Financial Services Alert - June 21, 2011

Two recent notices issued by the Internal Revenue Service (the “IRS”) and the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) have extended the deadline for filing Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (“FBAR”) by certain individuals with signature authority over, but no financial interest in, foreign financial accounts.

IRS Notice 2011-54

IRS Notice 2011-54 provides additional administrative relief to persons whose requirement to file an FBAR to report signature authority over foreign financial accounts held during calendar year 2009 or earlier calendar years was previously deferred.  In Notice 2010-23, which modified and supplemented Notice 2009-62, the IRS and the Treasury Department had extended until June 30, 2011, the deadline for filing FBARs for 2010 and prior years for individuals with signature authority over, but no financial interest in, foreign financial accounts.  (Notice 2009-62 was discussed in the August 10, 2009 Goodwin Procter Alert; Notice 2010-23 was discussed in the March 8, 2010 Goodwin Procter Alert.)

In light of reported difficulties that such individuals are having in compiling the information needed to file complete and accurate FBARs with respect to the 2009 or earlier calendar years by the June 30, 2011 deadline, however, the IRS and FinCEN have provided the following additional administrative relief in Notice 2011-54:  Persons having signature authority over, but no financial interest in, a foreign financial account in 2009 or earlier calendar years will now have until November 1, 2011, to file FBARs with respect to those accounts. 

Notice 2011-54 states that the deadline for reporting signature authority over, or a financial interest in, foreign financial accounts for the 2010 calendar year remains June 30, 2011.  The administrative relief provided in this Notice, however, does not limit the relief provided in FinCEN’s Notice 2011-1 (Revised), which was discussed in the June 7, 2011 Alert.  In addition, it does not limit the relief provided in FinCEN Notice 2011-2, discussed below, which was issued after the publication of Notice 2011-54.

FinCEN Notice 2011-2

FinCEN Notice 2011-2 has been issued to provide administrative relief in the case of officers or employees of investment advisers registered with the SEC who have signature or other authority over, but no financial interest in, certain foreign financial accounts.  This FinCEN Notice relates to certain exceptions provided in the Final Rule issued by FinCEN that went into effect on March 28, 2011.  (The Final Rule was discussed in the March 1, 2011 Alert.)  One of those exceptions applies to officers and employees of Authorized Service Providers who have signature or other authority over, but no financial interest in, a foreign financial account owned or maintained by an investment company that is registered with the SEC.  “Authorized Service Provider” means an entity that is registered with and examined by the SEC (such as a registered investment adviser) and that provides services to an investment company registered under the Investment Company Act of 1940 (“registered investment company”). 

Following the release of the Final Rule, FinCEN received questions about processing issues in filing the FBAR by the June 30, 2011 compliance date in the case of officers and employees of registered investment advisers when such individuals have signature or other authority over, but no financial interest in, the foreign financial accounts of persons that are not registered investment companies.  In light of these questions, FinCEN has issued FinCEN Notice 2011-2, granting an extension of the filing date to June 30, 2012, to allow officers and employees of registered investment advisers with signature or other authority over, but no financial interest in, the foreign financial accounts of persons that are not registered investment companies additional time to file FBARs.  The extension is applicable to FBARs for calendar year 2010 and FBARs for calendar year 2009 or earlier calendar years for which the filing deadline was properly deferred under Notice 2009-62 or Notice 2010-23.

The FRB, OCC and FDIC approved a final rule (the “Final Rule”) implementing certain provisions of Section 171 of the Dodd-Frank Act (commonly known as the Collins Amendment).  The Final Rule is being implemented as originally proposed in December 2010 (the “Proposed Rule”).  For more information regarding the Proposed Rule, please see the December 21, 2010 Alert.

Specifically, the Final Rule amends the “advanced approaches rule” of Basel II, as implemented in the United States, by removing the transitional floor periods in the advanced approaches rule and setting the generally applicable risk-based capital requirements as a permanent floor.  As a result, banking organizations operating under the advanced approaches rule must meet the higher of the minimum requirements under those rules and under the generally applicable risk-based capital rules.

The Final Rule also provides increased flexibility for the FRB in establishing appropriate capital requirements for certain low-risk exposures that generally are not held by banks, but may be held by bank holding companies or nonbank financial companies.  More specifically, the Final Rule allows banks, in limited circumstances, to use the capital requirements applicable to bank holding companies.  These circumstances are limited to situations where a bank could not hold the asset except under special authority, and the asset has a risk profile lower than other assets receiving a risk-weight less than 100%.

The Final Rule will be effective 30 days after its publication in the Federal Register, which is expected soon.

The North American Securities Administrators Association (“NASAA”), a voluntary organization of securities agencies across the United States, Canada and Mexico, has released a revised version of its proposed model rule (the “Revised Proposal”) that would generally exempt investment advisers from the obligation to register at the state level, if the advisers: (i) are not subject to disqualification based upon their prior disciplinary history; and (ii) solely advise funds that are excluded from the definition of “investment company” under Section 3(c)(7) or, in certain cases, Section 3(c)(1) of the Investment Company Act of 1940 (the “1940 Act”).

The Revised Proposal’s registration exemptions are broader than in NASAA’s original December 10, 2010 proposal (discussed in the February 1, 2011 Alert) primarily because the Revised Proposal exempts advisers to 3(c)(1) funds that either: (i) qualify as “venture capital funds” (to be defined by the SEC in regulations that the SEC is expected to adopt at its June 22 open meetings (as discussed in the June 14, 2011 Alert)); or (ii) admit only investors that are “qualified clients” (as defined in the Investment Advisers Act of 1940) (so long as the adviser also makes certain disclosures to those investors when they invest and delivers annual audited financial statements to them).  The Revised Proposal also includes what NASAA describes as an “optional grandfathering provision” designed to allow states that currently provide a registration exemption for advisers to 3(c)(1) funds to offer a continuing exemption for advisers to 3(c)(1) funds that include non-“qualified client” investors, provided those investors were admitted prior to the adoption of the Revised Proposal.  Under the Revised Proposal, advisers exempt from state registration obligations would still be required to make certain state notice filings and pay state filing fees. 

Despite the fact that it would provide broader exemptive relief at the state level than NASAA’s original proposal, uncertainty remains around the interaction between the Revised Proposal (to the extent it is adopted by the states relevant to a particular adviser’s business) and the relevant final SEC regulations, particularly because the SEC has not finalized its rulemaking.

NASAA is considering any comments on the Revised Model Rule before finalizing its proposal.  The deadline for submitting comments is July 13, 2011.  Once NASAA finalizes the Revised Proposal, one or more states may choose to formally adopt it (as proposed or in modified form) through legislation, rulemaking or other appropriate means.

On June 9, 2011, the Securities Division of the Secretary of the Commonwealth of Massachusetts (the “Securities Division”) issued a consent order (the “Order”) in settlement of an investigation of a major broker-dealer (the “Firm”).  The Securities Division alleged that, in an effort to generate more revenue to pay for research activities, the Firm developed a practice in which unpublished short-term trading ideas, sometimes varying from published ratings and recommendations, were provided to favored customers following so-called “trading huddles” involving research analysts and traders, and in calls by analysts directly to a particular client’s traders.  The Firm was required to pay a fine of $10 million and to undertake remedial actions specified in the Order.  The Firm admitted certain factual statements but neither admitted nor denied the legal conclusions of the Securities Division.

Background

In 2003, investigations by securities regulatory authorities raised issues concerning whether the research related activities of certain investment banks violated principles of good faith and fair dealing in various respects.  Those investigations arose from claims that research analysts were influenced by the investment banking departments of their firms to produce reports favorable to investment banking clients.  The regulatory authorities alleged that the firms failed to manage conflicts of interest in an adequate or appropriate manner.  Those investigations led to settlements by many such firms, including the Firm.  Statements of management personnel cited in the Order indicate that, following the settlement, the Firm, like other firms with research departments, sought ways to pay for the significant costs associated with producing research.

The Asymmetric Service Initiative

The Order describes an initiative begun at the Firm in 2007, called the Asymmetric Service Initiative, or “ASI”, to deliver enhanced services to certain clients with the hope of leading them to increase their business levels with the Firm.  According to the Order, the Firm developed lists of clients who were prioritized to receive ASI services based on the amount of trading revenue they generated or were expected to generate.  Clients who generated more revenue were moved up the list and clients who generated less revenue than expected were moved down the list.  Clients at the top of the list were contacted by traders at the Firm and provided unpublished research that had been discussed at huddles between research and trading personnel at the Firm.  Priority clients also sometimes received calls directly from research personnel communicating unpublished information.  According to the Order, selective disclosure of unpublished research violated the Firm’s existing policies and procedures.

Findings and Undertakings

The Securities Division based its order on Section 204(a)(2)(G) of the Massachusetts Uniform Securities Act (the “Act”), M.G.L. ch. 110A, which authorizes the Secretary to impose a fine or take other appropriate action if the Secretary finds that the order is in the public interest and that the person has engaged in prohibited conduct.  The Securities Division found that the Firm’s conduct had constituted each of the following:  (i) it had “engaged in … unethical or dishonest conduct or practice in the securities … business;” and (ii) it had “failed reasonably to supervise agents … or other employees to assure compliance with this chapter.”  Significantly, the Order states that it is not to be construed as a finding or admission of fraud under the Massachusetts Act.

In the Order, the Firm agrees to permanently discontinue both the Asymmetric Service Initiative and the trading huddles.  While the Firm is permitted to provide different levels and types of research services to clients based on, among other things, the client’s preferences as to frequency and manner of receiving communications, the client’s risk profile, investment focus and perspective, and the size and scope of the overall client relationship with the Firm, the Firm must disclose information about its different levels and types of services in the Term of Use section of its internal client website.

Reports appearing in the financial press following the announcement of the Order indicate that the SEC and FINRA are also conducting investigations in this area, although neither agency will confirm or deny the existence of any investigation.

The FRB issued an interim final rule (the “Interim Final Rule”) that allows bank holding companies (“BHCs”) organized as S Corps and BHCs organized in mutual form to exclude subordinated debt issued to the Department of the Treasury (“Treasury”) under the Small Business Lending Fund from treatment as debt for purposes of the debt-to-equity standard under the FRB’s Small Bank Holding Company Policy Statement (the “Policy Statement”).  In the same release, the FRB adopted a final rule (the “Final Rule”) that allows S Corp BHCs and mutual BHCs to include in their calculation of Tier 1 capital the full amount (subject to certain limitations) of any subordinated debt securities issued to the Treasury under the Treasury’s Troubled Asset Relief Program (“TARP”).  In the Final Rule, the FRB also allows small BHCs that are S Corps or organized as mutuals to exclude subordinated debt issued to Treasury under TARP from treatment as debt for purposes of the debt-to-equity standard under the Policy Statement.

The Final Rule became effective on June 2, 2011.  Comments on the Interim Final Rule are due by July 30, 2011.

The CFTC issued a proposed order that would provide temporary exemptive relief from certain requirements in the Commodity Exchange Act (the “CEA”) resulting from the Dodd-Frank Act that otherwise become effective on July 16, 2011 under the terms of the Act.  The proposed relief contains two principal elements.  The first would provide a temporary exemption from provisions that reference terms such as “swap,” “swap dealer,” “major swap participant,” or “eligible contract participant” that the Dodd-Frank Act requires the CFTC and SEC to “further define” (which the agencies will not have done by July 16); the exemption would continue until the effective date of final rules defining those terms or December 31, 2011, whichever is earlier.  The second element of the CFTC proposal would temporarily exempt certain transactions (primarily in financial and energy commodities) from certain CEA provisions that will apply as a result of the repeal of various CEA exemptions and exclusions under the Dodd-Frank Act; the exemption would apply until the repeal or replacement of certain CFTC regulations or December 31, 2011, whichever is earlier.  The CFTC is seeking public comment on the proposed order; comments must be received no later than July 1, 2011.

The SEC issued an order providing temporary exemptions from, other temporary relief from and guidance regarding, compliance dates for provisions of the Securities Exchange Act of 1934 that address and regulate security-based swaps as a result of the Dodd-Frank Act.  The SEC has requested public comment on the order subject to a submission deadline of July 6, 2011.

Goodwin Procter’s ERISA Litigation Practice has published its latest quarterly ERISA Litigation Update. The Update discusses a recent U.S. Supreme Court decision addressing two of ERISA’s major remedial provisions, a Seventh Circuit decision involving 401(k) plan fiduciaries’ alleged duty to seek a service provider RFP and a Fourth Circuit decision adopting the fiduciary exception to the attorney-client privilege in the context of relationships governed by ERISA.