United States: FRB Issues Supplemental Policy Statement Concerning the Internal Audit Function and its Outsourcing (Financial Services Alert For January 29, 2013)

Last Updated: January 30 2013
Article by Robert M. Kurucza

Edited by: Eric R. Fischer, Jackson B.R. Galloway and Elizabeth Shea Fries

In This Issue:

  1. Goodwin Procter Partner William Stern to Participate in Phone/Web Seminar Concerning "Bank Affiliate Transactions Under Scrutiny"
  2. FRB Issues Supplemental Policy Statement Concerning the Internal Audit Function and its Outsourcing
  3. Federal Financial Institutions Examination Council Issues Proposed Guidance on Social Media Usage by Financial Institutions
  4. SEC Settles Administrative Proceedings Against Registered Closed-End Fund Adviser and Subadviser Over Inadequate Disclosure of Fund Derivatives Activities
  5. SEC Adopts Rule Amendments Requiring Broker-Dealers to Search for Lost Securityholders and Paying Agents to Notify Unresponsive Payees

Goodwin Procter Partner William Stern to Participate in Phone/Web Seminar Concerning "Bank Affiliate Transactions Under Scrutiny"

Goodwin Procter Financial Services Group Partner, William Stern, will be participating in an upcoming live phone/web seminar hosted by Strafford Publications. The presentation, entitled "Bank Affiliate Transactions Under Scrutiny," is scheduled for Tuesday, February 5, 1:00pm-2:30 p.m. EST.

Sections 23A and 23B of the Federal Reserve Act (as implemented by the Federal Reserve Board's Regulation W) restrict certain transactions between banks and their non-bank affiliates. Considered by regulators to be an essential tool to ensure the soundness of banks, compliance with these provisions is critical in the current era of heightened scrutiny.

Several provisions in the Dodd-Frank Act tightened the restrictions on affiliate transactions, particularly with respect to derivatives transactions and transactions with certain types of investment funds.

The panel discussion will provide bank counsel with an analysis of Regulation W governing transactions that banks may conduct with affiliates, the impact of Dodd-Frank changes to the affiliate transaction rules, and best practices to comply with relevant requirements. After the presentations, the panelists will engage in a live question and answer session with participants.

For more information concerning the phone/web seminar or to register please click here.

FRB Issues Supplemental Policy Statement Concerning the Internal Audit Function and its Outsourcing

The FRB issued a supplemental policy statement on the internal audit function and its outsourcing (the "Supplemental Policy Statement"). The Supplemental Policy Statement supplements, but does not supersede, the 2003 interagency guidance distributed by the FRB in SR Letter 03-5, "Amended Interagency Guidance on the Internal Audit Function and its Outsourcing" (the "2003 Interagency Guidance"). The FRB said that the Supplemental Policy Statement reflects supervisory concerns noted in the aftermath of the recent financial crisis and applies to supervised financial institutions ("Institutions") with greater than $10 billion in total consolidated assets.

Enhanced Internal Audit Practices. The Supplemental Policy Statement states that Institutions should strengthen their internal audit function by, among other things: (1) analyzing the effectiveness of all critical risk management functions both with respect to individual risk dimensions (e.g., credit risk) and the Institution's overall risk management function; (2) identifying thematic macro control issues and considering the overall impact of such issues on the Institution's risk profile; (3) where deficiencies are identified, challenging management to adopt appropriate policies, procedures and internal controls; (4) reviewing the design and implementation of the Institution's infrastructure enhancements and alerting management to potential internal control issues; (5) confirming that the Board of Directors and senior management of the Institution are actively involved in setting and monitoring compliance with the Institution's risk tolerance limits; and (6) evaluating the adequacy and effectiveness of controls to respond to risks within the Institution's governance, operations and information systems that could adversely affect the Institution's achievement of its strategic objectives.

Internal Audit Function. The Supplemental Policy Statement next provides guidance that supplements and updates the 2003 Interagency Guidance concerning the characteristics, governance and operational effectiveness of an Institution's internal audit function. Among the topics covered in the Supplemental Policy Statement are the independence, professional competence, staffing and the elements of an internal audit charter for an Institution's internal audit function. Also discussed are the responsibilities of the Audit Committee with respect to the internal audit function and strategies for evaluating the adequacy of the internal audit function's risk assessment methodology, the internal audit plan, the internal audit function's use of continuing monitoring practices and the internal audit function's overall performance.

Internal Audit Outsourcing Arrangements. The Supplemental Policy Statement discusses the responsibilities of an Institution's Board of directors and senior management to provide appropriate oversight to outsourcing arrangements of the internal audit function. The FRB reminds Institutions that the responsibility for maintaining an effective system of internal controls cannot be delegated to a third party. The Supplemental Policy Statement discusses the need for a written contract with the vendor of internal audit outsourced services, policies and procedures for selection and oversight of internal audit vendors, and the need for contingency planning for managing temporary or permanent disruptions in outsourced internal audit services.

Independence Guidance for the Independent Public Accountant. The Supplemental Policy Statement updates the 2003 Interagency Guidance by noting the 2009 amendments to Section 36 of the Federal Deposit Insurance Act (applicable to insured depository institutions with total assets of $500 million or more) and pointing out that since 2009 the external auditor of an insured depository institution with total assets of $500 million or more is precluded from also providing outsourced internal audit services.

Examination Guidance. The FRB next discusses supervisory assessments of an Institution's internal audit function and the ability of FRB examiners to rely on work performed by the internal audit function. The Supplemental Policy Statement states that in determining the overall effectiveness of the internal audit function, the function will generally be considered effective by the FRB if the function's structure and practices are consistent with the 2003 Interagency Guidance and the Supplemental Policy Statement.

Federal Financial Institutions Examination Council Issues Proposed Guidance on Social Media Usage by Financial Institutions

On January 22, 2013, the Federal Financial Institutions Examination Council ("FFIEC") issued proposed guidance (the "Proposed Guidance") on the usage of social media by financial institutions ("FIs"). The Proposed Guidance does not contemplate the imposition of additional obligations upon FIs; instead, it highlights the diversity of risks posed to FIs by social media and emphasizes the need for FIs to maintain active risk management programs commensurate with their social media usage.

Brief Overview of FFIEC Proposed Guidance

The Proposed Guidance defines "social media" as "a form of interactive online communication in which users can generate and share content through text, images, audio and/or video." Social media can take many forms, including, micro-blogging sites, such as Facebook, Google Plus, MySpace, and Twitter; online forums, blogs, customer review websites and bulletin boards such as Yelp; photo and video sites, such as Flickr and YouTube; sites for professional networking, such as LinkedIn; "virtual worlds" such as Second Life; and social games such as FarmVille and CityVille. Social media offers potential benefits to FIs as well as enhanced risks. Social media permits FIs to distribute information more broadly to users of financial services and allows providers to more accurately match products and services to users' needs. The FFIEC states affirmatively in the Proposed Guidance that social media has the potential to improve market efficiency. The challenge for FIs is to capitalize on this enhanced market efficiency while operating in compliance with existing laws and regulatory requirements generally applicable to the banking transactions generated by social media. Because much of this interaction occurs in a more dynamic, real-time and less-secure environment than conventional marketing and correspondence, it also poses an added measure of risk.

The Proposed Guidance does not discourage social media use by FIs, and it does not call for the creation of additional rules or regulations. Instead, the Proposed Guidance attempts to present the range of risks to FIs posed by social media in its various forms, some of which may be obvious and others of which are much less apparent. The Proposed Guidance is intended to help FIs identify potential risk areas, and ensure that FIs are aware of their responsibilities to control these risks within their overall risk management programs and in a manner that permits them to identify, measure, monitor, and control the risks related to social media. To this end, the complexity of an FI's social media risk management program should be commensurate with the scale of its involvement in this medium.

The Proposed Guidance identifies three categories of risk: Compliance and Legal, Reputational, and Operational. The following is a brief summary of the FFEIC's description of each risk category.

Compliance and Legal. The Proposed Guidance emphasizes that existing laws do not contain exceptions regarding the use of social media. FIs must adhere to established rules and regulations applicable to banking practices such as lending, deposit services, or payment systems, regardless of whether a transaction involves social media. The categories of risk addressed in the Proposed Guidance are not exhaustive. The following is a sample of the laws and regulations identified in the Proposed Guidance as being of possible relevance to the social media aspects of an FI's risk management program.

  • Deposit and Lending Products: Social media may be used to market products and originate new accounts. The Proposed Guidance advises that FIs must ensure that all related advertising, account origination, and document retention are performed in compliance with existing consumer protection and compliance laws and regulations, including the Truth in Savings Act/Regulation DD and Part 707, fair lending laws such as the Equal Credit Opportunity Act, the Fair Housing Act, the Truth in Lending Act, the Real Estate Settlement Procedures Act, and the Fair Debt Collection Practices Act. The Proposed Guidance offers a number of examples, such as if an FI engages in residential mortgage lending and maintains a presence on Facebook, the Equal Housing Opportunity logo must be displayed on that FI's Facebook page. Similarly, under the Truth in Lending Act, FIs must provide consumers with all Regulation Z disclosures within the required time frames, regardless of the use of social media in the origination of a loan.
  • Payment Systems: The Proposed Guidance notes that under existing law, no additional disclosure requirements apply simply because social media is involved, but nonetheless emphasizes that FIs should be aware of the unique compliance challenges posed by social media in the context of payment systems. In addition to compliance with existing requirements for disclosure and error resolution mandated by the Electronic Fund Transfer Act, Article 4 of the Uniform Commercial Code, and the Expedited Funds Availability Act, the Proposed Guidance highlights the Bank Secrecy Act and anti-money laundering programs as being of particular relevance to a social media risk management program. The online world frequently operates with a measure of anonymity. This lack of transparency can present significant challenges to FIs which nonetheless must comply with existing requirements for customer identification, due diligence in the tracking of suspicious transactions, and the maintenance of records for electronic funds transfers. "Virtual world" or "second life" programs will often include "virtual economies" linked to real world payment systems. The Proposed Guidance notes that illicit actors are known to use these virtual economies as a means of money laundering and terrorist financing, and advises that FIs must be diligent in monitoring fund transfers associated with virtual world gaming.
  • Privacy: Social media presents additional challenges to compliance with existing laws for customer privacy and data security, such as the Gramm-Leach-Bliley Act. The Proposed Guidance advises FIs that the Controlling the Assault of Non-Solicited Pornography and Marketing Act (aka the "CAN-SPAM Act") and the Telephone Consumer Protection Act establish requirements for sending unsolicited messages by telephone or text message, and thus may be applicable to communications sent via a social media platform's messaging features. The social media marketplace is dynamic and often features a high volume of small-scale communication between businesses, customers, and prospective customers, and the Proposed Guidance advises FIs to take this reality into account when assessing risk management programs.

Reputational Risk. The Proposed Guidance defines "reputational risk" as the risk arising from negative public opinion, noting that activities that result in dissatisfied customers or negative publicity could harm the reputation of an FI even if it has not violated any laws. In this regard, the Proposed Guidance merely reflects best practices for any high-profile industry or company. Social media facilitates more frequent and more informal interactions between FIs and their customers, and along with it an increased potential for fraud, threats to brand identity, and reputational damage should customer complaints "go viral" and garner attention from conventional media or the public at-large. The Proposed Guidance also notes that compliance risk can arise when a customer uses social media to an effort to initiate a dispute.

Operational Risk. The Proposed Guidance defines operational risk as "the risk of loss resulting from inadequate or failed processes, people, or systems," noting that operational risk includes the risks posed by an FI's use of information technology, which encompasses social media. Social media platforms are generally viewed as more vulnerable to account takeover and the distribution of malware, particularly data-mining malware designed to gather financial account information. The Proposed Guidance advises that an FI's risk management program should account for the IT/operational risk posed by social media.

The FFIEC, in the Proposed Guidance, directs FIs to adopt a social media risk management program that is tailored to the risk profile of the FI and that includes the following key elements:

  • an appropriate governance program with effective controls;
  • appropriate policies and procedures;
  • a due diligence process regarding the selection and management of third-party vendors;
  • employee training;
  • an oversight process for information posted to the FI's social media sites;
  • adequate audit coverage and compliance verifications of the effectiveness of the program; and
  • periodic reporting to the FI's Board of Directors or senior management regarding the effectiveness of the social media program.

Request for Public Comment. In addition to general comments on the Proposed Guidance, the FFIEC specifically seeks comments in response to the following three questions:

  1. Are there any other types of social media, or ways in which FIs are using social media, that should be included in the Proposed Guidance?
  2. Are there any other consumer protection laws, regulations, policies or concerns that may be implicated by FIs' use of social media that should be discussed in the Proposed Guidance?
  3. Are there any technological or other impediments to FIs' compliance with otherwise applicable laws, regulations and policies when using social media of which the [agencies comprising FFIEC] should be aware?

Comments on the Proposed Guidance are due by March 25, 2013.

SEC Settles Administrative Proceedings Against Registered Closed-End Fund Adviser and Subadviser Over Inadequate Disclosure of Fund Derivatives Activities

On December 19, 2012, the SEC issued orders (the "Orders") settling administrative proceedings against the adviser (the "Adviser," whose order can be found here) and subadviser (the "Subadviser," whose order can be found here) to a registered closed-end investment company (the "Fund") regarding various failures to properly disclose certain derivative strategies implemented by the Subadviser in the registration statement (the "Registration Statement") for the Fund under the Investment Company Act of 1940 (the "1940 Act") and the Fund's annual and semi-annual shareholder reports filed with the SEC (the "Shareholder Reports"). This article summarizes the SEC's findings, which the Adviser and Subadviser have neither admitted nor denied.


The Adviser is an SEC-registered investment adviser that served as investment adviser and administrator to the Fund. The Adviser delegated day-to-day management of the Fund's portfolio to the Subadviser; however, under the Adviser's fund policies and procedures manual (the "Fund Manual") and its advisory agreement with the Fund, the Adviser continued to be responsible for supervising the Subadviser. In its capacity as administrator, the Adviser was responsible for monitoring on a post-trade basis the Fund's compliance with the investment objective, policies and restrictions set out in the Registration Statement. Under the Fund Manual, the Adviser was responsible, in conjunction with Fund counsel, for preparing the Fund's Registration Statement and for updating the Registration Statement as necessary to reflect any material changes in the Fund's investment policies and principal risks. As administrator, the Adviser was also charged with managing the preparation, filing and distribution of the Shareholder Reports including commentary provided by the Fund's portfolio managers at the Subadviser.

The Subadviser is an SEC-registered investment adviser that served as subadviser to the Fund and, subject to the Adviser's oversight and supervision, was responsible for managing the Fund's portfolio in accordance with the investment objective, policies and restrictions in the Registration Statement. The Subadviser was also responsible for reviewing and confirming certain information included in the Shareholder Reports.

As stated in the Registration Statement, the Fund's primary investment strategy was to invest in equities and write call options on a substantial portion of those equities to generate current income. The Fund was marketed on the basis of its income potential and had a goal of paying an annual dividend equal to an 8.5% yield on the Fund's initial public offering price.

The Derivative Transactions

In April 2007, the Fund started writing out-of-the-money S&P 500 put options and entering into short variance swaps (together, the "Derivative Transactions"). The Derivative Transactions went on to be part of the Fund's portfolio from July 2007 to October 2008 except for a 2 month period during this timespan. In writing (selling) an out-of-the-money S&P 500 put option, the Fund received a premium from the purchaser of the option in exchange for agreeing to compensate the purchaser if the S&P 500 declined during a specified period below a specified price, which typically was set between 6%-10% below the S&P 500's current level at the time the option was written. Throughout 2008, the Fund's notional exposure on out-of-the-money S&P 500 put options ranged from 60% to 140% of the Fund's net asset value. By entering into a variance swap, the Fund would seek to profit based on whether market volatility ended up being higher or lower than expected. With short variance swaps, the Fund would profit if the market was less volatile than expected.

The SEC found that from April 2007 through August 2008, the Fund's Derivative Transactions contributed materially to the Fund's performance. For the twelve month period ending November 30, 2007, written put options added approximately 2.0% to the Fund's net asset value, contributing to the Fund's 12.87% total return for this period. For the six month period ending May 31, 2008, written put options and variance swaps added approximately 2.1% and 0.8%, respectively, to the net asset value of the Fund, contributing to the Fund's 0.37% total return for this period. By comparison, the S&P 500 returned 7.72% and -4.50%, respectively, during these periods.

The SEC also found that the use of the Derivative Transactions materially altered the Fund's risk profile by increasing its sensitivity to market declines and volatility, and that in September and October 2008, the Derivative Transactions lead to significant losses for the Fund. During that two-month period, the Fund realized losses of approximately $45.4 million on its five Derivative Transactions. This represented a decline of 45% of the Fund's net assets, contributing significantly to an overall decline in its net asset value of 72.4%. By comparison, during this same period, the S&P 500 declined 24.5%.

Disclosure Regarding the Derivative Transactions

The Registration Statement

Form N-2, the SEC registration form used by the Fund, requires a fund to describe its investment policies, the types of investments it makes or intends to make, and the principal risks associated with the fund's investment policies and investments. Furthermore, Rule 8b-16 under the 1940 Act requires a closed-end fund to update its 1940 Act registration statement on an annual basis or disclose certain matters, including any material changes to its principal investment policies and practices and the principal risks associated with such investment policies and practices, in its annual report to shareholders.

The Registration Statement did not include a description of the Derivative Transactions in the list of principal strategies to be employed by the Fund or in the description of the types of investments the Fund would make under normal conditions. Specifically, the Registration Statement stated that the Fund could use a variety of derivative strategies, including "purchas[ing] and sell[ing] exchange listed and over-the-counter put and call options on securities, equity and fixed income indices and other instruments, purchas[ing] and sell[ing] futures contracts and options thereon and enter[ing] into various transactions such as swaps, caps, floors or collars." The statement of additional information also noted that the Fund could use index options, but did not include any detail on the extent to which these options would be used. Although the Registration Statement did reference the potential use of swaps, there was no specific disclosure in the Registration Statement regarding the use of variance swaps.

The "Risks" section in the Registration Statement did not describe the principal risks associated with the Derivative Transactions. In describing the risk disclosures in the Registration Statement, the SEC noted that "there was no mention of the downside risks the Fund could face by trading index put options and variance swaps, including the Fund's leveraged exposure to market declines and to spikes in market volatility. While the Registration Statement included a generic warning that the use of derivatives could leave the Fund worse off, depending on the adviser's ability to correctly predict movements in the securities and interest rate markets, it did not include anything specific regarding the type of market movements that could harm the Fund or the particular risks associated with writing index put options and trading variance swaps." The SEC found that the risk disclosures regarding index options focused on the risk that they might be imperfect hedges for the portfolio rather than on the specific risks associated with these types of transactions.

The Shareholder Reports

The Shareholder Reports typically included commentary from the Fund's portfolio managers at the Subadviser (the "Portfolio Manager Commentary") which discussed the Fund's performance during the relevant period, including which investments contributed to or detracted from the Fund's performance. The SEC found that, despite the fact that the Derivative Transactions had contributed significantly to the Fund's performance in 2007 and during the first half of 2008, neither the 2007 annual shareholder report (the "2007 Annual Report") nor the 2008 semi-annual shareholder report (the "2008 Semi-Annual Report") mentioned these strategies or their contribution to the Fund's performance. For example, in the 2008 Semi-Annual Report, in response to the question about which investments had contributed most to the Fund's performance, the Portfolio Manager Commentary stated "industry stock selection, the covered call strategy, and the hedge program" and that "during most of this period, the portfolio was strategically hedged for additional downside protection, and that proved to be a good decision as equity markets trended downward." There was no mention of the fact that the Fund had actually generated significant income from the Derivative Transactions during this period. Moreover, the S&P 500 actually increased during most of this period so the Fund actually lost money as a result of its long put options and long variance swaps (i.e., its hedging strategy).

Defects in Disclosures Regarding the Derivative Transactions

The SEC found that the Subadviser used the Derivative Transactions during 2007-2008 to such an extent that "those strategies became an integral part of how the Fund sought to achieve its investment objective and, those strategies exposed the Fund to new and material risks"; however, neither the Adviser nor the Subadviser took steps to include disclosures on these strategies or the principal risks associated with these strategies in either an amendment to the Registration Statement or in the Fund's 2007 Annual Report, as required by Rule 8b-16.

The SEC also found that the Portfolio Manager Commentary in the 2007 Annual Report and 2008 Semi-Annual Report failed to disclose the impact of the Derivative Transactions on Fund performance and also misrepresented the Fund's exposure to downside market risk by claiming that the Fund was strategically hedged against downside market risk when the Derivative Transactions had in fact increased sensitivity to market declines and volatility.

The Portfolio Manager Commentary was prepared by the Adviser based on interviews with the Fund's portfolio managers and was reviewed and approved by the Subadviser. By virtue of being, among other things, apprised of the Fund's portfolio on a daily basis, the Adviser was aware that the Subadviser was using the Derivative Transactions and that these transactions had contributed to the Fund's performance. Additionally, the Subadviser regularly prepared attribution reports regarding the Fund's performance and was also aware of the extent to which the Derivative Transactions had contributed to Fund performance. The SEC found, however, that neither the Adviser nor the Subadviser corrected the Portfolio Manager Commentary in the 2007 Annual Report or 2008 Semi-Annual Report and as a result these Reports contained misleading statements and omissions regarding the contributors to the Fund's performance and the risks associated with the Derivative Transactions.

Violations – The Adviser

  • Rule 8b-16 under the 1940 Act – The SEC found that by not providing appropriate disclosures regarding the Derivative Transactions in an amendment to the Registration Statement or in the 2007 Annual Report, the Adviser caused the Fund's violations of Rule 8b-16.
  • The SEC also found that Adviser failed to reasonably supervise the Subadviser.

Violations – The Subadviser

  • Section 34(b) of the 1940 Act – The SEC found that Subadviser willfully violated Section 34(b) of the 1940 Act, which prohibits any person from omitting material facts in any reports or documents filed with the SEC.
  • Section 206(4) and Rule 206(4)-8 under the Advisers Act – The SEC found that Subadviser willfully violated Section 206(4) and Rule 206(4)-8 under the Investment Advisers Act of 1940 (the "Advisers Act"), which prohibits fraudulent, deceptive or manipulative practices with respect to investors in a pooled vehicle.


Adviser. In addition to agreeing to censure and a cease and desist order, the Adviser established a plan to distribute up to $45 million to former shareholders of the Fund as reimbursement for 100% of the losses attributable to the Derivative Transactions between September and October 2008. In determining to accept the Adviser's offer, the SEC took into considerations certain remedial measures the Adviser has taken to strengthen its compliance program.

Subadviser. In addition to agreeing to censure and a cease and desist order, the Subadviser also agreed to pay disgorgement of $644,951, prejudgment interest of $134,978 and a civil penalty of $1.3 million.

Proceedings Instituted Against the Fund's Portfolio Managers

The SEC has instituted administrative proceedings against the two individuals employed by the Subadviser who served as portfolio managers of the Fund, related to the matters that are the subject of the Orders. Consistent with its findings with respect to the Adviser and Subadviser, the SEC alleges violations of Section 206(4) and Rule 206(4)-8 under the Advisers Act, and Section 34(b) and Rule 8b-16 under the 1940 Act. In addition, the SEC has alleged violations of Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder, which prohibit the use of manipulative and deceptive practices in connection with the purchase and sale of securities.

SEC Adopts Rule Amendments Requiring Broker-Dealers to Search for Lost Securityholders and Paying Agents to Notify Unresponsive Payees

On December 21, 2012, in response to a mandate under the Dodd-Frank Act, the SEC adopted amendments (the "Amendments") to Rule 17Ad-17 under the Securities Exchange Act of 1934 (the "Rule") to (1) extend to broker-dealers the existing obligation of recordkeeping transfer agents to search for securityholders with whom they have lost contact and (2) require broker-dealers and other securities market participants to provide written notification to persons who have not negotiated checks sent to the securityholder. The SEC adopted the Amendments largely as proposed. Addressing requests for exemptions or exceptions from the Rule for certain categories of persons submitted in public comment on the SEC's proposal to amend the Rule, the SEC stated that the Amendments were consistent with the statutory directives contained in the Dodd-Frank Act and that exercising exemptive authority at the adopting stage would be premature.

Obligation to Search for Lost Securityholders

As amended, the Rule applies to broker-dealers that have customer security accounts that include accounts of "lost securityholders." The Rule defines a "lost securityholder" as a securityholder to whom an item of correspondence that was sent has been returned as undeliverable and for whom the broker-dealer has not received a new mailing address. Accordingly, any broker-dealer that has customer security accounts will have to determine whether any of its customers have become lost securityholders for purposes of the Amendments.

The Amendments require that broker-dealers subject to the Rule exercise reasonable care to ascertain the correct addresses of lost securityholders and, in exercising such reasonable care, conduct certain database searches for them, at no charge to the securityholder. Specifically, such database searches must be conducted between three and twelve months after a securityholder becomes a lost securityholder and between six and twelve months after the first search. To account for instances in which an item of correspondence was returned because of simple addressing or delivery error, the Amendments provide that if the sender resends the returned item within one month of its return, the sender does not have to consider the securityholder lost until the item is again returned as undeliverable.

A broker-dealer's search obligation does not apply to lost securityholders when (i) it has received documentation that the securityholder is deceased, (ii) the aggregate value of assets in the securityholder's account is less than $25, or (iii) the securityholder is not a natural person.

Obligation to Send Notice to Unresponsive Payees

The Amendments require a "paying agent," defined to include any issuer, transfer agent, broker, dealer, investment adviser, indenture trustee, custodian, or any other person that accepts payments from the issuer of a security and distributes the payments to the holders of the security, to notify, in writing, an "unresponsive payee" that a check has been sent and has not yet been negotiated. Under the Amendments, a securityholder is considered an "unresponsive payee" if a check sent to the securityholder by the paying agent is not negotiated by the earlier of (i) the sending of the securityholder's next "regularly scheduled check," or (ii) six months after the sending of the check. Although the Amendments do not define what is meant by "regularly scheduled check," the SEC stated that it is "interpreting the term to include not only checks for interest and dividend payments but also any other regularly scheduled periodic payments from an issuer of securities to be distributed to securityholders as a class." Thus, "regularly scheduled check" for this purpose would not include checks for payment solely to an individual shareholder and not to a class of securityholders. The notification required by the Amendments must be sent within seven months after the sending of the not yet negotiated check and must inform the unresponsive payee that the person has been sent a check that has not yet been negotiated. The Amendments permit such notification to be sent along with a check or other mailing subsequently sent to the securityholder.

The Amendments also provide that a securityholder is no longer an unresponsive payee when the securityholder negotiates the check or checks that caused the securityholder to be considered an unresponsive payee. As a consequence, if an unresponsive payee negotiates the applicable check or checks prior to the expiration of the six month time period provided under the Amendments, the paying agent is not required to send a notification. A paying agent is also not required to send a notification if the value of a not yet negotiated check is less than $25.

Recordkeeping Requirements

Every recordkeeping transfer agent, every broker or dealer that has customer security accounts, and every paying agent is required to maintain records to demonstrate compliance with the Rule, including written procedures that describe the methodology for complying with the search and notification requirements.

No Effect on State Escheatment Laws

The Amendments include a provision clarifying that the notification requirements have no effect on state escheatment laws.

Compliance Date

The compliance date for the Amendments is January 23, 2014.

Goodwin Procter LLP is one of the nation's leading law firms, with a team of 700 attorneys and offices in Boston, Los Angeles, New York, San Diego, San Francisco and Washington, D.C. The firm combines in-depth legal knowledge with practical business experience to deliver innovative solutions to complex legal problems. We provide litigation, corporate law and real estate services to clients ranging from start-up companies to Fortune 500 multinationals, with a focus on matters involving private equity, technology companies, real estate capital markets, financial services, intellectual property and products liability.

This article, which may be considered advertising under the ethical rules of certain jurisdictions, is provided with the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin Procter LLP or its attorneys. © 2013 Goodwin Procter LLP. All rights reserved.

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  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.