FROM: SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Nov. 15, 2012 — The Securities and Exchange Commission today charged Massachusetts Mutual Life Insurance Company with securities law violations for failing to sufficiently disclose the potential negative impact of a "cap" it placed on a complex investment product that investors were planning to use for retirement.
The SEC's investigation found that MassMutual included a cap feature in certain optional riders offered to investors, and the cap potentially affected $2.5 billion worth of MassMutual variable annuities. Neither the prospectuses nor the sales literature sufficiently explained that if the cap was reached, the guaranteed minimum income benefit (GMIB) value would no longer earn interest. MassMutual's disclosures instead implied that interest would continue to accrue after the GMIB value reached the cap, and dollar-for-dollar withdrawals would remain available to investors. A number of MassMutual's own sales agents were confused by the language in the disclosures, and investors were not sufficiently informed of the potential negative effect of taking withdrawals if they reached the cap approximately a decade from now.
MassMutual, which removed the cap after the SEC's investigation to ensure that no investors will be harmed, has agreed to settle the charges and pay a $1.625 million penalty.
"Investors shouldn't have their retirement nest eggs at risk because of undisclosed investment complexities," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Through our proactive investigative efforts, we exposed a problem with a complex variable annuity investment at least a decade before it could have harmed investors."
According to the SEC's order instituting settled administrative proceedings, MassMutual offered GMIB 5 and 6 riders from 2007 to 2009 as an optional feature on certain variable annuity products. The GMIB rider sets a minimum floor for a future amount that can be applied to an annuity option, known as the "GMIB value." Unlike the contract value of the annuity that fluctuates with the performance of the underlying investment, the GMIB value increases by a compound annual interest rate of either 5 or 6 percent and allows investors to make withdrawals any time during the annuity's accumulation phase.
According to the SEC's order, MassMutual advertised its GMIB riders as providing "Income Now" if investors elected to make withdrawals during the accumulation phase or "Income Later" if they elected to receive annuity payments. MassMutual's sales literature highlighted the guarantee provided by the riders by stating, "Even if your contract value drops to zero, you can apply your GMIB value to a fixed or variable annuity." The riders included a maximum GMIB value, and investors could not reach this cap until 2022. If the GMIB value reached the cap, every dollar withdrawn would reduce the GMIB value by a pro-rata amount tied to the percentage decrease on the contract value. After a number of such withdrawals, depending on market conditions, both the contract value and the GMIB value could decline and adversely affect the amount a customer could apply to an annuity and the future income stream.
The SEC's investigation found that a number of MassMutual sales agents and others did not understand that all withdrawals taken after the GMIB value reached the cap would result in such pro-rata reductions. After reviewing MassMutual's prospectuses and other disclosures, they believed that if the GMIB value reached the cap, investors could take withdrawals and the GMIB value would remain at the cap. Some sales agents mistakenly believed that investors could maximize their benefits by waiting until the GMIB value reaches the cap, taking annual 5 or 6 percent withdrawals, and annuitizing their contracts in order to receive an income stream tied to the maximum GMIB value. But in reality, following such an investment strategy could have had severe adverse consequences for investors. By taking withdrawals annually after the cap is reached, investors would proportionately reduce their GMIB values and in turn potentially decrease their future income streams. In a worst-case scenario, they would withdraw all of their contract value, the GMIB value would decline to zero, and they would be left with nothing to annuitize and, consequently, no future income stream.
According to the SEC's order, while MassMutual was offering GMIB riders, there were indications that sales agents and others did not understand the effect of post-cap withdrawals on the GMIB value, which should have alerted the company to the fact that its disclosures were inadequate. Beginning May 1, 2009, after it stopped offering the riders, MassMutual revised its prospectuses to better explain the consequences of taking withdrawals after the GMIB value reaches the cap. Following the SEC's investigation, MassMutual undertook the remedial step of removing the cap entirely from these riders in order to guarantee that no investor will ever reach the cap. This action contributed to the determination of the penalty amount. MassMutual consented to the SEC's order without admitting or denying the findings. In addition to the $1.625 million penalty, MassMutual agreed to cease and desist from committing or causing any violations and any future violations of Section 34(b) of the Investment Company Act.
The SEC's investigation was conducted by Attorney-Advisor Daniel H. Rubenstein and supervised by Associate Director Stephen L. Cohen and Assistant Director C. Joshua Felker.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Nov. 15, 2012 — The Securities and Exchange Commission today charged BP p.l.c. with misleading investors while its Deepwater Horizon oil rig was gushing into the Gulf of Mexico by significantly understating the flow rate in multiple reports filed with the SEC.
The SEC alleges that the global oil and gas company headquartered in London made fraudulent public statements indicating a flow rate estimate of 5,000 barrels of oil per day. BP reported this figure despite its own internal data indicating that potential flow rates could be as high as 146,000 barrels of oil per day. BP executives also made numerous public statements after the filings were made in which they stood behind the flow rate estimate of 5,000 barrels of oil per day even though they had internal data indicating otherwise. In fact, they criticized other much higher estimates by third parties as scaremongering. Months later, a government task force determined the flow rate estimate was actually more than 10 times higher at 52,700 to 62,200 barrels of oil per day, yet BP never corrected or updated the misrepresentations and omissions it made in SEC filings for investors.
BP agreed to settle the SEC's charges by paying the third-largest penalty in agency history at $525 million. The SEC plans to establish a Fair Fund with the BP penalty to provide harmed investors with compensation for losses they sustained in the fraud. The SEC announced the case today along with the Attorney General and other senior officials at the Justice Department, which brought a criminal action against BP.
"The oil spill was catastrophic for the environment, but by hiding its severity BP also harmed another constituency – its own shareholders and the investing public who are entitled to transparency, accuracy, and completeness of company information, particularly in times of crisis," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Good corporate citizenship and responsible crisis management means that a company can't hide critical information simply because it fears the backlash."
Daniel M. Hawke, Director of the SEC's Philadelphia Regional Office and Chief of the Enforcement Division's Market Abuse Unit, said, "Without accurate critical flow rate data known only to BP, the company denied its shareholders and investors the opportunity to fairly assess BP's potential liabilities and true financial condition."
According to the SEC's complaint filed in the U.S. District Court for the Eastern District of Louisiana, BP stated that the flow rate was estimated to be 5,000 barrels of oil per day (bopd) in three separate Forms 6-K filed with the SEC following the Deepwater Horizon oil rig explosion on April 20, 2010. In a 6-K filed on April 29, BP stated in part, "[e]fforts continue to stem the flow of oil from the well, currently estimated at up to 5,000 bopd[.]" BP filed another report the next day similarly referencing "[e]fforts to stem the flow from the well, currently estimated at up to 5,000 barrels a day are continuing[.]"
The SEC alleges that when the company made those statements, BP possessed at least five different flow rate calculations, estimates, or data indicating a much higher flow rate. BP did not possess or generate any piece of data suggesting that 5,000 bopd represented a ceiling for the rate of oil flowing into the Gulf of Mexico or was the best estimate. The failure to disclose the existence of these higher estimates rendered BP's statements in its Reports on Form 6-K materially false and misleading.
According to the SEC's complaint, BP issued another 6-K on May 4 that stated, "Accurate estimation of the rate of flow is difficult, but current estimates by the U.S. National Oceanic and Atmospheric Administration (NOAA) suggest that some 5,000 barrels (210,000 US gallons) of oil per day are escaping from the well."
The SEC alleges that BP omitted from its disclosure the material fact that, by this date, it possessed at least six estimates, calculations and data indicating that the oil flow rate far exceeded 5,000 bopd. Therefore, it was no longer accurate to suggest that 5,000 bopd was the best estimate or that the NOAA estimate was the current estimate.
The SEC's complaint further alleges that BP executives made numerous public statements in May 2010 supporting the 5,000 bopd flow rate estimate and criticizing other estimates despite internal evidence showing that flow rates were likely well in excess of 5,000 bopd. Eventually on August 2, the Flow Rate Technical Group consisting of government and academic experts tasked with reaching a final official flow rate estimate announced that the flow rate estimate was 52,700 to 62,200 bopd. BP never corrected or updated its material misrepresentations and omissions about the flow rate.
BP has consented to the entry of a final judgment ordering it to pay the $525 million penalty and permanently restraining and enjoining the company from violating Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and Rules 10b-5, 12b-20 and 13a-16. The proposed final judgment is subject to court approval.
The SEC's investigation, which is continuing, has been conducted by Brian P. Thomas, Matthew S. Raalf, Kelly L. Gibson, Michael F. McGraw, John S. Rymas, Colleen K. Lynch, Jeffrey Boujoukos, Michael J. Rinaldi, and Elaine C. Greenberg in the Philadelphia Regional Office. The SEC appreciates the assistance of the Department of Justice's Deepwater Horizon Task Force and the United Kingdom Financial Services Authority.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
SEC Charges South Florida Man with Recruiting Victims of Ponzi Scheme
he Securities and Exchange Commission today charged a South Florida man with defrauding at least 14 investors by soliciting them to invest in a Ponzi scheme. A significant number of the victims were members of the gay community in Wilton Manors, Florida and included inexperienced, unaccredited investors.
In the complaint filed in the U.S. District Court for the Southern District of Florida, the SEC alleges that James F. Ellis, 69, a resident of Wilton Manors, Florida, fraudulently solicited investors for George Elia from 2004 to 2011. Elia operated pooled investment vehicles under the names Investor Funding Club and Vision Equities Funds. Elia purported to trade in stocks and earn annual returns as high as 26 percent, but was actually running a Ponzi scheme and paying returns to existing investors from new investor funds. In April 2012, the Commission charged Elia with securities fraud. See Litigation Release No. 22319 (April 6, 2012).
According to the Commission's complaint against Ellis, Ellis persuaded prospective investors by falsely telling them that he had personally invested with Elia at least $5 million that he had inherited from his parents. Ellis variously told investors that he earned 16% to 20% annual returns on his investment with Elia or that he earned $20,000 to $24,000 per month. Elia and his entities did in fact pay Ellis over $2.1 million over seven years. However, those payments were not investment returns because, as Ellis knew, he had not made an investment with Elia that would have returned such large sums of money. According to the complaint, Ellis also reassured prospective investors of the safety of the investment by falsely telling them that he had tested Elia by depositing a large amount of money with Elia, then asking for and receiving it back.
According to the complaint, Ellis bolstered his deceptive claims about the success of his investment with Elia with ostentatious displays of wealth, including expensive real estate, luxury cars, jewelry, opulent entertaining of his friends, and expensive cruises. Though Ellis claimed that his investments with Elia made his luxurious lifestyle possible, he failed to disclose to investors that his wealth derived not from legitimate investment returns but from the money that Elia paid him for fraudulently touting Elia's investment vehicles.
The Commission's complaint charges Ellis with securities fraud in violation of Section 17(a)(1), (2) and (3) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder. The complaint also alleges that Ellis violated the registration provisions of Sections 5(a) and (c) of the Securities Act. The Commission is seeking permanent injunctions against Ellis for violating the above provisions of the securities laws, disgorgement of ill-gotten gains plus pre-judgment interest, and civil penalties.
Separately, the United States Attorney's Office for the Southern District of Florida today announced criminal charges against Ellis for his conduct in the scheme.
The Commission thanks the U.S. Attorney's Office and the Federal Bureau of Investigation for their assistance in this matter.
FROM: U.S. DEPARTMENT OF LABOR
NEW YORK — The U.S. Department of Labor today announced a settlement that includes the payment of nearly $220 million to compensate employee benefit plans and other investors that suffered losses through investments in Bernard L. Madoff's Ponzi scheme. The settlement is pending approval by the U.S. District Court for the Southern District of New York and resolves department litigation, actions brought by New York's attorney general, and several private lawsuits and class actions brought on behalf of plans and other investors that invested with Madoff. The settlement was reached with Ivy Asset Management LLC, J.P. Jeanneret Associates Inc., Beacon Associates Management Corp., Andover Associates Management Corp., and their current and former owners and officers.
"The settlement agreement we're announcing today provides a measure of justice for those Americans who worked hard to prepare for their retirement and then saw hoped-for stability disappear," said Secretary of Labor Hilda L. Solis. "My department is committed to ensuring that workers and retirees receive the benefits they've earned and deserve. If approved by the court, this settlement, combined with expected payments from the Madoff bankruptcy estate, will allow worker benefit plans impacted by Bernard Madoff's illegal and reprehensible scheme to recover all, or nearly all, of the money they invested with him."
"Today's settlement brings accountability for one of the greatest financial frauds in American history and justice to defrauded investors. We have recovered over $210 million for the victims who were harmed as a result of the world's most notorious Ponzi scheme," said New York Attorney General Eric Schneiderman. "Ivy Asset Management violated its fundamental responsibility as an investment adviser by putting its own pecuniary interests ahead of the interests of its clients. An investment adviser should apprise its clients of risks, but Ivy deliberately concealed negative facts it uncovered in its due diligence of Madoff in order to keep earning millions of dollars in fees. As a result, its clients suffered massive and avoidable losses."
The department sued Ivy, Jeanneret, Beacon, Andover and their owners and officers Oct. 21, 2010, for alleged violations of the Employee Retirement Income Security Act. The suit alleged that they breached their fiduciary duties to a number of benefit plans by recommending, making and maintaining investments with Madoff, thus losing hundreds of millions of dollars in assets needed for the pension and health benefits of thousands of workers.
"Nothing can make up for the years-long agony that plan administrators and participants, and individual investors were put through by these defendants and Madoff," said Assistant Secretary of Labor for Employee Benefits Security Phyllis C. Borzi. "But this settlement should go a long way toward making victims financially whole and, hopefully, closing a painful chapter for many workers and families."
Ivy served as the investment adviser for Jeanneret, Beacon and Andover, and introduced those parties to Madoff. The suit alleged that Ivy misrepresented and concealed doubts and suspicions about Madoff, including the belief that no investment with Madoff was justified. The suit further alleged that Ivy concealed its suspicions because the investments made by Jeanneret, Beacon, and their plan clients and other investors generated enormous fees for Ivy and contributed significantly to the assets under Ivy's management. The department alleged that Ivy made the decision not to sacrifice those financial benefits by disclosing the true nature of its doubts about Madoff, especially because management did not think the company could escape legal liability for those investments.
Jeanneret served as the investment manager for more than 70 plans that invested with Madoff through several methods, including its own fund of funds, starting in 1991. The department's suit alleged that the company and its principals made material misrepresentations and failed to disclose material facts to their ERISA-covered plan clients that invested with Madoff. These included failing to disclose that Ivy had informed Jeanneret that it was unable to perform due diligence on Madoff. Jeanneret also allegedly failed to disclose to its clients that it had entered into a new agreement with Ivy in 2007 that eliminated Madoff from Ivy's due diligence responsibilities, and failed to disclose that Ivy recommended Jeanneret reduce plan client and investor exposure to Madoff.
Additionally, the suit alleged that Jeanneret largely ignored Ivy's recommendations to reduce its clients' Madoff investments and failed to take prudent steps to investigate irregularities about Madoff and his purported trading, while taking substantial amounts in fees as the investment manager for the plans. Finally, Jeanneret and its owners and officers allegedly violated ERISA based on their fee arrangement, which provided for higher fees for Madoff investments than for other types of investments. This arrangement gave them the ability to set their own compensation by exercising their discretion to recommend and make Madoff investments for plans.
Beacon and Andover were the investment managers for the Beacon and Andover funds, which invested heavily with Madoff starting in the early 1990s. Many employee benefit plans, including Jeanneret's clients, invested in the Beacon and Andover funds. Like Jeanneret, the department alleged that the two fund companies and their owners and officers largely ignored Ivy's recommendations to reduce their Madoff investments and failed to take prudent steps to investigate Madoff, while still taking substantial amounts in fees as the investment managers for the Beacon and Andover funds. The suit also charged Beacon, Andover and their principals with making misrepresentations and failing to disclose to their plan investors that Ivy had informed them it was unable to perform due diligence on Madoff, and that Beacon and Andover had entered into agreements with Ivy that eliminated Madoff from Ivy's due diligence responsibilities.
Under the settlement agreement, Ivy and its principals have agreed to pay a total of $210 million. Jeanneret and its owners, John P. Jeanneret and Paul Perry, have agreed to pay $3 million. Beacon and Andover and their owners, Joel Danziger and Harris Markhoff, have agreed to pay $3.5 million and relinquish a claim of more than $3.3 million for management fees.
The settlements resulted from investigations conducted by the New York and Boston regional offices of the Employee Benefits Security Administration, an agency of the Labor Department. Litigation was conducted by the Plan Benefits Security Division of the department's Office of the Solicitor in Washington, D.C.
Workers in employer-sponsored health and retirement benefit plans who feel that they have been denied a benefit inappropriately, or have questions about benefits laws, can contact an EBSA benefits adviser by visiting http://www.askebsa.dol.gov or calling 866-444-EBSA (3272).
FROM: COMMODITY FUTURES TRADING COMMISSION
Commissioner Scott D. O’Malia Before Mercatus Center, George Mason University
November 13, 2012
Jim, thanks for that kind introduction.
I am happy to be here and pleased to see the Mercatus Center, as it often does, putting the spotlight today on an issue that is near and dear to my heart: how government regulation affects the real world. That’s right: government regulation has real-world consequences. What a revolutionary concept. You may take this concept for granted, but too often government regulators fail to understand, or take into account, the effect that regulations will have on markets and market participants. And this problem has been especially true in the past two plus years, as government agencies have rushed to promulgate rules under the Dodd-Frank Act. As you know, we at the CFTC have been in the trenches of Dodd-Frank implementation. I would like to take this opportunity now to provide you with some of my thoughts on this implementation process.
Don’t worry – I won’t take you through an exhaustive review of the Commission’s work because at 39 final Dodd-Frank rules and counting we would be here until tomorrow. Instead, what I would like to do is talk to you about good government. You see, I am the government employee who believes that government doesn’t have all the answers and that it must do a better job of developing "good government" solutions.
What Is Good Government?
You may ask: what do I mean by good government? In a nutshell, good government regulation strikes the right balance in order to develop beneficial rules of the road and to implement them according to a measured and reasonable timeline. This approach requires fact-based analysis in order to come up with cost-effective solutions based on a range of policy options.
So, what does it mean specifically in the context of the Commission’s rulemaking process? For rules that have not yet been proposed, good government means faithful adherence to the statutory authority and a strong understanding of the markets that will be affected by the envisioned regulation. For rules that have not yet been finalized, it means understanding and addressing the concerns of market participants and adopting final rules that are clear, consistent and create a level playing field. For rules that have already been finalized, it means providing transparent implementation guidance that is consistent with the final rules. In addition, good government means being aware of the consequences of Commission regulations on market activity and maintaining the flexibility to reassess and revise such regulations where appropriate.
If we apply this framework of good government regulation to what the Commission has done in the past two plus years, we can see many places where we have fallen short of the standard. One example is the position limits rule, which a federal court recently struck down.1 The Commission will file an appeal, which I don’t support because I agree with the judge’s ruling that the Commission failed to justify its establishment of limits as required by the statute. I would like to point out that the Commission has now been sued three times within the past year on its rulemakings.2
Today I want to focus on three areas in particular of the Commission’s implementation of Dodd-Frank. These are: the October 12 effective date for swap regulations and the resulting ‘futurization’ of the swaps world, the Commission’s final rules for swap execution facilities (SEFs), and the Commission’s guidance on cross-border issues.
The Nightmare of Friday the 12th
I would like to start with the significant date on the Dodd-Frank implementation calendar that we passed last month. On October 12, the joint CFTC-SEC definition of the term swap became effective. This triggered compliance dates for a number of other Commission swaps regulations.
As it turned out, Friday, October 12 was a day of great drama, but certainly not in a good way and certainly not by design. Friday the 13th may have been more appropriate, given the nightmare scenario the Commission was trying to avoid at the absolute last minute. In truth, the nightmare was the fact that we had reached such a point in the first place.
By that evening, the Commission had rushed out 18 no-action letters and guidance documents in a last-minute attempt to mitigate the chaotic impact of all the rules that were to take effect the following Monday. Think about that for a second: 18 relief documents issued on the day before the compliance deadline. We don’t need a study by the Mercatus Center to tell us that this last-minute flurry fell embarrassingly short of the goal of regulatory certainty and the principles of good government regulation.
Good government should take a measured, well-thought out approach to developing a new regulatory regime. To that end, I have repeatedly asked the Commission to publish a clear and specific rulemaking timeline and implementation schedule. Frustratingly, my calls have gone unheeded. A clear and well-reasoned implementation schedule would have allowed the Commission to avoid the hurried, ad-hoc process of temporary relief and interpretations that we witnessed and would have done much to put the Commission’s rulemaking process in the good government category.
Even now, we are not out of the woods yet. The temporary relief provided expires on December 31, and we can’t risk keeping the markets in the dark until the eleventh hour again. The Commission needs to take action by mid-December in order to provide adequate clarity to the markets through the new year. Think of this as the Dodd-Frank Regulatory Cliff.
Let me go back for a minute to October 12. The big storyline is the migration of cleared energy products to the futures markets. In response to regulatory uncertainty in the swaps market, energy customers of both CME and ICE demanded that the markets move to listed futures, instead of swaps. There are good reasons to stay away from the swaps market, including the expansive and ill-defined swap dealer definition and the regulatory consequences of becoming designated as well as uncertainty as to what will be permitted to trade on SEFs. In addition, the capital efficiency of margining all trades in one account is also a powerful financial incentive.
On October 15, the day the new swap rules took effect, the entire market had shifted from a swaps market to the futures market. Liquidity simply dried up in the OTC space. To me, this is evidence of the Commission’s struggle to get swap regulations right.
This futurization of the cleared energy swap market may result in reduced flexibility for some firms because futures contracts, unlike swaps, can’t be individually tailored to meet specific risk needs. However, futures markets offer greater regulatory certainty and provide high liquidity to allow for the efficient hedging of commercial risk.
It was surely not the Commission’s intention to draft rules that would send market participants fleeing from the swaps market. But good government requires more than good intent; it requires good execution of that intent as well. Instead, the Commission has created such a regulatory nightmare that the energy markets have sought cover in the relative safe haven of the futures markets.
And we may very well be at just the start of the futurization of our markets. Again, it’s hard to believe that this brave new world of futurization is what the Commission envisioned would be the end result of its new swaps regulatory regime.
Learning Lessons and Moving Forward
But I bring up these examples not simply to say that the Commission should have done better. Rather, I raise them because learning from mistakes is the crucial first step toward getting us back on the road of good government regulation. And luckily for us, there are several significant rules on the horizon that will give us that opportunity. For example, the Commission has yet to consider final rules on capital and margin requirements. The Volcker rule, which will clarify and distinguish market-making trades from proprietary trading, is also in this category.
These rules will put a final price tag on over-the-counter trades and will have broad and significant consequences for the swaps markets, so it is very important that we get them right. If we make sure to identify concerns raised by market participants and properly address them in the final rules, and then implement the rules in a measured and consistent manner, I am confident that we can get them right.
In any case, those rules are still a bit further down the road. Of more immediate interest are two areas that the Commission will likely consider before the end of the year. These are trade execution, including SEF final rules, and the cross-border guidance.
Swap Execution Facilities
Let me address the SEF rules. This is an area that I am excited about. There are new trading models that offer exciting innovations and ideas that will make the swaps market more transparent and well as more competitive.
As you know, the concept of SEFs was heavily negotiated in Congress as well as at the Commission. SEFs represent a monumental shift away from the current bilateral swap trading model to a centrally regulated trading model. Centralized swap execution should offer market participants greater price transparency, increased access to larger pools of liquidity, and improved operational efficiency. Congress envisioned that SEFs would promote price discovery and competitive trade execution in all asset classes.
The Commission published the proposed SEF rules last January. While the proposal was a good start, a broad array of market participants – from buy-side asset managers, pension funds, commercial end users, farm credit banks and rural power cooperatives to sell-side dealers and even prospective SEFs – expressed concern that if the final rules are adopted as proposed, less liquid swaps will not be able to be executed on the SEF platforms because the proposed SEF rules would limit their choice of execution.
While I am supportive of the overarching objective of promoting pre-trade price transparency, I believe that the SEF final rules should allow for flexible methods of execution including request for quote systems (RFQs). These features will protect the confidential trading strategies of asset managers, pension funds, insurance companies, and farm credit banks and will provide commercial end users access to the swap market to fund their long-term capital and infrastructure projects.
Finally, I hope that the final SEF rules will provide a clear interpretation of the "by any means of interstate commerce" clause contained in the SEF definition. Dodd-Frank defines a SEF as a platform on which multiple participants have the ability to trade swaps by accepting bids and offers made by multiple participants, through any means of interstate commerce.
3 Instead of providing further meaning to the "any means of interstate commerce" clause, the proposal focused on two methods of execution on a SEF: an electronic platform and an RFQ.
Currently, the Commission is considering the suite of related execution rules that determine the viability of SEFs and the overall OTC market going forward. These include mandatory clearing, Core Principle 9, and the block and made available for trading rules in addition to the SEF rules. These rules must work together and reflect the new realities of the evolving market in reaction to the Commission’s already finalized rules.
I remain optimistic that we can develop rules that will encourage a competitive and innovative market in swap trading as envisioned by Congress and something the market has been developing over the past decade. It would be a shame if government rules stood in the way of this opportunity.
Regulatory Overreach: The Commission’s Cross-Border Guidance
Moving now to the third topic I want to discuss: the Commission’s Cross-Border Guidance.
Last week the Commission held a public meeting with regulators representing most of the largest markets across the globe, and their criticism of the Commission’s overreaching cross-border Guidance was consistent and firm. I certainly don’t want to see this draft proposal result in a regulatory tit-for-tat that would create an environment where U.S. financial institutions and market participants are put at a competitive disadvantage based on competing regulatory regimes. I am committed to resolving this regulatory matter to the satisfaction of all regulators and minimizing regulatory overlap and confusion so that market participants have a clear understanding of the new global regulatory paradigm. As such, it means we must redraft our cross-border Guidance.
Let me give you some background. The Commission published its proposed Guidance as well as a related exemptive order in July of this year. The objectives of the Guidance were to (1) clearly define the scope of the extra-territorial reach of Title VII of Dodd-Frank and (2) reinforce the Commission’s commitment to the goals of the G-20 summit by providing a harmonized approach to derivatives regulation.
4
These are sound objectives. However, the proposed Guidance missed the mark in several respects. Start with the fact that it was issued as guidance and not as a formal rulemaking, which would have required the Commission to conduct a cost-benefit analysis. As proposed, market participants will be deprived of an opportunity to review and comment on a cost-benefit assessment despite the significant costs that the Guidance will impose on them.
More fundamentally, the proposed Guidance exceeded the scope of the Commission’s statutory mandate. The statute provides that Dodd-Frank swaps regulations shall not apply to activities outside of the United States unless those activities have a direct and significant connection with activities in the United States.
5 This provision was drafted by Congress as a limitation on our authority, yet the proposed Guidance has interpreted it as the opposite.
As a result, the proposal empowers the Commission to find virtually any swap to have a direct and significant impact on our economy and imposes U.S. rules and obligations, including requirements on transactions, on non-U.S. entities. This has set off alarm bells in foreign capitals across the globe, and the Commission received an unprecedented number of letters from foreign regulators.
6 Just a few weeks ago, a strongly worded joint letter from the top finance officials of the UK, France, EU and Japan again urged the Commission to reconsider its approach and engage much more actively with them to coordinate regulatory efforts across borders. And as I mentioned earlier, these views were strongly echoed by representatives of several foreign regulators at a meeting last week of the Commission’s Global Markets Advisory Committee.
The Commission’s statutory overreach is reflected throughout the proposed Guidance. A prime example is the definition of U.S. person, which as drafted in the proposed Guidance sweeps numerous entities that are outside the U.S. into the Commission’s jurisdiction. The proposal requires non-U.S. counterparties to treat overseas branches of U.S. banks, unlike affiliates of U.S. banks, as U.S. persons. If these foreign companies do enough business with foreign-based U.S. banks, they will be subject to U.S. regulation.
The Commission has heard concerns from a number of U.S. banks that foreign competitors are trying to tempt clients away by pointing to the potential increased costs of doing business with U.S. banks as a result of the Commission’s proposed Guidance. Even more disturbing, the Commission has received more recent indications that many foreign firms are no longer doing business with U.S. banks. I’ve said it before and I’ll say it again: I cannot support a Commission proposal that puts U.S. firms at a competitive disadvantage to foreign banks, especially those that operate in the United States.
As I mentioned earlier, good government regulations address the concerns of market participants in drafting a final Commission document. In this case, both the market and foreign regulators have spoken loudly.
So here is what the Commission should do. First, the entire Guidance should be scrapped and the document should be re-drafted as a formal rulemaking that provides an opportunity for public comment and includes a cost-benefit assessment.
Second, the proposal should provide a clear, consistent interpretation of the "direct and significant" connection with a sufficient rationale for the extent of the Commission’s extraterritorial reach. Identifying more accurately those activities that could pose a risk to the U.S. will allow the Commission to assess how such risk could be mitigated through clearing and to determine whether other transaction rules must be applied.
Third, the definition of U.S. person should be narrowed to include only those entities that are residents of the U.S., are organized or have a principle place of business in the U.S., or have majority U.S. ownership. It should exclude a foreign affiliate or subsidiary of a U.S. end user that is guaranteed by that end user. This more reasonable definition is similar to the definition articulated by Commission staff in one of the flurry of no-action letters issued on October 12.
Finally, the rule must clearly interpret the concept of "substituted compliance." The proposal indicates that the Commission will review the comparability of non-U.S. regulations with Commission rules. This review should be a broad, big-picture assessment of comparability, not a rule-by-rule analysis. A rule-by-rule comparison could result in a hodgepodge of disparate regulatory requirements that would be a compliance nightmare for market participants. It would also undermine the coordinated regulatory effort that G-20 members have agreed to support.
The bottom line is that today’s swaps markets are global in nature and interconnected. Given this reality, the Commission needs to engage much more actively and meaningfully with foreign regulators and develop a more harmonized approach in order to eliminate redundancy and inconsistency among the respective regulatory regimes.
Conclusion
To conclude, I want to emphasize how important it is for the Commission to be mindful of the real and significant impact that its regulations have on market activity. Anyone who doubted this reality needs look no further than October 12, the new world of futurization that we are seeing in our industry and the mounting lawsuits that the Commission is facing.
Therefore, it is crucial that we apply the principles of good government so that our regulations are clear, consistent and not overly burdensome to market participants. As I’ve noted, we have at times failed to live up to these standards. But if we are willing to learn from these lessons, we can do better with the rules we have before us and on the horizon.
Thank you very much for your time.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
The Securities and Exchange Commission today charged a South Florida man with defrauding at least 14 investors by soliciting them to invest in a Ponzi scheme. A significant number of the victims were members of the gay community in Wilton Manors, Florida and included inexperienced, unaccredited investors.
In the complaint filed in the U.S. District Court for the Southern District of Florida, the SEC alleges that James F. Ellis, 69, a resident of Wilton Manors, Florida, fraudulently solicited investors for George Elia from 2004 to 2011. Elia operated pooled investment vehicles under the names Investor Funding Club and Vision Equities Funds. Elia purported to trade in stocks and earn annual returns as high as 26 percent, but was actually running a Ponzi scheme and paying returns to existing investors from new investor funds. In April 2012, the Commission charged Elia with securities fraud. See Litigation Release No. 22319 (April 6, 2012).
According to the Commission's complaint against Ellis, Ellis persuaded prospective investors by falsely telling them that he had personally invested with Elia at least $5 million that he had inherited from his parents. Ellis variously told investors that he earned 16% to 20% annual returns on his investment with Elia or that he earned $20,000 to $24,000 per month. Elia and his entities did in fact pay Ellis over $2.1 million over seven years. However, those payments were not investment returns because, as Ellis knew, he had not made an investment with Elia that would have returned such large sums of money. According to the complaint, Ellis also reassured prospective investors of the safety of the investment by falsely telling them that he had tested Elia by depositing a large amount of money with Elia, then asking for and receiving it back.
According to the complaint, Ellis bolstered his deceptive claims about the success of his investment with Elia with ostentatious displays of wealth, including expensive real estate, luxury cars, jewelry, opulent entertaining of his friends, and expensive cruises. Though Ellis claimed that his investments with Elia made his luxurious lifestyle possible, he failed to disclose to investors that his wealth derived not from legitimate investment returns but from the money that Elia paid him for fraudulently touting Elia's investment vehicles.
The Commission's complaint charges Ellis with securities fraud in violation of Section 17(a)(1), (2) and (3) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder. The complaint also alleges that Ellis violated the registration provisions of Sections 5(a) and (c) of the Securities Act. The Commission is seeking permanent injunctions against Ellis for violating the above provisions of the securities laws, disgorgement of ill-gotten gains plus pre-judgment interest, and civil penalties.
Separately, the United States Attorney's Office for the Southern District of Florida today announced criminal charges against Ellis for his conduct in the scheme.
The Commission thanks the U.S. Attorney's Office and the Federal Bureau of Investigation for their assistance in this matter.
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