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Vol. 1 No. 39
Goodwin, Procter & Hoar LLP, a firm of over 350 lawyers, has one of the largest financial services practices in the United States. We have created the Financial Services Alert as a service to advise our clients as well as other financial institutions and financial services companies to news of importance to the industry in a timely manner. Some issues of the Alert, such as this one, will principally summarize significant recent developments in financial services law and regulation. Other issues will provide more indepth analysis about specific areas of financial services law. We hope that you will find the Financial Services Alert to be helpful. We welcome your suggestions for future topics of interest.
Developments of Note
SEC Finalizes Amendments to Shareholder Proposal Rules; Extends Custody Rule Effective Date
Shareholder Rules. The SEC finalized its amendments to controls regarding shareholder proposals. The final rule, which is the first SEC rule in the "plain-English" question and answer format, reverses the SEC's position in its 1992 Cracker Barrel no action letter concerning employment-related shareholder proposals raising social policy issues. In Cracker Barrel, the SEC determined that employment-related shareholder proposals raising social policy issues generally would be excludable under the "ordinary business" exclusion. Instead, the SEC has decided to return to its case-by-case approach as to whether the ordinary business exclusion is warranted. That exclusion rests on two fundamental considerations: (1) certain tasks are so central to management's ability to run a company on a day-to-day basis that they should not be subject to direct shareholder oversight; and (2) shareholders cannot "micro-manage" the company by probing into matters of a complex nature upon which shareholders would not be in a position to make an informed judgement.
The final rule also provides clearer guidelines for a company's exercise of discretionary voting authority in connection with annual shareholder meetings. If a stockholder elects not to use the SEC procedures to place a proposal in a company's proxy materials, the company can have discretionary voting authority over a timely-submitted shareholder proposal if: (1) the company advises shareholders of the proposal in its proxy materials; and (2) the company has not received advance notice that the shareholder intends to solicit the percentage of shareholder votes required to carry the proposal, followed by specific evidence that the requisite percentage has actually been solicited. The proposed requirement of a separate voting box on the company's proxy card for such shareholder proposals was not adopted. The final rules also amend elements of the requirements for a shareholder to have a proposal included in the company's proxy statement, including increasing the required dollar value of stock the shareholder must hold to $2,000. The SEC declined, among other things, to: (1) increase the percentage of the vote a proposal needs before it can be resubmitted in future years, and (2) streamline the exclusion for matters considered irrelevant to corporate business.
Custody Rule Extension. The SEC also extended the date by when mutual funds must comply with most of the provisions of the May, 1997 amendments to Rule 17f-5. Rule 17f-5 governs the custody of investment company assets outside of the United States. The May, 1997 amendments primarily have expanded the class of foreign banks that are eligible to serve as custodians and have permitted fund directors to play a more traditional oversight role with respect to the custody of fund assets. The delay is in part to allow the mutual fund industry and the large U.S. banks that serve as foreign custodians to resolve certain differences over foreign custody arrangements that involve compulsory depositories. The new compliance date is February 1, 1999, except for the amended definition of "eligible foreign custodian," which remains June 16, 1998. Thus, until February 1, 1999, mutual funds may elect to comply with (1) old Rule 17f-5 (with the exception of the definition of eligible foreign custodian) or (2) amended Rule 17f-5. On and after February 1, 1999, they must comply with amended Rule 17f-5.
FDIC Issues Guidance on Interest Charges by Branches of Interstate State Banks
The FDIC issued an opinion addressing the applicability of state laws to interest charges on loans of state-chartered banks that operate through multi-state branches. More particularly, the opinion addresses: (1) where interstate state banks are "located" for purposes of federal law; (2) which state's interest provisions should govern the interest charged on a loan (i.e., those of the host state where an out-of-state branch is located, or the home state where the bank is chartered); and (3) the need for an appropriate disclosure to the customer that the loan is governed by applicable federal law, and the state law that will govern the loan. Essentially, the newly issued opinion seeks to afford state banks the same flexibility as national banks under Section 85 of the National Bank Act, which permits a national bank to "export" interest charges allowed by its home state to out-of-state borrowers. In reviewing the several recent interpretations by the OCC, FDIC General Counsel Bill Kroener concurred with each and embraced the three-part non-ministerial function analysis therein developed to avoid uncertainty regarding which state's interest rates apply to a particular loan. That is, a bank in one state (i.e., its "home state") that (1) approves a loan, (2) extends the credit, and (3) disburses the proceeds to a customer in another state, may apply the law of its home state even if the bank has a branch or agent in the other state and even if that branch or agent performed some ministerial functions such as providing credit card or loan applications or receiving payments. The agency opinion also indicates that state banks should make appropriate disclosures to the customer that the interest rate to be charged is governed by applicable federal law and by the law of the relevant state which will govern the application. Presumably, deference to the agency's analysis by the courts should ensue in light of the FDIC's supervisory role over state banks under the federal law.
Court of Appeals Rules Force Placed Car Insurance Premiums Not "Interest"
The Court of Appeals for the Seventh Circuit considered and rejected a borrower's assertion that the insurance premiums added by the bank to the borrower's automobile loan constituted "interest" and the loan therefore was usurious. Under the borrower's financing documents he was required to have the car insured. When he defaulted on that obligation, the national bank enforced the provision of the loan agreement that permits it to purchase insurance ("force placed insurance") and bought insurance for the car and added the amount of the insurance premiums to the principal debt. In citing an OCC Interpretive Ruling (7.4001), the Court noted a distinction between fees which compensate a bank for extending credit (which generally constitute interest), and fees, such as force placed insurance, that reimburse the bank for actual expenses associated with the loan (which generally do not constitute interest). The Court further declared that a default under which the creditor bank is merely reimbursed for expenses caused by the default generally should not be deemed interest because the bank is not enriched by the charge. The Court expressly declined to consider whether any markup or profit which a bank could earn on force placed insurance would constitute interest. Richardson v. National City Bank of Evansville.
FDIC Simplifies Deposit Insurance Rules
The FDIC finalized rules designed to simplify certain of its deposit insurance rules regarding fiduciary and agency accounts, the treatment of revocable living trusts held pursuant to a "living trust" agreement, and the continuation of insurance upon the death of a depositor. The changes generally are intended to ease or clarify the application of the general federal deposit insurance principle that different categories of account ownership by an account holder are entitled to separate deposit insurance coverage. As to the fiduciary and agency accounts, rather than requiring the deposit account records to specifically reference the existence of a fiduciary relationship (as well as the parties thereto), the final rule permits the FDIC, in its sole discretion, to determine that the titling of a deposit account and maintaining the underlying deposit account records as a fiduciary account, if done in good faith, sufficiently indicates the existence of a fiduciary relationship for pass-through treatment. For example, the revised regulation states that if the deposit account is held by an escrow agent the pass-through deposit insurance rules may apply despite the fact that the deposit account records themselves merely indicate the escrow agent is the depositor. Similarly, the final rules have eased the recordkeeping requirements for pass-through treatment to apply to multi-tiered fiduciary accounts, permitting the depository institution to merely indicate on the account records the existence of multiple levels of fiduciary accounts and declare the existence of records about additional levels maintained in good faith. As to living trusts, the final rules clarify that although a living trust generally will be insured as to each beneficiary named in the account, pass-through treatment will not be provided if the living trust includes a "defeating contingency" (i.e., a condition that would prevent a beneficiary from acquiring a vested and noncontingent interest in the account upon the owner's death). Finally, as to continuing deposit insurance in event of death, the final rules provide a grace period by declaring that the death of a deposit owner will not impact insurance coverage of the decedent's accounts for a period of six months following death unless the deposit account is otherwise restructured. This change is principally intended to enhance insurance coverage of deposit accounts with survivorship rights. The final rule becomes effective July 1, 1998.
FFIEC Issues Y2K Contingency Planning and Customer Awareness Guidance
The FFIEC issued interagency guidance on customer awareness and contingency in planning in connection with Year 2000 ("Y2K") issues.
Customer Awareness. The FFIEC declared that the financial institutions are expected to develop a customer awareness program addressing questions and communications with customers on Y2K matters. The guidance also declares that financial institutions should identify customers who should be informed proactively of efforts to address business concerns arising from Y2K issues and the most effective way of communicating with various types of customers. For example, the guidance suggests providing informational brochures, establishing a toll free hotline, or holding seminars to address customer issues, and recommends that banks consult with legal counsel before issuing information regarding Y2K efforts. The FFIEC also suggested potential areas of customer inquiries, including the safety of money in their accounts, whether they should withdraw cash before December 31, 1999, how the bank will assist any customers who may be affected by Y2K issues, recordkeeping practices, and other types of records customers should maintain prior to and after January 1, 2000. The FFIEC also noted that it will be distributing to banks a consumer brochure regarding the Y2K challenge in June, 1998.
Contingency Planning. The FFIEC also issued guidance on financial institution Y2K contingency planning (i.e., developing options if any or all of the institution's systems fail or cannot be made Y2K ready). The guidance states that banks should design Y2K contingency plans to mitigate risks associated with both (1) the failure to successfully meet renovation, validation or implementation of its Y2K readiness plan; and (2) the failure of systems at critical dates. As to the second risk, the guidance states that Y2K business resumption contingency planning should consist of four phases: (1) establishing planning guidelines that define the strategy; (2) completing a business impact analysis (i.e., assessing the impact of mission critical systems failures on core businesses); (3) based on the impact analysis, developing a contingency plan that establishes a timeline for implementation and action, circumstances and trigger dates for activation; and (4) developing a method of validation of the viability of the contingency plan.
OCC Proposes Amendments to Accounting for Fees and International Loans
The OCC proposed to amend its rules concerning international lending activity to eliminate the discussion concerning the particular accounting method to be followed in accounting for various fees and international loans, and instead require that national banks follow generally accepted accounting principles ("GAAP") when accounting for the fees. The OCC noted that the federal banking agencies had considered applying GAAP when rules concerning international loan fees were first published in 1984, but at that time the FASB had not issued a pronouncement or standard on the issue. Since that time FASB has revised the GAAP rules with respect to fee accounting for international loans in a manner that accommodates the requirements of the federal law. Comments on the proposal are due on or before June 5, 1998.
Massachusetts Enacts Insurance Legislation
On May 22, 1998, Governor Paul Cellucci signed into law a bill generally granting Massachusetts banks the authority to sell insurance products. A detailed description of the bill will be subject of a future issue of the Alert.
Congress/Administration Propose Curbing REIT Liquidation Benefits
The Administration and leaders of both houses of Congress have proposed legislation that would limit the tax benefits available through the liquidation of real estate investment trust subsidiaries. The legislation, if enacted, would require assets received from such liquidations to be treated as dividends, rather than tax free liquidated assets. The proposed effective date of the legislation is May 22, 1998.
Other Items of Note
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