Mr. Tarbert heads the firm's Financial Regulatory Reform Working Group, and Ms. Odoner and Ms. Dixon are members of that group.Mr. Tarbert is former Special Counsel to the U.S. Senate Banking Committee, and Ms. Dixon is former Chief Counsel of the SEC's Division of Corporation Finance.Ms. Odoner heads the firm's Public Company Advisory Group.
This interview addresses financial issues affecting nonfinancial corporations raised in the White House Letter and its attachments. See page 1 of this issue for a copy of the White House Letter and the accompanying Executive Summary as well as reference to a link to the Report, which was also attached to the White House Letter.
The following Q&A provides general information and should not be used or taken as legal advice for specific situations, which depend on the evaluation of the precise factual circumstances.The views expressed reflect those of the speakers and not necessarily the views of Weil, Gotshal & Manges LLP.
Editor: Does Section 731 of Dodd-Frank prevent a company's pension plan from employing swaps?
Tarbert: There is nothing in section 731 that legally prevents a swap dealer or major swap participant from having a pension plan as a counterparty or vice versa.However, before entering into the swap, the dealer or major participant must have a reasonable basis for believing that the pension plan (as a "special entity" under Dodd-Frank) is represented by an independent representative (or a fiduciary if ERISA governs) who, among other things, has sufficient knowledge to evaluate the transaction and risks, undertakes a duty to act in the best interest of the pension plan, and will provide written representation to the pension plan regarding fair pricing and the appropriateness of the transaction.
Determining whether these criteria are met with respect to a pension plan may cause the counterparty to act as a quasi-fiduciary for the plan.Given the potential exposure of counterparties to liability for a violation of this provision (or of any related federal statute governing transactions between fiduciaries and pension plans), this new obligation could discourage counterparties classified as swap dealers or major swap participants from entering into swaps with pension plans.
Editor: Does mandating separating OTC trading subsidiaries lead to near-term uncertainty in and reduced access to OTC markets? Would possible long-term implications include having fewer trading counterparties and higher cost for commercial end users looking to hedge commodity, FX and interest rate risk?
Tarbert: Section 716 of Dodd-Frank - the so-called "push-out" provision - prohibits "federal assistance" to any entity that is a swap dealer or major swap participant. Because federal assistance includes FDIC deposit insurance, banks and thrifts are effectively banned from dealing in OTC swaps, and must push those activities out to separately capitalized swaps trading affiliates.Capital is expensive, and some banks may simply leave the business.But my guess is that most large financial institutions will make the transition smoothly.
Dodd-Frank may lead to fewer trading counterparties and will almost inevitably (and unfortunately) raise costs for commercial end users, but that will be due largely to higher capital and margin requirements for uncleared swaps across the board.
Editor: Does Dodd-Frank increase the cost of funds or place restrictions on capital deployment for U.S.-based captive finance companies that will impede companies' ability to provide integrated financial services and compete globally?
Tarbert: If a given captive finance company is an insured depository and subject to capital regulation, then it will most likely see its capital and leverage requirements rise over the next few years due to a combination of Dodd-Frank and various initiatives by bank regulators.The good news is that, with respect to OTC swaps, many captive finance companies of commercial or manufacturing concerns will be permitted to rely on the end-user exemption to enter into swaps on their parent's behalf and to hedge commercial risks involved in their financing of the purchase or lease of the parent's products. As a result, captive finance companies will not be subject to the mandatory clearing requirement and also will most likely avoid capital and margin requirements.Nevertheless, captive finance companies that trade or enter into swaps on their own behalf and outside of the specific set of criteria established by Dodd-Frank will not be able to enjoy the end-user exemption.
Editor: Does the Administration's policy to subject captive finance companies to myriad state regulations instead of federal uniform rules unnecessarily increase costs and decrease financial service choices?
Tarbert: Captive finance companies not already supervised by a federal bank regulator may find themselves under the jurisdiction and supervision of the new U.S. Consumer Financial Protection Bureau (CFPB).Despite its vast power as a federal regulator, the CFPB has little in the way of robust pre-emptive authority. Indeed, Dodd-Frank reverses the trend toward greater federal preemption by affording states greater legislative and enforcement latitude.States may enact stricter substantive protections, and state attorneys general may even initiate civil actions to enforce federal consumer financial protection laws.Captive finance companies unfortunately may be vulnerable to multiple layers of new regulations and legal actions in the coming decade.More broadly, the overall uncertainty of Dodd-Frank's ultimate impact is itself a serious challenge to all American companies struggling to put the Great Recession behind them.
Editor: Is the SEC's recently adopted price test for short sales likely to have a negative impact on economic recovery, global competitiveness and job creation?
Dixon: We'll have to wait and see - in other words, we'll have to assess the effects of the alternative uptick test reflected in the new rule against the broader background of evolving global economic and market conditions and various European regulatory initiatives now underway in this area.Another set of variables will come into play in the coming months, as the SEC (and, in some cases, other regulators) implement relevant provisions of the Dodd-Frank Act that will require periodic disclosure of short positions by institutional investment managers subject to 13F reporting requirements, empower the SEC to require disclosure of beneficial ownership positions arising from cash-settled, equity-based derivatives and otherwise to deal with hedging of derivatives (which often entails short selling tied to predicate assets, including but not limited to equity securities and debt underpinning credit default swaps), and require the SEC both to report to Congress within one year on short sales and to act within two years to regulate the share-lending activities that are critical to the supply of equity securities needed to support equity short sales.That said, I personally believe that the SEC's alternative uptick rule reflects a relatively balanced, surgical approach to the perceived problem when considered together with the tighter ban on naked short selling and enhanced delivery requirements.
Editor: What are the implications of the SEC's whistleblowers' rewards program?
Dixon: This question is difficult to answer at this early stage, but three observations come immediately to mind.First, individual employees certainly will have greater financial incentive to furnish "original information" directly to the SEC (and/or CFTC), although it is unclear whether (if at all) these incentives will affect the viability of corporate compliance programs that encourage employees to report "up" (within the corporation) rather than "out" (i.e. to the SEC or other regulatory or law-enforcement authority).Second, public companies shouldn't wait for SEC (or CFTC) guidance before re-examining the effectiveness of existing whistleblower complaint mechanisms established and administered by their audit committees under the Sarbanes-Oxley Act of 2002 (covering accounting and audit-related matters), and considering whether the mechanisms need to be refined to address Dodd-Frank's heightened whistleblower protections (along with the revised U.S. Sentencing Guidelines coming into effect this fall).Finally, it is possible that we may see an increase in litigation instituted by putative whistleblowers invoking the protections of Dodd-Frank's anti-retaliation provision, since, in contrast with the Sarbanes-Oxley whistleblower regime, they will not have to exhaust administrative remedies.But the jury is still out.
Editor: The U.S. accounting standards board (FASB), in a convergence effort with the International Accounting Standards Board (IASB), is scheduled to release ten-plus proposed accounting exposure drafts over the next 18 months. Do U.S. multinational companies, FASB and IASB have sufficient technical resources to respond effectively to such a large quantity of complex proposals issued over a very short period of time and subsequently absorb and resolve all of the issues that would be posed by all of these proposed standards in such a compressed time period?
Odoner: Although they had started down this path before, the financial crisis and resulting calls from policymakers spurred the efforts of the FASB and the IASB to work together to achieve, to the extent possible, a single set of high-quality accounting standards that will promote the reliability and comparability of financial information about companies around the world. The profusion of exposure drafts and ultimately new standards will undoubtedly require companies and their audit committees to work very hard, but they will have the aid of the accounting profession, and hopefully this will all be to a very good end.
Published August 30, 2010.