DC Circuit orders review of OCC鈥檚 capital plan
10 August 2017 Chicago
Image: Shutterstock
The US Court of Appeals for the DC Circuit has called on the US Securities and Exchange Commission (SEC) to reconsider its premature acceptance of OCC鈥檚 amended capital plan.
The DC Circuit ordered the SEC to reevaluate OCC鈥檚 plan due to a lack of effective oversight when originally evaluating its appropriateness in 2015 and 2016.
According to the DC Circuit, the SEC allowed the clearinghouse鈥檚 capital plan, which has been in place since September 2015 and essentially allows OCC shareholder stock exchanges, including Nasdaq OMX Group and Chicago Board Options Exchange, to swap capital for dividends and refunds, to proceed without demanding adequate evidence and details on certain aspects of the terms.
Contentious features include an OCC pledge to include independent financial advice when setting dividend levels in order to ensure they are reasonable for the cost and risk associated.
The DC Circuit noted that the SEC failed to verify the appropriateness of OCC鈥檚 selection of this independent advice.
DC Circuit Chief Judge Merrick Garland stated in the court鈥檚 opinion: 鈥淭he order鈥檚 shortcomings are apparent in its discussion of whether the plan pays dividends to shareholder exchanges at a reasonable rate.鈥�
鈥淭hat is a central issue: if the dividend rate represents an unnecessary windfall for shareholders, as petitioners argue, then the plan may run afoul of the Exchange Act鈥檚 prohibitions by unnecessarily or inappropriately burdening competition, harming the interests of investors and the public, or unfairly discriminating against non-shareholders and clearing members.鈥�
Petitioners Miami International Securities Exchange, KCG Holdings and Susquehanna International Group argued that the plan overcompensated shareholder exchanges, which unjustifiably burdens competition.
They unsuccessfully tried to get the DC Circuit to block the plan before implementation began last year.
The petitioners further contended that the plan harms investors and the public by transforming OCC from a public utility to a profit-seeking monopoly, and by increasing the fees charged to OCC鈥檚 customers.
On this point, the DC Circuit added that 鈥渙nly four of nine [OCC] directors representing clearing members voted in favour of the plan, making it less than clear that the process struck an appropriate balance between the interests of shareholders and clearing members鈥�.
Chief Judge Garland summarised the DC Circuit鈥檚 concerns, explaining: 鈥淔irst, the order fails to support its conclusion that the plan鈥檚 capital target is reasonable.鈥�
鈥淪econd, the SEC was also too quick to accept OCC鈥檚 claims that the plan would not increase fees for customers.鈥�
鈥淭hird, the order fails to give any explanation at all for rejecting one of petitioners鈥� objections.鈥�
鈥淔inally, the order gives short shrift to petitioners鈥� objection that OCC, by failing to notify non-shareholder exchanges earlier in its development of the plan, violated its own bylaws.鈥�
OCC confirmed that it would provide commissioners and SEC staff with any information it needed to evaluate its capital plan in light of the decision by the DC Circuit to remand it to the agency for further review.
Craig Donohue, OCC executive chair and CEO, commented: 鈥淲hile we are disappointed in the court鈥檚 decision to remand, we are pleased by its ruling that the SEC鈥檚 order approving the capital plan remains in effect.鈥�
鈥淥CC鈥檚 capital plan is a vital component of our goal of providing world-class service to market participants and helping to ensure the resiliency of a systemically important financial market utility.鈥�
Donohue added: 鈥淲e intend to submit underlying data and any other information the SEC may request as it further evaluates the capital plan in consideration of the statements made by the DC Circuit in its opinion. We remain confident that the SEC will once again approve the capital plan.鈥�
The DC Circuit, with the agreement of the petitioners, has not ordered the capital plan to be unwound, only that the SEC apply a more appropriate level of security to its terms before moving forward.
The plan enables OCC to comply with regulatory requirements that ensure a systemically important clearing agency, such as OCC, retains sufficient liquid net assets funded by equity to cover potential general business losses, and also have a plan for raising additional equity if its equity falls close to or below the required amount.
This requirement is in the SEC鈥檚 Standards for Covered Clearing Agencies, which are in furtherance of Section 17A of the Securities Exchange Act.
The DC Circuit ordered the SEC to reevaluate OCC鈥檚 plan due to a lack of effective oversight when originally evaluating its appropriateness in 2015 and 2016.
According to the DC Circuit, the SEC allowed the clearinghouse鈥檚 capital plan, which has been in place since September 2015 and essentially allows OCC shareholder stock exchanges, including Nasdaq OMX Group and Chicago Board Options Exchange, to swap capital for dividends and refunds, to proceed without demanding adequate evidence and details on certain aspects of the terms.
Contentious features include an OCC pledge to include independent financial advice when setting dividend levels in order to ensure they are reasonable for the cost and risk associated.
The DC Circuit noted that the SEC failed to verify the appropriateness of OCC鈥檚 selection of this independent advice.
DC Circuit Chief Judge Merrick Garland stated in the court鈥檚 opinion: 鈥淭he order鈥檚 shortcomings are apparent in its discussion of whether the plan pays dividends to shareholder exchanges at a reasonable rate.鈥�
鈥淭hat is a central issue: if the dividend rate represents an unnecessary windfall for shareholders, as petitioners argue, then the plan may run afoul of the Exchange Act鈥檚 prohibitions by unnecessarily or inappropriately burdening competition, harming the interests of investors and the public, or unfairly discriminating against non-shareholders and clearing members.鈥�
Petitioners Miami International Securities Exchange, KCG Holdings and Susquehanna International Group argued that the plan overcompensated shareholder exchanges, which unjustifiably burdens competition.
They unsuccessfully tried to get the DC Circuit to block the plan before implementation began last year.
The petitioners further contended that the plan harms investors and the public by transforming OCC from a public utility to a profit-seeking monopoly, and by increasing the fees charged to OCC鈥檚 customers.
On this point, the DC Circuit added that 鈥渙nly four of nine [OCC] directors representing clearing members voted in favour of the plan, making it less than clear that the process struck an appropriate balance between the interests of shareholders and clearing members鈥�.
Chief Judge Garland summarised the DC Circuit鈥檚 concerns, explaining: 鈥淔irst, the order fails to support its conclusion that the plan鈥檚 capital target is reasonable.鈥�
鈥淪econd, the SEC was also too quick to accept OCC鈥檚 claims that the plan would not increase fees for customers.鈥�
鈥淭hird, the order fails to give any explanation at all for rejecting one of petitioners鈥� objections.鈥�
鈥淔inally, the order gives short shrift to petitioners鈥� objection that OCC, by failing to notify non-shareholder exchanges earlier in its development of the plan, violated its own bylaws.鈥�
OCC confirmed that it would provide commissioners and SEC staff with any information it needed to evaluate its capital plan in light of the decision by the DC Circuit to remand it to the agency for further review.
Craig Donohue, OCC executive chair and CEO, commented: 鈥淲hile we are disappointed in the court鈥檚 decision to remand, we are pleased by its ruling that the SEC鈥檚 order approving the capital plan remains in effect.鈥�
鈥淥CC鈥檚 capital plan is a vital component of our goal of providing world-class service to market participants and helping to ensure the resiliency of a systemically important financial market utility.鈥�
Donohue added: 鈥淲e intend to submit underlying data and any other information the SEC may request as it further evaluates the capital plan in consideration of the statements made by the DC Circuit in its opinion. We remain confident that the SEC will once again approve the capital plan.鈥�
The DC Circuit, with the agreement of the petitioners, has not ordered the capital plan to be unwound, only that the SEC apply a more appropriate level of security to its terms before moving forward.
The plan enables OCC to comply with regulatory requirements that ensure a systemically important clearing agency, such as OCC, retains sufficient liquid net assets funded by equity to cover potential general business losses, and also have a plan for raising additional equity if its equity falls close to or below the required amount.
This requirement is in the SEC鈥檚 Standards for Covered Clearing Agencies, which are in furtherance of Section 17A of the Securities Exchange Act.
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