Tag: Dodd-Frank

SEC Report Details Record-Shattering Year for Whistleblower Program

On November 15, the U.S. Securities and Exchange Commission (SEC) Whistleblower Program released its Annual Report to Congress for the 2021 fiscal year. The report details a record-shattering fiscal year for the agency’s highly successful whistleblower program. During the 2021 fiscal year, the SEC Whistleblower Program received a record 12,200 whistleblower tips and issued a record $564 million in whistleblower awards to a record 108 individuals. Over the course of the year, the whistleblower program issued more awards than in all previous years combined.

“The SEC’s Dodd-Frank Act whistleblower program has revolutionized the detection and enforcement of securities law violations,” said whistleblower attorney Stephen M. Kohn. “Congress needs to pay attention to this highly effective anti-corruption program and enact similar laws to fight money laundering committed by the Big Banks, antitrust violations committed by Big Tech, and the widespread consumer frauds often impacting low income and middle class families who are taken advantage of by illegal lending practices, redlining, and credit card frauds.”

“The report documents that whistleblowing works, and works remarkably well, both in the United States and worldwide,” continued Kohn. “The successful efforts of the SEC to use whistleblower-information to police Wall Street frauds is a milestone in the fight against corruption. Every American benefits from this program.”

In the report, Acting Chief of the Office of the Whistleblower Emily Pasquinelli states “[t]he success of the Commission’s whistleblower program in landmark FY 2021 demonstrates that it is a vital component of the Commission’s enforcement efforts. We hope the awards made this year continue to encourage whistleblowers to report specific, timely, and credible information to the Commission, which will enhance the agency’s ability to detect wrongdoing and protect investors and the marketplace.”

Read the SEC Whistleblower Program’s full report.

Geoff Schweller also contributed to this article.

Copyright Kohn, Kohn & Colapinto, LLP 2021. All Rights Reserved.
For more on SEC Whistleblower Rewards, visit the NLR White Collar Crime & Consumer Rights section.

How the Trump Administration May Impact the Oversight and Enforcement of Dodd-Frank’s Whistleblower Protections

Dodd-frank, WhistleblowerOn the campaign trail, President Trump vowed to “dismantle” Dodd-Frank. Dodd-Frank was enacted in the wake of the 2008 financial crisis to curtail risky investment activities and stop financial fraud through increased oversight and regulation of the banking and securities industries. Among other things, it amended the Sarbanes-Oxley Act, Securities Exchange Act, and Commodity Exchange Act to include monetary incentives for individuals to blow the whistle on suspected financial fraud and stronger protections for whistleblowers against retaliation by their employers. President Trump has criticized Dodd-Frank, arguing that it is overbroad and inhibits economic growth. Now that he is in office, President Trump has the statute squarely in his crosshairs, and he is poised to impact its whistleblower protections on the legislative, administrative, and judicial fronts.

From a legislative standpoint, President Trump has wasted no time in seeking to roll back Dodd-Frank’s statutory framework. Only two weeks after his inauguration, he issued an EO titled “Core Principles for Regulating the United States Financial System,” which directs the Treasury Secretary to consult with the heads of financial agencies, including the Commodity Futures Trading Commission and the Securities and Exchange Commission (“SEC”), to find ways to conform U.S. financial regulations, including Dodd-Frank, to the Trump administration’s “Core Principles.” These “Core Principles” (detailed in the second article of this Take 5) are broad-sweeping and include, among other things, requiring “more rigorous regulatory impact analysis” for new laws and “mak[ing] regulation efficient, effective, and appropriately tailored.” While the precise scope of these principles is undefined (perhaps intentionally so), they appear to demonstrate a clear first step toward deregulation in the financial sector and may be a shot across the bow signaling the President’s intent to scale back—or at least halt any expansion of—Dodd-Frank, including its whistleblower protections.

Additionally, President Trump is well positioned to substantially affect the SEC’s administrative enforcement of Dodd-Frank’s whistleblower laws. Dodd-Frank created the SEC Office of the Whistleblower (“OWB”) to enforce its comprehensive whistleblower program. As reported in the 2016 Annual Report to Congress on the Dodd-Frank Whistleblower Program, since the OWB was established, the SEC has (i) awarded more than $100 million in bounty awards to whistleblowers who provided information leading to successful enforcement actions, (ii) independently sued employers for retaliating against employees for reporting alleged securities violations, and (iii) made it a top priority to find and prosecute employers that use confidentiality, severance, and other agreements that impede their employees from communicating with the SEC.

The SEC’s enforcement agenda could change significantly, however, under the Trump administration. Specifically, in 2017, President Trump will have the opportunity to appoint four out of the five SEC Commissioners (three seats are now vacant, and another will become vacant in June). He has nominated Jay Clayton—a corporate attorney who has spent his career representing financial services firms in business transactions and regulatory disputes—to fill one of those vacancies and serve as SEC Chair. New SEC leadership may result in the potential replacement of the sitting OWB Chief and alter the OWB’s current enforcement strategies. Thus, through his administrative appointments, President Trump may attempt to temper the SEC’s aggressiveness and focus when it comes to enforcement of Dodd-Frank’s whistleblower protections to more closely reflect his vision for less onerous regulation of the financial sector.

The President is also uniquely situated to influence the application of Dodd-Frank in the courtroom. Indeed, President Trump has inherited more than 100 federal court vacancies that he must fill, including one on the U.S. Supreme Court, giving him the opportunity to shape how Dodd-Frank’s whistleblower laws will be interpreted and applied by federal judges across the country. One of the most critical issues that hangs in the balance is whether an employee who reports an alleged securities violation only to his or her employer, and not to the SEC, is protected by Dodd-Frank’s anti-whistleblower retaliation provision. At present, there is a circuit court split on this issue. In 2013, the U.S. Court of Appeals for the Fifth Circuit held in Asadi v. G.E. Energy United States, LLC, that an employee who only reports a suspected violation internally is not a protected whistleblower for the purposes of Dodd-Frank’s anti-relation provision. In 2015, however, the Second Circuit Court of Appeals reached the opposite conclusion in Berman v. Neo@Ogilvy LLC. The question has since come before the Sixth Circuit Court of Appeals (which declined to rule on it) and is currently pending before the Courts of Appeals for the Ninth and Third Circuits, and it will almost certainly end up before the U.S. Supreme Court for resolution. Accordingly, President Trump’s federal judicial appointments—particularly his nomination of Judge Neil Gorsuch to the U.S. Supreme Court—may play a pivotal role in establishing exactly who is protected under Dodd-Frank’s proscription against whistleblower retaliation.

Ultimately, it is unlikely that President Trump will actually be in a position to completely “dismantle” Dodd-Frank. Yet, there is no question that he has at his disposal the power to greatly impact the statute at the legislative, administrative, and judicial levels, and there is little doubt that change is on the horizon.

ARTICLE BY Jason Kaufman of Epstein Becker & Green, P.C.

©2017 Epstein Becker & Green, P.C. All rights reserved.

Dodd-Frank Rollback Begins – Congress Overturns SEC’s Resource Extraction Issuer Payment Disclosure Rule

SEC resource extractionLast week, Congress utilized the Congressional Review Act (CRA) to pass a joint resolution that disapproves Rule 13q-1 adopted by the SEC,1which would have implemented the resource extraction issuer payment disclosure provisions of Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The disapproval resolution has been sent to President Trump for his signature, which he is expected to sign.2

Under the SEC’s rule, a public company that qualified as a “resource extraction issuer” would have been required to publicly disclose in an annual report on Form SD information relating to any single “payment” or series of related “payments” made by the issuer, its subsidiaries or controlled entities of $100,000 or more during the fiscal year covered by the Form SD to a “foreign government” or the U.S. Federal government for the “commercial development of oil, natural gas, or minerals” on a “project”-by-“project” basis. Resource extraction issuers were not required to comply with the rule until their first fiscal year ending on or after September 30, 2018 and their first report on Form SD was not due until 150 days after such fiscal year end.

As a result of the disapproval resolution (assuming President Trump signs, and does not veto, the resolution), issuers that expected to be subject to the SEC’s rule can cease their compliance preparations. Under the CRA, a disapproved rule may not be reissued in substantially the same form or as a new rule that is substantially similar to the disapproved rule unless specifically authorized by a subsequently enacted law. Despite the disapproval resolution and the CRA, Dodd-Frank Section 1504’s mandate for the SEC to adopt a resource extraction disclosure rule remains intact unless and until Section 1504 is repealed. In light of the CRA’s prohibition on the reissuance of a substantially similar rule, the rule’s contested history3 and the expected reintroduction of the Financial CHOICE Act, which if enacted into law in the form introduced during the previous session of Congress would repeal Section 1504, the SEC is unlikely to commence the rulemaking process for resource extraction issuer payment disclosures for a third time.

Some public companies may still have to disclose similar payment information as required under the SEC’s rule pursuant to international resource extraction disclosure laws (for example, the EU Accounting Directive, the EU Transparency Directive and Canada’s Extractive Sector Transparency Measures Act).

ARTICLE BY G. Michael O’Leary & Scott L. Olson of Andrews Kurth Kenyon
© 2017 Andrews Kurth Kenyon LLP

1. H.J.Res.41, available at https://www.congress.gov/bill/115th-congress/house-joint-resolution/41/text.

2. The White House, Press Release, H.J. Res. 38, H.J. Res. 36, H.J. Res. 41, H.J. Res. 40, H.J. Res. 37 – Statement of Administration Policy (Feb. 1, 2017), available at https://www.whitehouse.gov/the-press-office/2017/02/01/statement-adminis….

3. For a brief discussion of the legal challenges to the rulemaking process, see our client alert dated December 17, 2015, SEC Re-Proposes Disclosure Rules for Payments by Resource Extraction Issuers.

Six Reasons Why Wholesale Repeal of Dodd-Frank is Unlikely

Donald Trump Dodd Frank repealIn the days following the November elections, U.S. President-elect Donald J. Trump promised that his Financial Services Policy Implementation team would be working to “dismantle” the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). However, a more recent account in the Wall Street Journal reported Mr. Trump’s transition team as tempering his promise in favor of rescinding or scaling back the individual provisions Republicans find most objectionable.

In light of the current political and macro-economic environment, here are six reasons why a wholesale repeal of Dodd-Frank is unlikely to occur:

  • Congressional Resistance – A wholesale repeal of Dodd-Frank would have to be effectuated through congressional action and would likely face a democratic filibuster. This would require opponents of Dodd-Frank to muster a 60-vote block in the Senate in order to advance the proposal. Legislative horse-trading to achieve specific objectives that are key to the Republican majority may ultimately prove to be more strategically advantageous.

  • Public Perception – Actions of the new administration which could be perceived as advocating for easing the burden on the financial services industry may alienate the middle-class constituency who were significantly impacted by the great recession and who ultimately propelled Mr. Trump to the Presidency.

  • Balance of Cost – Following massive investments in infrastructure and processes, the industry may perceive the costs of undoing the compliance programs put in place subsequent to Dodd-Frank as outweighing the benefits to be derived from decreased regulation.

  • Accepted Expectations – Counterparties have come to accept the safeguards and reporting requirements put in place by Dodd-Frank as constituting baseline expectations in business transactions. A repeal of Dodd-Frank would leave industry participants to reconstruct by contract what may have been previously mandated under law.

  • International Developments – In the wake of the Brexit vote, international financial organizations may be evaluating the relocation of their operational centers to locations in the U.S. The possibility of significant financial regulatory overhauls and the accompanying specter of an unknown business environment may dissuade consideration of the U.S. by such organizations.

  • Absence of a Perceptible Problem – Dodd-Frank was passed on July 21, 2010 with the wake of the great recession providing momentum and popular support for its enactment. Conversely, there is no corresponding economic situation presently existing that critics can point to for its repeal. The DJIA is up approximately 90% since July 2010. The real estate market has remained strong and, even with the recent increase by the Fed, interest rates remain low, allowing consumers access to both homeownership and financing on attractive terms.

In addition to the issues identified above, the incoming Presidential administration and congressional delegation may face additional hurdles in advancing comprehensive legislative initiatives to pare back Dodd-Frank. As the post-election environment cools and the country marches towards inauguration day, the financial services industry can only hope that clarity on the direction of the U.S. regulatory environment begins to emerge.

ARTICLE BY Anthony M. Drenzek of Proskauer Rose LLP
© 2016 Proskauer Rose LLP.

Dodd-Frank Whistleblower Litigation Heating Up

Barnes Thornburg

The past few months have been busy for courts and the SEC dealing with securities whistleblowers. The Supreme Court’s potentially landmark decision in Lawson v. FMR LLC back in March already seems like almost ancient history.  In that decision, the Supreme Court concluded that Sarbanes-Oxley’s whistleblower protection provision (18 U.S.C. §1514A) protected not simply employees of public companies but also employees of private contractors and subcontractors, like law firms, accounting firms, and the like, who worked for public companies. (And according to Justice Sotomayor’s dissent, it might even extend to housekeepers and gardeners of employees of public companies).

Since then, a lot has happened in the world of whistleblowers. Much of the activity has focused on Dodd-Frank’s whistleblower-protection provisions, rather than Sarbanes-Oxley. This may be because Dodd-Frank has greater financial incentives for plaintiffs, or because some courts have concluded that it does not require an employee to report first to an enforcement agency. The following are some interesting developments:

What is a “whistleblower” under Dodd-Frank?

This seemingly straightforward question has generated a number of opinions from courts and the SEC. The Dodd-Frank Act’s whistleblower-protection provision, enacted in 2010, focuses on a potentially different “whistleblower” population than Sarbanes-Oxley does. Sarbanes-Oxley’s provision focuses particularly on whistleblower disclosures regarding certain enumerated activities (securities fraud, bank fraud, mail or wire fraud, or any violation of an SEC rule or regulation), and it protects those who disclose to a person with supervisory authority over the employee, or to the SEC, or to Congress.

On the other hand, Dodd-Frank’s provision (15 U.S.C. §78u-6 or Section 21F) defines a “whistleblower” as “any individual who provides . . . information relating to a violation of the securities laws to the Commission.”  15 U.S.C. §78u-6(a)(6).  It then prohibits, and provides a private cause of action for, adverse employment actions against a whistleblower for acts done by him or her in “provid[ing] information to the Commission,” “initiat[ing], testif[ing] in, or assist[ing] in” any investigation or action of the Commission, or in making disclosures required or protected under Sarbanes-Oxley, the Exchange Act or the Commission’s rules.  15 U.S.C. §78u-6(h)(1). A textual reading of these provisions suggests that a “whistleblower” has to provide information relating to a violation of the securities laws to the SEC.  If the whistleblower does so, an employer cannot discriminate against the whistleblower for engaging in those protected actions.

However, after the passage of Dodd-Frank, the SEC promulgated rules explicating its interpretation of Section 21F. Some of these rules might require providing information to the SEC, but others could be construed more broadly to encompass those who simply report internally or report to some other entity.  Compare Rule 21F-2(a)(1), (b)(1), and (c)(3), 17 C.F.R. §240.21F-2(a)(1), (b)(1), and (c)(3). The SEC’s comments to these rules also said that they apply to “individuals who report to persons or governmental authorities other than the Commission.”

Therefore, one issue beginning to percolate up to the appellate courts is whether Dodd-Frank’s anti-retaliation provisions consider someone who reports alleged misconduct to their employers or other entities, but not the SEC, to be a “whistleblower.” The only circuit court to have squarely addressed the issue (the Fifth Circuit in Asadi v. G.E. Energy (USA) LLC) concluded that Dodd-Frank’s provision only applies to those who actually provide information to the SEC.

In doing so, the Fifth Circuit relied heavily on the “plain language and structure” of the statutory text, concluding that it unambiguously required the employee to provide information to the SEC.  Several district courts, including in Colorado, Florida and the Northern District of California, have concurred with this analysis.

More, however, have concluded that Dodd-Frank is ambiguous on this point and therefore have given Chevrondeference to the SEC’s interpretation as set forth in its own regulations. District courts, including in the Southern District of New York, New Jersey, Massachusetts, Tennessee and Connecticut, have adopted this view. The SEC has also weighed in, arguing (in an amicus brief to the Second Circuit) that whistleblowers should be entitled to protection regardless of whether they disclose to their employers or the SEC.  The agency said that Asadi was wrongly decided and, under its view, employees that report internally should get the same protections that those who report to the SEC receive. The Second Circuit’s decision in that case (Liu v. Siemens AG) did not address this issue at all.

Finally, last week, the Eighth Circuit also decided not to take on this question. It opted not to hear an interlocutory appeal, in Bussing v. COR Securities Holdings Inc., in which an employee at a securities clearing firm provided information about possible FINRA violations to her employer and to FINRA, rather than the SEC, and was allegedly fired for it. The district court concluded that the fact that she failed to report to the SEC did not exclude her from the whistleblower protections under Dodd-Frank. It reasoned that Congress did not intend, in enacting Dodd-Frank, to encourage employees to circumvent internal reporting channels in order to obtain the protections of Dodd-Frank’s whistleblower protection.  In doing so, however, the district court did not conclude that the statute was ambiguous and rely on the SEC’s interpretation.

A related question is what must an employee report to be a “whistleblower” under Dodd-Frank. Thus far, if a whistleblower reports something other than a violation of the securities laws, that is not protected. So, for example, an alleged TILA violation or an alleged violation of certain banking laws have been found to be not protected.

These issues will take time to shake out. While more courts thus far have adopted, or ruled consistently with, the SEC’s interpretation, as the Florida district court stated, “[t]he fact that numerous courts have interpreted the same statutory language differently does not render the statute ambiguous.”

Does Dodd-Frank’s whistleblower protection apply extraterritorially?

In August, the Second Circuit decided Liu. Rather than focus on who can be a whistleblower, the Court concluded that Dodd-Frank’s whistleblower-protection provisions do not apply to conduct occurring exclusively extraterritorially. In Liu, a former Siemens employee alleged that he was terminated for reporting alleged violations of the FCPA at a Siemens subsidiary in China.  The Second Circuit relied extensively on the Supreme Court’s Morrison v. Nat’l Aust. Bank case in reaching its decision. In Morrison, the Court reaffirmed the presumption that federal statutes do not apply extraterritorially absent clear direction from Congress.

The Second Circuit in Liu, despite Liu’s argument that other Dodd-Frank provisions applied extraterritorially and SEC regulations interpreting the whistleblower provisions at least suggested that the bounty provisions applied extraterritorially, disag
reed. The court concluded that it need not defer to the SEC’s interpretation of who can be a whistleblower because it believed that Section 21F was not ambiguous.  It also concluded that the anti-retaliation provisions would be more burdensome if applied outside the country than the bounty provisions, so it did not feel the need to construe the two different aspects of the whistleblower provisions identically.  And finally, the SEC , in its amicus brief, did not address either the extraterritorial reach of the provisions or Morrison, so the Second Circuit apparently felt no need to defer to the agency’s view on extraterritoriality.

Liu involved facts that occurred entirely extraterritorially. He was a foreign worker employed abroad by a foreign corporation, where the alleged wrongdoing, the alleged disclosures, and the alleged discrimination all occurred abroad. Whether adding some domestic connection changes this result remains for future courts to consider.

The SEC’s Use Of The Anti-Retaliation Provision In An Enforcement Action

In June, the SEC filed, and settled, its first Dodd-Frank anti-retaliation enforcement action. The Commission filed an action against Paradigm Capital Management, Inc., and its principal Candace Weir, asserting that they retaliated against a Paradigm employee who reported certain principal transactions, prohibited under the Investment Advisers Act, to the SEC. Notably, that alleged retaliation did not include terminating the whistleblower’s employment or diminishing his compensation; it did, however, include removing him as the firm’s head trader, reconfiguring his job responsibilities and stripping him of supervisory responsibility. Without admitting or denying the SEC’s allegations, both respondents agreed to cease and desist from committing any future Exchange Act violations, retain an independent compliance consultant, and pay $2.2 million in fines and penalties.  This matter marks the first time the Commission has asserted Dodd-Frank’s whistleblower provisions in an enforcement action, rather than a private party doing so in civil litigation.

The SEC Announces Several Interesting Dodd-Frank Bounties

Under Dodd-Frank, whistleblowers who provide the SEC with “high-quality,” “original” information that leads to an enforcement action netting over $1 million in sanctions can receive an award of 10-30 percent of the amount collected. The SEC recently awarded bounties to whistleblowers in circumstances suggesting the agency wants to encourage a broad range of whistleblowers with credible, inside information.

In July, the agency awarded more than $400,000 to a whistleblower who appears not to have provided his information to the SEC voluntarily.  Instead, the whistleblower had attempted to encourage his employer to correct various compliance issues internally. Those efforts apparently resulted in a third-party apprising an SRO of the employer’s issues and the whistleblower’s efforts to correct them. The SEC’s subsequent follow-up on the SRO’s inquiry resulted in the enforcement action. Even though the “whistleblower” did not initiate communication with the SEC about these compliance issues, for his efforts, the agency nonetheless awarded him a bounty.

Then, just recently, the SEC announced its first whistleblower award to a company employee who performed audit and compliance functions. The agency awarded the compliance staffer more than $300,000 after the employee first reported wrongdoing internally, and then, when the company failed to take remedial action after 120 days, reported the activity to the SEC. Compliance personnel, unlike most employees, generally have a waiting period before they can report out, unless they have a reasonable basis to believe investors or the company have a substantial risk of harm.

With a statute as sprawling as Dodd-Frank, and potentially significant bounty awards at stake, opinions interpreting Dodd-Frank’s whistleblower provisions are bound to proliferate. Check back soon for further developments.

 
ARTICLE BY

Brian E. Casey
 
OF 
Barnes & Thornburg LLP

Dodd-Frank Whistleblower Protection: For America Only

Sheppard Mullin 2012

 

The U.S. District Court for the Southern District of New York has held that thewhistleblower protection provisions of the Dodd-Frank Act do not apply outside the United States, even where the employee alleged he was terminated for raising compliance concerns under U.S. international law. Specifically, the court found that Dodd-Frank did not protect an employee of Siemens in China who alleged he was terminated in retaliation for raising compliance concerns under the U.S. Foreign Corrupt Practices Act (FCPA). The decision will strike many observers as remarkable, since the extraterritorial provisions of the FCPA itself have been construed so broadly. The opinion in the case, Liu v. Siemens AG, Civ. No. 13 Civ. 317 (WHP) Slip Op. (S.D.N.Y. Oct. 21, 2013), may be viewed online here.

The plaintiff in the case, Meng-Lin Liu, a resident of Taiwan, was employed by Siemens China as a Division Compliance Officer. Siemens China is a subsidiary of Siemens AG, a German company whose American Depositary Receipts trade on the New York Stock Exchange. After Liu raised anti-bribery compliance concerns at Siemens China, his employment contract was terminated in 2010. After his termination he reported possible violations of the FCPA to the U.S. Securities and Exchange Commission under the SEC’s whistleblower program.

Liu then brought action against Siemens under the Dodd-Frank anti-retaliation provision, which provides as follows:

No employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower . . . in making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201 et seq.), [the Securities Exchange Act of 1934 (15 U.S.C. § 78a et seq.)], section 1513(e) of Title 18, and any other law, rule, or regulation subject to the jurisdiction of the [SEC].

15 U.S.C. § 78u-6(h)(l)(a). The Dodd-Frank Act defines “whistleblower” as “any individual who provides . . . information relating to a violation of the securities laws to the [SEC], in a manner established, by rule or regulation, by the [SEC].” 15 U.S.C. § 78u-6(a)(6).

Siemens moved to dismiss the case for failure to state a claim, arguing (among other things) that the anti-retaliation provision is not applicable outside the United States. Liu argued that by using the phrases “any individual” and “no employer,” the statute evinces an intent to protect whistleblowers wherever they are. The Court rejected Liu’s hypothesis, stating that the statute is silent regarding whether it applies extraterritorially. That silence, said the Court, “invokes a strong presumption against extraterritoriality.” Liu, Slip Op. at 5. Consequently, the Court dismissed Liu’s claim.

Interestingly, the Court also rejected the idea that the anti-retaliation provision must protect foreign whistleblowers since the statute in essence creates foreign whistleblowers. The Court stated that “[t]he fact that a person outside the United States may be a “whistleblower” under Dodd-Frank does not compel the conclusion he is protected by the Anti-Retaliation Provision. Slip Op. at 6.

An earlier holding by the U.S. Court of Appeals for the 5th Circuit took a different approach but reached a similar result in July 2013. In that case, Asadi v. GE Energy, 720 F.3d 620 (5th Cir. 2013), the Court ruled that a GE Energy employee in Iraq who was terminated after reporting potential anti-bribery compliance concerns to his employer (but not to the SEC) did not qualify as a whistleblower under Dodd-Frank, and thus was not protected by the anti-retaliation provision. The Asadi opinion may be viewed online here. Interestingly, the lower court in Asadi reasoned (like the Liu court) that Asadi was not protected from retaliation because the Dodd-Frank anti-retaliation provisions are not extraterritorial. SeeAsadi v. GE Energy, 2012 U.S. Dist. LEXIS 89746 (S.D. Tex. 2012). The Fifth Circuit, reviewing the case de novo, declined to review that reasoning and based its holding on the inapplicability of the “whistleblower” definition. Asadi, id. at note 13.

The effects of these rulings warrant careful attention. For example, corporations involved in international business may wish to look closely at their own anti-retaliation policies and be careful to tailor them properly. While we would expect courts to continue to examine the limits on whistleblower retaliation under Dodd-Frank, the Asadiholding is not binding outside the Fifth Circuit, and the Liuholding is not binding outside the Southern District of New York.

Separately, it will be interesting to see whether the number of foreign whistleblowers is affected by these holdings. The SEC reported that in Fiscal Year 2012, it fielded over 3,000 whistleblower allegations. See U.S. Securities and Exchange Commission, Annual Report on the Dodd-Frank Whistleblower Program, Fiscal Year 2012, available online here. Of those, 115, or 3.8 percent, were FCPA-related allegations, and thus have inherently international fact patterns. Id. at Appendix A. If Dodd-Frank does not protect foreign whistleblowers or those who do not file formal allegations with the SEC, that may cause a chilling effect on the number of reports in the future.

Article by:

Lawrence M. Braun

Of:

Sheppard, Mullin, Richter & Hampton LLP

Working with 3rd Party Providers to Make Dodd Frank Conflict Mineral Compliance Easy

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At your firm or within your company dealing with conflict minerals, you might have recently heard the buzz about the latest Dodd Frank Conflict Mineral Compliance requirements. If these requirements affect the way law firms or companies do business, then working towards compliance initiatives remains a priority.

Regulatory Assessment and Scope Analysis

This involves examining the law firm’s client or company seeking compliance product portfolio and doing an analysis of whether the product are affected by the law and therefore must be in compliance, or “in scope” Vs “out of scope.” It can also include:

  • Examining corporate obligations
  • Determination of key regulatory compliance decision points
  • Creation of a conflict minerals technical document

Creation of a Compliance Plan

This involves creating an end to end compliance plan and associated processes

  • All activities detailed in chronological order
  • Creation of application of due diligence standards
  • Responsibilities assigned to personnel
  • Determination of compliance communication pathways

Software Set Up

Industry standard to date for the majority of companies in scope of this regulation involve using a software platform to manage the large amount of data and suppliers that will be surveyed.Vendor Selection

  • Vendor Selection
  • Decisions to integrate with Enterprise Resource Planning system  (ERP), which is used to design and manage resources within a company, as well as Product Lifecyle Management (PLM), used to design, manufacture and plan the development of products
  • Methodology of supplier communication

Supplier Engagement

This portion of the process involves communication and data collection from the supply chain. Includes:

  • Data collection methodology
  • Reporting and analytics of the data collected
  • Corrective action and addressing problem suppliers

Reporting

Once data has been collected firms enter the reporting phase to complete the process for the first year. This process is then replicated year over year. With the infrastructure in place firms enter the “maintenance” phase of compliance.

Standard practise in the compliance industry has also seen that Law firms or the company seeking Dodd Frank compliance are engaging 3-4 outside service providers.

They are usually:

1.       Law firms: To determine exact requirements and legal requirements.

2.       Software: To provide the platform for data collection, management and analytics.

3.    Accounting: To audit the data collected and ensure strong data backing the program.

4.    Consulting: To develop the processes, work with /train suppliers and help with data collection.

Assisting your clients with Dodd Frank Conflict Mineral Compliance does not have to be complicated. Working through the 5 step process above and working with other 3rd party providers makes compliance at any level easy.

Article By:

 of

Financial Services Legislative and Regulatory Update – Week of June 10, 2013

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Leading the Past Week

And the beat goes on… Another week with the White House dealing with another issue, this time news that the national security apparatus is collecting and combing through telephone record metadata.  The widespread revelation about a data mining program that would make any hedge fund quant jealous drowned out more positive news of the week, including that the U.S. recovery continues its sluggish, yet positive pace with 175,000 jobs added in May.

And in an interesting comparison, as noted by the extraordinary team at Davis Polk, while the agencies were silent during the Month of May, and did not announce any new implementations of the Dodd-Frank Act, last week, three major implications of the implementation were announced.  First, the SEC publicly released its much anticipated and long awaited money market mutual fund rules.  Second, the Fed announced an almost equally anticipate interim final “push out” rule that provided significant relief to foreign-based banks with operations in the United States.  Finally, the FSOC made its first round of non-bank systemically important financial institutions (“SIFIs”) designations.

Legislative Branch

Senate

As Administration Announces New Iran Sanctions, Senate Banking Members Skeptical of their Effectiveness

On June 4th, the Senate Banking Committee held a hearing to review sanctions against Iran. Witnesses and lawmakers were split regarding the efficacy of the sanctions, some arguing that their effectiveness has been proved by Iran’s continued inability to fund nuclear enrichment and other arguing that the sanctions have not had the desired result of fundamentally changing the governance of the country. Specifically, Ranking Member Mike Crapo (R-ID) and Senators Bob Corker (R-TN), Bob Menendez (D-NJ), and Chuck Schumer (D-NY) all expressed concerns that the sanctions have not measurably changed Iran’s behavior. Witnesses included: David Cohen, Under Secretary for Terrorism and Financial Intelligence for the Treasury; Wendy Sherman, Under Secretary for Political Affairs with the Department of State; and Eric Hirschhorn, Under Secretary for Industry and Security with the Department of Commerce. The hearing comes as the Administration announced a new set of sanctions against the country. An Executive Order released June 3rd takes aim at Iran’s currency and auto sector in addition to expanding sanctions against private business supporting the government of Iran.

Senate Finance Committee Releases Income and Business Entities Tax Reform Working Paper

On June 6th, the Senate Finance Committee released the latest in a series of options papers outlining tax reform options for individual and business income taxes and payroll taxes. The proposal outlines three options for tackling the integration of individual and corporate taxes, such as making the corporate tax a withholding tax on dividends and adjusting capital gains taxes for businesses to match the individual Code. In addition, the paper discusses ways in which to reach a long-term solution for taxing derivatives.

Senate Banking Approves Nomination to Ex-Im Bank

On June 6th, the Senate Banking Committee voted 20 to 2 in favor of Fred Hochberg to continue to head the Export-Import Bank. Senator Tom Coburn (R-OK) and Senator Patrick Toomey (R-PA) both voted against the nomination. Hochberg’s nomination now moves to the full Senate where, though he is expected to be confirmed, he must be approved before July 20th or else the bank would lose its quorum for voting on items.  During the same executive session, the Committee approved by voice vote the National Association of Registered Agents and Brokers Reform Act of 2013 (S. 534) which would make it easier for insurance agents to sell state-regulated insurance in multiple states.

Senator Brown Calls on CFPB to Target Debt Collectors

On June 4th, Senator Sherrod Brown (D-OH) wrote to the CFPB, urging the Bureau to enact rules to curb customer abuses by debt collectors. In a statement accompanying the letter, Brown, Chairman of the Senate Banking Subcommittee on Financial Institutions and Consumer Protection, said he intends to hold a hearing in the next month which will shine a light on bad practices and consumer abuses in the industry. The Dodd-Frank Act gives the CFPB authority to enforce and enact rules under the Fair Debt Collection Practices Act (FDCPA). Brown’s letter urged Director Cordray to pursue debt collectors as soon as possible, as the Bureau would lose its oversight authority in this space should Cordray’s nomination expire and a director not be in place.

Senate Banking Committee To Consider Flood Insurance As Soon As July

In remarks made on June 6th, Chairman of the Banking Committee Tim Johnson (D-SD) said the panel will hold hearings as soon as July to consider national flood insurance affordability. The announcement comes as a number of lawmakers express concerns that rate increases in the 2012 reauthorization are not affordable.

Senate Banking Subcommittee Looks into the State of the Middle Class

On June 6th, the Senate Banking Subcommittee on Economic Policy held a hearing titled “The State of the American Dream: Economic Policy and the Future of the Middle Class.” It was Senator Jeff Merkley’s first hearing as Chair of the Subcommittee, he said he wanted to feature witnesses whose voices were not normally heard in committee hearings and public policy debates. The witnesses included: Ms. Diedre Melson; Mr. John Cox; and Ms. Pamela Thatcher, who were subjects of the documentary movie American Winter; Dr. Atif Mian, Professor of Economics and Public Policy at Princeton University; Ms. Amy Traub, Senior Policy Analyst for Demos; Mr. Nick Hanauer with Second Avenue Partners; and Mr. Steve Hill, Executive Director of Nevada Governor’s Office of Economic Development.

House of Representatives

House to Consider Multiple Financial Services Bills Next Week

Next week the House is set to consider and vote on four separate bills dealing with the Financial Industry.  Three of the these bills, The Business Risk Mitigation and Price Stabilization Act (H.R. 634), The Reverse Mortgage Stabilization Act (H.R. 2167), the Swap Data Repository and Clearing House Indemnification Correction Act (H.R. 742) will be brought up on the suspension calendar, which is generally used for non-controversial measures.  The other bill, the Swap Jurisdiction Certainty Act (H.R. 1256) will be brought forward under a rule, which may allow for amendments to the bill that directs the SEC and CFTC to issue joint rules on swaps and security-based international swaps.  All are expected to pass the House.

Financial Services Subcommittee Examines Role of Proxy Advisory Firms

On June 5th, the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises met to examine the growing reliance on proxy advisory firms in proxy solicitations and corporate governance. Specifically, the Subcommittee sought to investigate the effect proxy advisory firms have on corporate governance standards, the market power of these firms, potential conflicts of interest, and SEC proposals seeking to modernize corporate governance standards. During the hearing Subcommittee Chairman Scott Garrett (R-NJ) voiced concern that institutions are overly reliant on proxy advisory firms in determining how to cast shareholder votes and questioned whether conflicts of interest and voting recommendations based on one-size-fits all policies affect shareholder value.

Witnesses at the hearing included: former SEC Chairman Harvey Pitt,  Timothy Bartl, President of the Center on Executive Compensation, Niels Holch, Executive Director of Shareholder Communications Coalition, Michael McCauley, Senior Offices for Investment Programs and Governance of the Florida State Board of Administration, Jeffrey Morgan, President and CEO of the National Investor Relations Institute, Darla Stuckey, Senior Vice President of the Society of Corporate Secretaries & Governance Professionals, and Lynn Turner, Managing Director of LitiNomics. The hearing comes as SEC Commission Daniel Gallagher recognized that lawmakers and regulators need to re-examine the role of advisory firms in the corporate governance matters as “no one should be able to outsource their fiduciary duties.”

Lawmakers Introduce Legislation Targeting Foreign Cyber Criminals

On June 6th, House Intelligence Committee Chairman Mike Rogers (R-MI) along with Representative Tim Ryan (D-OH) and Senator Ron Johnson (D-WI) introduced legislation that would impose visa and financial penalties on foreign cyber criminals who target American businesses. Specifically, the measure would deny foreign agents engaged in cybercrime from apply for visas or, if they reside in the U.S., would revoke visas and freeze financial assets. The bill also calls for the Department of Justice to bring more economic espionage criminal cases against offending foreign actors.

Online Gambling Legislation Introduced

On June 6th, Representative Peter King (R-NY) introduced legislation to create broad federal Internet gambling regulations and allow all online gambling with the exception of betting on sports and where Indian tribes opt not to participate. The legislation would also establish an office of Internet gaming housed within the Treasury. Following a 2011 ruling by the Justice Department that the 1961 Wire Act does not ban online gambling, several states, including Delaware, New Jersey, and Nevada, have moved forward with creating intra-state online gaming operations.  The movement at the state level has taken some of the momentum out of federal legalization efforts.

Executive Branch

Treasury

FSOC Selects First Group of Non-Banks to be SIFIs

On June 3rd, the Financial Stability Oversight Council (FSOC) voted on the preliminary list of systemically important financial institutions (SIFIs) which will be subject to additional regulation by the Fed. This additional regulation will include new stress tests to monitor stability, additional capital requirements, and the need to create living wills in the event of resolution. While the Council did not release the names or the number of non-banks that have been selected, several firms have announced that they have received notice from the FSOC regarding their designation, including GE Capital, Prudential Financial, and AIG. Now that designations have been made, companies selected will have 30 days to request a hearing to contest the designation. While Secretary Jack Lew called the designations an “important step forward,” Chairman of the House Financial Services Committee Jeb Hensarling criticized the move, saying perpetuating non-banks as “too big to fail” will only put taxpayers on the hook for another bailout.

Federal Reserve

Fed Approves Final Rule Clarifying Treatment of Foreign Banks Under Push-Out Rule

On June 5th, the Fed approved an interim final rule clarifying the treatment of uninsured U.S. branches of foreign banks under the Dodd-Frank Act swaps push-out measure. Dodd-Frank calls for banks to separate certain swap trading activities from divisions that are backed by federal deposit insurance or which have access to the Fed discount window. Under the clarification, the Fed states uninsured U.S. branches of foreign banks will be treated as insured depository institutions and that entities covered by the rule, including U.S. branches of foreign banks, can apply for a transition period of up to 24 months to comply with the push out provisions. The interim final rule also states that state member banks and uninsured state branches of foreign banks may apply for the transition period. The Institute of International Bankers, which represents international banks operating in the U.S., praised the Fed for offering clarity on a “widely acknowledged drafting error in the original legislation.”

Fed Vice Chairman Appears to Support Stronger Capital Rules for Large Banks

Speaking in Shanghai last week, Fed Vice Chairman Janet Yellen said that it may be necessary for regulators to impose capital requirements even higher than those set forth in the Basel III agreement. Agreeing with Fed Governors Daniel Tarullo and Jeremy Stein, Yellen said “fully offsetting any remaining “too big to fail” subsidies and forcing full internalization of the social costs of a SIFI failure may require either a steeper capital surcharge curve or some other mechanism for requiring that additional capital be held by firms that potentially pose the greatest risks to financial stability.” To that end, Yellen noted that the Fed and FDIC are “considering the merits” of requiring systemically significant firms to hold minimum levels of long-term unsecured debt to absorb losses and support orderly liquidation. Yellen who, is seen by many as the frontrunner for Fed Chairman following Bernanke’s term, is starting to generate a lot more attention as we come closer to the end of Bernanke’s reign.  However, she is not the only member of the Fed espousing this policy.  In a speech later in the week, Philadelphia Fed President Charles Plosser echoed Yellen’s sentiments, saying Dodd-Frank and other efforts to end “too big to fail” may not be “sufficient.” Plosser argued that current capital requirements should be made more stringent but also simpler by relying on a leverage ratio rather than the current practice of risk weighting.

SEC

SEC Proposes Long-Anticipated Money Market Mutual Fund Overhaul

On June 5th, the SEC released a proposal which would change the way the $2.6 trillion money market mutual fund industry is regulated. After months of internal disagreement within the SEC, the Commission voted unanimously to propose the plan. The goal of the proposal is to avoid future runs on the market, like that which occurred during the financial crisis, in tandem with ensuring that the industry still function as a viable investment vehicle. The Commission’s proposal sets out two alternative options for reform which could be enacted alone or in combination. The first would require institutional prime money market funds to operate with a floating net asset value (NAV). Notably, retail and government funds would still be allowed to operate with a fixed-NAV. The second alternative would require nongovernment funds whose liquid assets fell below 15 percent of total assets to impose a 2 percent liquidity fee on all redemptions. If this were to occur, a money market fund’s board would be permitted to suspend redemptions for up to 30 days. The proposal also calls for prompt public disclosure if a fund dips below the 15 percent weekly liquid asset threshold.

Coalition of Investment and Consumer Interests Call for Strong Uniform Fiduciary Standard

In a letter sent to the SEC on June 4th, a coalition of investment and consumer groups called on the Commission to enact a uniform fiduciary standard that would require broker-dealers and investment advisers to act in consumers’ best interest. The letter, signed by organizations such as AARP, the Consumer Federation of America, and the Investment Adviser Association, is in response to an SEC request for information (RFI) requesting input on regarding the possible extension of a fiduciary duty to broker-dealers. The groups assert that, the fiduciary standard set forth in the RFI is weak compared to current law and “seems to contemplate little more than the existing suitability standard supplemented by some conflict of interest disclosures.”

District Court Hears Challenge to SEC Critical Minerals Rule

On June 7th, the Court of Appeals for the D.C. Circuit heard a challenge brought on behalf of the American Petroleum Institute, the Chamber of Commerce, and others to the SEC’s critical minerals rule which requires companies to disclose payments made to foreign governments. Industry argues that the rule is overly burdensome and could result in proprietary information being shared with competitors. However, supporters of the rule, including Oxfam America, assert that the measure will increase transparency and help combat human rights abuses.

FDIC

FDIC Approves Non-Bank Resolution Final Rule

On June 4th, the FDIC approved a final rule establishing the criteria which will be used to determine which non-bank financial firms will be required to comply with the FDIC’s authority to liquidate large failing companies. The rule, which lays out factors used to determine if a company is “predominately engaged in financial activity,” requires companies where at least 85 percent of revenues are classified as financial in nature by the Bank Holding Company Act to comply. The FDIC’s rule closely resembles a final proposal by the Fed which established criteria for non-banks to be flagged for additional supervision under Dodd-Frank.

CFPB

CFPB Finalizes Ability-to-Repay Rule Amendments

On May 29th, the CFPB finalized rules designed to increase access to credit through exemptions and modifications to the Bureau’s ability-to-repay rule. The ability-to-repay rule, which was finalized in January 2013, requires that new mortgages comply with basic consumer protection requirements that are meant to ensure consumers do not take out loans they cannot pay back through Qualified Mortgages (QMs). In response to public and Congressional concerns about the scope of the rule, the Bureau’s finalized rules exempt certain nonprofit creditors and community-based lenders who service low- and moderate-income borrowers, facilitate lending by small creditors, banks and credit unions with less than $2 billion in assets and which make 500 or fewer mortgages loans per year, and establish how to calculate loan origination compensation. In announcing the amendments, the CFPB also delayed the effective date of provisions prohibiting creditors from financing certain credit insurance premiums in connection with certain mortgage loans. Currently, the effective date is January 10, 2014; however, the Bureau plans to solicit comment on an appropriate effective date for proposed credit insurance clarifications.

Bureau Issues Mortgage Rule Exam Guidelines

On June 4th, the CFPB issued an update to its exam procedures based on the new Truth in Lending Act (TILA) and the Equal Credit Opportunity Act (ECOA) mortgage regulations finalized in January. The guidance addresses questions about how mortgage companies will be examined such as for: setting qualification and screening standards for loan originators; prohibiting steering incentives; prohibiting “dual compensation,” protecting borrowers of higher-priced loans; prohibiting the waiver of consumer rights; prohibiting mandatory arbitration; requiring lenders to provide appraisal reports and valuations; and prohibiting single premium credit insurance.

CFPB Announced Further Study on Pre-Dispute Arbitration in Financial Products

In a notice and request for comment published on June 7th, the CFPB announced it will conduct phone surveys of credit card holders as part of its study of mandatory pre-dispute arbitration agreements. While Dodd-Frank gave the CFPB authority to ban the use of arbitration in mortgages, Section 1028(a) of the Dodd-Frank Act requires the Bureau to conduct a study before taking additional action to limit arbitration in other financial products. According to the notice, the survey will investigate “the extent of consumer awareness of dispute resolution provisions in their agreements with credit card providers” and consumers’ assessments of these tools.

International

IMF Working Paper Calls for Taxes on Large Banks to Level Playing Field, End “Too Big to Fail”

In a working paper published at the end of May, the International Monetary Fund (IMF), suggesting that large banks in advanced economies have more incentive to take risks due to cheaper funding sources, proposed taxing large banks to “extract their unfair competitive advantage.” The authors of the paper argue that such as tax would level the playing field from the perspective of competitive policy and reduce excess incentives of banks to grow, reducing the problem of “too big to fail” and increasing financial stability. Specifically, the paper found that the implicit guarantee that “too big to fail” banks will be bailed out in the event of failure or crisis can lead to a funding advantage of up to 0.8 percent a year. In related news, On June 5th, Representative Michael Capuano (D-MA) introduced legislation (H.R. 2266) which would require certain systemically important institutions to account for the financial benefit they receive as a result of the expectations on the part of shareholders, creditors, and counterparties that the government will bail them out in the event of failure.

Upcoming Hearings

On Wednesday, June 12th at 10am, in 1100 Longworth, the Trade Subcommittee of House Ways and Means Committee will hold a hearing titled “U.S.-Brazil Trade and Investment Relationship: Opportunities and Challenges.”

On Wednesday, June 12th at 10am, in 2128 Rayburn, the House Financial Services Committee will hold a hearing titled “Beyond GSEs: Examples of Successful Housing Finance Models without Explicit Government Guarantees.”

On Wednesday, June 12th at 2pm, in 2128 Rayburn, the Capital Markets and Government Sponsored Enterprises Subcommittee of House Financial Services Committee will hold a hearing on proposals intended to support capital formation.

On Thursday, June 13th at 10am, in 538 Dirksen, the Senate Banking, Housing, and Urban Affairs Committee will hold a hearing titled “Lessons Learned From the Financial Crisis Regarding Community Banks.”

On Thursday, June 13th at 10am, in 2128 Rayburn, the Monetary Policy and Trade Subcommittee of House Financial Services Committee will hold a hearing on changes to the Export-Import Bank.

On Thursday, June 13th at 1pm, in 2128 Rayburn, the Housing and Insurance Subcommittee of House Financial Services Committee will hold a hearing on international insurance issues.

The CFPB’s Consumer Complaint System: Key Points of Concern for Financial Services Companies

The National Law Review recently published an article by Stephanie L. Sanders and Richard Q. Lafferty of Poyner Spruill LLP regarding CFPB’s Consumer Complaint System:

The Dodd-Frank Act requires the Consumer Financial Protection Bureau (CFPB) to collect, investigate and respond to consumer complaints as part of its work in protecting consumers of financial products and services.  Over the past year, CFPB’s Consumer Response team has gradually begun taking complaints on credit cards, mortgages, private student loans, other consumer loans, and other bank products and services.  Because the complaint process could result in investigation or enforcement actions, financial services companies should be sure they understand the system and are prepared to respond promptly to complaints.  Below is a list of recommendations for financial service companies to deal with the complaint system.

Know How to Use the Complaint System

CFPB’s website now prominently includes a “Submit a Complaint” portal.  Consumers wishing to make a complaint in one of the above categories can simply click on the “Submit a Complaint” icon and follow the directions provided.  In addition, CFPB accepts complaints by telephone, mail, email, and fax.  The portal is the primary means of communication between CFPB and financial service companies, so companies should be familiar with the portal and establish procedures for fielding any complaints in a timely manner.  CFPB has provided aCompany Portal Manual explaining how the portal and the complaint process works.

Once a complaint is submitted, CFPB screens it to determine whether it falls within the agency’s primary enforcement authority, whether it is complete, and whether it is a duplicate submission.  If the complaint passes these tests, it is then forwarded to the company for response.  The company is notified of the complaint and can log into the portal to view all active cases.  Upon receipt of the complaint, the company must communicate with the consumer to determine the appropriate response.  The company’s response is submitted via the portal, and the consumer is invited to review the response.  The consumer can log onto the secure portal or call a toll-free number to receive status updates and review responses.  The consumer is then given an opportunity to dispute the response.

Be Prepared to Respond Quickly

CFPB requests that companies respond to complaints within 15 calendar days and resolve complaints within 60 days.  Failure to provide a timely response may trigger an investigation of the complaint by CFPB.  Since a complete response requires that the company correspond with the complaining consumer, companies should pursue a response quickly to ensure they meet CFPB deadlines.

Understand that Complaints May Result in Investigations or Enforcement Actions by CFPB

The Consumer Response Team prioritizes review and investigation of complaints where a consumer disputes the response or the company fails to provide a timely response.  In addition, the team analyzes groups of complaints to identify issue-specific trends.  In some cases, complaints are referred to CFPB’s Division of Supervision, Enforcement, and Fair Lending and Equal Opportunity for further action.  Financial services companies should thus be vigilant on the same matters, paying greater attention to disputed responses, ensuring that responses are timely, and monitoring for trends in the complaints received so that underlying problems are addressed before they are raised by the agency.

Understand that cCmplaints May Also Result in Investigations By Other Agencies

If a complaint is outside CFPB’s jurisdiction, it may be forwarded to the appropriate regulator (for example, while CFPB handles complaints on private student loans, it forwards complaints received about federal student loans to the Department of Education).

In addition, the Dodd-Frank Act requires CFPB to share consumer complaint information with the Federal Trade Commission (FTC) and other state and federal agencies.  For example, if CFPB receives a complaint about identity theft, it may share that with the FTC, which is the agency that has historically investigated such complaints.  As a result, financial services companies may need to anticipate receiving questions from the FTC about the effectiveness of their Red Flags program, which companies should have fully implemented in response to applicable FTC and other federal agency rules.  In addition, CFPB currently shares its complaints with the FTC’s Consumer Sentinel system, an online database of consumer complaints maintained by the FTC that is accessible by law enforcement.

Be Prepared for an Increase in the Volume of Complaints

Consumer use of the complaint system is off to a strong start.  CFPB recently issued a Consumer Response Annual Report summarizing the use of the complaint system from its launch in July 2011 through December 31, 2011.  The report indicates that CFPB received 13,210 consumer complaints during that time, including 9,307 credit card complaints and 2,326 mortgage complaints.  The most common credit card complaints involved billing disputes, identity theft, and APR or interest rates.  The most common mortgage complaints involved situations in which the consumer was unable to pay (loan modification, collection, foreclosure).  The complaint systems for bank products and services, private student loans, and other consumer loans only began in 2012, so the report did not cover those categories.  By the end of 2012, the CFPB expects that the complaint system will cover all consumer financial products and services.

Financial services companies should monitor these trends to identify issues that may affect their business.  They also should anticipate a significant increase in complaint volume as CFPB adds additional products to the complaint system and more consumers become aware of it.  By comparison, the FTC Consumer Sentinel fielded 1.8 million complaints in 2011.

© 2012 Poyner Spruill LLP

With Form PF Compliance Dates Quickly Approaching, Advisers Managing $150 Million or More of Private Fund Assets Should Begin to Prepare

An article about Form PF Compliance written by Eric R. Markus, Victor B. Zanetti, and William L. Rivers of Andrews Kurth LLP recently appeared in The National Law Review:

On October 26, 2011, the Securities and Exchange Commission (the “SEC”) adopted Rule 204(b)‑1 under the Investment Advisers Act of 1940 (the “Advisers Act”) to require certain investment advisers that advise private funds to periodically complete and file the SEC’s new Form PF.1 Rule 204(b)-1 implements sections 404 and 406 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and is intended to provide the SEC with information relevant to assessing the risks that certain advisers and funds pose to the stability of the financial system. Although Form PF is filed confidentially and exempt from the Freedom of Information Act, the SEC is permitted to share this information with other federal agencies (most notably the Commodity Futures Trading Commission and the Financial Stability Oversight Council).

The requirements of the rule and Form PF are novel and the amount of information required to be assembled can be—at least in certain instances—quite substantial. With the initial compliance dates for investment advisers to certain large private funds approaching in June 2012, now is the time for investment advisers to become familiar with this new regulatory requirement, to determine when their initial Form PF filing will be due, and to identify and begin to assemble the types and extent of the information that will be required.

The full text of the adopting release and the final rule is available here. The full text of Form PF is available here.

What Investment Advisers Are Subject to Rule 204(b)-1 and Must File Form PF?

The new rule requires any investment adviser registered (or required to register) with the SEC under the Advisers Act that advises one or more “private funds” and has, in aggregate, $150 million or more in private fund assets under management to file Form PF. For purposes of determining whether they meet certain regulatory thresholds established by Form PF, related advisers must aggregate their assets under management; however, related advisers do not need to aggregate their assets if they are “separately operated.”2

What is a “Private Fund”?

The term “private fund” is defined in Section 202(a)(29) of the Advisers Act as any issuer “that would be an investment company,” as defined in the Investment Company Act of 1940, as amended (the “ICA”), but is excepted by virtue of the exemptions provided in Section 3(c)(1) (funds with fewer than 100 beneficial owners) or Section 3(c)(7) (funds owned exclusively by qualified purchasers) of the ICA. Real estate funds relying on the exemption provided in Section 3(c)(5) of the ICA are not required to file Form PF (although many real estate funds, because of the nature and structure of their investments, rely on the exemptions provided under Section 3(c)(1) or (7) and therefore may be required to file).

Form PF establishes different treatment—in terms of initial filing dates, the frequency of filings and the content of those filings—based on the characteristics of the private funds involved and their advisers. The most important distinction that Form PF draws in this regard is between “Large Private Fund Advisers” and all other investment advisers to private funds.

What is a “Large Private Fund Adviser”?

A “Large Private Fund Adviser” is defined as a private fund adviser that meets any one or more of the following criteria:

  • it has at least $1.5 billion in regulatory assets under management attributable tohedge funds as of the end of any month in the most recently completed fiscal quarter;
  • it has at least $1.0 billion in combined regulatory assets under manage­ment attributable to liquidity funds and registered money market funds3 as of the end of any month in the most recently completed fiscal quarter; and/or
  • it has at least $2.0 billion in regulatory assets under management attributable toprivate equity funds as of the last day of the adviser’s most recently completed fiscal year.

How are Regulatory Assets Under Management Calculated?

The term “regulatory assets under management” has the same meaning given to it in the SEC’s recent amendments to Part 1A, Instruction 5.b of Form ADV. This definition measures assets under management gross of outstanding indebtedness and other accrued but unpaid liabilities.

In addition, in order to prevent an adviser from restructuring the way it manages money to avoid compliance with Form PF, the rule requires regulatory assets under management to include (a) assets of managed accounts advised by the adviser that pursue substantially the same investment objective and invest in substantially the same positions as private funds advised by the firm unless the value of those accounts exceeds the value of the private funds with which they are managed; and/or (b) assets of private funds advised by any of the adviser’s “related persons” other than related persons that are separately operated.

What is a “Hedge Fund”?

Form PF defines a “hedge fund” as any private fund that is not a securitized asset fund4 if it meets any of the three following criteria:

  • it is permitted to pay one or more investment advisers (or their related persons) a performance fee or allocation calculated by taking into account unrealized gains;
  • it is permitted to borrow an amount in excess of one-half of its net asset value (including any committed capital); and/or
  • it is permitted to sell securities or other assets short or enter into similar transactions (other than for the purpose of hedging currency exposure or managing duration).

Note that for purposes of the first criteria above, the fund must only be authorized to pay a fee based on unrealized gains (the classification applies whether or not the performance fee is actually paid). In the Adopting Release, the SEC clarified that the periodic calculation or accrual of performance fees based on unrealized gains solely for financial reporting purposes (as many private equity funds do) will not cause a private fund to be classified as a hedge fund. For purposes of the second and third criteria cited above, the private fund must be authorized to undertake such activities; actually undertaking the activities is not required.5

What is a “Liquidity Fund”?

Form PF defines a “liquidity fund” as any private fund “that seeks to generate income by investing in a portfolio of short term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors.” Thus, a liquidity fund would be a private fund that resembles a registered money market fund.

What is a “Private Equity Fund”?

Form PF defines a “private equity fund” as any private fund that is not a hedge fund, liquidity fund, securitized asset fund, real estate fund,6 or venture capital fund7 and does not provide investors with a right to redeem their interests in the ordinary course.

Does the SEC’s Focus on Hedge Funds, Liquidity Funds and Private Equity Funds Mean that Other Types of Private Funds are Not Subject to Rule 204(b)(1) and Form PF?

No. As the charts below show, an investment adviser that is not a Large Private Fund Adviser and that does not advise any hedge funds, liquidity funds or private equity funds must still prepare and file Form PF if it advises private funds with $150 million or more in private fund assets.

What are the Initial Compliance Dates for Form PF?

Form PF and Rule 204(b)-1 establish June 15, 2012 as the initial “compliance date” for any registered investment adviser (or an adviser that is required to register) that meets one or more of the following criteria:

  • it has at least $5.0 billion in regulatory assets under management attributable to hedge funds as of the last day of its fiscal quarter most recently completed prior to June 15, 2012;
  •  it has at least $5.0 billion in combined regulatory assets under management attributable to liquidity funds and registered money market funds as of the last day of its fiscal quarter most recently completed prior to June 15, 2012; and/or
  • it has at least $5.0 billion in regulatory assets under management attributable to private equity funds as of the last day of its first fiscal year to end on or after June 15, 2012.

An adviser subject to the June 15, 2012 compliance date as a result of its advice to hedge funds and/or liquidity funds/money market funds will need to file its initial Form PF for the first fiscal quarter ending after June 15, 2012. For most such advisers, this will be for the fiscal quarter ending June 30, 2012 (and will be due August 29, 2012 for hedge fund advisers and July 15, 2012 for liquidity fund advisers). An adviser subject to the June 15, 2012 compliance date as a result of its advice to private equity funds will need to file its initial Form PF for the first fiscal year ending after June 15, 2012. For most such advisers, this will be for the fiscal year ending December 31, 2012 (and will be due April 30, 2013).

For all investment advisers that are not subject to the June 15, 2012 compliance date, the compliance date will be December 15, 2012. However, whether such advisers will be filing with respect to the first fiscal quarter or first fiscal year ending after that date (and the deadline for such filing) will depend on the type of private funds advised and the amount of assets under management as set forth in Table I below.

TABLE I

Regulatory assets under management for the fiscal quarter or year (as the case may be) ending immediately after June 15, 2012 are, for hedge funds and liquidity funds, measured as of the last day of the fiscal quarter ending immediately prior to such date, and for private equity funds measured, as of the last day of the fiscal year ending immediately prior to such date. For any other Form PF filing under Rule 204(b)-1, regulatory assets under management, for quarterly Form PF filers, are measured as of the end of each month in the immediately preceding fiscal quarter (and the threshold is passed if, as of any month end, the assets under manage­ment exceed the relevant threshold), and, for annual Form PF filers, are measured solely as of the last day of the immediately preceding fiscal year.

What Type of Information Must Be Included in the Form PF?

As with other issues under the new Form PF, the answer to this question depends on the size and nature of the private funds advised. Investment advisers to private funds (other than Large Private Fund Advisers) have much more limited disclosure obligations than Large Private Fund Advisers. In addition, as it relates to Large Private Fund Advisers, the additional disclosures required have been tailored to whether the private fund advised is a hedge fund, liquidity fund or private equity fund. Table II below summarizes the information requirements imposed by Form PF.

TABLE II

Investment Advisers should start now to determine whether they will be required to file the new Form PF, to determine the applicable filing date for any form PF filing, and to identify and begin to assemble the required information necessary to complete the form.

1. See Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Release No. IA-3308; File No. S7-05-11 (October 31, 2011) (the “Adopting Release”).

2. An adviser is not required to aggregate its private fund assets with those of a related person if the adviser is not required to complete Section 7.A of Schedule D to its Form ADV with respect to such related person. The criteria for excluding a related person from Section 7.A of Schedule D to an adviser’s Form ADV include (i) the adviser having no business dealings with the related person in connection with advisory services provided to its clients; (ii) the adviser not conducting shared operations with the related person; (iii) the adviser not referring clients or business to the related person, and the related person not referring prospective clients or business to the adviser; (iv) the adviser not sharing supervised persons or premises with the related person; and (v) the adviser having no reason to believe that its relationship with the related person otherwise creates a conflict of interest with its clients.

3. An adviser that manages liquidity funds and registered money market funds must combine the assets in those funds for purposes of determining whether it qualifies as a Large Private Fund Adviser.

4. A securitized asset fund is a private fund whose main purpose is to issue asset backed debt securities.

5. This test does not require that the fund’s organizational documents expressly prohibit such leverage or short-selling as long as “the fund in fact does not engage in these practices … and a reasonable investor would understand, based on the fund’s offering documents, that the fund will not engage in these practices.” SeeAdopting Release at page 28.

6. A real estate fund is defined as a private fund that invests primarily in real estate and real estate-related assets as long as it is not a hedge fund and does not provide investors the right to redeem in the ordinary course.

7. A venture capital fund is defined by reference to Rule 203(l)-1 of the Advisers Act. That rule is complex, subject to various exceptions, definitions and other discussions, and easily could be the subject of its own client alert. In short, a venture capital fund is defined as a private fund that: (i) holds no more than 20 percent of the fund’s capital commitments in certain non-qualifying investments; (ii) does not incur leverage, other than limited short-term borrowing; (iii) does not offer its investors a right to redeem except in extraordinary circumstances; (iv) represents itself as pursuing a venture capital strategy; and (v) is not registered as a business development company.

8. For purposes of calculating the amount of regulatory assets under management by a manager to a liquidity fund, regulatory assets under management include the combined assets under management attributable to all liquidity funds and registered money market funds.

9. A “Large Private Fund Adviser” includes (i) any adviser that has at least $1.5 billion in regulatory assets under management attributable to hedge funds, (ii) any adviser that has at least $1.0 billion in regulatory assets under management attributable to liquidity funds and registered money market funds, or (iii) any adviser that has more than $2.0 billion in regulatory assets under management attributable to private equity funds.

10. An adviser solely to private funds other than hedge, liquidity and private equity funds would not be a Large Private Fund Adviser regardless of the assets under management in those funds.

11. See Note 9.

12. Form PF requires additional disclosures in Section 2b by Large Private Fund Advisers with respect to any hedge fund that has a net asset value of at least $500 million.

13. See Note 10.

© 2012 Andrews Kurth LLP