Financial Services Alert - October 26, 2010

The FDIC adopted a revised restoration plan (the "Restoration Plan") for the Deposit Insurance Fund ("DIF") and has issued a Notice of Proposed Rulemaking (“NPR”) in furtherance of its proposal to charge steady and predictable assessment rates and maintain a positive fund balance in the DIF.

The Restoration Plan

The FDIC Board of Directors approved the Restoration Plan to ensure that the DIF minimum designated reserve ratio reaches 1.35% of estimated insured deposits by September 30, 2020, as required by The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).  See the July 28, 2010 Special Edition of the Alert.  This revised Restoration Plan is effective immediately and supersedes the plan amended in September 2009, which was intended to restore the reserve ratio to 1.15% by the end of 2016 in compliance with the Helping Families Save Their Homes Act of 2009.  See the May 26, 2009 and October 6, 2009 Alerts.  

The Restoration Plan further provides that the FDIC will maintain the current schedule of assessment rates for all insured depository institutions and forego the three basis point uniform increase in initial assessment rates scheduled to be effective in January 2011.  The decision to maintain the current assessment rates reflects lower than expected losses estimated through 2014 and estimates that the DIF reserve ratio will reach 1.15% by the end of 2018, even without the three basis point increase. 

In accordance with the Dodd-Frank Act, the Restoration Plan must also offset the effect of the increase in the minimum reserve ratio on insured depository institutions (“IDIs”) with total consolidated assets of less than $10 billion (“Smaller IDIs”).  However, the FDIC indicates that it will pursue further rulemaking in 2011 regarding the method that will be used to reach the requisite 1.35% DIF minimum reserve ratio by September 2020 and how related burdens on the Smaller IDIs will be offset. 

The Restoration Plan further provides that the FDIC will update loss and income projections for the DIF semiannually and, as necessary, will modify assessment rates following notice-and-comment rulemaking. 

The NPR

Under the NPR, the FDIC proposes to amend its regulations to: (1) implement dividend provisions; (2) set assessment rates; and (3) set the DIF minimum designated reserve ratio at 2%.  These regulations would be intended to reduce pro-cyclicality in the existing system and achieve moderate, steady assessment rates through economic and credit cycles while also maintaining a positive fund balance even during a banking crisis, by setting an appropriate target DIF size and a strategy for assessment rates and dividends. 

Dividends .  Pursuant to the Dodd-Frank Act, the FDIC has the authority to declare dividends when the DIF reserve ratio at the end of a calendar year is at least 1.5% and to suspend or limit declaration or payment dividends from the DIF.  Accordingly, the NPR provides that dividends be suspended permanently when the DIF reserve ratio exceeds 1.5%, which would increase the probability that the DIF will reach a level sufficient to withstand a future crisis.  As discussed in further detail below, as an alternative to declaring dividends to prevent the DIF from becoming unnecessarily large, the FDIC would adopt progressively lower assessment rate schedules when the reserve ratio exceeds 2% and 2.5%.    

Assessment Rates.  Currently, the assessment rate for an IDI is contingent upon the IDI’s designated risk category, which turns on the IDI’s supervisory ratings and capital levels.  Under the NPR, assessment rates would also be based on the DIF reserve ratio as follows:

• When the DIF reserve ratio reaches 1.15%, assessment rates would be lowered significantly.  Risk Category I institutions, for example, would pay initial assessment rates between 8 and 12 basis points;
• When the DIF reserve ratio reaches 2.00%, assessment rates would be lowered by approximately 25%.  Risk Category I institutions, for example, would pay initial assessment rates between 6 and 10 basis points; and
• When the DIF reserve ratio reaches 2.50%, assessment rates would be lowered by approximately 50% below the rates that will take effect when the reserve ratio reaches 1.15%.  Risk Category I institutions, for example, would pay initial assessment rates between 4 and 8 basis points.

The NPR indicates that the progressively lower assessment rate schedules would serve to provide more stable and predictable assessment rates.  The secured liability adjustment and brokered deposit adjustment would also be subject to change based on the DIF reserve ratio.  In addition, the FDIC’s Board of Directors would retain its current authority to uniformly adjust the total base rate assessment schedule by 3 basis points without further rulemaking. 

In the NPR, the FDIC further indicated that in a future notice of proposed rulemaking it will amend the determination of an IDI’s assessment base pursuant to the Dodd-Frank Act’s requirement that the assessment base generally be defined as the average consolidated total assets of the insured depository institution during the assessment period minus the sum of the average tangible equity of the insured depository institution during the assessment period.  The NPR acknowledged that this amended definition will require some revision to the proposed assessment rates set forth therein. 

Minimum Designated Reserve Ratio .  As discussed above, the Dodd-Frank Act requires that the FDIC set the DIF minimum designated reserve ratio at 1.35%, and the Restoration Plan has been enacted pursuant to this requirement.  However, the FDIC must set and publish a designated reserve ratio annually, and in the NPR, proposes setting the ratio at 2.00% of estimated insured deposits.  In accordance with statutory requirements, the FDIC considered the following factors in determining the proposed 2% ratio: (1) risk of losses to the DIF; (2) economic conditions generally affecting IDIs; (3) preventing sharp swings in assessment rates; and (4) other factors that the FDIC deemed appropriate, which as noted in the NPR, included maintaining the DIF at a level that can withstand substantial losses.

Comments on the NPR are due no later than November 26, 2010. 

The FDIC issued Financial Institution Letter 66-2010 (“FIL-66-2010”), which provides guidance on regulatory expectations with respect to applications to make permissible golden parachute payments.  Golden parachute payments, which are certain termination payments to an institution-affiliated party (“IAP”) as defined by 12 C.F.R. Part 359 (“Part 359”), are subject to restrictions for “troubled” institutions (institutions with a composite rating of “4” or “5” or meeting other criteria) and their holding companies, even if such holding company is healthy.  Part 359 provides certain exceptions to the restrictions on golden parachute payments.  FIL-66-2010 clarifies the golden parachute application process for troubled institutions, specifies the type of information necessary to satisfy the certification requirements, and highlights factors considered by supervisory staff when determining whether to approve a golden parachute payment.

FIL-66-2010 provides detailed guidance on the type of information required and the factors considered by supervisory staff when evaluating a golden parachute application and any proposed payment amount.  Under the filing procedures set forth in FIL-66-2010, a troubled institution must demonstrate that: (1) the IAP has not committed any fraudulent act or omission, or breach of trust or fiduciary duty or insider abuse, that has had a material adverse effect on the institution or covered company; (2) that the IAP is not “substantially responsible” for the insolvency or troubled condition of the institution or covered company; and (3) that the IAP has not committed a violation of any applicable federal or state banking law that has had or is likely to have a material effect on the institution or covered company.  Pursuant to FIL-66-2010, an application should also identify the responsibilities and specific areas of the institution that report to and are supervised by the IAP as well as major policy and operational programs initiated or managed by the IAP.  A troubled institution must provide a certification of such information for each IAP as part of the application.  FIL-66-2010 states that golden parachute applications made on behalf of senior management will be subject to heightened scrutiny that will include an evaluation of the individual’s performance as well as his or her influence and involvement over major corporate initiatives and policy decisions, especially any actions that may have facilitated high-risk banking strategies.  If such an executive served as a voting member of any Board committees, FIL-66-2010 states that the executive can expect to be viewed as being accountable for those decisions.  When approving an application for a golden parachute payment, FIL-66-2010 provides that the FDIC may either require a staged dispersal of payments or a claw back provision.  FIL-66-2010 further states that the FDIC is unlikely to approve golden parachute payments for institutions that are in a precarious financial position, unless the institution can demonstrate near-term benefits that outweigh the cost of the payments and the payment is otherwise not contrary to the intent of the golden parachute restrictions.

FIL-66-2010 establishes a de minimis golden parachute payment for lower-level employees of up to $5,000 per individual without a supervisory application in most cases.  A troubled institution making such payments would be required to maintain a record of the individuals receiving the payments together with a signed and dated certification of the amounts received.  FIL-66-2010 also states that combined applications are also permitted in situations where a troubled institution seeks to pay relatively small amounts to lower-level employees with similar responsibilities and salary levels or implement a reduction-in-force or reorganization.

On October 18, 2010, the SEC issued proposed rules (the “Proposed Rules”) designed to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) which require issuers to (1) solicit a shareholder advisory vote on executive compensation at least once every three years, (2) allow shareholders to determine how frequently they will vote on executive compensation, and (3) solicit a shareholder advisory vote on so-called “golden parachute” compensation arrangements in connection with mergers or other extraordinary corporate transactions.  Under the Dodd-Frank Act, issuers are required to implement the first two of these requirements effective with respect to proxy statements for annual or other meetings occurring on or after January 21, 2011, regardless of whether the SEC’s implementing rules are in place.  Issuers are not, however, required to implement the advisory vote on golden parachute arrangements until after the SEC regulations have been finalized.  Comments on the Proposed Rules are due by November 18, 2010.

Shareholder Advisory Vote on Executive Compensation.  Proposed Rule 14a-21(a) sets forth the general requirement that at least once every three years, a proxy for a meeting of shareholders must include a separate resolution subjecting all of the executive compensation disclosed pursuant to Item 402 of Regulation S-K to a non-binding shareholder advisory vote (a “Say on Pay Vote”).  The Proposed Rule does not dictate the specific form of resolution for this advisory vote.  In addition to this general rule, the SEC has proposed that:

1. issuers be required to disclose in their proxy statements that they are conducting a Say on Pay Vote and the effects of the vote, such as whether each such vote is non-binding; and
2. issuers be required to disclose whether they have taken the Say on Pay Vote into account in determining executive compensation policies and decisions.

Frequency of Shareholder Advisory Votes on Executive Compensation.  Proposed Rule 14a-21(b) requires that at least every six years, a proxy for a meeting of shareholders must include a separate, non-binding resolution on whether the Say on Pay Vote should occur every one, two or three years (a “Frequency Vote”).  In addition to this general rule, the SEC has proposed that:

1. issuers disclose in their proxy statements that they are conducting a Frequency Vote and the effects of the vote, such as whether each such vote is non-binding;
2. shareholders be allowed four options:  voting for a one-, two- or three-year interval between Say on Pay Votes, or abstaining from voting;
3. an issuer be permitted to exclude a shareholder proposal on a Say on Pay Vote or Frequency Vote provided that the issuer has adopted a policy on the frequency of Say on pay Votes that is consistent with the plurality of votes cast in the most recent Frequency Vote.

Disclosure of Golden Parachute Arrangements and Shareholder Advisory Votes on those Arrangements.  Proposed Rule 14a-21(c) sets forth the general requirement that any proxy in which shareholders are asked to approve a merger or other extraordinary corporate transaction (including a tender offer, going-private transaction or sale of assets) must contain disclosures regarding the compensation arrangements among the target, the acquiring company and the named executive officers of both entities relating to the extraordinary corporate event (“Golden Parachute Arrangements”), and must provide for a separate non-binding shareholder advisory vote on the Golden Parachute Arrangements unless such arrangements have been previously approved pursuant to a Say on Pay Vote.  Golden Parachute Arrangements would have to be disclosed in a clear and simple form, including both tabular and narrative presentation.  The tabular presentation would have to include the following categories of compensation and an aggregate total:

• cash;
• equity (accelerated vesting of in-the-money options and cash-out of equity awards);
• pension and nonqualified deferred compensation benefit enhancement;
• perquisites and other personal benefits;
• tax reimbursement; and
• all other items.

An issuer could include Golden Parachute Arrangements in a Say on Pay Vote at an annual meeting by including the proposed new disclosure in its proxy statement and thereby avoid a subsequent vote at the special meeting approving the corporate transaction to which the Golden Parachute Arrangements relate, but any new Golden Parachute Arrangements not previously approved would have to be separately disclosed and subject to a separate advisory vote.

Proposed Amendments to Forms 10-K and 10-Q.  Proposed amendments to Forms 10‑K and 10-Q would require an issuer to disclose in the first Form 10-Q or Form 10-K due after a Frequency Vote its decision on the frequency of Say on Pay Votes over the next six years.

Transition Matters.  The SEC release describing the Proposed Rules (the “Proposing Release”) states that prior to adopting final rules on the Say on Pay Vote and Frequency Vote, the SEC will not require a preliminary proxy filing based solely on the fact that proxy materials include a Say on Pay Vote or Frequency Vote as required by the Dodd-Frank Act.  The Proposing Release includes relief from the certain SEC proxy rule requirements applicable to the presentation of voting options for the Frequency Vote that is designed to allow for proxy service provider limitations in the short-term.  Finally, the Proposing Release includes relief from the Dodd-Frank Act’s Frequency Vote requirements for issuers that conduct annual Say on Pay Votes because they are TARP recipients.

On October 21, 2010, FINRA issued Regulatory Notice 10-52 partially withdrawing interpretive guidance it had provided concerning the application of NASD Rules 2210 and 2211, governing communications with the public, to free writing prospectuses.  FINRA advises that it will now treat free writing prospectuses that are distributed by a broker-dealer in a manner reasonably designed to lead to broad unrestricted dissemination as advertisements subject to the requirements of Rules 2210 and 2211, including the content standards of the rules and the need to file with FINRA, if applicable.

In 2006, following rulemaking by the SEC permitting the use of free writing prospectuses, the Securities Industry Association and The Bond Market Association (the precursors to the Securities Industry and Financial Markets Association, or “SIFMA”) requested interpretive guidance from the NASD concerning the treatment of free writing prospectus under NASD Rules 2210 and 2211 and also NASD Rules 2710 and 2710 (now FINRA Rules 5110 and 5120).  On August 1, 2006, the NASD issued a letter confirming that it interpreted free writing prospectuses to be excluded from the provisions of Rule 2210 (which applies to communications with the public generally) and Rule 2211 (applicable to correspondence and institutional sales material).  Regulatory Notice 10-52 amends that guidance to provide that Rules 2210 and 2211 will be interpreted to apply to those free writing prospectuses distributed by a broker-dealer in a manner reasonably designed to lead to broad unrestricted dissemination, meaning that such material will be subject to the content standards and spot-check, supervisory review and filing requirements of Rules 2210 and 2211, to the extent otherwise applicable.

FINRA notes that its new interpretation is not intended to change its prior guidance with respect to the application of FINRA Rules 5110 and 5120 to free writing prospectuses.

The Financial Crimes Enforcement Network (“FinCEN”) announced that it has finalized an initiative to restructure its Bank Secrecy Act rules and regulations (the “FinCEN Regulations”), effective March 1, 2011.  The FinCEN Regulations, which are currently set forth in 31 C.F.R. Part 103, will be transferred to a new 31 C.F.R. Chapter X.  In addition, the FinCEN Regulations will be reorganized into general and industry-specific parts.  Despite these changes, no existing regulatory requirements will be altered and no new regulatory obligations will be imposed.  FinCEN explained that its objective in restructuring the FinCEN Regulations is to make them more accessible and understandable for covered financial institutions and individuals.  

To assist financial institutions with the transition of the FinCEN Regulations to 31 C.F.R. Chapter X, FinCEN has created a web tool called “Chapter X Citation Translator.  FinCEN has also published answers to frequently asked questions regarding the changes.

On October 21, 2010, the President’s Working Group on Financial Markets (“PWG”) released a report outlining possible options for operational and regulatory money market fund reform (the “Report”).  The Report discusses a number of alternatives for addressing the susceptibility of money market funds to mass redemptions, but offers no recommendations, instead urging that the Financial Stability Oversight Council created by the Dodd-Frank Wall Street Reform and Consumer Protection Act consider the alternatives and take appropriate steps.  A more detailed discussion of the Report will appear in a future issue of the Alert.

The SEC proposed rule and form amendments under the Securities Exchange Act of 1934 (the “1934 Act”) and the Investment Company Act of 1940 that would require an institutional investment manager subject to Section 13(f) of the 1934 Act to make an annual filing with the SEC providing information on how it voted proxies relating to the executive compensation matters that issuers are required to present to their shareholders under the Dodd-Frank Wall Street Reform and Consumer Protection Act (as discussed above in “SEC Proposes Say-on-Pay Rules”).  A future issue of the Alert will discuss this development in greater depth.

The Department of Labor (the “DOL”) proposed changes to the regulation defining “investment advice” under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).  Under Section 3(21)(A)(ii) of ERISA, a person is a “fiduciary” of a plan -- and is subject to fiduciary duties -- to the extent that he renders investment advice to the plan for a fee.  The proposal generally would expand the circumstances under which a person providing investment-related advice or recommendations to a plan (or a plan fiduciary, participant, or beneficiary) would be considered to be providing “investment advice” within the meaning of Section 3(21)(A)(ii).  Comments regarding the proposed changes must be submitted to the DOL by January 21, 2011.  This proposal will be discussed in greater detail in a future issue of the Alert.

The EU’s Alternative Investment Fund Managers Directive (the “AIFMD”), which includes elements that would significantly affect non-EU funds and managers that want to market to investors in the EU, continues to make its way through the process.  For commentary and analysis from SJ Berwin LLP on (a) a revised compromise proposal for the AIFMD that was recently accepted at a meeting of the Economic and Financial Affairs Council and (b) the powers of the European Securities and Markets Authority, the new European super-regulator, relative to non-EU funds and managers, click here.