"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.
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:
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.
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.
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.
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:
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
Federal Deposit Insurance Corporation
Office of Comptroller of Currency
Office of Thrift Supervision
National Credit Union Association
Federal Trade Commission
Department of Housing and Urban Development
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.