CASINO-GAMING COMPANY TO PAY HALF-MILLION PENALTY IN WHISTLEBLOWER RETALIATION CASE

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION

Press Release

SEC: Casino-Gaming Company Retaliated Against Whistleblower

FOR IMMEDIATE RELEASE

2016-204

Washington D.C., Sept. 29, 2016 — The Securities and Exchange Commission today announced that casino-gaming company International Game Technology (IGT) has agreed to pay a half-million dollar penalty for firing an employee with several years of positive performance reviews because he reported to senior management and the SEC that the company's financial statements might be distorted.

In its second whistleblower retaliation case since the Dodd-Frank Act authorized the agency to bring such charges, the SEC found that the employee was removed from significant work assignments within weeks of raising concerns about the company's cost accounting model.  He was terminated approximately three months later.

"Strong enforcement of the anti-retaliation protections is critical to the success of the SEC's whistleblower program.  This whistleblower noticed something that he felt might lead to inaccurate financial reporting and law violations, and he was wrongfully targeted for doing the right thing and reporting it," said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.

"Bringing retaliation cases, including this first stand-alone retaliation case, illustrates the high priority we place on ensuring a safe environment for whistleblowers,” said Jane A. Norberg, Chief of the SEC’s Office of the Whistleblower.  "We will continue to exercise our anti-retaliation authority when companies take reprisals for whistleblowing efforts."

According to the SEC's order, IGT conducted an internal investigation into the allegations made by the whistleblower, who did not oversee the company's accounting functions, and determined its reported financial statements contained no misstatements.

Without admitting or denying the SEC's findings, IGT agreed to pay the $500,000 penalty and cease and desist from committing or causing any further violations of Section 21F(h) of the Securities Exchange Act of 1934.

The SEC’s investigation was conducted by Brent W. Wilner, Rhoda H. Chang, and Gary Y. Leung, and the case was supervised by Diana K. Tani, John W. Berry, C. Dabney O’Riordan, and Michele W. Layne of the Los Angeles Regional Office.  The SEC appreciates the assistance of the U.S. Labor Department's Occupational Safety and Health Administration.

SEC TAKES ENFORCEMENT ACTION AGAINST COMPANY OFFERING COMPLEX DERIVATIVE PRODUCTS TO RETAIL INVESTORS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

06/17/2015 12:05 PM EDT

The Securities and Exchange Commission announced an enforcement action against a company that illegally offered complex derivatives products to retail investors.

The Dodd-Frank Act implemented two key requirements for any security-based swaps offering to a retail investor who doesn’t meet the high standard of an “eligible contract participant” defined in the law.  A registration statement must be effective for the offering, and the contracts must be sold on a national securities exchange.  These requirements are intended to make financial information and other significant details about the offering fully transparent to retail investors, and limit the transactions to platforms subject to the highest level of regulation.

An SEC investigation found that Silicon Valley-based Sand Hill Exchange was offering and selling security-based swaps contracts to retail investors outside the regulatory framework of a national securities exchange and without the required registration statements in effect.  The violations were detected shortly after the offering process began, and with cooperation from the company the platform was shut down before any investor harm occurred.

Sand Hill agreed to settle the SEC’s charges.

“The Dodd-Frank Act prohibits security-based swaps from being offered in the darkness to retail investors, and we were able to act quickly before any losses materialized in this offering that occurred outside the proper regulatory framework,” said Reid A. Muoio, Deputy Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit.  “We will continue to scrutinize this space for companies circumventing the law to offer security-based swaps without the safeguards provided to retail investors.”

According to the SEC’s order instituting a settled administrative proceeding against Sand Hill and two individuals:

Sand Hill began as two Silicon Valley entrepreneurs creating an online business involving the valuation of private startup companies in the region along the lines of a fantasy sports league.  But Gerrit Hall and Elaine Ou changed their business model multiple times, and earlier this year Sand Hill evolved to invite web users to use real money to buy and sell contracts referencing pre-IPO companies and their value.

Sand Hill sought people to fund accounts using dollars or bitcoins.  Hall and Ou did not ask users about their financial holdings or limit the offering to users with any specific amount of assets.  In fact, they wrote on the Sand Hill website: “We accept everybody regardless of accreditation status.”  Hall and Ou intended to pay users who profited from their contracts.

Hall and Ou understood that they were buying and selling derivatives linked to the value of private companies, and Ou falsely claimed that they were in the process of seeking regulatory approval for Sand Hill’s contracts.

For about seven weeks, Sand Hill offered, bought, and sold contracts through the website in violation of the Dodd-Frank provisions that limit security-based swaps transactions with people who don’t meet the definition of an eligible contract participant.  Hall and Ou exaggerated Sand Hill’s trading, operations, controls, and financial backing.

Sand Hill, Hall, and Ou ceased offering and selling security-based swaps following inquiries from the SEC in early April.

The SEC’s order finds that Sand Hill, Hall, and Ou violated Section 5(e) of the Securities Act and Section 6(l) of the Securities Exchange Act of 1934.  Without admitting or denying the findings, Sand Hill, Hall, and Ou agreed to cease and desist from committing or causing any future violations of the securities laws.  Sand Hill agreed to pay a $20,000 penalty.

The Complex Financial Instruments Unit will continue its scrutiny of the retail market for conduct that may violate the Dodd-Frank Act’s swaps provisions, including online competitions creatively monetizing what actually constitute security-based swaps transactions.  The SEC’s investigation of Sand Hill was conducted by Brent Mitchell and Creola Kelly, and the case was supervised by Michael Osnato and Mr. Muoio.  The investigation was assisted by Carol McGee and Andrew Bernstein of the Division of Trading and Markets as well as Amy Starr and Andrew Schoeffler of the Division of Corporation Finance.

SEC CHAIRMAN WHITE'S REMARKS BEFORE ADVISORY COMMITTEE ON SMALL AND EMERGING COMPANIES

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

Opening Remarks of SEC Chair Mary Jo White before the SEC Advisory Committee on Small and Emerging Companies

Chair Mary Jo White

June 3, 2015

Good morning. Thank you all for being here. Steve, Chris, and all committee members, I appreciate the full agenda you have today, and I will be brief in my update and comments so that you can get to the business at hand.

I am pleased to note that since your last meeting, the Commission in March adopted Regulation A+. I know this Committee was eager for that rule to be finalized, as were we. I believe the rule we adopted will provide an additional and effective path to raising capital that also provides strong investor protections. I look forward to seeing companies put the rules to good use to raise capital.

On other fronts, we continue to advance the completion of our other rulemaking mandates under the JOBS Act and the Dodd-Frank Act, and as we have discussed before, it is one of my priorities to complete the crowdfunding rulemaking this year, which is our last significant JOBS Act rulemaking. Crowdfunding in its various forms obviously remains a focus of many others, including this Committee, the states and in various countries around the world.

Indeed, more than 20 states have enacted some form of intrastate crowdfunding legislation or rules, and a number of others are considering similar initiatives. As states are seeking to expand the avenues in which issuers may conduct intrastate offerings, we have focused on the fact that some of our laws and rules were put into place years ago prior to widespread use of the internet and may present challenges to the states’ efforts.

For example, Securities Act Rule 147, which you will be discussing today, created a safe harbor that issuers often rely on for intrastate offerings. Rule 147 was adopted in 1974, and how an issuer might conduct an intrastate offering using the internet was not contemplated at that time. The staff in the Division of Corporation Finance is currently considering ways to improve the rule, by looking at, among other things, the conditions included in the rule for an offering to be considered intrastate. Securities Act Rule 504, an exemption that could be used to facilitate regional crowdfunding offerings for up to $1 million that are registered in one or more states, is another rule that may benefit from modernization and the staff is considering ways to do that. We look forward to having your input on these topics and to hearing your thoughts on whether there are aspects of these or other rules that could be usefully updated or changed.

It is also quite timely for this Committee to be taking up public company disclosure effectiveness. As you know, the staff in the Division of Corporation Finance is hard at work on our initiative to improve the effectiveness of the public company disclosure regime for investors and companies. The staff has sought input from a broad range of market participants and is in the process of developing recommendations for the Commission’s consideration. We welcome your thoughts in this area that I know is of particular interest to many of you.

I look forward to your input on the other topics on your agenda, including the Section 4(a)(1½) exemption, and the issues surrounding broker-dealer registration for those who identify or otherwise “find” potential investors in private placements. I am also glad to see a continuation of your consideration of venture exchanges as an avenue for secondary market liquidity.

I will stop here. As always, we very much appreciate the time and expertise you devote to this Committee. I wish you a very productive meeting.

Thank you.

CFTC CHAIRMAN MASSAD'S TESITMONY BEFORE U.S. SENATE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

FROM:  COMMODITY FUTURES TRADING COMMISSION

Testimony of Chairman Timothy Massad before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, Washington, DC

September 9, 2014

Thank you Chairman Johnson, Ranking Member Crapo and members of the Committee. I am pleased to testify before you today on behalf of the Commission. This is my first official hearing as Chairman of the CFTC. It is truly an honor to serve as Chairman at this important time.

I met and spoke with several members of this Committee during the confirmation process, and I appreciated hearing your thoughts and suggestions during that time. I look forward to this Committee’s input going forward.

During the last five years, we have made substantial progress in recovering from the worst financial crisis since the Great Depression. The Dodd-Frank Act was a comprehensive response, and much has been accomplished in implementing it. The CFTC has largely completed the rulemaking stage of Dodd-Frank implementation. However, much work remains to finish the job Congress has given us.

I look forward to working together with you, as well as my colleagues at the CFTC and others around the globe to ensure that our futures, swaps and options markets remain the most efficient and competitive in the world, and to protect the integrity of the markets.

The Significance of Derivatives Market Oversight

Very few Americans participate directly in the derivatives markets. Yet these markets profoundly affect the prices we all pay for food, energy, and most other goods and services we buy each day. They enable farmers to lock in a price for their crops, utility companies or airlines to hedge the costs of fuel, and auto companies or soda bottlers to know what aluminum will cost. They enable exporters to manage fluctuations in foreign currencies, and businesses of all types to lock in their borrowing costs. In the simplest terms, derivatives enable market participants to manage risk.

In normal times, these markets create substantial, but largely unseen, benefits for American families. During the financial crisis, however, they created just the opposite. It was during the financial crisis that many Americans first heard the word derivatives. That was because over-the-counter swaps – a large, unregulated part of these otherwise strong markets – accelerated and intensified the crisis like gasoline poured on a fire. The government was then required to take actions that today still stagger the imagination: for example, largely because of excessive swap risk, the government committed $182 billion to prevent the collapse of a single company – AIG – because its failure at that time, in those circumstances, could have caused our economy to fall into another Great Depression.

It is hard for most Americans to fathom how this could have happened. While derivatives were just one of many things that caused or contributed to the crisis, the structure of some of these products created significant risk in an economic downturn. In addition, the extensive, bilateral transactions between our largest banks and other institutions meant that trouble at one institution could cascade quickly through the financial system like a waterfall. And, the opaque nature of this market meant that regulators did not know what was going on or who was at risk.

Responding to the Crisis – Enactment and Implementation of the Dodd-Frank Act

The lessons of this tragedy were not lost on the leaders of the United States and the G-20 nations. They committed to bring the over-the-counter swaps market out of the shadows. They agreed to do four basic things: require regulatory oversight of the major market players; require clearing of standardized transactions through regulated clearinghouses known as central counterparties or CCPs; require more transparent trading of standardized transactions; and require regular reporting so that we have an accurate picture of what is going on in this market.

In the United States, these commitments were set forth in Title VII of the Dodd-Frank Act. Responsibility for implementing these commitments was given primarily to the CFTC. I would like to review where we stand in implementing the regulatory framework passed by Congress to bring the over-the-counter swaps market out of the shadows.

Oversight

The first of the major directives Congress gave to the CFTC was to create a framework for the registration and regulation of swap dealers and major swap participants. The agency has done so. As of August 2014, there are 104 swap dealers and two major swap participants provisionally registered with the CFTC.

We have adopted rules requiring strong risk management. We will also be making periodic examinations to assess risk and compliance. The new framework requires registered swap dealers and major swap participants to comply with various business conduct requirements. These include strong standards for documentation and confirmation of transactions, as well as dispute resolution processes. They include requirements to reduce risk of multiple transactions through what is known as portfolio reconciliation and portfolio compression. In addition, swap dealers are required to make sure their counterparties are eligible to enter into swaps, and to make appropriate disclosures to those counterparties of risks and conflicts of interest.

As directed by Congress, we have worked with the SEC, other US regulators, and our international counterparts to establish this framework. We will continue to work with them to achieve as much consistency as possible. We will also look to make sure these rules work to achieve their objectives, and fine-tune them as needed where they do not.

Clearing

A second commitment of Dodd-Frank was to require clearing of standardized transactions at central counterparties. The use of CCPs in financial markets is commonplace and has been around for over one hundred years. The idea is simple: if many participants are trading standardized products on a regular basis, the tangled, hidden web created by thousands of private two-way trades can be replaced with a more transparent and orderly structure, like the spokes of a wheel, with the CCP at the center interacting with other market participants. The CCP monitors the overall risk and positions of each participant.

Clearing does not eliminate the risk that a counterparty to a trade will default, but it provides us various means to mitigate that risk. As the value of positions change, margin can be collected efficiently to ensure counterparties are able to fulfill their obligations to each other. And if a counterparty does default, there are tools available to transfer or unwind positions and protect other market participants. To work well, active, ongoing oversight is critical. We must be vigilant to ensure that CCPs are operated safely and deliver the benefits they are designed to provide.

The CFTC was the first of the G-20 nations’ regulators to implement clearing mandates. We have required clearing for interest rate swaps (IRS) denominated in US dollars, Euros, Pounds and Yen, as well as credit default swaps (CDS) on certain North American and European indices. Based on CFTC analysis of data reported to swap data repositories, as of August 2014, measured by notional value, 60% of all outstanding transactions were cleared. This is compared to estimates by the International Swaps and Derivatives Association (ISDA) of only 16% in December 2007. With regard to index CDS, most new transactions are being cleared – 85% of notional value during the month of August.

Our rules for clearing swaps were patterned after the successful regulatory framework we have had in place for many years in the futures market. We do not require that clearing take place in the United States, even if the swap is in U.S. dollars and between U.S. persons. But we do require that clearing occurs through registered CCPs that meet certain standards – a comprehensive set of core principles that ensures each clearinghouse is appropriately managing the risk of its members, and monitoring its members for compliance with important rules.

Fourteen CCPs are registered with the CFTC as derivatives clearing organizations (DCOs) either for swaps, futures, or both. Five of those are organized outside of the United States, including three in Europe which have been registered since 2001 (LCH.Clearnet Ltd.); 2010 (ICE Clear Europe Ltd); and 2013 (LCH.Clearnet SA). In some cases, a majority of the trades cleared on these European-based DCOs are for U.S. persons.

At the same time, the CFTC has specifically exempted most commercial end-users from the clearing mandate. We have been sensitive to Congress’s directive that these entities, which were not responsible for the crisis and rely on derivatives primarily to hedge commercial risks, should not bear undue burdens in accessing these markets to hedge their risk.

Of course, central clearing by itself is not a panacea. CCPs do not eliminate the risks inherent in the swaps market. We must therefore be vigilant. We must do all we can to ensure that CCPs have financial resources, risk management systems, settlement procedures, and all the necessary standards and safeguards consistent with the core principles to operate in a fair, transparent and efficient manner. We must also make sure that CCP contingency planning is sufficient.

Trading

The third area for reform under Dodd-Frank was to require more transparent trading of standardized products. In the Dodd-Frank Act, Congress provided that certain swaps must be traded on a swap execution facility (SEF) or other regulated exchange. The Dodd Frank Act defined a SEF as “a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants.” The trading requirement was designed to facilitate a more open, transparent and competitive marketplace, benefiting commercial end-users seeking to lock in a price or hedge risk.

The CFTC finalized its rules for SEFs in June 2013. Twenty-two SEFs have temporarily registered with the CFTC, and two applications are pending. These SEFs are diverse, but each will be required to operate in accordance with the same core principles. These core principles provide a framework that includes obligations to establish and enforce rules, as well as policies and procedures that enable transparent and efficient trading. SEFs must make trading information publicly available, put into place system safeguards, and maintain financial, operational and managerial resources to discharge their responsibilities.

Trading on SEFs began in October of last year. Beginning February 2014, specified interest rate swaps and credit default swaps must be traded on a SEF or other regulated exchange. Notional value executed on SEFs has generally been in excess of $1.5 trillion weekly.

It is important to remember that trading of swaps on SEFs is still in its infancy. SEFs are still developing best practices under the new regulatory regime. The new technologies that SEF trading requires are likewise being refined. Additionally, other jurisdictions have not yet implemented trading mandates, which has slowed the development of cross-border platforms. There will be issues as SEF trading continues to mature. We will need to work through these to achieve fully the goals of efficiency and transparency SEFs are meant to provide.

Data Reporting

The fourth Dodd-Frank reform commitment was to require ongoing reporting of swap activity. Having rules that require oversight, clearing, and transparent trading is not enough. We must have an accurate, ongoing picture of what is going on in the marketplace to achieve greater transparency and to address potential systemic risk.

Title VII of the Dodd-Frank Act assigns the responsibility for collecting and maintaining swap data to swap data repositories (SDRs), a new type of entity necessitated by these reforms. All swaps, whether cleared or uncleared, must be reported to SDRs. There are currently four SDRs that are provisionally registered with the CFTC.

The collection and public dissemination of swap data by SDRs helps regulators and the public. It provides regulators with information that can facilitate informed oversight and surveillance of the market and implementation of our statutory responsibilities. Dissemination, especially in real-time, also provides the public with information that can contribute to price discovery and market efficiency.

While we have accomplished a lot, much work remains. The task of collecting and analyzing data concerning this marketplace requires intensely collaborative and technical work by industry and the agency’s staff. Going forward, it must continue to be one of our chief priorities.

There are three general areas of activity. We must have data reporting rules and standards that are specific and clear, and that are harmonized as much as possible across jurisdictions. The CFTC is leading the international effort in this area. It is an enormous task that will take time. We must also make sure the SDRs collect, maintain, and publicly disseminate data in the manner that supports effective market oversight and transparency. Finally, market participants must live up to their reporting obligations. Ultimately, they bear the responsibility to make sure that the data is accurate and reported promptly.

Our Agenda Going Forward

The progress I have outlined reflects the fact that the CFTC has finished almost all of the rules required by Congress in the Dodd-Frank Act to regulate the over-the-counter swaps market. This was a difficult task, and required tremendous effort and commitment. My predecessor, Gary Gensler, deserves substantial credit for leading the agency in implementing these reforms so quickly. All of the Commissioners contributed valuable insight and deserve our thanks. But no group deserves more credit than the hardworking professional staff of the agency. It was an extraordinary effort. I want to publicly acknowledge and thank them for their contributions.

The next phase requires no less effort. I want to highlight several areas going forward that are critical to realizing the benefits Congress had in mind when it adopted this new framework and to minimizing any unintended consequences.

Finishing and Fine-tuning Dodd-Frank Regulations

First, as markets develop and we gain experience with the new Dodd-Frank regulations, I anticipate we will, from time to time, make some adjustments and changes. This is to be expected in the case of a reform effort as significant as this one. These are markets that grew to be global in nature without any regulation, and the effort to bring them out of the shadows is a substantial change. It is particularly difficult to anticipate with certainty how market participants will respond and how markets will evolve. At this juncture, I do not believe wholesale changes are needed, but some clarifications and improvements are likely to be considered.

In fine-tuning existing rules, and in finishing the remaining rules that Congress has required us to implement, we must make sure that commercial businesses like farmers, ranchers, manufacturers, and other companies can continue to use these markets effectively. Congress rightly recognized that these entities stand in a different position compared to financial firms. We must make sure the new rules do not cause inappropriate burdens or unintended consequences for them. We hope to act on a new proposed rule for margin for uncleared swaps in the near future. On position limits, we have asked for and received substantial public comment, including through roundtables and face-to-face meetings. This input has been very helpful enabling us to calibrate the rules to achieve the goals of reducing risk and improving the market without imposing unnecessary burdens or causing unintended consequences.

Cross-Border Regulation of the Swaps Market

A second key area is working with our international counterparts to build a strong global regulatory framework. To succeed in accomplishing the goals set out in the G-20 commitments and embodied in the Dodd-Frank Act, global regulators must work together to harmonize their rules and supervision to the greatest extent possible. Fundamentally, this is because the markets that the CFTC is charged to regulate are truly global. What happens in New York, Chicago, or Kansas City is inextricably interconnected with events in London, Hong Kong and Tokyo. The lessons of the financial crisis remind us how easy it is for risks embedded in overseas derivatives transactions to flow back into the United States. And Congress directed us to address the fact that activities abroad can result in importation of risk into the United States.

This is a challenging task. Although the G-20 nations have agreed on basic principles for regulating over-the-counter derivatives, there can be many differences in the details. While many sectors of the financial industry are global in nature, applicable laws and rules typically are not. For example, no one would expect that the laws which govern the selling of securities, or the securing of bank loans, should be exactly the same in all the G-20 nations. While our goal should be harmonization, we must remember that regulation occurs through individual jurisdictions, each informed by its own legal traditions and regulatory philosophies.

Our challenge is to achieve as consistent a framework as possible while not lowering our standards simply to reach agreement, thus triggering a “race to the bottom.” We must also minimize opportunities for regulatory arbitrage, where business moves to locales where the rules are weaker or not yet in place.

The CFTC’s adoption of regulations for systemically important CCPs is a useful model for success. Our rules were designed to meet the international standards for the risk management of systemically important CCPs, as evidenced by the Principles for Financial Market Infrastructures (PFMIs) published by the Bank of International Settlement’s Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions, to which the Commission was a key contributor.

Since the day I joined the CFTC, I have been focused on cross-border issues. In my first month in office I went to Europe twice to meet with my fellow regulators, and I have been engaged in ongoing dialogue with them.

Robust Compliance and Enforcement

A third major area is having robust compliance and enforcement activities. It is not enough to have rules on the books. We must be sure that market participants comply with the rules and fulfill their obligations. That is why, for example, several weeks ago we fined a large swap dealer for failing to abide by our data reporting rules.

A strong compliance and enforcement function is vital to maintaining public confidence in our markets. This is critical to the participation of the many Americans who depend on the futures and swaps markets – whether they are farmers, oil producers or exporters. And even though most Americans do not participate directly in the futures and swaps markets, our enforcement efforts can help rebuild and maintain public confidence and trust in our financial markets.

We must aggressively pursue wrongdoers, big or small, and vigorously fulfill our responsibility to enforce the regulations governing these markets. Our pursuit of those who have manipulated benchmarks like LIBOR, a key global benchmark underlying a wide variety of financial products and transactions, is a prime example of this principle in practice. So is our successful litigation against Parnon Energy and Arcadia, two energy companies that systematically manipulated crude oil markets to realize illicit profits.

Dodd-Frank provided the Commission with a number of new statutory tools to ensure the integrity of our markets, and we have moved aggressively to incorporate these tools into our enforcement efforts. Our new anti-manipulation authority gives us enhanced ability to go after fraud-based manipulation of our markets. We have put that authority to good use in a host of cases and investigations, including actions against Hunter Wise and a number of smaller firms for perpetrating precious metals scams. Congress also gave us new authority to attack specific practices that unscrupulous market participants use to distort the markets, such as "spoofing," where a party enters a bid or offer with the intent to move the market price, but not to consummate a transaction. We used this new anti-spoofing provision to successfully prosecute Panther Energy for its spoofing practices in our energy markets.

Going forward, protecting market integrity will continue to be one of our key priorities. Market participants should understand that we will use all the tools at our disposal to do so.

Information Technology and Data Management

It is also vital that the CFTC have up to date information technology systems. Handling massive amounts of swaps data and effective market oversight both depend on the agency having up-to-date technology resources, and the staff – including analysts and economists, as well as IT and data management professionals – to make use of them. The financial markets today are driven by sophisticated use of technology, and the CFTC cannot effectively oversee these markets unless it can keep up.

Cyber-security is a related area where we must remain vigilant. As required by Congress, we have implemented new requirements related to exchanges’ cyber-security and system safeguard programs. The CFTC conducts periodic examinations that include review of cyber-security programs put in place by key market participants, and there is much more we would like to do in this area. Going forward, the Commission’s examination expertise will need to be expanded to keep up with emerging risks in information security, especially in the area of cyber-security.

Resources and Budget

All of these tasks represent the significant increases in responsibility that came with Dodd Frank. They require resources. But the CFTC does not have the resources to fulfill these tasks as well as all the responsibilities it had – and still has – prior to the passage of Dodd Frank. The CFTC is lucky to have a dedicated and resourceful professional staff. Although I have been at the agency a relatively short time, I am already impressed by how much this small group is able to accomplish. Still, as good as they are, the reality of our current budget is evident.

I recognize that there are many important priorities that Congress must consider in the budgeting process. I appreciate the importance of being as efficient as possible. I have also encouraged our staff to be creative in thinking about how we can best use our limited resources to accomplish our responsibilities. We will keep the Teddy Roosevelt adage in mind, that we will do what we can, with what we have, where we are.

But I hope to work with members of Congress to address our budget constraints. Our current financial resources limit our ability to fulfill our responsibilities in a way that most Americans would expect. The simple fact is that Congress’s mandate to oversee the swaps market in addition to the futures and options markets requires significant resources beyond those the agency has previously been allocated. Without additional resources, our markets cannot be as well supervised; participants cannot be as well protected; market transparency and efficiency cannot be as fully achieved.

Specifically, in the absence of additional resources, the CFTC will be limited in its ability to:

Perform adequate examinations of market intermediaries, including systemically important DCOs and the approximately 100 swap dealers that have registered with the Commission under the new regulatory framework required by Dodd-Frank.

Use swaps data to address risk in a marketplace that that has become largely automated, and to develop a meaningful regulatory program that is required to promote price transparency and market integrity.

Conduct effective daily surveillance to identify the buildup of risks in the financial system, including for example, review of CFTC registrant activity reports submitted by Commodity Pool Operators and banking entities, as well as to monitor compliance with rules regarding prohibitions and restrictions on proprietary trading.

Investigate and prosecute major cases involving threats to market integrity and customer harm and strengthen enforcement activities targeted at disruptive trading practices and other misconduct of registered entities such as precious metals schemes and other forms of market manipulation.
Conclusion

A few core principles must motivate our work in implementing Dodd-Frank. The first is that we must never forget the cost to American families of the financial crisis, and we must do all we can to address the causes of that crisis in a responsible way. The second is that the United States has the best financial markets in the world. They are the strongest, most dynamic, most innovative, most competitive and transparent. They have been a significant engine of our economic growth and prosperity. Our work should strengthen our markets and enhance those qualities. We must be careful not to create unnecessary burdens on the dynamic and innovative capacity of our markets. I believe the CFTC's work can accomplish these objectives. We have made important progress but there is still much to do. I look forward to working with the members of this Committee and my fellow regulators on these challenges.

Thank you again for inviting me today. I look forward to your questions.

Last Updated: September 9, 2014

CFTC CHARGES MAN AND BUSINESS WITH OPERATION OF ILLEGAL PRECIOUS METALS SCHEME

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 

CFTC Charges Florida-Based Southern Trust Metals, Inc. and Robert Escobio, and His BVI-Based Entity Loreley Overseas Corp., with Operating an Illegal Precious Metals Scheme, among other Violations

Defendants Solicited over $3.5 Million from Customers in the Precious Metals Scheme and in a Separate Unlawful Commodity Futures and Options Scheme

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) filed a civil enforcement Complaint in the U.S. District Court for the Southern District of Florida against Defendants Southern Trust Metals, Inc. (ST Metals) and Robert Escobio, both of Coral Gables, Florida, and Loreley Overseas Corp. (Loreley), a British Virgin Island entity that Escobio incorporated in 2004. The CFTC Complaint charges that, from at least July 16, 2011 to May 1, 2013, the Defendants operated a scheme that defrauded retail customers in connection with illegal, off-exchange, financed precious metals transactions. In operating the precious metals scheme, the Defendants received more than $2.6 million from at least 135 customers, who collectively lost $600,000 of the funds invested with ST Metals, according to the Complaint.

In a separate unlawful scheme, the Defendants, between February 2011 and May 2013, solicited and accepted more than $900,000 from customers for the purchase or sale of commodity futures and options, without registering with the CFTC as a Futures Commission Merchant, according to the Complaint.

ST Metals solicited retail customers to engage in off-exchange leveraged, margined, or financed precious metals transactions. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), these transactions are illegal unless they result in actual delivery of metal within 28 days. The Complaint alleges that metals were never actually delivered in connection with these precious metals transactions. Instead, the Complaint alleges, ST Metals engaged in a series of transactions that ended with over-the-counter derivative trades in margin trading accounts in the name of Loreley with two U.K.-based trading firms. Additionally, according to the Complaint, ST Metals told customers that it was making loans to purchase precious metals in connection with these transactions, but in fact, no loans were made, no metals were purchased, and the transactions were illegal commodity transactions under the Dodd-Frank Act.

In its continuing litigation against ST Metals, Loreley, and Escobio, the CFTC seeks disgorgement of ill-gotten gains, restitution for the benefit of customers, civil monetary penalties, permanent registration and trading bans, and a permanent injunction from future violations of the Commodity Exchange Act, as charged.

The CFTC thanks the U.K. Financial Conduct Authority for its assistance in this matter.

CFTC Division of Enforcement staff members responsible for this action are Carlin Metzger, Heather Johnson, Joseph Konizeski, Scott Williamson, and Rosemary Hollinger.

SEC AWARDS $875,000 IN WHISTLEBLOWER MONEY TO BE SPLIT BETWEEN TWO TIPSTERS

FROM:  U.S. SECURITIES AND EXCHANGE  COMMISSION 

The Securities and Exchange Commission today announced a whistleblower award of more than $875,000 to be split evenly between two individuals who provided tips and assistance to help the agency bring an enforcement action.

The SEC’s whistleblower program authorized by the Dodd-Frank Act rewards high-quality, original information that results in an SEC enforcement action with sanctions exceeding $1 million.  Whistleblower awards can range from 10 percent to 30 percent of the money collected in a case.

By law, the SEC must protect the confidentiality of whistleblowers and cannot disclose any information that might directly or indirectly reveal a whistleblower’s identity.

“These whistleblowers provided original information and assistance that enabled us to investigate and bring a successful enforcement action in a complex area of the securities market,” said Sean McKessy, chief of the SEC’s Office of the Whistleblower.  “Whistleblowers who report their concerns to the SEC perform a great service to investors and help us combat fraud.”

A total of eight whistleblowers have been awarded through the SEC’s whistleblower program since it began in late 2011.

SETTLEMENT CHARGES SETTLED IN "LONDON WHALE" SWAPS TRADES CASE

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
CFTC Files and Settles Charges Against JPMorgan Chase Bank, N.A., for Violating Prohibition on Manipulative Conduct In Connection with “London Whale” Swaps Trades

JPMorgan Admits to Reckless Conduct in First Case Charging Violation of Dodd Frank’s Prohibition Against Manipulative Conduct and is Ordered to Pay a $100 Million Civil Monetary Penalty

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today issued an Order against JPMorgan Chase Bank, N.A. (JPMorgan or Bank), bringing and settling charges for employing a manipulative device in connection with the Bank’s trading of certain credit default swaps (CDS), in violation of the new Dodd-Frank prohibition against manipulative conduct. As set forth in the CFTC’s Order, by selling a staggering volume of these swaps in a concentrated period, the Bank, acting through its traders, recklessly disregarded the fundamental precept on which market participants rely, that prices are established based on legitimate forces of supply and demand. As a result, after a thorough 17-month investigation, the Commission has found the Bank liable for violating Section 6(c)(1) of the Commodity Exchange Act (the “Act”), 7 U.S.C. §9 (2012), as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”), and Commission Regulation 180.1, 17 C.F.R. §180.1 (2012).

JPMorgan, which admits the specified factual findings in the Order including that its traders acted recklessly, is directed, among other things, to pay a $100 million civil monetary penalty.

“In Dodd-Frank, Congress provided a powerful new tool enabling the CFTC for the first time to prohibit reckless manipulative conduct,” said David Meister, the CFTC’s Director of Enforcement. “As this case demonstrates, the Commission is now better armed than ever to protect the market from traders, like those here, who try to ‘defend’ their position by dumping a gargantuan, record-setting, volume of swaps virtually all at once, recklessly ignoring the obvious dangers to legitimate pricing forces.”

Highlights of the CFTC Order

The CDS market comprises globally traded credit derivatives used to speculate on and hedge against credit defaults. Trillions of dollars (notional) of CDS instruments and baskets of CDS called credit default indices, some known as CDX, are used to transfer risk of defaults by companies in the United States and around the world. As such, the CDS market is an important aspect of the global economy.

From approximately 2007 through 2011, JPMorgan’s Chief Investment Office (“CIO”), operating through a trading desk in the Bank’s London branch, traded and held various credit default indices, including CDX, in a Synthetic Credit Portfolio (“SCP”). Each day the SCP traders marked their positions to market, assigning a value to the positions using market prices and other factors. That value was used to calculate the CIO’s profits and losses. At the end of each month an “independent” group at JPMorgan tested the validity of the traders’ month-end marks.

As of the end of 2011, the portfolio held $51 billion net notional of these credit instruments, the outsized amount spurring press reports referring to one CIO trader as the “London Whale.” Although previously quite profitable, the portfolio had taken a serious turn for the worse at least by late January 2012, with year-to-date mark-to-market losses of $100 million. In February 2012, daily losses were large and growing.

The violation charged in the CFTC’s Order concerns the Bank’s trading of one particular credit default index -- “CDX NA.IG9 10 year index” (“IG9 10Y”). As the end of February 2012 approached, the SCP’s net short position in the IG9 10Y grew to a mammoth $65 billion, which meant that relatively small favorable or adverse movements in market prices produced significant mark-to-market profits or losses for the CIO. Because the SCP was short IG9 10Y, the mark-to-market value of the position increased as the market price decreased.

On February 29, just ahead of the month-end testing of their marks, the traders believed the portfolio’s situation was grave. That day, desperate to avoid further losses, the traders developed a resolve, as they put it, to “defend the position.” Recognizing that the sheer size of their position in IG9 10Y had the potential to affect or influence the market, the traders recklessly sold massive amounts of protection on the IG9 10Y. They were short protection and they sold more protection.

Specifically, with the portfolio standing to benefit as the IG9 10Y market price dropped, on February 29 the CIO sold on net more than $7 billion of IG9 10Y, a staggering volume -- far and away the largest amount the CIO ever traded in one day -- $4.6 billion of which was sold during a three-hour period as the day drew to a close.

The Order provides comparative measures that demonstrate just how large and concentrated these February 29 sales of IG9 10Y were. For example, these sales alone accounted for more than 90% of the day’s net volume traded by the entire market, were 15% of the month’s net volume traded by the entire market, and were nearly 11 times the SCP’s average daily volume in February. The February 29 trading followed more than $3 billion in sales of the IG9 10Y during the prior two days. The net volume the CIO sold February 27-29 amounted to roughly one-third of the total volume traded for the entire month of February by all other market participants.

During this same period at month-end, the IG9 10Y market price dropped substantially. While the CIO was selling at generally declining prices, the value of the short position that the CIO held in the SCP benefited on a mark-to-market basis from the declining market prices.

As set forth in the Order, the trading strategy to “defend the position” -- selling $7.17 billion of the IG9 10Y on February 29 in a concentrated period -- constituted a manipulative device employed by the traders in reckless disregard of the possible consequences of their conduct, including obvious dangers to legitimate market forces. That conduct therefore violated section 6(c)(1) of the Act and Rule 180.1.

In addition to paying a $100 million penalty, JPMorgan must continue to implement written enhancements to its supervision and control system in connection with swaps trading activity, including trading and risk management controls reasonably designed to prevent and promptly detect mis-marking of its books, enhanced communications among risk, control and supervisory functions, and the development of additional surveillance tools to assist supervisors with monitoring trading activity in connection with swaps.

In addition to finding the violation, the Order describes aspects of the CFTC’s new business conduct rules applicable to swap dealers. JPMorgan registered with the Commission as a swap dealer as of December 31, 2012, and at that time became subject to the Commission’s new swap dealer regime, including rules that impose supervision and control obligations. Although these rules did not apply to the Bank at the time of the events in question, the Order explains how some of these new rules would have covered the matters set forth in the Order, and concludes that had the regulations been in place, much of the offending conduct at issue (and the significant losses it caused) may well have been detected and remedied internally much more quickly, thereby potentially reducing losses.

The CFTC acknowledges the valuable assistance of the United Kingdom’s Financial Conduct Authority, as well as that of the U.S. Securities and Exchange Commission and the United States Attorney’s Office for the Southern District of New York.

The CFTC also acknowledges JPMorgan’s cooperation with the Division of Enforcement’s investigation.

CFTC Division of Enforcement staff responsible for this action are Saadeh Al-Jurf, Allison Baker Shealy, Traci Rodriguez, Daniel Ullman, Joan Manley, and Paul G. Hayeck.

CFTC COMMISSIONER CHILTON'S STATEMENT ON CROSS-BORDER GUIDANCE AND EXEMPTIVE ORDER

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION 
“Just Say’n”

Statement of Commissioner Bart Chilton on Cross-Border Guidance and Exemptive Order, Washington, DC

July 12, 2013

We’ve done a lot of rules and we’ve done way more than other financial regulators. We have final clearing and transparency rules, recordkeeping, reporting, and registration rules, and we’re working hard to finalize other important areas (like, just gotta say, position limits and I hope we more actively engage on Volcker). We’ve done a heckuva job on a lot of issues. All of these are super important. Nothing we’ve done, however, will fully succeed without the critical action that I hope we will take today. Just say’n.

That’s because we don’t live in a void all to ourselves. We live in a world with intricate, inter-connected, interdependent international markets. There is a commonality of connections like never before in history. What happens in one nation impacts another. Risk travels around the globe with a click of the mouse.

We’ve learned that hurting lesson and come to this point where we can move forward. Here are the two key takeaways for me on what we can do today:

1. We can provide certainty to markets and market participants to give needed structure in our rapidly changing financial world;

2. We can do so in a fashion—through phased-in effective dates for rules—that is cognizant of other global regulators, particularly those in the European Union.

Like in the movie Field of Dreams, when the voice from the corn field says, “If you build it, he will come.” I’ve said repeatedly that if we and the E.U. build balanced and fairly harmonized financial regulatory regimes, the rest of the world will come. The rest of the world will build similar regulatory structures. And that’s the ticket to protecting consumers: a network of fairly comparable and comprehensive rules that guard against systemic risks for us, but for other nations as well.

Now, before I finish, there’s a key concept I want to highlight for all the naysayers out there. The economy crashed in 2008. Dodd-Frank was passed in 2010 and required—required—us to implement it in 2011. The G-20 even agreed that swaps reform should be done in 2012. We’ve had a guidance document floating around here for half-a-year. My point, and I do have one, is this: it isn’t like this regulatory reform or this guidance snuck up on us. And, there isn’t any reason for folks to come down with acute Reguphobia at this state of play—paranoia will destroya.

At the same time, we’re always going for balance, so let me highlight the important comment period here: 75 days. We want them, we need them, gotta have ‘em! I hope and expect to hear from the public on any and all issues relating to our implementation of Dodd-Frank—on all fronts. We all are down in the weeds implementing these things, and if we need to tweak or adjust, work on a few kinks, on any issue, from implementation of cross-border trading requirements to indemnification guidance—let us know. And to that end, let me reiterate something I said in October and repeated in December: during this interim period of phased in compliance, I cannot envision nor would I support the agency taking any action against an entity engaging in good faith compliance, nor can I envision an action in the future taken retroactively for non-compliance in this interim period. We’ve all gotta use a common sense, reasonable man standard here.

(Oh, and by the way, while your commenting, please feel free to tell us if we got something right, as well!)

We all know that once in a while regulators can leave a thread hanging loose, ‘cause ooh, we aren’t always perfect. In this regard, I plan to engage the Global Markets Advisory Committee (GMAC) during this comment period to ensure we have a live-action forum to hear from folks (not that people have been shy about airing their concerns to date).

Finally, I express my sincere gratitude to the Chairman for his tireless work on all of these issues. I also thank my colleagues, Commissioner Sommers (whom we will miss), Commissioners O’Malia and Wetjen and their staffs. Finally, special heartfelt thanks to the professional agency staff who have worked exceedingly hard on this key component of financial reform. We need to honor your tireless work by passing this thing—the guidance and phased-in compliance—today. Not to do so would allow consumers and our economy to be unprotected. That just wouldn’t be right. Just say’n.

Thank you.

FDIC CHAIRMAN GRUENBERG GIVES STATEMENT ON MITIGATING SYSTEMIC RISK THROUGH REFORM

FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 

Statement Of Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation on Mitigating Systemic Risk Through Wall Street Reform before the Committee on Banking, Housing, and Urban Affairs of the U.S. Senate; 538 Dirksen Senate Office Building

July 11, 2013 

Chairman Johnson, Ranking Member Crapo and members of the Committee, thank you for the opportunity to testify today on the Federal Deposit Insurance Corporation's (FDIC) actions to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

With the three-year anniversary of the Dodd-Frank Act approaching, the FDIC has made significant progress in implementing the new authorities granted by the Act, 1 particularly with regard to the authorities to address the issues presented by institutions that pose a risk to the financial system. We also have moved forward in our efforts to strengthen the Deposit Insurance Fund and to improve the resiliency of the capital framework for the banking industry.

My written testimony will address three key areas. First, I will provide a brief overview of the current state of the banking industry and the federal deposit insurance system. Second, I will provide an update on our progress in implementing the new authority provided to the FDIC to address the issues posed by systemically important financial institutions. Finally, I will discuss the Act’s impact on our supervision of community banks.

Overview of the Banking Industry

The financial condition of the banking industry in the United States has experienced three consecutive years of gradual but steady improvement. Industry balance sheets have been strengthened and capital and liquidity ratios have been greatly improved.

Industry net income has now increased on a year-over-year basis for 15 consecutive quarters. FDIC-insured commercial banks and savings institutions reported aggregate net income of $40.3 billion in the first quarter of 2013, a $5.5 billion (15.8 percent) increase from the $34.8 billion in profits that the industry reported in the first quarter of 2012. Half of the 7,019 FDIC-insured institutions reporting financial results had year-over-year increases in their earnings. The proportion of banks that were unprofitable fell to 8.4 percent, down from 10.6 percent a year earlier.

Credit quality for the industry also has improved for 12 consecutive quarters. Delinquent loans and charge-offs have been steadily declining for over two years. Importantly, loan balances for the industry as a whole have now grown for six out of the last eight quarters. These positive trends have been broadly shared across the industry, among large institutions, mid-size institutions, and community banks.

The internal indicators for the FDIC also have been moving in a positive direction over this period. The number of banks on the FDIC's "Problem List" – institutions that had our lowest supervisory CAMELS ratings of 4 or 5 – peaked in March of 2011 at 888 institutions. By the end of last year, the number of problem banks stood at 651 institutions, dropping further to 612 institutions at the end of the first quarter 2013. In addition, the number of failed banks has been steadily declining. Bank failures peaked at 157 in 2010, followed by 92 in 2011, and 51 in 2012. To date in 2013, there have been 16 bank failures compared to 31 through the same period in 2012.

Despite these positive trends, the banking industry still faces a number of challenges. For example, although credit quality has been improving, delinquent loans and charge-offs remain at historically high levels. In addition, tighter net interest margins and relatively modest loan growth have created incentives for institutions to reach for yield in their loan and investment portfolios, heightening their vulnerability to interest rate risk and credit risk. Rising rates could heighten pressure on earnings at financial institutions that are not actively managing these risks. The federal banking agencies have reiterated their expectation that banks manage their interest rate risk in a prudent manner, and supervisors continue to actively monitor this risk.

Condition of the FDIC Deposit Insurance Fund

As the industry has recovered over the past three years, the Deposit Insurance Fund (DIF) also has moved into a stronger financial position.

Restoring the DIF

The Dodd-Frank Act raised the minimum reserve ratio for the DIF (the DIF balance as a percent of estimated insured deposits) from 1.15 percent to 1.35 percent, and required that the reserve ratio reach 1.35 percent by September 30, 2020. The FDIC is currently operating under a DIF Restoration Plan that is designed to meet this deadline, and the DIF reserve ratio is recovering at a pace that remains on track under the Plan. As of March 31, 2013, the DIF reserve ratio stood at 0.59 percent of estimated insured deposits, up from 0.44 percent at year-end 2012 and 0.22 percent at March 31 of last year. Most of the first quarter 2013 increase in the reserve ratio can be attributed to the expiration of temporary unlimited deposit insurance coverage for noninterest-bearing transaction accounts under the Act on December 31, 2012

The fund balance has grown for thirteen consecutive quarters and stood at $35.7 billion at March 31, 2013. This is in contrast to the negative $21 billion fund balance at its low point at the end of 2009. Assessment revenue and fewer anticipated bank failures have been the primary drivers of the growth in the DIF balance.

Prepaid Assessments

At the end of 2009, banks prepaid to the FDIC more than three years of estimated deposit insurance assessments, totaling $45.7 billion. The prepaid assessments were successful in ensuring that the DIF had adequate liquidity to handle a high volume of bank failures without having to borrow from the Treasury. In accordance with the regulation implementing the prepaid assessment, the FDIC refunded almost $6 billion in remaining unused balances of prepaid assessments to approximately 6,000 insured institutions at the end of June.

Improving Financial Stability and Mitigating Systemic Risk

Capital Requirements

On July 9, the FDIC Board acted on two important regulatory capital rulemakings. First, the FDIC issued an interim final rule that significantly revises and strengthens risk-based capital regulations through implementation of Basel III. This rule consolidates the proposals issued in the three separate notices of proposed rulemakings (NPRs) that the agencies issued last year and includes significant changes from the original proposals to address concerns raised by community banks. Second, the FDIC issued a joint interagency NPR to strengthen the leverage requirements for systemically important banking organizations.

Interim Final Rule on Basel III

The interim final rule on Basel III would strengthen both the quality and quantity of risk-based capital for all banks by placing greater emphasis on Tier 1 common equity capital. Tier 1 common equity capital is widely recognized as the most loss-absorbing form of capital. The interim final rule adopts with revisions the three notices of proposed rulemakings or NPRs that the banking agencies proposed last year. These are the Basel III NPR, the Basel III advanced approaches NPR, and the so-called Standardized Approach NPR. These changes will create a stronger, more resilient industry better able to withstand environments of economic stress in the future.

This interim final rule is identical in substance to the final rules issued by the Federal Reserve Board and the Office of the Comptroller of the Currency (OCC) and allows the FDIC to proceed with the implementation of these revised capital regulations in concert with our fellow regulators. Issuing the interim final rule also allows us to seek comment on the interactions between the revised risk-based capital regulations and the proposed strengthening of the leverage requirements for the largest and most systemically important banking organizations which is described in more detail below.

During the comment period on these proposals, we received a large number of comments, particularly from community banks, expressing concerns with some of the provisions of the NPRs. The interim final rule makes significant changes to aspects of the NPRs to address a number of these community bank comments. Specifically, unlike the NPR, the rule does not make any changes to the current risk-weighting approach for residential mortgages. It allows for an opt-out from the regulatory capital recognition of accumulated other comprehensive income, or AOCI, except for large banking organizations that are subject to the advanced approaches requirements. Further, the rule reflects that the Federal Reserve has adopted the grandfathering provisions of section 171 of the Dodd Frank Act for Trust Preferred Securities issued by smaller bank holding companies. Comments received on all these matters were extremely helpful to the agencies in reaching decisions on the proposals.

The interim final rule includes requirements for large banking organizations subject to the advanced approaches requirements that do not apply to community banks. For example, these advanced approach large institutions would be required to recognize AOCI in regulatory capital and also would face strengthened capital requirements for over-the-counter derivatives.

Consistent with the Basel III international agreement, the interim final rule includes a three percent supplementary leverage ratio that applies only to the 16 large banking organizations subject to the advanced approaches requirements. This supplementary leverage ratio is more stringent than the existing U.S. leverage ratio as it would include certain off-balance sheet exposures in its denominator. Given the extensive off-balance sheet activities of many advanced approaches organizations, the supplementary leverage ratio will play an important role. Finally, the rule maintains the existing U.S. leverage requirements for all insured banks, with the minimum leverage requirements continuing to set a floor for the leverage requirements of advanced approaches banking organizations.

Although the new requirements are higher and more stringent than the old requirements, the vast majority of banks meet the requirements of the interim final rule. Going forward, the rule would have the effect of preserving and maintaining the gains in capital strength the industry has achieved in recent years. As a result, banks should be better positioned to withstand periods of economic stress and serve as a source of credit to local communities.

While much contained in these rules does not apply to community banks, we want to be certain that community banks fully understand the changes in the capital rules that do apply to them. To that end, the FDIC is planning an extensive outreach program to assist community banks in understanding the interim final rule and the changes it makes to the existing capital requirements. We will provide technical assistance in a variety of forms, targeted specifically at community banks, including community bank guides on compliance with the rule, a video that will be available on the FDIC website, a series of regional outreach meetings, and subject matter experts at each of our regional offices whom banks can contact directly with questions.

Interagency NPR on the Supplementary Leverage Ratio

The FDIC joined the Federal Reserve and the OCC in issuing an NPR which would strengthen the supplementary leverage requirements encompassed in the interim final rule for certain large institutions and their insured banks. Using the NPR’s proposed definitions of $700 billion in total consolidated assets or $10 trillion in assets under custody to identify large systemically significant firms, the new requirements would currently apply to eight U.S. bank holding companies and to their insured banks.

As the NPR points out, maintenance of a strong base of capital at the largest, most systemically important institutions is particularly important because capital shortfalls at these institutions can contribute to systemic distress and can have material adverse economy effects. Analysis by the agencies suggests that a three percent minimum supplementary leverage ratio would not have appreciably mitigated the growth in leverage among these organizations in the years preceding the recent crisis. Higher capital standards for these institutions would place additional private capital at risk before calling upon the DIF and the Federal government’s resolution mechanisms.

The NPR would require these insured banks to satisfy a six percent supplementary leverage ratio to be considered well capitalized for prompt corrective action (PCA) purposes. Based on current supervisory estimates of the off-balance sheet exposures of these banks, this would correspond to roughly an 8.6 percent U.S. leverage requirement. For the eight affected banks, this would currently represent $89 billion in additional capital for an insured bank to be considered well-capitalized.

Bank Holding Companies (BHCs) covered by the NPR would need to maintain supplementary leverage ratios of a three percent minimum plus a two percent buffer for a five percent requirement in order to avoid conservation buffer restrictions on capital distributions and executive compensation. This corresponds to roughly a 7.2 percent U.S. leverage ratio, which would currently require $63 billion in additional capital.

An important consideration in calibrating the proposal was the idea that the increase in stringency of the leverage requirements and the risk-based requirements should be balanced. Leverage capital requirements and risk-based capital requirements are complementary, with each type of requirement offsetting potential weaknesses of the other. Balancing the increase in stringency of the two types of capital requirement should make for a stronger and sounder capital base for the U.S. banking system.

Resolution of Systemically Important Financial Institutions

In addition to these capital proposals, the FDIC has made progress on policies and strategies to build a more effective resolution framework for large, complex financial institutions. One of the most important aspects of the Dodd-Frank Act is the establishment of new authorities for regulators to use in the event of the failure of a systemically important financial institution (SIFI).

Resolution Plans – “Living Wills”

Under the framework of the Dodd-Frank Act, bankruptcy is the preferred option in the event of the failure of a SIFI. To make this objective achievable, Title I of the Dodd-Frank Act requires that all bank holding companies with total consolidated assets of $50 billion or more, and nonbank financial companies that the Financial Stability Oversight Council (FSOC) determines could pose a threat to the financial stability of the United States, prepare resolution plans, or “living wills,” to demonstrate how the company could be resolved in a rapid and orderly manner under the Bankruptcy Code in the event of the company’s financial distress or failure. The living will process is an important new tool to enhance the resolvability of large financial institutions through the bankruptcy process.

The FDIC and the Federal Reserve Board issued a joint rule to implement Section 165(d) requirements for resolution plans (the 165(d) rule) in November 2011. The FDIC also issued a separate rule which requires all insured depository institutions (IDIs) with greater than $50 billion in assets to submit resolution plans to the FDIC for their orderly resolution through the FDIC’s traditional resolution powers under the Federal Deposit Insurance Act (FDI Act). The 165(d) rule and the IDI resolution plan rule are designed to work in tandem by covering the full range of business lines, legal entities and capital-structure combinations within a large financial firm.

The FDIC and the Federal Reserve review the 165(d) plans and may jointly find that a plan is not credible or would not facilitate an orderly resolution under the Bankruptcy Code. If a plan is found to be deficient and adequate revisions are not made, the FDIC and the Federal Reserve may jointly impose more stringent capital, leverage, or liquidity requirements, or restrictions on growth, activities, or operations of the company, including its subsidiaries. If compliance is not achieved within two years, the FDIC and the Federal Reserve, in consultation with the FSOC, can order the company to divest assets or operations to facilitate an orderly resolution under bankruptcy in the event of failure. A SIFI’s plan for resolution under bankruptcy also will support the FDIC’s planning for the exercise of its Title II resolution powers by providing the FDIC with a better understanding of each SIFI’s structure, complexity, and processes.

2013 Guidance on Living Wills

Eleven large, complex financial companies submitted initial 165(d) plans in 2012. Following the review of the initial resolution plans, the agencies developed Guidance for the firms to detail what information should be included in their 2013 resolution plan submissions. The agencies identified an initial set of significant obstacles to rapid and orderly resolution which covered companies are expected to address in the plans, including the actions or steps the company has taken or proposes to take to remediate or otherwise mitigate each obstacle and a timeline for any proposed actions. The agencies extended the filing date to October 1, 2013, to give the firms additional time to develop resolution plan submissions that address the instructions in the Guidance.

Resolution plans submitted in 2013 will be subject to informational completeness reviews and reviews for resolvability under the Bankruptcy Code. The agencies will be looking at how each resolution plan addresses a set of benchmarks outlined in the Guidance which pose the key impediments to an orderly resolution. The benchmarks are as follows:

Multiple Competing Insolvencies: Multiple jurisdictions, with the possibility of different insolvency frameworks, raise the risk of discontinuity of critical operations and uncertain outcomes.
Global Cooperation: The risk that lack of cooperation could lead to ring-fencing of assets or other outcomes that could exacerbate financial instability in the United States and/or loss of franchise value, as well as uncertainty in the markets.
Operations and Interconnectedness. The risk that services provided by an affiliate or third party might be interrupted, or access to payment and clearing capabilities might be lost;
Counterparty Actions. The risk that counterparty actions may create operational challenges for the company, leading to systemic market disruption or financial instability in the United States; and
Funding and Liquidity. The risk of insufficient liquidity to maintain critical operations arising from increased margin requirements, acceleration, termination, inability to roll over short term borrowings, default interest rate obligations, loss of access to alternative sources of credit, and/or additional expenses of restructuring.
As reflected in the Dodd-Frank Act and discussed above, the preferred option for resolution of a large failed financial firm is for the firm to file for bankruptcy just as any failed private company would. In certain circumstances, however, resolution under the Bankruptcy Code may result in serious adverse effects on financial stability in the United States. In such cases, the Orderly Liquidation Authority set out in Title II of the Dodd-Frank Act serves as the last resort alternative and could be invoked pursuant to the statutorily prescribed recommendation, determination and expedited judicial review process.

Orderly Liquidation Authority

Prior to the recent crisis, the FDIC’s receivership authorities were limited to federally insured banks and thrift institutions. The lack of authority to place the holding company or affiliates of an insured depository institution or any other non-bank financial company into an FDIC receivership to avoid systemic consequences severely constrained the ability to resolve a SIFI. Orderly Liquidation Authority provided under Title II of the Dodd-Frank Act gives the FDIC the powers necessary to resolve a failing systemic non-bank financial company in an orderly manner that imposes accountability on shareholders, creditors and management of the failed company while mitigating systemic risk and imposing no cost on taxpayers.

The FDIC has largely completed the core rulemakings necessary to carry out its systemic resolution responsibilities under Title II of the Dodd-Frank Act. For example, the FDIC approved a final rule implementing the Orderly Liquidation Authority that addressed, among other things, the priority of claims and the treatment of similarly situated creditors.

Under the Dodd-Frank Act, key findings and recommendations must be made before the Orderly Liquidation Authority can be considered as an option. These include a determination that the financial company is in default or danger of default, that failure of the financial company and its resolution under applicable Federal or State law, including bankruptcy, would have serious adverse effects on financial stability in the United States and that no viable private sector alternative is available to prevent the default of the financial company.

To implement its authority under Title II of the Dodd-Frank Act, the FDIC has developed a strategic approach to resolving a SIFI which is referred to as Single Point-of-Entry. In a Single Point-of-Entry resolution, the FDIC would be appointed as receiver of the top-tier parent holding company of the financial group following the company’s failure and the completion of the recommendation, determination and expedited judicial review process set forth in Title II of the Act. Shareholders would be wiped out, unsecured debt holders would have their claims written down to reflect any losses that shareholders cannot cover, and culpable senior management would be replaced. Under the Act, officers and directors responsible for the failure cannot be retained.

During the resolution process, restructuring measures would be taken to address the problems that led to the company’s failure. These could include shrinking businesses, breaking them into smaller entities, and/or liquidating certain assets or closing certain operations. The FDIC also would likely require the restructuring of the firm into one or more smaller non-systemic firms that could be resolved under bankruptcy.

The FDIC would organize a bridge financial company into which the FDIC would transfer assets from the receivership estate, including the failed holding company’s investments in and loans to subsidiaries. Equity, subordinated debt, and senior unsecured debt of the failed company would likely remain in the receivership and be converted into claims. Losses would be apportioned to the claims of former equity holders and unsecured creditors according to their order of statutory priority. Remaining claims would be converted, in part, into equity that will serve to capitalize the new operations, or into new debt instruments. This newly formed bridge financial company would continue to operate the systemically important functions of the failed financial company, thereby minimizing disruptions to the financial system and the risk of spillover effects to counterparties.

The healthy subsidiaries of the financial company would remain open and operating, allowing them to continue business and avoid the disruption that would likely accompany their closings. Critical operations for the financial system would be maintained. However, creditors at the subsidiary level should not assume that they avoid risk of loss. For example, if the losses at the financial company are so large that the holding company’s shareholders and creditors cannot absorb them, then the subsidiaries with the greatest losses would have to be placed into resolution, thus exposing those subsidiary creditors to loss.

The FDIC expects the well-capitalized bridge financial company and its subsidiaries to borrow in the private markets and from customary sources of liquidity. The new resolution authority under the Dodd- Frank Act provides a back-up source for liquidity support, the Orderly Liquidation Fund (OLF). If it is needed at all, the FDIC anticipates that this liquidity facility would only be required during the initial stage of the resolution process, until private funding sources can be arranged or accessed. The law expressly prohibits taxpayer losses from the use of Title II authority.

In our view, the Single Point-of-Entry strategy holds the best promise of achieving Title II’s goals of holding shareholders, creditors and management of the failed firm accountable for the company’s losses and maintaining financial stability at no cost to taxpayers.

Statement of Policy

Informing capital markets, financial institutions, and the public on what to expect if the Orderly Liquidation Authority were to be invoked is an ongoing effort. While the FDIC has already been highly transparent in our planning efforts, we also are currently working on a Statement of Policy which would provide more clarity on the resolution process. We anticipate the release of a proposal for public comment before the end of the year.

In addition, the Federal Reserve, in consultation with the FDIC, is considering the merits of a regulatory requirement that the largest, most complex U.S. banking firms maintain a minimum amount of unsecured debt at the holding company level. Such a requirement would ensure that there are creditors at the holding company level to absorb losses at the failed firm. Questions surrounding a debt requirement are complex and include issues on the amount, seniority structure, and its relation to equity capital.

Cross-border Issues

Advance planning and cross border coordination for the resolution of globally active, systemically important financial institutions (G-SIFIs) will be critical to minimizing disruptions to global financial markets. Recognizing that G-SIFIs create complex international legal and operational concerns, the FDIC is actively reaching out to foreign host regulators to establish frameworks for effective cross-border cooperation and the basis for confidential information-sharing, among other initiatives.

As part of our bilateral efforts, the FDIC and the Bank of England, in conjunction with the prudential regulators in our respective jurisdictions, have been working to develop contingency plans for the failure of G-SIFIs that have operations in both the U.S. and the U.K. Of the 28 G-SIFIs designated by the Financial Stability Board (FSB) of the G-20 countries, four are headquartered in the U.K, and another eight are headquartered in the U.S. Moreover, approximately 70 percent of the reported foreign activities of the eight U.S. G-SIFIs emanates from the U.K. The magnitude of these financial relationships makes the U.S.-U.K. bilateral relationship by far the most significant with regard to the resolution of G-SIFIs. As a result, our two countries have a strong mutual interest in ensuring that, if such an institution should fail, it can be resolved at no cost to taxpayers and without placing the financial system at risk. The FDIC and U.K authorities released a joint paper on resolution strategies in December 2012, reflecting the close working relationship between the two authorities. This joint paper focuses on the application of “top-down” resolution strategies for a U.S. or a U.K. financial group in a cross-border context and addresses several common considerations to these resolution strategies.

In addition to the close working relationship with the U.K., the FDIC is coordinating with representatives from other European regulatory bodies to discuss issues of mutual interest including the resolution of European G-SIFIs. The FDIC and the European Commission (E.C.) have established a joint Working Group comprised of senior executives from the FDIC and the E.C. The Working Group convenes formally twice a year -- once in Washington, once in Brussels -- with on-going collaboration continuing in between the formal sessions. The first of these formal meetings took place in February 2013. Among the topics discussed at this meeting was the E.C.’s proposed Recovery and Resolution Directive, which would establish a framework for dealing with failed and failing financial institutions. The overall authorities outlined in that document have a number of parallels to the SIFI resolution authorities provided here in the U.S. under the Dodd-Frank Act. The next meeting of the Working Group will take place in Brussels later this year.

The FDIC also is engaging with Switzerland, Germany, Japan, and Canada on a bilateral basis. Among other things, the FDIC has further developed its understanding of the Swiss resolution regime for G-SIFIs, including an in-depth examination of the two Swiss-based G-SIFIs with significant operations in the U.S. During the past year, we also have participated in several productive workshops with the Federal Financial Supervisory Authority (BaFin), the German resolution authority. The FDIC anticipates a principals-level meeting with Japan later this year.

To place these working relationships in perspective, the U.S., the U.K., the European Union, Switzerland and Japan account for the home jurisdictions of 27 of the 28 G-SIFIs designated by the Financial Stability Board (FSB) of the G-20 in November 2012. Progress in these cross-border relationships is thus critical to addressing the international dimension of SIFI resolutions.

The Volcker Rule

The Dodd-Frank Act requires the Securities and Exchange Commission (SEC), the Commodities Futures Trading Commission (CFTC), and the federal banking agencies to adopt regulations generally prohibiting proprietary trading and certain acquisitions of interest in hedge funds or private equity funds. The FDIC, jointly with the FRB, OCC, and SEC, published an NPR requesting public comment on a proposed regulation implementing the prohibition against proprietary trading. The CFTC separately approved the issuance of its NPR to implement the Volcker Rule, with a substantially identical proposed rule text.

The proposed rule also requires banking entities with significant covered trading activities to furnish periodic reports with quantitative measurements designed to help differentiate permitted market-making-related activities from prohibited proprietary trading. Under the proposed rule, these requirements contain important exclusions for banking organizations with trading assets and liabilities less than $1 billion, and reduced reporting requirements for organizations with trading assets and liabilities of less than $5 billion. These thresholds are designed to reduce the burden on smaller, less complex banking entities, which generally engage in limited market-making and other trading activities.

The agencies are evaluating a large body of comments on whether the proposed rule represents a balanced and effective approach or whether alternative approaches exist that would provide greater benefits or implement the statutory requirements with fewer costs. The FDIC is committed to developing a final rule that meets the objectives of the statute while preserving the ability of banking entities to perform important underwriting and market-making functions, including the ability to effectively carry out these functions in less-liquid markets. Most community banks do not engage in activities that would be impacted by the proposed rule.

The Dodd-Frank Act and Community Banks

While the Dodd-Frank Act has changed the regulatory framework for the financial services industry, many of the Act’s reforms are geared toward larger institutions, as discussed above. At the same time, the Act included a number of provisions that impacted community banks. Of particular relevance to the FDIC, the Act made changes to the deposit insurance system that have specific consequences for community banks.

In the aftermath of the crisis, the Dodd-Frank Act made permanent the increase in the coverage limit to $250,000, a provision generally viewed by community banks as a helpful means to attract deposits.

The FDIC also implemented the Dodd-Frank Act requirement to redefine the base used for deposit insurance assessments as average consolidated total assets minus average tangible equity. As Congress intended, the change in the assessment base shifted some of the overall assessment burden from community banks to the largest institutions, which rely less on domestic deposits for their funding than do smaller institutions. The result was a sharing of the assessment burden that better reflects each group's share of industry assets. Aggregate premiums paid by institutions with less than $10 billion in assets declined by approximately one-third in the second quarter of 2011, primarily due to the assessment base change.

In the aftermath of the financial crisis and recession, as well as the enactment of the Dodd-Frank Act, many community banks had concerns about their continued viability in the U.S. financial system. Prompted by that concern, the FDIC initiated a comprehensive review of the U.S. community banking sector covering 27 years of data and released the FDIC Community Banking Study in December 2012.

Our research confirms the crucial role that community banks play in the U.S. financial system. As defined by the Study, community banks represented 95 percent of all U.S. banking organizations in 2011. These institutions accounted for just 14 percent of the U.S. banking assets, but held 46 percent of all the small loans to businesses and farms made by FDIC-insured institutions. While their share of total deposits has declined over time, community banks still hold the majority of bank deposits in rural and micropolitan counties. 2 The Study showed that in 629 U.S. counties (or almost one-fifth of all U.S. counties), the only banking offices operated by FDIC-insured institutions at year-end 2011 were those operated by community banks. Without community banks, many rural areas, small towns and urban neighborhoods would have little or no physical access to mainstream banking services.

The Study found that community banks that grew prudently and that maintained diversified portfolios or otherwise stuck to their core lending competencies funded by stable core deposits during the Study period exhibited relatively strong and stable performance over time. Institutions that departed from the traditional community bank business model generally underperformed over the long run. These institutions pursued higher-growth strategies – frequently through commercial real estate or construction and development lending – financed by volatile funding sources. This group encountered severe problems during real estate downturns and characterized the community banks that failed during the aftermath of the crisis.

As the primary federal regulator for the majority of smaller institutions (those with less than $1 billion in total assets), the FDIC is keenly aware of the challenges facing community banks. The FDIC has tailored its supervisory approach to consider the size, complexity, and risk profile of the institutions it oversees. For example, large institutions (those with $10 billion or more in total assets) are generally subject to continuous supervision (targeted reviews throughout the year), while smaller banks are examined periodically (every 12 to 18 months) based on their size and condition. Additionally, the frequency of our examinations of compliance with the Community Reinvestment Act can be extended for smaller, well-managed institutions. Moreover, in Financial Institution Letters issued to the industry to explain regulations and guidance, the FDIC includes a Statement of Applicability to institutions with less than $1 billion in total assets.

In addition to the changes in the Dodd-Frank Act affecting community banks, the FDIC also reviewed its examination, rulemaking, and guidance processes during 2012 as part of our broader review of community banking challenges, with a goal of identifying ways to make the supervisory process more efficient, consistent, and transparent, while maintaining safe and sound banking practices. Based on the review, the FDIC has implemented a number of enhancements to our supervisory and rulemaking processes. First, the FDIC has restructured the pre-exam process to better scope examinations, define expectations, and improve efficiency. Second, the FDIC is taking steps to improve communication with banks under our supervision through the use of web-based tools, regional meetings and outreach. Finally, the FDIC has instituted a number of outreach and technical assistance efforts, including increased direct communication between examinations, increased opportunities to attend training workshops and symposiums, and conference calls and training videos on complex topics of interest to community bankers. The FDIC plans to continue its review of examination and rulemaking processes, and continues to explore new initiatives to provide technical assistance to community banks.

Conclusion

Thank you for the opportunity to share with the Committee the work that the FDIC has been doing to address systemic risk in the aftermath of the financial crisis. I would be glad to respond to your questions. (Attachment)

1 A summary of the FDIC’s progress implementing the provisions of the Dodd-Frank Act is attached to this testimony.

2 The 3,238 U.S. counties in 2010 included 694 micropolitan counties centered on an urban core with populations between 10,000 and 50,000 people, and 1,376 rural counties with populations less than 10,000 people.

CFTC CHARGES COMPANY, OWNER WITH INVOLVEMENT IN PRECIOUS METALS FRAUD

FROM: COMMODITY FUTURES TRADING COMMISSION
May 13, 2013

CFTC Charges Global Precious Metals Trading Company and Michael Ghaemi of Coral Gables, Florida with Fraudulent Precious Metals Scheme

Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today filed a civil injunctive enforcement action in the U.S. District Court for the Southern District of Florida against Defendants Global Precious Metals Trading Company, LLC (GPMT) of Coral Gables, Florida, and its owner Michael Ghaemi, who resides in Miami, Florida. The CFTC’s Complaint charges that, since July 2011, the Defendants solicited and accepted more than $800,000 from approximately nine U.S. customers in connection with illegal off-exchange retail commodity transactions and then misappropriated virtually all of the customers’ funds.

According to the CFTC Complaint, the Defendants claimed to purchase and store physical metal, including gold, silver, platinum, and palladium, for customers. Defendants told customers that the minimum investment to purchase physical metal was $25,000, and that the customers would finance the remaining amount of the total value of the physical metals purchased through a loan which GPMT would arrange.

These claims were false, according to the Complaint. Instead of purchasing, storing, or financing the purchase of physical metals, the Defendants misappropriated the customers’ funds and used the funds for Ghaemi’s benefit, including to make car payments, pay Ghaemi’s salary, pay for Ghaemi’s travel and entertainment expenses, and to margin their own speculative metals trading account in London. According to the Complaint, the Defendants have returned less than $65,000 of the over $800,000 obtained from customers and misappropriated the remaining funds.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) of 2010, which expanded the CFTC’s jurisdiction over retail commodity transactions like these, prohibits fraud in connection with such transactions, and requires that these transactions be executed on or subject to the rules of a board of trade, exchange, or contract market, according to the Complaint.

CFTC’s Precious Metals Fraud Advisory

In January 2012, the CFTC issued a Precious Metals Consumer Fraud Advisory to alert customers to precious metals fraud. The Advisory stated that the CFTC had seen an increase in the number of companies offering customers the opportunity to buy or invest in precious metals. The CFTC’s Advisory specifically warns that frequently companies do not purchase any physical metals for the customer, but instead simply keep the customer’s funds. The Advisory further cautions consumers that leveraged commodity transactions are unlawful unless executed on a regulated exchange.

In its continuing litigation against the Defendants, the CFTC is seeking preliminary and permanent civil injunctions in addition to other remedial relief, including restitution to customers.

The CFTC thanks the Florida Office of Financial Regulation and the United Kingdom Financial Conduct Authority for their assistance.

CFTC Division of Enforcement staff responsible for this action are Camille Arnold, Heather Johnson, Joseph Konizeski, Scott Williamson, Rosemary Hollinger, and Richard Wagner.