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March 2008

Published by RR Donnelley
Editorial Content by LegalWorks
Blake A. Bell, Editor in Chief

In This Issue:

TREASURY: Treasury Secretary Proposes Most Sweeping Overhaul of Financial Regulations Since Great Depression

On March 31, U.S. Treasury Secretary Henry Paulson released a proposal for the most sweeping overhaul of the nation's financial regulatory structure since the Great Depression. The three phase proposal includes short-term recommendations, intermediate-term recommendations and long-term recommendations.

Short-Term: The Treasury Secretary proposes to expand the President's Working Group on Financial Markets to include representatives from the nation's entire financial sector rather than only from the financial markets sector. Secondly, he proposes to create a "Mortgage Origination Commission" that will set nationwide licensing standards to be applied by each state and monitor each state's systems. The proposal also suggests clarification of the federal agency that should enforce mortgage lending laws. Finally, in the short-term, he proposes to expand the Fed's powers substantially.

Intermediate-Term: The proposal would do away with the Office of Thrift Supervision and turn over the monitoring and oversight of thrifts to the Office of the Comptroller of the Currency. Additionally, the plan proposes consideration of whether the Fed or the FDIC should have responsibility for overseeing state-chartered banks. Thirdly, the proposal would give the Fed supervisory control of systems that process payments and settlements involving transfer of securities. The proposal also suggests that Congress should create a new "Office of Insurance Oversight" within the Treasury Department as an initial step toward federal oversight of the insurance industry. Finally, the most interesting intermediate step would be to merge the Commodity Futures Trading Commission and the SEC.

Long-Term: Financial institutions, under the proposal, would be required to select from among three possible charters: (i) Federal Insured Depository Institution; (ii) Federal Insurance Institution; or (iii) Federal Financial Services Provider. Additionally, under the long-term elements of the proposal the Fed would serve as a "market stability regulator" to monitor threats to the stability of the financial system from all such institutions. The proposal would create a series of new federal agencies including: (i) a "Prudential Financial Regulatory Agency" to oversee institutions that have government guarantees associated with their services; (ii) a "Conduct of Business Regulatory Agency" to handle consumer protection across all financial institutions; (iii) a "Federal Insurance Guarantee Corp." to replace the FDIC; and (iv) a "Corporate Finance Regulator" to take over certain functions of the current SEC such as corporate disclosures, governance, accounting and other such responsibilities.

As might be expected, the plan has come under intense criticism from a wide variety of players. Pundits already give it a small chance for success although some of the proposals may emerge from Congress basically intact.



SEC I: SEC Staff Accountants Issue New Guidance on Pricing Hard to Value Asset-Backed Securities

In recognition of difficulties faced by public companies during the credit crisis as they attempt to value asset-backed securities or other assets where market prices or other relevant pricing measures have all but disappeared, in late March the Commission's Staff issued new guidelines on pricing such hard-to-value assets. The Commission sent a letter to the CFOs of many public companies and posted a "sample" copy of such a letter to its Web site.

According to the letter, when market prices or relevant observable inputs are not available for an asset, companies may rely on "unobservable inputs" to value the asset but must disclose whether doing so would have a material impact on their financial results. Additionally, companies must provide explanations of how the valuation was performed, how the values might change and what impact such change might have on operations, capital and liquidity. Additionally, the letter suggests even more detailed disclosure regarding the riskiest "level 3" assets and liabilities.



SEC II: SEC Considering Changes to Oversight of Credit-Rating Agencies

News reports that appeared during the third week of March revealed that at the direction of SEC Chairman Christopher Cox, senior SEC Staffers are examining credit-rating agencies (CRAs) and plan to propose changes "this spring" to "increase disclosure of conflicts of interest and establish different rating systems for different categories of assets". The reports seem to have arisen from an address given by the SEC's Director of the Division of Trading and Markets, Erik Sirri, delivered to the Investment Advisers Association, although Sirri's prepared remarks do not yet appear to have been posted to the Commission's Web site.

The move, of course, follows widespread criticism of the role played by credit rating agencies in the subprime meltdown and consequent credit crisis. One interesting element of the proposals still being massaged by Commission staffers is the possibility that the Commission may remove all references to reliance on credit ratings from all Commission rules despite the impact that such a move could have on money market mutual funds. Among other proposals being considered is one to distinguish ratings for corporate bonds from those for asset-backed securities.



SEC III: SEC Staff Issues No-Action Interpretive and Exemptive Letter To Address Issues in the Municipal Auction Rate Securities Market

U.S. Securities and Exchange Commission Division of Trading and Markets and Division of Corporation Finance, Letter Re: Municipal Auction Rate Securities (Mar. 14, 2008).

On March 14, the heads of the SEC's Division of Trading and Markets and Division of Corporation Finance issued a no-action interpretive and exemptive letter to address issues in the near-frozen municipal auction rate securities market. The letter, in effect, allows municipalities to bid on their own auction-rate securities and not face market manipulation charges so long as they give advance disclosure of how much they plan to buy and at what price.

The Commission's objective, of course, is to restore order and liquidity to a marketplace that has faced months of failed auctions due to the extended credit crisis. According to its guidance, the Commission decided to act when it realized that "a contributing factor [to the freeze-up in the market] may be the reluctance of participating dealers to purchase in the auctions due to uncertainty regarding the Staff's views on the circumstances under which participating dealers may accept bids from issuers desiring to participate in auctions".



SEC IV: SEC Proposes "Naked" Short Selling Anti-Fraud Rule

During its March 4 open meeting, the Commission voted unanimously to propose a new Naked Short-Selling Anti-Fraud rule: Rule 10b-21. The proposed rule is intended to highlight the specific liability of parties who deceive others, such as broker-dealers and purchasers, about their intention or ability to deliver securities in time for settlement and that fail to deliver securities by settlement date.

In a naked short sale, the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard three-day settlement period for trades. As a result, the seller fails to deliver stock to the buyer when delivery is due. This is known as a "failure to deliver." As noted by the Commission, "sellers sometimes intentionally fail to deliver securities to the buyer as part of a scheme to manipulate the price of a security, or possibly to avoid borrowing costs associated with short sales." In its statement announcing the development, the Commission emphasized that the "rule proposal will help protect and enhance the operation, integrity and stability of the markets in the clearance and settlement system, and also puts market participants on notice that the Commission will continue targeting abuses in this area."

RealCorporateLawyer.com is pleased to provide law firm memorandum guidance on these developments. See:



SEC V: SEC Proposes Amendments to Regulation S-P: Privacy of Consumer Financial Information

Also during its March 4 open meeting, the SEC voted unanimously to propose amendments to Regulation S-P to safeguard the privacy of consumer information held by institutions the Commission regulates. The proposed amendments deal with a host of issues including:

  • more detailed standards for information security programs with more specific requirements for safeguarding information and responding to information security breaches;
  • a new exception to permit the disclosure of limited personal information when representatives move from one broker-dealer or registered investment adviser to another;
  • updates to Regulation S-P’s safeguarding and disposal provisions;
  • extension of the application of the disposal provisions to individuals associated with brokers, dealers, investment advisers registered with the Commission and transfer agents registered with the Commission; and
  • amendments to permit a limited transfer of information without the required notice and opt out when personnel move from one broker-dealer or registered investment adviser to another.
In its statement announcing the unanimous vote to release the proposal for public comment, the Commission stated: “Today’s proposal should help guard against growing problems such as identity theft and intrusions into online brokerage accounts. . . . It also includes a pragmatic exception that would continue to protect information while providing an orderly mechanism for departing representatives to take limited customer information to their new firms. This should help give firms flexibility while facilitating the transfer of accounts, promoting investor choice, and providing firms with legal certainty.”

RealCorporateLawyer.com is pleased to provide law firm memorandum guidance on these developments. See:



SEC VI: SEC Proposes To Streamline ETF Approval Process

Another important development during the Commission's March 4 open meeting was the Commission's unanimous vote to propose two new rules under the Investment Company Act to permit exchange-traded funds to operate without the need to obtain individual exemptive orders from the Commission. As noted in its announcement, the Commission voted to propose the following rules and form:

  • Proposed Rule 6c-11 would provide several exemptions from the Act to permit ETFs to form and operate without the need to obtain individual exemptive relief from the Commission. The rule would codify most of the exemptions previously granted by the Commission to index-based ETFs and, pursuant to several recently-issued exemptive orders, to fully transparent actively managed ETFs.
  • Proposed Rule 12d1-4 would allow investment companies to make larger investments in ETFs than currently permitted under the Act, which limits one investment company to acquiring no more than 3 percent of another investment company’s shares. The exemptions in the proposed rule would be subject to several conditions designed to address the historical abuses associated with “pyramiding” schemes that often occurred with fund investment in other funds (so-called “fund of funds” arrangements).
  • Amendments to Form N-1A would accommodate the use of the form by ETFs. The proposed amendments are designed to provide key information to investors who purchase ETF shares in secondary market transactions, where most ETF investors (including retail investors) purchase their shares.


FINRA: FINRA Joins with NYSE Regulation and ORSA To Warn Against Spreading False Rumors and Other Abusive Market Activity

During the last week of March, the stock of Lehman Brothers took a pounding as rumors circulated that the firm might suffer a liquidity crunch. The rumors turned out to be false. Indeed, news reports now indicate that the SEC "is probing whether short-sellers are spreading bogus rumors to push down shares of Lehman Brothers Holdings". See SEC Probing If Short Sellers Hitting Lehman: Source, Reuters (Mar. 31, 2008).

Against this backdrop, also on March 31 the Financial Industry Regulatory Authority, NYSE Regulation and the Options Regulatory Surveillance Authority jointly released a warning to the marketplace against spreading false rumors and engaging in "other abusive market activity". Among other things, the statement cautioned:

"Firms are reminded of the prohibitions in FINRA and NYSE Rule 435(5) and FINRA Rule 5120(e) against the circulation in any manner of sensational rumors that might reasonably be expected to affect market conditions, as well as their obligations under FINRA Rule 2110 and NYSE Rule 476 to refrain from any conduct or activity inconsistent with just and equitable principles of trade. Similarly, firms are reminded of the prohibition on trading on material, non-public information.

Market participants should be especially aware that intentionally spreading false rumors or engaging in collusive activity to impact the financial condition of an issuer will not be tolerated and will be vigorously and aggressively investigated. This type of activity is highly detrimental both to the investing public and to companies constituting important components of the U.S. financial system."

Experts are suggesting that firms may wish to review internal controls and procedures designed to prevent circulation of such sensational rumors.



IOSCO: IOSCO Issues Consultation Paper on Changes to Code of Conduct for Credit Rating Agencies

On March 26, the Technical Committee of the International Organization of Securities Commission released a consultation paper entitled "The Role of Credit Rating Agencies in Structured Finance Markets". As might be expected in the midst of the current credit crisis, the paper is critical of credit ratings agencies and their role in the subprime crisis and credit crunch. The 36-page report outlines the following revisions under the three principal areas of IOSCO's Code of Conduct for such agencies:

  • Quality and Integrity of the Rating Process - Credit Ratings Agencies (CRAs) should:
    • ensure that the decision-making process for reviewing and potentially downgrading a rating of a structured finance product is conducted in an objective manner;
    • establish an independent function responsible for periodic reviews of the firm’s rating methodologies and models;
    • take reasonable steps to ensure that the information they use is of sufficient quality to support a credible rating. Ratings involving products with limited historical data should have these limitations made clear;
    • refrain from rating a product if the complexity or structure of a new type of rating creates doubts about the feasibility of a rating action; and
    • prohibit analysts from making proposals or recommendations regarding the design of structured finance products that the CRA rates.
  • CRA Independence and Avoidance of Conflicts of Interest - CRAs should:
    • establish policies and procedures for reviewing the work of analysts who leave to join an issuer the CRA rates, or a financial firm with which the CRA has significant dealings;
    • conduct formal and periodic reviews of remuneration policies and practices for its employees to ensure that these policies do not compromise the CRA’s rating process;
    • disclose whether any one client and its affiliates make up more than 10 percent of the CRA’s annual revenue; and
    • define what it considers and does not consider to be an ancillary business and why.
  • CRA Responsibilities to the Investing Public and Issuers - CRAs should:
    • assist investors in understanding what a credit rating is, the attributes and limitations of each credit opinion, and the limits to which it verifies information provided to it by the issuer of a rated security;
    • disclose on a periodic basis all cases where an issuer of a structured finance product has asked the CRA for a preliminary rating of the proposed structure, but does not subsequently contract that CRA for a final rating, or contracts for a final rating and does not publish it but does publish the ratings of another CRA for that same product.
    • when rating a structured finance product, provide investors/subscribers with the information to understand the basis for the CRA’s rating;
    • disclose whether it uses a separate set of rating symbols for rating structured finance products, and why;
    • disclose the methodology or methodology version in use in determining a rating.


PRACTICAL GUIDANCE: Courtesy of RealCorporateLawyer.com

RealCorporateLawyer.com provides its readers with free access to a very large collection of law firm memoranda providing practical guidance on current hot topics. Readers are encouraged to visit the frequently-updated "Emerging Legal Issues" area of the home page for such current memoranda, as well as the Expert Analysis: SEC Reform Portal section containing hundreds of other such memoranda. Recent additions include:

RR Donnelley offers a selection of reference publications of interest to corporate counsel. Click here to learn more.

COMINGS AND GOINGS: Who's Doing and Saying What and Where?

On March 27, the SEC announced the appointment of Jane Jarcho as an Associate Regional Director for Examinations in its Chicago Regional Office. She has been with the Commission for nearly two decades and most recently served as an Assistant Regional Director for Enforcement in the Chicago Regional Office. See U.S. Securities and Exchange Commission, Jane Jarcho Named Associate Regional Director for Examinations in SEC's Chicago Regional Office, News 2008-51 (Mar. 27, 2008). On March 6, the SEC's Office of the Chief Accountant announced it has selected six professional accounting fellows for two-year terms beginning in 2008: (1) Douglas K. Besch, currently a senior manager in KPMG LLP's Department of Professional Practice based in New York, N.Y.; (2) Brian W. Fields, currently a senior manager in KPMG LLP's Department of Professional Practice based in New York, N.Y.; (3) Douglas T. Parker, currently a senior manager in PricewaterhouseCoopers LLP's Washington, D.C., practice office; (4) Allison M. Patti, currently a senior manager in Deloitte & Touche LLP's National Office Accounting Consultation Group based in Wilton, Conn.; (5) Evan B. Sussholz, currently a senior manager in Ernst & Young LLP's Transaction Advisory Services group based in Chicago, Ill.; and (6) Arie S. Wilgenburg, currently a senior manager in Deloitte & Touche LLP's National Office Accounting Consultation Group based in San Francisco, Calif. See U.S. Securities and Exchange Commission, Office of the Chief Accountant Selects Six Professional Fellows, News Release 2008-34 (Mar. 6, 2008).

What Are the Commissioners and Commission Staffers Saying?

On March 17, Commissioner Paul S. Atkins delivered "Remarks Before the Investment Company Institute's 2008 Mutual Funds and Investment Management Conference" in Phoenix. During the March 4 Commission Open Meeting, SEC Chairman Christopher Cox delivered a series of remarks available in audiovisual format via Windows Media Player: (1) Regulation S-P; Privacy of Consumer Financial Information; (2) "Naked" Short Selling Anti-Fraud Rule; and (3) Exchange-Traded Funds. Commissioner Atkins also spoke on March 2, delivering "Remarks to the Institute of International Bankers".

Commission Staffers also were on the speaking circuit during March. On March 28, SEC General Counsel Brian G. Cartwright spoke on "The Role of the States (Foreign and Domestic)" in the context of securities regulation. A week before that, on March 21, the SEC's Director of the Division of Investment Management, Andrew J. Donohue, delivered "Remarks Before the IA Week and the Investment Adviser Association 10th Annual IA Compliance Best Practices Summit 2008". Lori Richards, Director of OCIE, spoke on March 20 regarding "Focus Areas in SEC Examinations of Investment Advisers: the Top 10". Andrew J. Donohue also spoke on March 10, delivering the "Keynote Address at the 9th Annual International Conference on Private Investment Funds".



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©2008 RR Donnelley

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