## _cr1591 — Detailed Assessment Report (selected findings and recommendations) ## Source details **Canonical URL:** [_cr1591 — Detailed Assessment Report (selected findings and recommendations)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1591.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1591.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1591.pdf.json) --- ### Executive summary and post-crisis changes - The United States has "large, well-developed and complex securities and derivatives markets." - The crisis and recent high profile failures have "provided important lessons that have significantly impacted the regulation and supervision of these markets." - Post-crisis, SEC and CFTC mandates "have significantly expanded." - Dodd-Frank Act effects: - Provided the SEC and CFTC with "shared responsibility over the swaps markets" and brought "HF managers and municipal advisors under the jurisdiction of the SEC." - CFTC "has already adopted the large majority of rules needed for swaps markets, and final registration of swap dealers is underway." - SEC's swaps-related rulemaking "is less advanced," while rulemaking "in connection with HF managers and municipal advisors" has been completed. - Assessment mission: October 27 to November 19, 2014; IOSCO Principles used (approved 2010, methodology 2011). Principle 38 not assessed. ### Supervisory and regulatory improvements - Strengthened prudential and conduct requirements for key regulated entities, including enhancements to: - "internal controls," - "risk management," and - "protection of client assets." - Agencies adopting a more forward-looking, risk-based supervisory approach by: - improving data collection, - developing automated tools for data analysis (examples: ENF corporate issuer risk tool; ORAS models; DERA API models; MIDAS; CAT initiative), - recruiting staff with diverse skill sets. - Enforcement use improved across agencies and SROs; assessors welcome continued efforts. ### Resourcing, funding, and capacity constraints - Funding challenges: - "The level of funding of both the SEC and CFTC is a key challenge" affecting rule delivery and program implementation. - Funding limitations have impacted timely delivery of new rules and implementation of registration programs. - Recommendation: "consideration should be given to making both agencies self-funded and allowing for multiyear budgeting." - CFTC FY 2015 budget figures: - President recommended $280 million (an increase of $65 million and 253 staff persons over 2014 levels). - 2015 Agriculture Appropriations Bill provides $218 million (increase of $3 million over FY 2014 enacted level, but $62 million below President’s request). - Bill allocates over $52 million for information technology until September 30, 2016. - Appropriations (Fiscal years 2010-2014, $ million): - CFTC: FY 2010: 169; FY 2011: 203; FY 2012: 205; FY 2013: 205; FY 2014: 215 - SEC: FY 2010: 1,111; FY 2011: 1,185; FY 2012: 1,346; FY 2013: 1,302; FY 2014: 1,372 - Staff and turnover snapshots: - CFTC staff as of May 31, 2014: Total employees: 646; Regulatory and supervision staff: 435; Management and support staff: 163; Executives: 48. - CFTC staff turnover: ranged from 8 to 12 percent over last five years. - SEC staff: more than 4,000 people; personnel compensation and benefits approximately $927 million for fiscal year 2014; turnover averaged less than 6 percent during fiscal years 2010–2013 (SEC turnover target below 8 percent). ### Market structure, transparency, and trading venues - Equity markets: - As of end 2013: 5,655 issuers listed on the three largest exchanges; total market capitalization approximately 150 percent of GDP. - Number of new listings in 2013: 614. - Selected exchange-level 2013 figures: - Number of issuers (2013): NYSE 3,016; NASDAQ 2,637; BATS 2 - Market capitalization (billion USD, 2013): NYSE 17,950; NASDAQ 6,974; BATS 1.4 - Market capitalization as percent of GDP (2013): NYSE 107; NASDAQ 42; BATS 0.0 - Market capitalization of top 10 issuers (billion USD, 2013): NYSE 2,683; NASDAQ 2,151; BATS 54 - Number of new listings (2013): NYSE 369; NASDAQ 239; BATS 6 - Annual turnover (trillion USD, 2013): NYSE 15.3; NASDAQ NA; BATS 3.5 - Average daily turnover (billion USD, 2013): NYSE 60.7; NASDAQ NA; BATS 17.4 - Trading venues and market share: - End of December 2014: 11 national securities exchanges and 39 ATS operating equity trading systems. - Market share estimates: - Some market sources estimate ATS + OTC up to approximately 40 percent of total value of equity trading. - SEC staff findings: ATSs executed 11.3 percent of total value of trading in NMS stocks during one week in May 2012. - One paper estimates 17 percent of total value executed OTC (excluding ATS) during one week in May 2012. - During May 2014–September 2014, ATSs accounted for 15 percent of trading volume for NMS stocks (by number of shares). - Transparency regime: - Equity pre- and post-trade rules governed by Regulation NMS; post-trade disclosure required "as soon as practicable" within a maximum delay of 10/90 seconds, but in practice dissemination occurs within milliseconds. - Dark trading and dark order types limit pre-trade transparency; SEC should remain vigilant about "the impact dark trading may have on overall price formation." - Recommendation: SEC to deepen analysis of pre-trade transparency impact of various order types and reference prices. - Derivatives markets: - Futures and options organized by 15 Designated Contract Markets (DCMs). - Number of contracts traded (end 2014, estimate): 3.7 billion (futures and options). - Swap trading volumes estimated: 13.5 billion contracts; majority of swap trading still OTC rather than on the 24 SEFs. - SEFs and SDRs: CFTC registered four SDRs and requires real time public reporting by SDRs; CFTC pursuing data quality metrics and established a Data and Reporting Branch. ### Systemic risk identification and inter-agency coordination - SEC and CFTC enhancing ability to identify emerging and systemic risks via: - improved data collection (e.g., MMFs’ holdings; private funds data), - creation of specialized units (OCIE ORAS, RAE, QAU, Risk and Examinations Office, Office of Risk Supervision in TM), - development of analytical tools (ENF, ORAS, API, MIDAS, CAT). - FSOC role: - Chairs of SEC and CFTC are FSOC members; FSOC identifies threats to financial stability and has designated certain entities as systemically important (examples: eight FMUs and three non-bank companies). - Assessors recommend enhanced mechanisms for a holistic view of risks and "the respective Commission (as a whole) of each agency becoming more involved in the process of assessing and monitoring responses to risks." - Coordination recommendations: - Continue and deepen SEC–CFTC coordination on rulemaking and supervision, and extend effective coordination to "all regulatory authorities—including banking regulators and SROs—with mandates that impact securities and derivatives markets." ### Assessment scope, methodology, and overall findings - IOSCO Principles assessment conducted October 27–November 19, 2014 using IOSCO Principles (2010) and Assessment Methodology (2011). - Main findings summary: - Both SEC and CFTC are independent agencies with clear mandates and sufficient powers (rulemaking, registration, examination, enforcement); accountability supported by public transparency. - Current level of resources poses challenges, particularly given expanded mandates. - Agencies increasingly adopting forward-looking risk-based supervision and enhancing risk identification, aiding FSOC contributions. - Strong reliance on SROs (FINRA, NFA) for frontline supervision; SROs are subject to oversight, including rule approval/notification and reporting/examination. - Enforcement powers are broad and actively used by SEC, CFTC and criminal authorities; coverage of examination programs generally prevents long intervals without inspection for most entities, except IAs where SEC coverage is limited. ### Key statistics on intermediaries and markets - CIS market (end 2013): 4,168 registered CIS funds with more than $17 trillion AUM. - Mutual funds (2013): $15,018 ($ billions) — Mutual funds accounted for 88 percent of securities CIS assets. - Total investment company assets (2013): 17,058 ($ billions). - Mutual fund assets (end-year totals): - 2011: 11,627 ($ billions) - 2012: 13,044 ($ billions) - 2013: 15,018 ($ billions) - Investment advisers and hedge funds (as of September 2014): - 2,691 IAs registered with the SEC advised at least one HF. - Registered IAs to HFs manage approximately $5.4 trillion in cumulative reported RAUM. - As of May 7, 2014: 544 IAs classified as large HF managers (i.e., with 1.5 billion HF AUM), with a total of 3,835 HFs under management. - ERAs: approximately 2,693 ERAs with 875 advisers or 32 percent of them managing HFs that account for approximately $846 billion in RAUM. - Municipal securities: - Outstanding amount as of end-2014: approximately $ 3.7 trillion. - Roughly 45,000 different municipalities issuing debt; about 12,000 bond issues on an annual basis. - Average issue size: $25 million. - Retail investor holdings: - Direct retail holdings: roughly 45–50 percent of total outstanding debt. - Indirect holdings (through mutual funds): about 25 percent. - Historical default rates: less than 1 percent for municipal issuers; 11–13 percent for issuers of corporate debt. - Commodity pools and CPOs (selected points): - Number of NFA Member CPOs and Total AUM (selected dates): - end-2011: Total Number of NFA Member CPOs 1,078; Total AUM 348 - end-2012: Total Number of NFA Member CPOs 1,105; Total AUM 493 - end-2013: Total Number of NFA Member CPOs 1,686; Total AUM 2,809 - Aug. 6, 2014: Total Number of NFA Member CPOs 1,658; Total AUM 2,928 - Derivatives reporting: - Large trader thresholds (Rule 13h-1): two million shares or $20 million during a calendar day; twenty million shares or $200 million during a calendar month. - Fiscal year 2013: 2,948 large traders registered via Form 13H. ### Supervision, examinations and enforcement activity (selected figures) - SEC enforcement actions — total by fiscal year: - 2014: 755 - 2013: 676 - 2012: 734 - 2011: 735 - 2010: 681 - 2009: 664 - SEC enforcement sanctions (selected totals): - 2013: Disgorgement Ordered $2.257 billion; Penalties Ordered $1.167 billion - CFTC enforcement filings FY2011–FY2014 (selected categories): - Fraud filings: FY2011 55; FY2012 57; FY2013 29; FY2014 26 - CFTC monetary relief obtained (presented totals): - FY11 Civil Monetary Penalties: $316,682,679; Restitution and Disgorgement: $181,844,807 - FY12 Civil Monetary Penalties: $475,360,925; Restitution and Disgorgement: $456,581,900 - FY13 Civil Monetary Penalties: $1,570,700,568; Restitution and Disgorgement: $201,409,408 - FY14 (to Apr 30) Civil Monetary Penalties: $961,072,836; Restitution and Disgorgement: $1,330,365,570 - Total Civil Monetary Penalties: $4,831,648,447 - Total Restitution and Disgorgement: $3,686,210,358 - PCAOB inspection program: - PCAOB staff dedicated to inspection programs: 504 - PCAOB total staff: 809 (majority in Division of Registration and Inspections) - Common finding rate: deficiencies in roughly 40 percent of inspections. ### Key recommended action plan (selected recommendations) - Principle 1: Continue SEC and CFTC coordination via joint regulations, unified reporting and/or substituted compliance; CFTC to review whether legal changes are needed to align CPO/CTA standards of care with IAs. - Principle 2: Consider mechanisms to make SEC and CFTC funding more stable (e.g., self-funding and/or multiyear budgeting). - Principle 3: Provide additional resources to SEC and CFTC commensurate with expanded mandates. - Principle 6: - SEC to improve data availability and automated tools to identify risks, particularly for asset managers; consider more formal arrangements for holistic risk discussions and accountability. - CFTC to improve quality of swaps data and expand swaps market monitoring mechanisms. - Principles 12, 24, 31: SEC should increase intensity of IA examination coverage. - Principle 16: Consider amending federal securities laws to grant SEC direct authority to impose disclosure requirements on issuers of municipal securities and to reassess exemptions available to non-municipal conduit borrowers. - Principle 17: SEC encouraged to consider reducing deadlines for beneficial ownership and insider reporting. - Principle 19 & 21: PCAOB to ensure timeliness of enforcement proceedings and to advance standard-setting agenda. - Principle 23: FINRA encouraged to finalize research analysis rules in debt and equity to address asymmetries relative to Global Settlement firms. - Principle 25: Consider amending the CEA to enable CFTC to require additional safeguards where a CPO or related entity has possession of pool assets. - Principle 27: CFTC or NFA should adopt a rule on treatment of investors adversely affected by pricing errors in a CP. - Principle 28: Authorities to review whether a comprehensive risk management framework for HFs is warranted as analysis of HF risks continues. - Principle 33: SEC to follow development of bilateral trading systems and adjust regulatory framework as needed; require ATSs to disclose order execution rules and procedures; consider lowering or removing the five percent fair access threshold. - Principle 35: SEC to deepen analysis of pre-trade transparency impact of various order types and reference prices used by dark order types; CFTC to finalize block trade rules. ### Specific supervisory and market structure observations - SRO reliance and oversight: - Extensive use of SROs (exchanges, FINRA, NFA); SROs carry out frontline surveillance and member supervision; regulators retain oversight via rule approval/notification, reporting and examinations. - Assessment for SRO oversight: Fully Implemented. - IAs and examination coverage: - SEC IA exam coverage limited: only a little over 10 percent of IAs examined each year despite sector importance; total mutual fund AUM approximately $17 trillion. - Assessment for collective investment schemes and IA supervision: Partly Implemented (examination coverage and explicit eligibility/internal controls requirements). - Municipal securities disclosure gap: - Municipal securities exempted from registration and reporting requirements under Securities Act and Exchange Act; indirect mechanisms (Rule 15c2-12, EMMA) in place but GAO and SEC reports found disclosure quality and timeliness challenges. - Assessment for issuer disclosure in municipal market: Broadly Implemented with recommendation to consider direct authority for SEC. ### Enforcement, investigations, and information sharing - Investigation and subpoena powers: - CFTC: Section 8(a)(1) grants comprehensive investigative powers including subpoenas; Section 6(c) authorizes subpoenas nationwide and abroad. - SEC: Section 21(b) grants subpoena power; RFPA and ECPA constraints noted for bank and electronic communication records. - Information sharing: - SEC and CFTC are signatories to IOSCO MMOU; both have authority to share information domestically and internationally (Exchange Act Section 24(c); CEA Section 8(e)); no external approval needed to share information but confidentiality assurances required. - Practical statistics: - SEC responded to 450, 508, and 548 requests for enforcement assistance from foreign authorities in fiscal years 2012, 2013 and 2014 respectively. - CFTC received 69 requests for assistance from 23 foreign regulators in fiscal year 2013 and provided completed responses to 65 thereof by fiscal year-end; over past three fiscal years CFTC responded to 173 requests with an average response time of 39.6 days. ### Closing observations and mission purpose - The purpose of the assessment: ascertain whether legal and regulatory securities market requirements and operations of securities regulatory authorities meet IOSCO Principles, identify gaps/weaknesses, and establish priorities for improvements. - Chairs of the SEC and CFTC "appreciate the IMF’s commitment of time and resources" and value the assessment as a tool to enhance regulatory programs and cooperation. *UNITED STATES — INTERNATIONAL MONETARY FUND (extracts from _cr1591 PDF chapter).* ### EXECUTIVE SUMMARY ___________________________________________________________________________ 8 ### EXECUTIVE SUMMARY ### Overview of markets and post-crisis changes - The United States has "large, well-developed and complex securities and derivatives markets." - The crisis and recent high profile failures have "provided important lessons that have significantly impacted the regulation and supervision of these markets." - Post crisis, the legal mandates of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) "have significantly expanded." - The Dodd-Frank Act provided the SEC and CFTC with "shared responsibility over the swaps markets" and brought "HF managers and municipal advisors under the jurisdiction of the SEC." - The CFTC "has already adopted the large majority of rules needed for swaps markets, and final registration of swap dealers is underway." - The SEC's rulemaking related to swaps "is less advanced," while its rulemaking "in connection with HF managers and municipal advisors" has been completed. ### Supervisory and regulatory improvements - Enhancements have been made to prudential requirements applicable to some key regulated entities, including in connection with: - "internal controls," - "risk management," and - "protection of client assets." - Agencies are taking an "increasingly forward looking risk-based approach to supervision" and enhancing risk identification by: - improving data collection, - developing automated tools for data analysis, and - recruiting staff with diverse skill sets. - Agencies and SROs have improved the use of the enforcement function. These improvements are welcomed and "efforts in all these areas should continue as appropriate." ### Resourcing and funding challenges - "The level of funding of both the SEC and CFTC is a key challenge" affecting their ability to deliver on mandates and provide confidence to markets and investors. - Funding limitations have impacted: - timely delivery of new rules, and - implementation of registration programs for new categories of participants. - The markets under agency supervision "have become larger and more complex." - The number of expert staff in the SEC and CFTC "does not appear to be sufficient to ensure a robust level of hands-on supervision," with the situation "becom[ing] clear in the case of investment advisers (IAs)." - Leveraging technology "can mitigate but not replace the need for additional human resources." - Recommendation: "consideration should be given to making both agencies self-funded and allowing for multiyear budgeting." ### Market structure challenges and transparency - "The fragmented structure of equity markets remains a key challenge for the SEC." - The existing SEC framework "has served its purpose of enhancing competition and providing a framework for best execution," but "the markets have evolved and the framework needs to be updated accordingly." - Updates should ensure: - "sufficient operational transparency for all types of trading venues," and - "fair and objective access." - The SEC should remain vigilant about "the impact dark trading may have on overall price formation." - The "recently announced Equity Market Structure Advisory Committee is an important step." ### Systemic risk identification and coordination - It is important that both agencies "continue to strengthen their ability to identify emerging and systemic risks." - Strengthened risk identification is critical for: - effective discharge of agency mandates, and - enhancing contributions to the Financial Stability Oversight Council (FSOC). - Enhancing mechanisms for a holistic view of risks is recommended, in particular by having "the respective Commission (as a whole) of each agency becoming more involved in the process of assessing and monitoring responses to risks." - The regulatory and supervisory arrangements are "quite complex," involving two agencies and a number of important self-regulatory organizations (SROs). - Effective supervision of the SROs and the Public Company Accounting Oversight Board (PCAOB), given its gatekeeping role, "remains a priority." - The SEC and CFTC have made efforts to ensure "effective communication and, where possible, coordination on rulemaking and supervision." Those efforts should continue, especially because many regulated entities operate in both securities and derivatives markets. - Effective coordination should extend to "all regulatory authorities—including banking regulators and SROs—with mandates that impact securities and derivatives markets." ### Assessment scope, methodology, and mission - The IOSCO Objectives and Principles of Securities Regulation (IOSCO Principles) assessment was conducted in the United States from "October 27 to November 19, 2014." - The assessment was made as part of the IMF FSAP by: - Ana Carvajal, IMF (currently seconded to the World Bank Group), - Eija Holttinen, IMF, and - Malcolm Rodgers, external expert working for the IMF. - The previous IOSCO assessment of the United States was conducted in "2009." - The assessment used the IOSCO Principles approved in "2010" and the Assessment Methodology adopted in "2011." - Principle 38 "was not assessed due to the existence of separate standards for securities settlement systems and central counterparties." - A review of regulatory and supervisory framework at the state level was "outside of the scope of this assessment"; assessors judge that this limitation "has not materially affected the overall judgment of the U.S regime." - The IOSCO Assessment Methodology requires assessment of both the legal/regulatory framework and "how it has been implemented in practice," including supervisory effectiveness, inspection programs, and enforcement follow-up. - The assessment drew on: - self-assessments and additional written responses prepared by the CFTC and SEC; - reviews of relevant legislation and regulations; - meetings with management and staff of the CFTC, SEC, PCAOB, and criminal authorities; - meetings with industry associations and market participants, including exchanges, broker-dealers (BDs), investment advisers (IAs), futures commission merchants (FCMs), commodity pool operators (CPOs), audit firms, and credit rating agencies (CRAs). *Source: EXECUTIVE SUMMARY, UNITED STATES, INTERNATIONAL MONETARY FUND* ### 14. State securities regulators coexist with the federal regulators; however their role is ### 14. State securities regulators coexist with the federal regulators; however their role ### Regulatory framework and responsibilities - Registration of securities for issuance to the public and of intermediaries, along with monitoring and supervision, are mainly carried out by the federal regulators. - State regulators maintain responsibility for issuances that are conducted at the state level only. - Both state and federal legislation provide a regulatory framework for BDs and IAs, but not for futures and derivatives intermediaries. - The role of state regulators has recently increased for smaller IAs. - Pursuant to the thresholds established in the Dodd-Frank Act, the registration and supervision of IAs with portfolios of $100 million or less (increased from $25 million) is generally now the responsibility of the state regulators. ### Self-regulatory organizations (SROs) and market supervision - The CFTC and SEC rely to a significant degree on SROs for the regulation of the markets and their participants. - SROs include exchanges, clearing organizations, and securities and futures associations. - Two registered associations with SRO functions: - Financial Industry Regulatory Authority (FINRA): has authority over BDs; member registration and supervision; role in market surveillance due to agreements with different exchanges and for OTC trading. - National Futures Association (NFA): has authority over all intermediaries in the futures and swaps markets; developing a similar market surveillance role for some SEFs. - Membership in an SRO is mandatory for the corresponding intermediaries.1 - Note: Only IAs are not required to be members of any SRO and are therefore exclusively supervised by the SEC. Municipal advisors must be registered with both the MRSB and the SEC. ### Enforcement and criminal prosecution - Criminal enforcement is the responsibility of federal, state and local authorities. - The SEC and CFTC have significant administrative and civil enforcement powers. - Criminal prosecution is available by other U.S. authorities to pursue securities and derivatives market violations. - Federal, state and local prosecutorial authorities play an active role in criminal (and in some cases civil) enforcement of securities laws, working both with the regulators and on their own initiative. ### Market structure — Issuers and equity markets - As of end 2013 there were 5,655 issuers listed on the three largest exchanges with a total market capitalization of approximately 150 percent of GDP. - Number of new listings in 2013: 614. - Selected exchange-level figures (Table 1): - Number of issuers (2013): NYSE 3,016; NASDAQ 2,637; BATS 2 - Market capitalization (billion USD, 2013): NYSE 17,950; NASDAQ 6,974; BATS 1.4 - Market capitalization as percent of GDP (2013): NYSE 107; NASDAQ 42; BATS 0.0 - Market capitalization of top 10 issuers (billion USD, 2013): NYSE 2,683; NASDAQ 2,151; BATS 54 - Number of new listings (2013): NYSE 369; NASDAQ 239; BATS 6 - Annual turnover (trillion USD, 2013): NYSE 15.3; NASDAQ NA; BATS 3.5 - Average daily turnover (billion USD, 2013): NYSE 60.7; NASDAQ NA; BATS 17.4 - Source for Table 1: NYSE, NASDAQ, BATS. ### Municipal securities - Outstanding amount of municipal securities as of end-2014: approximately $ 3.7 trillion (around one third of the size of the corporate and foreign bonds market). - Roughly 45,000 different municipalities issuing debt; about 12,000 bond issues on an annual basis. - Average issue size: $25 million. - Retail investors: - Direct retail holdings: roughly 45–50 percent of total outstanding debt. - Indirect holdings (through mutual funds): about 25 percent. - Historical rates of default: less than 1 percent for municipal issuers (compared to 11–13 percent for issuers of corporate debt); default rate for non-municipal conduit borrowers has been higher. ### Asset-backed securities (ABS) and RMBS/CMBS trends - Private label (non-U.S. agency) ABS issuers assets: - 2004: $2.6 trillion - 2007: $4.5 trillion - 2013: $1.6 trillion - Registered private-label RMBS new issuances: - 2004: $746 billion - 2008: $12 billion - 2013: $4 billion (0.5 percent of the 2004 issuance level) - Registered CMBS new issuances: - 2004: $74 billion - 2008: $11 billion - 2013: $53 billion - Consumer finance ABS (including credit card and auto securitizations): - Auto ABS issuance: $85 billion in 2005; $32 billion in 2008; $62 billion in 2013. ### Trading venues and market share estimates - Trading venues: national securities exchanges, alternative trading systems (ATS), and over-the-counter (OTC). - End of December 2014: 11 national securities exchanges and 39 ATS operating equity trading systems. - Some market sources estimate ATS + OTC to amount up to approximately 40 percent of total value of equity trading in the U.S. - SEC staff findings: - ATSs executed 11.3 percent of the total value of trading in National Market System (NMS) stocks during a one week period in May 2012. - One paper estimates 17 percent of the total value of trading in NMS stocks was executed OTC (excluding ATS trading) during one week in May 2012. - During May 2014–September 2014, ATSs accounted for 15 percent of the trading volume for NMS stocks (by number of shares). ### Derivatives markets and volumes - Futures and options trading organized by 15 Designated Contract Markets (DCMs). - Number of contracts traded (end 2014, estimate): 3.7 billion (futures and options). - Swap trading volumes estimated to amount to 13.5 billion contracts. - Majority of swap trading still takes place OTC rather than on the 24 SEFs. ### Collective Investment Schemes (CIS) - CIS market size (end 2013): 4,168 registered CIS funds with more than $17 trillion assets under management (AUM). - Mutual funds dominate securities CIS: at end 2013 they accounted for 88 percent of all securities CIS assets. - ETFs’ share of overall AUM has grown significantly over the last five years. - Retail investors held over 65 percent of assets in mutual funds at end-2013. - Investment Company Total Net Assets by type (selected totals, Table 2): - Total (2013): 17,058 ($ billions) - Mutual Funds (2013): 15,018 ($ billions) - Source: 2014 Investment Company Fact Book. ### Mutual fund ownership and advisers - Institutional and retail ownership of mutual funds (Table 3, totals): - Total mutual fund assets: - End-year 2011: 11,627 ($ billions) - End-year 2012: 13,044 ($ billions) - End-year 2013: 15,018 ($ billions) - Retail investor totals: - 2011: 9,882 ($ billions) - 2012: 11,123 ($ billions) - 2013: 12,857 ($ billions) - Institutional investor totals: - 2011: 1,745 ($ billions) - 2012: 1,921 ($ billions) - 2013: 2,161 ($ billions) - Investment advisers to hedge funds (as of September 2014): - 2,691 IAs registered with the SEC advised at least one HF. - Registered IAs to HFs manage approximately $5.4 trillion in cumulative reported regulatory assets under management (RAUM). - As of May 7, 2014 there were 544 IAs classified as large HF managers (i.e., with 1.5 billion HF AUM), with a total of 3,835 HFs under management. - Exempted reporting advisers (ERAs): approximately 2,693 ERAs with 875 advisers or 32 percent of them managing HFs that account for approximately $846 billion in RAUM. ### Commodity pools and CPOs - Inclusion of swaps in the definition of commodity under the Dodd-Frank Act led to growth in number and AUM of commodity pool operators (CPOs). - Retail participation in swaps-based CIS: CFTC estimates retail investors hold approximately 10 to 15 percent of total AUM in those pools. - Number of Commodity Pool Operators and AUM (Table 4, selected points): - end-2011: Total Number of NFA Member CPOs 1,078; Total AUM 348 (note: table formatting in source) - end-2012: Total Number of NFA Member CPOs 1,105; Total AUM 493 - end-2013: Total Number of NFA Member CPOs 1,686; Total AUM 2,809 - Aug. 6, 2014: Total Number of NFA Member CPOs 1,658; Total AUM 2,928 - Source: CFTC. ### Market intermediaries and registration trends - Separate regimes for securities and derivatives market intermediaries: - BDs registered under the Exchange Act; FCMs and IBs registered under the CEA. - Advisers: registered as IAs or CTAs under securities or futures legislation. - CIS operators: registered as IAs under the Advisers Act or CPOs under the CEA. - Number of registered BDs has fallen over the last five years. - Dodd-Frank effects: - IAs that previously were not subject to registration (such as IAs to HFs) are now required to register with the SEC. - Smaller IAs are now subject to registration by the state regulators only. - Small decline in the number of IAs registered with the SEC; total AUM for SEC registered IAs has increased. - SEC estimates total AUM for IAs, including mutual funds, is approximately $63 trillion. - Number of FCMs is relatively small; many larger FCMs are also registered as BDs. ### Registered intermediaries (selected tables) - Registered Broker-Dealers (Table 5): source SEC — table contains historical counts by SRO membership with totals for dates between January 1, 2010 and July 1, 2014 (table formatting preserved in source). - SEC Registered Investment Advisers (Table 6): - At January 2: - 2012: SEC-registered investment advisers 11,658 - 2013: 10,754 - 2014: 10,920 - SEC exempt reporting advisers: - 2012: 0 - 2013: 2,331 - 2014: 2,594 - Derivatives Market Intermediaries registered with the CFTC (Table 7, as of July 31, 2014): - Futures Commission Merchant: 78 - Introducing Broker: 1,354 - Commodity Pool Operator: 1,770 - Commodity Trading Advisor: 2,539 - Retail Foreign Exchange Dealer: 7 - Swap Dealer: 102 - Major Swap Participant: 2 - Floor Broker: 4,495 - Floor Trader: 827 - Notice-Registered IB: 46 - Notice-Registered FCM: 14 - Source: CFTC. ### Preconditions for effective securities regulation - All preconditions appear to be in place in the United States. - No barriers to entry: Registration requirements based on objective criteria; foreign investors can invest under the same conditions as domestic investors. - Taxation: No apparent distortions in market structure created by the tax regime. - Company law: Companies free to choose state of incorporation; majority choose Delaware. - Insolvency law: Bankruptcy Code provides two primary routes: - Chapter 11: reorganization; management usually continues day-to-day operations; significant decisions require bankruptcy court approval. - Chapter 7: liquidation; trustee appointed to liquidate assets. - Public companies generally file under Chapter 11 rather than Chapter 7. - Competition law: Strong and vigorously enforced anti-trust legislation applies to all sectors including financial sector. - Accounting and auditing standards: Globally recognized as of high international quality. - Protection of investors’ rights: - Judiciary acknowledged independent from political influence. - Private rights of action under company, securities and derivatives laws are actively exercised, including through class action suits. - SROs have obligatory mechanisms for alternative resolution of disputes between intermediaries and their clients. ### Main findings (summary) - Principles for the regulator: - The SEC and the CFTC are independent agencies with clear mandates from law. - Both have sufficient powers: rulemaking, registration, examination and enforcement powers. - High level of accountability supported by public transparency of regulatory actions and decisions. - Strong ethics rules apply to Commissioners and staff of both agencies. - Current level of resources poses challenges for the SEC and CFTC, particularly given their expanded mandates. - Agencies are increasingly adopting forward-looking risk-based supervision and enhancing risk identification processes, aiding contributions to the FSOC. - Both agencies have processes to review the perimeter of regulation. - Principles for self-regulation: - U.S. system relies strongly on SROs (e.g., FINRA, NFA) for supervision of markets and intermediaries. - SROs are subject to oversight including approval/notification of rules and ongoing monitoring via reporting and examinations. - Principles for enforcement: - SEC and CFTC have broad inspection, investigative and enforcement powers over regulated entities, individuals, and third parties. - Agencies and SROs have robust supervisory programs; programs are risk-based. - Coverage of examination programs generally prevents long intervals without inspection for entities, except coverage is more limited for IAs. - Market surveillance relies primarily on SROs’ automated tools. - SEC, CFTC and criminal authorities are active in pursuing securities and derivatives violations. - Principles for cooperation: - SEC and CFTC have ability and capacity to share information and cooperate domestically and internationally. - Signatories to many MOUs, including the IOSCO MMOU and bilateral MOUs; records of active cooperation. - SEC and CFTC do not need permission of any outside authority to share or obtain information. - Access to financial records of individuals and small partnerships requires notifying the customer; delaying such notice is possible in certain circumstances. *Italicized source attribution: UNITED STATES — INTERNATIONAL MONETARY FUND* ### 31. Principles for issuers. Generally issuers of public offerings, including ABS, are subject to ### _cr1591 - 31. Principles for issuers. Generally issuers of public offerings, including ABS, are subject to ### Principles for issuers - Generally issuers of public offerings, including ABS, are subject to strong disclosure requirements both at the moment of registration and on a periodic basis, except for municipal securities which are exempt from those registration and reporting requirements. - The current framework provides reporting companies with significant freedom to decide on their structure, and the classes of shares to be offered to the public. - Any limitations to the rights of shareholders must be clearly disclosed in the prospectus. - Federal laws allow the acquisition of control without triggering an obligation to make a tender offer; however, a number of features in the legal system, mainly state corporate laws, create disincentives from doing so. - The current regime requires reporting of insiders’ holdings and substantial holdings, as well as reporting of beneficial ownership. - The SEC has developed an active program to monitor and enforce issuers’ compliance with their disclosure obligations. - High quality accounting standards, the U.S. Generally Accepted Accounting Principles (GAAP), are set through an open and transparent process. ### Principles for auditors, credit rating agencies, and other information service providers - Auditors of reporting companies must be registered with the PCAOB. - The PCAOB has developed a credible examination program for audit firms. - Audit standards are considered of high quality. - The PCAOB is responsible for the enforcement of compliance with audit standards, and the SEC can also exercise its enforcement powers over auditors and has done so in an active manner. - CRAs that wish their credit ratings to be used for regulatory purposes must elect to register with the SEC as Nationally Recognized Statistical Rating Organizations (NRSROs). - In practice, ratings are currently used for regulatory purposes by the SEC in very limited cases, mainly in connection with money market funds (MMFs). - The registration process subjects NRSROs to appropriate requirements. - The SEC conducts NRSRO examinations on an annual basis. - BDs on the securities side and FCMs, IBs, swap dealers (SDs) and major swap participants (MSPs) on the derivatives side are subject to obligations in connection with the provision of research analysis that aim at managing potential conflicts of interest. ### Principles for collective investment schemes - IAs to mutual funds (MFs) and commodity pool operators (CPOs) are subject to registration with the SEC and CFTC, which focuses mainly on their integrity and disclosure to investors. - MFs and CPs are subject to disclosure obligations both at the moment of registration and on a periodic basis. - Self-custody and related party custody of MF and CP assets is allowed; however additional safeguards apply in the case of MFs. - MF and CP assets must be valued according to the U.S. GAAP. - MF and CP shares and units must be valued at net asset value (NAV), except MMFs. - IAs to HFs are subject to registration requirements that are based on disclosure. - Standards of organizational and operational conduct apply to them. - The SEC conducts only limited examinations of IAs to MFs, although it has implemented a presence examination program for newly registered IAs, including those that manage HFs. ### Principles for market intermediaries - The registration regime combined with the relevant SRO’s membership regime subjects all categories of participants except IAs and CTAs to comprehensive eligibility criteria that include integrity, capital requirements, and adequacy of internal controls. - All categories of intermediaries except IAs and CTAs are subject to capital requirements and periodic reporting of their financial position and capital adequacy. - IAs and CTAs’ registration regime is based on integrity criteria and disclosure. - IAs and CTAs are not permitted to hold clients assets nor deal on behalf of customers, though they may have discretion to make investment decisions. - Early warning systems are in place. - There are well-developed processes to deal with the failure of intermediaries that have been applied in practice. *Content unit: _cr1591 - 31. Principles for issuers. Generally issuers of public offerings, including ABS, are subject to* ### 35. Principles for secondary markets. Exchanges and DCMs are subject to detailed registration ### _cr1591 - 35. Principles for secondary markets. Exchanges and DCMs are subject to detailed registration ### Overview of regulatory framework and market structure - Exchanges and DCMs are subject to detailed registration requirements. - ATSs are subject to the SEC broker-dealer registration and FINRA membership processes along with SEC disclosure obligations. Limited public information is available on ATS operations, subscribers and market models. - The exchanges and FINRA share responsibility for market surveillance and member supervision in securities markets; DCMs and NFA carry out these functions in commodity futures and options markets. - The exchanges and DCMs are subject to active SEC and CFTC supervision. - Pre-and post-trade transparency requirements apply in both securities and derivatives markets, subject to certain derogations that may reduce pre-trade transparency. - Market abuse is addressed by the Exchange Act and CEA and is subject to administrative, civil and criminal sanctions. - Open positions in commodity futures and options markets are closely monitored by the SROs and CFTC; position information in securities markets is available through a DTCC service. - Default procedures apply in both clearing agencies and Derivatives Clearing Organizations (DCOs) and are disclosed through their rules. - Short selling is subject to disclosure and “locate” requirements; the SEC and SROs monitor compliance. ### Summary implementation grades and key findings (selected Principles) - Principle 1 — Grade: BI - The mandates of the SEC and CFTC are stated by law; agencies interpret laws and publish interpretations, guidance and no action letters. Coordination exists; CPO and CTA regimes may lead to different investor protection consequences than IAs. - Principle 2 — Grade: BI - SEC and CFTC are independent agencies; Commissioners removable only for cause; Congressional budget process can materially affect priorities and long-term planning. - Principle 3 — Grade: PI - Agencies have sufficient powers (rulemaking, registration, examination, investigation, enforcement) but current funding levels pose challenges given expanded mandates. - Principle 4 — Grade: FI - Rulemaking process includes public consultation and cost analysis; regulatory decisions subject to due process and judicial review. - Principle 5 — Grade: FI - Agencies bound by ethics and confidentiality rules; additional restrictions on staff trading and holding of securities and commodities. - Principle 6 — Grade: BI - Supervisory programs monitor entities/products/markets; data collection improved but enhancements needed particularly on asset management and swaps data; agency participation in FSOC contributes to systemic risk identification. - Principle 7 — Grade: FI - Multiple processes to review regulatory perimeter, including five year strategic plans. - Principle 8 — Grade: FI - Issuer conflicts addressed primarily through disclosure; new asset level data and retention requirements will become effective over the next two years. - Principle 9 — Grade: FI - Extensive use of SROs (exchanges, DCMs, FINRA, NFA) with ongoing SEC or CFTC oversight, including rule approval/notification and risk-based on-site examinations. - Principle 10 — Grade: FI - SEC and CFTC have broad inspection, information and investigation powers; CFTC and NFA conduct front line surveillance of derivatives; SEC and SROs cooperate on securities surveillance. - Principle 11 — Grade: FI - Robust subpoena and enforcement powers; administrative, civil and criminal remedies available; CFTC can seek restitution. - Principle 12 — Grade: BI - Robust, risk-based supervisory programs exist; IA examination coverage limited despite sector importance; improvements in SEC enforcement (case management, settlements including admissions, specialized units). - Principle 13 — Grade: FI - SEC and CFTC can share information with domestic and foreign authorities, subject to legal requirements and RFPA notification rules; IOSCO MMOU prior consultation practice followed. - Principle 14 — Grade: FI - Domestic MOUs, IOSCO MMOU signatory status, bilateral MOUs and ad hoc arrangements used; agencies respond to many foreign requests. - Principle 15 — Grade: FI - Agencies have assisted foreign authorities using powers to obtain and compel documents and testimony. - Principle 16 — Grade: BI - Strong issuer disclosure framework (annual audited financials, quarterly reports, material event disclosure); municipal securities exempted from registration/reporting but subject to indirect SEC disclosure mechanisms; SEC lacks direct authority to impose issuer disclosure on municipals except via antifraud. - Principle 17 — Grade: FI - Reporting issuers subject to disclosure of shareholder rights; strong fiduciary duties; reporting of insiders’ holdings, substantial holdings (over 10 percent), and beneficial owners within stipulated deadlines. - Principle 18 — Grade: FI - Reporting issuers use U.S. GAAP; foreign issuers may use IFRS; FASB sets U.S. GAAP overseen by FAF; SEC monitors compliance and has an accounting fraud task force. - Principle 19 — Grade: FI - Auditors must register with the PCAOB; PCAOB inspection program frequency depends on number of issuers audited; PCAOB can impose enforcement actions. - Principle 20 — Grade: FI - SEC auditor independence rules; PCAOB quality controls and inspection/enforcement; lead auditor rotation every five years. - Principle 21 — Grade: FI - PCAOB audit standards considered high quality; standard setting includes public consultation. - Principle 22 — Grade: FI - CRAs used for regulatory purposes must register with the SEC; SEC examines each NRSRO at least annually; sanctions range from fines to suspension or revocation; at least one CRA has been sanctioned in practice. - Principle 23 — Grade: FI - Equity research by BDs subject to SRO rules and past settlements (covering approximately 80 to 90 percent of the U.S. equity underwriting business); certifying/conflict disclosure rules in place; CFTC rules require information barriers and disclosure for commodities research by FCMs, IBs, SDs and MSPs. - Principle 24 — Grade: PI - IAs to MFs and CPOs subject to SEC/CFTC (CFTC delegated to NFA) registration focusing on disqualifications and disclosure; ongoing organizational and conduct obligations apply; SEC IA coverage limited. - Principle 25 — Grade: BI - MF assets must be segregated; custody by an IA or related entity allowed with additional safeguards (two unannounced auditor inspections); CFTC requires CP assets segregation but not a mandatory custodian/depository or additional safeguards when assets held by CPO or related custodian. - Principle 26 — Grade: FI - Publicly offered MFs and CPs subject to Securities Act prospectus obligations and periodic reporting (annual and semiannual reports); CPOs must provide detailed disclosure documents, annual audited financials and annual reports, plus quarterly or monthly reporting. - Principle 27 — Grade: BI - MFs and CPs required to value portfolios according to U.S. GAAP; MMFs may use fixed prices (not required to price units at market value) subject to strict eligible asset and duration rules; post-trade price information generally available; post-trade disclosure required as soon as practicable but within a maximum delay of 10/90 seconds; in practice dissemination occurs within milliseconds. - Principle 28 — Grade: FI - HF managers required to register as IAs or CPOs depending on assets; registration focuses on disqualifications and disclosure; HF managers with RAUM above a threshold subject to additional periodic reporting on assets, exposures and leverage; FSOC designation could lead to capital/prudential requirements. - Principle 29 — Grade: FI - Except IAs and CTAs, intermediaries face comprehensive eligibility criteria including integrity, capital and internal controls; IAs and CTAs are restricted from holding customer assets or dealing for customers. - Principle 30 — Grade: FI - All intermediaries except IAs and CTAs subject to net capital requirements with deductions for liquidity and market risks; ANC framework available to some large BDs with higher minimum capital and SEC approval of models; periodic financial reporting and notification when capital falls below thresholds. - Principle 31 — Grade: BI - With exception of IAs and CTAs, intermediaries required to have adequate internal controls and risk management; segregation obligations and know-your-customer requirements apply; IA examination coverage limited. - Principle 32 — Grade: FI - CFTC and SEC have plans/processes to deal with firm failures; early warning systems tied to minimum capital requirements; SIPC involvement for BDs in difficulty with SIPA trustees and compensation from the SIPC Fund up to a limit; failed FCM customers compensated on a pro rata basis; no SIPC equivalent for commodities; Dodd-Frank Title II may place systemically important intermediaries into FDIC receivership. - Principle 33 — Grade: BI - Exchanges and boards of trade must register under Exchange Act and CEA; ATSs must register as broker-dealers, join an SRO (practically FINRA) and file initial Form ATS; fair access requirements apply after ATS market share exceeds a five percent threshold; currently there are no ATSs above that threshold; limited public information on ATS order execution rules/procedures. - Principle 34 — Grade: FI - Ongoing supervision of exchanges and trading systems conducted via rule approval/review and on-site examinations; increased focus on technology and system safeguards; most SEFs have outsourced surveillance to NFA. - Principle 35 — Grade: BI - Pre- and post-trade transparency in equity markets based on Regulation NMS; dark order types and dark pool ATS trading limit pre-trade transparency; post-trade disclosure maximum delay 10/90 seconds; in practice disclosures occur within milliseconds. In commodity futures/options, block trades and bona fide exchanges are exempted from pre-trade transparency via DCM rules; block trade thresholds have decreased; CFTC harmonized block trade regulation not finalized. - Principle 36 — Grade: FI - Fraudulent and manipulative practices prohibited under Exchange Act, CEA and SRO rules; insider trading prohibited in securities; trading on material nonpublic information in commodities may violate CEA; SROs monitor and refer cases; administrative, civil and criminal sanctions applied. - Principle 37 — Grade: FI - DCMs and DCOs closely monitor open positions in commodity futures/options, complemented by CFTC; clearing agencies monitor securities member exposures; DTCC Limit Monitoring system facilitates cross-market post-trade monitoring; default procedures in place and disclosed; short selling subject to disclosure and “locate” requirements with SEC and SRO monitoring. - Principle 38 — Not assessed. ### Specific market structure and transparency issues - ATSs: must register as broker-dealers, join an SRO (in practice FINRA), and file Form ATS. Fair access rules triggered at a five percent market share threshold; currently no ATS exceeds that threshold. Voluntary disclosures limit public information on ATS order execution rules, subscribers, and market models. - Pre-trade transparency: Regulation NMS governs equity pre- and post-trade transparency; dark order types and dark pools permit non-disclosure of pre-trade interest. Commodity markets permit block trade and EFR exemptions under DCM rules; CFTC block trade harmonization pending. - Post-trade dissemination: required as soon as practicable, within a maximum delay of 10/90 seconds; in practice reported within milliseconds. - Market surveillance: exchanges, FINRA, DCMs and NFA perform front-line surveillance; SEC and CFTC supervise SROs and can initiate investigations independently. ### Recommended action plan (selected recommendations from Table 9) - Principle 1 - Continue SEC and CFTC coordination via joint regulations, unified reporting and/or substituted compliance; all relevant authorities should enhance coordination. CFTC to review whether legal changes are needed to align CPO/CTA standards of care with IAs. - Principle 2 - Consider mechanisms to make SEC and CFTC funding more stable (e.g., self-funding and/or multiyear budgeting). - Principle 3 - Provide additional resources to SEC and CFTC commensurate with expanded mandates. - Principle 6 - SEC to improve data availability and automated tools to identify risks, particularly for asset managers; consider more formal arrangements for holistic risk discussions and accountability. CFTC to improve quality of swaps data and expand swaps market monitoring mechanisms. - Principle 8 - SEC encouraged to review conflicts arising from BD affiliates’ participation in ATSs, order types, order routing and fee structures; continue review of BD and IA models for harmonization of standards of care. - Principles 12, 24, 31 - SEC should increase intensity of IA examination coverage. - Principle 16 - Consider amending federal securities laws to grant SEC direct authority to impose disclosure requirements on issuers of municipal securities and to reassess exemptions available to non-municipal conduit borrowers; review thresholds that trigger suspension of reporting obligations, especially for banks and bank holding companies. - Principle 17 - SEC encouraged to consider reducing deadlines for beneficial ownership and insider reporting. - Principle 19 - PCAOB to ensure timeliness of enforcement proceedings; SEC and PCAOB to analyze whether PCAOB proceedings should be public. - Principle 21 - PCAOB to ensure timely advancement of its standard setting agenda. - Principle 23 - FINRA encouraged to finalize research analysis rules in debt and equity to address asymmetries relative to Global Settlement firms. - Principle 24 - Authorities to consider explicitly requiring IAs to MFs and CPOs to implement internal controls and risk management. - Principle 25 - Consider amending the CEA to enable CFTC to require additional safeguards where a CPO or related entity has possession of pool assets. - Principle 27 - CFTC or NFA should adopt a rule on treatment of investors adversely affected by errors in pricing interests in a CP. - Principle 28 - Authorities to review whether a comprehensive risk management framework for HFs is warranted as analysis of HF risks continues. - Principle 29 - Consider requiring internal controls and risk management for IAs and CTAs that conduct portfolio management. - Principle 30 - SEC to continue review of capital and liquidity framework for ANC firms and adequacy of liquidity requirements for larger BDs. - Principle 33 - SEC to follow development of bilateral trading systems and adjust regulatory framework as needed; require ATSs to disclose order execution rules and procedures; consider lowering or removing the five percent fair access threshold; SEC and FINRA to ensure depth of analysis of new ATS order execution procedures and BD competence to operate ATSs; consider additional requirements on exchanges to manage direct electronic access risks. - Principle 35 - SEC to deepen analysis of pre-trade transparency impact of various order types and reference prices used by dark order types; CFTC to promptly finalize block trade rules for regulatory basis to assess pre-trade transparency waivers. - Principle 37 - Authorities encouraged to review whether current mechanisms provide a comprehensive view of total exposures of market participants active across equity, fixed income and commodity futures and options markets. *International Monetary Fund — assessment excerpt (Principles for secondary markets; exchanges, DCMs, ATSs, transparency, market surveillance, and recommended action plan).* ### 36. The Chairs of the SEC and the CFTC appreciate the IMF’s commitment of time and resources ### The Chairs of the SEC and the CFTC appreciate the IMF’s commitment of time and resources ### Appreciation and acknowledgement - "The Chairs of the SEC and the CFTC appreciate the IMF’s commitment of time and resources to the Financial Sector Assessment Program." - "We would like to express our gratitude to the IMF for fielding such a highly professional, hard working, and knowledgeable team of assessors to prepare the Detailed Assessment Report." - "As the United States has the largest and most complex financial markets in the world, we recognize and welcome the fact that the United States is held to the highest and most stringent grading standard." - "We value the objective assessment conducted of our Commissions’ regulatory regimes." ### Regulatory developments and actions - "In the aftermath of the financial crisis, our agencies were given new powers and broad new responsibilities to make our financial regulatory system stronger, more resilient and more effective." - "We are pleased to see that the Report reflects a recognition that over the past five years the SEC and CFTC have harnessed these new powers and seized upon these new responsibilities to implement more robust and comprehensive rulemaking, supervision and enforcement programs." - Example cited in the Report: "our agencies have introduced comprehensive regulatory reform of the OTC derivatives marketplace, improved supervisory programs to monitor compliance by registered entities, and made extensive use of our enforcement powers." ### Assessment outcomes, reactions, and next steps - "The overall ratings in the Report reflect the SEC’s and CFTC’s regulatory successes, while at the same time noting that there is room for improvement." - "Although staff disagrees with certain of the conclusions, recommendations, ratings and interpretations of the IOSCO Principles, we found the assessment process to be comprehensive and fair." - "SEC and CFTC staffs will continue to evaluate the Report as a tool for our respective Commissions to enhance their regulatory programs and to improve cooperation and coordination in rulemaking and regulatory oversight." - "We look forward to a continuing dialogue with the IMF to advance our shared goal of strengthening the U.S. financial regulatory system." ### Purpose of the Detailed Assessment - "The purpose of the assessment is primarily to ascertain whether the legal and regulatory securities markets requirements of the country and the operations of the securities regulatory authorities in implementing and enforcing these requirements in practice meet the standards set out in the IOSCO Principles." - The assessment is intended "to be a means of identifying potential gaps, inconsistencies, weaknesses and areas where further powers and/or better implementation of the existing framework may be necessary and used as a basis for establishing priorities for improvements to the current regulatory scheme." *Source: _cr1591 - 36. The Chairs of the SEC and the CFTC appreciate the IMF’s commitment of time and resources* ### 42. The assessment of the country’s observance of each individual Principle is made by ### _cr1591 - 42. The assessment of the country’s observance of each individual Principle is made by ### Assessment methodology for IOSCO Principles - Assessment categories: fully implemented; broadly implemented; partly implemented; not implemented; not applicable. - A Principle is considered: - fully implemented when all assessment criteria specified for that Principle are generally met without any significant deficiencies. - broadly implemented when the exceptions to meeting the assessment criteria specified for that Principle are limited to those specified under the broadly implemented benchmark for that Principle and do not substantially affect the overall adequacy of the regulation that the Principle is intended to address. - partly implemented when the assessment criteria specified under the partly implemented benchmark for that Principle are generally met without any significant deficiencies. - not implemented when major shortcomings (as specified in the not implemented benchmark for that Principle) are found in adhering to the assessment criteria specified for that Principle. - not applicable when it does not apply because of the nature of the country’s securities market and relevant structural, legal and institutional considerations. - The methodology recognizes variation in means of implementation depending on domestic context, structure, and stage of development of the country’s capital market. ### Principle 1 — The responsibilities of the regulator should be clear and objectively stated - Assessment: Broadly Implemented. - Key structural descriptions and responsibilities: - Federal regulation: - SEC responsible for securities markets and related derivatives markets (such as options on securities). - CFTC responsible for futures and other derivatives markets. - Dodd-Frank Act expanded federal coverage by: - Bringing swaps within federal legislation and allocating responsibility between CFTC and SEC. - Requiring registration of municipal advisors with the SEC while municipal securities offerings remain exempted from registration and reporting requirements of federal securities laws. - Requiring registration with the SEC of previously exempt advisers to HFs and private equity funds. - Expanding CFTC authority over off-exchange foreign currency transactions with members of the retail public. - Removing CFMA exemptions for foreign and other exempt boards of trade. - State-based securities regulation: - Smaller IAs (those with less than US$100 million in assets under management) generally not required to register with the SEC as IAs and are subject to state regulation. - NSMIA (1996) removed state registration requirements for certain "covered securities" while preserving state fraud investigation/prosecution rights. - SROs: - Extensive use of SROs, including exchanges with SRO roles and specialist SROs such as FINRA and the NFA; SROs are subject to authorization and oversight by relevant regulators. - CFTC (Responsibilities, interpretation, rulemaking, concerns): - Established under the CEA; mission per Section 3(b) CEA: protect market users and the public from fraud, manipulation, other abusive practices, and systemic risk related to derivatives subject to the CEA and foster open, transparent, competitive and financially sound markets. - Discretion to interpret authority via guidance and informal means; broad exemptive authority (Section 4(c)) and broad rulemaking authority (Section 8a(5)). - Rulemaking governed by Section 553 of the APA; rule proposals, adoptions and concept releases published in the Federal Register and on the CFTC’s website. - Concerns: reliance on guidance (not subject to formal consultation and cost-benefit analysis) and extensive use of time-limited no action letters adding uncertainty. - SEC (Responsibilities, interpretation, rulemaking): - Established under the Exchange Act; responsibilities set out in Securities Act, Exchange Act, Trust Indenture Act, ICA, Advisers Act, SOX, Dodd-Frank Act, JOBS Act. - Mission: protect investors; maintain fair, orderly, and efficient markets; facilitate capital formation. - Provides guidance via interpretive releases, interpretive letters, legal or accounting bulletins, FAQs; postings on SEC website and Federal Register. - Rulemaking governed by the APA; consultation and cost-benefit analysis; transparency via Federal Register and SEC website. - Multi-authority issues (gaps and overlaps): - General rule: SEC and CFTC have exclusive jurisdiction within statutory mandates, but overlaps exist; state authorities retain roles in certain activities. - Swaps (Title VII Dodd-Frank): CFTC regulates "swaps"; SEC regulates security-based swaps (SBS); SEC and CFTC jointly regulate "mixed swaps"; framework covers registration/regulation of dealers and major participants, clearing, trade execution, regulatory reporting, public dissemination of trade data. - Municipal brokers/dealers/advisors: banks transacting in municipal securities may be included in definition of municipal securities dealer and must register with SEC and MSRB; compliance responsibility divided among SEC, FINRA, federal bank regulators; FDIC, Federal Reserve, OCC also play roles. - Banks’ broker activity: GLBA (1999) provided exceptions from SEC oversight for specified securities activities; Exchange Act provides conditional exceptions from definition of “broker” for banks in specified contexts. - Commodity pools (CPs): solicitation for CP investment constitutes offer of a security and is subject to Securities Act and Exchange Act obligations; public offers generally use one prospectus complying with both securities laws and CFTC CP regulations; majority of CPs are private placements and subject primarily to CFTC substantive regulation; exchange traded products on national securities exchanges may be subject to dual regulation under CEA and federal securities laws. - Broker margin rules: Federal Reserve sets margin requirements for securities and futures intermediaries; delegated to CFTC in 1993 for futures (subject to annual reporting); Federal Reserve’s Regulation T applies directly to securities market intermediaries. - Clearing houses and SIFIs: Title VIII Dodd-Frank created framework for assessing systemic risk and grants authority to Federal Reserve, CFTC, SEC, FDIC to promulgate rules/standards and manage systemic risk; FSOC designates systemically important financial institutions. - Dual registration: BDs registered with SEC may dually register with CFTC; many large FCMs also registered as BDs; harmonization where possible for capital and financial reporting; swaps inclusion may require HF managers to register as CPOs under CEA and as IAs under Advisers Act. - Consistent regulation of like services/products: - Insurance products with performance based on securities are regulated as securities and subject to securities disclosure obligations. - CIS regulated either as MFs under securities laws or CPs under CEA; differences exist (e.g., IAs subject to strict fiduciary obligation; CPOs under CEA not subject to same fiduciary duty). - BDs providing advice incidental to broker-dealer business are not bound by same fiduciary standard as IAs. - Coordination and cooperation between regulators: - Chairs of CFTC and SEC are FSOC members; FSOC responsible for facilitating coordination to monitor systemic risk and promote financial stability. - Cross-government forums include Financial Fraud Enforcement Taskforce; regular meetings among SEC, CFTC, Federal Reserve, FDIC, OCC on Volcker rule implementation. - Numerous MOUs in place to support collaboration: regulatory liaison, oversight and information sharing about securities futures products, consultation and information sharing on CDS central counterparties (Federal Reserve also party). - Market participants report increased communication but express concern that coordination has had limited impact on regulatory consistency and reduction of duplicative reporting and inspections. - Assessment commentary (reasons for "Broadly Implemented"): - SEC and CFTC have clear mandates and considerable discretion; formal rulemaking process governed by legislation and transparent. - Concerns about less rigorous processes for guidance and extensive use of no action letters in new swaps jurisdiction. - Dodd-Frank Act addressed many prior coverage gaps (swaps activity, municipal advisors, advisers to HFs and private equity funds, retail FX activity); municipal securities offerings remain exempt from registration and reporting but subject to anti-fraud provisions. - Two issues affecting grade: consistent treatment of like conduct/products (Key Question 2(b)) and arrangements for cooperation between responsible regulators (Key Question 2(d)). - Differences identified in fiduciary standards between IAs and CPOs/CTAs; assessors note potential investor protection gap and suggest CFTC may examine whether legal changes are warranted to align standards. - Need for enhanced coordination and mutual reliance among SEC, CFTC, SROs and banking regulators on reporting, examinations, and supervisory activities—particularly governance, internal control and risk management areas. ### Principle 2 — The regulator should be operationally independent and accountable in the exercise of its functions and powers (CFTC focus in supplied content) - Independence and governance: - CFTC is an independent regulatory commission; accountable directly to Congress rather than the Executive Branch. - Commission governed by five Commissioners appointed by the President with Senate advice and consent; each Commissioner serves five years with staggered terms so one term expires each year; no more than three Commissioners may be from the same political party. - The President appoints a Chairman (serves at the pleasure of the President); replaced Chairman may complete term as Commissioner. - Case law: President may remove a Commissioner only for cause (e.g., neglect of duty or malfeasance). - CEA prohibits Commissioners from accepting employment/compensation from entities regulated by the CFTC and from participating directly or indirectly in transactions subject to CFTC regulation. - Interaction with government and other agencies: - CFTC can generally discharge functions without approval/consultation from other governmental authority. - Statutory requirements to consult/coordinate with other regulators in specific cases (e.g., Section 712(a)(1) Dodd-Frank requires consultation with SEC and prudential regulators on swaps rulemaking). - Coordination obligations with Treasury, Federal Reserve for DCM registration issues; coordination with FTC and FERC on cash markets underlying derivatives. - Congressional Review of Agency Rulemaking Act (CRARA) requires submission of proposed rules to Congress; non-major rules effective on agency proposal receipt; major rules generally effective 60 days after Congressional receipt. - Interaction with commercial and sectoral interests: - Explicit conflict of interest provisions addressing potential conflicts from previous relationships and financial holdings; further described under Principle 4. - Industry interaction primarily via open APA-prescribed rulemaking process; CFTC makes public summary records of ex parte communications in rulemaking and places written submissions on public record. - Funding stability and budgeting (exact figures preserved): - CFTC funded through annual appropriations process; submits budget request to President/OMB; request copied to relevant Congressional Committees. - For fiscal year 2015: - President recommended $280 million for the CFTC (an increase of $65 million and 253 staff persons over the 2014 levels). - The 2015 Agriculture Appropriations Bill provides the CFTC with a budget of $218 million. - This budget represents an increase of $3 million over the 2014 enacted level, but is $62 million below the President’s request. - The Bill allocates over $52 million for the purchase of information technology until September 30, 2016. - The CFTC’s budget has been subject to sequestration three times during the last five years; CFTC staff indicated sequestration did not have material consequences in practice, although a furlough had to be applied on one occasion. - Reauthorization process: - Subject to periodic reauthorization, typically at five year intervals. - If reauthorization not made within specified period, continued Congressional appropriations are taken to indicate continuing authorization. - CFTC senior officials view reauthorization as a point of accountability rather than a hindrance to discharging functions. - Legal protection: - Principles of sovereign immunity apply to the CFTC as a federal agency. - FTCA provides federal employees with immunity from individual liability for torts committed in scope of employment. - CFTC adopted indemnification rules covering Commissioners and staff for individual liability for possible violation of constitutional or statutory duties not covered by the FTCA. - Accountability: - CFTC accountable to Congress. - Principal Congressional oversight: House Committee on Agriculture and its Subcommittee on Risk Management and Specialty Crops; Senate Agriculture, Nutrition and Forestry Committee and its Subcommittee on Research, Nutrition and General Legislation. - These Committees handle reauthorization, budget/funding decisions for the CFTC, and bills affecting the CEA. - Transparency: - (Transparency noted in description of rulemaking, publication in Federal Register, public record of communications and written submissions; explicit textual detail preserved above.) *Source: UNITED STATES — INTERNATIONAL MONETARY FUND (content from supplied PDF chapter)._ ### Section 8(h) of the CEA requires the CFTC to submit to Congress a written report within 120 ### _cr1591 - Section 8(h) of the CEA requires the CFTC to submit to Congress a written report within 120 ### Governance, reporting and statutory duties - Section 8(h) of the CEA requires the CFTC to submit to Congress a written report within 120 days after the end of each fiscal year detailing the operations of the CFTC during that fiscal year. - The CFTC annual report must include any information, data and legislative recommendations the CFTC deems advisable with respect to the administration of the CEA and its powers and functions under the CEA. - Section 18(b) of the CEA requires that the annual report contain plans and findings regarding implementation of Section 18(a) of the CEA, which mandates certain research and information programs. - The APA governs CFTC rulemaking and requires interested persons be given an opportunity to comment on proposed rulemaking. - The Sunshine Act generally provides that meetings of the Commission must be open to the public and requires the CFTC to provide advance notice of such meetings. ### Oversight, audits and accountability - Section 8(i) of the CEA requires the Comptroller General (GAO) to conduct reviews and audits of the CFTC and make reports on them. - The CFTC must make available to the GAO any required information about its powers, duties, organization, transactions, operations and activities, as well as access to any books and records (subject to confidentiality requirements). - The CFTC’s independent Office of the Inspector General (OIG): - Conducts and supervises audits and investigations of CFTC programs and operations. - Reviews existing and proposed legislation and regulations. - Recommends policies to promote economy, efficiency and effectiveness in CFTC programs and operations, and to prevent and detect fraud and abuse. - Keeps the Chairman of the CFTC and Congress informed about any problems, deficiencies, and progress of corrective action in programs and operations. - OIG reports may be made public. - Under the APA, a person aggrieved by a decision or action of the CFTC can challenge that decision in a U.S. Federal District Court (applies to rule adoptions, denial of applications for registration, sanctions decisions). ### Confidentiality and information handling - Section 8(a)(1) of the CEA provides that, except as otherwise specified in the CEA, the CFTC must not publish data and information that would separately disclose market positions, business transactions, trade secrets or names of customers. - The CFTC must not make public any data or information concerning or obtained in connection with any pending investigation of any person. - Confidentiality of information is preserved through the accountability process by the code of ethics that applies to members of Congress and their staff, and by negotiation between the CFTC and Congress and its members. ### Interaction with other agencies and rulemaking (comparative SEC context) - Title VII of the Dodd-Frank Act requires the SEC to engage in joint rulemaking with the CFTC on aspects of the swaps market. - The APA governs SEC rulemaking and generally requires that interested persons are given an opportunity to comment on proposed rulemaking; the SEC posts rulemaking releases and public comment letters on its website. - The Sunshine Act requires open Commission meetings and advance notice; the SEC videocasts all open SEC meetings on the Internet. ### Funding, use of funds, and budgetary constraints - The CFTC budget process: the budget submitted to Congress must include an allocation request with a specific breakdown of proposed resource allocation; the final allocation is established when Congress adopts the bill funding the CFTC’s operations. - Significant changes in allocation of funds once appropriated require a reprogramming request to the relevant Committee of Congress. - Senior CFTC officials acknowledge current funding levels pose challenges, particularly in light of the expansion of the CFTC mandate brought by the Dodd-Frank Act. - Market participants expressed concerns about the impact that Congress’ approved budget has on the CFTC’s ability to deliver timely high quality regulations and effective supervision. - SEC-specific funding details included for comparison: - The current fee rate is approximately $0.02 per every $1,000 transacted. - The SEC has a reserve fund and can use up to $100 million from this fund each year. - Funding for that reserve is provided by deposits of $50 million per year in securities registration fees (with the remainder remitted to Treasury). - The level of funding approved by Congress has been significantly lower than that requested by the SEC. - The sequestration process affected budgets on three occasions during the last five years; in one occasion sequestration had a material effect on the final budget of the agency. - Use of funds and audits: - The SEC’s receipt and use of funds are subject to regular audit by the GAO and the SEC’s Office of Inspector General (OIG). - The GAO conducts annual audit of the SEC’s financial statements and internal controls over financial reporting; GAO and OIG conduct regular audits of SEC programs and operations; results reported to agency management, made available to Congress and OMB, and generally made public on the Internet. ### Dodd-Frank Act impacts and CFTC powers - The Dodd-Frank Act significantly enhanced the CFTC’s regulatory authority by: - Giving it new authorities over SDs, major swap participants (MSPs), DCMs, DCOs, SEFs and SDRs; - Significantly enhancing the CFTC’s enforcement anti-manipulation authority (see DEA Section 753); - Expanding the CFTC's authority to bring new types of enforcement actions alleging false statements to the CFTC (see CEA Section 6(c)(2)); - Expressly prohibiting certain trading practices that are disruptive of fair and equitable trading (see Section 747 of the Dodd-Frank Act and Section 4c(a) of the CEA); - Removing a number of previous exemptions from regulation; and - Including detailed Core Principles for DCOs to enhance the CEA regulatory regime for central counterparties. - The CFTC has undertaken extensive rulemaking to implement the requirements of the Dodd-Frank Act. Most mandated rulemaking is now complete. ### Staff, organizational structure and resource statistics - CFTC organization: four Divisions (Clearing and Risk (DCR); Enforcement (DOE); Market Oversight (DMO) and Swap Dealer and Intermediary Oversight (DSIO)) and eight Offices (including an Office of the Chief Economist, an Office of Data and Technology, an Office of international Affairs) and an Office of the Inspector General; 3 regional offices. - Staff resources as of May 31, 2014: - Total employees: 646 - Regulatory and supervision staff: 435 (attorneys, economists, auditors, risk and trade analysts, and other financial specialists) - Management and support staff: 163 - Executives: 48 ### Assessment, operational constraints and policy considerations - Assessment summary: Broadly Implemented - Key assessors' observations: - Both the SEC and the CFTC are operationally independent on a day-to-day basis and fully accountable to the legislature. - The annual budget process creates considerable uncertainties for medium and long term planning. - Significant gaps have existed between both agencies’ budget requests (supported by the President) and the funding they have received; this has affected the agencies’ ability to meet new responsibilities from the Dodd-Frank Act without reallocating internal resources (notably impacting the frequency of examinations). - The sequestration process has added uncertainty about budgets. - Legislative mandates can limit agencies’ ability to manage resources effectively, though current mandates have been fairly well aligned with agency priorities. - The political requirement that no more than three Commissioners belong to the same political party both protects against single-party dominance and risks a perception of political influence; the Sunshine Act mitigates that risk via transparency. - Considerations recommended by the assessors (as described in the source): - Consideration should be given to mechanisms that would allow the agencies to make longer term plans for the use of resources than is possible under an annual budget process. - Examples of such mechanisms include multi-year budgets, or a move toward some or all of the agencies’ budgets being self-funded. *Source: _cr1591 - Section 8(h) of the CEA requires the CFTC to submit to Congress a written report within 120* ### Section 2(a)(7) of the CEA permits the CFTC to maintain comparative compensation and ### _cr1591 - Section 2(a)(7) of the CEA permits the CFTC to maintain comparative compensation and ### CFTC: Compensation, staffing and turnover - Section 2(a)(7) of the CEA permits the CFTC to maintain comparative compensation and benefits in relation to other federal financial regulators for the purpose of retaining and attracting employees. - Current salaries are comparable to those paid by other federal financial regulators – although some of them can offer better benefits given their self-funded nature. - Staff turnover has ranged from 8 to 12 percent, and has remained in this range for the last five years. ### CFTC: Training - The CFTC’s Human Resources Branch provides a series of educational/training seminars keyed to the primary mission of the CFTC through its Talent Management and Leadership Development Section. - The Section employs a full-time Chief Learning Officer to ensure that the training needs of all employees are met. - Training seminars are focused on the financial and legal aspects of the futures, options and swaps markets. - The Commission recently announced that it has entered into a multi-year contract to allow all CFTC employees to take technical training related to financial management, financial marketplaces and business skill enhancement. ### CFTC: Technological resources - CFTC senior staff highlighted investments to develop robust automated mechanisms for market surveillance. - Current efforts focus on extending such tools to the swaps market as described in Principle 6. ### CFTC: Investor education - The CFTC has an Office of Consumer Outreach which creates and distributes financial education messages to help consumers avoid fraud and deception in the commodities markets. - The consumer protection section of the CFTC website: - educates consumers about the U.S. futures markets; - notifies the public about the types of fraud in the marketplace; - offers guidance on how to file complaints or send in tips regarding suspicious activities; and - provides updates on disciplinary actions. ### SEC: Structure and authorities - The SEC has five Divisions: Corporation Finance (CF); Enforcement; Investment Management (IM); Trading and Markets (TM); and Economic and Risk Analysis (DERA). - The SEC has 22 Offices, including the Office of Compliance Inspections and Examinations (OCIE), the Office of the Chief Accountant (OCA), the Office of Credit Ratings (OCR), the Office of Municipal Securities, and the Office of the Inspector General (OIG). - The SEC also has 11 regional offices. - The legislation administered by the SEC gives it extensive powers to seek information from regulated persons and others; to conduct surveillance of markets; to monitor compliance; to investigate suspected breaches; to impose sanctions; and to refer matters to the criminal authorities. - The Dodd-Frank Act expanded SEC authority to cover: - Previously exempt IAs to HFs and private equity funds with over US$100 million assets under management; - Municipal advisors; and - Security based swaps. ### SEC: Allocation of resources and funding constraints - Budget process: when the SEC submits its budget proposal to Congress, it must be accompanied by an allocation request establishing how resources will be spent by object class. - The SEC’s largest budget object class is for personnel compensation and benefits, which was approximately $927 million for fiscal year 2014. - Recent budget reallocation limit example: allowed to reallocate the lesser of $5 million or 10 percent of a category without Appropriations Committee permission. - The SEC budget has not increased in line with the expansion of its mandate as a result of the Dodd-Frank Act; senior staff indicate this has affected the SEC’s ability to implement a robust examination program for IAs. ### SEC: Staff resources and turnover - The SEC has a staff of more than 4,000 people. - The majority of SEC staff are lawyers and accountants; the agency has increased the number of economists and quantitative analysts. - The SEC is exempted from the general salary scale applicable to government employees; current salaries are comparable to those paid by other financial regulators – although some can offer better benefits given their self-funded nature. - The SEC implements enhanced employee benefits, market-based pay structure, multiple day telework, flexible work schedules, and pay-for-performance to retain skilled staff. - Turnover target and historical rate: - The SEC aims to keep its turnover rate relatively low, below 8 percent per year. - During fiscal years 2010 through 2013, the SEC experienced a turnover rate that averaged less than 6 percent. ### SEC: Training - The SEC has created SEC University to provide training and development opportunities to all staff. - SEC University: - develops SEC employees and managers to ensure high performance and productivity and a collaborative, effective, and engaged workplace; - plans and delivers internally held in-person courses; - assists employees who need to take a class offered by an outside organization; and - provides a variety of web based training. - Every new employee and Commissioner receives ethics education and training; regulatory requirements regarding ethics training are set forth in Government-wide ethics regulations. ### SEC: Technological resources - The SEC is increasingly using quantitative data to support rulemaking and supervisory activities. - Technology is a key component and sophisticated tools have been developed by the agency as described in Principle 6. ### SEC: Investor education - The SEC’s Office of Investor Education and Advocacy leads investor education initiatives by: - Handling investment-related complaints; - Providing responses to investor requests for information and assistance; - Raising awareness about the SEC’s online educational resources, including the SEC’s investor.gov website; - Implementing investor education programs; and - Participating in in-person events for investors. ### Assessment and comments on resources and implementation - Assessment for the section: Partly Implemented (for earlier combined assessment) and Fully Implemented (for procedural/confidentiality aspects as described under subsequent Principles). - Both the CFTC and the SEC have stated in budget testimonies that their levels of funding need to be increased to enable them to effectively fulfill their mandates. - SEC: supervision of IAs, including advisers to HFs and private equity funds, is affected by budget constraints. - CFTC: rulemaking for swaps has meant more limited resources are available for areas within its established jurisdiction, affecting the ability to: - carry out examinations of intermediaries; - make full use of swaps data; - conduct effective daily surveillance of market activity; and - investigate and prosecute violations. - The CFTC has been subject to specific requirements to allocate part of its budget to IT investments and activities, facing implementation challenges due to lack of sufficient funding for staff resources. - In practice, budget appropriations of both agencies have not kept pace with expanded mandates and increasingly complex markets. ### Appropriations (Fiscal years 2010-2014, $ million) - CFTC: FY 2010: 169; FY 2011: 203; FY 2012: 205; FY 2013: 205; FY 2014: 215 - SEC: FY 2010: 1,111; FY 2011: 1,185; FY 2012: 1,346; FY 2013: 1,302; FY 2014: 1,372 ### Procedural transparency, fairness and confidentiality - Both the CFTC and the SEC operate transparently: registration requirements, interpretations, guidance and (subject to confidentiality requests) no action letters are published. - Staff are required to work under the four eye principle for critical processes to ensure consistency of decisions. - Government-wide statutes that bind both agencies include: - The APA (Administrative Procedure Act); - The Sunshine Act; - The Paperwork Reduction Act (PRA); - The Regulatory Flexibility Act (RFA); - The Freedom of Information Act (FOIA); - The Privacy Act; and - The Right to Financial Privacy Act (RFPA). - Section 15(a) of the CEA requires the CFTC to consider costs and benefits of its action from five perspectives: protection of market participants and the public; efficiency, competitiveness and financial integrity of futures markets; price discovery; sound risk management practices; and other public interest considerations. - Confidentiality provisions: - Section 8(a)(1) of the CEA: except as otherwise specified, the CFTC may not publish data and information that would separately disclose market positions, business transactions, trade secrets or names of customers, and may withhold from public disclosure any data or information concerning or obtained in connection with any pending investigation. - Exchange Act and Advisers Act contain statutory provisions to safeguard confidentiality of information obtained in examinations or investigations. - SEC Rule 24c-1 permits nonpublic information to be provided to certain entities only if appropriate assurances of confidentiality are received. - Both agencies have a policy of not commenting publicly on ongoing investigations. ### Professional standards and ethics - Commissioners and staff at both agencies are subject to codes of ethics and professional conduct standards covering integrity, procedural fairness, prevention of conflict and confidentiality. - U.S. Office of Government Ethics (OGE) regulations apply, covering obligations of public trust; gifts; conflicting financial interests; impartiality; seeking other employment; misuse of position; and outside activities. - CFTC-specific provisions: - Subpart C of Part 140 of the CFTC Regulations establishes general ethical standards of conduct for CFTC employees and Commissioners, restricting business and financial transactions and interests; non-governmental employment and outside activities; and the receipt and disposition of foreign gifts and decorations. - CFTC Regulations prohibit, subject to some narrow exceptions, Commissioners and staff from trading in products regulated by the CFTC. - Section 9(d) of the CEA: punishable felony for a CFTC employee or Commissioner to share or otherwise benefit from information received in the course of employment which may affect or tend to affect the price of commodities. - Section 9(c) of the CEA: felony for a CFTC employee or Commissioner to trade commodity futures and options or participate in any investment transaction in an actual commodity, if nonpublic information is used or if prohibited by CFTC regulations. *Source: CFTC and SEC.* ### Section 9(a)(5) makes it a felony punishable by a fine of up to $500,000 and/or imprisonment ### _cr1591 - Section 9(a)(5) makes it a felony punishable by a fine of up to $500,000 and/or imprisonment ### Criminal penalties, procedural fairness, and monitoring compliance (CFTC and SEC) - Section 9(a)(5) makes it a felony punishable by a fine of up to $500,000 and/or imprisonment up to five years if any person willfully violates any other provision of the CEA. - Procedural fairness - CFTC Commissioners and staff are bound by the procedural fairness rules described under Principle 4. - SEC Commissioners and staff are bound by the procedural fairness rules described under Principle 4; statutory provisions are supplemented by detailed procedural rules governing administrative hearings and enforcement and rulemaking activities. - Monitoring compliance (CFTC) - Most CFTC staff are required to complete annual financial declarations, with more comprehensive information mandated for senior staff. - Approximately 170 staff members must also report financial transactions. - Compliance is monitored by the Office of General Counsel (OGC), which reviews disclosures. If non-compliance is detected, the OIG is asked if it wishes to investigate; if not, the matter is handled through management. - Serious violations potentially involving criminal breaches are referred to the Office of Public Integrity within the DOJ for a decision on whether to commence a criminal action. - Monitoring compliance (SEC) - The SEC’s OEC (established in 2011) administers the Commission’s ethics program and interprets supplemental ethics rules and federal government-wide ethics laws; OEC does not have investigative or disciplinary powers and refers potential breaches to management; criminal matters are referred to OIG. - OIG has investigative powers and is responsible for notification to the DOJ and OGE for referrals of potential violations of federal government-wide criminal conflict of interest statutes; OIG forwards reports of non-criminal misconduct to management for disciplinary or remedial action. - According to SEC staff, one staff member has been criminally prosecuted for false disclosure. ### Conflicts of interest, securities trading, and use of information (SEC) - Conflicts of interest - SEC Commissioners and staff are bound by government-wide rules prohibiting personal participation in matters that would have a direct and predictable effect on their own or imputed financial interests. - Non-financial conflicts creating the appearance of lack of impartiality are regulated; Commissioners and staff cannot participate in a matter involving a person with whom they have a “covered relationship” or if circumstances would cause a reasonable person to question their impartiality unless an SEC ethics official issues authorization to participate. - The SEC has adopted Supplemental Standards of Ethical Conduct for its Commissioners and employees, including comprehensive rules on securities holdings and transactions and stricter post-employment restrictions; positions at certain salary levels are subject to a one year cooling off period. - Securities trading and financial interests - The SEC’s Conduct Regulation covers securities holdings and transactions of all staff, including Commissioners, and includes employee’s spouse, minor children, or any person the employee serves as legal guardian. - SEC regulations require reporting of securities transactions, with certain exceptions, within five days of the receipt of confirmation. - The Supplemental Standards include prohibitions on transactions involving an issuer directly regulated by the SEC or under investigation, and require SEC staff to clear in advance any securities transactions or holdings. - Commissioners and some senior officers must file a public financial disclosure report when they assume office, on an annual basis thereafter, and upon termination. Employees with high risk of misuse of information or conflicts must file confidential financial disclosure forms. - Use of information and confidentiality - OGE Standards of Conduct prohibit misuse of one’s official position, including use of confidential or nonpublic information; the SEC’s regulation also prohibits misuse of confidential and nonpublic information. - SEC Commissioners and staff are bound by confidentiality provisions imposed by the statutes they administer (for example Section 24(b) of the Exchange Act). - Sanctions - Violations of federal government-wide conflict of interest statutes may be enforced either civilly or criminally. - Violations of the SEC’s administrative rules can result in disciplinary action. - Willful disclosure of nonpublic information under the Exchange Act is also a criminal offense. - Depending on circumstances and legal authority, an SEC employee may be imprisoned, fined, demoted, or terminated for violating an ethics provision. ### Principle 6 — Process to monitor, mitigate and manage systemic risk (assessment and agency practices) - Assessment: Broadly Implemented (comments detail weaknesses and strengths) - SEC: process to identify risks - The statutory mandate of the SEC does not explicitly refer to financial stability or systemic risk, but staff see contributing to identification of emerging and systemic risk as linked to statutory objectives. - Supervisory programs for issuers, mutual funds, securities intermediaries, and market supervision/surveillance are main channels for identifying emerging and systemic risks (see referenced Principles). - Recent enhancements to contribute to risk identification: - Data availability: periodic electronic reports; domestic corporate issuers already reporting in a mark-up language; mark-up being implemented for certain securitization issuers and NRSROs; new data from reforms include (i) MMFs’ holdings; and (ii) private funds (including HFs). - Addition of staff with different skill profiles and organizational changes: creation of OCIE offices such as (i) Office of Risk Analysis and Surveillance (ORAS), (ii) Risk Analysis Examination (RAE) team, and (iii) Quantitative Analytics Unit (QAU); creation of the Risk and Examinations Office (REO) in the Investment Management Division; creation of the Office of Risk Supervision in TM. - Development of sophisticated tools: ENF corporate issuer risk assessment tool using regression models and statistical analysis; ORAS risk models for BDs and IAs; DERA HF performance models (Aberrational Performance Inquiry or API models); MIDAS for near-instantaneous analysis of large trading data (currently comprises only exchange data); CAT initiative for a consolidated audit trail (described in Principle 36). - A risk analytics committee (created in 2013) coordinated by DERA to facilitate cross-departmental discussions on risk analytics. - Internal coordination: regular discussions across departments; directors hold weekly meetings with the SEC Chair; Chair holds weekly one-on-one meetings with each Commissioner; ad-hoc and routine briefings to counsels to each Commissioner; OCIE Market Event Response Team coordinates real-time responses across divisions and SROs. - Assessors’ observations: improvements underway but room to enhance mechanisms for a holistic view of risks, more formal/structured regular discussions on emerging and systemic risks, and stronger involvement/accountability of the Commission as a whole; Sunshine Act constraints noted. - CFTC: process to identify risks - CEA objectives include deterring price manipulation, ensuring financial integrity and avoidance of systemic risk, protecting market participants, and promoting responsible innovation and fair competition. - Supervisory processes include market surveillance and monitoring financial risk posed by regulated entities. - Daily surveillance: for all active futures and options contract markets staff monitor large traders, examine all price spikes, scheduled news release periods of market-sensitive data, all daily settlements in major commodities, and option and final settlements in major futures and options contracts; track key price relationships and supply/demand factors. - With addition of swaps, staff monitor credit events, evaluate CDS settlements for potential manipulation. - Risk surveillance: monitors financial risk posed to and by DCOs, clearing members, and market participants including market, liquidity, credit, and concentration risk; includes margin and financial resources monitoring, back-testing margin coverage at product level, independent stress testing of portfolios, and follow-up reviews leading to on-site review of clearing house risk management procedures. - Examinations of DCOs analyze adequacy of financial, operational, managerial resources, ability to manage clearing/settlement risks, risk analysis and oversight programs, and cyber security resilience. - Current focus: expand processes to monitor swaps markets — enhancing expertise, technology, and improving swaps data quality. Actions taken: - Registered four SDRs; implemented regulations requiring real time public reporting of swaps transaction data by SDRs on their websites; began publishing a weekly swaps report on the CFTC website. - Created a Data and Reporting Branch in the Division of Market Oversight. - Pursuing data quality metrics; constituted an interdivisional staff working group in January 2014 to improve swaps data quality and analysis capability. - Signed an MOU with the OFR in 2014 to establish a framework for assessing data quality and form a project plan for understanding swaps and OTC derivatives transactions and their impact on financial stability. - Internal coordination: significant informal coordination among divisions; weekly meetings of staff with the Chair; informal meetings between staff and individual Commissioners; closed door surveillance meetings at Commission level every Friday (permitted under an exception in the Sunshine Act) with three parts: surveillance, examination and enforcement — agenda set seven days in advance, briefs prepared, meetings recorded with participant lists and General Counsel certification. - External advisory: Market Risk Advisory Committee (MRAC) formed to conduct public meetings and submit reports and recommendations; membership of MRAC will consist of 20-25 members. - Coordination between agencies - SEC and CFTC staff meet frequently on specific firms or issues; Chairs meet regularly. - FSOC participation: Chairs of SEC and CFTC are voting members of FSOC; FSOC identifies risks to financial stability and responds to threats; systemic risk committee and Deputies Committee structure coordinate analysis and action; Deputies Committee convenes approximately every two weeks. - FSOC examples: issues discussed include MMFs and asset managers (SEC has led analysis and regulatory responses); FSOC designated eight financial market utilities and three non-bank financial companies as systemically important. - Assessors note FSOC has strengthened coordination but FSOC processes and tools are still evolving; GAO recommendations for a more robust framework referenced. - Assessment summary for Principle 6: Broadly Implemented with comments that SEC and CFTC have strengthened risk identification but gaps remain (SEC: holistic view, data gaps in asset management; CFTC: swaps market monitoring). ### Principle 7 — Review of regulatory perimeter - Assessment: Fully Implemented - Description and mechanisms - Reviews prompted by supervisory findings can prompt: (i) agency rulemaking; (ii) proposals for legislative changes; or (iii) other measures to address risks in products, entities or markets (regulated or unregulated). - Supervisory processes (see Principle 6) feed into perimeter reviews. - Examples: - SEC “presence examination program” for new registrants brought under jurisdiction by Dodd-Frank (e.g., IAs of private and HFs) involving meetings with senior firm staff to understand business model and risks. - CFTC increased presence in the FCM community with attention to liquidity risks via horizontal examinations. - Economic analysis units (DERA and OCE) support rulemaking via research and cost/benefit analysis; findings can lead to guidance and proposals (e.g., liquidity management guidance from BD examinations; proposals to review capital and liquidity framework for ANC firms). - Legislative requests: agencies have requested Congressional reviews/authority expansions based on supervisory findings (example: CFTC retail foreign exchange authority in the 2000s; SEC testimony in 2009 regarding advisers to private funds). - Other measures: investor education and alerts (SEC OIEA published 26 investor alerts and bulletins in fiscal year 2013; topics included Bitcoin and Other Virtual Currency-Related Investments and Advertising for Unregistered Securities Offerings). Joint alerts include SEC-CFTC investor alert on binary options, SEC-FINRA alert on pump-and-dump schemes, SEC-FINRA bulletin on pension and settlement income streams. - FSOC-level prompts: FSOC discussions contributed to significant reforms (example: MMF regulatory framework changes and the SEC’s review of asset management industry aspects). - Reviews of past events prompted regulatory changes (examples: SEC reforms after the 2010 flash crash; CFTC strengthened financial responsibility rules for FCMs after Peregrine and MF Global failures in 2011 and 2012). - Specific legal or mandated reviews: GAO review of municipal securities markets; JOBS Act-mandated review of Regulation S-K; Executive Order 13563 voluntary adherence by CFTC and resulting retrospective reviews; CFTC Regulatory Review Group to implement periodic retrospective examination. - Advisory committees: SEC Investor Advisory Committee (IAC) and others; CFTC Advisory Committees governed by FACA (Agricultural Advisory Committee, Global Markets Advisory Committee, Energy and Environmental Markets Advisory Committee, Technology Advisory Committee). - Strategic plans: agencies develop strategic plans that identify priorities and regulatory/supervisory actions (e.g., SEC Strategic Plan 2014-2018 review of equity markets; CFTC Strategic Plan 2011-2015 review and update of large traders report content requirements). - International participation: SEC and CFTC staff participate in IOSCO’s Committee on Emerging Risks (CER) and FSB’s Financial Innovation Network activities. ### Principle 8 — Conflicts of interest and misalignment of incentives - Assessment: Fully Implemented (with comments highlighting remaining concerns) - Description - Frameworks address conflicts via prohibitions, mandated disclosure, or required management/mitigation steps across issuers, intermediaries, SROs, auditors, and NRSROs. - Issuers - Primary mechanism relies on disclosure in prospectuses and filings; complemented by fiduciary duties of directors. - Regulation AB II requires increased transparency of ABS, including asset-level data (ALD) disclosure at offering and ongoing basis; enhanced disclosure about transaction parties and loss mitigation; shelf offerings of ABS require CEO certification about prospectus disclosure and structure of securitization. - Compliance deadlines: new rules compliance required by November 23, 2015 except ALD requirements required by November 23, 2016. - Final rule (jointly adopted by six federal agencies) implements Dodd-Frank risk retention: sponsors of ABS must retain no less than five percent of the credit risk of the assets collateralizing the ABS issuance; prohibits hedging or transferring required retained credit risk. - Rule defines QRM referencing Consumer Financial Protection Bureau’s qualified mortgage features that exclude interest-only loans, negative amortization loans, loans beyond 30 years, balloon loans, and loans with excessive up front points and fees, and require limits on debt to income ratio (not higher than 43 percent). - Agencies must review QRM definition not later than 4 years after the effective date of the rule (and every five years after that date). - Rule exempts certain commercial loans, commercial mortgages or automobile loans from retention if they meet specific high quality underwriting standards. - Rule effective timing: one year after publication in the Federal Register for RMBS and 2 years after publication for all other securitizations. - Dodd-Frank mandates SEC rules to address conflicts in SBS markets; two sets of rules under consultation: limiting certain concentrations in ownership/voting of SBS clearing agencies, security-based SEFs and national securities exchanges; and requiring SBSDs and MSBSPs to disclose to counterparties material information about SBS, including material incentives and conflicts. - Securities intermediaries - Intermediaries registered with SEC and CFTC subject to conflict of interest provisions relying on disclosures, prohibitions and/or information barriers; U.S. regime relies heavily on disclosure to affected parties, more predominant in commodities side. - Monitoring and enforcement - SEC monitors issuer disclosure compliance through CF file review program (Principle 16). - Examination programs by SEC, CFTC, FINRA, and NFA review registrant compliance with conflict obligations; PCAOB inspects auditor independence compliance. - Enforcement and remediation: when breaches are found, remediation actions and enforcement follow. Example enforcement action: SEC proceedings against an IA, CEO, CCO, and another employee for allegedly misleading investors, breaching fiduciary duties, entering into revenue sharing arrangements/kickbacks, failing to disclose conflicts, and concealing kickbacks. - Comments and remaining concerns - Market participants identified areas requiring further SEC action: (i) participation of affiliates of brokers that operate ATS in their platforms; (ii) impact of order types, order routing and related fee structures in equity markets; and (iii) flexibility in choice of registration as BD or IA and differing standards of care, compensation arrangements, and impacts on customer protection. - SEC has recommended establishment of an advisory committee to analyze equity market structure and requested data to better understand BD and IA regimes. ### Principle 9 — Use and oversight of Self-Regulatory Organizations (SROs) - Description - U.S. system extensively uses SROs in securities and derivatives markets; regulatory effectiveness depends on effective SRO supervision by CFTC and SEC. - SRO responsibilities include supervision of markets and market intermediaries; SRO functions recognized in the CEA/CEA regulations and the Exchange Act/SEC rules. - CEA SROs and counts - Categories with self-regulatory responsibilities: futures exchanges (DCMs), SEFs, DCOs, and RFAs. - CFTC Regulations define SRO as a contract market, SEF or RFA; DCOs not formally recognized as SROs but have self-regulatory obligations. - Counts provided: 16 registered DCMs of which 15 are active; 24 SEFs temporarily registered or with pending temporary registration; 14 DCOs; and one RFA (NFA). - DSRO arrangements and NFA - Because many FCMs are members of multiple DCMs, SROs may agree which SRO will be the designated self-regulatory organization (DSRO) to maintain ongoing financial and sales practice surveillance over member FCMs; Joint Advisory Committee (JAC) coordinates oversight activities; two DSROs in practice: CME (DSRO for clearing firms) and NFA (DSRO for non-clearing FCMs, swap dealers, independent IBs, CTAs and CPOs). - Some smaller DCMs contract NFA for market and trade practice surveillance; most SEFs contract NFA for market surveillance. - SROs remain responsible for SRO obligations under CEA. - NFA role and delegation - NFA is the only RFA; all firms and individuals acting as futures market intermediaries must apply for NFA membership or associate status. - NFA has incorporated CFTC segregation, recordkeeping, and reporting requirements into its rules by reference for SDs, MSPs, FCMs, IBs, CPOs, and CTAs. - CFTC has delegated to NFA registration processing functions and authority to take adverse action (e.g., revoke or deny registration) based on disqualifying conduct in Sections 8a(2) and (3) of the CEA; CFTC retains authority to take such actions. - CFTC has delegated responsibility to NFA to review CPO and CTA disclosure documents. - CFTC has general oversight responsibility for all NFA functions and full access to NFA information; CFTC monitors NFA enforcement of its own rules and by-laws. - Core principles for market operators and clearing organizations - CEA contains core principles: DCMs (23 Core Principles), SEFs (15 Core Principles), and DCOs (18 Core Principles). CFTC Regulations elaborate requirements. - Admission of participants: Core Principle 2 requires DCMs to establish, monitor and enforce impartial, transparent, non-discriminatory access requirement rules; similar rules apply to SEFs and DCO Core Principle C requires objective, publicly disclosed, fair and open access requirements. *Italic source: _cr1591 - Section 9(a)(5) makes it a felony punishable by a fine of up to $500,000 and/or imprisonment* ### Section 17(b)(2) of the CEA requires an RFA’s rules to provide that any person or entity ### _cr1591 - Section 17(b)(2) of the CEA requires an RFA’s rules to provide that any person or entity ### Membership and admission - Section 17(b)(2) of the CEA requires an RFA’s rules to provide that any person or entity registered under the CEA, a registered entity, or any other person designated under CFTC Regulations as eligible for membership may become a member of the RFA. - Under the Exchange Act, a national securities exchange, registered securities association, or clearing agency must have rules that permit any registered BD or natural person associated with a BD to become a member of the exchange or association. - If an exchange or FINRA denies membership or participation to an applicant, it must notify the SEC. A denial of membership or participation by an exchange or FINRA is reviewable by the SEC. ### Rules of conduct and professional standards - DCM Core Principle 12 requires DCMs to establish and enforce rules to: - Protect market participants from abusive practices committed by any party, including abusive practices committed by a party acting as an agent for a participant; and - Promote fair and equitable trading on the contract market. - The Exchange Act and CEA impose conduct standards requiring exchanges and SROs to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest. - Professional standards include: - Obligations to keep confidential material non-public information (CFTC Regulation 1.59(d)(ii) and information supplied to an SRO by the CFTC); and - Prohibitions on the misuse of information acquired as a result of carrying out SRO duties (Section 9(e)(1) CEA and CFTC Regulation 1.59(d)(ii)). - CFTC Regulation 1.69 requires that a member of an SRO’s governing board, disciplinary committee or oversight panel must abstain from voting on any matter and from deliberating on the same where that member is a named party or otherwise has an interest. ### Training, proficiency, and sales practices - Section 17(p) of the CEA requires an RFA to establish rules that require the RFA, among other things, to establish training standards and proficiency testing for persons involved in futures industry, and to establish minimum standards governing sales practices of its members and Associated Persons (APs). ### Disciplinary rules and proceedings - The CEA and CFTC Regulations require SROs to monitor and enforce compliance with rules and standards. - SROs (including NFA and DCMs) must monitor and enforce compliance with CFTC Regulations establishing standards for intermediaries, such as CFTC minimum financial and reporting requirements, requirements for the protection of customer funds and communications with customers. - Exchanges and FINRA must have rules that provide that their members will be appropriately disciplined for violation of the provisions of the Exchange Act and SEC rules and regulations, and their own rules. Sanctions must include expulsion, suspension, limitation of activities, functions and operations, fines, censure, and being suspended or barred from being associated with a member of any other fitting sanction. - Once an SRO has imposed a final disciplinary sanction against a member or person associated with a member, it must promptly file notice with the SEC. A final disciplinary sanction imposed by an SRO is reviewable by the SEC. ### Division of responsibilities between regulators and SROs - Although much of the day-to-day supervision of markets and industry participants is carried out by the SROs, the CFTC retains authority to inquire into any matters covered by SRO supervision. - Where an SRO does not have the ability to obtain necessary information (for example, where the investigation requires subpoenaing third party records) or impose sanctions (for example, in the case of a recidivist), CFTC enforcement staff can support the SRO responsibilities. - The CEA and CFTC Regulations directly oblige SROs to cooperate with the CFTC and with other SROs to investigate and enforce applicable laws and regulations. In view of the statutory obligations, MOUs between the CFTC and SROs are not used. - Under Sections 21(d) and (e) of the Exchange Act, the SEC has the authority to enforce an SRO’s rules and to compel an SRO to enforce its rules with regard to its members by filing an action in federal court. Section 21(f) of the Exchange Act allows the SEC to bring such actions when it appears that an SRO is unable or unwilling to take appropriate action. The SEC has authority to take disciplinary actions directly against a BD and associated persons. ### Rulemaking, filings, and CFTC/SEC review timelines - Section 5c(c) of the CEA requires DCMs, SEFs, and DCOs to file with the CFTC new products, new rules, and rule amendments. These entities can choose either to self-certify that the rule complies with the CEA or request the CFTC’s approval of the rule. - A rule subject to self-certification can be implemented 10 days after it has been filed. - The CFTC can make a decision to stay the certification of a rule for up to 90 days if the rule raises novel or complex issues, inadequate explanation was provided, or the rule is potentially inconsistent with the CEA. - For rules where the CFTC’s approval is sought, the CFTC has 45 days to consider the rule (this may be extended if the rule raises novel or complex issues). - Section 17 requires an RFA to provide the CFTC with copies of its constitution, charter or articles of incorporation or association, and all bylaws. An RFA must file with the CFTC copies of any changes or additions to its rules. The RFA may make any proposed change or addition effective 10 days after the receipt of a filing by the CFTC, unless it requests that the CFTC review and approve the submission or the CFTC informs the RFA of its intention to do so. - To deny certification of a rule made by an SRO, the CFTC must make a determination that the rule would be inconsistent with the CEA or regulations made under it. - Under Section 19(b)(1) of the Exchange Act, an SRO must file any proposed change in, addition to, or deletion from its rules. Thereafter, within 45 days after the publication date, the SEC must approve, disapprove, or institute proceedings to determine whether to approve or disapprove the rule change, subject to an extension of time from the SRO or on the SEC’s own motion up to a maximum of 90 days from the publication date. - The SEC must approve a proposed rule change, if it finds it consistent with the requirements of the Exchange Act and the rules and regulations thereunder. In making this determination, the SEC must consider whether the proposed rule change will promote efficiency, competition and capital formation. - Some proposed rule changes filed under Section 19(b)(3)(A) of the Exchange Act take effect upon filing, without need for SEC approval. The SEC has extended categories of rules that become effective on filing to include rules that do not significantly affect the protection of investors or the public interest or rules that do not impose a significant burden on competition (see SEC Rule 19b-4(f)). ### Governance, representation, and conflicts of interest - Acceptable Practices under DCM rules state that a board be composed of least 35 percent public (independent) directors, and executive committees must also have 35 percent public membership. - DCM boards must have a Regulatory Oversight Committee, consisting of only public directors, which monitors and oversees the DCM’s regulatory program and a DCM’s disciplinary panel be composed to minimize conflicts of interest. - Section 17 of the CEA requires that an RFA’s rules assure a fair representation of its members in the adoption of any rule of the association, the selection of its officers and directors, and in all other phases of the administration of its affairs. - An RFA must provide for meaningful representation on the governing board of a diversity of membership interests and that no less than 20 percent of the regular voting members of the board are comprised of qualified non-members who are not regulated by the RFA. - An RFA must provide on all major disciplinary committees for a diversity of membership sufficient to ensure fairness and to prevent special treatment or preference for any person in the conduct of disciplinary proceedings and the assessment of penalties. - Core Principles applying to DCMs, SEFs and DCOs contain provisions expressly requiring them to minimize and resolve conflicts of interest. ### Avoiding anti-competitive outcomes and misuse of oversight roles - Section 15 of the CEA requires the CFTC to take into consideration the public interest to be protected by the antitrust laws and endeavor to take the least anticompetitive means of achieving the objectives of the CEA in issuing any order or in approving any rule of a DCM or an RFA. - CFTC Regulation 170.9 requires that an applicant to become an RFA must demonstrate that it will promote fair and open competition among its members and will conduct its affairs consistent with the public interest to be protected by the antitrust laws. - DCM Core Principle 19, SEF Core Principle 11, and DCO Core Principle N require that the respective SRO must not adopt any rule or take any action that results in any unreasonable restraint of trade, or impose any material anticompetitive burden on trading on the contract market, unless necessary or appropriate to achieve the purposes of the CEA. ### Supervision, audits, and examinations - All current SROs (DCMs and NFA) participate in a joint audit program under the auspices of the JAC, which must meet the requirements of CFTC Regulation 1.52. This audit program focuses on the SROs’ supervision of FCMs’ financial and reporting requirements. - Recent amendments require that the program be separately evaluated by an “examination expert” at least once every three years, and that a report containing the content and any related responses to the findings of the examination be provided to the CFTC. The first evaluation has not yet taken place. - The CFTC requires that DSROs to ensure that each FCM is subject to an on-site examination within nine to 18 months of the date of the previous examination by the DSRO. - DMO’s Compliance Branch conducts rule enforcement reviews (RERs) of each DCM’s ongoing compliance with the Core Principles through their self-regulatory programs. - For the largest DCMs, the CFTC aims to conduct an RER each year focusing on at least one of the topics, and generally cover market surveillance and trade practice surveillance at least every two years. - For smaller DCMs, RERs are carried out less frequently (in practice every 3 to 4 years). - Systems safeguards examinations for critical exchanges such as CME and ICE are carried out every 12 to 18 months; for others, these reviews take place every 3 to 4 years. - Typically, the Compliance Branch selects a 12 month target period and examines a DCM’s audit trail reviews, trade practice and market surveillance investigations, investigation logs, hedge exemptions, surveillance systems, compliance manuals, summary fine schedules, disciplinary files, settlement agreements, and arbitration files. - The Compliance Branch’s findings, any deficiencies identified, or recommendations for improvement are included in a report presented to the Commission, which votes on whether to accept the report. The report is published on the CFTC’s website. - The CFTC also has a market surveillance program designed to prevent market manipulation in futures and options markets and monitor compliance with the CFTC rules and regulations. ### NFA and SRO oversight specifics - NFA is responsible for regulatory compliance matters with respect to its member IBs (except for IBs guaranteed by an FCM that does not have NFA as its DSRO) and for sales practice surveillance over all member CPOs and CTAs. - NFA’s oversight of CPOs and CTAs includes review of annual reports and disclosure documents, and the conduct of examinations of these firms on a periodic basis. - The CFTC monitors compliance by NFA with its self-regulatory obligations by conducting periodic reviews of NFA’s compliance programs. The CFTC has conducted reviews including: registration program in 2010; programs for CPO and CTA compliance, telemarketing supervision, FCM and IB financial reports, disciplinary actions, and arbitration. - In the past year, the CFTC has conducted 3 different reviews, with a focus on disclosure document processes, the financial disclosure process, and NFA examinations of registrants. ### Exchange Act SROs, FINRA, and related registration - Two main SRO functions are supervision of market activity (market surveillance) and supervision of market intermediaries. Exchanges can outsource some market surveillance responsibilities by contracting through a regulatory service agreement (RSA); the outsourcing exchange remains liable. - BDs generally must register with the SEC and become members of at least one SRO, such as a national securities exchange or a registered securities association. - FINRA is currently the only SRO that is a registered securities association. BDs that have a public customer business must be members of a registered securities association and therefore FINRA unless they limit their transactions to securities traded on an exchange of which they are a member. - Natural persons “associated with” a registered BD must register with the appropriate SRO (generally, FINRA), and take the appropriate qualifying examinations unless activities are strictly clerical and ministerial. There are about 630,000 individuals registered in this way. All BD staff with client facing responsibilities must be registered. - To trade directly on a particular exchange, a BD must become a member of that exchange. - MSRB rules govern transactions in municipal securities; compliance with MSRB rules is monitored and enforced by FINRA and/or the SEC (in the case of BDs and municipal advisors), and the federal bank regulators and the SEC (in the case of banks). *Source: _cr1591 - Section 17(b)(2) of the CEA requires an RFA’s rules to provide that any person or entity* ### Section 19(c) of the Exchange Act gives the SEC authority to abrogate, add to, and delete from ### _cr1591 - Section 19(c) of the Exchange Act gives the SEC authority to abrogate, add to, and delete from ### SEC authority over SROs - Section 19(c) of the Exchange Act gives the SEC authority to abrogate, add to, and delete from the rules of an SRO (other than a registered clearing agency). - Section 19(g)(1) mandates that every SRO comply with and enforce compliance with the provisions of the Exchange Act and the SEC rules and regulations and the SRO’s own rules, “absent reasonable justification or excuse.” - The SEC can bring enforcement action against an SRO for failure to act or adequately perform required functions, require changes to an SRO’s processes, and directly impose rule changes or take administrative or court action to impose remedies. ### Co-operation among regulators and SROs - All SROs are defined as SROs under the Exchange Act and have obligations imposed directly on them by the legislation and are subject to oversight by the SEC. MOUs are therefore not used. - Some SROs have entered into agreements under Exchange Act Section 17(d) and SEC Rule 17d-2 to coordinate allocation of regulatory responsibility regarding: - the receipt of regulatory reports from participants, - the examination of participants for compliance, - the enforcement of compliance. - All such agreements must be filed with the SEC and, after public notice and comment, may be declared effective by the SEC. - An SRO may enter into a regulatory service agreement (RSA) with a registered third-party SRO; the procuring SRO remains responsible for meeting its regulatory obligations under the Exchange Act unless an SEC-declared Rule 17d-2 plan allocates responsibility. ### Governance and fair representation - The Exchange Act requires that the rules of an SRO must assure a fair representation of its members in the selection of its directors and the administration of the affairs of the SRO. - Sections 6(b)(3) and 15A(b)(4) require that the rules of an exchange provide that one or more directors be representative of issuers and investors and not associated with a member of the exchange, broker or dealer. - The SEC has generally approved for SROs other than clearing agencies up to 20 percent member representation on SRO boards of directors and on SRO committees dealing with trading rules and member discipline. - For clearing agencies, the SEC evaluates procedures for meeting the fair representation requirement on a case-by-case basis. - Section 15B(b)(2)(B) (amended by the Dodd-Frank Act) requires that the number of public representatives on the MSRB at all times exceed the number of regulated representatives. ### Avoiding anti-competitive situations and misuse of oversight role - The Exchange Act requires that the rules of SROs (including MSRB) must not impose any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange Act. - When reviewing an SRO’s proposed rule, the SEC analyzes, among other things, the rule’s burden on competition. ### Oversight — supervision programs and examinations - The SEC has an examination and enforcement program to oversee the activities of the SROs, including exchanges, FINRA, and clearing agencies. - OCIE assesses SRO compliance by carrying out examinations of SROs as part of OCIE’s examination and inspection program. - During inspections, OCIE can review SROs’ examination and surveillance programs for: - member financial responsibility and operational compliance, - regulatory programs for monitoring trading activity, - disciplinary and enforcement programs, - exchange listing programs, - membership programs, - arbitration programs. - In the past three fiscal years, OCIE has conducted a total of 140 examinations of SROs. - SEC examinations of the national securities exchanges and FINRA are not done on a fixed cycle; generally a risk based approach is used. - In 2012 and 2013, the SEC assessed all national securities exchanges and FINRA to establish a baseline for governance, internal controls, and enterprise risk management programs. - Recent risk areas identified for examination of exchange SROs include: - internal controls and governance around their rule making process, - supervision of RSAs, - order types used by the options exchanges and the related governance, - systems outages, errors and integrity, - exchanges’ business continuity planning. - In the past year, OCIE conducted examinations across most of the national securities exchanges (and FINRA, SIPC, MSRB and 2 clearing organizations) focusing on listings processes, order types and governance and the collection of securities transaction fees. ### Information technology and resilience - The SEC has a program for review of SROs’ information technology systems to evaluate whether the systems have sufficient capacity and resiliency to accommodate conditions of increased volume and disruptions to normal operations. - This program is now carried out by OCIE and is staffed by information technology experts who regularly confer and meet with members of the SROs’ information technology staff. ### FINRA-specific oversight - Dodd-Frank Act Section 964 requires that, on a regular basis, the GAO submit a report to Congress on the SEC’s oversight of FINRA with respect to ten specified areas, including governance, examinations, arbitration services, and funding. - In 2013, OCIE completed an inspection of FINRA focusing on these ten areas to assist in risk scoping. - OCIE has developed a process to evaluate risks and prioritize areas of focus in inspections of FINRA. - FINRA is subject to periodic reviews; multiple reviews may occur concurrently. - A technology review is generally done annually. - Reviews of FINRA’s supervision of the sales practices of its BD members are carried out annually and involve three district offices. - In 2013, the SEC reviewed FINRA’s enforcement program. Other reviews include examination of market surveillance activities carried out by FINRA under RSAs. ### Professional standards, discipline, and conflicts of interest - SROs generally have internal policies or rules regarding ethical conduct for staff, including preservation of confidentiality and prohibition on use for personal benefit. - SROs are required to comply with Section 10(b) of the Exchange Act and Rules 10b-5 and 10b5-1, which prohibit trading on material, nonpublic information (insider trading). - Sections 6(b)(7), 15A(b)(8), and 17A(b)(3)(H) require that the rules of an exchange, association, and clearing agency provide for a fair procedure for disciplining members and persons associated with members, denying membership, and prohibiting or limiting access to services. - SROs must notify members of the specific charge, give them an opportunity to defend themselves, and keep a record of the proceeding. - The SEC reviews SRO proposals and operations to evaluate potential impacts of conflicts of interest on effective oversight, with a focus on proposed changes to ownership and regulatory structure. ### Record-keeping, customer identity, and information access - The SEC has the power under the Exchange Act, the Advisers Act, and the ICA to inspect regulated entities’ business operations, including books and records, at any time without giving notice and without judicial action. - Exchange Act Rules set out record-keeping rules for securities exchanges, registered securities associations (i.e., FINRA), clearing agencies and the MSRB, and for brokers and dealers. Rule 17a-4 governs retention of these records. - ICA Rules set out record keeping and retention rules for investment companies; Advisers Act Rules set out record keeping and retention rules for advisers, generally at least five years (the first two years in an appropriate office). - The SEC is developing record keeping and retention rules for regulated entities in the swap industry for which it has jurisdiction. - Registrants must maintain specified records concerning client identity under regulations promulgated under the Exchange Act, the Advisers Act, the BSA, and the PATRIOT Act. - Broker-dealers and mutual funds must maintain a CIP appropriate to their size and type of business. - Through its powers to require access to books and records and to compel information, the SEC has access to the identity of all customers of registrants, including broker-dealers, investment companies and IAs. - IAs cannot be compelled to disclose the identity of clients (Section 210(c) of the Advisers Act) except when disclosure may be necessary or appropriate in an enforcement investigation or proceeding; in practice this has not impeded the SEC. ### Outsourcing to SROs and third parties (comparative notes) - The SEC does not outsource its inspection or enforcement authority to SROs or third parties, but the system administered by the SEC makes extensive use of SROs, notably national securities exchanges and FINRA. - CFTC analogues: CFTC Regulation 38.154(a) permits a DCM to use an NFA or another registered entity to provide services; a DCM remains responsible for performance and must conduct periodic reviews of adequacy and effectiveness. Commission Regulation 37.204(a) provides analogous provisions for SEFs. ### Assessment and concluding observations - Assessment: Fully Implemented. - Comments: - SROs, including FINRA, NFA, and exchanges and clearing organizations, play a critical role as front line supervisors of markets and intermediaries; responsibilities are set out in legislation. - The legislation gives regulators full authority to oversee SRO conduct via rule approval, power to intervene and require changes, and examination powers. - Both the CFTC and the SEC have robust programs to monitor compliance by SROs and carry out regular examinations, with regular interactions often on a daily basis. - Examinations cover exchanges’ governance, compliance with record keeping and audit trail obligations, trade practice and market surveillance processes, investigation of suspected misconduct, membership application processes, ongoing supervision of sales practices, discipline and arbitration. - Timeframes for regulators’ review of SRO rule amendments can be limited (especially for the CFTC), but mitigants include: - practice of informal consultation with the CFTC prior to formal lodgment of rules, - ability of regulators to extend review time for more scrutiny including public consultation, - CFTC use of the stay procedure in some cases (e.g., SEF rules), - power of the CFTC and the SEC to mandate or impose changes to SRO rules. - Taking these factors into account, the assessors conclude that the requirements of Key Question 2(d) are met. *UNITED STATES — INTERNATIONAL MONETARY FUND* ### Section 8(a)(1) of the CEA gives the CFTC comprehensive power to conduct investigations to ### Section 8(a)(1) of the CEA gives the CFTC comprehensive power to conduct investigations to ### Investigation and subpoena powers - Section 8(a)(1) of the CEA gives the CFTC comprehensive power to conduct investigations to ensure compliance with laws and regulations. - Section 6(c) authorizes the CFTC to administer oaths and affirmations, subpoena witnesses, compel their attendance, take evidence, and require the production of any books, papers, correspondence, memoranda, or other records that the CFTC deems material to the inquiry. - These powers can be used to seek information from any person, whether regulated or not. - If an individual or firm named in a subpoena refuses to comply with its terms, the CFTC may apply to a federal district court to enforce the subpoena. - The CFTC has broad subpoena powers and may obtain information from any individual or entity, whether registered or not, in connection with possible violations of the CEA and Commission regulations. - Section 6(c) of the CEA authorizes the CFTC to subpoena the production of documentary and testimonial evidence from any place in the United States, any State, or any foreign country or jurisdiction. ### Enforcement powers (statutory scope and Dodd-Frank enhancements) - The CFTC may file a civil enforcement action in federal district court or an administrative enforcement proceeding in an administrative tribunal to ensure compliance with the CEA. - The CFTC maintains extensive rules relating to enforcement activity such as Part 11 of its rules (Investigations). - The Dodd-Frank Act added or amended provisions strengthening enforcement, including: - Section 6(c) (and CFTC Regulation 180.1) to prohibit any manipulative device, scheme or artifice in the swaps, futures and cash markets and explicitly prohibit false or misleading statements; - Section 4c(a) to prohibit disruptive trading practices, including violations of bids and offers, intentional or reckless disregard for the orderly execution of transactions during the close, and spoofing; - Section 4s (and CFTC Regulations 23.400-451), setting out business conduct standards for SDs and MSPs; - Sections 2(c)(2)(B) and 2(c)(2)(D), strengthening the CFTC’s enforcement authority over retail Forex and retail commodity transactions (e.g., precious metals); - Section 23 (and Regulation 165), creating whistleblower incentives and protection; and Section 4c(a)(4), prohibiting trading on confidential information emanating from government departments or agencies that may affect or tend to affect the price of any commodity in interstate commerce or swap. ### Civil proceedings: remedies and monetary penalties - Remedies available in a federal district court include: - injunctions; - ex parte orders to preserve records and freeze assets; - civil monetary penalties; - disgorgement; - restitution; - contract rescission; and - any other equitable relief needed. - Civil monetary penalties: - up to the greater of $140,000 or triple the monetary gain to the person can be imposed for each violation other than manipulation (plus post-judgment interest); - in the case of manipulation or attempted manipulation, a civil monetary penalty of up to the greater of $1 million or triple the monetary gain to the person can be imposed for each violation (plus post-judgment interest). ### Administrative proceedings: procedures and sanctions - Complaints initiating an administrative action under Sections 6(c) and 6(d) of the CEA are conducted under the CFTC's Rules of Practice in Part 10 of the CFTC Regulations. - Sanctions that can be imposed by administrative action include orders: - prohibiting a respondent from trading on or subject to the rules of any contract market and requiring all contract markets to refuse such person all trading privileges for any period specified in the order; - suspending (for a period of not more than six months), revoking or restricting a respondent's registration with the CFTC; - assessing civil monetary penalties against a respondent, up to $140,000 or triple the monetary gain to the person for each violation; not more than the greater of $1 million or triple the monetary gain to the person for each violation for manipulation; plus post-judgment interest; - directing that a respondent make restitution to customers of damages proximately caused by the respondent's violations; and - directing a respondent to cease and desist from violating the CEA or CFTC Regulations in an administrative action brought pursuant to Section 6(d). ### Criminal prosecutions and coordination with prosecutors - The CFTC can refer matters for criminal prosecution to DOJ and state criminal authorities, but it cannot independently initiate criminal actions. - The CFTC routinely works in parallel with criminal law enforcement authorities to investigate potential violations of the CEA. - Alleged criminal violations of the CEA pursuant to Section 9 of the CEA or violations of other federal laws that involve commodity futures trading are referred to DOJ for prosecution. - Conduct that may violate state laws is referred to the appropriate state authority. - A criminal prosecution does not preclude the CFTC from taking civil action for the same conduct, and similarly, CFTC action does not preclude a subsequent criminal prosecution. ### Power to require information: telecommunications and bank records - Telecommunications data: - The CFTC has power to access electronic communications from regulated entities, but a judicial decision based on internet privacy legislation has ruled that it cannot require access to the content of communications from an internet service provider without seeking judicial approval. - Bank records: - The RFPA creates a procedure that must be followed in an investigation before the CFTC can access bank records relating to individuals or partnerships of less than six people. - The Act generally requires prior notice to be given to the account holder, but it also permits delayed notice in specified circumstances, such as where there is a risk of the destruction of evidence, or where notice would seriously jeopardize an investigation. - These provisions do not apply to civil proceedings, where discovery rules apply. - In practice, the CFTC has not had difficulty in using the delayed notice provisions where circumstances warrant. ### Private rights of action - Section 22 of the CEA permits private rights of action under certain circumstances: - Section 22(a) permits private damage actions against anyone other than a SRO who violates, or willfully aids and abets a violation, of the CEA. - Section 22(b) establishes a private damage remedy against SROs and their officials, which in bad faith refuse to enforce their own rules, or enforce their own rules in violation of the CEA, and cause monetary loss to the plaintiff. - The CFTC’s enforcement powers do not compromise a private person’s right of action to seek remedies under the CEA. *Source: _cr1591 - Section 8(a)(1) of the CEA gives the CFTC comprehensive power to conduct investigations to* ### Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s rules ### _cr1591 - Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s rules ### CFTC: Reparations, information sharing, and investigative powers - Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s rules to apply to the CFTC for an order awarding damages caused by the violation. - Reparations procedures provide a variety of methods to resolve claims, including: - a voluntary procedure based on the submission of written documents; - a summary procedure for claims of less than $30,000; and - a formal procedure before an Administrative Law Judge. - Information sharing: - If information is available from another federal or state agency, such as a state securities regulator or the SEC, the CFTC can obtain this information by seeking access to the public and non-public information in that agency’s files. - The CFTC cooperates with other domestic enforcement authorities through explicit statutory authorization, formal MOUs and informal arrangements. ### SEC: Powers of investigation and enforcement framework - General investigation power: - The Securities Act, the Exchange Act, the Advisers Act, and the ICA give the SEC broad authority to investigate actual or potential violations of the federal securities laws, including the SEC’s rules and regulations and the rules of SROs. - Section 21(b) of the Exchange Act gives the SEC authority to subpoena witnesses, require production of books and records, and administer oaths and affirmations. - Civil proceedings: - The SEC can bring civil proceedings in a federal district court seeking remedies including injunctions, temporary restraining orders, disgorgement, civil money penalties and other equitable relief. - Example statutory maximum civil penalties under the Exchange Act (current amounts cited): - $160,000 for a natural person; - $775,000 for an entity; - or the gross amount of pecuniary gain (Section 21(d)(3) of the Exchange Act). - Insider trading penalties: up to three times the amount of profit gained or losses avoided (Section 21A of the Exchange Act). - Administrative proceedings: - The SEC can institute administrative actions litigated before an SEC ALJ; ALJ decisions are reviewable by the SEC and then appealable to a U.S. Court of Appeals. - Sanctions and remedies available through administrative proceedings include: - Securities industry suspensions of up to twelve months; - Bars as to regulated individuals; - Limitations on activities; - Civil penalties; - Disgorgement; - Revocation of the registration of an entity; - For professionals, suspension from or denial of the privilege of practicing before the SEC. - Criminal prosecutions: - The SEC can refer cases to federal and state criminal law enforcement authorities and routinely works in parallel with criminal authorities. - A criminal prosecution does not preclude the SEC from taking civil action for the same conduct, and vice versa. - Suspension of trading: - The SEC can summarily suspend trading in a security for up to ten business days under Exchange Act Section 12(k). - Under Section 8(d) of the Securities Act, the SEC can issue a stop order suspending the effectiveness of a registration statement that contains incomplete, inaccurate, false or misleading information. - Under Section 12(j) of the Exchange Act, the SEC can deny, suspend for up to twelve months, or revoke the registration of a security. - Dodd-Frank Act enhancements to SEC enforcement powers: - Authorizing the SEC to impose civil money penalties in cease-and-desist proceedings; - Authorizing the SEC to impose industry wide collateral bars on individuals found to have violated the securities laws; - Providing authority for charging aiding and abetting liability under the Securities Act and the ICA; - Authorizing the SEC to obtain penalties against aiders and abettors in civil actions under the Advisers Act; - Specifying that manipulative short sales are unlawful. - Power to require information: - The SEC can use supervisory powers described under Principle 10 to access information and records held by regulated entities and can compel production of documents or testimony from any person or entity in the U.S. under its subpoena authority. - Restrictions and safeguards: - U.S. federal law imposes restrictions on the SEC’s ability to obtain certain information regarding electronic communications. - The SEC must follow the procedures set out in the RFPA when it seeks financial records of an individual customer or small partnership from a financial institution. - Private rights of action: - Private persons can seek remedies under the federal securities laws; the SEC’s enforcement powers do not compromise private rights of action. - Examples: Section 11 of the Securities Act (misstatements or omissions in registration statements); Section 9 of the Exchange Act (specified manipulations of exchange-traded securities); implied private rights (notably Exchange Act Section 10(b) for securities fraud). - Information sharing: - Under Section 24(c) of the Exchange Act, the SEC can make nonpublic information and records available to persons the SEC deems appropriate, including domestic and foreign counterparts, if they have a need and provide appropriate confidentiality assurances. - Generally, the SEC is not reliant on other authorities to obtain evidence necessary for its investigations. ### CFTC: Inspection, surveillance, compliance monitoring and enforcement (Principle 12 assessment) - Staffing and examination capacity: - In 2014, the CFTC has 95 staff positions dedicated to examinations of registrants. - DMO and DCR in fiscal year 2014 have a total of 47 examination positions to carry out DCM and DCO supervision and will commence direct examinations of SEFs and SDRs in the near future. - The CFTC’s Division of Enforcement (DOE) has a total staff of just over 150 people, including over 20 investigators and 3 economists. - Intermediary oversight: - The CFTC does not conduct routine on-site direct inspections of intermediaries; the regulatory scheme relies on SRO supervision (DCMs and NFA) with CFTC oversight of SROs’ exercise of responsibilities. - The CFTC requires DSROs to ensure each FCM is subject to an on-site examination within nine to 18 months of the date of the previous examination by the DSRO. - In FY 2014, DSIO carried out 11 limited scope examinations of FCMs and one for cause examination of a swap dealer. - Market surveillance and trade practice detection: - DCM Core Principles and CFTC Regulations require automated trade surveillance systems capable of detecting potential trade practices violations; systems must process daily orders and trades no later than 24 hours after the completion of the trading day. - Regulation 38.157 requires DCMs to conduct real-time market monitoring of all trading activity on electronic trading platforms; SEFs have analogous requirements. - The CFTC independently conducts an extensive market surveillance program utilizing large trader reports and daily trading data analysis. - DMO’s Surveillance staff reviews exchange transaction details daily; the CFTC is upgrading its surveillance system to enhance detection of trade practice violations, including wash trading and trading ahead. - Intelligence, whistleblowers, and sources of investigations: - CFTC investigations often come from customer tips, complaints, or referrals (TCRs). - Over 200 TCRs were received from whistleblowers in the fiscal year 2014. - The Dodd-Frank Act added Section 23 (Commodity Whistleblower Incentives and Protection); the CFTC can pay awards, based on collected monetary sanctions, to eligible whistleblowers whose original information leads to a judicial or administrative action. - The CFTC made its first payment to a whistleblower in May 2014. - Other case sources include internal referrals, SROs, state and federal authorities, foreign regulators, press reports and websites. - Reconstruction and audit trails: - CFTC Regulation 38.551 requires a DCM to capture and retain all audit trail data necessary to detect, investigate, and prevent customer and market abuses; data must be usable to reconstruct all transactions within a reasonable period of time. - Regulation 37.205 makes analogous provisions for SEFs. - Enforcement activity and caseload (at time of assessment mission): - Approximately 99 litigation matters pending in United States District Courts throughout the U.S. - Approximately 433 pending investigations. - 77 preliminary inquiries. - DOE enforcement program targets include: - Allegations of manipulation, attempted manipulation, and false reporting; - Trade practice violations; - Fraud and other misconduct involving CPs, HFs, CPOs, and CTAs; - Financial, supervision, recordkeeping and other violations by registered entities and individuals. - DOE focuses on pervasive fraud involving retail forex futures, forex options, and off-exchange precious metal and retail forex transactions. - The CFTC has tended to bring cases in federal courts rather than through administrative proceedings before an ALJ; there are no permanent ALJs attached to the CFTC (where used they are sourced from outside the agency). Some matters (e.g., revocation of registration or statutory disqualification) must be done administratively. - Coordination with criminal authorities: - Over 90 percent of the CFTC’s major fraud cases (those with customer losses over $1 million) filed during fiscal year 2013 involved a parallel criminal proceeding. - During fiscal years 2010 to 2013, the CFTC referred an average of approximately 50 matters to domestic criminal and civil authorities annually, of which an average of 40 matters were referred to criminal authorities. - As a result of these criminal referrals, an average of 45 indictments were filed annually alleging a range of criminal misconduct arising out of activity in the futures and swaps markets. - Criminal sanctions in those cases included prison sentences, fines, and restitution. Defendants received prison sentences of up to 50 years, others received fines of over $100 million, and still others were ordered to pay restitution of more than $250 million. - CFTC enforcement filings by type (FY2011–FY2014 summary as presented): - Fraud: FY2011 55; FY2012 57; FY2013 29; FY2014 26 - Illegal Offering of Off-Exchange Transactions: FY2011 1; FY2012 0; FY2013 8; FY2014 13 - Trade Practice: FY2011 6; FY2012 15; FY2013 7; FY2014 6 - Financial Integrity and Controls: FY2011 3; FY2012 12; FY2013 23; FY2014 7 - Recordkeeping and Reporting: FY2011 1; FY2012 2; FY2013 0; FY2014 2 - Manipulation, Attempted Manipulation and False Reporting of Market Information: FY2011 3; FY2012 2; FY2013 4; FY2014 6 - Disclosure of Non-Public Material Information: FY2011 0; FY2012 0; FY2013 1; FY2014 0 - Statutory Disqualification: FY2011 1; FY2012 9; FY2013 5; FY2014 4 - False Statements and Omissions of Material Facts to the Commission/NFA/Exchanges: FY2011 2; FY2012 2; FY2013 1; FY2014 2 - Violation of a Commission Order: FY2011 0; FY2012 0; FY2013 1; FY2014 1 - Registration Violations: FY2011 25; FY2012 3; FY2013 1; FY2014 0 - Audit Failures: FY2011 2; FY2012 0; FY2013 2; FY2014 0 - CFTC monetary relief obtained in civil and administrative enforcement actions (as presented): - FY11 Civil Monetary Penalties: $316,682,679; Restitution and Disgorgement: $181,844,807 - FY12 Civil Monetary Penalties: $475,360,925; Restitution and Disgorgement: $456,581,900 - FY13 Civil Monetary Penalties: $1,570,700,568; Restitution and Disgorgement: $201,409,408 - FY14 (to Apr 30) Civil Monetary Penalties: $961,072,836; Restitution and Disgorgement: $1,330,365,570 - Total Civil Monetary Penalties: $4,831,648,447 - Total Restitution and Disgorgement: $3,686,210,358 ### SEC: Inspection, surveillance, compliance monitoring (OCIE and OCR) - OCIE activities and capacity: - OCIE carries out the SEC’s examination authority through its National Examination Program (NEP) and examines/inspects securities firms registered with the SEC, including BDs, municipal securities dealers, clearing agencies, transfer agents, IAs, investment companies, and municipal advisors; and examines and oversees the SROs. - As of early 2014, OCIE had approximately 805 examiners. - OCIE began publishing annual examination priorities in 2013. - OCR and NRSRO oversight: - The Office of Credit Ratings (OCR) conducts examinations of NRSROs and had 44 staff for fiscal year 2014; pursuant to the Dodd-Frank Act, examinations must be conducted on an annual basis. - OCIE and OCR examination volumes (as presented): - Broker-dealers: FY2011 390; FY2012 443; FY2013 438 - Large firm monitoring: FY2011 11; FY2012 11; FY2013 11 - Investment advisers: FY2011 1,004; FY2012 974; FY2013 964 - Investment companies (including administrators): FY2011 112; FY2012 104; FY2013 99 - Transfer agents: FY2011 46; FY2012 42; FY2013 42 - Clearing agencies: FY2011 2; FY2012 5; FY2013 17 - Municipal advisors: FY2013 5 - NRSROs: FY2011 10; FY2012 9; FY2013 10 - SROs: FY2011 52; FY2012 38; FY2013 50 - Technology control program: FY2011 11; FY2012 13; FY2013 13 - Compliance systems: - SEC and SRO rules require regulated entities to have supervisory and compliance procedures reasonably designed to prevent securities laws violations (examples: Rule 206(4)-7 of the Advisers Act; ICA Rule 38a-1; FINRA/NASD/NYSE rules). - FINRA Rules require annual CEO certification of BDs’ compliance and supervisory procedures. - OCIE exam staff and SROs review adequacy and implementation of firms’ written supervisory procedures. - The SEC can sanction broker-dealers and IAs and associated persons for failure reasonably to supervise. - Intelligence, whistleblowers, and TCRs: - OCIE reviews and evaluates TCRs from various external sources through the SEC-wide TCR system, with particular attention to fraud allegations. - The Office of the Whistleblower (OWB) administers the SEC’s whistleblower program under the Dodd-Frank Act and gathers intelligence from whistleblowers; the SEC has made a number of payments under this program. - The SEC has direct electronic access to suspicious activity reports (SARs) and other BSA-required reports. - Mechanisms to detect and investigate market abuse: - Mechanisms are described under Principles 34 and 36; when inspecting an SRO’s surveillance program, SEC staff assess whether automated surveillance parameters are appropriately designed and effectively detecting potential noncompliance. *Source: _cr1591 - Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s rules* ### Section 19(g) of the Exchange Act requires each SRO to enforce compliance with the SRO’s rules ### _cr1591 - Section 19(g) of the Exchange Act requires each SRO to enforce compliance with the SRO’s rules ### Surveillance and audit trail requirements - Section 19(g) of the Exchange Act requires each SRO to enforce compliance with the SRO’s rules by its members, including by having mechanisms for conducting surveillance of the markets and establishing an audit trail. - FINRA has taken over the Order Audit Trail System (OATS) established by NASD and later expanded to include OTC equity securities. - Several options exchanges use the Consolidated Options Audit Trail System (COATS). - The SEC in 2012 adopted Rule 613 to require the national securities exchanges and FINRA to submit a national market system (NMS) plan to create, implement, and maintain a consolidated order tracking system, or consolidated audit trail, with respect to the trading of NMS securities. This plan was recently submitted to the SEC (see Principle 36). ### SEC Enforcement — structure and resources - Enforcement staff: approximately 1,300 employees in Enforcement, including attorneys, accountants, and other professionals, located in each of the regional offices and in Washington D.C. - Enforcement budget: in fiscal year 2013, Enforcement had a budget of $449.35 million. - Enforcement has about 130 litigation lawyers who, along with staff attorneys, handle cases. ### Enhancements to SEC enforcement - Establishing a cooperation program to provide incentives for individuals and entities to cooperate and assist with SEC investigations and enforcement actions. - Adopting a new settlement protocol to require admission of wrongdoing in cases involving egregious conduct, significant investor harm, significant market risk and obstruction of an SEC investigation (14 cases have so far been settled in this way). - Establishing five new national specialized units: an Asset Management Unit; a Municipal Securities and Public Pensions Unit; a Foreign Corrupt Practices Act Unit; a Complex Financial Instruments Unit; and a Market Abuse Unit. Each of these units have taken significant enforcement actions since their establishment in 2010. - Establishing task forces on high priority areas, including: financial reporting and audit; microcap fraud; broker-dealers; and the JOBS Act. ### Sources of enforcement cases and referrals - Referrals from supervisory areas: Each Regional Office has a referral Committee; around 10-15 percent of OCIE examinations result in referrals to Enforcement. - Review by Enforcement’s Office of Market Intelligence of TCRs: around 16,000 TCRs are reviewed each year. - Tips from whistleblowers to the Office of the Whistleblower: in fiscal year 2013, there were about 3,200 tips. - Referrals from the SROs and other external sources. - Enforcement also initiates investigations on its own initiative through specialized units and task forces that monitor and surveil the market. ### Case types, processes, and outcomes - Enforcement brings cases as administrative proceedings before an ALJ and/or as civil cases in a District Court; choice depends on facts and remedies required. - At the end of fiscal year 2013, Enforcement had over 1,444 ongoing investigations, excluding litigation and other post investigative activities. - In fiscal year 2013, the SEC brought 676 enforcement actions, 15 percent of which were high impact cases or reflected a national priority. - The SEC obtained some form of relief in 93 percent of actions brought in 2013. - The majority of cases are settled; an increase in cases against individuals contributes to more cases going through full litigation. ### Total SEC Enforcement Actions — Fiscal Years - 2014: 755 - 2013: 676 - 2012: 734 - 2011: 735 - 2010: 681 - 2009: 664 ### SEC Enforcement Cases — Selected Types Of Action (FY 2010–FY 2013) - Market manipulation: FY 2010: 34; FY 2011: 35; FY 2012: 46; FY 2013: 50 - Insider trading: FY 2010: 53; FY 2011: 57; FY 2012: 58; FY 2013: 44 - Securities offerings: FY 2010: 144; FY 2011: 123; FY 2012: 89; FY 2013: 103 - Issuer reporting and disclosure: FY 2010: 126; FY 2011: 89; FY 2012: 79; FY 2013: 68 ### Sanctions ordered in SEC Enforcement Actions — Selected Fiscal Years - 2013: Disgorgement Ordered $2.257 billion; Penalties Ordered $1.167 billion; Officer and Director Bars 81; Trading Suspensions 371 - 2012: Disgorgement Ordered $2.083 billion; Penalties Ordered $1.021 billion; Officer and Director Bars 120; Trading Suspensions 651 - 2011: Disgorgement Ordered $1.878 billion; Penalties Ordered $928 million; Officer and Director Bars 82; Trading Suspensions 276 - 2010: Disgorgement Ordered $1.82 billion; Penalties Ordered $1.03 billion; Officer and Director Bars 71; Trading Suspensions 254 - 2009: Disgorgement Ordered $2.09 billion; Penalties Ordered $345 million; Officer and Director Bars 90; Trading Suspensions 192 ### Criminal cases and coordination with criminal authorities - Criminal prosecutions are undertaken by federal, state and local criminal authorities. At the federal level, the U.S. Attorney’s Office has 93 offices nationally and some 5,500 assistant U.S. attorneys. - The Fraud Section of the Criminal Division of the U.S. Department of Justice has a specialized group of prosecutors who bring criminal securities fraud cases throughout the United States. - The SEC works closely with criminal authorities, typically referring cases to the U.S. Attorney’s Offices and to the Fraud Section of the Criminal Division of the Department of Justice; referrals are also made to other authorities. - Cases requiring powers available to criminal authorities (such as wire-tapping and search warrants) are referred at an early stage; cases are often investigated in parallel and frequently filed simultaneously. - Criminal action was taken in 126 cases in 2013 as a result of SEC referrals. - The SEC provided assistance and access to files to domestic regulators in 504 investigations and to foreign regulators in 508 investigations in 2013. - The U.S. Department of Justice also brings civil actions for securities fraud and other financial fraud; it has a Financial Fraud Enforcement Task Force which coordinates certain criminal and civil actions in complex financial crimes cases. ### Assessment and supervisory comments - Assessment: Broadly Implemented - Comments: - Supervision and examination programs of the SROs, and of the SEC and the CFTC, for intermediaries and CIS provide for regular cycle examinations of most intermediaries so that even lower risk firms are examined on a regular basis; for-cause examinations respond to tips or complaints. - For intermediaries other than IAs, the NFA and FINRA carry out most examinations; assessors found these examinations to be well focused and thorough with appropriate follow up. - The SEC, and to a lesser extent the CFTC, also carry out direct risk-based examinations to test the effectiveness of SRO supervision. - SEC supervision of IAs, including those that operate mutual funds, is less intensive and examinations cover a relatively small percentage of the population each year; more frequent examinations of IAs are warranted given the importance of the mutual fund and asset management sectors. - Both the SEC and the CFTC make robust use of their enforcement powers and devote considerable resources to enforcement activities; SEC enhancements enable better detection and action on problematic behavior reported through tips and complaints. ### Principles for cooperation in regulation — Information sharing (Principle 13) - Legal authority: - Section 24(c) of the Exchange Act and Rule 24c-1 permit the SEC, in its discretion and upon showing that information is needed, to provide records and information in its possession to a range of domestic and foreign regulators and other authorities, subject to appropriate assurances of confidentiality. Rule 24c-1 specifically includes foreign financial regulatory authorities among recipients. - Upon request, the CFTC may share information with any domestic or foreign regulator (or other authority) acting within the scope of its jurisdiction, provided the requirements in Section 8(e) of the CEA are satisfied. - Scope of information sharing: - The SEC and CFTC information sharing rights cover that required under Key Questions 13.1(a)-(g) and 13.3(a)-(g). - Information shared can include beneficial ownership or control of a bank or brokerage account and information necessary to reconstruct a transaction, including bank records. - Procedures and safeguards: - No external approval is needed for the SEC or CFTC to share information. - The SEC and CFTC have procedures to ensure assurances of confidentiality and use are obtained either through an MOU or less formal arrangements, such as access request letters. - Specific Dodd-Frank authorities: - Sections 112(d)(1)-(2) of the Dodd-Frank Act authorize the FSOC to request and receive, and member agencies to provide, any data or information necessary to monitor the financial services marketplace to identify potential risks to U.S. financial stability or to carry out Dodd-Frank provisions. - Section 809(e) of the Dodd-Frank Act includes specific information sharing powers on designated financial market utilities (DFMUs) or financial institutions engaged in designated activities (DFMIs) with domestic and foreign authorities. - No requirement for breach of U.S. law: - Section 21(a)(2) of the Exchange Act authorizes the SEC to provide assistance to a foreign securities authority without regard to whether the facts would also constitute a violation under U.S. laws. - Section 12(f)(1) of the CEA expressly states that the CFTC may provide investigative assistance to a foreign futures authority without regard to whether the facts would also constitute a violation of U.S. laws. - Customer financial records and RFPA procedures: - If seeking financial records of a customer (as defined in the RFPA) from a covered financial institution, the SEC or CFTC must follow specific RFPA procedures: customer authorization or disclosure in response to an investigative subpoena after notice to the customer (Section 3402 RFPA); subpoenas must indicate the agency and relevance to a legitimate law enforcement inquiry; a copy must be served or mailed to the customer (Section 3405 RFPA). - Requests from foreign authorities under the IOSCO MMOU for RFPA-covered records require consulting the requesting authority before disclosing the request to the customer (Section 11.a of the MMOU). - Access can be gained if 10 days have expired from date of service or 14 days have expired from time of mailing and the customer has not challenged the inquiry; grounds to challenge are limited. - The SEC and CFTC can, in certain circumstances, obtain financial records through a delayed notice provision without first notifying the customer; SEC would seek court approval under Section 21(h) Exchange Act where delay is necessary for specified reasons (listed in source). - The CFTC may delay notice under RFPA conditions by court order subject to specified conditions (listed in source). - When receiving foreign requests that involve the RFPA, agencies explain RFPA requirements and notice provisions to the foreign authority; the CFTC has received fewer information requests from foreign authorities than the SEC, and in the most recent case the foreign authority requested use of the delayed notification procedure. - Other restrictions: - U.S. government agencies are subject to restrictions on obtaining certain information from internet service providers under the Electronic Communications Privacy Act (ECPA). - Unsolicited information: - The SEC may share nonpublic information with appropriate authorities under Section 24(c) of the Exchange Act upon showing that it is needed and that the recipient provides appropriate confidentiality assurances; in some instances both requirements can be satisfied without a request for assistance, as under various MOUs. - Section 13 of the IOSCO MMOU authorizes a signatory to proactively share information without prior request under specified conditions. *United States — International Monetary Fund, from the source content provided.* ### Section 8(g) of the CEA provides that the CFTC may provide, on its own initiative, registration ### _cr1591 - Section 8(g) of the CEA provides that the CFTC may provide, on its own initiative, registration ### Information sharing powers and legal framework (Principle 14) - The SEC and CFTC have the power to enter into information-sharing arrangements with domestic and foreign authorities under Section 24(c) of the Exchange Act and Section 8(e) of the CEA, respectively. - Both agencies’ MOUs are approved by the respective Commissions and signed by the Chair or his/her designee. - Agencies may also use less formal arrangements, such as ad hoc requests for information, access request letters, or other arrangements that provide necessary assurances of confidentiality and limitations on use. - No written, confidential information can be shared with a domestic or foreign regulator without an MOU or another type of arrangement that provides confidentiality assurances. - The Dodd-Frank Act provisions relevant to information sharing: - Section 752(a) permits the CFTC, SEC and prudential regulators to agree to any necessary or appropriate information sharing arrangements to promote effective and consistent global regulation of swaps and security-based swaps. - Section 752(b) specifically references the CFTC’s right to agree on information sharing arrangements for the regulation of commodity futures and options on such futures. ### Existing arrangements (domestic and foreign) - Domestic MOUs include: - The SEC and the Federal Reserve MOU (July 2008); - The SEC, the Federal Reserve and the CFTC MOU on CDS CCPs (November 2008); - The SEC and CFTC MOU establishing a permanent regulatory liaison and providing for enhanced information sharing (March 2008). - International arrangements: - Both the CFTC and the SEC have been signatories to the IOSCO MMOU since 2002. - The CFTC primarily uses the IOSCO MMOU for enforcement purposes. - Prior to the IOSCO MMOU, the SEC had bilateral enforcement MOUs with the securities authorities of 20 different countries. - The SEC now recommends negotiating bilateral MOUs for enforcement cooperation only if a foreign securities authority can provide assistance beyond the IOSCO MMOU. - The SEC has supervisory MOUs for cross-border regulated entities and protocols for sharing nonpublic issuer-specific information relating to IFRS and U.S. GAAP for dually listed issuers. - CFTC arrangements include supervisory, prudential and risk assessment MOUs, financial information sharing, supervision of CIS and alternative investment fund industry, and participation in the Boca Declaration on Cooperation and Supervision of International Futures Exchanges and Clearing Organizations. - The CFTC has supervisory MOUs for regulated entities operating on a cross-border basis. - Where a foreign authority is not a signatory to the IOSCO MMOU, the CFTC may use bilateral cooperative arrangements or informal letter arrangements. ### Confidentiality protections - SEC confidentiality tools: - Section 24(d) of the Exchange Act: basis for denying FOIA third-party requests for records provided by a foreign securities authority that indicates disclosure would violate its domestic laws. - Section 24(f) of the Exchange Act: the SEC cannot be compelled to disclose privileged information obtained from a foreign securities or law enforcement authority if so informed. - Section 24(g) of the Exchange Act: the SEC is not authorized to withhold information from Congress or prevented from complying with a court order in a U.S. action; however, the SEC practices keeping foreign-provided information non-public to preserve cooperative relationships. - CFTC confidentiality tools: - CFTC Regulation 11.3: information and documents obtained in the course of any investigation are deemed non-public and confidential, unless made a matter of public record. - CFTC Regulations 145.5(g)(1) and (4): FOIA exemptions where disclosure could interfere with enforcement activities or disclose confidential sources, including foreign agencies. - Section 8(a)(1) CEA: except for legally enforceable demands, the CFTC cannot be compelled to disclose information obtained from a foreign futures authority if public disclosure would violate the foreign authority’s laws and the information was obtained pursuant to an MOU or other relevant procedure. - CFTC Regulation 10.42(b)(2)(v): DOE may withhold from producing in an administrative enforcement proceeding information obtained from a domestic or foreign governmental entity that is not relevant or was provided on condition of non-disclosure or limited disclosure. - The CFTC follows a similar approach to the SEC with regards to information requests from Congress (Section 8(a)(1) CEA). ### Practice and operational statistics - SEC practice: - Requests for assistance from foreign authorities are handled centrally by the Office of International Affairs (OIA) in coordination with Enforcement and other Divisions and Offices, including OCIE and OCR. - In fiscal years 2012, 2013 and 2014, the SEC responded to, respectively, 450, 508, and 548 requests for enforcement assistance from foreign authorities. - The SEC also provided and received assistance in cross-border examinations and other supervisory matters. - CFTC practice: - Within the CFTC, foreign information sharing for derivatives law investigation and prosecution is handled by the DOE’s International unit. - During fiscal year 2013, the CFTC received 69 requests for assistance from 23 foreign regulators and authorities and provided completed responses to 65 of them by the end of the fiscal year. - Over the past three fiscal years, the CFTC responded to 173 requests, with an average response time of 39.6 days. - The CFTC also shares information in connection with cross-border examinations and other supervisory matters. ### Assistance to foreign regulators (Principle 15) - SEC authority: - Section 21(a)(2) of the Exchange Act authorizes the SEC to open a formal investigation to provide assistance to a foreign securities authority to determine whether any person has violated, is violating or is about to violate laws or rules relating to securities matters administered or enforced by the requesting authority. - The SEC may provide such assistance without regard to whether the facts would constitute a violation of U.S. laws. - In exercising this authority, the SEC considers whether the requesting authority has agreed to provide reciprocal assistance and whether compliance would prejudice the U.S. public interest. - Requests made pursuant to an MOU, including the IOSCO MMOU, generally satisfy the reciprocity requirement. - Under Section 21(b) of the Exchange Act, the SEC may require production of documents held by regulated entities and use subpoena powers to compel documents or testimony from any person or entity anywhere within the U.S. - CFTC authority: - Section 12(f)(1) of the CEA permits the CFTC, upon request from a foreign futures authority, to provide assistance in conducting investigations deemed necessary to determine whether any person has violated, is violating, or is about to violate laws, rules or regulations relating to futures or options matters administered or enforced by the requesting authority. - The CFTC may conduct investigations as it deems necessary to collect information and evidence pertinent to the request for assistance. - The practical scope of the CFTC’s assistance authority is described as practically identical to that of the SEC. *International Monetary Fund — Extract from _cr1591 PDF chapter on U.S. information sharing authorities and practice* ### Section 12(f)(2) of the CEA requires the CFTC, in deciding whether to provide assistance, to ### _cr1591 - Section 12(f)(2) of the CEA requires the CFTC, in deciding whether to provide assistance, to ### Assistance, information sharing, and independent interest - Section 12(f)(2) of the CEA requires the CFTC, in deciding whether to provide assistance, to consider whether the requesting authority has agreed to provide reciprocal assistance to the CFTC in futures and options matters and whether compliance with the request would prejudice the U.S. public interest. - Assistance may be provided without regard to whether the facts stated in the request would also constitute a violation of the laws of the United States. - As in the case of the SEC, the CFTC may compel on behalf of a foreign futures authority the production of documents and the taking of statements. - The SEC and CFTC are not restricted from sharing information or obtaining information even if they do not have an independent interest in a matter. ### Providing other assistance and limitations - Both the SEC and CFTC are able to offer assistance to foreign regulators in securing compliance with the laws and regulations identified in Key Question 2. - They can provide information on the relevant regulatory processes in the U.S. - They do not have the power to use their statutory authority to seek urgent injunctions and asset freezes on behalf of foreign regulators. - They can assist in advising foreign regulators on how to initiate a proceeding in civil court or request the assistance of the DOJ. - Foreign regulators may also pursue assistance in obtaining court orders through a mutual legal assistance treaty or a multilateral instrument such as the U.N. Convention against Transnational Organized Crime (UNTOC). - DOJ has the ability to assist foreign regulators and foreign criminal authorities in obtaining court orders to issue search warrants, obtain asset freezes, summon witnesses, and compel the production of documents and other evidence. - The ability to assist a foreign regulator depends on the specific language of the mutual legal assistance treaty between the U.S. and the foreign country or the terms of UNTOC; typically the remedies offered are only available to prosecutors for criminal violations. ### Supervisory information on financial conglomerates and MOUs - The SEC can provide supervisory assistance under Section 24(c) of the Exchange Act. - The CFTC can share supervisory information under Section 8(e) of the CEA and obtain information under Section 12(f)(1) of the CEA. - Such supervisory information sharing is based on information that the SEC and CFTC already have in their possession or that they can receive from the books and records of supervised entities. This can include information covered by Key Question 7. - Supervisory MOUs provide a mechanism by which the SEC, CFTC and their counterparts can consult, cooperate, and share information on a confidential basis about regulated entities that operate across borders. - These supervisory MOUs facilitate the easier sharing of supervisory information, including on financial conglomerates. ### Assessment - Assessment: Fully - Implemented ### Principle 16—Full, accurate and timely disclosure (overview) - Principle 16. There should be full, accurate and timely disclosure of financial results, risk and other information that is material to investors’ decisions. - Description Background: Disclosure obligations associated with the public offering of securities stem from federal securities laws. Monitoring issuers’ compliance with such obligations is a function entrusted to the SEC. In addition, each exchange’s listing requirements impose a set of disclosure obligations on issuers, which in general replicate federal requirements, although in a few areas they supplement them. Therefore this assessment focuses on the federal framework—although where appropriate complementary requirements of the exchanges are mentioned. Monitoring compliance with such listing requirements is the exchanges’ responsibility. ### Public offering of securities and exemptions - Under the Securities Act (Sections 3-5), every offer or sale of a security must be registered with the SEC unless an exemption is available. - The Securities Act provides exemptions from registration for: - (i) specific types of securities (such as any security issued or guaranteed by the government (other than foreign governments) or a bank but not a bank holding company, offerings of short-term commercial paper and municipal securities) or - (ii) certain types of transactions (in general such exemptions include limitations on the amount that can be raised and/or the type of investors to which the offer can be addressed). - The JOBS Act expanded some of the transactional exemptions currently available by: - (i) allowing general solicitation of certain offers provided that the securities are only sold to accredited investors or qualified institutional buyers depending on the exemption; - (ii) exempting from registration offerings up to $50 million, subject to certain conditions including SEC review and the SEC qualifying the offering statement; and - (iii) permitting offerings through crowdfunding up to $1 million annually without registration. - The SEC has already approved regulations for (i) and issued proposals for consultation for (ii) and (iii). ### Registration statement and prospectus requirements - To register a securities offering under the Securities Act, an issuer must file a registration statement with the SEC. The registration statement includes a prospectus. - SEC regulations require a prospectus to include disclosure in specific items: - (i) information with respect to the issuer, including financial statements (3 years), subject to scaling for smaller reporting companies and emerging growth companies, and selected financial data; the management’s discussion and analysis of financial condition and results of operations; description of the issuer and its business; material legal proceedings; description of properties; identification of directors and executive officers; executive compensation and corporate governance; security ownership of certain beneficial owners and management; and transactions with related persons, promoters, and certain control persons; - (ii) description of the securities to be registered; - (iii) risk factors relating to the issuer and the offering; - (iv) dilution; - (v) use of proceeds; - (vi) a plan of distribution; - (vii) the manner of determining the offering price; and - (vii) the interests of named experts and counsel. - In addition to the specific line items, the prospectus and registration statement must include “such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading.” - A registration statement must also include certain information that is not required to be contained in a prospectus, such as detailed expenses of the offering and information about the issuer’s indemnification policies and disclosure regarding recent sales of unregistered securities. - Exhibits must include various documents such as the underwriting agreement, the issuer’s certificate of incorporation and bylaws, legal opinions, and material contracts. ### Presentation of information, shelf registration, and distribution - Presentation of information: - The SEC’s rules under the Securities Act allow for different methods to present information in the prospectus, depending on the characteristics of the issuer and the offering transaction. - In most IPOs, all information must be directly presented in the prospectus. - For other types of transactions, an issuer may be permitted to use “incorporation by reference,” under which a prospectus refers to past or future reports that are filed under the Exchange Act. - Shelf registration: - Shelf registration is available to eligible issuers, whereby they can register their securities up to three years in advance of the offering. - They initially file a short registration statement that may be reviewed by the SEC staff unless the issuer files an automatically effective shelf registration statement which is available to certain larger issuers. - Once it becomes effective, the issuer files a prospectus supplement for each offering with no additional action required by the SEC for the offering to become effective. - Distribution of prospectus: - The Securities Act requires delivery of a prospectus meeting specified requirements under the Securities Act, known as a “final prospectus,” to each investor in a registered offering. - Under current rules (updated in 2005) which are based on an “access equals delivery” model, investors are presumed to have access to the Internet, and issuers and intermediaries can satisfy their delivery requirements if the documents are posted to a website. - In an IPO, Rule 15c2-8 under the Exchange Act requires a broker or dealer to deliver a preliminary prospectus to investors at least 48 hours before the confirmation of the sale of the securities is sent. ### Periodic reporting requirements (issuers covered) - The following issuers are subject to the periodic reporting requirements of the Exchange Act: - Issuers that want to list on a national securities exchange (Section 12(b) of the Exchange Act). - Issuers with registered offerings unless they satisfy one of the following "thresholds," in which case their filing obligations are suspended after the initial filing year: - (i) the company has fewer than 300 shareholders of record of the class of shares offered (1,200 shareholders of record if the company is a bank or bank holding company). SEC staff indicated that in the case of banks and bank holding companies, 96 bank holding companies elected to suspend obligations. Currently there are roughly 500 reporting banks, but approximately 150 meet the criteria to suspend reporting. - Non-Listed Companies: - U.S. issuers which, on the last day of their fiscal year, have more than $10 million in total assets and a class of equity securities held by either (i) 2,000 or more record holders; or (ii) 500 or more record holders who are not accredited investors must register that class of securities. - For banks or bank holding companies, the requirement applies if the company has more than $10 million in total assets and a class of equity securities held by 2,000 or more record holders (Section 12(g) Exchange Act). - These are generally smaller issuers that trade in the OTC markets. According to market participants, the majority of trading is from retail investors. ### Annual reports, financial statements, and SOX requirements - Annual reports: - Reporting issuers must file annual reports on Form 10-K. - The annual report requires disclosure about the company in all of the same areas, and addresses the same topics, as is required in a prospectus for an IPO under the Securities Act, other than offering-related information. - Financial statements required in the annual report: - Include three years of statements of income, cash flow, and changes in shareholders’ equity, two years of balance sheets, and a discussion of subsequent events. - The issuer must present the information on a consolidated basis and provide comprehensive footnote disclosure. - The financial statements must be audited by an independent public accountant registered with the PCAOB. - Pursuant to SOX 404 the annual audited financial statements for issuers with a public float of $75 million or more must be accompanied by an attestation of the auditor regarding the effectiveness of the internal controls for financial reporting. - MD&A: - The MD&A must accompany the financial statements. - The MD&A addresses the financial condition, results of operations, liquidity and capital resources as well as events and uncertainties known to the issuer’s management that may cause the reported results not to be indicative of future financial performance. This disclosure also includes off-balance sheet disclosures and contractual obligations. - Filing deadlines for annual reports: - Large accelerated filers must file annual reports within 60 days, accelerated filers within 75 days and all other U.S. filers within 90 days of the fiscal year-end covered by the report. - SOX reports: - Section 302 of the Sarbanes-Oxley Act (SOX) and corresponding SEC Rules 13a-14(a) and 15d-14(a) require issuers’ principal executive officer(s) and principal financial officer(s) to certify in each quarterly and annual report that the reports fairly represent the financial condition and results of operation of the issuer, as well as certify on the effectiveness of financial reporting controls. - Section 906 of SOX requires that each periodic report be also accompanied by a certification by the same officers that the report fairly presents, in all material respects, the financial condition and results of operations of the issuer. - A person who certifies any statement knowing that the report does not comply with the requirements set forth in SOX is subject to criminal sanctions ranging from fines to imprisonment. ### Quarterly reports and material events - Quarterly reports: - Issuers must also file quarterly reports for the first three fiscal quarters on Form 10-Q. - They must describe their financial condition and results of operations for the preceding fiscal quarter and the corresponding period from the prior fiscal year and also include condensed financial statements. - The financial statements in quarterly reports include balance sheets as of the close of the quarter and the comparable quarter of the preceding year, comparative statements of operations for the quarter and for the beginning of the year through quarter-end and comparative statements of cash flow from the beginning of the year through quarter-end. - These financial statements are not required to be audited; however, they are required to be reviewed by an independent public accountant. - Financial statements in quarterly reports also are required to be accompanied by an MD&A. - The requirements for quarterly reports with respect to non-financial statement and related information are not as extensive and do not require updating of all information required in the annual report. - Filing deadlines for quarterly reports: - Large accelerated filers and accelerated filers must file a quarterly report within 40 days and all other domestic filers within 45 days after the end of the fiscal quarter covered by the report. - Material events: - Domestic issuers must file current reports on Form 8-K upon the occurrence of a set of enumerated events. This is an “exhaustive” list of events (expanded by the SEC in 2004 as a result of SOX). - These reports must be filed within 4 business days. - In addition, each registered securities exchange generally requires its listed companies to (i) timely disclose information that may affect security values or influence investment decisions; and (ii) timely provide the exchange with other information in order to maintain an orderly market in the company’s securities (See for example 202.05 of the Listed Company Manual of the NYSE and Nasdaq Rule 5250(b)(1)). - As a result of these obligations, in practice the communication of material events by listed issuers usually takes place on shorter deadlines than the 4 business days required under the SEC framework. ### Selective disclosure and shareholder voting - Selective disclosure: - Regulation FD requires a reporting issuer to make simultaneous or prompt public disclosure, depending on whether the disclosure was intentional, when it discloses material nonpublic information to certain individuals or entities (generally, securities market professionals, such as stock analysts or holders of the issuer’s securities who may trade on the basis of the information). - Regulation FD defines public disclosure as furnishing or filing a Form 8-K, or disseminating the information through another method that is reasonably designed to provide broad, non-exclusionary distribution of information to the public. - Shareholder’s voting decisions: - Any solicitation of a proxy with respect to an equity security registered under Section 12 of the Exchange Act must comply with the proxy rules under Regulation 14A of the Exchange Act. - These rules require that a proxy statement contain specific disclosures, including material information about the matters that will be voted on, and that the proxy statement be delivered to shareholders that are being asked to vote on those matters. ### Scaled disclosure (Smaller reporting companies and Emerging growth companies) - The SEC rules allow certain type of companies to “scale” their disclosure. These companies fall under two categories: - Smaller reporting companies, which are companies with public equity float of less than $75 million or less than $50 million in annual revenue, and - Emerging growth companies (created under the JOBS Act), which are companies with gross revenues of less than $1 billion during their most recently completed fiscal year. - Overall, under the current framework such companies are allowed to include less extensive narrative in their disclosure documents, in particular in connection with compensation, include financial statements for two years only, and are not subject to the auditor attestation of internal control over financial reporting required by SOX. ### Asset-backed securities (ABS)—disclosure, prospectus, and periodic reporting - Regulation AB: - Disclosure requirements for ABS, both arising from the Securities Act and the Exchange Act, are contained in Regulation AB, which the SEC initially adopted in 2004. - In August 2014, the SEC adopted significant revisions to Regulation AB and other rules regarding the offering process, disclosure, and reporting for ABS as described in Principle 8. - In addition, in 2011, the SEC adopted several rules to implement provisions of the Dodd-Frank Act governing the disclosure for ABS, including requiring disclosure of fulfilled and unfulfilled repurchase requests, requiring issuers to review the assets underlying the ABS, and providing for the suspension of the duty to file reports under Section 15(d) of the Exchange Act. - Prospectus requirements for ABS must include information on the following areas: - (i) disclosure about the transaction parties; - (ii) static pool information (to the extent material); - (iii) pool assets; - (iv) review of assets (the review must be designed and effected to provide reasonable assurance that the prospectus disclosure about the assets is accurate in all material respects. Disclosure about the nature of the review and the findings and conclusions of the review is required to be provided in the prospectus. ABS issuers must also provide disclosure in the prospectus about any assets in the pool that deviate from the disclosed underwriting criteria, including data on the amount and characteristics of those assets that did not meet the disclosed underwriting criteria); - (v) information on significant obligors; - (vi) description of the securities and structure of the transaction; - (vii) credit enhancements; - (viii) use of derivative instruments; - (ix) reports and additional information; and - (x) other disclosure items. - In addition to the disclosure items discussed above, the SEC’s rules also require disclosure of, among other things, the most significant risk factors that make the ABS offering speculative and risky and how those risks affect investors, including tailored disclosure if certain risks affect only certain classes of investors. - Periodic reporting for ABS: - ABS are subject to periodic reporting under the Exchange Act in two circumstances: - If ABS are to be listed on a national securities exchange (registered under Section 12 of the Exchange Act); and - If ABS are not going to be listed on a national securities exchange, an offering of ABS that has been registered under the Securities Act triggers a reporting obligation until the securities registered are no longer held by non-affiliates of the depositor (i.e. the issuer is subject to ongoing periodic obligations as long as the securities are held by non-affiliates). *Italic: IMF staff report content as provided in the source PDF.* ### Section 15(d) of the Exchange Act). ### _cr1591 - Section 15(d) of the Exchange Act) ### Annual reports (ABS issuers) - ABS issuers must file an annual report on Form 10-K with modified requirements. - In lieu of audited financial statements, the issuing entity must file as exhibits to the Form 10-K: - (i) a report on assessment of compliance with the required servicing criteria from each party participating in the servicing function; and - (ii) an attestation report from a registered public accounting firm about the servicer’s assessment of compliance with the required servicing criteria. - A servicer compliance statement must be filed as an exhibit to the Form 10-K addressing the servicer’s compliance with its obligations under the servicing agreement for that particular ABS transaction. - ABS issuers must include a certification pursuant to Section 302 of SOX with their annual report on Form 10-K. - The annual report for asset-backed transactions must be filed within 90 days after the end of the fiscal year covered by the report. ### Quarterly reports (ABS issuers) - In lieu of quarterly reports, an ABS issuer is required to file reports on Form 10-D containing periodic distribution and pool performance information for each distribution period. - Form 10-D must also include certain non-financial disclosures, such as legal proceedings and matters submitted to a vote of security holders that occurred during the period. - The Form 10-D must be filed within 15 days after each required distribution date of the ABS. ### Material events - ABS issuers must file current reports on Form 8-K upon the occurrence of enumerated events as set forth for other reporting issuers. ### Foreign issuers — overview and key differences - Approximately 940 foreign private issuers have registered a class of securities or a transaction and file reports with the SEC under the Exchange Act. - The SEC’s disclosure regime for foreign private issuers differs from U.S. issuers in specific ways: - Foreign private issuers may present financial statements in accordance with: - (i) U.S. GAAP; - (ii) another comprehensive body of accounting standards reconciled to U.S. GAAP; or - (iii) IFRS as issued by the IASB without reconciliation to U.S. GAAP. - Foreign private issuers are permitted to follow home country requirements for disclosure of executive compensation. - Foreign private issuers are required to file annual reports within four months of the fiscal year end. - Foreign private issuers are not subject to the quarterly reporting requirements of the Exchange Act. - Foreign private issuers are not subject to Regulation FD. - Foreign private issuers are exempt from the requirements to file proxy or information statements under the Exchange Act. - Foreign private issuers’ securities are exempt from Section 16 of the Exchange Act (insiders and substantial holdings disclosure). - SEC staff indicated the majority of foreign registered issuers are also listed on a national securities exchange and thus subject to additional exchange-imposed disclosure requirements (for example, at least semiannual reporting). - Exchange listing practice example: - An interim balance sheet and income statement must be provided as of the end of the company's second quarter not later than six months following the end of the second quarter, in English, but they do not have to be reconciled to U.S. GAAP. - Market practice: foreign issuers also routinely provide quarterly statements. ### Advertisements and communications (post-2005 rule amendments) - Since 2005, SEC rules allow issuers to communicate more openly and freely with investors and the marketplace, including: - The largest publicly traded companies (e.g., those with a public float in excess of $700 million, among other criteria) are permitted to engage at any time in oral and written offering communications, subject to enumerated conditions (including, in specified cases, filing the communications with the SEC). - All reporting issuers are permitted, at any time, to continue to publish regularly released factual business information and forward-looking information. - Communications by issuers more than 30 days before filing a registration statement are permitted so long as they do not reference a securities offering that is or will be the subject of a registration statement. - All eligible issuers and offering participants in eligible issuer offerings are permitted to use “free writing prospectuses” generally after the filing of the registration statement, subject to enumerated conditions (including, in specified cases, filing with the SEC). - A broader category of routine communications regarding issuers, offerings, and procedural matters (e.g., schedule for an offering, account-opening procedures) are excluded from the definition of prospectus. - Exemptions for research reports were expanded. - Most of these rules are not available to blank check companies, penny stock issuers, or shell companies. ### Sufficiency of information — SEC tools and measures - Measures supporting robust issuer disclosure include: - Staff’s filing review process: although the Securities Act does not specifically provide for staff review, the staff has assumed a selective review function for registration statements and prospectuses under the Securities Act. - Required certifications relating to the content of disclosure (such as the SOX certifications). - Loss of certain benefits if disclosure obligations are not met consistently and timely (e.g., scaled disclosure or use of shelf registration). - A registration statement stop order, investigation, or enforcement action for violations of disclosure requirements: - Under Section 8 of the Securities Act, the SEC may issue an order preventing or suspending the effectiveness of a registration statement if it believes it includes any untrue statement of a material fact or omits any material fact. - Under Section 12(j) of the Exchange Act, the SEC may deny, suspend, or revoke the registration of a security if the issuer failed to comply with any provision of the Exchange Act or rules thereunder; trading and inducement effects follow such actions. ### Liability — private actions and anti-fraud provisions - The Securities Act provides rights of action against persons involved in the sale of securities: - Section 11: private action for material misstatements or omissions in a registration statement against (i) the issuer; (ii) each of its directors; (iii) each underwriter; (iv) each person signing the registration statement (including principal executive officer, principal financial officer, principal accounting officer); (v) the independent accountant with respect to audited financial statements; and (vi) each expert relied upon in the registration statement. All persons other than the issuer are entitled to certain due diligence defenses. - Section 12: private action against any person who offers or sells a security by means of a prospectus or oral communication in connection with material misstatements or omissions; an ordinary negligence standard applies and the seller may assert a due diligence defense. - Section 17(a): general anti-fraud provision enforceable by the SEC that imposes liability upon any person who commits fraud in connection with the offer or sale of securities. - Exchange Act overlap: since Exchange Act filings are often incorporated by reference into Securities Act filings, issuers may also be liable under Section 10(b), Rule 10b-5, and Section 18 of the Exchange Act. - Market participants noted active exercise of private rights of action and significant market discipline effects. ### Derogations from full disclosure (confidential treatment, trading suspensions) - The SEC may grant confidential treatment of information included in an exhibit if the information is filed for nonpublic review and meets the FOIA legal test for exclusion. - Confidential treatment requests often relate to limited information in material contracts filed as exhibits. - SEC staff undertake a preliminary review of confidential treatment applications to determine full review, targeted issue review, or no review; following resolution, staff may publicly grant an order for confidential treatment of redacted information. - Under Section 12(k) of the Exchange Act, the SEC can temporarily suspend trading in an issuer’s security for up to ten business days. - Exchanges have adopted rules relating to temporary suspension of trading of listed securities in certain circumstances relating to pending announcement of material information (example: Rules 202.06(B) and 202.07 of the NYSE Listed Company Manual). ### Availability of information - The SEC’s website provides public access to the EDGAR system, which provides free electronic access to disclosure documents filed with the SEC. ### Practice — Monitoring program (CF structure and review practice) - Monitoring of issuers’ disclosure obligations under the Securities Act and the Exchange Act is the responsibility of SEC’s CF, comprised of roughly 500 staff. - CF performs reviews through 12 offices organized by industry; these offices comprise approximately 80 percent of CF’s employees. - Each office is staffed with 25 to 35 professionals, primarily accountants and lawyers. - CF is complemented by three specialized offices (created in 2010) focusing on large financial institutions, asset-backed securities and other structured products, and securities offering trends. - CF assigns filings to the review office responsible for the company’s industry. - As required by Section 408 of SOX, CF undertakes some level of review of periodic reports made under Section 13(a) of the Exchange Act of each reporting company at least once every three years. - CF selectively reviews transactional filings (public offerings, business combinations, proxy solicitations). - CF concentrates review resources on critical disclosures that conflict with SEC rules or accounting standards and disclosure that appears materially deficient in explanation or clarity. - Levels of review include: - (i) full cover-to-cover review for compliance; - (ii) financial statement review examining financial statements and related disclosure (e.g., MD&A) for compliance; or - (iii) targeted issue review examining one or more specific items of disclosure. - CF establishes annual review goals and generally focuses on companies comprising the majority of market capitalization (roughly 2,500 companies account for 98 percent of market capitalization). - Historical CF review percentages by fiscal year: - FY 2013: 52 percent; - FY 2012: 48 percent; - FY 2011: 48 percent; - FY 2010: 44 percent; - FY 2009: 40 percent. - Typical review requires four people. - Staff may request supplemental information, revisions to filed disclosure, additional disclosure in a filed document, or additional/different disclosure in a future filing. - When all comments are resolved, CF provides a “no further comment” letter; comment letters and company responses are published on EDGAR no earlier than 20 business days after CF completes its review or declares a registration statement effective. The “no further comment” letter is included in the public posting. - For Securities Act transactional filings, staff seeks to provide initial comments on filings selected for review within 30 days of the filing date; this 30-day target has become a de facto industry expectation. There is no comparable target for Exchange Act filings. - The Office of Disclosure Standards (created in 2013) has roughly 15 staff and evaluates outcomes of CF’s filing review program and creates a self-assessment structure, providing comments and recommendations to CF (e.g., highlighting inconsistencies). - CF staff indicated the SEC is engaged in a comprehensive review of disclosure requirements to assess effectiveness and eliminate potential duplications. ### Enforcement initiatives and specialized task forces - The SEC has instituted a Delinquent Filings Program whereby the Division of Enforcement investigates failures to make required filings and prosecutes civil actions and administrative proceedings. - Enforcement initiatives include: - The Financial Reporting and Audit Task Force, focusing on financial reporting and accounting fraud. - The Microcap Fraud Task Force, monitoring and pursuing misconduct related to microcap securities (targeting false/misleading marketing campaigns, manipulative trading strategies, executives, gatekeepers, repeat players; aims to identify and shut down schemes early). - The Cross-Border Working Group, focusing on companies with substantial foreign operations publicly traded in the U.S.; to date, the SEC has filed fraud cases against more than 65 foreign issuers or executives and deregistered the securities of more than 50 companies. ### Municipal securities — market size, investor composition, and regulatory carve-outs - Outstanding amount of municipal securities as of 2014: roughly US$ 3.7 trillion. - Number of different municipalities issuing debt: roughly 45,000. - Annual bond issues: approximately 12,000 bond issues on an annual basis with an issue size of an average of US$25 million. - Retail investor holdings: - Direct retail holdings estimated at roughly 45-50 percent of total outstanding debt. - Indirect holdings (through CIS) estimated at about 25 percent. - Historical rates of default: - Municipal securities: less than 1 percent. - Issuers of corporate debt: 11-13 percent. - Rate of default for non-municipal conduit issuers has been higher (no exact figure provided). - Municipal securities (including obligations of non-municipal conduit borrowers) are exempted from the registration and reporting requirements established by the Securities Act and the Exchange Act. - The “Tower Amendment” to the Exchange Act prohibits the SEC and the MSRB from requiring state and local government issuers of municipal securities, either directly or indirectly through their underwriters, to make any specific disclosure filing with the SEC or MSRB prior to the sale of these securities. - Antifraud provisions remain applicable. *Source: _cr1591 - Section 15(d) of the Exchange Act).* ### Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 ### Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 ### Application to municipal securities and Rule 15c2-12 - Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 promulgated thereunder apply to transactions in municipal securities. - Federal regulators are prohibited from directly requiring issuers to file presale information on municipal securities, but the SEC adopted rules applicable to BDs acting as underwriters relating to primary market and continuing disclosures. - Using its authority over BDs and its broad authority to prevent fraud in connection with the offer, purchase, or sale of securities, the SEC adopted Rule 15c2-12 in 1989. - Rule 15c2-12 and accompanying guidance require underwriters of municipal securities to obtain and review issuers’ official statements and provide them to investors. - The rule was amended in 1995 to require underwriters to reasonably determine that issuers have entered into a written continuing disclosure agreement to provide: - (i) annual financial information and operating data of the type included in the official statement and, if available, audited financial statements; and - (ii) notices of certain material events. - Beginning in 2009, issuers have been required by the agreements to provide the continuing disclosure information and data to the Electronic Municipal Market Access (EMMA) database held by the MSRB (either directly or by engaging a third-party dissemination agent to submit such information and data on their behalf). ### Findings from GAO and SEC reports; disclosure quality issues - The GAO issued reports on the municipal market in 2011 and 2012 and the SEC issued a report on the municipal market in 2012. - These reports found significant challenges in the quality, consistency and timeliness of disclosure by municipal issuers and with mechanisms available to enforce compliance with contractual disclosure obligations. - The SEC report provided recommendations including: - legislative proposals to provide the SEC with additional authority to impose disclosure requirements on municipal issuers; and - proposals for actions within the current scope of the authority of the SEC. ### SEC organizational and enforcement responses - The SEC created the Office of Municipal Securities to coordinate its municipal securities activities. The Office: - works closely with the municipal securities industry to educate state and local officials and conduit borrowers about risk management issues and SEC policies; - reviews and processes MSRB rule filings; and - acts as the Commission's liaison with the MSRB, FINRA, and various industry groups on municipal securities issues. - The Division of Enforcement created the Municipal Securities and Public Pensions Unit (MSPPU) in 2010 to focus on enforcement in the municipal securities market and in connection with pension funds for state and local government employees. - MSPPU enforcement highlights include: - the first case charging a municipal issuer with falsely stating to bond investors that it had been providing the required annual financial information and notices in its prior bond offerings; and - the first case against an underwriter charging violations of the MSRB’s pay-to-play rule for “in-kind” political donations. - MSPPU launched the Municipalities Continuing Disclosure Cooperation Initiative to encourage issuers and underwriters who made false representations as to prior compliance with Rule 15c2-12 filing requirements to self-report in exchange for favorable settlement terms. ### Assessment and comments on the disclosure regime - Assessment: Broadly Implemented - Main reason for the grade: the disclosure regime applicable to offerings of municipal securities. - Observations: - U.S. legal and regulatory framework subjects issuers of securities offered to the public to robust disclosure at offering and on an ongoing basis, but municipal securities are exempt from the registration and reporting requirements of the Securities Act and the Exchange Act. - Indirect mechanisms have made municipal issuers subject to disclosure obligations at offering and on an ongoing basis; however, GAO and SEC reports and conversations with market participants and SEC senior staff indicate these indirect mechanisms have been insufficient to ensure consistency and quality of information provided (including the accounting principles used) and consistency in timeliness of such information to investors. - The MSPPU is of recent creation (2010), and it is too early to assess whether increased enforcement focus alone, without additional direct SEC authority, can bring municipal issuer disclosure to a satisfactory level. - The municipal securities market has a significant level of retail participation; although historical default rates have been low, these securities are exposed to default risk. This legal gap in statutory authority affected the grade. - Additional issues noted (not taken into account for the grade): - SEC-imposed obligations to disclose material events are limited to a list of predefined events; there could be material events not communicated until quarterly reports. The deadline to communicate material events included in the list appears long compared with international best practices. Exchanges impose on listed companies a general obligation to disclose events that can affect the price of securities on a prompt basis (understood to mean immediate release); most issuers of registered securities are listed, so this issue was not considered for the grade. - Foreign issuers are not subject to periodic reporting other than an annual report, so the regime does not provide a similar level of disclosure as domestic issuers. However, these issuers are generally listed and thus subject through their listing to stronger disclosure obligations. - On periodic reporting thresholds: - Assessors consider linking periodic reporting obligations to a minimum level of dispersion of a company's securities reasonable; however current thresholds—established by law—appear high, leaving shareholders of companies with an already high level of dispersion without the benefit of periodic information. This applies especially to banks and bank holding companies. ### Principle 17 — Holders of securities should be treated in a fair and equitable manner: Background - Shareholder rights and corporate governance are governed by: - State corporate law: formation and incorporation, and governance terms among shareholders, the board, and management; - Corporate chartering documents: state law allows chartering documents to provide for different rights than statutory provisions (Delaware Corporate Law is especially relevant); - Federal securities laws: the Securities Act and the Exchange Act regulate offerings/sales and ongoing disclosure by public company issuers; the Exchange Act also regulates proxy solicitation; and - Exchange rules: corporate governance listing requirements of exchanges including the NYSE and NASDAQ. ### Voting - State corporate laws cover shareholders’ voting rights: - Right to vote under one share one vote unless otherwise provided in the certificate of incorporation (DGCL 212(a)); - Corporation may provide different voting rights by issuing more than one class or series of stock as stated in the certificate of incorporation (DGCL Section 151); - Right to authorize another person to act for a stockholder by proxy (DGCL Section 212(b)); - Need for written notice not less than 10 and not more than 60 days before the day of the meeting (DGCL Section 222); - Record date fixing rules: record date must not be more than 60 or less than ten days before the date of the meeting; if adjourned, board may fix a new record date observing the same 60 day/ten day notice provisions (Section 213). - Federal securities laws complement state law in proxy voting: - Proxy statement disclosure pursuant to Schedule 14A under the Exchange Act must set forth date, time, place of meeting and record date; requires disclosure of how stockholders may exercise votes, the voting powers of each class or series, and availability/effect of cumulative voting (if any). - Schedule 14C applies where actions are taken in lieu of a meeting; information must cover applicable items in Schedule 14A. - Domestic issuers have obligations under proxy rules to distribute proxy and soliciting material to banks and brokers timely for forwarding to beneficial owners. - Exchange rules complement these obligations: - Notice of meetings: Section 401.01 of the NYSE Listed Company Manual requires immediate publicity for a shareholders’ meeting where any matter affecting rights or privileges of shareholders or any other non-routine matter is to be considered; - Notice to exchanges: Section 401.02 of the NYSE Listed Company Manual requires a company to notify the exchange a minimum of ten days prior to the record date of any stockholders meeting called (Nasdaq does not require the notice if a proxy statement is filed via EDGAR); - Time of meetings: NYSE recommends a minimum of 30 days between record and meeting dates (Section 401.03); - Proxy voting: Section 402.04 of the NYSE Listed Company Manual and Section 5620 of the NASDAQ Listing Rules require companies to solicit proxies from all stockholders, whether registered or beneficial owners; - Rights of shareholders: Section 313.00 of the NYSE Listed Company Manual and Section 5640 of the NASDAQ Listing Rules provide that voting rights of existing shareholders cannot be disparately reduced or restricted through corporate actions or issuances (examples listed). ### Election of directors - State corporate laws require an annual meeting for election of directors (DGCL Section 211(b)). - Cumulative voting is possible if provided for in the certificate of incorporation (DGCL Section 214). ### Corporate changes affecting terms and conditions of securities - Amendments to certificate of incorporation that would increase/decrease authorized capital, cancel or affect shareholder rights, or create new classes of stock (DGCL Section 242(a)) generally require: - board adoption of a resolution declaring advisability and calling a special meeting or directing consideration at the next annual meeting; and - approval by a majority of outstanding stock entitled to vote and a majority of outstanding stock of each class entitled to vote thereon as a class. - Exchange rules: - NYSE Section 204.13 requires at least 20 days’ advance notice for proposed changes in form or nature of listed securities or rights attached to such securities (filing of a listing application required). - NYSE Section 312.03 requires shareholder approval for: - (i) issuances resulting in common stock with voting power equal to or in excess of 20 percent; - (ii) issuances in a change of control of the issuer; - (iii) issuance of securities in an equity compensation plan; or - (iv) issuance of common stock in transactions with related parties if the number of shares to be issued or converted exceeds either 1 percent of the number of shares of common stock or 1 percent of the voting power outstanding before the issuance. - NASDAQ Section 5635 has similar shareholder approval requirements. ### Other fundamental corporate changes - Mergers and consolidations: - DGCL Section 251 requires the board to adopt a resolution regarding proposed merger or consolidation and either call a special meeting or direct consideration at the next annual meeting at least 20 days prior to the meeting; notice must contain the agreement or a brief summary. Adoption generally requires approval of shareholders holding a majority of outstanding stock entitled to vote, with limited exceptions. - Transfer of assets: - DGCL Section 271(a) permits sale, lease, or exchange of all or substantially all property and assets only if the board deems it expedient and shareholders holding a majority of outstanding stock entitled to vote adopt a resolution at a meeting called upon at least 20 days’ notice; notice must state the resolution will be considered. - Appraisal rights: - DGCL Section 262(c) permits a corporation to provide in its certificate of incorporation for appraisal rights for any class or series of stock as a result of amendment, merger/consolidation, or sale of all or substantially all assets. DGCL Section 262(b) also confers appraisal rights where shareholders are required in the merger to accept cash or certain other consideration for their shares. - Dissolution: - DGCL Section 275(a) permits dissolution if deemed advisable by the board and shareholders holding a majority of outstanding stock entitled to vote adopt a resolution at a meeting called for that purpose. ### Tender offers and acquisition-related protections - Federal securities laws and SEC rules do not contain a specific statutory definition of tender offer; judicial decisions have enumerated eight non-exclusive factors to determine whether a transaction constitutes a tender offer: - (i) active and widespread solicitation of public shareholders; - (ii) solicitation for a substantial percentage of the target’s stock; - (iii) offer at a premium above the prevailing market price; - (iv) terms are firm rather than negotiable; - (v) offer contingent on tender of a fixed minimum number of shares; - (vi) offer open for a limited period of time; - (vii) shareholders subject to pressure from the bidder to sell; and - (viii) bidder publicly announces intention to gain control and then rapidly accumulates stock. - In practice, acquisitions via open market transactions or private agreement generally would not trigger federal tender offer requirements. - State law features that create disincentives to acquire control other than negotiation with the board or a full tender offer: - Directors owe fiduciary duties to shareholders; courts apply enhanced scrutiny to board actions in change-of-control transactions. - Business combination statutes prohibit certain transactions between the company and an interested stockholder. Example: in Delaware an acquirer of 15 percent or more of a company’s outstanding stock is prohibited from engaging in certain transactions with the company unless either: - its acquisition of stock has been approved in advance by the board of directors; or - it owned at least 85 percent of the company’s outstanding stock after the transaction in which it became an interested stockholder. To reach that 85 percent level, as a practical matter, an acquiring person would need to make a tender offer to all stockholders. - Transactions with a controlling stockholder are subject to strict “entire fairness” review by the courts unless procedural safeguards (e.g., independent committee, majority of the minority approval) are in place to protect minority stockholders. *International Monetary Fund — Section excerpt from the U.S. country report chapter on securities regulation and corporate governance.* ### Section 14(d) and corresponding Regulation 14D apply to all tender offers for Exchange Act ### _cr1591 - Section 14(d) and corresponding Regulation 14D apply to all tender offers for Exchange Act ### Scope and applicability - Section 14(d) and Regulation 14D apply to all tender offers for Exchange Act registered equity securities made by parties other than the issuer provided that upon consummation of the tender offer the offeror would beneficially own more than 5 percent of the class of equity securities subject to the offer. - An offeror must include any shares it owns before the commencement of the tender offer in calculating the 5 percent amount. - Such offers are subject to a set of disclosure and procedural safeguards summarized below. ### Disclosure requirements - Section 14(d) requires any person or group intending to make a tender offer to file with the SEC a disclosure document on Schedule TO outlining the terms of the offer. - A copy of Schedule TO must be delivered to the target issuer and any competing offerors. - Schedule TO is immediately available to the public via the EDGAR system. - Rules 14d-4(c) and 14d-6(d) require an offeror to disclose promptly any material change in information previously disseminated and to give security holders adequate time to consider the new information. ### Time to consider the offer - Rule 14e-1(a) of Regulation 14E requires that an offer remain open for a minimum offering period of 20 business days from the date the offer commences. - Rule 14e-1(b) of Regulation 14E requires that the offer remain open for ten business days following a change in the offering price or the percentage of the class of securities being sought. - If the offering period is extended voluntarily or involuntarily, notice of such extension must be provided pursuant to Rule 14e-1(d) of Regulation 14E by press release or other public announcement prior to 9:00 a.m. Eastern time and identify the number of securities tendered. ### Withdrawal rights and proration - Under Rule 14d-7(a), an offeror may not purchase securities during a time in which a security holder maintains the right to withdraw the securities; effectively the offeror is prohibited from purchasing any tendered securities until the offering period has expired. - Rule 14d-8: where more shares are tendered in a partial tender offer within the first ten calendar days of an offer than the offeror is bound or willing to take up, the securities must be taken up pro-rata, disregarding fractions, according to the number of securities deposited by each tendering security holder. ### Best price protections and payment - Rule 14d-10 requires that each tendering security holder must receive the highest consideration paid to any security holder during the period of the tender offer. - Rule 14e-1(c) of Regulation 14E requires that the offeror promptly pay for or return securities when the tender offer expires. - Antifraud provisions (mainly Section 14(e) of the Exchange Act) apply in connection with a tender offer. ### Obligations of the target company - Rule 14d-9 requires the target of the tender offer to send to security holders specific disclosure about its recommendation, file a Schedule 14D-9 containing that disclosure, and send the Schedule 14D-9 to the offeror. - Tender offers featuring an offer to exchange securities are further subject to having the securities offering aspect of the transaction registered under the Securities Act. ### Issuer tender offers (Rule 13e-4) - Rule 13e-4 regulates cash tender offers and exchange offers by issuers for their equity securities and applies to issuer affiliates where the tender offer is not subject to Section 14(d). - Rule 13e-4 applies even if the class of securities sought is not registered under Section 12 and regardless of the amount of securities sought. - Rule 13e-4 provides disclosure, filing and procedural safeguards generally mirroring Section 14(d)/Regulation 14D. - Rule 13e-4 defines certain fraudulent, deceptive, or manipulative acts or practices and prescribes disclosure and dissemination requirements to prevent such acts. - Rule 13e-4 requires an issuer making a cash tender offer or exchange offer to allow tendering security holders the opportunity to withdraw tendered securities. - Rule 13e-4(f)(8) (“equal treatment provision”) provides the offer must be open to all security holders in the class subject to the offer and that each tendering security holder must receive the highest consideration paid to any security holder during the period of the tender offer. ### Other change of control transactions - State corporate law generally would not apply to a change of control transaction if the transaction does not involve a business combination or shareholders’ vote; federal securities laws would not apply if the transaction does not involve a tender offer, an offer of securities, or a shareholders’ vote. - Depending on circumstances, disclosure obligations might apply (e.g., Schedule 14C information statements where management may control sufficient shares to constitute a quorum and produce a favorable vote, or where a solicitation of proxies is made only to certain security holders or certain security holders act by written consent). ### Ownership registration and transfer of shares - Under the DGCL, the officer in charge of the stock ledger must prepare at least ten days before every meeting a complete list of the stockholders entitled to vote; the list must remain accessible to any stockholder during the meeting. - Exchange rules may require the use of a qualified registrar (most often a transfer agent) to perform a registrar function. ### Receipt of dividends and other distributions - State corporate laws are the primary source of regulation on payment of dividends; typically a declared cash dividend on common stock must be paid to stockholders of record on the declared record date. - Federal securities laws (Regulation S-K) require disclosure relating to dividends in registration statements and annual reports. - Exchange listing rules may require notice to the exchange regarding dividends (examples cited from NYSE and Nasdaq listing rules). ### Responsibility of directors - DGCL 141(a) provides that the business and affairs of a corporation are to be managed or under the control of its board of directors. - Delaware common law imposes fiduciary duties (duty of care and duty of loyalty) on directors; jurisprudence addresses subsets of duty of loyalty, including good faith and candor. - Remedies for shareholders include DGCL Section 102(b) (certificate of incorporation may not eliminate or limit personal liability of a director under certain circumstances), shareholder derivative lawsuits, and individual actions by directly injured stockholders. ### Bankruptcy or insolvency of the company - The Bankruptcy Code provides two primary routes for business bankruptcy: - Chapter 11: company attempts to reorganize; management usually continues day-to-day operations but significant decisions require bankruptcy court approval. - Chapter 7: company stops operations and liquidates; a trustee liquidates assets to pay creditors and investors per federal bankruptcy rules. - Public companies generally file under Chapter 11 and may continue filing SEC reports and disclosing material information while securities continue to trade. - The SEC has statutory authority to participate in all Chapter 11 cases but generally limits activity to large public company cases, focusing on: - (i) ensuring plans and disclosure statements contain adequate information; - (ii) ensuring public investors are adequately represented by an official committee, if appropriate; - (iii) ensuring Bankruptcy Code exemptions from Securities Act registration are not misused; - (iv) participating in legal issues affecting the rights of public investors (e.g., improper efforts by debtors to shield officers and directors from lawsuits for securities fraud). - The SEC reviews disclosure of reorganization plans but does not get involved in the economic terms of plans. ### Beneficial ownership reporting (Sections 13(d) and 13(g)) - A person who beneficially owns, following an acquisition, more than 5 percent of a voting class of equity security registered under the Exchange Act must file a Schedule 13D within ten days after the acquisition; Schedule 13D must contain the percentage owned and reasons for the acquisition (including intent to acquire control). - Section 929R of the Dodd-Frank Act authorizes the SEC to shorten the initial filing deadline for Schedules 13D; the SEC has not initiated formal regulatory action to shorten the current ten-day initial reporting period. - Material changes must be disclosed in an amended filing, filed promptly; under the rules, acquisition or disposition of beneficial ownership equal to 1 percent or more of the class is deemed material (though smaller changes may be material). - Schedule 13G (short-form) is available to certain institutional investors holding securities in the ordinary course and not with a control purpose: - Schedule 13G must be filed within 45 days after December 31 of the year in which the 5 percent threshold was exceeded. - Amendments to Schedule 13G filings must be filed on an annual basis and no later than 45 days following the end of the calendar year in which the information previously reported changes regardless of materiality. - Other classes of investors (not beneficial owners of 20 percent or more) may file Schedule 13G if acquisition is not for the purpose of acquiring control; for these investors the initial filing due date is ten days after the acquisition that caused the five percent threshold to be exceeded. - When two or more individuals or entities come together for the purpose of acquiring, holding or disposing of a company’s securities, the group is deemed a single “person” for filing requirements under Sections 13(d) and 13(g); a Schedule 13D or Schedule 13G must be filed by group members when they collectively beneficially own more than 5 percent of the class. - Beneficial ownership of directors and executive officers as a group and any person known to the issuer to be the beneficial owner of more than 5 percent of any class of voting securities must be disclosed in annual reports pursuant to Item 403 of Regulation S-K. - All these reports are immediately available to the public via EDGAR. ### Insiders and substantial holdings — issuer disclosure - Issuers must disclose, as of the most recent practicable date, in a specified tabular format for each class of equity securities: - beneficial ownership of all directors and nominees (naming them); - each of the five mostly highly compensated executive officers (naming them); - all directors and executive officers as a group (without naming them). - Disclosed information must include title of class of securities, name of beneficial owner, amount and nature of beneficial ownership, and percent of the class; must specify shares pledged as security and shares the named persons have the right to acquire. - This disclosure must appear in a prospectus for an offering under the Securities Act and in a registration statement under the Exchange Act, and be updated at least yearly in the annual report or in the issuer’s proxy or information statement in connection with the election of directors. ### Section 16 reporting regime (insider reporting) - Section 16 applies to every officer and director of an issuer with a class of equity securities registered under Section 12 and any person who beneficially owns more than 10 percent of the class of equity securities registered under Section 12. - Upon becoming a reporting person or upon Section 12 registration, Section 16(a) requires filing an initial ownership report with the SEC disclosing beneficial ownership within 10 days of becoming a reporting person or on or before the effective date of the Section 12 registration statement. - Section 16(a) requires reporting persons to report changes in such ownership, or the purchase or sale of an SBS or SBS agreement involving such equity security, before the end of the second business day following the day on which the subject transaction was executed. - The SEC has adopted rules exempting insiders from reporting some changes in security ownership (e.g., routine acquisitions pursuant to broad-based, non-discriminatory employee benefit plans). - Insiders delinquent in current transaction reporting, or engaging in transactions for which deferred reporting is permitted (e.g., bona fide gifts), must file an annual statement to report previously unreported transactions. - All Section 16 filings must be filed electronically through EDGAR and are immediately publicly available on filing. - The SEC’s Delinquent Filings Program applies to Section 16 filings; the SEC has brought enforcement actions against insiders who have not complied. ### Foreign issuers and corporate governance differences - Prospectuses and annual reports must disclose material “risk factors”; foreign private issuers frequently disclose differences in shareholder rights between the foreign jurisdiction and the United States or provisions of foreign corporate law or charter documents that materially affect shareholder remedies. - Since September 2008, the SEC requires annual reports of foreign private issuers listed on a U.S. exchange to provide a concise summary of significant ways corporate governance practices differ from those followed by U.S. companies under the relevant exchange’s listing standards. ### Review of transaction files and enforcement - CF (the SEC division) is the main SEC division responsible for monitoring issuers’ compliance with federal securities laws and would review transactional filings (e.g., those submitted in connection with a tender offer) and notifications of holdings obligations. - Violations of shareholders’ rights that do not involve federal securities law obligations must be taken by shareholders to the judiciary; Delaware courts provide abundant precedent on fiduciary duties of board members. ### Assessment — implementation and comments - Assessment: Fully Implemented - Comments: - U.S. legal regime allows companies that offer securities to the public significant freedom in structure and shareholder rights (e.g., dual class shares) with robust disclosure in prospectuses and related filings about actual shareholder rights. - Directors are subject to strong fiduciary duties enforceable through the judiciary; assessors consider the framework complies with Principle 17 in respect to treatment of shareholders. - Certain mechanisms to acquire control do not constitute a tender offer and therefore do not trigger federal securities law obligations (including equal treatment of shareholders); state corporate law features create disincentives for parties to acquire control other than by negotiating with the board in statutory mergers or making a tender offer for all shares. - Foreign issuers may follow domestic frameworks relating to shareholders’ rights, subject to robust disclosure obligations including descriptions of differences in shareholder rights in prospectuses. - The deadline for submission of the first “insider” report appears long compared to other jurisdictions; however, once the first report has been filed, any changes in holdings must be reported within 2 days. ### Accounting standards and audited financial statements (Principle 18) - Regulation S-X requires issuers’ registration statements to include audited financial statements: balance sheet, profit and loss statement, statement of comprehensive income, statement of cash flows, and statement of changes in equity. - Financial statements for each year presented must be audited by an independent public accountant registered with the PCAOB. - Annual reports and quarterly reports under the Exchange Act must also include financial statements as described; unaudited interim financial statements are required to be reviewed by an independent public accountant registered with the PCAOB. - Section 108 of SOX gives the SEC authority to recognize the standards of a standard setting body as “generally accepted” for U.S. federal securities laws, subject to criteria about the nature, governance, funding, capacity to consider changes to accounting principles, and ability to assist the SEC in improving financial reporting accuracy and investor protection. *Source: _cr1591 - Section 14(d) and corresponding Regulation 14D apply to all tender offers for Exchange Act* ### Section 108, however, ratified the SEC’s authority to establish accounting principles or standards ### _cr1591 - Section 108, however, ratified the SEC’s authority to establish accounting principles or standards ### SEC authority and presentation of financial statements - Section 108 ratified the SEC’s authority to establish accounting principles or standards for purposes of enforcement of the securities laws. - Pursuant to Section 108 authority the SEC has recognized the standards of the FASB as “generally accepted”. - The financial statements of U.S. public companies whether in the annual or interim reports are required to be prepared and presented in accordance with U.S. GAAP. - Under SEC rules, the financial statements of foreign private issuers may be presented in accordance with: - (i) U.S. GAAP; - (ii) another comprehensive body of accounting standards reconciled to U.S. GAAP; or - (iii) IFRS as issued by the IASB without reconciliation to U.S. GAAP. - Each company may elect the basis of presentation. - U.S. GAAP comprises standards and interpretations established by the FASB and its predecessors, as modified or supplemented by rules and guidance from the SEC and its staff. - SEC staff indicated that the SEC has rarely used its authority to supplement the standards (the last substantive time was roughly 35 years ago in connection with oil and gas companies); what is more common is the issuance of guidance on how to interpret them. ### FASB: mission, governance, funding, and standard setting - Mission: - To establish and improve standards of financial accounting and reporting that foster financial reporting by non-governmental entities that provides decision-useful information to investors and other users of financial reports. - Guiding principles include: - To be objective in its decision making; - To actively solicit and carefully weigh the views of stakeholders; - To issue standards only when the expected benefits exceed the perceived costs; - To issue high-quality standards; - To manage the process of improving standards in ways that balance the desire to minimize disruption of accounting and financial reporting processes with the need to improve the decision-usefulness of information in financial reports; - To provide clear and timely communications; and - To review the effects of past decisions and interpret, amend or replace standards in a timely fashion if such action is indicated. - Governance and advisory bodies: - The FASB is overseen by the Financial Accounting Foundation (FAF) which is responsible for selecting the seven full-time FASB members, selecting members of its advisory council and ensuring adequate funding of its activities. - The FAF is an independent, non-profit organization run by a Board of Trustees of between 14 and 18 members. - The FASB is supported by the Financial Accounting Standards Advisory Council, responsible for consulting with the FASB as to technical issues on the FASB’s agenda and project priorities. - Funding: - Funding is received through an annual accounting support fee assessed against issuers as provided for under Section 109 of the Sarbanes-Oxley Act. - Standard setting process: - The FASB describes itself as “committed to following an open, orderly process for setting standards”. - Standard setting meetings (including those of the Emerging Issues Task Force) are open to the public and information about the status of all projects is available on its website. - Proposed standards may be developed with input from task forces, working groups and public roundtables. - The FASB exposes its proposed standards and interpretations for public comment; comments received are discussed in public meetings and the proposed standard is re-deliberated by the Board in light of the public input received. - Market participants expressed positive views about the standard setting process, in particular its transparency and the thoroughness of the consultation. - FASB standards do not require formal approval from the SEC; in practice the SEC staff closely monitors FASB standards development so that any input necessary is given as part of the standard setting process. ### Enforcement of accounting standards and SEC actions - SEC staff selectively reviews the financial information contained in prospectuses, listing documents, registration statements, periodic reports, ongoing material disclosure reports, and proxy statements. - Reviews assess: - Compliance with accounting standards and reporting requirements; - Compliance with auditing standards and reporting requirements; - Accuracy and completeness of disclosure; - Timeliness and other qualities. - Review process: - If staff notes a perceived accounting or disclosure deficiency during review, the staff will send a comment letter to the company setting forth specific concerns. - The company may address the staff’s comments in a response letter. - Financial Reporting and Audit Task Force (created July of 2013): - Purpose: to renew SEC focus on financial reporting and accounting fraud. - Background: in the wake of the financial crisis the SEC devoted significant resources to financial crisis cases while fewer accounting fraud investigations were undertaken. - Investigation and enforcement activity comparisons: - In FY2012 the SEC opened 124 financial fraud/issuer disclosure investigations compared to 304 in FY2006 and 228 in FY2007. - The SEC filed 79 financial fraud/issuer disclosure actions in FY2012 compared to 219 in FY2007. - The task force has about 12 staff, both lawyers and accountants. - Objectives and coverage include: - (i) the manner in which management and auditors make decisions with respect to reserves; - (ii) revenue recognition; - (iii) independence violations by auditors; and - (iv) audit committees. - Recent enforcement examples cited: - The SEC charged three top executives at a publicly-traded fund with overstating the company’s assets during the financial crisis by failing to fairly value its debt securities and certain collateralized loan obligations. - The SEC charged a Fortune 200 company for various accounting deficiencies that distorted their financial reporting to investors in the midst of the financial crisis. ### PCAOB: establishment, structure, funding, staffing, registration, and oversight - Establishment and jurisdiction: - Section 101 of SOX established the PCAOB to oversee the audits of public companies. - The Dodd-Frank Act expanded PCAOB jurisdiction to also cover BDs’ audits. - Structure and board: - SOX created the PCAOB as a non-profit corporation, under the oversight of the SEC. - Its board is composed of five members, including two CPAs. - All members serve on a full time basis and must be independent from the audit profession. - The SEC selects the board members. - Funding: - Similar to the FASB, the PCAOB receives funding through an annual accounting support fee, as provided for under Section 109 of SOX. - The issuer accounting support fee is allocated between equity issuers and investment company issuers in relation to their market capitalization. - As of 2014, 8,217 issuers were subject to fees. - The largest 100 issuers pay 42 percent of issuer fees. - Staffing and challenges: - At the time of the assessment the PCAOB had 809 staff, the majority in its Division of Registration and Inspections. - According to the PCAOB Chair, a key challenge is the Board’s ability to compete with large firms for talent; however, the Chair indicated that overall the PCAOB is able to offer competitive salaries given its private sector status and funding model. - Registration requirement (Section 102 and 106 of SOX and PCAOB Rule 2100): - Each public accounting firm (including foreign firms) must register with the PCAOB if the firm: - (i) prepares or issues any report with respect to any issuer, broker or dealer; or - (ii) plays a substantial role in the preparation or furnishing of an audit report with respect to any issuer, broker or dealer. - The term issuer is defined as an issuer the securities of which are registered under Section 12 of the Exchange Act (listed issuer) or that is required to file reports under Section 15(d) of the Exchange Act (issuer with a registration statement filed with the SEC or that files or has filed a registration statement that has not yet become effective under the Securities Act and that it has not withdrawn). - The term substantial role has been defined as performing material services or performing the majority of the audit with respect to a subsidiary or component that constitutes 20 percent or more of the assets or revenues of the issuer. - Registration practice and requirements: - Under PCAOB rules, the PCAOB will not register a firm unless it finds that registration is consistent with the Board's responsibilities under SOX to protect the interests of investors and to further the public interest in the preparation of informative, accurate, and independent audit reports. - In practice registration requirements are limited; PCAOB staff indicated the reason is not to create barriers to competition. - Registration includes requirements such as being duly licensed in the respective state (or another country); a clean disciplinary record; an adequate description of the firm’s systems of quality control; and the ability to cooperate with the PCAOB (the latter consideration incorporated in 2010 due to challenges accessing working papers in certain foreign jurisdictions). - Licensing requirements for individual auditors: - Vary by state but in general include the need for an accounting degree and continuing education. - Registration staffing and firm population: - There are currently six staff in charge of firm registration. - PCAOB staff indicated that it infrequently denies an application for registration. - There are currently about 800 firms that conduct audits of issuers – the majority of them audit fewer than five issuers. *Source: _cr1591 - Section 108, however, ratified the SEC’s authority to establish accounting principles or standards* ### Section 104 of SOX requires the PCAOB to conduct a continuing program of inspections to ### _cr1591 - Section 104 of SOX requires the PCAOB to conduct a continuing program of inspections to ### Inspection mandate and scope (Section 104 of SOX) - Inspections are to be performed annually for firms that provide audit reports for more than 100 issuers and at least once every three years for most other registered firms. - The PCAOB is required to provide a written report for each inspection to the SEC, and to make portions of the reports publicly available. ### PCAOB inspection staffing and experience - The PCAOB currently has 504 staff dedicated to the inspection programs. - Staff composition and experience: - Auditors with a minimum of 6 years of experience. - Inspection team leaders for the large annually inspected firms have an average of 30 years of relevant experience. - Inspection team members assigned to the global network firms have an average of 16 years of relevant experience. ### Inspection program structure - Two inspection programs: - Global Network firms program: - Includes U.S. firms subject to annual examination along with their non U.S. affiliates. - Currently 6 global network firms are subject to annual examination. - Approximately 170 non U.S. firms affiliated with such firms are subject to triennial examination. - Non affiliate firms program: - Three of these firms audit more than 100 issuers and are therefore subject to annual inspections. - The remaining firms are inspected on a triennial basis. - On average the PCAOB inspects 175 firms per year. - Risk assessments may motivate more frequent inspections for triennially inspected firms. ### Non-U.S. inspections and cooperative frameworks - Non-U.S. inspections have been conducted since 2005 using: - (i) PCAOB-only inspections (PCAOB conducts inspection on its own in coordination with the home country regulator); and - (ii) inspections conducted jointly with the home country regulator. - The PCAOB has entered into formal cooperative arrangements with several countries. - Under a cooperative framework for non-U.S. inspections adopted by the Board, the PCAOB may rely on inspection work performed by the home country regulator. - The Dodd-Frank Act provided the PCAOB with the authority to share confidential information with foreign audit oversight authorities. - PCAOB staff highlighted access challenges to working papers in a number of jurisdictions, including China and some European countries, due to local confidentiality provisions. - The PCAOB publishes and regularly updates a list identifying each issuer whose PCAOB-registered auditor is located in a jurisdiction where obstacles to PCAOB inspections exist. - Progress noted with China in connection with the development of a framework for cooperation. - The SEC has taken enforcement actions against affiliates of the big four for allegedly failing to produce audit work. ### Inspection process, reporting, and remediation - Inspection process includes fieldwork review of firms’ systems of quality control and audit engagements. - Audit engagements for review are generally selected based on an assessment of risk factors (including the size of the issuer, the sector that it belongs to, etc.). - Preliminary draft reports go through multiple levels of internal PCAOB review and evaluation including by inspection staff, staff in the office of the Chief Auditor and in the Office of the General Counsel. - Firms are provided the draft report and may provide a written response; inspection staff can make changes based on such response. - Final report is sent to the Board for issuance; when satisfied, the Board issues a final report and transmits it to the firm. - All PCAOB inspection reports have a public portion and most also have a non-public portion. - Public portion: describes the inspection process and any identified audit deficiencies that inspection staff judged to have resulted in an audit opinion that was insufficiently supported when issued. - Non-public portion: may provide additional discussion of deficiencies; criticisms of firms’ system of quality control; and potentially other process issues related to the firm, such as the possibility of Board disciplinary actions. - Remediation and confidentiality: - If the PCAOB issues a final inspection report that contains criticisms of, or potential defects in, a firm’s quality control systems, the firm may avoid having that portion of the report become public by addressing that criticism to the Board’s satisfaction within 12 months of the date of the PCAOB report. - For the largest firms there is a team assigned to follow up on remediation actions and there is communication throughout the year on the plan for remediation and the status of actions taken. - For smaller firms, the PCAOB assigns a staff in charge of follow up, but the level of contact varies. - The PCAOB cannot disclose to an audit committee the non-public portion of an inspection report or other non-public inspection information—including whether the inspection identified deficiencies in the audit that the audit committee oversees—and the PCAOB Board cannot compel an audit firm to disclose such information to an audit committee. - The audit committee can request such information from the audit firm and potentially recommend that the firm be fired if the firm refuses to share it. - PCAOB guidance on inspection reports: PCAOB Release No. 2012-003 provides information about the inspection process and the meaning of reported results to better equip audit committees. ### Inspection findings and potential program changes - PCAOB staff highlighted that deficiencies have been found in roughly 40 percent of the inspections. - Common findings relate to weaknesses in auditing: - (i) internal control over financial reporting; - (ii) fair value measurement and disclosures; - (iii) revenue recognition; and - (iv) management estimates. - PCAOB staff noted that in general the majority of the firms have managed to satisfactorily address deficiencies during the 12 month remediation period established. - Staff commented that while improvements have been observed, concerns remain as to the quality of the audits. - Because engagements for inspections are generally selected based on risk, staff considers it difficult to make generalizations. - Staff indicated that the PCAOB is currently analyzing the possibility to expand the review of engagements beyond those triggered by the risk-based approach. ### Enforcement authority, structure, and common violations - The PCAOB has authority to investigate and discipline registered public accounting firms and persons associated with those firms for noncompliance with SOX, PCAOB rules and the SEC, and other laws, rules, and professional standards governing the audits of public companies. - If the PCAOB finds evidence of a violation the PCAOB may report it to the SEC or state regulatory body or open an enforcement investigation pursuant to Section 105 of the SOX. - Investigations are conducted by the Division of Enforcement, which is comprised of 28 attorneys, 22 accountants and support staff totaling over 60 staff. - Cases are litigated before a hearing officer (a PCAOB employee insulated from the investigative function); decisions of the hearing officer can be appealed to the Board and those in turn to the SEC. - Pursuant to the SOX, PCAOB investigations are confidential and nonpublic. The SOX also requires that disciplinary proceedings are confidential and nonpublic, unless both the auditor and the PCAOB consent to public proceedings, or until there is a final decision imposing sanctions. - Common types of investigations referred to: - (i) violations of professional standards (audit failures not limited to matters involving GAAP departures); - (ii) independence violations; and - (iii) failure to cooperate with an inspection or investigation. ### Enforcement outcomes and statistics - A total of 69 settled disciplinary orders have been issued since the establishment of the PCAOB in 2002, and another 12 disciplinary orders have been issued in proceedings that were adjudicated to conclusion. - In addition, a number of other proceedings are currently in litigation, but they are non-public as required by the SOX. - In practice the PCAOB has imposed sanctions on 61 registered firms including 42 revocations of firm registrations and sanctions on 79 individuals including 69 suspensions or bars. - The key enforcement actions used have been revocation of registration and bars, which the PCAOB considers to be more effective than monetary penalties given the impact that they have in the actual business of the firm and the individuals. - A significant portion of the enforcement orders and the corresponding sanctions have been imposed during the last 3-5 years. - Internal review: - A recent review of the enforcement division by the Office of Independent Oversight and Performance Assurance (IOPA) concluded that overall the PCAOB has been able to establish a comprehensive enforcement program. - The review highlighted opportunities to improve internal processes and, potentially, case timeliness. - PCAOB staff noted they are currently looking at ways to improve the enforcement process and make it more efficient. - Confidentiality challenges: - PCAOB staff considers the confidentiality provisions of the SOX in connection with disciplinary proceedings to be a challenge for effective enforcement. - Confidentiality through the appeal process (unless the SEC lifts the stay) adds more incentive for firms to litigate as long as possible regardless of whether they believe they will ultimately prevail. - SEC staff noted differences in the treatment of PCAOB disciplinary proceedings versus SEC proceedings must be analyzed in the context of the different nature of the PCAOB versus the SEC and the different due process that accompanies SEC proceedings. ### SEC enforcement activity related to auditors - During the last 5 years the SEC has taken 99 actions against audit firms: - 28 in 2014; - 18 in 2013; - 17 in 2012; - 18 in 2011; and - 18 in 2010. - Actions taken in 2014 involved both small and large audit firms. - Types of sanctions have varied and included suspensions and monetary penalties. - The number of actions taken in the last year reflects renewed SEC attention to financial reporting and accounting fraud through a recently created Task Force described in Principles 16 and 18. - Staff highlighted increased effectiveness in coordination of enforcement actions with the PCAOB. ### Oversight of the PCAOB by the SEC - The PCAOB is under the oversight of the SEC; technical oversight is conducted through the Office of the Chief Accountant. - The SEC approves the PCAOB budget and accounting support fees and can provide input on PCAOB strategic priorities and work program during the budget approval process. - The budget order approval establishes reporting obligations for the PCAOB. For example, the order approval for the 2014 budget directs the PCAOB during the 2014 budget cycle to continue to include in its quarterly reports to the SEC information about the PCAOB’s inspection program, including: - (i) statistics relative to the numbers and types of firms budgeted and expected to be inspected in 2014, including by location and by year the inspections that are required to be conducted in accordance with SOX and PCAOB rules; - (ii) information about the timing of the issuance of inspection reports for domestic and non-U.S. inspections; and - (iii) updates on the PCAOB’s efforts to establish cooperative arrangements with respective non-U.S. authorities for inspections required in those countries. - The SEC also approves PCAOB auditing standards and rules. - The SEC has conducted onsite inspections of the PCAOB; the last inspections were conducted around 2009, when the registration and inspection programs were formally reviewed. - The SEC receives a copy of all examination reports and is informed of all investigations opened by the PCAOB. - In practice there is very close contact between the PCAOB and SEC staff in addition to formal oversight mechanisms. ### Assessment and key comments - Assessment: Fully Implemented - Comments: - The assessment considered that both the PCAOB and the SEC can file enforcement cases against audit firms. - PCAOB enforcement actions have increased over time, and the SEC has made gatekeepers a focus of its enforcement program with important cases filed during the last five years, complementing PCAOB efforts. - The IOPA recommendations on timeliness of PCAOB cases were noted; timeliness of procedures can be a challenge for credible deterrence and the PCAOB is working to improve procedures. - Confidentiality of PCAOB proceedings could potentially undermine the deterrent effect of PCAOB enforcement efforts. - Efforts by the PCAOB to address access to audit work in certain foreign jurisdictions were noted, including disclosure to investors via the PCAOB website of countries where limitations remain. - For new audit firms this access limitation has been addressed via inclusion of a registration requirement related to their ability to cooperate with the PCAOB. - Limited recent use of inspections by the SEC for PCAOB oversight appears largely offset by IOPA work and other regular interactions between the SEC and PCAOB. ### Auditor independence (Principle 20) - Independence requirements: - Independence of the external auditor both in fact and in appearance is required under the U.S. system. - Addressed by the SEC’s auditor independence rules adopted in 2000 and subsequently strengthened in 2003 after the passage of SOX. - Rule 2-01 of Regulation S-X: - Sets forth the general standard of auditor independence which considers whether a relationship or the provision of a service: - (i) creates a mutual or conflicting interest between the accountant and the audit client; - (ii) places the accountant in the position of auditing his or her own work; - (iii) results in the accountant acting as management or an employee of the audit client; or - (iv) places the accountant in a position of being an advocate for the audit client. - Covers specific areas including financial interests, employment relationships, business relationships, non-audit services, contingent fees, partner rotation, audit committee administration of the audit engagement, quality controls, definitions and other matters. - The PCAOB has adopted certain auditor independence requirements. - Restrictions on financial relations: - Rule 2-01(c) of Regulation S-X prohibits financial, business, employment and other relationships with an entity that the firm audits that would threaten an auditor’s independence. - Threats to independence addressed by Rule 2-01(c): - Self-interest: non-exclusive list of circumstances inconsistent with independence, including financial relationships, employment relationships, business relationships and non-audit services, prohibitions on contingent fees and compensation paid to an audit partner for procuring engagements for non-audit work. - Advocacy: Rule 2-01(c)(4)(x) prohibits providing an expert opinion or other service for the purpose of advocating a client’s interests in litigation or in a regulatory or administrative proceeding or investigation; Rule 2-01(c)(4)(ix) prohibits providing legal services to a client (legal service defined by circumstances requiring someone licensed to practice law). - Familiarity: rotation requirements: - Rotation of an audit partner who has performed the services of a lead or concurring partner for an issuer for more than five consecutive years. - Certain other members of the audit team who have worked on the audits of an issuer for more than seven consecutive years. - Rule 2-01(c)(2) provides restrictions on certain employment relationships and a cooling off period for certain participants in the audit. - Rule 2-01(c)(4) prohibits an auditor from providing management or human resource functions for an audit client. - Intimidation: audit committee (not management) is responsible for hiring and retention of the auditor; auditor required under Rule 2-07 of Regulation S-X and PCAOB standards to communicate audit-related matters to the audit committee; Rule 13b2-2 under the Exchange Act prohibits certain persons from coercing, manipulating, misleading or fraudulently influencing an auditor. - Non-audit services: - Rule 2-01(c)(4) lists non-audit services that would impair independence, including bookkeeping services, financial information systems design and implementation, appraisal or valuation services, actuarial services, internal audit outsourcing services, management functions, human resources, broker-dealer, investment adviser or investment banking services, legal services or expert services unrelated to the audit. - Rule 2-01(c)(3) prohibits the auditor from having, directly or indirectly, any business relationship with the client or certain persons associated with the client. - The PCAOB has rules governing provision of certain tax services to audit clients. - Both the SEC and PCAOB have rules requiring pre-approval by the audit committee of any non-audit service provided by the auditor. - Internal controls and quality control systems: - The PCAOB requires auditors to have a system of quality controls that provides reasonable assurance that personnel maintain independence in fact and appearance in all required circumstances (QC 20.09). - Rule 2-01(d) provides a safe harbor from certain independence violations if the auditor had in place a quality control system that provides reasonable assurance that the accounting firm and its employees do not lack independence. - For accounting firms that annually provide audit, review or attest services to more than 500 issuers, the quality control system must include: - written independence policies and procedures; - an automated system that identifies investments of partners and managerial employees; - a system that provides timely information about entities requiring independence; - an annual or on-going training program; - an annual internal inspection and testing program; - notification of the member of senior management responsible for compliance with independence requirements; - written policies and procedures requiring notice when professionals are engaged in employment negotiations; and - a disciplinary mechanism. - Rule 2-01(c)(6) provides that an accountant will not be independent if an audit partner performs the services of a lead partner on an audit engagement for more than five consecutive years or the services of a concurring partner for more than seven consecutive years. ### Appointment of auditors, audit committee responsibilities, and disclosures - SOX and Rule 2-01 require rigorous independence; Preliminary Note to Rule 2-01 states rule is designed to ensure auditors are independent in both fact and appearance. - Listing standards mandated by SOX (Rule 10A-3 under the Exchange Act) require: - Each member of the audit committee of the issuer must be independent according to specified criteria in addition to the general director independence requirement in the listing standards; - The audit committee must be directly responsible for appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged for audit, review or attest services, and the firm must report directly to the audit committee; - Each audit committee must establish procedures for receipt, retention and treatment of complaints regarding accounting, internal accounting controls, or auditing matters, including confidential, anonymous submission by employees; - Each audit committee must have authority to engage independent counsel and other advisors as necessary; and - Each issuer must provide appropriate funding for the audit committee. - SEC rules implementing Sections 10A(h) and 10A(i) of the Exchange Act require all audit and non-audit services to be pre-approved by the issuer’s audit committee, subject to a de minimis exception; pre-approval responsibilities are required to be disclosed in the issuer’s annual report. - The auditor is required by PCAOB standards to communicate information to the audit committee regarding auditor independence. - Market participants believe audit committees are increasingly taking an active role in oversight of accounting firms’ work, though more progress is necessary. - Disclosure of auditor resignation, removal or replacement: - Prompt public disclosure is required when the auditor has resigned during a current audit, declined to stand for re-election after completion of the audit, or was dismissed. - For U.S. companies this occurs by filing a Form 8-K within four business days of the termination date. - Item 304 of Regulation S-K specifies information required in the Form 8-K, including disagreements with the former auditor on accounting matters, whether the former auditor’s report for the last two years involved an adverse opinion or disclaimer of opinion or other qualifications, whether the change was recommended or approved by the board or audit committee, and other matters relating to the change in auditors. - Supervision and enforcement of independence: - The PCAOB assesses a firm’s independence as part of its regular inspection program and can require remedial action and impose enforcement actions. - The SEC can also bring enforcement actions against firms that have violated its independence rules. ### Assessment for Principle 20 - Assessment: Fully Implemented - Comments: - Legal limitations prevent the PCAOB from sharing the confidential portion of inspection reports with audit committees. - The PCAOB has taken steps to encourage audit committees to take a proactive approach and ask relevant questions of audit firms. ### Auditing standards background (Principle 21) - Before SOX and establishment of the PCAOB in 2002, auditing standards for registered public companies were established by the AICPA. - The AICPA’s Auditing Standards Board (ASB) had developed Statements of Auditing Standards (SAS) through public deliberations and public exposure of draft statements. *International Monetary Fund — assessment and description extracted from the provided content unit.* ### Section 103 of SOX gave the PCAOB authority to establish auditing, ethics, independence and ### _cr1591 - Section 103 of SOX gave the PCAOB authority to establish auditing, ethics, independence and ### PCAOB authority, standards, and standard-setting process - Section 103 of SOX gave the PCAOB authority to establish auditing, ethics, independence and quality control standards for registered public accounting firms and specified that the PCAOB may establish standards through its own development and/or through the adoption of standards proposed by other professional groups of accountants, all pursuant to SEC oversight. - The PCAOB adopted the auditing and related professional practice standards of the ASB as they existed in April 2003 as interim professional standards. - The PCAOB has reviewed these standards to determine whether they need to be modified, superseded or adopted as permanent standards. - Examples of PCAOB auditing standards proposed and adopted: - audit documentation (AS No. 3) - an audit of internal control over financial reporting that is integrated with an audit of financial statements (AS No. 5) - engagement quality review (AS No. 7) - risk assessment (AS Nos. 8-15) - communications with audit committees (AS No. 16) - PCAOB standard setting agenda includes projects on: - the auditor’s reporting model - related parties - the auditors' responsibilities with respect to other accounting firms and specialists - auditing accounting estimates, including fair value measurements - Standard-setting governance and process: - Section 103(a)(4) of the Sarbanes-Oxley Act authorizes the PCAOB to convene expert advisory groups; the PCAOB has convened a Standing Advisory Group. - PCAOB staff draft proposed standards, ordinarily consulting the Standing Advisory Group and other public fora (e.g., roundtable discussions). - Proposed standards approved by PCAOB are published for public comment; after evaluation of comments, staff recommend final standards. - PCAOB meetings considering proposed or final standards are open meetings. - Final standards adopted by the PCAOB are submitted to the SEC for approval and do not become effective unless approved by the SEC. - The SEC reviews the rules, issues them for public comments, considers comments received and then determines whether to approve the standards. ### Enforcement of auditing standards and assessment - Enforcement bodies and tools: - The PCAOB is the main body responsible for enforcing compliance with auditing standards through its inspection program and enforcement proceedings (described in Principle 19). - The SEC can use formal and informal mechanisms to enforce compliance with auditing standards (described in Principle 19). - The SEC has constituted the Financial Reporting and Audit Task Force and has increased enforcement efforts in accounting and auditing. - Assessment status: - Assessment: Fully Implemented - Comments: Assessors note an important agenda of revision to audit standards yet to be approved. SEC staff and market participants view current standards as high quality but emphasize the importance of proposals to enhance auditors’ work quality, particularly given PCAOB findings of important deficiencies in auditors’ reports. ### Principle 22 — Oversight of credit rating agencies (CRAs / NRSROs): scope and definitions - Principle statement: Credit rating agencies should be subject to adequate levels of oversight. The regulatory system should ensure that credit rating agencies whose ratings are used for regulatory purposes are subject to registration and ongoing supervision. - Definitions from the Exchange Act: - “[c]redit [r]ating” = “an assessment of creditworthiness of an obligor as an entity or with respect to specific securities or money market instruments.” - “[c]redit [r]ating [a]gency” = any person (i) engaged in the business of issuing credit ratings on the Internet or through another readily accessible means, for free or for a reasonable fee, but does not include a commercial credit reporting company; (ii) employing either a quantitative or qualitative model, or both, to determine credit ratings; and (iii) receiving fees from either issuers, investors, or other market participants, or a combination thereof. - Use for regulatory purposes: - A CRA wishing its ratings to be used for regulatory purposes in the U.S. must elect to register with the SEC as an NRSRO. - Credit ratings issued by affiliates (including affiliates located outside the United States) to be used for regulatory purposes must be properly identified by the NRSRO in its registration form and are treated as credit ratings issued by the NRSRO, subject to NRSRO Regulations and direct SEC oversight. - Currently credit ratings are used for limited purposes in SEC regulations, most notably in MMF regulation (and reporting forms). CFTC regulations do not reference ratings. ### Registration requirements and Form NRSRO - 2007: SEC adopted rules establishing framework for voluntary registration of CRAs as NRSROs. - 2014: A number of these rules were amended in 2014; effective dates vary but generally will be effective mid-2015. - Form NRSRO requirements (applicant must complete properly to be eligible for approval) include information on: - class or classes of credit ratings applied for, specifying for each class: the approximate number of credit ratings currently outstanding; the approximate date the applicant began issuing credit ratings for the class; and performance measurement statistics - procedures and methodologies used in determining credit ratings - identification of conflicts of interest - policies and procedures to address and manage conflicts and prevent misuse of material, non-public information - corporate organizational and managerial structure and information about credit rating analysts, credit rating analyst supervisors, and designated compliance officer - audited financial statements of the applicant or its parent for each of the three prior fiscal years, unaudited revenue information including amount of revenue generated from determining and maintaining credit ratings for the most recently concluded fiscal year, and information regarding the total and median annual compensation of credit analysts - information regarding any violations of law or other regulations by the applicant or persons associated with the applicant - Applicant obligations: - Notify the SEC and submit a supplement if any information in the application becomes materially inaccurate prior to grant or denial. - SEC denial and suspension/revocation grounds: - SEC must deny an application if applicant lacks adequate financial and managerial resources to: consistently produce credit ratings with integrity; materially comply with procedures and methodologies; materially comply with NRSRO Regulations to prevent misuse of non-public information, manage conflicts of interest, prohibit unfair/coercive/abusive practices, and require designation of a compliance officer. - SEC must also deny if a condition exists that would subject the applicant, if registered, to suspension or revocation. - The SEC may suspend or revoke registration, entirely or with respect to one or more classes of credit ratings, for reasons including willful misstatements or omissions on Form NRSRO; willful violation of federal securities laws or failure to reasonably supervise; convictions of certain crimes; certain foreign regulatory findings; final orders by state or federal authorities finding violations to prevent fraudulent/manipulative/deceptive conduct; injunctions by courts; failure to file annual amendment and certification of Form NRSRO; failure to “maintain adequate financial and managerial resources to consistently produce credit ratings with integrity;” and effective June 15, 2015 a violation of the SEC’s conflicts of interest rules that affected a credit rating. ### Quality, integrity, records, and resources - Internal controls and methodologies: - Pursuant to Section 15E(c)(3)(A) of the Exchange Act, NRSROs are required to “establish, maintain, enforce and document an effective internal control structure governing the implementation of and adherence to policies, procedures, and methodologies for determining credit ratings taking into consideration such factors as the Commission may prescribe by rule.” - NRSROs must consider information they find “credible and potentially significant to a rating decision,” including information “from a source other than the issuer or underwriter.” - Each NRSRO must publicly disclose on Form NRSRO a description of procedures and methodologies used to determine credit ratings. - Internal records retention: - Required retained records (to the extent made or received) include internal records, non-public information and work papers used to form basis of a credit rating; credit analysis reports; credit assessment reports; private credit rating reports; internal and external communications related to initiating, determining, maintaining, monitoring, changing or withdrawing a credit rating. - NRSROs must retain a record documenting established procedures and methodologies used to determine credit ratings. - For each current credit rating, records must show identity of credit analysts who participated and any other person who approved the credit rating prior to issuance. - Any written communication from third parties containing complaints about performance of a credit rating analyst must be retained. - For structured finance securities where a quantitative model plays a substantial role, the NRSRO must record the rationale for any material difference between the model-implied rating and the final rating issued. - Sufficiency of resources and disclosures: - Form NRSRO requires applicants to provide information about resources including managerial resources and to disclose employment history and educational background of designated compliance officer. - NRSROs must disclose annually the number of credit analysts and credit analyst supervisors and required qualifications. - Each NRSRO must provide audited financial statements for itself or its parent (and, if applicable, unaudited consolidating financial statements) with its initial application and, on an ongoing basis, within 90 days of its fiscal year end. - Along with financial statements, an NRSRO must provide unaudited revenue information specifying revenue generated from determining and maintaining credit ratings and the total aggregate and mean annual compensation of credit analysts. ### Conflicts of interest: prohibitions, management, compensation disclosures - Prohibitions (NRSRO Regulations prohibit issuing or maintaining a credit rating in certain circumstances, including): - Issuing/maintaining a credit rating solicited by a person that provided the NRSRO with 10 percent or more of its total net revenue in its most recently ended fiscal year; - Issuing/maintaining a credit rating where the related fee was negotiated/discussed/arranged by a person within the NRSRO who has responsibility for participating in determining credit ratings or developing/approving related procedures and methodologies; - Issuing/maintaining a credit rating for an affiliate of the NRSRO; - Issuing/maintaining a credit rating for a security where the NRSRO or its affiliate made recommendations about corporate/legal structure, assets, liabilities, or activities of the obligor or issuer; - Issuing/maintaining a credit rating for a person where the NRSRO directly owns securities of the person that would be subject to the rating; - Issuing/maintaining a credit rating for a person where an employee of the NRSRO that participated in determining or approving the rating directly owns securities of the person; - Issuing/maintaining a credit rating for a person where an employee of the NRSRO that participated in determining or approving the rating is an officer or director of the person; - Issuing/maintaining a credit rating where an employee who participated in determining or monitoring the rating or is responsible for approving it received gifts valued over $25 from the person being rated; - Effective June 15, 2015, issuing/maintaining a credit rating where a person within the NRSRO who participates in determining or monitoring the rating, or developing/approving procedures or methodologies (including qualitative and quantitative models), also (i) participates in sales or marketing of a product or service of the NRSRO or an affiliate or (ii) is influenced by sales or marketing considerations. - Management of conflicts (permissible only if identified and managed): - Being paid by obligors, issuers, sponsors of asset-backed securities, or underwriters to determine credit ratings for such entities or securities or for other services - Being paid for services in addition to determining credit ratings by issuers, underwriters, or obligors that have paid the NRSRO to determine a credit rating - Being paid by subscribers to receive access to credit ratings or other services if such subscribers may use the ratings to comply with statutes/regulations using the term “nationally recognized statistical rating organization” or if such subscribers may own investments or have transactions impacted by the rating - Allowing persons within the NRSRO to have ownership interests in rated obligors or securities or business relationships that are not arm’s length - Having an affiliate that is a broker or dealer engaged in underwriting activities - Any other type of conflict material to the organization and identified in its Form NRSRO disclosures - Conflict-related recordkeeping and disclosure: - Each NRSRO must disclose on Form NRSRO written policies and procedures to manage applicable conflicts of interest. - NRSROs must have policies and procedures for an internal review process to determine whether a conflict of interest of a former employee influenced a credit rating action in certain instances (e.g., if a former employee is subsequently employed by an entity rated by the NRSRO and participated in a rating action during the one-year period preceding that action). - NRSROs must retain a record of each person who has paid for a credit rating and who has subscribed for a credit rating or credit rating analysis. - The twenty largest issuers, subscribers, obligors, and underwriters by revenue must be identified to the SEC annually. - NRSROs must keep records of general types of products and services offered. - Compensation disclosures: - NRSROs are required to disclose actual and potential conflicts of interest on Form NRSRO, including those arising from compensation arrangements (e.g., issuer-paid ratings or subscriber-paid ratings). - Instructions for Form NRSRO list potential conflicts and require disclosure to the extent they apply; Form NRSRO must be updated annually and certified for accuracy; prompt amendment required if information becomes materially inaccurate. - A NRSRO must make its Form NRSRO publicly available on its website. - Effective June 15, 2015, each NRSRO will be required to disclose the source of payment for its fees, if applicable, with respect to the credit rating and whether it was paid for any other services provided during the most recently ended fiscal year to the person paying for the credit rating. ### Transparency, timeliness, methodologies, and performance disclosure - Dissemination and pending ratings: - NRSROs must maintain and enforce written policies and procedures reasonably designed to prevent inappropriate dissemination of a pending credit rating action before issuing the rating on the Internet or through another readily accessible means. - Policies may include ensuring rating actions are readily accessible to the marketplace (e.g., posting on website, through news/information service, or making available to all subscribers simultaneously). - Information on methodologies: - NRSROs must publish a description of procedures and methodologies so outside parties can understand how a rating was determined and the attributes/limitations of ratings. - Form NRSRO disclosures must be sufficiently detailed and include, among other items: - description of sources of information used - how verification of collateral for structured finance products is relied upon - how quality of originators of assets underlying structured finance products factors into ratings - quantitative and qualitative models and metrics used - procedures for interacting with management of rated entity - structure and voting process of credit rating committees - procedures for monitoring, reviewing, and updating credit ratings, including review frequency - procedures to withdraw or suspend maintenance of a credit rating - The list of items in instructions to Form NRSRO is not exhaustive; NRSROs must disclose descriptions “sufficiently detailed to provide users of credit ratings with an understanding of the processes employed.” - NRSROs must define credit rating categories, notches, grades and rankings used to disclose general attributes of their ratings. - Effective June 15, 2015, NRSROs will be required to disclose certain information about procedures, methodologies, and assumptions when taking certain credit rating actions, including: - the version of the procedure or methodology used - main assumptions and principles used in constructing procedures/methodologies, including qualitative methodologies and quantitative inputs - potential limitations and types of risks excluded - information regarding uncertainty and reliability of data relied on - explanation or measure of potential volatility and factors likely to lead to a change - information on sensitivity of the credit rating to assumptions made by the NRSRO - Historical default rates and performance statistics: - NRSROs are required to publish on Form NRSRO information about historical default rates of their credit ratings. - Performance measurement statistics must include historical credit ratings transition and default rates showing changes over 1-, 3-, and 10-year periods through the most recent calendar year end. - Data must be provided separately for each class and certain subclasses of credit ratings for which the NRSRO is registered. - Amendments to instructions for Exhibit 1 to Form NRSRO, effective January 1, 2015, standardize production and presentation of performance statistics, and provide a standardized definition of default. - Amendments require statistics for subclasses of structured finance products and for ratings where the obligation was paid off or the rating withdrawn for reasons other than default or pay-off. - Under enhanced credit rating history disclosure requirements effective June 15, 2015, an NRSRO will be required to publicly disclose historical information concerning each credit rating that could be used to generate statistics, including default statistics. ### Confidential information and pending ratings protections - Protection of nonpublic information: - NRSRO Regulations require policies and procedures reasonably designed to prevent inappropriate dissemination within or outside the NRSRO of material non-public information obtained in connection with credit rating services and to prevent NRSRO personnel from trading securities when aware of such information. - These policies and procedures must be publicly disclosed on Form NRSRO. - Pending ratings protections: - NRSRO Regulations require written policies and procedures to prevent inappropriate dissemination of a pending credit rating action before issuing the rating via Internet or other readily accessible means; these policies must be disclosed on Form NRSRO. ### SEC oversight, reporting, and examinations of NRSROs - Continuing oversight: - Once registered as an NRSRO, a CRA is subject to continuing oversight by the SEC to monitor compliance with federal securities laws, including Section 15E of the Exchange Act and related rules (the NRSRO Regulations). - SEC authority to require information: - Exchange Act requires NRSROs to make and keep records for prescribed periods, furnish copies, and make and disseminate reports as the Commission prescribes as necessary or appropriate in the public interest or for protection of investors. - All records maintained by an NRSRO are subject to examination by the SEC. - NRSROs must update Form NRSRO annually and certify the accuracy of updated information; material changes must be communicated promptly via amendment. - Designated compliance officer must file an annual report with the SEC discussing compliance with federal securities laws and the NRSRO’s own policies and procedures, including description of material changes to code of ethics and conflict-of-interest policies and a certification that the report is accurate and complete. - Commencing January 1, 2015, each NRSRO must deliver a report to the SEC containing management’s assessment of the effectiveness during the fiscal year of the internal control structure governing implementation of and adherence to policies, procedures, and methodologies for determining credit ratings. - Examinations: - All NRSROs, whether located in the U.S. or elsewhere, are subject to an annual examination process and to further examination and enforcement by the SEC when appropriate. *International Monetary Fund — UNITED STATES country report content unit* ### Section 15E(p)(3) of the Exchange Act requires the SEC to conduct examinations of each NRSRO ### Section 15E(p)(3) of the Exchange Act requires the SEC to conduct examinations of each NRSRO ### SEC examination mandate - Section 15E(p)(3) of the Exchange Act requires the SEC to conduct examinations of each NRSRO at least annually. - Each examination must include, but is not limited to, review of the following specified areas: - Whether the NRSRO conducts business in accordance with its policies, procedures, and rating methodologies ; - The management of conflicts of interest by the NRSRO; - Implementation of ethics policies by the NRSRO; - The internal supervisory controls of the NRSRO; - The governance of the NRSRO; - The activities of the designated compliance officer; - The processing of complaints by the NRSRO; and - The NRSRO’s policies governing the post-employment activities of former staff of the NRSRO. - In addition to required annual examinations, the SEC has broad discretion to conduct examinations of NRSROs whenever it considers an examination necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the Exchange Act. ### Establishment and resourcing of the Office of Credit Ratings (OCR) - The Dodd-Frank Act required the SEC to establish an Office of Credit Ratings and provide it with sufficient staff. This Office was formally established in June 2012. - OCR staffing and focus: - OCR had 44 staff for fiscal year 2014 (and 6 more staff were requested in the budget for fiscal year 2015). - In fiscal year 2014, approximately half of the staff focused on examinations, and the remaining half focused on policy and monitoring work. - Staff recruited by OCR include former supervisors and CRA employees as well as attorneys. - A quantitative analyst was added to OCR’s staff in fiscal year 2015. ### Registration of NRSROs - Currently 10 CRAs are registered as NRSROs, of which two are foreign and are subject to the same process as the domestic NRSROs. - With one exception, all the registrations took place in 2007. - An application to rate new asset classes is treated as a “mini registration”. ### Examinations: risk assessment, scope, and procedures - The Dodd-Frank Act requires OCR to include eight areas for review in its examinations. - OCR conducts a risk-assessment for each NRSRO to identify specific issues to focus on for each exam, and also identifies issues or risks that are present at multiple NRSROs. - Initial information reviewed for risk assessment includes: - Each NRSRO’s response to deficiencies identified in previous exams; - Form NRSRO submissions and NRSROs’ public disclosures; - Any tips, complaints, and referrals concerning NRSROs submitted to the SEC; - News articles and other sources. - Examination team composition: - For large CRAs the examination team would consist of approximately 3-6 examiners; - For the smaller CRAs the examination team would consist of approximately 2-3 examiners. - Certain examiners of the big 3 CRAs are exclusively dedicated to that exam. - OCR generally implements rotation of the exam team lead to avoid the risk of regulatory capture and provide fresh perspectives. - Onsite work and document review: - OCR staff gathers information, typically visits one or more of the NRSRO’s offices and interviews analytical personnel, senior management, compliance personnel, board of directors, business development/marketing personnel, and other personnel. - OCR reviews documents received from the NRSRO including internal and nonpublic documents and other sources of information used to conduct its risk assessment, such as the Form NRSRO submissions, and tips, complaints, and referrals sent to the SEC. - Post-examination process: - Upon completion of the annual examination, OCR examination staff discusses results with the corresponding NRSRO and issues a letter identifying deficiencies and recommending remedial measures. - An NRSRO is typically requested to submit a written response within 30 days of the final recommendations of the examination staff. - Examples of remedial actions requested included evaluation of staffing and resources to manage volume of business and reviewing disclosures relating to process and methodologies for rating certain asset classes to assess compliance with law. ### Public reporting and thematic work - OCR prepares an annual public report summarizing essential findings of examinations, responses of each NRSRO to any material regulatory deficiencies identified, and whether prior recommendations have been addressed. - The public report for 2013 highlighted remedial measures taken in response to 2012 recommendations, including adoption or revision of procedures, enhancement or implementation of internal controls, new software systems, and compliance and analytical training. - Noted improvements and trends among NRSROs (five general areas of improvement): - Enhanced documentation, disclosure, and Board oversight of criteria and methodologies; - Investment in software or computer systems; - Increased prominence of the role of the DCO within NRSROs; - Implementation or enhancement of internal controls; - Adherence to internal policies and procedures. - The public report concluded there has been a noticeable positive shift in the compliance culture of NRSROs. - OCR initiatives: - In 2014 OCR conducted the first examination abroad of affiliates of domestic CRAs. - OCR has started to conduct thematic reviews. - Consistent with the IOSCO Final Report, supervisory core and general colleges for CRAs were established for the three largest globally active CRAs (Fitch, Moody’s and S&P). - Two of the colleges are chaired by the SEC and the third by ESMA. - The first meeting of the core colleges took place in November 2013 (two day meeting). - The second meeting of the core colleges took place in December 2014 (three days, one day for each CRA). - The first meeting of the general colleges for CRAs took place in December 2014 (one day). ### Enforcement authority and notable actions - The SEC has authority to bring enforcement actions against NRSROs for possible violations of the federal securities laws, rules and regulations, including the ability to censure, place limitations on activities, functions, or operations, suspend, or revoke registration of any NRSRO upon occurrence of certain events. - The SEC may seek an injunction, civil penalty and/or equitable relief for violations of the Exchange Act or rules thereunder. - Notable enforcement action: - In 2012 the SEC brought an enforcement action against an NRSRO and its president charging willful and material misrepresentations and omissions in the NRSRO’s Form NRSRO application to register for issuers of ABS and issuers of government, municipal and foreign government securities. - The NRSRO consented to the SEC’s order revoking its NRSRO registration with respect to issuers of asset-backed securities and issuers of government, municipal and foreign government securities, but providing for the right to re-apply for registration in these classes after 18 months. - The president of the NRSRO was barred from association with any NRSRO registered in these two classes of credit ratings, with the right to apply to the SEC for re-entry after 18 months. - The SEC’s order required the NRSRO to complete a comprehensive review of its policies, procedures, practices, and internal controls related to the findings set forth in the SEC’s order and the findings of the 2012 examination by OCR staff. - The settlement required adoption, implementation, and maintenance of policies, procedures, practices, and internal controls correcting identified issues and submission of a report to OCR detailing corrective steps, and required the NRSRO and its president to cease and desist from committing or causing future violations. ### Regulation and oversight of sell-side analysts and equity/debt research - Global Settlement and SRO framework: - In 2003 and 2004, the SEC and the SROs (collectively “U.S. Broker-Dealer Regulatory Agencies”) and other regulatory agencies settled charges against twelve leading U.S. broker-dealers (the Global Settlement) in connection with research analysis. - The Global Settlement required structural changes such as information barriers between research analysts and investment bankers. - The Global Settlement applies to BDs who account for roughly 80 to 90 percent of the equity underwriting activity in the U.S. - The Global Settlement has been amended over time; Global Settlement firms continue to be subject to more requirements than the rest of the industry based on U.S. Broker Dealer Regulatory Agencies rules. - SEC Regulation AC (adopted 2003): - Seeks to address conflicts of interest related to research analysis at an industry level. - Covers research on equity and debt securities. - Requires analysts to include a statement certifying that views expressed reflect personal views and disclosure of whether compensation was, or will be, directly or indirectly, related to specific recommendations or views. - Requires periodic certifications by analysts in connection with public appearances. - Additional SRO rules for equity analysts (NASD Rule 2711 and NYSE Rule 472): - Address conflicts arising when analysts work at firms with investment banking or other business relationships with issuers, and when the analyst or firm owns securities of the issuer that an analyst covers. - Contain provisions on trading activities, financial interests, business relationships, reporting lines, and compensation to increase analyst independence and manage conflicts. - Restrictions on analyst trading: - Rules restrict analyst and household members from purchasing or receiving securities before an issuer’s IPO if issuer is principally engaged in same type of business as companies the analyst follows. - Rules generally restrict analyst and household members from trading securities of an issuer the analyst follows during certain periods before and after publication of a research report, and from trading inconsistent with the analyst’s most recent published recommendation. - Prior approval by legal or compliance personnel is required for certain transactions by persons who oversee research analysts. - Disclosure obligations (examples preserved as stated): - If the analyst or a household member has a financial interest in the subject company, the existence and nature of such interest (including any option, right, warrant, future, long or short position; - Ownership by the member firm or one of its affiliates of 1 percent or more of the subject company’s equity securities. - Disclosure if an analyst or household member serves as an officer, director or advisory board member of the subject company. - Disclosure in research reports if the firm was making a market in the subject company’s securities at the time a research report was published. - Disclosures regarding investment banking business and compensation, including: - The analyst received compensation based upon the firm’s investment banking business or from the subject company in the past 12 months; - The firm, or its affiliates, (i) managed or co-managed a public offering of securities for the subject company in the past 12 months; (ii) received compensation for investment banking services from the subject company in the past 12 months; or (iii) expects to receive or intends to seek compensation for investment banking services from the subject company in the next 3 months; - The firm received compensation for products or services other than investment banking services in the past 12 months; - The analyst or an employee who has the ability to influence the substance of a report knows that an affiliate has received compensation for products or services other than investment banking in the past 12 months; - The firm or the analyst has reason to know that an affiliate received such compensation in the past 12 months; - A subject company is, or during the prior 12-month period was, a client of the firm and types of service provided to the subject company. - Rules mandate certain compensation disclosures in public appearances. - Reporting lines, independence, and senior management responsibilities: - No analyst may be subject to supervision or control of any investment banking department employee. - No personnel engaged in investment banking activities may have influence or control over compensatory evaluation of an analyst. - Analyst compensation must be reviewed and approved by a committee that reports to a firm’s board of directors or a senior executive officer; the committee cannot include representation from the investment banking department and must consider specific factors in its review. - Rules restrict sharing draft research reports with subject companies except to verify factual accuracy; draft reports cannot contain research rating or price target when shared for factual verification. - Complete draft must be submitted to legal or compliance personnel before a section is sent to the subject company. - Rules prohibit offering favorable research, a specific rating, or price target to an issuer as consideration or inducement for business or compensation. - Required disclosures must be presented on the front page of a research report or the front page must refer to the page where disclosures are found; disclosures must be clear, comprehensive, and prominent. - Written or oral communications by an analyst related to an investment banking services transaction must be fair, balanced and not misleading. - Investment banking personnel are prohibited from directing analysts to engage in sales or marketing efforts related to investment banking transactions or communicating with customers about such transactions. - Rules specifically mandate no retaliation by investment banking employees against analysts for issuing negative research that may adversely affect investment banking business. - Firms must adopt and implement written supervisory procedures reasonably designed to ensure compliance with rules regarding analyst conflicts; a senior officer must annually attest that the firm has adopted and implemented those procedures. - Written policies and procedures must reasonably restrict or limit information flow between research and trading departments to prevent trading ahead of information to be released in a research report. - Debt research: - Neither the Global Settlement nor most U.S. Broker Dealer Regulatory Agency rules apply to fixed income research, though Regulation AC does. - In absence of specific SRO rules beyond Regulation AC for fixed income, NASD (now FINRA) and NYSE rely on antifraud statutes and other SRO rules and comprehensive supervisory schemes. - Industry guidance: In 2004 the Bond Market Association (BMA) issued voluntary, principle-based guidelines for fixed income analyst conflicts. - Pending proposals and reviews: - A recent GAO report recommended a review of current requirements vis-à-vis the Global Settlement to determine whether all firms should be subject to the same requirements and review potential expansion of current rules beyond Regulation AC regarding research on debt securities. - FINRA has been working on both topics (see Regulatory Notice 11-11, March 2011 for debt research). ### Monitoring and supervisory outreach - The SEC has conducted examinations of select firms not covered by the Global Settlement to analyze voluntary compliance with the Global Settlement and compliance with U.S. Broker Dealer Regulatory Agency rules. - Reviewed firms represented larger, mid-sized and smaller broker-dealers. - SEC staff found these firms had voluntarily adopted at least some Global Settlement requirements, but controls were not as formal as for firms covered by the Global Settlement. - SEC staff identified instances of non-compliance with U.S. Broker Dealer Regulatory Agency rules, mainly related to disclosure of conflicts. *Source: _cr1591 - Section 15E(p)(3) of the Exchange Act requires the SEC to conduct examinations of each NRSRO* ### Section 732 of the Dodd-Frank Act (amending section 4d of the CEA) directed FCMs and IBs to ### _cr1591 - Section 732 of the Dodd-Frank Act (amending section 4d of the CEA) directed FCMs and IBs to ### Conflict of interest framework for FCMs and IBs (CFTC Regulation 1.71) - Section 732 of the Dodd-Frank Act amended section 4d of the CEA to require informational partitions between those researching or analyzing prices or markets for commodities and those involved in trading or clearing activities. - CFTC Regulation 1.71 implements the conflict of interest provisions for FCMs and IBs and includes: - Prohibitions on improper interference with clearing decisions and undue influence on customers. - Disclosure of any financial interest that a research analyst maintains in any derivative of a type that the research analyst follows and the general nature of the financial interest. - Under Regulation 1.71 firms must adopt written policies and procedures reasonably designed to ensure compliance. - Subsections 1.71(b) and (c) substantive requirements include: - Restrictions on relationships with the research department: - Non-research personnel may not direct a research analyst's decision to publish a research report or direct the views and opinions in the report. - Research analysts may not be under the supervision, control (including with respect to performance evaluation and compensation) of employees of the firm's business trading unit or clearing unit. - Non-research personnel may not review or approve a research report prior to publication except for certain specified reasons; reviews must be done by authorized legal and compliance personnel. - Restrictions on communications: - A research analyst's written or oral communication to customers relating to a derivative may not omit any material fact or qualification that would make the communication misleading to a reasonable person. - Restrictions on research analyst compensation: - FCMs and IBs may not consider a research analyst's contribution to the firm's trading or clearing business in determining compensation. - Prohibitions and disclosure: - Prohibited from offering favorable research or threatening to change research to a customer as consideration or inducement for business or compensation. - Must comply with specific disclosure requirements relating to a research analyst's financial interest in any derivative that the research analyst follows. - Anti-retaliation: - Trading or clearing personnel are prohibited from retaliating against a research analyst for a good faith research report that may adversely affect trading or clearing activities. - Exemption for smaller IBs: - IBs that, over the preceding 3 years, have generated $5 million or less in aggregate gross revenues from their IB activities are exempt from the above requirements but must establish structural and institutional safeguards and informational partitions. - Regulation 1.71(e): - Requires FCMs and IBs, regardless of size, to adopt written policies and procedures to disclose to customers any material incentives and any material conflicts of interest regarding a customer's decision as to trade execution and/or clearing of a derivatives transaction. - Subsection 1.71(d): - Sets forth specific requirements for FCMs related to clearing activities; these provisions become effective when swap dealers and major swap participants are required to apply for registration under CFTC Regulation 3.10. ### Swap Dealers (SDs) and Major Swap Participants (MSPs) — Regulation 23.605 - Dodd-Frank amendments to Section 4 of the CEA require SDs and MSPs to implement conflict of interest systems and procedures establishing structural and institutional safeguards to separate research/analysis/clearing roles from pricing, trading, or clearing functions that might bias judgment or contravene open access or business conduct standards. - Commission Regulation 23.605 implements these conflict provisions and requires: - Disclosure of any financial interest in any derivative of a type that a research analyst follows and the general nature of the financial interest. - Appropriate informational partitions between business trading units of a SD or MSP and clearing units of any affiliated clearing member of a DCO. ### NFA framework and treatment of research reports - Research reports disseminated to the public are considered promotional material under NFA rules and are subject to promotional material requirements, including Compliance Rule 2-29 that the report not be misleading or omit facts that make it misleading. - NFA Compliance Rule 2-4: - Requires Members and Associates to observe high standards of commercial honor and just and equitable principles of trade; giving preferable treatment to certain customers or using research-derived information to advantage over customers would violate Rule 2-4. - NFA Interpretive Notice: Obligations to Customers and Other Market Participants: - Prohibits Members and Associates from purposefully establishing, increasing, decreasing or liquidating a position in any SFP in anticipation of issuance of a research report regarding the underlying security or a derivative based on it. - Recommends development and implementation of firewalls to isolate specific information within research and relevant departments to prevent trading departments from using advance knowledge of issuance. - Recognizes supervisory procedures should be adaptable to firm size and business practices and gives flexibility to develop appropriate firewalls. - Notes limited trading in SFPs and no regulatory oversight issues found with use of research reports. ### Monitoring and enforcement - NFA conducts compliance monitoring for CFTC regulations on conflicts of interest through its regular examination program. - NFA staff indicated inspections have not found significant problems in connection with research analysis. - Other information service providers: - SEC and CFTC review the perimeter of regulation on a regular basis; reviews have not triggered concerns to regulate other categories of information service providers beyond CRAs and sell side analysts. - Assessment: Fully Implemented - Comments note lack of more comprehensive rules applicable to research for debt securities; Regulation AC covers it and antifraud provisions apply to BDs. Differences between firms covered by the Global Settlement and others are noted; FINRA work is welcome. ### Principles for Collective Investment Schemes — CPO/CIS framework (Principle 24) - CFTC: Marketing and operating a CIS - Under section 4m of the CEA, most individuals and firms intending to act as a CPO (including marketing CPOs) must register with the CFTC; definition in section 1a(11) of the CEA. - CFTC has delegated registration of CPOs to the NFA; NFA decisions are appealable to the CFTC and courts. - Natural person principals (including beneficial owners of more than ten percent of the firm’s capital) and APs must register; firms submit Form 7R. - Eligibility criteria and organizational requirements: - CEA (Sections 8a(2) and (3)) specifies disqualifying factors including prior disciplinary and criminal offenses. - To register as an AP, disclosure of background and passing proficiency tests required. - CPOs are not required to meet minimum financial requirements. - No specific statutory requirements mandating particular human and technical resources or explicit internal controls and risk management as part of registration; NFA Rule 2-9 imposes supervisory obligations and effectively requires compliance programs and annual reviews. - Primacy of investor interests: - Regulatory system is primarily disclosure-based. CFTC Regulation 4.24 requires CPOs to disclose fees, expenses, potential conflicts, and material transactions with affiliates. - Relationship with pool participants depends on pool structure; state corporate law may impose fiduciary obligations depending on structure. - International cooperation: - All pools offered to U.S. investors, including foreign-managed pools, are required to be registered under the CEA with limited de minimis exceptions; foreign operators often form a separate domestic pool. - NFA performs additional background checks for foreign applicants, consulting foreign regulatory bodies and Interpol where appropriate. - Sanctions for non-compliance: - NFA’s Business Conduct Committee can impose sanctions including expulsion, suspension, fine, censure, or other fitting penalties. - CFTC DOE can impose civil penalties (including bans and monetary penalties) and pursue criminal penalties, particularly for breaches of registration obligations. ### Supervision, monitoring and examinations (CPOs) - Responsibility and powers: - CFTC and NFA oversee CPOs. Under Section 17 of the CEA, as an RFA, NFA must establish training standards, proficiency testing, audit and enforcement programs, and minimum sales practice standards. - Registration process: - NFA reviews Form 7R and the Disclosure Document for compliance; does not routinely ask about procedures, internal controls and risk management at registration unless adverse information exists. - CPO principals and APs complete Form 8R and meet competence standards (Series 3 examinations). - Ongoing monitoring and examinations: - NFA conducts periodic examinations: generally within the first year after activation and then every 3 to 4 years, with higher risk firms examined more frequently. - NFA carried out 186 examinations of CPOs in calendar year 2012; 155 in 2013; and 100 up to November 2014. - Common focus areas: disclosure and performance reporting; promotional material review; handling of pool funds; financial records and reporting; valuation of assets. - NFA reviews compliance programs, policies and procedures, internal controls and risk management; enforcement actions taken for deficiencies. - NFA reviews Disclosure Documents, pool quarterly reports (PQRs), pool certified annual financial statements, promotional material, and investigative matters. - CFTC conducts ongoing oversight of NFA. ### Record-keeping, reporting and changes in management (CPOs) - Record-keeping: - CFTC Regulation 4.23 requires a CPO to make and keep books and records relating to the pool and its operation in an accurate, current and orderly manner in its main business office and in accordance with CFTC Regulation 1.31. - Reporting: - CFTC Regulation 4.22(c) requires distribution to pool participants of an annual report within 90 days of the period end; reports must include financial statements of pool investments. - CFTC Regulation 4.22(d)(1) requires these statements be prepared in accordance with GAAP and audited by an independent public accountant. - NFA requires annual updates to registration information and an annual self-assessment questionnaire. - Changes in management and operations: - CFTC Regulation 4.26 requires each CPO to correct any materially inaccurate or incomplete Disclosure Document the CPO knows of; amendments must be filed electronically with NFA and accepted before operative; changes must be made available to existing participants within 21 days of awareness; NFA reviews within this 21 day period. ### Conduct of business and conflicts of interest (CPOs) - NFA Rule 2-4 requires a CPO to observe high standards of commercial honor and just and equitable principles of trade. - Regime is largely disclosure-based; CPOs must adhere to trading strategies and disclosures in the Disclosure Document. - CPOs are required under CFTC Regulation 4.24(h)(2) to disclose material restrictions or limitations on trading. - Relationship between a CPO and pool participants is not fiduciary by statute, but anti-fraud provisions of the CEA apply to enforce good conduct and best execution. - Allocation of trades: - CFTC Regulation 1.35(b)(5) provides detailed rules for post-trade allocation, requiring allocations be made in a fair and equitable manner and that the general nature of the allocation methodology be disclosed to customers. - Due diligence and disclosure: - No statutory requirement for CPOs to perform due diligence in selecting investments beyond disclosure obligations; CFTC Regulation 4.24(h) requires detailed description of the pool’s investment program and CFTC Regulation 4.25 requires detailed past performance statistics. - Fees and commissions: - CFTC Regulation 4.24(i) requires full description of all fees, commissions and other expenses incurred in the preceding fiscal year and expected for the current fiscal year, including fees of investee CPs and funds. - Conflicts of interest: - The CEA and CFTC Regulations do not mandate minimizing conflicts; the regime is disclosure-based. CFTC Regulation 4.24(j) requires full description of actual or potential conflicts involving the CPO, trading manager, major CTAs, CPOs of major investee pools, principals, and service providers. ### Delegation and liability (CPOs) - Delegation permitted; delegating CPO remains legally responsible under the CEA and CFTC Regulations. - Delegating CPO is jointly and severally liable with the delegate where the delegate is a related party. - Staff letters allowing delegation require the delegate to register with the CFTC as a CPO and be an NFA member in relevant cases; oversight maintained via periodic audits and access to records by NFA and CFTC. - Delegation generally performed through contractual arrangements; termination depends on contract terms. - CFTC Regulation 4.24 requires disclosure about entities and individuals providing services, conflicts of interest and related party transactions. ### SEC framework for Collective Investment Schemes (mutual funds, ETFs, UITs) - CIS vehicles under federal securities legislation: - Open-end funds (mutual funds), closed-end funds, and UITs are registered under the ICA; mutual fund and closed-end fund operators are IAs registered under the Advisers Act. - ETFs commonly structured as investment companies and subject to ICA and Securities Act disclosure; SEC has provided exemptive relief for ETF features such as trading at market prices rather than redemption at NAV. - REITs are not covered by the ICA; governed under issuer framework and subject to disclosure via Form S-11; exchange listing corporate governance applies to most REITs. - Market composition as at 31 December 2013: - Mutual funds accounted for 78 percent of total ICA regulated AUM; ETFs for 18 percent; closed-end funds for 3 percent; and UITs for less than 1 percent. - Marketing and operating a mutual fund: - To operate a mutual fund, a person must register as an IA under Section 203 of the Advisers Act; fund shares can be marketed by the fund, operator or a broker-dealer, each required to register with the SEC. - Eligibility, governance and compliance: - Statutory disqualification applies based on criminal and disciplinary history. - No explicit statutory mandate for specific human/technical resources or internal controls at registration, but Advisers Act Rule 206(4)-7 requires written compliance policies and procedures reasonably designed to prevent Advisers Act violations, annual review, and designation of a Chief Compliance Officer. - SEC expectations for compliance policies include portfolio management, trading practices, proprietary trading, disclosure to clients, safeguarding client assets, record keeping, marketing, and valuation. - Mutual fund board composition and oversight: - A fund board must be composed of at least 40 percent independent directors; practice generally to have a majority independent directors. - Under Sections 15(a) and (c) of the ICA, advisory contracts and renewals must be approved by a majority of independent directors and a majority of outstanding voting securities; boards meet at least quarterly and annually to review performance and fees. - Boards must have independent legal counsel and the fund must have a Chief Compliance Officer; SEC has enforced board oversight failures. - Capital requirements: - Mutual funds subject to a minimum capital requirement of at least $100,000 in net worth. - UIT trustees must be banks with minimum capitalization of $500,000. ### SEC supervision, monitoring, examinations and reporting - SEC authority: - SEC can register and inspect mutual funds and IAs, investigate violations and take remedial actions; sanctions available under Principle 11. - Registration requirements: - IAs register via Form ADV with public disclosures; both fund and securities must be registered under ICA and Securities Act. - Mutual fund registration statements consist of a prospectus, a statement of additional information (SAI), and Part C containing exhibits and material contracts; UIT registration statements consist of nine parts. - For new funds the SEC must declare documents “effective” before sales; adding new series requires post-effective amendments that become effective 75 days after filing. - SEC reviews registration statements focusing on: - Disclosure of fees and compensation arrangements; - Investment policies and associated risks; - The role of the IA and other service providers. - OCIE examinations and priorities: - OCIE administers an examination program covering mutual funds and their IA operators; program focuses on eligibility standards and compliance with federal securities laws. - OCIE publishes National Examination Priorities annually (examples for 2014: alternative investment companies focusing on leverage, liquidity and valuation and governance; MMFs focusing on stress event management). - Firm selection for examination uses quantitative and qualitative factors, registrant-wide data, and OCIE’s ORAS group leveraging data analytics. - IM’s REO monitors a select number of largest asset managers based on risk characteristics and engages senior management and fund boards on market and operational risks. - OCIE conducts cause examinations based on complaints, tips, press reports, and risk-targeted sweep examinations on particular practices (e.g., soft dollar practices). - Examination staffing and process: - Typical team: senior manager, examination manager and 2 to 3 examiners. - SEC systems require supervisor approval at least three points in the process to ensure quality standards. - Examination reports with deficiencies are provided to the firm with requests for remediation details. - In fiscal year 2014 OCIE carried out approximately 170 examinations of IAs that operate mutual funds (out of over 1,600 firms in the category); typically around 100 investment companies examined each year out of approximately 840 fund complexes. - Record-keeping and reporting: - ICA, Advisers Act and SEC rules require mutual funds and IAs to maintain and preserve detailed books and records, subject to SEC examination at any time. *Source: _cr1591 - Section 732 of the Dodd-Frank Act (amending section 4d of the CEA) directed FCMs and IBs to (PDF).* ### Section 30(e) of the ICA requires a mutual fund to provide shareholders with annual and semi- ### _cr1591 - Section 30(e) of the ICA requires a mutual fund to provide shareholders with annual and semi- ### Reporting requirements for funds and CPOs - Section 30(e) of the ICA requires a mutual fund to provide shareholders with annual and semi-annual reports, and under SEC rules these reports must be provided within 60 days of period end. - These reports must contain detailed information about: - the financial position of the fund; - changes in net assets; and - the amount and value of each security held. - CFTC requirements for CPs: - A CPO must provide a report to each participant at least monthly (quarterly for pools with less than $500,000 in assets), containing detailed financial information including realized and unrealized gains and losses, all management and advisory fees and brokerage commissions paid by the pool, and the net asset value of the pool. - A CPO must also provide an annual report containing all items of the monthly report plus a statement of financial condition for the current and preceding fiscal year. - Accounting standards: - CFTC Regulation 4.22 requires financial statements in periodic and annual reports to be presented and computed in accordance with U.S. GAAP consistently applied. - The pool’s annual report must be certified by an independent public accountant. ### Changes in management and organization - Information about management and organization must be described in an IA’s Form ADV, and the IA must keep the information in its Form ADV current by promptly amending it to correct any responses that become materially inaccurate. - A mutual fund is required to keep current its prospectus which contains information about its management and organization. - Disclosure to investors of delegation arrangements and the identity of delegates is made as part of the shareholder vote approving the sub-advisory contract; a fund generally must disclose the same information about the delegate in its registration statement. ### Conduct of business and fiduciary duties - As a fiduciary, an IA has an obligation to seek to obtain best execution for its clients, including mutual funds. - Trade allocation obligations: - Trades must be allocated across accounts in a manner that is fair, reasonable and consistently applied on a timely basis. - Antifraud and market conduct: - Antifraud provisions apply to churning. - Self-regulatory organizations (SROs), including FINRA, prohibit churning and excessive trading by BDs executing trades for clients, including a mutual fund. - Codes of ethics: - SEC rules require mutual funds and their IAs and principal underwriters to adopt codes of ethics governing the personal securities transactions of employees. ### Conflicts of interest - Legislative and SEC rule framework: - Some conflicts are prohibited (for example, some transactions between the mutual fund and its affiliates or IA). - Some conflicts require shareholder approval (for example amendments to a distribution plan to increase materially the amount spent on marketing or distribution). - Some conflicts require independent review or approval by the fund’s board, especially the independent directors. - Conflicts must be disclosed. - The conflict of interest provisions apply equally to delegates. ### Delegation of advisory functions - No statutory prohibition on delegation of operator functions if the advisory contract permits delegation. - Systematic and complete delegation of core advisory responsibilities is not statutorily prohibited; if advisory responsibilities are delegated: - The delegate is considered an IA and may perform services for the fund only under a written contract approved by a majority of the fund’s shareholders and a majority of the fund’s independent directors. - The delegate must be registered with the SEC as an IA and, as an IA, owes a fiduciary duty to the fund. - Responsibility for delegate actions depends on advisory and sub-advisory contracts; both IA and delegate may be responsible in some contracts, in others only the delegate is responsible. - SEC enforcement: - The SEC can bring an enforcement action against an IA for failure to supervise a delegate if the delegate violates the law and is subject to the IA’s supervision. - Termination: - If the delegate is a sub-adviser, the ICA does not permit the IA to terminate the contract without approval by either a majority of the fund’s directors or its shareholders. - If the delegate is another kind of service provider, termination depends on contract terms. ### Assessment: Partly Implemented — examination coverage and eligibility requirements - Assessment summary: - Grade: Partly Implemented. - Main reasons: limited examination coverage of IAs and investment companies (Key Question 8) and absence of express eligibility requirements for CPOs and IAs in relation to internal controls and risk management (Key Question 2). - Examination coverage of IAs: - The SEC has a risk assessment system that uses automated tools and regional staff evaluations to identify higher risk firms for examination. - Examinations that occur appear intensive and thorough. - Resource constraints mean that only a little over 10 percent of IAs are examined each year. - Total mutual fund AUM is approximately $17 trillion; the current rate of examinations is less than the importance the sector warrants. - The assessors note other monitoring work (disclosure and reports reviewed by IM staff and active engagement with largest firms) does not substitute for on-site inspections, which are essential per IOSCO. - Eligibility requirements: internal controls and risk management - IOSCO Assessment Methodology requires eligibility standards to include human and technical resources and financial capacity (Key Question 2(e)) and internal controls and compliance arrangements (Key Question 2(f)). - The methodology allows verification of these requirements at a moment different from registration. - Current U.S. regime for IAs and CPOs is based on integrity and disclosure; no other requirement is needed for registration. - IAs and CPOs are subject to certain organizational and operational conduct obligations on an ongoing basis, including compliance programs monitored by examinations (including NFA’s examination of new registrants within their first year). - Many elements of a risk management framework are covered by existing obligations (compliance rule, custody and record-keeping rule for the SEC; obligation to supervise, segregation and record-keeping requirements for the NFA). - The assessors consider the current framework broadly achieves the objectives but recommend authorities consider an explicit rule on internal controls and risk management to align with IOSCO Principles and clarify expectations. - The SEC is considering whether broad risk management programs should be required for mutual funds and ETFs to address liquidity and derivatives risks, and measures to ensure comprehensive oversight of those programs. ### Principle 25 — legal form, structure, segregation and protection of client assets (CFTC and SEC frameworks) - CFTC — legal form and investors’ rights: - CFTC Regulation 4.20(a) generally requires a CPO to operate its pool as a legal entity separate from the CPO; typical forms are limited partnerships or LLCs, with CPO as general partner or managing member. - Increase in pools structured as investment companies registered under securities legislation and the CEA. - CFTC — disclosure and oversight: - CFTC Regulation 4.24(d) requires a CPO to disclose the pool’s form of organization in the Disclosure Document. - When registering as a CPO, an entity must submit a Disclosure Document to NFA for review prior to soliciting participants; the CFTC reviews NFA’s review as part of oversight. - CFTC — investment and borrowing restrictions: - CFTC Regulation 4.24(h)(2) requires disclosure in the Disclosure Document of any material restrictions or limitations on trading required by the pool’s organizational documents or otherwise. - CFTC — changes to investor rights: - CFTC Regulation 4.26 requires Disclosure Documents to be current and requires a CPO to provide notice of changes to participants within 21 days of becoming aware of the changes. - CFTC Regulation 4.24(w) requires disclosure of all material information to existing or prospective participants even if not specifically required by Regulations. - CFTC — separation of assets / safekeeping: - The CEA does not require a separate custodian for CPs. - CFTC Regulations require that all funds, securities and property received by a CPO must be received in the name of the CP and not commingled with property of any other person. - A CPO must disclose the entity that will hold the pool’s assets and the manner in which assets will be held in segregation; if held by an affiliate, that must be disclosed. - Practical data as of June 30, 2014: Of approximately 6,000 pools for which CPOs had filed information with the CFTC, only 374 did not list a separate custodian or broker. - Of that 374, 268 only invest in other funds or pools, per their schedule of investments, and 89 had a NAV of $0. - Of the remaining 17 pools without custodians, 13 have added a broker or custodian since the filing date. - Where a custodian is used, it may be a related party of the CPO; this is likely for larger CPOs that are members of financial services groups. - CFTC — winding up: - CFTC Regulations require filing of a final annual report containing financial statements within 90 days of a pool’s permanent cessation of trading or return of funds to participants. - Section 6c of the CEA provides the CFTC with the ability to obtain court orders to freeze pool and/or CPO assets and have receivers appointed to operate the CP for the benefit of participants. - SEC — legal form and investors’ rights: - The ICA imposes no specific legal-form requirements for open-end or closed-end funds; a fund must be organized under U.S., state, or foreign law. - An open-end or closed-end fund may be organized as a corporation, partnership, association, joint-stock company, trust, or any organized group of persons; most open-end and closed-end funds are structured as business trusts or corporations. A UIT must be organized under a trust indenture, contract of custodianship or agency, or similar instrument. - Section 18 of the ICA requires all common stock issued by a fund be voting stock and have equal voting rights; closed-end funds are permitted only one class of debt and one class of preferred stock in addition to one class of common stock. - Open-end funds must offer redeemable securities that entitle a fund investor to redeem shares at the fund’s NAV; closed-end funds do not issue redeemable securities. - SEC — disclosure and structure monitoring: - A fund must disclose in its registration statement whether it is open-end, closed-end, or a UIT, information about redeemability and jurisdiction of organization; registration exhibits include organizational documents. - Responsibility for ensuring compliance rests primarily with the mutual fund board and those who signed its registration statement; the SEC reviews fund registration statements and OCIE examinations detect material non-compliance. - SEC — investment and borrowing restrictions — fund liquidity: - Under SEC rules, open-end funds must have 85 percent of assets as liquid assets, where “liquid” means assets that can be sold within 7 days at their carrying value (understood to mean in normal market conditions). - Money market funds (MMFs) liquidity rules (introduced in 2010): - Daily Requirement: all taxable money market funds must hold at least 10 percent of assets in cash, U.S. Treasury securities, or securities that convert into cash (e.g., mature) within one day; - Weekly Requirement: all money market funds must hold at least 30 percent of assets in cash, U.S. Treasury securities, certain other government securities with remaining maturities of 60 days or less, or securities that convert into cash within one week; - Illiquidity restriction: MMFs are restricted from purchasing illiquid securities if, after the purchase, more than 5 percent of the fund's portfolio will be illiquid securities (defining "illiquid" any security that cannot be sold or disposed of within seven days at carrying value). - SEC — separation of assets / custodians: - Pursuant to Section 17(f) of the ICA and related rules, a mutual fund must place securities and similar investments in the custody of certain eligible custodians, including: - Banks subject to federal or state regulation that have capital of at least $500,000; - Members of a national securities exchange (i.e., certain broker-dealers); - Securities depositories; - FCMs and commodity clearing organizations; and - Certain foreign entities subject to certain conditions. - UITs may not maintain custody of their own assets and must designate one or more banks with aggregate capital of not less than $500,000 as trustees or custodians. - SEC — related-party trustee-custodian (self-custody) safeguards: - No requirement that a fund’s custodian be independent from the IA; if the operator or affiliate acts as custodian the fund is deemed to have “self-custody” and is subject to ICA Rule 17f-2, which requires, among other things: - Deposit of securities in the safekeeping of, or in a vault or other depository maintained by a bank or other company whose functions and physical facilities are supervised by federal or state authorities; - Physical segregation of securities and similar investments from those of any other person; - The board of directors must designate which employees (not more than five persons) are authorized to have access to the assets; and - Written notations must document each deposit or withdrawal of securities. - Additional requirement: an independent public accountant must verify, by actual examination, the fund’s assets at least three times each year (twice without prior notice), and a certificate of this accountant must be sent to the SEC after each examination. - In practice, self-custody is rare: less than 200 out of the 4,200 registered funds use it; most custodians are independent. - SEC — winding up: - A mutual fund remains subject to all provisions of the ICA until deregistration, which requires an SEC order declaring that it has ceased to be a fund and registration is no longer in effect. - The SEC may impose conditions on deregistration necessary for investor protection and in practice requires that to deregister a fund must have distributed all assets to shareholders, sold assets to another fund, or merged with another fund. - Assessment outcome: - Principle 25 Assessment: Broadly Implemented. - Comment: For CPs the regime requires additional safeguards where CPO or related entity performs custodian/depositary functions; assessors recommend considering legislative amendment to require additional safeguards. For mutual funds additional safeguards exist via independent public accountant examinations at least three times a year (twice surprise). ### Principle 26 — disclosure necessary to evaluate suitability and value - CFTC — disclosure regime: - Most CPs are institutional; only 10-15 percent have retail investors. - Retail pools are subject to CEA Disclosure Document rules and Securities Act prospectus obligations; compliance can generally be met with a single set of disclosure documents. - Offering documents: - CFTC Regulation 4.24 sets detailed requirements for Disclosure Documents, including information on the pool and its operator; fees and expenses; conflicts of interest; risks of futures trading; specific risks of the pool; investment program and use of proceeds; and redemption provisions. - Regulation 4.25 regulates performance information, including requiring a prescribed format. - NFA Rule 2.35(a)(1) requires Disclosure Documents to be written using plain English principles. - If a CPO knows or should know a Disclosure Document is materially inaccurate or incomplete, it must correct the defect and distribute the correction within 21 calendar days. - Periodic reports and regulator powers: - All offering materials and account statements must be filed with NFA; NFA reviews these documents and conducts periodic on-site examinations of CPOs. - NFA must accept a Disclosure Document before a CPO may use it; the CFTC conducts quarterly reviews of NFA’s review by sampling accepted Disclosure Documents. - Advertising: - CFTC Regulation 4.41 prohibits fraudulent and misleading advertising; NFA reviews all promotional material and proactively monitors broadcast media. - SEC — disclosure regime for mutual funds: - Prospectuses must comply with detailed disclosure obligations set out in forms for each fund type: open-end (Form N-1A), closed-end (Form N-2) and UIT (Form N-8B-2). - Prospectuses must contain all information required by Key Question 5 of the IOSCO Methodology and all material information for an investor’s decision; detailed fee disclosure is required including mandated fee tables and more detailed fee information available via the SAI. - Summary prospectus: - SEC rules require a summary of key information at the front of a fund’s prospectus in plain English in a standardized order. - Delivery of the summary prospectus is optional; if delivered its content must match the summary in the full prospectus and investors must have access to the full prospectus on an Internet website. - In practice: - Most investors in closed-end funds acquire shares in the secondary market and may not receive a prospectus because delivery requirement applies only to the primary offer; for these investors the main source of information (e.g., fees) is the annual and semi-annual reports. - Changes to investor rights and disclosure timing: - Under the ICA, some material changes (such as approval of an advisory contract) require shareholder approval. - Material changes that do not require shareholder approval require updating registration statements and prospectuses so new or existing investors making a new investment are informed. - A fund must provide shareholders with at least 60 days’ notice prior to changing a fundamental investment policy of investing at least 80 percent of the fund’s assets in the type of investments suggested by the fund’s name (SEC Rule 35d-1). *Source: IMF staff summary of the referenced assessment section.* ### Section 30(e) of the ICA requires that funds provide annual and semi-annual reports to ### _cr1591 - Section 30(e) of the ICA requires that funds provide annual and semi-annual reports to ### Reporting requirements under Section 30(e) of the ICA - Funds must provide annual and semi-annual reports to shareholders that include: - financial statements, - a statement of operations, - a statement of changes in net assets, - a schedule of portfolio holdings showing the amount and value of each security owned by the fund on that date, - a financial highlights schedule (financial highlights information shows financial results for a single share of a fund). - Only the annual reports must include audited financial statements accompanied by a certificate of an independent public accountant registered with the PCAOB. - Reports must be transmitted to shareholders within sixty days of the close of the relevant period. - Sections 30(a) and (b) of the ICA and SEC Rule 30a-1 require a fund to file with the SEC a semi-annual report on Form N-SAR within 60 days of the close of the relevant period. - Form N-SAR contains information designed to aid in the SEC’s monitoring of a fund’s operations. ### Material event reporting and continuous offerings - Open-end funds that continuously offer shares to the public must have at all times a current, effective registration statement. - Open-end funds amend their registration statement at least annually to include updated financial information, or more frequently, if necessary, to reflect material changes in operations. - The Securities Act requires a fund making a continuous offering to maintain a current statutory prospectus. - A fund can update its prospectus by filing a post-effective amendment to its registration statement containing updated financial statements and other information. ### Regulator’s powers over offerings and disclosures - To sell shares to the public, a mutual fund must register under the ICA and register the offering of its securities under the Securities Act. - The Securities Act gives the SEC power to intervene in an offering if an offering document contains incomplete, inaccurate, or false and misleading information, including through: - stop orders (Section 8), - cease and desist orders (Sections 8A and 10(b)). - The SEC reviews all registration documents and material amendments, including prospectuses (as noted under Principle 24). ### Advertising and marketing materials - All marketing materials are subject to the antifraud provisions of the federal securities laws and are prohibited from containing material misstatements or omissions. - Different disclosure requirements apply depending on the type of advertisement. - Section 24(b) of the ICA requires open-end investment companies and UITs and their underwriters, in connection with a public offering, to file copies of all advertisements and sales literature with the SEC or with FINRA (if shares are sold by a FINRA member). - FINRA requires a BD to file with FINRA any advertisement or sales literature it uses to market the company; FINRA reviews these. - Advertisements and sales literature filed with the SEC may be reviewed by SEC staff as part of an inspection to ensure the material is not false or misleading. ### Accounting standards for fund financial statements - Financial statements in a fund’s annual and semi-annual reports must be prepared in accordance with the U.S. GAAP. - Regulation S-X requires that an independent public accountant registered with the PCAOB perform an audit of the fund’s financial statements in accordance with PCAOB standards and state that the financial statements are prepared in accordance with U.S. GAAP. ### Ensuring compliance with investment policies - OCIE examinations of funds and their IAs (described under Principle 24) include checks of compliance with a fund’s stated investment policy or trading strategy. *Source: IMF staff report text (UNITED STATES), _cr1591* ### Principle 27 — Asset valuation, pricing, and redemption (excerpts) #### CFTC regime: valuation and redemption for pools (CPs) - Asset valuation - CFTC Regulations require CPOs to use U.S. generally accepted accounting principles (GAAP) in calculating the net asset value of a pool. - These principles include FAS 157 (now FASB ASC 820), Fair Value Measurements. - Timing - No CEA or CFTC Regulation rules on timing of asset valuations other than requirements to value at least monthly (quarterly for small pools) for account statements sent to all pool participants. - Independent audit - Annual financial reports of CPs must be audited by an independent public accountant. - Pricing and redemption of interests - CFTC Regulation 4.24(p) requires a pool’s Disclosure Document to contain a complete description of any transferability restrictions and a complete description of the frequency, timing, and manner in which a participant may redeem interests. - The redemption description must specify how the redemption value is calculated, conditions under which redemption will be made (including time between request and payment), and any restrictions on redemptions. - CFTC Regulation 4.22 requires CPOs to distribute Account Statements monthly (quarterly if the pool has AUM less than $500,000). These reports include all material information relevant to the net asset value per participation of the pool. - Similar information must be included in the Disclosure Document provided to prospective participants. - Pricing errors - The regulatory regime (including NFA rules) does not contain specific provisions dealing with errors in the pricing of interests; authorities are not aware of industry standards or protocols for treating investors adversely affected by pricing errors. - Suspension/deferral of redemptions - A pool’s Disclosure Document must disclose circumstances under which redemptions can be suspended. - If a CPO suspends or defers redemptions inconsistent with its Disclosure Document it must update the Disclosure Document and provide a copy to the NFA; such action may trigger NFA or CFTC enforcement. - A CPO’s quarterly report on Form CPO-PQR is required to disclose any halt or any other material limitation on redemptions during the reporting period. - Regulatory authority - The CFTC and NFA have the power to take action where a CPO has violated CFTC or NFA rules with respect to valuation and redemption. #### SEC regime: valuation and fair value reporting for investment companies - Principles for valuation - Valuation of investment companies’ portfolio securities is governed by the ICA and related SEC rules. - Regulations require a fund to value securities with readily available market quotations at current market value, and other securities and assets at fair value as determined in good faith by the fund’s board of directors. - The SEC has addressed many valuation and pricing issues in its Accounting Series Releases. - Financial statements filed with the SEC generally must be prepared in accordance with U.S. GAAP. - The FASB Accounting Standards Codification requires investment companies to report investments at fair value. *Source: IMF staff report text (UNITED STATES), _cr1591* ### Section 2(a)(41) of the ICA provides that the board of directors of a fund must determine, in ### _cr1591 - Section 2(a)(41) of the ICA provides that the board of directors of a fund must determine, in ### Valuation responsibilities and standards - Section 2(a)(41) of the ICA provides that the board of directors of a fund must determine, in good faith, the fair value of portfolio securities (and other assets) for which market quotations are not readily available. - The methodology approved by the board must be consistent with U.S. GAAP. - ICA Rule 38a-1 requires a fund to adopt written policies and procedures to, among other things, regularly review the appropriateness and accuracy of the method used to value securities. - The board of directors is responsible for approving valuation criteria and continuously reviewing valuation methods to assure valuations are fair and accurate. ### Timing and NAV computation - ICA Rule 22c-1 generally requires that an open-end fund compute its NAV at least once daily, Monday through Friday. - SEC Rule 22c-1 requires that sales and redemptions must be effected at the current net asset value next computed after receipt of an order to redeem, purchase or sell. ### Independent audit and oversight of valuation - As part of the annual audit, PCAOB registered independent auditors review and evaluate the processes used by funds to value their portfolio securities, including processes used by the board to arrive at fair value for securities without readily available market quotations. - OCIE reviews fund asset valuation and pricing during its examinations of funds, fund operators, and third-party administrators that perform operational and administrative functions. - The SEC has taken enforcement actions for inappropriate valuation practices. ### Pricing and redemption regimes - Closed-end funds do not redeem their shares but they can repurchase them; Section 23 of the ICA generally prohibits a closed-end fund from selling its common stock at a price below current NAV. - MMFs are subject to different rules and currently permitted to apply constant NAV for sales and redemptions; recent rules which will become effective in 2016 would require institutional prime MMFs and institutional municipal MMFs to use variable NAV. - Under rules made in 2010 and recently amended: - MMFs are permitted to permanently suspend redemptions in certain circumstances to facilitate an orderly liquidation if the board including a majority of independent directors approves the liquidation. - Amendments to come into effect in 2016 will allow the board of an MMF that holds other than government securities to temporarily suspend redemptions (impose redemption gates) in specified circumstances for a limited amount of time and will allow (and in some circumstances require) a non-government MMF’s board to impose a liquidity fee on shareholder redemptions in certain circumstances. - Generally a fund (other than an MMF in specified circumstances) cannot suspend the right of redemption or postpone the date of payment more than seven days after the tender of the security to the fund or its redemption agent. - The fund must amend its prospectus to discuss any suspension or deferral of redemption rights, and the amended prospectus must be filed with the SEC. - Suspension of redemptions for other reasons requires an order from the SEC; the SEC can grant such an order only if it determines the order is necessary for the protection of the fund’s shareholders. ### Disclosure of pricing and subscription/redemption procedures - Disclosure of the procedures for subscription and redemption of shares is required in the prospectus of an open-end fund and a UIT. - The federal securities laws do not require that the prices of a fund be disclosed or published on a regular basis to investors other than in semi-annual reports; however, the price of a fund is generally available in financial publications and web sites and may also be available on the fund’s or IA’s website. ### Pricing errors: rules, practice, and enforcement - The SEC indicated that it may bring an enforcement action against a fund or its IA if a pricing error violates, or results in violation of, the U.S. federal securities laws. - There are voluntary industry rules of practice, adopted by many funds, to address pricing errors; these include rules on circumstances in which compensation should be made to shareholders for losses resulting from pricing errors. - The valuation procedures of a fund generally provide for the reporting of any material pricing errors to the board of directors, and may call for the board to review or approve any corrective action that was taken. - Pricing errors that are not considered material would be corrected on a going-forward basis. - A fund typically would not report pricing errors to the SEC unless the error is required to be reflected in its financial statements filed with the SEC. ### Regulatory authority to monitor compliance - The SEC has the power to ensure compliance with the rules applicable to asset valuation and pricing through its examinations of registrants and through enforcement actions. - OCIE reviews fund asset valuation and pricing during its examinations. - The SEC has taken enforcement actions for inappropriate valuation practices. ### Assessment and comments on valuation/pricing framework - Assessment: Broadly Implemented - Comments: - The issue that impacted the grade for this Principle is the absence of any regulatory requirements, rules of practice and/or rules addressing pricing errors in CPs, as contemplated by Key Question 8 of the Methodology. - The assessors consider that the Methodology envisages rules that provide for the way investors are to be treated if errors in the pricing of CIS interests occur, going further than merely accounting adjustments when errors are discovered. - There is a voluntary industry code of practice dealing with pricing errors for MFs, which deals with compensation to investors for losses arising from pricing errors; however, the code is voluntary and the SEC does not have explicit authority to enforce it, although in some cases it may be able to take action on pricing errors if they resulted in a violation of the federal laws. - The assessors acknowledge authorities’ observation that in practice there appear to be few examples of pricing errors in CPOs, and the issue does not appear to arise in customer complaints or NFA arbitration cases. ### Principle 28 — Regulation and oversight of hedge funds and managers/advisers - U.S. federal securities and commodities laws do not specifically define HFs. - CIS in the U.S. are regulated by the ICA when the CIS invests primarily in securities and the CEA when the CIS invests primarily in commodities. - A HF (as defined in the IOSCO Assessment Methodology) may be regulated by the ICA if it meets the definition of “investment company” and is ineligible for an exemption or exclusion. - Common statutory exclusions relied upon by private pools: - Section 3(c)(1) of the ICA excludes any issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than 100 investors and that does not make a public offering. - Section 3(c)(7) of the ICA excludes any issuer whose outstanding securities are owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers” (as defined by Section 2(a)(51) of the ICA) and that does not make a public offering. Qualified purchasers are generally individuals with $5 million in investments or entities with $25 million in investments. - A HF may be regulated under the CEA if it meets the definition of a “CP” described in Principle 24 and is ineligible for an exclusion or exemption; in practice most HFs that invest in commodities are as a product exempted from registration. ### Registration and reporting for HF managers (IAs) - Title IV of the Dodd-Frank Act expanded categories of IAs subject to SEC registration: each IA with AUM over S$100 million must be registered with the SEC, unless an exemption applies (including advisers to a “venture capital fund”, advisers solely to “private funds” with total U.S. AUM of less than $150 million, or a foreign private adviser). - Managers relying on exemptions (i) and (ii) are “exempt reporting advisers” (ERAs) and are subject to SEC examination; all advisers, even if exempt from registration, remain subject to antifraud provisions. - IAs register by filing Form ADV; ERAs report certain information on Form ADV. - Form ADV disclosure includes: (i) background of organization and ownership; (ii) assets under management; (iii) services offered; (iv) types of clients; (v) fees charged; (vi) investment related affiliates; (vii) investment strategies utilized; (viii) identification of key service providers; and (ix) conflicts of interest. - Forms ADV are public from the moment of filing and can be accessed via the SEC website. - Rule 204-1 requires registered advisers to complete and file an annual update of Part 1A and 2A of Form ADV through IARD; advisers must file an annual updating amendment to Form ADV within 90 days after the end of the firm’s fiscal year and amend promptly when certain information becomes inaccurate. - Pursuant to Section 204 and Rule 204(b)-1, IAs with at least $150 million in private fund RAUM are subject to additional ongoing reporting through Form PF, filed confidentially to assist FSOC in identification of systemic risk. - Advisers with at least $1.5 billion in HF RAUM must file Form PF quarterly with respect to their HFs; for each Qualifying HF (i.e., $500 million or more in net assets), additional information is required; these reports must be filed within 60 days. - Advisers with at least $1 billion in combined liquidity fund and registered money market fund RAUM must file Form PF quarterly with respect to their liquidity funds; these reports must be filed within 15 calendar days. - Advisers with at least $2 billion in private equity fund RAUM must file Form PF annually with respect to their private equity funds; these reports must be filed within 120 calendar days. - Form PF requires reporting of information on counterparty credit exposure in relation to OTC derivatives positions, loans, and loan commitments. ### Ongoing regulatory duties and firm-level obligations for IAs - IAs to HFs are subject to: - The “Books and Records Rule” (retain most books and records for five years from the end of the year created, in an easily accessible location). - Segregation of client assets rule; if an adviser has custody of client assets, an independent public accountant must verify those client assets by actual examination at least once during each calendar year. - The “Code of Ethics Rule” requiring a code of ethics that addresses personal trading by supervised persons. - The “Advertising Rule” prohibiting false or misleading advertisements. - The “Compliance Rule” requiring written policies and procedures reasonably designed to prevent violation of the Advisers Act, annual review of adequacy of policies, and designation of a chief compliance officer. - IAs to hedge funds are subject to fiduciary duties. ### Hedge funds that invest in commodities — CPO registration and reporting - Post Dodd-Frank, CPOs that manage HFs must register with the CFTC; in practice registration is conducted by the NFA pursuant to delegation. - CPOs must submit Form 7R to the NFA providing details including prior criminal and disciplinary history; NFA review focuses on integrity of the applicant and requires information about principals and APs. - CPOs must provide an annual registration update and complete the Annual Questionnaire. - CFTC Regulation 4.27 requires all CPOs registered with the CFTC to file Form CPO-PQR with the NFA under these rules: - Schedule A: All registered CPOs irrespective of AUM must provide basic information about the CPO, AUM, pools managed, certain service providers, monthly returns, and subscription and redemption activity. - Schedule B: CPOs with AUM in the amount of $500 million or greater must provide pool borrowings, counterparty credit exposure, fund strategy, derivatives exposure, and a full schedule of investments. - Schedule C: CPOs with AUM greater than $1.5 billion must also provide pools’ geographical exposure, liquidity, and risk testing based upon several specific scenarios. - Filing frequency: - Smaller and mid-size CPOs must file annually, within 90 days of the end of each calendar year. - Large CPOs must file quarterly within 60 days of the end of the calendar year. - Rule 4.7 relief for Rule 4.7 pools (accredited investor pools) allows streamlined disclosure practices: - No obligation to file a disclosure document with the NFA (market practice is to provide an offering memorandum with a disclaimer that it has not been reviewed by the NFA). - Account statements need to be provided only quarterly under relief, though most CPOs provide monthly statements in practice. - Annual Report information requirements are also more streamlined under relief. ### Other ongoing CPO obligations - Recordkeeping obligations: CFTC Rule 4.23 imposes detailed recordkeeping obligations; Rule 4.7 pools must maintain copies of account statements and annual reports at the main business address and preserve books and records for the same time periods as any other CPO. - Asset protection: CFTC Regulations require proper segregation by the CPO of all funds, securities and property of the pools it operates. - General supervisory obligations: NFA Compliance Rule 2-9 requires each NFA member to diligently supervise employees and agents; CPOs must establish and implement written supervisory policies and procedures. - CPOs to HFs do not have fiduciary duties stemming from federal laws but are subject to antifraud provisions. ### Oversight, enforcement, and information sharing - Under Section 204(a) of the Advisers Act, the SEC has authority to require IAs to maintain records and provide reports; Section 204(b)(2) deems private fund records to be records of the IA, giving SEC staff access for examination or inspection. - Similar powers over CPOs are provided to the CFTC by the CEA. - The FSOC may subject certain nonbank financial companies to oversight by the Federal Reserve and additional prudential standards if it determines they could pose a threat to financial stability; at the time of assessment FSOC had not designated any IA or CPO to HFs as systemically important. - The SEC and the CFTC have broad enforcement authority against IAs and CPOs that manage HFs. - Pursuant to federal securities and commodities laws, the SEC and CFTC can share information related to HFs advisers/operators with foreign supervisors. - The SEC has shared Form PF filings with the OFR, subject to confidentiality provisions of the Dodd-Frank Act. ### Supervision of HF managers — practice - For HFs that invest in securities: - Periodic reports that IAs submit to the SEC are a key mechanism for ongoing supervision; such reports are shared with FSOC. - The SEC launched the “Presence Exam Initiative” at the start of fiscal year 2013 to examine a significant percentage of advisers registered since Title IV effective date; examinations focused on marketing, portfolio management, conflicts of interest, safety of client assets, and valuation. - Annual CEO certification and IA annual review requirements compel firms to monitor adequacy of written supervisory procedures; OCIE reviews IAs’ annual compliance reviews as part of examinations. - The SEC may use Form PF information for examining SEC-registered IAs. - For HFs that invest in commodities: - Analysis of reports that CPOs submit is a key mechanism for ongoing monitoring. - The NFA follows a risk-based approach and uses available data (including complaints and SEC information) to “score” firms for potential on-site examinations; the NFA aims to conduct on-site examinations of non-FCM entities at least every 3-4 years. - Supervision modules include review of the CPO’s compliance program. ### Assessment of HF manager regulation - Assessment: Fully Implemented - Comments: - The current registration regime for IAs and CPOs that manage HFs is based on integrity criteria and disclosure requirements, supplemented by ongoing organizational and operational conduct standards. - The assessors note that most elements in the Assessment Methodology are part of ongoing obligations for HF managers. While there is no explicit obligation to implement risk management arrangements, many elements are covered by compliance program obligations, custody/segregation rules, and record-keeping requirements. Audited financial statements are market practice. - The assessors encourage authorities to review whether an explicit obligation to implement a comprehensive risk management framework is required as authorities continue analyzing HF risks. - The current regime does not impose capital requirements on IAs or CPOs that manage HFs; the Methodology acknowledges jurisdictions may vary in prudential regulation. The assessors consider current reporting obligations (Form PF and CPO-PQR), segregation of clients’ assets rules, and compliance program obligations as prudential in nature, and note FSOC powers to impose additional prudential requirements on designated non-bank entities. The assessors consider that the current framework meets the minimum requirements of Key Question 7 of the Assessment Methodology. _International Monetary Fund — United States assessment (excerpts)._ ### Section 8a of the CEA requires intermediaries that intend to do business in the markets ### Section 8a of the CEA requires intermediaries that intend to do business in the markets regulated by the CFTC to be registered with the CFTC, subject to limited exceptions ### Registration categories and process - Registration categories include: - SDs and MSPs; - Futures industry participants: - FCMs, who deal on exchange and hold customer assets and positions; - IBs, who solicit or accept orders, but do not hold client assets or positions; - CTAs, who advise on dealing in futures and manage individual discretionary accounts, but who are not permitted to deal on behalf of customers or hold client assets. - Floor brokers and floor traders, who trade on exchange floors; - RFEDs, who deal in foreign exchange contracts with retail clients. - (CPOs are dealt with under the Principles for CIS) - Registration is performed by the NFA under authority delegated by the CFTC. - The CFTC’s rules on registration are set out in Parts 3 and 23 of its regulations, and NFA’s requirements and procedures for registration are set out in Part 200 of its Manual/Rules. ### Integrity and competence requirements - NFA’s registration process includes an examination of an applicant’s past conduct and proficiency requirements. - Forms and disclosures: - Form 7-R: used for applicants for registration; requires disclosure of prior criminal or regulatory actions. - Form 8-R: used for principals and APs of applicants; requires disclosure of criminal, civil, regulatory, financial, professional, educational and residential background, and evidence of the satisfaction of proficiency examination requirements. - Applicants must submit fingerprint cards to enable criminal background checks. - Applicants for registration must also provide certified financial statements. - If there are material inadequacies in the accounting system, internal accounting control, or procedures for safeguarding customer funds or assets, the certified accountant must notify the applicant, who in turn must notify NFA, the DSRO, and the CFTC. ### Capital requirements - CFTC Regulation 1.17 prescribes the minimum levels of adjusted net capital that FCMs and non-guaranteed IBs must have. - CFTC Regulation 5.7 prescribes the minimum level of adjusted net capital for RFEDs. - For SDs and MSPs, Section 4s(e) of the CEA requires the adoption of rules establishing capital and margin requirements. - If an SD or MSP applicant has a prudential regulator, that regulator’s capital and margin rules apply; if there is no prudential regulator, CFTC rules apply. - The CFTC is in the process of finalizing the SD and MSP capital and margin rules. - No capital requirements exist for CTAs or floor brokers and traders. ### Internal controls and risk management - CFTC Regulation 1.11 requires each FCM to establish, enforce and monitor a system of risk management policies and procedures designed to monitor and manage the risk associated with the activities of an FCM; and to provide its risk management policies and procedures to the CFTC and to the firm’s DSRO upon its application for registration or upon request by the CFTC. - NFA membership requirements include adequacy of internal controls and risk management: - As part of its review of applications for membership the NFA requests firms to provide a copy of their procedures and processes and conducts a review of them. - The NFA can require an applicant to submit details about specific procedures, for example order routing systems, promotional materials and the supervision of APs. - For SDs, registration requirements prescribed under the CEA require participants to demonstrate compliance with all CEA requirements, which include having in place appropriate policies, procedures and risk management. - NFA practice for SDs: - Initially conducted a provisional registration for which SDs were required to submit the information required by Form N-R. - The NFA conducted a top line review to confirm that the applicant had submitted documentation covering all requirements (i.e., it was a review of completeness of documentation). - If all information was submitted the applicant was granted temporary registration. - The NFA is currently in the process of conducting a thorough review of applications with a view towards final registration. - NFA reports its findings on these issues to the CFTC to seek comments and feedback. ### Authority of regulator, sanctions, and ongoing requirements - The CEA and CFTC regulations give the CFTC (and the NFA as the CFTC’s delegate) authority to refuse to register an intermediary if a statutory bar to registration exists. - Appeals: - NFA decisions can be appealed to the CFTC, and CFTC decisions to the courts. - Sanctions and restrictions: - Section 8a(4) of the CEA allows the CFTC to suspend, revoke or place restrictions on the registration of any persons registered under the CEA in specified circumstances, which include violations of the CEA or CFTC Regulations. - NFA Rule 501 allows the NFA to suspend, revoke or impose conditions on the registration of any registrant. - Ongoing requirements: - CFTC Regulation 3.31 requires each registrant or applicant for registration to promptly correct any deficiency or inaccuracy in its registration information including information about its principals and APs. ### Public disclosure of licensed intermediaries - NFA’s Background Affiliation Status Information Center (BASIC), accessible through the NFA website, contains information on each registrant, the category of license held by the firm or individual, the main office, its listed principals, and membership/registration history. - Disciplinary actions against the firm or individual are also included. ### Investment advisers and CTAs (CFTC regime) - CTAs can manage discretionary accounts on behalf of clients and typically have authority to trade individual or pool accounts, but they are not permitted to deal on behalf of customers or to have custody of client assets. - There is a limited exclusion from the definition of a CTA for FCMs with respect to advising which occurs and is solely incidental to their other business as an FCM. In this case, all the FCM requirements regarding record-keeping, protection of client assets, including segregation and periodic risk-based inspections, capital, and organizational requirements (see Principle 31) would apply fully. - CTAs’ registration is disclosure based. CTAs are required to disclose specific information, including: - the business background of the CTA and its principals that will make trading or operational decisions, - any material actions against the CTA and its principals, - a description of the trading program and related risk factors, - fees, - any actual or potential conflicts of interest, and - past performance of its client accounts (Regulations 2.34 and 4.35). - Conflict of interest rules are based on a requirement to disclose and include material conflicts relating to the trading program offered by the CTA. - CTAs are required to keep accurate, current and orderly books and records (CFTC Regulation 4.33). ### SEC: Authorization of licensees and registration categories - Broker-dealers (BDs): - A person engaged in the business of effecting transactions in securities for the account of others, or buying and selling securities for their own account, through a broker or otherwise, must generally register as a broker-dealer (BD) with the SEC. - Foreign broker-dealers who engage in such activities in the U.S. are required to register with the SEC except in connection with non-solicited transactions by U.S. investors and in certain other circumstances. - Banks enjoy certain targeted exceptions and exemptions from BD registration in connection with a limited set of activities, such as networking arrangements, trust activities, custody activities and sweep accounts. - BBDs must generally be members of FINRA unless they do not do business with the public. - BDs may also need to register with the securities authority of one or more states. - A BD registers with the SEC by filing an application for registration on Form BD. Form BD requests extensive background information about the applicant, including its principals, control persons (having 25 percent or more of the shareholdings of the company), and whether the applicant has been subject to criminal, regulatory or civil actions in connection with any investment-related activity. - The BD registration process is coordinated through the Central Registration Depository (CRD) system operated by FINRA. In practice, for a BD to be eligible to carry on business it generally must register with the SEC and be a member of an SRO, typically FINRA. - OTC derivatives dealers: - OTC derivatives dealers are a special class of BDs that are exempt from certain broker-dealer requirements, including membership of an SRO, regular broker-dealer margin rules, and membership of SIPC. - They are registered directly by the SEC, and are subject to special requirements, including limitations on the scope of their securities activities as well as specified internal risk management control system, record-keeping, and reporting responsibilities. - Very few participants are currently registered in this category; however, due to the new regulatory framework for swaps, several market participants have inquired about registering as an OTC derivatives dealer. - Security-based swap dealers (SBSD): - The Exchange Act definition of “dealer” does not include certain security-based swap dealers, but Section 15F of the Exchange Act prohibits any person from acting as an SBSD without being registered with the SEC, and requires that the SEC issue rules to provide for registration of these entities. - The SEC is in the process of finalizing rules for their registration. - Investment advisers (SEC regime): - The SEC registers IAs that have $100 million or more of assets under management or that provide advice to an investment company (CIS). - Foreign IAs who provide services in the U.S. must also be registered unless that adviser can fit within an exemption (e.g., a foreign private adviser). - An IA that has between $25 million and $100 million of assets under management must also register with the SEC, if it is not required to be registered as an adviser with, and is not subject to examination by, the state securities authority where it maintains its principal office and place of business. - IAs that are not registered with the SEC generally must register with the state securities authorities of the state in which they are organized and in each of the states in which they do business as an IA. - An IA registers with the SEC by filing an application for registration on Form ADV under the Advisers Act. Form ADV requests extensive information regarding the adviser’s background and business practices. *Source: _cr1591 - Section 8a of the CEA requires intermediaries that intend to do business in the markets* ### Section 975 of the Dodd-Frank Act amended Section 15B of the Exchange Act to create a new ### _cr1591 - Section 975 of the Dodd-Frank Act amended Section 15B of the Exchange Act to create a new ### Municipal advisor registration and integrity - Section 975 of the Dodd-Frank Act created a new class of regulated persons, municipal advisors, and requires these advisors to register with the SEC and comply with MSRB rules. - As of October 1, 2010, it became unlawful for municipal advisors to provide certain advice to or on behalf of, or to solicit municipal entities or obligated persons without registering with the SEC. - SEC transitional and final actions: - SEC adopted an interim final temporary rule to provide a temporary means to satisfy the registration requirement. - SEC adopted a final rule providing for municipal advisor registration in September 2013. - SEC provided a four month phased-in compliance period that began on July 1, 2014 and ended on October 31, 2014 for existing municipal advisors to comply with the requirement to register with the SEC on Form MA. - All municipal advisors must register with the SEC by filing Form MA. - Form MA disclosures are based generally on Form BD for BDs and Form ADV for IAs and require extensive information on the applicant’s background, business and associated persons. - Firms must file Form MA-I for each natural person associated with the municipal advisory firm and engaged in municipal advisory activities on the firm’s behalf. - Registration denial and integrity: - Registration may be denied for all classes of applicants on the basis of past criminal, administrative or civil action against the applicant or, in some instances, persons associated with the applicant, subject only to administrative or judicial review. ### Competence and registration scope - BDs: - FINRA membership rules require most persons associated with a BD to register with FINRA using Form U4 and impose qualification requirements based on activities. - Registered representatives, general sales personnel, principals, general officers and other management personnel involved in day-to-day investment banking or securities business must pass qualification examinations. - IAs and municipal advisors: - Only the firm, not the persons associated with it, must register with the SEC; statutory framework is disclosure-based rather than SEC review of individual competence. - Part 2 of Form ADV must be provided to prospective clients to enable evaluation of adviser risks. - Many states require registration of individual persons associated with state-registered IAs and may impose educational and professional training requirements on representatives of SEC-registered IAs with a place of business in that state. - Municipal advisors must provide Form MA-I for each natural person associated with the firm; Form MA and Form MA-I(s) are publicly available on the SEC’s website. ### Internal controls and compliance frameworks - BDs (FINRA requirements): - Financial controls to ensure compliance with federal securities laws, rules and regulations. - Compliance, supervisory, operational and internal control practices including written supervisory procedures. - An appropriate supervisory structure. - Appropriate systems of customer protection, risk management and internal controls. - A designated chief compliance officer. - OTC derivatives dealers / ANC BDs: - Exchange Act Rule 15c3-4 requires establishment, documentation, and maintenance of internal risk management controls addressing market, credit, leverage, liquidity, legal, and operational risks. - IAs: - Rule 206(4)-7 requires adoption and implementation of written compliance and control procedures (CP&P) reasonably designed to prevent violations of the Advisers Act. - SEC guidelines set minimum standards for CP&P and require designation of a single chief compliance officer (CCO). - Municipal advisors: - MSRB rulemaking to establish the full regulatory regime is not yet complete. - Exchange Act requires MSRB rules to, at minimum, prescribe means reasonably designed to prevent acts, practices, and courses of business inconsistent with a municipal advisor’s fiduciary duty, provide continuing education requirements, and provide professional standards. ### Authority of regulator — assessment, refusal, revocation - BD registration: - SEC registration process for BDs focuses on completeness of Form BD and statutory disqualification checks; SEC order generally not effective until BD becomes SRO member (typically FINRA). - FINRA pre-membership process (Form NMA) includes review of supervisory and record-keeping procedures, bank statements, and membership interview; FINRA conducts an examination of a new firm within six months to one year after membership. - IA registration: - Prospective IA submits Form ADV; SEC reviews to ensure (i) applicant meets conditions for registration (for example, that the applicant has AUM of $100 million or more); (ii) required information submitted; and (iii) no statutory disqualification exists. - SEC staff contacts IA’s CCO by phone to obtain information about compliance plans. - Municipal advisor registration: - SEC reviews Form MA and required Form MA-I(s) for completeness and statutory disqualifications; staff may perform cross checks using other registration numbers and may contact applicant as needed. - Refusal and timelines: - SEC can refuse licensing of a BD, subject to administrative or judicial review, if authorization requirements not met; FINRA can condition or deny membership subject to hearing. - SEC may refuse to register an IA or municipal advisor if authorization requirements are not met. - Generally the SEC has 45 days from receipt of an application to grant a registration or commence denial proceedings. - Revocation/suspension: - SEC and FINRA have authority to withdraw, suspend or condition a BD’s registration and impose sanctions; SEC has similar powers over IAs and municipal advisors. - SEC and/or SROs can bar individuals from future association with registrants for certain willful misconduct. ### Ongoing requirements, disclosure and public availability - Form and amendment requirements: - BDs must promptly file an amendment to Form BD if information becomes inaccurate; registered individuals must promptly update Forms U-4 if inaccurate. - IA’s Form ADV must be updated each year by filing an annual updating amendment within 90 days of the adviser’s fiscal year end; material inaccuracies must be amended promptly. - Similar provisions apply to municipal advisors (Form MA and MA-I). - Public disclosure: - Completed Forms BD and the non-confidential portion of BDs’ annual audited financial statements are publicly available through the SEC's public reference office. - FINRA’s CRD system compiles regulatory information; certain CRD-derived information is available via BrokerCheck. - Forms ADV and MA are publicly available on the SEC’s website; Part 2B of Form ADV (brochure supplement) must be made available to clients. - Form MA-I records are publicly available on the SEC’s website. - Investment advisers and custody: - To buy or sell securities on behalf of customers, an IA must also be registered as a BD. - Advisers Act Rule 206(4)-2: an IA cannot hold client assets as a “qualified custodian” unless separately regulated to hold assets (e.g., registered as a BD or chartered/regarded as a bank). - Client assets must be held with a qualified custodian (bank, BD, FCM or foreign custodian); additional safeguards include an independent public accountant conducting a surprise audit at least once a year. - If adviser or related person acts as qualified custodian additional safeguards apply: annual surprise audit by a PCAOB registered auditor unless related person is “operationally independent”; auditor must report to the IA annually on internal controls relating to custody of client assets. - Custody practice statistics (as of January 2015): - 88 out of more than 11,500 registered IAs act as qualified custodians. - 400 SEC-registered IAs for which a related person acts as qualified custodian in connection with advisory services the IA provides to its clients. - Definition of “custody”: - Advisers Act deems an adviser to “have custody” in some circumstances where IA can access client assets (e.g., power of attorney), broader than IOSCO Methodology’s “physically” holding concept. - Pooled investment vehicles (other than CIS): - Pool’s financial statements must be audited by a PCAOB registered auditor; statements must be sent to investors annually; custodian must send quarterly statements to each investor; pool’s assets subject to a surprise audit. - Record-keeping and conflicts: - Advisers Act Rule 204-2 imposes detailed record keeping requirements. - Rule 206(4)-7 requires written compliance policies and procedures, annual review of adequacy, and designation of a Chief Compliance Officer. - Fiduciary duty: IA must disclose to clients any material facts that might cause adviser to render advice that is not disinterested and must disclose all material potential conflicts of interest. - Form ADV requires extensive disclosures about business, ownership, clients, employees, business practices, and disciplinary events. - Rule 204A-1 requires codes of ethics addressing personal trading and reporting of personal securities holdings and transactions. ### Key numeric thresholds and timelines (preserved exactly) - October 1, 2010 (unlawful to provide certain municipal advisory services without SEC registration). - September 2013 (SEC adopted final rule for municipal advisor registration). - July 1, 2014 to October 31, 2014 (four month phased-in compliance period). - AUM threshold cited for SEC review: $100 million or more. - IA Form ADV annual updating amendment: within 90 days of the adviser’s fiscal year end. - SEC generally has 45 days from receipt of an application to grant registration or commence denial proceedings. - As of January 2015: 88 out of more than 11,500 registered IAs act as qualified custodians. - As of January 2015: 400 SEC-registered IAs for which a related person acts as qualified custodian. ### Assessment findings and policy observations - Assessment: Fully Implemented (registration, capital and internal controls frameworks where applicable). - For most intermediaries, registration requires SRO membership; legislative registration focuses on integrity and statutory disqualification checks while SRO membership assesses internal organization, risk management and supervisory systems and individual competence. - IAs are registered directly by the SEC and rely on a disclosure-based regime supported by comprehensive disclosure obligations and the requirement to implement a compliance program. - The IOSCO Assessment Methodology contemplates a disclosure-based regime for IAs as an alternative to substantive licensing criteria; assessors conclude the disclosure-based approach complies with Key Question 7 of the Assessment Methodology given definitions of custody. - Assessors encourage authorities to consider whether more comprehensive internal control and risk management requirements relating to portfolio management are needed given the large scale of U.S. portfolio management (total AUM about $63 trillion, of which about $17 million is in mutual funds). ### Capital requirements (Principle 30) — SEC and CFTC highlights - SEC (BDs): - Exchange Act Rule 15c3-1 (net capital rule, NCR) requires BDs to maintain specified net capital; minimum dollar amounts range from $5,000 to $250,000 depending on activity. - NCR methods: - 15-to-1 aggregate indebtedness to net capital ratio (basic method); for firms in their first year of operation an 8-to-1 ratio. - 2 percent of aggregate debit items ratio (alternative method). - ANC BDs and OTC derivative dealers may use internal models with SEC approval; ANC BDs higher minimums (currently $500 million in net capital, $1 billion in tentative capital and an early warning level of $5 billion). - Proposal noted to increase ANC BD minimums to $1 billion (net capital), $5 billion (tentative net capital) and early warning level to $6 billion. - Concentration charge applies when a position exceeds 10 percent of the BD’s net capital. - Reserve account: Rule 15c3-3 requires possession and control of customer fully paid and excess margin securities and maintenance of a reserve account containing at least the net dollar amount of cash owed to customers. - CFTC (FCMs, IBs, SDs, MSPs): - FCM minimum adjusted net capital requirement is the greatest of: - $1,000,000; - The FCM's risk-based capital requirement, computed as eight percent of the total risk margin requirement for positions carried by the FCM in customer accounts and non-customer accounts; - The amount of adjusted net capital required by the NFA; or - For securities brokers and dealers, the amount of net capital required by SEC Rule 15c3-1(a). - IB minimum adjusted net capital for those subject to requirements is the greatest of: - $45,000; - The amount required by the NFA; or - For securities brokers and dealers, the amount required by SEC rules. - Proposed CFTC requirements for SDs and MSPs include a $20 million minimum fixed dollar net capital requirement for SDs/MSPs that are also FCMs, and tangible net equity equal to $20 million for SDs/MSPs that are neither FCMs nor bank holding company subsidiaries, with additional amounts for market risk and OTC derivatives credit risk. - Regulation 1.12(b): FCMs must provide immediate notification to the CFTC and their DSROs if capital falls below: - 110 percent of the risk-based capital requirement; - 150 percent of the minimum dollar requirement, or of the requirement for minimum capital under NFA rules; or - If the FCM is a securities BD, the early warning level established under SEC rules. - CFTC Regulation 1.12(g)(1): If net capital of an FCM declines by 20 percent or more from the amount last reported, the FCM must provide notice within 2 business days of the event or series of events causing the reduction. ### Monitoring, reporting and regulator intervention - Reporting: - BDs: Exchange Act Rule 17a-5(a) requires unaudited financial reports monthly or quarterly including net capital computations (FOCUS Report); Exchange Act Rule 17a-11 early warning triggers include net capital falling below 120 percent of required net capital and other thresholds. - FCMs/IBs: CFTC Regulation 1.10 and 1.17 require month-end net capital computations and other filings; FCMs must file annual financial reports certified by independent certified public accountant within 90 days of period end. - Independent audit: - BDs: Exchange Act Rule 17a-5(d) requires audited annual report by independent public accountant registered with the PCAOB. - FCMs/RFEDs/IBs: annual certified reports, PCAOB-registered accountants for FCM examinations. - Regulator monitoring and intervention powers: - SROs conduct front-line supervision; SEC and CFTC conduct oversight and specialized monitoring programs (e.g., Large Firm Monitoring). - CFTC Regulation 1.17(a)(4): FCM failing to demonstrate sufficient capital must transfer all customer accounts and immediately cease doing business as an FCM until compliance demonstrated; may trade only for liquidation except as prohibited. - SROs and regulators can require increased reporting frequency and impose conditions, restrictions, or suspensions where firms are in financial difficulty. ### Principle 31 — Internal compliance function (high-level) - CFTC and SEC frameworks require registrants (except certain APs) to diligently supervise activities of partners, officers, employees and agents. - FCMs and other registrants must maintain risk management programs with independent review and testing, report annual reviews to the CCO, senior management and governing body, and maintain internal audit independence. - SDs and MSPs must establish systems to diligently supervise activities and maintain risk management programs with quarterly reporting to senior management and annual testing by independent internal audit or qualified third party. *International Monetary Fund — United States assessment content from the provided document.* ### Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s ### _cr1591 - Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s ### Reparations and claimant procedures - Section 14 of the CEA permits anyone complaining of a violation of the CEA or the CFTC’s rules to apply to the CFTC for an order awarding damages caused by the violation. - Reparations procedures include: - A voluntary procedure based on the submission of written documents. - A summary procedure for claims of less than $30,000. ### Client information, KYC, AML and suitability requirements - AML requirements and the PATRIOT Act require intermediaries to conduct identity checks of their customers. - CFTC and NFA rules and requirements: - CFTC Regulation 1.37: requires each FCM, RFED, IB and member of a contract market to record in permanent form details about customers for whom they operate accounts. - CFTC Regulations 23.402(b) and 23.402(c): require SDs to have systems to record details of each counterparty whose identity is known to the SD prior to the execution of a transaction. - CFTC Regulation 1.55: requires detailed disclosures, including prescribed risk disclosures and firm-specific information, to be made before an FCM or IB opens an account with a customer. - NFA Know Your Customer rule (2-30): requires each Member to obtain extensive information about each customer's experience, income, net worth and age before opening an account, and to judge the adequacy of disclosure and whether additional risk disclosures are required. - NFA Compliance Rule 2-4: requires FCMs, or IBs for introduced accounts, to make available to customers, prior to the commencement of trading, information concerning the costs associated with futures transactions. - CFTC Regulation 23.431: requires an SD or MSP to disclose to non-dealer counterparties material information concerning the swap to allow the counterparty to assess material risks, characteristics, incentives and conflicts of interest. - Notable policy point: In some cases for futures, the only adequate risk disclosure may be that futures trading is too risky for that customer, even if no recommendation is made. ### Disclosure, conduct and conflict rules - NFA Compliance Rule 2-4: Members and Associates must observe high standards of commercial honor and just and equitable principles of trade in commodity futures business. - Part 23 of CFTC Regulations: - Requires SDs and MSPs to communicate in a fair and balanced manner based on fair dealing and good faith. - Prohibits fraud, manipulation, and other abusive practices. - CFTC Regulation 23.431(a)(3): requires SDs and MSPs to disclose material incentives and conflicts of interest, including compensation or other incentives from any source in connection with a particular swap. - An SD advising a “special entity” has a duty to make a reasonable determination that any recommended swap or trading strategy is in the best interests of the special entity. - For securities intermediaries (SEC/FINRA): - FINRA rules require BDs to deal fairly with customers, observe high standards, have a reasonable basis for recommendations, provide best execution, disclose conflicts of interest, and offer dispute redress through arbitration. - Investment advisers (IAs) have a fiduciary obligation under Section 206 of the Advisers Act to act in the utmost good faith. ### Record-keeping and reporting requirements - CFTC record rules: - CFTC Regulation 1.31: requires all books and records required by the CEA and CFTC regulations to be kept for a period of five years and to be readily accessible during the first 2 years of the 5-year period; all books and records must be open to inspection by any representative of the CFTC or DOJ. - CFTC Regulation 1.33(a): requires FCMs to provide monthly statements to customers who have active accounts. - CFTC Regulation 1.33(b): requires each FCM to furnish trade confirmations no later than the next business day; for customers of an IB, the carrying FCM provides these statements. - SEC record rules: - Length of preservation varies by record type (example: 6 years for records of securities transactions; 3 years for trade confirmations). - Advisers Act Rule 204-2: requires advisers to maintain business accounting records and records related to fiduciary nature of the business; general rule: required books and records must be maintained in an adviser’s office for two years after the last entry date and three additional years in an easily accessible place. - Advisers Act Rule 206(4)-2: requires an IA with custody of client assets to have reasonable belief that a qualified custodian sends each client, not less frequently than once every three months, an itemized statement. ### Supervision, SRO roles and examination resources - Supervision structure and responsibilities: - Front-line supervision is with SROs (exchanges and NFA); NFA has supervision responsibilities for CTAs. - For FCMs, JAC arrangements govern allocation of supervision for financial requirements; CME is the DSRO for the majority of FCMs, with NFA playing this role for around 20 FCMs. - CME supervision of FCMs includes monitoring compliance with sales practices and AML obligations for FCMs for which it is the DSRO. - NFA resourcing and activity: - NFA Examinations group consists of about 200 people. - NFA inspects all FCMs for which it is DSRO at least once every 15 months; in practice an additional horizontal examination on segregation is carried out annually. - For non-FCMs and CTAs, NFA uses a risk scoring system; on-site inspections about every 3 to 4 years expected. - On average, the NFA carries out between 550 and 650 examinations each year. - In recent years, NFA has been doing a higher number of examinations for cause; disciplinary actions resulting from examinations have increased. - CFTC Examinations group: - Comprised of approximately 40 staff members, mostly auditors and accountants. - In fiscal year 2014, the examinations branch of DSIO performed 11 limited scope reviews of FCMs, one for cause examination of a swap dealer, and no examinations of IBs. - CFTC staff indicates examinations are increasingly focusing on control environment and risk management processes; supplemented by Registration and Compliance group reviewing annual and quarterly reports. - FINRA and SEC resources and activity: - FINRA’s Member Regulation Department: approximately 1,100 staff (over 800 in District Offices, over 200 in ROOR, over 80 in Shared Services). - FINRA conducts about 1,700 cycle examinations each year, and about 3,000 for cause examinations; 8 to 10 percent of FINRA examinations result in formal investigations and disciplinary action. - SEC has a dedicated team of 300 staff for BD examinations and 450 staff for IA examinations. - OCIE examinations of BDs: 443 in FY 2012; 438 in FY 2013; 493 in FY 2014. - OCIE examinations of IAs: 1,004 in FY 2011; 974 in FY 2012; 964 in FY 2013; 1,150 in FY 2014 (includes approximately 170 examinations of the over 1,600 IAs that are mutual fund operators). - Coverage and resource observations: - The IA population is large and diverse; in fiscal year 2014, 11,523 regulated IAs had $63.1 trillion in AUM (contrast: fiscal year 2011 where 11,728 regulated advisers had $43.5 trillion in AUM). - The number of IA examinations in 2014 represents roughly 10 percent of the IA population and 30 percent of AUM. - SEC staff acknowledge coverage is limited; more resources for on-site examinations of IAs are warranted. - Absence of a formal suitability requirement for futures intermediaries noted; NFA contends its know-your-customer rule provides comparable protection and that suitability determinations for futures must be customer-by-customer. ### Conflicts of interest and internal controls - CFTC and NFA: - Regulatory regime for conflicts is primarily disclosure based. - CTAs are subject to mandatory conflict disclosure obligations. - Part 155 rules require FCMs and IBs to establish and enforce internal rules, procedures and controls to ensure customer orders are transmitted before proprietary orders to the extent possible. - SEC/FINRA: - BDs must implement supervisory systems, appoint a CCO, and have annual CEO certification of compliance policies. - OTC derivatives dealers and ANC broker-dealers must establish, document, and maintain internal risk management controls for market, credit, leverage, liquidity, legal, and operational risks. - Exchange Act sanctions exist for failure to supervise; affirmative defense where reasonable procedures are established and effectively implemented (Exchange Act Sections 15(b)(4)(E) and (b)(6)(A)). ### Procedures for intermediary failure, early warning and bankruptcy - CFTC framework: - CFTC has a market disruption contingency plan covering capital incidents, liquidity incidents, natural events, and failure of an intermediary; plan provides guidance on required information, escalation, and involved divisions. - Early warning mechanisms include FCM obligations to notify CFTC when early warning capital thresholds are met, and notifications from a DSRO or a DCO. - If the CFTC determines an FCM is likely to fail, it will attempt to cause transfer of customer accounts (CFTC Regulation 1.17(a)(4)) and determine effects on counterparties and futures markets. - DCO default rules typically permit liquidation or transfer of positions, access to proprietary and customer account property under specified conditions, and access to guarantee fund contributions. - Section 6(c) of the CEA: CFTC may request appointment of a monitor, receiver, curator or other administrator for an FCM believed to have violated provisions of the CEA and CFTC Regulations. - Part 190 of CFTC Regulations and Subchapter IV of Chapter 7 of the Bankruptcy Code specifically address bankruptcy of commodity brokers, enabling prompt transfer of customer positions and associated collateral or prompt return of customer property. - Investor compensation under CFTC regime: - There is no insurance scheme or guarantee fund for customer recompense in the event of intermediary failure when there is a shortfall in customer property; focus is on segregation, rapid shortfall identification, transfer of business, and priority claims under bankruptcy. - SEC/SIPC framework: - If SEC staff becomes aware a BD is in financial difficulty, they assemble information, contact BD’s DEA and clearing firm, and notify SIPC so SIPC can assess whether to initiate liquidation. - BDs are subject to early warning rule obligations to provide notice promptly (but within 24 hours) to the SEC and under SRO rules to the DEA when reporting trigger levels are reached. - The SEC, SIPC, and a firm’s DEA have authority to restrict activities of a BD approaching financial distress, including limits on business expansion and active reduction of business. - SIPC liquidation (SIPA) process: trustee appointed; customers receive securities already registered in their names; remaining customer assets divided pro rata; SIPC Fund supplements distribution up to $500,000 per customer including a maximum of $250,000 for cash claims (increased from $100,000 by the Dodd-Frank Act). - SIPC Fund: target $2.5 billion; current level around $2.1 billion; funded by annual assessments (assessments in 2013 were approximately $418 million). SEC may lend SIPC up to $2.5 billion to be borrowed from the Treasury if needed. - For SBSDs that are not BDs, stockholder provisions of the Bankruptcy Code apply instead of SIPA; SIPC not involved in Bankruptcy Code liquidations. - Cross-regulatory cooperation: - SIPC board structure includes Treasury and Federal Reserve Board employees; SEC works closely with SIPC and may participate as a party in SIPC proceedings. - Title II of the Dodd-Frank Act contemplates an alternative insolvency regime (orderly liquidation) for large financial companies; for a BD determined systemically important under section 203, Federal Reserve Board and SEC, in consultation with the FDIC, may issue an orderly liquidation recommendation to the Secretary of the Treasury. ### Trading systems, exchanges, and alternative trading systems (ATS) - Exchange definition and authorization: - Exchange Act Section 3(a)(1) defines an exchange as an organization providing a marketplace or facilities for bringing together purchasers and sellers of securities or performing functions commonly performed by a stock exchange. - Rule 3b-16 defines criteria for whether a system qualifies as an exchange; systems meeting the criteria must register with the SEC as a national securities exchange or seek an exemption. - A DCM may register by notice filing with the SEC as a national securities exchange for listing and trading security futures products; currently one exchange trades both commodity and security futures: OneChicago, LLC. - Alternative Trading Systems and Regulation ATS: - Rule 3a1-1(a)(2) and Rule 300(a) of Regulation ATS provide an exemption framework for systems that register as broker-dealers and comply with Regulation ATS. - An ATS must be a multilateral system meeting Rule 3b-16 criteria; in practice a BD operates an ATS as a system rather than separate legal entity. - As of the end of December 2014, there were 88 ATSs with an active Form ATS on file with the SEC; FINRA data included 39 equity ATSs. - Majority of ATSs are dark pool ATSs with no pre-trade transparency; a few equity ATSs operate as lit ECNs. - There is no public, consolidated information available on trading models, subscribers, and specific instruments organized by ATSs; varying levels of information exist on ATS websites. - DCMs, SEFs, SB SEFs and FBOTs: - Markets seeking to trade futures, options on futures or options on commodities must apply to the CFTC to become a DCM; there are currently no exemptions. - Swap execution facilities (SEFs) and security-based swap execution facilities (SB SEFs) are multilateral trading facilities for swaps; SEFs must register with the CFTC; SB SEFs must register with the SEC by rule-specified date, though interim operation without registration is permitted. - CFTC Regulation 48.3: FBOTs providing U.S. members or participants with direct access to electronic trading/order matching systems must register with the CFTC. *Italicized source: Excerpt from _cr1591 (PDF chapter/section) provided in the input content.* ### Section 6(b) of the Exchange Act includes the criteria that an applicant has to fulfill in order to ### _cr1591 - Section 6(b) of the Exchange Act includes the criteria that an applicant has to fulfill in order to ### Criteria to register as a national securities exchange (Section 6(b)) - Applicant must have the organization and capacity to enforce compliance by its members and their associated persons with the Exchange Act, the SEC rules and regulations, and the exchange rules. - Enable any registered broker or dealer to become an exchange member. - Assure a fair representation of its members in selection of the exchange’s directors and provide that one or more directors is a representative of issuers and investors. - Provide for the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities. - Provide for appropriate and fair procedures for disciplining its members for law or rule violations. - Applicant must demonstrate ability to operate as part of the National Market System (Section 11A Exchange Act) and satisfy Regulation NMS requirements (see below). ### Regulation NMS requirements (applicants must satisfy) - Order Protection Rule: requires exchanges and other trading centers, including ATSs, to establish policies and procedures reasonably designed to prevent execution of trades at prices inferior to automated quotations that are the best quote of another exchange or another automated trading center, subject to applicable exceptions. - Access Rule: requires fair and non-discriminatory access to quotations, establishes a limit on access fees to harmonize pricing of quotations across different exchanges and other trading centers, and requires rules addressing locked and crossed markets. - Sub-Penny Rule: prohibits market participants from accepting, ranking, or displaying orders for securities priced $1.00 or more in increments smaller than a penny. ### Application content requirements (Section 6(a), SEC Rule 6a-1 and Form 1) Application must include: - Information about the exchange operators. - The manner of operation of the trading system, including the means of access; procedures for entering and displaying quotes; procedures of executing, reporting, clearing and settling transactions; and fees. - Lists of officers, governors and members of all standing committees. - For exchanges with one or more owners, shareholders or partners that are not also members of the exchange, lists of shareholders that own 5 percent or more of a class of voting shares. - Criteria for exchange membership and the conditions and process for suspension or termination of membership. - A list of all members. - A schedule of all securities listed or traded on the exchange. - SEC must publish notice of the application for public comment and, generally within 90 days of publication, by order grant the registration or institute proceedings to determine whether the application should be denied. - Once registered, a national securities exchange becomes an SRO. (Section 19(a) Exchange Act) ### Alternative Trading Systems (ATS) — registration and ongoing obligations - To comply with Regulation ATS, a firm needs to register as a BD and become a member of an SRO (in practice FINRA). - A BD wishing to operate an ATS must file a notice (an Initial Operation Report) with the SEC on Form ATS at least 20 days prior to commencing operation as an ATS. Form ATS must provide: - A description of the class of subscribers and any differences in access to services offered by the ATS to different groups or classes of subscribers. - The name of any entity, other than the BD operating the ATS, involved in the operation of the ATS. - The manner of operation of the ATS, procedures governing entry of orders, means of access, and procedures governing execution, reporting, clearing and settlement of transactions effected through the ATS. - Procedures for ensuring subscriber compliance with system guidelines. - A copy of the ATS’ subscriber manual and any other materials provided to subscribers. - A brief description of the ATS’s procedures for reviewing system capacity, security, and contingency planning procedures. - SEC’s Trading and Markets Division’s Office of Market Supervision reviews Forms ATS for compliance with Form ATS instructions and potential inconsistencies with Regulation ATS and federal securities laws. A compliant form is deemed filed as of receipt; an incomplete form is deemed not filed and must be resubmitted. - Forms ATS are not required to be published; a few BDs have voluntarily published them. The SEC Chair has asked staff to prepare a recommendation to expand information about ATS operations submitted to the SEC and to make the information available to the public. ### FINRA process for BDs that are ATS operators - A registered BD that is a FINRA member and plans to operate an ATS must file an application for approval of a change in its business operations under FINRA Rule 1017 using the Continuing Membership Application Form. - FINRA’s Department of Member Regulation reviews the form, working closely with FINRA’s Market Regulation Group for ATS-related changes. - FINRA staff consider ability to comply with Regulation ATS requirements, evaluate business plan, manner orders interact in the ATS, and ATS connectivity arrangements. FINRA obtains a copy of the Form ATS. - The Department of Member Regulation generally must make a decision on the application within 45-60 days of receiving the application, depending on whether an interview or additional information is required. - A member may not implement the change in its business operations until conclusion of the FINRA proceeding. ### Regulation ATS thresholds and specific ATS requirements - Rule 301(b)(3) (order display and execution access) applies to ATSs that display orders to at least one person other than an employee and whose average daily trading volume in a particular NMS stock was at least five percent of the stock’s average daily trading volume (measured in shares) during at least four of the preceding six months. - Fair access requirement under Rule 301(b)(5) applies when an ATS’s trading volume reaches or exceeds the five percent threshold, unless an exception in Rule 301(b)(5)(iii) applies. - An ATS with an at least 20 percent market share must follow certain procedures to ensure capacity, integrity and security of its trading system (Rule 301(b)(6)). - Note: the threshold has been lowered and amended to be calculated on the basis of average daily dollar volume in Regulation Systems Compliance and Integrity (Regulation SCI) (see technical system standards). The new requirements will apply to equity ATSs with at least one percent market share of the average daily dollar volume in all NMS stocks, or five percent market share in any single NMS stock together with 0.25 percent market share in all NMS stocks. ### Exchange and trading venue designations under CEA and CFTC procedures - DCMs: To be designated and maintain designation as a contract market, a board of trade must comply with the 23 Core Principles set forth in Section 5(d) of the CEA. Applicants must submit Form DCM and follow CFTC Regulation 38.3; CFTC reviews pursuant to the 180-day time frame and procedures specified in Section 6(a) of the CEA. - SEFs: To be registered and maintain registration, a SEF must comply on a continuing basis with the 15 Core Principles in Section 5h(f) of the CEA. CFTC Regulation 37.3 sets requirements and procedures for registration; the CFTC issues an order granting registration upon determination of demonstrated compliance and may grant registration subject to conditions. - SB SEFs: Will have to comply with 14 Core Principles and any other rule the SEC may adopt; the SEC has proposed rules on registration process and compliance with the 14 Core Principles. - FBOTs: Criteria, procedures and requirements are in Section 4(b) of the CEA and Part 48 of the CFTC’s regulations. In determining whether to register an FBOT, the CFTC evaluates whether the FBOT’s home regulatory authority oversees the FBOT comparably to the CFTC’s oversight of DCMs. After registration, an FBOT is not subject to the CFTC’s oversight except in relation to trading in linked contracts (see Principle 36). ### Prudential requirements, clearing and settlement - National securities exchanges generally do not assume principal, settlement, guarantee or performance risk; clearing and settlement occur through registered CCPs and CSDs that operate separately from exchanges and are registered with the SEC as clearing agencies. - Exchange level of funding may differ depending on business model, trading systems, regulatory responsibilities, and types of members. - ATS: An ATS operator must have sufficient clearing capabilities by either becoming a member of a clearing agency, or being affiliated with a member of a clearing agency through which the ATS can clear and settle trades. - DCM Core Principle 21 (Financial Resources): requires a DCM to have adequate financial, operational, and managerial resources to discharge its responsibilities. Financial resources are considered adequate if they exceed the DCM’s operating costs for a one year period, calculated on a rolling basis. - DCM Core Principle 11: requires rules and procedures to ensure financial integrity of transactions, including clearing and settlement with a registered DCO. - SEF Core Principle 13: SEFs subject to same financial resources requirements as DCMs. Transactions executed on or through a SEF that are required or voluntarily cleared must be cleared through a DCO. ### Market surveillance, member supervision, dispute resolution and appeals - National securities exchanges must be able to enforce compliance by members and associated persons with the Exchange Act, SEC rules and their own rules. Registration requires submission of information on arrangements for monitoring, surveillance and supervision of the trading system and its participants. - SEC evaluates whether applicant has adequate surveillance measures and sufficient resources, including staff expertise and capital, to monitor its markets, conduct member and market surveillance, and address potential violations. - ATSs are not required to conduct market surveillance (ATSs are not SROs) but, as BDs and SRO members, are responsible for monitoring trading activity on or through their systems and meet supervisory obligations under the SRO rules. - DCM Core Principle 2: requires a DCM to establish, monitor and enforce rules prohibiting abusive trading practices and have capacity to detect, investigate and sanction violations (CFTC Regulations 38.250 and 38.251). - DCM Core Principle 12: requires rules to protect markets and participants from abusive practices, market surveillance systems, and disciplinary processes; sufficient compliance staff and resources are required (CFTC Regulation 38.155(a)). - DCM Core Principle 4: requires capacity and responsibility to prevent manipulation, price distortion, and disruptions through market surveillance, compliance, enforcement practices, real-time monitoring, and comprehensive and accurate trade reconstructions. - SEF Core Principle 2 and related CFTC Regulations (37.203, 37.206): require SEFs to establish and enforce trading, trade processing, and participation rules; to have monitoring, surveillance and supervision programs; and disciplinary procedures and sanctions. - SEF Core Principle 4 and CFTC Regulation 37.404(a): requires SEFs to monitor swaps trading to prevent manipulation, price distortion, and disruptions; methods for real-time monitoring and accurate trade reconstructions; and access to sufficient information to assess whether trading is being used to affect prices on its market. - Similar requirements are expected to apply to SB SEFs. ### Technical system standards, Regulation SCI, and testing - SEC ARP I (1989) recommended SROs’ programs have three objectives: (i) establishing current and future capacity estimates; (ii) conducting periodic capacity stress tests; and (iii) obtaining an annual assessment of adequacy in light of estimated capacity levels and threats. - ARP II (1991) set forth views on nature of reviews for automated trading and information dissemination systems; contents of annual reports on major systems changes; process for notification of material systems changes; and notifications of significant systems problems. - ATSs meeting or exceeding a 20 percent market share become subject to certain system-related requirements, including independent review of system controls according to established audit procedures and standards. - On November 19, 2014, the SEC adopted Regulation SCI to replace ARP statements and certain Regulation ATS system requirements. Regulation SCI requires an SCI entity (including national securities exchanges and ATSs trading certain equity securities above specified dollar volume thresholds) to: - Establish, maintain, and enforce policies and procedures reasonably designed to ensure adequate levels of capacity, integrity, resiliency, availability, and security. - Establish, maintain, and enforce policies and procedures reasonably designed to ensure systems operate in compliance with the Exchange Act, the SEC’s rules and regulations under the Exchange Act, and the entity’s rules and governing documents. - Take timely corrective action in response to systems disruptions, systems compliance issues, and systems intrusions (SCI events). - Notify the SEC on certain SCI events and material changes to its systems. - Disseminate information to applicable members or participants about certain SCI events. - Conduct an annual review of compliance with Regulation SCI, submit a report of the annual review to senior management, and provide the report and senior management’s response to the board of directors (or equivalent) and the SEC. - Designate members or participants to participate in testing of business continuity and disaster recovery plans at least once every 12 months, and coordinate testing with other entities on an industry- or sector-wide basis. - Make, keep, and preserve records relating to compliance with Regulation SCI. - Regulation SCI effective timing: will become effective 60 days after publication in the Federal Register, with required compliance generally to begin nine months later, and required compliance with the business continuity and disaster recovery plan testing provision to begin an additional 12 months after that. - DCM Core Principle 20 and SEF Core Principle 14: require programs of risk oversight to identify and minimize operational risk, develop reliable, secure, and scalable automated systems; establish emergency procedures, backup facilities, and disaster recovery plans; and periodically conduct tests to verify backup resources for continued order processing, trade matching, price reporting, market surveillance, and audit trail maintenance. ### Ability to deal with disorderly trading conditions (cross-market halts and LULD) - In May 2012, the SEC approved a NMS Plan to Address Extraordinary Market Volatility (Limit-Up Limit-Down or LULD) proposed by the SROs, implemented on a pilot basis. - LULD prevents trades in individual securities from occurring outside of a specified price band, which varies depending on the security and time of day. - Trading pauses occur if the price moves to and remains outside the band for a specified period. - An individual stock enters a limit state if its price moves a certain percentage–generally 5, 10 or 20 percent–over a five minute period. - If the market does not naturally exit the limit state within 15 seconds, there is a five minute trading pause. *Source: _cr1591 - Section 6(b) of the Exchange Act includes the criteria that an applicant has to fulfill in order to (IMF PDF).* ### conclusion of which trading resumes under normal reopening procedures. SROs, ATSs, and ### _cr1591 - conclusion of which trading resumes under normal reopening procedures. SROs, ATSs, and ### Trading controls, emergency authority, and market safeguards - SROs, ATSs, and BDs executing internally must establish policies and procedures reasonably designed to: - prevent trades from occurring outside the applicable price band, - honor any trading pause, - otherwise comply with the NMS Plan. - DCMs: - CFTC Regulation 38.255 requires a DCM to establish and maintain risk control mechanisms to prevent and reduce the potential risk of price distortions and market disruptions, including, but not limited to, market restrictions that pause or halt trading in market conditions prescribed by the DCM. - DCM Core Principle 6 requires the DCM, in consultation or cooperation with the CFTC, to adopt rules to provide for the exercise of emergency authority, including authority to: - liquidate or transfer open positions in any contract; - suspend or curtail trading in any contract; - require market participants in any contract to meet special margin requirements. - SEFs: - CFTC Regulation 37.203: a SEF must have authority to adjust trade prices or cancel trades when necessary to mitigate market-disrupting events caused by malfunctions or errors in orders. - CFTC Regulation 37.405: requires SEFs to establish and maintain risk control mechanisms to prevent and reduce market disruptions, including market restrictions that pause or halt trading under market conditions prescribed by the SEF. - SEF Core Principle 8: provides for exercise of emergency authority, in consultation or cooperation with the CFTC, including authority to liquidate or transfer open positions in any swap or to suspend or curtail trading in a swap. ### Record-keeping requirements - National securities exchanges: - Every exchange is required to make and keep for prescribed periods of time such records, furnish such copies thereof, and make and disseminate such reports as prescribed by the SEC in Rule 17a-1 (Section 17(a) Exchange Act). - ATS: - Subject to reporting and record-keeping requirements under Regulation ATS, including maintaining an audit trail of all orders and transactions entered into the system, and the record-keeping requirements of registered broker-dealers (see Principle 31). - DCMs: - DCM Core Principle 10 requires a DCM to maintain rules and procedures to provide for the recording and safe storage of all identifying trade information to assist in prevention of customer and market abuses and to provide evidence of any violations of its rules. - These requirements are further specified in CFTC Regulations 38.551, 38.552 and 38.256. - SEFs and SB SEFs: - SEF Core Principle 10 requires a SEF to maintain records of all activities relating to its business, including a complete audit trail in a form and manner acceptable to the CFTC for a period of 5 years. - CFTC Regulation 37.406 requires a SEF to have the ability to comprehensively and accurately reconstruct all trading on its facility. - The Exchange Act requires SB SEFs to maintain audit trails and records of all activities relating to the business of their facilities and comply with any other recordkeeping and reporting requirements the SEC may adopt. ### Delegation and outsourcing - National securities exchanges: - No specific requirements on outsourcing by exchanges, but the SEC can supervise outsourced activities based on the general requirement of the Exchange Act that national securities exchanges must always be able to fulfill their obligations under the Act. - DCMs and SEFs: - Required to provide the CFTC with copies of any service provider agreements as a registration application exhibit. - If a CFTC registered entity delegates a function to another registered entity, the CFTC has authority to access the books and records of the entity to which the function was delegated. - If a registered entity outsources a function to a non-registered entity, the CFTC maintains authority to obtain relevant books and records from the registered entity itself. ### Admission of securities and derivatives - National securities exchanges: - An exchange’s listing criteria are set out in its rules. - Pursuant to Section 19(b) of the Exchange Act and Rule 19b-4, every SRO must file with the SEC any proposed rule, or any proposed change to a rule. - The rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and to protect the investors and the public interest (Section 6(b)(5) of the Exchange Act). - Exchange Act Rule 19-4(e): the listing of certain new derivative products does not require prior approval of the rule changes by the SEC, if the SEC has approved the SRO’s trading rules, procedures and listing standards for the product class that would include the new product. - DCMs and SEFs: - Under Section 5c of the CEA and Part 40 of the CFTC regulations, DCMs and SEFs must inform the CFTC of the types of products to be traded through either: - self-certification (CFTC Regulation 40.2); or - voluntary submission for CFTC review and approval (CFTC Regulation 40.3). - CFTC prior approval is required for certain enumerated agricultural commodities. - For self-certification, DCMs and SEFs must file submissions no later than the opening of business on the business day preceding the initial listing of the product and include: - the product’s rules, - the intended listing date, - a certification by the DCM or SEF that the product complies with the CEA and CFTC Regulations, - a concise explanation and analysis of the product and its compliance, - a certification posted on its website that a notice of pending product certification is with the CFTC. - If requested, the DCM or SEF must provide additional information or data; the CFTC may stay the listing for false certification or pending petitions to alter or amend contract terms. - DCMs and SEFs may voluntarily request CFTC approval; products submitted for approval are generally deemed approved 45 days after receipt by the CFTC or at the conclusion of an extended period. - In practice the large majority of contracts is subject to the self-certification procedure. - DCM Core Principle 3 requires that listed contracts not be readily susceptible to manipulation; DCMs listing new futures contracts must provide the CFTC with information, including data and a detailed cash market description. Specific requirements are in CFTC Regulations 38.252 and 38.253. ### Admission of market participants and fair access - National securities exchanges: - Must have rules permitting any registered BD or natural person associated with a BD to become its member (Section 6(b)(2) Exchange Act). - Must deny membership to any non-registered BD and may deny membership to any BD subject to a statutory disqualification; denials on statutory disqualification grounds must be reported to the SEC. - May deny membership to a BD that does not meet financial responsibility or operational capability standards or required training, experience or competence prescribed by the exchange’s rules. - Exchange rules may not be designed to permit unfair discrimination between BDs or impose burdens on competition that are not necessary or appropriate in furtherance of the Exchange Act. - Regulation NMS and ATS fair access: - Rule 610(a) of Regulation NMS prohibits an SRO from imposing unfairly discriminatory terms that prevent or inhibit any person from obtaining efficient access through a SRO member to the quotations in a NMS stock displayed in the SRO trading facility. - Rule 610(c) limits the amount of fees that may be charged by a trading facility to access its best bids and offers. - ATS fair access requirement: if an ATS accounted for five percent or more of the average daily trading volume during at least four of the preceding six calendar months in any equity security, municipal security, or corporate debt security, it would need to comply with fair access requirements of Rule 301(b)(5)(ii) of the Exchange Act, including establishing written standards for granting access and maintaining these standards in records (Rule 301(b)(5)(ii) and Rule 303(a)(2)(ii)). - Certain ATSs specified in Rule 301(b)(5)(iii) of Regulation ATS would not need to comply with the fair access requirement even if they exceeded the five percent threshold. - DCMs: - CFTC Regulation 38.151(b) requires a DCM to provide members, persons with trading privileges, and independent software vendors (ISVs) with impartial access, including impartial, transparent, and non-discriminatory access criteria. - CFTC Regulation 38.151(b)(2) requires comparable fee structures for equal access. - CFTC Regulation 38.151(c) requires impartial rules governing denial, suspension, or permanent barring of access, applied in a non-discriminatory manner. - SEFs and SB SEFs: - SEF Core Principle 2 requires SEFs to provide market participants with impartial access. - CFTC Regulation 37.202 requires SEFs to provide any eligible contract participant and any ISV with impartial access to markets and market services, including indicative quote screens or similar pricing data displays, with impartial criteria, comparable fee structures, and impartial enforcement. - SB SEFs must establish and enforce trading, trade processing, and participation rules that include means to provide market participants with impartial access. ### Order routing and execution procedures - National securities exchanges: - An exchange’s rules must cover order routing and execution procedures; the SEC reviews such procedures as part of exchange registration. - Procedures can only be approved if consistent with relevant securities laws and regulations, including those with respect to precedence, front running and trading ahead of customer orders, and are not unfairly discriminatory. - The SEC analyzes proposed rules that would give a member a trading advantage against the obligations the member has to the market (for example, specialists and market makers may trade for their own account ahead of public orders in certain instances due to obligations to maintain a fair and orderly market). - Section 11(b) of the Exchange Act regulates specialists and odd-lot dealers and requires SRO rules to reflect appropriate rules for their registration and activities. - Terms of any service that impacts access to the exchange and its facilities, such as co-location services, including the fees charged, are required to be filed as proposed rule changes; the SEC takes these into account when reviewing such rule changes. *IMF staff summary based on provided chapter text.* ### Section 6(b)(4) of the Exchange Act that requires that the rules of the exchange provide for ### Section 6(b)(4) of the Exchange Act that requires that the rules of the exchange provide for ### Legal and regulatory requirements for exchanges and trading systems - Section 6(b)(4) Exchange Act: rules of the exchange must provide for "the equitable allocation of reasonable dues, fees, and other charges among its members and issuers and other persons using its facilities." - Section 6(b)(5) Exchange Act: rules cannot be designed to permit unfair discrimination between customers, issuers, brokers, or dealers. - Section 6(b)(8) Exchange Act: rules cannot impose any burden on competition not necessary or appropriate in furtherance of the Exchange Act. ### Alternative Trading Systems (ATS) — supervisory focus and shortcomings - OCIE and FINRA examinations of BDs operating ATSs may review: - BD algorithmic trading systems or proprietary trading systems for fair allocation and execution of orders, non-discrimination among order types, and absence of use of non-public order-flow information to benefit the firm’s own account. - BD order handling practices and processes. - Shortcomings identified by assessors: - ATSs are not required to disclose their order execution rules and procedures to market participants; voluntary disclosures (websites, Forms ATS) are insufficient to satisfy Key Questions 5(a), 5(b) and 6 of the IOSCO Assessment Methodology. - Fair access requirements apply to an ATS only after it reaches or exceeds a five percent market share in a particular NMS security; assessors consider the five percent threshold should be removed or significantly lowered. - Recommendation/encouragement: - SEC should pursue the SEC Chair’s initiative to enhance public information about ATS operations. - SEC and FINRA should ensure processes provide sufficiently in-depth analysis of order execution procedures of new ATSs, with specific focus on fairness and BD operational competence for ATS operations. ### Designated Contract Markets (DCMs) — transparency and algorithm disclosure - DCM Core Principle 7: make available to market authorities, market participants, and the public information on rules, regulations, and mechanisms for executing transactions. - DCM Core Principle 9: provide a competitive, open, and efficient market and a mechanism for executing transactions that protects the price discovery process. - CFTC Regulation 1.38 (commodity futures and options): requires competitive execution; permits certain noncompetitive trades executed pursuant to CFTC-approved rules. - Form DCM Exhibit Q requirement: applicants must describe trading system and trade matching algorithm and provide examples of algorithm behavior across trading scenarios and order types. - DCM rulebooks required to be publicly available. - Listing of new products: CFTC does not pre-approve DCM rules on admission of new futures/options contracts, but retains the ability to stay the listing of a new contract; assessors consider this sufficient for Principle 33. ### Swap Execution Facilities (SEFs) — disclosure and trade execution formats - SEF registration applicants must: - Disclose execution rules to the regulator and market participants and ensure fair application to all participants. - Make SEF rulebooks publicly available. - Explain operation of the trading system/platform and satisfy trade functionality requirement of CFTC Regulation 37.3(a)(2). - Trade execution formats for swaps subject to trade execution requirement: - Must be executed either in an order book or in a request for quote (RFQ) system that operates in conjunction with an order book where requests are submitted to at least three participants. - Form SEF Exhibit Q requirements: - For order book systems: explanation of trade matching algorithm and examples for various trading scenarios and order types. - For RFQ systems: explanation of how a requester may transact on resting bids or offers along with responsive orders. - SB SEFs: CCO required to submit annual financial report and report describing compliance with the Exchange Act and policies/procedures, including code of ethics and conflict of interest policies (Section 3D(d)(14)(C) Exchange Act). - SB SEFs will be required to make public timely trade information on the basis of SEC rules pending finalization. ### Direct market access — rules and controls - SEC Rule 15c3-5 (November 2010): Risk Management Controls for Brokers or Dealers with Market Access. - Applicability: - BDs with access to trading in securities by virtue of being an exchange member or an ATS subscriber. - Broker-dealer operators of an ATS that provides market access to non-BD subscribers. - BD obligations: establish, document, and maintain a system of risk management controls and supervisory procedures reasonably designed to manage financial, regulatory, and other risks of market-access activities. - Specific design objectives of risk management controls and supervisory procedures: - Prevent entry of orders that exceed appropriate pre-set credit or capital thresholds, or that appear to be erroneous. - Prevent entry of orders unless compliance with all pre-order-entry regulatory requirements has occurred. - Prevent entry of orders that the BD or customer is restricted from trading; restrict market access technology and systems to authorized persons; assure appropriate surveillance personnel receive immediate post-trade execution reports. - Rule 15c3-5 permits broker-dealers to use third party technology (including provided by exchanges) provided the broker-dealer maintains direct and exclusive control of the risk management system. - DCMs — CFTC Regulation 38.607: - Requires DCMs permitting direct electronic access by customers to have effective systems and controls reasonably designed to facilitate FCM’s management of financial risk, such as automated pre-trade controls enabling member FCMs to implement appropriate financial risk limits. - DCM must implement and enforce rules requiring member FCMs to use provided systems and controls. - Assessors’ view: - Obligation to ensure sufficient pre-trade controls applies to BDs; exchanges are not subject to particular requirements in this regard. - Assessors consider current approach sufficient for minimum requirement of Principle 33 but encourage SEC to consider additional requirements on exchanges to enhance ability to manage direct electronic access risks. ### Access to trading information and reporting timelines - NMS Plans require participating SROs to collect and promptly report both pre- and post-trade information to NMS plan processors; processors consolidate and disseminate to the public. - Reporting requirements: - SROs must report stock symbol, volume, and price at which transactions executed to the plan processor, in most cases within 10 seconds after time of execution (see Principle 35). - Same 10-second reporting requirement applies to trades made on an ATS. - In practice, exchanges and ATSs report transactions on an as real-time basis as technologically possible. - If transaction not reported within set deadline, SRO must designate last sale price as "late" in report to NMS plan processor. - Consolidated tape: reports latest price and volume data on sales of exchange-listed stocks. - Proprietary feeds and direct access: - In practice, exchanges provide subscriptions to direct access to proprietary trading information to exchange members and other market participants to enable more effective risk monitoring/risk management than NMS data. - DCMs and SEFs: - Required to provide market participants, on a fair, equitable and timely basis, information regarding prices, bids and offers. ### Assessment grade and rationale (Principle 33 focus) - Assessment: Broadly Implemented. - Two main shortcomings driving grade: - Lack of mandatory ATS disclosure of order execution rules/procedures to market participants (voluntary disclosures insufficient for Key Questions 5(a), 5(b), 6). - Five percent market share threshold for applying fair access requirements to an ATS is too high and should be removed or significantly lowered. - Authorization and oversight of new ATSs: - Current approach: BD informs SEC on Form ATS and files application with FINRA on business operation changes; SEC and FINRA assess ATS order execution procedures and BD operational competence within respective processes. - Assessors encourage deeper analysis of order execution procedures for fairness and BD operational competence specific to ATS operations. ### Market surveillance arrangements and data initiatives - Securities exchanges: - SROs have primary responsibility for daily surveillance of trading activities under SEC oversight. - All securities exchanges conduct real-time "market watch" surveillance; some conduct market-specific surveillance in-house; some outsource to FINRA through RSAs. - NASDAQ OMX Group outsources cross-market surveillance to FINRA but runs NASDAQ-specific surveillance internally. - NYSE Regulation to directly perform market surveillance for NYSE Group’s equities and options exchanges starting January 1, 2015 (announcement October 2014). - FINRA: - After integration of BATS Exchange into FINRA’s program, FINRA conducts cross-market surveillance for 99 percent of the U.S. listed equity market. - FINRA conducts automated options surveillance in hybrid and electronic options marketplaces for approximately 40 percent of U.S. options exchange trading. - Through RSAs, FINRA oversees trading activity on multiple options venues and provides equity market insider trading surveillance pursuant to the Consolidated Insider Trading Plan 17d-2. - SEC Market Surveillance Group (Enforcement Division’s Office of Market Intelligence): - Oversight over all domestic equity and securities options markets; can obtain surveillance/trading data from SROs and coordinate to detect anomalous market activity. - Large Trader Reporting Rule 13h-1 and Form 13H (July 2011): - Large trader definition context (footnote): "A person is considered to be a large trader, when it (directly or indirectly) exercises investment discretion over one or more accounts and effects transactions exceeding two million shares or $20 million during a calendar day or twenty million shares or $200 million during a calendar month (Rule 13h-1(a)(7)))." - Fiscal year 2013: 2948 large traders had registered with the SEC. - Large traders register via Form 13H through EDGAR; SEC assigns unique identification number for reporting and investigative purposes. - MIDAS (launched 2013): - Collects and processes data from consolidated tapes and proprietary feeds of each equity exchange; includes data on listed stocks, exchange-traded products, equity options and futures contracts, posted orders and quotes, modifications and cancellations, and trade executions. - Uses include identifying possibly troublesome or illegal behavior and reconstructing market events. - DCM surveillance obligations (Core Principle 2): - Conduct effective trade practice surveillance, market surveillance, and real-time market monitoring. - Maintain an automated trade surveillance system capable of detecting and investigating potential trade practice violations and capable of real-time market monitoring of all trading activity on electronic trading platforms to identify disorderly trading and anomalies. - Automated system must load and process daily orders and trades no later than 24 hours after completion of the trading day. - Automated trade surveillance system must detect and flag specific trade execution patterns and trade anomalies. - Some DCMs conduct surveillance in-house; NFA provides trade practice and market surveillance services for others; 16 SEFs have outsourced surveillance to the NFA. - CFTC market surveillance: - Monitors trading and positions on an on-going basis; daily monitoring of large traders and examination of price spikes, scheduled market-sensitive news release periods, daily settlements in major commodities and futures/options contracts. - Tracks key price relationships, relevant supply and demand factors, and conducts deep forensic examinations periodically to uncover market abuses linking cash markets and derivatives. ### SEC supervision of trading systems — filings, reporting, and technology oversight - Rule approval: exchanges must file proposed changes, additions, or deletions to rules with the SEC (Section 19(b)(1) Exchange Act). - Reporting: - National securities exchanges must submit within 10 days amendments to certain exhibits of Form 1 (Rule 6a-2(a)). - Annually, exchanges file amendments to other Form 1 exhibits relating to financial information, ownership, membership, and listed securities. - Every three years, exchanges must file completely updated information on governing documents, managers, and facility operators. - Exchanges may provide required information through alternatives including publications and Internet websites controlled by the exchange. - Rule 6a-3 requires exchanges to submit notices, circulars, bulletins, and lists or periodicals issued or made generally available to members/participants/subscribers. - ATS reporting: - ATSs must file quarterly reports on Form ATS-R within 30 days of quarter end, including list of subscribers and securities traded, and statistics on trading volume and value. - ATSs must amend Form ATS to correct inaccurate information within 30 days after quarter end and at least 20 calendar days prior to implementing a material operational change. - Technology Control Program (TCP): - SEC implemented TCP to review exchanges’ trading and information technology systems for capacity and resiliency to handle increased volumes and disruptions. - TCP staff evaluate systems capability, exchange capital sufficiency to maintain automated systems, and technical expertise of staff; may perform routine, for-cause, or special focus examinations. - OCIE’s TCP staff monitors planned significant system changes at exchanges and certain high-volume ATSs and responds to system failures and disruptions; TCP staff regularly meets with exchanges’ IT staff. *International Monetary Fund — UNITED STATES country report excerpt* ### Section 5c(c) of the CEA requires DCMs and SEFs to file with the CFTC new rules and rule ### _cr1591 - Section 5c(c) of the CEA requires DCMs and SEFs to file with the CFTC new rules and rule amendments ### Rulemaking, filing, and self-certification - Section 5c(c) of the CEA requires DCMs and SEFs to file new rules and rule amendments with the CFTC. - Self-certification: - DCMs and SEFs may self-certify new rules and rule amendments and implement them no earlier than 10 business days following the CFTC’s receipt of the submission (CFTC Regulation 40.6). - Alternatively, they may voluntarily submit new rules and rule amendments for CFTC review and approval (CFTC Regulation 40.5). - Note: Self-certification of products is discussed under Principle 33; see Principle 9 for further details. ### Reporting and examinations - Reporting obligations: - DCMs and SEFs must report material changes in their operations on an ongoing basis to the CFTC. - Quarterly financial statements must be submitted to the CFTC within 40 days of the end of the first three fiscal quarters and within 60 days of the end of the fiscal year. - Systems safeguards examinations: - CFTC reviews one or more of: (i) enterprise risk management and governance; (ii) information security; (iii) capacity planning; (iv) systems operations; (v) systems development methodology; (vi) business continuity and disaster recovery; and (vii) physical security. - Such examinations are conducted at the systemically important DCMs every 12-18 months. - The CFTC’s examinations of exchanges’ self-regulatory functions are discussed in Principle 9. ### Enforcement powers and recent actions - SEC powers: - Under Section 19(a)(3) of the Exchange Act, the SEC may cancel, suspend, or revoke an SRO’s registration. - Section 19(h) of the Exchange Act authorizes the SEC to: (i) suspend or revoke the registration of an SRO; (ii) censure or impose limitations on its activities; and (iii) remove from office or censure officers or directors of an SRO for violations. - Recent SEC enforcement examples: - NYSE and NYSE Euronext agreed to a $5 million penalty and undertakings to settle SEC charges for alleged compliance failures giving certain customers improper early access to trading information. - NASDAQ agreed to a $10 million penalty to settle SEC charges arising from systems and decision-making failures during the IPO and secondary trading of Facebook shares. - SEC enforcement regarding BDs/ATSs: - The SEC’s ability to cancel, suspend or revoke the registration of a BD, including an ATS, is discussed in Principle 29. - The SEC has recently taken enforcement action against two ATS operators for alleged violation of confidentiality requirements. - CFTC powers: - The CFTC can direct DCMs and SEFs to alter or supplement their rules and take action deemed necessary to maintain or restore orderly trading (Sections 8a(7) and (9) CEA). - The CFTC can suspend or revoke a registrant’s registration for failure or refusal to comply with provisions of the CEA, CFTC regulations, or CFTC orders (Sections 5(d)(1), 5b(c)(2), 5h(a)(1) and 6(b) CEA). ### Principle 35 — Transparency of trading: national market system and equities - National market system (NMS): - Section 11A(a)(2) and 11A(a)(1) of the Exchange Act direct the SEC to facilitate an NMS to link all markets for qualified securities. - Several NMS plans exist: CQ/CTA Plan (SIAC processor), NASDAQ UTP Plan (NASDAQ processor), and OPRA Plan (SIAC processor). - Section 11A(c)(1)(C) and 11A(c)(1)(D) require equitable access to market information and non-unreasonably discriminatory terms. - Pre-trade transparency for securities: - Rule 602 of Regulation NMS requires exchanges and FINRA to collect and make bid/offer information available to vendors; responsible brokers/dealers must promptly submit best bids, best offers, and quotation sizes. - Fee-based access to the consolidated tape is available; most non-professional investors receive access via brokers. - Limit order display rule: - Rule 604 of Regulation NMS requires display of public customer limit orders that improve a specialist’s or market maker’s bid or offer, and inclusion of size for orders priced equal to the specialist’s or market maker’s bid or offer. - Requirement does not apply to customer limit orders for at least 10,000 shares or $200,000 (block size). - ATSs and dark pools: - An ATS that displays its orders to at least one person (other than an ATS employee) becomes subject to the order display and execution access rule if its market share in a particular NMS stock was five percent or more during at least four of the preceding six months. - Currently there are no such ATSs; therefore all current equity ATSs can operate as dark pools without pre-trade transparency to subscribers or the public. - Regulation NMS Order Protection Rule (Rule 611) constrains ATS trading to prices at or between the current national best bid and offer (NBBO); common practice includes pegging to the NBBO midpoint. - ATSs and national exchanges can choose whether their reference price is derived from the NMS feed or proprietary feeds. - Market makers and hidden orders: - Real-time reporting of OTC quotes is required if the quote is from a registered market-maker or an OTC market maker whose executed volume exceeds 1 percent of aggregate trading volume in the security. - Some exchanges have fully hidden order types that can match displayed orders, subject to exchange priority rules; such order types require SEC approval as part of SRO rule approval. - SEC staff analysis measured hidden order executions; the Hidden Volume Ratios analysis showed the hidden volume ratio for stocks was typically between 11 percent and 14 percent. - Priority and dissemination: - Exchange rules typically give displayed orders priority over undisplayed orders at the same price (e.g., BATS Rule 11.2; NYSE Rule 72). - Proprietary feeds often provide data to subscribers more expeditiously than the NMS feed due to extra processing steps for the NMS plan processors. - Exchanges make full order books available to subscribers of proprietary data feeds; Rule 603(a) prohibits releasing proprietary data before sending to SIPs. - Institutional review and rule changes: - SEC staff conducted analyses on on-exchange dark trading and included order-type reviews in OCIE National Examination Programs in 2013 and 2014. - In June 2014, the SEC Chair asked exchanges to review order types and consider rule changes; these rule changes were published for comments after the assessment mission. ### Principle 35 — Transparency: futures, options, swaps, and SEFs/DCMs - Futures and options (DCMs): - DCM Core Principle 9 and CFTC Regulation 1.38 require open and competitive execution methods to protect price discovery; in practice, DCMs utilize central limit order books, some maintain trading floors. - Iceberg order types are allowed and designed to permit the hidden part to retain time priority of the visible part. - Non-competitive trades (e.g., exchanges of derivatives for related positions, office trades, transfer trades) are exempt from pre-trade transparency (Regulation 1.38; Regulation 38.500). - FCMs acting as principal or agent can enter or confirm futures contracts if reported/recorded/cleared per DCM/DCO rules, enabling off order book block trades under DCM rules; current thresholds are determined in each DCM’s rules. - Block trade thresholds have in some markets fallen (e.g., energy futures: in some cases block trade threshold is only one trading lot). - The CFTC proposed 2012 rules on block transactions aiming for thresholds that would result in a relatively high percentage (such as 85 percent) of trading occurring through the central limit order book but did not finalize them; the CFTC continues to work on them. - Dissemination for DCMs: - DCMs must provide impartial access to markets to independent software vendors to collect, aggregate, and disseminate trade information. - Swaps and SEFs: - SEF registration seeks to promote pre-trade transparency in swaps markets (Section 5h(e) CEA). - The CFTC interprets pre-trade transparency to include bid/offer prices, quantity available, and other relevant information prior to execution. - In practice, most SEFs are request-for-quote systems and do not provide order-book style pre-trade transparency. - Pre-trade transparency is waived for swap transactions that qualify as block trades (Part 43 CFTC Regulations) and for large notional off-facility swaps. - SEFs/DCMs must transmit publicly reportable swap transaction data to an SDR as soon as technologically practicable; SDRs must disseminate this information as soon as technologically practicable, unless the swap is a block trade subject to a time delay (CFTC Regulation 43.3). - SDRs must make transaction information freely available to the public in a non-discriminatory manner through their websites. - SB SEFs will be required to make public timely information on price, trading volume, and other trading data on security-based swaps as prescribed by the SEC. - Post-trade transparency timing: - FINRA Rules 6300A and 6300B require OTC transactions in NMS securities to be reported to the FINRA TRF as soon as practicable but within no later than 10 seconds. - CTA Plan amendment filed May 14, 2014, (published for comments December 31, 2014) would reduce reporting to the CTA Plan processor from 90 seconds to 10 seconds. - In practice, post-trade transparency information is provided within milliseconds of trades. - DCM rules typically permit delayed publication of block trade information, with delays ranging from 5 to 15 minutes. - There is no delay for reporting or disseminating block trade information in equities per the NMS plans. ### Information, monitoring, and assessments of dark trading - ATS disclosures and reporting: - National exchanges must describe order types and execution procedures in their rules. - An ATS must disclose such information in Form ATS Exhibit F submitted to the SEC (not required to be published). - ATS trade information is reported to FINRA for the consolidated tape but is currently identified as OTC transactions without identifying the executing ATS. - FINRA Rule 4552 requires ATSs to report aggregate weekly trading volume and number of trades on a security-by-security basis and to use a unique market participant identifier for reporting to FINRA. - FINRA makes the reported volume and trade count information for equity securities publicly available on its website. - Monitoring and data-driven approach: - The SEC staff continues to evaluate the impact of dark liquidity on price discovery and market quality using a data-driven approach. - The SEC’s MIDAS system provides information on on-exchange dark trading. - Assessments and findings: - Assessment: Fully Implemented (for the CFTC filing/self-certification and enforcement descriptions earlier in the unit). - Assessment: Broadly Implemented (for Principle 35). - Comments on deficiencies and concerns: - Pending finalization of CFTC block trade rules, current block trade thresholds for futures and options are set by each DCM’s rules, making it difficult for the CFTC to address concerns about lowering thresholds. - The lack of finalized CFTC block trade rules reduces the CFTC’s ability to assess appropriateness of DCM pre-trade transparency waivers for block trades. - Dark pool ATSs do not currently provide sufficient public information on handling and execution of orders, a deficiency taken into account in the grade for Principle 35. - A significant proportion of U.S. equity trading takes place without pre-trade transparency; estimates on the value of trading on dark pools and OTC ranged between 28 and 40 percent in 2012-2014. The proportion of on-exchange dark trading ranged between 11 and 14 percent in 2013. - Factors impacting pre-trade transparency include: - Most equity ATSs operate as dark pools using order types executed at or within the NBBO. - National exchanges use fully undisplayed order types. - A relatively large proportion of trading occurs outside exchanges and ATSs through OTC mechanisms. - The IOSCO Assessment Methodology’s requirements for conditions for derogations from pre-trade transparency are met by Regulation NMS constraining dark trading to prices at or within the NBBO, but further SEC analysis of pre-trade transparency impacts of order types and reference prices is recommended to ensure no adverse impact on price discovery, particularly given differences in timeliness between NMS and proprietary feeds. *International Monetary Fund — assessment text from the provided content.* ### Section 10(b) of the Exchange Act and makes it unlawful for any person, directly or indirectly, ### _cr1591 - Section 10(b) of the Exchange Act and makes it unlawful for any person, directly or indirectly, ### Securities law anti-fraud provisions - Section 10(b) of the Exchange Act: makes it unlawful for any person, directly or indirectly, to use any device, scheme or artifice to defraud, to make any untrue statements of material fact or to omit to state a material fact necessary in order to make the statements made not misleading, and to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. - Section 9 of the Exchange Act: prohibits manipulative practices in connection with the trading of securities. - Section 15(c) of the Exchange Act: prohibits fraudulent and manipulative conduct by BDs. - Section 14(e) of the Exchange Act: prohibits fraudulent, deceptive, and manipulative acts in connection with a tender offer. - Front running and trading ahead of customer orders: illegal under the anti-fraud provisions of the federal securities laws. - SEC Rule 10b-21: a specific naked short selling anti-fraud rule; it states that it is a manipulative device or contrivance to deceive about a seller’s intention or ability to deliver securities in time for settlement. ### Commodity futures and options — enforceable violations under the CEA - Price manipulation, cornering a market, squeezing a futures contract, and communication of false information that tend to affect commodity prices (Sections 6(c), 6(d) and 9(a)(2) CEA). - Position limit violations (Section 4a(e) CEA). - Trade practice violations, such as wash trades, accommodation trades and fictitious sales (Section 4c(a) CEA). - Disruptive practices, such as violating bids or offers, spoofing, and disregard for the orderly execution of transactions during the closing period (Section 4c(a) CEA). - Use or attempted use of any manipulative device, scheme or artifice to defraud, untrue or misleading statement, false report or any act that operates or would operate as a fraud (Section 4b(a) CEA). ### Insider trading — securities markets - General description: trading on the basis of material nonpublic information that has been used or obtained in breach of a fiduciary duty or a duty of trust or confidence. - Legal basis: prohibition is derived from federal courts’ interpretation of the general anti-fraud provisions of Section 17(a) of the Securities Act, as well as the Exchange Act (primarily Section 10(b) and Rule 10b-5 thereunder). - Tippee liability: it is unlawful for a tippee to trade on material nonpublic information that the tippee knew or should have known was communicated by a tipper in breach of a duty owed by the tipper. - Specific provisions: - Section 14(e) of the Exchange Act and corresponding Rule 14e-3: prohibit tipping and trading while in possession of material, nonpublic information in connection with a tender offer. - SEC Regulation FD: requires a reporting issuer to make simultaneous or prompt public disclosure, depending on whether the disclosure was intentional, when it discloses material nonpublic information to certain individuals or entities (such as stock analysts or holders of the issuer’s securities). - Section 16(b) of the Exchange Act: imposes liability for short-swing profits in the issuer’s stock upon officers, directors, and beneficial owners of more than 10 percent of any class of equity security; such insiders must disgorge to the issuer any profit realized as a result of a purchase and sale of equity securities occurring within a six-month period. ### Insider trading — commodity futures and options markets - CEA stance: does not prohibit trading in the commodity futures and options markets on the basis of lawfully obtained material nonpublic information; rationale is that prohibiting such trading would hinder traders’ ability to hedge commercial risks. - Prohibited conduct: - Knowing communication of false or misleading information that tends to affect commodity prices is a violation of Section 9(a)(2) of the CEA. - Depending on facts and circumstances, a person who engages in deceptive or manipulative conduct in connection with swaps or commodity futures or options — for example by trading on the basis of material nonpublic information in breach of a pre-existing duty to disclose (under another law, rule, agreement, understanding, or some other source), or by trading on the basis of material nonpublic information that was obtained through fraud or deception — may be in violation of CFTC Rule 180.1. - The CFTC considers CFTC Rule 180.1 would enable it to address conduct where trading is conducted with knowledge of information that is subject to a specific disclosure requirement. - Section 9(e) of the CEA: prohibits insider trading and disclosure of insider information by employees and board and board committee members of the NFA, a DCM or a registered entity; insider trading by other persons on the basis of such information is also prohibited. *Source: _cr1591 - Section 10(b) of the Exchange Act and makes it unlawful for any person, directly or indirectly,* ### Section 746 of the Dodd-Frank Act also added an insider trading prohibition regarding ### Section 746 of the Dodd-Frank Act also added an insider trading prohibition regarding ### Monitoring — Securities and Commodities - Section 746 of the Dodd-Frank Act added an insider trading prohibition regarding information emanating from Federal government departments and agencies that may affect or tend to affect the price of any commodity in interstate commerce or swap (Section 4c(a)(4) CEA). - Division of responsibilities between the SROs and the SEC for surveillance of market manipulation, insider trading and other market abuse is described in Principle 34. - SRO electronic monitoring is designed to identify unusual trading activity; SROs review alerts intra-day and after the close of the trading day to determine potential violations. - FINRA automated surveillance: - Monitors trading for aberrant movements in stock prices or volumes. - Generates alerts based on set parameters. - If staff determine a strong likelihood of insider trading, review can expand to a full investigation. - Audit trail systems: - 1996: SEC ordered FINRA (then NASD) to design and implement an audit trail system → FINRA developed OATS; BDs report order details to OATS. - 1999: SEC ordered NYSE to implement similar system → NYSE developed FESC and OTS. - October 2011: NYSE discontinued FESC and OTS when NYSE adopted OATS rules and FINRA added NYSE-listed securities to OATS. - 2012: SEC Rule 613 under the Exchange Act required national securities exchanges and FINRA to create a consolidated audit trail (CAT) to collect and identify every order, cancellation, modification, and trade execution for all exchange-listed equities and equity options across all U.S. markets. - SROs’ plan submitted to the SEC on September 30, 2014. - The transitional period for the new system will last three years from the effective date of the plan. - SEC Market Surveillance Group coordinates with SROs to detect anomalous market activity, reviews merger and acquisition activity and major market-moving events in coordination with relevant SROs. - Commodity futures and options: - DCMs must adopt speculative position limits or position accountability for each contract; for contracts subject to a CFTC position limit, the DCM must set position limits at a level not higher than the CFTC limit (DCM Core Principle 5; CFTC Regulation 38.300). - CFTC staff contacts large position holders to understand business practices behind positions, execution of economic physical substitution and orderly futures position liquidations. - DCMs and NFA conduct market and trade practice surveillance; majority of SEFs have outsourced surveillance to the NFA in swaps markets. ### Enforcement — SEC and CFTC - Number of SEC Market Abuse Enforcement Actions (Market manipulation / Insider trading): - Fiscal year 2009: 39 / 37 - Fiscal year 2010: 34 / 53 - Fiscal year 2011: 35 / 57 - Fiscal year 2012: 46 / 58 - Fiscal year 2013: 50 / 44 - Total: 204 / 249 - Source: SEC - CFTC enforcement (over fiscal years 2011-2014): - Total manipulation, attempted manipulation and false reporting cases: 15 cases (2011: 3; 2012; 2; 2013: 4; 2014: 6). - Total trade practice violations addressed: 34 (2011: 6; 2012; 15; 2013: 7; 2014: 6), including first actions in 2013 using anti-spoofing/disruptive trading authority enacted under the Dodd-Frank Act. ### Cross-market trading — Information Sharing and Coordination - Intermarket Surveillance Group (ISG): - All U.S. national securities exchanges and FINRA are ISG members; ISG coordinates intermarket surveillance. - ISG membership open to recognized market centers meeting requirements; ISG is not subject to regulatory oversight and does not file rule changes with the CFTC or SEC. - ISG focuses on information sharing among markets that trade securities, options on securities, security futures products, and futures and options on broad-based security indexes; many DCMs are ISG members. - ISG information sharing is confidential, used only for regulatory purposes, and shared on an as-needed basis and upon request. - Full ISG generally meets twice a year; meetings open only to representatives of members, prospective members, SIAC, and by invitation appropriate governmental authorities. - Joint Compliance Committee (JCC) for futures exchanges: - Developed uniform definitions of trade practice offenses; meets typically twice a year. - FBOTs with linked contracts: - FBOTs applying for registration to provide direct access to U.S. participants must identify any contract linked to a DCM-listed contract (CFTC Regulation 48.7(c)(3)) and comply with ongoing obligations (CFTC Regulation 48.8(c)(2)). - Obligations include quarterly reporting to CFTC of members with positions above FBOT trade position limits, reporting of hedge exemptions or disciplinary action, providing trade execution and audit trail data on a trade date plus one basis, and promptly taking similar emergency action if directed by the CFTC to the linked DCM. ### Principle 37 — Clearing, Settlement, and Large Exposure Management - Clearing and settlement — Equities: - Clearing of on-exchange equities trades at National Securities Clearing Corporation (NSCC); NSCC clears off-exchange equities trades between two brokers, including ATS trades. - Equity trades settle at T+3 at the Depository Trust Company (DTC). - Commodity futures and options: - Trades must be cleared on a DCO; many DCMs operate as DCOs (e.g., Chicago Mercantile Exchange (CME)); ICE Futures U.S. trades are cleared at ICE Clear U.S. - SEC net capital rule: - BDs apply haircuts to securities positions; if market value of a securities position exceeds 10 percent of tentative net capital of the BD, BD must apply an additional haircut to the amount in excess. - BD monitoring and SRO powers: - SEC staff and relevant DEA staff monitor open positions and credit exposures via FOCUS reports, meetings, and examinations. - SROs can invoke trading limits, forced liquidation, increased margin requirements, revocation of trading privileges, suspension, and imposition of higher capital charges; may shut down a BD through suspension, bar, or revocation of membership. - SROs set margin maintenance requirements and may set initial margin higher than Federal Reserve’s Regulation T. - Clearing agency risk management (SEC Rules 17Ad-22(b)(1)–(4)): - Procedures implemented by SEC-registered CCPs include: - Measuring credit exposures at least once a day. - Setting margin coverage at a 99 percent confidence level over a set period. - Using risk-based model parameters to set margin requirements. - Establishing a fund that mutualizes losses of defaults exceeding margin coverage. - Maintaining sufficient financial resources to withstand default of at least the largest participant family (for SBS transactions, default of two largest participant families). - DTCC Limit Monitoring (mid-2014 launch): - Alerts clearing firms to trading activity nearing credit limits set for their own and correspondents’ accounts. - NSCC’s Universal Trade Capture feeds broker-to-broker trading to DTCC Limit Monitoring in near real-time. - Users can set intraday limits; “early warning” limit breaches generate standard protocol messages to affected clearing broker. - Use is compulsory for all NSCC member clearing firms that need to monitor correspondent firms and NSCC member proprietary trading firms. ### Large Exposure Monitoring and CFTC Surveillance - DCM reporting requirements: - Every trading day, DCMs report to the CFTC each clearing member’s open long and short positions, purchases and sales, exchanges of futures for cash, and futures delivery notices for the previous trading day (Part 16 CFTC Regulations). - Reports are separated by proprietary and customer accounts by futures month; for options by puts and calls, expiration date and strike price. - Reporting firms (clearing members, FCMs, foreign brokers) file daily reports showing traders with positions at or above CFTC reporting levels (Part 17 CFTC Regulations). - CFTC aggregates related accounts and may require identification reports when traders reach reportable levels. - Special calls: - CFTC may institute a special call to gain additional information about a firm’s traders, trading and delivery activity, persons controlling or with interest in the account, and positions/transactions in underlying commodity (Parts 18 and 21 CFTC Regulations). - Large trader reporting for covered physical commodity swaps: - Routine reports required from DCOs, clearing members and swap dealers with reportable positions in certain covered physical commodity swaps (Part 20 CFTC regulations) to identify significant traders in covered swaps and reconstruct market events. - Special disclosure forms required for some contracts: - Exposure forms filed before last day of trading of a specific contract month where large OTC physical markets are linked to futures contract. - CFTC Risk Surveillance Group (RSG): - Defines risk as potential that a market participant may not fulfill financial obligations on a contract subject to CFTC jurisdiction under the CEA. - Identifies positions in cleared products that pose significant financial risk at trader, clearing member, and DCO levels. - Four primary components: - i) Identify traders, clearing members, and DCOs at risk based on account characteristics and market conditions. - ii) Estimate magnitude of risk through stress testing and risk estimation techniques. - iii) Compare risk to available financial resources (initial margin, trader assets, clearing member capital, and DCO resources). - iv) Assess risk management practices of traders, clearing members, and DCOs. - RSG uses a number of tools and is improving and integrating them; currently lacks the same ready access to financial information about traders or self-clearing firms as it has about FCMs and DCOs. - Program for futures and options is well-established; RSG is developing tools for interest rate swaps and CDS and to integrate swaps program with futures and options program. - DCM Core Principle 6: - DCMs must adopt rules, in consultation or cooperation with CFTC, to provide emergency authority to liquidate or transfer open positions, suspend or curtail trading, and require special margin; emergency action involving fungible contracts across platforms must be directed or agreed by CFTC or staff, and DCM must promptly notify CFTC. - Similar requirements apply to SEFs. ### Sharing of Information — SEC and CFTC - SEC: - MOU with the Federal Reserve for information sharing; bilateral agreements with various agencies for timely information sharing; participates in supervisory colleges for large global financial institutions and ongoing supervisory meetings to discuss ANC BDs. - CFTC: - Arrangements with DCMs to share information, including on large exposures; DCMs inform CFTC of exemptions granted when managing position limits; DCMs can monitor exposure size intraday. - Boca Declaration on Cooperation and Supervision of International Futures Markets and Clearing Organizations (Declaration) and Exchange MOU (1995) provide framework for sharing information when triggering events occur. - Special arrangement with UK FCA for WTI Crude Oil: CFTC and UK FCA entered an MOU on November 17, 2006 to share daily information regarding large exposures for contracts effectively forming a single market. ### Default Procedures — Clearing and DCO Member Failure - Clearing agency member failure: - Clearing participants that clear customer positions are registered BDs subject to SEC’s customer protection Rule 15c3-3 and hypothecation Rule 8c-1; insolvency of a BD with customer accounts administered by SIPC under SIPA framework. - Registered clearing agencies required to establish and make key aspects of default procedures publicly available and ensure timely action to contain losses and liquidity pressures (SEC Rule 17Ad-22(d)(11)). - Clearing agency rules typically state default triggers, decision authority, and steps to protect clearing agency and participants; rules grant authority to take over accounts, manage positions, and utilize defaulting participant’s collateral. - Uniform Commercial Code Articles 8 and 9 and provisions in U.S. Bankruptcy Code, Federal Deposit Insurance Act, FDICIA, and SIPA provide legal certainty regarding a clearing agency’s lien and authority in insolvency. - Clearing agencies generally treat participants as principals and will work with SIPC receiver to distribute customer cash and securities in a participant default. - DCO member failure: - DCOs provide information on rules and default procedures to market participants (Section 5b(c)(2)(L) CEA); most DCOs publish default procedures on their websites. - If CFTC determines an FCM is likely to fail, it will attempt to cause transfer of customer accounts; under CFTC Regulation 1.17(a)(4), an FCM holding less than required minimum capital generally must transfer customer accounts and cease conducting business until compliant. - DCO default rules typically permit: - (i) Liquidation or transfer of positions carried by defaulting member. - (ii) Access to all property in proprietary accounts of defaulting member. - (iii) Access to customer account property if default resulted from customer default. - (iv) Access to amounts contributed by defaulting member to guarantee fund. - If losses exceed these, DCO rules may permit: - (i) Access to amounts that non-defaulting members contributed to guarantee fund. - (ii) Use of DCO capital. - (iii) Levying assessments on all members. ### Short Selling — Rules, Reporting, and Monitoring - Regulation SHO four general principles: - Detailed provisions on when a sell order can be marked long, short, or short exempt; an order can be marked long only if seller deemed to own the security and security is in broker/dealer possession or control or reasonably expected to be by settlement. - Locate requirement: broker/dealer must borrow or arrange to borrow the security prior to effecting a short sale. - Close-out requirement: clearing firm must deliver securities by settlement date or immediately purchase/borrow to close out a fail to deliver by no later than the morning of T+4; for certain market makers engaged in bona fide market making, close-out extended to morning of T+6. - Price test: restricts price at which short sales can be made when security drops 10 percent or more from prior trading day’s close; prevents short sales at or below the National Best Bid (NBB) once triggered. - Exceptions: - Deemed-to-own exceptions for certain arbitrage or hedging activity; market maker exception to locate requirement. - SEC Rule 10b-21: - Naked short selling anti-fraud rule; manipulative device to deceive about seller’s intention or ability to deliver securities in time for settlement; SEC took enforcement action in 2014 under these provisions. - Reporting and monitoring: - Several SROs provide daily aggregate short selling volume information for individual equity securities on their websites. - SROs provide one-month delayed disclosure of individual short sale transaction information in all exchange-listed equity securities. - SEC discloses fails to deliver data twice a month for all equity securities. - SROs’ websites provide threshold securities lists. - SEC has examination and enforcement programs to monitor and prosecute violations; SROs monitor short selling activity, including fails to deliver. ### Assessment and Comments - Assessment for relevant provisions presented: - Assessment: Fully Implemented (for Principle 37 and related applicable areas described). - Assessment: Not Assessed (for Principle 38). - Comments: - IOSCO Assessment Methodology assigns responsibility for monitoring open positions or credit exposures on unsettled trades to market authorities (regulatory body, SRO, and/or market). - Complexity of U.S. market structure with multiple regulators, SROs, national securities exchanges, DCMs, and CCPs makes assessment challenging. - Individual market authorities—particularly CCPs—are subject to requirements to monitor open positions; in commodity futures and options this is complemented by ongoing CFTC monitoring. - Mechanisms exist to gather additional information and take appropriate action; information-sharing mechanisms have been developed domestically and internationally. - Clearing agencies are not required to distinguish between participants’ customer and proprietary positions; SIPC process considered to provide means to protect customer funds and assets as required under Key Question 4 of Assessment Methodology (see Principle 32). - CFTC has wide powers to intervene in potential failures, including requiring transfer of customer accounts (see Principle 32). - Minimum requirements of IOSCO Assessment Methodology appear to be complied with; Principle assessed as Fully Implemented. - Authorities are encouraged to review whether current mechanisms are sufficient to provide a comprehensive view of total exposures of market participants active across various markets (equity, fixed income, commodity futures and options). *International Monetary Fund — United States country report excerpt* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1591.pdf_