Financial Services Alert - October 5, 2010

In response to a petition filed by the Business Roundtable and the U.S. Chamber of Commerce with the U.S. Court of Appeals for the District of Columbia Circuit asking the Court to vacate recent changes to the SEC’s proxy rules designed to facilitate shareholder nomination of directors (as discussed in the September 1, 2010 Goodwin Procter Client Alert and the September 7, 2010 Alert), the SEC has issued an order staying the effectiveness of newly adopted Rule 14a-11, related amendments to the proxy rules and amendments to Rule 14a-8, pending the Court’s review.

The House of Representatives has passed the Investment Company Modernization Act of 2010 (H.R. 4337), which was originally introduced in the House at the end of 2009.  The Act would modify a number of Internal Revenue Code provisions applicable to regulated investment companies (RICs) to:

• allow RICs to carry forward their net capital losses indefinitely (while modifying the treatment of RIC loss carryovers to be similar to the current treatment applicable to individuals)
• allow RICs to treat income (including gain from sale) from direct investments in commodities or derivatives on commodities as qualifying income for purposes of the 90% gross income test
• add new savings provisions for a RIC’s failure to satisfy the asset diversification tests and add savings provisions for gross income test failures
• repeal the preferential dividend rule for publicly traded RICs
• require RICs to “report” their capital gain dividends and certain other dividends in a written statement furnished to shareholders (such as the IRS Form 1099), instead of “designating” such dividends
• allow fund of funds to pass through exempt-interest dividends and foreign tax credits to shareholders as long as the upper-tier fund invests at least 95% of the value of its total assets in other RICs
• modify rules relating to spillback dividends, with the effect of generally extending the due date for such dividends
• clarify the tax treatment of redemptions by shareholders in publicly traded RICs
• allow a RIC to take into account in earnings and profits calculations its net capital loss carryforwards and tax-exempt interest-related expenses
• allow a RIC to elect to “push” forward to the first day of the next taxable year all or part of any late-year capital losses and certain late-year ordinary losses (with such an election applying for all purposes of the Code)
• amend certain provisions relating to the excise taxes and penalties payable by RICs.

The provisions of the Act generally would apply for taxable years beginning after the date of enactment.  The Senate has taken no action on the Act other than placing it on the Senate Legislative Calendar.

The Financial Crimes Enforcement Network ("FinCEN") published a notice of proposed rulemaking (the “Proposed Rules”) that would broaden the reporting obligations of banks and money transmitters for cross-border electronic transmittals of funds (“CBETFs”).  The Proposed Rules would require certain banks to furnish FinCEN with (1) copies of transmittal orders or advices (or equivalent information in a format to be developed by FinCEN) for CBETFs sent to or received from foreign financial institutions and (2) an annual report that provides the account numbers for accounts that transmitted or received a CBETF and the U.S. taxpayer identification numbers (“TINs”) for the corresponding accountholders.  The Proposed Rules would also require certain money transmitters to submit reports regarding CBETFs of $1,000 or more sent to or received from foreign financial institutions. 

Financial Institutions Subject to the Proposed Rules

The reporting requirements under the Proposed Rules would apply to a bank or money transmitter which is either a “first-in” or “last-out” financial institution” for a CBETF.  A “first-in” financial institution would be defined as the recipient of a transmittal order or advice for a CBETF from a foreign financial institution, while a “last-out financial institution” would be the sender of a transmittal order or advice for a CBETF to a foreign financial institution.

A separate, but related, annual TIN reporting requirement would apply to banks (even those which are not “first in” or “last-out” financial institutions) that maintain accounts through which CBETFs were originated or received.

CBETF Transactions Subject to the Proposed Rules

The Proposed Rules would define a CBETF as “[a] transmittal of funds where either the transmittal order or advice is: (i) communicated through electronic means; and (ii) sent or received by either a first-in or a last-out financial institution.”  For banks, the Proposed Rules would apply to all CBETFs regardless of the amount, but the Proposed Rules would only apply to such CBETFs of $1,000 or more in the case of money transmitters.  The Proposed Rules would also apply in cases where the funds transfer is not effected.

The Proposed Rules would provide exemptions under which reporting would not be required for CBETFs that do not involve third parties (e.g., bank-to-bank transactions) or transmittal orders or advices that are communicated solely through a bank’s proprietary systems.

CBETF Reporting Requirement

FinCEN recognizes that there is a large degree of standardization in the formats of transmittal orders currently used by banks.  Accordingly, the Proposed Rule would permit banks to satisfy the CBETF reporting requirement by submitting a full copy of any transmittal order or advice which is in a standardized form that has been approved for direct submission by FinCEN.  A bank would also be able to comply with this filing obligation by directing a third-party carrier, such as SWIFT, to submit the transmittal order to FinCEN on behalf of the bank.

If a bank is not able to submit (or cause to be submitted) copies of transmittal orders for CBETFs in a standardized format, FinCEN would accept submission of the required information in an alternative format to be prescribed by FinCEN.  Banks using such an alternative reporting format would be required to submit the following information, if available, about a CBETF: (i) unique transaction identifier number; (ii) either the name and address or the unique identifier of the transmittor’s financial institution; (iii) name and address of the transmittor: (iv) the account number of the transmittor (if applicable); (v) the amount and currency of the funds transfer; (vi) the execution date of the funds transfer; (vii) the identity of the recipient’s financial institution; (viii) the name and address of the recipient; (ix) the account number of the recipient; and (x) any other specific identifiers of the recipient or transaction.  These data points coincide with the combined recordkeeping requirements currently imposed under the so-called “Recordkeeping Rule” and “Travel Rule” for funds transfers, with the addition of the unique transaction identifier number.

Money transmitters would be required to provide such information in the alternative format prescribed by FinCEN for all CBETFs of $1,000 or more.  Additionally, for CBETFs of $3,000 or more, the money transmitter would need to report the U.S. TIN of the transmittor or recipient (as applicable), or if none, the alien identification number of passport number and country of issuance.  Money transmitters would not be permitted to submit copies of transmittal orders. 

FinCEN acknowledges that some of the reportable fields of CBETFs collected through either method (submitting copies of the actual transmittal orders or using an alternative format prescribed by FinCEN) might be empty or contain incomplete data.

All reporting would need to be completed electronically unless an institution can demonstrate that this would be unnecessarily onerous.  The CBETF reports would need to be filed no more than five business days after the financial institution issues or receives the transmittal order. 

Annual TIN Reporting Requirement

The Proposed Rules would also require banks to file an annual report with FinCEN by April 15 of each year that contains the account number and TIN for all accountholders whose accounts were used to originate or receive a CBETF.  Money transmitters would not be subject to the annual reporting requirement, but would be required to provide FinCEN with the TIN of the transmittor or recipient of a transmittal order or advice as part of its CBETF reporting requirement for each CBETF of $3,000 or more. 

Public Comments; Effective Date

Comments on the Proposed Rules are due by December 29, 2010.  FinCEN does not anticipate issuing final rules prior to January 1, 2012 to give it adequate time to put the necessary technology in place to accept required reports.  In addition, FinCEN anticipates that this delay in issuing final rules will give financial institutions time to obtain or adjust the relevant compliance systems.

The SEC issued an order amending Rule 100 of Regulation FD to remove the exemption for disclosures of material non-public information disclosed to rating agencies.  This amendment, which implements section 939B of the Dodd-Frank Wall Street Reform and Consumer Protection Act, became effective without a public comment period on October 4, 2010.  In the view of the SEC, publication for comment was not required by the Administrative Procedure Act because the change was required by Congress and notice and a comment period would be unnecessary, impracticable and contrary to the public interest.

Rule 100 of Regulation FD provides that if an issuer or a person acting on its behalf discloses material nonpublic information regarding that issuer or its securities to any person listed in paragraph (b)(1) of the rule, the issuer must make public disclosure of the information as required by Rule 101(e).  Public disclosure must be made by furnishing or filing a Form 8-K with the SEC, unless the issuer instead disseminates the information through another method or combination of methods of disclosure reasonably designed to provide broad, non-exclusionary distribution of the information to the public.  The persons described in paragraph (b)(1) include broker-dealers, investment advisers and investment companies, and certain persons associated or affiliated with them, and any person “who is a holder of the issuer’s securities, under circumstances in which it is reasonably foreseeable that the person will purchase or sell the issuer’s securities on the basis of the information.”

Paragraph (b)(2) of Rule 100 contains exemptions for disclosures to certain persons.  Paragraph (b)(2)(i) exempts disclosure to a person that owes a duty of trust or confidence to the issuer, while paragraph (b)(2)(ii) exempts disclosures to a person who expressly agrees to maintain the disclosed information in confidence.  Paragraph (b)(2)(iii), which has been removed by the SEC’s order, exempted disclosures made solely for the purpose of determining or monitoring a credit rating to (A) any nationally recognized statistical rating organization (“NRSRO”) or (B) any credit rating agency that makes its credit ratings publicly available. 

Issuers that wish to disclose material non-public information to credit rating agencies must now determine whether the credit rating agency is a person listed in paragraph (b)(1).  Some credit rating agencies have been registered as investment advisers; indeed, Rule 203A-2(a) under the Investment Advisers Act of 1940 specifically permits any NRSRO to be registered federally (rather than by the states) notwithstanding the amount of its assets under management.  If the credit rating agency is a person listed in paragraph (b)(1), the issuer must either determine whether the agency owes them a duty of trust or confidence or obtain a confidentiality agreement before disclosing material nonpublic information to the agency.  (Credit rating agencies may not agree that they have a duty of trust and confidence sufficient to satisfy the requirements of the exemption.  In its comment letter to the SEC at the time Regulation FD was originally proposed, Moody’s Investors Service, Inc. expressly denied having such a duty, requesting instead a separate exemption under Regulation FD for disclosures to credit rating agencies.)

The FDIC, FRB, OCC and OTS (collectively, the “Agencies”) announced an interagency final rule (the “Rule”) promulgated under the Community Reinvestment Act (the “CRA”).  The Rule, which implements a provision of the Higher Education Opportunity Act, requires the Agencies to consider low-cost higher education loans made to low-income borrowers as a positive factor when assigning a financial institution’s rating for meeting community credit needs under the CRA.  The Rule specifies that “low-cost education loans” are education loans originated by financial institutions with interest rates and fees no greater than comparable education loans offered directly by the U.S. Department of Education.  The Rule applies only to education loans made to borrowers with an individual income that is less than 50 percent of the area median income for expenses incurred in connection with post-secondary education.

The Rule also implements a statutory provision permitting the Agencies to consider capital investment, loan participation and other ventures with minority-owned, women-owned and low-income credit unions when assessing the CRA rating for non-minority and non-women owned financial institutions.  To be eligible, such activities must help meet the credit needs of the local communities in which the minority-owned and women-owned financial institutions are chartered.

In a separate development concerning the CRA, the Democratic leaders of the House Financial Services Committee introduced a bill imposing more demanding requirements for financial institutions to receive an “outstanding” rating on exams conducted under the CRA, as well as adding a new “sufficient” rating and requiring bank affiliates and subsidiaries to be included in CRA evaluations.

The staff of the SEC’s Division of Investment Management (the “staff”) updated its FAQ on Rule 206(4)-2 under the Advisers Act of 1940 (the “Custody Rule”).  The Custody Rule imposes a number of requirements on SEC-registered investment advisers that are deemed to have custody of their clients’ funds and securities under the Rule.  The staff updated the FAQ in May 2010 to address questions regarding whether or not custody exists under particular circumstances (as discussed in the June 1, 2010 Alert).  The new/revised questions in the September 2010 update address issues regarding whether or not custody exists when an adviser has the authority to instruct a qualified custodian to remit certain funds or securities to a client at his or her address of record, and the related issue of the adviser’s ability to change the client’s address of record without being deemed to have custody.  Additionally, the new/revised questions in the September 2010 update provide links to examples of (i) a report that maybe issued by an independent public accountant performing a surprise examination, and (ii) a report that would satisfy internal control report requirements.

The staff of the SEC’s Division of Investment Management provided guidance to the effect that a broker-dealer would not be an investment adviser with respect to clients of an investment manager that used research services provided by the broker‑dealer through a soft-dollar commission pooling arrangement in making investment decisions for those clients’ accounts, provided certain conditions were met.  The request for guidance arose out of a concern that if the opposite were true, i.e., the broker-dealers were investment advisers with respect to the clients of investment managers using the broker-dealers’ research services acquired through a soft dollar pooling arrangement, then the broker-dealers would be subject to the restrictions of Section 206(3) of the Investment Advisers Act of 1940 if they engaged in principal transactions with those clients.

On September 30, 2010 Goodwin Procter’s ERISA Litigation Practice published the latest edition of its quarterly ERISA Litigation Update.  The Update discusses recent developments in a number of  401(k) fee cases, including certification of a class in a case challenging the use of actively managed mutual funds in a retirement plan and entry of the first trial judgment in one of the dozens of pending fee cases.  The Update also reports on recent developments in class actions challenging securities lending practices and a decision impacting the ability of financial service firms to recover erroneous benefits payments to retirement plan participants.