Capital markets, derivatives, and the law : positivity and preparation

Cover
Capital Markets, Derivatives, and the Law
Copyright
Dedication
Contents
Acknowledgments
Preface
Introduction
1. The Financial Crisis: The Seeds of New Regulation
	I. Origins of the Great Recession
	II. Subprime Lending
	III. Government-​Sponsored Entities
	IV. Legislative Reforms
		A. Multiple Guarantor Model
		B. Multiple Insurer Model
2. The Liquidity Crisis and Government Reaction
	I. Buildup to Crisis
	II. Providing Liquidity and Stabilizing the Financial Markets
	III. Regulatory Reaction at the Height of the Crisis
		A. The Emergency Economic Stabilization Act
		B. American Recovery and Reinvestment Act
	IV. Dodd-​Frank
3. Dodd-​Frank and the Regulation of Depository Institutions Capital Requirements
	I. The Volcker Rule and “Too Big to Fail”
	II. Bank Holding Companies and Systemically Significant Nonbanks
	III. Living Wills, Credit Exposure Reports, and Concentration Limits
	IV. Other Prudential Standards
4. Using Financial Instruments
	I. Goal-​Oriented Investing
		A. Using Financial Instruments to Hedge Risk
		B. Using Financial Instruments to Enhance Yield
		C. The Economy’s Impact on Financial Instruments
	II. Achieving Investment Goals
		A. The Investor’s Perspective
		B. Financial Instrument Objectives
	III. Managing Risk
5. Financial Instruments and the Capital Markets
	I. The Capital Markets
		A. Primary versus Secondary Markets
		B. Long-​Term versus Short-​Term Marketplaces
		C. Case Study: The Auction Rate Securities (ARS) Market
	II. Financial Instruments
		A. Types of Financial Instruments
			1. Equity-​Based Financial Instruments
			2. Debt-​Based Financial Instruments
			3. Derivatives
			4. Cryptocurrency and Digital Assets
		B. Distinction between Debt and Equity
		C. Federal Regulation
	III. The Role of the Attorney
		A. Competent Representation
		B. Duty to Advise Client
		C. Drafting Financial Instruments
		D. Regulatory Compliance
		E. Opinion Letters
6. Bureau of Consumer Financial Protection
	I. Structure
	II. Roles and Function of the BCFP
		A. The Bureau’s Regulatory Authority
		B. The Bureau’s Supervisory Authority
		C. The Bureau’s Enforcement Authority
	III. Significant Changes in Financial Consumer Protection by the BCFP
		A. The Judicial Review of BCFP’s Power
	IV. BCFP under President Trump’s Administration
	V. The Judicial BCFP Structures under President Trump’s Administration
		A. Constitutionality of the Bureau
		B. Single Directorship
	VI. Ongoing Enforcement Action Status
		A. Wells Fargo Case
7. Understanding Interest Rates and the Economy
	I. Background
		A. The Federal Reserve
		B. The Federal Reserve Banking System
			1. Composition
			2. Purpose
			3. Responsibilities
	II. Economic Indicators and Interest Rates
		A. Key Economic Statistics
			1. Statistics
		B. Monetary Policy Objectives
		C. Inflation Targeting
	III. Monetary Policy: The Financial Crisis and Beyond
	IV. Quantitative Easing
		A. Balance Sheet Normalization
		B. Fiscal Considerations
	V. FOMC Minutes
8. Asset Valuation
	I. The Use of Interest Rates in Asset Valuation
	II. Interest Rate Yield Curve
		A. Types of Yield Curves
		B. Why the Yield Curve May Be Flat or Inverted
			1. Increase in Market Demand for Long-​Term Securities
			2. Long-​Term Yield Affected by Federal Reserve Monetary Policy
9. United States Treasury Securities
	I. Purpose and Goals
		A. Risk-​Free Nature
		B. Primary Dealers
	II. Description of U.S. Treasury Securities
		A. Types of Treasury Securities
			1. Treasury Bills
			2. Treasury Notes and Bonds
		B. Pricing
			1. Discounts and Premiums
			2. Factors Affecting Yield
	III. Bond Auctions and Price
		A. Interruption of Supply: SEC v. Davis et al.
		B. Manipulation of the Auction Process: United States v. Salomon Brothers
	IV. Interest Rates
		A. Fixed-​versus Floating-​Rate Securities
		B. Treasury Inflation-​Protected Securities (TIPS)
	V. STRIPS
		A. Description
		B. Valuation
		C. Uses
		D. Abuses: In the Matter of Orlando Joseph Jett
10. Debt Securities
	I. Description
		A. Features of Bonds
		B. Types of Bonds
		C. The Indenture
	II. Bond-​Rating Agencies
		A. Independence and Conflicts of Interest
		B. Regulation of Bond-​Rating Agencies
	III. Special Types of “Debt” Instruments
		A. Repos
			1. Description
			2. Orange County Case Study
			B. Mortgage-​Backed Securities
			1. Mortgage-​Backed Bonds
			2. Pass-​Through Securities
			3. Collateralized Mortgage Obligations and Real Estate Mortgage Investment Conduits
			4. Stripped Mortgage-​Backed Securities (SMBS)
			5. Subprime Mortgage Crisis
	IV. Securities Act Registration
		A. Government Securities
		B. Government Agency Securities
		C. Municipal Securities
			1. SEC Disclosure Requirements
			2. MSRB Disclosure Requirements
		D. Corporate Debt Securities
			1. Securities Act Requirements
			2. Trust Indenture Act Requirements
		E. Private Placements of Debt Securities
11. Derivatives
	I. Introduction
		A. Description
		B. Counterparty Credit Risk
		C. Over-​the-​Counter versus Exchange-​Traded Derivatives
		D. Exchange-​Traded versus OTC Derivatives
	II. Shifting Risk
		A. The Concept of Leverage
		B. Basis Risk
		C. Market Risk
		D. Effective Tools of Risk Management
	III. Types of Derivatives
		A. Forwards
		B. Futures
			1. Reduction of Counterparty Risk
			2. Suitability as Hedging Instruments
		C. Distinction between Forwards and Futures
		D. Foreign Exchange Forwards and Futures
		E. Options
		F. Swaps
			1. Characteristics of Swaps
			2. The ISDA Master Agreement
		G. Credit Derivatives
	Appendix CME Filing: Self-​Certification for the initial listing of the Bitcoin Futures Contract
12. Types of Swaps
	I. “Plain Vanilla” Interest Rate Swaps
	II. Currency Swaps
	III. Credit-​Default Swaps
		A. Purpose and Function
		B. ISDA Master Agreement
		C. Importance of Clearly Defined Terms
			1. Credit Event
			2. Reference Entity
		D. Collateralized Debt Obligations
		E. OTC Derivatives and the Financial Crisis
	IV. The Move toward Regulatory Reform
		A. The Central Clearing Model
		B. The OTC Model
		C. Confidence in the New Regulatory Regime: The Case of MF Global
13. Options
	I. Characteristics of Options
	II. How Options Work
		A. Calls and Puts
			1. Call Option
			2. Put Option
		B. Case Study: Levy v. Bessemer Trust
			1. Facts
			2. Theories of Liability in Levy
	III. The Black-​Scholes Model and Option Pricing
		A. Assumptions
		B. Required Data
		C. Volatility
			1. Types of Volatility
			2. Measures of Volatility
		D. Authority of the Black-​Scholes Model
	IV. Delta Hedging
		A. Contracts That Are Economically Options
		B. OTC versus Exchange-​Traded Options
		C. Regulation of Options
	V. Option Strategies
		A. Synthetic Call
		B. Covered Call
		C. Collar
14. Regulation of Swaps
	I. The Dodd-​Frank Regulatory Regime
		A. Dodd-​Frank and Derivatives Trading
		B. Jurisdiction and Registration
		C. Clearing Requirements, Exchange Requirements, and the End-​User Exemption
		D. Capital and Margin Requirements
		E. Reporting Requirements
			1. Commodity Position Limits
		F. Futures Commission Merchants, Dodd-​Frank, and Regulation 1.25
			1. Title VII Enforcement
			2. Updated Enforcement Advisory on Self-​Reporting and Full Cooperation
			3. Enforcement Actions for Data Reporting Violations
			4. Action for Failure to Submit Accurate Large-​Trader Commodity Swap Reports
			5. Increase of CFTC’s Enforcement Actions following the Change of CFTC Chairman
			6. Reduction of Counterparty and Systemic Risk
				a. Counterparty Risk
				b. Systemic Risk
		G. Rationale behind Exemptions and Exclusions
			1. The End-​User Exemption
			2. Physical Settlement Exclusion
			3. Customization Exceptions
		H. The Lincoln Rule
			1. Futures Commission Merchants
		I. Criticisms of Dodd-​Frank’s Derivatives Trading Provisions
			1. Concentration of Systemic Risk in Clearinghouse and “Too Big to Fail”
			2. Exceptions Swallowing the Rule: Incentivizing of Customization and De Minimis Exceptions
			3. Lack of Global Harmonization
			4. The Impact of the Change of U.S. Administration
			5. The Change of CFTC Chairman
				a. CFTC’s New Priorities
				b. Improving SEF rules
				c. Fixing Data Reporting
				d. Achieving Cross-​Border Harmonization
				e. Project KISS
			6. Recent Actions of the CFTC and Announcements of Further Actions to Come
				a. Amendment of Swap Trading Rules
				b. Review of Swap Dealers De Minimis Threshold
				c. Review of Position Limits
				d. Improvement of Clearinghouse Stress Testing
			7. Propositions of Reforms from the U.S. Treasury Report on Capital Markets
15. Securities Regulation
	I. Regulatory Overview
		A. The Securities and Exchange Commission
			1. Jurisdiction
		B. What Constitutes a Security
			1. Stocks
			2. Notes
			3. Investment Contracts—​The Howey Test
				a. Control and Splitting the Transaction
				b. Prepurchase Efforts
				c. State Regulation and the Hawaii Market Test
		C. Sellers’ Representations
		D. Consequences of Securities Violations
			1. Preliminary Injunction
			2. Disgorgement
			3. Permanent Injunction
			4. Antifraud Statutes
			5. Attorney’s Potential Liability
		E. Hedge Funds
			1. Post-​crisis Hedge Fund Regulation
			2. Other Regulations
	II. Derivatives Regulation: The SEC after Dodd-​Frank
	Appendix A: Implementing the Dodd-​Frank Wall Street Reform and Consumer Protection Act
	Appendix B: Checklist for Stocks, Notes, and Investment Contracts
16. Suitability
	I. The Suitability Doctrine
		A. Suitability Duty
		B. Scope and Applicability
		C. Control and Enforceability
		D. Investment Advisors
			1. Rule: A Fiduciary Standard
		E. Scope and Applicability
		F. Control and Enforceability
		G. Basis of the Suitability Doctrine
		H. Special Circumstances
		I. FINRA and Self-​Regulated Organizations (SROs)
			1. Financial Industry Regulatory Authority Creation of the Agency
		J. Rule: A Suitability and Know-​Your-​Customer Duty
		K. Scope and Applicability
		L. Control and Enforceability
		M. NYSE Know-​Your-​Customer Rule
			1. Consumer Financial Protection Bureau
			2. Scope and Applicability
			3. Control and Enforceability
			4. Department of Labor
				a. Employee Retirement Income Security Act
			5. Scope and Applicability
				a. The Antifraud Provisions of the Federal Securities Laws—​Section 10b Cause of Action
	II. Futures and Options: Suitability
		A. Commodity Futures Trading Commission Disclosure Rules
			1. Commodity Futures Trading Commission
				a. Commodity Exchange Act
				b. Rule: A Suitability and Fair-​Dealing Duty
				c. Scope and Applicability
				d. Control and Enforceability
		B. National Futures Association
			1. Rule: Suitability and Know-​Your-​Customer Duty
				a. Scope and Applicability
				b. Control and Enforceability
		C. CEA Antifraud Provision
		D. Municipal Securities Rule-​Making Board
	Appendix A: Various Suitability Rules and Diagrams of Applicability
	Appendix B: Survey of Rules Adopted by the SEC under Dodd-​Frank​
17. The History of the CFTC
	I. Role of the CFTC
	II. Structure
	III. Disciplinary Action
	IV. Regulatory Background
		A. Commodity Exchange Act (CEA) of 1936
		B. Commodity Futures Modernization Act (CFMA) of 2000
		C. Jurisdictional Disputes
		D. The Commodity Futures Modernization Act
		E. Exclusions
		F. Forwards
		G. Options
		H. Futures
		I. Regulatory Distinctions between Forwards and Futures
		J. Swaps
		K. Hybrid Instruments
		L. Foreign Exchange Products
			1. The Treasury Amendment
			2. CFTC Reauthorization
	Appendix A: Enforcement Case Study: CFTC v. Amaranth Advisors, LLC
	Appendix B: Case Study: CFTC v. Zelener
	Appendix C: Structure of CFTC
	Appendix D: Case Study: CFTC v. Patrick McDonnell
18. Fiduciary Obligation to Manage Risk
	I. Controlling Risk
		A. Duty to Manage Risk
			1. Risk Management for Financial and Non-​financial Institutions
		B. Financial Risk
		C. Quantifying Financial Risk
			1. Value at Risk
			2. Volatility Risk
			3. Stress Testing
		D. Portfolio Dynamics
	II. Operational Risk Management
		A. Directors’ and Officers’ Understanding of Financial Instruments
		B. Risk Policy
		C. Reporting Lines and Audit Techniques
		D. Empowering Board Members
		E. Reporting Structures
		F. Information Flow
			1. Daily Exception Report
			2. Red Flags
		G. Ethical Concerns
			1. Compensation
			2. Code of Conduct
			3. Free Flow of Information
		H. Flexibility
	III. Executive Protection
		A. Responsibility for Risk Management
		B. Business Judgment Rule
		C. Education at Financial Institutions
		D. Disclosure under Sarbanes-​Oxley Act
			1. Disclosures in Management’s Discussion and Analysis (MD&A)
			2. Off-​Balance-​Sheet Transactions
	Appendix A: Case Study: JPMorgan and the London Whale
19. Litigation Issues
	I. Federal Securities Laws
		A. The Retail Investor: Broker-​Dealers and Investment Advisers
		B. Securities Exchange Act of 1934 Rule 10b-​5 Claim
		C. Securities Act of 1933
		D. Liability under the Commodity Exchange Act
			1. Antifraud Provision
			2. Disclosure
	II. Common Law Theories
		A. Breach of Fiduciary Duty
		B. Common Law Fraud
		C. Shingle Theory
		D. Tort Theory
		E. Contract Theory
	III. State Blue Sky Laws
	IV. Swaps Case Study
20. Synthesis and Conclusion
	I. Synthesis
	II. Structured Note Case Study: Securities and Exchange Commission v. Goldman, Sachs & Co. & Fabrice Tourre
	III. Historical Example: Erlanger “Cotton” Bonds
	IV. Range Notes
	V. Internal Leverage and Market Risk
	VI. Risks Involved
		A. Interest Rate Risk
		B. Liquidity Risk
		C. Reinvestment Risk
		D. OCC Warning
Index