10 August 2017
Reporter: Drew Nicol

DC Circuit orders review of OCC’s capital plan

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’s amended capital plan.

The DC Circuit ordered the SEC to reevaluate OCC’s 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’s 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’s selection of this independent advice.

DC Circuit Chief Judge Merrick Garland stated in the court’s opinion: “The order’s shortcomings are apparent in its discussion of whether the plan pays dividends to shareholder exchanges at a reasonable rate.”

“That 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’s prohibitions by unnecessarily or inappropriately burdening competition, harming the interests of investors and the public, or unfairly discriminating against non-shareholders and clearing members.”

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’s customers.

On this point, the DC Circuit added that “only 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”.

Chief Judge Garland summarised the DC Circuit’s concerns, explaining: “First, the order fails to support its conclusion that the plan’s capital target is reasonable.”

“Second, the SEC was also too quick to accept OCC’s claims that the plan would not increase fees for customers.”

“Third, the order fails to give any explanation at all for rejecting one of petitioners’ objections.”

“Finally, the order gives short shrift to petitioners’ objection that OCC, by failing to notify non-shareholder exchanges earlier in its development of the plan, violated its own bylaws.”

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: “While we are disappointed in the court’s decision to remand, we are pleased by its ruling that the SEC’s order approving the capital plan remains in effect.”

“OCC’s 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.”

Donohue added: “We 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.”

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’s Standards for Covered Clearing Agencies, which are in furtherance of Section 17A of the Securities Exchange Act.

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