SEC CHAIRMAN SCHAPIRO TESTIFIES REGARDING THE OVER-THE-COUNTER DERIVATIVES MARKETS ACT OF 2009

SEC Chairman Mary L. Schapiro appeared before the House Committee on Agriculture on September 22, 2009, to testify regarding the regulation of over-the-counter (“OTC”) derivatives. In particular, she spoke about the Over-the-Counter Derivatives Markets Act of 2009, which was proposed in August by the Department of the Treasury. Ms. Schapiro noted that the recent financial crisis had revealed serious weaknesses in U.S. financial regulation, including a lack of regulation of OTC derivatives.

Ms. Schapiro noted that the framework provided by the Treasury proposal is designed to achieve four broad objectives: (1) preventing activities in the OTC derivatives markets from posing risk to the financial system; (2) promoting efficiency and transparency of those markets; (3) preventing market manipulation, fraud, and other market abuses; and (4) ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties. However, she laid out several broad areas in which the proposal could be strengthened to further avoid regulatory gaps and eliminate regulatory arbitrage opportunities.

One of Ms. Schapiro’s suggestions was aimed at minimizing regulatory arbitrage and gaming opportunities by regulating swaps like their underlying “references.” Ms. Schapiro noted that gaming, or regulatory arbitrage, possibilities abound when economically equivalent alternatives are subject to different regulatory regimes.

Under the Treasury’s proposal, regulatory responsibility for securities-related OTC derivatives would be divided between the SEC and the CFTC. Regulatory responsibility for other OTC derivatives would be given to the CFTC. Ms. Schapiro noted that although this could help to eliminate differences within the broad and varied world of “swaps,” it could result in significant regulatory differences between “swaps” products and the currently “regulated” securities and futures products. These regulatory differences could perpetuate existing regulatory arbitrage opportunities that encourage the migration of activities from the traditional regulated markets into the differently regulated swaps market.

Ms Schapiro suggested that the Treasury’s proposal be modified so that all securities-related OTC derivatives be regulated more like securities; and commodity and other non securities-related OTC derivatives be regulated more like futures. This would result in securities-related OTC derivatives and the underlying securities being regulated consistently. Ms. Schapiro suggested that Congress could implement this strategy by extending the federal securities laws to all securities-related OTC derivatives and extending the Commodity Exchange Act to all commodity-related and non-securities related OTC derivatives. This could significantly reduce the arbitrage opportunities between the regulated markets (securities or futures) and the differently regulated swaps market.

A complete copy of Ms. Schapiro’s testimony before the House Committee on Agriculture can be found here.

NOTES FROM NASAA ANNUAL CONFERENCE

Cosgrove Law members attended the North American Securities Administrators (NASAA) annual conference last week. The conference provided us with great opportunities to interact with state regulators from around the country and directly hear from these regulators about their issues. They focused on a wide variety of topics involving broker-dealers and investment advisers because the regulatory changes being discussed at the federal level was on everyone’s mind. Where these discussions will lead and what effect any regulatory changes might have on everyone is not known at this time. What we did take away is that all of us need to be aware of the changes being proposed e.g. the Consumer Financial Protection Agency, understand the implications to our businesses, and be ready to implement best practices to ensure compliance.

Blue Sky Compliance for Investment Advisers-NASAA’s findings from Audit Sweep

NASAA coordinated a comprehensive audit sweep by the states of Investment Advisers this year. At the conference, they presented their findings and the deficiencies they most often found. Registration, Books and Records, Unethical Business Practices, Supervision, Privacy policy and Fees and Custody were the most frequent violations uncovered, but inaccurate ADV filings were the number one deficiency found. We can assume that States will now be closely looking at Investment Adviser ADV filings. Are your ADV filings compliant? Is your firm ready to face a regulator’s scrutiny? Are you aware of FINRA’s recent releases for changes to the IARD/CRD system? If not, or you just want to ensure your current practices are compliant, contact us to review and analyze your firm’s registration practices.

CREDIT RATING AGENCIES TO UNDERGO GREATER SCRUTINY

On September 17, 2009, the SEC voted unanimously to adopt or propose several measures aimed at improving the overall quality of credit ratings. The proposals are intended to provide a more robust regulatory framework for Nationally Recognized Statistical Rating Organizations (“NRSROs”) by (1) requiring greater disclosure; (2) fostering competition; (3) helping to address conflicts of interest; (4) shedding light on rating shopping; and (5) promoting accountability.

In particular, the SEC has agreed to consider six proposals related to NRSROs:

• A recommendation to adopt rules to provide greater information concerning ratings histories — and to enable competing credit rating agencies to offer unsolicited ratings for structured finance products, by granting them access to the necessary underlying data for structured products.

• A recommendation to propose amendments that would seek to strengthen compliance programs through requiring annual compliance reports and enhance disclosure of potential sources of revenue-related conflicts.

• A recommendation to adopt amendments to the Commission's rules and forms to remove certain references to credit ratings by nationally recognized statistical rating organizations.

• A recommendation to reopen the comment period to allow further comment on Commission proposals to eliminate references to NRSRO credit ratings from certain other rules and forms.

• A recommendation to require disclosure of information including what a credit rating covers and any material limitations on the scope of the rating and whether any "preliminary ratings" were obtained from other rating agencies — in other words, whether there was "ratings shopping"

• A recommendation to seek comment on whether we should amend Commission rules to subject NRSROs to liability when a rating is used in connection with a registered offering by eliminating a current provision that exempts NRSROs from being treated as experts when their ratings are used that way.

SEC Chairman Mary S. Schapiro stated that the proposed measures “are needed because investors often consider ratings when evaluating whether to purchase or sell a particular security.” In 2006, with the passage of the Credit Rating Agency Reform Act, the SEC was given exclusive authority over rating agency registration and qualifications.

A copy of Ms. Schapiro’s opening statement before the SEC Open Meeting can be found here.

SHARE OUR BLOG ON YOUR FAVORITE SOCIAL NETWORKING SITES

For our readers' convenience, we recently added a social networking feature to our site. You can now share our blog on Twitter and Facebook by clicking on the links under "Share this Page" (located on the left hand side of the page).

In addition, Cosgrove Law, LLC is pleased to announce that it is now a member of Twitter.com.

MISSOURI’S NEW SENIOR PROTECTION ACT PACKS A STRONG PUNCH

On August 28, 2009, Missouri’s new “Senior Protection Act” took effect with the goal of better protecting investors from fraud. The Act, which gained bipartisan support from Missouri legislators, was influenced by Secretary of State Robin Carnahan’s pledge to enact stronger protections for those particularly susceptible to fraud—seniors and disabled investors.

The Senior Protection Act creates harsh penalties for those who wish to take advantage of these individuals. In particular, the Act establishes a minimum penalty of $50,000.00 for anyone who commits criminal securities fraud against an elderly or disabled person—with the maximum penalty being $1,000,000.00 and up to ten years in prison—along with an additional penalty of up to $5,000.00. The Act defines an “elderly person” as a person sixty years of age or older.

The newly-enacted Senior Protection Act can be found here, under Missouri Revised Statute § 409.5-508.

SEC CHAIRMAN SCHAPIRO ACKNOWLEDGES THE MADOFF FRAUD AND EMPHASIZES THE SEC’S COMMITMENT TO CHANGE

The Executive Summary of the Inspector General’s report regarding the Bernard Madoff fraud was released on August 31, 2009. In a statement issued by SEC Chairman Mary L. Schapiro upon the release the report, Ms. Schapiro acknowledged the Madoff fraud as a failure by the SEC to protect investors. However, Ms. Schapiro emphasized the SEC’s quick and drastic reaction in the wake of the fraud, stating that the SEC has since been “reviewing [its] practices and procedures, addressing shortcomings, and implementing the lessons learned.” Ms. Schapiro anticipates that the changes implemented by the SEC will help the agency better detect fraud in the future, thus preventing the financial turmoil caused by the Madoff fraud.

Our previous blog entry discussing some of the SEC's recent changes can be found here. In addition, click here for an in-depth analysis of the SEC’s post-Madoff reforms.

BROKER-DEALER FIRM CEOs ON CLOSE WATCH

SEC Chairman Mary Schapiro issued an order yesterday to broker-dealer firms addressing concerns regarding the recruiting methods for broker-dealer registered representatives. Ms. Schapiro noted that some types of recruiting methods, such as enhanced compensation practices wherein firms provide large up-front bonuses and enhanced commissions for sales of investment products, may in turn lead to greater risks for investors. In particular, recruiting methods based on these types of financial rewards create the risk that broker-dealer registered representatives will act in their own interest when selecting investment products for their customers, thereby violating their obligations to investors.

As such, Ms. Chapiro issued the order to remind broker-dealer firms, and in particular their CEOs, of the “significant supervisory responsibilities [they] have under the federal securities laws to oversee broker-dealer activities, particularly with respect to sales practices.”

A copy of the order can be found here.