MFDF Forum News Feed

House Financial Services Committee to Consider Legislation on SEC Cost-Benefit Analysis

2012-02-15T09:00

On Thursday, February 16^th, the House Financial Services Committee will mark-up the "SEC Regulatory Accountability Act" introduced by Rep. Scott Garrett (NJ-R). The legislation would impose additional requirements on the SEC's cost-benefit analyses of rules and orders, including mandating that the SEC Office of the Chief Economist participate in the cost-benefit analysis process and specifying eleven new factors for the SEC to consider during its analysis. Last fall, SEC Chairman Mary Schapiro testified that the requirements under the bill were extensive and onerous. In addition, she raised concerns that requiring cost-benefit analyses for orders could have detrimental effects including delaying enforcement orders, exemptive orders and orders accelerating registration statements.

The SEC has been under recent scrutiny for inadequate cost-benefit analysis. Most recently, the SEC's proposed proxy access rule was struck down last year for failing to adequately assess the economic effects of the rule. Last week, Federated announced that it would take legal action to block money market reforms being considered by the SEC on the basis that the agency had not done sufficient cost-benefit analysis.

CFTC Agrees with Forum that Directors Should Not be Required to Register as CPOs

2012-02-14T09:00

The Commodity Futures Trading Commission (CFTC) has issued a rule that requires most funds investing in commodity-related instruments to register with the CFTC. As such, these funds will be subject to dual registration requirements by the CFTC and SEC. Because the regulatory regimes of the CFTC and SEC directly conflict, the CFTC has also proposed amendments to its regulations regarding requirements applicable to registered investment companies that will be subject to registration with the CFTC.

In its comment letter on the proposed rule, the Forum had been particularly concerned that the proposal could force fund directors to be designated as "commodity pool operators." This would potentially expand director liability and subject directors to additional obligations, including passing a rigorous exam required of all individuals who purchase and sell commodities or futures products. Citing the Forum's comment letter on this point, the CFTC concluded in the final rule release that the investment adviser, and not the fund directors, should be required to register, because requiring board members to register "would raise operational concerns for the registered investment company as it would result in piercing the limitation on liability for actions undertaken in the capacity of director." (Adopting Release, p. 29.)

The Forum's comment letter, along with many letters from other industry participants, also argued that CFTC registration was unnecessary and would impose significant additional costs on registered funds without clearly providing investors with protections over and above those contained in the 1940 Act. While the final rule release acknowledged that this point was made by both the Forum and the ICI, it merely asserted that "[t]he [CFTC] believes that because Congress empowered the [CFTC] to oversee the derivatives market, the [CFTC] is in the best position to oversee entities engaged in more than a limited amount of non-hedging derivatives trading." (Adopting Release, p. 11).

The release also notes that "the final regulations will impose some significant costs on the industry," but that "proper regulation and oversight of market participants is necessary to promote fair and orderly derivatives markets." (Adopting Release, p. 119). Such cursory analysis prompted CFTC Commissioner Jill Sommers to write a dissent, in which she called it "unlikely" that the rules would "survive judicial scrutiny if challenged."

SEC Seeks Public Comment on Investor Disclosure Issues

2012-02-13T09:00

As part of a review mandated by the Dodd-Frank Act, the SEC has requested public comment on financial literacy and investor disclosure issues, including issues affecting mutual funds. The public comments will supplement the SEC's own qualitative and quantitative research which includes investor testing. The SEC is seeking comment on:

methods to improve the timing, content and format of disclosures to investors regarding financial intermediaries, investment products and investment services;
information that retail investors need to make informed financial decisions before engaging a financial intermediary or purchasing investor products or services typically sold to retail investors, including mutual funds; and
how to make expenses and conflicts of interest more transparent to investors, including during mutual fund transactions.

More information, including the SEC comment request, can be found here.

Controversial PCAOB Appointment

2012-02-10T08:59

In an unusual split decision, the SEC named Jeanette M. Franzel to be a member of the Public Company Accounting Oversight Board (PCAOB) on February 3rd. After the appointment, Commissioner Luis Aguilar issued a dissent. He stated that the SEC failed to meet its legal obligation to appoint an individual with "a demonstrated commitment to the interests of investors" because she has no record of investor advocacy. In announcing Ms. Franzel's appointment, SEC Chairman Mary Schapiro stated that "Jeanette's commitment to the public trust and America's investors is demonstrated by her life-long public service and her constant dedication to increasing accountability, audit quality and audit standards."

Ms. Franzel is currently a Managing Director of the U.S. Government Accountability Office (GAO) with over 20 years of public service. She will replace Daniel L. Goelzer, one of the founding members and a former interim Chairman of the five-member Board. Ms. Franzel currently leads all aspects of GAO's financial audit oversight of the U.S. federal government. She heads a team of approximately 250 staff that focuses on financial and performance audits, proper use of federal funds, internal control, financial systems, and federal audit and financial management policy.

CFTC Requires Funds to Register as Commodity Pool Operators

2012-02-09T18:41

Today, the CFTC announced that they have adopted a final rule requiring funds that invest more than a de minimus amount in commodities to register as commodity pool operators ("CPOs"). According to CFTC Chairman Gary Gensler, this will "reinstate the regulatory requirements in place prior to 2003 for registered investment companies."

Notably, citing the comment letter submitted by the Mutual Fund Directors Forum, the final rule release specifically states that fund directors do not have to register as CPOs. This is significant because registering as a CPO carries numerous obligations and responsibilities, as well as additional liability risk. In relevant part, the release stated:

The Commission agrees that the investment adviser is the most logical entity to serve as the registered investment company's CPO. To require a member or members of the registered investment company's board of directors to register would raise operational concerns for the registered investment company as it would result in piercing the limitation on liability for actions undertaken in the capacity of director. Thus the Commission concludes that the investment adviser for the registered investment company is the entity required to register as the CPO.

The final rule received a 4-1 vote in a private voting process with Commissioner Jill E. Sommers dissenting. In her dissent, Commissioner Sommers stated that the rule gives the false impression that the CFTC will be able to actively monitor pools for systemic risk. She also challenged the adequacy of the cost-benefit analysis performed, stating "it is unlikely, in my view, that the cost-benefit analysis supporting the rules will survive judicial scrutiny if challenged."

Money Market Fund Proposal May Be Imminent

2012-02-08T09:00

The SEC staff is reportedly set to propose several extensive changes to money market fund regulations. The proposal would require money market funds to float their NAV and have a capital buffer, attained by a corporate cash injection (likely from the fund's sponsor), issuing stock or debt securities, or collecting more money from shareholders. The proposal would also implement a so-called "liquidity fee" on investors who are trying to sell all their shares at once-such investors would only receive 95% of their money back immediately, with the remaining 5% returned to them 30 days later.

The proposal is strongly opposed by the industry and comes at a time when money market funds are struggling in a low-interest rate environment. In recent years, firms have waived fees in an effort to keep yields above 0%. A majority of the SEC's five commissioners must approve the proposal before it can be submitted to the public for comment. According to the Wall Street Journal, three out of the five commissioners have expressed reluctance to support changes to current money market fund regulations.

Senate Passes Insider Trading Bill for Members of Congress

2012-02-06T09:00

Last Thursday, the Senate overwhelmingly (93-7) passed a bill that would prohibit lawmakers and staff from trading on non-public information obtained from private congressional briefings. Whether legislators and staff are already subject to bans on trading non-public information is a matter of debate. Robert Khuzami, Director of the SEC's Division of Enforcement, testified late last year that insider trading laws do apply to Congressmen, but also noted that the situation is "without direct precedent and may present some unique issues." For example, to be guilty of insider trading there must be a breach for duty (such as the duty a corporate insider has to shareholders). For Members of Congress, the question of whether and to whom a duty exists is more novel. In other contexts, courts have held that there is a fiduciary relationship between elected officials and the United States. However, without direct precedent it is unclear how a court would rule on this question.

The legislation also would require Members of Congress and their staff to disclose their stock trades within 30 days (currently, they make such disclosures once a year). In addition, "political intelligence practitioners" would be required to disclose their activities for the first time. Political intelligence practitioners are often hired by hedge funds and other investors to gather information about pending public policy changes.

The bill now goes to the House where a vote is expected this week.

Dodd-Frank Progress Report

2012-02-03T08:59

Davis Polk recently released a Dodd-Frank Progress Report. The report provides several useful charts detailing the status of required rulemakings under the Dodd-Frank Act. In summary:

As of February 1, 2012, a total of 225 Dodd-Frank rulemaking requirement deadlines have passed. Of these 225 passed deadlines, 164 (72.9%) have been missed and 61 (27.1%) have been met with finalized rules.

Major rulemaking activity in January 2012 included CFTC final rules on business conduct standards and registration of swap dealers and major swap participants.

The GAO published seven studies in January 2012.

SEC Inspector General Criticizes Cost-Benefit Analysis

2012-02-02T09:00

On his final day with the SEC, outgoing Inspector General David Kotz issued a report criticizing the SEC for its cost-benefit analyses of Dodd-Frank rules. Specifically, the report found that the extent of the quantitative discussion of cost-benefit analyses varied among rulemakings, the SEC sometimes used multiple inconsistent baselines in its cost-benefit analyses, and rulemakings lacked clear, explicit explanations of the justification for regulatory action. The report also stated that "the SEC may not be fulfilling the essential purposes of such analyses-providing a full picture of whether the benefits of a regulatory action are likely to justify its costs and discovering which regulatory alternatives would be most cost-effective." The report made several recommendations to improve cost benefit analyses, including that the SEC should:

Consider ways for economists to provide additional input;
Consider whether a pre-statute baseline should be used whenever possible;
Either specify a single consistent baseline to be used in the analysis or explain why multiple baselines are necessary; and
Consider directing rulemaking teams to more fully discuss the market failure or compelling social purpose that justifies regulatory action.

This report comes at a time when the SEC has received a number of public criticisms for inadequate cost-benefit analysis. Most recently, the SEC's proposed proxy access rule was struck down last year for failing to adequately assess the economic effects of the rule.

Federated Willing to Legally Challenge Money Market Fund Proposals

2012-02-01T16:01

According to a Bloomberg article, Federated is willing to use legal action to block money market fund regulation changes proposed by the SEC. In a conference call with analysts last Friday, the CEO of Federated, Christopher Donahue, stated that Federated would challenge proposals by the SEC to either (1) float the NAV or (2) require a capital buffer with a 30-day holdback of 3% of any client withdrawal. The article noted that the SEC is expected to make these proposals by the end of March. According to Bloomberg, Donahue would take legal action under the Administrative Procedures Act, claiming the SEC had not done sufficient analysis of the rules' impact.