Financial Services Alert - August 26, 2014

Best Lawyers has named Goodwin Financial Institutions Group partner Marco Adelfio as 2015 “Lawyer of the Year.” The distinction, based on peer­review, is presented annually to a single stand-out lawyer in each practice area and major metropolitan area.

Marco, recognized for practicing in Mutual Funds Law, is Washington D.C.'s Private Funds/Hedge Funds Law “Lawyer of the Year.”  He is a member of the firm’s Investment Management Practice. Marco has served for over 30 years as outside counsel to investment companies, independent directors and investment advisers.  He also serves on the Advisory Board of BoardIQ, an industry publication geared towards independent directors.

In addition to Marco, seventeen Financial Institutions Group partners and counsel – Lynne Barr, Martin Carmichael, John J. Cleary, Daniel M. Glosband, Michael H. Goldstein, Laura Hodges Taylor, Paul W. Lee, William P. Mayer, Philip H. Newman, Regina M. Pisa, William E. Stern, Scott A. Webster and William P. Weintraub – will be listed in the 2015 edition of Best Lawyers.

The New York State Department of Financial Services (“DFS”) entered into a settlement agreement (the “Settlement Agreement”) with PricewaterhouseCoopers LLP (“PwC”) related to consulting services performed by PwC for the Tokyo Branch of The Bank of Tokyo—Mitsubishi UFJ, Ltd. (“BTMU”) under which PwC:  (1) paid a $25 million fine; (2) was suspended for 24 months from accepting consulting engagements for PwC’s Regulatory Services unit at financial institutions regulated by the DFS; and (3) was required to implement a series of reforms to its practices and procedures designed to address conflicts of interest that may arise in consulting arrangements.

In 2013, the DFS and BTMU entered into a consent order (the “Consent Order”) under which BTMU paid a $250 million penalty for unlawfully clearing through BTMU’s New York licensed branch (“BTMU NY”) approximately 28,000 U.S. dollar payments with an aggregate value of approximately $100 billion to Iran, Sudan, Myanmar and certain entities that were, at the applicable time, on the Office of Foreign Assets Control’s Specifically Designated Nationals list.  Under the Consent Order, BTMU was required to hire an independent consultant “to conduct a comprehensive review of the BSA/AML related sanctions compliance programs, policies and procedures currently in place at BTMU NY.”  The independent consultant selected was a Regulatory Services unit of PwC, and PwC conducted a Historical Transaction Review (“HTR”) of BTMU’s U.S. dollar-clearing activity between April 1, 2006 and March 31, 2007.  In June 2008, BTMU submitted PwC’s HTR Report (“HTR Report”) to the DFS’s predecessor agency.  The HTR Report stated that “it was the product of an objective and methodologically sound process.”  The Settlement Agreement provides, however, that “[DFS] and PwC agree that PwC’s work for [BTMU NY]…did not demonstrate the necessary objectivity, integrity, and autonomy that is now required of consultants performing regulatory compliance work for entities supervised by the [DFS].”  The DFS said that, under pressure from BTMU senior managers, PwC removed a warning in the HTR Report concerning BTMU’s scheme to falsify wire transfer information for Iran, Sudan and other sanctioned entities.  Superintendent Lawsky of the DFS declared that “[w]hen bank executives pressure a consultant to whitewash a supposedly ‘objective’ report to regulators—and the consultant goes along with it—that can strike at the very heart of our system of prudential oversight.”  PwC, said the DFS, repeatedly reacted to BTMU’s demands and revised the HTR Report to omit and downplay issues of material regulatory concern to the DFS.

The DFS stated that it is concerned because it is continuing to find examples of improper influence and misconduct in the bank consulting industry.  There is an indirect tension and conflict in such engagements because, while the consulting firm is working in a quasi-regulatory capacity, its fees are being paid by the bank whose compliance record is being evaluated.  The reforms that PwC is required to implement as part of the Settlement Agreement are designed to mitigate the effect of these conflicts of interest.

The SEC announced an initiative in which its Office of Compliance Inspections and Examinations (OCIE) plans to examine a significant percentage of newly registered municipal advisors over the next two years using an approach that focuses on identified risk areas.  Areas targeted for scrutiny may include a municipal advisor’s compliance with its fiduciary duty to its municipal entity clients, books and recordkeeping obligations, disclosure, fair dealing, supervision, and employee qualifications and training.  The initiative will have three phases: engagement with municipal advisors, examinations, and use of information obtained during examinations to inform SEC policy.  A letter describing the initiative sent by OCIE to newly registered municipal advisors provides additional details.

The Internal Revenue Service (the “IRS”) issued Revenue Ruling 2014-24 (the “Ruling”).  The Ruling amends Revenue Ruling 81-100, the ruling that established the requirements applicable to a tax-qualified group trust.  The Ruling expressly permits participation in a group trust by pension, profit sharing and stock bonus plans described in Section 1022(i)(1) of the Employee Retirement Income Security Act of 1974 (“ERISA”), all of the participants of which are residents of Puerto Rico (i.e., a plan that is qualified only under Section 1165 of the Puerto Rico Internal Revenue Code).  The Ruling also extends the transition relief provided in Revenue Ruling 2008-40 relating to certain transfers to plans qualifying under Section 1165 of the Puerto Rico Internal Revenue Code through January 1, 2016.  Further, the Ruling clarifies that separate accounts maintained by an insurance company whose assets consist solely of plans that are otherwise eligible to invest in a group trust may participate in a group trust, provided the assets of the separate account are insulated from the claims of the insurance company’s general creditors.  Sponsors of group trusts should consider the impact of the Ruling on their group trusts and client agreements if they permit or want to permit Puerto Rico plans and/or insurance company separate accounts.

The U.S. Department of Labor (“DOL”) published a request for information (the “RFI”) regarding the use of brokerage windows, self-directed brokerage accounts, and similar arrangements (collectively referred to in this article as “Brokerage Windows”) in 401(k) plans and other participant-directed defined contribution plans that are subject to the fiduciary duty rules of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).  The DOL indicated that its goal in issuing the RFI is to obtain information that will assist it in determining whether, and to what extent, regulatory standards or other guidance concerning the use of Brokerage Windows may be necessary to protect participants.  Comments responding to the RFI are due November 19, 2014.

Background

Defined contribution plans that permit participants to direct investments typically designate a specific set of investment options (“Designated Investment Alternatives” or “DIAs”) from which participants may select investments for their plan accounts.  Some plans make investments available through Brokerage Windows in addition to, or in lieu of, Designated Investment Alternatives. 

Investments made available through a Brokerage Window are treated differently from Designated Investment Alternatives under DOL regulations.  For example, plan fiduciaries are subject to ERISA fiduciary duties in selecting and monitoring DIAs, but those obligations do not apply with respect to investments made available through a Brokerage Window.  Further, investments made available through a Brokerage Window are not subject to detailed rules concerning disclosures to participants that apply to DIAs.

In Field Assistant Bulletin (“FAB”) 2012-02 (May 7, 2012), the DOL stated that if an investment made available through a Brokerage Window were selected by a significant number of participants, the relevant plan fiduciary would have an affirmative obligation to examine that investment and determine whether it should be treated as a Designated Investment Alternative for purposes of disclosure requirements.  The DOL also indicted that, in its view, the failure to designate a “manageable number” of investment alternatives would “raise[ ] questions” regarding whether the relevant fiduciaries had satisfied their fiduciary duties under ERISA. 

In response to a substantial reaction from groups representing plan sponsors and service providers, the DOL subsequently revised the FAB to eliminate the statement that heavily utilized investments made available through a Brokerage Window may need to be treated as Designated Investment Alternatives, but emphasized that, in its view, the failure to specify any DIAs under a plan—e.g., in order to avoid compliance with the disclosure obligations applicable to DIAs – raises questions under ERISA’s fiduciary duties of prudence and loyalty.  See FAB 2012-02R (July 30, 2012).  In revising the FAB, the DOL stated that it intended to engage in a process of discussion with interested parties about the potential need to revise regulations to address the use of Brokerage Windows in participant-directed plans.  The RFI is part of that process.

Information Requested in the RFI

The RFI requests a wide range of information regarding a number of topics, including (among others) the following:

• The appropriate definition and scope of the term “Brokerage Window” for this purpose;
• The number of DIAs a plan typically designates and the number of plans offering Brokerage Windows;
• The number of participants that utilize Brokerage Windows and the benefits Brokerage Windows provide to plans;
• The process fiduciaries use in selecting a Brokerage Window for their plan; and
• The types of disclosures made to participants regarding Brokerage Windows and the investments made available through Brokerage Windows.

The RFI also encourages interested parties to address any other matters they believe are relevant to Brokerage Windows and participant-directed plans.

Beginning in September, Goodwin Procter’s weekly Financial Services Alert will have a new look, a new name and expanded national and international coverage. The new publication will be called the Financial Services Weekly News Roundup, and will provide headlines and brief summaries of legislative, regulatory, judicial, and industry developments of note with links to primary sources.  We will continue to distribute more detailed analyses of financial industry news and trends through regular and timely client alerts, and of course, are always pleased to respond to requests for more information on any particular topic of interest.

Goodwin Procter has a long history of serving the financial services industry, and has been reporting on legal and regulatory developments for more than 15 years.  We look forward to continuing to keep you informed and updated.  We hope you find the new format, which was based in part on reader feedback, easier to use and share and, as always, we welcome your suggestions on ways we can further improve the publication.