United States: U.S. Securities And Exchange Commission’s Division Of Market Regulation Priorities For 2007

On February 9, 2007, the Practicing Law Institute sponsored the Securities and Exchange Commission ("SEC") Speaks 2007, in which SEC staff members and commissioners discussed the forthcoming year in securities regulation. At two workshops held by the SEC Division of Market Regulation, members of the staff reviewed several of the Division’s upcoming projects for 2007 and accomplishments over the past year.

Due to the impending deadlines for compliance, a main focus of the workshop was Regulation NMS.¹ Dan Gray, Senior Special Counsel, Office of Market Supervision, reminded the workshop participants that on March 5, 2007 all ten Exchanges and Alternative Display Facilities ("ADFs") must protect against trade-throughs in accordance with Rule 611 of Regulation NMS.² Protecting against trade-throughs is a significant change for Nasdaq. All of the ten exchanges and the ADFs will have to be capable of accepting Intermarket Sweep Orders ("ISOs"), and therefore may only trade-through the market in accordance with Rule 611(b)(5)-(6). Mr. Gray reminded participants that if a broker-dealer intends to route ISOs they must ensure that they have proper policies and procedures in place and that each participant in the process has a clear understanding of their responsibilities (i.e., who takes the snapshot of the quotes, and who is responsible for sending ISOs to hit protected quotes).

The duty to seek best execution for customers in the context of Regulation NMS was a topic that received considerable attention both from the Division panel and workshop participants. Mr. Gray and Robert Colby, Deputy Director of the Division, noted that compliance with Regulation NMS does not necessarily fulfill a broker-dealer’s duty to seek best execution. Mr. Gray and Mr. Colby reminded the workshop participants that in addition to complying with Regulation NMS, they must consider the best routing arrangements for their customers, as well as all sources of liquidity readily available to them, including the displayed quotes a broker-dealer can access, potential liquidity on the floor of exchanges, and the quotes that are not displayed, such as dark books.

Beginning April 2, 2007, the NYSE, NASD, and the CBOE will commence a pilot program in which they move away from position-based margin requirements to risk-based margin requirements in order to determine market risk in portfolios ("Portfolio Margining"). The effect for investors will be a dramatic reduction in margin requirements. Michael Macchiaroli, Associate Director, Office of Financial Responsibility, described portfolio margining as a "radical departure from the past" and from Regulation T. The SEC staff is also considering permitting firms to calculate customer margin using firms’ own internal models, subject to SEC review, instead of the structure outlined in the Portfolio Margining rules using the Theoretical Intermarket Margining System ("TIMS") model. Mr. Macchiaroli noted that there are still hurdles, for example, the CFTC still takes the position that futures cannot be held in a securities account and requires its own margin calculation for futures products.

The SEC has published a number of proposed rules and rule amendments over the past year, including:

• Proposed amendments to Rule 10a-1 under the Securities Exchange Act of 1934 ("Exchange Act") to eliminate the price test for short sales;³
• Proposed amendments to Rule 105 of Regulation M under the Exchange Act to prohibit the receipt of offering shares by individuals who entered into short sales during the restricted period;⁴
• Proposed rules to register Nationally Recognized Statistical Rating Organizations ("NRSROs") in accordance with the Credit Rating Agency Act of 2006;⁵
• Proposed new Regulation R, in conjunction with the Federal Reserve Board, the Office of the Comptroller of the Currency ("OCC"), Federal Deposit Insurance Corporation ("FDIC") and the Office of Thrift Supervision ("OTS"), to implement certain provisions of the Gramm-Leach Bliley Act;⁶ and
• Proposed amendments to the NASD’s and NYSE’s research analyst rules, which, among other things, would permit disclosures to be made on a firm’s website as opposed to on the physical research report.⁷

The panel encouraged all interested persons to submit comments on these proposals, even if the comment period has expired, as the SEC staff is currently determining how to proceed with the proposals. The Division expects the SEC to adopt some version of these proposals this year.

Over the past year, the SEC staff has also published interpretive guidance regarding the use of "soft dollar" arrangements for permissible and non-permissible items of brokerage and research services,⁸ as well as two class letters regarding traditional and commodity-based exchange traded funds ("ETFs").⁹ The Division is considering issuing additional class letters to:

• Exempt purchases outside of a tender offer from the provisions of Rule 14e-5 under the Exchange Act in jurisdictions where such activity is permissible; and
• Exempt fixed income ETFs from various provisions of the securities laws.

The Securities Industry and Financial Markets Association ("SIFMA") has also submitted a draft no-action letter to the Division staff proposing procedures for agency lending disclosures.¹⁰ The SEC, however, has not yet granted SIFMA’s requested relief.

Further, the Division panel stated that the SEC Staff intends to issue interpretive guidance regarding best practices associated with various financial responsibility issues including bank sweep programs, day-trading firms, and securities lending. Thomas McGowan, Assistant Director, Office of Financial Responsibility, stated that the guidance would focus on the recordkeeping obligations surrounding bank sweep programs and whether such programs should require customer consent when a broker-dealer changes the bank into which customer funds are swept. The Division panel also stated that the SEC intends to publish interpretive guidance regarding day-traders trading their own funds in the name of a firm for the purpose of avoiding day-trading restrictions imposed on customers.

The SEC staff also noted that they have several proposals under consideration, including:

• Defining a broker-dealer’s "business as such" for which records must be retained under Rule 17a-4;
• Allowing broker-dealers to cease using the Write Once Read Many ("WORM") form of storage for electronic records and instead move to a "procedures only" retention of records, due to cost issues; and
• Addressing the issue of over-voting of shares, which may occur when both the buyer/borrower and seller/lender vote the same shares in the context of stock lending.

Circular 230 Disclosure: Internal Revenue Service regulations provide that, for the purpose of avoiding certain penalties under the Internal Revenue Code, taxpayers may rely only on opinions of counsel that meet specific requirements set forth in the regulations, including a requirement that such opinions contain extensive factual and legal discussion and analysis. Any tax advice that may be contained herein does not constitute an opinion that meets the requirements of the regulations. Any such tax advice therefore cannot be used, and was not intended or written to be used, for the purpose of avoiding any federal tax penalties that the Internal Revenue Service may attempt to impose.

www.bingham.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.