Developments of Note
Eighth Circuit Rules National Banks Not Subject to Certain State ATM Laws
The U.S. Court of Appeals for the Eighth Circuit ruled that the National Bank Act preempted enforcement of the Iowa Electronic Funds Transfer Act against national banks. The Court first reasoned that the state law restrictions affecting the location and operation of a national bank’s automated teller machines ("ATMs") are preempted. The Court pointed to federal legislation adopted in 1996 that excludes ATMs from the definition of "branch" for purposes of the McFadden Act, 12 U.S.C. § 36(c), as signaling a Congressional "intention to foreclose the states from imposing location and approval restrictions on a national bank’s ATMs." In addition, the Court struck down the applicability of those provisions of the Iowa statute that prohibit the use of ATMs to advertise individual financial institutions or a group of financial institutions, citing earlier Supreme Court precedent that a state’s attempt to regulate advertisements by a national bank was preempted. The majority opinion specifically acknowledged that recent federal legislation, as explained by the legislative history of the 1996 enactment, was intended to "allow financial institutions to devote additional resources to productive activities, such as making loans, rather than to compliance with unnecessary regulations." The Court expressly determined that the provisions of the federal Electronic Funds Transfer Act that preserve certain state rights to regulate electronic banking did not apply in these circumstances. Bank One, Utah, National Association v. Guttau, No. 98-3166 (8th Cir. Sept. 2, 1999)
NASD Proposes Rules on Communication and Compensation; Updates Guidance
The NASD issued Notices to Members addressing proposed amendments to its provisions regarding public communications and proposed salesperson compensation rules (Notices 99-79 and 99-81, respectively) and also updated its Form U-4 and U-5 Interpretive Guidance.
Communications
. The NASD proposed rules which would substantially modify and simplify its current regulations governing member communications with the public. Among other things, the proposal would exempt from NASD Rule 2210's pre-use approval and filing requirements advertisements and sales literature distributed solely to "institutional investors," which generally are defined as banks, insurance companies, registered investment companies, registered investment advisers, and any other entity or individual with total assets of at least $50 million. The sales materials distributed to beneficiaries of institutional accounts, such as 401(k) plan participants, however, would be treated as retail rather than institutional sales materials. In addition, the proposal would exempt from these requirements all form letters and group e-mails sent to existing retail customers and to fewer than 25 prospective retail customers. The proposal also would exempt from the filing requirements, but not the pre-use approval requirements, article reprints used as sales materials and press releases regarding investment companies that are made available only to members of the media. The proposal also would codify an existing NASD policy by requiring members that have filed a draft version of a "story board" of a television or video advertisement pursuant to a filing requirement also to file a final filmed version within 10 days of the first use or broadcast of the advertisement. Despite member comment, the NASD chose not to propose rules to: exempt mutual fund shareholder reports from the filing requirements, permit electronic filing of communications, or eliminate the requirement that members file a copy of the ranking or comparison used in sales materials that contain rankings. The proposal also would simplify the provisions concerning disclosure of member names by requiring that every member communication that promotes a product or service prominently disclose the member’s name, although a member could disclose a fictional name by which the member is commonly recognized. As to ranking guidelines, the proposal also would make changes to Interpretive Material 2210-3 by eliminating the requirement that certain disclose appear in "close proximity" to any headline or other prominent statement that refers to the ranking, and by modifying the requirement that rankings be based on total returns for 1, 5, and 10 year periods to require instead that the rankings to be based on the total returns for short, medium and long-term periods for investment companies in the same category. The proposal also would substantially revise communications about collateralized mortgage obligations by rewriting Interpretive Material 2210-1. Comments on this proposal are due by October 29, 1999.Compensation
. The NASD also proposed rules prohibiting the payment of higher payout ratios to salespersons for the sale of proprietary investment company products, prohibiting single securities sales contests, and requiring disclosure of accelerated payout arrangements for salespersons who change firms. The NASD issued the proposed rules in response to a 1995 report on compensation practices in the industry known as the Tully Report, which declared that a number of compensation practices exist which may create conflicts of interest. As to the payment of higher commissions for the sale of proprietary products, the proposed rule would prohibit the payment of a higher percentage of gross dealer concessions to representatives for the sale of proprietary investment company securities than the percentage paid for non-proprietary investment securities. As to security sales contests, the proposal prohibits all single securities sales contests, not just those (such as are governed by the Non-Cash Compensation Rules) involving investment companies shares and variable products. Finally, as to accelerated payouts, which are higher commission payouts for a short, specified period of time upon a person moving from one firm to another, the proposal would require the new firm to provide a written disclosure of the existence and general nature of the compensation arrangements to customers whose accounts are being transferred (as well as new customers); the specific compensation formula or amount paid to representatives would not need to be disclosed. Comments on this proposal also are due by October 29, 1999.Interpretive Questions
. The NASD also updated its list of Frequently Asked Questions regarding a member’s obligation to file Forms U-4 or U-5. The interpretive questions contain revisions to many of the answers already provided by the NASD. Among the new questions included are whether (with respect to Form U-4) a registered person must report an oral complaint, and what happens if the oral complaint is resolved with a written settlement for $10,000 or more. The guidance responds that while an oral complaint by itself is not reportable, an oral complaint that alleges a sales practice violation that settles for more than $10,000 is reportable. As to Form U-5, a new question was added regarding the need for affirmative monitoring of all former associate employees to ensure that an NASD member has adequately responded to Questions 16 and 17, which concern criminal or regulatory actions involving a former member that were initiated after the person left the firm but were based on events that occurred while the individual was employed by the firm. To this question, the guidance responds that firms must answer "yes" only if they have "actual notice" of the violation, which generally exists only if the action is based on events in connection with the former associate’s employment.District Courts Rule on Challenges to Mutual Fund Director Independence
The U.S. District Court for the Southern District of New York and the U.S. District Court for the District of New Jersey each dismissed a complaint against a mutual fund’s investment adviser alleging, among other things, violation of the Investment Company Act of 1940 (the "Act") rule that 40% of the directors of funds must be independent. In each case, a principal basis of the plaintiff’s claim was that since the independent directors at issue had served on multiple affiliated fund boards and received substantial fees from the investment adviser for that service, they no longer were independent as required by the Act. In rejecting the plaintiffs’ claims, the Courts noted that plaintiffs had to demonstrate actual control of the independent directors by the adviser or its affiliates to succeed on their claim of the lack of independence of those individuals. A Court stated that even though the governing documents of the funds could permit an investment adviser to exercise strong influence over the funds, such influence actually had to be demonstrated, and serving on the boards of multiple funds might be an indication of the dereliction of the directors’ duties rather than of their lack of independence. Krantz v. Prudential Investment Fund Management LLC; Verkouteren v. Black Rock Financial Management, Inc.
If you would like anyone else to receive issues of the Financial Services Alert, would like to receive any past issues, or would like the background materials for any of the matters discussed above, please contact Greg Lyons by telephone: Boston - (617) 570-1329 or DC - (202) 974-1032; facsimile: Boston - (617) 523-1231 or DC - (202) 331-9330; mail (Boston or DC office) or email ([email protected] ).
The contents of this publication are intended for informational purposes only and should not be construed as legal advice or legal opinion, which can be rendered properly only when related to specific facts. This document may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts. ©GPH LLP 1999
