Regulatory Risk Report: June 1, 2011 1

Regulatory Watch List

Articles in This Issue

U.S. Investment: SEC whistleblower rules adopted; Bad actor issuers; SEC,CFTC commissioners, Risk-Fin head; MSRBvariable rate security transparency; FINRA suitability rule extension, FAQ; FINRA new issue allocation – page 3.

Home Help False Claims Act charge from HUD audits seek to increase bank mortgage settlement to $20-30bn. NY Fed investigates Goldman servicer denial of modification, as House Dems seeks subpoenas against six firms.

Quote of the Week

Swiss Finish UBS considers moving investment bank out of Switzerland, in response 19% SIFI capital charge. EU States want flexible implementation of Basel III without hard-coding, EC denies concessions on hybrid capital.

Whistle-for-it SEC adopts whistleblower rule despite claims it encourages staff to avoid firm-compliance units. Authorities rely on internal investigations of FCPA wrongdoing, as firms relax policies on use of social networking.

EU: Short-selling and CDS regulation agreed; Backstop for banks that fail stress test; EC reminds to implement CRD3; EMIRregulation on OTC derivatives, clearing, repositories; Deposit insurance directive; Hedge fund directive – page 5.

U.S. Banking: CFPB mortgage loan disclosures; CFPB structure and director; OCC transfer from OTS and pre-emption;House bill defers swaps rules to 2012; OTC deferral for non-US affiliates; Interest on demand deposit accounts– page 2.

International: IOSCO dark liquidity principles; FSB peer review of compensation; G-8 aid for Arab spring; IMF new MD; HKshort-position reporting; HK mutual fund and investment assurance; HK mystery shopping program results – page 7.

AML & Enforcement: US sanctions on Syria; SEC first deferred prosecution; UK BoS pays £20mn for complaints; FINRAfines CS and ML $7.5mn for RMBS; FINRA fines Nuveen $3mn re ARS; FINRA disciplinary database – page 8.

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Regulatory Risk ReportReg-Room

June 1, 2011

Rating Agencies: SEC credit rating agency rules, controls, methodology, look-back, ABS due-diligence, transparency; ESMA extends use of non-EU credit ratings, flexible equivalency assessment; EU sets rating agencies fees – page 4.

UK: Complaint handling rules; Insurance bill Information onus on issuers; Trade reporting exchange derivatives; Unratedsecuritization; Prudential Regulation Authority; OFT reviews audit market; implementation of EU rules – page 6.

Inter-change Senate sponsors of bill offer to reduce delay and study of debit fee cap to 15 months, not 2 years.Industry makes this Dodd-Frank repeal top lobbying priority, emphasizes impact on small banks, anti-fraud costs.

“For an agency with limited resources like the SEC, it is critical to be able to leverage the resources of people who may have first-hand information about violations...The tips received have been better since Dodd Frank became law. We expect this to continue and the rule maps out simplified procedures for whistleblowers to provide us critical information” - SEC Chairman, Mary Schapiro

Regulatory Risk Report: : June 1, 2011 2

U.S. Banking

On May 18, CFPB proposed combining the federal mortgage disclosures into a single, simpler form.

CFPB Combine Mortgage Loan Disclosures

• Know Before You Owe project makes cost and risks of loan clearer for consumer comparison.

• CFPB testing two alternate prototype forms on consumers who recently applied for mortgage.

• Gives consumers upfront, easy-to-understand information to compare different mortgages.

• Current law requires that mortgage applicants receive two documents per TILA and RESPA.

• Old forms have overlapping information and complicated terms, so difficult to understand.

• Dodd-Frank Act requires CFPB to integrate forms and reissue July 2012 for notice and comment.

NY Seeks OTC Deferral for Non-US Affiliates

On May 17, bipartisan NY lawmakers asked for deferral of Dodd Frank Act OTC margin rule to foreign affiliates.• Rules require margin on derivative by non-US

subsidiary of US firm and foreign counterpart.• Concerned that proposals result in competitive

disadvantage for US firms operating globally.• Exceed intent of Congress of territorial scope outside

US, was only if there is a concern of arbitrage.• Harsher treatment of US firms may encourage market

participants to deal with non-US firms.

House Bill Defers New Swaps Rules to 2012On May 24, U.S. House financial services panel passed billto defer Dodd-Frank Act swaps rules to September 2012.

• Bill effective date brought forward from December, so it falls before the 2012 presidential election.

• Concern rules could disadvantage US firms compared to foreign competitors, aligns with G-20 deadline.

• Extends rule date but leaves Act reform intact, keeps rule dates for definitions and reporting.

• Party-line vote attacked by House Democrats, described as an attack on the Dodd-Frank Act.

• On May 25, U.S. Senate hearing on derivatives and clearinghouses, supported need for early rules.

Hearings on CFPB Structure and Director

On May 19, GOP senators asked Democrats for hearing on the need to revise CFPB’s governance structure.• Seeks board of director oversight, and subject to

appropriation, safety-and-soundness review.• Follows House panel passage of similar bills, but Sen.

Johnson said too early to revise body.• Democrats push Obama to nominate Warren director,

as recess appointment before July 21.• House oversight chair accuses Warren of lying about

role in State’s bank-servicer settlement.• On May 26, House held hearing on FDIC role in

resolution, DIF, bank failures, and lending.

On May 25, FDIC issued guidance for client notice on interest-paying demand deposit account (DDA). .

Interest on Demand Deposit Accounts

• Dodd-Frank Act allows DDA interest, and no limit on insurance for non-interest transaction a/c’s.

• If bank pays DDA interest after July 21, notify client that no longer has unlimited insurance.

• No specific requirements as to form of notice, but act reasonably, comply with State, U.S. law.

On May 25, OCC proposed rules on transfer from OTSand federal pre-emption, per Dodd-Frank Act.

OCC Transfer from OTS, Federal Pre-emption

• OCC assumes responsibility for regulation and exams of federal savings associations July 21.

• Revises OCC rules for their internal functions required to transfer jurisdiction of OTS thrifts.

• Combine assessment fee for banks and thrifts in September 2012, until then thrifts charged lower.

• Plan to publish those OTS rules the OCC will enforce at transfer date, renumbered for OCC.

• Eliminate OCC preemption rules for operating subsidiaries of national banks, apply to thrifts.

• Remove preemption of State law that obstruct, impair or condition powers of a national bank.

• Recognize State AG’s enforcement in court of non-preempted State laws vs. national banks.

Regulatory Risk Report: : June 1, 2011 3

U.S. Investment

On May 25, SEC voted 3-2 to adopt whistleblower rules under Dodd-Frank Act, effective in 60 days.

SEC Whistleblower and Bad Actors Rules

• Pay awards to whistleblowers who voluntarily provide SEC with information on a violation.

• If leads to successful enforcement over $1M, SEC will pay whistleblower 10-30% of funds.

• Will pay for original information from whistleblower’s independent knowledge or analysis-not public.

• Can first report information to firm’s internal whistle-blower, legal, or compliance process.

• Compliance and internal audit staff qualify if prevent substantial injury or firm is impeding.

• Treat employee as whistleblower from date of internal report-if also give to SEC in 120 days.

• Simpler procedure for submitting information via single-form and making claim after action.

On May 16, MSRB raised transparency on EMMA for muni variable rate demand obligations-VRDO.

MSRB Variable Rate Security Transparency

• VRDO liquidity facility documents, letters of credit and standby bond purchase agreements.

• Identity of securities’ tender agent, amount of VRDO held as bank bond, or if held by others.

• Bidding information for auction rate securities (ARS) with description of auction procedures.

• How ARS interest rate for a successful auction determined, a bid-to-cover ratio for each ARS.

• MSRB Rules G-8, G-34(c) effective May 16, requires new information collected by dealers.

• Collect and disseminate via MSRB Short-term obligation rate transparency -SHORT system.

On May 18, FINRA issued FAQ and new effective date for know-your-customer and suitability rules.

FINRA Suitability Rule Extension and FAQ

• New implementation date July 9, 2012, allows firms to update procedures, systems, training.

• Does not require firm to update all its existing account documentation by the effective date.

• Does not require any explicit documentation, and allows a firm to take risk-based approach.

• Guidance re new customer factors: investment experience, age, time-horizon, liquidity, risk.

• A customer with many accounts at a firm can have different investment profile across them.

• Strategy includes recommendation, even if not on an explicit security, includes security-hold.

• Recommended hold if financial advisor explicitly tells client not to sell (excludes implicit action or silence).

• Hold recommendation not create ongoing duty to monitor or make further recommendations.

• Hold riskier if on short-term security, or client is concentrated, or is inconsistent with profile.

• Financial advisor must still perform diligence and suitability, even if approved by firm’s product committee.

On May 20, SEC named Craig Lewis of Vanderbilt University as RiskFin director and chief economist.

SEC,CFTC Commissioners, Risk-Fin Head

On May 18, SEC approved FINRA new issue rules on allocation, distribution to delay implementation..

FINRA New Issue Allocation Rule Extended

• Effective September 26 (had been May 27), to allow process to identify new issue orders, spinning.

• Prohibits firm accepting market order in share of new issue prior to trading commencement.

• Simplifies spinning rule that had banned IPOs in account of investment bank client’s officer.

• Relies on firm written policies and procedures for compliance with the spinning prohibitions.

In May, President Obama nominated Mark Wetjen to CFTC, Luis Aguilar, Dan Gallagher to SEC.

• Also proposed disqualify a securities offering by felon, bad actor from Rule 506 safe harbor.

• Limits Reg D registration exemption if issuer has a criminal conviction, injunction or order.

• Also covers directors, officers, partners, 10% beneficial owners and promoters of the issuer.

Bad Actor Issuers

Regulatory Risk Report: June 1, 2011 4

Rating Agencies

On May 18, SEC proposed rules for transparency and integrity of credit ratings, under Dodd-Frank Act.

SEC Credit Ratings Rules

• Enhances SEC rules on nationally recognized statistical rating organizations (NRSROs).

• NRSRO to file an annual report assessing the effectiveness of its internal control structure.

• NRSRO c ompliance officer to submit annual report on compliance with laws and policies.

• Address conflicts by prohibiting rating analyst from sales and marketing of NRSRO products.

• Establish training, experience and competence standard for analysts, cover complex products.

• Test analysts on rating procedures, require one involved in rating to have three years experience.

Look-Back• Review rating if NRSRO staff is then hired by an entity,

issuer or underwriter that was rated.• If look-back review identifies any conflicts of interest,

put rating on credit-watch, and revise.

Transparency• Publish information on history of firm ratings, as well as

information on methodologies used. • Publish form with each rating on methodology and

provide to all persons that access a rating. • Include all ratings outstanding June 26, 2007, and

subsequent actions taken on those ratings.• NRSRO may stop disclosing rating history no earlier

than 20 years after rating is withdrawn.

ESMA Extends Use of Non-EU RatingsOn May 18, ESMA extended use of credit ratings from non-EU countries not yet judged equivalent.

• Guidelines on endorsing ratings issued outside the EU, if regime is as-stringent-as that in EU.

• EU CRA can continue to issue non-EU ratings after June 6 for three months and may extend to six.

• June 6 is original date for ESMA registration, but delay in process mean this will not be met.

• Extension periods given to avoid potential for EU market disruption or financial instability.

• EU financial institutions may also continue to rely on non-EU rating for capital calculations.

• Japan approved, reviewing equivalence of US after Dodd-Frank Act, Australia, and Canada.

• Will be flexible in assessing third-country rule that do not need to be identical to those in EU.

• ESMA chair Maijoor addressed the Bundestag on role as direct supervisor of CRA from July.

ESMA Rating Agencies FeesOn May 17, ESMA advised EC on new fees for its registration and licensing of credit rating agencies.• Fees are based on costs to ESMA to carry out CRA

supervision, certification or registration.• Supervisory fee: based on audited turnover of CRA

relative to total of all CRAs, at least €5K.• Annual supervisory fee payable in two pieces, first at

end of February, second by September.• Registration fee: based on bands per number of CRA

employees, to reflect firm complexity.• Fee range €2K- €150K, also depends if a CRA rates

structured finance, branches, or endorses.• Certification fee: of €2K-15K for third-country

regulated CRAs, then supervisory fee of €5K.

Methodology• Require NRSRO to have policies to strengthen

methodology used to determine credit ratings.• Ensure that board of directors approves them. • Make major methodology change consistently and

update its surveillance in reasonable time. • Publish notice of all material changes to rating

methodologies, or discovery of errors in these. • Disclose which version of methodologies are used with

respect to a particular credit rating.

ABS Due Diligence• Proposed third-party ABS due diligence firm to provide

certification to NRSRO on work, conclusions.• Require it to be made public by NRSRO, or if it does

not by issuer or underwriter of security.

Regulatory Risk Report: : June 1, 2011 5

EUShort-Selling and CDS RegulationOn May 17, EU Council approved short selling and CDSrule, aim for Parliament agreement on June 6.• Covers short-selling in all financial instrument types

proportionate to the potential risk posed.• Anyone entering a short sale must, at the time, have

borrowed instrument or agreed a borrow.• EU listed company shares to have two-tiers of

transparency of significant net short positions.• At lower threshold, notify position privately to regulator,

higher threshold-disclose to market.Sovereign Debt and CDS• Net short positions in sovereign debt of issuers in EU

always privately disclosed to regulators.• Also notify positions in credit default swap or CDS if

related to an EU sovereign debt issuer.• Short sale tests not applied to sovereign debt if is to

hedge a long position in debt of an issuer.• If liquidity of its sovereign debt falls, national authority

may suspend restriction on its shorts.• If a stability threat, authority can impose more

restrictions on derivatives, CDS, short-selling.• ESMA intervention power if threat to stability, to first

consult nation on sovereign short sales.• No proposed ban on use of uncovered CDS on

government bonds, EU Parliament still backs.

Backstop for Banks that Fail Stress TestOn May 17, EU Council required States to prepare backstop measures for all banks that fail stress test.• Covers banks that fail to meet the threshold of five

percent Core Tier 1 capital ratio defined by EBA.• Banks above five percent but close to threshold subject

to enhanced prudential scrutiny, remediation.• Require bank’s plan to address three months after

results, and to implement by November 2011.• Include audits, reporting, monitoring, capital-

conservation, capital-raising, risk mitigation. • Also restructuring non-core activities, sale or transfers

of assets, merger, orderly resolution.

EC Reminds Countries to Implement CRD3On May 19, EC requested Greece, Italy, Poland, Portugal, Slovenia and Spain to notify measures in two months to implement capital and remuneration rules, as per CRD III, that was effective on January 1.

On May 13, EU Parliament, Council issued revised Alternative Investment Fund Managers Directive.• AIFMD hedge funds directive expected to be soon be

adopted by EU Council of Ministers.• ESMA policy on implementing measures for AIFMD,

industry seeks minimum of guidance.

Hedge Fund Directive

OTC Derivatives EMIR RegulationOn May 24, EU Parliament panel approved rule on OTC derivatives, swap clearing, trade repositories.• Contracts done after rule effective, need to be cleared

through central counterparties (CCPs). • ESMA to assess the types of derivatives that will be

subject to a central clearing obligation.• ESMA to also authorize new CCPs in market, and be

allowed to perform on-site inspections.• Report all OTC contracts to trade repositories, and so

be accessible to supervisory authorities.• Agree with G20 to only apply clearing to OTC

derivative, reporting applies to all derivatives.• Interoperability between clearers for traders to choose

where trades clear limited to securities.• CCP has to function per standards for three years to

apply for EU interoperability authorization.• Rule goes to full Parliament for a vote July 5.

On May 23, EU Parliament panel approved higher €100K bank deposit insurance and State discretion.

• Schemes full 1.5 % funded in 15 years instead of EC’s proposed ten, payouts in five days, not seven.

• More scheme funds for measure to keep bank functional, higher fee on banks with most risk.

• Inform customer if deposit not guaranteed and offer withdrawal, disclose detail on statement.

Deposit Insurance Directive

UK

Regulatory Risk Report: : June 1, 2011 6

On May 19, Bank of England/FSA issued paper on new UK Prudential Regulation Authority (PRA).• How PRA will approach supervision of banks, building

societies, investment firm from 2013.• Subsidiary of Bank, but will build on intensive

approach that FSA has adopted after the crisis.• Focused objective is to promote UK financial

stability, based on forward looking judgments. • Paper discussed at London conference, with

speeches by Hector Sants and Andrew Bailey. • PRA approach to insurance companies will be

addressed in a separate paper issued in June.

Prudential Regulation Authority ApproachConsumer Complaint Handling Rules On May 27, FSA issued complaints-handling rules to raise standards that are effective from late 2011.• End two-stage complaint rule, so firms resolve fairly

and do not first dismiss, from July 2012.• Firms to identify senior individual responsible for

complaint handling, from September 2011.• Guidance on root cause analysis of complaints and

taking account of ombudsman’s decisions.• Financial ombudsman (FOS). customer awards limit up

from £100K to £150K, from January 2012.

Trade Reporting of Exchange DerivativesOn May 18, FSA proposed guidance for reporting of derivative transactions via exchange platforms.• Products traded on platforms, off-order-book, e.g. ,

Bclear and Turquoise, should be reported.• Applies whether or not derivatives fungible or differs

from exchange’s standardized product.• Rule now requires trade on exchange platform be

reported as OTC if non-standard derivative.• FSA Market Watch update on Zen monitoring system

as a replacement of its Sabre II system.

On May 17, OFT may refer issues in audit market competition to the UK Competition Commission.• First discuss if remedies exist that could allow the

Commission to resolve these problems.• Audit market for large firms concentrated to 4 firms,

significant barriers to entry, switching.• OFT will conduct roundtables and bilateral discussions

with parties in May and June.• Follows review of audit market by House of Lords

Select Committee on Economic Affairs.

OFT Reviews Audit Market for Competition

On May 23, UK issued guidance for government's principles on EU measures, aim to end goldplating.• Look at cumulative impact, argue alternatives to

regulation if possible, exert UK influence.• Copy out transposition if available, except if doing so

would adversely affect UK interests.• Measures come into force on (not before) the directive

deadline, unless compelling reasons.

UK Principles to Implement EU legislationOn May 23, FSA proposed guidance on calculating risk-weighted exposures on unrated securitizations.• For firms using Supervisory Formula Method on a

securitisation as an originator or sponsor.• Concerned use of SFM undermines significant risk

transfer requirement via reduced weights.• To prevent disproportionate risk transfer, firm must

obtain public rating on retained tranches.• Use Ratings based approach (RBA) instead of SFM on

positions, except if approved by FSA.

Unrated Securitizations to Require Ratings

Insurance Bill Information Onus on IssuersOn May 17, UK introduced bill to radically change the relationship of consumers, insurance-providers.• Consumer insurance disclosure representation bill ,

was recommended by Law Commission.• Current law imposes duty on consumers to tell insurers

anything that would influence policy.• Requires insurers to ask specific questions and

information on customers, before issue policy.• Consumer insurance was subject to code, FSA rules,

and FOS, so overlap and inconsistency.

Regulatory Risk Report: : June 1, 2011 7

International

FSB Peer Review of Compensation PracticeOn May 18, FSB began second peer review on country and firm implementation of compensation practice.• First pay review in 2010 concluded issues not resolved,

implementation far from complete.• Survey regulators and a sample of major firms using a

set questionnaire, complete by autumn.• Seek feedback on firm’s experiences on pay re gaps,

challenges, best practices, by June 15.• Questions on new laws and rules, supervision, level of

implementation, global co-operation.• Follows Basel final report on the alignment of bank

remuneration with risk and performance.HK Mutual Funds and Investment Assurance On May 13, HK SFC and HKMA issued guidance on mutual funds, and investment-linked assurance.• For existing funds and ILAS that continue to be

marketed to HK public after June 25, 2011.• Managers provide product key facts statement (KFS)

and revised offering document (ROD). • Existing fund/ILAS without KFS/ROD cannot be

marketed or accept investor subscriptions.• Funds do not submit KFS/ROD to SFC review but ILAS

schemes need have them authorized.IMF Seeks New MD, Lipsky Acting DirectorOn May 18, IMF said John Lipsky acting MD after resignation of Strauss-Kahn.• Fund has issued press release on the process of

selecting a new Managing Director.• US Treasury seeks open process with emerging

markets for prompt succession.

IOSCO Dark Liquidity PrinciplesOn May 20, IOSCO issued final principles on dark liquidityto assist authorities in dealing with issues.• Issues: transparency, price-discovery, market

fragmentation, trade intention, access, volume.• Minimize adverse impacts on price-discovery, by

promoting pre-and post-trade transparency. • Encourage priority for transparent orders, and

consolidate information on trade-transparency. • Regulatory access over information to monitor dark

pools and orders, for market surveillance. • Participants to have information to understand how

their orders will be handled and executed.• Vary implementation per platform so regulator will not

always require full trade transparency.

HK Short Position ReportingOn May 25, HK SFC proposed legislation to effect the shortposition reporting regime, issued in 2010.• Report short position of 0.02% of share capital or value

of $30M if lower, on a weekly basis.• Covers stocks of Hang Seng Index, HS China

Enterprises Index, financial stocks set by SFC.• Beneficial owner of short position responsible for

reporting on SFC’s template, weekly basis.• Publish aggregated short position of all stocks

anonymously, one week after receipt of report. • Report gross position, exclude OTC trades and

derivatives, groups to separate by legal entity. • Reporting may be tightened in a contingency, comment

by June 30, -then issue effective date.

G-8 Leaders Summit Aid for ‘Arab Spring’On May 26-27, G8 leaders summit in Deauville on finance and political reforms, aid for Arab Spring.• Committed to G20 policy on financial sector reform,

mitigating commodity price volatility. • Agreed $20B aid , $3.5B for Egypt, Tunisia, EBRD to

focus on Africa, was backed by US.

HK Mystery Shopping Program FindingsOn May 24, HK SFC and HKMA issued guidance from mystery shopping program on sales practices.• Deficiencies include lack of understanding of

recommended products, and of HK SFC rules.• Inadequate explanation of the features and/ or

disclosure of risks on recommended products.

AML & Enforcement

Regulatory Risk Report: : June 1, 2011 8

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US, Europe Sanctions on Syria On May 18, President Obama signed an Executive Orderimposing sanctions on government of Syria. .• Against Syrian President Bashar al-Assad and six

other senior officials of that Government.• Treasury also designated10 Syrian individuals and

entities under executive order of April 29.• Property in US or under control of US persons blocked,

prohibits from transacting with them.• On May 9-18, Syria sanctions were announced by the

EU and by FINMA in Switzerland.

On May 16, FINRA launched Disciplinary Actions Onlinedatabase for transparency of enforcements.

FINRA Disciplinary Actions Database

• Search for actions by case number, type, date, or individual or firm name and CRD number.

• Acceptance, waiver and consent -AWC, NAC decisions, settlements, hearings, complaints.

• BrokerCheck report links to actions in system, as will Monthly Disciplinary Actions in June.

• On May 17, 2011, Enforcement head Bennett spoke at SIFMA on increased actions in 2011.

.

SEC First Deferred Prosecution, for FCPAOn May 17, SEC entered first deferred prosecution agreement, with Tenaris, to reward its cooperation.

• Violated foreign corrupt practices act (FCPA) by bribing Uzbekistan government officials.

• The firm informed SEC that its internal review discovered FCPA violations by Uzbek staff.

• Firm cited for self-reporting, full cooperation with SEC, enhanced procedures, and training.

• Firm to pay $5.4M disgorgement and $3.5M penalty to DoJ in non-prosecution agreement.

UK BoS Pays £20M for Complaint HandlingOn May 25, FSA settled with the Bank of Scotland (BOS) for allegedly mishandling retail product complaints. • 2,592 complaints, many from older customers who

lacked experience of investment product. • Firm wrongly rejected many of these, internal review

found 45% should have been upheld.• Were not investigated or assessed competently and

fairly, or if investments suitable for client.• Firm to pay £17M compensation and £3.5M penalty,

follows FSA bank complaint review.

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