Financial Services Alert - November 30, 2010 November 30, 2010
In This Issue

FinCEN Issues Rule, Advisory and Guidance Regarding SAR Confidentiality, Sharing with Affiliates

The Financial Crimes Enforcement Network (“FinCEN”) released an advisory (the “Advisory”), a final rule (the “Rule”), and two guidance documents (the “Bank Guidance” and the “Securities/Futures Industry Guidance and, collectively, the “Guidance”) and a Notice of Availability of Guidance (the “Notice”), which together clarify the confidentiality requirements for Suspicious Activity Reports (“SARs”) and expand the ability of certain financial institutions to share SAR information with certain affiliates.  The Rule and the Guidance finalize proposed regulations and interpretive guidance which were described in the March 10, 2009 Alert.

The Rule and Guidance will be effective 30 days after they are published in the Federal Register.

The Advisory

FinCEN released the Advisory to regulatory and law enforcement agencies, SROs, and financial institutions in connection with its release of the Rule and Guidance to reinforce and reiterate the requirement to preserve the confidentiality of SAR information.  FinCEN explained that, in addition to violating federal law, the unauthorized disclosure of SARs could undermine ongoing and future investigations by tipping off suspects, deter financial institutions from filing SARs, and threaten the soundness and security of institutions and individuals who file such reports.

FinCEN also described certain steps that institutions and authorities could take to ensure that SAR confidentiality is maintained, including making certain that all employees, agents, and individuals entrusted with information in a SAR are informed of the individual obligation to maintain SAR confidentiality, with respect to not only the SAR itself but also information that would reveal the existence of the SAR, and the potential penalties for unauthorized disclosure of such information.  In addition, FinCEN suggested that financial institutions consider emphasizing the confidentiality of SARs in employee training programs and taking other risk-based measures to protect SAR confidentiality, such as providing limited access to SARs on a “need to know” basis only, creating restricted areas for reviewing SARs, keeping a log of access to SARs, using cover sheets for SARs or supporting information that indicates the filing of a SAR, and/or providing electronic notices that highlight confidentiality concerns before a person may access or disseminate SARs or SAR information.

The Rule

The Rule amends the Bank Secrecy Act (“BSA”) regulations regarding the confidentiality of SARs to (1) clarify the scope of the statutory provision against disclosure by a financial institution of a SAR; (2) address the statutory prohibition against the disclosure; (3) clarify that the exclusive standard applicable to the disclosure of a SAR is to fulfill official duties consistent with the purposes of the BSA; (4) modify the safe harbor provision for SAR filers to address changes made by the USA Patriot Act; and (5) make minor technical revisions for consistency and harmonization among the SAR rules for different categories of financial institutions.

Scope of Confidentiality Requirement

The Rule clarifies that the SAR confidentiality requirements extend not only to the SAR but also to information that would reveal the existence of a SAR.  The Rule also provides that any financial institution, or any director, officer, employee, or agent of a financial institution, that is subpoenaed or otherwise requested to disclose a SAR or information that would reveal the existence of a SAR (collectively, “SAR Information”), must decline to provide the SAR Information and provide notification of the request and its response to FinCEN.  A proposed requirement that would have required an institution to notify its primary federal regulator of such a request was not included in the Rule, but FinCEN noted that institutions are not relieved from requirements to comply with such requirements under provisions of similar but distinct rules administered by separate agencies, such as the Federal Reserve, the OCC, and the FDIC.

Rules of Construction

The Rule also includes three rules of construction which clarify the scope of the SAR disclosure prohibition.  Under these rules of construction, provided that no person involved in any reported suspicious transaction is notified that the transaction has been reported, the Rule shall not be construed as prohibiting:

  • The disclosure by a financial institution, or any director, officer or employee or agent of the financial institution, of SAR Information to (a) FinCEN, (b) any federal, state, or local law enforcement agency, (c) any federal regulator that examines the financial institution for compliance with the BSA, (d) if applicable, any state regulatory authority administering a state law that the requires the financial institution to comply with the BSA or otherwise authorizes the state authority to ensure that the institution complies with the BSA, or (e) if applicable, any SRO that examines the financial institution for compliance with SAR requirements, upon the request of the applicable federal regulator (i.e., the SEC or the CFTC).
  • The disclosure by a financial institution, or any director, officer or employee or agent of the financial institution, of the underlying facts, transactions, and documents upon which a SAR is based, including but not limited to, disclosures to another financial institution, or any director, officer, employee or agent of a financial institution, for the preparation of a joint SAR.  For banks, securities broker-dealers, futures commission merchants, and introducing brokers in commodities, this rule of construction also applies to disclosure in connection with certain employment references or termination notices, to the extent authorized in 31 U.S.C. § 5318(g)(2)(B).
  • The sharing by a financial institution, or any director, officer or agent of the financial institution, within the financial institution’s governance structure for purposes consistent with Title II of the BSA as determined by regulation or in guidance.  FinCEN explained in the adopting release that this rule of construction recognizes that financial institutions may find it necessary to share SAR information to fulfill reporting obligations under the BSA, and facilitates more effective enterprise-wide BSA monitoring, reporting, and risk management.  However, as explained in the discussion of the Guidance below, FinCEN has not extended the Guidance to permit sharing with affiliates by those financial institutions, which do not have a primary federal functional regulator. 

Disclosure by Governmental Authorities

The Rule prohibits a federal, state, local, territorial or tribal government authority, or any director, officer, employee or agent of any of the foregoing, from disclosing SAR Information except as necessary to fulfill official duties consistent with Title II of the BSA.  The Rule specifies that “official duties” does not include the disclosure of SAR Information in response to a FOIA request or a request for use in a private legal proceeding.

Safe Harbor from Liability

The Rule also clarifies the scope of the safe harbor for financial institutions which file SARs to include voluntary disclosures of possible violations of law and regulation.  The Rule also expands the scope of the limit of liability of include any liability which may exist “under any contract or other legally enforceable agreement (including any arbitration agreement).”  In addition, to comport with the second rule of construction described above, the Rule clarifies that the safe harbor applies to joint disclosures with other financial institutions.


The compliance provision in the Rule provides that (1) FinCEN or its delegatees may examine the financial institution for compliance with the SAR requirement, (2) that a failure to satisfy the requirements of the SAR rule may constitute a violation of the BSA or BSA regulations, and (3) for banks with parallel SAR requirements under federal banking regulations, that failure to comply with FinCEN’s SAR requirement may also constitute a violation of the parallel federal banking regulations.

The Guidance

In January 2006, FinCEN and the federal banking agencies issued guidance which permits a U.S. branch or agency of a foreign bank to share a SAR with its head office.  This guidance also stated that a U.S. bank or savings association may share a SAR with its controlling company (whether domestic or foreign).  Also in January 2006, FinCEN, in consultation with the SEC and the CFTC, issued guidance which allows a securities broker‑dealer, futures commission merchant, or introducing broker in commodities to share a SAR with its parent entity (whether domestic or foreign).  FinCEN subsequently issued guidance in October 2006 which states that a mutual fund may share SARs with any domestic or foreign investment adviser that controls the fund.

FinCEN deferred taking a position in 2006 regarding the permissibility of sharing SARs with affiliates.  Taken together, the Bank Guidance and the Securities/Futures Industry Guidance now allow a bank, savings association, securities broker-dealer, futures commission merchant, or introducing broker in commodities to share SAR Information with an affiliate, provide the affiliate is required to file SARs.  However, the affiliate which receives SAR Information may not share such SAR Information with its own affiliates, even those affiliates which are subject to SAR rules.

As is the case with sharing SARs with head offices, controlling companies, and parent entities, the sharing institution, as part of its internal controls, should have policies and procedures to ensure that its affiliates protect the confidentiality of the SAR Information.  In addition, no SAR Information may be disclosed to an affiliate if the sharing institution has reason to believe the SAR Information may be disclosed to any person involved in the suspicious activity that is the subject of the SAR.

In the Notice, FinCEN explained that it would not expand the SAR sharing authority under the Guidance to other types of financial institutions that currently have a FinCEN SAR requirement.  Due to the particular sensitivity of SAR information, FinCEN declined to expand the Guidance to additional industries, such as money services businesses.  However, as explained above, the second rule of construction in the Rule establishes the regulatory framework for additional categories of financial institutions to share SAR information within their corporate structure in the future, without necessarily requiring an amendment to the applicable SAR confidentiality provisions.

FSOC Seeks Comment on Financial Market Utilities Risk

On November 23, 2010, the Financial Stability Oversight Council (“FSOC”) issued an advance notice of proposed rulemaking (the “ANPR”) on the designation of certain financial market utilities as systemically important.  The Dodd-Frank Act (“DFA”) defines a “financial market utility” as “any person that manages or operates a multilateral system for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and the person,” with certain exclusions for designated contract markets, national securities exchanges and some others.  The ANPR notes that financial market utilities perform critical functions in the financial system and that some utilities may require designation as systemically important.  Payment, clearing or settlement activities performed by financial institutions are not covered by the ANPR and will be addressed separately.

In considering whether a financial market utility should be designated as systemically important, the DFA requires the FSOC to consider:

  1. The aggregate monetary value of transactions processed by the financial market utility;
  2. The aggregate exposure of the financial market utility to its counterparties;
  3. The relationship, interdependencies, or other interactions of the financial market utility with other financial market utilities or payment, clearing or settlement activities;
  4. The effect that the failure of or a disruption to the financial market utility would have on critical markets, financial institutions, or the broader financial system; and
  5. Any other factors that the FSOC deems appropriate.

The ANPR seeks comment on the criteria the FSOC should use in meeting the DFA requirements.  Several questions included in the ANPR invite public comment on the types of information that should be used in the designation process, objective measures that may be considered in determining systemic importance, and means to assess relationships and interdependencies of financial market utilities.  Comments on the ANPR are due 30 days after publication in the Federal Register.

CFTC Proposes Rules Implementing Regulatory Program for Swaps Dealers and Major Swap Participants

In accordance with Title VII of the Dodd-Frank Act, the CFTC issued three releases designed to implement various elements of the Act’s oversight program for swap dealers and major swap participants.

  • Registration – this proposal would establish the process for registering swap dealers and major swap participants. The proposed regulations would require these entities to become members of the National Futures Association and to confirm their associated persons are not subject to a statutory disqualification under the Commodity Exchange Act.  The proposing release also discusses the CFTC’s proposed timetable for implementing the registration, definitional and regulatory elements of the Dodd-Frank Act’s oversight program for swap dealers and major swap participants.
  • Duties – this proposal would establish the duties of swap dealers and major swap participants registered with the CFTC with regard to risk management procedures; monitoring of position limits; supervision; business continuity and disaster recovery; regulatory reporting and related recordkeeping; and antitrust matters.
  • Conflicts of Interest – this proposal would create requirements related to potential conflicts of interest for swap dealers and major swap participants.  Among the topics addressed in the proposed rules are the preparation and release of research reports; the use of informational barriers; and clearing services.

Comments on the proposals are due by January 24, 2011.

FINRA Announces Effective Date of New Rule 5131 Prohibiting Abuses in the Allocation and Distribution of IPO Shares

In Regulatory Notice 10-60, issued on November 29, 2010, FINRA announced that its new Rule 5131, governing the IPO allocations process for underwriters, will become effective on May 27, 2011.  The prohibitions and requirements of Rule 5131 are directed at broker-dealers and their associated persons involved in the distribution of IPO shares, but will also indirectly affect purchasers.  In particular, investment funds that wish to purchase IPO shares may need to provide information to IPO underwriters about their beneficial interest holders sufficient to permit the underwriters to determine that they are not selling to a prohibited account.

The prohibitions and requirements of Rule 5131 include the following:

  • No Quid Pro Quo Allocations.  A firm participating in the underwriting may not offer or threaten to withhold IPO shares as consideration or inducement for the receipt of compensation that is excessive in relation to the services provided by the firm.
  • Spinning – No Investment Banking Involvement in Allocations.  Member firms must have procedures to ensure that investment banking personnel have no involvement or influence, directly or indirectly, in the IPO allocation decisions made by the firm’s sales force.
  • Spinning – Restrictions on Allocations to Certain Persons.  Member firms participating in a distribution of IPO shares, and their associated persons, may not allocate shares to any account in which an executive officer or director of a public company or a non-public company meeting size requirements, specified in the Rule, based on income, revenue and shareholder equity, or a person materially supported by such an officer or director, has a beneficial interest:  (1) if the company is currently an investment banking services client of the member or the member has received compensation from the company for such services in the past year, (2) if the person responsible for making the allocation decision knows or has reason to know that the member intends to provide or be retained to provide investment banking services in the next three months, or (3) on the express or implied conditions that the executive officer or director, on behalf of the company, will retain the member for the performance of future investment banking services.
  • Policies Concerning Flipping.  In order to reduce flipping of IPO shares (i.e., sales into the market within 30 days after the offering), underwriters have in the past imposed penalties on associated persons whose customers flip their shares.  The Rule prohibits the imposition of such penalties unless the managing underwriter has assessed a penalty bid on the entire syndicate.  Firms will also be required to maintain records of the assessment of penalty bids.
  • IPO Pricing – Indications of Interest.  The Rule will require the book-running lead manager to provide the issuer’s pricing committee (or if none, its board of directors) with regular reports of indications of interest before the offering and final allocations after settlement, including the names of institutional investors and number of shares indicated or purchased, and aggregate numbers for retail investors.
  • Lock-Up Agreements.  Any lock-up agreement or other restriction on the transfer of the issuer’s shares by officers and directors of the issuer entered into in connection with a new issue shall provide that (1) such restrictions will apply to their issuer-directed shares and (2) at least two business days before the release or waiver of the lock-up (other than a waiver to permit a transfer not for consideration to a party who has agreed to be bound by the same lock-up agreement), the book-running lead manager will notify the issuer of the impending release or waiver and announce the impending release or waiver through a major news service.
  • Returned Shares.  The agreement among underwriters must require that (to the extent not inconsistent with SEC Regulation M) any shares trading at a premium to the public offering price that are returned by a purchaser to a syndicate member after secondary market trading commences must be used to offset the existing syndicate short position or, if there is no short position, either offered to fill unfilled customer orders pursuant to a random allocation methodology or sold on the secondary market with the profits donated to an unaffiliated charity on an anonymous basis.
  • No Acceptance of Pre-Issue Market Orders.  Member firms may not accept a market order for the purchase of shares of a new issue in the secondary market prior to the commencement of trading of such shares in the secondary market.

With respect to the prohibition on allocations to the “account” of certain persons, including executive officers and directors of companies to whom the member firm has or may provide investment banking services, FINRA notes that a hedge fund or other private investment fund is an account of a person who has a beneficial interest is the fund.  Rule 5131 permits member firms selling to funds to rely on information provided by fund managers about their beneficial owners (thus allowing fund managers to maintain the confidentiality of their investor lists) and also to use some of the exemptions provided by Rue 5130 (the New Issue Rule).

SEC Staff Extends Indefinitely No-Action Relief Permitting Omission of Credit Ratings from Registration Statements under Regulation AB

The staff of the SEC’s Division of Corporation Finance (the “staff”) issued a letter extending indefinitely prior no-action relief under which an issuer of asset-backed securities may omit the credit ratings disclosure required by Item 1103(a)(9) and 1120 of Regulation AB from a prospectus that is part of a registration statement relating to an offering of asset‑backed securities.  Items 1103(a)(9) and 1120 of Regulation AB require disclosure of whether an issuance or sale of any class of offered asset‑backed securities is conditioned on the assignment of a rating by one or more rating agencies.  Section 939G of the Dodd-Frank Act nullified Rule 436(g) under the Securities Act of 1933 (the “1933 Act”).  (Rule 436(g) formerly provided that ratings issued by NRSROs on debt securities, convertible debt securities and preferred stock were not considered part of the registration statement for the purposes of Sections 7 and 11 of the 1933 Act with the result that NRSROs were not treated as experts and not subject to related 1933 Act liability.)  The prior relief was prompted by an unwillingness on the part of NRSROs to provide consents following the effectiveness of Section 939G.  In extending the relief, the staff cited continued reluctance on the part of NRSROs to provide consents, ongoing uncertainty in the asset-backed securities markets and its need to consider whether and, if so, how regulatory action related to the Dodd-Frank Act should affect the SEC’s disclosure requirements regarding credit ratings for asset‑backed securities offerings.

Goodwin Procter Issues Client Alert on SEC Proposal Defining New Adviser Registration Exemptions under Dodd-Frank Act and Related Reporting Requirements

Goodwin Procter has issued a Client Alert that discusses the SEC proposal to implement new exemptions from registration under the Advisers Act created by the Dodd-Frank Act for (i) venture capital fund advisers, (ii) advisers whose only clients are private funds that represent less than $150 million under management in the United States and (iii) non-U.S. advisers who manage less than $25 million attributable to U.S. persons.  The Client Alert also addresses a related SEC proposal that would require certain of the foregoing advisers, despite being exempt from Advisers Act registration, to nevertheless report a range of information regarding themselves and the private funds they manage to the SEC.