IRS Rules that Restorative Payments to a Money Market Fund to Avoid "Breaking the Buck" May Be Expensed
The IRS published a technical advice memorandum ("TAM"), Letter Ruling 200247007, permitting a mutual fund operator to expense payments it made to prevent certain money market funds it advised from "breaking the buck" (having their net asset values fall below $1 per share). In the particular case addressed by the TAM, a commercial bank was permitted to deduct payments it made to maintain the $1 net asset value of two of its proprietary money market funds because the bank’s motivation in making the payments was primarily to protect, maintain and preserve its business, not to create long-term benefits for the funds.
The bank was the investment adviser to a number of proprietary mutual funds. An unexpected hike in interest rates caused the value of structured securities offered by U.S. government agencies held by two of its largest money market funds to decline in value. Significant shareholder redemptions required the fund to liquidate holdings at a loss. Within two months, both funds were in danger of breaking the buck. If the bank did nothing and permitted the funds to break the buck, it believed that its reputation and goodwill would be damaged and that it would be subject to lawsuits by fund shareholders. If it purchased troubled fund assets at par and held them to maturity, the bank worried that the transaction would become public and would subject the bank to even bigger losses if interest rates continued to rise, which could result in lawsuits by the bank’s own shareholders. Therefore, the bank decided to make restorative payments to the funds in the aggregate amount of the funds’ realized losses.
The funds treated the restorative payments as capital gains, offsetting the realized losses. The bank expensed the payments. In determining whether this treatment was acceptable or whether the payments should have been capitalized, the IRS focused on the motivation of the bank in making the payments. Based upon the facts in this case, the IRS found that the bank’s primary motivation for the payments was to defend its existing business, not to create a long-term benefit, and so the bank was entitled to expense the cost.
Although the TAM applies only to the taxpayer to which it was addressed, it is indicative of IRS views on restorative payments by a money market fund’s adviser designed to prevent a deviation in the fund’s $1 net asset value. As long as the payments are used for the purpose of defending or preserving an existing business, restorative payments should be tax-deductible when made. Restorative payments are therefore an additional remedial option to consider, along with fee waivers and the purchase of securities at par, if "breaking the buck" becomes an issue for a money market fund.
FRB Proposes Changes to Regulation Z Commentary
The FRB issued proposed revisions to the official staff commentary on Regulation Z, which implements the federal Truth in Lending Act. The proposed revisions are as follows: (1) Expedited Payment Fee: A fee imposed when a consumer requests that a particular payment on its credit plan be expedited should be disclosed as an "other charge" rather than as a "finance charge," and no change in terms notice is required for changes involving such a fee; (2) Expedited Delivery Fee: A fee imposed when a consumer requests expedited mailing of a credit card does not need to be disclosed as either a finance charge nor an other charge; (3) Exceptions to "One-For-One" Rule: A credit card issuer may (i) replace a debit/credit card with a credit card and another card with only debit functions (which may include an overdraft feature), and (ii) replace an accepted card with more than one renewal or substitute card on the same account, subject to certain conditions; (4) Disclosure of Mortgage Insurance Premiums: The commentary provides additional guidance on how to disclose mortgage insurance premiums when some premiums are collected in advance and placed in escrow at the time the loan closed; (5) Determining Coverage under The Home Ownership and Equity Protection Act of 1994 ("HOEPA") : The commentary provides a standard for determining the yield on comparable Treasury securities for purposes of applying the interest rate test in HOEPA, requiring lenders to use the FRB’s "Selected Interest Rates" (statistical release H-15), which is posted on the FRB’s website. Comments on the proposed revisions are due January 27, 2003. The FRB expects to adopt the final revisions in March 2003, with an effective date for mandatory compliance of October 1, 2003.
SBA Expands Investment Authority of SBICs
The Small Business Administration ("SBA") issued a final rule (the "SBA Final Rule") amending its regulations regarding Small Business Investment Companies ("SBICs"). The SBA Final Rule greatly expands the investment authority of SBICs (and indirectly, the investment authority of banking organizations) by amending the provision of the SBA’s regulation (13 C.F.R. § 107.865), which prohibits SBICs from exercising control over the small businesses in which they invest. As amended, this provision now permits SBICs directly (and banking organizations indirectly) to assume control over a small business concern, without notice to the SBA, through the ownership of voting securities, management agreements, voting rights, majority representation on the board of directors, or otherwise. The SBA Final Rule, however, limits the period of control to seven years from the date on which the SBIC initially acquired control (or any earlier date specified by the terms of any investment agreement). Moreover, upon the prior written approval of the SBA, an SBIC may extend its period of control as may be reasonably necessary to complete divestiture of its control or to ensure the financial stability of the portfolio company.
In addition, the FRB informally has stated that the SBA Final Rule does not change the FRB’s position on this matter and that bank holding companies may invest in SBICs as long as such investments are consistent with the conditions of Section 302(b)(1) of the Small Business Investment Act. The SBA Final Rule also amends 13 C.F.R. § 107.885 allowing an SBIC to sell equity securities in a portfolio concern to a competitor of that portfo lio concern. The SBA Final Rule became effective on November 21, 2002.
Federal Banking Agencies Issue Joint Notice Concerning FinCEN’s Moratorium on Governmental Requests for Information under the USA PATRIOT Act
The FRB, FDIC, OCC, OTS and NCUA (the "Agencies") jointly issued a notice (the "Notice") concerning two actions taken by the U.S. Department of the Treasury’s Financial Crimes Enforcement Network ("FinCEN") related to implementation of Section 314(a) of the USA PATRIOT Act ("Section 314(a)") concerning information sharing. FinCEN’s final rule concerning implementation of Section 314(a) became effective on September 26, 2002 (the "Final Rule") and provided a means for law enforcement authorities to "communicate names of suspected terrorists and money launderers to financial institutions in order to promptly locate accounts and transactions involving the suspects." A number of logistical issues and questions have arisen since implementation of the governmental request process enacted by the Final Rule. As a result, FinCEN declared a brief moratorium on new requests by law enforcement authorities. During the moratorium FinCEN and the Agencies will address the issues raised. The Notice also states that FinCEN has advised the Agencies that the FBI will no longer use the "Control List" of persons suspected of involvement in terrorist financing, but instead will use the Section 314(a) process when it requests that financial institutions provide information regarding suspected terrorists and money launderers.
FRB Interprets Anti-Tying Combined-Balance Exception to Include "Households"
The FRB issued an opinion regarding the application of its safe harbor for combined-balance discounts under the anti-tying restrictions of the Bank Holding Company Act Amendments of 1970. The FRB determined that, for purposes of that restriction, members of a household or family taken together may be considered a "customer," so long as they satisfy the definition of "immediate family" set forth at 12 C.F.R. 225.41(b) and res ide at the same address. The interpretation notes that such anaggregation would make it easier to receive favorable pricing on bank products and services and would not appear to create any anti-competitive effects.
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