Financial Services Alert - November 23, 2010 November 23, 2010
In This Issue

FRB Releases Proposed Rule to Implement Volcker Rule Conformance Periods

The FRB released a proposed rule (the “Proposed Rule”) to implement the conformance periods during which banking entities and nonbank financial companies supervised by the FRB must bring their activities and investments into compliance with the prohibitions and restrictions on proprietary trading and relationships with hedge funds and private equity funds imposed by section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the “Volcker Rule.”

General Conformance Period.  The Volcker Rule takes effect on the earlier of July 21, 2012 or 12 months after issuance of final regulations implementing the Volcker Rule.  In order to allow the markets and firms to adjust to the Volcker Rule’s prohibitions and restrictions, the Volcker Rule provides banking entities and nonbank financial companies supervised by the FRB with an additional conformance period after the Volcker Rule takes effect during which the entity or company can wind down, sell, or otherwise conform its activities, investments, and relationships to the requirements of the Volcker Rule.  The Proposed Rule implements the Volcker Rule’s conformance period provisions and clarifies how the conformance period applies to a company that first becomes a banking entity after July 21, 2010 (the date of enactment of the Dodd-Frank Act) because, for example, the company acquires or becomes affiliated with an insured depository institution for the first time.  In these circumstances, the restrictions and prohibitions of the Volcker Rule would first become effective with respect to the company only at the time it became a banking entity.  Accordingly, the Proposed Rule provides that such a company generally must bring its activities, investments, and relationships into compliance with the requirements of the Volcker Rule before the later of: (1) the date the Volcker Rule’s prohibitions would otherwise become effective with respect to the company, and (2) 2 years after the date on which the company first becomes a banking entity.  For example, a company that first becomes a banking entity on January 1, 2015 would have until January 1, 2017 to bring its activities and investments into conformance with the requirements of the Volcker Rule and its implementing regulations.

Extension of Conformance Period.  The FRB may extend the generally available two-year conformance period by up to three additional one-year periods for an aggregate conformance period of up to 5 years.  Under the Proposed Rule, a banking entity seeking an extension of the conformance period must submit a request to the FRB.  Any such request for an extension must: (1) be submitted in writing to the FRB at least 90 days prior to the expiration of the applicable time period; (2) provide the reasons why the banking entity believes the extension should be granted; and (3) provide a detailed explanation of the banking entity’s plan for divesting or conforming the activity or investment(s).  The Proposed Rule lays out several matters that must be addressed in such requests and the factors the FRB will evaluate in considering a request.  The factors provided are not exclusive.  The Proposed Rule would allow the FRB to impose conditions on any extension granted.

Extended Transition Period for Illiquid Funds.  The Volcker Rule permits a banking entity to request in writing the FRB’s approval for an additional extension of up to 5 years in order to permit the banking entity to meet contractual commitments in place as of May 21, 2010 to a hedge fund or private equity fund that qualifies as an “illiquid fund,” defined as a hedge fund or private equity fund that: (1) as of May 1, 2010, was principally invested in illiquid assets, or was invested in, and contractually committed to principally invest in, illiquid assets; and (2) makes all investments pursuant to, and consistent with, an investment strategy to principally invest in illiquid assets.  The Proposed Rule defines several important terms, including “illiquid asset,” “principally invested” in illiquid assets, “contractually committed to principally invest” in illiquid assets, and “investment strategy to principally invest” in illiquid assets.  Any extended transition period with respect to an illiquid fund may not exceed 5 years and may be in addition to the conformance period available under other provisions of the Volcker Rule.  Such extended transition period automatically terminates on the date during any such extension on which the banking entity is no longer under a contractual obligation to invest in, or provide capital to, the illiquid fund.  With respect to the extended conformance period for illiquid funds, it is important to note that a banking entity will only be considered to have a contractual obligation to take or retain an equity, partnership or other interest in an illiquid fund or to provide capital to an illiquid fund if the banking entity’s obligation may not be terminated by the banking entity or any of its subsidiaries or affiliates under the terms of its agreement with the fund and, in the case of an obligation that may be terminated with the consent of other persons, the banking entity and its subsidiaries and affiliates have used reasonable best efforts to obtain such consent and such consent has been denied. 

Nonbank Financial Companies.  The Proposed Rule also implements the conformance period for nonbank financial companies supervised by the FRB.  Like banking entities, the Volcker Rule provides a nonbank financial company supervised by the FRB two years after the date the company becomes a nonbank financial company supervised by the FRB to conform its activities to any applicable requirements of the Volcker Rule, which also provides the FRB the ability to extend this two-year conformance period by up to three additional one-year periods.  Such entities seeking an extension must submit a request to the FRB under the same time frame as required for banking entities.

The FRB requests comment on all aspects of the Proposed Rule.  Comments should be submitted within 45 days of publication of the Proposed Rule in the Federal Register, which is expected shortly.

FRB Issues Guidelines for Evaluating Capital Distributions

The FRB issued guidelines (the “Guidelines”), set forth in a temporary addendum to SR letter 09-4, for evaluating proposals by large bank holding companies to undertake capital actions, including increasing dividend payments or stock repurchases.  The Guidelines apply to the 19 large bank holding companies that participated in the Supervisory Capital Assessment Program (the “SCAP”) in 2009:  Citigroup Inc., J.P. Morgan Chase & Co., Wells Fargo & Co., Goldman Sachs Group, Morgan Stanley, MetLife, PNC Financial Services Group, US Bancorp, Bank of New York Mellon Corp., SunTrust Banks Inc., State Street Corp., Capital One Financial Corp., Fifth Third Bancorp, BB&T Corp., Regions Financial Corp., American Express Co., Keycorp, and GMAC.  The FRB stated that it will review the Guidelines on or before December 31, 2011. 

These 19 large bank holding companies will be required to submit a comprehensive capital plan, which the FRB strongly encouraged to be filed by January 7, 2011.  Such capital plans will include a “stress test” of the bank holding company’s ability to absorb losses over the following two years under several economic scenarios, including an adverse macroeconomic scenario specified by the FRB.  The capital plan must also address the bank holding company’s plans to address the proposed Basel III capital requirements and the anticipated impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act on the bank holding company’s business model or capital adequacy.  If applicable, the bank holding companies must also address their plans to repay U.S. government investments through the Troubled Asset Relief Program.  The FRB will also review the bank holding company’s exposure to losses if it is required to repurchase mortgages and mortgage-related securities.  Unlike the SCAP, the results of the stress tests included in these capital plans will not be made public.  The FRB noted the high value of horizontal reviews across groups of firms and indicated that it plans to undertake capital plan reviews on a regular basis in consultation with the other federal banking agencies.

The FRB indicated that it expects to respond to capital distribution requests by such bank holding companies beginning in the first quarter of 2011.  Bank holding companies with outstanding U.S. government investments in the form of preferred shares or common equity must repay such investments prior to increasing dividends or implementing stock repurchases.  The FRB stated that it expects that plans submitted in 2011 will reflect conservative dividend payout ratios and net share repurchase programs and indicated that requests that imply a dividend payout ratio above 30% of after-tax net income will receive particularly close scrutiny.

DOL Proposes Amendment to Regulation Defining “Investment Advice” for purposes of Fiduciary Status under ERISA

The Department of Labor (“DOL”) proposed an amendment (the “Proposed Amendment”) to the regulation that defines “investment advice” for purposes of determining fiduciary status under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).  The Proposed Amendment would significantly expand the circumstances under which financial services companies and other persons providing services to ERISA plans are considered to be plan fiduciaries.  The deadline for  submitting comments to the DOL regarding the Proposed Amendment is January 20, 2011. 


ERISA imposes strict standards of conduct on fiduciaries, prohibits specified transactions involving plans, and subjects fiduciaries to substantial potential liability if those standards or prohibited transaction rules are violated.  Under ERISA, a person is a fiduciary to the extent he has or performs certain specified functions – including rendering “investment advice” for a fee or other compensation, or having the responsibility or authority to do so.  Over the past 35 years, an understanding regarding the scope of what constitutes “investment advice” for this purpose has developed based on two DOL pronouncements issued shortly after ERISA’s enactment.

Since 1975, the current ERISA regulation defining investment advice has provided that, for this purpose, a person or entity generally is considered to render investment advice to a plan only in the following circumstances:

  • the person or entity provides advice as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property,
  • on a regular basis,
  • pursuant to a mutual agreement, arrangement, or understanding, with the plan or plan fiduciary, that
  • the advice will serve as a primary basis for investment decisions with respect to plan assets, and that
  • the advice will be individualized based on the particular needs of the plan.

In addition, a 1976 DOL advisory opinion concluded that, under this definition, an entity was not rendering investment advice when it provided a valuation of closely-held securities to be relied upon by an ERISA plan in making a decision whether to purchase the securities.

The Proposed Amendment would fundamentally change the standards established by the existing regulation and the 1976 advisory opinion.  As discussed below, the Proposed Regulation would (i) provide a new, broader definition of “investment advice;” (ii) identify conditions under which rendering investment advice would confer fiduciary status; (iii) establish exceptions regarding certain aspects of the definition; (iv) provide an expansive definition of the types of fees (or other compensation) for purposes of fiduciary status based on investment advice; and (v) make clear that the Proposed Amendment would apply for purposes of the prohibited transaction excise tax provisions of Section 4975 of the Internal Revenue Code of 1986, as amended (“IRC”), regarding individual retirement arrangements (“IRAs”) and other tax-favored plans.

Definition of Investment Advice

Under the Proposed Amendment, “investment advice” would encompass making recommendations as to the advisability of investing in, purchasing, holding, or selling securities or other property.  In addition, investment advice would include providing advice, or an appraisal or fairness opinion, concerning the value of securities or other property.  In its preamble to the Proposed Amendment, the DOL specifically noted that this change was intended to supersede the 1976 advisory opinion, and emphasized that the modified definition would include valuations and appraisals of not only securities but also other property such as real estate.  Finally, the definition would also include providing advice or making recommendations as to the “management” of securities or other property (e.g., advice regarding the voting of proxies or the selection of investment managers).

Conditions to Fiduciary Status

Even if a person’s activities fall within the definition of investment advice, he will not be considered to be a fiduciary under the Proposed Amendment unless one or more of the following conditions are satisfied by such person directly or indirectly (e.g., through or together with an affiliate):

  • the person represents or acknowledges that it is acting as an ERISA fiduciary with respect to providing advice or making recommendations within the scope of the definition of investment advice described above;
  • the person is a fiduciary with respect to the plan based on other components of the ERISA statutory definition of fiduciary (i.e., the person exercises discretionary authority or control respecting management or administration of the plan, or any authority or control regarding management or disposition of plan assets);
  • the person is an investment adviser within the meaning of Section 202(a)(11) of the Investment Advisers Act of 1940; or
  • the person provides advice or makes recommendations within the scope of the definition of investment advice described above, pursuant to an agreement, arrangement, or understanding, written or otherwise, between such person and the plan, a plan fiduciary, or a plan participant or beneficiary that such advice may be considered in connection with making investment or management decisions with respect to plan assets, and will be individualized to the needs of the plan, a plan fiduciary, or a participant or beneficiary.

While this fourth condition may in some respects resemble the standards of the current regulation (as discussed above), there are a number of significant differences.  For example, under the Proposed Amendment there would be no requirement that the advice be provided “on a regular basis” and there need only be an understanding that the advice will “be considered in connection” with the decision, rather than serving as “a primary basis” for decision-making.  Moreover, the requirements of the fourth condition would not need to come into play if any of the other three conditions are satisfied.


Even if a person’s activities fall within the definition of investment advice, and one or more of the conditions described above are satisfied, he would not be considered to be a fiduciary by reason of such advice if one of the following exceptions under the Proposed Amendment applied.

One exception would apply if the person can demonstrate that the recipient of the advice knows (or reasonably should know), that the person providing the advice or recommendations (i) is acting as purchaser or seller (of securities or other property) whose interests are adverse to the plan (or an agent of, or appraiser for, such a purchaser or seller), and (ii) is not undertaking to provide impartial investment advice.  This exception is not available where the person, directly or indirectly (i.e., through an affiliate) represents or acknowledges that it is acting as an ERISA fiduciary with respect to providing advice or making recommendations within the scope of the definition of investment advice above.

Other exceptions would be available where the plan is an individual account plan (such as a 401(k) plan).  For example, a person would not be considered to be a fiduciary solely by reason of providing investment education and materials to participants and beneficiaries of an individual account plan, as described in the DOL’s Interpretive Bulletin 96-1.  Another exception would apply to a provider of an investment platform (through which the plan makes investments available to participants and beneficiaries) so long as the provider discloses in writing to the plan fiduciary that the provider is not undertaking to provide impartial investment advice.  This exception would be available where the platform provider provided the plan fiduciary with general financial information and data to be used for selection and monitoring of the plan’s investment alternatives.

The Proposed Amendment also includes an exception for preparation of general reports or statements reflecting the value of a plan investment that is provided for purposes of complying with reporting or disclosure requirements of ERISA or federal tax law.  However, this exception would not apply where the report (i) involves assets that have no generally recognized market, and (ii) is the basis for making distributions to plan participants or beneficiaries.

Definition of Fee or Other Compensation

As noted above, a person is a fiduciary by reason of rendering investment advice only if that advice is “for a fee or other compensation, direct or indirect.”  The Proposed Amendment would expansively define this term to include fees or other compensation received by the person rendering the advice (or the person’s affiliate) from any source, and any fee or other compensation incident to the transaction in which the advice has been (or will be) rendered.  This would include, for example, commissions for brokerage, or mutual fund or insurance sales, and would encompass fees and commissions based on multiple transactions involving different parties.

Application to IRAs and Other Arrangements Subject to IRC §4975

The Proposed Amendment would apply not only for purposes of the fiduciary provisions of ERISA, but also to determinations made under IRC §4975, which imposes excise taxes on certain “prohibited transactions” involving IRAs and certain other tax-favored arrangements (such as qualified retirement plans under IRC §401(a)), whether or not subject to ERISA.  For example, the Proposed Amendment would apply for purposes of determining whether a financial services company is acting as a fiduciary of an IRA where the financial services company may be subject to excise taxes under IRC §4975 if it engages in self-dealing with respect to assets of the IRA.

SEC Proposes Rules to Implement Dodd-Frank Act Changes to Advisers Act Exemptions, Registration Requirements and Reporting

The SEC issued two releases proposing rules designed to implement (a) three new exemptions from registration under the Investment Advisers Act of 1940 (the “Advisers Act”) created by the Dodd-Frank Act and (b) changes to the registration and reporting requirements under the Advisers Act effected by the Dodd-Frank Act.  (The statutory changes do not take effect until July 21, 2011.)   One release describes proposed rules that would address various elements of the new registration exemptions for: (1) an adviser whose sole clients are “venture capital funds”;  (ii) an adviser whose sole clients are investment companies that rely on either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 (“private funds”) and represent less than $150 million in assets under management in the United States; and (iii) a non-U.S. adviser with less than $25 million in aggregate assets under management from fewer than 15 U.S. clients and private fund investors (a “foreign private adviser”). 

The second release (the “Implementing Release”) proposes rule changes and form amendments that address a range of matters associated with implementing changes to Advisers Act registration and reporting requirements under the Dodd-Frank Act, including: (a) the transition to state registration for advisers that fail to meet the higher assets under management threshold for SEC registration established by the Dodd-Frank Act; (b) changes in the calculation of an adviser’s assets under management for various purposes under the Advisers Act; (c) changes to existing Advisers Act exemptions (e.g., increasing the threshold for plan assets advised to $200 million for the pension consultant exemption); (d) how venture capital advisers and private fund advisers with assets under management of less than $150 million (both types of advisers being referred to as “exempt reporting advisers”) will meet their limited SEC reporting obligations through Form ADV filings that respond to only certain items in Part 1 of the Form; and (e) revisions to Form ADV Part 1 that apply to both exempt reporting advisers and adviser registrants and are designed to capture additional information on private funds they manage (e.g., information on private fund service providers) and additional information the SEC believes will better inform its examination program (e.g., whether all soft dollars received by an adviser fall within the safe harbor of Section 28(e) of the Securities Exchange Act of 1934).  The Implementing Release also proposes changes to Advisers Act Rule 206(4)-5, the “pay-to-play” rule, that would cause it to apply to exempt reporting advisers and foreign private advisers. 

Comments on the releases are due by the 45th day after their publication in the Federal Register.  Both releases will be covered in more detail in a future edition of the Alert or another Goodwin Procter publication that will be made available to Alert readers.

FDIC Approves Temporary Unlimited Deposit Insurance Coverage for Noninterest-Bearing Transaction Accounts

The FDIC approved a final rule (the “Final Rule”) implementing Section 343 of the Dodd‑Frank Wall Street Reform and Consumer Protection Act which provides temporary unlimited deposit insurance for noninterest-bearing transaction accounts and requires banks to notify their customers about any changes to the insurance coverage on their accounts.  In the Final Rule, the FDIC creates a new category of deposit insurance for noninterest‑bearing transaction accounts that is separate from, and is in addition to, coverage provided for other bank accounts.  This new category of insurance is similar to the FDIC’s Transaction Account Guarantee Program, which expires December 31, 2010, but differs significantly in the definition of “noninterest-bearing transaction account” in that it includes no interest-bearing accounts and therefore excludes IOLTA and NOW accounts (regardless of the interest rate paid on the account).  The Final Rule includes new disclosures that require banks to (1) post notices in their branches and on their websites about the new program, (2) inform customers with IOLTA and NOW accounts that such accounts will no longer be covered by unlimited deposit insurance upon the expiration of the Transaction Account Guarantee Program, and (3) notify customers of actions that affect the insurance coverage of funds held in noninterest-bearing transaction accounts.  The FDIC pointed out that IOLTAs may, nonetheless, qualify for “pass through” deposit insurance coverage so that each client for whom a law firm holds funds in an IOLTA may be insured up to $250,000 for his or her funds.  The Final Rule is effective on December 31, 2010 and expires on December 31, 2012.

Closed-End Fund Opting into Maryland Control Share Acquisition Act Inconsistent with Investment Company Act of 1940 According to SEC Staff

The staff of the SEC’s Division of Investment Management provided guidance on whether a registered closed-end fund organized as a Maryland corporation could opt into the Maryland Control Share Acquisition Act (the “MSCAA”) without violating Section 18(i) of the Investment Company Act of 1940 (the “1940 Act”).  The MSCAA provides that:

Holders of control shares of the corporation acquired in a control share acquisition have no voting rights with respect to control shares except to the extent approved by the stockholders at a meeting . . . by the affirmative vote of two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.

Control shares are generally shares that cause the holder’s total ownership of an issuer’s voting securities to fall within certain ranges of voting power (e.g., from 10% to less than one-third).  The statute was designed to compel prospective acquirers to deal directly with a company’s management rather than attempt to effect change by obtaining significant voting power through market purchases of a company’s shares.  Section 18(i) of the 1940 Act provides, in relevant part, that “[e]xcept as . . . otherwise required by law, every share of stock hereafter issued by a registered management company… shall be a voting stock and have equal voting rights with every other outstanding voting stock . . .”

The SEC staff concluded that the MSCAA was inconsistent with the wording of, and purposes underlying, Section 18(i) specifically and of the 1940 Act generally, since the MSCAA would discriminate against certain shareholders by denying their voting rights and would contribute to the entrenchment of management.  The SEC staff noted that for similar reasons it would take the same view of a business development company organized under Maryland law that failed to opt out of the MSCAA.  (Under the MSCAA, closed-end funds are excluded by default; however, business development companies are subject to the MSCAA by default and must affirmatively opt out of its provisions.)

European Parliament Adopts Alternative Investment Fund Managers Directive

The European Parliament has adopted final legislation for the Alternative Investment Fund Managers Directive.  The extensive implications of the Directive for EU and non-EU managers of collective investment vehicles that are not regulated UCITS are discussed in an Overview and Briefing Note from Travers Smith LLP.

SEC Proposes Rules Governing the Reporting of Security-Based Swap Transaction Information

Pursuant to mandates under the Dodd-Frank Act, the SEC issued two rule proposals relating to its oversight of security-based swaps (“SBS”).  The first addresses the SEC registration process for security-based swap data repositories (“SDRs”), which will receive SBS transaction information from market participants, and outlines the proposed duties of SBRs, including recordkeeping and providing access and reports to regulators.  The second would provide for reporting of SBS information to registered SDRs or the SEC and the public dissemination of SDR transaction, volume, and pricing information.  Comments on each proposal are due within 45 days of its publication in the Federal Register.

CFTC Proposes Compliance Rules for Certain Swap Market Participants

The CFTC proposed rules supplementing the Dodd-Frank Act’s requirements relating to the compliance programs of futures commission merchants, swap dealers and major swap participants.  The proposed rules prescribe the qualifications for a chief compliance officer (“CCO”), define the internal reporting structure for a CCO, standardize CCO duties across all the foregoing entities and establish procedures and additional content requirements for annual CCO reports provided to the organization and the SEC.  Comments on the proposed rules are due by January 18, 2011.