.cftc.gov/PressRoom/SpeechesTestimony/massadstatement041816
Statement of Mary Jo White:
https://www.sec.gov/news/statement/white-statement-041816.html

Futures Exchanges Conform Rules to Latest CFTC OCR No Action Relief:

CFE:
http://cfe.cboe.com/framed/PDFframed.aspx?content=/publish/CFEregcirc/CFERG16-009.pdf&section=SEC_ABOUT_CFE&title=CFERG16-009+Ownership+and+Control+Reporting+Implementation+-+Updated
CME:
http://www.cmegroup.com/market-regulation/files/16-160_1.pdf

Related Broker-Dealers Agree to Pay US $1 Million Penalty to FINRA for Allegedly Not Sending Certain Required Information to Private Bank Clients:
/ckfinder/userfiles/files/FINRA%20JPMorgan.pdf

SEC Claims Broker-Dealer’s Attempt to Escape FINRA Disciplinary Action is Untimely:
/ckfinder/userfiles/files/SEC%20FINRA%20Scottsdale.pdf

Swap Execution Facility Alleges in Lawsuit That Banks Conspired to Prevent Its Success:
/ckfinder/userfiles/files/Tera%20Exchange.pdf

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 23, 2016. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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Bridging the Week by Gary DeWaal: April 18 - 22 and 25, 2016 (SEF Claims Foul; Compensation Deferrals and Claw-Backs; Financial Stability)

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