FROM: SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., March 29, 2013 —The Securities and Exchange Commission today charged Michael Steinberg, a portfolio manager at New York-based hedge fund advisory firm Sigma Capital Management, with trading on inside information ahead of quarterly earnings announcements by Dell and Nvidia Corporation
The SEC alleges that Steinberg's illegal conduct enabled hedge funds managed by Sigma Capital and its affiliate S.A.C. Capital Advisors to generate more than $6 million in profits and avoided losses. Steinberg received illegal tips from Jon Horvath, an analyst who reported to him at Sigma Capital. Horvath was charged last year among several hedge fund managers and analysts as part of the SEC's broader investigation into expert networks and the trading activities of hedge funds. Earlier this month, Sigma Capital and two affiliated hedge funds agreed to a $14 million settlement with the SEC for insider trading charges.
"Steinberg essentially got an advance copy of Dell and Nvidia's quarterly earnings announcements, allowing him to trade on tomorrow's news today," said George S. Canellos, Acting Director of the SEC's Division of Enforcement.
Sanjay Wadhwa, Senior Associate Director of the SEC's New York Regional Office, added, "The SEC's aggressive pursuit of hedge fund insider trading, including this enforcement action against Steinberg, underscores its steadfast commitment to leveling the playing field for all investors by rooting out illicit conduct by well-capitalized traders."
In a separate action, the U.S. Attorney's Office for the Southern District of New York today announced criminal charges against Steinberg.
According to the SEC's complaint filed in federal court in Manhattan, Steinberg traded Dell and Nvidia securities based on nonpublic information in advance of at least four quarterly earnings announcements in 2008 and 2009. Horvath provided Steinberg with nonpublic details that he had obtained through a group of hedge fund analysts with whom he regularly communicated. Steinberg used the inside information to obtain more than $3 million in profits and losses avoided for a Sigma Capital hedge fund.
The SEC's complaint further alleges that Steinberg also illegally tipped inside information about Dell's quarterly earnings to another portfolio manager at Sigma Capital. Horvath sent an e-mail to the other portfolio manager and copied Steinberg on the message. The e-mail stated:
"I have a 2nd hand read from someone at the company - this is 3rd quarter I have gotten this read from them and it has been very good in the last quarters. They are seeing GMs miss by 50-80 [basis points] due to poor mix, [operating expenses] in-line and a little revenue upside netting out to an [earnings per share] miss. . . . Please keep to yourself as obviously not well known."
The SEC alleges that two minutes later, Steinberg chimed in, "Yes, normally we would never divulge data like this, so please be discreet." Only 24 minutes after Horvath's e-mail, the other portfolio manager began to sell shares of Dell stock on behalf of the Sigma Capital hedge fund and reduced the hedge fund's Dell holdings by 600,000 shares ahead of Dell's quarterly earnings announcement. In the days following the negative announcement, Steinberg closed out a short position in Dell stock and multiple options positions for a $1 million illicit profit to the Sigma Capital hedge fund. The other portfolio manager's sales of Dell stock enabled the Sigma Capital hedge fund and a hedge fund managed by S.A.C. Capital Advisors to avoid more than $3 million in losses.
The SEC's complaint charges Steinberg with violating Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The complaint seeks a final judgment ordering Steinberg to pay disgorgement of his ill-gotten gains plus prejudgment interest and financial penalties, and permanently enjoining him from future violations of these provisions of the federal securities laws.
The SEC's investigation, which is continuing, has been conducted by Joseph Sansone, Daniel Marcus, and Stephen Larson of the Market Abuse Unit in New York as well as Matthew Watkins, Justin Smith, Neil Hendelman, Diego Brucculeri, and James D'Avino of the New York Regional Office. The case has been supervised by Sanjay Wadhwa. The SEC appreciates the assistance of the U.S. Attorney's Office for the Southern District of New York and the Federal Bureau of Investigation.
FROM: U.S. DEPARTMENT OF JUSTICE
Financial Fraud Enforcement Task Force Executive Director Michael J. Bresnick at the Exchequer Club of Washington, D.C.
Washington, D.C. ~ Wednesday, March 20, 2013
Good afternoon. Thank you for that kind introduction, and thank you all for having me here today. I’d especially like to thank John Ryan, my friend and President and Chief Executive Officer of the Conference of State Bank Supervisors, for inviting me to speak.
As you heard, I am the Executive Director of President Barack Obama’s Financial Fraud Enforcement Task Force. It has been my great pleasure to lead this Task Force for the past year and a half, and to work closely with Attorney General Eric Holder, Deputy Attorney General James Cole, Acting Associate Attorney General Tony West, and so many others throughout government. The Task Force was created in 2009 with the understanding that no matter the office or agency -- federal, state, or local; law enforcement or regulatory -- all of us within government share a common desire and have a core obligation to do everything that we can to protect the American public from the often devastating effects of financial fraud, whether it be mortgage fraud or investment fraud, grant or procurement fraud, consumer fraud or fraud in lending. And we know that we can accomplish so much more by working together than by working in isolated, compartmentalized silos. Through the efforts of the Financial Fraud Enforcement Task Force, that’s exactly what we’ve done.
Today I’m going to start by telling you about some of our recent accomplishments -- which were only made possible by our working together -- and then move on to a few priorities we will be focusing on in the coming year.
Just recently Task Force members announced the filing of parallel civil complaints -- by the Department of Justice and more than ten states -- against the ratings agency Standard and Poor’s, shedding a powerful light on conduct that went to the heart of the recent financial crisis. The Department alleged that from at least 2004 to 2007, S&P lied about its objectivity and independence. The evidence revealed that S&P promised investors and the public that their ratings were based on data and analytical models reflecting the company’s true credit judgment. In fact, internal S&P documents made clear that the company regularly altered, or delayed altering, its ratings models to suit the company’s own business interests. We also alleged that from at least March 2007 to October 2007, S&P issued ratings for certain CDOs that it knew were inflated at the time it issued them. By working closely with the states, and coordinating our collective efforts, we have never been more strategic, or effective.
Moreover, in Fiscal Year 2012, the Department, in close partnership with the U.S. Department of Housing and Urban Development and its Office of Inspector General, sued for or settled claims with banks for losses related to the mortgage crisis totaling over $2 billion, including recovering nearly $500 million from settlements with Deutsche Bank AG, CitiMortgage and Flagstar Bank.
Through the Task Force’s Non-Discrimination Working Group, in coordination with our partners at the OCC, Federal Reserve, and many others, our enforcement of fair lending laws has never been more robust. Since 2010 the Civil Rights Division’s Fair Lending Unit has filed or resolved 24 lending matters under the Fair Housing Act, the Equal Credit Opportunity Act, and the Servicemembers Civil Relief Act. The resolutions in these matters provide for a minimum of $660 million in monetary relief for impacted communities and for more than 300,000 individual borrowers.
The Residential Mortgage-Backed Securities Working Group is actively investigating fraud in the securitization and sale of residential mortgage-backed securities -- conduct that contributed to the financial crisis. Already we have seen significant action from Working Group members, including complaints filed against Credit Suisse and J.P. Morgan by the New York Attorney General’s Office, with the Department of Justice having offered substantial assistance by interviewing witnesses, reviewing documents, and providing additional investigative support. And the Securities and Exchange Commission entered into settlements with both J.P. Morgan and Credit Suisse totaling more than $400 million. Many more investigations are ongoing.
Mortgage Fraud Working Group members are creating training sessions for federal and state prosecutors and civil attorneys, as well as arming distressed homeowners with the information they need to avoid becoming victims of fraud. And efforts by the Consumer Protection Working Group to protect servicemembers and their families from predators targeting them as vulnerable marks includes recently creating and disseminating enforcement tool-kits to state attorneys general, U.S. Attorneys’ Offices, and JAG legal assistance officers that provide an overview of common scams targeting members of the military, available federal and state laws to address these schemes, opportunities for support from federal and state partners, and sample legal materials.
As you can see, the Task Force, through its spirited and energetic members, is tackling financial fraud on many fronts, with a focus on enforcement, prevention, and victim assistance. And by working together, we are able to identify fraud trends occurring throughout the country, develop priorities and national fraud enforcement strategies, create and coordinate national initiatives, and establish training events and guidance for our nation’s criminal prosecutors and civil attorneys. It is an example of what we can accomplish when we eliminate unnecessary boundaries and work together towards a common goal.
While the Task Force has done, and continues to do, much in these and other areas, I’d now like to discuss a few additional issues that we have prioritized, among others.
First, Task Force members have been focused on the government’s ability to protect its interests and ensure that it does business only with ethical and responsible parties. According to a recent GAO report, in Fiscal Year 2010 government spending on contracted goods and services was more than $535 billion. Accordingly, we are encouraging greater cooperation with government agencies involved in the suspension and debarment process, actions taken to exclude businesses or individuals who are not behaving in an ethical and lawful manner from receiving contracts.
Second, the Non-Discrimination Working Group has placed an increased focus on enforcement of discrimination by auto lenders. Currently, the law does not require auto lenders to give consumers the best interest rate they qualify for, and does not prohibit lenders from basing compensation on the ability to charge higher interest rates. As we found in the mortgage context, however, this practice may violate the fair lending laws if it causes minorities to be charged more than similarly qualified white borrowers. The Department’s Civil Rights Division is working closely with Consumer Financial Protection Bureau on this issue.
And third, the Consumer Protection Working Group has prioritized the role of financial institutions in mass marketing fraud schemes -- including deceptive payday loans, false offers of debt relief, fraudulent health care discount cards, and phony government grants, among other things -- that cause billions of dollars in consumer losses and financially destroy some of our most vulnerable citizens. The Working Group also is investigating the businesses that process payments on behalf of the fraudulent merchants -- financial intermediaries referred to as third-party payment processors. It’s this third priority that I’d like to discuss in a little more detail.
The reason that we are focused on financial institutions and payment processors is because they are the so-called bottlenecks, or choke-points, in the fraud committed by so many merchants that victimize consumers and launder their illegal proceeds. For example, third-party payment processors are frequently the means by which fraudulent merchants are able to get paid. They provide the scammers with access to the national banking system and facilitate the movement of money from the victim of the fraud to the scam artist. And financial institutions through which these fraudulent proceeds flow, we have seen, are not always blind to the fraud. In fact, we have observed that some financial institutions actually have been complicit in these schemes, ignoring their BSA/AML obligations, and either know about -- or are willfully blind to -- the fraudulent proceeds flowing through their institutions.
Our prioritization of this issue is based on this principle: If we can eliminate the mass-marketing fraudsters’ access to the U.S. financial system -- that is, if we can stop the scammers from accessing consumers’ bank accounts -- then we can protect the consumers and starve the scammers. This will significantly reduce the frequency of and harm caused by this type of fraud. We hope to close the access to the banking system that mass marketing fraudsters enjoy -- effectively putting a chokehold on it -- and put a stop to this billion dollar problem that has harmed so many American consumers, including many of our senior citizens.
Sadly, what we’ve seen is that too many banks allow payment processors to continue to maintain accounts within their institutions, despite the presence of glaring red flags indicative of fraud, such as high return rates on the processors’ accounts. High return rates trigger a duty by the bank and the third-party payment processor to inquire into the reasons for the high rate of returns, in particular whether the merchant is engaged in fraud.
Nevertheless, we have actually seen instances where the return rates on processors’ accounts have exceeded 30%, 40%, 50%, and, even 85%. Just to put this in perspective, the industry average return rate for ACH transactions is less than 1.5%, and the industry average for all bank checks processed through the check clearing system is less than one-half of one percent. Return rates at the levels we have seen are more than red flags. They are ambulance sirens, screaming out for attention.
A perfect example of the type of activity I’m talking about is the recent complaint against the First Bank of Delaware filed by the Department in the Eastern District of Pennsylvania, in Philadelphia. There, investigators found that in just an eleven-month period from 2010 to 2011, the First Bank of Delaware permitted four payment processors to process more than $123 million in transactions. Amazingly, more than half of the withdrawal transactions that the bank originated during this time were rejected, either because the consumer complained that the transaction was unauthorized, there were insufficient funds to complete the transaction, or the account was closed, each of which may indicate potential fraud and trigger the need for further inquiry. But the bank did nothing. Nothing, but continue to collect its fees per transaction, while consumers continued to get gouged by unscrupulous scam artists. Ultimately, the government alleged that the bank was engaged in a scheme to defraud under the Financial Institutions Reform, Recovery, and Enforcement Act and the bank agreed to pay a civil money penalty before surrendering its charter and closing its doors.
Underscoring the importance of this case, in the press release announcing a parallel action with the Financial Crimes Enforcement Network, the Acting Chairman of the FDIC, Martin Gruenberg, said, "Effective Bank Secrecy Act and anti-money laundering programs that are commensurate with the risk profile of the institution are vital to protecting our financial system." He added that "[t]he significant penalty assessed in this case emphasizes the importance of having strong internal controls to assure compliance with anti-money laundering regulations and to detect and report potential money laundering or other illicit financial activities."
So, the First Bank of Delaware is a model of irresponsible behavior by a bank.
Of course, this conduct is completely unacceptable. And it is receiving significant attention from the Department of Justice. In fact, right now within the Civil Division there are attorneys and investigators who are investigating similar unlawful conduct, and they will not hesitate to act when they see evidence of wrongdoing. Our message to banks is this: Maintaining robust BSA/AML policies and procedures is not merely optional or a polite suggestion. It is absolutely necessary, and required by law. Failure to do so can result in significant civil, or even criminal, penalties under the Bank Secrecy Act, FIRREA, and other statutes.
Consequently, banks should endeavor not only to know their customers, but also to know their customers’ customers. Before they agree to do business with a third-party payment processor, banks should strive to learn more about the processors’ merchant-clients, including the names of the principals, the location of the business, and the products being sold, among other things. If they are going to allow their institutions to be used by others as a gateway to access the bank accounts of our nation’s consumers, banks need to know for whom they are processing payments. Because if they don’t, they might be allowing some unscrupulous scam artist to be taking the last dollars of a senior citizen who fell prey to another fraud scheme, and hundreds of millions of dollars of additional proceeds of fraud to flow through their institutions. And in that case, they might later find themselves in the unfortunate position of the First Bank of Delaware.
In addition, as part of our focus on the role of financial institutions and third-party payment processors in mass-marketing fraud schemes, we naturally also are examining banks’ relationship with the payday lending industry, known widely as a subprime and high-risk business. We are aware, for instance, that some payday lending businesses operating on the Internet have been making loans to consumers in violation of the state laws where the borrowers reside. And, as discussed earlier, these payday lending companies are able to take the consumers’ money primarily because banks are originating debit transactions against consumers’ bank accounts. This practice raises some questions.
As you know, the Bank Secrecy Act demands that banks have effective compliance programs to prevent illegal use of the banking system by the banks’ clients. Bank regulatory guidance exhorts banks to collect information sufficient to determine whether a client poses a threat of criminal or other unlawful conduct.
Banks, therefore, should consider whether originating debit transactions on behalf of Internet payday lenders -- particularly where the loans may violate state laws -- is consistent with their BSA obligations.
Understandably, it may not be so simple a task for a bank to determine whether the loans being processed through it are in violation of the state law where the borrower resides. The ACH routing information, for example, may not indicate to the bank in which state the consumer lives, and variations in state laws could preclude blanket conclusions. Yet, at a minimum, banks might consider determining the states where the payday lender makes loans, as well as what types of loans it offers, the APR of the loans, and whether it make loans to consumers in violation of state, as well as federal, laws. By asking these questions, a bank may become aware of certain red flags, inviting further scrutiny and further action. The bury-your-head-in-the-sand approach, to the contrary, is certain to result in no action, even where some might be warranted, and is fraught with danger to consumers.
It comes down to this: When a bank allows its customers, and even its customers’ customers, access to the national banking system, it should endeavor to understand the true nature of the business that it will allow to access the payment system, and the risks posed to consumers and society regarding criminal or other unlawful conduct.
As I said at the outset, we in government share a unity of purpose and a common resolve to tackle the most pressing financial fraud issues of our time, and know that we must work together if we are to be successful in protecting the American public from harm. We are committed to doing so, and are approaching these issues in a smart, systematic, and coordinated way.
It has been a pleasure to address this distinguished group today. I thank you, again, for the opportunity, and now look forward to addressing any questions you may have.
FROM: COMMODITY FUTURES TRADING COMMISSION
CFTC Approves Final Regulations Governing Dual and Multiple Associations of Associated Persons of Swap Dealers and Major Swap Participants
Washington, DC — The Commodity Futures Trading Commission (Commission) has approved final regulations governing dual and multiple associations of associated persons (APs) of swap dealers (SDs), major swap participants (MSPs) and other Commission registrants. The regulations make clear that each SD, MSP and other Commission registrant with whom an AP is associated is required to supervise the AP and is jointly and severally responsible for the activities of the AP with respect to customers common to it and any other SD, MSP or other Commission registrant.
The CFTC voted 5 to 0 via seriatim to approve the final regulations, which will become effective 60 days after publication in the Federal Register.
FROM: COMMODITY FUTURES TRADING COMMISSION
CFTC Orders Florida Firms, Joseph Glenn Commodities LLC and JGCF LLC, and Owners Scott Newcom and Anthony Pulieri to Pay over $1 Million in Restitution and Penalties for Fraudulent Off-Exchange Transactions in Precious Metals with Retail Customers
Washington DC – The U.S. Commodity Futures Trading Commission (CFTC) today issued an Order filing and settling charges against two Boca Raton, Fla., companies, Joseph Glenn Commodities LLC (Joseph Glenn) and JGCF LLC (JGCF), and their sole owners and principals, Scott Newcom and Anthony Pulieri (the Respondents) for engaging in illegal, fraudulent off-exchange financed transactions in precious metals with retail customers.
The CFTC Order, filed on March 27, 2013, requires Joseph Glenn, JGCF, Newcom, and Pulieri to pay approximately $635,000 in restitution to customers for their losses and to return approximately $330,000 remaining in customers’ accounts. The Order requires Pulieri to pay a civil monetary penalty of $100,000. The Order also permanently prohibits the Respondents from registering with the CFTC and imposes a five-year trading ban on trading for others. In addition, the Order prohibits the Respondents from violating the Commodity Exchange Act, as charged, and requires them to comply with certain undertakings, including fully and expeditiously cooperating with the CFTC.
The Illegal and Fraudulent Transactions
The CFTC Order finds that from July 2011 through June 2012, the Respondents solicited retail customers, generally by telephone or through Joseph Glenn’s website, to buy physical precious metals such as gold, silver, copper, platinum, or palladium in what are known as off-exchange leverage transactions. According to the Order, the customers paid the Respondents a portion of the purchase price for the metals, and Joseph Glenn and JGCF purportedly financed the remainder of the purchase price, while charging the customers interest on the amount they purportedly loaned to customers.
The CFTC Order states that such financed off-exchange transactions with retail customers have been illegal since July 16, 2011, when certain amendments of the Dodd-Frank Wall Street and Consumer Protection Act of 2010 (Dodd-Frank Act) became effective. As explained in the Order, financed transactions in commodities with retail customers like those engaged in by the Respondents must be executed on, or subject to, the rules of an exchange approved by the CFTC. Since the Respondents’ transactions were done off-exchange with retail customers, they were illegal.
Furthermore, the CFTC Order states that when Joseph Glenn and JGCF engaged in these illegal transactions they were acting as dealers for a metals merchant called Hunter Wise Commodities, LLC (Hunter Wise), which the CFTC charged with fraud and other violations in federal court in Florida on December 5, 2012 (see CFTC Press Release 6447-12). Hunter Wise was purportedly Joseph Glenn’s and JGCF’s source for the metal and the loans. As alleged in the CFTC Complaint against Hunter Wise and according to the CFTC Order in this case, however, neither Joseph Glenn, JGCF, nor Hunter Wise purchased or held metal on the customers’ behalf, or disbursed any funds to finance the remaining balance of the purchase price. The Order finds that the Respondents’ customers thus never owned, possessed, or received title to the physical commodities that they believed they purchased.
The Order also finds that the Respondents defrauded their customers by misrepresenting the profitability of the financed off-exchange transactions and failing to disclose associated commissions, service, and interest fees.
CFTC staff responsible for this matter are Jon J. Kramer, Joy H. McCormack, Elizabeth M. Streit, Scott R. Williamson, Rosemary Hollinger, and Richard Wagner.
FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
Federal Court in California Orders Victor Yu and His Company to Pay over $3.2 Million in Foreign Currency Fraud Action
Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced that it obtained a federal court Order requiring Defendants Victor Yu of San Jose, Calif., and his company, VFRS, LLC (VFRS), to pay restitution of nearly $2.15 million, disgorgement of more than $270,000, and a civil monetary penalty of over $800,000. The Order also imposes permanent trading and registration bans against Yu and VFRS and permanently prohibits them from further violations of federal commodities law, as charged.
The Order for Default Judgment and Permanent Injunction was entered on March 26, 2013, by Judge Yvonne Gonzales Rogers of the U.S. District Court for the Northern District of California. The Order stems from a CFTC Complaint filed on July 26, 2012, that charged Yu and VFRS with defrauding clients in connection with off-exchange foreign currency (forex) trading and failing to register with the CFTC as a Commodity Trading Advisor (CTA).
The court’s Order finds that the Defendants fraudulently induced more than 100 individuals to open forex trading accounts. In their client solicitations, the Defendants misrepresented that they had developed trading software that made forex trading "extremely safe" and that would prevent clients from ever reaching certain loss thresholds, the Order finds. The Defendants also misrepresented to some prospective clients that their trading software had shown positive returns on every trade it ever made and had successfully predicted activity in the currency markets back to the 1920s, according to the Order.
The Order further finds that, from 2009 to the present, the Defendants induced their clients to invest over $5 million in forex trading accounts, and clients lost almost $2.15 million during the same period. The Defendants received over $270,000 in service fees from those clients, the Order finds.
Once clients opened forex trading accounts, the Order finds that Yu and VFRS instructed them to give Defendants their log-in and password information so that the Defendants could place trades in their accounts. By this conduct, Yu acted as a CTA without being registered as such, according to the Order.
CFTC Division of Enforcement staff members responsible for this case are Robert Howell, Jennifer Smiley, Joseph Patrick, Susan Gradman, Scott Williamson, Rosemary Hollinger, and Richard Wagner.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Key Note:
Symposium on Building the Financial System of the 21st Century: An Agenda for Europe and the United States
by
Commissioner Daniel M. Gallagher
U.S. Securities and Exchange Commission
Washington, D.C.
March 21, 2013
Rüschlikon, Switzerland
March 21, 2013
Thank you very much, Hal [Scott] for that kind introduction and for inviting me to speak here today. It is a great pleasure to be here at a conference devoted to promoting trans-Atlantic dialogue between the U.S. and Europe.
Before I start, let me keep my chief ethics officer happy and advise you that my remarks here today are my own and do not necessarily represent the views of the SEC or my fellow Commissioners.
We in America have been blessed with a wonderful combination of geography, natural resources, and free market principles. These and other factors have allowed our economy and our financial system, including our capital markets, to thrive in the post-World War II era.
Although the United States has suffered its share of financial crises, most recently the one that erupted in 2008, our free market economy and robust capital markets have conferred an enviable prosperity on our people over a period of many years, and few in America can remember a time when the United States did not have strong and competitive capital markets.
However, the very strength and resilience of our capital markets could lead us to fall into the trap of believing that we are somehow entitled to such prosperity. Indeed, such a sense of complacency may well have taken root in our government and may threaten to jeopardize that prosperity. The reality is that we live in a world in which we must be constantly vigilant — sometimes taking affirmative action, but more often choosing not to act — in order to preserve the vitality of our markets.
An important part of my job, and that of my colleagues on the Commission, is to ensure that America’s capital markets remain strong, vibrant, and competitive. That’s not just good for U.S. investors, but also for other investors around the world. And, conversely, the rise of robust capital markets in other parts of the world has the potential to benefit the United States and the American people as well.
Today, financial services firms and investors are able to transact their business in markets around the world without leaving the confines of their homes or offices, much less their home jurisdictions. Companies are increasingly eschewing traditional venues like London or New York and instead turning to rising markets in Asia, Latin America, the middle east, and elsewhere for their capital needs.
Indeed, policymakers, business and financial industry representatives, and other market participants in the United States have been concerned about these developments for some time. In a November 2006 opinion piece in the Wall Street Journal, U.S. Senator Charles Schumer of New York and New York City Mayor Michael Bloomberg sounded the alarm about challenges to New York City’s status as the financial capital of the world.
1 In the preface to a consulting report commissioned by New York on this issue, Senator Schumer and Mayor Bloomberg acknowledged other international financial centers’ challenges to New York’s status, warning that "we can no longer take our preeminence in the financial services industry for granted."2
In March 2007, a report issued by a bipartisan commission established by the U.S. Chamber of Commerce identified and analyzed a number of these emerging challenges for U.S. capital markets.3 The report cited more than 70 years of capital markets excellence enjoyed by the United States and the "unmatched prosperity" that came with it, but also noted that the United States was steadily losing market share to other international financial centers.4 The report drew a distinction between two types of causes for this shift in market share. On the one hand, the report explained, this shift was "a reflection of natural economic and market forces that cannot, and should not, be reversed" and that indeed the development of European and Asian markets was a "positive development for the United States."5 However, the report also cited internal, self-inflicted factors — such as an increasingly costly regulatory environment and the burdensome level of civil litigation — as negatives that should be corrected.6 Later, in March 2008, the Chamber’s Center for Capital Markets Competitiveness issued a report calling for a modern, coherent regulatory structure and fair legal, regulatory, and enforcement processes.7 In this report, they cited "robust global competition from overseas markets" and noted that "[t]he reality is that America is no longer the sole capital markets superpower."8
In November 2006 and December 2007, the Committee on Capital Markets Regulation, an independent and nonpartisan research organization led by Hal Scott, issued a pair of reports calling attention to the declining competitiveness of the U.S. public equity markets.9 Among other things, the Committee cited a significant decline in the U.S. share of equity raised in global public markets, a precipitous decline in the U.S. share of the twenty largest global IPOs, and a legion of statistics indicating that foreign and domestic issuers were taking steps to raise capital either privately or in overseas markets rather than in the U.S. public equity markets.10
In November 2007, the non-partisan Financial Services Roundtable added its voice to this growing chorus, issuing a detailed blueprint for maintaining U.S. financial competitiveness.11 This blueprint noted the decades-long prosperity enjoyed by U.S. financial markets and firms, but concluded that this landscape was changing dramatically.12 The report went on to cite the relentless growth of foreign capital markets and the development of modern regulatory regimes in foreign jurisdictions. The report concluded that the United States should make changes to its regulatory system that would enable it to adapt and respond to "growing global competition," "innovative market developments," and "the dynamic financial needs of all consumers."13
In March 2008, then-U.S. Treasury Secretary Hank Paulson neatly summed up these concerns in the Treasury Department’s blueprint for reshaping the U.S. financial regulatory system:
Due to its sheer dominance in the global capital markets, the U.S. financial services industry for decades has been able to manage the inefficiencies in its regulatory structure and still maintain its leadership position. Now, however, maturing foreign financial markets and their ability to provide alternate sources of capital and financial innovation in a more efficient and modern regulatory system are pressuring the U.S. financial services industry and its regulatory structure. The United States can no longer rely on the strength of its historical position to retain its preeminence in the global markets.
14
That same month, the financial crisis in the U.S. began in earnest with the bailout of Bear Stearns, followed by the bankruptcy of Lehman Brothers in September 2008 and the low point of the U.S. equities markets in March 2009. In July 2010, well before the complex causes of the financial crisis were sorted out and understood by policymakers, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act as its reaction to the meltdown.
Unfortunately, this legislative response to the financial crisis bore little resemblance to the competitiveness-enhancing regulatory reform contemplated by pre-crisis regulators and market participants. The Dodd-Frank Act was not a carefully crafted product of bipartisan compromise, as opposed to the Congressional response to the stock market crash of 1929. Rather, Congress — having been exhorted not to let a crisis go to waste — allowed the urgent need for regulatory reform to be overwhelmed by a grab bag of disparate wish-list items, many of which had nothing to do with the financial crisis but were derived instead from long-held ambitions of policymakers, bureaucrats, and special interest groups.
What continues to amaze me about Dodd-Frank is not only what it covers in its 2319 pages, but also the crucial regulatory issues that it failed to address. For example, the act mandates that the SEC create unprecedented new disclosure rules relating to conflict minerals from the Congo — but it omits any mention of money market mutual funds, which Dodd-Frank’s own FSOC tells us are ticking time bombs of systemic risk. The Act requires disclosure of extractive resource payments made by U.S.-listed oil, gas, and mining companies — but it leaves the reform of Fannie Mae and Freddie Mac for another day. The Act was intended to end "too big to fail," but in reality it enshrined that concept by creating an entire system of special regulation for financial institutions that are "systemically important." This system threatens to aggravate the problem by conferring a competitive advantage on these already "too big to fail" institutions.
Rather than responding appropriately to the crisis, which would include developing a modern regulatory system with the flexibility to adapt to changes in the global financial system, we instead have been saddled with an increasingly prescriptive and inflexible regulatory environment that is characterized far more by more regulation than by smart regulation. Put another way, Congress, in fact, did let a crisis go to waste. The calls for proactive reform contained in the various reports I mentioned were ignored when the patient was on the operating table. Far from cured, things have, indeed, gotten even worse. To extend the analogy, under the surgeons’ care, the patient’s infection turned into sepsis.
Rather than addressing the competitive concerns raised before the crisis by policymakers and business leaders, the Dodd-Frank Act represents a vast increase in precisely the type of regulation that raised those concerns in the first place. Indeed, Dodd-Frank marked a tremendous expansion of prescriptive financial regulation, with much of the law’s rulemaking burden, including about 100 of its 400 rulemaking mandates, falling on the SEC. The very volume of Dodd-Frank’s prescriptive mandates to the SEC has had the unintended effect of significantly limiting the agency’s ability to bring its traditional expertise and judgment fully to bear in the rulemaking process. In that sense, it has had a negative impact on the Commission’s ability to develop sound, sensible regulation and to adapt quickly and flexibly to the continuing transformation of global capital markets.
Given these limitations, how can the Commission and other capital markets regulators best approach the challenges of this brave new world? Recognizing that capital markets and their participants are becoming increasingly de-localized in a world where new and complex financial products are traded around the clock and across the globe, it is certain that financial products and the entities that trade them will be regulated in different ways in different countries. As products cross international borders and move from one jurisdiction to another, simultaneously satisfying each of the overlapping regulatory requirements of multiple jurisdictions can be costly to investors, not to mention confusing — and the only ones smiling are the lawyers.
In the past, the standard response to cross-border jurisdictional conflicts was to seek to negotiate one-size-fits-all norms for all to implement. That approach is increasingly seen as impractical and obsolete. Certainly, it cannot hope to keep pace with product development, trading techniques, and even national regulation. Still, we must recognize the significant impediment to global trading posed by duplicative regulation of the same transaction or activity.
The key, it seems to me, is for regulators to accept the reality that, as to any given financial product or activity, there are likely to be high quality regulatory regimes other than ours — or, for that matter, yours. With that in mind, it seems that the best way to ensure high quality, but not layered and oppressive, regulation of those products and activities will be for one jurisdiction to defer to another’s regulatory approach, at least in certain situations.
This is not a new idea — but implementing it effectively will require new approaches. Academics as well as regulators have developed formulations like "substantial equivalence" and "mutual recognition" to describe a situation in which one country’s securities regulators would defer to another’s when their securities regulations were, in substance, largely the same. The goal under such an approach is to allow one regulator to accept as sufficient the regulatory actions of a different regulator with respect to financial services activities and participants that span multiple jurisdictions. Accordingly, this deference would have to be mutual, not unilateral, to have any hope of achieving its objective.
Notwithstanding the complexities involved, exploring this concept strikes me as a matter of common sense, given the pace of change in our financial services world, with investment products evolving before regulations can be written to cover them.
The SEC began to explore concepts of regulatory equivalence about five years ago, an effort that yielded limited success. The financial crisis of 2008 forced the agency to shelve this initiative. Two years later, the extraordinary expansion of financial regulation stemming from the Dodd-Frank Act further clouded the regulatory landscape, even as it made conspicuous the point that a one-size-fits-all approach had become utterly impractical.
The issue of extraterritorial application of laws and rules is best illustrated by the current debate over how U.S. regulators will apply the OTC derivatives provisions of the Dodd-Frank Act to activities that cross national borders. Given the complexity of the overall regulatory scheme for derivatives set forth in Title VII of the Act, the question of how to apply that regime to cross-border transactions is significant. Because derivatives are perhaps the most global and mobile financial products that exist, with dealers and other intermediaries spread across the world trading products for widely dispersed clients, the SEC staff is, of necessity, discussing this matter with foreign regulators. We must, in addition, coordinate our efforts with our domestic colleagues at the CFTC, who were given responsibility for swaps that are not security-based — the vast majority of the market.
As most of you know, this has not been an easy exercise. As has been widely reported, the CFTC has taken a very aggressive approach, attempting to extend the reach of its OTC derivatives rules deeply into foreign jurisdictions. Not surprisingly, key foreign regulators have expressed serious reservations at the CFTC’s approach. You may recall that leading policymakers from the European Commission, the United Kingdom, France, and Japan wrote a joint letter to the CFTC requesting that it refrain from taking action that would risk fragmenting and damaging the derivatives market, arguing instead for an approach grounded in principles of regulatory equivalence and substituted compliance.15
Subsequently, in a joint statement issued after their November 2012 meeting, the leaders of twelve national and supranational entities responsible for regulating OTC derivatives expressed interest in regulatory approaches that included voluntary regulatory deference. In their statement, this diverse group of regulators agreed that some form of limited regulatory "recognition," acceptance of "substituted compliance," or specific "exemptions" "should be considered" in crafting regulatory regimes applicable to OTC derivatives, given the "need to prevent the application of conflicting rules and the desire to minimize … the application of inconsistent and duplicative rules."16 I, too, believe it will be critical to incorporate some sort of regulatory deference into any cross-border approach to regulating security-based swaps.
Reaching beyond derivatives, you will also know that the European Union has adopted an "equivalence"-based approach to enable deference to non-EU regulators in various areas, including the regulation of credit rating agencies. In the United States, the SEC’s rules implementing the Credit Rating Agency Reform Act of 2006 established a registration and oversight regime for CRAs that register with the SEC. Three years later, in the wake of the global financial crisis, the EU adopted a directive establishing its own regulatory scheme applicable to CRAs. The EU directive included a provision allowing for non-duplicative regulation where the CRA is subject to a regulatory regime the EU has found "equivalent" to its own.17 After some serious bumps and bruises during the early stages of the equivalency determination process, the European Securities and Markets Authority concluded that U.S. regulation of CRAs was, in fact, equivalent to that under the applicable EU regulations. This prompted the European Commission to follow with its own equivalency determination several months later.18
While this experience was not, from a U.S. standpoint, a shining endorsement of the equivalency experiment, I do not think the problem lies in the concept of "substituted compliance," so much as in the manner of its implementation. To succeed as it surely must, all involved will have to proceed without preconceptions, with clarity of vision, and perhaps with unaccustomed levels of restraint.
In other words, because the equivalency determination is the precondition to one jurisdiction’s acceptance of the regulatory actions of any other jurisdiction, it is inherently subject to misuse of a sort that would fly in the face of the very purpose of substituted compliance. It could, for example, be used as a chokepoint to force the other jurisdiction to regulate in the same way or to the same degree as the determining jurisdiction; it could be used as a protectionist tool, wielded for parochial and anti-competitive reasons.
So I want to stress: If "equivalency" and "substituted compliance" are to have a future — if international commerce in derivatives are not to be dragged down in regulatory confusion and cost — equivalency determinations must be made in good faith and with openness to approaches other than those of the evaluating entity or its political organs. Speaking on this topic, my colleague, CFTC Commissioner Jill Sommers, stressed the key point: "It is important that assessments of comparability be made at a high level, keeping in mind the core policy objectives … rather than a line-by-line comparison of rulebooks."19
And, I am very happy to report, a bipartisan bill introduced in the House of Representatives just two days ago strikes precisely the appropriate balance, requiring that the SEC and CFTC jointly issue rules on OTC derivatives that show deference to broadly equivalent foreign regulatory regimes. The House bill provides, in pertinent part, that the joint SEC-CFTC rules "shall provide that a non-U.S. person in compliance with the swaps regulatory requirements of a G20 member nation, or other foreign jurisdiction as jointly determined by the Commissions, shall be exempt from United States swaps requirements … unless the Commissions jointly determine that the regulatory requirements of the G20 member nation or other foreign jurisdiction are not broadly equivalent to United States swaps requirements."
Returning to my larger point: Much of America’s post-war prosperity has been driven by our free market economy and vibrant capital markets. More recent experience in other parts of the world, Europe included, underscores that connection. We must not take the vitality of our capital markets for granted. We must instead foster them, and in the process protect investors, whether large or small, domestic or foreign. We must all regulate in a balanced manner — smartly.
Smart regulation today requires, at a minimum, that we keep pace with the evolution of global markets, but that we do so without adding unnecessary costs — that we avoid imposing layers of complex, overlapping, and, to that extent, incoherent regulation. We must not look in isolation at the potential benefits of regulation, but also in each instance at whether they are sufficient to justify the costs that they entail. And we can, I submit, increasingly keep pace with developments in the industries and markets we regulate, while reducing the burdens we impose on those we regulate, by deferring to our peer regulators in appropriate situations.
Thank you very much for your kind attention, and I wish you a productive and successful conference.
1 Hon. Charles E. Schumer & Hon. Michael R. Bloomberg, Op-Ed., To Save New York, Learn From London Wall St. J., Nov. 1, 2006, http://online.wsj.com/article/SB116234404428809623.html.
2 Hon. Michael R. Bloomberg & Hon. Charles E. Schumer, Sustaining New York’s and the US’ Global Financial Services Leadership, at i (2007).
3 Commission on the Regulation of U.S. Capital Markets in the 21st Century, Report and Recommendations (2007) [hereinafter 21st Century Report].
4 21st Century Report, at 11, 15.
5 21st Century Report, at 11 and 17.
6 21st Century Report, at 16.
7 Center for Capital Markets Competitiveness, Strengthening U.S. Capital Markets: A Challenge for All Americans, at 4, 23-26 (2008) [hereinafter Strengthening U.S. Capital Markets].
8 Strengthening U.S. Capital Markets, at 3.
9 Committee on Capital Markets Regulation, Interim Report of the Committee on Capital Markets Regulation (2006); Committee on Capital Markets Regulation, The Competitive Position of the U.S. Public Equity Market (2007).
10 See, e.g., The Competitive Position of the U.S. Public Equity Market, at 1-5.
11 The Financial Services Roundtable, The Blueprint for U.S. Financial Competitiveness (2007).
12 See The Blueprint for U.S. Financial Competitiveness, at 7.
13 The Blueprint for U.S. Financial Competitiveness, at 8.
14 The Department of the Treasury, Blueprint for a Modernized Financial Regulatory Structure, at 2 (2008).
15 See Letter from Hon. George Osborne, Hon. Michel Barnier, Hon. Ikko Nakatsuka, and Hon. Pierre Moscovici to Hon. Gary S. Gensler (Oct. 17, 2012), available at http://www.fsa.go.jp/en/news/2012/20121018-1.html.
16 See "Joint Press Statement of Leaders on Operating Principles and Areas of Exploration in the Regulation of the Cross-Border OTC Derivatives Market" (Dec. 4, 2012) (relating to Nov. 28, 2012 meeting), SEC Press Release No. 2012-251, at item 4.
17 Regulation (EC) No 1060/2009 (Sept. 16, 2009), Art. 5(6), OJ L 302 (Nov. 17, 2009), at 1.
18 European Commission Implementing Decision 2012/628/EU, October 5, 2012, OJ L 274/32 (9 Oct. 2012). In separate decisions on the same day, the EU also found the CRA regulations of Australia and Canada equivalent to those of the EU.
19 Statement of Commissioner Jill E. Sommers at a hearing of the Subcommittee on General Farm Commodities and Risk Management, Committee on Agriculture, U.S. House of Representatives, Dec. 12, 2012.
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