United States: Financial Services Alert

As an initial matter, the Staff clarifies that Reg. S-P does not apply to funds that are excluded from regulation under the Investment Company Act of 1940 (the "1940 Act") pursuant to sections 3(c)(1) and 3(c)(7) of the 1940 Act, that is, private investment companies. Under the Gramm-Leach-Bliley Act of 1999 (the "GLBA"), private investment companies are subject to the regulatory authority of the Federal Trade Commission, which has promulgated its own privacy regulations.

In its discussion of consumer and customer relationships, the Staff indicates that a customer relationship exists between a wrap account client and a wrap account portfolio manager even if the wrap account client has a written contract only with the wrap account sponsor. The Staff further states that the customer relationship between a wrap account client and portfolio manager, and thus the obligation for the portfolio manager to provide the relevant privacy notice, arises no later than the time the portfolio manager begins to provide services to the wrap account client.

With respect to privacy notices, the Staff states that a fund can deliver a single initial or annual privacy notice covering all of a customer’s accounts as long as: (1) it is clear which accounts the notice covers; (2) the notice is accurate with respect to each account’s privacy policies; and (3) the method of delivering notice has a reasonable expectation of providing the customer with actual notice in writing of each account’s privacy policy. The Staff also addresses a number of issues under the Reg. S-P provisions that permit financial institutions to deliver a single privacy notice to multiple customers sharing the same address ("householding"). Moreover, the Staff provides no action relief to permit the householding of initial privacy notices to existing customers prior to July 1, 2001 during the phase-in of privacy notice requirements.

The federal banking agencies (the "Agencies") jointly issued guidance (the "Guidance") concerning financial institutions’ management of risk related to leveraged financing. The Guidance states that leveraged financing has become an important financing vehicle "for mergers and acquisitions, business recapitalizations and business expansions." These transactions use a degree of financial leverage that exceeds industry standards for debt, cash flow and other ratios and, accordingly, leveraged borrowers "typically have a diminished ability to adjust to unexpected events and changes in business conditions." Recently, the Guidance notes, many financial institutions have experienced deteriorations in the quality of their leveraged finance portfolios.

The Guidance states that the Agencies expect financial institutions that engage in leveraged finance to oversee leveraged portfolios with a high degree of care. Leveraged finance risk management programs should require, among other matters, adequate risk rating, underwriting, pricing, tracking and monitoring of leveraged finance transactions, and a financial institution’s risk management policy should "specify conditions that would require a change in risk-rating, accrual status, loss recognition or reserves" related to leveraged finance transactions. The Guidance further notes that many leveraged transactions are "underwritten with a reliance on the imputed value of a business (or enterprise value) which often exhibits a high degree of volatility." As part of their ris k management programs, financial institutions, says the Guidance, are expected to use sound valuation methods, frequent stress testing and close oversight of enterprise values used to support credit analyses of leveraged finance transactions. In addition, the Guidance emphasizes that financial institutions should take steps to avoid concentrations of highly leveraged assets. Moreover, the Guidance states that the Boards of Directors and senior managers of a financial institution should receive quarterly "comprehensive reports about the characteristics and trends" in the financial institution’s leveraged loan portfolio.

OTS Director Ellen Seidman suggested in a presentation to the American Commu nity Bankers Government Affairs Conference that Congress should take certain steps to enhance the thrift charter to make it more comparable to a commercial bank charter. In particular, Ms. Seidman recommended that : (1) the exemption from registration available to banks under the Investment Advisers Act of 1940 be extended to thrifts; (2) the broker-dealer registration exemption available to banks under the Securities Exchange Act of 1934 be extended to thrifts; (3) thrifts be granted authority equivalent to that enjoyed by banks by eliminating the requirement that a service company must be organized under the laws of the state where the home office of the thrift is located; (4) thrifts be granted the authority to merge with one or more of their nonthrift subsidiaries or affiliates for "sound business reasons;"and (5) thrifts should (through the repeal of a provision of the Home Owners Loan Act that currently restricts certain investments to "geographic areas or neighborhoods receiving concentrated development assistance from the U.S. Department of Housing and Urban Development") be authorized to participate in community development activities regardless of the geographic location of the business. The foregoing enhancements to the thrift charter, stated Ms. Seidman, would make the thrift charter more valuable and "do it in a manner consistent with maintaining both safety and soundness and the [thrift] industry’s community focus."

The FRB, OCC and FDIC issued a joint proposal (the "Proposal") designed to implement Section 106 of the GLBA and expand the prohibitions against use of interstate branches primarily for the production of deposits. Section 109 of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") prohibits a bank from establishing or acquiring a branch or branches outside of the bank’s home state primarily for the purpose of deposit production. Section 106 of the GLBA expanded the coverage of Section 109 of the Interstate Act to include any branch of a bank controlled by an out-of-state bank holding company. Accordingly, the Proposal, which is designed to implement Section 106 of the GLBA, amends the regulatory prohibitions against branches being used primarily as deposit production offices to include any bank or branch of a bank controlled by an out-of-state bank holding company, including a bank consisting only of a main office.

In determining whether a bank has established or acquired an interstate branch primarily to generate deposits, the applicable federal banking agency under the Interstate Act, applies, no sooner than one year after the establishment or acquisition of the branch, a loan-to-deposit ratio screen. This screen compares a bank’s loan-to-deposit ratio within the state where the bank’s covered interstate branches are located (the "host state") with the loan-to-deposit ratio of all banks in the host state. If the bank’s ratio in the host state is at least 50% of the host state’s ratio, the bank is deemed to have met the statutory requirement. If the bank’s ratio in the host state is less than 50% of the host state’s ratio, the banking agency must perform a credit needs determination. The applicable federal banking agency then reviews such matters as the bank’s lending activity and its performance under the Community Reinvestment Act and determines whether the bank is helping to meet the credit needs of the communities it serves in the host state. The Proposal would apply the above-described loan-to-deposit ratio screen not only to branches established pursuant to the Interstate Act, but also to any bank or branch of a bank controlled by an out-of-state bank holding company. A bank that is determined not to have taken reasonable steps to help meet the credit needs of communities in which it has interstate branches may be subject to sanctions under the Interstate Act as amended by the GLBA. Comments on the Proposal are due by June 8, 2001.