Wednesday, 15 April 2020

FSB addresses financial stability and COVID-19

By Amy Leisinger, J.D.

The Financial Stability Board has published a report that it delivered to the G20 on international cooperation and coordination to address the potential effects of COVID-19 on global financial stability. The financial system faces a challenge in sustaining credit flow while battling declining growth and managing risks, according to the FSB. Among other things, the board is monitoring the ability of financial institutions and markets to move funds to the real economy and the ability of financial intermediaries to manage liquidity risk, the organization noted.

FSB response. In a letter, FSB Chair Randal Quarles noted the two challenges that the global financial system must respond to in the face of COVID-19: (1) an increased need for credit around the world; and (2) uncertainty regarding the value of assets, which complicates market operations. The FSB is assessing vulnerabilities in the financial system and is considering the ability of the financial system to finance businesses and meet liquidity demands while managing counterparty risks, according to the organization. The FSB is also engaged in policy work to support a strong recovery after the pandemic, the letter explained.

Global cooperation. In its report, the FSB set out principles that support the response to help the real economy, maintain financial stability, and minimize the risk of market fragmentation. According to the report, the organization is sharing information on evolving financial stability threats and the measures that financial authorities are considering to address these issues. The FSB also is assessing potential vulnerabilities in individual jurisdictions around the world, and its members are coordinating their responses to provide flexibility and/or reduce operational burdens.

“The pandemic constitutes an unprecedented global macro-economic shock, pushing the global economy into a recession of uncertain magnitude and duration,” the FSB noted.

According to the FSB, providers of funding are increasingly preferring short-term safe assets, and credit risks are rising. As such, demands on capital and liquidity are growing, but operational risks are adding to potential vulnerabilities. Downward revisions of growth expectations and heightened risk aversion, coupled with high uncertainty regarding the magnitude and duration of the pandemic, have led to volatility in equity, the FSB explained.

The organization stated that the most critical issues include the ability: (1) to channel funds to the real economy; (2) to ensure that market participants can obtain U.S. dollar funding; (3) to effectively manage liquidity risk; and (4) to manage counterparty risks.

Authorities will continue share information to assess financial stability risks from COVID-19 to maximize the potential benefits of a global response, as well as to support market functioning and to accommodate robust business continuity planning, according to the FSB. Jurisdictions around the world also will work to delay implementation deadlines, provide flexibility, and reprioritize initiatives to support the financial system, the organization said. To address concerns, jurisdictions around the world have taken steps to provide macroprudential support, and central banks are working to provide liquidity to banks and markets. For example, the Federal Reserve has established facilities to provide liquidity and support credit needs, and the Basel Committee on Banking Supervision extended by one year the implementation of outstanding standards.

“The financial system is more resilient and better placed to sustain financing to the real economy as a result of the G20 regulatory reforms in the aftermath of the financial crisis,” the FSB noted. “However, financial intermediaries and markets face growing challenges in lending and funding,” the organization stated.

CFTC votes on bankruptcy, Form CPO-PQR, and EU margin rules

By Jay Fishman, J.D.

CFTC Chairman Heath Tarbert and Commissioners Rostin Behnam, Dan Berkovitz, Brian Quintenz, and Dawn Stump, on Tuesday April 14, 2020, held an opening meeting virtually in light of the COVID-19 pandemic to discuss and vote on proposed rules pertaining to commodity broker-dealer bankruptcies; Form CPO-PQR revisions; and swap clearing requirement exemptions, along with voting on final rules permitting margin relief for the European Stability Mechanism and protecting consumer financial privacy information. The commissioners unanimously approved all five rules and set a 90-day public comment period for the three proposals. The commissioners emphasized that comments submitted after the deadline would most likely be considered because of current coronavirus disruptions.

Chairman Tarbert and commissioners Behnam, Berkovitz, Quintenz, and Stump each acknowledged in their opening statements the hard work and number of hours their staff has devoted amid the coronavirus, as well as wished this meeting’s virtual attendees, market participants, and their families around the world good health during this difficult time. They also emphasized that they would devote the rest of 2020 to simply following through on the commodities matters undertaken in 2019, which include the three proposed rules discussed and voted on at this meeting. The commissioners also remarked upon their ongoing intentions to: (1) monitor the financial markets and their market participants’ activities; (2) clarify rules (even rules that are substantively okay) to remove ambiguous language to avoid future complications; and (3) continue to work as a team not only with each other but with other U.S. and international financial regulators, as well as with Congress, the importance of which has been brought to light by the COVID-19 pandemic.

Final rules. Margin relief for the European Stability Mechanism. This approved final rule relieves the European Stability Mechanism (ESM) from having to comply with the Commodity Exchange Act’s (CEA) Regulation 23.151 (the Margin Rule), which requires the posting of initial and variation margin for uncleared swaps that certain swap dealers, major swap participants, and financial end users enter into. The approved rule amends the definition of a “financial end user” to exclude the ESM.

While the five Commissioners had approved the final rule, Commissioner Quintenz said that his support came only after COVID-19. Before the coronavirus, Quintenz was against the Margin Rule revision because the European Union (EU) failed to honor the international Central Counterparty (CCP), which allowed each individual country member to oversee and regulate its respective market participants’ activities that occurred in a foreign country. But while he found the EU to have, in the past, overreached its authority by interfering with the CFTC’s ability to regulate its U.S. participants’ oversees commodity operations, he voted for the amendment out of faith that COVID-19 would bring out each financial regulator’s desire to cooperate with each other for the greater good.

Consumer financial privacy regulation. The commissioners, without any discussion, voted to approve this proposed regulation because of its importance in today’s world, to help protect consumers confidential personal and account information from cybersecurity incidents and identity theft. The final rule specifically restores certain requirements regarding the privacy of consumer financial information that were inadvertently deleted in a 2011 rulemaking. According to the 2019 rule proposal, CFTC regulation §160.30 requires every futures commission merchant (FCM), registered foreign exchange dealer (RFED), commodity trading advisor (CTA), commodity pool operator (CPO), introducing broker (IB), major swap participant (MSP), or swap dealer (SD) subject to the jurisdiction of the Commission to have policies and procedures to safeguard customer records and information. However, when the regulation was revised in 2011 to add SDs and MSPs to the list of covered entities, some requirements were inadvertently deleted. The final rule amends §160.30 to restore the deleted requirements. A statement of support for the final rule was issued by Chairman Tarbert.

Proposed rules. Updates to CFTC’s bankruptcy regime. Chairman Tarbert and Commissioners Behnam, Berkovitz, Quintenz, and Stump unanimously voted in favor of the proposed amendments to the bankruptcy regime but admitted that CFTC’s Part 190 was pretty much fine as initially adopted in 1983. Specifically, during Part 190’s 37-year history, very few CFTC bankruptcies occurred because market participants abided by the rules. There were, of course, some large bankruptcies in more recent times, namely MF Global’s in 2011 and Peregrine’s in 2012. But overall, presenter Bob Wasserman from the Division of Clearing and Risk said that amending the initially well-written rules at this juncture would clarify ambiguous language and replace outdated cross references to help resolve matters quickly in bankruptcy court that might otherwise result in a long, expensive court process. But, moreover, he said that the new rules are necessary to stem systemic disruptions that can arise much faster because of persistent market fluctuations in today’s global economy.

As Wasserman explained, the proposed amendments to Part 190 would comprise model rules pertaining to bankruptcy proceedings for commodity broker-dealers, composed of both FCMs and derivatives clearing organizations (DCOs). He proclaimed that the proposed model rules would substantively protect both customers and the financial system in the following ways:
  1. When an FCM or DCO is on the verge of bankruptcy, instead of liquidating the FCM, the customer funds’ would be ported (or transferred) to a stable FCM or DCO, thereby allowing the customers’ to quickly retrieve at least 60 or 70 percent of the money they would have otherwise lost in the bankrupt FCM’s or DCO’s liquidation.
  2. The FCM’s or DCO’s trustee would have much more discretion over the FCM’s or DCO’s liquidation, thereby permitting the trustee authority to administer the liquidation in a way better befitting the customers’ ability to recover their lost funds, as long as the trustee abides by the federal bankruptcy regulations while doing so. Also, Wasserman emphasized that while the trustee would be independent, the trustee would work closely with the CFTC in bankruptcy court.
  3. Treating customers as a class instead of individuals and distribution funds to them pro rata would allow each customer to retrieve at least lost money rather than certain individual customers receiving a lot of it while others receive nothing. Also, by treating the customers as a class for a pro rata distribution, the funds could be processed and distributed faster than if having to be processed separately for each victim. Lastly, pro rata distribution gives the money back first to the people who need it the most. 
Commissioner Quintenz asked whether the above distributions would include virtual currencies, to which Wasserman answered “yes” because the FCM’s or DCO’s assets and property would be separately classified as physical or nonphysical deliverables, with nonphysical deliverables comprising virtual currencies.
Commissioner Stump asked how DCOs particularly would be treated under the model rules, to which Wasserman declared that the trustee would take action under the DCO bankruptcy rules to the extent practical but subject to the trustee’s discretion.

Commissioner Berkovitz asked whether the proposal’s objectives would be contradictory, to which Wasserman replied “no,” specifically stating the objectives: (1) to protect customers; (2) protect financial systems; and (3) protect the confidence in the markets so that customers do not panic or fear a run on the bank before investing. And the model rules would “make the creditor no worse off than the credit would be in liquidation.” Wasserman further asserted that ensuring these objectives would bolster U.S. markets’ competitiveness in the current global economy.

Amendments to compliance requirements for commodity pool operators on Form CPO-PQR. Chairman Tarbert expressed support for the proposed Form CPO-PQR revisions, along with Commissioners Behnam and Quintenz. Joshua Sterling and Amanda Olear from the Division of Swap Dealer and Intermediary Oversight (DSIO) presented on the proposed amendments to Form CPO-PQR, declaring that the proposal’s dual purpose is to eliminate duplicative and non-useful information requirements from the form but add requirements for information that would be useful to the CFTC. Commissioners Berkovitz and Stump were glad that all of Schedule C and most of Schedule B (except for providing a CPO’s investment-type such as gold or platinum) would be eliminated.

The item that particularly caught the commissioners’ attention was the proposed requirement for CPOs to provide legal entity identifier (LEI) information on the form. Sterling said that LEIs would help regulators to better oversee CPO transactions and track the exposure and risk from the CPO to the swap dealer, namely both sides of the transaction. He also did not believe that providing LEI information on the form would have a negative effect on consumers. Regarding Sterling’s major point that LEIs apply only to swap transactions, Commissioner Berkovitz requested that a future requirement be for the form to mandate LEIs for non-swaps, i.e., exchange-traded commodities. Olear said that it’s too late for mid- and small-size CPOs to extend their filings due in March but that because of COVID-19, these CPOs will get a 90-day extension on their next quarterly filing.

The other important points made during this discussion included the following:
  • Commissioner Quintenz proclaimed the difficulty of aggregating Form CPO-PQR information in real time so that by the time the CFTC obtains it for review, the information is already 60 days old. Sterling acknowledged that the information provided on the form is just a snapshot in time, and also that it is difficult to aggregate the submitted form information because that information varies so much by CPO type and size.
  • The Financial Stability Oversight Council (FSOC) created from the Dodd-Frank Act did not mandate that Form CPO-PQR be revised. Furthermore, Olear stated that the FSOC has never requested information about a particular CPO’s activities.
  • Mention was made about CPOs having to quarterly file Form NAF-PQR. But Sterling and Olear pointed out that there would be no duplicative filing burden because CPOs could file either Form NAF-PQR or the proposed amended Form CPO-PQR.
  • Mention was also made about the need to file Form PF with the SEC. Sterling and Olear said that before proposing the Form CPO-PQR revisions, they asked SEC staff whether the staff had any concerns about the CFTC’s proposed changes, and the staff expressed no concerns. Moreover, Sterling and Olear said that filing revised Form CPO-PQR with the CFTC would not interfere with the SEC-filing of Form PF. 
Part 50 clearing requirement. Simultaneously approved with the above final Margin Rule revision was a proposed amendment to the CFTC’s Part 50 rules pertaining to the CEA’s Section 2(h)(1) on swap clearing agreements. As proposed, new regulations 50.75 and 50.76 would codify existing exemptions from the clearing requirement for swaps entered into with certain central banks, sovereign entities, and international financial institutions. The major reason for approving the proposal, as stated by Commissioner Berkovitz, is twofold: (1) the proposed new rules would basically be a mere codification of exemptions that the abovementioned central banks, sovereign entities and international financial institutions have been successfully relying for years; and (2) the number of swaps that would fall within the exemptions would be relatively small compared to the swaps requiring CFTC clearance.

Tuesday, 14 April 2020

Urban Outfitters CEO urges SEC to reinstate uptick rule for short selling

By Amanda Maine, J.D.

Writing on behalf of his company, Urban Outfitters Chairman and CEO Richard A. Hayne submitted a petition to the SEC requesting that the Commission consider reinstitute former rule 10a-1 relating to short selling in response to the market impact of COVID-19. While returning to the original uptick rule would not prevent further market volatility, it would limit the ability of short sellers to sell into negative market trends, according to Hayne.

Original and alternative uptick rule. Short selling involves a sale of a security that the seller does not own or a sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller. Short selling, in addition to being used to provide liquidity in response to unanticipated demand or to hedge the risk of an economic long position in the same security or in a related security, can be used to profit from an expected downward price movement.

In 1938, the SEC adopted Rule 10a-1 to restrict short selling in a declining market, and the rule remained mostly unchanged for nearly 70 years. After implementing a pilot program in 2004 that temporarily suspended the Rule 10a-1 tick test, the SEC found little empirical justification for maintaining short sale price test restrictions, especially for actively traded securities.

In 2007, after reviewing comment letters and the results of the pilot, as well as and taking into account the market developments that had occurred in the securities industry, the SEC eliminated former Rule 10a-1 and added Rule 201 of Regulation SHO, prohibiting any SRO from having a short sale price test.

In light of the financial crisis of 2008 and the market volatility that followed, the SEC in 2010 adopted an "alternative uptick rule," which imposed restrictions on short selling only when a stock has triggered a circuit breaker by experiencing a price decline of at least 10 percent in one day. At that point, short selling would be permitted if the price of the security is above the current national best bid.

Urban Outfitters petition. Hayne’s petition to the SEC recommends that the Commission reinstitute the original uptick rule as provided in former Rule 10a-1. The original rule stated that a listed security may be sold short: (1) at a price above the price at which the immediately preceding sale was effected (plus tick); or (2) at the last sale price if it is higher than the last different price (zero-plus tick). According to the petition, reinstituting the rule would mean that short sales are not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions.

Hayne stressed that his company does not think the practice of short selling itself should be banned but expressed that reinstituting the Rule 10a-1 uptick rule would improve the regulation of short selling. While Rule 10a-1 would not, by itself, prevent further market volatility, certain safeguards should be put in place during these uncertain times, he wrote.

Financial regulators on short selling. SEC Chairman Jay Clayton, in an interview with CNBC last month, said that the agency would not ban short selling, advising that short selling can be used "to facilitate ordinary market trading." In the same interview, Clayton voiced support for the 2010 alternative uptick rule, which "closely matches the electronic trading environment of today."

The European Securities and Markets Authority (ESMA) in March temporarily required the holders of net short positions in shares traded on an EU regulated market to notify the relevant national competent authority if the position reaches or exceeds 0.1 percent (down from the earlier threshold of 0.2 percent) of the issued share capital after the entry into force of the decision. ESMA stated that lowering the reporting threshold is a precautionary action due to the "exceptional circumstances" linked to the COVID-19 pandemic. The U.K.’s Financial Conduct Authority (FCA) confirmed that ESMA’s decision applied to the U.K. during the Brexit transition period. The FCA also confirmed that the required changes to its systems have been made to comply with the decision.

ESMA also approved a ban on short selling by the French securities regulator, the Autorite des marches financiers (AMF). The French emergency prohibition is set to expire on April 16.

Monday, 13 April 2020

CFTC grants brief extensions for rule comments in response to COVID-19 disruptions

By Brad Rosen, J.D.

The CFTC voted 3-2 to extend certain currently open comment periods in light of disruptions brought about by the COVID-19 (coronavirus) pandemic. The extensions address five separate rules proposed by the Division of Market Oversight (DMO) for which the current comment periods had started earlier in 2020. Commissioners Dan Berkovitz and Rostin Behnam issued sharp dissenting statements which asserted that the extensions were inappropriate and so short in duration so as to lack meaning.

Certain comment periods extended. The CFTC’s press release, issued late on the Friday afternoon before the Easter holiday, provides details for each rulemaking and its respective extension as follows:
  • Position Limits for Derivatives extended 16 days until May 15, 2020;
  • SEF Requirements and Real-Time Reporting Requirements extended 32 days until May 22, 2020;
  • Certain SDR and Data Reporting Requirements extended two days until May 22, 2020;
  • Amendments to the Real-Time Public Reporting Requirements extended two days until May 22, 2020; and
  • Amendments to the SDR Reporting Requirements extended two days until May 22, 2020.
Chairman claims extensions strike the right balance. Chairman Heath Tarbert declared, "I respectfully disagree with those who insist our important policy work could or should be put on pause." In support of the appropriateness of the extensions, he stated, "These extensions reflect my commitment to providing market participants with additional flexibility during this pandemic. Commenters on recently proposed rules will now have at least 90 days, and in many cases more, to provide feedback that we value tremendously as we seek to finalize rules."

Dr. Tarbert also noted that the swap data reporting proposals would give the Commission a more panoramic view into systemic risk by requiring for the first time the reporting of uncleared margin data and that the position limits proposal could help prevent corners and squeezes. In the chairman’s view, the subject extensions strike the right balance to address the current circumstances.

Commissioner Berkovitz asserts extensions reflect bad public policy. Commissioner Berkovitz zeroed in on the inconsistency underlying the CFTC’s extensions in his dissenting statement. He also observed that market participants and the public need more time to be able to provide high-quality comments on pending CFTC rulemakings in light of the disruptions resulting from the novel coronavirus pandemic. Moreover, he stated, "Not providing the public sufficient time to obtain additional perspective and develop meaningful comments in these extraordinary times is bad public policy."

Berkovitz also pointed to the COVID-19 related regulatory relief previously granted by the CFTC as clear evidence that the pandemic has disrupted normal operations of market participants. He also noted that many functions cannot be performed in a timely manner due to physical displacements and other extraordinary demands on market participants.

In a harsh criticism of the Commission’s action, Berkovitz observed "The Commission’s refusal to grant meaningful rulemaking comment period extensions stands in contrast to its swift recognition of requests by market participants for relief from the Commission’s reporting and registration regulations." The commissioner added, "It is not clear why the Commission believes that market participants who state that it is difficult to comply with fundamental reporting or registration requirements nonetheless will be able to evaluate proposed rules and prepare comments with minimal delay." At a minimum, Berkovitz advocated that the Commission should extend all pending comment periods by 60 days, noting that the two-week and two-day extensions granted by the Commission today are inadequate.

Commissioner Behnam claims extensions are illusory. Commissioner Behnam, in his dissenting statement, observed for the three rules where the comment periods are extended for a mere two days, "That is not an extension at all. Instead, it is essentially an announcement that the Commission will not be extending these deadlines." He added, "For two of these rules, the comment period opened on February 20, so the entire comment period has essentially spanned the COVID-19 pandemic."

With respect to the comment period for the high-profile position limits rule which was extended by 16 days, Behnam observed, "Prior position limits proposals have garnered hundreds of public comments totaling thousands of pages. Producing these comments presumably takes months of work and careful thought by market participants and other stakeholders. Extending the deadline to May 15 as market and public health uncertainty continues is not sufficient."

Behnam has previously advocated for the CFTC to temporarily table all non-critical policy work and to shift its efforts and resources towards monitoring market and institutional stability and resiliency, and to consider necessary agency action that will alleviate market disruptions and support stable financial markets. Notwithstanding, the commissioner concluded by indicating his readiness to work with the chairman and fellow commissioners to reach agreement on meaningful extensions for the subject comment periods.

Senators urge Fed to end capital distributions during coronavirus pandemic

By J. Preston Carter, J.D., LL.M.

Senators Sherrod Brown (D-Ohio), Brian Schatz (D-Hawaii), and Elizabeth Warren (D-Mass) sent a letter to Federal Reserve Board Chairman Jerome Powell calling for the Fed to prohibit banks with more than $50 billion in assets from making further capital distributions, such as stock buybacks and dividends, as the economy recovers from the coronavirus pandemic. The senators urged the Fed "to do more to help small business owners and hardworking families instead of allowing Wall Street to take advantage of the crisis to skirt important financial protections." The senators wrote, "Ending capital distributions now will refocus these banks on their core mission: lending into their communities, a critical goal during these difficult economic times."

According to the senators, higher capital requirements support increased lending activity, as capital is the critical funding mechanism for all banking activity. "The evidence is clear," they wrote, "banks with greater amounts of loss-absorbing capital lend more, in good times and in bad, and well-capitalized banks are far more likely to survive in a stressed environment without requiring a government bailout."

Therefore, the senators found it "hard to understand" recent actions of the Fed. For example, they wrote, as recently as March, in the midst of the pandemic, the Board took steps to reduce capital standards when it proposed eliminating the requirement that banks pre-fund buybacks and dividends. Also, the Fed has given large banks "far too long" to adopt reforms for recognizing expected losses under the current expected credit loss methodology.

"Perhaps most concerning," the senators stated, "the Board has rolled back one of the most important capital standards for the biggest, riskiest banks in the country." The supplementary leverage ratio is a simple rule based on direct experience from the financial crisis. More equity capital means safer banks and a more stable financial system. "The Board’s decision to reduce this capital requirement by two thirds at banks with more than $250 billion in assets further harms our financial system," the letter states.

Brookings blog. A Brookings Institution blog post says that banks’ higher capital and liquidity positions now than in 2007 is allowing banking regulators to encourage banks to use their capital and liquidity buffers to support new lending, and to work with borrowers to modify existing loans. The blog post notes that the Fed reduced the leverage ratio capital requirement, which should promote more lending, and added that "Banks should collectively agree now to suspend share repurchases for at least as long as the leverage ratio is eased."

New lawsuits zero in on Zoom’s alleged data security failures

By John M. Jascob, J.D., LL.M.

Two new shareholder suits have charged Zoom Video Communications, Inc. with misrepresenting the data security of its video conferencing services. In separate class action complaints filed in federal court in San Francisco, investors allege that the company violated Exchange Act Section 10(b) and Rule 10b-5 by significantly overstating the degree to which its video communication software was encrypted. Once the company’s obfuscations about its encryption became clear following the increasing reliance on video conferencing during the COVID-19 pandemic, the complaints allege, businesses prohibited employees from using Zoom’s platform, causing the company’s share price to plummet (Drieu v. Zoom Communications, Inc., April 7, 2020; Brams v. Zoom Video Communications, Inc., April 8, 2020).

Zoom. Founded in 2011 and headquartered in Silicon Valley, Zoom provides a cloud-based communications application that allows users to interact with each other by means of face-to-face video, audio, and chat. On April 17, 2019, the registration statement for Zoom’s initial public offering (IPO) was declared effective by the SEC.

According to the complaints, Zoom, CEO Eric Yuan, and CFO Kelly Steckelberg made materially false and misleading statements regarding the company’s business, operational, and compliance policies, both in connection with the IPO and in subsequent filings with the SEC. Contrary to Zoom’s assertions, the shareholders claim, Zoom’s video communications service was not end-to-end encrypted, thus putting users at an increased risk of having their personal information accessed by unauthorized parties. A decline in the use of Zoom’s video communications services was foreseeably likely when these facts came to light, the complaints allege, making Zoom’s SEC filings and public statements materially false and misleading at all relevant times.

Pomerantz lawsuit. The complaint filed by the Pomerantz law firm alleges that the truth began to emerge on July 8, 2019, when security researcher Jonathan Leitschuh posted on Twitter a link to an article he had published, which allegedly exposed a flaw allowing hackers to take over Zoom webcams. Just three days later, the Electronic Privacy Information Center (EPIC) filed a complaint against Zoom with the Federal Trade Commission, alleging that Zoom had intentionally designed their web conferencing service to bypass browser security settings for webcams, exposing users to the "risk of remote surveillance, unwanted videocalls, and denial-of-service attacks." Despite these disclosures, however, Zoom’s stock continued to trade at artificially inflated levels, the complaint alleges.

The Pomerantz complaint alleges that the truth fully emerged, however, as businesses increasingly turned to Zoom’s video communication software to facilitate remote work activity in the midst of the COVID-19 pandemic and shelter-in-place orders from state and local governments. For example, the New York Times reported on March 30, 2020, that Zoom was under scrutiny by the New York attorney general for its data privacy and security practices. According to the article, the attorney general's investigation cited, among other things, Leitschuh’s findings regarding webcam security issues, the complaint filed with the FTC, and revelations from an article by Vice Media’s Motherboard segment that the iOS version of the Zoom app was sending some analytics data to Facebook, even if Zoom users didn’t have a Facebook account. The New York Times article also reported that "trolls have exploited a Zoom screen-sharing feature to hijack meetings and do things like interrupt educational sessions or post white supremacist messages to a webinar on anti-Semitism—a phenomenon called ‘Zoombombing.’"

After additional negative news, the Pomerantz complaint states, New York City’s Department of Education announced on April 6, 2020, that it had banned the use of Zoom in the city’s classrooms. Instead, the Department recommended Google or Microsoft Teams for classroom communications purposes during New York State’s shelter-in-place order. That same day, a Yahoo! Finance article reported that someone on a popular dark web forum had posted a link to a collection of 352 compromised Zoom accounts. According to a spokesperson for the cybersecurity firm Sixgill who was quoted in the article, "these links included email addresses, passwords, meeting IDs, host keys and names, and the type of Zoom account," and that, "given that many are using Zoom for business purposes, confidential information could be compromised."

As a result of the defendants’ wrongful acts and omissions, the complaints assert, the plaintiffs and other class members have suffered significant losses and damages.

The cases are No. 20-cv-02353 (Drieu) and No. 20-cv-02396 (Brams).

Friday, 10 April 2020

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Scam artists target Main Street investors in midst of the COVID-19 pandemic

By Brad Rosen, J.D.

The SEC’s Office of Investor Education and Advocacy (OIEA) and Retail Strategy Task Force issued an alert to educate and inform Main Street investors about current investment frauds, including those scams related to the Coronavirus (COVID-19) pandemic. In the alert, the SEC noted how fraudulent actors often exploit national crises and periods of uncertainty to lure investors into various scams.  These scam artists frequently play off investors’ hopes and fears, as well as their charity and kindness, in attempts to exploit confusion or rumors in the marketplace. 

Enforcement remains on the beat. Despite the prevalence of social distancing measures and work-at-home mandates, the alert makes it clear the SEC’s Division of Enforcement continues to execute on its mission of protecting investors and remains fully operational during this time of crisis. Specifically, the alert advises that that SEC continues to actively monitor the markets for frauds, illicit schemes and other misconduct affecting U.S. investors relating to COVID-19. Moreover, as circumstances warrant, the agency is prepared to issue trading suspensions and use tools in its enforcement arsenal as appropriate.  

Keep the guard up. The alert also advises investors not to let their guard down when it comes to spotting fraudulent investment schemes, including those masquerading as charities or targeting certain affinity groups. Additionally, the alert urges people to exercise good investment hygiene such as verifying that the seller is currently registered or licensed by using search tools available on As always, potential investors should be on the lookout for promises of guaranteed high investment returns and be wary of unsolicited investment offers.

If you see something, say something. The alert also urges members of the public to report possible securities fraud or nefarious activity to the SEC.  Potential fraud can be reported to the SEC by completing a complaint form at the SEC’s online tip, complaint, and referral (TCR) system.

Thursday, 9 April 2020

SEC provides relief for BDCs affected by COVID-19

By Amanda Maine, J.D.

Business development companies (BDCs) have been granted temporary conditional relief to help enable them to make investments in small and medium-sized businesses, the SEC announced. Under the exemptive relief, BDCs will be permitted to issue and sell senior securities in order to provide capital to these companies. According to the Commission, many BDCs face challenges in the current environment in providing capital to their portfolio companies due to the impact of COVID-19 on the financial and credit markets. The relief includes the method for calculating permitted financing and applies conditions designed to protect investors (Order Under Sections 6(c), 17(d), 38(a), and 57(i) of the Investment Company Act of 1940 and Rule 17d-1 Thereunder Granting Exemptions from Specified Provisions of the Investment Company Act and Certain Rules Thereunder, Release No. IC-33837, April 8, 2020).

In a statement announcing the relief, SEC Chairman Jay Clayton said, “Many small and medium-sized businesses across the country are struggling due to the effects of COVID-19.” The exemptive relief “will enable BDCs to provide their businesses with additional financial support” in light of the challenges arising from the pandemic, Clayton advised.

BDCs and COVID-19. The Commission’s order notes that BDCs were created to provide capital to smaller domestic operating companies (“portfolio companies”) that otherwise may not be able to readily access the capital markets. Under the challenges posed by the effects of COVID-19, BDCs may be unable to satisfy the asset coverage requirements under the Investment Company Act due to temporary markdowns in the value of loans to its portfolio companies. Certain affiliates may also be prohibited from participating in additional investments in the BDC’s portfolio companies due to restrictions on an existing exemptive order permitting co-investments.

Issuance and sale of senior securities by BDCs. The exemptive order provides that during the exemption period, a BDC may issue or sell a senior security that represents an indebtedness or that is a stock (“covered senior securities”) notwithstanding the Investment Company Act’s asset coverage requirement, subject to several conditions. A BDC may use values calculated as of December 31, 2019 (“Adjusted Portfolio Value”) to meet an Adjusted Asset Coverage Ratio. The order outlines how to calculate the Adjusted Asset Coverage Ratio.

A BDC that elects to rely on this exemption must disclose it on Form 8-K and may not for 90 days make an initial investment in any portfolio company in which the BDC was not already invested as of the date of the order, unless its asset coverage ratio complies with Investment Company Act Section 18.

The order also requires that the BDC’s election to rely on the exemption be approved by the BDC’s board of directors or trustees, which must also determine that each issuance of senior securities is in the best interests of the BDC and its shareholders. To make this determination, the BDC’s investment adviser must certify the recommendation and the investment adviser’s reasons for certifying that it is in the best interests of the BDC and its shareholders. The board must also review reports prepared by the BDC’s investment adviser at least monthly to determine efforts the BDC has made towards achieving compliance with Section 18 asset coverage requirements.

In addition, the order imposes certain recordkeeping requirements, including preserving the minutes of board meetings and the investment adviser’s reports to the board. Finally, the order states that no affiliated person of the BDC shall receive transaction fees or other renumeration from an issuer in which the BDC invests during the Exemption Period. The order provides relief only to issue or sell senior securities representing an indebtedness or that is a stock, and does not provide relief in connection with dividends or other distributions.

Expansion of relief for BDCs with existing co-investment orders. BDCs that currently have an existing co-investment order from the Commission permitting co-investment transactions in portfolio companies with certain affiliated persons may participate in a follow-up investment provided that: (1) it has previously participated in a co-investment transaction with the BDC with respect to the issuer (if the participant is a regulated fund); or (2) it either previously participated in a co-investment transaction with the BDC with respect to the issuer or is not invested in the issuer (if the participant is an affiliate fund). This exemption is also conditioned on the oversight of and the review by the board of directors or trustees.

Exemption period. The relief provided is limited to the period from the date of the order to the earlier of: (1) December 31, 2020; or (2) the date by which the BDC ceases to rely on the order. The Commission may extend the exemptive relief as it deems appropriate.

The release is No. IC-33837.

Wednesday, 8 April 2020

SEC approves offering and communication reforms for BDCs and closed-end funds

By John M. Jascob, J.D., LL.M.

By a three-to-one vote, the SEC has approved rule and form amendments modifying the registration, communications, and offering processes available to business development companies (BDCs) and registered closed-end funds. The amendments, which implement certain provisions of the Small Business Credit Availability Act and the Economic Growth, Regulatory Relief, and Consumer Protection Act, seek to increase the availability of funding to small- and mid-sized private companies and harmonize the treatment of BDCs and most registered closed-end funds with that of operating companies. Among other things, the new rules permit eligible funds to engage in a more streamlined registration process and use communications and prospectus delivery rules currently available to operating companies while providing for new reporting and structured data requirements (Securities Offering Reform for Closed-End Investment Companies, Release No. 33–10771, April 8, 2020).

“The amendments we are adopting will modernize the offering process for eligible funds in a way that, as borne out by our experience with operating companies, will benefit both investors in these funds and the companies in which they invest,” said SEC Chairman Jay Clayton in a news release. “This is another example of our staff’s laudable efforts to modernize our rules in a manner that furthers all aspects of our mission."

Commissioner Allison Herren Lee was the lone dissenter, expressing concerns over both the timing and the substance of the rule amendments. In her view, the amendments drop important investor protection features that had been included in the SEC’s original proposal in 2019 while also reducing the Commission’s oversight of material changes to existing funds.

Shelf offerings and new short-form registration statement. Under the amended rules, eligible BDCs and closed-end funds (“affected funds”) will be able to engage in a streamlined registration process, allowing them to sell securities “off the shelf” more quickly and efficiently in order to take advantage of market opportunities. Similar to operating companies, affected funds will generally be eligible to use the new short-form registration statement if they meet certain filing and reporting history requirements and have a public float of $75 million or more.

WKSI status. Like operating companies, eligible affected funds will now be able to qualify as Well-Known Seasoned Issuers (WKSIs) in order to benefit from a more flexible registration process and greater latitude to communicate with the market. Affected funds will qualify as WKSIs if they meet certain filing and reporting history requirements and have a public float of $700 million or more

Communications and reporting. In further measures to harmonize the communication rules applicable to BDCs and closed-end funds with those that apply to operating companies, the amendments allow affected funds to use a “free writing prospectus,” certain factual business information, forward-looking statements, and certain broker-dealer research reports. Also like operating companies, affected funds will be able to satisfy their final prospectus delivery obligations by filing their prospectuses with the SEC.

To support the short-form registration statement framework, affected funds filing a short-form registration statement will be required to include certain key prospectus disclosures in their annual reports. In addition, affected funds filing a short-form registration statement will be required to disclose material unresolved staff comments. Registered closed-end funds also will be required to provide management’s discussion of fund performance (MDFP) in their annual reports, similar to requirements that currently apply to mutual funds, exchange-traded funds, and BDCs.

Effective dates. Most of the rule and form amendments will become effective on August 1, 2020. The amendments related to registration fee payments by interval funds and certain exchange-traded products, which will become effective on August 1, 2021.

Virtual open meeting. The session marked the first time that the SEC has ever held an open meeting using a virtual format and was the first open meeting held by the Commission in any form since the onset of the crisis resulting from the rapid spread of the coronavirus in the United States. Each of the four commissioners thanked the SEC staff for their dedication and commitment despite the uncertainties caused by COVID-19, which has resulted in staff working in a largely teleworking environment for the past month. “In the face of the uncertainties caused by COVID-19 and circumstances in which we all must prioritize health and safety, they have remained committed to our mission, focusing on the interests of our long-term Main Street investors and the integrity of our markets,” said Chairman Clayton.

The release is No. 33–10771.

Cryptocurrency mining company extracts investors’ money by falsely promising COVID-19 benefit

By Jay Fishman, J.D.

The Alabama Securities Commission and Texas State Securities Board separately ordered a mining company and its agent to stop operating a fraudulent cryptocurrency scheme generated partly from a promise that the Alabama and Texas resident investors’ funds would be donated to UNICEF for medical equipment to help COVID-19 pandemic victims around the world. The company additionally promised the residents that the remainder of the raised funds would be invested in computing power to mine cryptocurrencies, which would yield large returns.

Texas investigation uncovers cryptocurrency scheme. The Texas State Securities Board discovered that the mining company operated a fraudulent cryptocurrency scheme from information the State Securities Board obtained during its investigation. The State Securities Board subsequently passed the following information onto the Alabama Securities Commission:
  • The mining company, through its agent, continuously promised investors that it would donate their funds to UNICEF to help the COVID-19 victims but refused to provide any information verifying the donation.
  • The company promised investors “eye-opening” returns; for example, a $10,000 investment in computing power would return nearly $10,500 per year.
  • The company runs a recession special by offering investors an extra 30 percent of purchased cryptocurrency mining power for an initial $10,000 deposit.
  • The company runs an affiliate program that pays commissions to individuals who recruit new investors, permitting the affiliates to receive 5 percent of the new investors’ deposits.
  • The company and agent failed to disclose the principals or financials of the cryptocurrency mining operation.
  • The mining company is a “dealer” under the Texas Securities Act; the agent is an “agent of a dealer” under the Act; and the cryptocurrency is a “security” under the Act yet none were registered as required by the Act to sell the cryptocurrency in Texas.
  • The mining company has already raised $18 million from Texas resident investors. 
These administrative orders are Nos. CD-2020-0007 and ENF-20-CDO-1801.

IOSCO redirects resources to address COVID-19 matters

By John Filar Atwood

The Board of the International Organization of Securities Commissions (IOSCO) is redeploying its resources to focus primarily on COVID-19 matters, including addressing areas of market-based finance which are most exposed to greater volatility, constrained liquidity and the potential for pro-cyclicality. The decision means that the work on the priorities outlined in its 2020 work program will be delayed.

IOSCO’s new focus will include examining investment funds, as well as margin and other risk management aspects of central clearing for financial derivatives and other securities. IOSCO said that it will continue a limited number of work streams that are close to completion, and will continue its efforts on G-20 deliverables.

In deciding on which priorities to delay, the board considered several factors, including that a delay would relieve untoward pressure on IOSCO members who are addressing core crisis challenges. The board also recognized that operational constraints on financial institutions would likely impede their ability to contribute to IOSCO projects and follow up on final reports.

Overtaken by events. A third factor IOSCO considered was that it may be inappropriate to issue reports during the crisis given that they may be overtaken by events and would need to be modified to take account of lessons learned or factor in a substantially changed financial landscape as a result of the crisis. Finally, the board said that it recognized that the standard-setting bodies with which it collaborates are busy focusing on helping to address the crisis.

The work that IOSCO is placing on the back burner includes its analysis of the use of artificial intelligence and machine learning by market intermediaries and asset managers. The board also will pause its study of the impact of the growth of passive investing and potential conduct-related issues in index provision, issues around market data, outsourcing, and implementation monitoring.

The 2020 annual work program also includes among its five focus areas cryptoassets and retail distribution and digitalization. The program indicates that IOSCO also was planning, based on its 2020 risk outlook, to study the rising levels of corporate debt and the potential resulting risks in capital markets.

Work continues. IOSCO plans to proceed with its work on good practices for deference, as well as other projects near completion that will not burden limited regulatory or industry resources. In addition, the board intends to examine specific investor protection issues, market integrity, or conduct risks that may arise in the context of the crisis.

Tuesday, 7 April 2020

OCIE issues Risk Alerts for compliance with Regulation BI, Form CRS

By Amanda Maine, J.D.

The SEC’s Office of Compliance Inspections and Examinations (OCIE) has published two Risk Alerts that provide information to firms for compliance with Regulation Best Interest (Reg BI) and Form CRS, which were adopted in June of last year and have a compliance date of June 30, 2020. The Alerts are intended to provide broker-dealers and investment advisers with information about the scope and content of first examinations to be conducted under the new rules.

According to OCIE Director Pete Driscoll, “Based on conversations we have had with the industry, we know firms have made substantial progress in implementing these new rules.” Driscoll added that OCIE staff’s “focus will be on firms continuing good faith and reasonable efforts, including taking into account firm-specific effects from disruptions caused by COVID-19.”

Regulation Best Interest compliance. When OCIE begins its initial examinations for compliance with Reg BI, the staff will primarily evaluate whether firms have established policies and procedures reasonably designed to comply with the new regulation, according to the Alert. Reg BI requires broker-dealers to act in the best interest of the retail customer without placing its own financial or other interest ahead of the customer’s interest. The Risk Alert outlines four component obligations of this general obligation: disclosure, care, conflicts of interest, and compliance obligations.

Under the disclosure obligation, the firm must provide in writing to a retail customer all material facts relating to the scope and terms of its relationship with the customer and all material facts related to conflicts of interest that are associated with the broker’s recommendation. During an examination, the staff may review the contents of these disclosures and other firm records to assess compliance. These documents may include schedules of fees, the broker-dealer’s compensation methods, disclosures related to the monitoring of customer accounts, and lists of proprietary products sold to customers.

The care obligation requires a broker-dealer to understand and consider the risks, rewards, and costs associated with the obligation in light of the customer’s investment profile. Documents reviewed under this obligation may include new account forms, the process undertaken by the broker-dealer to assess its decision that a recommendation was in the customer’s best interest, and how risky, complex, or expensive product recommendations were made.

Under the conflicts of interest obligation, the staff may review documents concerning material limitations, such as a limited product menu offering only proprietary products. The staff may also review policies and procedures relating to the elimination of sales contests, sales quotas, bonuses, and non-cash compensation based on the sale of specific securities within a limited period of time.

Finally, under the compliance obligation, may review the broker-dealer’s policies and procedures and evaluate any controls, remediation of noncompliance, training, and periodic review and testing of its policies and procedures.

Form CRS. Form CRS requires SEC-registered broker-dealers and investment advisers (firms) to deliver to retail investors a brief customer or client relationship summary that provides information about the firm and to file their initial relationship summaries with the Commission. According to the Form CRS Risk Alert, areas of focus for the staff regarding compliance with Form CRS include issues relating to delivery and filing of the form, the content of the form itself, and issues such as formatting, updates, and recordkeeping.

Specifically relating to the delivery and filing of Form CRS, the Alert states that the staff may review records of the dates that each relationship summary was provided to investors and validate that the firm complied with delivery obligations pertaining to existing retail investors and new retail investors.

The staff may also review the content of the relationship summary to assess whether it includes all required information and to assess that the information it contains is accurate and true. The Alert gives several examples of what the staff may assess in reviewing the relationship summary’s content, including how it describes its services, how it describes fees and costs, how it describes how the firm’s professionals are compensated, how it describes conflicts of interest, and whether legal or disciplinary history is accurately disclosed.

Both Alerts note that OCIE will work with firms and the Division of Trading and Markets on challenges that COVID-19 has created for firms. The Reg BI Alert also contains an appendix listing samples of information that OCIE may request during an examination.