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FDIC to Consider QRM Proposal Next Week
This week, the FDIC released the agenda for an August 28, 2013 Board Meeting at which the Board will consider the re-proposal of a rule to implement the credit risk retention requirements of the Dodd-Frank Act, including provisions regarding “qualified residential mortgages” or QRMs. The FDIC and other federal banking and housing agencies originally proposed a rule in April 2011 that would have required sponsors of asset-backed securities (ABS) to retain at least five percent of the credit risk of the assets underlying the securities. Exemptions to the proposed rule included U.S. government-guaranteed ABS and mortgage-backed securities that are collateralized exclusively by residential mortgages that qualify as QRMs. The proposed rule would have established a definition of QRMs incorporating criteria designed to ensure that such QRMs were of very high credit quality, including a 20% down payment requirement or a requirement that the borrower’s debt-to-income ratio not exceed 36%. It recently has been reported that, in response to overwhelming objections from industry participants, the re-proposed rule will loosen those standards and align the QRM definition with the CFPB’s qualified mortgage or QM definition.
RMBS Task Force Announces New Suits Over Sale of Jumbo Prime RMBS
On August 6, the DOJ and the SEC announced parallel civil fraud actions filed in the U.S. District Court for the Western District of North Carolina. The DOJ alleged that a national bank and related entities misled investors about the residential jumbo prime mortgage loans backing an $850 million RMBS the bank offered for sale, made false statements after failing to perform proper due diligence, and filled the securitization with a disproportionate amount of risky mortgages originated through third party mortgage brokers. The DOJ action represents the enforcement agency’s latest effort to employ the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) to seek civil penalties. The SEC is seeking an order requiring disgorgement and civil penalties under the Securities Act. The complaints were announced as part of the Financial Fraud Enforcement Task Force’s RMBS Working Group, and Task Force participants Attorney General Eric Holder, Associate Attorney General Tony West, and New York Attorney General Eric Schneiderman all promised additional investigations and actions, using every tool and resource available to the group.
SEC Adopts New Broker-Dealer Requirements, Amends Others
On July 31, the SEC approved a final rule that amends certain broker-dealer annual reporting, audit, and notification requirements. The amendments require, among other things, (i) that broker-dealers conduct audits in accordance with PCAOB standards, (ii) that broker-deals that clear transactions or carry customer accounts agree to allow the SEC or the broker-dealer’s designated examining authority (DEA) to review the documentation associated with certain reports of the broker-dealer’s independent public accountant and to allow the accountant to discuss the findings relating to the reports of the accountant with those representatives when requested in connection with a regulatory examination of the broker-dealer, and (iii) that broker-dealers file a new form with their DEA that elicits information about the broker-dealer’s practices with respect to the custody of securities and funds of customers and non-customers. Broker-dealers are required to begin filing new quarterly reports with the SEC and annual reports with the Securities Investor Protection Corporation by the end of 2013, and must begin filing annual reports with the SEC June 1, 2014. The SEC also approved amendments to the net capital, customer protection, books and records, and notification rules for broker-dealers. Those amendments take effect 60 days after publication in the Federal Register.
FINRA To Begin Sharing Additional MBS Information
On July 22, FINRA announced that it will begin to disseminate information for so-called specified pool transactions in agency pass-through mortgage-backed securities and SBA-backed securities, including transaction information such as the time of the trade, price and volume. Transactions must be reported to within two hours of execution (the reporting period is reduced to one hour after a six month implementation period), and are disseminated as soon as received. Combined with FINRA’s action last year to begin disseminating transaction information for agency pass-through mortgage-backed securities traded "to-be-announced" (TBA), FINRA now will be sharing information for securities that represent over 90 percent of the par value traded in all asset- and mortgage-backed securities.
Senate Banking Committee Approves FHFA Director Nominee, Other Nominees
On July 18, the Senate Banking Committee approved Rep. Mel Watt (D-NC) to be the next Director of the FHFA, on a 12-10 party line vote. On a voice vote, the Committee also approved Michael Piwowar and Kara Stein as members of the Securities Exchange Commission, Jason Furman to serve as member and chairman of the Council of Economic Advisers, and Richard Metsger to sit on the National Credit Union Administration Board. Finally, again by voice vote, the Committee voted to extend the term of SEC Chair Mary Jo White until June 5, 2019. The nominations could come before a vote of the full Senate in the coming weeks.
California Federal District Court Allows Government's FIRREA-Based RMBS Suit to Proceed
On July 16, the U.S. District Court for the Central District of California denied a major credit rating agency’s motion to dismiss a DOJ complaint alleging that the firm defrauded investors in residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) by issuing inflated ratings that misrepresented the securities’ true credit risks, and by falsely representing that its ratings were uninfluenced by its relationships with investment banks. U.S. v. McGraw-Hill Cos., Inc., No. 13-779, slip. op (C.D. Cal. Jul. 16, 2013). The court held that the government met its initial pleading burden, in part, because it sufficiently had alleged that the rating agency “engaged in a ‘scheme to defraud investors in RMBS and CDOs tranches’ and ‘to obtain money from these investors by means of material false and fraudulent pretenses, representations, and promises, and the concealment of material facts’ with ‘intent to defraud.’” In doing so, the court allowed the government to pursue its $5 billion claims grounded in the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). The court did not, however, consider the weight of the government’s evidence, specifically whether the rating agency’s alleged statements and conduct were part of an actual “scheme to defraud,” a key element to any FIRREA claim.
Tenth Circuit Affirms Dismissal of Securities Act Claims Against Banks That Underwrote Stock of Failed Mortgage Lender
On July 9, the U.S. Court of Appeals for the Tenth Circuit affirmed a district court’s order dismissing claims brought by investors against banks that had underwritten a mortgage lender’s stock offerings. Slater v. A.G. Edwards & Sons, Inc., No. 11-2170, 2013 WL 3390038 (10th Cir. Jul. 9, 2013). The lender, which focused on the adjustable-rate mortgage market, attempted to raise new capital through a series of stock offerings in 2007 and 2008 before filing for bankruptcy in 2009. Investors in those offerings filed suit after the stock price dropped following the lender’s disclosure that it had been subject to margin calls triggered by a decline in the value of certain Alt-A mortgages that backed securities the lender had purchased. The investors alleged that documents related to the offerings violated Section 11 of the Securities Act because they did not disclose, among other things, the existence of the Alt-A MBS. In affirming dismissal of the claims against the underwriters, the Tenth Circuit concluded that plaintiffs had not alleged “an actionable misrepresentation or omission at the time of [the] stock offerings.” The court explained that the lender was not under any obligation to disclose the MBS to make its statements true and accurate, and that the picture it provided was materially accurate, in part because the prospectus warned that the lender’s liquidity conditions could worsen.
SEC Approves FINRA Rule Change to Publicly Release Additional Disciplinary Action Information
On June 21, the SEC approved a change to FINRA’s rules that will allow the self-regulatory organization to publish greater information about FINRA’s disciplinary actions. Under existing rules, FINRA only releases disciplinary actions upon request, unless the action meets specified criteria established for use in determining whether an action is worthy of publication. Once the new rules take effect – likely several months from now – those publication criteria will be removed, and most FINRA disciplinary actions will be released as a matter of course. FINRA will retain authority to redact information to protect privacy of individuals. The new rules also update and codify FINRA’s practices related to the publication of other FINRA actions, including temporary cease and desist orders, statutory disqualification decisions, expedited proceeding decisions, summary actions, and others.
SEC Plans to Alter Policy on Seeking Admissions
On June 18, numerous media outlets reported that SEC Chair Mary Jo White indicated that the SEC will shift its policy toward extracting admissions from parties facing allegations of wrongdoing as a condition of resolving those allegations. While a majority of cases likely still will be settled under the current “neither admit nor deny” rubric, the SEC will seek admissions in cases that meet certain criteria, which likely will include “widespread harm to investors.” The shift would extend a policy adopted last year by then-SEC Enforcement Director Robert Khuzami to no longer allow defendants who are convicted of or admit guilt with regard to criminal charges to neither admit nor deny the parallel civil liability. The SEC now may seek an admission even where there is no criminal finding or admission. This change follows increasing pressure from members of Congress on federal regulators and law enforcement authorities to more vigorously pursue allegations of wrongdoing by financial institutions, including, most recently, an inquiry by Senator Elizabeth Warren (D-MA) as to whether the SEC and other agencies have conducted any internal research or analysis on trade-offs to the public between settling an enforcement action without admission of guilt and going forward with litigation to obtain a judicial finding of unlawful conduct.
SEC Chairman Names Chief Counsel
On June 3, the SEC Chairman Mary Jo White appointed Robert E. Rice as Chief Counsel. Mr. Rice previously served as a federal prosecutor in the Southern District of New York. Most recently he was head of governance, litigation, and regulation for the Americas, and the global co-head of the governance, litigation, and regulation operating committee for an international financial institution.