Washington regulatory update

June 8, 2011

"In Boston serpents whistle at the cold." Robert Lowell (Famous Boston Poet)

"Boston is actually the capital of the world. You didn't know that? We breed smart-ass, quippy, funny people. Not that I'm one of them. I just sorta sneaked in under the radar." John Krasinsky (Jim Halpert on "The Office")

SEC Adopts New Whistleblower Rules

On May 25, 2011, the U.S. Securities and Exchange Commission (SEC) voted 3-2 along party lines to adopt rules establishing a whistleblower program. The final rules implement Section 922 of the Dodd-Frank Act (Dodd-Frank or the Act), which authorizes the SEC to pay rewards to individuals who provide the SEC with original information that leads to successful SEC enforcement actions and certain related actions.

The whistleblower rules are on a short list of the most contentious rules to emerge from Dodd-Frank. Concerns have been expressed by corporate America that they would undermine companies' internal compliance programs - a point reinforced by Commissioner Kathleen Casey in voting against the rules. The new rules, like other corporate changes in Dodd-Frank, are more about corporate reform than the financial crisis -- the new rules will impact a broad range of entities including public companies and their subsidiaries and affiliates, broker-dealers, investment advisers, investment companies, rating agencies, and hedge funds. Lastly, is the concern that the play-to-get-paid feature will lead to a significant increase in whistleblower activity and litigation. The SEC has said that it expects to receive approximately 30,000 tips per year and plaintiffs' law firms have set up websites to attract whistleblower leads in the United States and abroad.

Highlights of some key provisions follow:

Who Can Be A Whistleblower?


The question is "who" because a whistleblower must be an individual (alone or jointly with others), a company or similar entity is not eligible. A whistleblower -- let's call her Aunt Bee -- must voluntarily provide the SEC with original information that relates to a possible violation of the federal securities laws that has occurred, is ongoing, or is about to occur. If before providing the information, Aunt Bee received a request, inquiry or demand from the SEC or other legal authorities for the information, including Congress, any information provided is not voluntary. Thus if Aunt Bee received a request relating to possible insider trading on pie recipes, she can't profit from turning in Barney Fife for the same transgression. The information must also be original knowledge or the result of independent analysis -- if Aunt Bee discovers a Ponzi scheme on her own analysis she's still in the game, unless it's already known to the SEC.

Information that Leads to Successful Enforcement 


To qualify for an award, Aunt Bee's information must "lead to" the successful enforcement by the SEC of a federal court or administrative action in which the agency obtains monetary sanctions totaling more than $1 million. The whistleblower is entitled to an award between 10 and 30 % of the aggregate recovery. To meet this "lead to" test the information must have been sufficiently specific to cause staff to open or reopen an investigation. The rules also allow Aunt Bee to benefit if she reported the information through a company's internal legal or compliance reporting procedures before or at the same time it is reported to the SEC and the company reports the information to the SEC (see below).

Persons Generally Excluded from Eligibility for Awards


Certain individuals generally will not be considered eligible for awards under the final rules, including: (i) people who have a pre-existing legal duty or contractual duty to report their information to the SEC; attorneys (including in-house counsel) who attempt to use information obtained from client engagements to make whistleblower claims for themselves (unless disclosure of the information is permitted under SEC rules or state bar rules);officers, directors, trustees or partners of an entity who are informed by another person of allegations of misconduct, or learned the information in connection with the entity's processes for identifying, reporting and addressing possible violations of law; compliance or audit personnel; public accountants working on an engagement under federal securities laws, if the engagement relates to a violation by the engagement client; people who obtain the information by means or in a manner that is determined by a US. court to violate federal or state criminal law; and foreign government officials.

In certain instances, however, compliance and internal audit personnel, as well as public accountants, could become whistleblowers when: (a) the whistleblower has a reasonable basis to believe that disclosure of the information to the SEC is necessary to prevent the relevant entity from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or investors;(b) the whistleblower has a reasonable basis to believe that the relevant entity is engaging in conduct that will impede an investigation of the misconduct; (c) at least 120 days have elapsed since the whistleblower provided the information to the relevant entity's audit committee, chief legal officer, chief compliance officer, (d) or 120 days have elapsed since the whistleblower received the information, if the whistleblower received it under circumstances indicating that these people were already aware of the information.

Internal Compliance

The final rules do not require whistleblowers to first report information to corporate compliance programs before reporting to the SEC in order to qualify for an award. However, the SEC included several provisions in the final rule that it believes will incentivize whistleblowers to first report internally:

  • Whistleblowers who first report internally to company compliance programs are eligible to receive an award from the SEC if they report the same information to the agency within 120 days (this is an extension from the 90 day period provided in the proposed rule).
  • A whistleblower's voluntary participation in a company's internal compliance program may increase the amount of an award; interference with the compliance program may decrease the amount of an award.
  • A whistleblower may also be eligible to receive an award if the whistleblower first reports information to his company's internal compliance program and the company then reports the information to the SEC. The information submitted by the company will be credited to the whistleblower even if he did not report it to the SEC.

Providing Information and Seeking a Reward

The final rules set forth procedures for submitting information to the SEC and for making a claim for an award after an action is brought. The claim procedures provide for opportunities for whistleblowers to fairly present their claim before the SEC makes a final award determination. The SEC will also pay an award based on amounts collected in related actions brought by certain agencies that are based upon the same original information that led to a successful SEC action.

Anti-Retaliation Provisions

Under the final rules, a whistleblower who provides information to the SEC is protected from employment retaliation if he possesses a reasonable belief that the information he is providing relates to a possible securities law violation that has occurred, is ongoing, or is about to occur. The retaliation protections apply to a whistleblower regardless of whether or not he ultimately meets the requirements to qualify for an award. The rules expressly state that the SEC may enforce the anti-retaliation provisions.

Confidentiality of Submissions

The SEC may not disclose information that could reasonably be expected to reveal the identity of a whistleblower, except in certain circumstances. The rules provide that a whistleblower may submit information to the SEC anonymously. However, the whistleblower must also: (i) have an attorney represent him in connection with the submission of information and claim for an award; (ii) follow procedures for submitting original information anonymously; and (iii) before the SEC will pay any award, the whistleblower must disclose his/her identity to the SEC and must be verified by the SEC.

The rules will become effective 60 days from the date of their publication in the Federal Register.

SIFI Capital Requirements -- Fed Governor Tarullo's View

In a speech before the Peter G. Peterson Institute for International Economics on June 3, 2011, Federal Reserve Governor Daniel K. Tarullo, said he wanted to get a "head start" on the Dodd-Frank requirement that the Federal Reserve establish special prudential standards for systemically important financial institutions (SIFIs)-- in particular the requirement for more stringent capital standards.

Governor Tarullo emphasized that a "post-crisis regulatory regime" must include a significant "macroprudential" component. As in a period of financial stress, "the disorderly failure of one or more SIFIs carries the potential for a devastating impact on the financial system." In Governor Tarullo's view, a macroprudential perspective on capital requirements "complements" what he views as the "micro prudential orientation of Basel III" on individual firms. The Governor emphasized that there "would be very large negative externalities associated with the disorderly failure of any SIFI, distinct from the costs incurred by the firm and its stakeholders." In his view, the failure of a SIFI, especially in a period of stress, significantly increases the chances that other financial firms will fail.

While acknowledging that the ability to have an orderly resolution of a SIFI under Dodd-Frank would greatly reduce the externalities that concern him, he points out that there is much work to be done in the orderly resolution area, noting in particular that if, as in the fall of 2008, several SIFIs were to come under severe stress at the same time "even the best-prepared team of officials would be hard-pressed to manage multiple resolutions simultaneously." For that reason, Governor Tarullo views increased capital and specialized resolution regimes as complementary not substitutes for each other.

Features of the Enhanced Capital Requirement

Noting that Dodd-Frank mandates an enhanced capital requirement for SIFIs, but does not specify the form of that requirement, Governor Tarullo describes what he considers to be five desirable characteristics of such requirements.

  • First, in keeping with the macroprudential aims of SIFI regulation, an additional capital requirement should be calculated using a metric based upon the impact of a firm's failure on the financial system as a whole. 
  • Second, the metric should be transparent and replicable. In establishing the metric, there will be a trade-off between simplicity and nuance.
  • Third, the enhanced capital standards should be progressive in nature. Dodd-Frank itself mandates that they "increase in stringency" with the systemic footprint of the firm, though the statute gives the Federal Reserve discretion in deciding how to realize this goal. The Governor noted that "systemic importance is not a binary determination, but one of degree." To emphasize this point, he noted that while Dodd-Frank requires the Fed to apply enhanced capital standards "to all bank holding companies with more than $50 billion in assets, we would not want a big difference between the capital requirements for firms with assets just over that level and those just under that level. Thus the supplemental capital requirement for a $50 billion firm is likely to be very modest."
  • Fourth, it is important that an enhanced requirement be met with high-quality capital. 
  • Fifth, U.S. requirements for enhanced capital standards should, to the extent possible, be congruent with international standards.

Calibrating the Enhanced Capital Standards

In moving from the micro prudential to macroprudential rationale for capital regulation, the Governor said there was no single accepted method for calibration. Several different methodologies have been considered by the Basel Committee.

  • The "expected impact" approach tries to determine how much additional capital would be needed to reduce the probability of failure of a SIFI sufficiently to equalize the expected impact on the financial system of the failure of a SIFI and the failure of a banking firm just outside systemic status. For example, if the loss to the financial system from the failure of a SIFI would be five times that resulting from failure of the non-systemic firm, then the SIFI would have to hold additional capital sufficient to make the expected probability of failure one-fifth that of the non-SIFI. "The enhanced capital requirement implied by this methodology can range between about 20% to more than 100% over the Basel III requirements, depending on choices made among plausible assumptions."
  • Another methodology uses macroeconomic models to estimate both the costs and benefits of higher capital requirements to the economy as a whole.
  • A third methodology tries to determine how much additional capital would be needed to offset any reduction in funding costs associated with the perceived too-big-to-fail status of SIFIs.

While noting the Fed will consider all these approaches, "the expected impact methodology has had the most influence on our staff's analysis."

IMF Working Paper Seeks to Quantify Possible Impact of Basel III on Credit Costs

In a May 23rd IMF Staff Paper, entitled "Bank Behavior in Response to Basel III: A Cross-Country Analysis; by Thomas F. Cosimano and Dalia S. Hakura, the authors noted that there has been much speculation concerning the increase in the cost to banks and borrowers due to the more stringent capital provisions of Basel III. The study examines the behavior of banks across developed countries from 2001-2009 to determine whether and to what extent the increase in capital requirements may lead to higher loan rates and slower loan growth.

Using a structural model of bank behavior based on previous studies, this study seeks to identify the optimal holding of equity by banks. On this basis the Study estimated that the largest banks in the world would raise their lending rates by on average 16 basis points in order to increase their equity-to-asset ratio by the 1.3 percentage points needed to achieve the new Basel regulation of 7 percent equity to new risk-weighted asset ratio. To the authors, this estimate suggests the cost of equity is about 16 basis points above the bank’s alternative source of financing. Given an estimated elasticity of loan demand with respect to the loan rate of 0.33 percent for the group of largest banks, the increase in lending rates is estimated to cause loan growth to decline by 1.3 percent in the long run.

The paper’s results also suggest that banks’ responses will vary considerably from one advanced economy to another reflecting cross-country variations in the tightness of capital constraints, banks’ net cost of raising equity, and elasticities of loan demand with respect to changes in loan rates. The country-by-country estimations which include both large and small banks for which data is available in each country suggest that the net cost of raising equity by 1.3 percentage points ranges from 0 basis points in Canada to 26 basis points in Japan. Similarly, the estimated elasticities of loan demand range from 0.92 percent in the United States to 6.6 percent in Denmark. As a result, the average impact of a 1.3 percentage point increase in the equity-asset ratio on loan growth for the crisis countries is 4.9 percent. This impact is significantly higher in the non-crisis countries such as Japan and Denmark.

The authors noted that an additional feature of Basel III is a countercyclical capital requirement which can lead to an additional 2.5 percent increase in the capital ratios under a declaration of "excessive credit growth." The estimations in the paper imply that such a declaration is predicted to reduce the largest banks loans by 2.5 percent. As a result, a declaration of excessive credit growth could have a significant countercyclical impact on the developed countries’ economies. This result suggests that such a declaration should be closely coordinated with monetary policy decision-making. The simultaneous declaration of excessive credit growth alongside a contractionary monetary policy could conspire to an excessive policy-tightening. The converse of this is that this additional capital requirement should be considered part of the monetary authority’s tool kit.

OCC NPR Regarding Supervision of Thrifts Subject to OTS Supervision


On May 26, 2011, the Office of the Comptroller of the Currency (OCC) issued a Notice of Proposed Rulemaking (NPR) to implement provisions of Title III of Dodd-Frank related to the transfer of functions from the Office of Thrift Supervision (OTS) to the OCC beginning July 21, 2011. The NPR also makes changes to preemption and the OCC’s visitorial authority as required by the Act. The NPR proposes to amend the OCC’s rules regarding agency functions and operations, including assessment fees imposed on supervised institutions. Thrifts will be subject to a transitional assessment fee schedule, under which the OCC will compute assessment fees under both the OCC and OTS schedules for assessments charged in September 2011 and March 2012, and thrifts will pay the lesser of the two fees. A single fee schedule will become effective in September 2011 for all banks under the OCC's supervision.

The proposal also includes changes to the OCC's regulations necessary to implement certain revisions to the banking laws resulting from the Act, including a moratorium on changes in control of credit card banks and trust banks and revisions to reflect the permanent increase in deposit insurance coverage applicable to the few FDIC-insured federal branches of foreign banks. In addition, the NPR includes amendments to OCC rules pertaining to preemption and visitorial powers, including:

  • Elimination of preemption for national bank operating subsidiaries;
  • Application of preemption standards and visitorial powers standards for national banks to federal thrifts and their subsidiaries -- meaning federal thrifts lose "filed" preemption and will be subject to the same preemption rules as national banks;
  • Revision of the OCC's visitorial powers rule to conform to the Supreme Court's Cuomo decision, recognizing the ability of state attorneys general to bring enforcement actions in court to enforce non-preempted state laws against national banks.

National banks and thrifts should work with legal counsel to determine the impact the preemption and visitorial standards may have on the organization and its activities. The OCC is seeking comments on the NPR and are due by June 27, 2011.

The OCC also plans to issue an Interim Final Rule for comment that republishes OTS regulations that the OCC will have authority to enforce upon transfer of supervisory authority. The rules will be renumbered and issued as new OCC rules, including technical amendments required to reflect the OCC's supervision of federal thrifts.

CFPB Publishes Comment Request on Identification of Enforceable Rules and Orders


On May 31, 2011, the Consumer Financial Protection Bureau (CFPB) published a list of rules in the Federal Register that are proposed to be enforced by the CFPB, pursuant to Section 1063(i) of Dodd-Frank. Subject to the limitations of the Act, the CFPB will be authorized to enforce, rules and orders issued by the Agencies under the "enumerated consumer laws", as defined in the Act. Section 1063(i) provides that, not later than the designated transfer date (July 21, 2011), the CFPB ‘‘(1) shall, after consultation with the head of each transferor agency, identify the rules and orders that will be enforced by the Bureau; and (2) shall publish a list of such rules and orders in the Federal Register.’’ The CFPB has consulted with each of the Agencies pursuant to Section 1063(i) and has developed a list of rules below for proposed transfer to their mandate:

Federal Reserve Board

  • Regulation B- Equal Credit Opportunity Act (12 CFR Part 202)
  • Regulation C -Home Mortgage Disclosure (12 CFR Part 203)
  • Regulation E -Electronic Fund Transfers (12 CFR Part 205)
  • Regulation H - Subpart I—Registration of Residential Mortgage Loan Originators (12 CFR 208.101–105 & Appendix A to Subpart I)
  • Regulation M -Consumer Leasing (12 CFR Part 213)
  • Regulation P -Privacy of Consumer Financial Information (12 CFR Part 216)
  • Regulation V -Fair Credit Reporting, except with respect to §§ 222.1(c) (effective dates), 222.83 (Disposal of consumer information), 222.90 (Duties regarding the detection, prevention, and mitigation of identity theft), 222.91 (Duties of card issuers regarding changes of address), & Appendix J (Interagency Guidelines on Identity Theft Detection, Prevention, and Mitigation) (12 CFR Part 222)
  • Regulation Z -Truth in Lending (12 CFR Part 226)
  • Regulation DD -Truth in Savings (12 CFR Part 230)

Federal Deposit Insurance Corporation

  • 12 CFR Part 332 -Privacy of Consumer Financial Information
  • 12 CFR Part 334 -Fair Credit Reporting, except with respect to §§ 334.83 (Disposal of consumer information), 334.90 (Duties regarding the detection, prevention, and mitigation of identity theft), 334.91 (Duties of card issuers regarding changes of address), & Appendix J (Interagency Guidelines on Identity Theft Detection, Prevention, and Mitigation)
  • 12 CFR 365.101-.105 & Appendix A to Subpart B—Registration of Residential Mortgage Loan Originators

Office of Comptroller of Currency

  • 12 CFR 34.20 .25 -Adjustable-Rate Mortgages (but only as applied to non-federally chartered housing creditors under the Alternative Mortgage Transaction Parity Act (‘‘AMTPA’’))
  • 12 CFR 34.101 -.105 & Appendix A to Subpart F - Registration of Residential Mortgage Loan Originators
  • 12 CFR Part 40 - Privacy of Consumer Financial Information
  • 12 CFR Part 41 - Fair Credit Reporting, except with respect to §§ 41.83 (Disposal of consumer information), 41.90 (Duties regarding the detection, prevention, and mitigation of identity theft), 41.91 (Duties of card issuers regarding changes of address), & Appendix J (Interagency Guidelines on Identity Theft Detection, Prevention, and Mitigation)

Office of Thrift Supervision

  • 12 CFR 560.35 - Adjustments to home loans (but only as applied to non-federally chartered housing creditors under AMTPA)
  • 12 CFR 560.210 - 220 -Alternative Mortgage Transactions (but only as it relates to AMTPA)
  • 12 CFR 563.101 - .105 & Appendix A to Subpart D - Registration of Residential Mortgage Loan Originators 12 CFR Part 571—Fair Credit Reporting, except with respect to §§ 571.83 (Disposal of consumer information), 571.90 (Duties regarding the detection, prevention, and mitigation of identity theft), 571.91 (Duties of card issuers regarding change of address), & Appendix J (Interagency Guidelines on Identity Theft Detection, Prevention, and Mitigation)
  • 12 CFR Part 573 -Privacy of Consumer Financial Information

National Credit Union Association

  • 12 CFR 701.21 - Loans to members and lines of credit to members (but only as applied to non-federally chartered housing creditors under AMTPA)
  • 12 CFR Part 707 -Truth in Savings
  • 12 CFR Part 716 - Privacy of Consumer Financial Information
  • 12 CFR Part 717 -Fair Credit Reporting, except with respect to §§ 717.83 (Disposal of consumer information), 717.90 (Duties regarding the detection, prevention, and mitigation of identity theft), 717.91 (Duties of card issuers regarding changes of address), & Appendix J (Interagency Guidelines on Identity Theft Detection, Prevention, and Mitigation)
  • 12 CFR Part 741 -Requirements for Insurance, but only with respect to §§ 741.217 (Truth in savings), 741.220 (Privacy of consumer financial information), & 741.223 (Registration of residential mortgage loan originators)
  • 12 CFR Part 761 - Registration of Mortgage Loan Originators

Federal Trade Commission

  • 16 CFR Part 310 - Telemarketing Sales Rule
  • 16 CFR Part 313 - Privacy of Consumer Financial Information
  • 16 CFR Part 320 - Disclosure Requirements for Depository Institutions Lacking Federal Depository Insurance
  • 16 CFR Part 322 - Mortgage Assistance Relief Services
  • 16 CFR Part 425 -Use of Prenotification Negative Option Plans
  • 16 CFR Part 429 -Rule Concerning Cooling-Off Period for Sales Made at Homes or at Certain Other Locations
  • 16 CFR Part 433 -Preservation of Consumers’ Claims and Defenses
  • 16 CFR Part 444 -Credit Practices
  • 16 CFR Part 435 - Mail or Telephone Order Merchandise
  • 16 CFR Part 436 -Disclosure Requirements and Prohibitions Concerning Franchising
  • 16 CFR Part 437 -Disclosure Requirements and Prohibitions Concerning Business Opportunities
  • 16 CFR Subchapter F, Parts 603 et seq.—Fair Credit Reporting Act, except with respect to Part 681 (Identity Theft Rules), Part 682 (Disposal of Consumer Report Information and Records), & Appendix A to Part 681 (Interagency Guidelines on Identity Theft Detection, Prevention, and Mitigation)
  • 16 CFR Part 901 -Procedures for State Application for Exemption from the Provisions of the [Fair Debt Collection Practices] Act

Department of Housing and Urban Development

  • 24 CFR 26.28-.56 -Hearing Procedures Pursuant to the Administrative Procedure Act
  • 24 CFR Part 30 - Civil Money Penalties: Certain Prohibited Conduct (but only as applied to the Real Estate Settlement Procedures Act of 1974 (‘‘RESPA’’) and the Interstate Land Sales Full Disclosure Act (‘‘ILSA’’))
  • 24 CFR Part 1710 -Land Registration
  • 24 CFR Part 1715 - Purchasers’ Revocation Rights, Sales Practices, and Standards
  • 24 CFR Part 1720 -Formal Procedures and Rules of Practice
  • 24 CFR Part 3500 - Real Estate Settlement Procedures Act
  • 24 CFR Part 3800 - Investigations in Consumer Regulatory Programs (but only as applied to RESPA and ILSA)

The CFPB will consider public comment until June 30, 2011 and publish a final list in the Federal Register no later than July 21, 2011.

The lists above demonstrate the hegemony of the CFPB in the field of federal consumer protection in the financial area. It also reinforces the challenge facing the new agency in having to gear up for its role without a director and fending off various legislative attacks to its structure, all the while the controversy over Professor Elizabeth Warren takes more twists and turns than a bad reality show.