Financial Services Alert - October 1, 2013 October 01, 2013
In This Issue

New ERISA Litigation Update Available – Upcoming ERISA Litigation Webinar on Fiduciary Issues

Goodwin Procter’s ERISA Litigation Practice published its latest quarterly ERISA Litigation Update.  The update discusses (1) the Third Circuit’s decision in Edmonson v. Lincoln National Life Insurance Company holding that the settlement of claims via retained asset accounts was not a breach of the insurer’s fiduciary duty, (2) the Sixth Circuit’s decision in Pipefitters Local 636 Insurance Fund v. Blue Cross and Blue Shield of Michigan holding that an entity providing services to a self-funded health plan acts as a fiduciary where it exercises discretion to determine and assess a fee paid by the plan to the service provider, and (3) the Seventh Circuit’s decision in Abbott v. Lockheed Martin Corporation which continues the court’s analysis of when a class may be certified in a case alleging breach of fiduciary duties with respect to a defined contribution plan.

Webinar on Fiduciary Issues.  On Tuesday, October 29, 2013, from 12:00 – 1:00 p.m. EDT, Goodwin Procter partners Jamie Fleckner and Alison Douglass will host a complimentary webinar on the fiduciary issues facing service providers in light of the appellate decisions discussed in the Update.  Register here to attend this webinar discussion.

FRB Issues Two Interim Final Rules Concerning Incorporation of Basel III Regulatory Capital Plans and Stress Tests

The FRB issued two interim final rules concerning incorporation of Basel III regulatory capital reforms into covered banking organizations’ capital and business projections used in the organization’s capital plan and stress tests during the next reporting cycle.  On July 2, 2013, the FRB approved revised risk-based and leverage capital requirements for banking organizations that implement the Basel III regulatory reforms and makes certain other changes.  See, a discussion of the foregoing FRB rule (the “Basel III Rule”), in the July 9, 2013 Financial Services Alert.

The FRB’s first interim final rule, “Application of the Revised Capital Framework to the Capital Plan and Stress Test Rules” (the “First Interim Final Rule”) applies only to bank holding companies with $50 billion or more in total consolidated assets (“Large Banking Organizations”).  Under the First Interim Final Rule, Large Banking Organizations must incorporate the revised regulatory capital framework into their capital planning projections and stress tests using the transition paths available under the Basel III Rule.   The FRB also clarifies in the First Interim Final Rule that the FRB will continue to assess a Large Banking Organization’s capital adequacy in the reporting cycle beginning October 1, 2013 “using the current 5% minimum tier 1 common ratio calculated in the same manner as under previous stress and capital plan submissions.”  Large Banking Organizations, however, will need to reflect in their capital plan and stress tests the increased requirements under the Basel III Rule for the leverage ratio, the tier 1 capital ratio and the total risk-based capital ratio.  The First Interim Final Rule also discusses when a Large Banking Organization “would estimate its minimum regulatory capital ratios using the advanced approaches for a given capital plan and stress test cycle.”

The FRB’s second interim final rule, “Annual Company- Run Stress Tests at Banking Organizations with Total Consolidated Assets of More than $10 Billion but less than $50 Billion; One Year Transition Period to Revised Regulatory Capital Framework for 2013-2014 Stress Test Cycle” (the “Second Interim Final Rule”) provides a one-year transition period for intermediate-sized banking organizations, those with total consolidated assets of more than $10 billion but less than $50 billion (“Intermediate-Sized Banking Organizations”) during which they may conduct stress tests (which will be the first set of stress tests submitted to the FRB by Intermediate-Sized Banking Organizations) using the FRB’s current capital rules without reflecting the changes in the Basel III Rule.  The FRB stated that this delay in requiring Intermediate-Sized Banking Organizations to use the Basel III Rule framework is intended to allow such organizations sufficient time “to adjust their internal systems to the revised capital framework.”  Intermediate-Sized Banking Organizations will be required to reflect the Basel III Rule in the stress testing cycle that will begin on October 1, 2014.  The FRB also makes it clear that a state member bank with more than $10 billion in assets but that is a subsidiary of a bank holding company with $50 billion or more of total consolidated assets will be required to reflect the Basel III Rule requirements in the same manner as its parent bank holding company and will not be able to avail itself of the one-year transition period provided to Intermediate-Sized Banking Organizations in the Second Interim Final Rule.

Both the First Interim Final Rule and the Second Interim Final Rule became effective on September 30, 2013 and comments on both rules are due no later than November 25, 2013.

SEC Reopens Comment Period on Proposed Amendments to Regulation D Requiring Additional Reporting and Disclosure for Private Offerings

The SEC reopened the comment period on its proposal to create additional reporting and disclosure obligations with respect to private offerings in reliance on Regulation D, including the new Rule 506(c) offerings under which an issuer may engage in general solicitation and general advertising.  The SEC’s proposal was described in the July 23, 2013 Financial Services Alert.  The SEC reopened the comment period to allow “the public additional time to consider thoroughly the matters addressed by the release and comments submitted to date and to submit comprehensive responses would benefit the Commission in its consideration of final rules.”  The reopened comment period will end 30 days after the announcement of the SEC’s action is published in the Federal Register.

National Futures Association Advises Commodity Pool Operators on Prohibited Loans

The National Futures Association (the “NFA”) issued a notice advising its members that amendments to its Compliance Rule 2-45 and a related Interpretive Notice became effective on September 13, 2013.  Compliance Rule 2-45 prohibits a commodity pool operator (“CPO”) from making a direct or indirect loan or advance of pool assets to the CPO or any other affiliated person or entity.  The NFA has determined that Compliance Rule 2-45 was not intended to prohibit certain transactions that are entered into in the ordinary course of business by funds managed by certain CPOs that were previously exempt from registration prior to December 31, 2012.  Accordingly, the NFA amended Compliance Rule 2-45 to provide that certain transactions specified in the Interpretive Notice are permitted despite having characteristics similar to a loan.

Other Applicable Compliance Rules.  The Interpretive Notice notes that under NFA’s existing compliance rules, any such arrangements must be consistent with a pool’s current disclosure document or offering materials, and both the loan(s) or advance(s) and the related conflicts of interest must be fully disclosed to pool participants.   In addition, NFA’s rules require a loan or advance to be secured by marketable, liquid assets (e.g., a CPO participant’s pro rata interest in the pool’s liquid assets).

Types of Pools.  The Interpretive Notice specifies certain types of pools that a CPO may cause to engage in enumerated transactions (specified below) without violating Compliance Rule 2-45.   The Interpretive Notice applies with respect to a pool that is:

  • a registered investment company (“RIC”),
  • a business development company (“BDC”),
  • exempt pursuant to CFTC Regulations 4.7 or 4.13(a)(3),
  • excluded from registration pursuant to Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (the “1940 Act”), or
  • securities registered under the Securities Act of 1933. 

Types of Transactions.  The enumerated transactions are:

  • certain securities borrowings/securities loans pertaining to short sales, provided that no later than the close of business on the day of the securities loan, the pool lending the security has received from the pool borrowing the security collateral with a market value at least equal to the market value of the borrowed security;
  • securities loans in which a pool lends securities to an affiliate as part of a prime brokerage service, and receives cash based on the market value of the securities lent, provided that: (i) the transaction is cleared by an affiliated prime broker that is registered with the SEC as a broker-dealer, and is a member of FINRA, the Depository Trust Company and the National Securities Clearing Corporation; and (ii) the transaction is documented under an Master Securities Loan Agreement;
  • a direct or indirect debt or equity investment by a pool in a subsidiary or other affiliated entity for tax, legal, regulatory, or other reasons coupled with a guarantee  or other credit support (e.g., a pledge of collateral) in accordance with the pool’s relative investment, provided that a pool is not liable for an amount that is materially above its proportionate share (based on the pool’s relative investment in the guaranteed entity from time to time);
  • repurchase agreements and reverse repurchase agreements among affiliated pools in which there is a sale of securities combined with a contemporaneous agreement for the seller to buy back the securities at a later date at a higher price (which the Interpretive Notice states do not violate Compliance Rule 2-45 because the buyer’s possession of the securities effectively collateralizes its exposure in respect to the seller’s obligation to repurchase the securities);
  • tax-related loans, advances, or distributions by a pool to its CPO or a related party, provided that (a) such distributions are made in strict accordance with the provisions of the pool’s organizational documents that expressly permit the distribution and (b) certain other conditions are met; and
  • transactions by a CPO operating a pool that is a RIC or BDC that are permitted by (1) the 1940 Act and its exemptive rules, (2) an exemptive order issued by the SEC, or (3) a no‑action letter issued by the SEC staff under Section 17 or Section 57 of the 1940 Act.

Transactions Outside the Exceptions – Notice Obligation.  The Interpretive Notice provides that a CPO whose pool is involved in a direct or indirect loan or advance of pool assets that falls outside the exceptions described in the Interpretive Notice must notify the NFA of the arrangement by October 13, 2013 .  Persons that become NFA member CPOs in the future must notify the NFA of such arrangements within thirty days of becoming an NFA member CPO.

OCC and FinCEN Take Enforcement Actions and Assess Civil Money Penalty Against Small Bank for BSA/AML Violations

The OCC entered into a consent order with a small, New Jersey-based bank with approximately $118 million in total assets for violations of the Bank Secrecy Act (the “BSA”).  The OCC assessed a civil money penalty (“CMP”) against the bank of $4.1 million.  The consent order and CMP come after the OCC’s examination and investigation of the bank’s anti-money laundering (“AML”) compliance programs, in which the OCC found deficiencies in the bank’s former foreign correspondent business with casas de cambios (“CDCs”).  The OCC found that, among other deficiencies, the bank failed to adequately monitor more than $1.5 billion of dollars of wire transfer activity in CDC accounts, failed to comply with the statutory requirements regarding customer due diligence and enhanced due diligence of the CDCs, and filed over 190 untimely SARs involving suspicious transactions conducted through the bank.  The OCC previously took enforcement action against the bank in 2011 related to similar violations in which the bank was required to undertake remedial actions with respect to its BSA/AML compliance program.

In a separate action, the Financial Crimes Enforcement Network (“FinCEN”) took an enforcement action against the bank for related BSA/AML compliance violations. FinCEN found that the bank was “deficient in all four pillars” of the requirements of the Bank Secrecy Act.  In particular, FinCEN found that since June 2009, the bank lacked an effective AML program, failed to adequately and timely report suspicious activities in the Mexican and Dominican Republic CDC accounts, and failed to conduct adequate due diligence on foreign correspondent accounts.  Of particular import to FinCEN was the fact that information concerning the heightened risk of the foreign correspondent accounts was publicly available. FinCEN pointed to its 2006 advisory notifying financial institutions of the potential threat of narcotics-based money laundering between Mexico and the United States; and in particular, the risk to financial institution posed by transactions with CDC accounts.

FinCEN also imposed a CMP of $4.1 million against the bank, but the OCC and FinCEN actions were collectively deemed satisfied by the bank making one $4.1 million payment to the U.S. Treasury.