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District Court Says Bank/RMBS Trustee Must Face Suit Filed by Institutional Investors Claiming Breach of Trust Agreement
On March 30, a federal court in the Southern District of New York denied in part a bank’s motion to dismiss claims brought in five consolidated actions by institutional investors alleging breach of contract and conflict of interest in connection with billions of dollars of alleged losses stemming from the bank’s role as a trustee of 53 residential mortgage-backed securities (RMBS). The RMBS investors alleged, among other things, that the trustee took “virtually no action” to require lenders to repurchase or cure defaulted or improperly underwritten loans that backed the securities, despite having knowledge of “systemic violations.” The investors further alleged that the trustee’s failure to take corrective action was due to concerns that it might expose its own “misconduct” in other RMBS trusts and/or jeopardize its business dealings with lenders and servicers.
Ultimately, the Court granted in part and denied in part the bank-trustee’s motion to dismiss, finding that the plaintiffs may pursue breach of contract and conflict of interest claims related to the trusts, as well as certain claims alleging breaches of fiduciary duty and due care. In reaching its conclusion, the Court explained that, having identified internal bank documents that raise legitimate questions about whether bank officials knew about lenders’ “alleged breaches of the trusts’ governing agreements” and failed to address the problems, the plaintiffs’ allegations “go far beyond many other RMBS trustee complaints, which themselves have been found sufficient to state a claim.” The Court did, however, dismiss the investors’ claims that alleged negligence and those alleging a breach of the covenant of good faith and fair dealing and negligence because, among other reasons, “[a] tort claim cannot be sustained if it ‘do[es] no more than assert violations of a duty which is identical to and indivisible from the contract obligations which have allegedly been breached.’” The Court also nixed several claims asserting violations of certain provisions of the New York law governing mortgage trusts for which no private right of action exists.
DOL Extends Fiduciary Rule Applicability Date by 60 Days
On April 4, the U.S. Department of Labor (DOL) issued a 60-day extension of the applicability dates of its “Fiduciary Rule”—a 2016 final rule expanding the definition of who qualifies as a “fiduciary” under ERISA and the Internal Revenue Code. The rule treats persons who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan or IRA as fiduciaries in a wider array of “advice relationships.” The extension also delays (by 60 days) the applicability of certain prohibited transaction exemptions. Accordingly, exemptions such as the “Best Interest Contract Exemption” and the “Principal Transaction Exemption” will become applicable on June 9, 2017. In its press release announcing the issuance of the final rule, the DOL noted, among other things, that the extensions are necessary to enable the DOL to perform the examination of the fiduciary rule directed by the President in his February 3 Presidential Memorandum (see previously posted InfoBytes summary regarding February 3 memo) to consider possible changes with respect to the fiduciary rule and related Prohibited Transaction Exemptions based on new evidence or analysis developed pursuant to the examination.
The 60-day extension was published in the Federal Register on April 7. As previously covered on InfoBytes, the DOL has released two sets of “frequently asked questions” about the Fiduciary Rule.
SEC Announces Investigation Concerning Alleged $6.7 Million Michigan Real Estate Scheme
On March 30, the SEC announced charges against a Michigan pastor, his company, and business associate (Defendants) for allegedly cheating church members, retirees, and laid-off autoworkers out of approximately $6.7 million by convincing them to invest in a “successful” real estate scheme. The complaint alleges the pastor presented the investment opportunity at churches nationwide and through media outlets using “faith-based rhetoric” and guaranteed high returns. The Defendants—who were never registered to sell investments—raised the money from more than 80 investors who were told their money would be kept in qualified IRAs and could be rolled over tax-free. However, investors stopped receiving agreed-upon interest payments, and to date, Defendants owe more than 40 Michigan-based investors $2 million in past due promissory notes and also allegedly have obligations to investors outside the State of Michigan. The complaint claims violations of the Securities Act of 1933 and the Securities Exchange Act of 1934, and seeks disgorgement of ill-gotten gains plus interest, penalties, and permanent injunctions.
Supporting America’s Innovators Act of 2017 Passes in House Vote
On April 6, a bipartisan bill entitled, Supporting America’s Innovators Act of 2017 (H.R. 1219) was received in the Senate after passing through the House by a 417-3 margin. The securities-related bill – which is now pending before the Senate Committee on Banking, Housing, and Urban Affairs, amends the provisions of the Investment Company Act of 1940 that require venture capital funds with more than 100 investors to register with the SEC. As previously reported in InfoBytes, the bill would serve to raise the cap on the number of investors from 100 to 250, thereby facilitating greater access to venture capital funding for small businesses and startups. In a press release issued by the House Financial Services Committee, the bill’s sponsor, Rep. Patrick McHenry explains that H.R. 1219 is intended to, among other things, “address the challenges facing angel investing so that startups and small businesses can have better access to capital,” by “creating a regulatory framework that encourages innovation and growth, while ensuring that shareholder and investor protections remain strong.”
FINRA Bars Broker Charged in NY Pension Fund Scandal
On March 28, FINRA filed a disciplinary action in the form of a Letter of Acceptance, Waiver and Consent (Letter of Acceptance) against one of the brokers charged in December of last year for participating in a "pay-for-play" bribery scheme involving the $184 billion New York State Common Retirement Fund (NYSCRF). The Letter of Acceptance bars the broker from the industry and prohibits association with “any FINRA member in any capacity.” From 2014 through 2016, the broker, along with two other individuals, engaged in a scheme to defraud the pension fund, its members and beneficiaries, by paying bribes to a portfolio manager totaling more than $100,000 in the form of entertainment, travel expenses, narcotics, luxury gifts, and other items in “exchange for fixed-income business from the NYSCRF.” The broker was charged with allegedly conspiring to commit securities fraud, conspiring to obstruct justice in a Securities and Exchange Commission investigation, as well as wire fraud charges. Currently the SDNY criminal case and SEC civil action are pending against the broker.
Members of the House Financial Services Committee Weigh in on Rollout of the DOL Fiduciary Rule
On March 17, GOP members of the House Financial Services Committee sent a letter to Acting Labor Secretary Ed Hugler expressing their support for the Department of Labor’s (DOL’s) proposal to delay the implementation of its Fiduciary Rule from April 10 until June 9. The letter asserts, among other things, that a delay is “necessary to review the rule’s scope and assess potential harm to investors, disruptions within the retirement services industry, and increases in litigation, as required by the Presidential Memorandum signed by President Trump on February 3, 2017.” The GOP Members also note that they “have long been concerned with the DOL Fiduciary Rule's impact on retail investors and the U.S. capital markets,” and, have therefore “advocated that the expert regulator—the Securities and Exchange Commission (SEC)—should craft an applicable rule.”
Later that day, House Democrats sent their own letter to the Acting Labor Secretary expressing opposition to the DOL’s proposed 60-day delay of its Fiduciary Rule. Specifically, the Democratic members contend that “the rule is reasonable and workable for advisers,” because, among other reasons, “the DOL provided appropriate relief that mitigates industry concerns and compliance costs.”
SEC Denies Application for Bitcoin ETF Due to Lack of Regulation, Potential for Manipulation
On March 10, 2017, the SEC issued an Order disapproving of a proposed rule change by the BATS BZX Exchange (“the Proposal”), which proposed to list and trade “commodity-based trust shares” issued by the Winklevoss Bitcoin Trust. The Proposal, if approved, would have established a bitcoin exchange-traded fund (“ETF”) that market participants could invest in through the BATS BZX Exchange platform. Specifically, in rejecting the Proposal, the Commission emphasized the lack of regulation in the bitcoin market, noting both (i) that the BATS BZX Exchange platform “would currently be unable to enter into, the type of surveillance-sharing agreement that helps address concerns about the potential for fraudulent or manipulative acts and practices in the market for the Shares”; and (ii) that bitcoin regulation, at present, would leave a bitcoin ETF more susceptible to manipulation than an ETF comprised of other commodities, such as gold and silver. Ultimately, the Commission concluded that, “[a]bsent the ability to detect and deter manipulation of the Shares—through surveillance sharing with significant, regulated markets related to the underlying asset—the [Commission] does not believe that a national securities exchange can meet its” regulatory obligations.
Comments submitted in response to the original BATS BZX Exchange proposed rule change can be accessed here.
Proposed FINRA Rule Would Streamline Securities Competency Exams for Industry Professionals
On March 8, the Financial Industry Regulatory Authority (FINRA) filed a proposed rule with the SEC to streamline its competency exams for professionals entering or re-entering the securities industry. Currently, only individuals associated with FINRA-regulated firms are eligible to take the qualification exam. The proposed rule would allow individuals with no prior securities industry experience to take FINRA’s Securities Industry Essentials exam, an “important first step to entering the industry,” which would serve to “provide enhanced flexibility and efficiency in [the] qualifications programs, while maintaining important standards and investor protections.” While these individuals would also be required to pass a more specialized knowledge exam—and must be associated with, and sponsored by, a firm—the proposed change would potentially expand the pool of qualified candidates for positions. Further, under this proposal, individuals who transfer to a financial services affiliate of a FINRA-regulated firm may qualify for a waiver that allows their credentials to be reinstated without re-taking their qualification exams, should they return to the industry within a seven-year period and meet the requirements of the waiver program. Currently, a registered individual who transfers for two or more years must re-take an exam to be re-qualified. The proposed rule is under review with the SEC.
Securities-Related Bills Advanced Through Committees in Both Senate and House
On March 9, the Senate Banking Committee and the House Financial Services Committee introduced and advanced five securities-related bills out of committee. The bills—listed below—now await scheduling for consideration by each chamber in full.
- S. 327 / H.R. 910 - Fair Access to Investment Research Act of 2017. This legislation will direct the SEC to provide a safe harbor for certain investment fund research reports.
- S. 444 / H.R. 1219 - Supporting America’s Innovators Act of 2017. This legislation will amend the Investment Company Act of 1940 by expanding “the limit on the number of individuals who can invest in certain venture capital funds before those funds must register with the SEC as ‘investment companies.’”
- S. 462 / H.R. 1257 - Securities and Exchange Commission Overpayment Credit Act. This legislation will require the SEC to refund or credit excess payments made to the Commission under a 10-year statute of limitations.
- S. 484 / H.R. 1366 - U.S. Territories Investor Protection Act of 2017. This legislation will amend the Investment Company Act of 1940 to terminate an exemption for companies located in Puerto Rico, the Virgin Islands, and any other possession of the United States.
- S. 488 / H.R. 1343 - Encouraging Employee Ownership Act. This legislation will increase the threshold for disclosures required by the SEC relating to compensatory benefit plans.
H.R. 1312 - The Small Business Capital Formation Enhancement Act. The House Financial Services Committee also approved a sixth bill, which seeks to amend the Small Business Investment Inventive Act of 1980 to require an annual review by the SEC of any findings set forth in the annual government-business forum on capital formation.
DOJ Fraud Section Unveils New Guidelines on Corporate Compliance Programs
The DOJ’s Fraud Section recently published an “Evaluation of Corporate Compliance Programs.” The guidelines were released on February 8 without a formal announcement. Their stated purpose is to provide a list of “some important topics and sample questions that the Fraud Section has frequently found relevant in evaluating a corporate compliance program.” The guidelines are divided into 11 broad topics that include dozens of questions. The topics are:
- Analysis and Remediation of Underlying Conduct
- Senior and Middle Management
- Autonomy and Resources
- Policies and Procedures
- Risk Assessment
- Training and Communications
- Confidential Reporting and Investigation
- Incentives and Disciplinary Measures
- Continuous Improvement, Periodic Testing and Review
- Third Party Management
- Mergers & Acquisitions
According to the Fraud Section, many of the topics also appear in, among other sources, the United States Attorney’s Manual, United States Sentencing Guidelines, and FCPA Resource Guide published in November 2012 by the DOJ and SEC. While the content of the guidelines is not particularly groundbreaking, it is nonetheless noteworthy as the first formal guidance issued by the Fraud Section under the Trump administration and new Attorney General Jeff Sessions. By consolidating in one source and making transparent at least some of the factors that the Fraud Section considers when weighing the adequacy of a compliance program, the guidelines are a useful tool for companies and their compliance officers to understand how the Fraud Section and others at the DOJ may proceed in the coming months and years.
However, while the guidelines may give some indication of what the DOJ views as a best practices compliance program, they caution that the Fraud Section “does not use any rigid formula to assess the effectiveness of corporate compliance programs,” recognizes that “each company’s risk profile and solutions to reduce its risks warrant particularized evaluation,” and makes “an individualized determination in each case.”