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Dodd-Frank Act Reforms

Dodd-Frank Act Reforms

March 23, 2017

Authored by: Robert Klingler

Much of the discussion we’re having with our clients and other professionals relates to the prospects for financial regulatory reform.  To that end, and looking at it from the political rather than industry perspective, Bryan Cave’s Public Policy and Government Affairs Team has put together a brief client alert examining the political, legislative and regulatory issues currently under consideration.

In his first weeks in office, President Trump has taken steps to undo or alter major components of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). These include delaying implementation of the “Fiduciary Rule,” which regulates the relationship between investors and their financial advisors, directing the Treasury Secretary to review the Dodd-Frank Act in its entirety, and signing a resolution passed by Congress that repeals a Dodd-Frank regulation on disclosures of overseas activity by energy companies.

Read the rest of this alert on Bryan Cave’s homepage.

We’ve also posted about the impact of the proposed regulatory off-ramp on community banks, recorded a podcast episode on the Financial Choice Act, and discussed some of the causes, including hopes for regulatory relief, of the rise in bank stock prices in our podcast episode on the issues associated with elevated stock prices in bank mergers and acquisitions.

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Are the Assets in Custody?

Are the Assets in Custody?

March 22, 2017

Authored by: Matthew D'Amico

Lender Beware:
The custody assets you are lending against may not actually be held in custody.

Lenders to funds and other borrowers often extend credit based on a security interest over assets that are held in custody.  The lender is granted a security interest in the relevant custody account and all of the cash, securities and other assets therein, and then perfects the security interest by entering into a “control agreement” with the custodian.  The lender may have made two big assumptions: (1) the custodian has “custody” of the assets, and (2) upon receipt of instructions from the lender after default, the custodian can readily transfer or otherwise dispose of the relevant assets.  Upon closer examination, however, these assumptions may prove to be incorrect.

There are two broad categories of assets that are capable of being held in custody:

(1) Assets such as a bearer bond, a stock certificate in the name of the borrower (together with an undated stock power in blank), or gold bullion.  This is referred to as “on premises custody” or “direct custody”; the custodian has physical custody of the asset.  In each of these cases, the custodian has the power to transfer title to the asset by delivery thereof – it may not have the right vis-à-vis the borrower (i.e., the custodian may be liable for breach of its duty to the borrower), but it does have the power.

(2) Assets that are held in an indirect holding system.  This is referred to as “off premises custody” or “indirect custody.”  One typical example of how an indirect holding system works: a clearing company (such as Depository Trust Company) holds a master share certificate for 500 million shares of an S&P 500 publicly‑traded company. The clearing company identifies on its books and records 10 million of such shares as being held for the account of the custodian (in its capacity as a member of the clearing company) and, in turn, the custodian identifies on its books and records 100,000 of such shares as being held for the account of the borrower.  In this case, the custodian has the power to (a) “move” some or all of those 100,000 shares on its books and records to another of its custody clients, or (b) advise the clearing company that some or all of such shares have been transferred to a third party that does not maintain an account with the custodian (in which case the clearing company would revise its books and records to reflect that such shares are held by or through another member of such clearing company).  In any event, as a general rule, the custodian has the power to transfer the borrower’s interests in these shares.

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Trump May Not be the Only Catalyst for Administrative Reform

In the past few months, there has been a lot of speculation regarding the future of many administrative agencies under Trump’s administration. However, two current cases pending in the D.C. Circuit have the potential to have a dramatic impact on administrative agencies and past and present regulatory enforcement actions by such agencies.

In Lucia v. SEC, the SEC brought claims against Lucia for misleading advertising in violation of the Investment Advisers Act of 1940. The enforcement action was initially resolved by an administrative law judge (ALJ); however Luica was later granted a petition for review based on an argument that the administrative hearing was unconstitutional because the ALJ was unconstitutionally appointed. The issue made it up to the U.S. Court of Appeals for the D.C. Circuit who recently held that the ALJ was constitutionally appointed because the judge was an “employee”, not an officer. However, other courts have held just the opposite. In December, the 10th Circuit held in Bandimere v. SEC that ALJs were “inferior officers” and thus must be appointed pursuant to the Appointments Clause. A rehearing en banc has been granted in Lucia to address this issue.

On the heels of Lucia, in PHH v. CFPB, the CFPB brought claims against PHH for violations of the Real Estate Settlement Procedures Act. Similarly, this enforcement proceeding was originally decided by an ALJ. However, PHH appealed the ALJ decision for a multitude of reasons and the appeal has also made it up to the D.C. Circuit where a rehearing en banc was granted last month. In the court’s order granting a rehearing en banc, the court ordered, among other things, that the parties address what the appropriate holding would be in PHH if the court holds in Lucia that the ALJ was unconstitutional.

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The Strategic Approach to Vendor Negotiations

the-bank-accountOn March 17, 2017, Jonathan and I sat down with Bryan Cave Partner Sean Christy in the latest episode of The Bank Account for a discussion of the FDIC’s Office of Inspector General’s Report on Technology Service Provider Contracts.  Before diving into the OIG report, Jonathan and I briefly discuss the potential impact on deposits with regard to the Federal Reserve’s latest increase in rates, the OCC’s draft supplement for fintech bank charters (and related BankBryanCave.com blog post), and the change in Federal Reserve policy lessening the examination of certain smaller bank mergers.

Sean is a partner in our Strategic Sourcing group, and has significant experience representing bank and other financial services providers in the negotiation of the their technology contracts.  In this episode, Sean helps us look at the key takeaways from the February 2017 FDIC OIG’s report on Third Party Service Provider Contracts with FDIC-Supervised Institutions.  Sean provides some practice advice for institutions as they approach negotiations with their service providers, and also breaks down some of the common issues identified in the report that he also regularly sees in the contracts he reviews.

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OCC Moves Forward on Fintech Bank Charters

Amid criticism from virtually every possible constituency, on March 15, 2017, the Office of the Comptroller of the Currency (OCC) released a draft supplement  to its chartering licensing manual related to special purpose national banks leveraging financial technology, or fintech banks. As we indicated in our fintech webinar discussing the proposal last December, the OCC is proposing to apply many conventional requirements for new banks to the fintech charter. While the OCC’s approach is familiar to those of us well versed on the formation of new banks, there are a few interesting items of note to take away from the draft supplement.

  • More bank than technology firm. Potential applicants for a fintech charter should approach the project with the mindset that they are applying to become a bank using technology as a delivery channel, as opposed to becoming a technology company with banking powers. While the difference might seem like semantics, the outcome should lead potential applicants to have a risk management focus and to include directors, executives, and advisors who have experience in banking and other highly regulated industries. In order to best position a proposal for approval, both the application and the leadership team will need to speak the OCC’s language.
  • Threading the needle will not be easy. Either explicitly or implicitly in the draft supplement, the OCC requires that applicants for fintech bank charters have a satisfactory financial inclusion plan, avoid products that have “predatory, unfair, or deceptive features,” have adequate profitability, and, of course, be safe and sound. Each bank in the country strives to meet those goals, yet many of them find themselves under pressure from various constituencies to improve their performance in one or more of those areas. For potential fintech banks, can you fulfill a mission of financial inclusion while offering risk-based pricing that is consistent with safety and soundness principles without having consumer groups deem your practices as unfair? On the other hand, can you offer financial inclusion in a manner that consumer groups appreciate while achieving appropriate profitability and risk management? We think the answer to both questions can be yes, but a careful approach will be required to convince the OCC that it should be comfortable accepting the proposed bank’s approach.
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UK Must Get to Grips with Brexit and MiFID II

Asset Managers Face Some Difficult Decisions

2017 is proving to be a stressful and costly year for asset managers. The terms of the UK’s exit from the EU will continue to be the subject of extensive debate, both politically and in the press. At the same time, MiFID II is just around the corner, coming into force in January 2018 after having been put back a year due to the complexity of its implementation.

MiFID II recasts and broadens MiFID (the EU’s Markets in Financial Instruments Directive) in response to the financial crisis. It will change the way asset managers operate and not just in terms of enhanced investor protection. The new rules affecting allocation of costs for research, the impact on the fixed income market, the prohibition on payments to financial advisers and the new significantly more onerous reporting requirements are all major issues for the industry players to deal with. One commentator has estimated that MiFID II will cost the financial services industry more than EUR 2.5 billion to implement. And smaller players will be hit hardest, having less ability to absorb these hefty costs.

As for the UK’s proposed exit from the EU (the UK has yet to formally pull that trigger) we can expect the UK’s financial services industry to be significantly impacted. However, quite what that impact will be is as yet unknown and will depend on what model is eventually negotiated for the relationship between the UK and the EU in place of the UK’s current position as a full member of the EU. Of particular relevance for asset managers will be what the UK’s access to EU markets will look like. Currently, asset managers along with other UK authorised firms have full access to EU markets under passporting rights, which allow them to carry on business in another EEA state whether or not through a branch.

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Riding the High Stock Price Wave

the-bank-accountOn March 7, 2017, Jonathan and I recorded lucky episode 13 of The Bank Account where we discussed the implications of stock prices, particularly in connection with bank mergers.  We note that the current levels of stock pricing in the banking sector appears to be driven by expectations for higher interest rates, tax reform, and regulatory relief, in that order of likelihood and importance.  We also note that if these expectations aren’t achieved, bank stock prices are likely to take a hit.

As mentioned on the podcast, Jonathan was recently quoted in an American Banker story on bank merger activity.

“We’re telling buyers to be aggressive and sellers to be thoughtful,” said Jonathan Hightower, a lawyer at Bryan Cave. “The potential for legislative changes, lower corporate taxes, higher rates and reform to Dodd-Frank … are already priced into bank stocks. There could be a pullback if any of those things don’t occur.”

Subsequent to recording, the American Banker also published an excellent look at increasing skepticism for the chances for meaningful regulatory relief.

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Walt Moeling Always Has a Story

March 3, 2017

Categories

The February/March 2017 edition of Banking Exchange contains a lengthy interview between Bank Exchange’s Executive Editor, Steve Cocheo, and our own Walt Moeling.  Framed in the context of seven questions asked of Walt, the interview does a great job illustrating Walt’s use of stories to prove a point.

Talking to banking attorney Walter Moeling about an organization that forbade talk about mergers and acquisitions—because it may make folks unhappy—leads to his gentle scoff: “There’s nobody involved in banking who is not interested in mergers.”

And then, in typical Moeling fashion, a short point brings him to a story. Walt Moeling always has a story—nearly always with a point or moral for the listener to let sink in.

“I was called upon to do a board session, a strategic planning meeting. I told the CEO I was going to talk about mergers. ‘Oh, you don’t need to do that,’ he told me. ‘My board isn’t interested in mergers.’

“I told the CEO, ‘If I’m going to talk about strategy, I’m going to talk about M&A. You can’t plan a strategy without knowing where you are heading.’”

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Parents, not Banks, Should Aim For Empty Nests

I recently happened to find myself among a group of young professionals who had grown up in the same rural area of Georgia, but had dispersed to not only different parts of the state, but also different parts of the country and even at times, the world. At some point in the evening, it became the topic of conversation that one of the members of this group still banked at his hometown community bank despite no longer living there and spending almost a decade traveling the world. His childhood friends were shocked, uttering things like “Wait, you still bank there?” and “Isn’t it time you leave the nest?”

As someone who did not grow up in Georgia and thus was an outsider to the conversation, I really began to think about this. Why should you have to leave the bank you’ve grown up with and trusted for years just because you have left the proverbial nest?

Admittedly, when I left for college, it was before the advent of mobile banking and federal preemption of interstate branching restrictions. When I moved out of state I was forced to switch banks so that I could actually deposit checks and bank efficiently. However, legislative changes, combined with drastic changes in technology, have eliminated the necessity for young adults to switch banks when they move away from home.

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IPO Market for Closed-End Funds Poised for Serious Rebound

It’s clear to anyone paying attention that the market for initial public offerings of closed‑end funds has fallen off dramatically over the last few years.  Undoubtedly, the primary cause of this fall off has been the gaping average trading discount of existing closed‑end funds (i.e., on average these funds have been trading at steep discounts to net asset values).  That made it difficult, if not a practical impossibility, for asset managers to sell shares of a new closed-end fund when investors could simply purchase shares of a similar, existing closed-end fund at a significant discount.

Also contributing somewhat to this fall off has been the relative increase in the cost of leverage as a result of the phasing in of new capital rules for banks.  Many closed-end funds employ leverage to deliver additional returns to investors; these increased costs (which correspondingly reduce returns to investors) have made it incrementally more difficult for asset managers looking to launch new closed-end funds to make their case to investors.

On top of all of this, according to many industry observers the so-called “fiduciary rule” (finalized on April 6, 2016) would make it nearly impossible for financial advisors to recommend to investors that they purchase shares of a closed‑end fund at the IPO stage.  The key problem for closed-end fund IPOs under the fiduciary rule is not necessarily inherent; it arises out of the fact that, at times, while many closed-end funds trade at a premium at and shortly after the initial offering, thereafter they begin to trade at a discount.  This can have the effect of creating at best a short-term paper loss, and at worst a short-term actual loss, for investors.

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