FDIC Proposes Affiliate Transaction Rules

The FDIC proposed regulations governing transactions between insured state nonmember banks and their affiliates. The proposal is in large part intended to track the FRB’s Regulation W, which became effective in April, 2003. (See the November 5, 2002, Alert for a detailed description of Regulation W). However, the FDIC’s proposal does vary from Regulation W in certain significant ways. First, in a departure from the FDIC’s past practice, the proposal contemplates that the FDIC, rather than the FRB, will interpret, and issue exemptions from, the affiliate transaction rules. Moreover, unlike Regulation W, the FDIC exempts from the affiliate transaction rules (on an initial and ongoing basis) subsidiaries of banks established under Section 24 of FDIA (including subsidiaries that invest in equity and real estate) on or before March 17, 2004. The FDIC believes that conditions generally imposed by the agency on those subsidiaries are sufficient to protect the bank and thus no affiliate transaction rules need apply. Other transactions with "affiliates" as determined by Regulation W should have been in compliance with that regulation concurrently with Regulation W’s effective date. Comments on the proposal are due by May 3, 2004.

The staff of the SEC’s Division of Investment Management granted no action relief to permit the investment advisers (the "Advisers") to certain registered open-end funds (the "Funds") to amend their advisory agreements with the Funds to include performance fee adjustments (the "Fee Arrangements") without seeking the approval of Fund shareholders. The Fee Arrangements would involve a base fee and a performance adjustment that would decrease or increase the advisory fee based on a Fund’s performance relative to an appropriate index of securities prices. The Fee Arrangements would comply with the requirements of Section 205(b)(2) of the Investment Advisers Act of 1940, as amended (the "Advisers Act"), and Advisers Act Rules 205-1 and 205-2. The performance adjustment would increase a Fund’s advisory fee when performance was better than that of the relevant index and decrease the advisory fee when performance fell below that of the relevant index. The Fee Arrangements could not result in an advisory fee greater than that already paid by a Fund. In granting relief, the SEC staff noted several other features of the Fee Arrangements. The Fee Arrangements would comply with Section 15 of the Investment Company Act of 1940, as amended, other than the requirement that Fund shareholders approve them. Each Fund’s trustees approved the Fee Arrangements in order to improve the quality of services that an Adviser provides to a Fund by aligning the Adviser’s interests more closely with the Fund’s. Each Fund’s trustees also determined that the Fee Arrangements would be in the Fund’s best interests. Implementation of the Fee Arrangements will not result in any decrease or modification in the nature or level of services that an Adviser provides to a Fund. And finally, each Fund will provide appropriate notice of the Fee Arrangements to existing and prospective shareholders. .

The Treasury Department released proposed regulations designed to address the appropriate tax treatment of contingent nonperiodic payments made under notional principal contracts ("NPCs," which mainly consist of swaps), an area in which there has been ongoing uncertainty. In 2001, the IRS described four alternative approaches then under consideration for adoption. One of those approaches, used by many taxpayers, holds that a payment need only be taken into account when it becomes fixed and determinable. Ultimately, the IRS concluded that the "wait-and-see" approach was inconsistent with existing requirements and presented the potential for abuse. The proposed regulations therefore prohibit "wait-and-see" treatment and require the accrual of the contingent nonperiodic payment over the full term of a swap using the "noncontingent swap" method. This method requires taxpayers to annually project the expected amount of contingent payments on a swap and then accrue the appropriate portion of that amount, including any differences due to changes in the expected amount. Using this method, the entire expected amount will be accrued ratably over the term of the swap. As an alternative to the "noncontingent swap" method, the proposed regulations allow taxpayers to elect the use of a "mark-to-market" method for most swaps, including actively-traded swaps and swaps held by regulated investment companies. Under the mark-to-market method, income or deductions would be recognized annually based upon the change in a swap’s market price at the end of each year of the swap term. (This method is consistent with the mark-to-market treatment of financial derivatives many taxpayers must use for financial statement purposes, which may ease the transition if the proposed regulations are adopted.)

The proposed regulations provide that periodic and contingent nonperiodic payments are generally recognized as ordinary income by the payee and deductible by the payor as ordinary business expenses, even if a payment is the final scheduled payment. However, payments under a forward contract or "bullet swap," in which all parties’ obligations are settled at or close to the maturity of the contract, would produce capital gain or loss under the proposed regulations. If adopted, the proposed regulations will generally be effective for NPCs entered into on or after 30 days after the issuance of final regulations by the Treasury Department. The proposed regulations also call for taxpayers who have not adopted a method of accounting for NPCs and enter into an NPC on or after March 27, 2004 to adopt a method of accounting that uses a reasonable amortization method, such as the methods in the proposed regulations, to take the contingent nonperiodic payments into account over the term of the NPC. A public hearing on the proposed regulations is scheduled for May 25, 2004. Comments on the proposed regulations and requests to speak at the public hearing (accompanied by outlines of the topics to be discussed) must be received by the IRS no later than May 4, 2004.

The OCC issued a proposed rule (the "Proposed Rule") that would require a national bank to file an annual report with the OCC in which the bank would identify its operating subsidiaries (subsidiaries that may only engage in activities permissible for its parent national bank) that are not functionally regulated by other regulators (such as the SEC, CFTC or state insurance or securities regulators) and that do business directly with consumers. Under the Proposed Rule, an operating subsidiary does business with consumers if it "provides products or services to individuals to be used primarily for personal, family or household purposes." In a national bank’s annual report to the OCC it would be required under the Proposed Rule to provide information including the name, mailing address and telephone number of the operating subsidiary, the name and charter number of the operating subsidiary’s parent bank and the operating subsidiary’s lines of business. The OCC would post this information on its website. Comments are due to the OCC no later than April 26, 2004.

The FRB issued a release deferring the effectiveness of proposed changes to the "clear and conspicuous" disclosure format requirements of Regulation Z.

Goodwin Procter’s Private Equity Group issued an update concerning the impact of recent Massachusetts cases on the enforcement of non-competition agreements. The Labor & Employment Practice Area issued an Alert concerning the requirement imposed on employees by the Fair and Accurate Credit Transactions Act of 2003 to give disciplined employees summaries of third-party investigative reports regarding workplace misconduct. Goodwin Procter’s ERISA Practice Area issued an informational bulletin that includes an article on plan fiduciary responses to reports of mutual fund trading abuses as well as articles on various other ERISA developments. Copies of each of these informational updates are available upon request.

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