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September 9, 2019 |
Dodd-Frank 2.0: U.S. Agencies Revise the Volcker Rule on Proprietary Trading

Click for PDF Since it was enacted in July 2010, the Dodd-Frank Act’s Volcker Rule has challenged banks and their regulators alike.  This is particularly the case with respect to its restrictions on proprietary trading.  It has been one thing for former Federal Reserve Chairman Volcker to state that “you know it when you see it,” quite another to formulate a regulation that accurately defines proprietary trading and implements a broad statutory directive across complex business operations. On August 20, 2019, the Office of the Comptroller of the Currency and the Board of Directors of the Federal Deposit Insurance Corporation, Director Gruenberg dissenting, approved an expected rewrite of the regulation on proprietary trading, along with some minor amendments to the provisions governing private equity funds and hedge funds (Revised Rule).  The preamble stated that a new proposal to revise the funds’ provisions more broadly would be forthcoming.  The other Agencies charged with implementing the Volcker Rule are expected to follow. As with most of the revisions to Dodd-Frank since 2016, the revision – proposed in somewhat different form in June 2018 (2018 Proposal) – is a moderate approach that recalibrates the original regulation (Original Rule) and removes certain unworkable excesses.  This “Volcker 2.0” approach also focuses more intelligently on risk than the Original Rule and is more faithful to the statutory text.  At the same time, it still aligns with the most defensible reason for the Volcker Rule, maintaining the nature of banking institutions as customer-serving businesses.  The result is a pruning of some of the excesses of the Original Rule, while leaving the regulation targeted at banks with the largest trading operations. New Risk-Based Approach The Revised Rule, like the 2018 Proposed Rule, applies the statutory provisions differently depending on the size of a banking entity’s trading assets and liabilities.  It adopts a three-tiered approach, under which compliance obligations under the Rule’s market-making, underwriting, and risk-mitigating hedging exemptions, as well as overall compliance program requirements, differ based on the tier in which tier a banking entity finds itself. Tier Trading Assets/Liabilities[1] Significant $20 billion or more Moderate $1 billion to $20 billion Limited Less than $1 billion For non-U.S. banks, the final rule looks to the bank’s combined U.S. operations only, and not its worldwide operations, when determining in which tier to place the non-U.S. bank. The tiering revision alone is a substantial improvement.  The Original Rule deemed a banking entity worthy of heightened compliance obligations based on total asset size, and set that threshold at an irrationally low number – $50 billion.  Being based on amounts of trading assets and liabilities, the new tiers align more closely to the risks posed.  The Agencies raised the threshold of the “Significant” tier from $10 billion in the 2018 Proposal to $20 billion, but they declined to make changes to the other tiers. In addition, under the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, a banking entity is completely exempt from the proprietary trading restrictions if: It has, and is not controlled by a banking entity that has, total consolidated assets of $10 billion or less; and It has total trading assets and liabilities of 5% or less of total assets. New Definition of Proprietary Trading – Closer to the Statute The Dodd-Frank Act defined “proprietary trading,” as well as the associated term “trading account,” very obscurely: “[P]roprietary trading” . . . means engaging as principal for the trading account of the banking entity . . . in any transaction to purchase or sell, or otherwise acquire of dispose of, [Volcker covered financial instruments]. “[T]rading account” means any account used for acquiring or taking positions in [Volcker covered financial instruments] principally for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from short-term price movements), and any such other accounts [as determined by regulation].[2] The interpretive issue under these definitions is the concept of the “trading account.”  This is not a recognized term under prior banking law, nor do banking institutions organize their operations around such accounts.  For this reason, the Volcker Agencies originally took considerable leeway with the statutory text in expanding these definitions, with the result that most principal activity in covered financial instruments was brought within the trading prohibition, and then was required to find an exempted “permitted activity” like underwriting or market making to justify itself. Specifically, the Original Rule had three tests for determining what was proprietary trading, and one presumption that was rebuttable in theory, but not in fact: Purpose Test: a purchase and sale is principally for the purpose of short-term resale, benefiting from actual or expected short-term price movements, realizing short-term arbitrage profits, or hedging one or more such positions. Market-Risk Capital Test: the banking entity is subject to the market-risk capital rule and the financial instruments are both market-risk covered positions and trading positions (or hedges thereof). Status Test: the banking entity is licensed/registered as a dealer, swap dealer or security-based swap dealer, or the banking entity engages in any such business outside the U.S.; and the covered financial instrument is purchased and sold in connection with such activities. Rebuttable presumption that a short-term resale purpose exists if an instrument is held for fewer than 60 days, or its risk is substantially transferred within 60 days. The Revised Rule, by contrast, has two principal tests that will bind most institutions subject to the Revised Rule – the Market-Risk Capital Test and the Status Test.  The former has been slightly modified so as not to apply to a banking entity that is not consolidated with an affiliate that calculates risk-based capital ratios under the market risk capital rule for regulatory reporting purposes; the latter was substantively unchanged.  The Purpose Test is retained for those institutions that are not required to calculate market-risk capital, and do not elect to do so for Volcker purposes.  (Such an election must be for a banking entity and all its wholly-owned subsidiaries.)  The Revised Rule also reverses the Original Rule’s presumption so that, with respect to the Purpose Test, a position that is held for 60 days or more and where the risk is not substantially transferred within 60 days is presumed not to be proprietary trading. This simplification of the Original Rule is welcome and is a more reasonable construction of the statute.  First, the Purpose Test – which looked to a banking institution’s intent in purchasing and selling a Volcker instrument – is in many cases duplicative of the Market-Risk Capital Test.  It was also not unreasonably characterized by JPMorgan Chief Executive Officer Jamie Dimon as requiring “a lawyer and a psychiatrist” to analyze every trade.  Second, the Volcker Agencies never had enough staff to engage with banks on rebutting the 60-day presumption – this avenue of compliance was thus effectively read out of the Original Rule.  Finally, for reasons that were never persuasive, the Original Rule did not provide any indication of what period of time would suffice for a banking entity to have certainty that it was not proprietary trading. Expanded Exclusions from Proprietary Trading Certain purchase and sale transactions are wholly outside the Volcker Rule, some statutorily, some under the Original Rule.  The Revised Rule expands the number of regulatory exclusions to include: Purchases and sales of foreign exchange swaps and forwards, and cross-currency swaps (including nondeliverable cross-currency swaps), under the Liquidity Management Plan exclusion. Purchases and sales to correct bona fide trade errors; unlike the 2018 Proposal, there is no requirement that instruments bought or sold in such transactions be transferred to a special “trading error” account. For banking entities that are not dealers, swap dealers or security-based swap dealers, matched swap transactions entered into in connection with customer-driven swaps, such as a back-to-back swap entered into at the same time as a fixed-to-floating interest rate swap with a customer. Hedges of mortgage servicing rights or assets in connection with a documented hedging strategy. Purchases and sales of instruments that are not “trading assets” or “trading liabilities” under regulatory reporting forms. Revised Definition of “Trading Desk” For purposes of the conditions to the permitted activities of market-making and underwriting, the Original Rule included a definition of “trading desk,” the place where many of the conditions were measured.  In keeping with interpreting the statute’s restrictions broadly, the Original Rule defined the term as “the smallest discrete unit of organization of a banking entity that purchases or sells financial instruments for the trading account of the banking entity or an affiliate thereof.”[3]  This definition did not align with the manner in which banking entities generally organized their businesses for operational, management or compliance purposes. The Revised Rule adopts a more flexible definition, which should align better with banks’ organizational structures and result in fewer compliance costs: “A unit of organization of a banking entity that purchases or sells financial instruments for the trading account of the banking entity or an affiliate thereof” that is either: Structured to implement a well-defined business strategy, organized to ensure appropriate setting, monitoring, and review of the desk’s limits, loss exposures and strategies, and characterized by a clearly defined unit that engages in coordinated trading activity with a unified approach to its key elements; operates subject to a common and calibrated set of risk metrics, risk levels and joint trading limits; submits compliance reports and other information as a unit for monitoring by management; and books its trades together; or For a banking entity that calculates risk-based capital ratios under the market risk capital rule, or a consolidated affiliate for regulatory reporting purposes of such a banking entity, established by the banking entity or its affiliate for purposes of market risk capital calculations under the market risk capital rule. Underwriting and Market-Making: RENTD Compliance Through Internal Limits The Volcker statute distinguishes permitted underwriting and market-making activities from impermissible proprietary trading in that the former are “designed not to exceed the reasonably expected near term demands of clients, customers, or counterparties” (RENTD).[4]  The Original Rule required “demonstrable analysis” of complex and opaque conditions as a means of satisfying the RENTD requirement, and in so doing, imposed considerable compliance obligations on banking entities.  In addition, studies since the enactment of the Volcker Rule found that liquidity in certain financial markets had been constrained[5] – itself a cause of supervisory concern. The Revised Rule seeks to reduce these obligations and increase market liquidity by permitting banking entities to make use of their own risk limits in showing compliance with the RENTD condition.  It therefore contains a rebuttable presumption of compliance with the Rule if a banking entity has established and implements, maintains, and enforces internal limits for the relevant trading desk designed to not to exceed RENTD.  The relevant supervisor may rebut the presumption of compliance if it believes that a banking entity’s trading desk is exceeding RENTD, after notice to the banking entity. With respect to underwriting, the internal limits must address, based on the nature and amount of the trading desk’s underwriting activities: the amount, types, and risk of its underwriting position; the level of exposures to relevant risk factors arising from its underwriting position; the period of time a security may be held; and the liquidity, maturity, and depth of the market for the relevant types of securities. With respect to market making, the internal limits must address: the amount, types, and risks of the trading desk’s market-maker positions; the amount, types, and risks of the products, instruments, and exposures the trading desk may use for risk management purposes; the level of exposures to relevant risk factors arising from its financial exposure; the period of time a financial instrument may be held; and the liquidity, maturity, and depth of the market for the relevant types of financial instruments. These limits are not required to be approved in advance, but they are subject to supervisory review and oversight on an ongoing basis.  Unlike the 2018 Proposal, the Revised Rule does not require banking entities to report limit breaches, but they must maintain and make available to their supervisors on request records regarding any limit that is exceeded and any temporary or permanent increase to a limit. If a banking entity breaches or increases a limit, the presumption of compliance will continue to be available only if the banking entity takes action as promptly as possible after a breach to bring the trading desk into compliance, and follows established written authorization procedures regarding the breach or increase, including demonstrable analysis of the basis for any temporary or permanent increase to a trading desk’s limit. In addition, the Revised Rule eliminates the specific compliance program requirements for the underwriting and market-making exemptions for banking entities that do not have significant trading assets and liabilities. Simplification of Hedging Permitted Activity; Risk-Tailored Compliance Like underwriting and market making, risk-mitgating hedging is an activity permitted by the statute even if it involves a purchase and sale of an instrument in the short term.  The Original Rule imposed substantial conditions on this activity, however, in an effort to guard against abuse.  These original conditions imposed a significant compliance burden and were not easily monitored in practice.  In particular, the requirements that the banking entity conduct a correlation analysis and continuously show that the hedge was demonstrably reducing or significantly mitigating identifiable risks was a significant challenge. The Revised Rule simplifies the conditions to risk-mitigating hedging and gives banking entities more flexibility in demonstrating compliance.  It removes the Original Rule’s requirements that a banking entity undertake a correlation analysis and show that the hedge was demonstrably reducing or significantly mitigating identifiable risks.  Instead, and more closely following the statute, the hedging must be “designed to reduce or otherwise significantly mitigate one or more specific, identifiable risks” being hedged and be “subject, as appropriate, to ongoing calibration” to ensure that the hedging does not become prohibited trading. In addition, for banking entities that have only moderate trading activities (greater than $1 billion in trading assets/liabilities but less than $20 billion), the Revised Rule reduces the scope of the required compliance program.  For such firms, the requirement for a separate internal compliance program for hedging has been eliminated, as well as certain specific requirements,[6] limits on compensation arrangements for persons performing risk-mitigating activities, and documentation requirements. For banking entities that have significant trading activities, the Revised Rule moderates the Original Rule’s requirement for maintaining additional documentation for hedges and hedging techniques not established by a trading desk’s policies and procedures.  The requirement does not apply to purchases and sales of financial instruments for hedging activities that are identified on a written list of financial instruments pre-approved by the banking entity that are commonly used by the trading desk for the specific types of hedging activity, if the banking entity complies with appropriate pre-approved limits for the trading desk when doing the hedging. Relaxation of Trading Outside the United States (TOTUS) Requirements Unlike many statutes, the Bank Holding Company Act of which the Volcker Rule is a part applies extraterritorially, subject to specific exemptions for non-U.S. banking organizations.  The Revised Rule relaxes the conditions that the Original Rule applied to the permitted activity of a non-U.S. bank trading “outside the United States,” the so-called TOTUS permitted activity.  In so doing, the Revised Rule focuses more clearly on potential risks to the United States caused by TOTUS activity. Under the new conditions, a trade qualifies for TOTUS if: the banking entity engaging as principal in the purchase or sale (including relevant personnel) is not located in the United States or organized under the laws of the United States or of any State; the banking entity (including relevant personnel) that makes the decision to purchase or sell as principal is not located in the United States or organized under the laws of the United States or of any State; and the purchase or sale, including any transaction arising from risk-mitigating hedging related to the instruments purchased or sold, is not accounted for as principal directly or on a consolidated basis by any branch or affiliate that is located in the United States or organized under the laws of the United States or of any State. Unlike the Original Rule, the trade can be with a U.S. counterparty and financing for the trade can be provided by the U.S. offices of the non-U.S. banking entity.  A non-U.S. banking entity may also use a non-affiliated U.S. investment adviser in the trade as long as the actions and decisions of the banking entity as principal occur outside of the United States. Modest Revisions to Covered Fund Provisions The Revised Rule makes only minor revisions to the Volcker funds restriction; the preamble states a new proposal on this subpart will be forthcoming.  In particular, the thorny question of whether a foreign excluded fund should be exempted from the definition of “banking entity” is left for another day, with some indication that the Agencies may still believe this is a question for Congress.[7]  The only amendments are the following: The Revised Rule removes the Original Rule’s requirement that banking entities include for purposes of the aggregate fund limit and capital deduction the value of any ownership interests of a third-party covered fund (i.e., covered funds that the banking entity does not advise or organize and offer) acquired or retained in accordance with the underwriting or market-making exemptions. The Revised Rule permits a banking entity to acquire or retain an ownership interest in a covered fund as a hedge when acting as intermediary on behalf of a customer that is not itself a banking entity to facilitate the exposure by the customer to the profits and losses of the covered fund (as in a fund-linked note). The Original Rule’s prohibition of such activities had no clear statutory basis. The Revised Rule removes the Original Rule’s condition to the SOTUS fund exemption that no financing be provided by U.S. offices. The Revised Rule codifies the Agency staff interpretation that the SOTUS marketing restriction applies only to funds sponsored by – and not to third-party funds invested in – by non-U.S. banking entities.[8] Tiered, Risk-Base Compliance Regime Consistent with its approach to risk, the Revised Rule substantially modifies the required compliance regime for banking entities with moderate and limited trading assets and liabilities.  Significantly, the CEO certification, which the Original Rule had required for banking entities with $50 billion or greater in total consolidated assets, is eliminated for all such banking entities.  This in itself is significant regulatory relief.  In addition, the six-pillar compliance regime of the Original Rule applies only to banking entities with significant trading assets and liabilities.  Banking entities with only moderate trading assets and liabilities may include in their existing compliance policies and procedures appropriate references to the Volcker Rule and its implementing regulation, with adjustments as appropriate given the activities, size, scope, and complexity of the banking entity.  Entities with limited trading assets and liabilities benefit from a rebuttable presumption of compliance with the Volcker Rule. Effective Date The Revised Rule will be effective on January 1, 2020.  In order to give banking entities a sufficient amount of time to comply with the changes adopted, banking entities will not be required to comply with the Revised Rule until January 1, 2021.  Because the Revised Rule relaxes the Original Rule’s requirements, the Agencies are permitting banking entities to comply voluntarily, in whole or in part, with the Revised Rule prior to January 1, 2021, subject to the Agencies’ completion of necessary technical changes, principally with respect to metrics reporting.[9] Conclusion Ultimately, the fundamental issue with the Volcker Rule is the statute Congress passed.  In an effort to cover every activity that could be proprietary trading, while at the same time using opaque and imprecise language, Congress ensured a “hard slog” for both banking entities and their supervisors.  The Original Rule compounded this problem by interpreting the statute to expand its reach in virtually all close cases.  The Revised Rule appropriately takes a different approach, focusing on what is the overall purpose of Dodd-Frank:  the reduction of risk to banking entities and the financial system more broadly.  By streamlining overall requirements, and focusing most stringently on the banking entities with the largest trading portfolios, “Volcker 2.0” provides better guidance to banking entities and will be easier for regulators to enforce. [1]   For purposes of these thresholds, the amount of trading assets and liabilities are calculated as the “average gross sum” of assets and liabilities on a trailing 4-quarter basis, and the following obligations are excluded:  U.S. government- and U.S. government agency-issued and -guaranteed securities, and securities issued or guaranteed by certain government-sponsored enterprises. [2]   12 U.S.C. §§ 1851(h)(4), (h)(6). [3]   12 C.F.R. § 248.3(e)(13). [4]   12 U.S.C. § 1851(d)(1)(B). [5]   See, e.g., J. Bao, M. O’Hara & A. Zhou, “The Volcker Rule and Market-Making in Times of Stress,” Finance and Economics Discussion Series 2016-102, Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2016.102, at 3 (“Our results show that bond liquidity deterioration around rating downgrades has worsened following the implementation of the Volcker Rule. We find such adverse effects whether we benchmark to the pre-crisis period or to the period just before the Volcker Rule was enacted, and we find that the relative deterioration in liquidity around these stress events is as high during the post-Volcker period as during the Financial Crisis. Given how badly liquidity deteriorated during the Financial Crisis, this finding suggests that the Volcker Rule may have serious consequences for corporate bond market functioning in stress times.”). [6]   These requirements include the requirements that at inception, the hedging position not give rise to significant new or additional risk that is not hedged contemporaneously and that hedging activity be subject to continuous review, monitoring and management. [7]   Stating that “[c]ertain concerns raised by commenters may need to be addressed through amendments to section 13 of the BHC Act,” the preamble notes how community banks were statutorily excluded from the definition of “banking entity” in 2018. [8]   The Revised Rule also clarifies that the SOTUS exemption does not preclude a non-U.S. banking entity from engaging a non-affiliated U.S. investment adviser as long as the actions and decisions of the banking entity to invest in a fund occur outside of the United States. [9]   In a formal acknowledgment of what Agency staff had previously unofficially stated, the Revised Rule relaxes the metrics that banking entities with significant trading assets and liabilities have to report. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the following: Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) James O. Springer – New York (+1 202-887-3516, jspringer@gibsondunn.com) © 2019 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

August 15, 2019 |
Gibson Dunn Lawyers Recognized in the Best Lawyers in America® 2020

The Best Lawyers in America® 2020 has recognized 158 Gibson Dunn attorneys in 54 practice areas. Additionally, 48 lawyers were recognized in Best Lawyers International in Belgium, Brazil, France, Germany, Singapore, United Arab Emirates and United Kingdom.

July 26, 2019 |
New UK Prime Minister – what has happened?

Click for PDF Boris Johnson has won the Conservative leadership race and is the new Prime Minister of the UK. Having been supported by a majority of Conservative MPs, this week the former mayor of London won a 66% share (92,153 votes) in the ballot of Conservative party members. Although there is some criticism of the fact that the new Prime Minister has been elected by such a narrow constituency, it is the case that most political parties in the UK now select their leaders by way of a members ballot. As things stand, the UK is due to leave the European Union (EU) at 23:00 GMT on 31 October 2019. Boris Johnson’s new Cabinet, and the 17 related departures, has set a new tone of determination to leave the EU by that date with or without a deal – “no ifs or buts”. Although only 12 of the 31 members of the new Cabinet originally voted to leave the EU, these “Brexiteer” MPs now dominate the senior Cabinet positions. The newly elected President of the European Commission, Ursula von der Leyen, has however indicated she is willing to support another extension to Brexit talks. In Parliament the Conservatives govern in alliance with the Northern Irish DUP and can only stay in power with the support of the House of Commons. Following defections earlier in the year and the recent suspension of a Conservative MP facing criminal charges, the Government now has an overall working majority of only two MPs (and if, as expected, the Conservatives lose a by-election on 1 August, the Government’s working majority will fall to one). A number of the members of Prime Minister May’s Government who resigned before Boris Johnson took office have made it clear that they will do everything they can to prevent the UK leaving without a deal including voting against the Government. There is therefore a heightened prospect of a general election. This theory is supported by the appointment as Special Adviser to the Prime Minister of political strategist Dominic Cummings who was the chief architect of the campaign to leave the EU in 2016. There has been some debate about whether the new Prime Minister would prorogue Parliament (effectively suspending it) to prevent it stopping a no deal Brexit. That would undoubtedly trigger a constitutional crisis but, despite the rhetoric, it feels like an unlikely outcome. Indeed Parliament recently passed a vote to block that happening. It is difficult to tell where the mood of the House of Commons is today compared to earlier in the year when Prime Minister May’s deal was voted down three times. Since then both the Conservative and Labour parties suffered significant losses in the EU election in May. The new Brexit Party which campaigned to leave made significant gains, as did the Liberal Democrats who have a clear policy to remain in the EU. The opinion polls suggest that, if an election was called today, no party would gain overall control of the House of Commons. It is just possible, however, that some MPs on both sides of the House who previously voted against the May deal would now support something similar, particularly to avoid a no-deal exit from the EU. It may be the case that Boris Johnson, who led the campaign to leave the EU, is the last chance those supporting Brexit have to get Brexit through Parliament. If he fails then either a second referendum or a general election will probably follow. It is not clear what the result of a second referendum would be but it is likely that Labour, the Liberal Democrats and the SNP would all campaign to remain. The EU has consistently said that it will not reopen Prime Minister May’s Withdrawal Agreement although the non-binding political declaration is open to negotiation. The so-called “Irish backstop” remains the most contentious issue. The backstop is intended to guarantee no hard border between Ireland and Northern Ireland but Boris Johnson is concerned it could “trap” the UK in a customs union with the EU. Boris Johnson claims that technology and “trusted trader schemes” means that checks can be made without the need for a hard border. Others, including the EU, remain to be convinced. Parliament has now gone into recess until 3 September 2019 and then, mid-September, there will be another Parliamentary break for the two week party conference season. The Conservative Party Conference on 29 September – a month before the UK’s scheduled exit from the EU – will be a key political moment for the new Prime Minister to report back to the party supporters who elected him. Finally, it is not clear what “no deal” really means. Even if the UK leaves without adopting the current Withdrawal Agreement, it is likely that a series of “mini deals” would be put in place to cover security, air traffic control, etc. A new trading agreement would then still need to be negotiated to establish the ongoing EU-UK relationship. And the issue of the Northern Irish border will still need to be resolved. This client alert was prepared by Charlie Geffen, Ali Nikpay and Anne MacPherson in London. We have a working group in London (led by Patrick Doris, Charlie Geffen, Ali Nikpay and Selina Sagayam) addressing Brexit related issues.  Please feel free to contact any member of the working group or any of the other lawyers mentioned below. Ali Nikpay – Antitrust ANikpay@gibsondunn.com Tel: 020 7071 4273 Charlie Geffen – Corporate CGeffen@gibsondunn.com Tel: 020 7071 4225 Sandy Bhogal – Tax SBhogal@gibsondunn.com Tel: 020 7071 4266 Philip Rocher – Litigation PRocher@gibsondunn.com Tel: 020 7071 4202 Jeffrey M. Trinklein – Tax JTrinklein@gibsondunn.com Tel: 020 7071 4224 Patrick Doris – Litigation; Data Protection PDoris@gibsondunn.com Tel:  020 7071 4276 Alan Samson – Real Estate ASamson@gibsondunn.com Tel:  020 7071 4222 Penny Madden QC – Arbitration PMadden@gibsondunn.com Tel:  020 7071 4226 Selina Sagayam – Corporate SSagayam@gibsondunn.com Tel:  020 7071 4263 Thomas M. Budd – Finance TBudd@gibsondunn.com Tel:  020 7071 4234 James A. Cox – Employment; Data Protection JCox@gibsondunn.com Tel: 020 7071 4250 Gregory A. Campbell – Restructuring GCampbell@gibsondunn.com Tel:  020 7071 4236 © 2019 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

June 5, 2019 |
EMIR Refit Enters into Force on June 17, 2019 – Impacts and Action Items for End-Users

Click for PDF On May 28, 2019, final text was published in the Official Journal of the European Union (“OJEU”) for substantive amendments to the European Market Infrastructure Regulation (“EMIR”)[1] relating to the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for uncleared OTC derivatives contracts, the registration and supervision of trade repositories, and the requirements for trade repositories (“EMIR Refit”).[2]  EMIR Refit becomes effective on June 17, 2019 (20 days after publication in the OJEU)[3], and most of its provisions will begin applying on that date, while others will be phased in. Many of the changes of EMIR Refit aim to reduce compliance costs for end-user counterparties that are non-financial counterparties (“NFCs”) and smaller financial counterparties (“FCs”).  Some of these changes include (i) an exemption from the reporting of intragroup transactions; (ii) an exemption for small FCs from the clearing obligation, (iii) removal of the obligation and legal liability for reporting when an NFC transacts with an FC, and (iv) a determination of the NFC clearing obligation on an asset-class-by-asset-class basis.  While these amendments provide relief, end-users should be keenly aware of the nuances of the text of EMIR Refit, the extent to which relief applies, the timing and steps involved in these changes and any notifications which must be filed.  In particular, with the fast-approaching June 17, 2019 implementation date for EMIR Refit, end-users should take note of two immediate action items.  The first relates to an end-user’s requirement to perform a new calculation to determine whether or not it exceeds the clearing threshold, while the second requires an end-user to file a notification with the relevant national competent authorities (“NCAs”) in order to take advantage of an exemption for the reporting of intragroup transactions. In this alert, we outline some of the key impacts of EMIR Refit on end-users, including the changes to the clearing threshold calculations, the intragroup exemption from reporting and the relief provided to shift responsibility of the reporting obligation from NFCs below the clearing threshold to FCs, as well as the action items resulting from these changes.[4] I.  Changes to Clearing Threshold Calculation – Immediate Action Required EMIR Refit creates a new regime to determine when an NFC and an FC are subject to the clearing obligation.  These determinations will be based on whether the position of an NFC or an FC, as applicable, exceeds the requisite clearing thresholds.  In particular, the NFCs and FCs must determine whether their aggregate month-end average position for the previous 12 months across the entire group exceeds any of the thresholds for a particular asset class.  If an NFC or FC does not make this calculation by June 17, 2019, or if it exceeds the calculation, it must notify the European Securities and Markets Authority (“ESMA”) and the relevant NCA immediately and such NFC or FC will become subject to the clearing obligation beginning four months following such notifications.[5]  Further, NFCs and FCs that are currently subject to the clearing obligation and that remain subject to the clearing obligation under EMIR Refit must still provide notifications to ESMA and the relevant NCA. A.  Impacts on and Action Items for NFCs Under EMIR Refit, whether an NFC is subject to the clearing obligation is separately determined for each particular asset class for which the clearing threshold is exceeded.  Previously, EMIR required that if an NFC exceeded the clearing threshold in one asset class, then all of its OTC derivatives would be subject to the clearing obligation (to the extent the clearing obligation was applicable); however, EMIR Refit modifies this “all or nothing” requirement for NFCs.  Instead, the clearing obligation under EMIR Refit is determined on an asset-class-by-asset-class basis such that an NFC may exceed the clearing threshold for one asset class and be subject to the clearing obligation for that asset class, but may not be subject to the clearing obligation for other asset classes where the NFC does not exceed the clearing threshold.  If an NFC exceeds the clearing obligation in one asset class, it is nonetheless subject to margin requirements for all of its OTC derivatives transactions as the NFC exemption from margin for OTC derivatives remains an “all or nothing” determination.[6] EMIR Refit changes the way in which the entities calculate their positions by replacing Articles 10(1) and (2) of EMIR (which provided that NFCs are required to determine whether their rolling average position over 30 working days) with new provisions that provide that NFCs may calculate, every 12 months, their aggregate month-end average OTC derivatives positions for the previous 12 months across their entire worldwide group and for each asset class.[7]  NFCs would exclude from the calculation transactions that are “objectively measurable as reducing risks related to commercial activity or treasury financing activity” of the NFC or the NFC group (e.g., hedging transactions do not count towards the clearing threshold calculation) but would include intragroup transactions in the calculation.[8]  This average position in each asset class must then be compared against the following clearing thresholds[9]: Asset class Gross Notional Threshold Credit Derivatives €1 billion Equity Derivatives €1 billion Interest Rate Derivatives €3 billion Foreign Exchange Derivatives €3 billion Commodity and Other Derivatives €3 billion The first calculation must be performed by June 17, 2019 and once a year thereafter.  As mentioned above, if an NFC does not calculate its positions it will by default become subject to the clearing obligation in all asset classes.  We note that NFCs that make the calculation and determine that they fall below the clearing threshold in all asset classes, while not required to notify ESMA or their NCA, will nonetheless be required to notify their counterparties.  Indeed, ESMA recently updated its EMIR Q&A to explain that a “counterparty should obtain representations from its counterparties detailing their status” and noted that if a representation is not obtained from a counterparty it must be assumed that the counterparty is subject to the clearing obligation.[10] Four Key Action Items for NFCs Collect the necessary data and calculate OTC derivatives positions by asset class by June 17, 2019 and compare against the clearing thresholds (failure to do so will render the NFC subject to the clearing obligation and margin requirements).  NFCs should make such calculation in accordance with the requirements under EMIR Refit and should maintain appropriate documentation of such calculation for audit purposes. Notify ESMA and the relevant NCA (i) if the clearing threshold is breached in one or more asset classes or (ii) if no calculation is performed.  In the event the notifying NFC is subject to the clearing obligation, such NFC is required to establish clearing arrangements within four months of the notification. Notify counterparties of clearing status (i.e., whether above or below the threshold) and make any relevant changes to existing documentation. Ensure that reporting fields are consistent with any changes to the NFC’s clearing requirements. Impacts on and Action Items for Small FCs EMIR Refit enables certain FCs with limited OTC derivatives activities to be excluded from the clearing obligation.  Previously, EMIR required all FCs to comply with the relevant clearing requirements regardless of the amount of their activities such that every FC was subject to the clearing obligation.  By comparison, the exclusion for FCs is much more limited than the exclusion for NFCs; unlike NFCs, FCs are required to include all OTC derivatives activities in their clearing threshold calculation, including hedging transactions, and FCs maintain the “all or nothing” calculation and do not benefit from the more nuanced asset-class-by-asset-class determination.[11]  In all cases, FCs will remain subject to margin requirements on OTC derivatives.[12] Under EMIR Refit, FCs may calculate, every 12 months, their aggregate month-end average OTC derivatives positions for the previous 12 months across their entire worldwide group and for each asset class.  FCs would not exclude any OTC derivatives transactions from these calculations and would include hedging and intragroup transactions for other entities within the FC’s group.  This average position in each asset class must then be compared against the same clearing thresholds described above for NFCs. Just like NFCs, FCs must make their first calculation by June 17, 2019 and then each year thereafter.  Those FCs that do not make the calculation or that exceed the clearing threshold in one asset class would be subject to the clearing obligations in all asset classes and must notify ESMA and the relevant NCA immediately.  Further, even those FCs that fall below the clearing threshold will be required to notify by their counterparties of their status. Four Key Action Items for FCs Collect the necessary data and calculate OTC derivatives positions by asset class by June 17, 2019 and annually thereafter (failure to do so will render the FC subject to the clearing obligation).  FCs should make such calculation in accordance with the requirements under EMIR Refit and should maintain appropriate documentation of such calculation for audit purposes. Notify ESMA and relevant NCA (i) if the clearing threshold is breached in one or more asset classes or (ii) if no calculation is performed.  In the event the notifying FC is subject to the clearing obligation, such FC is required to establish clearing arrangements within four months of the notification. Notify counterparties of clearing status (i.e., whether above or below the threshold) and make any relevant changes to existing documentation. Ensure that reporting fields are consistent with any changes to the FC’s clearing requirements. II.  Exemption from Intragroup Transaction Reporting – Immediate Action Required Under the current reporting requirements in Article 9 of EMIR, all counterparties subject to EMIR are required to report their intragroup transactions (i.e., inter-affiliate transactions) to a trade repository.  However, effective June 17, 2019, EMIR Refit provides relief to NFCs from the requirement to report these intragroup transactions in certain circumstances.  Specifically, EMIR Refit provides an exemption from the reporting of derivatives contracts “within the same group where at least one of the counterparties is [an NFC] or would be qualified as [an NFC] if it were established in the [EU]” subject to the following criteria: Both counterparties are included in the same consolidation on a full basis; Both counterparties are subject to appropriate centralized risk evaluation, measurement and control procedures; and The parent undertaking is not an FC.[13] While this intragroup exemption from reporting is likely to provide significant relief to NFCs (particularly the global nature of the exemption), it is important to note that the exemption is not self-executing and that notification to the relevant NCA is required.  Specifically, the text requires counterparties wishing to take advantage of the exemption to “notify their competent authorities of their intention to apply the exemption.”[14]  The text further explains that “[t]he exemption shall be valid unless the notified competent authorities do not agree upon the fulfilment of the conditions [of such exemption] within three months of the date of notification.”[15] The language as drafted lacks some clarity as to how such notification to an NCA may be achieved in order to perfect this intragroup exemption.  For example, it is not clear what form the notification must take, whether it can cover multiple entities and whether a notification for one jurisdiction on behalf of the group may be recognized in another jurisdiction.  Further, while EMIR Refit creates a notification requirement and not an “approval” requirement, market participants must determine whether they seek to take advantage of the intragroup exemption upon notification to the NCA(s) or choose to wait until the three-month NCA response period lapses. NCAs may have different views and requirements with respect to what is required of this notification, but a multinational corporation with affiliates in multiple EU countries may be required to notify the NCA of each jurisdiction in which an affiliate seeking to rely on the intragroup exemption is located.  Accordingly, any counterparty seeking to take advantage of the intragroup exemption should review whether its NCA has provided guidance regarding the notification and/or reach out to its NCA to review with the applicable notification requirements for purposes of claiming the intragroup exemption.[16] Key Action Item for NFCs Those NFCs that wish to rely on the intragroup exemption from reporting must notify their relevant NCAs that they intend to rely on the exemption in order for such exemption to be available (following such notification(s), the intragroup exemption will apply unless the NCA responds three months to inform the NCA that it does not agree that the conditions for the intragroup exemption are met). III.  Changes to Reporting Obligation for NFCs Below the Clearing Threshold (“NFC-s”) Article 9 of EMIR currently provides a dual-sided reporting regime where all parties subject to EMIR must report the details of their OTC derivatives to a trade repository.  EMIR Refit seeks to ease these reporting burdens for NFC-s by providing that FCs will be “solely responsible and legally liable” for reporting contracts concluded with an NFC- on behalf of both counterparties, as well as for ensuring the accuracy of the details so reported.[17]  In other words, EMIR Refit does not create a single-sided reporting regime, but rather modifies its existing dual-sided reporting regime such that the FC will be responsible for reporting data for itself and for the NFC- where the NFC- retains no legal liability for the reporting of such data or the accuracy of the details of such data.[18]  NFC-s are responsible for providing the FC that is reporting the data with the details of the contracts that the FC “cannot be reasonably expected to possess” and the NFC- will remain responsible for the accuracy of that information.[19] EMIR Refit notably does not extend this reporting relief to OTC derivatives between an NFC- and a third-country counterparty that would be an FC if established in the EU (a “third-country FC”), unless the third-country reporting regime has been deemed equivalent and the third-country FC has reported the relevant transactions under such equivalent regime.  These restrictions on third-country FCs are particularly important given that the United States has not been deemed an equivalent regime and counterparties domiciled in the United Kingdom will become third-country FCs following the United Kingdom’s expected exit from the EU later this year.[20] Additionally, EMIR Refit provides NFC-s that have already invested in a reporting system with the option to opt out of this new regime and continue to report the details of their contracts that have been executed with FCs in the same manner as they report under EMIR, rather than having the FC counterparty report on behalf of the NFC-, by informing the FC that they would like to do so.[21] Unlike the intragroup exemption and the changes to the clearing obligation, these changes to the reporting obligation do not come into force until June 18, 2020. Three Key Action Items for NFC-s NFC-s should identify which of their counterparties are FCs in order to determine the counterparty relationships that will benefit from this relief and those where the NFC- will retain the reporting obligation (this will help to identify where delegated reporting agreements can be terminated and where they should remain in place). Provide information to FC counterparties that they cannot reasonably be expected to possess (FCs will likely reach out for this information (e.g., whether a transactions is a hedging transaction)). NFC-s that wish to opt out of the new reporting regime and continue to report the details of their OTC derivatives should notify their FC counterparties as soon as possible.    [1]   Regulation (EU) No 648/2012 of the European Parliament and Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories.    [2]   Regulation (EU) No 2019/834 of the European Parliament and Council of 20 May 2019 amending Regulation (EU) No 648/2012 as regards the clearing obligation, the suspension of the clearing obligation, the reporting requirements, the risk-mitigation techniques for OTC derivatives contracts not cleared by a central counterparty, the registration and supervision of trade repositories and the requirements for trade repositories.    [3]   In 2015, the European Commission conducted a comprehensive review of the EMIR to help to reduce disproportionate costs and burdens imposed by EMIR and simplify rules without putting financial stability at risk.  This review included, among other things, the European Commission’s Public Consultation on the Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories and their broader Call for Evidence on the European Union (“EU”) regulatory framework for financial services.  See Public Consultation on Regulation (EU) No 648/2012 on OTC Derivatives, Central Counterparties and Trade Repositories; see also Call for Evidence, EU Regulatory Framework for Financial Services.  Following this review, on May 4, 2017, the European Commission proposed amendments to EMIR in the context of its Regulatory Fitness and Performance (Refit) program.  The EU Council published its compromise text on December 11, 2017 and ECON Committee report was adopted by EU Parliament on May 16, 2018.  The EU Council and EU Parliament reached political agreement on EMIR Refit on February 5, 2019.  Following that, Parliament’s ECON Committee approved the text, it was approved in plenary, adopted by EU Council and ultimately signed on May 20, 2019.    [4]   EMIR Refit also (i) extends the definition of “financial counterparties” to include EU alternative investment funds (AIFs) and their EU alternative investment fund managers (AIFMs); (ii) ends the frontloading requirement; (iii) ends the backloading requirement; (iv) provides power for ESMA and the European Commission to suspend the clearing and derivatives trading obligation; (v) extends the clearing exemption for risk-reducing transactions of pension schemes for two additional years with the ability to extend further; (vi) creates an obligation to provide clearing services on fair, reasonable, non-discriminatory and transparent terms (FRANDT); and (vii) requires regulators to validate risk management procedures for the exchange of collateral.    [5]   See ESMA Public Statement, Implementation of the new EMIR Refit regime for the clearing obligation for financial and non-financial counterparties, March 28, 2019, available at https://www.esma.europa.eu/sites/default/files/library/esma70-151-2181_public_statement_on_refit_implementation_of_co_regime_for_fcs_and_nfcs.pdf.    [6]   Recital (8) of EMIR Refit explains that “[NFCs] should nonetheless remain subject to the requirement to exchange collateral where any of the clearing thresholds is exceeded.”    [7]   Article 1(8)(a) of EMIR Refit.    [8]   Article 10(1) of Commission Delegated Regulation (EU) No 149/2013.    [9]   The clearing thresholds are defined under Article 11 of Commission Delegated Regulation (EU) No 149/2013. [10]   ESMA, Questions and Answers, Implementation of the Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR), pp. 21-22 (May 28, 2019). [11]   Article 1(3) of EMIR Refit. [12]   Recital (7) of EMIR Refit explains that “small financial counterparties should be exempted from the clearing obligation, but they should remain subject to the requirement to exchange collateral to mitigate any systemic risk.” [13]   Article 1(7)(a) of EMIR Refit. [14]   Id. [15]   Id. [16]   We note that some NCAs have provided guidance or forms on how notification of the reliance on the intragroup exemption should be submitted while others have not.  See, e.g., EMIR: FCA Notification for an Intragroup Exemption from Reporting, available at https://www.fca.org.uk/publication/forms/emir-reporting-exemption-form.pdf. [17]   Article 1(7)(b) of EMIR Refit. [18]   While many NFC-s currently delegate the reporting responsibility to their counterparties, under EMIR delegated reporting the NFC-s retain the legal liability to report and for the accuracy of the data that is reported by the counterparties on the NFC-’s behalf. [19]   Id. [20]   For example, if an NFC- were to transact with an EU bank, the NFC- would no longer have a reporting obligation; however, if the NFC- were to transact with a US-based bank, the NFC- would retain the reporting obligation and delegated reporting would likely be desired. [21]   It should be noted that if an NFC- decides to opt-out of the new EMIR Refit reporting regime, it will retain the legal liability for reporting the OTC derivatives data as well as the liability for ensuring the accuracy of such data. The following Gibson Dunn lawyers assisted in preparing this client update: Jeffrey Steiner and Erica Cushing. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions and Derivatives practice groups, or any of the following: Europe: Patrick Doris – London (+44 20 7071 4276, pdoris@gibsondunn.com) Amy Kennedy – London (+44 20 7071 4283, akennedy@gibsondunn.com) Lena Sandberg – Brussels (+32 2 554 72 60, lsandberg@gibsondunn.com) United States: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Erica N. Cushing – Denver (+1 303-298-5711, ecushing@gibsondunn.com) © 2019 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

May 16, 2019 |
Impact of CFTC’s Proposed Amendments to Swap Data Reporting Requirements on Reporting and Non-Reporting Counterparties

Click for PDF On May 13, 2019, the Commodity Futures Trading Commission (the “Commission” or the “CFTC”) published a notice of proposed rulemaking titled Proposed Amendments to the Commission’s Regulations Relating to Certain Swap Data Repository and Data Reporting Requirements (the “Proposal”).[1]  The Proposal seeks to modify existing swap data reporting requirements in Part 23 of the Commission’s regulations for swap dealers (“SDs”) and major swap participants (“MSPs”), Parts 43 and 45 of the Commission’s regulations for “reporting parties” and “reporting counterparties” (as such terms are defined in the Commission’s regulations),[2] and Part 49 of the Commission’s regulations for swap data repositories (“SDRs”).  The Proposal is the first rulemaking adopted by the CFTC following its Division of Market Oversight’s (the “Division”) July 2017 comprehensive analysis of the CFTC’s swap data reporting regulations, which was titled the Roadmap to Achieve High Quality Swaps Data (the “Roadmap”).[3]  In the Roadmap, the Division solicited public feedback on potential improvements to the CFTC’s swap data reporting regime in a manner that would achieve the CFTC’s regulatory goals of swap data transparency under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”)[4] without imposing unnecessary burdens on market participants. Consistent with the Roadmap’s goals, the CFTC’s expressed objectives in adopting the Proposal are to “improve the accuracy of data reported to, and maintained by, SDRs,” “require reporting counterparties to verify the accuracy of swap data pursuant to […] SDR procedures,” and “provide enhanced and streamlined oversight over SDRs and data reporting generally.”[5]  The CFTC notes that the Proposal is the first of three planned rulemakings as described in the Roadmap.[6]  While most of the Proposal’s amendments are intended to modify Part 49 of the Commission’s regulations, which covers SDR registration requirements, SDR operational duties, and the CFTC’s oversight over SDRs generally, the Proposal also would make certain substantive amendments to the swap data reporting requirements for SDs and MSPs under Part 23 and reporting counterparties (and non-reporting counterparties) under Parts 43 and 45 (the “Counterparty Reporting Rules”).[7]  This Client Alert focuses on the Proposal’s modifications to the Counterparty Reporting Rules.  With respect to the Counterparty Reporting Rules, the Proposal notes that current swap data that is available to the CFTC lacks accuracy.  This view has been specifically echoed by CFTC Chairman J. Christopher Giancarlo and several other past and current CFTC Commissioners.[8] To address these concerns regarding accuracy and data quality, the Proposal includes specific amendments to the Counterparty Reporting Rules.  In particular, the Proposal, if adopted, would establish:  (1) new swap data accuracy verification requirements for reporting counterparties within certain timeframes depending on the type of reporting counterparty (i.e., different requirements for SDs/MSPs versus non-SDs/MSPs); (2) revisions to existing swap data error and omission rules for reporting counterparties; and (3) enhanced requirements for SDs and MSPs in terms of their written policies and procedures for swap data reporting under Parts 43 and 45 of the Commission’s regulations.  In the sections below, we have summarized each of these three proposed amendments to the Counterparty Reporting Rules and its impact on the reporting counterparties. The Proposal’s comment period deadline is July 29, 2019.  Since the Proposal and two anticipated proposed rulemakings that are expected to follow will address interconnected issues, the CFTC plans to re-open the comment period for the Proposal at the same time it issues each anticipated rulemaking so that commenters can provide comments on the three rulemakings altogether. Please contact a member of Gibson Dunn’s Derivatives Team if you have any questions regarding the Proposal. 1.    Swap Data Verification The Proposal, if adopted, would establish new swap data accuracy verification requirements for reporting counterparties within certain timeframes depending on the type of reporting counterparty.  The Proposal’s amendments relating to data verification fall under Part 45 of the Commission’s regulations, which generally focuses on the duties of reporting counterparties to report swap data to SDRs for regulatory purposes.  The current Counterparty Reporting Rules do not explicitly require reporting counterparties to verify the data reported with the relevant SDR.  However, the Proposal would create a mandate that all reporting counterparties must verify their swap data for accuracy and completeness with reports provided by the SDR.[9]  Effectively, the Proposal would require a reporting counterparty to reconcile their internal books and records for each open swap against any and all open swaps reflected in an open swap report received from an SDR.[10]  Further, reporting counterparties would be required to conform to any swap data verification policies and procedures enacted by an SDR.[11] The Proposal includes specific timing requirements for reporting counterparty data verification as well as the timing of the frequency of the open swaps reports to be distributed by the SDR.  The open swaps reports must be distributed by the SDR to SD, MSP and DCO reporting counterparties on a weekly basis and to non-SD and non-MSP reporting counterparties on a monthly basis.[12]  Upon receipt and review of the open swaps report, reporting counterparties must submit either a (i) verification of data accuracy[13] or (ii) notice of discrepancy in response to every open swaps report received from an SDR within the following timeframes:  (a) 48 hours of the SDR’s providing the open swaps report if the reporting counterparty is a SD or MSP; or (b) 96 hours of the SDR’s providing the open swaps report for non-SD/MSP reporting counterparties.[14]  In the event that the reporting counterparty finds no discrepancies between its books and records and the data in the SDR’s open swap report, the reporting counterparty must nonetheless submit a verification of data accuracy indicating that the swap data is complete and accurate to the SDR in accordance with the aforementioned timing requirements.[15]  If, however, the reporting counterparty finds a discrepancy in the swap data (i.e., over-reporting or under-reporting), the reporting counterparty must submit a notice of discrepancy to the SDR in accordance with the timing outlined above.[16] The Commission explains that the Proposal’s swap data verification rules aim to improve swap data quality by facilitating the swift resolution of any discrepancies between the swap data maintained by an SDR and the information on record with a reporting counterparty.  However, the data verification requirements of the Proposal would impose new and notable obligations on all reporting counterparties (including smaller, non-SD/non-MSP reporting counterparties) that are not in existence under today’s reporting rules.  In particular, the Proposal would require reporting counterparties to review the SDR’s policies and procedures around the verification process, to build comprehensive systems to verify the swap data reported to the SDR by comparing its internal records against open swaps reports received from the SDR, and to send verification or discrepancy notices to the SDR within relatively short timeframes.  As reporting counterparties already report information to SDRs under the Counterparty Reporting Rules, the Commission expressed its belief that SDRs and reporting counterparties would coordinate with one another to implement a system which is efficient and convenient for both parties, with particular attention to not be unnecessarily burdensome to non-SD/MSP and non-derivatives clearing organization reporting counterparties.[17]  Further, many reporting counterparties report swap data to more than one SDR and given that each SDR will have its own unique policies and procedures, the verification process will differ between SDRs. 2.    Changes to Errors and Omissions Reporting If adopted, the Proposal would also revise the swap data error and omission correction requirements for reporting counterparties.[18]  Currently, the error and omission correction requirements under Part 43 and those under Part 45 have substantive differences from one another.  For example, Part 43 requires a reporting counterparty that “becomes aware of an error or omission in the swap transaction and pricing data” to “promptly notify the other party of the error and/or correction” while Part 45 does not have a similar notification requirement for the reporting counterparty to provide such notice.[19]  The Proposal would seek to fix the gaps between the two rules and would require reporting counterparties to correct any errors and omissions to which they may be aware, including, but not limited to, errors or omissions present in the swap data in the open swaps reports provided as part of the verification process specific in the Proposal.  For example, Proposed regulations 43.3(e)(1) and 45.14(b)(1) provide that to the extent that a reporting counterparty becomes aware of any error or omission in swap data previously reported to an SDR, the reporting counterparty must submit corrected swap data to the SDR.[20]  The error and omissions correction requirements would apply regardless of the state of the swap.  In other words, it would include the correction of live swaps and swaps that are no longer active (i.e., which are commonly referred to as “dead trades”). In addition, the Proposal would establish specific error and correction procedures for reporting counterparties.  In particular, the Proposal would retain the current error and correction procedure in the Counterparty Reporting Rules that requires reporting counterparties to correct swap data “as soon as technologically practicable” following discovery of the errors or omissions.[21]  The Proposal would modify the “as soon as technologically practicable” timing requirement by creating a backstop of three business days after the discovery of the error or omission.[22]  In the event that the reporting counterparty is unable to correct errors or omissions within three business days of discovery, the Proposal would require the reporting counterparty to immediately inform the Director of DMO, or such other CFTC employees whom the Director of DMO may designate, in writing, of the errors or omissions and provide an initial assessment of the scope of the errors or omissions and an initial remediation plan for correcting the errors or omissions.[23]  Proposed regulations 43.3(e)(1)(iii) and 45.14(b)(1)(iii) would require that a reporting counterparty conform to the SDR’s policies and procedures for correction of errors and omissions that the SDRs would be required to create under the Proposal.[24] The Proposal would also establish new requirements for non-reporting counterparties.  Proposed regulations 43.3(e)(2) and 45.14(b)(2) would require a non-reporting counterparty that “by any means becomes aware” of an error or omission in swap data previously reported to an SDR, or the omission of swap data for a swap that was not previously reported to an SDR as required, to notify its counterparty to the swap (i.e., the reporting counterparty) as soon as technologically practicable following discovery of the errors or omissions, but no later than three business days following the discovery of the errors or omissions.[25]  This section of the Proposal also specifies that a non-reporting counterparty that does not know the identity of the reporting counterparty for a swap must notify the SEF or DCM where the swap was executed of the errors or omissions as soon as technologically practicable following discovery of the errors or omissions, but no later than three business days after the discovery.[26]  In the Proposal, the Commission expressed its hope that the requirement to correct all swap data, regardless of status, would ensure that reporting counterparties establish and maintain properly functioning reporting systems to prevent the reporting of errors or omissions. The Proposal’s modifications to the errors and omissions correction requirements would notably make Parts 43 and 45 of the Commission’s regulations consistent in this regard.  In particular, the Proposal would remove the counterparty notification requirement set forth in current CFTC regulation 43.3(e)(1)(i).  However, the Proposal would create a more definitive timeframes in which reporting counterparties are required to correct errors and omissions and in which non-reporting counterparties are required to notify their counterparties of any such errors or omissions.  With respect to non-reporting counterparties, the current rules require that when a non-reporting counterparty “discovers” an error or omission it must “promptly notify” the reporting counterparty of such error or omission.  The Proposal would create more stringent requirements in this regard such that non-reporting counterparties that merely become “aware” of an error or omission by “any means” must notify the reporting counterparty “as soon as technologically practicable” but no later than three business days.  Further the Proposal clarifies that the non-reporting counterparty’s notification obligation with respect to omissions extends to data that was not reported to an SDR (but that presumably should have been reported). 3.    SD and MSP Requirements The Proposal would also establish enhanced requirements for SDs and MSPs with respect their written policies and procedures for swap data reporting under parts 23, 43, and 45 of the Commission’s regulations.  Under the current regime, SDs and MSPs are required to report all information and swap data required for swap transactions when they are reporting counterparties for purposes of regulatory and real-time public reporting.[27]  SDs and MSPs are also required to implement electronic systems and procedures necessary to transmit electronically all information and swap data required to be reported in accordance with Part 43 and Part 45.[28]  The Proposal would require each SD and MSP to establish, maintain and enforce written policies and procedures that are reasonably designed to ensure that the SD and MSP comply with all obligations to report swap data to an SDR, which would include any requirements under Part 43 and Part 45, as well as any rules established by the SDR.[29]  The preamble to the Proposal sets forth specific content that would be expected to be included in the SD or MSP’s policies and procedures.[30] The Proposal also would require SDs and MSPs to review their policies and procedures on an annual basis and to update them as needed to reflect the requirements in Part 43 and Part 45.[31]  The Commission believes that the annual review requirement in the Proposal would ensure that SDs’ and MSPs’ policies and procedures remain current and effective over time.  SDs and MSPs are currently expected to establish policies and procedures related to all of their swap market activities, including their swap data reporting obligations.[32]  The Proposal’s amendments to Part 23 would make the expectations around these policies and procedures explicit by creating new obligations and setting forth guidance around content regarding reporting policies and procedures, rather than merely cross-referencing Parts 43 and 45 as we see under the current regulations. [1]      Certain Swap Data Repository and Data Reporting Requirements, 84 Fed. Reg. 21044 (May 13, 2019). [2]      See 17 C.F.R. § 43.3(a)(3) (sets forth the determination of which counterparty to a swap transaction is the “reporting party” and has the obligation to report swap data to an SDR for purposes of real-time public reporting); 17 C.F.R. § 45.8 (sets forth the determination of which counterparty to a swap transaction is the “reporting counterparty” and has the obligation to report swap data to an SDR for purposes of regulatory reporting).  For purposes of this Client Alert, the term “reporting counterparty” will refer to both a “reporting party” under Part 43 and a “reporting counterparty” under Part 45. [3]      Division of Market Oversight, Roadmap to Achieve High Quality Swaps Data, U.S. Commodity Futures Trading Commission, July 10, 2017, available at http://www.cftc.gov/idc/groups/public /@newsroom/documents/file/dmo_swapdataplan071017.pdf. [4]      Dodd-Frank Wall Street Reform and Consumer Protection Act, 124 Stat. 1376, Pub. Law 111-203 (July 21, 2010), as amended. [5]      Proposal at 21044. [6]      Proposal at 21045. [7]      The Proposal also includes proposed amendments to the reporting requirements for derivatives clearing organizations (“DCOs”), swap execution facilities (“SEFs”), and designated contract markets (“DCMs”) to the extent that these entities are also reporting counterparties.  This Client Alert is focused on the Proposal’s specific impact on the Counterparties and, for that reason, does not discuss the proposed amendments impacting DCOs, SEFs, and DCMs. [8]      Speech by Commissioner J. Christopher Giancarlo, Making Market Reform Work for America (Jan. 18, 2017), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-19 (“The CFTC has faced many challenges in optimizing swap data ranging from data field standardization and data validation to analysis automation and cross-border data aggregation and sharing.  Market participants vary significantly in how they report the same data field to SDRs.  Those same SDRs vary in how they report the data to the CFTC”). Statement by Commissioner Scott D. O’Malia, SIFMA Compliance and Legal Society Annual Seminar (Mar. 19, 2013), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opaomalia-22 (“In a rush to promulgate the reporting rules, the Commission failed to specify the data format reporting parties must use when sending their swaps to SDRs.  In other words, the Commission told the industry what information to report, but didn’t specify which language to use.  This has become a serious problem. . . .  The end result is that even when market participants submit the correct data to SDRs, the language received from each reporting party is different.  In addition, data is being recorded inconsistently from one dealer to another.”). Speech by Commissioner Dan M. Berkovitz, Proposed Amendments to the Commission’s Regulations Relating to Certain Swap Data Repository and Data Reporting Requirements (Apr. 25, 2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement042519 (“Accurate, complete, and timely information is therefore vital to any successful swap data reporting regime.  These objectives were central to post-crisis reform efforts, and they must remain the primary considerations as the Commission moves to enhance its reporting rules”). [9]    Proposal at 21098.  Proposed § 45.14(a) addresses the verification of swap data accuracy against the SDR’s open swaps report. [10]   Proposal at 21098.  Proposed § 45.14(a)(1) addresses a reporting counterparty’s requirement to verify the accuracy and completeness against the open swap reports from the SDR. [11]   Proposal at 21103.  Proposed § 49.11 would set forth rules around such SDR policies and procedures relating to verification of swap data accuracy and would require the SDR to verify the accuracy of the data with reporting counterparties. [12]   Proposal at 21103.  Proposed §§ 49.11(b)(2) and (3) address the timing obligations for SDRs to distribute open swaps reports to reporting counterparties. [13]   For purposes of clarification, examples of unsatisfactory verification may include:  (i) failure to perform the verification in a timely manner and (ii) providing a verification of data accuracy indicating that the swap data was complete and accurate for swap that was not correct when verified. [14]   Proposal at 21098.  Proposed § 45.14(a)(2) addresses the timing in which such verification against the open swap reports from the SDR must occur.  This proposed requirement would also treat DCO reporting counterparties in the same way it does SD and MSP reporting counterparties. [15]   Proposal at 21098.  Proposed § 45.14(a)(3) addresses the requirement to submit a verification of data accuracy regardless of whether there are discrepancies identified.  Such verification would be required to be submitted in the form and manner required by the SDR’s swap data verification policies and procedures. [16]   Proposal at 21098.  Proposed § 45.14(a)(4) addresses the requirement to submit a notice of discrepancy in the event of any inconsistencies.  Such notice of discrepancy would need to be submitted in the form and manner required by the SDR’s swap data verification policies and procedures. [17]   Proposal at 21068. [18]   Proposal at 21097-21099.  Proposed §§ 43.3(e) and 45.14(b) address the error and omission correction requirements for Parts 43 and 45 of the CFTC’s regulations. [19]   17 C.F.R. § 43.3(e)(1)(i). [20]   Proposal at 21098-21099. [21]   17 C.F.R. §§ 43.3(e)(3), 43.3(e)(4), 45.14(a). [22]   Proposal at 21098-21099.  Proposed §§ 43.3(e)(1)(i) and 45.14(b)(1)(i) address the timing for errors and corrections. [23]   Proposal at 21098-21099.  Proposed §§ 43.3(e)(1)(ii) and 45.14(b)(1)(ii) address the requirement to notify the Director of the Division of Market Oversight if the error correction timing cannot be met. [24]   Proposal at 21098-21099. [25]   Proposal at 21098-21099.  The Proposal makes clear that the non-reporting counterparty is not only responsible for notifying the reporting counterparty of errors or omissions in the data that is reported, but also to notify the reporting counterparty of data that was not reported to an SDR. [26]   Proposal at 21099-21099.  Proposed §§ 43.3(e)(2) and 45.14(b)(2) would also require that if the reporting counterparty, SEF or DCM, as applicable, and the non-reporting counterparty agree that the swap data for a swap is incorrect or incomplete, the reporting counterparty, SEF or DCM, as applicable, must correct the swap data in accordance with proposed § 43.3(e)(1) or § 45.14(b)(1), as applicable. [27]   See 17 C.F.R. §§ 23.204(a), 23.205(a). [28]   See 17 C.F.R. §§ 23.204(b), 23.205(b). [29]   Proposal at 21097. [30]   With respect to Part 45, the Proposal explains that such policies and procedures would include, but not be limited to: (i) the reporting process and designation of responsibility for reporting swap data, (ii) reporting system outages or malfunctions (including the use of back-up systems), (iii) verification of all swap data reported to an SDR, (iv) training programs for employees responsible for reporting under Part 45, (v) control procedures relating to reporting under Part 45 and designation of personnel responsible for testing and verifying such policies and procedures; and (vi) reviewing and assessing the performance and operational capability of any third party that carries out any duty required by Part 45 on behalf of the SD or MSP as well as any rules established by the SDR.  With respect to Part 43, the Proposal explains that such policies and procedures would include, but not be limited to:  (i) the reporting process and designation of responsibility for reporting swap transaction and pricing data, (ii) reporting system outages or malfunctions (including use of back-up systems), (iii) training programs for employees responsible for reporting under Part 43, (iv) control procedures relating to reporting under Part 43 and designation of personnel responsible for testing and verifying such policies and procedures, (v) reviewing and assessing the performance and operational capability of any third party that carries out any duty required by Part 43 on behalf of the SD or MSP; and (vi) the determination of whether a new swap transaction or amendment, cancelation, novation, termination, or other lifecycle event of an existing swap, is subject to the real-time reporting requirements under Part 43.  Proposal at 21073. [31]   Proposal at 21097. [32]   See, e.g., 17 C.F.R. § 3.3(d)(1) (requiring a chief compliance officer to administer each of the registrant’s policies and procedures relating to its business as an SD/MSP that are required to be establish pursuant to the Act and the Commission’s regulations); 17 CFR § 3.2(c)(3)(ii) (requiring the National Futures Association to assess whether an entity’s SD/MSP documentation demonstrates compliance with the Section 4s Implementing Regulation to which it pertains which includes § 23.204 and § 23.205). The following Gibson Dunn lawyers assisted in preparing this client update: Jeffrey Steiner, Carl Kennedy and Erica Cushing. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions and Derivatives practice groups, or any of the following: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) Erica N. Cushing – Denver (+1 303-298-5711, ecushing@gibsondunn.com) © 2019 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

March 22, 2019 |
LSTA, LMA and APLMA Publish Sustainability Linked Loan Principles

Click for PDF Sustainability linked loans, a fast-growing loan product introduced in the United States last year, got a significant boost this week with the promulgation of the Sustainability Linked Loan Principles by the leading syndicated lending industry associations.  The SLLPs establish a voluntary framework for designing and negotiating sustainability linked loans, in order to assure the integrity of the asset class and promote its development. Sustainability Linked Loans – an Offshoot of Green Finance This week, the sustainable lending asset class took another step forward with the publication of the Sustainability Linked Loan Principles (the “SLLPs”) by the top three global syndicated lending industry associations.  The Loan Syndications and Trading Association (LSTA), the Loan Market Association (LMA), and the Asia Pacific Loan Market Association (APLMA) promulgated the SLLPs as a voluntary framework representing “the next step in collaboratively developing global standards for sustainable lending” (see LSTA’s Week in Review, March 22, 2019). A type of loan product that has taken root in Europe over the past few years, and arrived in 2018 in the United States, “sustainability linked loans” are loans that have certain of their terms, most typically the pricing, tied to sustainability performance targets – such as the borrower’s use of renewable energy, or its ESG (Environmental, Social and Governance) score as evaluated by a third party rating agency.  This is distinct from traditional “green finance”, in which the proceeds of the financing are earmarked for specific green projects; in most instances, sustainability linked loans are used for general corporate purposes. In order to meet their objective of facilitating and supporting environmentally and socially sustainable economic activity and growth – and to provide appropriate assurances to investors, regulators and other stakeholders – sustainability linked loans must tie their incentives (such as reduced pricing) to sustainability performance targets (1) that are “ambitious and meaningful to the borrower’s business”, and (2) that represent some improvement relative to the performance baseline.  The SLLPs’ goal is “to promote the development and preserve the integrity of the sustainability linked loan product” by setting out a framework of voluntary recommended guidelines, to be applied on a case-by-case basis by market participants, in order to secure these sustainability benefits. Core Components for Sustainability Linked Loans The SLLPs outline four core components for sustainability linked loans: 1. Relationship to Borrower’s Overall Corporate Social Responsibility (CSR) Strategy The borrower should align the loan’s sustainability performance targets with its overall sustainability objectives, as set forth in its CSR strategy, and communicate clearly to the lenders how the performance targets incentivized by the loan fit within those overall objectives. 2. Target Setting – Measuring the Sustainability of the Borrower Appropriate – and appropriately ambitious – performance targets need to be negotiated between the borrower and the lender group for each transaction.  The performance targets can be internal (tracking metrics such as energy efficiency, water consumption, sustainable sourcing and recycling, among others), or external – assessed by independent service providers against external rating criteria.  Appendix 1 of the SLLPs provides an indicative list of common categories of sustainability performance targets, but different, customized performance targets may be appropriate for specific transactions. In some cases, it may be helpful to seek an expert third party’s opinion in developing suitable metrics and performance targets.  It is important that the targets be meaningful and apply over the life of the loan, to incentivize ongoing positive change. 3. Reporting Borrowers should maintain up to date information relating to their performance targets, whether those targets are internally or externally scored.  The SLLPs recommend that such information be provided to the lender group at least once a year, and preferably also made publicly available. 4. Review Validation of the borrower’s performance is imperative.  However, the need for external review is to be negotiated on a case-by-case basis.  Where the information relating to the performance target is not made publicly available or otherwise accompanied by an audit statement, external review of the borrower’s performance is strongly recommended, and the SLLPs recommend that such review be performed on an annual basis at least.  By contrast, where the borrower is a public company that includes information on its sustainability performance metrics in its public disclosures, the need for additional third party validation is less pressing, though such validation may still be desirable. Conclusion Green finance, and sustainability linked loans, are on an upward trajectory.  LPC saw almost $60B globally in green and sustainability linked loans in 2018, quadrupling the volume recorded in 2017 (see LSTA’s Week in Review, February 1, 2019).  2018 was also the year that sustainability linked loans were first seen in the United States, with two loans that adopted internal sustainability performance metrics.  Earlier this month, Xylem Inc. became the first U.S. company to issue a sustainability linked loan with an external performance target – a comprehensive ESG score assessed by Sustainalytics, an expert third party provider of ESG ratings.  (Gibson Dunn represented Xylem in the transaction.) The publication of the SLLPs represents another milestone in the development of this loan product, providing market participants with an important framework to guide expectations, inform market practice, and enhance the integrity of the asset class. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the issues discussed in this update. For further information, please contact the Gibson Dunn lawyer with whom you work or the following authors in New York: Aaron F. Adams (+1 212.351.2494, afadams@gibsondunn.com) Yair Y. Galil (+1 212.351.2313, ygalil@gibsondunn.com) © 2019 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

January 18, 2019 |
Developments in the Defense of Financial Institutions – Calculating the Financial Exposure

Click for PDF Our financial institution clients frequently inquire about how best to address their regulatory and financial exposure in inquiries by the U.S. Department of Justice (“DOJ”) and regulators in the United States.[1]  With corporate entities[2] being held criminally liable under the U.S. legal doctrine of respondeat superior for the actions of even non-executive relationship managers and other employees, it is essential for boards of directors and senior management to have a clear understanding of the ways in which U.S. enforcers determine penalties for organizations, particularly regulated financial institutions. This alert is part of a series of regular analyses of the unique impact of white collar issues on financial institutions.  In this edition, we examine the frameworks that DOJ and other U.S. enforcers have used in their corporate penalty calculations involving financial institutions.[3]  We begin in Section 1 by providing a general overview of the potential components of financial penalties imposed by DOJ and other U.S. enforcers.  Section 2 includes an analysis of DOJ resolutions involving financial institutions over a 10-year period and outliers within that same 10-year period.  Section 3 reviews the enforcement resolutions of certain other U.S. enforcers in order to highlight differences in the imposition of financial penalties (as discussed below) between those enforcers and DOJ.  Section 4 analyzes recent guidance and public statements for a preview of how corporate penalties may be calculated in the near future.  The alert concludes by presenting a series of key observations, which a financial institution should bear in mind if it finds itself forced to negotiate with DOJ or other U.S. enforcers in connection with a criminal or civil enforcement action. 1.      Potential Components of Financial Penalties Financial penalties generally consist of some combination of the following three potential components:  monetary fines; restitution; and disgorgement.[4]  In calculating financial exposure, it is useful to understand the policy objectives and legal underpinnings of each component.  This section discusses those objectives and legal underpinnings, and details how DOJ calculates the first component (i.e., monetary fines) as part of a criminal resolution. a.       Fines Many federal statutes contain their own fine provisions, including a maximum fine amount.  For example, the Bank Fraud statute provides for fines of up to $1 million per violation.[5]  Similarly, the mail and wire fraud statutes provide for a $1 million fine per occurrence.[6] It would be a mistake, however, to focus solely on the upper bounds contained in a specific federal statute in determining potential financial exposure, as those ranges often bear little resemblance to the penalty amount being sought in an enforcement action.  That is because federal law allows DOJ to calculate maximum fines as a multiple of the total amount of gross gain or loss attributable to an offense.[7]  Even relying on the statutory penalties, an aggressive U.S. enforcer may be able to augment a specific statutory range or cap by asserting that there are multiple discrete violations and aggregating those individual instances together to increase the potential penalty. The practical reality is that U.S. enforcers have broad discretion in assessing the ultimate fine amount.  That discretion is generally guided by a set of factors these enforcers consider when settling on a monetary penalty.  Each U.S. enforcer has its own set of factors, the application of which is sometimes difficult to discern in individual enforcement actions. DOJ’s determination of an appropriate fine or monetary penalty in a federal criminal investigation is driven by the concepts and principles codified in the U.S. Sentencing Guidelines (“Guidelines”), the most recent edition of which took effect on November 1, 2018.[8]  Chapter 8 of the Guidelines describes the principles used in calculating appropriate criminal fines for organizational or corporate defendants, which may be imposed instead of, or in addition to, restitution and/or disgorgement.  As described in further detail below, Chapter 8 of the Guidelines includes a number of aggravating or mitigating factors that can have a significant impact on the final fine amount. A number of U.S. enforcers also publish policies applicable to violations of particular statutory provisions.  These policies often offer reductions in the amount of a penalty if and when a corporate entity fulfills certain specific criteria. One recently promulgated policy is DOJ’s FCPA Corporate Enforcement Policy (the “FCPA Policy”), which was established as a pilot program in 2016 and formalized in DOJ’s Justice Manual in November 2017.[9]  The FCPA Policy incentivizes organizations to voluntarily self-disclose FCPA violations to DOJ.[10]  Under the FCPA Policy’s terms, a company’s voluntary self-disclosure, full cooperation, and timely efforts to remediate alleged misconduct are factors considered when determining whether the company qualifies for a mitigated penalty, which can range from a declination (i.e., a decision not to impose a fine at all), to a flat 50-percent reduction off the low end of the potential fines imposed where “aggravating factors” are present (e.g., the involvement of executive management).[11]  Not all factors need be present for a company to qualify for mitigation of the ultimate penalty.  For example, a company that fails to self-disclose, but which otherwise cooperates fully and makes remediation efforts, may still qualify to receive a fine reduction of up to 25 percent.  The FCPA Policy includes a set of detailed standards that specifically set forth what constitutes voluntary self-disclosure and full cooperation, and describe the basic requirements for a company to receive full credit for timely and appropriate remediation.  We discussed voluntary self-disclosure by financial institutions in greater detail in our July 2018 Defense of Financial Institutions Client Alert. b.      Restitution Restitution is an equitable remedy in criminal actions brought by U.S. enforcers.  Restitution is intended to compensate alleged victims based on the amount of their loss.[12]  In civil and administrative actions, restitution is available when a defendant is alleged to have violated a statute that provides for equitable remedies.  In these types of actions, a court looks to the statutory system under which a remedy is sought and determines its authority to order equitable relief.  Many state and federal statutes—such as the 1933 Securities Act and the 1934 Exchange Act—expressly confer equity jurisdiction on the courts.  Even when a statute is unclear regarding the scope of the grant of authority to issue equitable relief, courts have taken an expansive view of their implied powers to provide equitable relief.[13] As discussed in greater detail below, in the criminal context, DOJ will use the Guidelines to calculate restitution amounts.  The Guidelines mandate restitution for all federal offenses, except under certain circumstances. c.       Disgorgement Disgorgement is also an equitable remedy, but, unlike restitution, disgorgement focuses on the defendant (not the alleged victim) in an enforcement action.[14]  Specifically, disgorgement is intended to deprive the defendant of its profits or other gain associated with the alleged conduct that is the subject of the enforcement action. As with restitution, in the criminal context, the Guidelines expressly address disgorgement as a component of the sentencing process.[15]  Generally, however, restitution takes precedence over disgorgement, such that disgorgement may appropriately be viewed as a supplemental penalty imposed if and when a defendant retains any gains after restitution has been imposed.[16] Although disgorgement has traditionally been secondary to restitution in criminal proceedings, DOJ recently has sought disgorgement through its FCPA Policy as a primary remedy in FCPA enforcement actions.  In particular, DOJ has taken this novel approach by issuing resolutions involving declinations with disgorgement.[17] DOJ appears poised to extend this new approach in seeking declination-with-disgorgement resolutions beyond the FCPA context, potentially increasing the number of DOJ resolutions seeking disgorgement as the sole remedy.  In September 2018, DOJ reached a declination-with-disgorgement resolution with Barclays Bank PLC after an investigation involving fraud and market manipulation allegations.  In publicly discussing this resolution, the Principal Deputy Assistant Attorney General of the DOJ’s Criminal Division and the then Chief of DOJ’s Securities and Financial Fraud Unit stated that DOJ would consider declination-with-disgorgement resolutions in cases involving federal laws other than the FCPA, including the False Claims Act, the Dodd-Frank Act, and the Sarbanes-Oxley Act.[18] d.      Calculating the Fine under the Guidelines The Guidelines contain aggravating and mitigating factors that are used to determine a fine range.  These factors present opportunities for principled advocacy to explain why a particular enhancement is not warranted or, conversely, why a mitigating factor should be applied that would decrease the fine. In advocating for how specific factors contribute to a given fine calculation, financial institutions can rely on a number of sources, including: the text of the Guidelines themselves and the interpretive guidance contained in their application notes; case law, which is fairly limited given how infrequently organizations choose to litigate criminal cases; and the precedent established by prior criminal resolutions. Of these, prior resolutions can be very significant.  For that reason, financial institutions should seek to demonstrate that the application of relevant factors within the Guidelines is consistent with how similarly-situated organizations have been treated by DOJ.  Alternatively, financial institutions should seek to demonstrate that the result sought by the U.S. enforcer is inconsistent with prior cases, particularly when negotiating with government attorneys responsible for a wider range of enforcement matters, such as with one of the U.S. Attorney’s Offices most active in the corporate enforcement arena. We begin with an overview of the framework for calculating organizational fines under Chapter 8 of the Guidelines and then include a more detailed analysis of three of the most commonly used variables—prior history, the role of management, and placement within the resulting Guidelines range—that feed into the final fine calculation.  The overview and detailed analysis of each variable concludes with a discussion of potential advocacy points that financial institutions can utilize in negotiating DOJ resolutions.  i.      Overview of Criminal Fine Calculations under Chapter 8 of the Guidelines The determination of an appropriate criminal fine begins with the calculation of the base fine.  The base fine represents the greatest of: the amount correlating to the offense level calculated under the relevant section the Guidelines;[19] the pecuniary gain to the organization; or the pecuniary loss caused by the organization, to the extent it was caused intentionally, knowingly, or recklessly.[20] Section 8C2.4(d) contains a fine table with base fines ranging from $8,500 to $150,000,000 depending on the offense level calculated under the Chapter 2 of the Guidelines.  However, the pecuniary gain or loss involved in the alleged misconduct at hand often will exceed that number and will therefore serve as the base fine. To determine the applicable fine range, the base fine will be multiplied by a figure determined based on the “culpability score.”  The culpability score begins at a base level of five,[21] and can be increased or decreased based on certain “aggravating” or “mitigating” factors.[22]  The resulting culpability score determines the multiplier applicable to the base fine in order to determine the fine range, which can vary from as low as a multiplier of 0.05 for a culpability score of zero or below, to as high as a multiplier of 4.0 for a culpability score of 10 or above.[23] As the broad range of available multipliers suggests, even a modest change in culpability score can drastically affect the resulting penalty amount.  For example, in a matter with a $100 million base fine, a single point culpability score increase from five to six raises the top-end fine by $40 million, from $200 million to $240 million.  This fine amount is independent of the restitution, disgorgement, and any other financial components of the contemplated resolution.  Given the significant effect of the culpability score on the resulting penalty, financial institutions should arm themselves with principled arguments to explain why a particular culpability score factor should (or should not) be applied. There are three aspects of the fine calculation that often are relevant to financial institutions:  the organization’s prior history of allegedly similar misconduct; the extent to which a sentence can be enhanced or reduced based on the role of management; and the placement of the fine amount within the applicable fine range.     ii.      Prior History Enhancement Chapter 8 of the Guidelines provides a two-point enhancement in culpability score if “the organization (or a separately managed line of business) committed any part of the instant offense less than 5 years after (A) a criminal adjudication based on similar misconduct; or (B) civil or administrative adjudication(s) based on two or more separate instances of similar misconduct.”[24]  An organization can be subject to a one-point enhancement if either of these conditions occurred within the last 10 years prior to the alleged misconduct.[25] As financial institutions—particularly large, diversified organizations with several different business lines—may be subject to a wide range of regulatory or enforcement actions, it is important to understand the nuances of this enhancement to make arguments against its imposition.  The most salient aspects of this enhancement and the advocacy points most relevant for each are as follows: Policy Justification:  The organizational Guidelines do not specify the rationale for the prior history enhancement, but the guidance underlying analogous sections of the individual Guidelines roots this enhancement in the principles that recidivists are more culpable than first offenders and that stronger enforcement for repeat offenses acts as a general deterrent.[26]  Based on this yardstick, financial institutions can argue that recidivism concerns are misplaced if the government is relying on prior regulatory actions or findings—those regulatory actions serve different purposes than enforcement actions and should not properly be considered prior criminal history. “Adjudication:”  The Guidelines do not define what types of regulatory actions qualify as a prior “civil or administrative adjudication.”[27]  Other sources suggest the most salient characteristic of an adjudication is its adversarial nature.[28]  Based on this principle, financial institutions can potentially argue that administrative consent decrees (in which a party negotiates with the enforcer on how it will address a prior compliance deficiency or potential violation) and regulatory audits (which by their nature identify areas of improvement) should not serve as the basis of a sentencing enhancement, particularly where the organization has complied with the terms of the consent order or remediated the issues identified in the audit.  The specific and nuanced wording of individual consent decrees and audits can often aid with advancing this argument. Timing of Prior History:  Given the lengthy time span and multi-agency aspect of many enforcement inquiries involving financial institutions, any regulatory action involving similar misconduct must be issued prior to the instant alleged misconduct to justify the imposition of this enhancement.[29]  As such, the conduct underlying a prior regulatory adjudication should not both be part of the alleged misconduct forming the basis for the resolution and the basis for a prior history enhancement. Similar Misconduct:  For the prior history enhancement to be applied, the prior criminal, civil, and/or administrative adjudication(s) must be based on “similar misconduct” to the alleged misconduct in the instant case.[30]  The Guidelines define “similar misconduct” broadly to mean “prior conduct that is similar in nature to the conduct underlying the instant offense,” giving the example of Medicare fraud and another type of fraud,[31] and case law supports this broad interpretation.[32]  Nonetheless, organizations should be prepared to substantively distinguish the alleged misconduct from the conduct forming the basis of the alleged “prior adjudication(s).” “Separately Managed Lines of Business:”  The prior history enhancement applies if “an organization (or separately managed line of business)” was subject to a prior adjudication based on similar misconduct.[33]  The Guidelines indicate that a “separately managed line of business” may include a corporate subsidiary or division,[34] and that in determining the prior history of a separately managed line of business, the enforcer should only consider the history of that separately managed line of business.[35]  Thus, financial institutions could seek to demonstrate that a prior action involved a different subsidiary or unit than the component(s) involved in the current matter. In addition to the specific terms of this provision of the Guidelines, organizations may advocate against the application of the prior history enhancement based on its infrequent historical application in prior corporate criminal resolutions.  According to aggregate annual statistics published by the U.S. Sentencing Commission, the prior history enhancement has been applied in a mere 1.39 percent (12 of 865) cases involving detailed organizational sentencing calculations between 2006 and 2017.[36]  To go beyond data available at sentencing, we have reviewed 119 major corporate resolutions (including guilty pleas, deferred prosecution agreements (“DPAs”), and non-prosecution agreements (“NPAs”)) since the beginning of 2008,[37] and have identified only four resolutions in which a one- or two-point enhancement for prior history was applied.[38]  The circumstances of these resolutions suggest that DOJ will generally apply this enhancement only for cases involving clear instances of recidivism in breach of a prior resolution arising from the same type of misconduct. iii.      Sentencing Enhancements or Reductions Based on Management’s Role In recent years, U.S. enforcers have emphasized the importance of “corporate culture,” particularly as it relates to the “tone at the top” set by an organization’s senior management.  In the compliance context, the theory is that if an organization’s top management demonstrates a firm commitment to ensuring that the company complies with its legal and regulatory obligations—which must go beyond simply establishing written policies and procedures on paper—this emphasis will filter down to rank-and-file employees, ensuring a higher level of overall compliance.  Conversely, DOJ takes the view that if management fails to adequately invest in compliance and emphasizes profitability above all else, line employees throughout the organization will see compliance as an obstacle rather than as a point of emphasis. The alleged role of management is one of the largest drivers of an organization’s culpability score.  Organizations may be subject to a culpability score enhancement of up to five points if either “(i) high-level personnel of the organization [or unit] participated in, condoned, or was willfully ignorant of the offense; or (ii) tolerance of the offense by substantial authority personnel was pervasive throughout the organization [or organizational unit].”[39]  According to the Guidelines, the magnitude of the enhancement is based on the total headcount of the culpable organization (or unit) because the larger the organization, the more significant the consequences of management’s complicity or willful ignorance of misconduct, and the more substantial the risk that misconduct in one area will spread to the rest of the organization.[40]  Based on the significant impact that the role of management can play in the calculation of a monetary fine, financial institutions should consider the following advocacy points. Determining the Relevant Organization or Unit:  The biggest driver of the culpability score enhancement for management involvement is the size of the organization or unit implicated in the alleged misconduct.  Therefore, financial institutions should seek to precisely define what unit(s) or division(s) were implicated in the conduct at issue and which were not, and consequently should argue for an enhancement based on that more limited scope (if it is appropriate to impose one at all).  Recent corporate criminal resolutions involving only specific units or subsidiaries of large, multinational companies suggest that DOJ is receptive to these arguments and will resolve a matter with only the culpable unit(s) if doing so is warranted by the facts.[41] “Willful Ignorance:”  This enhancement may be applied if a high-level manager “participated in, condoned, or was willfully ignorant of the offense.”[42]  The Guidelines definition indicates that an individual is willfully ignorant if “the individual did not investigate the possible occurrence of unlawful conduct despite knowledge of circumstances that would lead a reasonable person to investigate whether unlawful conduct had occurred.”[43]  This fairly flexible definition—suggesting that mere failure to investigate the reasonable possibility of unlawful conduct will suffice—is in tension with recent Supreme Court precedent defining willful ignorance as characterized by employees’ efforts to “deliberately shield[] themselves from clear evidence of critical facts that are strongly suggested by the circumstances.”[44]  Given the non-mandatory nature of the Guidelines following the Supreme Court’s decision in United States v. Booker,[45] organizations should advocate that the Supreme Court’s more exacting standard be applied. Definition of an “Effective Compliance and Ethics Program:”  The Guidelines call for a three-point reduction in an organization’s culpability score if the organization had an “effective compliance and ethics program” in place at the time the offense occurred.[46]  This is a credit that is generally unavailable to organizations subject to the enhancement for management involvement.[47]  The Guidelines define this program by reference to seven “minimal” features needed to show that the organization “exercise[s] due diligence to prevent and detect criminal conduct” and “promote[s] an organizational culture that encourages ethical conduct and a commitment to compliance with the law.”[48]  The Guidelines further indicate that an ethics and compliance program must be “generally effective” at detecting and preventing criminal conduct, based on applicable industry and regulatory standards, the size and sophistication of the organization, and the organization’s history of prior misconduct.[49] Precedential Application of the Compliance and Ethics Program Reduction:  A review of all corporate sentencings between 2006 and 2017 indicates that a mere 5 of 860 (0.58 percent) of corporate defendants received this three-point credit.[50]  Given the emphasis over the last twenty years on corporate compliance, the paucity of companies qualifying for an effective compliance program is discouraging.  The infrequency with which organizations receive this credit at sentencing should not, however, prevent financial institutions from advocating for this credit in a pre-charge resolution, particularly since arguments about the state of a company’s compliance controls are relevant to placement in the fine range and may have implications for other civil or administrative proceedings.    iv.      Placement of the Penalty Within the Fine Range Even after DOJ calculates and establishes the key inputs of a financial penalty under the Guidelines (i.e., the base fine and culpability score), DOJ retains a potentially significant degree of discretion in situating a penalty within the resulting fine range. The Guidelines identify 11 factors that DOJ should consider in determining the appropriate placement of a penalty in the fine range.[51]  The Guidelines further indicate that DOJ may consider “the relative importance of any factor used to determine the range,” including the amount of pecuniary loss or gain, specific offense characteristics, or the aggravating or mitigating factors used to calculate the culpability score.[52]  Thus, DOJ has significant latitude in advocating for the placement of the fine relative to the range. Despite the seeming flexibility DOJ has in setting an appropriate fine relative to the applicable range, in practice, most fines are situated at or in some cases substantially below the lower end of the fine range.[53]  In some cases, companies were fined at or below the low end of the range as part of an articulated enforcement program that leads to different results than those suggested by Guidelines § 8C2.8. For one example, the DPA for the DOJ Tax Division’s recent Swiss Bank Program $98 million resolution with Zürcher Kantonalbank (“ZKB”), filed in August 2018, highlighted that the bank’s cooperation credit was reduced because it discouraged two indicted, separately represented bankers from cooperating with U.S. authorities, contributing to the employees’ decision to resist cooperating with the government’s investigation for about two years.[54]  Notwithstanding this seemingly imperfect cooperation, ZKB’s $35 million penalty represented a 50 percent discount below the bottom of the applicable fine range in recognition of its “substantial cooperation” with the investigation.[55]  For that reason, advocacy regarding the fine calculation should focus on the underlying basis for the base fine and the principles that feed into the culpability score, since those inputs will determine the range, and there will be ample precedent supporting a bottom-range or below-range fine. 2.      How DOJ Utilizes the Financial Penalty Components in Practice To understand how the three potential components—fine, restitution, and disgorgement—play out in practice, we analyzed 10-years’ worth of DOJ resolutions involving financial institutions.  In addition, we make reference to DOJ’s most notable resolutions in 2018 involving financial institutions.  Finally, to illuminate how DOJ can exercise complete discretion in calculating the penalties for a particular case in a manner that is either higher or lower than those penalties imposed in similar cases, we review DOJ resolutions where the financial penalties assessed were outliers in comparison to the majority of DOJ resolutions over the last 10 years. a.       10-Year Review of DOJ Resolutions Involving Financial Institutions We have identified 143 resolutions where DOJ assessed a penalty to a financial institution between 2008 to 2018.[56]  The findings below relate only to the penalties assessed by DOJ—not other U.S. enforcers.  It is not uncommon, however, particularly in larger resolutions, for financial institutions to enter into a global structure that includes resolutions with multiple U.S. agencies—both at the federal and state levels—and even foreign regulatory enforcement agencies.  The data and analysis in this subsection is limited to the penalty assessed by DOJ itself since that amount tends to be the largest single driver of financial exposure. Chart 1 below illustrates how frequently DOJ uses restitution, disgorgement/forfeiture, fines, or a mix of these penalties in resolutions with financial institutions. Chart 1 Chart 1 illustrates that approximately 68 percent of the resolutions that DOJ has entered into with financial institutions in the past decade have involved only a fine, without any disgorgement or restitution component.  Part of the explanation for this high percentage is that there were approximately 80 NPAs between DOJ and certain Swiss banks as part of a special DOJ program.  These resolutions only involved a fine.  However, fine-only resolutions are not limited to the Swiss bank context.  Resolutions between DOJ and financial institutions in matters resolving allegations of fraud or manipulation of the London Inter-bank Offered Rate (“LIBOR”), for instance, often involve only a fine component.  As such, resolutions involving only a fine are quite common. By contrast, resolutions involving only restitution are incredibly rare, occurring just 1.4 percent of the time.  Meanwhile, resolutions involving only disgorgement—which occur 14 percent of the time—are somewhat more common but still relatively rare.  The data also demonstrates that it is not uncommon for DOJ resolutions with financial institutions to involve multiple penalty components.  Approximately 16 percent of DOJ resolutions involve more than one penalty component.[57] If we analyze the amount of the penalties that DOJ assessed using each of these components, the importance of disgorgement and forfeiture as a penalty component becomes clearer.  Chart 2 illustrates the total amount of financial penalties DOJ has assessed to financial institutions using each penalty component between 2008 and 2018. Chart 2 As the data in Chart 2 shows, forfeiture and disgorgement account for nearly 61 percent of the dollars DOJ has assessed in penalties to financial institutions in the past decade, nearly twice as much as through fines alone.  A key factor that helps explain this data is that forfeiture has been the only, if not the predominant, penalty component in many of the largest resolutions between DOJ and financial institutions in the past decade.  Indeed, of the seven largest resolutions with DOJ in the past 10 years, disgorgement or forfeiture accounted for the majority of the financial penalty amounts.  For example, forfeiture comprised $8,833,600,000 of the $8,973,600,000 penalty in BNP Paribas’ 2014 sanctions resolution, and the entire penalty in HSBC’s $1.256 billion 2012 sanctions resolution, JP Morgan’s 2014 $1.7 billion BSA resolution, and Société Générale S.A.’s 2018 $717 million sanctions resolution. b.      Notable 2018 Resolutions In 2018, there were 13 resolutions between DOJ and financial institutions in which the overall financial penalty was more than $5 million.[58]  Five of the 13 involved penalties over $100 million, including the second largest penalty ever imposed on a financial institution for alleged violations of U.S. economic sanctions.  Gibson  Dunn’s 2018 Year-End NPA/DPA update offers a detailed analysis of these resolutions. c.       Outlier Resolutions When assessing how U.S. enforcers might assess penalties in a particular case, it is worth analyzing penalties that fall outside of the norm in order to understand whether the conduct at issue in a particular matter might carry significantly more or less financial exposure.  This subsection discusses two notable outliers, which illuminate how U.S. enforcers can exercise discretion in calculating the penalties for a particular case in a manner that is either higher or lower than those penalties imposed in similar cases.  At the high end, DOJ’s $8.9 billion resolution with BNP Paribas remains the largest criminal penalty assessed to date against a financial institution.  This DOJ resolution was notable not only in terms of the overall size of the penalty, but also in the way that it was calculated.  At the low end, DOJ resolutions with “Category Two” banks as part of DOJ’s Swiss Bank Program (as further discussed in the subsection below) were significantly less aggressive in terms of the way in which DOJ calculated financial penalties.     i.      On the High End – BNP Paribas In June 2014, BNP Paribas pled guilty to violating U.S. sanctions laws, agreeing to pay total financial penalties of $8.9 billion.[59]  This remains the largest criminal penalty that the United States has ever imposed on a financial institution or any other organization.  Of that $8.9 billion, BNP Paribas agreed to forfeit $8.8336 billion and pay a fine of $140 million.[60]  In addition to the sheer magnitude of the penalty, the way in which DOJ calculated the penalty was notable in two respects.  First, the forfeiture amount represented “the amount of proceeds traceable to the violations” set forth in the charging document.[61]  In other words, BNP Paribas was required to forfeit one dollar for every dollar that it cleared in a transaction violating U.S. sanctions laws, even though the bank only received a very small commission for clearing that dollar.  Second, the $140 million fine that DOJ assessed against BNP Paribas represented “twice the amount of pecuniary gain to [BNP Paribas] as a result of the offense conduct.”[62]  Thus, BNP Paribas’s fine was two times the amount of profits it received from this activity. It is quite rare for a penalty to include both a one-to-one forfeiture ratio (particularly in cases involving the violation of economic sanctions) and a two-to-one disgorgement ratio.  This extreme penalty may have reflected DOJ’s perception of the egregiousness of BNP Paribas’s alleged conduct and its level of cooperation.  Regarding its conduct, the bank cleared over $8.8 billion through the U.S. financial system that allegedly violated U.S. sanctions laws.[63]  It also continued to clear U.S. dollar transactions allegedly in violation of the Cuba embargo, according to DOJ, “long after it was clear that such business was illegal.”[64]  Moreover, the bank continued clearing transactions allegedly in violation of U.S. sanctions on Iran “nearly two years after the bank had commenced an internal investigation into its sanctions compliance and pledged to cooperate with the [g]overnment.”[65]  Ultimately, as the Assistant Attorney General for DOJ’s Criminal Division explained, “BNP Paribas flouted U.S. sanctions laws to an unprecedented extreme, concealed its tracks, and then chose not to fully cooperate with U.S. law enforcement, leading to a criminal guilty plea and nearly $9 billion penalty.”[66]     ii.      On the Low End – Swiss Bank Program In contrast to the BNP Paribas resolution, the total penalties that DOJ assessed in enforcement resolutions under its Swiss Bank Program with “Category Two” banks were on average less than five percent of the undeclared U.S. assets that these banks maintained. As noted above, DOJ’s Swiss Bank Program allowed Swiss banks to resolve potential criminal liabilities in the United States by voluntarily disclosing undeclared U.S. accounts held at their banks.[67]  There were four categories of banks covered under the Swiss Bank Program.  Category One banks were under active criminal investigation and thus ineligible for the program.[68]  Category Two banks were those that had “reason to believe” that they may have committed tax-related offenses under U.S. law.[69] Since the program began, DOJ has entered into 81 NPAs with Swiss banks.[70]  The vast majority of these NPAs were with Category Two banks.  In NPAs with Category Two banks, DOJ agreed to significantly more modest penalty calculations.  The NPAs generally disclose in the statement of facts the aggregate value of the U.S.-related accounts that the bank maintained and did not disclose.  The average penalty assessed in NPAs with Category Two banks was approximately three percent of the aggregate value of the undisclosed accounts. 3.      Other U.S. Enforcers In addition to DOJ, other U.S. enforcers impose monetary fines against financial institutions and other organizations for violations of relevant federal laws and regulations.  These other U.S. enforcers’ frameworks for calculating financial penalties, however, are not as well-defined as DOJ’s framework under the Guidelines.  In the subsections below, we highlight 2018 resolutions imposed by the OCC and the FRB.  What becomes most apparent in analyzing these resolutions is that certain U.S. enforcers only impose fines (and not restitution or disgorgement penalties). a.       2018 OCC Resolutions In 2018, the OCC entered into seven resolutions with financial institutions where involving a settlement amount of $10 million or greater.  In addition to the penalties that the OCC assessed to U.S. Bank (discussed in the 2018 DPA/NPA mid-year alert) and Rabobank NA, it also assessed two other notable penalties over $50 million in 2018.  First, Wells Fargo, National Association, entered into an order with the OCC, which included a $500 million in civil money penalties to resolve matters regarding the bank’s compliance risk management program and past practices.[71]  This penalty matched the largest penalty that the OCC has ever issued.  In addition, the bank submitted a plan for the management of remediation activities conducted by the bank.  Second, in October 2018, the OCC issued a consent order against Capital One Bank (U.S.A.), N.A., in which it assessed a $100 million civil penalty.[72]  This consent order was issued for BSA/AML violations, including violating a 2015 Consent Order.[73]  The fines in these OCC resolutions only included fines (i.e., the OCC did not include restitution or disgorgement). b.      2018 Federal Reserve Board Resolutions In 2018, the FRB issued five cease-and-desist orders, 12 civil monetary penalties, and three resolutions that included both a cease-and-desist order and a civil monetary penalty to financial institutions.  These three resolutions were the SocGen sanctions resolution, the U.S. Bank BSA/AML resolution (both referenced above), and a $54.75 million settlement with The Goldman Sachs Group, Inc. resolving allegations surrounding the bank’s foreign exchange trading business.[74]  All of these financial penalties were composed entirely of fines. 4.      Forward-Looking Guidance from Enforcers Recent guidance by U.S. enforcers provides helpful clues as to how they will approach financial penalties for corporations.  In particular, enforcers have been focused on enhancing inter-agency coordination in order to avoid imposing duplicative penalties. a.       Recent Guidance One example of a written policy is DOJ’s Justice Manual, which contains guidance with respect to the bringing of criminal actions against organizations and penalties associated with those actions.  The Justice Manual lists factors DOJ should consider in determining whether and how to charge a corporate entity, such as the nature of the offense, the “pervasiveness of the wrongdoing,” the “history of similar misconduct,” the “adequacy and effectiveness of the corporation’s compliance program,” among others.[75]  The Justice Manual also specifically outlines how voluntary self-disclosure and cooperation may affect the outcome of a criminal action against a legal entity, much like we discussed earlier in the context of the FCPA Policy.[76] In another example, the OCC issues written policies and guidance with respect to civil monetary penalties in its Policies and Procedures Manual (“PPM”), most recently updated on November 13, 2018.[77]  In the PPM, the OCC lays out the factors it considers in determining penalty amounts, including:  “(1) the size of financial resources and good faith of the institution . . .  charged; (2) the gravity of the violation; (3) the history of previous violations; and (4) such other matters as justice may require,” as well as 13 additional factors set forth in an Interagency Policy issued by the Federal Financial Institutions Examination Council (“FFIEC”) in 1998.[78]  The OCC includes matrices as appendices to the PPM, which apply “factor scores” to the different factors considered in determining an appropriate penalty.  Although these matrices “are only guidance” and “do not reduce the [penalty] process to a mathematical equation and are not a substitute for sound supervisory judgment,” they provide guidance and may give financial institutions a sense of how the factors are weighed when the OCC considers a monetary penalty.[79] The FDIC publishes a similar matrix and issues guidance on the factors it considers when imposing penalties.  These factors are essentially the same as those considered by the OCC, which is unsurprising due to the coordination of the federal banking regulators through the FFIEC.[80] Further guidance—although nonbinding—regularly comes in the form of speeches at conferences and events by DOJ and other officials.  Given the flexibility and judgment calls involved in each decision, however, any review or estimate of financial exposure must include a review of the enforcement actions brought by these agencies in order to glean which factors will be applied and how they will be weighted. b.      Recent Guidance Focused on Inter-Agency Coordination Although many different U.S. enforcers have the authority to impose financial penalties, there have been efforts to coordinate resolutions between these agencies and, in some cases, to attempt to avoid duplicative fines.  For example, in May 2018, Deputy Attorney General Rod Rosenstein announced a new DOJ Policy on Coordination of Corporate Resolution Penalties, which was then incorporated into the Justice Manual.[81]  This policy—commonly referred to as the “Anti-Piling On Policy”—seeks to avoid the unnecessary “piling on” of duplicative criminal and civil penalties and to encourage cooperation among enforcement agencies both within DOJ as well as between DOJ and other domestic and foreign enforcers.  The new Anti-Piling On Policy encourages DOJ to coordinate with other enforcers when considering appropriate penalties, listing specific factors that may lead to the imposition of multiple penalties, including:  (1) “the egregiousness of a company’s misconduct;” (2) “statutory mandates regarding penalties, fines, and/or forfeitures;” (3) “the risk of unwarranted delay in achieving a final resolution;” and (4) “the timeliness of a company’s disclosures and its cooperation” with DOJ.[82] In Rosenstein’s May 9, 2018 speech announcing the policy, he explicitly referred to coordination with the SEC, the CFTC, the FRB, the FDIC, the OCC, and OFAC, and stressed that “[b]y working with other agencies . . . our Department is better able to detect sophisticated financial fraud schemes and deploy adequate penalties and remedies to ensure market integrity.”[83]  In practice, the Anti-Piling On Policy does not reflect a major shift in DOJ’s approach, as DOJ had already been coordinating with other U.S. enforcers on many matters.  However, this new official policy does formalize and reduce to writing DOJ’s commitment to coordination. We have seen DOJ’s new Anti-Piling On Policy play out in a number of resolutions over the past year.  For example, in recent resolutions involving U.S. Bank and Rabobank NA (both referenced above), the various U.S. enforcers acknowledged and credited fines imposed by others.  While the Rabobank NA and U.S. Bank resolutions occurred before the official announcement of the Anti-Piling On Policy, they reflect the same coordination principles and appeared consistent with Rosenstein’s November 2017 remarks indicating that DOJ had intended to apply those principles going forward.  More recently, in the June 2018 SocGen FCPA and LIBOR DPA discussed above, DOJ credited the penalty paid to a foreign regulator—the Parquet National Financier—reducing its imposed fine by 50 percent on that basis.[84] Other U.S. enforcers have not yet officially announced parallel policies but many have demonstrated the same crediting of fines imposed by other agencies.  For example, the SEC in recent speeches has addressed its desire to work with other enforcers and to take into consideration other enforcement actions.  On May 11, 2018, just two days after the announcement of DOJ’s Anti-Piling On Policy, SEC Commissioner Hester Peirce remarked at a conference that “[a]nother way to conserve resources for matters most in need of our enforcement attention is to work with other regulators and the criminal authorities” and that “[i]n deciding whether to pursue a matter, the Enforcement Division . . . can take into consideration whether other regulatory or criminal authorities are looking at the same conduct.”[85]  This plays out in the amount of penalties imposed in addition to the decision to bring an action in the first place.  For example, in a July 2018 FCPA resolution with CSHK (discussed above), the SEC imposed disgorgement and accrued interest amounts totaling approximately $30 million, but did not require a separate fine, crediting the $47 million criminal penalty paid to DOJ.[86] Along the same lines, in June 2018, the FFIEC rescinded a previous policy statement from 1997 and replaced it with a new inter-agency policy reflecting coordination in enforcement actions against financial institutions by the OCC, the FRB, and the FDIC.[87]  This new policy reflects the same goal of coordinating actions and resolutions in order to avoid the piling on of duplicative monetary fines. Despite the efforts of agencies to coordinate and credit penalties imposed by others, the SocGen sanctions-related enforcement action discussed above does not appear to have involved credits by the settling agencies for fines paid to others.  In reaching the global resolution of $1.4 billion, DOJ did not credit payments to other U.S. enforcers and in fact referred to “separate agreements” under which SocGen “shall pay additional penalties.”[88]  Similarly, the OFAC Enforcement Information referred to the global settlement involving resolutions with DOJ, the FRB, the New York County District Attorney’s Office, the U.S. Attorney’s Office for the Southern District of New York, and the New York Department of Financial Services, but did not credit any of the other fines in assessing its penalty of nearly $54 million.[89]  OFAC has not publicly stated whether it is moving away from the crediting of payment to other enforcers or whether the SocGen resolution is an outlier.[90]  In any event, it is still too soon to know whether the trends toward cooperation and the avoiding of duplicative penalties will reduce the total penalty paid by an organization facing a multi-agency enforcement action. 5.      Conclusion Although most financial penalties in civil and criminal matters may contain the same potential components (i.e., fines, restitution, and/or disgorgement) as seen in the majority of DOJ corporate resolutions over a 10-year period, there can be significant variance in how these components are calculated. Additionally, although the determination of any base fine or penalty is driven by specific principles and elements for the sentencing of organizations in the Guidelines, these principles and elements will be informed by the facts that are the subject of any government investigation.  Often conduct can be viewed as implicating different statutes and violations.  For example, most alleged violations can be viewed according to the underlying problem (e.g., sanctions) as well as AML.  When negotiating with U.S. enforcers, financial institutions, and their counsel should consider how best to shape the narrative around the scope of the alleged misconduct and how those enforcers view different statutory violations.  By advocating effectively in this regard, a financial institution can position itself to reduce its potential financial penalty or even take advantage of a program designed to encourage cooperation (e.g., FCPA Policy). Financial institutions should also consider that fine calculations can be adjusted up or down based on culpability scores, prior history enhancements, and the role of management in the alleged misconduct.  Financial institutions should accordingly be prepared to make principled arguments rooted in the facts of the instant case and be familiar with the outcomes of other analogous cases in order to appeal to relevant organizational precedent.  Nonetheless, although the Guidelines’ principles are helpful in determining an organization’s exposure to a potential criminal penalty, financial institutions should be mindful of the significant discretion prosecutors wield in determining whether to apply a given enhancement or reduction and in situating the penalty amount within the applicable fine range. Finally, financial institutions should also keep in mind these criminal sentencing principles when negotiating civil or administrative resolutions.  For example, by negotiating for language explicitly disclaiming that a cease-and-desist order or consent decree should be regarded as a “civil or administrative adjudication,” a financial institution may limit its exposure to the prior history aggravating factor in potential future criminal actions. We believe that it is essential for our financial institution clients to understand their potential financial exposure when assessing matters involving DOJ or other U.S. enforcers.  We hope this publication serves as a helpful primer on this issue, and look forward to addressing other topics that raise unique issues for financial institutions in this rapidly-evolving area in future editions. [1]      Throughout this alert, we generally use the term “U.S. enforcers” to refer to U.S. regulatory agencies and departments, which bring criminal or civil enforcement against persons for violations of federal law. [2]      We use the terms “corporate entity” and “organization” to refer to non-individual persons subject to investigation by enforcers, regardless of the specific legal structure of a given organization.  Throughout this client alert, we use the two terms interchangeably.  For example, in several places, we refer to a penalty imposed against a financial institution or other organization simply as a “corporate penalty” for ease of reference. [3]      This alert also discusses other U.S. enforcers and regulatory agencies, including the U.S. Department of Treasury’s Office of Foreign Assets Control (“OFAC”), the U.S. Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”), the Office of the Comptroller of the Currency (“OCC”), the U.S. Securities and Exchange Commission (“SEC”), the U.S. Commodity Futures Trading Commission (“CFTC”), and the Board of Governors of the Federal Reserve System (“FRB”). [4]      For the purposes of this client alert, forfeiture is considered as a form of disgorgement.  As noted below, forfeiture is a unique driver of financial institution liability, and the complexities it presents will be the focus of a future Developments in the Defense of Financial Institutions client alert. [5]      18 U.S.C. § 1344. [6]      18 U.S.C. §§ 1341, 1343. [7]      See, e.g., 18 U.S.C. § 3571(d), which provides that a defendant may be fined up to twice the gross gain or gross loss attributable to an offense. [8]      This citation to the Guidelines in this client alert is drawn from the 2018 edition of the U.S. Sentencing Guidelines Manual, a publication of the United States Sentencing Commission, available at https://www.ussc.gov/sites/default/files/pdf/guidelines-manual/2018/GLMFull.pdf. [9]      U.S. Dep’t of Justice, Justice Manual §  9-47.120 (2017), available at https://www.justice.gov/jm/jm-9-47000-foreign-corrupt-practices-act-1977#9-47.120.  We discussed the FCPA Policy in greater detail in our 2017 Year-End FCPA Update. [10]    Id.; see also Rod J. Rosenstein, Deputy Att’y Gen., Deputy Attorney General Rosenstein Delivers Remarks at the 34th International Conference on the Foreign Corrupt Practices Act (Nov. 29, 2017), https://www.justice.gov/opa/speech/deputy-attorney-general-rosenstein-delivers-remarks-34th-international-conference-foreign/. [11]    U.S. Dep’t of Justice, Justice Manual §  9-47.120. [12]    See, e.g., United States v. Boccagna, 450 F.3d 107, 115 (2d Cir. 2006) (“[T]he purpose of restitution is essentially compensatory:  to restore a victim, to the extent money can do so, to the position he occupied before sustaining injury.”). [13]   See, e.g., FTC v. WV Universal Mgmt., LLC, 877 F.3d 1234, 1239 (11th Cir. 2017) (quoting FTC v. General Merch. Corp., 87 F.3d 466, 468 (11th Cir. 1996)) (noting that even though the Federal Trade Commission Act did not expressly provide for monetary equitable relief, Congress’s “unqualified grant of statutory authority to issue an injunction . . . carries with it the full range of equitable remedies”). [14]    See, e.g.,  SEC v. Contorinis, 743 F.3d 296, 301 (2d Cir. 2014); see also SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987) (“The paramount purpose of enforcing the prohibition against insider trading by ordering disgorgement is to make sure that wrongdoers will not profit from their wrongdoing.”). [15]    See U.S. Sentencing Guidelines Manual [hereinafter, the “Guidelines”] §§  5E1.1, 8B1.1, 8C2.9. [16]    Guidelines § 8B1.1(c). [17]    DOJ’s resolutions with NCH Corporation, HMT LLC, CDM Smith Inc., and Linde North America Inc. are examples of this approach.  See Letter to Paul E. Coggins & Kiprian Mendrygal, Locke Lord LLP, Counsel for NCH Corporation (Sept. 29, 2016), available at https://www.justice.gov/criminal-fraud/file/899121/download; Letter to Steven A. Tyrell, Weil, Gotshal & Manges LLP, Counsel for HMT LLC (Sept. 29, 2016), available at https://www.justice.gov/criminal-fraud/file/899116/download; Letter to Nathaniel B. Edmonds, Paul Hastings LLP, Counsel for CDM Smith Inc. (June 21, 2017), available at https://www.justice.gov/criminal-fraud/page/file/976976/download; Letter  to Lucina Low & Thomas Best, Steptoe & Johnson LLP, Counsel for Linde North America Inc. (June 16, 2017), available at https://www.justice.gov/criminal-fraud/file/974516/download. [18]   See Jody Godoy, DOJ Expands Leniency Beyond FCPA, Lets Barclays Off, Law360 (Mar. 1, 2018), https://www.law360.com/articles/1017798/doj-expands-leniency-beyond-fcpa-lets-barclays-off. [19]     Common chapters of the Guidelines potentially applicable to financial institutions include 2B (fraud and embezzlement), 2C (bribery and gratuities), 2S (money laundering), and 2T (tax violations). [20]    Guidelines § 8C2.4(a).  “Pecuniary gain” and “pecuniary loss” are defined with reference to the definitions at § 8A1.2 cmt. n.3(H), and (I), respectively.  “Pecuniary gain” refers to “the additional before-tax profit to the defendant resulting from the relevant conduct of the offense,” and “pecuniary loss” refers to the greater of the reasonably foreseeable actual loss or intended loss from the offense conduct, as defined at § 2B1.1 cmt. n.3(A). [21]    Id. § 8C2.5(a). [22]     Aggravating factors, which increase the culpability score, include the size of the organization, involvement of high-level management, history of prior enforcement resolutions for similar misconduct, violations of an existing judicial or administrative order and conduct alleged to be indicative of obstruction of justice.  Id. § 8C2.5(b)-(e). Mitigating factors, which decrease the culpability score, include the existence of an effective compliance and ethics program at the time of the alleged misconduct, prompt, voluntary self-disclosure of the conduct, full cooperation in the government’s investigation, and clearly demonstrated acceptance of responsibility for the conduct at issue.  Id. § 8C2.5(f)-(g). [23]    Id. § 8C2.6. [24]   Id. § 8C2.5(c)(2). [25]   Id. § 8C2.5(c)(1). [26]   See id. Ch. 4, pt. A, Introductory Commentary (“A defendant with a record of prior criminal behavior is more culpable than a first offender and thus deserving of greater punishment. General deterrence of criminal conduct dictates that a clear message be sent to society that repeated criminal behavior will aggravate the need for punishment with each recurrence.”). [27]   Id. § 8A1.2 cmt. n.3(G) (defining “prior criminal adjudication” as “conviction by trial, plea of guilty . . . or plea of nolo contendere“). [28]   See, e.g., Black’s Law Dictionary (10th ed. 2014) (defining “adjudication” as “[t]he legal process of resolving a dispute” or “the process of judicially deciding a case,” and “administrative adjudication” as “[t]he process used by an administrative agency to issue regulations through an adversary proceeding”).  In the context of administrative adjudications, the Administrative Procedures Act sets forth a series of basic requirements for so-called “formal” agency adjudications, including the presentation of evidence before a presiding official, the opportunity to present rebuttal evidence or cross-examine witnesses, and a written decision on the record.  See 5 U.S.C. § 554 et seq. [29]   Guidelines § 8C2.5(c) indicates that the prior adjudication(s) must occur within five to ten years before the organization committed any part of the “instant offense.”  Chapter 8 of the Guidelines defines “instant,” when applied to modify the term “offense,” as used “to distinguish the violation for which the defendant is being sentenced from a prior or subsequent offense.”  Guidelines § 8A1.2 cmt. n.3(A). [30]   § 8C2.5(c). [31]   § 8A1.2 cmt. n.3(F). [32]   See, e.g., United States v. Hernandez, 160 F.3d 661, 669–70 (11th Cir. 1998) (failure to pay employees minimum wage is similar to committing bankruptcy fraud); United States v. Starr, 971 F.2d 357, 361–62 (9th Cir. 1992) (possession of stolen property and embezzlement are similar to bank robbery); United States v. Cota-Guerrero, 907 F.2d 87, 89 (9th Cir. 1990) (illegal possession of firearm is similar to assault with a deadly weapon). [33]   Guidelines § 8C2.5(c) (emphasis added). [34]   Id. cmt. n.5 (defining “separately managed line of business” as “a subpart of a for-profit organization that has its own management, has a high degree of autonomy from higher managerial authority, and maintains its own separate books of account”). [35]   Id. [36]   This figure was calculated using the statistics contained in Table 54 of the U.S. Sentencing Commission’s Annual Sourcebooks of Federal Sentencing Statistics for the years 2006 to 2017, which are available at https://www.ussc.gov/research/sourcebook/archive/. [37]   For this analysis, we reviewed all corporate criminal resolutions based on alleged violations relating to the FCPA, AML statutes, LIBOR, and foreign exchange issues, sanctions, and tax fraud, as identified by running searches using the Corporate Prosecution Registry available at http://lib.law.virginia.edu/Garrett/corporate-prosecution-registry/browse/browse.html. [38]   See Plea Agreement, United States v. Rabobank, Nat’l Ass’n, No. 18-cr-00614 (S.D. Cal. Feb. 7, 2018), available at https://www.justice.gov/opa/press-release/file/1032101/download; Deferred Prosecution Agreement, United States v. Zimmer Biomet Holdings, No. 12-cr-00080 (D.D.C. Jan. 12, 2017), available at https://www.justice.gov/opa/press-release/file/925171/download; Plea Agreement, United States v. ABB Inc., No. 4:10-cr-00664 (S.D. Tex. Sept. 29, 2010), available at https://www.justice.gov/sites/default/files/criminal-fraud/legacy/2015/03/05/09-29-10abbinc-plea.pdf; Deferred Prosecution Agreement, United States v. ABB Ltd., No. 4:10-cr-00665 (S.D. Tex. Sept. 29, 2010), available at https://www.justice.gov/sites/default/files/criminal-fraud/legacy/2011/02/16/09-29-10abbjordan-dpa.pdf. [39]   Guidelines § 8C2.5(b). “High-level personnel” are defined as those who have substantial control or policy-making responsibility within the organization or unit (such as directors, executives officers, or the heads of significant units or divisions).  Guidelines § 8A1.2 cmt. n.3(B).  “Substantial authority personnel” are those who “exercise a substantial measure of discretion,” which encompasses “high-level personnel,” individuals who exercise substantial supervisory authority, or non-managerial personnel with a significant degree of discretionary authority, such as those who can negotiate prices or approve significant contracts.  Id. § 8A1.2 cmt. n.3(C).  “Pervasiveness” is described as a sliding scale based on “the number, and degree of responsibility of individuals within substantial authority personnel who participated in, condoned, or were willfully ignorant of the offense.”  Id. § 8C2.5 cmt. n.4. [40]   Id. § 8C2.5, Background note. [41]   See, e.g., Plea Agreement at 8, United States v. Tyco Valves & Controls Middle East, Inc., No. 1:12-cr-00418 (E.D. Va. Sept. 24, 2012), available at https://www.justice.gov/sites/default/files/criminal-fraud/legacy/2012/09/27/2012-09-24-plea-agreement.pdf (one-point enhancement applied for the regional subsidiary of organization, which had only a fraction of the entire organization’s approximate 70,000 employees according to 2012 annual report, available at http://www.tyco.com/uploads/files/tyco_annual-report_2012.pdf); Deferred Prosecution Agreement at 8, United States v. Shell Nigeria Exploration and Prod. Co., No. 4:10-cr-00767 (S.D. Tex. Nov. 4, 2010), ), available at https://www.justice.gov/sites/default/files/criminal-fraud/legacy/2011/02/16/11-04-10snepco-dpa.pdf (three-point enhancement applied for the Nigerian subsidiary of organization, which had only a fraction of the entire organization’s approximate 90,000 employees according to 2011 annual report, available at https://reports.shell.com/annual-report/2011/servicepages/filelibrary/files/collection.php). [42]   Guidelines § 8C2.5(b) (emphasis added). [43]   Guidelines § 8A1.2 cmt. n.3(J). [44]   Global-Tech Appliances, Inc. v. SEB S.A., 563 U.S. 754, 766 & 767 n.7 (2011) (approving “willful ignorance” jury instruction). [45]   543 U.S. 220, 245 (2005) (Breyer, J.) (modifying the federal sentencing statutes so as to render the Guidelines “effectively advisory,” by requiring a sentencing court to consider sentencing ranges, while permitting it to tailor a given sentence in light of other statutory considerations). [46]   Guidelines § 8C2.5(f)(1). [47]   An organization is not eligible for this mitigating factor if it was subject to an enhancement under § 8C2.5(b) based on the involvement, condonation, or willful ignorance of high-level personnel within a unit of 200 or more employees, id. § 8C2.5(f)(3)(A), and is presumptively ineligible if the relevant unit(s) had less than 200 employees or if only substantial authority personnel were implicated, id. § 8C2.5(f)(3)(B).  However, a limited exception is available if non-culpable compliance and ethics personnel identified the problem before it was discovered by outside parties and promptly reported it to the appropriate governmental authorities.  See id. § 8C2.5(f)(3)(C)(iii). [48]   Id. § 8B2.1(a), (b).  These factors are:  (1) established standards and procedures to prevent and detect criminal conduct; (2) the organization’s governing authority must be knowledgeable about the content and function of the program and exercise reasonable oversight, and specific high-level individuals must be assigned responsibility for oversight; (3) reasonable efforts not to give substantial authority to personnel the organization knew or should have known has engaged in illegal or non-compliant activities; (4) reasonable steps to periodically communicate compliance and ethics standards to all staff through training and other forms of dissemination; (5) reasonable monitoring and auditing programs to ensure the compliance and ethics program is followed; (6) consistent promotion and enforcement at all levels of the organization through appropriate incentives and disciplinary measures; and (7) reasonable steps to respond to identified criminal conduct and prevent further such conduct, including by modifying the compliance and ethics program as necessary. [49]   Id. § 8B2.1(a) cmt. n.2. [50]   See note 36 supra. [51]   These factors are: (1) policy considerations, such as the severity of the offense, need to promote respect for the rule of law, deterrence, and the protection of the public from future crimes; (2) the organization’s role in the offense; (3) the potential collateral consequences of a conviction; (4) non-pecuniary losses caused or threatened by the offense; (5) whether the offense involved a vulnerable victim; (6) the prior criminal records of individuals within the high-level personnel of the organization or applicable unit who were involved in the criminal conduct; (7) prior civil or criminal conduct not covered by the prior history enhancement under § 8C2.5(c); (8) if the culpability score is higher than 10 or lower than 0 (meaning the minimum or maximum multiplier is applicable); (9) partial but incomplete satisfaction of the aggravating or mitigating factors under § 8C2.5 which feed into the culpability score; (10) the factors listed at 18 U.S.C. § 3572(a) (which include the defendant’s income and capacity to pay, the burden of the fine on the defendant, the degree of pecuniary loss inflicted on others, the need for restitution or the deprivation of ill-gotten gains, the extent to which the cost of the fine can or will be passed onto consumers or other persons, or the steps taken to discipline culpable employees); and (11) if the organization lacked an effective compliance program at the time of the offense conduct.  Guidelines § 8C2.8(a). [52]   Id. § 8C2.8(b). [53]   As discussed in section 2 below, our review of 119 corporate resolutions involving bribery, AML, sanctions, criminal tax, and currency violations in the past 10 years has determined that of the 82 DPAs and guilty pleas explicitly referencing the placement of the penalty relative to the applicable fine range, 16 (19.5 percent) were placed near or at the bottom of the fine range, and 60 (73.2 percent) received a discount below the low end of the fine range.  Thus, based on our analysis, for nearly 93 percent of all resolutions involving these types of violations, the fine was placed near, or even below, the bottom of the fine range. [54]   Deferred Prosecution Agreement ¶ 9, Ex. C at 7–8, Zürcher Kantonalbank (S.D.N.Y. Aug. 7, 2018), available at https://www.justice.gov/usao-sdny/press-release/file/1086876/download. [55]   Id. at ¶ 9. [56]   This number does not include resolutions where DOJ did not assess a penalty but instead deemed the financial institution’s payment to other regulators sufficient to satisfy any monetary penalty.  This was the structure, for instance of the resolutions in 2011 between DOJ and a number of financial institutions regarding alleged antitrust violations in the municipal reinvestment industry. [57]   It is important to note that other U.S. regulators may order disgorgement or restitution as part of a global settlement even if DOJ does not. [58]   DOJ also entered into NPAs with Red Cedar Services, Inc. and Santee Financial Services for $2,000,000 and $1,000,000, respectively.  See Non-Prosecution Agreement with Red Cedar Services at 2, April 25, 2018, available at https://www.gibsondunn.com/wp-content/uploads/2018/07/Red-Cedar-Services-NPA-2018.pdf; Non-Prosecution Agreement with Santee Financial Services at 2, April 13, 2018, available at  https://www.gibsondunn.com/wp-content/uploads/2018/07/Santee-Financial-Services-NPA-2018.pdf. [59]    Press Release, U.S. Dep’t of Justice, BNP Paribas Agrees to Plead Guilty and to Pay $8.9 Billion for Illegally Processing Financial Transactions for Countries Subject to U.S. Economic Sanctions (June 30, 2014), https://www.justice.gov/opa/pr/bnp-paribas-agrees-plead-guilty-and-pay-89-billion-illegally-processing-financial. [60]    Id. [61]    Plea Agreement at 1, United States v. BNP Paribas S.A., No. 14-cr-00460 (S.D.N.Y. June 27, 2014), BNP Paribas Plea Agreement at 1, June 27, 2014, available at  https://www.justice.gov/sites/default/files/opa/legacy/2014/06/30/plea-agreement.pdf (“BNP Paribas Plea Agreement”). [62]    Id. at 4. [63]     BNP Paribas Agrees to Plead Guilty and to Pay $8.9 Billion for Illegally Processing Financial Transactions for Countries Subject to U.S. Economic Sanctions, U.S. Dep’t of Justice (June 30, 2014), available at https://www.justice.gov/opa/pr/bnp-paribas-agrees-plead-guilty-and-pay-89-billion-illegally-processing-financial. [64]     Id. [65]     Id. [66]     Press Release, U.S. Dep’t of Justice, BNP Paribas Sentenced for Conspiring to Violate the International Emergency Economic Powers Act and the Trading with the Enemy Act (May 1, 2015), https://www.justice.gov/opa/pr/bnp-paribas-sentenced-conspiring-violate-international-emergency-economic-powers-act-and. [67]    Swiss Bank Program, U.S. Dep’t of Justice, available at https://www.justice.gov/tax/swiss-bank-program  (last visited Jan. 8, 2019). [68]   U.S. Dep’t of Justice, Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks, available at https://www.justice.gov/iso/opa/resources/7532013829164644664074.pdf. [69] Id. The Program also included two additional categories.  Categories Three and Four, however, are not relevant for the purposes of this discussion. [70]   Swiss Bank Program, U.S. Dep’t of Justice, available at https://www.justice.gov/tax/swiss-bank-program (last visited Jan. 8, 2019). [71]    Consent Order for a Civil Monetary Penalty, OCC, In re Wells Fargo Bank, N.A. (Apr. 20, 2018), available at https://www.occ.gov/static/enforcement-actions/ea2018-026.pdf. [72]   Consent Order, OCC, In re Capital One, N.A. and Capital One Bank (U.S.A.), N.A. (Oct. 23, 2018), available at https://www.occ.gov/static/enforcement-actions/ea2018-080.pdf. [73]   Id. [74]     Press Release, FRB, Federal Reserve Board Fines Goldman Sachs Group, Inc., $54.75 Million for Unsafe and Unsound Practices in Firm’s Foreign Exchange (FX) Trading Business, (May 8, 2018), https://www.federalreserve.gov/newsevents/pressreleases/enforcement20180501b.htm. [75]   U.S. Dep’t of Justice, Justice Manual §§ 9-28.200, 9-28.300, available at https://www.justice.gov/jm/jm-9-28000-principles-federal-prosecution-business-organizations#9-28.200. [76]   Id. §§ 9-28.700, 9-28.900, available at https://www.justice.gov/jm/jm-9-28000-principles-federal-prosecution-business-organizations#9-28.700. [77]   OCC, Policies and Procedures Manual 5000-7 (Nov. 13, 2018), https://www.occ.gov/publications/publications-by-type/other-publications-reports/ppms/ppm-5000-7.pdf. [78]   Id. at 4. [79]   Id. at 5.   [80]   FDIC, DSC Risk Management Manual of Examination Policies § 14.1, Civil Money Penalties, available at https://www.fdic.gov/regulations/safety/manual/section14-1.pdf. [81]   Justice Manual § 1-12.100, available at https://www.justice.gov/jm/jm-1-12000-coordination-parallel-criminal-civil-regulatory-and-administrative-proceedings#1-12.100.  Although this policy was officially implemented in May 2018, Rosenstein had also already announced DOJ’s efforts to improve coordination in a November 2017 speech.  Rod Rosenstein, Deputy Att’y Gen., Deputy Attorney General Rosenstein Delivers Remarks at the Clearing House’s 2017 Annual Conference (Nov. 8, 2017), https://www.justice.gov/opa/speech/deputy-attorney-general-rosenstein-delivers-remarks-clearing-house-s-2017-annual (announcing DOJ’s efforts to “consider[] proposals to improve coordination” and “help avoid duplicative and unwarranted payments”). [82]   Justice Manual § 1-12.100, available at https://www.justice.gov/jm/jm-1-12000-coordination-parallel-criminal-civil-regulatory-and-administrative-proceedings#1-12.100. [83]   Rod Rosenstein, Deputy Att’y Gen., Deputy Attorney General Rod Rosenstein Delivers Remarks to the New York City Bar White Collar Crime Institute (May 9, 2018), https://www.justice.gov/opa/speech/deputy-attorney-general-rod-rosenstein-delivers-remarks-new-york-city-bar-white-collar. [84]   Press Release, U.S. Dep’t of Justice, Société Générale S.A. Agrees to Pay $860 Million in Criminal Penalties for Bribing Gaddafi-Era Libyan Officials and Manipulating LIBOR Rate (June 4, 2018), https://www.justice.gov/opa/pr/soci-t-g-n-rale-sa-agrees-pay-860-million-criminal-penalties-bribing-gaddafi-era-libyan. [85]   Commissioner Hester M. Peirce, The Why Behind the No: Remarks at the 50th Annual Rocky Mountain Securities Conference (May 11, 2018), https://www.sec.gov/news/speech/peirce-why-behind-no-051118. [86]   Press Release, SEC, SEC Charges Credit Suisse With FCPA Violations (Jul. 5, 2018), https://www.sec.gov/news/press-release/2018-128. [87]   Interagency Coordination of Formal Corrective Action by the Federal Bank Regulatory Agencies, 83 Fed. Reg. 113, 27329 (June 12, 2018), https://www.govinfo.gov/content/pkg/FR-2018-06-12/pdf/2018-12557.pdf. [88]   Press Release, U.S. Dep’t of Justice, Manhattan U.S. Attorney Announces Criminal Charges Against Société Générale S.A. For Violations Of The Trading With The Enemy Act (Nov. 19, 2018), https://www.justice.gov/usao-sdny/pr/manhattan-us-attorney-announces-criminal-charges-against-soci-t-g-n-rale-sa-violations. [89]   OFAC Enforcement Information, Société Générale S.A. Settles Potential Civil Liability for Apparent Violations of Multiple Sanctions Programs (Nov. 19, 2018), https://www.treasury.gov/resource-center/sanctions/CivPen/Documents/20181119_socgen_web.pdf. [90]   In previous OFAC resolutions involving other enforcers, OFAC resolution documents had explicitly noted that penalties (or portions of penalties) were deemed “satisfied” by payments or conditions in agreements with other agencies.  See, e.g.,  OFAC Enforcement Information, National Oilwell Varco, Inc. Settles Potential Civil Liability for Apparent Violations of the Cuban Assets Control Regulations, the Iranian Transactions and Sanctions Regulations, and the Sudanese Sanctions Regulations (Nov. 14, 2016), https://www.treasury.gov/resource-center/sanctions/CivPen/Documents/20161114_varco.pdf.OFAC Enforcement Information, Alcon Laboratories, Inc., Alcon Pharmaceuticals Ltd., and Alcon Management, SA, Settle Potential Civil Liability for Apparent Violations of the Iranian Transactions and Sanctions Regulations and the Sudanese Sanctions Regulations (Jul. 5, 2016),  https://www.treasury.gov/resource-center/sanctions/CivPen/Documents/20160705_alcon.pdf. The following Gibson Dunn attorneys assisted in preparing this client update:  M. Kendall Day, Stephanie L. Brooker, F. Joseph Warin, Carl Kennedy, Chris Jones, Jaclyn Neely, Chantalle Carles Schropp, and Alexander Moss. Gibson Dunn has deep experience with issues relating to the defense of financial institutions, and we have recently increased our financial institutions defense and AML capabilities with the addition to our partnership of M. Kendall Day. Kendall joined Gibson Dunn in May 2018, having spent 15 years as a white collar prosecutor, most recently as an Acting Deputy Assistant Attorney General, the highest level of career official in DOJ’s Criminal Division. For his last three years at DOJ, Kendall exercised nationwide supervisory authority over every BSA and money-laundering charge, DPA and NPA involving every type of financial institution. Kendall joined Stephanie Brooker, a former Director of the Enforcement Division at FinCEN and a former federal prosecutor and Chief of the Asset Forfeiture and Money Laundering Section for the U.S. Attorney’s Office for the District of Columbia, who serves as Co-Chair of the Financial Institutions Practice Group and a member of White Collar Defense and Investigations Practice Group. Kendall and Stephanie practice with a Gibson Dunn network of more than 50 former federal prosecutors in domestic and international offices around the globe. For assistance navigating white collar or regulatory enforcement issues involving financial institutions, please contact any Gibson Dunn attorney with whom you work, or any of the following leaders and members of the firm’s White Collar Defense and Investigations and Financial Institutions practice groups: Washington, D.C. F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) Richard W. Grime (+1 202-955-8219, rgrime@gibsondunn.com) Patrick F. 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November 21, 2018 |
Gibson Dunn Ranked in the 2019 UK Legal 500

The UK Legal 500 2019 ranked Gibson Dunn in 13 practice areas and named six partners as Leading Lawyers. The firm was recognized in the following categories: Corporate and Commercial: Equity Capital Markets Corporate and Commercial: M&A – Upper Mid-Market and Premium Deals, £250m+ Corporate and Commercial: Private Equity – High-value Deals Dispute Resolution: Commercial Litigation Dispute Resolution: International Arbitration Finance: Acquisition Finance Finance: Bank Lending: Investment Grade Debt and Syndicated Loans Human Resources: Employment – Employers Public Sector: Administrative and Public Law Real Estate: Commercial Property – Hotels and Leisure Real Estate: Commercial Property – Investment Real Estate: Property Finance Risk Advisory: Regulatory Investigations and Corporate Crime The partners named as Leading Lawyers are Sandy Bhogal – Corporate and Commercial: Corporate Tax; Steve Thierbach – Corporate and Commercial: Equity Capital Markets; Philip Rocher – Dispute Resolution: Commercial Litigation; Cyrus Benson – Dispute Resolution: International Arbitration; Jeffrey Sullivan – Dispute Resolution: International Arbitration; and Alan Samson – Real Estate: Commercial Property and Real Estate: Property Finance. Claibourne Harrison has also been named as a Next Generation Lawyer for Real Estate: Commercial Property.

November 19, 2018 |
Brexit – The Draft Divorce Deal and Its Fall-Out

Click for PDF 1. Negotiators for the European Union and the United Kingdom have agreed a 585-page draft withdrawal agreement (the “Withdrawal Agreement”).  A copy of the Withdrawal Agreement can be found here. 2. The draft Withdrawal Agreement sets out how and when the UK will leave the EU and will be legally binding.  A separate, non-binding draft declaration (available here) sets out the aspirations for the future trading relationship between the UK and EU (this draft declaration is still being negotiated, with the UK and EU expected to agree a final draft this week). 3. This long-awaited “divorce deal” has been agreed by the UK Government’s senior ministers (the Cabinet) but it now needs to be approved by MPs in the UK House of Commons and by the 27 other EU member states and the European Parliament. Next steps 4. An EU summit is currently due to be held on 25 November 2018, where EU 27 leaders are expected to sign off on the Withdrawal Agreement and the future relationship declaration. 5. Following the EU meeting the deal will be put to the House of Commons in the UK Parliament for a “meaningful vote”. It is not yet clear what the motion will be nor what amendments will be permitted.  But, for all practical purposes, it is a critical vote to approve the deal. 6. The House of Commons vote is expected around 7 December 2018 and at present it looks unlikely that the vote will be passed.  That could change if amendments are agreed to the Withdrawal Agreement or future relationship declaration. 7. If the House of Commons votes the deal down, the Government will have up to 21 days to put forward a new plan.  Any new agreement would need to be agreed with the EU. 8. Two of the key issues relate to (i) the circumstances in which the UK can withdraw from the transition arrangements and whether it can do so without an EU veto and (ii) whether Northern Ireland will have a different regulatory regime to the rest of the UK, creating a border down the Irish Sea.  “Backstop” arrangements are in place to prevent that happening but there is a lack of consensus over whether those arrangements are good enough.  The political debate in the UK is focused on whether improvements can be made to the provisions relating to these two issues in particular.  The EU position is that no changes of substance will be allowed but “some tweaking” of the language in the political declaration may be possible. Some of the EU 27 countries are also thought to be considering comments. 9. The UK Cabinet backed the divorce deal.  However, two cabinet ministers and two junior ministers subsequently resigned, including the Brexit secretary Dominic Raab.  New cabinet appointments have been made, including one Brexit supporter and one Remain supporter. 10. A number of leading backbench Conservative Party MPs have called for the Prime Minister to stand down, and are seeking to move for a vote of no confidence in her leadership of the Conservative Party.  A challenge is triggered if 15% of Conservative MPs (48 in total) write letters to the Party’s Chief Whip demanding a confidence vote.  As of today, at least 24 MPs have publicly confirmed they have submitted letters.  If a confidence vote is called, then it is passed if a simple majority of Conservative MPs vote in favour.  It is not clear that this will happen and, if Theresa May wins, the rules then prevent another vote of confidence for twelve months.  If she lost, there would be a separate process to elect a new leader but Theresa May, or a caretaker, would remain as Prime Minister until a new leader was elected. Content of Withdrawal Agreement 11. The UK is due to leave the EU at 11 pm on Friday 29 March 2019 (midnight CET on 30 March 2019).  The Withdrawal Agreement sets out the terms of the UK’s departure from the EU: Transition period: The Withdrawal Agreement proposes a 21-month transition period after the UK’s departure at the end of March 2019.  That end date can be extended once if more time is needed for a trade deal to be secured and to avoid the UK entering into the backstop (see below).  The draft Withdrawal Agreement does not yet give a specific end-date for this extension, stating only that it will end by “20xx”. Governance: During the transition period, and if the transition period is extended into a backstop, the UK will have to follow all EU rules and abide by Court of Justice of the European Union (CJEU) rulings.  Opponents argue this leaves the UK as a rule taker and no longer a rule maker. Financial arrangement: The Withdrawal Agreement does not specify the “divorce bill” but additional notes provided by the Government estimate a “fair financial settlement” of around £39 billion from the UK.  This covers financial liabilities accrued but not yet paid during the UK’s membership of the EU and payments to be made to the EU Budget during the transition period. Future trading relations: The Withdrawal Agreement does not include a trade deal, which will be hammered out in the transition period.  Under the Withdrawal Agreement, there will be a “single customs territory” until the end of the transition period on 31 December 2020.  The UK will then remain indefinitely in a customs union with the EU if a new trade agreement is not reached in that time.  This arrangement is intended to avoid a “hard border” between Northern Ireland and the Republic of Ireland – see below.  Among the political difficulties with this proposed arrangement is that a customs union is, along with the single market, essentially one of the key structures of the EU, and remaining in such a customs union is likely to be characterised as hollowing out the whole purpose of Brexit. Northern Ireland backstop: The management of the flow of goods and people across the Irish land border, and between Northern Ireland and the UK, have become critical issues in the Brexit debate and negotiations.  Both sides want to avoid a “hard border” (physical checks or infrastructure between Northern Ireland and Ireland), and a key part of the negotiations for the Withdrawal Agreement has been agreeing the position of last resort in the event that the UK leaves the EU without securing an all-encompassing deal (the so-called “backstop”).  The agreed backstop would involve Northern Ireland being in the same customs territory as the rest of the UK and the EU.  It would, however, mean different (EU) regulations for Northern Ireland in agriculture, the environment, state aid and other areas.  There would also be checks on goods traded from Northern Ireland to the rest of the UK.  The agreement states that the EU and the UK will use their “best endeavours” to come to a future trade agreement to avoid the backstop, and notes the transition period can also be extended.  While this arrangement can likely command the support of the other 27 EU member states, including, critically, the Republic of Ireland, the fact that it creates trade barriers, however technical, between Northern Ireland and Great Britain is likely to render it unacceptable to a large minority of Conservative MPs and to the DUP. Exiting the backstop: There will be no unilateral right of withdrawal from any backstop arrangement and Britain will not be able to implement free trade deals during this time.  It can request to pull out, but the final decision will rest with an independent arbitration panel with members nominated by both sides: two from the UK-side, two from the EU-side and one chairperson agreed by both parties. Immigration: EU nationals who have lived in the UK continually for five years, and UK citizens who have lived in EU countries, will have the right to stay permanently in the UK (or the EU, as the case may be), along with their family members.  Free movement of workers between the EU and UK will come to an end, although there will be visa-free travel to EU countries. Conclusion 12. Some UK business leaders and senior City figures have backed the deal as a significant breakthrough in Brexit negotiations.  If Brexit is to happen, many businesses will be pleased that the Withdrawal Agreement offers at least a foundation for moving forward.  Other commentators are critical of the “half-way house” set out in the Withdrawal Agreement and doubt whether Theresa May’s strategy can hold.  EU negotiations typically go right to the wire but the political state in the UK remains volatile while this plays out and there can be no certainty of outcome. This client alert was prepared by London partners Nicholas Aleksander, Patrick Doris and Charlie Geffen and of counsel Anne MacPherson. We have a working group in London (led by Nicholas Aleksander, Patrick Doris, Charlie Geffen, Ali Nikpay and Selina Sagayam) addressing Brexit related issues.  Please feel free to contact any member of the working group or any of the other lawyers mentioned below. Ali Nikpay – Antitrust ANikpay@gibsondunn.com Tel: 020 7071 4273 Charlie Geffen – Corporate CGeffen@gibsondunn.com Tel: 020 7071 4225 Nicholas Aleksander – Tax NAleksander@gibsondunn.com Tel: 020 7071 4232 Philip Rocher – Litigation PRocher@gibsondunn.com Tel: 020 7071 4202 Jeffrey M. Trinklein – Tax JTrinklein@gibsondunn.com Tel: 020 7071 4224 Patrick Doris – Litigation; Data Protection PDoris@gibsondunn.com Tel:  020 7071 4276 Alan Samson – Real Estate ASamson@gibsondunn.com Tel:  020 7071 4222 Penny Madden QC – Arbitration PMadden@gibsondunn.com Tel:  020 7071 4226 Selina Sagayam – Corporate SSagayam@gibsondunn.com Tel:  020 7071 4263 Thomas M. Budd – Finance TBudd@gibsondunn.com Tel:  020 7071 4234 James A. Cox – Employment; Data Protection JCox@gibsondunn.com Tel: 020 7071 4250 Gregory A. Campbell – Restructuring GCampbell@gibsondunn.com Tel:  020 7071 4236 © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 15, 2018 |
SEC Announces First Enforcement Action Against Digital Token Platform as Unregistered Securities Exchange

Click for PDF On November 8, 2018, the U.S. Securities and Exchange Commission (SEC) announced that it had taken its first enforcement action against a digital “token” trading platform on the basis that the platform operated as an unregistered national securities exchange.  This action follows on a number of recent enforcement actions relating to unregistered broker-dealers and unregistered initial coin offerings (ICOs) and demonstrates that the SEC continues to be vigilant in the area of digital tokens. In its Order accepting an offer of settlement,[1] the SEC found that EtherDelta founder, Zachary Coburn, caused the EtherDelta platform to operate as an unregistered national securities exchange in violation of Section 5 of the Securities Exchange Act of 1934 (Exchange Act).  EtherDelta is an online platform that allows buyers and sellers to trade digital assets issued and distributed on the Ethereum Blockchain that use the standard coding protocol (ERC20) used by the majority of issuers in ICOs.  Coburn launched the website in July 2016; it made limited token pairs available for trading (particular tokens for Ether only) and displayed current top 500 firm bids and offers by symbol, price, and size.  Users could therefore enter orders to buy or sell specified quantities of a particular token at a specified Ether price and with a specified time-in-force. The SEC noted that in July 2017, it had issued its Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 on The DAO (DAO Report).  The DAO Report had advised that if a platform offered the trading of digital assets that are securities and operates as an “exchange” under the federal securities laws, then it must register as an exchange or be able to claim an exemption from registration.  It further noted that 3.3  million buy and sell orders in ERC20 tokens were processed on EtherDelta between the issuance of the DAO Report and December 15, 2017.[2]  The EtherDelta platform was available to anyone, including U.S. persons, and had no limits on its hours of operation.  Certain of the tokens traded were securities within the meaning of the federal securities laws. The SEC further asserted that Coburn was responsible for performing due diligence on the tokens traded before those tokens were added to EtherDelta’s list of official token listings – a list that included approximately 500 tokens. Under Exchange Act Rule 3b-16(a), a platform will be considered to be an exchange if the platform “(1) brings together the orders for securities of multiple buyers and sellers; and (2) uses established non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of the trade.”[3]  If a platform is an exchange, it must register with the SEC or have an exemption, such as for an alternative trading system (ATS). The SEC stated that EtherDelta satisfied the Rule 3b-16(a) criteria in that it “receiv[ed] and stor[ed] orders in tokens in [its] order book and display[ed] the top 500 orders (including token symbol, size, and price) as bids and offers” on its website.  The platform was the means “for these orders to interact and execute through the combined use of the EtherDelta website, order book, and pre-programmed trading protocols” defined in the platform’s smart contract – which were “established, non-discretionary methods” within the meaning of Rule 3b-16(a).  In addition, certain of the tokens were securities under the Howey test:  purchasers invested money with a reasonable expectation of profits, including through the increased value of their investments in secondary trading, based on the managerial efforts of others. Because EtherDelta did not register as a national securities exchange or operate pursuant to an exemption, it violated Section 5 of the Exchange Act.  Coburn, as the founder of EtherDelta, should have known that his actions would contribute to EtherDelta’s violations, and thus he caused EtherDelta’s violations within the meaning of Section 21C(a) of the Exchange Act. In settling the action, Coburn agreed to pay disgorgement of $300,000 plus prejudgment interest.  In addition, the SEC imposed a $75,000 civil money penalty.  The order notes that Coburn cooperated in the investigation and agreed to testify in any related enforcement action, suggesting that the civil money penalty would have been higher absent this co-operation. Conclusion The EtherDelta action demonstrates that the SEC continues to keep a watchful eye on ICO and token offerings, and that it believes that it put participants in these markets on notice when it issued the DAO Report in July 2017.  In addition, just as the order does not indicate precisely how many of the EtherDelta tokens were securities under the Howey test, it also does not contain any mention of the extent or quality of Coburn’s diligence under Howey – his civil money penalty appears to have been low due to his cooperation with the SEC alone.  The action is the first unregistered securities exchange action taken by the SEC, but it may well not be the last.  Given the continued vigilance of the SEC, it is to be expected that more and more firms will seek to buy or establish ATSs for token trading, because this exemption from registration as a national securities exchange is clearly available for tokens that are securities under Howey.    [1]   In the Matter of Zachary Coburn, Respondent (November 8, 2018), available at https://www.sec.gov/news/press-release/2018-258.    [2]   Coburn entered into an agreement to sell EtherDelta to non-U.S. buyers in November 2017.    [3]   17 C.F.R. § 240.3b-16(a) (emphasis added). The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long, Alan Bannister, Nicolas Dumont, Michael Mencher, and Jordan Garside. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions, Capital Markets or Securities Enforcement practice groups, or the following: Financial Institutions and Capital Markets Groups: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) J. Alan Bannister – New York (+1 212-351-2310, abannister@gibsondunn.com) Nicolas H.R. Dumont – New York (+1 212-351-3837, ndumont@gibsondunn.com) Stewart L. McDowell – San Francisco (+1 415-393-8322, smcdowell@gibsondunn.com) Michael A. Mencher – New York (+1 212-351-5309, mmencher@gibsondunn.com) Securities Enforcement Group: Marc J. Fagel – San Francisco (+1 415-393-8332, mfagel@gibsondunn.com) Mark K. Schonfeld – New York (+1 212-351-2433, mschonfeld@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 30, 2018 |
Webcast: Spinning Out and Splitting Off – Navigating Complex Challenges in Corporate Separations

In the current strong market environment, spin-off deals have become a regular feature of the M&A landscape as strategic companies look for ways to maximize the value of various assets. Although the announcements have become routine, planning for and completing these transactions is a significant and multi-disciplinary undertaking. By its nature, a spin-off is at least a 3-in-1 transaction starting with the reorganization and carveout of the assets to be separated, followed by the negotiation of separation-related documents and finally the offering of the securities—and that does not even account for the significant tax, corporate governance, finance, IP and employee benefits aspects of the transaction. In this program, a panel of lawyers from a number of these key practice areas provided insights based on their recent experience structuring and executing spin-off transactions. They walked through the hot topics, common issues and potential work-arounds. View Slides (PDF) PANELISTS: Daniel Angel is a partner in Gibson Dunn’s New York office, Co-Chair of the firm’s Technology Transactions Practice Group and a member of its Strategic Sourcing and Commercial Transactions Practice Group. He is a transactional attorney who has represented clients on technology-related transactions since 2003. Mr. Angel has worked with a broad variety of clients ranging from market leaders to start-ups in a wide range of industries including financial services, private equity funds, life sciences, specialty chemicals, insurance, energy and telecommunications. Michael J. Collins is a partner in Gibson Dunn’s Washington, D.C. office and Co-Chair of the Executive Compensation and Employee Benefits Practice Group. His practice focuses on all aspects of employee benefits and executive compensation. He represents buyers and sellers in corporate transactions and companies in drafting and negotiating employment and equity compensation arrangements. Andrew L. Fabens is a partner in Gibson Dunn’s New York office, Co-Chair of the firm’s Capital Markets Practice Group and a member of the firm’s Securities Regulation and Corporate Governance Practice Group. Mr. Fabens advises companies on long-term and strategic capital planning, disclosure and reporting obligations under U.S. federal securities laws, corporate governance issues and stock exchange listing obligations. He represents issuers and underwriters in public and private corporate finance transactions, both in the United States and internationally. Stephen I. Glover is a partner in Gibson Dunn’s Washington, D.C. office and Co-Chair of the firm’s Mergers and Acquisitions Practice Group. Mr. Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, including spin-offs and related transactions, as well as other corporate matters. Mr. Glover’s clients include large public corporations, emerging growth companies and middle market companies in a wide range of industries. He also advises private equity firms, individual investors and others. Elizabeth A. Ising is a partner in Gibson Dunn’s Washington, D.C. office, Co-Chair of the firm’s Securities Regulation and Corporate Governance Practice Group and a member of the firm’s Hostile M&A and Shareholder Activism team and Financial Institutions Practice Group. She advises clients, including public companies and their boards of directors, on corporate governance, securities law and regulatory matters and executive compensation best practices and disclosures. Saee Muzumdar is a partner in Gibson Dunn’s New York office and a member of the firm’s Mergers and Acquisitions Practice Group. Ms. Muzumdar is a corporate transactional lawyer whose practice includes representing both strategic companies and private equity clients (including their portfolio companies) in connection with all aspects of their domestic and cross-border M&A activities and general corporate counseling. Daniel A. Zygielbaum is an associate in Gibson Dunn’s Washington, D.C. office and a member of the firm’s Tax and Real Estate Investment Trust (REIT) Practice Groups. Mr. Zygielbaum’s practice focuses on international and domestic taxation of corporations, partnerships (including private equity funds), limited liability companies, REITs and their debt and equity investors. He advises clients on tax planning for fund formations and corporate and real estate acquisitions, dispositions, reorganizations and joint ventures. MCLE CREDIT INFORMATION: This program has been approved for credit in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 1.50 credit hours, of which 1.50 credit hours may be applied toward the areas of professional practice requirement. This course is approved for transitional/non-transitional credit. Attorneys seeking New York credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. This program has been approved for credit in accordance with the requirements of the Texas State Bar for a maximum of 1.50 credit hours, of which 1.50 credit hour may be applied toward the area of accredited general requirement. Attorneys seeking Texas credit must obtain an Affirmation Form prior to watching the archived version of this webcast. Please contact Jeanine McKeown (National Training Administrator), at 213-229-7140 or jmckeown@gibsondunn.com to request the MCLE form. Gibson, Dunn & Crutcher LLP certifies that this activity has been approved for MCLE credit by the State Bar of California in the amount of 1.50 hours. California attorneys may claim “self-study” credit for viewing the archived version of this webcast. No certificate of attendance is required for California “self-study” credit.

October 22, 2018 |
IRS Provides Much Needed Guidance on Opportunity Zones through Issuance of Proposed Regulations

Click for PDF On October 19, 2018, the Internal Revenue Service (the “IRS“) and the Treasury Department issued proposed regulations (the “Proposed Regulations“) providing rules regarding the establishment and operation of “qualified opportunity funds” and their investment in “opportunity zones.”[1]  The Proposed Regulations address many open questions with respect to qualified opportunity funds, while expressly providing in the preamble that additional guidance will be forthcoming to address issues not resolved by the Proposed Regulations.  The Proposed Regulations should provide investors, sponsors and developers with the answers needed to move forward with projects in opportunity zones. Opportunity Zones Qualified opportunity funds were created as part of the tax law signed into law in December 2017 (commonly known as the Tax Cuts and Jobs Act (“TCJA“)) to incentivize private investment in economically underperforming areas by providing tax benefits for investments through qualified opportunity funds in opportunity zones.  Opportunity zones are low-income communities that were designated by each of the States as qualified opportunity zones – as of this writing, all opportunity zones have been designated, and each designation remains in effect from the date of designation until the end of the tenth year after such designation. Investments in qualified opportunity funds can qualify for three principal tax benefits: (i) a temporary deferral of capital gains that are reinvested in a qualified opportunity fund, (ii) a partial exclusion of those reinvested capital gains on a sliding scale and (iii) a permanent exclusion of all gains realized on an investment in a qualified opportunity fund that is held for a ten-year period. In general, all capital gains realized by a person that are reinvested within 180 days of the recognition of such gain in a qualified opportunity fund for which an election is made are deferred for U.S. federal income tax purposes until the earlier of (i) the date on which such investment is sold or exchanged and (ii) December 31, 2026. In addition, an investor’s tax basis in a qualified opportunity fund for purposes of determining gain or loss, is increased by 10 percent of the amount of gain deferred if the investment is held for five years prior to December 31, 2026 and is increased by an additional 5 percent (for a total increase of 15 percent) of the amount of gain deferred if the investment is held for seven years prior to December 31, 2026. Finally, for investments in a qualified opportunity fund that are attributable to reinvested capital gains and held for at least 10 years, the basis of such investment is increased to the fair market value of the investment on the date of the sale or exchange of such investment, effectively eliminating any gain (other than the deferred gain that was reinvested in the qualified opportunity fund and taxable or excluded as described above) in the investment for U.S. federal income tax purposes (such benefit, the “Ten Year Benefit“). A qualified opportunity fund, in general terms, is a corporation or partnership that invests at least 90 percent of its assets in “qualified opportunity zone property,” which is defined under the TCJA as “qualified opportunity zone business property,” “qualified opportunity zone stock” and “qualified opportunity zone partnership interests.”  Qualified opportunity zone business property is tangible property used in a trade or business within an opportunity zone if, among other requirements, (i) the property is acquired by the qualified opportunity fund by purchase, after December 31, 2017, from an unrelated person, (ii) either the original use of the property in the opportunity zone commences with the qualified opportunity fund or the qualified opportunity fund “substantially improves” the property by doubling the basis of the property over any 30 month period after the property is acquired and (iii) substantially all of the use of the property is within an opportunity zone.  Essentially, qualified opportunity zone stock and qualified opportunity zone partnership interests are stock or interests in a corporation or partnership acquired in a primary issuance for cash after December 31, 2017 and where “substantially all” of the tangible property, whether leased or owned, of the corporation or partnership is qualified opportunity zone business property. The Proposed Regulations – Summary and Observations The powerful tax incentives provided by opportunity zones attracted substantial interest from investors and the real estate community, but many unresolved questions have prevented some taxpayers from availing themselves of the benefits of the law.  A few highlights from the Proposed Regulations, as well as certain issues that were not resolved, are outlined below. Capital Gains The language of the TCJA left open the possibility that both capital gains and ordinary gains (e.g., dealer income) could qualify for deferral if invested in a qualified opportunity fund.  The Proposed Regulations provide that only capital gains, whether short-term or long-term, qualify for deferral if invested in a qualified opportunity fund and further provide that when recognized, any deferred gain will retain its original character as short-term or long-term. Taxpayer Entitled to Deferral The Proposed Regulations make clear that if a partnership recognizes capital gains, then the partnership, and if the partnership does not so elect, the partners, may elect to defer such capital gains.  In addition, the Proposed Regulations provide that in measuring the 180-day period by which capital gains need to be invested in a qualified opportunity fund, the 180-day period for a partner begins on the last day of the partnership’s taxable year in which the gain is recognized, or if a partner elects, the date the partnership recognized the gain.  The Proposed Regulations also state that rules analogous to the partnership rules apply to other pass-through entities, such as S corporations. Ten Year Benefit The Ten Year Benefit attributable to investments in qualified opportunity funds will be realized only if the investment is held for 10 years.  Because all designations of qualified opportunity zones under the TCJA automatically expire no later than December 31, 2028, there was some uncertainly as to whether the Ten Year Benefit applied to investments disposed of after that date.  The Proposed Regulations expressly provide that the Ten Year Benefit rule applies to investments disposed of prior to January 1, 2048. Qualified Opportunity Funds The Proposed Regulations generally provide that a qualified opportunity fund is required to be classified as a corporation or partnership for U.S. federal income tax purposes, must be created or organized in one of the 50 States, the District of Columbia, or, in certain cases a U.S. possession, and will be entitled to self-certify its qualification to be a qualified opportunity fund on an IRS Form 8996, a draft form of which was issued contemporaneously with the issuance of the Proposed Regulations. Substantial Improvements Existing buildings in qualified opportunity zones generally will qualify as qualified opportunity zone business property only if the building is substantially improved, which requires the tax basis of the building to be doubled in any 30-month period after the property is acquired.  In very helpful rule for the real estate community, the Proposed Regulations provide that, in determining whether a building has been substantially improved, any basis attributable to land will not be taken into account.  This rule will allow major renovation projects to qualify for qualified opportunity zone tax benefits, rather than just ground up development.  This rule will also place a premium on taxpayers’ ability to sustain a challenge to an allocation of purchase price to land versus improvements. Ownership of Qualified Opportunity Zone Business Property In order for a fund to qualify as a qualified opportunity fund, at least 90 percent of the fund’s assets must be invested in qualified opportunity zone property, which includes qualified opportunity zone business property.  For shares or interests in a corporation or partnership to qualify as qualified opportunity zone stock or a qualified opportunity zone partnership interest, “substantially all” of the corporation’s or partnership’s assets must be comprised of qualified opportunity zone business property. In a very helpful rule, the Proposed Regulations provide that cash and other working capital assets held for up to 31 months will count as qualified opportunity zone business property, so long as (i) the cash and other working capital assets are held for the acquisition, construction and/or or substantial improvement of tangible property in an opportunity zone, (ii) there is a written plan that identifies the cash and other working capital as held for such purposes, and (iii) the cash and other working capital assets are expended in a manner substantially consistent with that plan. In addition, the Proposed Regulations provide that for purposes of determining whether “substantially all” of a corporation’s or partnership’s tangible property is qualified opportunity zone business property, only 70 percent of the tangible property owned or leased by the corporation or partnership in its trade or business must be qualified opportunity zone business property. Qualified Opportunity Funds Organized as Tax Partnerships Under general partnership tax principles, when a partnership borrows money, the partners are treated as contributing money to the partnership for purposes of determining their tax basis in their partnership interest.  As a result of this rule, there was uncertainty regarding whether investments by a qualified opportunity fund that were funded with debt would result in a partner being treated, in respect of the deemed contribution of money attributable to such debt, as making a contribution to the partnership that was not in respect of reinvested capital gains and, thus, resulting in a portion of such partner’s investment in the qualified opportunity fund failing to qualify for the Ten Year Benefit.  The Proposed Regulations expressly provide that debt incurred by a qualified opportunity fund will not impact the portion of a partner’s investment in the qualified opportunity fund that qualifies for the Ten Year Benefit. The Proposed Regulations did not address many of the other open issues with respect to qualified opportunity funds organized as partnerships, including whether investors are treated as having sold a portion of their interest in a qualified opportunity fund and thus can enjoy the Ten Year Benefit if a qualified opportunity fund treated as a partnership and holding multiple investments disposes of one or more (but not all) of its investments.  Accordingly, until further guidance is issued, we expect to see most qualified opportunity funds organized as single asset corporations or partnerships. Effective Date In general, taxpayers are permitted to rely upon the Proposed Regulations so long as they apply the Proposed Regulations in their entirety and in a consistent manner.    [1]   Prop. Treas. Reg. §1.1400Z-2 (REG-115420-18). Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these developments.  For further information, please contact the Gibson Dunn lawyer with whom you usually work, any member of the Tax Practice Group, or the following authors: Brian W. Kniesly – New York (+1 212-351-2379, bkniesly@gibsondunn.com) Paul S. Issler – Los Angeles (+1 213-229-7763, pissler@gibsondunn.com) Daniel A. Zygielbaum – New York (+1 202-887-3768, dzygielbaum@gibsondunn.com) Please also feel free to contact any of the following leaders and members of the Tax practice group: Jeffrey M. Trinklein – Co-Chair, London/New York (+44 (0)20 7071 4224 / +1 212-351-2344), jtrinklein@gibsondunn.com) David Sinak – Co-Chair, Dallas (+1 214-698-3107, dsinak@gibsondunn.com) David B. Rosenauer – New York (+1 212-351-3853, drosenauer@gibsondunn.com) Eric B. Sloan – New York (+1 212-351-2340, esloan@gibsondunn.com) Romina Weiss – New York (+1 212-351-3929, rweiss@gibsondunn.com) Benjamin Rippeon – Washington, D.C. (+1 202-955-8265, brippeon@gibsondunn.com) Hatef Behnia – Los Angeles (+1 213-229-7534, hbehnia@gibsondunn.com) Dora Arash – Los Angeles (+1 213-229-7134, darash@gibsondunn.com) Scott Knutson – Orange County (+1 949-451-3961, sknutson@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 17, 2018 |
SEC Warns Public Companies on Cyber-Fraud Controls

Click for PDF On October 16, 2018, the Securities and Exchange Commission issued a report warning public companies about the importance of internal controls to prevent cyber fraud.  The report described the SEC Division of Enforcement’s investigation of multiple public companies which had collectively lost nearly $100 million in a range of cyber-scams typically involving phony emails requesting payments to vendors or corporate executives.[1] Although these types of cyber-crimes are common, the Enforcement Division notably investigated whether the failure of the companies’ internal accounting controls to prevent unauthorized payments violated the federal securities laws.  The SEC ultimately declined to pursue enforcement actions, but nonetheless issued a report cautioning public companies about the importance of devising and maintaining a system of internal accounting controls sufficient to protect company assets. While the SEC has previously addressed the need for public companies to promptly disclose cybersecurity incidents, the new report sees the agency wading into corporate controls designed to mitigate such risks.  The report encourages companies to calibrate existing internal controls, and related personnel training, to ensure they are responsive to emerging cyber threats.  The report (issued to coincide with National Cybersecurity Awareness Month) clearly intends to warn public companies that future investigations may result in enforcement action. The Report of Investigation Section 21(a) of the Securities Exchange Act of 1934 empowers the SEC to issue a public Report of Investigation where deemed appropriate.  While SEC investigations are confidential unless and until the SEC files an enforcement action alleging that an individual or entity has violated the federal securities laws, Section 21(a) reports provide a vehicle to publicize investigative findings even where no enforcement action is pursued.  Such reports are used sparingly, perhaps every few years, typically to address emerging issues where the interpretation of the federal securities laws may be uncertain.  (For instance, recent Section 21(a) reports have addressed the treatment of digital tokens as securities and the use of social media to disseminate material corporate information.) The October 16 report details the Enforcement Division’s investigations into the internal accounting controls of nine issuers, across multiple industries, that were victims of cyber-scams. The Division identified two specific types of cyber-fraud – typically referred to as business email compromises or “BECs” – that had been perpetrated.  The first involved emails from persons claiming to be unaffiliated corporate executives, typically sent to finance personnel directing them to wire large sums of money to a foreign bank account for time-sensitive deals. These were often unsophisticated operations, textbook fakes that included urgent, secret requests, unusual foreign transactions, and spelling and grammatical errors. The second type of business email compromises were harder to detect. Perpetrators hacked real vendors’ accounts and sent invoices and requests for payments that appeared to be for otherwise legitimate transactions. As a result, issuers made payments on outstanding invoices to foreign accounts controlled by impersonators rather than their real vendors, often learning of the scam only when the legitimate vendor inquired into delinquent bills. According to the SEC, both types of frauds often succeeded, at least in part, because responsible personnel failed to understand their company’s existing cybersecurity controls or to appropriately question the veracity of the emails.  The SEC explained that the frauds themselves were not sophisticated in design or in their use of technology; rather, they relied on “weaknesses in policies and procedures and human vulnerabilities that rendered the control environment ineffective.” SEC Cyber-Fraud Guidance Cybersecurity has been a high priority for the SEC dating back several years. The SEC has pursued a number of enforcement actions against registered securities firms arising out of data breaches or deficient controls.  For example, just last month the SEC brought a settled action against a broker-dealer/investment-adviser which suffered a cyber-intrusion that had allegedly compromised the personal information of thousands of customers.  The SEC alleged that the firm had failed to comply with securities regulations governing the safeguarding of customer information, including the Identity Theft Red Flags Rule.[2] The SEC has been less aggressive in pursuing cybersecurity-related actions against public companies.  However, earlier this year, the SEC brought its first enforcement action against a public company for alleged delays in its disclosure of a large-scale data breach.[3] But such enforcement actions put the SEC in the difficult position of weighing charges against companies which are themselves victims of a crime.  The SEC has thus tried to be measured in its approach to such actions, turning to speeches and public guidance rather than a large number of enforcement actions.  (Indeed, the SEC has had to make the embarrassing disclosure that its own EDGAR online filing system had been hacked and sensitive information compromised.[4]) Hence, in February 2018, the SEC issued interpretive guidance for public companies regarding the disclosure of cybersecurity risks and incidents.[5]  Among other things, the guidance counseled the timely public disclosure of material data breaches, recognizing that such disclosures need not compromise the company’s cybersecurity efforts.  The guidance further discussed the need to maintain effective disclosure controls and procedures.  However, the February guidance did not address specific controls to prevent cyber incidents in the first place. The new Report of Investigation takes the additional step of addressing not just corporate disclosures of cyber incidents, but the procedures companies are expected to maintain in order to prevent these breaches from occurring.  The SEC noted that the internal controls provisions of the federal securities laws are not new, and based its report largely on the controls set forth in Section 13(b)(2)(B) of the Exchange Act.  But the SEC emphasized that such controls must be “attuned to this kind of cyber-related fraud, as well as the critical role training plays in implementing controls that serve their purpose and protect assets in compliance with the federal securities laws.”  The report noted that the issuers under investigation had procedures in place to authorize and process payment requests, yet were still victimized, at least in part “because the responsible personnel did not sufficiently understand the company’s existing controls or did not recognize indications in the emailed instructions that those communications lacked reliability.” The SEC concluded that public companies’ “internal accounting controls may need to be reassessed in light of emerging risks, including risks arising from cyber-related frauds” and “must calibrate their internal accounting controls to the current risk environment.” Unfortunately, the vagueness of such guidance leaves the burden on companies to determine how best to address emerging risks.  Whether a company’s controls are adequate may be judged in hindsight by the Enforcement Division; not surprisingly, companies and individuals under investigation often find the staff asserting that, if the controls did not prevent the misconduct, they were by definition inadequate.  Here, the SEC took a cautious approach in issuing a Section 21(a) report highlighting the risk rather than publicly identifying and penalizing the companies which had already been victimized by these scams. However, companies and their advisors should assume that, with this warning shot across the bow, the next investigation of a similar incident may result in more serious action.  Persons responsible for designing and maintaining the company’s internal controls should consider whether improvements (such as enhanced trainings) are warranted; having now spoken on the issue, the Enforcement Division is likely to view corporate inaction as a factor in how it assesses the company’s liability for future data breaches and cyber-frauds.    [1]   SEC Press Release (Oct. 16, 2018), available at www.sec.gov/news/press-release/2018-236; the underlying report may be found at www.sec.gov/litigation/investreport/34-84429.pdf.    [2]   SEC Press Release (Sept. 16, 2018), available at www.sec.gov/news/press-release/2018-213.  This enforcement action was particularly notable as the first occasion the SEC relied upon the rules requiring financial advisory firms to maintain a robust program for preventing identify theft, thus emphasizing the significance of those rules.    [3]   SEC Press Release (Apr. 24, 2018), available at www.sec.gov/news/press-release/2018-71.    [4]   SEC Press Release (Oct. 2, 2017), available at www.sec.gov/news/press-release/2017-186.    [5]   SEC Press Release (Feb. 21, 2018), available at www.sec.gov/news/press-release/2018-22; the guidance itself can be found at www.sec.gov/rules/interp/2018/33-10459.pdf.  The SEC provided in-depth guidance in this release on disclosure processes and considerations related to cybersecurity risks and incidents, and complements some of the points highlighted in the Section 21A report. Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues.  For further information, please contact the Gibson Dunn lawyer with whom you usually work in the firm’s Securities Enforcement or Privacy, Cybersecurity and Consumer Protection practice groups, or the following authors: Marc J. Fagel – San Francisco (+1 415-393-8332, mfagel@gibsondunn.com) Alexander H. Southwell – New York (+1 212-351-3981, asouthwell@gibsondunn.com) Please also feel free to contact the following practice leaders and members: Securities Enforcement Group: New York Barry R. Goldsmith – Co-Chair (+1 212-351-2440, bgoldsmith@gibsondunn.com) Mark K. Schonfeld – Co-Chair (+1 212-351-2433, mschonfeld@gibsondunn.com) Reed Brodsky (+1 212-351-5334, rbrodsky@gibsondunn.com) Joel M. Cohen (+1 212-351-2664, jcohen@gibsondunn.com) Lee G. Dunst (+1 212-351-3824, ldunst@gibsondunn.com) Laura Kathryn O’Boyle (+1 212-351-2304, loboyle@gibsondunn.com) Alexander H. Southwell (+1 212-351-3981, asouthwell@gibsondunn.com) Avi Weitzman (+1 212-351-2465, aweitzman@gibsondunn.com) Lawrence J. Zweifach (+1 212-351-2625, lzweifach@gibsondunn.com) Washington, D.C. Richard W. Grime – Co-Chair (+1 202-955-8219, rgrime@gibsondunn.com) Stephanie L. Brooker  (+1 202-887-3502, sbrooker@gibsondunn.com) Daniel P. Chung (+1 202-887-3729, dchung@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Patrick F. Stokes (+1 202-955-8504, pstokes@gibsondunn.com) F. Joseph Warin (+1 202-887-3609, fwarin@gibsondunn.com) San Francisco Marc J. Fagel – Co-Chair (+1 415-393-8332, mfagel@gibsondunn.com) Winston Y. Chan (+1 415-393-8362, wchan@gibsondunn.com) Thad A. Davis (+1 415-393-8251, tdavis@gibsondunn.com) Charles J. Stevens (+1 415-393-8391, cstevens@gibsondunn.com) Michael Li-Ming Wong (+1 415-393-8234, mwong@gibsondunn.com) Palo Alto Paul J. Collins (+1 650-849-5309, pcollins@gibsondunn.com) Benjamin B. Wagner (+1 650-849-5395, bwagner@gibsondunn.com) Denver Robert C. Blume (+1 303-298-5758, rblume@gibsondunn.com) Monica K. Loseman (+1 303-298-5784, mloseman@gibsondunn.com) Los Angeles Michael M. Farhang (+1 213-229-7005, mfarhang@gibsondunn.com) Douglas M. Fuchs (+1 213-229-7605, dfuchs@gibsondunn.com) Privacy, Cybersecurity and Consumer Protection Group: Alexander H. Southwell – Co-Chair, New York (+1 212-351-3981, asouthwell@gibsondunn.com) M. Sean Royall – Dallas (+1 214-698-3256, sroyall@gibsondunn.com) Debra Wong Yang – Los Angeles (+1 213-229-7472, dwongyang@gibsondunn.com) Christopher Chorba – Los Angeles (+1 213-229-7396, cchorba@gibsondunn.com) Richard H. Cunningham – Denver (+1 303-298-5752, rhcunningham@gibsondunn.com) Howard S. Hogan – Washington, D.C. (+1 202-887-3640, hhogan@gibsondunn.com) Joshua A. Jessen – Orange County/Palo Alto (+1 949-451-4114/+1 650-849-5375, jjessen@gibsondunn.com) Kristin A. Linsley – San Francisco (+1 415-393-8395, klinsley@gibsondunn.com) H. Mark Lyon – Palo Alto (+1 650-849-5307, mlyon@gibsondunn.com) Shaalu Mehra – Palo Alto (+1 650-849-5282, smehra@gibsondunn.com) Karl G. Nelson – Dallas (+1 214-698-3203, knelson@gibsondunn.com) Eric D. Vandevelde – Los Angeles (+1 213-229-7186, evandevelde@gibsondunn.com) Benjamin B. Wagner – Palo Alto (+1 650-849-5395, bwagner@gibsondunn.com) Michael Li-Ming Wong – San Francisco/Palo Alto (+1 415-393-8333/+1 650-849-5393, mwong@gibsondunn.com) Ryan T. Bergsieker – Denver (+1 303-298-5774, rbergsieker@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 11, 2018 |
Financing Arrangements and Documentation: Considerations Ahead of Brexit

Click for PDF Since the result of the Brexit referendum was announced in June 2016, there has been significant commentary regarding the potential effects of the UK’s withdrawal from the EU on the financial services industry. As long as the UK is negotiating its exit terms, a number of conceptual questions facing the sector still remain, such as market regulation and bank passporting. Many commentators have speculated from a ‘big picture’ perspective what the consequences will be if / when exit terms are agreed.  From a contractual perspective, the situation is nuanced. This article will consider certain areas within English law financing documentation which may or may not need to be addressed. Bank passporting The EU “passporting” regime has been the subject of much commentary since the result of the Brexit referendum.  In short, in some EU member states, lenders are required under domestic legislation to have licences to lend.  Many UK lenders have relied on EU passporting (currently provided for in MiFID II), which allows them to lend into EU member states simply by virtue of being regulated in the UK (and vice versa). The importance for the economy of the passporting regime is clear. Unless appropriate transitional arrangements are put in place to ensure that the underlying principle survives, however, there is a risk that following Brexit passporting could be lost.  Recent materials produced by the UK Government suggest that the loss of passporting may be postponed from March 2019 until the end of 2020, although financial institutions must still consider what will happen after 2020 if no replacement regime is agreed.  The UK Government has committed to legislate (if required) to put in place a temporary recognition regime to allow EU member states to continue their financial services in the UK for a limited time (assuming there is a “no deal” scenario and no agreed transition period). However, there has not to date been a commitment from the EU to agree to a mirror regime. Depending on the outcome of negotiations on passporting, financial institutions will need to consider the regulatory position in relation to the performance of their underlying financial service, whether that is: lending, issuance of letters of credit / guarantees, provision of bank accounts or other financial products, or performing agency / security agency roles. Financial institutions may need to look to transfer their participations to an appropriately licensed affiliate (if possible) or third party, change the branch through which it acts, resign from agency or account bank functions, and/or exit the underlying transaction using the illegality protections (although, determining what is “unlawful” for these purposes in terms of a lender being able to fund or maintain a loan will be a complex legal and factual analysis).  More generally, we expect these provisions to be the subject of increasing scrutiny, although there seems to be limited scope for lenders to move illegality provisions in their favour and away from an actual, objective illegality requirement, owing to long-standing commercial convention. From a documentary perspective, it will be necessary to analyse loan agreements individually to determine whether any provisions are invoked and/or breached, and/or any amendments are required.  For on-going structuring, it may be appropriate for facilities to be tranched – such tranches (to the extent the drawing requirements of international obligor group can be accurately determined ahead of time) being “ring-fenced”, with proportions of a facility made available to different members of the borrower group and to be participated in by different lenders – or otherwise structured in an alternative, inventive manner – for example, by “fronting” the facility with a single, adequately regulated lender with back-to-back lending mechanics (e.g. sub-participation) standing behind.  In the same way, we also expect that lenders will exert greater control – for example by requiring all lender consent in all instances – on the accession of additional members of the borrowing group to existing lending arrangements in an attempt to diversify the lending jurisdictions.  Derivatives If passporting rights are lost and transitional relief is not in place, this could have a significant impact on the derivatives markets.  Indeed, without specific transitional or equivalence agreements in place between the EU and the UK, market participants may not be able to use UK clearing houses to clear derivatives subject to mandatory clearing under EMIR.  Additionally, derivatives executed on UK exchanges could be viewed as “OTC derivatives” under EMIR and would therefore be counted towards the clearing thresholds under EMIR.  Further, derivatives lifecycle events (such as novations, amendments and portfolio compressions) could be viewed as regulated activities thereby raising questions about enforceability and additional regulatory restrictions and requirements. In addition to issues arising between EU and UK counterparties, equivalence agreements in the derivatives space between the EU and other jurisdictions, such as the United States, would not carry over to the UK.  Accordingly, the UK must put in place similar equivalence agreements with such jurisdictions or market participants trading with UK firms could be at a disadvantage compared to those trading with EU firms. As a result of the uncertainty around Brexit and the risk that passporting rights are likely to be lost, certain counterparties are considering whether to novate their outstanding derivatives with UK derivatives entities to EU derivatives entities ahead of the exit date.  Novating derivatives portfolios from a UK to an EU counterparty is a significant undertaking involving re-documentation, obtaining consents, reviewing existing documentation, identifying appropriate counterparties, etc. EU legislation and case law Loan agreements often contain references to EU legislation or case law and, therefore, it is necessary to consider whether amendments are required. One particular area to be considered within financing documentation is the inclusion of Article 55 Bail-In language[1].  In the last few years, Bail-In clauses have become common place in financing documentation, although they are only required for documents which are governed by the laws of a non-EEA country and where there is potential liability under that document for an EEA-incorporated credit institution or investment firm and their relevant affiliates, respectively.  Following withdrawal from the EU, the United Kingdom will (subject to any transitional or other agreed arrangements) cease to be a member of the EEA and therefore English law governed contracts containing in-scope liabilities of EU financial institutions may become subject to the requirements of Article 55.  Depending on the status of withdrawal negotiations as we head closer to March 2019, it may be appropriate as a precautionary measure to include Bail-In clauses ahead of time – however, this analysis is very fact specific, and will need to be carefully considered on a case-by-case basis. Governing law and jurisdiction Although EU law is now pervasive throughout the English legal system, English commercial contract law is, for the most part, untouched by EU law and therefore withdrawal from the EU is expected to have little or no impact.  Further, given that EU member states are required to give effect to the parties’ choice of law (regardless of whether that law is the law of an EU member state or another state)[2], the courts of EU member states will continue to give effect to English law in the same way they do currently.  Many loan agreements customarily include ‘one-way’ jurisdiction clauses which limit borrowers/obligors to bringing proceedings in the English courts (rather than having the flexibility to bring proceedings in any court of competent jurisdiction). This allows lenders to benefit from the perceived competency and commerciality of the English courts as regards disputes in the financial sector. Regardless of the outcome of the Brexit negotiations, such clauses  are likely to remain unchanged due to the experience of English judges in handling such disputes and the certainty of the common law system. It is possible that the UK’s withdrawal will impact the extent to which a judgement of the English courts will be enforceable in other EU member states.  Currently, an English judgement is enforceable in all other EU member states pursuant to EU legislation[3].  However, depending on the withdrawal terms agreed with the EU, the heart of this regulation may or may not be preserved. In other words, English judgements could be in the same position to that of, for example, judgements of the New York courts, where enforceability is dependent upon the underlying law of the relevant EU member state; or, an agreement could be reached for automatic recognition of English judgements across EU member states.  In the same vein, the UK’s withdrawal could also impact the enforcement in the UK of judgements of the courts of the remaining EU member states. Conclusion Just six months ahead of the UK’s 29 March 2019 exit date, there remains no agreed legal position as regards the terms of the UK’s withdrawal from the EU. It is clear that, for so long as such impasse remains, the contractual ramifications will continue to be fluid and the subject of discussion.  However, what is apparent is that the financial services sector, and financing arrangements more generally, are heavily impacted and it will be incumbent upon contracting parties, and their lawyers, to consider the relevant terms, consequences and solutions at the appropriate time. [1]   Article 55 of the Bank Resolution and Recovery Directive [2]   Rome I Regulation [3]   Brussels I regulation. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn lawyer with whom you usually work, any member of the firm’s Global Finance practice group, or the authors: Amy Kennedy – London (+44 (0)20 7071 4283, akennedy@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Alex Hillback – Dubai (+971 (0)4 318 4626, ahillback@gibsondunn.com) Please also feel free to contact the following leaders and members of the Global Finance and Financial Institutions practice groups: Global Finance Group: Thomas M. Budd – London (+44 (0)20 7071 4234, tbudd@gibsondunn.com) Gregory A. Campbell – London (+44 (0)20 7071 4236, gcampbell@gibsondunn.com) Richard Ernest – Dubai (+971 (0)4 318 4639, rernest@gibsondunn.com) Jamie Thomas – Singapore (+65 6507 3609, jthomas@gibsondunn.com) Michael Nicklin – Hong Kong (+852 2214 3809, mnicklin@gibsondunn.com) Linda L. Curtis – Los Angeles (+1 213 229 7582, lcurtis@gibsondunn.com) Aaron F. Adams – New York (+1 212 351 2494, afadams@gibsondunn.com) Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 10, 2018 |
Why We Think the UK Is Heading for a “Soft Brexit”

Click for PDF Our discussions with politicians, civil servants, journalists and other commentators lead us to believe that the most likely outcome of the Brexit negotiations is that a deal will be agreed at the “softer” end of the spectrum, that the Conservative Government will survive and that Theresa May will remain as Prime Minister at least until a Brexit deal is agreed (although perhaps not thereafter).  There is certainly a risk of a chaotic or “hard” Brexit.  On the EU side, September’s summit in Salzburg demonstrated the possibility of unexpected outcomes.  And in the UK, the splits in the ruling Conservative Party and the support it relies upon from the DUP (the Northern Irish party that supports the Government) could in theory result in the ousting of Prime Minister May, which would likely lead to an extension of the Brexit deadline of 29 March 2019.  However, for the reasons set out below we believe a hard or chaotic Brexit is now less likely than more likely. Some background to the negotiations can be found here.  It should be noted that any legally binding deal will be limited to the terms of the UK’s departure from the EU (“the Withdrawal Agreement”) and will not cover the future trading relationship.  But there will be a political statement of intent on the future trading relationship (“the Future Framework”) that will then be subject to further detailed negotiation. There is a European Council meeting on 17/18 October although it is not expected that a final agreement will be reached by then.  However, the current expectation is that a special meeting of the European Council will take place in November (probably over a weekend) to finalise both the Withdrawal Agreement and the Future Framework. Whatever deal Theresa May finally agrees with the EU needs to be approved by the UK Parliament.  A debate and vote will likely take place within two or three weeks of a deal being agreed – so late November or early December.  If Parliament rejects the deal the perceived wisdom is that the ensuing political crisis could only be resolved either by another referendum or a general election. However: the strongest Brexiteers do not want to risk a second referendum in case they lose; the ruling Conservative Party do not want to risk a general election which may result in it losing power and Jeremy Corbyn becoming Prime Minister; and Parliament is unlikely to allow the UK to leave without a deal. As a result we believe that Prime Minister May has more flexibility to compromise with the EU than the political noise would suggest and that, however much they dislike the eventual deal, ardent Brexiteers will likely support it in Parliament.  This is because it will mean the UK has formally left the EU and the Brexiteers live to fight another day. The UK’s current proposal (the so-called “Chequers Proposal”) is likely to be diluted further in favour of the EU, but as long as the final deal results in a formal departure of the UK from the EU in March 2019, we believe Parliament is more likely than not to support it, however unsatisfactory it is to the Brexiteers. The key battleground is whether the UK should remain in a Customs Union beyond a long stop date for a transitional period.  The UK Government proposes a free trade agreement in goods but not services, with restrictions on free movement and the ability for the UK to strike its own free trade deals.  This has been rejected by the EU on the grounds that it seeks to separate services from goods which is inconsistent with the single market and breaches one of the fundamental EU principles of free movement of people.  The Chequers Proposal is unlikely to survive in its current form but the EU has acknowledged that it creates the basis for the start of a negotiation. There has also been discussion of a “Canada style” free-trade agreement, which is supported by the ardent Brexiteers but rejected by the UK Government because it would require checks on goods travelling across borders.  This would create a “hard border” in Northern Ireland which breaches the Good Friday Agreement and would not be accepted by any of the major UK political parties or the EU.  The consequential friction at the borders is also unattractive to businesses that operate on a “just in time” basis – particularly the car manufacturers.  The EU has suggested there could instead be regulatory alignment between Northern Ireland and the EU, but this has been accepted as unworkable because it would create a split within the UK and is unacceptable to the DUP, the Northern Ireland party whose support of the Conservatives in Parliament is critical to their survival.  This is the area of greatest risk but it remains the case that a “no deal” scenario would guarantee a hard border in Ireland. If no deal is reached by 21 January 2019 the Prime Minister is required to make a statement to MPs.  The Government would then have 14 days to decide how to proceed, and the House of Commons would be given the opportunity to vote on these alternate plans.  Although any motion to reject the Government’s proposal would not be legally binding, it would very likely catalyse the opposition and lead to an early general election or a second referendum.  In any of those circumstances, the EU has already signalled that it would be prepared to grant an extension to the Article 50 period. This client alert was prepared by London partners Charlie Geffen and Nicholas Aleksander and of counsel Anne MacPherson. We have a working group in London (led by Nicholas Aleksander, Patrick Doris, Charlie Geffen, Ali Nikpay and Selina Sagayam) addressing Brexit related issues.  Please feel free to contact any member of the working group or any of the other lawyers mentioned below. Ali Nikpay – Antitrust ANikpay@gibsondunn.com Tel: 020 7071 4273 Charlie Geffen – Corporate CGeffen@gibsondunn.com Tel: 020 7071 4225 Nicholas Aleksander – Tax NAleksander@gibsondunn.com Tel: 020 7071 4232 Philip Rocher – Litigation PRocher@gibsondunn.com Tel: 020 7071 4202 Jeffrey M. Trinklein – Tax JTrinklein@gibsondunn.com Tel: 020 7071 4224 Patrick Doris – Litigation; Data Protection PDoris@gibsondunn.com Tel:  020 7071 4276 Alan Samson – Real Estate ASamson@gibsondunn.com Tel:  020 7071 4222 Penny Madden QC – Arbitration PMadden@gibsondunn.com Tel:  020 7071 4226 Selina Sagayam – Corporate SSagayam@gibsondunn.com Tel:  020 7071 4263 Thomas M. Budd – Finance TBudd@gibsondunn.com Tel:  020 7071 4234 James A. Cox – Employment; Data Protection JCox@gibsondunn.com Tel: 020 7071 4250 Gregory A. Campbell – Restructuring GCampbell@gibsondunn.com Tel:  020 7071 4236 © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 5, 2018 |
OFAC Issues Economic Sanctions Guidance on Digital Currencies

Click for PDF Over the last several months, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) has expressed a clear interest in protecting the U.S. financial system from illicit activities in the digital currency space and has posited that transactions involving digital currencies be treated similarly to transactions involving traditional fiat currency.[1]  OFAC released Frequently Asked Questions (FAQs) on March 19 and June 6, 2018 that addressed the treatment of digital currencies.  In particular, the FAQs suggest that compliance obligations apply to digital currencies in the same manner as they would apply to traditional fiat currencies.[2]  Moreover, the FAQs note that OFAC may add digital currency addresses associated with blocked persons to its List of Specially Designated Nationals (SDN List) and put the onus on individuals[3] engaging in such transactions to screen and ensure that they are not dealing with banned persons.[4]  Finally, an Executive Order from President Trump and related guidance from OFAC prohibited transactions involving “petro,” a digital currency issued by the Venezuelan government to evade U.S. sanctions.[5] Through this series of FAQs, OFAC has begun to stake out its position on certain compliance obligations for digital currency transactions as well as OFAC sanctions for those who use digital currency for illicit transactions.  However, key questions still remain around the scope and application of such obligations.  We discuss OFAC’s guidance on digital currencies in more detail below. FAQ 559: Definitions of “virtual currency,” “digital currency,” “digital currency wallet,” and “digital currency address” for purposes of OFAC sanctions programs OFAC’s FAQ 559 defined “virtual currency” as “a digital representation of value that functions as (i) a medium of exchange; (ii) a unit of account; and/or (iii) a store of value; is neither issued nor guaranteed by any jurisdiction; and does not have legal tender status in any jurisdiction.”[6]  Similarly, OFAC defined the broader term, “digital currency,” which involves “sovereign cryptocurrency, virtual currency (non-fiat), and a digital representation of fiat currency.”[7]  Next, it was explained that a “digital currency wallet” is typically a software application that holds, stores, and transfers digital currency.[8]  And finally, the FAQ explained that a “digital currency address” consists of “an alphanumeric identifier that represents a potential destination for a digital currency transfer.”[9]  These definitions are used throughout OFAC’s other FAQs. FAQ 560: Compliance obligations for digital currency and traditional fiat currency In FAQ 560, OFAC indicated its view that individuals are subject to identical compliance obligations regardless of whether a transaction involves digital currency or traditional fiat currency,[10] including prohibitions on the following:  trade or other transactions with persons on OFAC’s SDN List; “unauthorized transactions prohibited by OFAC sanctions, such as dealings with blocked persons or property, or engaging in prohibited trade or investment-related transactions”; and transactions involving entities in which a blocked person has an ownership interest of 50 percent or more.[11]  These restrictions include “transactions that evade or avoid, have the purpose of evading or avoiding, cause a violation of, or attempt to violate prohibitions imposed by OFAC under various sanctions authorities.”[12]  Accordingly, OFAC warns that “persons that provide financial, material, or technological support for or to a designated person may be designated by OFAC under the relevant sanctions authority.”[13] OFAC recommends that individuals should develop a compliance solution that is tailored to each circumstance.  In particular, the FAQ states that “technology companies; administrators, exchangers, and users of digital currencies; and other payment processors should develop a tailored, risk-based compliance program, which generally should include sanctions list screening and other appropriate measures.”[14] FAQ 561: Using the SDN List to sanction the illicit use of digital currencies OFAC recognizes in FAQ 561 that there is a “growing and evolving threat posed by malicious actors using new payment mechanisms” and is determined to sanction those who use digital currency and other emerging payment systems to conduct prohibited financial transactions and evade United States sanctions.[15]  Accordingly, the FAQ explains that in order “[t]o strengthen our efforts to combat the illicit use of digital currency transactions under our existing authorities, OFAC may include as identifiers on the SDN List specific digital currency addresses associated with blocked persons” (emphasis added).[16]  This practice of using the SDN list would mirror OFAC’s current practice of adding people and governments to such list and would enable OFAC and other users to screen for digital currency addresses. FAQ 562: Identifying digital currency-related information on the SDN List In FAQ 562, OFAC recognizes that although it may add digital currency addresses to the SDN List, those address listings are not likely to be exhaustive.[17]  Consequently, OFAC states that individuals should take the necessary steps to block questionable digital currencies and file reports with OFAC if and when they identify digital currency identifiers or wallets that they believe are owned by or are “associated with[] an SDN” (emphasis added).[18] FAQ 563: Format of digital currency addresses on the SDN List OFAC explains that the structure of a digital currency address on the SDN List will include a currency’s unique alphanumeric identifier and will identify the specific digital currency to which the address corresponds (e.g., Bitcoin (BTC), Litecoin (LTC), petro (PTR), etc.).[19] FAQ 594: Querying a digital currency address using OFAC’s Sanctions List Search tool OFAC confirmed that it is not possible to query for digital currency addresses using OFAC’s Sanctions List Search Tool.[20]  Instead, FAQ 594 recommends that OFAC will use its SDN List to screen for listed digital currency addresses.[21] OFAC’s Guidance and President Trump’s Executive Order Concerning Venezuela On March 19, 2018, OFAC released a set of FAQs to deal with the situation in Venezuela at the same time President Trump issued Executive Order 13827 on “Taking Additional Steps to Address the Situation in Venezuela” (“Executive Order”).[22]  The Executive Order aimed to combat Venezuela’s attempts to use digital currencies to bypass sanctions that were implemented against it by the United States.[23]  Specifically, the Executive Order bans individuals from engaging in transactions involving “any digital currency, digital coin, or digital token that was issued by, for, or on behalf of the Government of Venezuela on or after January 9, 2018.”[24]  In February 2018, the Venezuelan government launched a digital currency known as the “petro” to try to enable the national oil company of Venezuela, Petróleos de Venezuela, S.A., to engage in transactions that were not denominated in U.S. Dollars.  OFAC’s FAQ 564 confirmed that the phrases “digital currency, digital coin, or digital token” referenced in the Executive Order include the petro and petro-gold.[25] Concluding Thoughts Through issuing a series of FAQs, OFAC has begun to stake out its position on certain compliance obligations for digital currency transactions as well as OFAC sanctions for those who use digital currency for illicit transactions.  However, key questions still remain around the scope and application of such obligations.  For example, it is unclear how broadly OFAC will apply its definitions of “virtual currency” and “digital currency” to various cryptoassets that are fundamentally unlike major cryptocurrencies such as bitcoin.  Also, under FAQ 562, it is unclear to what extent an entity is “associated” with an SDN and when parties are obligated to block questionable digital currencies and file reports with OFAC.  Further, it is unclear under FAQ 560 as to what specifically should be included within a “tailored, risk-based compliance program, which include[s] . . . sanctions list screening and other appropriate measures.” The FAQs also fail to address significant practical concerns.  For example: To what extent do parties have the technical abilities to block incoming transactions?  Are there exceptions for companies that are hacked and subsequently forced to pay ransom to an address on the SDN List?  How will OFAC address the use of private blockchain addresses?  These uncertainties highlight the complexity and evolving nature of digital currency transactions and blockchain technology and, perhaps more importantly, they suggest the need for additional guidance from OFAC. [1] See Statements & Remarks, U.S. Department of the Treasury, U.S. Department of the Treasury Under Secretary Sigal Mandelker Speech before the Securities Industry and Financial Markets Association Anti-Money Laundering & Financial Crimes Conference (Feb. 13, 2018), https://home.treasury.gov/news/press-release/sm0286. [2] Office of Foreign Assets Control, Frequently Asked Questions, Questions 559-63, 594, available at https://www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_compliance.aspx [hereinafter “OFAC FAQ”]. [3] The term “individual,” as used by OFAC in its FAQs, generally encompasses persons, parties, corporations, and other entities subject to OFAC jurisdiction. See OFAC FAQ, Question 560. [4] Id. [5] Exec. Order No. 13827, 83 Fed. Reg. 12469 (Mar. 21, 2018). [6] OFAC FAQ, Question 559. [7] Id. [8] Id. [9] Id. [10] OFAC FAQ, Question 560. [11] Id. [12] Id. [13] Id. [14] Id. [15] OFAC FAQ, Question 561. [16] Id. (emphasis added). [17] OFAC FAQ, Question 562. [18] Id. (emphasis added). [19] OFAC FAQ, Question 563. [20] OFAC FAQ, Question 594. [21] Id. [22] Exec. Order No. 13827, 83 Fed. Reg. 12469 (Mar. 21, 2018). [23] Id. [24] Id. [25] Office of Foreign Assets Control, Frequently Asked Questions, Question 564, available at https://www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_other.aspx#venezuela. The following Gibson Dunn lawyers assisted in preparing this client update: Judith Lee and Jeffrey Steiner. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding the above developments.  Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s International Trade or Financial Institutions practice groups: International Trade Group – United States: Judith Alison Lee – Co-Chair, International Trade Practice, Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com) Ronald Kirk – Co-Chair, International Trade Practice, Dallas (+1 214-698-3295, rkirk@gibsondunn.com) Jose W. Fernandez – New York (+1 212-351-2376, jfernandez@gibsondunn.com) Marcellus A. McRae – Los Angeles (+1 213-229-7675, mmcrae@gibsondunn.com) Adam M. Smith – Washington, D.C. (+1 202-887-3547, asmith@gibsondunn.com) Christopher T. Timura – Washington, D.C. (+1 202-887-3690, ctimura@gibsondunn.com) Ben K. Belair – Washington, D.C. (+1 202-887-3743, bbelair@gibsondunn.com) Courtney M. Brown – Washington, D.C. (+1 202-955-8685, cmbrown@gibsondunn.com) Laura R. Cole – Washington, D.C. (+1 202-887-3787, lcole@gibsondunn.com) Stephanie L. Connor – Washington, D.C. (+1 202-955-8586, sconnor@gibsondunn.com) Helen L. Galloway – Los Angeles (+1 213-229-7342, hgalloway@gibsondunn.com) William Hart – Washington, D.C. (+1 202-887-3706, whart@gibsondunn.com) Henry C. Phillips – Washington, D.C. (+1 202-955-8535, hphillips@gibsondunn.com) R.L. Pratt – Washington, D.C. (+1 202-887-3785, rpratt@gibsondunn.com) Scott R. Toussaint – Palo Alto (+1 650-849-5320, stoussaint@gibsondunn.com) International Trade Group – Europe: Peter Alexiadis – Brussels (+32 2 554 72 00, palexiadis@gibsondunn.com) Attila Borsos – Brussels (+32 2 554 72 10, aborsos@gibsondunn.com) Patrick Doris – London (+44 (0)207 071 4276, pdoris@gibsondunn.com) Penny Madden – London (+44 (0)20 7071 4226, pmadden@gibsondunn.com) Benno Schwarz – Munich (+49 89 189 33 110, bschwarz@gibsondunn.com) Michael Walther – Munich (+49 89 189 33-180, mwalther@gibsondunn.com) Richard W. Roeder – Munich (+49 89 189 33-160, rroeder@gibsondunn.com) Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 27, 2018 |
New York Office of the Attorney General Publishes Report on Virtual Currency Platforms and Their Potential Risks

Click for PDF This Alert reviews the New York State Office of the Attorney General’s (the “OAG”) Virtual Markets Integrity Initiative Report (the “Report”), which was published on September 18, 2018.[1]  The publication of the OAG’s 42-page Report brings to a close its six-month fact-finding inquiry of several virtual currency platforms.[2]  The OAG sent out detailed letters and questionnaires to a number of virtual currency platforms seeking information from the platforms across a wide-range of issues, including trading operations, fees charged to customers, the existence of robust policies and procedures, and the use of risk controls. The OAG’s purpose in conducting this inquiry was to inform investors and consumers of the risks they face when considering whether to trade on virtual currency platforms.  The OAG is charged with enforcing laws that protect investors and consumers from unfair and deceptive practices and that safeguard the integrity of financial markets.  To that end, the OAG “compil[ed] and analyz[ed] the responses, compar[ed] [those responses] to the platforms’ publicly available disclosures,” and gave the platforms opportunities to confirm the OAG’s analysis in advance of the Report’s publication.[3] The Report focuses on three main concerns.  First, the OAG highlighted that virtual currency platforms may not sufficiently disclose or take measures to mitigate potential conflicts of interest.  Second, the OAG opined that virtual currency platforms currently do not take sufficient efforts to impede market manipulation and protect market integrity.  And third, the OAG expressed its view that virtual currency platforms may not have adequate safeguards for the protection of customer funds. We believe that the virtual currency industry (i.e., investors, consumers, platforms and other stakeholders) should view the Report as a best practices or best standards document, upon which virtual currency platforms may be measured in terms of their riskiness and viability. Please contact Gibson Dunn’s Digital Currencies and Blockchain Technology Team if you have any questions regarding the Report or any of the information discussed in this Alert. I.   The Virtual Currency Markets and New York’s Oversight Authority In order to have a better understanding of the potential impact of the Report, a primer on virtual currency markets generally and the State of New York’s oversight of virtual currency platforms is appropriate.             a.   Primer on Virtual Currency Markets The virtual currency markets have only been in existence for roughly ten years.  While these virtual or digital units of currency have no intrinsic value and are generally traded outside of the purview of direct government controls, the market’s popularity and trading volumes have catapulted it to a total market capitalization of approximately USD 218 billion as of September 27, 2018.[4]  One market analyst has estimated the existence of approximately 2,001 different virtual currencies, which are traded on platforms or “exchanges” around the globe.[5] The most popular virtual currency, Bitcoin, currently has a market capitalization of approximately USD 113 billion and a price of USD 6,523.[6]  There are several other virtual currencies—including ether, XRP, EOS, litecoin, and bitcoin cash—that are also widely traded. Investors and consumers generally access the virtual currency markets through trading platforms, most of which are unregistered and/or not subject to comprehensive governmental oversight in a manner similar to registered exchanges in other financial markets such as securities, commodities, and derivatives markets.  There are approximately 100 different virtual currency trading platforms in the world; not all are open to U.S. persons.[7] In the United States, government supervision over virtual currency markets continues to evolve at both the federal and state levels.  At the federal level, several federal regulators—including the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”)—have all begun to bring virtual currency trading more squarely under governmental supervision and control, either through defining their authority in federal court cases,[8] issuing regulatory guidance or consumer advisories,[9] or bringing enforcement actions against fraudsters and market participants and trading platforms, which violate existing laws.[10] In addition, states have enacted legislation or adopted regulations requiring virtual currency platforms to become licensed before offering trading access to their residents.  Some of these states, including New York, have also taken a more aggressive posture in warning consumers about fraudsters and platform operators that prey on their investor and consumer residents.[11]             b.   The State of New York’s Oversight of Virtual Currency Platforms New York has been a leader in establishing regulatory oversight over virtual currency markets in two important respects.  First, in 2014, New York—through its Department of Financial Services (“NYDFS”)—issued a comprehensive regulatory framework requiring virtual currency platforms and operators to secure a special business license called a “BitLicense” when engaging in virtual currency activities, and for those platforms and operators to establish consumer protections, anti-money laundering compliance, and cybersecurity guidelines.[12]  NYDFS has also granted limited purpose trust charters under New York banking law to virtual currency companies and has issued specific virtual currency product approvals.[13]  NYDFS has awarded eight BitLicenses, and it has granted two virtual currency limited-purpose trust company charters.[14] Second, New York has issued detailed guidance focusing on fraud detection and prevention.[15]  NYDFS’s guidance mandates that virtual currency licensees and chartered entities implement measures designed to effectively detect, prevent, and respond to fraud, attempted fraud, and similar wrongdoing in the trading of virtual currencies.  Many industry observers have viewed this guidance as amplifying and strengthening the monitoring requirements that already exist in New York’s regulations applying to BitLicensees. The OAG’s recent inquiry and its publication of the Report thus build on a developed framework of state regulation. II.   The Report and Its Three Key Areas of Concern The Report covers the following broad topics: (a) The jurisdiction in which virtual currency platforms operate; (b) The platforms’ acceptance of currencies (i.e., fiat and/or virtual); (c) Fees charged and disclosures of fee structures to customers; (d) The robustness of a platform’s trading policies and procedures; (e) How the platforms manage various types of conflicts of interest; (f) How the platforms safeguard customer funds through the establishment of security processes and procedures, the role of insurance, and the use of independent audits; and (g) The platforms’ processes around providing access to customers’ funds, as well as how the platforms handle trading suspensions and outages. We have produced the following chart that summarizes the OAG’s assessment of, and key findings from analyzing, the questionnaire responses received with respect to each of the topics above.  The Report also offered recommendations to assist virtual currency investors and consumers (i.e., platform customers) in making educated choices when deciding whether to invest or trade on a particular virtual currency platform. Topical Area Assessment Recommendations Jurisdiction Knowing where a platform is incorporated and headquartered is important because the platform’s domicile impacts which laws apply to any rights and remedies an investor or consumer may have in the event of a dispute, loss, theft or insolvency. Participating platforms claimed to limit trading access to authorized customers from particular locations; however, many of these platforms do not have effective know-your-customer (“KYC”) programs or actively monitor customers’ IP addresses in order ensure the identity and location of particular customers. Customers should know the jurisdictions from which their virtual currency trading platforms are located and headquartered. Platforms need to significantly enhance and improve their KYC programs and to develop effective IP monitoring systems in order to properly monitor and limit the platforms’ trading systems to authorized customers.   Acceptance of Currency To obtain virtual currency initially, customers must find a platform that accepts fiat currency (i.e., government-backed currency). It is important to know which trading platforms accept fiat currency; the acceptance of fiat currency demonstrates that the platform has a relationship with a regulated bank. Customers should be mindful of whether a virtual currency platform has a formal banking relationship in place.  The existence of such a relationship may offer customers a useful indicator for evaluating that a particular platform is a legitimate business concern. Fees and Fee Disclosures Most virtual currency trading platforms charge fees per transaction.  However, many virtual currency platforms’ fees may differ based on the price of the virtual asset that is bought or sold, the volume of trades executed by the customer, the order type chosen, or the timing of an order submission. Some platforms offer significant discounts to high-volume trading customers.  This discounting is known as a “maker-taker” fee model. Additionally, some platforms charge fees for withdrawals and deposits of customer fiat and virtual currencies. Customers should understand which actions will trigger fees, the size of those fees, and whether the platform will charge hidden fees.  To that end, the OAG recommends that customers should review and understand a platform’s complete fee schedule before the customer begins trading. Fee transparency is absolutely essential and customers should understand when a particular platform offers high-volume customer discounts. Trading Policies The Report drew several comparisons between virtual currency markets and the policies and market structure seen in securities trading. The OAG observed that, similar to securities platforms, the virtual currency platforms that participated in the inquiry do provide special features to professional traders. The OAG also noted that these platforms allow automated and algorithmic trading but few if any have robust policies in place to address such trading. The OAG noted that, while all of the participating platforms expressed a commitment to stamp out abusive trading practices, few had actual policies in place to define, detect, prevent, or penalize suspicious trading or market manipulation. The OAG noted that only a couple of platforms that responded to the questionnaire allow margin trading, whereby customers were allowed to borrow funds to trade a virtual asset. Since monitoring trading activity on a platform is critical to the integrity of the entire market, the OAG recommended that virtual currency platforms develop robust policies around automated and algorithmic trading, provide more transparency around the special trading features and order types offered to professional traders, improve customer onboarding procedures and implement serious market surveillance capabilities akin to those in securities trading venues  in order to detect and punish suspicious trading activity.   Conflicts of Interest The OAG noted that virtual currency platforms may have conflicts in terms of: (1) the standards applied when considering whether to list virtual assets; (2) compensation that they receive for listing particularly virtual assets; (3) the lack of consistent industry policies and procedures regarding platform employee trading; and (4) the ability of a platform to trade on its venue in a proprietary capacity. The OAG recommended that virtual currency platforms disclose payments and other compensation that they receive for listing a particular virtual currency. The OAG noted that, while the measures taken to monitor or prevent employee trading on platforms differed, virtual currency platforms should generally make their policies around employee trading more transparent to customers. Although proprietary trading certainly occurs in other markets, the OAG cautioned that customers should be aware that: (1) a platform could be trading on its own account on its own venue on an undisclosed basis; (2) high levels of proprietary trading may raise serious questions about the true available liquidity on a platform; and (3) the platforms may be trading with informational advantages. Safeguarding Customer Funds The OAG noted that, although safeguarding customer funds is of paramount importance, the virtual currency platforms that submitted responses did not consistently employ measures to ensure the security of those funds in the platforms’ custody The OAG also noted that industry standards have not yet developed around insurance for virtual currency platforms (i.e., what assets should be insured, against what risks, and at what price). The OAG noted that, although a number of the platforms reported that they have retained outside firms to conduct independent audits, the industry lacked common auditing standards. The OAG recommended that virtual currency platforms require two-factor identification by default to ensure that customer’s data is secure.  The OAG also recommended that platforms make better use of “cold storage” (i.e., a security practice wherein private keys to virtual currency are kept off of the internet).  Finally, the OAG recommended that platforms regularly conduct “penetration testing” in order to identify security holes in a platform’s information technology and data security infrastructure. The OAG recommended that customers should demand more information from trading platforms about how those platforms insure risks related to the virtual or fiat currency held within their custody. The OAG recommended that the industry come together to develop common auditing standards for virtual currency platforms. Access to Customer Funds During Suspensions/Outages The OAG noted that platforms often fail to detail their procedures for transferring virtual currency from customer accounts to private wallets, or for processing fiat currency withdrawals both under normal market conditions and during a suspension or outage.  The platforms that participated in the inquiry had differing policies. The OAG further noted that platforms do not have adequate policies or procedures for suspending trading or delaying pending trades, and the handling of open orders during and immediately following suspension and/or platform outage. The OAG recommended that customers should familiarize themselves with how pending trades and currency withdrawals are treated under normal market conditions and during a trading suspension or outage. Disclosure of Historical Outages The OAG noted that while most platforms notify customers of any trading suspensions or outages, few of the platforms provide full disclosure of past outages or suspensions, and the reasons for those events. The OAG suggested that customers examine whether a platform provides a history of prior outages and trading interruptions because by doing so it helps customers evaluate historical stability, reliability, and transparency of a venue. After conducting the general assessment described above, the OAG highlighted its three principal areas of concern: Virtual Currency Platforms Do Not Disclose or Take Measures to Mitigate Potential Conflicts of Interest.  Virtual currency platforms may operate with several conflicts of interest, including:  (1) operating several lines of business that would be restricted or carefully regulated if those platforms were exchanges in traditionally regulated markets; (2) receiving fees and other incentives to list particular virtual currencies; (3) having insufficient policies and procedures for limiting access to platforms employees to trade alongside of customers; and (4) engaging in proprietary trading alongside customers when platforms have access to nonpublic information. Virtual Currency Platforms Do Not Take Serious Efforts to Impede Market Manipulation and Protect Market Integrity.  The Report opined that many virtual currency platforms are susceptible to manipulative and fraudulent trading activity.  Such platforms lack robust real-time and historical market surveillance capabilities like those found in the securities and commodities and derivatives markets. Customer Fund Safeguards on Platforms are Limited and Often Illusory.  The Report also flagged that virtual currency markets may lack consistent and transparent approaches to ensure the protection of customer funds.  While many virtual currency platforms use independent auditors to conduct reviews of the platforms’ holdings, and some platforms have insurance, the scope and sufficiency of the audits and insurance do not provide adequate protections to customers for losses of their virtual or fiat currency. The OAG reiterated that New York’s virtual currency regulations address many of these concerns and the topics identified in its assessment.  The OAG reminded BitLicense registrants that they should be adhering to these requirements already. III.   Conclusion Although the Report was directed at New York investors and consumers, its assessment principles and recommendations may also establish more generally applicable industry standards.  Indeed, platforms operating outside of New York can use the OAG’s assessment and recommendations to enhance and improve their existing operations. The Report noted that the OAG has made referrals to NYDFS to initiate investigatory proceedings against three platforms that appear to engage in a virtual currency business in New York.  The Report may also influence other states and the federal government to consider developing regulations or guidance based on the OAG’s assessment and recommendations.    [1]   See Office of the New York State Attorney General, Virtual Markets Integrity Initiative Report, Sept. 18, 2018, available at https://ag.ny.gov/sites/default/files/vmii_report.pdf.    [2]   See Office of the New York State Attorney General, Press Release, A.G. Schneiderman Launches Inquiry Into Cryptocurrency “Exchanges”, Apr. 17, 2018, available at https://ag.ny.gov/press-release/ag-schneiderman-launches-inquiry-cryptocurrency-exchanges.    [3]   Report, p.2.    [4]   See CoinMarketCap, Sept 27, 2018, available at https://coinmarketcap.com/all/views/all/.    [5]   See Report p.2 (“there are more than 1,800 different virtual currencies. . . .”); see also CoinMarketCap, Sept. 27, 2018, available at https://coinmarketcap.com/all/views/all/.    [6]   See CoinMarketCap, Sept. 27, 2018, available at https://coinmarketcap.com/all/views/all/.    [7]   The website CoinMarketCap estimates that there are 14,252 different “markets” for trading cryptocurrencies.  See id.  The definition of “markets” also includes offline commercial areas or arenas for trading.    [8]   Through administrative decisions issued in 2015, the CFTC set forth its interpretation that virtual currencies (which include cryptocurrencies like Bitcoin) are commodities under the Commodity Exchange Act.  See In the Matter of: Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan, CFTC Docket No. 15-29, available here.    [9]   See, e.g., CFTC Advisory, Customer Advisory: Use Caution When Buying Digital Coins or Tokens, July 16, 2018, available at https://www.cftc.gov/sites/default/files/2018-07/customeradvisory_tokens0718.pdf. [10]   See, e.g., CFTC v. Kantor et al., Civ. Act. No. CV182247, Apr. 17, 2018, available at https://www.cftc. gov/sites/default/files/2018-04/enfbluebitbancorder041718.pdf. [11]   Georgia, Illinois, Kansas, Massachusetts, Tennessee, Texas and Washington have established streamlined application processes for financial technology firm applicants to obtain money transmitter licenses. [12]   See 23 NYCRR Part 200 (Virtual currencies) (2018). [13]   See https://www.dfs.ny.gov/banking/virtualcurrency.htm. [14]   See id. [15]   See NYSDFS, Guidance on Prevention of Market Manipulation and Other Wrongful Activity, Feb. 7, 2018, available at https://www.dfs.ny.gov/legal/industry/il180207.pdf. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the authors: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Carl E. Kennedy – New York (+1 212-351-3951, ckennedy@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 24, 2018 |
Dodd Frank 2.0: U.S. Federal Banking Agencies Propose New HVCRE Capital Regulations

Click for PDF On September 18, 2018, the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, and Federal Deposit Insurance Corporation (together, the Banking Agencies) proposed revisions to their Basel III capital rules regarding so-called High Volatility Commercial Real Estate (HVCRE) loans.  The purpose of the revisions is to conform the regulatory definition of HVCRE to the changes made by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (EGRRCPA), which was enacted in May. The proposed regulations generally follow the statutory changes, with certain clarifications, as we discuss below.  The proposal, however, does not address certain interpretive issues that are still outstanding over five years after the original HVCRE regulations were promulgated, although the Banking Agencies do ask in the preamble’s request for comments whether the proposed rule is ambiguous in certain areas and whether “further discussion or interpretation is appropriate.” HVCRE Capital Treatment Under the Original Basel III Capital Rule and the Banking Agencies’ Interpretations HVCRE treatment is a purely American phenomenon; it was not included in the international Basel III framework.  A form of capital “gold plating,” it imposes a 50% heightened capital treatment on certain commercial real estate loans that are characterized as HVCRE exposures. Prior to enactment of the EGRRCPA, the Banking Agencies’ Basel III capital rule defined an HVCRE exposure as follows: A credit facility that, prior to conversion to permanent financing, finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances: One- to four-family residential properties; Certain community development properties The purchase or development of agricultural land, provided that the valuation of the agricultural land is based on its value for agricultural purposes and the valuation does not take into consideration any potential use of the land for non-agricultural commercial development or residential development; or Commercial real estate projects in which: The loan-to-value ratio is less than or equal to the applicable maximum supervisory loan-to-value ratio under Banking Agency standards – e.g., 80% for a commercial construction loan; The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15% of the real estate’s appraised “as completed” value; and The borrower contributed the amount of capital required before the bank advances funds under the credit facility, and the capital contributed by the borrower, or internally generated by the project, is contractually required to remain in the project throughout the life of the project.[1] The original rule provided that the life of a project concluded only when the credit facility was converted to permanent financing or was sold or paid in full.[2] The original Basel III capital rule raised many interpretative questions; few, however, were answered by the Banking Agencies, and others were answered in a non-intuitive, unduly conservative manner.[3]  In particular, the Banking Agencies interpreted the requirement relating to internally generated capital as foreclosing distributions of such capital even if the amount of capital in the project exceeded 15% of “as completed” value post-distribution.[4]  In addition, the Banking Agencies did not permit appreciated land value to be taken into account for purposes of the borrower’s capital contribution. Proposed Regulations – Definition of HVCRE The proposed regulations follow the statute in narrowing the definition of an HVCRE exposure, in particular by requiring that a credit facility have the purpose of improving property into income-producing property.  The proposal defines an HVCRE exposure as: A credit facility secured by land or improved real property that— (A) primarily finances or refinances the acquisition, development, or construction of real property; (B) has the purpose of providing financing to acquire, develop, or improve such real property into income-producing real property; and (C) is dependent upon future income or sales proceeds from, or refinancing of, such real property for the repayment of such credit facility. The proposal interprets this provision as follows.  First, relying on the instructions to bank Call Reports, the proposed regulation defines a “credit facility secured by land or improved real property” as a credit facility where “the estimated value of the real estate collateral at origination (after deducting all senior liens held by others) is greater than 50 percent of the principal amount of the loan at origination.”  Second, the determination of whether the credit facility meets the above HVCRE definition is made once, at the facility’s origination.  Third, the Banking Agencies propose that the HVCRE definition include “other land loans” – generally loans secured by vacant land except land known to be used for agricultural purposes. Proposed Regulations – Exclusions from HVCRE Treatment The statute retained, and in certain important cases, expanded, the exclusions from HVCRE treatment.  The proposed regulations implement these provisions and provide additional definitional interpretation. Certain Commercial Real Estate Projects This exclusion proved the most controversial under the original Basel III treatment, and indeed the Banking Agencies’ conservative approach to the exclusion is likely responsible for the statute’s enactment. Under the proposal, as in the original regulation, the loan-to-value (LTV) ratio for the loan must be less than or equal to the applicable regulatory maximum LTV for the type of property at issue. Next, the borrower must have contributed “capital” of at least 15 percent of the real property’s appraised “as completed” value.  The proposal permits real property (including appreciated land value) to count as capital, along with cash, unencumbered readily marketable assets, and development expenses paid out-of-pocket, that is, “costs incurred by the project and paid by the borrower prior to the advance of funds” by the lending bank.  With respect to the value of contributed real property, the proposal follows the statute and defines it as “the appraised value” under a qualifying appraisal, reduced by the aggregate amount of any other liens on such property.  Notably, the Banking Agencies invite comment on “whether it is appropriate and clear that the cross-collateralization of land in a project would not be included as contributed real property.” The Banking Agencies state that in certain circumstances, such as in the case of purchasing raw land without near-term development plans,” an “as-is” appraisal may be used instead of an “as completed” one, and in certain cases, an evaluation is permissible – for transactions under $500,000 that are not secured by a single one- to four-family residential property and certain other transactions with values less than $400,000. The proposal includes a clarification for what a “project” is for purposes of the “as completed” value and 15 percent capital contribution calculation.  In the case of a project with multiple phases or stages, each phase or stage must have its own appraised “as completed” value, or if applicable, its own evaluation, in order for it to be deemed to be a separate “project.” Finally, the statute overrode the existing regulation by providing that HVCRE status may end prior to the replacement of an ADC loan with permanent financing, upon: the substantial completion of the development or construction of the real property being financed by the credit facility; and cash flow being generated by the real property being sufficient to support the debt service and expenses of the real property, in accordance with the bank’s applicable loan underwriting criteria for permanent financings. The proposed regulations do not further interpret these provisions – and although “substantial completion” is a term of art in the real estate industry, there is still some imprecision as to its exact meaning. One- to Four-Family Residential Properties With respect to the exclusion for one- to four-family residential properties, the proposal defines such properties as properties “containing fewer than five individual dwelling units, including manufactured homes permanently affixed to the underlying property (when deemed to be real property under state law).”  Condominiums and cooperatives would generally not qualify for the exclusion.  However, if the underlying property is a true one- to four-family residential property, the exclusion would cover ADC as well as construction loans, and, in addition, lot development loans.  The exclusion would not cover loans used solely to acquire undeveloped land. Community Development Properties With respect to this exclusion, the proposal refers to the Banking Agencies’ Community Reinvestment Act (CRA) regulations and their definition of community development investment to determine which properties qualify – the “primary purpose” of the applicable loan must be to foster such investment.  These regulations are quite detailed, and therefore a case-by-case analysis of particular properties will be required if the regulations are finalized as proposed. Agricultural Land Relying on bank Call Report Instructions, the Banking Agencies propose a broad definition for this exclusion – “all land known to be used or usable for agricultural purposes.” Existing Income-Producing Properties that Qualify as Permanent Financings Finally, the statute added a new exclusion, for credit facilities for: the acquisition or refinance of existing income-producing real property secured by a mortgage on such property;  and improvements to existing income-producing improved real property secured by a mortgage on such property, in each case, “if the cash flow being generated by the real property is sufficient to support the debt service and expenses of the real property, in accordance with the institution’s applicable loan underwriting criteria for permanent financings.” With respect to this exclusion, the Banking Agencies state only that they “may review the reasonableness of a depository institution’s underwriting criteria for permanent loans” as part of the regular supervisory process. Loans Made Prior to January 1, 2015 Under the statute, loans made prior to January 1, 2015 may not be classified as HVCRE loans.  A 100 percent risk weight may therefore now be applied to any such loans that were previously classified as HVCRE exposures unless a lower risk weight would apply, as long as the loans are not past 90 days or more past due or on nonaccrual. Conclusion With the HVCRE statute and this proposal, the door has closed on the Banking Agencies’ unfortunate prior approach to HVCRE exposures.  The proposed regulations, however, like the ones they replace, do not clearly state their application to the complex structures of real estate transactions, with multiple tranches of financing and different capital instruments, that are common in the market today.  In addition, although it is clear that certain of the 2015 Interagency FAQs are no longer applicable, the proposal does not discuss those FAQs at all – thus missing an opportunity to subject them to the full notice and comment process that the Banking Agencies only recently stated is necessary for agency interpretation to be considered binding law.[5]  It is hoped that the public comment period will provide the Banking Agencies with evidence of the proposal’s ambiguities and that “further discussion and interpretation” of HVCRE treatment in the final regulation is appropriate.    [1]   See, e.g., 12 C.F.R. § 3.2.    [2]   Id.    [3]   The Banking Agencies published certain responses to HVCRE Frequently Asked Questions (Interagency FAQs) in April 2015.    [4]   See Interagency FAQ Response 15.    [5]   See Interagency Statement Clarifying the Scope of Supervisory Guidance, September 11, 2018 (Banking Agencies and the National Credit Union Administration). The following Gibson Dunn lawyers assisted in preparing this client update: Arthur Long and James Springer. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions or Real Estate practice groups, or any of the following: Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com) Real Estate and Finance Groups: Jesse Sharf – Los Angeles (+1 310-552-8512, jsharf@gibsondunn.com) Erin Rothfuss – San Francisco (+1 415-393-8218, erothfuss@gibsondunn.com) Aaron Beim – New York (+1 212-351-2451, abeim@gibsondunn.com) Linda L. Curtis – Los Angeles (+1 213-229-7582, lcurtis@gibsondunn.com) Drew C. Flowers – Los Angeles (+1 213-229-7885, dflowers@gibsondunn.com) Noam I. Haberman – New York (+1 212-351-2318, nhaberman@gibsondunn.com) Andrew A. Lance – New York (+1 212-351-3871, alance@gibsondunn.com) Victoria Shusterman – New York (+1 212-351-5386, vshusterman@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 10, 2018 |
Jeffrey Steiner Named a Cryptocurrency, Blockchain and Fintech Trailblazer

The National Law Journal named Washington, D.C. counsel Jeffrey Steiner a 2018 Cryptocurrency, Blockchain and Fintech Trailblazer [PDF]. Steiner is recognized for leading one of the Dodd-Frank rulemaking teams for OTC derivatives while at the U.S. Commodity Futures Trading Commission and helping create Gibson Dunn’s digital currencies and blockchain technology group. Steiner advises a range of clients, including commercial end-users, financial institutions, dealers, hedge funds, private equity funds, clearinghouses, industry groups and trade associations on regulatory, legislative and transactional matters related to OTC and listed derivatives, commodities and securities. The list was published in the September 2018 issue.

August 20, 2018 |
Dodd-Frank 2.0: Potential Reform to the Federal Reserve Board’s “Control Rules” — What Is at Stake and Who May Benefit

Click for PDF 2018 has seen significant but pragmatic developments in the implementation of bank regulation by the Board of Governors of the Federal Reserve System (Federal Reserve) under its new Vice Chairman for Bank Supervision, Randal Quarles.  Vice Chairman Quarles has frequently touted transparency in regulation as a significant virtue, and has himself frequently adopted such transparency in his public speeches, by signaling areas that he considers a priority. One area where the Federal Reserve has not yet published a reform is in the area of “control” under the Bank Holding Company Act of 1956, as amended (BHC Act).  In January, Vice Chairman Quarles suggested that it would be on his to-do list: Under the Board’s control framework – built up piecemeal over many decades – the practical determinants of when one company is deemed to control another are now quite a bit more ornate than the basic standards set forth in the statute and in some cases cannot be discovered except through supplication to someone who has spent a long apprenticeship in the art of Fed interpretation . . . . We are taking a serious look at rationalizing and recalibrating this framework.[1] This description would be an understatement.  The control rules have become challenging for corporate lawyers and clients alike – one may be greeted with “That can’t be right!” when explaining the likely Federal Reserve view of control.  As such, “rationalization and recalibration” in this area would be highly welcome. This Client Alert describes the most important aspects of the Federal Reserve’s control rules as of today’s date, and suggests certain areas of potential reform. Reform of the control rules would be important for quite a few constituencies.  It would certainly benefit private investors that wish to commit capital to banks but that do not wish to become regulated as BHCs.[2]  It would benefit nonbanking companies that might wish to partner with banks and acquire bank equity at the same time.  And it has the potential to affect certain rules applicable to bank holding companies (BHCs) themselves, particularly in the area of so-called 4(c)(6) investments and the Volcker Rule. The Statutory Language The BHC Act defines “control” as follows: Any company has control over a bank or over any company if— (A)   the company directly or indirectly or acting through one or more other persons owns, controls, or has power to vote 25 per centum or more of any class of voting securities of the bank or company; (B)   the company controls in any manner the election of a majority of the directors or trustees of the bank or company; or the [Federal Reserve] determines, after notice and opportunity for hearing, that the company directly or indirectly exercises a controlling influence over the management or policies of the bank or company.[3] The Principal Federal Reserve Control Positions For over forty years, the Federal Reserve has issued interpretations of the “controlling influence” prong of the statutory definition to erect a detailed common law of control, and one that is more focused on “influence” than the statutory “controlling influence.”  Although some of the Federal Reserve’s positions are in its Regulation Y and some in policy statements,[4] many are set forth in interpretations granted to individual banks, and some are unwritten lore.  The Federal Reserve’s current principal positions may be described as follows: Voting Securities.  This definition is critical for purposes of the 25 percent control test that is the first part of the statutory definition.  Regulation Y defines “voting securities” as “shares of common or preferred stock, general or limited partnership shares or interests, or similar interests if the shares or interests, . . . in any manner, entitle the holder: To vote for or to select directors, trustees, or partners (or persons exercising similar functions) . . . or To vote on or to direct the conduct of the operations or other significant policies of the issuing company.”[5] The Federal Reserve takes the position that if a holder of a limited partnership interest has the right to vote on replacing a general partner or who the replacement general partner will be, the interest is a “voting security.” Class of Voting Securities.  The 25 percent control test applies to any “class” of voting securities.  Under Federal Reserve regulation, a class of voting securities is determined by considering whether the shares are voted together as a single class on all matters for which the shares have voting rights, other than certain very limited fundamental matters described immediately below (Fundamental Matters).[6] This approach makes it virtually impossible to give particular investors special voting rights outside of Fundamental Matters, because such rights will almost certainly make the investors own more than 25 percent of a separate class of voting securities and thus be in control.  Moreover, approval of a new line of business or a merger or acquisition that does not affect the rights of an investor’s security is not considered a Fundamental Matter for these purposes, and therefore cannot be subject to a separate class vote. The Federal Reserve considers the general partner of a partnership or a managing member of a limited liability company to hold 100% of a class of voting securities, and for that reason, a general partner or managing member always is deemed to control an entity. Nonvoting Securities.  One way of permitting an investor additional economic rights in a deal is to issue nonvoting securities.  The Federal Reserve, however, has placed substantial limitations on such securities.  Under Regulation Y, preferred shares, limited partnership shares or interests, or similar interests are not voting securities if: Any voting rights associated with the shares or interest are limited solely to the type customarily provided by statute with regard to Fundamental Matters; The shares or interest represent an essentially passive investment or financing device and do not otherwise provide the holder with control over the issuing company; and The shares or interest do not entitle the holder, . . . in any manner, to select or to vote for the selection of directors, trustees, or partners (or persons exercising similar functions).[7] Under Federal Reserve regulation and practice, Fundamental Matters are matters that “significantly and adversely affect the rights or preferences of the security,” and are generally limited to: the issuance of additional amounts or classes of senior securities; the modification of the terms of the security or interest; the dissolution of the issuing company; or the payment of dividends by the issuing company when preferred dividends are in arrears.[8] If a security is subject to a restriction on its voting rights, that restriction will be effective only if it is contained in the constitutive documents of the issuing entity – it cannot be in a side agreement.  The rationale for this position is that if contained in an agreement alone, the parties to the agreement could breach it and waive any consequences; such a breach is not possible when the restriction is contained in, for example, a corporate charter. Amount of Nonvoting Securities That May Be Held.  The Federal Reserve generally permits an investor to own one-third of the total equity of a company before finding control, as long as no more than 14.9 percent of that equity is voting.[9] Restrictions on Nonvoting Securities Becoming Voting Securities.  The Federal Reserve’s traditional position is that a security remains a voting or nonvoting security throughout its life – it cannot switch back and forth.  There is a long-standing exception designed to permit a degree of liquidity for nonvoting securities.  Such securities may become voting in a limited set of transfers: A transfer back to the issuer A transfer in a public offering A transfer in a private offering in which no transferee acquires more than 2% of the issuer’s voting securities A transfer in a change-of-control, where more than 50 percent of the issuer’s securities are transferred to a new owner (not counting the investor’s nonvoting securities for purposes of the 50 percent test) In practice, the Federal Reserve has also limited the transfers of nonvoting securities themselves to these four circumstances.[10]  This is because the Federal Reserve generally views control over the disposition of a security as control of the security. There is long-standing precedent for this position in the context of voting securities, although one may question its application to nonvoting securities.  In a 1982 letter, the Federal Reserve disapproved of a proposal whereby an investor that had an option for 32.4 percent of the voting shares of a bank holding company stated that it intended only to acquire 24.9 percent and sell the other 7.5 percent, stating: The [Federal Reserve] is concerned that approval of your proposal, which would effectively allow control of up to 32.4 per cent of the voting shares of Florida National, could seriously impair the objectives and purposes of the Change in Bank Control Act and Bank Holding Company Act. General approval of such arrangements would establish a precedent permitting acquirors of bank holding company stock to accumulate up to 24.9 per cent of voting shares, proceed to dispose of these shares in a form subject to their control, acquire additional shares up to the 24.9 per cent level, and then possibly repeat this process.[11] Options and Warrants as Voting Securities/Fed Math.  The Federal Reserve has taken the position that an option or warrant for a voting security that is freely exercisable must be counted as a voting security, no matter how out-of-the-money the warrant or option is.  Compounding the effects of this position, the Federal Reserve has also taken the position that when calculating the percentage of voting securities owned by an investor, one must treat the investor’s options or warrants as exercised (as long as they are freely exercisable, no matter how out of the money), but no one else’s.  This is the position that elicited the “That can’t be right!” statement cited above. Tear Down Rule.  The Federal Reserve has taken the position that if a party has control of a company – for example, controlling 25 percent of more of a class of voting securities – it is more difficult to shed control.  It has therefore insisted on sell downs to a lower level of control than would otherwise be the case – selling down to 24.9 percent has generally been insufficient, with 10 percent, and sometimes less, frequently desired.  This is a position more suited to metaphysics than law, and can have perverse results particularly when a BHC is seeking to divest a business but retain some form of economic interest in it. Directors/Observers.  The statute defines “control” as the ability to control the election or appointment of a majority of directors.  The Federal Reserve’s articulated position on “controlling influence,” however, is that a 24.9 percent voting share investor or a 14.9 percent voting/one-third total equity investor may generally only appoint one director to the company’s board.  Moreover, as a general matter, an investor’s director representation should be proportional to the percentage of voting shares it owns.  The Federal Reserve now generally permits an additional observer as long as the observer is truly an observer.[12] In addition, the director representative cannot be the chairman of the board and generally cannot chair a board committee.  Such a director may participate on a committee as long as he or she does not make up more than 25 percent of the seats on the committee or have the authority or practical ability to make or block the making of policy decisions.[13] Veto Rights.  Although an investor may wish to have the ability to veto material business decisions, the Federal Reserve has limited such veto rights generally to Fundamental Matters, not without some potential inconsistency in its written statements.  The 2008 Policy Statement declares that the Federal Reserve has traditionally been concerned about restrictions on the ability to raise “additional debt or equity capital,” but in the next paragraph states that it is permissible to have a veto over “issuing senior securities or borrowing on senior basis,”[14] in addition to modifications to the terms of the investor’s security or dissolution of the company. Business Relationships.  The extent of business connections between an investor and the company invested in is an area to which the Federal Reserve staff applies considerable attention.  The general principle is that such business relationships must be “quantitatively limited and qualitatively immaterial,”[15] but the Federal Reserve looks at the facts of each transaction and make its determination on a case-by-case basis.  Critical factors are that the connections be on market terms, be non-exclusive, and be terminable without penalty by the company invested in.  The 2008 Policy Statement stated a preference for allowing more extensive business relationships when the investor’s voting securities percentage was closer to 10 than 25 percent.[16] Why the Control Definition Is Important The Federal Reserve definition of control affects bank holding companies and nonbanks alike.  In the first instance, it limits the ability of private investors – principally private equity funds and hedge funds – from making equity investments in banks and their holding companies, because it is an extremely rare private fund that will take on the burdens of Federal Reserve supervision and regulation, including activity restrictions and capital requirements.  The disincentives have increased immeasurably with the Volcker Rule, which generally limits BHCs to owning no more than 3% of the ownership interests of any private fund they sponsor.  In the Financial Crisis, the current control rules – and other restrictions imposed by the Federal Deposit Insurance Corporation – clearly limited the ability of private capital to support the banking sector. In addition to private investors, the control definitions are relevant to nonbanking companies that wish to partner with banking organizations and may wish to obtain equity in their partner as well – since a controlling investment would subject them to the restrictions on commercial activities contained in the BHC Act. Finally, revised control interpretations would also be relevant to BHCs themselves.  One legal authority available to BHCs to make equity investments is the so-called “Section 4(c)(6)” authority permitting an investment in up to 5 percent of the voting shares of any company.  Such investments – which may also include nonvoting securities – must also be noncontrolling.  And because the Volcker Rule applies to every company that a BHC or other insured depository institution holding company controls, reform of the control rules would have beneficial effects in this area as well. Areas of Potential Rationalization and Recalibration The areas below are only certain examples where current Federal Reserve precedent may be an unduly restrictive interpretation of the statutory language.  Any suggested recalibrations, too, are only possible ones. Combination of Voting and Nonvoting Securities.  The current limitations to 14.9% voting and one-third total equity do not derive from any particular aspect of the statute – which is focused only on control of voting securities.  In another context, so-called “portfolio investments” under the Federal Reserve’s Regulation K, an investor may own 19.9% voting securities and up to 40 percent total equity of a company without being deemed in control.[17]  But this is but one alternative to the current limitation. Fed Math/Tear Down Rule.  It is very difficult to justifying treating freely exercisable but out-of-the-money warrants and options as voting securities, particularly when that rule applies only to the investor in question, but no other holder of the same securities – and so this “new math” should be one of the first candidates for “rationalization.”  Similarly, the so-called “tear down” rule is unanchored to the statutory language and thus is a prime candidate for reconsideration. Directors.  The Federal Reserve has stated that generally the number of directors must be proportionate to voting shareholdings.  Again, although a greater number of directors suggests “influence,” it does not necessarily lead to a “controlling influence.”  If an investor has contributed 40 percent of a company’s total equity, it does not seem unreasonable to permit a right to appoint 40 percent of a company’s board.  Moreover, the restriction on committee chairing is arguably inconsistent with the statutory language, and keeps qualified candidates – for example, retired Federal Reserve Governors or Reserve Bank Presidents affiliated with private investors – on the sidelines. Limitations on Transfer of Nonvoting Securities. Although one can understand the Federal Reserve’s concern about the circumstances in which nonvoting securities can become voting, this is a separate issue from the issue of transfers of nonvoting securities.  If one focuses on the statutory term “controlling influence,” it would seem reasonable to permit transfers of nonvoting securities to a wider group of transferees than the four limited circumstances in which nonvoting securities can currently become voting.  This is a prime example of the side effects of the piecemeal construction of the current control framework – one might have concerns about “seriously impair[ing] the objectives and purposes” of the BHC Act when control over transfer of 25 percent or more voting securities is at issue.  It is not clear that these concerns apply in the nonvoting securities context where there are substantial limitations on the securities ever becoming voting at all. In addition, recalibrating the circumstances when nonvoting securities may become voting should also be given consideration, because certain aspects of the current rules – such as not counting the transfer of an investor’s nonvoting securities for purposes of the 50 percent transfer test – seem to be conservative simply for conservatism’s sake. Veto Rights/Class Votes. Current Federal Reserve regulation and policy limit an investor’s veto rights to matters that “significantly and adversely affect the rights and privileges” of the investor’s security.  Even if this formulation is correct as an original matter (and a recalibration subject to notice and comment would allow for discussion of this point), there may well be more corporate matters than those the Federal Reserve currently permits that may be viewed as having such an effect.  Holding an equity interest of course gives economic rights, but it can also be considered as taking a fundamental stake in a particular business – and therefore, to use but one example, it is not clear why a material change to the nature of that business should not be a Fundamental Matter subject to an investor veto.  To the extent the scope of permissible investor vetoes is broadened, similar broadening of matters that may be subject to a class vote without creating a separate class of voting securities should also be considered. Business Relationships. The area of permitted business relationships between an investor and a bank or other company is one in particular where “supplication to someone who has spent a long apprenticeship in the art of Fed[eral Reserve] interpretation” is frequently necessary.  Granting that it is impossible to predict in advance every possible contemplated business relationship, it does seem that a retreat from the current all-facts-and-circumstances test is both possible and desirable, such as through the use of regulatory presumptions of permissible arrangements, in a manner similar to the approach taken in aspects of the proposed recalibration of the Volcker Rule. Conclusion If the hinted-at rationalization and recalibration of the control rules occurs, it is hoped that the Federal Reserve will do so – as it has done this year in other areas of federal banking law – in the transparent manner of a proposal subject to notice and comment.  The peculiarities of the common law of control that have developed over more than four decades provide considerable material for interested parties to share their perspectives on improvements for the future.    [1]   Vice Chairman Randal K. Quarles, “Early Observations on Improving the Effectiveness of Post-Crisis Regulation,” January 19, 2018.    [2]   Although this Client Alert focuses on control under the BHC Act, with the abolition of the Office of Thrift Supervision, the Federal Reserve also interprets control under the Savings and Loan Holding Company Act, which has a similar, if not identical, definition, including a “controlling influence” prong.    [3]   12 U.S.C. § 1841(a)(2).    [4]   See, e.g., 12 C.F.R. §§ 225.31, 225.143; Policy Statement on Investments in Banks and Bank Holding Companies (2008).    [5]   12 C.F.R. § 225.2(q)(1).    [6]   Id. § 225.2(q)(3).    [7]   Id. § 225.2(q)(2).  The Federal Reserve has considered certain subordinated debt to be a nonvoting security.    [8]   Id. [9]   See Policy Statement on Investments in Banks and Bank Holding Companies (2008). [10]   See, e.g., Letter from Scott G. Alvarez, Esq. to Peter Heyward, Esq., June 29, 2011.  An investor may also generally transfer nonvoting securities to one of its affiliates. [11]   See Letter of William W. Wiles (March 18, 1982). [12]   See Policy Statement on Investments in Banks and Bank Holding Companies (2008). [13]   See id. [14]   Id.  The two statements are reconcilable if a veto over additional pari passu and subordinated instruments is impermissible, but one over senior debt and equity issuances is permissible. [15]   Id. [16]   Id. [17]   See 12 C.F.R. § 211.8(c)(3). Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work in the firm’s Financial Institutions practice group, or the authors: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) James O. Springer – Washington, D.C. (+1 202-887-3516, jspringer@gibsondunn.com) © 2018 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.