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Thursday, October 31, 2013


Dissenting Statement of Commissioner Scott D. O’Malia, Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations1

October 30, 2013

I respectfully dissent from the Commission’s approval today of the final Customer Protection Rules.

I supported the proposed rules because I wanted to solicit public comment and engage market participants in an open discussion about how the Commission should improve its customer protection regulatory oversight.

In the wake of the global financial crisis, it is extremely important to intensify regulatory efforts to strengthen customer protection policies in order to promote the financial stability of the derivatives markets. There is no dispute customer protection must be the cornerstone of the Commission’s oversight. Sound customer protection policies and measures, such as the electronic customer verification confirmation services will improve the efficiency and transparency of financial markets.2

The Commission must promulgate workable regulations that provide clear guidance to industry participants and ensure cost-effective access to markets. Such regulations must be designed to address real weaknesses in the current regulatory regime and allow industry participants to continue with well-established industry practices that had nothing to do with the financial crisis or the recent bankruptcies of MF Global and Peregrine Financial.

Unfortunately, the Commission’s customer protection rules fall short of these objectives. Instead of mitigating customer risk, the rules create a false sense of security by imposing broad and ambiguous requirements and introducing another layer of governmental oversight. Even worse, they force a change in a longstanding and generally accepted industry practice that will likely result in seriously harmful consequences for small FCMs and their end-user customers.

I do support several provisions that allow customers greater insight into the operations of an FCM. These provisions include: an improved FCM disclosure regime that will give customers new and critical information about their FCM exposures, elimination of the alternative method of calculating segregation requirements for §30.7 funds (treatment of foreign futures or foreign options), improved reporting of segregated fund balances, and enhancements to risk management procedures. However, I am unable to support the final rule for the reasons stated below.

Reinterpretation of the residual interest deadline will result in costly prefunding of margin payments.

My main concern with the final rules is their radical reinterpretation of the longstanding residual interest deadline. This reinterpretation decreases the time in which customers’ margin calls must arrive to their FCM from the current three days to just one day.

Such a change would mean a drastic increase in pre-funding of margin, perhaps nearly double the amounts currently required. As a result, many small agribusiness hedgers will have to consider alternative risk management tools or, even worse, will be forced out of the market.3 I am disappointed that yet again the Commission has rushed to implement a rule that disregards the express Congressional directive to protect end-users.

I recognize that the Commodity Exchange Act (CEA) does not permit an FCM to use the money or property of one customer to margin the futures or option positions of another customer.4 Despite this fact, it has been the prevailing industry practice authorized by the Commission for decades.

To the extent that the Commission must reinterpret this statutory provision, I believe this reinterpretation must be based on the thorough analysis of the market data and the full evaluation of the costs of strict compliance with the statute before implementing policy changes, and not after as is the case with the residual interest deadline.

The residual interest deadline rule makes no effort to respond to the commenters’ concerns that the residual interest deadline would be especially costly for smaller FCMs and end-users.5 Given the express Congressional directive to protect end-users, I would have expected the Commission to conduct meaningful cost-benefit analysis to justify the costs when compared to the actual risk to customer accounts and the derivatives markets and to explain why the Commission could not have adopted an alternative approach. Regrettably, the Commission has failed to do so.

Even the Commission’s own cost benefit analysis points out, while significantly understating the impact, that:

“Smaller FCMs may have more difficulty than large FCMs in absorbing the additional cost created by the requirements of the rules (particularly §1.22). It is possible that some smaller FCMs may elect to stop operating as FCMs as a result of these costs.”6

I cannot support a rule that will impose such onerous costs and compliance burdens on the smallest FCMs and small, non-systemically relevant customers.

Finally, although I support a phase-in compliance schedule for the residual interest deadline, I am disappointed that the Commission, in deciding whether to change the deadline at a future time, is not required to make such a decision based on data. Instead, the Commission will simply come up with another arbitrary residual interest deadline that has nothing to do with customer or FCM risk exposure.

Yet again, the Commission has chosen to avoid fact-based analysis. I strongly believe that the Commission should utilize facts and data to make an informed decision about the appropriate time for the residual interest deadline.

The rules fail to provide a clear standard for compliance.

In addition to my serious concerns about the final rules’ treatment of the residual interest deadline, I am concerned that the rules unreasonably expand the scope of the new regulatory compliance regime without providing a clear regulatory objective.

For example, the rules require that a Self-Regulatory Organization (SRO) supervisory program “address all areas of risk to which [FCMs] can reasonably be foreseen to be subject (emphasis added).”7 This broad language requires the SRO to guess at what criteria the programs would be measured against, and under what framework the SRO would make this determination. In short, the new language does nothing but adds more ambiguity to the SRO’s customer protection program and increases the cost of compliance with vague requirements.

Examination experts do not add value to the customer protection regime.

I also have concerns about the requirement that each SRO supervisory program of its member FCMs be reviewed by an “examinations expert.”8 I question the benefit of this requirement given the fact that the Joint Audit Committee (JAC) currently performs this function. The JAC’s primary responsibility is to oversee the practices and procedures that each SRO must follow when it conducts audits and financial reviews of FCMs. This regulatory task is already in place and implemented in a less costly and more efficient manner than set forth in the final rules.

Moreover, in light of the Commission’s regulatory oversight of all SROs and the Commission’s review of all JAC examination programs, this additional layer of review does not provide any benefit except for isolating the Commission from its primary responsibility to oversee customer protection programs.

Customers deserve better protections in bankruptcy proceedings

Going forward, the Commission should address key customer protections in the areas of bankruptcy. Congress should make changes to the Bankruptcy Code to ensure that certain bankruptcy protections are afforded to FCM customers. Specifically, Congress should amend the pro-rata distribution rules in bankruptcy. Despite the Commission’s customer segregation requirements, individual customer accounts are still subject to a pro-rata distribution in bankruptcy. In addition to these changes to the Bankruptcy Code, the Commission should amend its rules to allow the Commission to appoint a trustee to oversee derivatives customers’ accounts in the bankruptcy of a broker-dealer FCM.


I support implementation of a rigorous customer protection program that provides clear and meaningful mechanisms for mitigating customer risks. However, the customer protection rules approved today have missed the mark.

In sum, many of the new rules impose overly broad and nonsensical regulatory requirements and, in doing so, impede the industry’s ability to operate in an efficient manner. Regrettably, the negative effects will be felt most by farmers and other end-users, whose ability to hedge risk in a cost-effective manner will be hampered if not eliminated altogether. This is contrary to the Congressional directive, and I cannot support rules that result in such an outcome.

1 “Customer Protection Rules”

2 In this regard, I applaud the efforts of the Chicago Mercantile Exchange Inc. (CME) and the National Futures Association (NFA) to protect customer accounts by introducing daily electronic confirmation services. This new technology allows CME and NFA to review balances held at bank depositories and compare the balances with customer account information provide by futures commission merchants (FCMs).

3 See e.g.; National Grain and Feed Association Comment Letter at 2 (Dec. 28, 2012) (stating that the Commission’s proposed changes “could have the unintended impact of disadvantaging smaller and mid-size FCMs that provide ‘hands-on’ service to many of the relatively smaller hedgers in agribusiness”); Texas Cattle Feeders Association Comment Letter (Jan. 14, 2013) (warning that such changes “could have the potential to cause unintended consequences such as added costs eventually borne by customers”); Iowa Cattlemen’s Association Comment Letter (Feb. 15, 2013) (“it is imperative that the CFTC understand all sizes of businesses . . . [in order to have] . . . a better opportunity to write rules that provide a logical fit. Our fear is that if this rule is put in place, we will have members who will not take advantage of the risk management tools . . ..”).

4 CEA § 4d(a)(2).

5 Futures Industry Association Comment Letter at 16 (Feb. 15, 2013).

6 Customer Protection Rules at 313.

7 § 1.52 (c)(2).

8 § 1.52.


Statement of Commissioner Mark P. Wetjen, Public Meeting of the Commodity Futures Trading Commission
October 30, 2013

Thank you Chairman Gensler. And my thanks to the professional staff for their hard work on the important final rule we are considering today regarding customer protection.

Customer Protection

The CFTC's core mission is to protect futures and swaps customers from fraud, manipulation, abusive practices and systemic risk. In pursuing this mission, it is vital that the commission unceasingly look to update and improve the protections we have in order to better protect the public and ensure the safety, soundness, and integrity of those operating in the derivatives marketplace.

The final customer protection rule before us today requires important improvements to a range of protections that have been implemented by the commission and industry in recent months. It fills certain remaining regulatory gaps to prevent future failures in the FCM community, and enhances nearly every protection afforded customers of FCMs in the futures and cleared-swaps markets. Customers will benefit from enhancements to FCM risk management programs, modernized audit programs and streamlined measures that will better insulate customers from fellow customer risk.

Residual Interest

The residual-interest provisions have been the most discussed part of the proposal. The commission received a significant number of comment letters in response to that proposal, which would have required FCMs to maintain “at all times” enough residual interest in their segregated accounts to cover all customer margin deficits. That approach was intended to limit fellow-customer risk by ensuring that one customer would in no circumstance be responsible for unwittingly covering another customer’s margin obligations.

Although the proposal offered one permissible construction of the Commodity Exchange Act, it suffered from some practical shortcomings. Those practical shortcomings, in my judgment, are appropriately addressed in the document before us today.

For example, many suggested that the “at all times” requirement under the proposal likely would have imposed significant capital costs on FCMs, which could have led to the unintended effect of limiting access to the derivatives markets. Many contended that this would be too high a price to pay when measured against the corresponding benefit of mitigating fellow-customer risks. The commission has considered these comments and has taken a different approach in today’s release.

The compromise reflected in the final rule is intended to usher in improvements to margin-collection practices over time and to protect access to the markets for a broad cross-section of participants. As a general matter, I strongly support improvements to the residual-interest requirements because of the critical policy objectives they are designed to achieve. First, they will better protect the excess segregation funds of a customer in the event of an FCM bankruptcy. Second, they will encourage FCMs to more actively monitor customer accounts for instances when those accounts are under-margined. And third, they will incentivize FCMs to address those circumstances when an account is under-margined. Together, these enhancements will better protect the safety and soundness of the FCM.

Importantly, the commission has given itself sufficient time to evaluate the FCM community’s progress in implementing the residual-interest policy in the final rule, and to change course if necessary. Indeed, the phased compliance schedule provided in today’s release was a critical component of getting to this final compromise on residual interest.

That compromise is reasonable and measured. For one year, there will be no change to current practice with respect to the treatment of residual interest. After that year, FCMs will be required to comply with the residual-interest requirement as of the close of business on the day following the margin-deficit calculation. This is a necessary and significant change to current market practice.

Thirty months after today’s release is published, commission staff is obligated to conduct a study determining the feasibility, costs and benefits of moving the residual-interest deadline to the completion of the first clearing-settlement cycle following the trade date. The study will be published for public comment, and a public roundtable will be held to solicit the views of market participants.

Finally, after five years, the residual-interest requirement will move up to the first clearing settlement cycle of the day, typically first thing in the morning, should the commission choose not to change course based upon recommendations in the study or in reaction to public feedback at the roundtable.

To be sure, if this end-state were implemented today it would no doubt create a significant cost to FCMs and to market participants. The five-year phase-in period, however, provides the industry an opportunity to streamline margin-collection practices and to take advantage of any technological solutions that may be developed in the meantime.

Equally important, today’s release ensures that future residual-interest requirements will not be imposed on the FCM community if the facts on the ground regarding feasibility and cost do not support it. It is important to note that the study and roundtable are not optional but rather mandated by law, which means that the newly updated information will be brought to the commission before the phase-in period would end.

If the commission decides that it is appropriate to change the residual-interest deadline, the commission may act nimbly and implement a new compliance schedule for that deadline by order, without the procedural hurdles of notice and comment. I am confident that if the commission is presented with convincing facts through this process, it will be compelled to respond appropriately.

All stakeholders in today’s release – including policymakers, FCMs and their customers – rightly anticipate that new services and technologies will provide solutions to today’s compliance challenges. I know that all of us not only welcome those advancements but hope they are brought to market as quickly as practicable. The approach of this rulemaking appropriately incentivizes that outcome.

For that reason, I anticipate that technological solutions will facilitate compliance with residual-interest requirements in the near future for those who could not comply today. I must point out that the comment file to this rule suggests that the vast majority of the marketplace could comply with more abbreviated timelines for margin calls and payments today.

I also anticipate that the flexibility built into this final rule will help avoid the less desirable, alternative methods of compliance suggested by commenters, including self-funding or pre-funding residual interest or margin obligations, as some have predicted. To be more clear, I strongly prefer, and indeed expect, that FCMs will not pursue these options in order to comply with today’s release. This judgment is based in part on the rapid advancement in settlement solutions in recent years, as well as the fact that the latter options may not – all things considered – be as commercially viable.

The expense of pre-funding margin accounts was a special concern of the agricultural community raised in their comments. I spent many days with agricultural producers over the last several months, discussing this issue and others. I met with a number of producers in my home state of Iowa who actively use the derivatives markets to hedge their production risks. I have listened to and carefully considered their concerns about the residual-interest requirement. Today’s release takes those concerns into account, and I believe that their most-pressing fears will not be realized because of this rule.

Meanwhile, even today producers can make intra-day margin payments to FCMs through banking or credit relationships once a margin call is received. Based on what I have learned over recent months, these types of relationships are at a minimum common in the producer community, and seemingly the norm for larger producers. For those producers who do not currently rely on these services, again, I expect other solutions to payment settlement will be offered, or producers will in time embrace those already available, with marginal added expense to them.

I also would like to clarify that today’s release does require FCMs to take a capital charge for failure to meet its residual-interest requirement, but this falls on the FCM at the close of business the day after its residual-interest obligation. Importantly, today’s release phases in the timing of this capital-charge obligation until one year after its publication in the federal register, as some commenters suggested.

I would like to thank the staff for their work in putting together this balanced approach. With the concerns about residual interest properly addressed, I am happy to support the final rule as an important step forward in the commission’s ongoing efforts to protect customers.

As a final note, I look forward to taking up the Volcker Rule and the position-limits proposal by year-end, along with a number of commission determinations on substituted compliance. As I said at the time we finalized our cross-border guidance, those determinations will benefit from as much transparency as practicable. With that, I look forward to supporting the staff’s recommendations on the rule before the commission today.


Opening Statement, Commissioner Scott D. O’Malia, Open Meeting On Rules Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations

October 30, 2013

Mr. Chairman,

I would like to thank staff for their hard work on the customer protection rules. I appreciate the hard work of the staff of DSIO, DCR and OGC who have contributed to this rulemaking.

In the wake of the global financial crisis, it is extremely important to intensify regulatory efforts to strengthen customer protection policies in order to promote the financial stability of the derivatives markets. There is no dispute customer protection must be the cornerstone of the Commission’s oversight. Sound customer protection policies and measures will improve the efficiency and transparency of financial markets.

I do support several provisions of the rules that allow customers greater insight into the operations of an FCM. These provisions include: an improved FCM disclosure regime that will give customers new and critical information about their FCM exposures, elimination of the alternative method of calculating segregation requirements for §30.7 funds (treatment of foreign futures or foreign options), improved reporting of segregated fund balances, and enhancements to risk management procedures.

However, my main concern with the draft final rules is their radical reinterpretation of the longstanding residual interest deadline. This reinterpretation decreases the time in which customers’ margin calls must arrive to their FCM from the current three days to just one day.

Such a change would mean a drastic increase in pre-funding of margin, perhaps nearly double the amounts currently required. As a result, many small agribusiness hedgers will have to consider alternative risk management tools or, even worse, will be forced out of the market.

I recognize that the Commodity Exchange Act (CEA) does not permit an FCM to use the money of one customer to margin the futures or option positions of another customer.1 However, I believe that the Commission, in deciding whether to reinterpret this provision, must make such a decision based on data.

Therefore, I am proposing my amendment that would continue to make progress to accelerate the collection of margin of customers from 3 days after the settlement date to 1 day after settlement at 6 pm EST. Just like the draft final rule, the amendment would be phased in one year following the date of publication of the rules in the Federal Register; and just like the draft final rule, the amendment will also require a study to determine the feasibility of changing the collection date and the costs associated with such a move.

The main difference between my amendment and the draft final rule is that my amendment doesn’t mandate that in 5 years’ time, customers will need to meet their margin obligations by the end of the settlement cycle. The amendment simply lets a future Commission make a determination about the best way to proceed after it has collected all the evidence.

In other words, the amendment does not bias the study with an outcome that has been previously determined. Instead, my amendment will task a future Commission to perform the analysis and decide at that point, analyzing against future technology and payment methodologies what the best course of action should be. This way, the future Commission can make an informed and unbiased decision.

If the Commission votes for my amendment, I will be able to support this rule.

Again, I want to express my thanks to the Commission staff for their efforts on this rule.

Let me close by also thanking so many staff from the Division of Enforcement, who devoted their efforts and long hours bringing the recent charges against Rabobank and all of the other LIBOR settlements. Their work must be recognized by the Commission as well as the work from staff from OCE and DMO. We couldn’t do it without their hard work.

Anne M. Termine
Stephen T. Tsai
Maura M. Viehmeyer
Philip P. Tumminio
Timothy Kirby
Jonathan Huth
Brian Mulherin
Rishi Gupta
Aimée Katimer-Zayets
Jason Wright
Elizabeth Padgett
Terry Mayo

Mr. Chairman, thank you for you indulgence to all us to recognize all of their hard work.

1 CEA § 4d(a)(2).


Statement of Chairman Gary Gensler on Settlement Order against Rabobank
October 29, 2013

Washington, DC — Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler today made the following statement on the CFTC’s enforcement action that requires Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A. (Rabobank) pay a $475 million penalty for manipulation and false reporting charges related to LIBOR and Euribor:

“With today’s settlement, the CFTC has shown – now for the fifth time – how banks have pervasively rigged key interest rate benchmarks, such as LIBOR and Euribor.

“Unfortunately, we once again see how the public trust can be violated through bad actors readily manipulating benchmark interest rates.

“Through hundreds of manipulative acts spanning six years, in six offices, and on three continents, more than two dozen Rabobank employees, including a senior manager, manipulated, attempted to manipulate and falsely reported crucial reference rates in global financial markets.  Rabobank employees also aided and abetted other banks to manipulate benchmark interest rates.

“I wish I could say that this won’t happen again, but I can’t.  LIBOR and Euribor are not sufficiently anchored in observable transactions.  Thus, they are basically more akin to fiction than fact. That’s the fundamental challenge so sharply revealed by Rabobank and our prior cases.

“This fifth instance of benchmark manipulative conduct highlights the critical need to find replacements for LIBOR and Euribor – replacements truly anchored in observable transactions.

“Though addressing governance and conflicts of interest regarding benchmarks is critical, that will not solve the lack of transactions in the market underlying these benchmarks.

“That is why the work of the Financial Stability Board to find alternatives and consider potential transitions to these alternatives is so important. The CFTC looks forward to continuing to work with the international community on much needed reforms.”

Wednesday, October 30, 2013


OCC and FDIC Propose Rule to Strengthen Liquidity Risk Management

The Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) proposed a rule on Wednesday to strengthen the liquidity risk management of large banks and savings associations.

The OCC and FDIC’s proposed liquidity rule is substantively the same as the proposal approved by the Board of Governors of the Federal Reserve System on October 24, 2013. That proposal, which was developed collaboratively by the three agencies, is applicable to banking organizations with $250 billion or more in total consolidated assets; banking organizations with $10 billion or more in on-balance sheet foreign exposure; systemically important, non-bank financial institutions that do not have substantial insurance subsidiaries or substantial insurance operations; and bank and savings association subsidiaries thereof that have total consolidated assets of $10 billion or more (covered institutions). The proposed rule does not apply to community banks.

Liquidity generally is a measure of how much cash or cash-equivalents and highly marketable assets a company has on hand to meet its obligations. Under the proposed rule, covered institutions would be required to maintain a standard level of high-quality liquid assets such as central bank reserves, government and Government Sponsored Enterprise securities, and corporate debt securities that can be converted easily and quickly into cash. Under the proposal, a covered institution would be required to hold such high-quality liquid assets on each business day in an amount equal to or greater than its projected cash outflows less its projected cash inflows over a 30-day period. The ratio of the firm's high-quality liquid assets to its projected net cash outflow is specified as a "liquidity coverage ratio," or LCR, by the proposal.

"We learned during the financial crisis just how important liquidity is to the stability of the system as a whole, as well as for individual banks," said Comptroller of the Currency Thomas J. Curry. "A number of large institutions, including some with sufficient levels of capital, encountered difficulties because they did not have adequate liquidity, and the resulting stress on the international banking system resulted in extraordinary government actions both globally and at home. The proposed liquidity rule will help ensure that a bank’s cash, and not tax-payer money, is the first line of defense if it faces a short-term funding stress."

"The recent financial crisis demonstrated that liquidity risk can have significant consequences to large banking organizations with effects that spill over into the financial system as a whole and the broader economy. The proposed rule acted on today would establish first quantitative liquidity requirement applied by federal banking agencies and is an important step in helping to bolster the resilience of large internationally active banking organizations during periods of financial stress," said FDIC Chairman Martin J. Gruenberg.

The liquidity proposal is based on a standard agreed to by the Basel Committee on Banking Supervision. The proposed rule is generally consistent with the Basel Committee's LCR standard, but is more stringent in some respects such as the range of assets that will qualify as high-quality liquid assets and the assumed rate of outflows of certain types of funding. In addition, the proposed rule’s transition period is shorter than that included in the Basel framework. The accelerated transition period reflects a desire to maintain the improved liquidity positions that U.S. institutions have established since the financial crisis. Under the proposal, U.S. firms would begin the LCR transition period on January 1, 2015, and would be required to be fully compliant by January 1, 2017.


Rabobank to Pay $475 Million Penalty to Settle Manipulation and False Reporting Charges Related to LIBOR and Euribor

CFTC Order Finds that for Nearly Six Years, Rabobank Engaged in Acts of Manipulation, Attempted Manipulation and False Reporting of U.S. Dollar, Yen and Sterling LIBOR and Euribor

Washington, DC - The U.S. Commodity Futures Trading Commission (CFTC) today issued an Order against Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A. (Rabobank or the Bank), bringing and settling charges of false reporting and attempted manipulation of the London Interbank Offered Rate (LIBOR) for U.S. Dollar, Yen and Sterling, and of the Euro Interbank Offered Rate (Euribor) and charges of successful manipulation of Yen LIBOR. The CFTC also settled charges that Rabobank, at times, aided and abetted the attempts of derivatives traders at other banks to manipulate Yen LIBOR and Euribor. These violations, which spanned nearly six years, involved more than two dozen employees working out of six offices on three continents. Rabobank is obligated to pay a penalty of $475 million, and the company is ordered to take further steps to ensure the integrity of its LIBOR and other benchmark interest rate submissions in the future.

David Meister, the Director of Enforcement stated, "The CFTC has now charged five global financial institutions for LIBOR manipulative schemes, with nearly $1.8 billion in penalties imposed by the Commission alone. The sheer number of institutions and individuals involved in these cases reflects a truly shocking and brazen degree of unlawfulness, warranting the historic enforcement response we bring forth today and in our prior cases. I want to personally commend Gretchen Lowe and the Division staff who have all painstakingly worked to investigate and prosecute these cases in the finest traditions of law enforcement."

Ms. Lowe, Acting Director of Enforcement-designate, commented, “For years, Rabobank allowed profit-driven traders located in offices around the globe to corrupt the submission process for critical benchmark interest rates. When an institution threatens the integrity of the financial markets, we bring the full force of our authority to bear. Accordingly, today the Commission holds Rabobank accountable for its egregious, manipulative misconduct.”

Highlights of the CFTC Order

Rabobank was one of the global banks that submitted borrowing rate information on a daily basis for use in the calculation of LIBOR for various currencies and for Euribor. Rabobank also traded and held cash and derivatives positions whose value depended on these same benchmarks.

From at least mid-2005 through early 2011, Rabobank traders engaged in hundreds of manipulative acts undermining the integrity of U.S. Dollar and Yen LIBOR, Euribor and, to a lesser extent, Sterling LIBOR. The violations took various forms:

• Rabobank traders, some of whom doubled as LIBOR and Euribor submitters, regularly made and accommodated their fellow traders’ requests to make favorable rate submissions to benefit their trading positions through attempts to manipulate U.S. Dollar and Yen LIBOR and Euribor. On occasion, they did the same with respect to Sterling LIBOR. Making submissions that were, as some Rabobank employees said at the time, “ridiclous,” “obseenly high” and “silly low,” more than two dozen traders, including several desk managers and at least one senior manager located in Rabobank’s New York, London, Utrecht, Tokyo, Hong Kong, and Singapore offices engaged in this wrongful conduct or knew it was ongoing at the time but did nothing to stop it.

• At times, Rabobank was successful in its attempts to manipulate Yen LIBOR. In fact, the misconduct with respect to Yen LIBOR was so entrenched that as traders assumed the role of submitter, their predecessors would train them on the unlawful practices.

• Rabobank also, at times, aided and abetted other banks’ attempts to manipulate Yen LIBOR and Euribor, including coordinating with an interdealer broker on Yen LIBOR submissions to aid the manipulations of the Senior Yen Trader at UBS AG. As one senior Rabobank employee put it: “You know, scratch my back, yeah, and all,” to which the broker observed, “Yeah oh definitely, yeah, play the rules.”

The CFTC Order further finds that Rabobank ignored the obvious conflict of interest it created by assigning traders with trading positions tied to LIBOR and Euribor to serve as Rabobank’s LIBOR and Euribor submitters. Submitters were improperly left to choose between their responsibility to make an honest assessment of borrowing costs and their desire to maximize the profitability of their trading positions. Here, Rabobank’s submitters often resolved the conflict in favor of profit. This conflict was exacerbated by traders and submitters sitting together so that traders could simply shout requests for unlawful submissions across the trading desk. Rabobank thus provided these employees with unfettered opportunities to attempt to manipulate LIBOR and Euribor for profit, and the traders took advantage of those opportunities. The Order also finds that Rabobank otherwise lacked sufficient controls around the LIBOR and Euribor submission process and failed to adequately supervise its traders and submitters.

According to the Order, this manipulative conduct occurred even after the Commission had commenced its investigation of Rabobank’s U.S. Dollar LIBOR practices in April 2010, when Rabobank received the Commission’s request that the Bank internally investigate its U.S. Dollar LIBOR practices. In late 2010, after Rabobank submitters refused, as instructed by a manager, to consider a trader’s requests for particular Yen LIBOR submissions, the Rabobank trader promptly obtained the assistance of an interdealer broker to continue attempting to manipulate Yen LIBOR to benefit his trading positions through early 2011.

The Order requires Rabobank to pay a civil monetary penalty of $475 million, cease and desist from its violations of Commodity Exchange Act, and adhere to specific undertakings to ensure the integrity of its LIBOR and other benchmark interest rate submissions in the future. The Order also recognizes the significant cooperation of Rabobank with the Division of Enforcement in its investigation.

In related actions, the U.S. Department of Justice entered into a deferred prosecution agreement with Rabobank, deferring criminal wire fraud charges in exchange for Rabobank continuing to cooperate and agreeing to a penalty of $325 million; the United Kingdom Financial Conduct Authority (FCA) issued a Final Notice regarding its enforcement action against Rabobank and imposed a penalty of £105 million (approximately $170 million); the Japanese Financial Services Agency (JFSA) issued an administrative action against Rabobank for failure of its internal controls within its Tokyo office; De Nederlandsche Bank (or the Dutch National Bank (DNB)) took action by imposing remedial measures on Rabobank; and the Dutch Public Prosecutor’s Office (DPP)) agreed to a payment of €70 million (approximately $96.5 million) by Rabobank in order for Rabobank to avoid a criminal prosecution.

The CFTC acknowledges the valuable assistance of the U.S. Department of Justice, the Washington Field Office of the Federal Bureau of Investigation, the FCA, the JFSA, the DNB, and the DPP.


With this Order, the CFTC has now imposed penalties of $1.765 billion on entities for manipulative conduct with respect to LIBOR and other benchmark interest rates. See In re ICAP Europe Limited, CFTC Docket No. 13-38 (September 25, 2013) ($65 Million penalty) (CFTC Press Release 6708-13); In re The Royal Bank of Scotland plc and RBS Securities Japan Limited, CFTC Docket No. 13-14 (February 6, 2013) ($325 Million penalty) (CFTC Press Release 6510-13); In re UBS AG and UBS Securities Japan Co., Ltd., CFTC Docket No. 13-09 (December 19, 2012) ($700 Million penalty) (CFTC Press Release 6472-12); and In re Barclays PLC, Barclays Bank PLC, and Barclays Capital Inc., CFTC Docket No. 12-25 (June 27, 2012) ($200 million penalty) (CFTC Press Release 6289-12). In these actions, the CFTC orders each institution to undertake specific steps to ensure the integrity and reliability of its benchmark interest rate submissions.

CFTC Division of Enforcement staff members responsible for this case are Rishi K. Gupta, Anne M. Termine, Jonathan K. Huth, Philip P. Tumminio, Maura M. Viehmeyer, Elizabeth Padgett, Jordan Grimm, Terry Mayo, James A. Garcia, Kassra Goudarzi, Boaz Green, Timothy M. Kirby, Aimée Latimer-Zayets, Michael Solinsky, Jason T. Wright, Gretchen L. Lowe, and Vincent A. McGonagle.

Tuesday, October 29, 2013


SEC Obtains Final Judgment Against New Jersey-Based Consultants to Chinese Reverse Merger Companies

The United States Securities and Exchange Commission announced today that the Honorable Ronnie Abrams of the United States District Court for the Southern District of New York entered a final judgment against defendants Huakang Zhou (a/k/a David Zhou) and Warner Technology and Investment Corporation on October 18, 2013. The judgment permanently enjoins Zhou and Warner Investment from violating Sections 5 and 17(a) of the Securities Act of 1933, Sections 10(b), 13(d), 15(a), and 16(a) of the Securities Exchange Act of 1934, and Rules 10b-5, 13d-1, 13d-2, and 16a-3 thereunder.

Zhou and Warner Investment agreed to pay more than $1.4 million to settle the SEC's charges. Zhou and Warner Investment consented to the entry of judgment, without admitting or denying the allegations, and are liable to pay disgorgement in the amount of $983,375 plus prejudgment interest thereon in the amount of $82,449, and Zhou is liable to pay civil penalties in the amount of $400,000. The Commission's complaint alleged that Zhou and Warner Investment, consultants to numerous Chinese reverse merger companies, in connection with such work for various clients from 2007 through at least 2010, engaged in a scheme to list one client on a national securities exchange through manipulative trading and by facilitating in effect an artificial shareholder base sufficient for listing. Further, the complaint alleged that Zhou and Warner Investment made material misstatements and omissions in connection with an offering for another client through the misuse of proceeds. The complaint also alleged that Zhou and Warner Investment did not disclose certain holdings and transactions; sold unregistered securities; and acted as unregistered brokers and aided and abetted others' unregistered broker activity.

Based on the final judgment, the Commission issued an Order Instituting Administrative Proceedings Pursuant to Section 15(b) of the Securities Exchange Act of 1934, Making Findings, and Imposing Remedial Sanctions that bars Zhou and Warner Investment by consent from association with any investment adviser, broker, dealer, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any offering of a penny stock, with the right to apply for reentry after five years.

Monday, October 28, 2013


SEC Obtains Jury Verdict in Its Favor Against Minneapolis Attorney, Real Estate Finance Fund and Fund Manager On Fraud Claims

The Securities and Exchange Commission announced today that, on October 22, 2013, following a five-week trial, a jury in federal district court in St. Paul, Minnesota, returned a verdict against Todd A. Duckson, a Minneapolis, Minnesota attorney, Capital Solutions Monthly Income Fund, LP, a Minneapolis-based real estate lending fund (the "Fund"), and Transactional Finance Fund Management LLC, a company owned by Duckson that became the fund's investment advisor in November 2008. The Commission's complaint, which was filed in September 2010, alleged that the defendants engaged in securities fraud in connection with their offer and sale of interests in the Fund.

The complaint alleged that, from approximately March 2008 through December 2009, the Fund raised $21.6 million from investors in a series of unregistered offerings. During most of the period of the Fund's existence, it made "mezzanine loans" - or loans subordinate to more senior loans - to a single borrower. That borrower encountered financial problems in 2007 and, by May 2008, had defaulted on its obligations to the Fund. As a result, the Fund had no meaningful income-producing assets. The complaint alleged that in written documents provided to investors between March 2008 and late 2009, the Defendants made materially false and misleading statements that effectively hid the Fund's deteriorating financial condition. The complaint also alleged that the Fund would use proceeds raised in offerings primarily to make real estate loans and other investments, when in fact the Fund needed to use most of the proceeds to pay senior lenders on properties the Fund had acquired and to make interest payments to existing investors. Duckson played a key role in drafting the written documents provided to investors, first as the attorney for the Fund and, in and after November 2008, as the Fund's manager.

At the conclusion of a five-week trial, the jury returned a verdict for the Commission and against all three Defendants. In particular, the jury found in favor of the Commission on its claims that Duckson and the Fund violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, that Duckson aided and abetted the Fund's violation of Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, and that Transactional Finance Fund Management LLC violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. Finally, the jury found in favor of Transactional Finance Fund Management LLC on the Commission's claim that it violated Section 17(a) of the Securities Act. The jury specifically found that Duckson and the Fund acted with knowledge in committing the violations described above.

The trial team from the Commission's Chicago Regional Office consisted of trial attorneys Eric M. Phillips, Daniel J. Hayes, Benjamin J. Hanauer, attorney Marlene Key-Patterson and paralegal Terri Roberts.

Sunday, October 27, 2013


"Understood and Understanding"

Remarks of Commissioner Bart Chilton before the International Regulators Conference (Chicago, Illinois)

October 25, 2013

Good afternoon. It’s a pleasure to be with you, international regulators, here at the Federal Reserve Bank of Chicago. Thanks to Myra Silberstein for all of her work on this conference. Thanks also to the Federal Reserve staff who picked up the ball on the conference when the CFTC had to stop operations due to our government shutdown. And thanks to each of you for making the journey to the States.

The efforts that we are all part of, to ensure that we never again experience an economic calamity like we witnessed in 2008, is not only worthy but imperative.

I view what we all do in the next few years to really set the global regulatory rules for the financial sector for a generation. What we do now, will provide the rules of the road and the guidance for the next 20 to 30 years.

In order to get there we need to work together, to learn from each other and to build appropriate regulatory systems that make sense.

There is a movie that starred actor Kevin Costner. It’s called, “Field of Dreams.” In it, a voice from the Iowa corn field whispers, “If you build it, he will come.” The voice was talking about Shoeless Joe Jackson of the Chicago White Sox.

Well, if we build global regulatory regimes, others will come. We start here in the US and in the European Union and in your countries, and the entire world will come.

That’s why meetings like this are so very important, so that we can listen and learn from each other. We need not just to be understood, but even more importantly, to be understanding what others are saying. That’s our challenge. If we do it correctly, markets will be better and citizens will be protected.

Thanks for being here.



The Securities and Exchange Commission today sanctioned three investment advisory firms for repeatedly ignoring problems with their compliance programs.

The enforcement actions arise from the agency’s Compliance Program Initiative, which targets firms that have been previously warned by SEC examiners about compliance deficiencies but failed to effectively act upon those warnings.  Had the problems been addressed, the firms could have prevented their eventual securities law violations.  The SEC Enforcement Division’s Asset Management Unit has coordinated with examiners to bring several cases since the initiative began two years ago.

The firms charged today – Modern Portfolio Management Inc., Equitas Capital Advisers LLC, and Equitas Partners LLC – have agreed to settlements in which they will pay financial penalties and hire compliance consultants.

“The Compliance Program Initiative is designed to address repeated compliance failures that may lead to bigger problems,” said Andrew J. Ceresney, co-director of the SEC’s Division of Enforcement.  “That risk materialized with these firms, whose compliance programs were not adequate to prevent misleading statements in marketing materials or inadvertent overbilling of clients.  Firms must not only have policies and procedures in place, but also need to properly implement those policies and procedures.”

Andrew Bowden, director of the SEC’s National Exam Program, added, “After SEC examiners identified significant deficiencies, these firms did little or nothing to address them by the next examination.  Firms must fix deficiencies identified by our examiners.”

Under what is known as the “Compliance Rule” (Rule 206(4)-7 of the Investment Advisers Act), investment advisers are required to adopt and implement written policies and procedures that are reasonably designed to prevent securities law violations.  The rule requires advisers to review their policies and procedures at least once a year for adequacy and effectiveness of implementation.  Advisers also must designate a chief compliance officer responsible for administering the policies and procedures.

The SEC’s order against Modern Portfolio Management (MPM) and its owners G. Thomas Damasco II and Bryan Ohm finds that they failed to correct ongoing compliance violations at the firm despite prior warnings from SEC examiners.  In particular, they failed to complete annual compliance reviews in 2006 and 2009 and made misleading statements on MPM’s website and investor brochure.  For instance, one location on MPM’s website misleadingly represented that the firm had more than $600 million in assets.  However, on its Form ADV filing to the SEC during that same time period, it reported that the firm’s assets under management were $359 million or less.

MPM, Damasco, and Ohm agreed to be censured and pay a total of $175,000 in penalties.  Damasco and Ohm must complete 30 hours of compliance training, and MPM has agreed to designate someone other than Damasco or Ohm to be its chief compliance officer.  MPM, which is based in Holland, Ohio, must retain a compliance consultant for three years.

According to the SEC’s orders against New Orleans-based Equitas Capital Advisers and Equitas Partners as well as owner David S. Thomas, Jr., chief compliance officer Susan Christina, and former owner and chief compliance officer Stephen Derby Gisclair, they failed to adopt and implement written compliance policies and procedures and conduct annual compliance reviews to satisfy the Compliance Rule.  The Equitas firms made false and misleading disclosures about historical performance, compensation, and conflicts of interest, and they inadvertently yet repeatedly overbilled and underbilled their clients.  Many of these violations occurred despite warnings by SEC examiners during examinations of the Equitas firms in 2005, 2008, and 2011.  The firms, Thomas, and Gisclair failed to disclose these deficiencies to potential clients in response to questions in certain due diligence questionnaires or requests for proposals.  Gisclair also caused Compliance Rule violations and the incorrect billing of clients at Crescent Capital Consulting LLC, an investment advisory firm that he opened in late 2010.  Gisclair inflated the amounts of assets managed by Equitas and Crescent in their Form ADV filings to the SEC, and he improperly removed and retained nonpublic personal client information when he left Equitas.

Equitas Capital Advisers and Crescent have reimbursed all overcharged clients, and Equitas Capital Advisers, Thomas, and Gisclair agreed to pay a total of $225,000 in additional penalties. The Equitas firms have agreed to censures, the Equitas firms and Crescent have hired independent compliance consultants, and the Equitas firms and Gisclair must give clients notice of the SEC enforcement actions.

The SEC’s investigation into the Equitas firms was conducted by David Neuman of the Asset Management Unit and Virginia Rosado Desilets, and was supervised by Jeffrey Finnell of the Asset Management Unit.  Examinations of the firms were conducted by Conston Casey, David Marsh, Kenny Clowers, and Mavis Kelly.  The SEC’s investigation of Modern Portfolio Management was conducted by Amy Flaherty Hartman and Jamie Davidson following examinations of the firm by Michael Esposito, Sarah Kuhn, Arthur Stoll, Louis Gracia, Steven Levine, Kiley Hamilton, Belinda Hoskins, and Maureen Dempsey of the Chicago Regional Office.

Saturday, October 26, 2013


Remarks to the Independent Directors Council Annual Fall Meeting
 Norm Champ
Director, Division of Investment Management
U.S. Securities and Exchange Commission
Chicago, IL

Oct. 22, 2013

Good afternoon.  Thank you, Susan, for your kind introduction, and thank you for inviting me to speak at the Independent Directors Council Conference today.  Before I continue, let me remind you that the views I express are my own and do not necessarily reflect the views of the Commission, any of the Commissioners, or any of my colleagues on the staff of the Commission.[1]

It is a privilege to appear before a group that is so important to the strength and integrity of the fund industry.  Independent directors have significant responsibilities, and it requires tremendous effort and time on your part to do your job well.  I applaud your efforts to learn from the professionals who are participating in this conference.  The insights of the panels you heard yesterday and this morning, and those you will hear after lunch will provide valuable information.

The importance of mutual funds in the lives of American investors is clear.  Mutual funds hold close to $14 trillion of the hard earned savings of over 53 million American households.[2]  The majority of Americans access the markets through mutual funds.  They invest in funds, and hope their investments will grow, for many reasons -- to make a down payment on a house, to save for a college education, and ultimately to pay for a retirement.

The Commission’s mission in this landscape is clear.  It is charged with protecting investors, ensuring fair and orderly markets, and promoting capital formation.  Every one of us in the Division of Investment Management takes seriously how our work fits into that mission.  Indeed, our mission statement was drafted with the help of the entire Division.  In drafting our mission statement, we wanted to determine how our efforts fit in the overall SEC mission.  And we agreed that we work to protect investors, promote informed investment decisions, and facilitate appropriate innovation in investment products and services through regulating the asset management industry.  As I consider the Division’s mission, I see common themes to our mission in the role that independent directors play.  Although you do not regulate the asset management industry, you are first and foremost “independent watchdogs.”  As watchdogs, you oversee funds to protect the shareholders you serve.  You also help facilitate innovation in new products that are designed to meet investor needs.  And you monitor the information your funds provide that helps investors make informed decisions.

Today I want to talk about our common purpose, and how we can work together to advance it.  Specifically, I will talk about the key role communication can play in helping us collaborate to protect investors.  First, I will focus on your role in overseeing funds and how it complements ours at the Commission.  Then I will discuss developments in our efforts to oversee the industry.  Finally, I will highlight how we are striving to improve communication with you to support the mission that we share.

The Role of Independent Directors

Like any corporate director, mutual fund directors must abide by the duties they owe to shareholders under state law.  That is, they are subject to the state law duty of care and the duty of loyalty.[3]  The duty of care requires independent directors to act with the care that an ordinarily prudent person in a similar position would use under similar circumstances.[4]  In satisfying the duty of care, directors should be well informed.  They also should base their decisions on reasonable diligence.[5]  Your duty includes overseeing corporate management and overseeing service providers.[6]   Your oversight includes asking questions when there are red flags.[7]

Under the duty of loyalty, a director must place the best interests of the corporation and its shareholders before his or her own interests or those of anyone else, whether it is a person or an organization.[8]  As the Delaware Supreme Court has stated, “[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation’s best interest.”[9]  Directors stand in a fiduciary relationship to the corporation and its shareholders.[10]  This relationship requires directors not only to protect the interests of the corporation and its shareholders, but also to refrain from doing anything that would cause injury to the corporation.[11]

In fulfilling their obligations, mutual fund directors must apply those general state law principles in the context of the specific responsibilities and restrictions imposed under the federal law.[12]  Federal law doesn’t generally preempt state laws that govern the powers of corporate directors.  But federal law does preempt state law if the state law permits action that federal law prohibits, or if the application of state law would be inconsistent with the federal policy underlying the federal cause of action.[13]  Because of the “extensive layering” of federal regulation under the Investment Company Act, “fund directors must, as a practical matter, consider their responsibilities under state law as inextricably linked to those under federal law.”[14]

Under the Investment Company Act, as independent directors, you have express duties in the governance of mutual funds.  These responsibilities arise because mutual funds are formed and operate so differently from other corporations.  As you well know, conflicts are inherent in a fund’s structure.  The potential for abuses are ever present because the fund is organized by a sponsor -- an investment adviser -- whose primary loyalty and financial interests lie outside the fund, and because third parties provide all the services that allow the fund to operate, including investment management, distribution and custody.

Congress gave fund directors, and particularly independent directors, specific responsibilities to address the conflicts of interest that arise because of the way funds are formed and operate.  Under the Investment Company Act, you are the “independent watchdogs” for shareholder interests by being a check on management.  You address the potential for abuse that accompanies those conflicts of interest.

Your responsibilities under the Act flow from the same underlying purpose as do your duties under state law -- to protect the fund’s shareholders.  The purpose underlying the Commission’s responsibilities is the same.  To achieve our common mission of protecting investors, we both oversee funds, but in different ways.  While you are on the front lines overseeing the funds you serve, we are monitoring the entire fund industry.

Division Improvement Initiatives

As the investment landscape changes, with evolving investor needs and new products designed to meet those needs, we as regulators are challenged every day -- to provide effective oversight and to protect investors.  And in the Division, we are working to meet those challenges.  We are focusing our energy, trying to become smarter, more strategic and more targeted.

One area where we have spent a lot of time focusing our energy is on rulemaking initiatives.  To ensure that we are allocating our resources wisely, over the past year, we have taken a fresh look at policy initiatives with a view to analyzing those matters based on four factors:  First, the risk to be mitigated; Second, the urgency associated with a particular initiative; Third the potential impact of an initiative on investors, registrants, capital formation, efficient markets, and the Division’s and the SEC’s operational efficiency; and Fourth, the resources associated with a policy initiative.  We’re looking at factors that we believe would further the SEC’s mission as well as the impact that various regulatory initiatives would have on investors, capital formation, and efficient markets. The analysis has helped to inform the Chairman, in collaboration with the Commissioners, in her determination of which regulatory priorities the Commission will pursue.

I am pleased to report that we have completed the first of the priorities that we identified early this year.  In April, the Commission adopted the “Identity Theft Red Flags Rules” -- rules to detect and prevent theft of the identities of mutual fund investors and clients of asset managers.[15]  I want to mention two other regulatory projects that the staff is focused on now.  The first is additional money market fund reform.  As I’m sure you know, the Commission proposed additional money market fund reforms in June.[16]  The comment period officially closed on September 17, although we continue to receive comments.  The staff is currently reviewing and analyzing the more than 1300 letters we have received to date.

Another rulemaking initiative we’re focused on involves ETFs.  In 2008, the Commission proposed a rule that would basically codify certain exemptive relief that we routinely grant for these funds.[17]  The proposed exemptive rule would have allowed certain ETFs to launch without having to file an exemptive application -- a process that, while important for novel products, can be costly and time-consuming.  If ETFs of new sponsors could come to market without having to obtain their own exemptive relief, the Division could reallocate staff resources from the review of these “plain vanilla” applications to more novel applications.  The Division is considering how to advance consideration of this type of ETF rule.

In our efforts to work smarter, we also focused on the Division as a whole.  During the past year, we began a process to better understand our strengths and areas for improvement.  Enhanced communication and collaboration are key elements of that initiative.  We gathered input from inside the Division as well as from our colleagues throughout the Commission.  We identified and prioritized issues confronting the Division and created teams of managers and staff to address these issues.  These teams have made recommendations, and I am pleased at the number of creative ideas that were generated.  As a result, we have implemented a number of initiatives, which are designed to – First, encourage an inclusive collaborative working environment within IM, across the Commission, and with outside stakeholders.  Second, increase information and knowledge sharing.  And third, provide transparency into our work processes.

An important tool in our efforts to increase communication and collaboration is our newly created Risk and Examinations Office, or “REO.”  REO supports the Division’s work primarily through two functions.  REO is a multi-disciplinary office staffed with analysts with strong quantitative backgrounds, along with examiners, lawyers and accountants.  REO maintains an industry monitoring program that provides ongoing financial analysis of the investment management industry.  In particular, REO is charged with monitoring activities of investment companies, investment advisers and investment products.  REO intends to conduct rigorous quantitative and qualitative financial analysis of the investment management industry, with a particular focus on strategically important investment advisers and funds.  The REO monitoring program’s work includes analysis of the information the industry provides through various regulatory reports, including Form ADV, the form that investment advisers use to register with the Commission, Form PF, the form that certain investment advisers to private funds use to report risk data, and Form N-MFP, the reporting form that money market funds use to report their portfolio holdings and other key information.  REO also draws on industry information from third party providers.  In addition, REO conducts an examination program that gathers additional information from the investment management industry to inform the Division’s policy making.  Although REO may conduct its own exams, where practical, REO will join examiners from the Commission’s Office of Compliance Inspections and Examinations (OCIE) on their examinations of firms.  So far all REO exams have been in association with OCIE.

All of REO’s work will inform the initiatives to which the Division devotes resources and will help inform the rules we are drafting.

I am excited at the prospect that REO can help the staff to be proactive and get out in front of new industry trends, rather than reacting to past practices.  We hope to use the work of REO to make our oversight more efficient and effective.  REO represents a new area of focus for the Division of Investment Management, and I expect REO to complement the work of the SEC as a whole.

I also believe that we can make REO even more effective with enhanced information.  We are working to do this in two ways.  First, we are seeking to be more in tune with industry developments and investors’ experiences.  This effort involves getting a better and more first-hand understanding of the workings of the investment management industry through meeting with fund boards and senior fund management.  I will talk more about this in a moment.

Second, we are working to enhance REO and the Division’s ability to collect and analyze data.  As you know, as part of the money market fund reforms adopted by the SEC in 2010, we now receive monthly data on money market fund portfolio holdings through Form N-MFP.  This new data has been extremely valuable.  We are able to use it to monitor trends, identify outliers and better inform our rule-writing efforts.  What we don’t have, however, is similar information on other mutual funds, closed-end funds and ETFs.  Instead, we have a hodgepodge of data collection and reporting forms with outdated technology behind them.  These forms provide only a patchwork of data that does not tell us detail about mutual funds but often allows rounding and summary information.  That is why Division staff is undertaking an initiative to consider potential ways to streamline the fund reporting forms and develop reporting for funds other than money market funds that could give us timely and accurate information about their operations and portfolio holdings.

In addition to our focus on communication within the Division, we are working on better communication with our colleagues throughout the Commission.  For example, we have worked intentionally towards better coordination and cooperation with other offices in connection with major initiatives, doing this as an integral part of the process, rather than a late stage check-in with another office after the essential work on the matter has been completed.  This involves comparing notes with others on our initiatives early and often, and seeking meaningful substantive input at all stages of a major undertaking like a rulemaking.

We are also working to enhance our communications with the outside.  To further this goal, we are issuing guidance updates in addition to our traditional no-action and interpretive letters.  A recent example that may be of interest to fund directors addresses the merger of two affiliated exchange traded funds – a transaction that is generally not covered in the exemptive orders that the Commission issues to ETFs and their advisers in response to applications.  The guidance provides staff views regarding such a merger that is executed in accordance with the Commission’s exemptive rule permitting fund mergers and where all applicable disclosure and other requirements are met.[18]

The staff also has issued guidance on complying with the representations and conditions of exemptive orders issued to funds and advisers.  The staff noted that funds risk violating the federal securities laws if they fail to comply with the conditions and representations in their orders.  The guidance observed one way to address those risks, and offered approaches on how a fund’s compliance program might address conditions relating to board of directors’ review.[19]

The staff’s guidance and issues of interest are posted on the Division’s recently redesigned website.  They are easy to find on the Guidance Updates section, which we are using to get more information out quickly.  In addition, the IM website has a section that highlights the Division’s current news, which makes it easy to find the most recent guidance.

Communication and Support on Fund Governance

I have just outlined several ways in which we are working toward continuous improvement in the Division, including how we oversee funds.  As independent directors, you have a special perspective that makes your oversight different from but complementary to ours.  You are monitoring the funds you serve rather than the entire industry, and you best understand those funds.  You know the funds’ investment objectives and thus the shareholders’ expectations.  You scrutinize the funds’ advisory contracts and fees.  You oversee fund distributions, the valuation and pricing of fund shares, custody arrangements, securities lending, and many other fund activities.  You confer regularly with fund management.  You are on the front lines, seeing new developments and troubleshooting problems as they arise.  As a result of all your interactions, you are closer to the needs of investors than we can be and you are better positioned to understand how best to serve their interests.  Just as I expect the Commission will benefit from the work that REO will do, I believe that we already benefit from the work of independent directors.  And to help you be the most effective in your work, we want to do what we can to support you.

Our interest in this collaboration is not new.  The Division and the Commission have considered fund governance and have engaged with independent directors on how to maximize their value over many years.  For example, more than twenty years ago, in 1992, the staff reviewed the role of independent directors.  It concluded that the governance model embodied in the Investment Company Act is sound, and that the “watchdog” function you perform has served investors well at minimal cost.[20]  But the staff also recognized that independent directors faced increasing responsibilities, and so it made recommendations, many of which were adopted by the Commission, to reduce those responsibilities that involved more ritual than substance.

Several years later, in 1999, the Commission held a roundtable devoted to examining the role of independent directors.  Many recommendations emerged from the roundtable on ways to improve the mutual fund governance structure.  Following the roundtable, the industry and the Commission both worked to enhance the role of independent directors.  In June 1999, the ICI’s Advisory Group on Best Practices for Fund Directors published a report identifying best practices for fund boards to enhance the independence and effectiveness of investment company directors.[21] And I note the success of that effort because by 2003, a significant portion of mutual funds had followed all or most of the recommendations of that report.[22]  In November 1999, the Commission proposed rule changes, which it adopted in 2001, “designed to reaffirm the important role that independent directors play in protecting fund investors, strengthen their hand in dealing with fund management, reinforce their independence, and provide investors with greater information to assess the directors’ independence.”[23]

More recently in 2007, one of my predecessor’s as Division Director began a series of meetings designed to determine what the Commission and its staff could do to enable fund directors to be more effective in their oversight role.  We gained valuable insights in these meetings, and learned how we might be able to assist directors.  For example, in response to concerns we heard, the Division issued guidance on approaches a fund board could take regarding determinations they must make when they perform their quarterly review of certain transactions permitted under our exemptive rules.[24]  

This type of communication, I believe, is essential to a successful collaboration.  I mentioned earlier that the Division has been reaching out to boards of directors and senior fund management.  Our meetings with the industry have started with the largest or most strategically important funds.  We have identified a number of potential firms, and at this point we have conducted a number of visits.  Our outreach will extend to other funds as well.  In these discussions, we want to learn from directors and fund management about specific fund risks and how they manage those risks.  We also want to know what you perceive to be the critical risks to the industry as a whole.  I have been joined by REO in these meetings because we believe this information will further inform REO’s work, and REO’s work in turn will inform the initiatives to which the Division devotes resources and the rules we are drafting.

I think that the conversations between us can be the most productive when we can speak with you and your fund management directly and get to know you better.  To illustrate our commitment to the process, we have met with fund management and boards at their headquarters.

These meetings allow us to obtain a first-hand view of the systems, controls, personnel, and even a sense of the culture of an individual firm.  And we find we can learn more about a firm’s business operations by seeing the board and fund management at their offices.  We will be better regulators to the extent that we better understand the workings of the industry we regulate.  And if you and fund managers see our willingness to reach out and to listen, we hope you and they will respond with increased cooperation and more effective communication.

The discussions we have had with fund management and directors to date have already borne fruit.  Boards have shared with us their different perspectives on a variety of issues, including risk management, valuation and compliance, and how those perspectives inform many of their fund practices.  Those perspectives help us understand the different methods that might be brought to bear in addressing pressing fund issues and implementing compliance programs.  And in turn, if it’s appropriate we are sharing the good practices that we learn about from one firm with other funds.

In addition, we encourage directors to share with us ways in which the Division could help them be more effective.  If we hear ideas in our meetings on where you need additional guidance or where you have uncertainty about the law, we will work diligently to get the appropriate guidance out there.

We will continue to seek ways in which we can provide guidance or otherwise assist fund boards, and particularly independent directors, in fulfilling their duties.  This is one way we can better serve the public and industry participants.

I look forward to future meetings as our initiative advances.  I am particularly glad to have an opportunity today to share views with you and receive feedback.  In addition, as I have mentioned, the Division’s door is open, and we want to hear from you what we can do to help make you more effective.  Working together, we are better positioned to accomplish our common mission of protecting investors.

Thank you for your time today.

[1]              The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees.  The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues on the staff of the Commission.

[2]              See Investment Company Institute (“ICI”), Trends in Mutual Fund Investing August 2013 ( ); ICI, Profile of Mutual Fund Shareholders 2013, available at ( ).

[3]              Edward Brodsky & M. Patricia Adamski, Law of Corporate Officers and Directors:Rights, Duties and Liabilities 6 (2013).

[4]              Graham v. Allis-Chalmers Mfg. Col, 188 A.2d 125, 130 (Del. Ch. 1963); see also Shenker v. Laureate Educ. Inc., 983 A.2d 408, 419 (Md. 2009).

[5]              See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).

[6]              See Robert A. Robertson, Fund Governance: Legal Duties of Investment Company Directors § 2.04[1] (2011) (“Fund Governance”).

[7]              See id., at § 2-04[2][b](ii); see also Graham, 188 A.2d, at130.

[8]              See, e.g., Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993), modified on reargument, 636 A.2d 956 (Del. 1994).

[9]              Guttman v. Huang, 823 A.2d 492, n.34 (Del. Ch. 2003).

[10]            Guth v. Loft, 5 A.2d 503, 510 (Del. 1939).

[11]            Id.

[12]            Burks v. Lasker, 441 U.S. 471, 486 (1979).

[13]            Id. at 479.

[14]            Fund Governance, supra note 6, § 2.01.

[15]            Identity Theft Red Flags Rules, Investment Company Act Release No. 30456 (Apr. 10, 2013), 78 FR 23637 (Apr. 19, 2013), available at

[16]            Money Market Fund Reform; Amendments to Form PF, Investment Company Act Release No. 30551 (June 5, 2013), 78 FR 36834 (June 19, 2013), available at

[17]            Exchange-Traded Funds, Investment Company Act Release No. 28193 (Mar. 11, 2008), 73 FR 14618 (Mar. 18, 2008), available at

[18]            Merger of Two Exchange-Traded Funds, IM Guidance Update No. 2013-06 (Sept. 2013), available at

[19]            Compliance with Exemptive Orders, IM Guidance Update No. 2013-02 (May 2013), available at

[20]            Division of Investment Management, Protecting Investors:  A Half Century of Investment Company Regulation 253 (1992), available at

[21]            Investment Company Institute, Report of the Advisory Group on Best Practices for Fund Directors:  Enhancing a Culture of Independence and Effectiveness (June 24, 1999), available at .

[22]            See Richard M. Phillips, Mutual Fund Independent Directors: A Model for Corporate America?, Investment Company Institute Perspective, Aug. 2003, at 3, available at .

[23]            Role of Independent Directors of Investment Companies, Investment Company Act Release No. 24816 (Jan. 2, 2001), at paragraph preceding section I [66 FR 3759 (Jan. 16, 2001)].

[24]            See Staff Letter to the Independent Directors Council and the Mutual Fund Directors Forum (Nov. 2, 2010), available at



The Securities and Exchange Commission today charged a Michigan-based medical technology company with violating the Foreign Corrupt Practices Act (FCPA) when subsidiaries in five different countries bribed doctors, health care professionals, and other government-employed officials in order to obtain or retain business.

An SEC investigation found that Stryker Corporation’s subsidiaries in Argentina, Greece, Mexico, Poland, and Romania made illicit payments totaling approximately $2.2 million that were incorrectly described as legitimate expenses in the company’s books and records.  Descriptions varied from a charitable donation to consulting and service contracts, travel expenses, and commissions.  Stryker made approximately $7.5 million in illicit profits as a result of the improper payments.

Stryker has agreed to pay more than $13.2 million to settle the SEC’s charges.

“Stryker’s misconduct involved hundreds of improper payments over a number of years during which the company’s internal controls were fatally flawed,” said Andrew M. Calamari, director of the SEC’s New York Regional Office.  “Companies that allow corruption to occur by failing to implement robust compliance programs will not be allowed to profit from their misconduct.”

The SEC’s order instituting settled administrative proceedings details improper payments by employees of Stryker’s subsidiaries as far back as 2003.  They used third parties to make the payments in order to win or keep lucrative contracts for the sale of Stryker’s medical technology products.  For example, in January 2006, Stryker’s subsidiary in Mexico directed a law firm to pay approximately $46,000 to a Mexican government employee in order to secure the winning bid on a contract.  The result was $1.1 million in profits for Stryker.  The subsidiary reimbursed the Mexico-based law firm for the bribe and booked the payment as a legitimate legal expense.  However, no legal services were actually provided and the law firm simply acted as a funnel to pay the bribe.

According to the SEC’s order, Stryker’s subsidiary in Greece made a purported “donation” of nearly $200,000 in 2007 to a public university in Greece to fund a laboratory that was a pet project of a public hospital doctor.  In exchange for the payment, the doctor agreed to provide business to Stryker.

The SEC’s investigation also found that Stryker’s subsidiaries bribed foreign officials by paying their expenses for trips that lacked any legitimate business purpose.  For example, in exchange for the promise of future business from the director of a public hospital in Poland, Stryker paid travel costs for the director and her husband in May 2004.  This included a six-night stay at a New York City hotel, attendance at two Broadway shows, and a five-day trip to Aruba.

The SEC’s order requires Stryker to pay disgorgement of $7,502,635, prejudgment interest of $2,280,888, and a penalty of $3.5 million.  Without admitting or denying the allegations, Stryker agreed to cease and desist from committing or causing any violations and any future violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934.

The SEC’s investigation was led by Sharon Binger and Justin Alfano of the New York Regional Office with significant assistance from the Enforcement Division’s FCPA Unit.

Thursday, October 24, 2013


Jury Finds Mark Cuban Not Liable for Insider Trading

On October 16, 2013, after a three-week trial, a nine-person federal jury found Mark Cuban not liable for insider trading. On November 17, 2008, the Commission filed a Complaint against Cuban alleging that he engaged in insider trading in securities issued by in violation of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.



Former Securities Professional Aleksey Koval Settles Insider Trading Case

The Securities and Exchange Commission announced that on October 7, 2013, the Honorable Alvin K. Hellerstein of the United States District Court for the Southern District of New York entered a final judgment against Aleksey P. Koval a/k/a Alexei Koval, formerly a registered securities professional. Koval had been charged with involvement in a long-running insider trading scheme in which a former UBS investment banker tipped Koval about eleven impending acquisitions, tender offers, or other business combinations. Koval traded on the basis of that information and tipped another couple, who also participated in the trading.

The Commission's complaint, filed on March 24, 2010, alleged that, from at least July 2005 through February 2009, Koval participated in an insider trading ring that netted over $1 million in illicit profits. According to the complaint, Koval traded securities in each of the impending corporate transactions based on material, nonpublic information which he obtained from Igor Poteroba, an investment banker in UBS's Global Healthcare Group. Pursuant to the insider trading scheme as described in the complaint, Koval also tipped his friend, defendant Alexander Vorobiev. In a parallel criminal proceeding, Koval pleaded guilty to three counts of securities fraud, was ordered to pay a forfeiture of $1,414,290, and was sentenced to twenty-six months of imprisonment.

Koval consented to the entry of a judgment that permanently enjoins him from violating Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and Rules 10b-5 and Rule 14e-3 thereunder. In addition, the final judgment found Koval liable for disgorgement in the amount of $1,086,457, representing profits obtained as a result of the conduct alleged in the Complaint, together with prejudgment interest in the amount of $159,620, with those amounts deemed satisfied by the criminal forfeiture order. The Commission determined not to seek a civil penalty in light of Koval’s term of imprisonment.

Separately, the Commission today issued an administrative order that bars Koval from association with any investment adviser, broker, dealer, municipal securities dealer, or transfer agent, and from participating in any offering of a penny stock, based on his criminal conviction in the parallel proceeding.

Wednesday, October 23, 2013


SEC Obtains Jury Verdict in Its Favor Against All Defendants On All Counts

The Securities and Exchange Commission announced today that, on October 10, 2013, a jury in the Eastern District of Tennessee, Knoxville Division, returned a verdict against AIC, Inc., Community Bankers Securities, LLC, and Nicholas D. Skaltsounis on all counts.  Defendant AIC was a financial services holding company for three broker-dealers and an investment adviser based in Richmond, Virginia.  Defendant Community Bankers Securities was one of the subsidiary broker-dealers.  Defendant Skaltsounis was the founder, President, and Chief Executive Officer of AIC and Community Bankers Securities.  The Commission’s complaint, which was filed in April 2011, alleged that Skaltsounis devised and orchestrated an offering fraud by offering and selling millions of dollars of AIC promissory notes and stock.

The complaint alleged that, from at least January 2006 through November 2009, Skaltsounis, directly and through registered representatives associated with Community Bankers Securities, offered and sold AIC promissory notes and stock to numerous investors across multiple states, many of whom were elderly, unsophisticated brokerage customers of CB Securities.  The Defendants misrepresented and omitted material information to investors relating to, among other things, the safety and risk associated with the investments, the rates of return on the investments, and how AIC would use the proceeds of the investments.  AIC and its subsidiaries were never profitable.  AIC earned de minimis revenue, and its subsidiaries did not earn sufficient revenue to meet their expenses.  The Defendants used money raised from new investors to pay back principal and returns to existing investors.  

Prior to trial, the United States District Court for the Eastern District of Tennessee granted the Commission’s motion for partial summary judgment and found in favor of the Commission on its claims against AIC, Community Bankers Securities, and Skaltsounis under Sections 5(a) and 5(c) of the Securities Act of 1933.  The court also found in favor of the Commission on its claims against three relief defendants, Allied Beacon Partners, Inc. (f/k/a Waterford Investor Services, Inc.), Advent Securities, Inc., and Allied Beacon Wealth Management, LLC (f/k/a CBS Advisors, LLC), all of which were subsidiaries of AIC and all of which received proceeds from the Defendants’ illegal and fraudulent conduct.  In addition, prior to trial, two co-defendants, John B. Guyette, of Greeley, Colorado, and John R. Graves, formerly of Pensacola, Florida, and now incarcerated at the Federal Detention Center at Oakdale, Louisiana, both of whom were participants in the scheme, entered into settlement agreements with the Commission.  A final judgment ordering injunctive relief, disgorgement of ill-gotten gains, and civil penalties was entered against Guyette, and a final judgment ordering injunctive relief and civil penalties was entered against Graves.

At the conclusion of the almost three-week trial, the jury returned a verdict for the Commission and against Defendants AIC, Community Bankers Securities, and Skaltsounis on all of the remaining claims.  In particular, the jury found in favor of the Commission on its claims under Section 17(a) of the Securities Act and under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.  In addition, the jury found in favor of the Commission on its claims against Defendants AIC and Community Bankers Securities under Section 20(a) of the Exchange Act and against Skaltsounis under Section 20(e) of the Exchange Act.

The trial team from the Commission’s Philadelphia Regional Office consisted of trial attorneys Michael J. Rinaldi, John V. Donnelly III, G. Jeffrey Boujoukos, and Scott A. Thompson and trial paralegal Nichelle Pridgen.

Tuesday, October 22, 2013


SEC Charges Diebold with FCPA Violations in China, Indonesia, and Russia

The Securities and Exchange Commission today charged Diebold, Inc. ("Diebold"), an Ohio corporation that is a global provider of ATMs and bank security systems, with violations of the Foreign Corrupt Practices Act ("FCPA") for lavishing international leisure trips, entertainment, and other improper gifts on foreign officials to obtain and retain lucrative business with government owned banks in China and Indonesia, and for paying other bribes in connection with the sale of ATMs to private banks in Russia. The SEC's complaint, filed in the United States District Court for the District of Columbia, alleges that Diebold paid approximately $3 million in illicit payments in these countries from 2005 through 2010. To settle the SEC's charges, Diebold has agreed to consent to final judgment, which is subject to court approval, ordering a permanent injunction, payment of $22,972,942 in disgorgement and prejudgment interest, and appointment of independent compliance monitor.

As alleged in the SEC's complaint, from 2005 through 2010, through its Chinese subsidiary Diebold Financial Equipment Company (China), Ltd., Diebold provided international leisure trips and entertainment to officials of government owned banks in China. This included trips to Europe, with stays in Paris, Amsterdam, Florence, Rome and other European cities, and trips to the United States, with travel to the Grand Canyon, Napa Valley, Disneyland, Las Vegas, and other popular tourist destinations. The SEC alleges that Diebold spent approximately $1.6 million on leisure trips, entertainment, and other improper gifts for government bank officials in China. During this same time period, the SEC alleges, Diebold spent over $147,000 on leisure trips and entertainment for officials of government banks in Indonesia. As alleged in the complaint, Diebold executives in charge of the company's operations in Asia knew of these improper payments, which were falsely recorded in Diebold's books and records as training or other legitimate business expenses.

The SEC's complaint further alleges that from 2005 through 2008, through its Russian subsidiary Diebold Self-Service Ltd., Diebold paid bribes on the sale of ATMs to private banks in Russia. As alleged in the complaint, these bribes totaled approximately $1.2 million, and were funneled through a Diebold distributor in Russia. According to the complaint, Diebold's Russian subsidiary executed phony service contracts with its distributor to hide and falsely record the payments as legitimate business expenses.

The SEC's complaint charges Diebold with violating Sections 30A, 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934. Diebold has agreed to consent to a final judgment that permanently enjoins the company from future violations of these provisions, orders Diebold to pay $22,972,942 in disgorgement and prejudgment interest, and requires the appointment of an independent compliance monitor. In a parallel criminal proceeding, Diebold has agreed to pay a $25.2 million criminal fine as part of a deferred prosecution agreement with the U.S. Department of Justice.

The SEC's investigation was led by Devon A. Brown and Brian O. Quinn with assistance from Jennifer Baskin of the FCPA Unit and Kristen Dieter. The SEC thanks the U.S. Department of Justice's Fraud Section, the United States Attorney's Office for the Northern District of Ohio, and the Federal Bureau of Investigation, for their assistance in this matter.