Eversheds Sutherland Regulatory

Reform Task Force -



IX - Investor Protections and Improvements to the Regulation of Securities

Title IX of the Dodd-Frank Act is referred to as the "Investor Protection Securities Reform Act of 2010" (Title IX). Title IX focuses on a number of areas including broker-dealer and investment adviser standards of conduct and certain disclosure issues (Subtitle A), as well as a number of other areas impacting securities regulation by the Securities and Exchange Commission (SEC), including increasing regulatory SEC enforcement and remedies (Subtitle B), asset-backed securities (Subtitle D), and executive compensation (Subtitle E). Like other titles of the Act, the impact of Title IX will be shaped significantly by studies and rulemakings conducted by the SEC and others.

Subtitle A - Broker-Dealer and Investment Adviser Standards of Conduct - A Study and Freestanding Rulemaking Authority

The Act provides two different avenues for the SEC to regulate broker-dealers' standard of care: (1) a rulemaking resulting from an SEC study required by January 21, 2011; and (2) rulemaking authority under Section 913(g) of the Act that provides for regulations addressing standard of conduct and other disclosure issues. Importantly, the trigger for nearly all proposed sales practice regulation is the provision of personalized investment advice about securities to retail customers.

The Study. Much of the fanfare related to financial services regulatory reform has focused on the proposal to impose equal standards of care on broker-dealers and investment advisers serving retail investors. Section 913 of the Act requires the SEC to conduct a very detailed study of the broker-dealer and investment adviser regulatory framework and submit the report to the House Committee on Financial Services and the Senate Banking Committee by January 21, 2011. The SEC is required to seek and consider public comments in order to create the report. The study must evaluate:

  • The effectiveness of existing legal or regulatory standards of care for broker-dealers and investment advisers; and
  • Whether there are legal or regulatory gaps, or overlap, in the protection of retail investors related to the standards of care for broker-dealers and investment advisers.

In addition, the Act sets forth 14 "considerations" related to the regulation of broker-dealers and investment advisers that must be reviewed including, but not limited to, the following:

  • The regulatory, examination and enforcement resources devoted by the SEC and the Financial Industry Regulatory Authority, Inc., to broker-dealer and investment adviser standards of care;
  • The substantive differences in the regulation of broker-dealers and investment advisers providing personalized investment advice to retail customers;
  • Specific instances in which retail customers of a broker-dealer receive greater protections than an investment adviser receives, and vice versa;
  • The potential impact on retail customers of the range of products and services offered by broker-dealers if the fiduciary duty standard of care is applied to broker-dealers;
  • The ability of investors to understand the differences in standards of care provided by broker-dealers and investment advisers; and
  • The varying level of services provided by broker-dealers and investment advisers and the varying terms of retail customer relationships.

The SEC is granted rulemaking authority "to address the legal or regulatory standards of care" for broker-dealers and investment advisers providing personalized investment advice about securities. In any such rulemaking, the SEC is required to take into consideration the findings of the study.

Freestanding Rulemaking Authority on the Standard of Conduct. The Act amends Section 15(g) of the Securities Exchange Act of 1934, as amended (1934 Act), to provide authority to the SEC to promulgate rules that would make the standard of conduct for broker-dealers providing personalized investment advice to retail customers the same as provided for under Section 211 of the Investment Advisers Act of 1940, as amended (Advisers Act). As amended under the Act, Section 211 of the Advisers Act provides the SEC with rulemaking authority to impose the following standard of conduct:

To act in the best interest of the customer without regards to the financial or other interest of the broker, dealer or investment adviser providing the advice.

Section 913 of the Act also addresses certain issues that arise in raising the standard of care owed by broker-dealers as follows:

  • Commissions. The receipt of commissions or other traditional transaction-based compensation by broker-dealers is not, in and of itself, a violation of the "best interest" standard.
  • Ongoing Duty. Broker-dealers and registered representatives do not owe a continuing duty of care of loyalty after providing personalized investment advice.
  • Proprietary or Limited Range of Products. Where broker-dealers sell "only proprietary or other limited range of products" as determined by the SEC, the SEC has rulemaking authority to compel such broker-dealers to provide notice and receive consent of the customer. The sale of such proprietary or limited range of products is not deemed to be a per se violation of the broker-dealer's standard of conduct.

There is no explanation of the interplay between the rulemaking to be conducted under the study and the independent rulemaking authority granted under the new Section 15(g) of the 1934 Act. We are not aware of any legislative history that explains the interplay of the two sections. It seems unlikely that the SEC would rely on the Section 15(g) rulemaking authority in advance of, or without reference and deference to, the study.

Enhanced Disclosures and Sales Practice Rulemaking

Section 913(g) of the Act also adds Section 15(I) to the 1934 Act, which provides additional authority to the SEC to regulate and prescribe disclosure to investors describing the terms of their relationships with their broker-dealers or investment advisers, including conflicts of interest. This provision appears to be designed to address the perceived lack of understanding by customers about their relationships with their investment professionals.

The SEC is also required to examine, and where necessary promulgate, rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes that adversely impact investor protection.

Mutual Fund Advertising Study

Section 918 of the Act provides that the Comptroller General shall conduct a study on mutual fund advertising. Within 18 months of the date of enactment of the Act, the study must be submitted to the House Financial Services Committee and the Senate Banking Committee. The study focuses on existing practices, particularly with respect to performance, and requires the Comptroller General to provide recommendations for improving the current requirements in a way that allows for investors to make better informed decisions.

Disclosure Requirements Before Purchase

Section 919 of the Act adds a new Section 15(n) to the 1934 Act, which grants authority to the SEC to issue rules that designate documents or information that must be provided by a broker-dealer to a retail investor before the purchase of an investment product or service. Any such rule must provide for documentation that is in a summary format, and must contain clear and concise information about investment objectives, strategies, costs, risks and compensation received by a broker-dealer or any other intermediary in connection with the purchase.

Use of Financial Planner and Similar Designations. Section 919(C) of the Act requires the Government Accountability Office to conduct a study on financial planners and the use of financial designations for the purpose of assessing current regulation and oversight and identifying any gaps. This study could revive debate over practices entailing the use of "financial adviser" designations for registered persons.

CRD and IARD Access. Section 919B of the Act requires the SEC to complete a study on ways to improve investor access to registration information and disciplinary information on broker-dealers and investment advisers, and consider whether to further centralize the two systems.

Investor Qualification and Education. Section 917 of the Act requires the SEC to conduct a study regarding the "financial literacy" of investors. The results of this study could influence the shape of future rulemaking. There may be increased focus on investor education initiatives such as generic investment product brochures.  This study could call into question conventional practices for qualifying customers as experienced investors.

New Approach for SEC Rulemaking. Sections 911 and 912 of the Act authorizes the SEC to use investor testing to develop rules and provides for the formation of an "investor Advisory Committee," which the SEC is directed to consult on, among other things, "issues relating to the regulation of securities products, trading strategies, and fee structures, and the effectiveness of disclosure."

Streamlined Rulemaking Proceedings. Section 916 of the Act revises the rulemaking process for self-regulatory organizations to require the SEC to act within 45 days after publishing a notice of a proposed rule change unless it has taken action to delay the proceeding. It also deems a rule proposal approved if the SEC does not take any of the permissible courses of action by the end of the 45-day period.

Subtitle C - Improvements to the Regulation of Credit Rating Agencies

One of the principal sections of the Dodd-Frank Act relates to the regulation of credit rating agencies that service a critical "gatekeeper" role in the debt markets, but that were seen as contributors to the economic crisis by not providing accurate credit ratings for various structured financial products.

The Dodd-Frank Act seeks to improve the regulation of credit rating agencies by: (1) subjecting them to greater corporate governance requirements and allowing private rights of action to be brought against them; (2) establishing a new office in the Securities and Exchange Commission (SEC) to oversee and examine the work of credit rating agencies; (3) tasking the SEC with examining the conflicts of interest present in the issuance of credit ratings; and (4) limiting the market reliance placed on ratings issued by credit rating agencies. In addition, the Dodd-Frank Act repealed Ruled 436(g) under the Securities Act, which previously provided an exemption from having to provide a consent from a credit rating agency.

Enhanced accountability and liability. The Dodd-Frank Act characterizes credit rating agencies as serving a similar gatekeeper role in the debt markets that independent auditors serve in the capital markets. As a result, the legislation requires that each credit rating agency comply with corporate governance policies similar to those required for public companies. For example, each credit rating agency must have a board of directors, at least half of which must be independent. In addition, the compensation of directors of a credit rating agency cannot be tied to the performance of the credit rating agency. Further, the board of directors must establish and maintain an effective internal control structure relating to its policies, procedures and methodologies related to how it determines credit ratings and to submit a report to the SEC describing the effectiveness of such internal controls annually.

In addition, the Dodd-Frank Act allows private investors to bring a private right of action against a credit rating agency in the same manner and to the same extent as a private right action is brought against a registered public accounting firm or securities analyst firm. Specifically, Section 933 allows a private right of action to be brought if there is a "strong inference that the credit rating agency knowingly or recklessly failed ... to conduct a reasonable investigation of a rated security ... or ... to obtain reasonable verification of such factual elements ... from other sources that the credit rating agency considered to be competent and that were independent of the issuer and underwriter."

Office of Credit Ratings. The Dodd-Frank Act establishes a new offices within the SEC to be called the Office of Credit Ratings (OCA). The OCA is tasked with overseeing credit rating agencies and conducting examinations, at least annually, of each credit rating agency.

The Office of Credit Ratings is also tasked with rulemaking initiatives aimed at: (1) determining the feasibility and desirability of standardizing among all credit rating agencies credit rating terminology and market stress conditions under which ratings are evaluated; and (2) ensuring that all persons employed by a credit rating agency meet certain professional standards and possess sufficient experience to produce accurate ratings.

Conflicts of interest. The Dodd-Frank Act requires that, in connection with its policies, procedures and methodologies for producing a credit rating, the credit rating agency must consider information about the issuer obtained from a source other than the issuer or the underwriter of the debt securities. This is designed to improve the accuracy of a credit rating by ensuring that not all information underpinning the rating is obtained from the issuer or underwriter, both of whom have an inherent conflict of interest in obtaining a higher credit rating.

In addition, by not allowing employees to be compensated based on the performance of the credit rating agency, Congress sought to limit the conflicts of interest present within a credit rating agency, specifically between the sales and marketing arm of a credit rating agency and the individuals tasked with producing accurate ratings.

Limiting market reliance on credit ratings. Finally, the Dodd-Frank Act seeks to limit the market's reliance on credit ratings issued by credit rating firms. Within one year of the enactment of the Dodd-Frank Act, each federal agency that has previously issued regulations that require the use of credit ratings is required to modify any such regulations to remove such requirement and substitute it with such other standard as determined by the federal agency. The policy rationale behind this requirement is to allow for market alternatives to ratings issued by credit rating agencies.

Consents. A final requirement relating to credit rating agencies that has generated a substantial amount of concern is that the Dodd-Frank Act repealed Rule 436(g) under the Securities Act, which previously provided an exemption to credit rating agencies from the general requirement that experts provide consents in connection with registered public offerings of securities. Issuers of debt securities typically include disclosure related to the rating of the debt security being registered. Plus, Regulation AB requires such disclosure of ratings received by a credit rating agency in the issuer's prospectus if the offering is conditioned upon a certain rating. Credit rating agencies have thus far indicated an unwillingness to provide such consents. As a result, an interim framework has developed to allow issuers to sell their debt securities despite this logjam. First, the SEC has issued a compliance and disclosure interpretation that confirms that disclosures relating to a change in a credit rating or the liquidity of the issuer, for example, do not require the filing of a consent. Second, consents are not required with respect to the filing of free writing prospectuses (which may be term sheets) or in press releases or term sheets that comply with Rule 134  under the Securities Act. Third, registration statements that went effective prior to July 22, 2010, and that contain information beyond issuer disclosure-related ratings information, may continue to use such registration statement without filing a consent until the registration statement is required to be updated through the filing of a post-effective amendment. Finally, the Division of Corporation Finance at the SEC issued a 'no action' letter, which allows issuers to omit credit ratings from registration statements filed under Regulation AB for a period of 6 months.

Subtitle D - Improvements To The Asset-Backed Securitization Process

Title IX, Subtitle D of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) takes a two-pronged approach to reforming the asset-backed securitization markets.  The first approach is aimed at ensuring that securitizers (i.e., issuers of asset-backed securities or sponsors of asset-backed securities issued) and originators of assets sold to securitizers retain a continuing economic interest in the assets, so called “skin-in-the-game.” To accomplish goal, the Act requires that regulations be established to require originators and securitizers to retain a portion of the credit risk of securitized assets. These regulations will determine the appropriate allocation of risk among originators and servicers, and will prohibit these entities from hedging or transferring the retained credit risk. Except with respect to commercial mortgage-backed securitizations, the Act does not specify whether the risks required to be retained must be in the first loss position, i.e., the bottom tranche,  or vertical, i.e., a portion of each tranche of securities. Presumably, this question will be clarified by the implementing regulations. The second approach seeks to improve transparency and ensure that investors have adequate information regarding the underlying assets that collateralize asset-backed securities and the terms of any securitization. This goal is accomplished through disclosure and reporting requirements imposed on securitizers and issuers of asset-backed securities and on the agencies that rate these securities.

Risk Retention Requirements

With respect to risk retention requirements, three broad categories of assets or asset-backed securities that can be delineated in the Act. The first category involves assets that should present more limited credit risk. The Act requires the assigned regulators1 to establish classes of assets (e.g., “auto loans”). For each such class, regulators will formulate underwriting standards that specify terms, conditions and characteristics within the class that indicate a low credit risk. Originators and securitizers of assets meeting such underwriting requirements may be required to retain, in the aggregate, less than 5% of the credit risk of these assets.

The second category is comprised of all assets that do not meet the underwriting standards of the first category and do not qualify for an exemption described in the third category below. Originators and securitizers of assets falling within the second category will be required to retain, in the aggregate, at least 5% of the credit risk of these assets.

The third category includes securities that are either totally or partially exempted from the Act’s risk retention requirements. Total exemptions are provided for (i) asset-backed securities that are secured solely by “qualified residential mortgages”;2 (ii) any loan or other financial asset made, insured, guaranteed or purchased by any institution that is subject to the supervision of the Farm Credit Administration; and (iii) any residential, multifamily, or health care facility loan asset which is insured or guaranteed by an agency of the United States, or any securitization comprised of such assets. The Act also requires total or partial exemptions for any securitization of an asset issued or guaranteed by (i) the United States, any agency thereof (excluding Fannie Mae and Freddie Mac) or any State; (ii) any political subdivision of a State or territory; (iii) any public instrumentality of a State or territory that is exempt from the registration requirements of section 3(a)(2) of the Securities Act of 1933; and (iv) certain qualified scholarship funding bonds. In addition, the Act allows for other exemptions as regulators may determine to be in the public interest and for the protection of investors.

Disclosure and Reporting Requirements

The Act requires the Securities and Exchange Commission (the SEC) to adopt regulations requiring issuers and securitizers of asset-backed securities, and agencies that rate asset-backed securities, to comply with certain disclosure and reporting requirements.3 The objective of these requirements is to enable investors to independently assess the quality of the assets collateralizing an asset-backed securitization. Issuers of asset-backed securities will be required to disclose specific information regarding the assets backing each security. At a minimum, issuers will be required to provide certain asset-level data if such data is necessary for investors to independently perform due diligence. The asset-level data may include unique identifiers of loan originators, the type and amount of compensation received by the originator and the amount of risk retained by the originator and securitizer. Rules will also be promulgated that require issuers to perform a review of the assets underlying an asset-backed security and disclose the nature of the review in the related registration statement. 

The Act also requires the SEC to prescribe regulations on the use of representations and warranties in the market for asset-backed securities that impose certain requirements on rating agencies and securitizers. Each rating agency will be required to include in its rating report a description of the representations, warranties and enforcement mechanisms available to investors, and an analysis of how these terms compare to those of similar securities. Securitizers will be required to disclose fulfilled and unfulfilled repurchase obligations across all asset-backed security issuers aggregated by the securitizer, in order to assist investors in identifying asset originators with underwriting deficiencies.  

Prohibiting Conflicts of Interest

Section 621 of Title VI of the Act requires the SEC to prescribe rules prohibiting certain entities involved in a securitization from entering into any transaction that would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity. The rules will apply to any underwriter, placement agent, initial purchaser, or sponsor, or any affiliate or subsidiary of any such entity, of an asset-backed security, and will prohibit these transactions during the one-year period following the first closing of the sale of the asset-backed security. Prohibitions will not apply to the following activities: (i) risk-mitigating hedging activities in connection with holdings arising out of the underwriting, placement, initial purchase, or sponsorship of an asset-backed security; (ii) purchases and sales of asset-backed securities made pursuant to commitments to provide liquidity for the asset-backed security; and (iii) bona fide market-making in the asset-backed security.

Subtitle E – Accountability and Executive Compensation

Shareholder Vote on Executive Compensation

Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) requires issuers of securities covered by the SEC’s proxy solicitation rules to institute an up or down advisory vote on executive compensation (a Say on Pay vote). The Say on Pay vote is non-binding and is not meant to alter or overrule any specific action or decision by the issuer. The proxy materials for the first annual or other shareholder meeting occurring six months after the enactment of the Dodd Frank Act are required to contain this Say on Pay resolution; based on this timing, the Say on Pay requirement will be in effect for the 2011 proxy season.

Notably, while prior iterations of the legislation contemplated annual Say on Pay votes, the Act requires public companies to provide in their proxy statements a separate resolution to determine the frequency of such Say on Pay votes. At the first annual or other shareholder meeting occurring six months after the enactment of the Act, issuers are required to put to a shareholder vote whether to hold Say on Pay votes annually, biennially or triennially. Thereafter, shareholders must again be provided the opportunity to vote on the frequency of Say on Pay votes at least once every six years. This provision has raised several interpretive questions, including whether this frequency vote will be binding upon issuers.

During the conference process, a further provision was added to give the SEC the authority to exempt companies from the Say on Pay requirements after taking into account, among other considerations, whether the requirements would disproportionately burden smaller companies. During conference negotiations, the Senate conferees also accepted a proposal from House conferees to require large institutional investment managers to disclose their Say on Pay votes.

Compensation Committee Independence

Section 952 of the Act requires each member of a board’s compensation committee to meet independence requirements to be established by the national exchanges.  Any compensation consultants or other advisers retained by the compensation committee also must meet independence standards to be identified by the SEC. The Act also adds a provision mandating that the SEC conduct a study to be submitted to Congress within two years of the enactment of the Act on the use of compensation consultants and the effects of such use.

Under this provision, an issuer is required to disclose in its annual proxy statement whether the compensation committee hired a compensation consultant, whether the consultant’s work raised any conflicts of interest, and, if so, the nature of the conflict and how it is being addressed.

The Act provides the compensation committee with the authority to appoint, oversee and determine the compensation for independent legal counsel and other advisers. The compensation committee is under no obligation to implement the adviser’s recommendations nor is the committee to be relieved of any of its existing obligations. 

The Act also directs the SEC, within one year of enactment, to issue rules requiring national exchanges and securities associations to prohibit the listing of any securities of issuers that are not in compliance with these requirements. A non-compliant issuer does have an opportunity under the Act to cure any related defects.

Executive Compensation Disclosures

Section 953 of the Act directs the SEC to adopt enhanced rules relating to disclosure of executive compensation. Each issuer is required to include in its annual proxy statement a clear description of compensation paid to its executives and how the compensation relates to the issuer’s financial performance.  

Recovery of Erroneously Awarded Compensation

Section 954 of the Act requires issuers to adopt “clawback” policies on excessive incentive-based compensation. These policies apply if the issuer is required to prepare an accounting restatement based on material noncompliance with financial reporting requirements under federal securities laws. Issuers must recover from current and former executive officers any incentive-based compensation (including stock options) awarded in excess of what would have been awarded under the restated accounting numbers. The recovery applies to a three-year “look-back” period preceding the date that the restatement was required. 

The Act further requires issuers to disclose their policies on incentive-based compensation that are based on financial information reported under federal securities laws. It also mandates that national exchanges and securities associations prohibit the listing of any class of equity security of issuers that do not comply with these requirements. 

Disclosure Regarding Employee and Director Hedging

Section 955 of the Act requires the SEC to adopt rules requiring issuers to disclose in their proxy statements whether employees or directors may purchase financial instruments designed to hedge or offset decreases in the value of equity securities. This disclosure includes not only equity securities granted to employees or directors as part of employee compensation, but also equity securities held directly or indirectly by the employee or director. 

Enhanced Compensation Structure Reporting

Section 956 of the Act further requires that issuers disclose the median total annual compensation of all employees other than the CEO, the annual total compensation of the CEO, and the ratio of these two amounts. It is worth noting that the Act does not mandate whether any particular analysis will be required to put this ratio in context. However, it is possible that the SEC might adopt such rules going forward.

Voting by Brokers

Section 957 of the Act, in certain circumstances, prohibits brokers that are not beneficial owners of shares from exercising their discretion to vote those shares by proxy. Brokers are prohibited from voting on director elections, executive compensation or any other “significant matter” (to be defined in future SEC rules) without specific voting instructions from the beneficial owner of the shares. The Act does provide an exception for broker voting in uncontested elections of directors at a registered investment company.

Although prior iterations of the Act would have mandated that directors be elected by a majority (in uncontested elections) or a plurality (in contested elections) of votes cast, the Senate conferees agreed to drop the majority voting provision from the Act.

Subtitle G – Strengthening Corporate Governance

Proxy Access for Shareholder Nominees

Section 971 of the Act gives the SEC explicit authority to make rules requiring an issuer to include shareholder nominees in its proxy solicitation materials.  Notably, however, it does not require the SEC to issue such rules.

Although particular ownership thresholds and holding periods with regard to proxy access had been discussed during conference negotiations, the final version of the Act delegates the setting of any standards to the SEC. While the Act does not contemplate any ownership or holding period limits, it does give the SEC explicit authority to exempt an issuer or a class of issuers from the proxy access requirements and directs the SEC to take into account whether the requirements disproportionately burden small issuers.

Separation of Chairman and CEO

Section 972 of the Act directs the SEC, within 180 days of enactment, to adopt rules requiring issuers to disclose in their annual proxy statements the reasons why they have chosen the same person, or different people, to serve as chairman of the board and as chief executive officer (or the equivalent position). 

Subtitle H - Provisions Affecting the Municipal Securities Markets

Subtitle H of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) includes a number of provisions that affect the municipal securities markets, including provisions that expand the composition and authority of the Municipal Securities Rulemaking Board (MSRB), require the registration of municipal advisers, prohibit fraudulent or deceptive practices by municipal advisers, and impose a fiduciary duty upon municipal advisers. The amendments to the Exchange Act enacted by Subtitle H take effect October 1, 2010.

Subtitle H also requires studies of, and reports on, the municipal securities markets, including a study of whether the Tower Amendment should be repealed.

Municipal Securities Rulemaking Board

Subtitle H expands the composition of the MSRB to include eight independent members unaffiliated with a municipal broker, dealer or advisor.  The independent members must include at least one investor representative, one issuer representative, and one “member of the public” with knowledge of the industry. The MSRB may expand its membership beyond 15 members, so long as the number of public representatives exceeds the number of regulated representatives, and the total number of MSRB is an odd number.

Most significantly, however, Subtitle H expands the authority of the MSRB beyond broker-dealers and investor protection to cover municipal advisers, apparently with a view to providing protection not only to investors, but also to municipal entities and “obligated persons,” which includes any person who is committed to support payment of all or part of a municipal security. The Act does so by:

  • Requiring registration of municipal advisers with the MSRB;
  • Imposing a fiduciary duty on municipal advisers;
  • Requiring the MSRB to adopt rules that determine standards of competence and other qualifications for municipal advisers that the MSRB finds necessary or appropriate for the protection of municipal entities and obligated persons; and
  • Providing the MSRB with the authority to discipline municipal advisers who violate MSRB rules or act in contravention of such municipal adviser’s fiduciary duty to a municipal entity.

The term “municipal advisers” includes among other things financial advisers, GIC brokers, placement agents and swap providers. Broker-dealers acting in the capacity of underwriters, registered investment advisers, registered commodity trading advisers, attorneys and engineers are not covered.  
Fee for Support of GASB

The only direct change in Subtitle H affecting broker-dealers is a provision authorizing, but not requiring, the SEC to direct FINRA to assess and collect a fee from dealers to support the annual budget of the Governmental Accounting Standards Board.

Office of Municipal Securities

Subtitle H also creates an Office of Municipal Securities within the SEC. The Office of Municipal Securities is charged with the responsibility to administer SEC rules with respect to the practices of municipal securities broker-dealers, advisers, and investors and to coordinate with the MSRB on rulemaking and enforcement.

Mandatory Studies and Reports

The Act requires a number of studies and reports on the municipal securities markets:

  • Within 24 months, a study by the Government Accountability Office (GAO) of the disclosure practices of issuers of municipal securities, including the advisability of repealing or retaining the Tower Amendment, which prohibits the SEC and the MSRB from regulating municipal securities disclosure or requiring registration or similar actions with respect to the offer and sale of municipal securities.
  • Within 18 months, a study of the municipal securities markets by GAO, and within six months after receipt of such study, a report from the SEC stating the actions the SEC has taken in response to the GAO study.
  • Within 180 days, a study of the role, importance and funding of the Governmental Accounting Standards Board.

Other Provisions Affecting Municipal Securities Markets
Other provisions of the Act also can or will affect the municipal securities markets, such as the provisions affecting credit rating agencies (Title IX, Subtitle C) and derivatives and swaps (Title VII, Part II). 

Credit Rating Agency Provisions

The credit rating agency provisions, among other things:

  • Require rating agencies to disclose methodologies, reliance on third-party due diligence reports, and ratings track records.
  • Require arrangers and sponsors of asset-backed securities, which could include issuers and underwriters of exempt municipal securities that constitute asset-backed securities, to disclose the findings and conclusions of third party due diligence reports. 
  • Impose expert liability on rating agencies under Section 11 of the 1933 Act to the same extent as accountants, and require issuers of registered securities to file with their registration statements the rating agencies’ written consents to INCLUDE the ratings assigned. 
  • Direct the SEC to remove the exemption from Regulation FD (Fair Disclosure) under the 1934 Act for statements made to a credit rating agency. 

Because municipal securities are exempt from the registration requirements of the 1933 Act and the filing requirements of the 1934 Act, these changes do not directly affect municipal securities. Nonetheless, the changes could impact the municipal securities market. For example, while issuers of municipal securities do not file registration statements, and therefore are not required to file rating agency consents, with the SEC, underwriters might begin requiring similar consents before underwriting an exempt security – which is exactly what happened with accountants’ consents. Likewise, while issuers of municipal securities are not required to comply with Regulation FD, many issuers take the principles of Regulation FD into account in determining their disclosure practices. 
Although the credit rating agency provisions have the potential to change municipal securities market practices, at this time, they do not appear to have had much of an effect.

Derivatives and Swaps Provisions

The derivatives provisions require reporting of municipal swap transactions and SET new rules regarding the business conduct standards for swap providers and swap advisers that provide services to certain “special entities,” which include federal agencies, municipal entities, endowments and certain ERISA plan governmental entities. 

The Act requires the SEC to adopt business conduct requirements that would require swap dealers and major swap participants (entities which are not “swap dealers” but which hold substantial positions in certain major categories of swaps) to:

  • Verify that any counterparty meets certain eligibility standards.
  • Disclose to counterparties information about the material risks and characteristics of the swap, as well as any material incentives or conflicts of interest the swap dealer or major swap participant may have.
  • When acting in the capacity of AN advisor to special entities, to act in the best interests of the special entity. 

When acting in the capacity of a swap provider to a governmental entity, a swap dealer must:

  • Have a reasonable basis to believe that the governmental entity has an independent representative meeting certain requirements that will, among other things, act in the best interests of the special entity, and provide written representations to the special entity regarding fair pricing and appropriateness of the trade. 
  • Disclose to the special entity in writing the capacity in which the swap dealer is acting before the initiation of the trade.

Subtitle I - Public Company Accounting Oversight Board (PCAOB), Portfolio Margining, And Other Matters
Subtitle I of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act is a “catch-all” subtitle that includes measures that will affect a variety of areas.  Among other things, this subtitle amends the Sarbanes-Oxley Act:

  • To expand the scope of the PCAOB’s authority to include registered public accounting firms that audit broker-dealers that are not public companies;
  • To permit the PCAOB to share certain confidential information regarding public accounting firms with foreign auditor oversight authorities; and
  • To exempt an issuer that is neither a “large accelerated filer” nor an “accelerated filer” (as those terms are defined in Rule 12b-2 of the Securities Exchange Act of 1934 (the 1934 Act) from the Sarbanes-Oxley Section 404(b) requirement that such issuers obtain annual audits of internal controls over financial reporting.

Subtitle I requires that the Securities and Exchange Commission (SEC) and Government Accountability Office (GAO) each conduct a study on how to reduce the burden of complying with Sarbanes-Oxley Section 404(b).

Several measures in Subtitle I are designed to enhance the oversight of the financial regulatory system and the authority of inspectors general. Subtitle I creates a Council of Inspectors General on Financial Oversight and requires that the new council make regular reports to Congress. Subtitle I also strengthens inspector general accountability, and provides for the independence of designated federal entity inspector generals and for the removal of such inspector generals. This Subtitle also requires that the Chairman of the Board of Governors of the Federal Reserve System, the Commodity Futures Trading Commission, the National Credit Union Administration, the SEC, and the Director of the Pension Benefit Guaranty Association either take action to address the deficiencies identified by an Inspector General report or an investigation of his or her agency, or certify to both Houses of Congress that no action is necessary or appropriate in connection with identified deficiencies.

Subtitle I also includes provisions that: (1) amend the Securities Investor Protection Act of 1970 by including certain provisions relating to portfolio margining; (2) amend the 1934 Act to grant the SEC the power to prescribe rules and regulations involving the loan or borrowing of securities; (3) establish a grant program of up to $500,000 for each of three consecutive fiscal years to state securities or insurance commissions that have adopted rules on the appropriate use of “senior” designations in the offer or sale of securities or insurance products or the provision of investment advice, and with respect to fiduciary or suitability standards in the sale of annuities, that meet or exceed certain minimum requirements; (4) require GAO studies on proprietary trading and person-to-person lending to determine the optimal Federal regulatory structure; and (5) create an exemption under Section 3(a)(8) of the Securities Act of 1933 for certain fixed insurance products, including indexed annuities. 


1 For promulgating the risk retention requirements described in this summary, including the exemptions thereto, the Act assigns joint-rulemaking authority to the OCC, the Board and the FDIC (the Federal Banking Agencies), and the SEC (and for the regulations regarding securitized residential mortgage assets, the Secretary of HUD and the FHFA), coordinated by the Chairperson of the Council. The asset classes described in this summary will be developed by the joint rulemaking of the Federal Banking Agencies and the SEC, coordinated by the Chairperson of the Council. The underwriting standards developed under such asset classes will be established by the joint rulemaking of the Federal Banking Agencies, coordinated by the Chairperson of the Council.

2 This term will be defined through regulation to capture residential mortgages that have characteristics which indicate a lower likelihood of default. The term must be no more broad than the definition of “qualified mortgage” under Section 129C(c)(2) of the Truth in Lending Act.

3 §932(a)(8) of the Act also imposes disclosure requirements on rating agencies that are designed to enhance transparency and the information available to investors with respect to asset ratings.

If you have any questions about anything you have read on Title IX, please feel free to contact any of the attorneys listed below or the Eversheds Sutherland attorney with whom you regularly work.

Broker-Dealers/Adviser and Investor Protection Issues
Eric A. Arnold +1.202.383.0741 EricArnold@eversheds-sutherland.com
Clifford E. Kirsch +1.212.389.5052 CliffordKirsch@eversheds-sutherland.com
Michael B. Koffler +1.212.389.5014 michael.koffler@eversheds-sutherland.com
Susan S. Krawczyk +1.202.383.0197 susan.krawczyk@eversheds-sutherland.com
Holly H. Smith +1.202.383.0245 HollySmith@eversheds-sutherland.com
Corporate Governance and Executive Compensation
B. Scott Burton +1.404.853.8217 ScottBurton@eversheds-sutherland.com
Cynthia M. Krus +1.202.383.0218 CynthiaKrus@eversheds-sutherland.com
Henry S. Pangas +1.202.383.0805 HarryPangas@eversheds-sutherland.com
Mary Jane Wilson-Bilik +1.202.383.0660 MJWilson-bilik@eversheds-sutherland.com
Improvements to the Asset-Backed Securitization Process
Eric R. Fenichel +1.404.853.8483 EricFenichel@eversheds-sutherland.com
SEC Enforcement, Remedies, and Structure
Peter J. Anderson +1.404.853.8414 PeterAnderson@eversheds-sutherland.com
Bruce M. Bettigole +1.202.383.0165 BruceBettigole@eversheds-sutherland.com
Neil S. Lang +1.202.383.0277 NeilLang@eversheds-sutherland.com
S. Lawrence Polk +1.404.853.8225 LarryPolk@eversheds-sutherland.com
Brian L. Rubin +1.202.383.0124 BrianRubin@eversheds-sutherland.com
Securities Exemptions for Insurance Products/Harkin Amendment
Frederick R. Bellamy +1.202.383.0126 FredBellamy@eversheds-sutherland.com
Thomas E. Bisset +1.202.383.0118 ThomasBisset@eversheds-sutherland.com
Stephen E. Roth +1.202.383.0158 SteveRoth@eversheds-sutherland.com
Mary Jane Wilson-Bilik +1.202.383.0660 MJWilson-bilik@eversheds-sutherland.com
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