Financial Services Alert - April 10, 2012

The Financial Stability Oversight Council (the “FSOC”) issued a final rule (the “Final Rule”) and related interpretive guidance implementing certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  The Final Rule establishes criteria and procedures for use by the FSOC in indentifying non‑bank financial companies the failure of which could trigger wider instability in U.S. financial markets (“non‑bank systemically important financial institutions” or “SIFIs”). Companies that are subject to designation by the FSOC as systemically important financial institutions include, among others, savings and loan holding companies, private equity firms, hedge funds, asset management companies and other nonbank companies (both foreign and domestic) that are determined to be predominantly engaged in activities that are financial in nature. Companies designated as SIFIs are subject to enhanced prudential standards and are subject to consolidated supervision by the FRB.

The Final Rule is substantially similar to the proposed rule, which was summarized in the October 18, 2011 Financial Services Alert.  The Final Rule consists of a three-stage screening process in which the FSOC will identify non-bank companies that may qualify as a SIFI. The first stage (“Stage 1”) consists of specific quantitative thresholds that the FSOC will use to identify the nonbank financial companies that will be subject to further review as to whether such companies are a non-bank systemically important financial institution.  In particular, a nonbank financial company with $50 billion or more in “total consolidated assets” will be subject to further evaluation in a second stage of evaluation (“Stage 2”) if such company has:

• $20 billion or more of total debt outstanding;
• a leverage ratio of 15 to 1 or greater; 
• $30 billion or more of outstanding credit default swaps for which it is the reference entity;
• $3.5 billion or more of derivative liabilities; or
• a short-term debt-to-assets ratio of 10% or more.

The interpretative guidance relating to the Final Rule provides, however, that the FSOC may conduct an evaluation of any nonbank financial company regardless of whether such company meets the Stage 1 thresholds.

A nonbank financial company identified for further review in Stage 1 will be subject to a Stage 2 analysis in which the FSOC will conduct an individualized review of the company’s risk profile, which consists of both quantitative analysis and qualitative judgment by the FSOC. The FSOC will conduct the Stage 2 review by analyzing six categories: (i) size; (ii) interconnectedness; (iii) substitutability; (iv) leverage; (v) liquidity risk and maturity mismatch; and (vi) existing regulatory scrutiny.

After completion of a Stage 2 review, the FSOC will provide each nonbank financial company selected for a third stage of evaluation (“Stage 3”) with written notice that such company is being considered for determination.  A company selected for Stage 3 consideration may respond to the notice of consideration with a rebuttal within at least 30 days following the notice.  If the FSOC ultimately makes a determination that a nonbank financial company is a SIFI, the FSOC must provide a second notice accompanied by an explanation of the basis for the proposed determination. The nonbank financial company is entitled to an informal nonpublic hearing before the FSOC to contest the proposed determination.

As noted above, the Final Rule is substantially similar to proposed rule, but there are several differences.  Among other differences from the proposed rule, the Final Rule and related interpretative guidance:

• broadens one of the Stage 1 quantitative thresholds, changing “loans and bonds outstanding” to “total debt outstanding,” such that loans, bonds, repurchase agreements, commercial paper, securities lending arrangements, surplus notes, and other forms of indebtedness are now included in the relevant Stage 1 quantitative analysis; 
• clarifies that the FSOC will generally apply the Stage 1 thresholds using information prepared in accordance with GAAP;
• requires that any final determination be reevaluated at least annually and provides a designated company the opportunity to submit materials to contest the continuation of the designation; and
• notes that the FSOC will refrain from publicly identifying nonbank financial companies under evaluation by the FSOC.

The Final Rule will become effective 30 days following publication in the Federal Register, although the FSOC may begin evaluating nonbank financial companies prior to the effective date.

The SEC issued a release reopening the comment period on proposed amendments (the “Proposed Amendments”) to Rule 482 under the Securities Act of 1933, as amended, and Rule 34b-1 under the Investment Company Act of 1940, as amended, that are designed primarily to provide potential investors with additional information about target date funds (“TDFs”).  (The Proposed Amendments were described in the June 29, 2010 Financial Services Alert.)  The reopening of the comment period on the Proposed Amendments follows the release by the SEC of a third-party study that it sponsored regarding investors’ understanding of TDFs and related advertisements (the “Study”).  The results of the Study were described in the March 13, 2012 Financial Services Alert.

The reopened comment period extends through May 21, 2012.

The Financial Crimes Enforcement Network (“FinCEN”) issued an advisory (FIN-2012-A005, the “Advisory”) to assist financial institutions (“FIs”) with identifying tax refund fraud and reporting the activity through the filing of Suspicious Activity Reports (“SARs”).  FinCEN stated that since individual income tax returns are tracked and processed by an individual’s name and Taxpayer Identification Number (“TIN”), fraudulent actors use phishing schemes, the establishment of fraudulent tax preparation businesses and other criminal schemes to obtain TINs and defraud taxpayers.  The Advisory notes that FIs are critical to identifying tax refund fraud because the proceeds of tax refunds are generally distributed through transactions at FIs.

To assist FIs with identifying potential tax refund fraud, the Advisory provides a number of examples of “red flags” of tax refund fraud.  FinCEN then reminds FIs that, generally, they are required to file SARs if they know, suspect, or have reason to suspect that tax refund fraud has been conducted or attempted by, at or through the FI.