Marketplace lending surely had its day in the sun in 2014.  Peer-to-peer lending, which now goes by the term marketplace lending, took a big step forward last year.  We saw the IPO of Lending Club rocket in its first day of trading on December 11, 2014 by first pricing above the range at $15 per share and then touching a high mark of 67% that day. Lending Club has been the leader in this field and its IPO highlighted the importance and the emergence of this new lending alternative. Despite this surge, however, not everyone attended the party in 2014. Noticeably, the SEC still has not finalized its crowdfunding rules, which are an important next step for the marketplace lending industry.

So what exactly is marketplace lending? Put simply, it is an Internet based lending market that is created by connecting borrowers with lenders or investors.  There are various companies with different approaches to the concept.  In Lending Club’s case, potential borrowers fill out online loan applications.  The company (and its bank behind the scenes) then uses online data and technology to evaluate the credit risks, set interest rates and make loans.  On the other side of the equation, Investors are offered notes for investment that correspond to portions of the loans and can earn monthly returns on their notes that are backed by borrower payments.  As a result, marketplace lending effectively offers secondary market trading for loans.

On the positive side, marketplace lending can be good for borrowers because the lower cost structure of an online platform can be passed along to borrowers in the form of lower interest rates.  The use of the Internet and online credit resources can also speed up the credit approval process so that borrowers can get funds faster.  In addition, some borrowers may get access to loans that they could not get from traditional banks.  In other words, the marketplace could help individuals with lower credit scores or negative credit histories find loans.  Thus, despite its critics, marketplace lending can help serve a niche that has historically been underserved by the banking industry.

Marketplace lending, however, at least when it comes to Lending Club and those like it, still has a bank at its core. So some borrowers will still not be able to get loans through this marketplace model.  Also, the investors are buying registered securities with interests in the loans made in the marketplace.  Lending Club turned to registering their notes with the SEC when Continue Reading Marketplace lending: A hot new industry looking for crowdfunding

How Congo Became a Corporate Governance IssueA few months ago, the U.S. Court of Appeals for the D.C. Circuit upheld portions of Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, known as the “conflicts mineral rule.” The rule, enacted by Congress in July of 2010,requires certain public companies to provide disclosures about the use of specific conflict minerals supplied by the Democratic Republic of Congo (DRC) and nine neighboring countries. In the D.C. Circuit case, the National Association of Manufacturers, or NAM, challenged the SECs final rule implementing the conflicts mineral rule, raising Administrative Procedure Act, Exchange Act, and First Amendment claims. The D.C. Circuit agreed with NAM on its third claim and held that the final rule violates the First Amendment to the extent the rule requires regulated companies to report to the SEC and to post on their publically available websites information on any of their products that have not been found to be “DRC conflict free.” Despite this adverse ruling, the SEC made it clear that the conflicts minerals rule is here to stay: in a statement on the effect of the D.C. Circuit’s decision, the SEC communicated its expectation that public companies continue to comply with those deadlines and substantive requirements of the rule that the D.C. Circuit’s decision did not affect. So, what is the conflicts mineral rule, how far does it reach, and what are public companies doing to comply?

In an unusual attempt to curtail human rights abuses in Africa through regulation of U.S. public companies, the conflicts mineral rule requires companies to trace the origins of gold, tantalum, tin, and tungsten used in manufacturing and to Continue Reading Despite First Amendment concerns, the conflict minerals rule is here to stay

BSA ComplianceGenerally speaking, the Bank Secrecy Act (“BSA”) requires financial institutions in the United States to assist U.S. government agencies to detect and prevent money laundering. But while anyone can imagine that the BSA and its implementing regulations apply to those entities we typically classify as “financial institutions” such as banks and other depository institutions, it is important to note that the BSA Rules also apply to other entities that we may not traditionally think of as “financial institutions” including securities broker-dealers.

The BSA rules require brokers-dealers to, among other things, develop and implement BSA compliance programs. In accordance with the BSA rules, FINRA Rule 3310 sets forth minimum standards for broker-dealers’ BSA compliance programs. First, the rule requires firms to develop and implement a written BSA compliance program. The program has to be approved in writing by a member of senior management and be reasonably designed to achieve and monitor the firm’s ongoing compliance with the requirements of the BSA Rules. Additionally, and consistent with the BSA Rules, the rule also requires firms, at a minimum, to:

  • establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of suspicious transactions;
  • establish and implement policies, procedures, and internal controls reasonably designed to achieve compliance with the BSA and implementing regulations;
  • provide for annual (on a calendar-year basis) independent testing for compliance to be conducted by member personnel or by a qualified outside party. If the firm does not execute transactions with customers or otherwise hold customer accounts or act as an introducing broker with respect to customer accounts (e.g. engages solely in proprietary trading or conducts business only with other broker-dealers), the independent testing is required every two years (on a calendar-year basis);
  • designate and identify to FINRA (by name, title, mailing address, e-mail address, telephone number, and facsimile number) an individual or individuals responsible for implementing and monitoring the day-to-day operations and internal controls of the program.  Such individual or individuals are associated persons of the firm with respect to functions undertaken on behalf of the firm.  Each member must review and, if necessary, update the information regarding a change to its BSA compliance person within 30 days following the change and verify such information within 17 business days after the end of each calendar year.

Compliance with the BSA Rules is no easy task. To effectively address these rules, Continue Reading Bank Secrecy Act: Broker-Dealers Must Also Comply

Uncertainty lingers in recent exception to Volcker Rule
Photo by Patrik Jones

In a joint press release issued on January 15, 2014, five federal agencies indicated their approval of an interim final rule to permit banking entities to retain interests in collateralized debt obligations backed primarily by trust preferred securities (“TruPS CDOs”).  These interests would have otherwise been prohibited under the new Volcker Rule, which prohibits certain investments by banks and is found in Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). The interim final rule comes just weeks after the agencies’ approval of the Volker Rule on December 10, 2013.

With the hope of avoiding the need for future bailouts of the financial system, the Volker Rule prohibits an insured depository institution and its affiliates from engaging in “proprietary trading,” from acquiring or retaining any equity, partnership, or other ownership interest in a hedge fund or private equity fund, and from sponsoring a hedge fund or a private equity fund. Essentially, the Volcker Rule is intended to limit profit-seeking proprietary trading at commercial banks by essentially banning these banks, which accept federally insured deposits, from making speculative bets with that money.

So, preventing banks from taking unreasonable risk with customer money, isn’t this a good thing? Well, according to critics, the issue with the Volker Rule is that, in strict application, the rule would capture a substantial amount of legitimate activity conducted by banks, activity that is essential to growing jobs and small businesses. In this regard, the American Bankers Association took specific issue with the Volcker Rule provisions that would force banks to rid themselves of TruPS CDOs, arguing that such provisions are against the spirit of the rule since banks that invested in TruPS CDOs “do not pose the kind of systemic risk the Volcker rule is intended to capture” and are “facing unexpected and precipitous write-downs on these investments that are not justified by any safety and soundness concern.”

In the run-up to the financial crisis, some banks issued trust-preferred securities, which have characteristics of both debt and equity, to raise capital. Some of those securities were then packaged into CDOs and sold to banks and other financial institutions, i.e. TruPS CDOs. These securities lost much of their value during the financial crisis, and banks that invested in them have been holding on to them in the hope that they will recover in value. The Volcker Rule, if left unchanged, would have forced banks not only to sell those securities but also to recognize the losses on them.

In issuing the interim rule, the regulators have sought to balance the spirit of the Volker Rule with the need for banks to engage in legitimate types of trading. Among other exemptions provided, the interim final rule permit the retention of an interest in or sponsorship of covered funds such as a TruPS CDO by banking entities if the following qualifications are met:

  • the TruPS CDO was established, and the interest was issued, before May 19, 2010;
  • the banking institution reasonably believes that the offering proceeds received by the TruPS CDO were invested primarily in Qualifying TruPS Collateral; and
  • the banking institution’s interest in the TruPS CDO was acquired on or before December 10, 2013, the date the agencies issued final rules implementing Section 619 of the Dodd-Frank Act.

While the rapidity with which the regulators responded to industry-wide concerns demonstrates the regulators’ intent to cooperate with industry stakeholders, it might also show a more reactionary approach to implementing final rules under other controversial Dodd-Frank Act provisions, which have taken them years to write. If this is the case, the full impact of the Volker Rule, and other controversial Dodd-Frank Act provisions not yet finalized, will continue to remain an uncertainty.

Publicly traded bankDid you know that banks can go public and trade on Nasdaq and not have to file reports on the SEC’s EDGAR filing system?  Well, they can, but it may not be such a good thing.  You get this result when a bank goes public without a holding company.  These banks are instead required to register with their primary federal regulator (i.e., the FDIC, the Federal Reserve or the Office of the Comptroller of the Currency) and these regulators do not use the SEC’s EDGAR filing system.  So no EDGAR filings are required for these banks.

The problem is that EDGAR helps public companies satisfy SEC and other requirements.  For example, the national exchanges have listing requirements that are in addition to the reporting requirements of the SEC and the bank regulators. To comply, listed banks and bank holding companies must, on or before the applicable due date, file copies of all reports and other documents filed with the SEC or their appropriate regulatory authority. For listed bank holding companies, compliance with these requirements is easy because they file on EDGAR, which provides public access and download capabilities at no cost. Due to electronic links with the EDGAR system, most national exchanges generally provide that their filing requirements are considered fulfilled if the bank holding company files a required report or document with the SEC on EDGAR.  This is the result for the vast majority of publicly traded banks in the U.S.  According to the Federal Reserve, currently, about 84% of commercial banks in the U.S. are part of a bank holding company, and in addition, only a limited few publicly traded banks don’t have holding companies.

But what about banks that do not have holding companies? These banks can still go public by registering with their primary federal bank regulator, but they don’t get the benefit of the EDGAR system.  Instead, the bank regulatory authorities have their own filing requirements and the banks must comply with these rules to maintain their good standing as a public company. Where does this leave these publicly traded banks when it comes to their Nasdaq or national exchange filing requirements?  The answer is that these banks must still comply with the reporting requirements of Nasdaq or the national exchanges by undertaking an alternative filing process. For example, the Nasdaq requires these banks to provide it with three paper copies of the applicable filing. So there are more filings involved and more room for error.

Another problem with not using the EDGAR system is that Continue Reading Publicly Traded Banks Illustrate the Side Benefits of EDGAR

Protecting your board from shareholder lawsuits when you announce a dealFor a board of directors of a company, perhaps no decision is as important (and litigious) as the sale of the company in a change-of-control transaction. Shareholder lawsuits aimed at merger and acquisition (“M&A”) transactions (usually in the form of a putative shareholder class action or derivative suit) often allege that the directors of the acquisition target company breached their fiduciary duties in approving the transaction in question, and name the acquiring company and other defendants as aiders and abettors of the fiduciary violation. In support of their claim, the plaintiffs typically assert one, all, or a few of the following:

  • Transaction price is inadequate,
  • Directors failed to exercise due care to maximize the price being offered,
  • Transaction is coercive to shareholders because of so-called deal protection measures included in the agreements,
  • Public disclosures associated with the transaction are inadequate or misleading, and/or
  • Some or all of the directors have some form of conflict of interest.

The rationale for shareholder litigation generally stems from the idea that managerial agency costs are high, and that class actions and derivative suits are key shareholder monitoring mechanisms necessary to keep managers in line. On the other hand, representative litigation claims are often lawyer-driven, reflecting the agency costs that arise out of contingency fee suits that make the lawyer the real party in interest in these cases. In any event, the fact is that shareholder litigation in the United States has exploded in recent years. According to one study, in 2012, shareholders challenged 93 percent of M&A deals valued over $100 million and 96 percent of transactions valued over $500 million.

And while the deferential business judgment rule (i.e., the presumption that the directors’ actions were informed and taken in the good-faith belief that the actions were in the company’s best interests) generally enables directors to Continue Reading Protect your Board from merger and acquisition lawsuits with these five critical considerations

SEC wants you to confessSEC Chair Mary Jo White has indicated that the SEC will require that, in certain cases, admissions be made as a condition of settling rather than permitting the defendant to “neither admit nor deny” the allegations in the complaint of its enforcement action.  The move marks a departure from the typical practice at the SEC and many other civil federal regulatory agencies of allowing defendants to settle cases without admitting or denying the charges.  The policy of allowing defendants to neither admit nor deny the allegations has been increasingly criticized for its inherent lack of transparency regarding both the alleged wrongdoing and the corresponding disgorgement and forfeiture penalties.

According to White, the new policy will apply only in select cases, such as those where there is egregious conduct and/or wide spread public interest. While the precise parameters of the new policy have not been specified, White did note that the new policy would be applied on a case by case basis and that for most cases currently settling, the old policy would still apply.

Debate about the old policy began about two years ago, when Judge Jed S. Rakoff rejected a $285 million settlement that the SEC negotiated with Citigroup, in part because the deal included “neither admit nor deny” language.  The SEC has appealed, and the case is pending before a panel of the U.S. Second Circuit Court of Appeals. Since then, a handful of other judges have voiced their discomfort with allowing defendants to pay fines without admitting liability.

In previously defending the old policy, the SEC has argued that most defendants would refuse to settle if they had to admit wrongdoing.  Essentially, companies and executives would rather fight in court than admit liability and face additional liability in parallel civil lawsuits, as well as the added difficulty of losing director and officer indemnification coverage which often pays the legal fees for corporate officers (a benefit which can be lost if Continue Reading It was me! SEC to toss “neither admit nor deny” policy in certain cases

SEC wants you to confessSEC Chair Mary Jo White has indicated that the SEC will require that, in certain cases, admissions be made as a condition of settling rather than permitting the defendant to “neither admit nor deny” the allegations in the complaint of its enforcement action.  The move marks a departure from the typical practice at the SEC and many other civil federal regulatory agencies of allowing defendants to settle cases without admitting or denying the charges.  The policy of allowing defendants to neither admit nor deny the allegations has been increasingly criticized for its inherent lack of transparency regarding both the alleged wrongdoing and the corresponding disgorgement and forfeiture penalties.

According to White, the new policy will apply only in select cases, such as those where there is egregious conduct and/or wide spread public interest. While the precise parameters of the new policy have not been specified, White did note that the new policy would be applied on a case by case basis and that for most cases currently settling, the old policy would still apply.

Debate about the old policy began about two years ago, when Judge Jed S. Rakoff rejected a $285 million settlement that the SEC negotiated with Citigroup, in part because the deal included “neither admit nor deny” language.  The SEC has appealed, and the case is pending before a panel of the U.S. Second Circuit Court of Appeals. Since then, a handful of other judges have voiced their discomfort with allowing defendants to pay fines without admitting liability.

In previously defending the old policy, the SEC has argued that most defendants would refuse to settle if they had to admit wrongdoing.  Essentially, companies and executives would rather fight in court than admit liability and face additional liability in parallel civil lawsuits, as well as the added difficulty of losing director and officer indemnification coverage which often pays the legal fees for corporate officers (a benefit which can be lost if Continue Reading It was me! SEC to toss "neither admit nor deny" policy in certain cases

Investment advisers vs broker-dealersWhen managing investments and strategies for personal financial goals, retail investors often seek guidance from their investment advisers, and on an increasing basis, from their broker-dealers.  Broker-dealers and investment advisers are regulated extensively, but the regulatory requirements differ.  Broker-dealers and investment advisers are also subject to different standards under federal law when providing investment advice about securities.

The Investment Advisers Act of 1940 regulates specified financial professions, including financial planners, money managers, and investment consultants.  Under the Advisers Act, an investment adviser is any person who, for compensation, is engaged in a business of providing advice to others or issuing reports or analyses regarding securities.  With regard to the required standard of care applied to investment advisers when providing advice to their clients, applicable case law requires a fiduciary standard which, essentially, requires that the advisor put the client’s interests first, ahead of his or her own interest.

The Securities Exchange Act of 1934 and its implementing rules comprise the most central regulatory apparatus for broker-dealers. The Exchange Act defines a broker as a “person engaged in the business of effecting transactions in securities for the account of others,” while a dealer is a “person engaged in the business of buying and selling securities for his own account.” In comparison to the fiduciary obligation of an investment advisor, broker-dealers currently have a less stringent “suitability standard” that requires that investment products they sell fit an investor’s financial needs and risk profile.

Under the Investment Advisers Act, registered broker-dealers are excluded from its terms so long as Continue Reading Uniform fiduciary standard for broker-dealers and investment advisers? Proceed with caution!

Foreign Corrupt Practices Act (FCPA)The Foreign Corrupt Practices Act (“FCPA”), enacted to deter bribery and other corrupt practices in the conduct of international business, originally claimed jurisdiction over U.S. companies and individuals who used the mail or other instrumentalities of interstate commerce to further a bribe.  A 1998 amendment, however, expanded the FCPA’s jurisdictional reach to include, among others, “issuers” of securities listed on U.S. exchanges (including foreign companies so listed).  Thus, as businesses strategize to capitalize on the increasingly global market, those with securities issued in the United States must make sure to stay in compliance with the FCPA.  If companies like Walmart, Ralph Lauren and Tyco International weren’t doing so before, they certainly are now.

So what is the FCPA and what conduct does it proscribe? Well, the FCPA has two separate and distinct prohibitions.  First, the FCPA’s “anti-bribery provisions” prohibit the offer, promise, or payment of “anything of value” to a “foreign official” in order to “obtain or retain business.” Importantly, the FCPA covers payments to consults, agents, and any other intermediaries or representatives when the party making the payment knows, or has reason to believe, that some part of the payment will be used to bribe or influence a foreign official.

Second, the FCPA’s “books and records” provision imposes affirmative duties on issuers to maintain accurate books and a system of internal controls, and prohibits behavior intended to conceal an issuer’s lack of compliance with these duties.  Essentially, issuers must maintain books that accurately and fairly reflect their transactions and disposition of assets, and must have internal accounting controls adequate to provide reasonable assurance of the integrity of the company’s financial systems and its disclosures.

In the last few years, FCPA enforcement has been on the rise as the SEC and the Department of Justice (“DOJ”), the agencies charged with enforcing the FCPA, have Continue Reading Continued increased enforcement of Foreign Corrupt Practices Act (FCPA) shift toward financial services industry