Financial Services Alert - March 1, 2011

The U.S. Treasury Department's Financial Crimes Enforcement Network ("FinCEN") adopted a rule  (the “Final Rule”) which amends its existing regulations regarding Reports of Foreign Bank and Financial Accounts (“FBARs” and each an “FBAR”) required to be filed with the Internal Revenue Service (“IRS”) on Form TD-F 90-22.1.  On February 26, 2010, FinCEN issued a Notice of Proposed Rulemaking (the “Proposed Rule”), which the Final Rule largely adopts, but with certain changes.  (The Proposed Rule was discussed in detail in the March 2, 2010 Alert.)  The Final Rule aims to provide greater clarity regarding various aspects of the FBAR filing requirements and expands certain of the reporting exemptions now provided in the FBAR’s filing instructions.

The Final Rule is effective March 28, 2011 and applies to FBARs required to be filed by June 30, 2011 with respect to foreign financial accounts maintained in calendar year 2010 and for reports required to be filed with respect to all subsequent calendar years.  In addition, although the Final Rule is not retroactive, FinCEN stated that filers who properly deferred filing obligations pursuant to IRS Notice 2010-23 may, if they wish, apply the provisions of the Final Rule in determining their FBAR filing requirements for reports due June 30, 2011, with respect to foreign financial accounts maintained in years before 2010.

General Overview

Like the Proposed Rule, the Final Rule:

• defines a “United States person” required to file FBARs and defines the types of reportable bank, securities, and other financial accounts;
• clarifies what it means to have a “financial interest” in a foreign account;
• exempts certain persons with signature or other authority over, but no financial interest in, foreign financial accounts from filing FBARs;
• exempts certain low-risk accounts for which reporting will not be required, such as accounts of federal or state governmental entities;
• exempts participants and beneficiaries in certain types of retirement plans and includes a similar exemption for certain trust beneficiaries;
• includes provisions intended to prevent persons from avoiding FBAR reporting requirements; and
• permits summary filing by persons who have a financial interest in or signature or other authority over 25 or more foreign financial accounts and permits consolidated filings by an entity on behalf of subsidiaries in which it owns more than a 50 percent interest.

The Final Rule adopts most of the Proposed Rule without significant changes.  However, in response to comments received regarding the Proposed Rule, FinCEN also made some modifications to the Proposed Rule and provided clarification regarding certain requirements that had been set forth in the Proposed Rule, as discussed below.  In particular, FinCEN has attempted to:

Definition of “Foreign Account”

FinCEN attempted to clarify whether an account is foreign and therefore reportable as a foreign financial account and address the treatment of custodial accounts in this context.  First, in comments accompanying the Final Rule, FinCEN explained that, as a general matter, an account is not a foreign account for FBAR reporting purposes if the account is maintained with a financial institution located in the United States.  Accordingly, if an individual purchases securities of a foreign company for an investment portfolio held by an individual with a securities broker located in the United States, the account is not “foreign” for FBAR purposes merely because it contains holdings or assets of foreign entities.  In addition, in response to requests for clarification regarding treatment of custodial arrangements, FinCEN explained that where a U.S. bank acts as global custodian and creates pooled cash and securities accounts in the non-U.S. market to hold the assets of multiple investors on an omnibus basis and the U.S. customers can only access their holdings outside the United States through the U.S. global custodian, the U.S. customers do not need to file an FBAR with respect to assets held in the omnibus account.  If the custodial arrangement permits the customer to directly access their foreign holdings maintained at the foreign institution, however, the U.S. customers will have a reportable foreign account.

Definition of “Other Financial Account”

In addition to bank and securities accounts, certain “other financial accounts” need to be reported on FBARs.  The Final Rule defines “other financial account” for FBAR reporting purposes to include certain categories of accounts, such as an insurance policy with a cash value, an annuity policy, or an account with a mutual fund or similar pooled fund.

In response to comments, FinCEN amended the definition to clearly reflect that only those life insurance or annuity policies with a cash value are reportable.  With respect to mutual funds, FinCEN explained that the definition of mutual fund for FBAR purposes includes a requirement that shares be available to the general public in addition to having a regular net asset value determination and regular redemption feature, but did not make any revisions to the definition that had been included in the Proposed Rule.

Financial Interest

The Final Rule includes the definition of “financial interest” from the Proposed Rule without significant changes.  However, the Final Rule includes some adjustments to clarify the application of the definition in the context of trusts.

First, under the Proposed Rule, the definition of “financial interest” would have included “a trust, if the U.S. person is the trust settlor and has an ownership interest in the account for United States federal tax purposes.”  The definition also would have specified that whether a settlor has an ownership interest in a trust’s financial account for a year should be determined with reference to 26 U.S.C. §§ 671– 679.  FinCEN agreed with a comment that this definition needed clarification because, although FinCEN incorporates the provisions of 26 U.S.C. §§ 671-679 for determining ownership interest, those sections refer to “grantor” rather than “settlor.”  Accordingly, FinCEN replaced the work “settlor” with “grantor” in the Final Rule.  In addition, the word “account” has been replaced with “trust” in the Final Rule.

The Proposed Rule’s definition of “financial interest” also would have included “a trust in which the U.S. person either has a beneficial interest in more than 50 percent of the assets or from which such person receives more than 50 percent of the income.”  In response to comments, FinCEN explained that it recognizes that in the case of trusts, the determination of beneficial interest for these purposes may be difficult if the person is a beneficiary of a discretionary trust or has a remainder interest in a trust.  Therefore, FinCEN changed the term “beneficial interest” in the Final Rule to “present beneficial interest.”  FinCEN explained that it does not intend for a beneficiary of a discretionary trust to have a financial interest in a foreign account simply because of his/her status as a discretionary beneficiary.  In addition, FinCEN stated that it does not intend to include a remainder interest within the scope of the term “present beneficial interest” for FBAR filing purposes.  FinCEN also added the word “current” before the word “income” in the Final Rule to correct an inadvertent omission from the Proposed Rule.

Signature or Other Authority

FinCEN revised the definition of signature or other authority to more clearly apply to individuals who have the authority to control the disposition of assets in the account by direct communication (whether in writing or otherwise) to the foreign financial institution.  In the Proposed Rule, FinCEN defined “signature or other authority” as the “authority of an individual (alone or in conjunction with another) to control the disposition of money, funds, or other assets held in a financial account (whether communicated in writing or otherwise) directly to the person with whom the financial account is maintained.”  In the Final Rule, FinCEN replaced the italicized language with the phrase “by direct communication (whether in writing or otherwise).”  FinCEN explained that this revised definition is intended to make clear that the test for determining whether an individual has signature or other authority over an account is whether the foreign financial institution will act upon a direct communication from that individual regarding the disposition of assets in the account, and that the phrase “in conjunction another” is intended only to address situations where a foreign financial institution requires a “direct communication” from more than one individual.

Recordkeeping and Filing Related to Signature Authority

FinCEN clarified that in the case of officers or employees who file an FBAR because of signature or other authority over foreign financial accounts of their employer, FinCEN does not expect such officers or employees to personally maintain the records of the foreign financial accounts of their employers. 

FBAR Filing Exemptions

The Proposed Rule included exemptions from FBAR requirements for certain types of persons and accounts; however, FinCEN received a number of comments asking for broader exemptions.  FinCEN explained that it does not believe that it is appropriate to adopt additional exemptions, and therefore FinCEN generally did not expand the exemptions from those in the Proposed Rule.  FinCEN also clarified that the exemption for “Authorized Service Providers” registered with the SEC, such as registered investment advisers, applies only with respect to reportable amounts of clients which are investment companies registered under the Investment Company Act of 1940.  In addition, the Final Rule clarified that the exemption in the Proposed Rule for officers and employees with signature authority but no financial interest in a foreign financial account of a U.S. subsidiary of an entity with a class of equity securities listed on a U.S. national exchange and which is included in the consolidated report of its parent applies only with respect to a U.S. subsidiary of a “United States [parent] entity.”  FinCEN rejected comments that the exemption should be extended in some way to U.S. subsidiaries of foreign parents.  It also rejected comments that the exemption should apply with respect to officers or employees of a U.S. parent who have signature authority over (but no financial interest in) a foreign financial account of a U.S. subsidiary, or vice versa, limiting the exemption only to accounts of the officer or employee’s respective “employer.”

Other

FinCEN noted that several commenters requested the option to file FBAR forms electronically, and indicated that it is in the process of updating its IT system so that it can allow for electronic filing in the future.  Although several commenters also requested that the due date for filing FBARs be changed from June 30 to a date that conforms with the filing of a U.S. person’s federal income tax returns, FinCEN said that these comments were not addressed since they did not fall within the scope of the changes in the Proposed Rule. 

In addition, no mention was made of the fact that many commenters had requested that FinCEN adopt the “timely mailing-timely filing” rule that applies to federal income tax returns, and thus the requirement that FBARs must be received by the due date in order to be considered timely filed remains unchanged.

Lastly, the Proposed Rule contained a draft revised Form TD-F 90-22.1 and instructions.  The Final Rule makes no mention of whether or when such a revised form will be issued, but we understand based on a discussion with FinCEN staff that the Treasury Department still intends to issue a revised form and instructions prior to the June 30 due date for 2010 FBARs.  The revised form and instructions will be published on FinCEN’s website once they are available. 

The staff of the Division of Investment Management (the "staff") issued a no-action letter to three specifically named closed-end funds (the “funds”) providing relief under Section 5(b) or 6(a) of the Securities Act of 1933 (the “1933 Act”) for those funds to treat post-effective amendment filings involving changes to such funds’ financial statements or routine non‑material changes to such funds’ registration statements as immediately effective in reliance on Rule 486(b) under the 1933 Act, although the funds could not technically rely on such rule.  The relief enables the funds to take advantage of market conditions to more quickly sell securities from their effective shelf registration statements without the costs or delays of staff review and comment.

Section 5 of the 1933 Act, in relevant part, makes it unlawful for any person, including issuers, to: (1) transmit a prospectus, unless such prospectus meets the requirements set forth in Section 10 of the 1933 Act; and (2) carry a security for the purpose of sale or delivery, unless preceded or accompanied by a prospectus that meets the requirements of Section 10 of the 1933 Act.  Section 10 of the 1933 Act, in relevant part, requires that a prospectus: (1) contain certain information set forth in an issuer’s registration statement; and (2) for prospectuses that are used more than nine months after the effective date of the registration statement, contain information not more than 16 months old.  Closed-end funds, including the funds, undertake to file a post-effective amendment containing a prospectus that meets these requirements during any period in which offers or sales are being made. 

The funds had filed post-effective amendments annually with the Commission to meet these requirements.  Such post-effective amendments must typically be declared effective by the staff in order to take effect, subjecting those filings to staff review and comment, even for non-material amendments.  During such review and comment period, no issuances can take place potentially preventing the funds from taking advantage of what may be an attractive market to raise assets.

Accordingly, the funds sought relief to have such filings become effective immediately pursuant to Rule 486 under the 1933 Act.  Rule 486(b) is available to “interval” funds, which are closed-end funds or business development companies that make repurchase offers at periodic intervals under certain conditions.  The rule permits post-effective amendments filed by interval funds to become effective immediately, if, among other things, the post‑effective amendment is filed for no purpose other than, among other things, bringing the financial statements up to date or making non-material changes, and the registrant makes certain representations about the purpose of the amendment.  Although the funds were not interval funds, the funds contended that this line of thought should apply to them as well and that they, shareholders, and potential shareholders would benefit if they were permitted to rely on the rule.  The funds contended that that they would be able to raise capital in continuous offerings at non-dilutive prices, without significant periods of disruption to such offering process and that fund shareholders would benefit by reducing the costs of the typical post-effective amendment process.  In addition, the funds contended that their use of Rule 486 would not erode investor protections and that investors could have faster access to important information about the funds.

In granting the relief, the staff cited representations made by the funds that each fund would comply with the conditions of Rule 486(b), sell all shares at a price no lower than the sum of the fund’s net asset value plus the per share commission or underwriting discount, and file a post-effective amendment through the normal staff review and comment process prior to any offering of its securities at a price below net asset value.

Contrary to the more typical situation where the relief granted in a no-action letter is available to third parties whose circumstances are substantially similar to those of the party originally requesting the relief, the staff’s response noted that, in light of the very fact specific nature of the funds’ request, the position in the letter applied only to the funds and no other entity may rely on it.  In addition, the staff warned that it could withdraw any assurance granted in the letter if the staff finds that a fund is misusing Rule 486(b) for any other reason.  The staff did, however, note that it would be willing to consider similar requests from other registered closed-end funds or business development companies.

The Financial Crimes Enforcement Network (“FinCEN”) issued an advisory (the “Advisory”) to assist financial institutions in reporting on Suspicious Activity Reports (“SARs”) instances of financial abuse of the elderly.  The Advisory identifies certain “red flags” that can be indicators of financial exploitation of the elderly.  The Advisory notes two general categories of red flags.

The first category of red flags is “Erratic or unusual banking transactions, or changes in banking patterns,” which include the following:

• frequent large withdrawals from an ATM;
• uncharacteristic non-payment for services;
• uncharacteristic attempts to wire large sums of money; and
• closing certificates of deposit without regard to penalties. 

The second category of red flags is “Interactions with customers or caregivers,” which include the following:

• a caregiver or other individual shows excessive interest in the elderly person’s finances or assets;
• the elderly person shows an unusual degree of fear or submissiveness toward a caregiver;
• the financial institution is unable to speak directly with the elderly person an elderly person’s financial management suddenly changes, such as through a change of power of attorney; and
• an elderly person lacks knowledge about his financial status or shows a sudden reluctance to discuss financial matters.

With respect to suspicious activity reporting, the Advisory requests that in reporting instances of suspected financial abuse of the elderly, financial institutions first select the appropriate characterization on the SAR form and then include the term “elder financial exploitation” in the narrative section of the SAR.  The Advisory also notes that the potential victim of elder financial exploitation should not be reported as the subject of the SAR, but the victim’s name should be included in the narrative section of the SAR.