The Financial Industry Regulatory Authority issued an investor
alert regarding closed-end funds to explain what investors should
know before investing. Like other mutual funds, closed-end funds
are professionally managed portfolios of stocks, bonds and other
investments. They can charge annual fees, utilize leverage to
enhance returns, and invest in a diverse pool of assets to minimize
exposure to unsystematic risk. Unlike open-end mutual funds, which
issue new and redeem outstanding shares on a continuous basis,
closed-end funds offer a fixed number of shares in an initial
public offering (IPO) that are then traded on an exchange. Buyers
and sellers can trade these shares like stocks or bonds. The market
price of a closed-end fund is therefore determined not only by its
net asset value (NAV), but also the market price investors are
willing to pay for fund shares. The price of shares of a closed-end fund is based largely on
distributions. Distributions derive from interest income,
dividends, capital gains and occasionally a return of principal.
Distribution amounts are calculated differently than open-end
mutual fund yields. A yield shows income as a percentage of the
fund's current share price; closed-end fund distribution can
vary with share price or a fund's NAV, or be fixed by fund
management prior to the IPO. Funds that return
principal—especially those that do so because of previously
fixed distribution rates—carry higher levels of risk because
the fund must sometimes erode its asset base to generate income for
distributions. Investors are encouraged to consider this and other
factors before investing in closed-end funds, including personal
investment objectives, the fund's investment strategy, the
percentage of IPO price actually invested, tax implications, how
the distribution rate is set and whether shares are trading at a
premium or discount to NAV. The FINRA alert may be accessed here. On October 30, the Commodity Futures Trading Commission adopted
final rules designed to enhance customer protection. The rules
expand the information provided to customers regarding the risks of
trading generally and the potential risks of trading through a
particular futures commission merchant (FCM). The rules require
each FCM to post on its website, or otherwise make available to
customers, a disclosure document, to be updated at least annually,
describing the FCM's business activities, product lines, risk
profile and recent financial information. The final rule also
requires FCMs to post certain financial information, including the
daily segregation calculation, on their websites. In addition, FCMs
must adopt written risk management policies and procedures that
address the risks of their business. The final rule also expands
the early warning notice requirements under CFTC Rule 1.12 and
provides that such notices must be filed electronically with the
CFTC and applicable self-regulatory organizations. Perhaps the most controversial rule is the so-called
"residual interest" rule. Beginning one year after
publication in the Federal Register, FCMs will be required to use
their own funds to cover any individual customer margin deficits
outstanding as of 6:00 p.m. Eastern Time on the business day
following the trade date. The final rule calls for the CFTC to
complete within 30 months a study assessing the feasibility of
reducing the time for residual interest calculations. Unless the
CFTC takes further action no later than five years thereafter, FCMs
will be required to calculate and fund their residual interest
requirement prior to the time of daily settlement with each
applicable derivatives clearing organization. The customer protection rules will become effective 60 days
after publication; however, certain provisions have alternative
compliance dates as set forth in the final rules. The final rules are available here. On October 30, the Commodity Futures Trading Commission adopted
final rules regarding (i) the protection of collateral and (ii) the
treatment of securities in a portfolio margining account in a
commodity broker bankruptcy. The protection of collateral rules
were adopted to codify Section 746(c) of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, which requires swaps dealers
and major swap participants in connection with uncleared swaps to
inform their counterparties that they have the right to require
their initial margins to be held by an independent custodian. Under
the final rule, if a counterparty elects segregation for its
initial margin, the account must be held by an independent
custodian pursuant to a written custody agreement that fulfills
certain minimum criteria. The final rule related to portfolio margining clarifies that
securities held in a futures or cleared swaps customer account that
is subject to portfolio margining are customer property under the
Bankruptcy Code. The final rules will be effective 60 days after publication in
the Federal Register. Swap dealers and major swap
participants must comply with the notification requirements set
forth in the final rules no later 180 days after publication for
uncleared swap transactions with new counterparties and no later
than 360 days after publication for uncleared swap transactions
with existing counterparties. The final rules are available here. On October 30, the Commodity Futures Trading Commission approved
final rules that implement position and trading activity based
reporting requirements for market participants that trade futures
and swaps. The final rules modify the existing Form 102 and 102S
(Identification of "Special Accounts") and Form 40
(Statement of Reporting Trader) and implement two new forms that
will be used to identify and collect information related to
accounts that exceed a specified daily trading volume. Under the
final rules, these reports will be submitted to the CFTC
electronically. Form 102A (revised Form 102) requires clearing members to
identify special accounts (as defined in Part 15 of the CFTC
Regulations) as well as the underlying trading accounts. Form 102S
has been updated and will continue to be used to collect
information related to certain categories of swaps. Form 102B is a
new form that will be used by clearing members and certain
reporting markets to identify accounts with daily trading volumes
that exceed a specified level regardless of whether the accounts
maintain positions at the end of the day. Form 71 is a new form
that will be sent pursuant to a special call to identify the
ultimate owners and controllers of omnibus accounts that exceed
specified trading volumes. Revised Form 40 must be submitted to the CFTC upon receipt of a
special call; however, each reporting trader that is required to
complete a Form 40 will be under a continuing obligation to update
and maintain the accuracy of the information it provides. The
compliance date for the final rule will be 270 days after
publication in the Federal Register. The final rules are available here. On October 30, the Commodity Futures Trading Commission's
chief information officer announced that registered entities and
swap counterparties subject to CFTC swap data recordkeeping and
reporting requirements concerning legal entity identifiers (LEIs)
may now comply with those regulations by using any LEI issued by a
provider that has been endorsed by the Regulatory Oversight
Committee (ROC) of the global LEI system. Following this
announcement, market participants may use CFTC Interim Compliant
Identifiers (CICIs) issued by the CICI utility operated by
DTCC-SWIFT or any other LEI codes endorsed by the ROC. A complete listing of LEIs that have been endorsed by the ROC is
available here. The CFTC notice is available here. On October 29, the Commodity Futures Trading Commission
requested public comment on a made-available-to-trade certification
submitted by TW SEF, LLC, a temporarily registered swap execution
facility (SEF). By submitting this certification, TW SEF seeks to
implement available-to-trade determinations for certain interest
rate and credit default swaps. If certified by the CFTC, these
swaps would be subject to the mandatory trade execution requirement
set forth in Section 2(h)(8) of the Commodity Exchange Act, which
would generally require these swaps to be executed on or pursuant
to the rules of a designated contract market or SEF. Comments are
due by November 29. The CFTC's request for public comment is available here. The US Court of Appeals for the Second Circuit recently affirmed
the decision of the District Court for the Southern District of New
York to disqualify Fair Laboratory Practices Associates (FLPA) from
its qui tam suit against Quest Diagnostics (Quest) and
Unilab Corporation (Unilab) because the FLPA used confidential
information provided by Unilab's former general counsel, Mark
Bibi. FLPA sued under the False Claims Act (FCA), alleging that from
at least 1996 to 2005 Unilab illegally priced its medical testing
services by providing sharp discounts to medical care providers to
induce them to refer Medicare and Medicaid business. Unilab then
billed the incoming federal business at significantly higher rates.
The US Department of Health and Human Services Office expressly
prohibited this "pull-through" scheme in a 1999 advisory
opinion. Less than five months after instructing Unilab's chief
executive officer on the advisory opinion, Bibi was replaced as
general counsel. Bibi, along with two colleagues from Unilab, formed FLPA in
2005. Although Bibi knew he had confidential information, he
concluded exceptions to the ethical rules applied in this FCA case
brought against Unilab and Quest. The District Court disagreed that
the attorney-client confidentiality rules did not apply and
disqualified FLPA as a potential plaintiff. The Second Circuit affirmed, noting that the FCA did not preempt
state ethical rules, and that Bibi's disclosures exceeded what
was reasonably necessary to prevent a crime as permitted by the
ethical rules. The court also upheld the District Court's
decision to dismiss FLPA's complaint due to Bibi's ethical
violation because allowing the case to proceed would permit FLPA to
use unethical disclosures against Quest and Unilab. United States v. Fair Laboratory Practices Assoc.s, No.
11-1565-cv (2d Cir. Oct. 25, 2013). The US District Court for New Jersey recently granted a motion
to dismiss by defendants, Columbia Laboratories, Inc. (Columbia)
and Watson Pharmaceuticals, Inc. (Watson). The plaintiff group
brought an action under Section 10(b) of the Securities and
Exchange Act of 1934 and under Securities and Exchange Commission
Rule 10b-5 for fraudulent misrepresentation. The District Court
held that the plaintiff group's second amended complaint failed
the scienter pleading requirement of the Private Securities
Litigation Reform Act because it failed to allege Columbia knew
about a heightened statistical significance standard for a study to
approve a new drug.In 2004, Columbia started a clinical study to
evaluate a new drug called Prochieve. The US Food and Drug
Administration (FDA) advised that one study might be enough if it
showed a more robust statistical significance (99% confidence) than
usually required (95% confidence). Although the 2004 study did not
produce significant results, Prochieve was later tested from 2008
to 2010 for a new use. Columbia and Watson announced on June 27,
2011, that the FDA had accepted the filing for Prochieve based on
test results meeting the 95% confidence standard. On June 28, 2011,
the FDA issued a letter that there was a problem with discrepancies
in the data between tests in the United States and abroad that
would be a potential review issue. The District Court found that plaintiffs failed adequately to
allege facts creating a strong inference that Columbia or Watson
knew the FDA would not approve Prochieve. In their second amended
complaint, the plaintiff group focused on the original
conversations between Columbia and the FDA regarding the more
robust 99% confidence standard for the test trials, alleging that
Columbia knew this standard was meant for the 2008 to 2010 trial as
well. The District Court concluded that even if that were true, the
plaintiffs did not plead that the FDA ever communicated this fact
to Columbia, and thus could not plead that Columbia knew the
statements were false when made. In re Columbia Lab.s, Inc. Sec. Litig., No. 12-614 (FSH) (D.N.J.
Oct. 21, 2013). On October 30, the Office of the Comptroller of the Currency
(OCC) issued guidance (Bulletin 2013-29) to national banks and
federal savings associations (collectively, banks) for assessing
and managing risks associated with third-party relationships. A
third-party relationship is "any business arrangement between
a bank and another entity, by contract or otherwise." The
bulletin rescinds OCC Bulletin 2001-47, "Third-Party
Relationships: Risk Management Principles" and OCC Advisory
Letter 2000-9, "Third-Party Risk." The OCC "expects a bank to practice effective risk
management regardless of whether the bank performs the activity
internally or through a third party. A bank's use of third
parties does not diminish the responsibility of its board of
directors and senior management to ensure that the activity is
performed in a safe and sound manner and in compliance with
applicable laws." The OCC "is concerned that the quality
of risk management over third-party relationships may not be
keeping pace with the level of risk and complexity of these
relationships." The OCC stated that it has identified
instances in which bank management has According to the OCC, an effective third-party risk management
process follows a continuous life cycle for all relationships and
incorporates the following phases: In addition, a bank should perform the following throughout the
life cycle of the relationship as part of its risk management
process: The entire Bulletin is available here. On October 30, as expected, the Office of the Comptroller of the
Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC)
each proposed a rule to strengthen the liquidity risk management of
large banks and savings associations. The OCC's and FDIC's
proposed liquidity rules are substantively the same as the proposal
approved by the Board of Governors of the Federal Reserve System on
October 24. That proposal, as reported in the Corporate and Financial Weekly Digest edition
of October 25, 2013, was developed collaboratively by the three agencies, is
applicable to banking organizations with $250 billion or more in
total consolidated assets; banking organizations with $10 billion
or more in on-balance sheet foreign exposure; systemically
important, non-bank financial institutions that do not have
substantial insurance subsidiaries or substantial insurance
operations; and bank and savings association subsidiaries thereof
that have total consolidated assets of $10 billion or more (covered
institutions). The proposed rule does not apply to community
banks. 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.BROKER DEALER
FINRA Issues New Investor Alert on Closed-End Funds
CFTC
CFTC Adopts Enhanced Customer Protection Rules
CFTC Adopts Rules Regarding the Protection of Collateral and
Treatment of Securities in a Portfolio Margining Account in a
Bankruptcy
CFTC Adopts Final Rules for Ownership and Control Reports
CFTC Announces Mutual Acceptance of Approved Legal Entity
Identifiers
CFTC Seeks Comments on TW SEF Available-to-Trade
Certification
LITIGATION
Second Circuit Affirms Dismissal of Qui Tam Case Based
on Attorney's Use of Confidential Information
District Court Dismisses a Shareholder Suit for Failing to
Plead Scienter
BANKING
OCC Issues Risk Management Guidance
OCC and FDIC Propose Rule to Strengthen Liquidity Risk
Management
ARTICLE
27 November 2013
Corporate And Financial Weekly Digest - November 1, 2013
The Financial Industry Regulatory Authority issued an investor alert regarding closed-end funds to explain what investors should know before investing.