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January 9, 2020 |
Developments in the Defense of Financial Institutions – The International Reach of the U.S. Money Laundering Statutes

Click for PDF Our clients frequently inquire about precisely when U.S. money laundering laws provide jurisdiction to reach conduct that occurred outside of the United States.  In the past decade, U.S. courts have reiterated that there is a presumption against statutes applying extraterritorially,[1] and explicitly narrowed the extraterritorial reach of the Foreign Corrupt Practices Act (“FCPA”)[2] and the wire fraud statute.[3]  But the extraterritorial reach of the U.S. money laundering statutes—18 U.S.C. §§ 1956 and 1957—remains uncabined and increasingly has been used by the U.S. Department of Justice (“DOJ”) to prosecute crimes with little nexus to the United States.  Understanding the breadth of the money laundering statutes is vital for financial institutions because these organizations often can become entangled in a U.S. government investigation of potential money laundering by third parties, even though the financial institution was only a conduit for the transactions. 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 how DOJ has stretched U.S. money laundering statutes—perhaps to a breaking point—to reach conduct that occurred outside of the United States.  We begin by providing a general overview of the U.S. money laundering statutes.  From there, we discuss how DOJ has relied on a broad interpretation of “financial transactions” that occur “in whole or in part in the United States” to reach, for instance, conduct that occurred entirely outside of the United States and included only a correspondent banking transaction that cleared in the United States.  And while courts have largely agreed with DOJ’s interpretation of the money laundering statutes, a recent acquittal by a jury in Brooklyn in a case involving money laundering charges with little nexus to the United States shows that juries occasionally may provide a check on the extraterritorial application of the money laundering statutes—for those willing to risk trial.  Next, we discuss three recent, prominent examples—the FIFA corruption cases, the 1MDB fraud civil forfeitures, and the recent Petróleos de Venezuela, S.A. (“PDVSA”) indictments—that demonstrate how DOJ has increasingly used the money laundering statutes in recent years to police corruption and bribery abroad.  The alert concludes by illustrating the risks that the broad reach of the money laundering statutes can have for financial institutions. 1. The U.S. Money Laundering Statutes and Their Extraterritorial Application In 1980, now-Judge Rakoff wrote that “[t]o federal prosecutors of white collar crime, the mail fraud statute is our Stradivarius, our Colt 45, our Louisville Slugger, our Cuisinart—and our true love.”[4]  In 2020, the money laundering statutes now play as an entire string quartet for many prosecutors, particularly when conduct occurs outside of the United States. Title 18, Sections 1956 and 1957 are the primary statutes that proscribe money laundering.  “Section 1956 penalizes the knowing and intentional transportation or transfer of monetary proceeds from specified unlawful activities, while § 1957 addresses transactions involving criminally derived property exceeding $10,000 in value.”  Whitfield v. United States, 543 U.S. 209, 212-13 (2005).  To prosecute a violation of Section 1956, the government must prove that: (1) a person engaged in a financial transaction, (2) knowing that the transaction involved the proceeds of some form of unlawful activity (a “Specified Unlawful Activity” or “SUA”),[5] and (3) the person intended to promote an SUA or conceal the proceeds of an SUA.[6]  And if the person is not located in the United States, Section 1956 provides that there is extraterritorial jurisdiction if the transaction in question exceeds $10,000 and “in the case of a non-United States citizen, the conduct occurs in part in the United States.”[7]  The word “conducts” is defined elsewhere in the statute as “includ[ing] initiating, concluding, or participating in initiating, or concluding a transaction.”[8]  Putting it all together, establishing a violation of Section 1956 by a non-U.S. citizen abroad requires: Figure 1: Applying Section 1956 Extraterritorially Section 1957 is the spending statute, involving substantially the same elements as Section 1956 but substituting a requirement that a defendant spend proceeds of criminal activity for the requirement that a defendant intend to promote or conceal an SUA.[9] a. “Financial Transaction” and Correspondent Banking Although the term “financial transaction” might at first blush seem to limit the reach of money laundering liability, the reality is that federal prosecutors have repeatedly and successfully pushed the boundaries of the types of value exchanges that qualify as “financial transactions.”  As one commentator has noted, “virtually anything that can be done with money is a financial transaction—whether it involves a financial institution, another kind of business, or even private individuals.”[10]  Indeed, courts have confirmed that the reach of money laundering statutes extends beyond traditional money.  One such example involves the prosecution of the creator of the dark web marketplace Silk Road.  In 2013, federal authorities shut down Silk Road, which they alleged was “the most sophisticated and extensive criminal marketplace on the Internet” that permitted users to anonymously buy and sell illicit goods and services, including malicious software and drugs.[11]  Silk Road’s creator, Ross William Ulbricht, was charged with, among other things, conspiracy to commit money laundering under Section 1956.[12]  The subsequent proceedings focused in large part on the meaning of “financial transactions” as used in Section 1956 and specifically, whether transactions involving Bitcoin can qualify as “financial transactions” under the statute.  Noting that “financial transaction” is broadly defined, the district court reasoned that because Bitcoin can be used to buy things, transactions involving Bitcoin necessarily involve the “movement of funds” and thus qualify as “financial transactions” under Section 1956.[13] In addition to broadly interpreting “financial transaction,” DOJ also has taken an expansive view of what constitutes a transaction occurring “in part in the United States”—a requirement to assert extraterritorial jurisdiction over a non-U.S. citizen.[14]  One area where DOJ has repeatedly pushed the envelope involves correspondent banking transactions. Correspondent banking transactions are used to facilitate cross-border transactions that occur between two parties using different financial institutions that lack a direct relationship.  As an example, if a French company (the “Ordering Customer”) maintains its accounts at a French financial institution and wants to send money to a Turkish company (the “Beneficiary Customer”) that maintains its accounts at a Turkish financial institution, and if the French and Turkish banks lack a direct relationship, then often those banks will process the transaction using one or more correspondent accounts in the United States.  An example of this process is depicted in Figure 2. Figure 2: Correspondent Banking Transactions[15] Although correspondent banking transactions can occur using a number of predominant currencies, such as euros, yen, and renminbi, U.S. dollar payments account for about 50 percent of correspondent banking transactions.[16]  Not only that, but “[t]here are indications that correspondent banking activities in US dollars are increasingly concentrated in US banks and that non-US banks are increasingly withdrawing from providing services in this currency.”[17]  As a result, banks in the United States play an enormous role in correspondent banking transactions. Given the continued centrality of the U.S. financial system, when confronted with misconduct taking place entirely outside of the United States, federal prosecutors are often able to identify downstream correspondent banking transactions in the United States involving the proceeds of that misconduct.  On the basis that the correspondent banking transaction qualifies as a financial transaction occurring in part in the United States, prosecutors have used this hook to establish jurisdiction under the money laundering statutes.  Two notable examples are discussed below. i. Prevezon Holdings The Prevezon Holdings case confirmed DOJ’s ability to use correspondent banking transactions as a jurisdictional hook for conduct occurring overseas.  The case arose from an alleged $230 million fraud scheme that a Russian criminal organization and Russian government officials perpetrated against hedge fund Hermitage Capital Management Limited.[18]  In 2013, DOJ filed a civil forfeiture complaint alleging that (1) the criminal organization stole the corporate identities of certain Hermitage portfolio companies by re-registering them in the names of members of the organization.  Then, (2) other members of the organization allegedly filed bogus lawsuits against the Hermitage entities based on forged and backdated documents.  Later, (3) the co-conspirators purporting to represent the Hermitage portfolio companies confessed to all of the claims against them, leading the courts to award money judgments against the Hermitage entities.  Finally, (4) the representatives of the purported Hermitage entities then fraudulently obtained money judgments to apply for some $230 million in fraudulent tax refunds.[19]  DOJ alleged that this fraud scheme constituted several distinct crimes, all of which were SUAs supporting money laundering violations.  DOJ then sought forfeiture of bank accounts and real property allegedly traceable to those money laundering violations. The parties challenging DOJ’s forfeiture action (the “claimants”) moved for summary judgment on certain of the SUAs, claiming that those SUAs, including Interstate Transportation of Stolen Property (“ITSP,” 18 U.S.C. § 2314), did not apply extraterritorially.  The district court rejected claimants’ challenge to the ITSP SUA.  The court held that Section 2314 does not, by its terms, apply extraterritorially.[20]  Nevertheless, the court found the case involved a permissible domestic application of the statute because it involved correspondent banking transactions.  Specifically, the court held that “[t]he use of correspondent banks in foreign transactions between foreign parties constitutes domestic conduct within [the statute’s] reach, especially where bank accounts are the principal means through which the relevant conduct arises.”[21]  In support of this holding, the court described U.S. correspondent banks as “necessary conduits” to accomplish the four U.S. dollar transactions cited by the government, which “could not have been completed without the services of these U.S. correspondent banks,” even though the sender and recipient of the funds involved in each of these transactions were foreign parties.[22]  The court also rejected claimants’ argument that they would have had to have “purposefully availed” themselves of the services of the correspondent banks, on the basis that this interpretation would frustrate the purpose of Section 2314 given that “aside from physically carrying currency across the U.S. border, it is hard to imagine what types of domestic conduct other than use of correspondent banks could be alleged to displace the presumption against extraterritoriality in a statute addressing the transportation of stolen property.”[23] ii. Boustani The December 2019 acquittal of a Lebanese businessman on trial in the Eastern District of New York marks an unusual setback in DOJ’s otherwise successful efforts to expand its overseas jurisdiction by using the money laundering statutes and correspondent banking transactions. Jean Boustani was an executive at the Abu Dhabi-based shipping company Privinvest Group (“Privinvest”).[24]  According to prosecutors, three Mozambique-owned companies borrowed over $2 billion through loans that were guaranteed by the Mozambican government.[25]  Although these loans were supposed to be used for maritime projects with Privinvest, the government alleged that Boustani and his co-conspirators created the maritime projects as “fronts to raise as much money as possible to enrich themselves,” ultimately diverting over $200 million from the loan funds for bribes and kickbacks to themselves, Mozambican government officials, and Credit Suisse bankers.[26]  According to the indictment, Boustani himself received approximately $15 million from the proceeds of Privinvest’s fraudulent scheme, paid in a series of wire transfers, many of which were paid through a correspondent bank account in New York City.[27] Boustani did not engage directly in any activity in the United States, and he filed a motion to dismiss arguing that, with respect to a conspiracy to commit money laundering charge, as a non-U.S. citizen he must participate in “initiating” or “concluding” a transaction in the United States to come under the extraterritorial reach of 18 U.S.C. § 1956(f).[28]  Specifically, he argued that “[a]ccounting interactions between foreign banks and their clearing banks in the U.S. does not constitute domestic conduct . . . as Section 1956(f) requires.”[29]  In response, prosecutors argued that Boustani “systematically directed $200 million of U.S. denominated bribe and kickback payments through the U.S. financial system using U.S. correspondent accounts”[30] and that such correspondent banking transactions are sufficient to allow for the extraterritorial application of Section 1956.[31] The court agreed with the government’s position.  In denying the motion to dismiss, the court held that correspondent banking transactions occurring in the United States are sufficient to satisfy the jurisdictional requirements of 18 U.S.C. § 1956(f).[32]  It cited to “ample factual allegations” that U.S. individuals and entities purchased interests in the loans at issue by wiring funds originating in the United States to locations outside the United States and that Boustani personally directed the payment of bribe transactions in U.S. dollars through the United States, describing this as “precisely the type of conduct Congress focused on prohibiting when enacting the money laundering provisions with which [Boustani] is charged.”[33] The jury, however, was unconvinced.  After a roughly seven-week trial, Boustani was acquitted on all charges on December 2, 2019.[34]  The jurors who spoke to reporters after the verdict said that a major issue for the jury was whether or not U.S. charges were properly brought against Boustani, an individual who had never set foot in the United States before his arrest.[35]  The jury foreman commented, “I think as a team, we couldn’t see how this was related to the Eastern District of New York.”[36]  Another juror echoed this sentiment, adding, “We couldn’t find any evidence of a tie to the Eastern District. . . .  That’s why we acquitted.”[37] The Boustani case illustrates that even if courts are willing to accept the position that the use of correspondent banks in foreign transactions between foreign parties constitutes domestic conduct within the reach of the money laundering statute, juries may be less willing to do so. b. Using “Specified Unlawful Activities” to Target Conduct Abroad Another way in which the U.S. money laundering statutes reach broadly is that the range of crimes that qualify as SUAs for purposes of Sections 1956 and 1957 is virtually without limit.  Generally speaking, most federal felonies will qualify.  More expansively, however, the money laundering statutes include specific foreign crimes that also qualify as SUAs.  For example, bribery of a public official in violation of a foreign nation’s bribery laws will qualify as an SUA.[38]  Similarly, fraud on a foreign bank in violation of a foreign nation’s fraud laws qualifies as an SUA.[39]  In addition to taking an expansive view of what constitutes a “financial transaction” and when it occurs “in part in the United States,” DOJ also has increasingly used the foreign predicates of the money laundering statute to prosecute overseas conduct involving corruption or bribery.  This subsection discusses a few notable recent examples. i. FIFA In May 2015, the United States shocked the soccer world when it announced indictments of nine Fédération Internationale de Football Association (“FIFA”) officials and five corporate executives in connection with a long-running investigation into bribery and corruption in the world of organized soccer.[40]  Over a 24-year period, the defendants allegedly paid and solicited bribes and kickbacks relating to, among other things, media and marketing rights to soccer tournaments, the selection of a host country for the 2010 FIFA World Cup, and the 2011 FIFA presidential elections.[41]  The defendants included high-level officials in FIFA and its constituent regional organizations, as well as co-conspirators involved in soccer-related marketing (e.g., Traffic Sports USA), broadcasting (e.g., Valente Corp.), and sponsorship (e.g., International Soccer Marketing, Inc.).[42]  Defendants were charged with money laundering under Section 1956(a)(2)(A) for transferring funds to promote wire fraud, an SUA.[43]  Two defendants were convicted at trial.[44]  The majority of the remaining defendants have pleaded guilty and agreed to forfeitures.[45] One of the defendants, Juan Ángel Napout, challenged the extraterritorial application of the U.S. money laundering statutes.  At various points during the alleged wrongdoing, Napout served as the vice president of FIFA and the president of the Confederación Sudamericana de Fútbol (FIFA’s South American confederation).[46]  Napout was accused of using U.S. wires and financial institutions to receive bribes for the broadcasting and commercial rights to the Copa Libertadores and Copa America Centenario tournaments.[47]  He argued that the U.S. money laundering statutes do not apply extraterritorially to him and that, regardless, this exercise of extraterritorial jurisdiction was unreasonable.[48]  The district court rejected these arguments, concluding that extraterritorial jurisdiction was proper because the government satisfied the two requirements in 18 U.S.C. § 1956(f): the $10,000 threshold and conduct that occurred “in part” in the United States.[49]  Notably, at trial, the jury acquitted Napout of the two money laundering charges against him but convicted him on the other three charges (RICO conspiracy and two counts of wire fraud).[50]  At the same trial, another defendant, José Marin, was charged with seven counts, including two for conspiracy to commit money laundering.  Marin was acquitted on one of the money laundering counts but convicted on all others.[51] ii. 1MDB The 1MDB scandal is “one of the world’s greatest financial scandals.”[52]  Between 2009 to 2014, Jho Low, a Malaysian businessman, allegedly orchestrated a scheme to pilfer approximately $4.5 billion from 1 Malaysia Development Berhad (“1MDB”), a Malaysian sovereign wealth fund created to pursue projects for the benefit of Malaysia and its people.[53]  Low allegedly used that money to fund a lavish lifestyle including buying various properties in the United States and running up $85 million in gambling debts at Las Vegas casinos.[54]  The former Prime Minister of Malaysia, Rajib Nazak, also personally benefited from the scandal, allegedly pocketing around $681 million.[55]  Additionally, his stepson, Riza Aziz, used proceeds from the scandal to fund Red Granite Pictures, a U.S. movie production company, which produced “The Wolf of Wall Street,” among other films.[56] In 2016, DOJ filed the first of a number of civil forfeiture actions against assets linked to funds pilfered from 1MDB, totaling about $1.7 billion.[57]  As the basis of the forfeiture, DOJ asserted a number of different violations of the U.S. money laundering statutes on the basis of four SUAs.[58] In March 2018, Red Granite Pictures entered into a settlement agreement with the DOJ to resolve the allegations in the 2016 civil forfeiture action.[59]  On October 30, 2019, DOJ announced the settlement of a civil forfeiture action against more than $700 million in assets held by Low in the United States, United Kingdom and Switzerland, including properties in New York, Los Angeles, and London, a luxury yacht valued at over $120 million, a private jet, and valuable artwork.[60]  Although neither Red Granite Pictures nor Low challenged the extraterritoriality of the U.S. money laundering statute as applied to their property, the cases nevertheless serve as noteworthy examples of DOJ using its authority under the money laundering statutes to police political corruption abroad. iii. PDVSA To date, more than 20 people have been charged in connection with a scheme to solicit and pay bribes to officials at and embezzle money from the state-owned oil company in Venezuela,  Petróleos de Venezuela, S.A.[61]  The indictments charge money laundering arising from several SUAs, including bribery of a Venezuelan public official.[62] Many of the defendants have pled guilty to the charges, but the charges against two former government officials, Nervis Villalobos and Rafael Reiter, remain pending.[63]  In March 2019, Villalobos filed a motion to dismiss the FCPA and money laundering claims against him on the basis that these statutes do not provide for extraterritorial jurisdiction.[64]  As to the money laundering charges, he argued that “[e]xtraterritorial jurisdiction over a non-citizen cannot be based on a coconspirator’s conduct in the United States,” and that extraterritorial application of the money laundering statute would violate international law and the due process clause.[65]  As of this writing, the court has not ruled on the motion. 2. The Risks to Financial Institutions The degree to which the U.S. money laundering statutes can reach extraterritorial conduct outside the United States has important implications for financial institutions.  Prosecutions of foreign conduct under the money laundering statutes frequently involve high-profile scandals, as shown above.  Financial institutions are often drawn into these newsworthy investigations.  In the wake of the FIFA indictments, for instance, “[f]ederal prosecutors said they were also investigating financial institutions to see whether they were aware of aiding in the launder of bribe payments.”[66]  Indeed, more than half a dozen banks reportedly received inquiries from law enforcement related to the FIFA scandal.[67] At a minimum, cooperating with these investigations is time-consuming and costly.  The investigations can also create legal risk for financial institutions.  In the United States, “federal law generally imposes liability on a corporation for the criminal acts of its agents taken on behalf of the corporation and within the scope of the agent’s authority via the principle of respondeat superior, unless the offense conduct solely furthered the employee’s interests at the employer’s expense (for instance, where the employee was embezzling from the employer).”[68]  And prosecutors can satisfy the intent required by arguing that individual employees were “deliberately ignorant” of or “willfully blind” to, for instance, clearing suspicious transactions.[69] The wide scope of potential corporate criminal liability in the United States is often surprising to our clients, particularly those with experience overseas where the breadth of corporate liability is narrower than in the United States.  As one article explained, the respondeat superior doctrine is “exceedingly broad” as “it imposes liability regardless of the agent’s position in the organization” and “does not discriminate” in that “the multinational corporation with thousands of employees whose field-level salesman commits a criminal act is as criminally responsible as the small corporation whose president and sole stockholder engages in criminal conduct.”[70] Given the breadth of corporate criminal liability, DOJ applies a 10-factor equitable analysis to determine whether to impute individual employee liability to the corporate employer.  These 10 factors are the “Principles of Federal Prosecution of Business Organizations,” and are often referred to by the shorthand term “Filip Factors.”  The factors include considerations such as the corporation’s cooperation, the pervasiveness of the wrongdoing, and other considerations meant to guide DOJ’s discretion regarding whether to pursue a corporate resolution.[71]  They are not equally weighted (indeed, there is no specific weighting attached to each, and the DOJ’s analysis will not be mathematically precise).  Financial institutions should continually assess, both proactively and in the event misconduct occurs, the actions that can be taken to ensure that they can persuasively argue that, even if there is legal liability under the doctrine of respondeat superior, prosecution is nevertheless unwarranted under the Filip Factors. 3. Conclusion In recent years, DOJ has expansively applied the money laundering statutes to reach extraterritorial conduct occurring almost entirely overseas.  Indeed, a mere correspondent banking transaction in the United States has been used by DOJ as the hook to prosecute foreign conduct under the U.S. money laundering statutes.  Because of the extraordinary breadth of corporate criminal liability in the United States, combined with the reach of the money laundering statutes, the key in any inquiry is to quickly assess and address prosecutors’ interests in the institution as a subject of the investigation. ____________________ [1]              Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010). [2]              United States v. Hoskins, 902 F.3d 69 (2d Cir. 2018).  Although the Second Circuit rejected the government’s argument that Hoskins could be charged under the conspiracy and complicity statutes for conduct not otherwise reachable by the FCPA, id. at 97, he was nevertheless found guilty at trial in November 2019 on a different theory of liability: that he acted as the agent of Alstom S.A.’s American subsidiary.  See Jody Godoy, Ex-Alstom Exec Found Guilty On 11 Counts In Bribery Trial, Law360 (Nov. 8, 2019), https://www.law360.com/articles/1218374/ex-alstom-exec-found-guilty-on-11-counts-in-bribery-trial. [3]              See, e.g., United States v. Elbaz, 332 F. Supp. 3d 960, 974 (D. Md. 2018) (collecting cases where extraterritorial conduct not subject to the wire fraud statute). [4]              Jed S. Rakoff, The Federal Mail Fraud Statute (Part I), 18 Duq. L. Rev. 771, 822 (1980). [5]              Many of the SUAs covered by Section 1956 are incorporated by cross-references to other statutes.  See 18 U.S.C. § 1956(c)(7).  All of the predicate acts under the Racketeer Influenced and Corrupt Organizations Act, for instance, are SUAs under Section 1956.  18 U.S.C. § 1956(c)(7)(a).  One commentator has estimated that there are “250 or so” predicate acts in Section 1956.  Stefan D. Cassella, The Forfeiture of Property Involved in Money Laundering Offenses, 7 Buff. Crim. L. Rev. 583, 612 (2004).  Another argues this estimate is “exceptionally conservative.”  Charles Doyle, Cong. Research Serv., RL33315, Money Laundering: An Overview of 18 U.S.C. § 1956 and Related Federal Criminal Law 1 n.2 (2017). [6]              See, e.g., Fifth Circuit Pattern Jury Instructions (Criminal Cases) Nos. 2.76A, 2.76B, available at   http://www.lb5.uscourts.gov/viewer/?/juryinstructions/Fifth/crim2015.pdf; Ninth Circuit Manual of Model Criminal Jury Instruction Nos. 8.147-49, available at http://www3.ce9.uscourts.gov/jury-instructions/sites/default/files/WPD/Criminal_Instructions_2019_12_0.pdf. [7]              18 U.S.C. § 1956(f). [8]              18 U.S.C. § 1956(c)(2). [9]              See, e.g., Fifth Circuit Pattern Jury Instructions (Criminal Cases) No. 2.77; Ninth Circuit Manual of Model Criminal Jury Instruction No. 8.150. [10]             Stefan D. Cassella, The Money Laundering Statutes (18 U.S.C. §§ 1956 and 1957), The United States Attorneys’ Bulletin, Vol. 55, No. 5 (Sept. 2007); see also 18 U.S.C. § 1956(c)(4)(i) (definition of “financial transaction”). [11]             United States v. Ulbricht, 31 F. Supp. 3d 540, 549-50 (S.D.N.Y. 2014). [12]             Id. at 568-69. [13]             Id.  Ultimately, Ulbricht was convicted and his conviction was affirmed on appeal.  See United States v. Ulbricht, 858 F.3d 71 (2d Cir. 2017).  The Second Circuit did not address the district court’s interpretation of the term “financial transactions” under Section 1956. [14]             18 U.S.C. § 1956(f)(1). [15]             International Monetary Fund, Recent Trends in Correspondent Banking Relationships: Further Considerations, at 9 (April 21, 2017), https://www.imf.org/en/Publications/Policy-Papers/Issues/2017/04/21/recent-trends-in-correspondent-banking-relationships-further-considerations. [16]             Id. [17]             Bank for International Settlements Committee on Payments and Market Infrastructures, Correspondent Banking, at 12 (July 2016), https://www.bis.org/cpmi/publ/d147.pdf. [18]             See generally Bill Browder, Red Notice: A True Story of High Finance, Murder, and One Man’s Fight for Justice (2015).  The alleged scheme was discovered by Russian tax lawyer Sergei Magnitsky, who was arrested on specious charges and died after receiving inadequate medical treatment in a Russian prison.  In response to Magnitsky’s death, the United States passed a bill named after him sanctioning Russia for human rights abuses.  See Russia and Moldova Jackson–Vanik Repeal and Sergei Magnitsky Rule of Law Accountability Act of 2012, Pub. L. 112–208 (2012). [19]             Second Amended Complaint at 10-12, United States v. Prevezon Holdings Ltd., No. 13-cv-06326 (S.D.N.Y. Oct. 23, 2015), ECF No. 381. [20]             United States v. Prevezon Holdings Ltd., 251 F. Supp. 3d 684, 691-92 (S.D.N.Y. 2017). [21]             Id. at 692. [22]             Id. at 693. [23]             Id.  [24]             Stewart Bishop, Boustani Acquitted in $2B Mozambique Loan Fraud Case, Law360 (Dec. 2, 2019), https://www.law360.com/articles/1221333/boustani-acquitted-in-2b-mozambique-loan-fraud-case. [25]             Superseding Indictment at 6, United States of America v. Boustani et al., No. 1:18-cr-00681 (E.D.N.Y. Aug. 16, 2019), ECF No. 137. [26]             Id. at 6-7. [27]             Id. at 33. [28]             Motion to Dismiss at 35-36, United States of America v. Boustani et al., No. 1:18-cr-00681 (E.D.N.Y. June 21, 2019), ECF No. 98. [29]             Id. at 36. [30]             Opposition to Motion to Dismiss at 38, United States of America v. Boustani et al., No. 1:18-cr-00681 (E.D.N.Y. July 22, 2019), ECF No. 113. [31]             Id. at 34-35 (citing United States v. All Assets Held at Bank Julius (“All Assets”), 251 F. Supp. 3d 82, 96 (D.D.C. 2017).) [32]             Decision & Order Denying Motions to Dismiss at 14, United States of America v. Boustani et al., No. 1:18-cr-00681 (E.D.N.Y. Oct. 3, 2019), ECF No. 231. [33]             Id. at 15-16; see also All Assets, 251 F. Supp. 3d at 95 (finding correspondent banking transactions fall within U.S. money laundering statutes because “[t]o conclude that the money laundering statute does not reach [Electronic Fund Transfers] simply because [defendant] himself did not choose a U.S. bank as the correspondent or intermediate bank for his wire transfers would frustrate Congress’s intent to prevent the use of U.S. financial institutions ‘as clearinghouses for criminals’”).  In United States v. Firtash, No. 13-cr-515, 2019 WL 2568569 (N.D. Ill. June 21, 2019), the defendant recently moved to dismiss an indictment on grounds including that correspondent banking transactions do not fall within the scope of the U.S. money laundering statute.  The court has sidestepped the argument for now, concluding that this argument “does not support dismissal of the Indictment at this stage” because “the Indictment does not specify that the government’s proof is limited to correspondent bank transactions.”  Id. at *9. [34]             Stewart Bishop, Boustani Acquitted in $2B Mozambique Loan Fraud Case, Law360 (Dec. 2, 2019), https://www.law360.com/articles/1221333/boustani-acquitted-in-2b-mozambique-loan-fraud-case. [35]             Id. [36]             Id. [37]             Id. [38]             18 U.S.C. § 1956(c)(7)(B)(iv).  In United States v. Chi, 936 F.3d 888, 890 (9th Cir. 2019), the Ninth Circuit recently rejected the argument that the term “bribery of a public official” in Section 1956 should be read to mean bribery under the U.S. federal bribery statute, as opposed to the article of the South Korean Criminal Code at issue in that case. [39]             18 U.S.C. § 1956(c)(7)(B)(iii). [40]             U.S. Dep’t of Justice, Attorney General Loretta E. Lynch Delivers Remarks at Press Conference Announcing Charges Against Nine FIFA Officials and Five Corporate Executives (May 27, 2015), https://www.justice.gov/opa/speech/attorney-general-loretta-e-lynch-delivers-remarks-press-conference-announcing-charges. [41]             Superseding Indictment at ¶¶ 95-360, United States v. Hawit, No. 15-cr-252 (E.D.N.Y. Nov. 25, 2015), ECF No. 102. [42]             See, e.g., id. at ¶¶ 30-93. [43]             See, e.g., id. at ¶ 371. [44]             Press Release, U.S. Dep’t of Justice, High-Ranking Soccer Officials Convicted in Multi-Million Dollar Bribery Schemes (Dec. 26, 2017), https://www.justice.gov/usao-edny/pr/high-ranking-soccer-officials-convicted-multi-million-dollar-bribery-schemes. [45]             U.S. Dep’t of Justice, FIFA Prosecution United States v. Napout et al. and Related Cases, Upcoming Court Dates, https://www.justice.gov/usao-edny/file/799016/download (last updated Nov. 5, 2019). [46]             Superseding Indictment, supra note 41, at ¶ 41. [47]             Superseding Indictment, supra note 41, at ¶¶ 376-81, 501-04. [48]             Memorandum of Law in Support of Defendant Juan Angel Napout’s Motion to Dismiss All Charges for Lack of Extraterritorial Jurisdiction, at 3-4, Hawit, supra note 41, ECF No. 491-1. [49]             United States v. Hawit, No. 15-cr-252, 2017 WL 663542, at *8 (E.D.N.Y. Feb. 17, 2017). [50]             United States v. Napout, 332 F. Supp. 3d 533, 547 (E.D.N.Y. 2018). [51]             Id.  On appeal, Napout challenged the extraterritoriality of the honest-services wire-fraud statutes, a case currently pending before the Second Circuit.  See United States of America v. Webb et al., No. 18-2750 (2d. Cir. appeal docketed Sept. 17, 2018), Dkt. 107.  Marin did not raise the extraterritoriality of the money laundering statute on appeal.  Id., Dkt. 104. [52]             Heather Chen, Mayuri Mei Lin, and Kevin Ponniah, 1MDB: The Playboys, PMs and Partygoers Around a Global Financial Scandal, BBC (Apr. 2, 2019), https://www.bbc.com/news/world-asia-46341603; see generally Tom Wright & Bradley Hope, Billion Dollar Whale: The Man Who Fooled Wall Street, Hollywood, and the World (2018). [53]             Complaint at 6, United States v.“The Wolf of Wall Street,” No. 2:16-cv-05362 (C.D. Cal. July 20, 2016), ECF No. 1, https://www.justice.gov/archives/opa/page/file/877166/download. [54]             Complaint, supra note 53, at 37. [55]             Najib 1MDB Trial: Malaysia Ex-PM Faces Court in Global Financial Scandal, BBC (Apr. 3, 2019), https://www.bbc.com/news/world-asia-47194656.  In the aftermath of the scandal, Nazak was voted out of office and currently faces trial in Malaysia.  Id. [56]             Complaint, supra note 53, at 63-65. [57]             Complaint, supra note 53; Rishi Iyengar, ‘Wolf of Wall Street’ Maker Settles US Lawsuit for $60 Million, CNN Business (Mar. 7, 2018), https://money.cnn.com/2018/03/07/media/wolf-wall-street-red-granite-1mdb-settlement/index.html. [58]             See Complaint, supra note 53, at 132. [59]             Consent Judgment of Forfeiture, No. 2:16-cv-05362 (C.D. Cal. Mar. 8, 2018), ECF No. 143.  As a part of the settlement, Red Granite Pictures agreed to forfeit $60 million.  Id. at 5. [60]             See United States v. Any Rights to Profits, Royalties and Distribution Proceeds Owned by or Owed Relating to EMI Music Publishing Group, Stipulation and Request to Enter Consent Judgment of Forfeiture, No. 16-cv-05364 (C.D. Cal. Oct. 30, 2019), ECF No. 180; Press Release, U.S. Dep’t of Justice, United States Reaches Settlement to Recover More Than $700 Million in Assets Allegedly Traceable to Corruption Involving Malaysian Sovereign Wealth Fund (Oct. 30, 2019), https://www.justice.gov/opa/pr/united-states-reaches-settlement-recover-more-700-million-assets-allegedly-traceable. [61]             See Indictment, United States v. De Leon-Perez et al., No. 4:17-cr-00514 (S.D. Tex. Aug. 23, 2017), ECF No. 1; Press Release, U.S. Dep’t of Justice, Two Members of Billion-Dollar Venezuelan Money Laundering Scheme Arrested (July 25, 2018), https://www.justice.gov/opa/pr/two-members-billion-dollar-venezuelan-money-laundering-scheme-arrested. [62]           Criminal Information at 1-2, United States v. Krull, No. 1:18-cr-20682 (S.D. Fla. Aug. 16, 2018), ECF No. 23; Criminal Complaint at 6, United States v. Guruceaga, et al., No. 18-MJ-03119 (S.D. Fla. July 23, 2018), ECF No. 3. [63]           Press Release, U.S. Dep’t of Justice, Former Venezuelan Official Pleads Guilty to Money Laundering Charge in Connection with Bribery Scheme (July 16, 2018), https://www.justice.gov/opa/pr/former-venezuelan-official-pleads-guilty-money-laundering-charge-connection-bribery-scheme-0. [64]           See Defendant’s Motion to Dismiss at 9-24, United States v. Villalobos, No. 4:17-cr-00514 (S.D. Tex. Mar. 28, 2019), ECF No. 123. [65]           See id. at 21-35. [66]           Gina Chon & Ben McLannahan, Banks face US investigation in Fifa corruption scandal, Financial Times (May 27, 2015); see also Christie Smythe & Keri Geiger, U.S. Probes Bank Links in FIFA Marketing Corruption Scandal, Bloomberg (May 27, 2015). [67]           Christopher M. Matthews & Rachel Louise Ensign, U.S. Authorities Probe Banks’ Handling of FIFA Funds, Wall St. Journal (July 23, 2015). [68]           Fed. Ins. Co. v. United States, 882 F.3d 348, 368 (2d Cir. 2018). [69]           See, e.g., Global-Tech Appliances, Inc. v. SEB S.A., 563 U.S. 754, 769 (2011); United States v. Florez, 368 F.3d 1042, 1044 (8th Cir. 2004). [70]           Philip A. Lacovara & David P. Nicoli, Vicarious Criminal Liability of Organizations: RICO as an Example of a Flawed Principle in Practice, 64 St. John’s L. Rev. 725, 725-26 (1990). [71]           See U.S. Department of Justice, Principles of Federal Prosecution of Business Organizations (Aug. 28, 2008), https://www.justice.gov/sites/default/files/dag/legacy/2008/11/03/dag-memo-08282008.pdf. The following Gibson Dunn attorneys assisted in preparing this client update:  M. Kendall Day, Stephanie L. Brooker, F. Joseph Warin, Chris Jones, Jaclyn Neely, Chantalle Carles Schropp, Alexander Moss, Jillian Katterhagen Mills, Tory Roberts, and summer associates Beatrix Lu and Olivia Brown. Gibson Dunn has deep experience with issues relating to the defense of financial institutions.  For assistance navigating white collar or regulatory enforcement issues involving financial institutions, please contact the Gibson Dunn lawyer with whom you usually work, any of the leaders and members of the firm’s Financial Institutions, White Collar Defense and Investigations, or International Trade practice groups, or the following authors in the firm’s Washington, D.C., New York, and San Francisco offices: M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) Stephanie Brooker –  Washington, D.C.(+1 202-887-3502, sbrooker@gibsondunn.com) F. Joseph Warin – Washington, D.C. (+1 202-887-3609, fwarin@gibsondunn.com) Jaclyn Neely – New York (+1 212-351-2692, jneely@gibsondunn.com) Chris Jones* – San Francisco (+1 415-393-8320, crjones@gibsondunn.com) Chantalle Carles Schropp – Washington, D.C. (+1 202-955-8275, cschropp@gibsondunn.com) Alexander R. Moss – Washington, D.C. (+1 202-887-3615, amoss@gibsondunn.com) Jillian N. Katterhagen* – Washington, D.C. (+1 202-955-8283 , jkatterhagen@gibsondunn.com) Please also feel free to contact any of the following practice group leaders: Financial Institutions Group: Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) White Collar Defense and Investigations Group: Joel M. Cohen – New York (+1 212-351-2664, jcohen@gibsondunn.com) Charles J. Stevens – San Francisco (+1 415-393-8391, cstevens@gibsondunn.com) F. Joseph Warin – Washington, D.C. (+1 202-887-3609, fwarin@gibsondunn.com) International Trade Group: Ronald Kirk – Dallas (+1 214-698-3295, rkirk@gibsondunn.com) Judith Alison Lee – Washington, D.C. (+1 202-887-3591, jalee@gibsondunn.com) *Mr. Jones and Ms. Katterhagen Mills are not yet admitted in California and Washington, D.C., respectively.  They are practicing under the supervision of Principals of the Firm. © 2020 Gibson, Dunn & Crutcher LLP Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

December 10, 2019 |
Brexit – Reporting of Derivatives under EMIR

Click for PDF In the event of the United Kingdom leaving the European Union without an agreed deal on 31 January 2020, UK counterparties will need to make changes to their derivatives reporting arrangements in advance of that date to ensure that they comply with the UK’s European Market Infrastructure Regulation (“EMIR”) reporting requirements immediately post-Brexit. This briefing sets out what steps UK counterparties to derivatives transactions should take now in relation to their reporting arrangements to ensure a smooth transition on and after Brexit. EMIR and much of its secondary implementation legislation takes the form of a Regulation and is therefore (before exit) directly applicable in UK law. The European Union (Withdrawal) Act 2018 provides that EU legislation that is directly applicable, such as EU EMIR, will form part of UK law on exit day and gives power to the UK government to amend the legislation so that it operates effectively post-Brexit. Consequently, post-Brexit there will be two versions of EMIR: the original EU version which will continue to apply to EU counterparties to derivatives transactions, EU central counterparties (“CCPs”) and EU trade repositories (“TRs”) (“EU EMIR”); and the UK version incorporating amendments during the onshoring process to ensure the regime continues to operate effectively post-Brexit (“UK EMIR”). UK EMIR will operate parallel to EU EMIR. Both regimes aim to increase the resilience and stability of OTC derivative markets. UK EMIR sets out the regulatory regime relating to OTC derivatives transactions, CCPs and TRs in the UK. Like EU EMIR, UK EMIR imposes a number of requirements on derivatives market participants which include, among other things: The obligation to centrally clear certain standardised OTC derivative contracts; Requirements to reduce the risk arising from non-centrally cleared derivatives contracts through risk mitigation techniques; and The obligation to report derivatives transactions to a TR. From exit day onwards, UK counterparties to derivatives contracts will need to comply with UK EMIR rather than EU EMIR (assuming that the UK leaves the EU with no transitional arrangements in place), including in relation to the reporting of its derivatives transactions. The UK Financial Conduct Authority (“FCA”) released a statement to explain the changes that will be in store for TRs operating in the UK, UK counterparties and UK CCPs and what is expected with respect to compliance.[1] The UK government has confirmed that, as far as possible, the policy approach set out in the EMIR legislation will not change after the UK has left the EU. This is unsurprising given that much of EMIR derived from commitments made at international level at the G20 in 2009. What should UK counterparties be doing in advance of Brexit? Undertake an audit of the UK EMIR validation rules that will apply to reports submitted on or after Brexit to UK TRs. The UK EMIR validation rules diverge from the EU EMIR validation rules and therefore it is likely that operational changes will be necessary to ensure your UK EMIR reports are compliant post-Brexit. To the extent that a UK counterparty is currently reporting its trades to an EU TR, ensure that the necessary operational changes are made in advance of exit day to ensure that trades can be reported to a UK TR immediately post-Brexit. This may involve entering into new arrangements with a UK TR. For UK counterparties who have engaged a third party or their counterparty to perform their reporting for them (i.e., “delegated” reporting), engage with their third party service provider or counterparty to ensure that they are making any necessary changes to ensure compliance post-Brexit. Any UK counterparties who have accepted a delegation from clients and agreed to report on their behalf, where those clients are based in the EU, reporting will need to be provided to an EU TR post-Brexit and for UK clients, reporting will need to be made to a UK TR for those clients. Ensuring that the necessary operational changes are made will be critical for all firms providing delegated reporting services. As all outstanding derivatives contracts entered into by a UK counterparty on or after 16 August 2012 must be held in a UK TR (whether registered or recognised) on exit day, UK counterparties should engage with their TRs to ensure all relevant trades are identified and to understand the porting process to their UK TR of choice by the date of exit. What happens to outstanding trades post-Brexit? All outstanding derivative trades entered into by UK counterparties on or after 16 August 2012, must be held in a UK registered, or recognised, TR by 11:00 p.m. UK time on exit day. This will require derivatives transactions of UK counterparties that remain outstanding to be ported to a UK TR in time for exit day and will require the necessary steps to ensure that new derivatives transactions will be reported to a UK TR beginning on exit day. UK counterparties would be well-advised to engage with their TRs to ensure orderly porting to their UK TR of choice by exit day and to ensure that all their relevant trades have been identified. UK counterparties should note that any updates to these trades required after Brexit will need to be made to the UK TR and not to the original EU TR. ______________________    [1]   See FCA statement on the reporting of derivatives under the UK EMIR regime in a no-deal scenario, available at https://www.fca.org.uk/news/statements/fca-statement-reporting-derivatives-under-uk-emir-regime-no-deal-scenario (7 November 2019). 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 the authors: Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com) Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, jsteiner@gibsondunn.com) Please also feel free to contact any of the following practice leaders and members: Europe: Patrick Doris – London (+44 20 7071 4276, pdoris@gibsondunn.com) Amy Kennedy – London (+44 20 7071 4283, akennedy@gibsondunn.com) Michelle M. Kirschner – London (+44 20 7071 4212, mkirschner@gibsondunn.com) Lena Sandberg – Brussels (+32 2 554 72 60, lsandberg@gibsondunn.com) United States: Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@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) © 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.

November 22, 2019 |
New York State Department of Financial Services Proposes New Regulation Easing Information Sharing Between Regulated Entities and Professional Advisors

Click for PDF Last week, the New York State Department of Financial Services (“DFS”) proposed a new regulation allowing regulated entities to share “confidential supervisory information” with their legal counsel and independent auditors without first obtaining approval from DFS.[1] Announced by superintendent Linda Lacewell, DFS stated that the new regulation will make it easier for banks to share confidential information with attorneys[2] and other advisors by seeking to “streamline” the disclosure process.[3] The regulation will be subject to a 60-day comment period following publication in the state register on November 27, 2019.[4] DFS’s Current Outlier Approach As New York’s chief financial regulator,[5] DFS has broad “supervisory” authority[6] to examine and investigate banks, trust companies, investment companies, and other banking organizations in order to “protect the public interest.”[7] In exercising that authority, DFS has long mandated that reports, memoranda, or correspondence relating to such investigations and examinations, including materials from banks or regulatory agencies, be deemed “confidential” and not be subject to subpoena or disclosed to the public without DFS approval.[8] This confidentiality requirement, which is more than a century old,[9] applies even after an entity has received a disclosure request pursuant to New York’s Freedom of Information Law.[10] DFS and its predecessors have long maintained that such a rule is intended to “encourage frank and open communications” between regulated entities and DFS.[11] And that is because the restriction can, in some cases, facilitate “effective” and “comprehensive” examinations by DFS[12] and allow the agency to make “frank and forceful criticism” without fear of disclosure.[13] Indeed, other important bank regulators have imposed similar restrictions on disclosure of confidential supervisory information, including the Consumer Financial Protection Bureau (“CFPB”),[14] the Office of the Comptroller of the Currency (“OCC”),[15] the Board of Governors of the Federal Reserve System (“FRB”),[16] and the Federal Deposit Insurance Corporation (“FDIC”).[17] Nevertheless, the sheer breadth of DFS’s prohibition and the agency’s aggressive approach in interpreting its own mandate have led some to criticize DFS’s rule as out of step with more sensible restrictions imposed by other regulators.[18] For example, DFS has often asserted restrictions to prevent regulated companies from sharing information with other regulators. It has also taken the position that its prohibition applies even when a regulated entity seeks to provide confidential supervisory information to important professional advisors such as legal counsel—an interpretation that raises constitutional concerns[19] in light of its obvious impact on the attorney-client relationship and which, in any event, may lack statutory support[20] given the New York Legislature’s prohibition on disclosure of such information to the “public.”[21] As a result of DFS’s aggressive approach, legal counsel with financial clients are often forced to take the cumbersome, time-consuming step of obtaining DFS approval before considering such confidential supervisory information and can be impaired from providing timely and thorough advice with respect to compliance with the state’s banking statutes. The Proposed Regulation  The new regulation would provide a “limited exception” to DFS’s restrictions as they relate to regulated entities and professional advisors.[22] In particular, regulated entities would now be able to share confidential supervisory information with legal counsel and auditors without first obtaining DFS’s approval, provided that they enter into a written agreement stating, among other things, that the information will be used solely to provide “legal representation or auditing services”; that the information will be disclosed solely to employees, directors, or officers on a “need to know” basis; that the counsel or auditors will notify DFS of demands or requests for such information; and that the advisors will assert legal privileges or protections as requested by DFS and on the agency’s behalf.[23] In addition, the regulated entities must keep a record of all disclosed confidential supervisory information[24] and a copy of each required written agreement.[25] The new regulation would place DFS closer in line with other regulators of financial institutions, which also permit disclosure to legal counsel and other professionals.[26] The CFPB, FDIC, OCC, and FRB all currently allow certain service providers to access confidential supervisory information without seeking additional approval from the regulator.[27] “With this action, DFS is delivering on a promise I made to ensure the Department engages in an open dialogue with the financial services industry,” said Superintendent Lacewell,[28] who was confirmed as Superintendent this year.[29] “This is one of the many steps DFS is taking to ensure an efficient regulatory structure to assist the industry.”[30] Conclusion The new DFS administration is likely to be applauded for this proposed regulation, which reflects a meaningful attempt to “modernize and transform” DFS’s practices[31] and to adhere to its statutory mandate to “foster the growth of the financial industry in New York and spur state economic growth through judicious regulation.”[32] Moving forward, financial institutions should view this new measure as a favorable development, and sophisticated legal counsel are likely to find it easier to provide prompt legal advice to their clients. ___________________________    [1]   Click here.    [2]   https://www.law.com/newyorklawjournal/2019/11/14/dfs-proposes-new-regulation-streamlining-info-sharing-between-banks-and-their-lawyers/.    [3]   Click here.    [4]   https://www.dfs.ny.gov/reports_and_publications/press_releases/pr1911141.    [5]   See, e.g., N.Y. Financial Services Law §§ 101-a, 102; see also, e.g., Dep’t of Fin. Servs., 2018 Annual Rep. at 1, https://www.dfs.ny.gov/system/files/documents/2019/07/dfs_annualrpt_2018.pdf.    [6]   See, e.g., N.Y. Financial Services Law §§ 201(a), 202, 301-302.    [7]   See, e.g., N.Y. Banking Law §§ 10, 36(1); see id. §§ 2(11), 11, 14(1), 38-39; see also, e.g., N.Y. Financial Services Law §§ 102(j), 104(a)(4).    [8]   N.Y. Banking Law § 36(10); 3 N.Y.C.R.R. Sup. Proc. G 106.8; see ch. 146, 1961 N.Y. Laws, 779, 680; see also here.    [9] See, e.g., ch. 41, 1914 N.Y. Laws 1264, 1264. [10]   See 3 N.Y.C.R.R. Sup. Proc. G 106.8. [11]   See, e.g., Banking Dep’t Mem. of Bill Before the Gov. for Exec. Action (June 29, 1999), reprinted in Bill Jacket for ch. 206 (1999) (“Bill Jacket”), at 11. [12]   Ltr. from Sen. Hugh T. Farley to Hon. James M. McGuire (June 28, 1999), reprinted in Bill Jacket at 4. [13]   See, e.g., Stratford Factors v. New York State Banking Dep’t, 10 A.D.2d 66, 70-71 (1st Dep’t 1960) (citation and internal quotation marks omitted). [14]   See 12 C.F.R. § 1070.42. [15]   See id. § 4.37. [16]   See id. § 261.20. [17]   See id. § 309.6. [18]   See, e.g., https://www.law360.com/articles/980300/ny-regulator-s-untenable-authority-over-confidential-info. [19]   N.Y. Const. art. Art. 1, § 6. [20]   See, e.g., https://www.law360.com/articles/980300/ny-regulator-s-untenable-authority-over-confidential-info. [21]   See Banking Law § 36(10) (“All reports of examinations and investigations, correspondence and memoranda concerning or arising out of such examination and investigations . . . shall not be made public unless, in the judgment of the superintendent, the ends of justice and the public advantage will be subserved by the publication thereof.” (emphasis added)). [22]   See 3 N.Y.C.R.R. § 7.2(b) (proposed 2019); see also here. [23]    See 3 N.Y.C.R.R. § 7.2(c) (proposed 2019); see also here. [24]    See 3 N.Y.C.R.R. § 7.2(c) (proposed 2019); see also here. [25]   See 3 N.Y.C.R.R. § 7.2(c) (proposed 2019); see also https://www.law.com/newyorklawjournal/2019/11/14/dfs-proposes-new-regulation-streamlining-info-sharing-between-banks-and-their-lawyers/. [26]   See 12 C.F.R. §§ 4.37(b)(2), 261.20(b), 309.6(a), 1070.42(b)(2). [27]   Id. [28]   https://www.dfs.ny.gov/reports_and_publications/press_releases/pr1911141. [29]   https://money.usnews.com/investing/news/articles/2019-06-21/ny-state-senate-confirms-linda-lacewell-as-new-chief-of-financial-regulator. [30]   https://www.dfs.ny.gov/reports_and_publications/press_releases/pr1911141. [31]   N.Y. Financial Services Law § 101-a. [32]   N.Y. Financial Services Law § 201; see 3 N.Y.C.R.R. § 7.2(c) (proposed 2019) (citing § 201). Gibson, Dunn & Crutcher’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, any member of the firm’s Public Policy or Financial Institutions practice groups, or the authors: Mylan L. Denerstein – Co-Chair, Public Policy Practice, New York (+1 212-351-3850, mdenerstein@gibsondunn.com) Matthew L. Biben – Co-Chair, Financial Institutions Practice, New York (+1 212-351-6300, mbiben@gibsondunn.com) Seth M. Rokosky – New York (+1 212-351-6389, srokosky@gibsondunn.com) Randi Kira Brown* – New York (+1 212-351-6205, rbrown@gibsondunn.com) Please also feel free to contact the following practice group leaders: Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Stephanie L. Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) *Not admitted to practice in New York; practicing under the supervision of Gibson, Dunn & Crutcher LLP. © 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.

November 21, 2019 |
U.S. Banking Agencies Finalize Regulation on “High Volatility Commercial Real Estate” Capital Treatment

Click for PDF On November 19, 2019, the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, and Federal Deposit Insurance Corporation (Agencies) finalized their regulation (Final Rule) on High Volatility Commercial Real Estate (HVCRE) that had been proposed in September 2018. The Final Rule made few changes from the 2018 proposal. Although the text of the rule and its preamble do not answer all HVCRE questions, there is now a much more reasonable framework for borrowers than under the original Basel III capital rule and the Agencies’ interpretations of it. The Original Basel III Capital Rule and the 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 real estate loans that are characterized as HVCRE exposures. The original 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; 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 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 Basel III capital rule raised many interpretative questions; the few to which the Agencies responded were answered in a non-intuitive, unduly conservative manner.[2] In particular, the Agencies interpreted the requirement relating to “internally generated capital” as forbidding distributions of earned income even if the amount of capital in the project would exceed the 15% of “as completed” value post-distribution.[3] In addition, the Agencies did not permit appreciated land value to be taken into account for purposes of the borrower’s capital contribution – even though it would count if the land were sold and the cash contributed instead. In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 became law, and certain of its provisions overrode the original Basel III capital rule. The Final Rule implements the 2018 statute. Final Rule – Definition of HVCRE The Final Rule follows the statute in narrowing the definition of an HVCRE exposure requiring 50% additional capital to be held. Such an exposure is: 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 Final Rule states that a “credit facility secured by land or improved real property” is 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.” In addition, the preamble states that “other land loans” – i.e., loans secured by vacant land other than land known to be used for agricultural purposes – are not automatically included as an HVCRE exposure, but must be analyzed under the three-prong test. HVCRE Exclusion for Certain Commercial Real Estate Projects With respect to commercial real estate projects, under the Final Rule, 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. Unlike the original regulation, the Final Rule permits internally generated income to be distributed out of the project as long as the 15% originally contributed stays in. With respect to the 15% test itself, the preamble indicates that funds borrowed (such as from a corporate parent) can count as equity if they are not “derived from [or] related to,” or do not “encumber” the project that the credit facility is financing or “encumber any collateral that has been contributed to the project.” The Final Rule also permits real property and improvements “directly related to” the project to count as part or all of the required 15% capital (reduced by the amount of any liens), along with cash, unencumbered readily marketable assets, and development expenses paid out-of-pocket.[4]It states that “readily marketable assets” are insured deposits, other financial instruments, and bullion, in each case that can be sold reasonably promptly for fair value. With respect to the value of contributed real property, the Final Rule states that it is “the appraised value” under a qualifying appraisal, reduced by the aggregate amount of any other liens on such property. The Final Rule includes a clarification regarding projects with separate phases, stating that each project phase being financed by a credit facility should have a proper appraisal or evaluation with an associated “as completed” value. Where appropriate and in accordance with the banking organization’s applicable underwriting standards, however, a banking organization may look at a multiphase project as a complete project rather than as individual phases.[5] The Final Rule also provides, without interpretive gloss, 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. HVCRE Exclusion for One- to Four-Family Residential Properties With respect to the exclusion for one- to four-family residential properties, the Final Rule is more generous to borrowers than the proposal. Construction loans secured by single-family dwelling units, duplex units, and townhouses will qualify for the one- to four-family residential property exclusion, as will condominium and cooperative construction loans, even if the loan is financing the construction of a building with five or more dwelling units as long as the repayment of the loan comes from the sale of individual condominium dwelling units or individual cooperative housing units. Loans secured by vacant lots in established multifamily residential sections, however, will not qualify for the exclusion, nor will credit facilities that solely finance land development activities, such as the laying of sewers, water pipes, and similar improvements to land, without any construction of one- to four-family residential structures. The Agencies also clarified that when both a land acquisition and development loan and a loan to construct one- to four-family dwellings are originated simultaneously, the individual exposures must be evaluated separately to determine whether each loan on its own qualifies for an HVCRE exclusion. HVCRE Exclusion for Community Development Properties With respect to this exclusion, the Final Rule refers to Agencies’ Community Reinvestment Act (CRA) regulations and their definition of community development investment to determine which properties qualify. These regulations are quite detailed, and therefore a case-by-case analysis of particular properties will be required when this exclusion is considered. HVCRE Exclusion for Agricultural Land Relying on bank Call Report Instructions, the Final Rule uses a broad definition for this exclusion – “all land known to be used or usable for agricultural purposes,” but excluding loans for farm property construction and land development purposes. HVCRE Exclusion for Income-Producing Properties Qualifying 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 Agencies stated that they expect banking institutions to have and rely on “prudent, clear and measurable” underwriting standards, which the Agencies may review as part of the regular supervisory process. Effective Date; Treatment of Loans Made Prior to Effective Date; Agency FAQs The Final Rule is effective on April 1, 2020. Under the 2018 statute, loans made prior to January 1, 2015 may not be classified as HVCRE loans. With respect to loans made between January 1, 2015 and March 31, 2020, banking institutions will have the option to apply the original Basel III capital rule or the Final Rule. Non-HVCRE determinations made in this period are generally not required to be re-evaluated, but if loans made after January 1, 2015 and prior to the effective date are amended in a manner that materially changes the underwriting (increases to the loan amount, changes to the size and scope of the project, or removal of all or part of the 15 percent minimum capital contribution in a project), then banking institutions should re-analyze the loan for HVCRE. As of the effective date, the Agency FAQs under the original Basel III capital rule are deemed superseded. Conclusion HVCRE has taken a long and somewhat winding road since 2013. With the Final Rule, a more reasonable approach to the heightened capital treatment for HVCRE loans is now in place, and one that fulfills the intent of Congress in the 2018 legislation. _________________    [1]   See, e.g., 12 C.F.R. § 3.2 (2013).    [2]   The Banking Agencies published certain responses to HVCRE Frequently Asked Questions (Interagency FAQs) in April 2015.    [3]   See Interagency FAQ Response 15.    [4]   The 15 percent equity must be contributed before loan is made, except for nominal sums meant to secure the banking organization’s lien on the real property.    [5]   The Agencies do not provide any further gloss on this statement. 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 or Real Estate practice groups, or the following: Financial Institutions Group: Arthur S. Long – New York (+1 212-351-2426, along@gibsondunn.com) Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Michael D. Bopp – Washington, D.C. (+1 202-955-8256, mbopp@gibsondunn.com) Stephanie Brooker (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day (+1 202-955-8220, kday@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) Real Estate Group: 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) 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) Kahlil T. Yearwood – San Francisco (+1 415-393-8216, kyearwood@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.

November 20, 2019 |
Comptroller of the Currency and Federal Deposit Insurance Corporation Propose Rules on Maximum Interest Rate Authority

Click for PDF On November 18, 2019, the U.S. Office of the Comptroller of the Currency (OCC) issued a proposed regulation (OCC Proposal) that would codify, for national banks and federal thrifts, the common law “valid when made” doctrine of usury law. Yesterday, the Federal Deposit Insurance Corporation (FDIC) issued a similar proposal (FDIC Proposal) for FDIC-insured state banks and thrifts. In so doing, the agencies entered a lively debate that has gone on since the Second Circuit’s 2015 decision in Madden v. Midland Funding, LLC, with significant ramifications for banks, thrifts, and nonbank lending companies. This Client Alert discusses the OCC and FDIC Proposals. The OCC and FDIC will receive comments on their proposals for 60 days from their publication in the Federal Register. I.   The “Valid When Made” and “Most Favored Lender” Doctrines The “valid when made” doctrine is a common law doctrine that states that a loan that is not usurious at inception cannot subsequently become usurious by reason of its sale. It has been traced back to Supreme Court cases in the first half of the 19th century,[1] and has been cited by federal courts frequently since then.[2] With respect to loans made by a national bank or federal thrift, this doctrine has operated in tandem with the “most favored lender” doctrine, which also dates to the 19th century. Under the latter doctrine, which derives from court interpretations of 12 U.S.C. § 85, a national bank or federal thrift that has operations in more than one state may choose the law of its home state to govern interest rates on all its loans – including home states that have no usury limitations in their statutes.[3] II.   Madden v. Midland Funding Taken together, the “valid when made” and “most favored lender” doctrines provide significant benefits to national banks and federal thrifts – such institutions that operate in a state without usury limitations not only have made loans nationwide with higher interest rates than permitted in some states, but those rates have also applied when the loans were assigned to third parties for value. These benefits, however, were opened to challenge when the United States Court of Appeals for the Second Circuit handed down its decision in Madden v. Midland Funding, LLC in 2015.[4] In Madden, the plaintiff lived in New York, a state that has usury limits, but had a credit card with a national bank located in Delaware, which places no limitations on the amount of interest that can be charged. The national bank sold the plaintiff’s credit card debt to Midland Funding, which sought to collect it at an interest rate of 27%, a rate higher than permitted in New York. Although the Second Circuit recognized the “most favored lender” doctrine in Madden, it did not apply the “valid when made” doctrine. Rather, it analyzed the case as a question of federal preemption of state usury limits under the National Bank Act. It held that although courts had extended National Bank Act preemption to benefit subsidiaries and affiliates of national banks, it would not be appropriate to permit Midland Funding, a non-affiliate, to benefit from such preemption.[5] Refusing to give Midland Funding the benefit of preemption, in the Second Circuit’s view, would not – under the relevant preemption test – “significantly interfere” with a national bank’s ability to exercise its powers under the National Bank Act.[6] Although the Second Circuit’s Madden holding was extremely controversial and arguably in conflict with decisions in other circuits, the United States Supreme Court denied Midland Funding’s petition for certiorari. Congress has taken no action to amend the National Bank Act since Madden was decided. III.   The Proposed Rules The OCC styled its proposal as a clarification of doctrine under the National Bank Act; the text of the OCC Rule states that “[i]nterest on a loan that is permissible under 12 U.S.C. 85 [and 1463(g) (the Most Favored Lender doctrine)] shall not be affected by the sale, assignment, or other transfer of the loan.”[7] The OCC set forth the following arguments in support of the Proposed Rule. First is the “valid when made” doctrine itself: “this longstanding rule relating to usury certainly applies here; a loan by a bank that complies with section 85 or 1463(g) is by definition not usurious when it is originated, and a subsequent assignment of the loan does not render the loan usurious.”[8] Second, the interpretation flows from the valid bank power to assign loan contracts to third parties: “[b]ecause the assignee steps into the bank’s shoes upon assignment, the third party receives the benefit of and may enforce the permissible interest term.”[9] The OCC stated further that the Supreme Court recognized this principle as prudent risk management in the mid-19th century: “[banks] must be able to assign or sell [their] notes when necessary and proper, as, for instance, to procure more specie in an emergency . . . .”[10] Finally, in what is the preamble’s strongest point, the OCC stated that Congress had extended the “most favored lender” doctrine – with the implicit “valid when made” gloss – to federal thrifts, state-chartered insured depository institutions, and insured credit unions in 1980.[11] Then, in 2010, while revisiting federal preemption generally in the Dodd-Frank Act, Congress expressly preserved national banks’ authority under 12 U.S.C. § 85 and thereby reaffirmed the importance of that provision in the banking system.[12] The FDIC Rule is similar to the OCC Rule, but reflects the different statutory scheme applicable to FDIC-insured state banks and savings associations. That scheme dates from 1980, when Congress amended the Federal Deposit Insurance Act (FDIA) to add Section 27, which provides that: In order to prevent discrimination against State-chartered insured depository institutions, . . . if the applicable rate prescribed in this subsection exceeds the rate such State bank . . . would be permitted to charge in the absence of this subsection, such State bank . . . may, notwithstanding any State constitution or statute which is hereby preempted for the purposes of this section, take, receive, reserve, and charge on any loan or discount made . . . interest at a rate of not more than 1 per centum in excess of the discount rate on ninety-day commercial paper in effect at the Federal Reserve bank in the Federal Reserve district where such State bank . . . is located or at the rate allowed by the laws of the State, territory, or district where the bank is located, whichever may be greater.[13] The FDIC has interpreted Section 27 to provide parity with national banks, and therefore insured state banks can export the interest rates permitted by their home states even if they have a branch in a different state in which the borrower resides. In the preamble to its proposal, the FDIC stated that it was filling a statutory gap – Section 27 does not “state at what point in time the permissibility of interest should be determined” for purposes of judging compliance with Section 27.[14] The FDIC stated that its proposal would fill that gap by providing that this time is when the loan is first made, not when interest is taken or received.[15] The FDIC therefore, unlike the OCC, did not rely on the “valid when made” doctrine, but it stated that its interpretation was consistent with it. Like the OCC, the FDIC also relied on the inherent power of banks to assign their loans, and noted that the Madden decision made the power of a state bank to make a loan at Section 27’s rate “illusory.”[16] IV.   Conclusion The Proposed Rules are likely to generate substantial comment, from both the banking industry and consumer advocates. The proposals are highly likely to be controversial with certain members of the latter constituency. Tellingly, and in likely reaction to recent skepticism over bank regulatory “guidance,” the OCC and FDIC issued their interpretations in the traditional form of a rule proposal subject to notice and comment. If the rules are adopted as proposed, it would not be surprising if they are challenged as an impermissible construction of the National Bank Act and FDIA, thus raising again the issue of how much deference to accord bank regulators in interpreting federal banking law. Whether the proposals will restore uniformity to the secondary market for loans – an area where there is undoubtedly a federal interest, and where Madden was an unfortunate departure – therefore remains to be seen. _________________    [1]   See Nichols v. Fearson, 32 U.S. (7 Pet.) 103, 109 (1833).    [2]   See, e.g., FDIC v. Lattimore Land Corp., 656 F.2d 139, 148-49 (5th Cir. 1981).    [3]   In 1980, Congress granted this benefit to federal thrifts. See 12 U.S.C. § 1463(g).    [4]   Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), cert. denied, 136 S. Ct. 2505 (2016).    [5]   See id.    [6]   See id.    [7]   Office of the Comptroller of the Currency, Notice of Proposed Rulemaking: Permissible interest on loans that are sold, assigned, or otherwise transferred (November 18, 2019).    [8]   Id. at 9.    [9]   Id. at 10. [10]   Id. (quoting Planters’ Bank of Miss. v. Sharp, 47 U.S. 301, 323 (1848)). [11]   See 12 U.S.C. §§ 1463(g), 1785, and 1831d. [12]   See Office of the Comptroller of the Currency, Notice of Proposed Rulemaking: Permissible interest on loans that are sold, assigned, or otherwise transferred (November 18, 2019), at 11-12. [13]   12 U.S.C. § 1831d (emphasis added). [14]   See Federal Deposit Insurance Corporation, Notice of Proposed Rulemaking: Federal Interest Rate Authority (November 19, 2019), at 14. [15]   See id. [16]   See id. at 12. 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.

November 19, 2019 |
Revised Section 13(3) of the Federal Reserve Act

New York partner Arthur Long is the author of “Revised Section 13(3) of the Federal Reserve Act,” [PDF] published in Business Law Today on March 22, 2019.

November 11, 2019 |
Steps Toward Reforming U.S. Housing Finance

Click for PDF This fall, the U.S. financial agencies have taken initial, but substantial, steps towards reforming the U.S. housing finance system. In September, the U.S. Department of the Treasury (Treasury) published a detailed proposal (Housing Reform Plan), which included a call to tackle the last unfinished piece of regulatory business stemming from the Financial Crisis, the conservatorships of the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac).[1] The Housing Reform Plan set forth 49 specific legislative and administrative reform measures and is thus the most ambitious financial proposal put forth since the enactment of the Dodd-Frank Act. In addition, Treasury and the Federal Housing Finance Agency (FHFA), the regulator and conservator of Fannie Mae and Freddie Mac (GSEs), amended the Preferred Stock Purchase Agreements (PSPAs) with the GSEs to permit the GSEs to retain up to $45 billion in capital.[2] And, on October 28th, the FHFA published its 2019 Strategic Plan for the GSE conservatorships and an accompanying Scorecard.[3] Although the prospects of legislative housing finance reform are slim given the current political environment and the upcoming 2020 election, these actions are nonetheless significant. Both GSEs have been in conservatorship for over eleven years, and government control was never intended to be permanent. Even if legislative action may be stymied until after November 2020, the Housing Reform Plan establishes an overall framework that can influence future legislative action, and other actions toward reform may be taken – as they have begun to be – as an administrative matter. I.   The Housing Finance System: Conservatorships of the GSEs Privatized in 1970 and 1989, respectively, Fannie Mae and Freddie Mac work in conjunction with regulatory agencies like the FHFA, Federal Housing Administration (FHA) and the Department of Housing and Urban Development to provide the structural support necessary for the current housing market to function. For example, the GSEs own or guarantee approximately 44% of all outstanding single-family mortgage debt, and the FHA is responsible for more than 10% of mortgage originations. Early in the Financial Crisis, the U.S. government put the GSEs into conservatorship as a result of their excessive risk taking in the years leading up to the Crisis. As part of this process, the FHFA, the GSEs’ regulator and conservator, entered into the PSPAs with Treasury. The PSPAs provided the Treasury with a cash-sweep right that required the GSEs to dividend to the government all net income above a miniscule capital reserve amount. Since entering into the PSPAs, the GSEs have returned to profitability, and they have paid over $300 billion to the Treasury. At the same time, however, the PSPAs have prevented them from maintaining sufficient capital to operate independently of government support. This has required the FHFA conservatorship to continue year after year. II.   Overview of the Housing Reform Plan A principal goal of the Housing Finance Plan is to reduce the amount of U.S. government support for the U.S. housing finance system. It sets forth 18 legislative and 31 administrative measures focused on preparing the regulators and GSEs for a transition out of conservatorship and establishing a legislative framework to ensure that such a transition is orderly. Although congressional action is necessary for a permanent solution, the Housing Reform Plan notes that “reform should not and need not wait on Congress” and thus makes significant administrative recommendations as well. The Housing Reform Plan framework is organized into 12 distinct goals, each comprising several legislative and administrative recommendations: Clarifying Exiting Government Support: Recognizing the need for reduced taxpayer exposure, the Housing Reform Plan sets forth four legislative and five administrative recommendations directed at providing an explicit, paid-for federal guarantee of certain mortgage-backed securities (MBS) by the Government National Mortgage Association. Support of Single-Family Mortgage Lending: In an effort to refocus GSE activities on providing stability to the lending markets, the Housing Reform Plan sets forth one legislative and two administrative recommendations directed at limiting the scope of GSE single-family mortgage activities to securitizing government-guaranteed MBS and taking a first-loss position on those MBS ahead of the government guarantee. Support of Multifamily Mortgage Lending: Citing recent regulatory shortcomings with respect to GSE multifamily mortgage loan acquisitions, the Housing Reform plan sets forth two legislative and one administrative recommendation directed at limiting the scope of GSE multifamily mortgage activities to a specified affordability mission. Additional Support for Affordable Housing: Concerned with the GSEs’ divergence from statutorily defined affordability goals and the associated lack of transparency with respect to underwriting criteria, the Housing Reform Plan sets forth one legislative and three administrative recommendations directed at increasing efficiencies related to affordable housing. Ending Conservatorships: Setting the stage for legislative action, the Housing Reform Plan recommends three administrative actions aimed at ending the GSE conservatorships. Capital and Liquidity Requirements: Recognizing the shortcomings of previous GSE capital and liquidity regulation, the Housing Reform Plan sets forth one legislative and four administrative recommendations directed at restricting regulatory discretion in establishing such requirements and increasing transparency when promulgating them. Resolution Framework: Similar to the resolution planning requirements for large banks, the Housing Reform Plan sets forth one legislative and one administrative recommendation directed at ensuring that GSEs maintain loss-absorbing instruments (e.g., long-term debt convertible into equity) sufficient to facilitate timely resolution. Retained Mortgage Portfolios: In an effort to scale down the size of the GSEs, the Housing Reform Plan sets forth one legislative and one administrative recommendation directed at curtailing the investment activities of GSEs in mortgage-related assets, in another effort to focus GSE activities on securitizing federally-guaranteed MBS. Credit Underwriting Parameters: In light of past less-than-sound underwriting practices, the Housing Reform Plan sets forth one legislative and one administrative recommendation directed at restricting the underwriting criteria for MBS eligible for a government guarantee. Leveling the Playing Field: Revisiting past attempts to encourage private market participants in the housing finance system, the Housing Reform Plan sets forth one legislative and eight administrative recommendations directed at limiting the current competitive advantages of GSEs. Competitive Secondary Market: To ensure more competition than is the case currently, the Housing Reform Plan sets forth three legislative recommendations directed at establishing a system for chartering private market actors to compete with the GSEs. Competitive Primary Market: To ensure a robust primary market, the Housing Reform Plan sets forth two legislative and two administrative recommendations requiring GSEs and guarantors to provide cash windows for small lenders and restrict volume-based pricing. III.   Legislative Proposals The legislation proposed by the Housing Reform Plan would be revolutionary in the same manner as the Dodd-Frank Act. Although perhaps not as substantial as the final version of Dodd-Frank, any such legislation would do away with the GSE framework that has developed since the creation of Fannie Mae in 1938, seek to create more competition, and reduce overall government support. An Explicit Federal Guarantee, but More Limited: Treasury supports legislation to create an explicit, paid-for guarantee backed by the full faith and credit of the U.S. government. Somewhat surprising for a conservative Republican Administration, this support reflects the reality that after decades of GSE growth, failing to continue some form of government guarantee would be hugely disruptive. The Housing Reform Plan, however, states that any such guarantee should be limited to a subset of MBS, “qualifying MBS.” It therefore calls on Congress and regulators to reexamine the products that may qualify for a guarantee. Open Chartering Process for GSE Competitors: The Housing Reform Plan recommends legislation that would authorize the chartering of new private actors to compete with GSEs in securitizing MBS and providing first-loss protection. Treasury reasons that leveling the playing field would diversify the secondary markets and encourage greater competition among market participants. Capital and Liquidity Requirements for Market Participants: The Housing Reform Plan recommends that the FHFA should require capital sufficient to withstand a severe economic downturn, and require shareholders and unsecured creditors, rather than taxpayers, to bear losses on insolvency. To foster a level playing field, the Housing Reform Plan recommends that similar credit risks should generally bear similar credit-risk capital charges and that the FHFA should establish a simple, transparent, leverage restriction to act as a credible supplementary measure to risk-based capital requirements. Enhanced liquidity requirements would also be mandated. Limitation of Activities of Market Participants Benefiting from a Federal Guarantee: The Housing Reform Plan would seek to limit the scope of GSE and newly chartered competitor activities, by requiring them to be effectively monoline businesses focused on the business of securitizing guaranteed MBS. Treasury suggests that such a limitation could be “statutorily defined to include credit enhancing the mortgage collateral securing Government-guaranteed MBS and ancillary activities such as operating a cash window, loss mitigation on mortgage loans, and holding and disposing of property acquired in connection with collecting on mortgage loans.” These restrictions, however, would not necessarily extend to affiliate businesses. Creation of a Federal Mortgage Insurance Fund: Although private companies would collect their own fees as compensation for taking the first-loss position on the mortgage collateral supporting the MBS, the Administration recommends that any legislation ensure that these actors compensate taxpayers for default risk by authorizing the FHFA to charge fees for government guarantees of qualifying MBS. Such fees would be used to create a mortgage insurance fund that would fund government-guarantee obligations. In the event that such funds are inadequate, the Housing Reform Plan suggests that legislation provide the FHFA with authority to recapitalize the fund through industry assessments. These recommendations are laid out only as a framework, with the critical details to be left to congressional action. As such, their immediate effect will most likely be to frame one side of the debate over housing finance reform before the 2020 election. IV.   Administrative Proposals The focus of the Housing Reform Plan’s administrative proposals is to set the stage for the transition of the GSEs out of conservatorship. In particular, nearly one-third of the contemplated administrative reforms relate to amendment of the PSPAs. These proposed amendments would largely serve to: Reduce Non-Mission Oriented Activities: As noted above, one of the key themes to the Housing Reform Plan is to realign GSE activities by scaling back permissible activities. It therefore calls for the FHFA to amend the PSPAs to (i) reaffirm commitments to support single-family and multi-family MBS, (ii) limit federal support of each GSE’s multifamily business to its underlying affordability mission, and (iii) reduce the cap on GSE investments in mortgage-related assets, setting a different cap for each GSE, and restrict retained mortgage portfolios to solely supporting the business of securitizing MBS. Begin the Recapitalization Process: Pending congressional action, the Housing Reform Plan recommends adding the following provisions to the PSPAs: (i) the establishment and periodic payment of commitment fees by the GSEs to the federal government to be used as part of the mortgage insurance fund contemplated under the legislative proposals, (ii) establishing a pre-capitalization plan that will allow GSEs to retain additional earnings, and (iii) requiring GSEs to maintain long-term debt convertible into equity and other loss-absorbing instruments to further reduce taxpayer risks. Support the Primary Market: To better encourage primary market competition, the Housing Reform Plan calls for an amendment to the PSPAs to require GSEs to provide cash windows for small lenders and restrictions on volume-based pricing. The Housing Reform Plan also calls for interim preliminary rulemaking measures in anticipation of congressional action. Treasury recommends that the FHFA begin the process of considering, among other things: (i) post-conservatorship GSE capital and liquidity requirements, (ii) operational and competitive issues relating to the private guarantor model, (iii) permissibility of new activities and products, (iv) clarification to supervisory roles between regulators, and (v) effects on secondary and primary markets. V.   FHFA Actions The FHFA, as the GSE’s regulator and conservator, has begun to take some actions recommended by the Housing Reform Plan. First, in late September, it entered into PSPA amendments that permit the GSEs to retain additional capital – $25 billion for Fannie Mae, $20 billion for Freddie Mac. (Because, prior to the amendments, GSE leverage was approximately 1000-1, there is still a long way to go before the GSEs can become self-supporting; most large U.S. banks have at least 10-1 leverage.) Second, on October 28, the FHFA issued its Strategic Plan and Scorecard. The Strategic Plan has three central goals for the near term – increasing competition, increasing FHFA authority, and making changes to the ways the GSEs operate. The Scorecard is the FHFA’s means of assessing the GSEs’ alignment with these overriding principles. It has three sections that are intended to ensure that the GSEs: Focus on their core mission responsibilities to foster “Competitive, Liquid, Efficient, and Resilient” (CLEAR) national housing finance markets that support sustainable home ownership and affordable rental housing; Operate in a safe and sound manner in conservatorship; and Prepare for their eventual exit from government control. The Scorecard is therefore evidence of active FHFA monitoring to advance the principles of the Housing Reform Plan in the coming year. VI.   The Future The Strategic Plan’s statement that “restor[ing] the GSEs to their proper role as fully-private, well-capitalized, and well-regulated financial institutions . . . will take time and a great deal of effort” is likely an understatement. Although the Housing Reform Plan is ambitious in approach, the practical realities of implementing it must be seriously considered. Some considerations that we believe could hinder comprehensive reform, absent a new political impetus, are: The Upcoming Presidential Election and Extent of Political Will With the upcoming presidential election, legislative action is almost certain not to occur until after November 2020. Although few would disagree with the need for reform, political paralysis has only grown in Washington, and reform is not a hot button issue that is likely to get substantial airtime in the coming year. Sensing this, Senator Michael Crapo – the Senate Banking Committee Chairman who was able to craft some bipartisan financial legislation notwithstanding the current political atmosphere – stated in the Senate Banking Committee hearing on the Housing Finance Plan that “it’s time for the Administration to act and to start building the foundation in taking the necessary steps it can take in order to address this issue and actually help Congress get to a comprehensive solution.”[4] Fractured Constituencies As with any legislation having the potential to upend existing financial interests, a shift from government-favored enterprises to a free market, more level playing field will affect many interests that are reliant on the regulatory status quo. Because the beneficiaries of the current regulatory regime will be competing with private market actors standing to benefit from reform, there is a risk that congressional constituencies may fracture rather than coalesce behind a single, comprehensive framework. Ideological Differences Although members of Congress appear to agree on the need for a legislative solution, the particulars as to how to effectuate reform may suffer from the same ideological divisions that plagued GSE regulation in the years before the Financial Crisis. For example, some Democrats cite concerns over the Housing Reform Plan’s impact on affordable housing, in that financial products for lower-income individuals may fall outside the scope of a more limited federal guarantee, with the potential to increase mortgage costs for those persons.[5] Conversely, many Republicans have sought to rally support around their answer to affordable housing, the reduction of state and local regulations,[6] but this view is far from universally shared. Lack of bipartisan support for some of the more basic concepts proposed by the Housing Reform Plan may indicate challenges to producing a viable bill even after 2020. Challenges to the FHFA As the Housing Reform Plan notes, there are substantial actions that the FHFA itself may take in moving reform forward. In September, however, the U.S. Court of Appeals for the Fifth Circuit held that the FHFA’s structure – having a single director that may be removed only “for cause” – is unconstitutional,[7] and the U.S. Supreme Court has granted certiorari on a similar challenge to the structure of the Consumer Financial Protection Bureau, with a likely decision by June 2020. How these cases will ultimately affect the ability of the FHFA to take prompt actions that fall within its regulatory authority, such as promulgating new, heightened GSE capital and liquidity requirements, is currently unclear. Conclusion The Housing Reform Plan is generally a positive development in articulating a coherent vision for U.S. housing finance in the 21st century. The seventy years between the creation of Fannie Mae and the onset of the Financial Crisis demonstrate that supporting private-sector mortgage finance can be both highly profitable and potentially calamitously risky. The concept of a private-sector support system backed by a paid-for, explicit government guarantee, and subject to the same strict capital and liquidity standards as the nation’s largest banks, has many reasons to suggest it as a far better alternative to both the pre- and post-Financial Crisis housing finance system. ___________________    [1]   U.S. Department of the Treasury, Housing Finance Reform Plan (September 5, 2019), available at https://home.treasury.gov/system/files/136/Treasury-Housing-Finance-Reform-Plan.pdf.    [2]   The PSPAs are available on the FHFA’s website at: https://www.fhfa.gov/Conservatorship/Pages/Senior-Preferred-Stock-Purchase-Agreements.aspx.    [3]   See https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Releases-New-Strategic-Plan-and-Scorecard-for-Fannie-Mae-and-Freddie-Mac-.aspx.    [4]   Remarks of Senator Michael Crapo, United States Senate Committee on Banking, Housing and Urban Affairs, Housing Finance Reform: Next Steps (Sept. 10, 2019).    [5]   Senator Sherrod Brown (D-OH) argued that the Housing Reform Plan “will make mortgages more expensive and harder to get.” United States Senate Committee on Banking, Housing and Urban Affairs, Housing Finance Reform: Next Steps (Sept. 10, 2019). Similarly, a former Obama administration housing adviser argued that “[i]nvestors will be much pickier and charge more for the loans they are willing to invest in.” Andrew Ackerman and Kate Davidson, Trump Administration Aims to Privatize Fannie Mae and Freddie Mac, The Wall Street Journal (Sept. 5, 2019), available at https://www.wsj.com/articles/trump-administration-aims-to-privatize-fannie-mae-and-freddie-mac-11567717213.    [6]   Senators Pat Toomey (R-PA) and Tom Cotton (R-AK) both spent their allotted times at the Senate Banking Committee Hearing discussing issues with state and local level regulations impeding affordable housing construction – as Senator Toomey stated, “[t]he primary driver is state and local regulations and it really does concern me the damage that’s being done to our economy and to affordability and access from these barriers. It’s causing a crisis in many parts of this country. We have to recognize that while the mortgage market and mortgage finance does play a role, it cannot fix this problem by itself.” Remarks of Sen. Pat Toomey, United States Senate Committee on Banking, Housing and Urban Affairs, Housing Finance Reform: Next Steps (Sept. 10, 2019).    [7]   See, e.g., https://www.reuters.com/article/otc-cfpb/5th-circuit-holds-fhfa-structure-unconstitutional-boost-for-supreme-court-challenge-to-cfpb-idUSKCN1VU2D7. 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.

October 4, 2019 |
Best Practices for AML Compliance Self-Assessments

The Bank Secrecy Act requires financial institutions to establish an anti-money laundering (AML) compliance program to prevent and detect financial crime. Failure to institute an effective program can subject an institution to significant regulatory oversight and penalties. AML compliance missteps have caught numerous banks in the United States and abroad flatfooted with inadequate compliance programs, resulting in massive fines and government scrutiny that distracts from core business missions. Given the importance of AML compliance, financial institutions are increasingly turning to outside experts and consultants to assess the sufficiency of their AML programs. These ad hoc “assisted self-assessments”— often called “gap analyses”—are typically commissioned by chief compliance officers, senior management, or boards of directors either proactively or as a result of an unfavorable internal audit or exam findings, which can give rise to a fear of future enforcement actions. Voluntary self-assessments are important to a sustainable and vigorous AML program, but, if they’re not implemented properly, these voluntary self-assessments can open financial institutions up to serious risk. In the following article, recently published in the New York Law Journal, Gibson Dunn partner Matthew L. Biben provides an analysis of these risks and six best-practices AML assessment recommendations to assist compliance officers, senior management, and boards of directors in setting up their financial institutions for AML success, while ensuring that they fulfill Bank Secrecy Act obligations to help the government combat financial crime. Best Practices for AML Compliance Self-Assessments (click on link) © 2019, New York Law Journal, September 27, 2019, ALM Media Properties. Reprinted with permission. 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 Matt Biben, who Co-Chairs the Financial Institutions Practice Group. Matt spent 12 years as a prosecutor before serving for 10 years as a General Counsel and Executive Vice President of two global financial institutions. In private practice, he has extensive experience advising on AML compliance issues, conducting AML investigations, and litigating and negotiating AML related settlements with federal and state bank regulators and prosecutors. Kendall Day 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. Matt and 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 the White Collar Defense and Investigations Practice Group. Stephanie, Kendall and Matt practice with a Gibson Dunn network of more than 50 former federal prosecutors in domestic and international offices around the globe. Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these AML developments.  Please contact any member of the Gibson Dunn team: Matthew L. Biben – New York (+1 212-351-6300, mbiben@gibsondunn.com) Stephanie Brooker – Washington, D.C. (+1 202-887-3502, sbrooker@gibsondunn.com) M. Kendall Day – Washington, D.C. (+1 202-955-8220, kday@gibsondunn.com) Lee R. Crain, an associate at the firm, assisted in the preparation of the article. © 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.

September 24, 2019 |
UK Supreme Court Decides Suspending UK Parliament Was Unlawful

Click for PDF The UK’s highest court has today ruled (here) that Prime Minister Boris Johnson’s decision to suspend (or “prorogue”) Parliament for five weeks, from September 9, 2019 until October 14, 2019, was unlawful. The Supreme Court, sitting with eleven justices instead of the usual five, unanimously found “that the decision to advise Her Majesty to prorogue Parliament was unlawful because it had the effect of frustrating or preventing the ability of Parliament to carry out its constitutional functions without reasonable justification”. It is a well-established constitutional convention that the Queen is obliged to follow the Prime Minister’s advice. The landmark Supreme Court ruling dealt with two appeals, one from businesswoman Gina Miller and the other from the UK Government. Mrs Miller was appealing a decision of the English Divisional Court that the prorogation was “purely political” and not a matter for the courts. The UK Government was appealing a ruling of Scotland’s Court of Session that the suspension was “unlawful” and had been used to “stymie” Parliament. A link to the full judgment is here. A key question before the Court, therefore, was whether the lawfulness of the Prime Minister’s advice to Her Majesty was “justiciable”, i.e. whether the court had a right to review that decision or whether it was purely a political matter. The Court held that the advice was justiciable: “The courts have exercised a supervisory jurisdiction over the lawfulness of acts of the Government for centuries”. The next question was on the constitutional limits of the power to prorogue. The Court decided that prorogation would be unlawful if it had the effect of “frustrating or preventing, without reasonable justification, the ability of Parliament to carry out its constitutional functions as a legislature and as the body responsible for the supervision of the executive”. The Court stated that it was not concerned with the Prime Minister’s motive; the key concern was whether there was good reason for the Prime Minister to prorogue as he did. The subsequent question related to the effect of the prorogation. The Supreme Court held that the decision to prorogue Parliament prevented Parliament from carrying out its constitutional role of holding the government to account and that, in the “quite exceptional” surrounding circumstances, it is “especially important that he [the Prime Minister] be ready to face the House of Commons.” The Court held that it was “impossible for us to conclude, on the evidence which has been put before us, that there was any reason – let alone a good reason – to advise Her Majesty to prorogue Parliament for five weeks”. The final question was on the legal effect of that finding and what remedies the Court should grant. The Court declared that as the advice was unlawful, the prorogation was unlawful, null and of no effect; Parliament had not been prorogued. The Supreme Court’s judgment further explained that “as Parliament is not prorogued, it is for Parliament to decide what to do next.” Almost immediately after judgment was handed down, it was announced that both the House of Commons and House of Lords will resume sitting tomorrow, Wednesday September 25, 2019. Prime Minister’s Questions – usually scheduled for each Wednesday that Parliament is in session – will not take place due to notice requirements. The UK Government has pledged to “respect” the judgment and the Prime Minister plans to return to the UK from New York, where he is due to address the U.N. General Assembly. Shortly before Parliament was prorogued, a new law was passed requiring the Prime Minister to seek an extension to the current October 31 deadline for the UK to leave the EU unless Parliament agreed otherwise (European Union (Withdrawal) (No. 2) Act 2019). The Government has asserted that this legislation is defective and continues to insist that the UK will leave the EU on October 31, 2019. The Supreme Court’s judgment does not directly affect the position in respect of the October 31 deadline. This client alert was prepared by Patrick Doris, Anne MacPherson, Charlie Geffen, Ali Nikpay and Ryan Whelan 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.

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. Stokes (+1 202-955-8504, pstokes@gibsondunn.com) Judith A. Lee (+1 202-887-3591, jalee@gibsondunn.com) Stephanie Brooker (+1 202-887-3502, sbrooker@gibsondunn.com) John W.F. Chesley (+1 202-887-3788, jchesley@gibsondunn.com) Daniel P. Chung (+1 202-887-3729, dchung@gibsondunn.com) M. Kendall Day (+1 202-955-8220, kday@gibsondunn.com) David Debold (+1 202-955-8551, ddebold@gibsondunn.com) Stuart F. Delery (+1 202-887-3650, sdelery@gibsondunn.com) Michael S. Diamant (+1 202-887-3604, mdiamant@gibsondunn.com) Adam M. Smith (+1 202-887-3547, asmith@gibsondunn.com) Linda Noonan (+1 202-887-3595, lnoonan@gibsondunn.com) Oleh Vretsona (+1 202-887-3779, ovretsona@gibsondunn.com) Christopher W.H. Sullivan (+1 202-887-3625, csullivan@gibsondunn.com) Courtney M. Brown (+1 202-955-8685, cmbrown@gibsondunn.com) Jason H. Smith (+1 202-887-3576, jsmith@gibsondunn.com) Ella Alves Capone (+1 202-887-3511, ecapone@gibsondunn.com) Pedro G. 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Welch (+852 2214 3716, owelch@gibsondunn.com) São Paulo Lisa A. Alfaro (+55 (11) 3521-7160, lalfaro@gibsondunn.com) Fernando Almeida (+55 (11) 3521-7095, falmeida@gibsondunn.com)   © 2019 Gibson, Dunn & Crutcher LLP, 333 South Grand Avenue, Los Angeles, CA 90071 Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

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.