Financial Services Alert - September 24, 2013

Goodwin Procter issued a Labor and Employment Alert that describes an expansion of the Department of Labor regulations that require government contractors and subcontractors to engage in affirmative action for veterans and disabled individuals.  Among other things, the new rules will require covered entities to implement written affirmative action plans with benchmarked hiring and employment goals.

By a 3-2 margin, the SEC voted to issue a proposal that would amend Item 402 of Regulation S-K to require an issuer to disclose (1) the median of the annual total compensation of all its employees other than its CEO, (2) the annual total compensation of its CEO, and (3) the ratio of the two.  The proposed disclosure would appear in annual reports, proxy or information statements, and registration statements that are required to include Item 402 executive compensation disclosure.  The proposal is designed to fulfill a rulemaking mandate under Section 953(b) of the Dodd‑Frank Act.  The proposed requirements would not apply to emerging growth companies, smaller reporting companies, foreign private issuers, or registered investment companies.  Comments on the proposal may be submitted no later than 60 days after it appears in the Federal Register.

Comptroller of the Currency Thomas J. Curry made a presentation at the American Institute of Certified Public Accountants (AICPA) Banking Conference on September 16, 2013 in which he expressed his support for the Financial Accounting Standard Board’s (“FASB”) proposed new standard on impairment measurement that would require banks to use a current expected credit loss (CECL) model rather than the currently used incurred loss model to measure asset impairment for financial accounting purposes.  If FASB’s proposed CECL standard is adopted, banks will be required to use historical information, current conditions, and reasonable and supportable forecasts to estimate expected shortfalls over the lifetime of a loan.  Comptroller Curry said that the incurred loss model, which requires a bank to wait until the occurrence of an incurred loss event, such as a payment default, to recognize an impairment “precludes banks from taking appropriate provisions for emerging risks that the bank can reasonably anticipate to occur” and results in banks delaying their recognition of losses.  Use of the incurred loss model, said the Comptroller, results in banks making large loan provisions at a later time, and often in the midst of a credit downturn when the bank’s earnings are already in stress.

Comptroller Curry stated that banks of all sizes will need to be provided with a sufficient transition period to train their respective staffs and to reprogram their systems.  The Comptroller noted that the OCC and other bank regulatory agencies are particularly concerned that the change to the CECL standard would have a significant operational impact on community banks and he stated that the OCC has “urged FASB to provide adequate implementation time for these smaller, less complex institutions and to modify disclosure requirements in light of the resource constraints these institutions face.”

Comptroller Curry conceded that adoption of the CECL standard would likely result in banks having to increase their reserves for loan and lease losses, but he stated the OCC projected that the increase in reserves would be in the 30% to 50% range system-wide (if applied at this time) and would not be likely to result in the more dramatic increases in reserves that other banking industry observers have suggested would be required.

The deadline for comments to the FASB regarding the proposed CECL standard expired on May 31, 2013.  In addition to reviewing public comments, FASB is seeking to converge its proposed standard with the international standards proposed by the International Accounting Standards Board (IASB).  The IASB’s approach is based on three “buckets” or stages in the life of a loan or other financial asset that correspond to the relative condition of the financial asset in question.  It has been reported that FASB is aiming to issue a final standard regarding measurement of the impairment of a loan or other financial asset by July 2014.

Comptroller of the Currency, Thomas J. Curry, made a speech at the Exchequer Club in Washington, D.C. on September 18, 2013 in which he discussed the increasing risks to banks and the financial system from the growing sophistication and frequency of cyberattacks.  The Comptroller pointed out that hackers now can conduct their activity from almost any location and the cost of the tools used by hackers “has dropped precipitously” and sometimes can be obtained without any cost.  At the same time, the operational risks to banks are increasing, said the Comptroller, because banks are increasing their reliance on technology and telecommunications and because banks’ systems are often interconnected, directly or through third-party vendors and servicers.  The Comptroller noted that there is every reason to think that these risks will continue to increase as banks are today “leveraging cloud computing, social media, mobile banking, and new payment solutions and it is impossible to guess what opportunities technology will bring ten years from now.”  The Comptroller also suggested that as the largest banking institutions strengthen their defenses against cyberattacks, hackers may increasingly focus attacks on community banks.

Comptroller Curry stressed the importance to banks that their respective boards and senior management understand the risks posed by cyberattacks and “set the right tone at the top” to inculcate risk management into the culture at their banks.  He also stressed that, to address cybersecurity compliance effectively, banks need to communicate with each other, their regulators and other relevant government agencies.  As an example of how bank regulators are working collectively to consider cybersecurity issues, Comptroller Curry stated that, in his capacity as Chairman of the Federal Financial Institutions Examination Council (“FFIEC”), he has appointed an FFIEC Cybersecurity and Critical Infrastructure Working Group that “is already meeting with intelligence, law enforcement, and homeland security officials” to consider “how best to implement appropriate aspects of the President’s Executive Order on Cybersecurity, as well as how to address the recommendations of the Financial Stability Oversight Council.”

The National Futures Association (the “NFA”) announced that amendments to Compliance Rule 2-46 that require commodity trading advisors (“CTAs”) to report to the NFA on a quarterly basis will be effective beginning with the quarter ending September 30, 2013.  This obligation is in addition to the pre-existing requirement included in CFTC Rule 4.27, which mandates that CTAs file with the NFA an annual report on Form CTA-PR.

The amended NFA rule requires CTAs to file reports on NFA Form PR on a quarterly basis within 45 days of the end of the calendar quarters ending in March, June, and September of each year; a year-end report is required to be submitted within 45 days of the calendar year end.  The NFA Form PR consists of the CFTC’s Form CTA-PR plus additional questions pertaining to certain trading programs offered by the CTA.  The year-end report on NFA Form PR will satisfy the CFTC’s annual filing requirement.

The first report under the amended rule, for the quarter ending September 30, 2013, will be due on November 14, 2013.  All CTAs that are members of the NFA must submit the required form each quarter even if they are not currently active.

The NFA will host a webinar on October 3rd to discuss the new requirements.

The Supreme Judicial Court of the Commonwealth of Massachusetts (the “SJC”) interpreted “on at least an annual basis” as used in the bylaws (the “Bylaws”) of two closed-end investment companies organized as Massachusetts business trusts (the “Funds”) to mean that each Fund must hold an annual shareholders’ meeting no later than one year and thirty days (395 days) after the Fund’s last annual shareholders’ meeting.

Background.  The defendant Funds are registered under the Investment Company Act of 1940 and listed on the New York Stock Exchange (the “NYSE”).  The Bylaws require each Fund to hold, on at least an annual basis, an election of trustees so long as the Funds’ are listed for trading on the NYSE.  The Bylaws provide that in the event that such a meeting is not held in any annual period, whether by oversight or otherwise, a subsequent special meeting may be held in lieu of such meeting.  To comply with the NYSE Listed Company Manual (the “NYSE Manual”), each Fund must " hold an annual shareholders' meeting during each fiscal year."  The Funds, whose fiscal years end July 31, routinely held a joint shareholders’ meeting in December.  Consistent with this practice, the Funds notified shareholders that the Funds planned to hold the annual meeting for the 2012 fiscal year in December 2011.  In September 2011, the plaintiffs, who were the second-largest beneficial owners of preferred shares of each of the Funds (the “Plaintiffs”), provided the Funds with written notice that the Plaintiffs intended to nominate one of their partners for election as a trustee of each Fund at the December 2011 meeting.  In October 2011, the Funds issued a press release stating that their December 2011 meeting was being rescheduled to July 31, 2012, the last day of the Funds’ 2012 fiscal years.

Superior Court Ruling.  In December 2011, the Plaintiffs filed a complaint in the Superior Court of the Commonwealth of Massachusetts (the “Superior Court”) alleging that the Funds intended to commit a breach of their Bylaws by postponing the annual meeting to a date that was nineteen months after the Funds' last annual meeting in December 2010.  The complaint sought, among other things, a declaration that the Funds' Bylaws require "that a meeting of shareholders for the election of trustees ... [be] held at least once within any [twelve] month period."  In relevant part, the Superior Court ruled that the Bylaws require the Funds "to schedule future annual shareholder meetings in or within twelve months of their last annual shareholder meetings."  The Funds filed an appeal which on its own motion, the SJC transferred to its docket.

SJC Ruling.  The SJC stated that as with a Massachusetts corporation’s articles of incorporation and bylaws, a Massachusetts business trust’s declaration of trust and bylaws are a contract between the trust’s trustees and shareholders that define the rights of shareholders, and must be interpreted according to traditional principles of contract law.  In the course of its analysis, the SJC invoked various principles of contract interpretation, including that to the extent that there is any ambiguity in a bylaw provision, the ambiguity must be construed against the drafters, in this case, the Funds.  The SJC ruled that the Bylaw requirement that the annual shareholders' meeting be held “on at least an annual basis" so long as the Funds are listed for trading on the NYSE clearly means that such meeting must be held at least “each fiscal year” as required by the NYSE Manual.

The SJC noted that the Bylaws’ notice provisions governing a shareholder trustee nomination are different if an “annual meeting” is not scheduled to be held within a period that commences thirty days before the first anniversary date of the annual meeting for the preceding year and ends thirty days after such anniversary date.  The Court further noted that such an annual meeting date outside such period was referred to in the Bylaws as an "Other Annual Meeting Date.”  The SJC also noted that the Bylaws provided that "the term 'annual meeting' refers to any annual meeting of [s]hareholders as well as any special meeting held in lieu of an annual meeting."  Based on these Bylaw provisions, the SJC concluded that the Bylaws suggest that a regular annual shareholder meeting must be scheduled within the “annual period,” which ends thirty days after the anniversary date of the last annual shareholders’ meeting.  The SJC found this interpretation to be more consistent with the usual meaning of "on at least an annual basis" than the Funds' interpretation, under which they potentially could have held annual shareholders' meetings twenty-three months apart.  The SJC observed that until the Plaintiffs declared their intent to nominate a new trustee, the Funds had not held a regular annual shareholder meeting more than thirty days after the anniversary date of the last annual meeting.  Based on the foregoing, the SJC interpreted the Funds’ Bylaws to require that each Fund schedule future annual shareholders’ meetings no later than thirty days after the anniversary of its last annual shareholders’ meeting.

Brigade Leveraged Capital Structures Fund v. Pimco Income Strategy Fund, 466 Mass. 368 (2013).