Financial Services Alert - April 5, 2011

On March 29, 2011, the FDIC’s Board of Directors issued a proposed rule (the “Proposed Rule”) outlining the information bank holding companies with assets of $50 billion or more and systemically significant nonbank financial companies (“Covered Companies”) must include in required resolution plans – so-called “living wills.”  Section 165 of the Dodd‑Frank Act (the “Act”) requires that Covered Companies periodically submit resolution plans and report significant credit exposures.  The intent of this provision is to require Covered Companies to provide a roadmap to allow for a more rapid and orderly dissolution of the Covered Company, if necessary, with the goal of ending “too big to fail.”  The Proposed Rule is based on the resolution plans found in Chapter 11 bankruptcy proceedings. 

The Proposed Rule requires Covered Companies to disclose extensive information on an annual basis in their resolution plan.  U.S. based Covered Companies are required to provide information on their domestic and foreign operations, while foreign-based Covered Companies are required to include only U.S. based operations in their resolution plan.  The Proposed Rule would require that Covered Companies file resolution plans within 180 days of the effective date of the final rule and thereafter submit a revised resolution plan 90 days after the end of every calendar year.  In addition, a revised resolution plan must be submitted no more than 45 days after a change to the Covered Company’s business that could have a material impact on the Covered Company’s resolution plan, including, among other changes (i) a significant acquisition or sale, (ii) a material reorganization or loss of a material contract, (iii) a transfer or relocation of 5% or more of the total domestic assets of the Covered Company to a location outside the U.S. and (iv) a reduction in the market capitalization or book value of the consolidated capital of 5% or more of the Covered Company.

A Covered Company’s resolution plan is required to include, among other disclosures:

• An integrated analysis of the Covered Company’s corporate structure, including a hierarchical list of organizations, jurisdiction information and ownership disclosures.  The plan must also describe the interconnections and interdependencies among the Covered Company’s entities and affiliates.
• A description of the Covered Company’s corporate governance structure, including (i) how resolution planning is incorporated into such governance structure and (ii) the identity of the senior management official responsible for overseeing the development and maintenance, implementation and filing of the resolution plan and compliance with the Proposed Rule.
• A mapping of core business lines, funding, liquidity, critical service support and other resources to legal entities and a description of how those core business lines could be resolved and transferred to potential acquirors, with emphasis on external service level agreements that provide services essential to the continued operation of the core business lines and critical operations.
• An unconsolidated balance sheet and information regarding material assets, liabilities, hedges, derivates capital and funding sources and major counterparties.  Assets and liabilities should be mapped to material entities with location information.  Material trading, payment, clearing and settlement systems utilized should be included.  The resolution plan should also describe the systems and processes used to compile the resolution plan.
• An analysis of the impact of the bankruptcy of a major counterparty on the financial health of the Covered Company, including whether such counterparty failure would result in the material financial distress or failure of the Covered Company or any entity thereof.
• A demonstration of how critical business operations would survive in an environment of material financial distress or the failure or insolvency of one or more legal entities within the Covered Company.
• An accounting of the Covered Company’s credit and other exposures.
• A summary of the Covered Company’s strategic plan.
• A strategic analysis of how the resolution plan can be implemented to facilitate an orderly resolution, including how the Covered Company would be resolved under the Bankruptcy Code.
• For Covered Companies with foreign operations, the resolution plan should identify the risks related to its foreign operations and the Covered Company’s strategy for addressing such risks, including practical responses to the complications created by differing national laws and regulations.  The plan should also provide information regarding the ability to maintain foreign core business lines in the event of financial distress or insolvency.
• The resolution plan must demonstrate that service level agreements will survive insolvency.

A Covered Company will be informed if its resolution plan contains the necessary information within 60 days of submission.  If the plan is accepted, the FDIC will thereafter review such plan for deficiencies and require that the Covered Company correct any identified deficiencies.  The Covered Company will generally have 90 days after notice of such deficiencies to submit a revised plan.  The revised plan must: (i) describe the revisions to the deficiencies identified; (ii) describe any changes to the Covered Company’s business operations and corporate structure that the Covered Company proposed to take to implement the revised plan; and (iii) explain why the revised plan is credible and would result in an orderly dissolution of the Covered Company.  Failure to adequately cure deficiencies on resubmission of a resolution plan or failure to file a revised plan may result in more stringent capital, leverage or liquidity requirements or restrictions on growth, activity or operations.  If the Covered Company fails, within the two-year period following the imposition of such sanctions, to submit a revised resolution plan that adequately remedies the identified deficiencies, the FDIC and the FRB may order the Covered Company to divest assets or operations as the FDIC and the FRB jointly determine is necessary to facilitate an orderly resolution of the Covered Company under the Bankruptcy Code.

Covered Companies must request confidential treatment of their resolution plans or risk public disclosure.

In addition, the Proposed Rule requires that Covered Companies file Credit Exposure Reports quarterly.  These reports should detail (i) the nature and extent of the Covered Company’s credit exposures to significant bank holding companies and significant nonbank financial companies with exposure to the Covered Company and (ii) the nature and extent of credit exposures of significant bank holding companies and significant nonbank financial companies to the Covered Company.

Comments on the proposed rule are due no later than 60 days after its publication in the Federal Register.

The SEC issued a rulemaking proposal (the “Proposal”) that is designed to implement provisions of Section 952 of the Dodd-Frank Act, which added new Section 10C to the Securities Exchange Act of 1934 (“1934 Act”).  Section 10C requires the SEC to adopt rules directing the national securities exchanges and national securities associations to prohibit the listing of any equity security of an issuer that is not in compliance with Section 10C’s requirements regarding compensation committees and compensation consultants, legal counsel and other advisers retained by a compensation committee (“compensation advisers”).  The Proposal would direct national securities exchanges to establish listing standards that impose independence standards on a compensation committee’s members and on its compensation advisers and that require a compensation committee to have the authority to engage, oversee and compensate compensation advisers.  The Proposal would also revise the disclosure requirements for proxy materials relating to the election of directors at an annual meeting to include additional disclosures regarding a compensation committee’s use of a compensation consultant.  Current SEC rules do not require, and the Proposal would not mandate, that an issuer establish a compensation committee.  However, current national securities exchange listing standards generally require listed issuers either to have a compensation committee or to have independent directors determine, recommend or oversee specified executive compensation matters.  Principal provisions of the Proposal are summarized below.

Compensation Committee Independence.  The Proposal would require national securities exchanges to establish listing standards that require each member of a listed issuer’s compensation committee (or such other committee that determines executive compensation) to be a member of the board of directors and to be “independent.”  The term “independent” is not defined by federal statute or by the Proposal.  Instead, the term “independent” is to be defined by the national securities exchanges after taking into consideration “relevant factors,” such as (1) the source of compensation of a member of the board of directors of an issuer, including any consulting, advisory, or other compensatory fee paid by the issuer to such member of the board of directors, and (2) whether a member of the board of directors of an issuer is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer. 

Retention, Oversight and Compensation of Compensation Consultants.  The Proposal would direct the national securities exchanges to prohibit the listing of any security of an issuer that is not in compliance with the following requirements relating to compensation committees and compensation advisers: (1) a compensation committee must have the authority, in its sole discretion, to retain or obtain the advice of compensation advisers; (2) before selecting any compensation adviser, a compensation committee must take into consideration specific factors identified by the SEC that may affect the independence of compensation advisers; (3) a compensation committee must be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser; and (4) a listed issuer must provide appropriate funding for the payment of reasonable compensation, as determined by its compensation committee, to compensation advisers.

Exemptions.  Under the Proposal, the following five categories of issuers would be exempt from the listing standards regarding compensation committee independence:  controlled companies, limited partnerships, companies in bankruptcy proceedings, open-end management investment companies registered under the Investment Company Act of 1940 and certain foreign private issuers.  The proposed rules would also permit an exchange to exempt additional categories of issuers from the independence requirements and create exemptions for types of relationships between compensation committee members and an issuer that might otherwise be viewed as impairing a committee member’s independence.

Proxy Disclosure.  Section 10C(c)(2) of the 1934 Act requires the SEC to adopt new proxy disclosure requirements concerning the use of compensation consultants and related conflicts of interest.  The SEC proposes to implement this mandate by revising existing disclosure requirements regarding the use of compensation consultants in Item 407(e) of Regulation S-K.  The proposed revisions would require disclosure, in any proxy or information statement relating to an annual meeting of shareholders at which directors are to be elected (or special meeting in lieu of the annual meeting), of whether the issuer’s compensation committee retained or obtained the advice of a compensation consultant; whether the work of the compensation consultant has raised any conflict of interest; and, if so, the nature of the conflict and how the conflict is being addressed.

Implementation Schedule.  The Dodd-Frank Act requires the SEC to adopt final rules related to Section 10C by July 16, 2011.  The SEC proposes to require each exchange to submit a rule proposal within 90 days of the date of publication of the SEC’s final rules relating to Section 10C and require each exchange to secure final SEC approval of the exchange’s implementing rule changes within one year of that publication date.  Compliance with the proposed proxy disclosure requirements would not be required for proxy or information statements filed in definitive form prior to the effective date of the proposed implementing rules.

Comment Deadline.  The deadline for commenting on the Proposal is April 29, 2011.

On March 30, 2011 Goodwin Procter’s ERISA Litigation Practice published the latest edition of its quarterly ERISA Litigation Update.  In addition to discussing recent district court and appellate decisions, the Update describes Department of Labor initiatives that could affect future ERISA litigation.

On March 31, 2011, the FRB made information publicly available concerning its emergency lending and financial assistance to private companies during the financial crisis of 2008.  The FRB had initially sought to retain the confidentiality of this information, but in the aftermath of successful challenges in the federal courts by news organizations that sought disclosure by the FRB of such information under the Freedom of Information Act, the FRB made the information publicly available.

The Financial Crisis Enforcement Network (“FinCEN”) issued an advisory (the “Advisory”) to alert financial institutions (“FIs”) to ways in which they can better assist law enforcement agencies when the FIs file Suspicious Activity Reports (“SARs”) concerning potential incidents of commercial real estate fraud.  The Advisory provides examples of common types of commercial real estate fraud schemes and suggests that FIs use the key term “CREF” when reporting incidents of commercial real estate fraud on a SAR.

The OCC issued a bulletin (the “Bulletin,” OCC 2011-11) that provides guidance on risk management to national banks that delegate responsibility for investment management of collective investment funds (“CIFs”) to a third party such as a registered investment adviser.  The Bulletin stresses that a bank must continue to oversee the administration of the CIF and that the bank’s delegation of CIF management to a third party “does not, in any way, relieve the bank of its responsibility as fiduciary.”  In addition, the Bulletin provides guidance to banks that delegate CIF management to third parties regarding OCC supervisory expectations as to the bank’s risk assessment of, due diligence with respect to, written contracts with, and continuing oversight of, the applicable third party vendor.