FINRA The State of the System

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Cadwalader Cabinet - December 21, 2021

by: Cadwalader, Wickersham & Taft LLP of Cadwalader, Wickersham & Taft LLP - Cadwalader Cabinet

Tuesday, December 21, 2021

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FSOC Provides Recommendations on Climate Risk, Digital Assets, LIBOR and Cybersecurity

In its 2021 Annual Report, the Financial Stability Oversight Council ("FSOC") assessed the state of the financial system and provided recommendations concerning climate-related financial risk, digital asset risk, the orderly transition away from LIBOR, and cybersecurity.

The wide-ranging report offered a comprehensive update on, among other topics, (i) FSOC activities over the past year as the Council worked to combat disruptions to financial conditions caused by COVID-19, (ii) significant financial market and regulatory developments, (iii) ongoing and potential threats to financial stability, and (iv) FSOC recommendations to promote financial stability.

Recommendations

With respect to climate-related financial risk, FSOC recommended:

improving the availability of data and risk-measurement tools;
improving assessments of climate-related financial risks;
incorporating such risks into risk-management practices; and
promoting disclosures that allow investors to take climate-related financial risks into account in their investment decisions.

On digital assets, FSOC urged (i) regulators to continue to examine and address risks to the financial system caused by the use of digital assets, and (ii) member agencies to consider recommendations provided in the November 2021 Report on Stablecoins. FSOC also noted that it would be prepared to act to address risks associated with stablecoins if comprehensive legislation is not enacted.

On the transition away from LIBOR, FSOC called on:

market participants to act promptly in transitioning to an alternative rate;
member agencies to determine whether to provide regulatory relief to encourage market participants to address their existing portfolios that reference LIBOR; and
member agencies to continue to use their authority to understand and monitor the status of regulated entities' transition from LIBOR.

On cybersecurity, FSOC recommended that agencies continue to conduct cybersecurity examinations of financial institutions and ensure effective cybersecurity monitoring.

Statements

Treasury Secretary Janet L. Yellen, who also serves as Chair of FSOC, said that over the last year, she focused on three priorities: nonbank financial intermediation, the resilience of the U.S. Treasury market and climate-related financial risks. The purpose of the report, she added, was to "analyze[] recent episodes of financial turmoil to understand weak points in our financial system and identif[y] potential threats."

FDIC Chair Jelena McWilliams stated that, in sharp contrast to its condition during the financial crisis of 2008, the banking system generally remained resilient following 2020's events. Ms. McWilliams noted that banks remained, and continue to remain, strongly capitalized in 2021.

In a statement on the annual report, SEC Chair Gary Gensler said the SEC is going to do everything possible to "strengthen the resiliency of [money market] funds." Mr. Gensler added that the SEC will be focused on ensuring Treasury market resilience, the regulation of crypto assets, and developing climate-related disclosures that are "consistent, comparable, and decision-useful."

It's not clear whether FSOC, as presently structured, can fulfill its intended role of being a watchdog for risks that might otherwise escape notice. Given that its membership is drawn exclusively, or almost so, from one party, it arguably serves more as an echo chamber for the positions of that party. A financial report that discusses inflation, rises in the debt level, and the shortening of the average term of government securities, but does not tie all those events to government spending and fiscal policy, is seemingly averting attention from important systemic risk factors that are regarded as politically unpleasant. The discussion of energy prices in the report is in the same vein: a number of factors for rising energy prices are mentioned, but there is no mention of the executive decision on the Keystone Pipeline.

The purpose of FSOC should not be to support or dissent from Presidential or Congressional decisions as to the level of spending or the building of pipelines. Rather, its purpose should be to make connections between events and to point to risks that may arise from those connections. If FSOC is not willing to make connections that seem obvious on their face, what is its value-add? If Congress wants to create an advisory group that may serve as a challenge to accepted governmental positions, or to complacency, it needs a different approach, whether that is including minority party representatives on the committee or representatives of non-governmental bodies.

SEC Commissioner Roisman to Step Down

SEC Commissioner Elad L. Roisman notified President Joseph R. Biden that he will resign from the Commission by the end of January 2022. Mr. Roisman served as an SEC Commissioner since 2018, and was briefly Acting SEC Chair from December 2020 until January 2021.

Prior to joining the SEC, Mr. Roisman served on the U.S. Senate Banking Committee as Chief Counsel. Before working in the Senate, he served as Counsel to SEC Commissioner Daniel M. Gallagher, and also had worked as a Chief Counsel at NYSE Euronext.

In a statement, Mr. Roisman called his time at the SEC the "greatest privilege" of his professional life. SEC Chair Gary Gensler said that, despite their policy disagreements, he came to "rely on [Commissioner Roisman's] judgment and expertise."

Commentary

Commissioner Roisman's departure from the SEC will be a significant loss to the agency. He has been a consistent voice of moderation and practicality, albeit largely a voice of dissent in recent months.

FinCEN and OCC Penalize Texas-Based Bank for AML Violations

FinCEN and the OCC penalized a Texas-based bank for willful violations of the Bank Secrecy Act ("BSA") and its implementing regulations. The civil money penalty comes after the bank, which services small- to mid-sized businesses as well as professionals, admitted that it failed to implement an AML program.

In determining that the bank's AML program was inadequate, FinCEN considered several shortcomings, including that:

the bank's compliance office was understaffed, requiring BSA analysts to skip reviewing supporting documentation as they reviewed over 100 case alerts per day;
bank analysts improperly cleared case alerts without investigating the customer activity that caused the case alerts;
Customer Due Diligence questionnaires were not regularly updated and therefore lacked "critical" information; and
the bank failed to file suspicious activity reports even though it knew that certain customers were subject to criminal investigations and may have engaged in illegal activities, such as tax evasion, illegal gambling and money laundering.

Separately, the OCC found that the AML deficiencies resulted in the bank's failure to "timely file complete suspicious activity reports for approximately $100 million of suspicious activity."

To settle the charges, the bank agreed to an $8 million civil monetary penalty with FinCEN, $1 million of which will be credited against a separate civil monetary penalty agreed on with the OCC in connection with its parallel investigation.

Primary Sources

Federal Court Grants Injunction and Penalties in CFTC Cattle Fraud Scheme

The U.S. District Court for the Eastern District of Washington approved a Consent Order in a CFTC action against a cattle supplier who allegedly made false representations to the Chicago Mercantile Exchange "concerning its cattle inventory, purchases, and sales" and violated exchange-set position limits.

The Consent Order concluded that the supplier engaged in a years-long endeavor to fraudulently file invoices and reimbursement requests for cattle on behalf of a beef producer, without raising or buying the cattle as represented. The CFTC's original allegations were made in a Complaint on March 31, 2021, against the cattle supplier and its former president. The CFTC's Complaint included allegations that the supplier made false allegations to the Chicago Mercantile Exchange and violated exchange-set position limits in furtherance of its fraud.

The Order requires that the cattle supplier "pay a combined $263 million in restitution and civil monetary penalty in connection with a phantom cattle fraud scheme."

In dissent, CFTC Commissioner Dawn Stump disagreed with the CFTC's decision to pursue a fraud charge in addition to the position limit and false statement charges. Ms. Stump criticized the CFTC for "inject[ing] itself into this cash market, single-victim, business fraud" and expressed concern that market participants would view the agency's action as government overreach. She noted that, due to the supplier's impending closure and bankruptcy protection, the supplier was not likely to actually pay the amounts due under the Consent Order.

Primary Sources

NFA Amends Branch Office Manager Exam Requirement

NFA adopted an amendment to the examination requirement for branch office managers of firms that engage only in swap activities.

As previously covered, NFA proposed an amendment to NFA Compliance Rule 2-7 to eliminate the branch office manager examination requirement (Series 30) for associated persons who have satisfied NFA's swap proficiency requirements to permit them to supervise the branch office of an NFA member that engages only in swap activities.

The amendment will become effective on January 3, 2022.

Primary Sources

FINRA Imposes Fee Limits on Proxy Distributions

FINRA adopted amendments to a rule on reporting and fee requirements for the delivery by broker-dealers of proxy and other issuer-related materials.

As previously covered, the amendments to FINRA Rule 2251 ("Processing and Forwarding of Proxy and Other Issuer-Related Materials") would:

allow certain registered investment companies to satisfy their shareholder report delivery obligations by making the reports available electronically on a website using a "notice and access" process;
limit the maximum fees that its member broker-dealers could charge to issuers utilizing the process; and
make conforming revisions to match the fee provisions set forth by the New York Stock Exchange.

The amendments are immediately effective and comments must be submitted by January 10, 2022.

Primary Sources

FINRA Seeks Comment on Proposal on Borrowing and Lending to Customers

FINRA is seeking comment on proposed amendments to FINRA Rule 3240 ("Borrowing from or Lending to Customers") to expand prohibitions against outside borrowing and lending agreements between registered individuals and their customers.

The proposed amendments would (i) expand the general prohibition under the rule to cover lending arrangements that may predate new broker-customer relationships and that may be entered into six months after the customer relationship has ended, (ii) expand the application of the rule to arrangements involving a customer of the registered individual transacting with a family member of the registered individual and (iii) better define the exceptions to the prohibition.

FINRA has specifically requested that commenters address key points of the proposed amendments and suggested that the prohibition could be further expanded.

FINRA is seeking comment on these proposals by February 14, 2022.

Commentary

FINRA has generally been seeking to limit relationships between registered representatives and their customers that are outside of the business and supervision of the firm, and that may provide a benefit to the representative. See, e.g., FINRA Adopts Restrictions on Registered Person Becoming Customer Beneficiary or Trustee. These regulatory limitations and prohibitions are particularly significant because FINRA and other financial regulators are concerned with any aging customer population who may be vulnerable to overreach by their agents.

Primary Sources

Proposed Amendments to FINRA Rule 3240 and Retrospective Rule Review Report

FINRA Proposes Changes to Modify Trade Reporting Fees for FINRA/NYSE Trade Reporting Facility

FINRA filed for immediate effectiveness a proposed update to the trade reporting fees for broker-dealers that use the FINRA/NYSE Trade Reporting Facility (the "FINRA/NYSE TRF") under FINRA Rule 7620B ("FINRA/NYSE Trade Reporting Facility Reporting Fees").

The proposal would:

increase the monthly fees for use of the FINRA/NYSE TRF for all non-retail participants to match those of all other participants; and
subject participants to a monthly fee that would be based on whether or not they submitted trade reports to the FINRA/NYSE TRF (and the number of trades reported).

Under the current fee structure, participants are not required to pay a fee if they do not report any trades for a given month; under the new proposal, however, they would pay a fixed fee for that month.

FINRA established an operative date of April 1, 2022.

Primary Sources