United States: SEC Issues Release Proposing Proxy Rule Changes to Permit Delivery of Proxy Materials Via Website
(Financial Services Alert – Developments of Note)

1. SEC Issues Release Proposing Proxy Rule Changes to Permit Delivery of Proxy Materials Via Website

2. FRB Governor Bies Discusses Risk and Capital Allocation; RMA Proposes Alternative to US Basel IA ANPR

3. FDIC Publication Provides Guidance on Governance by FIs of Financial Models

4. Federal Court of Appeals Upholds Ruling that Lawyers are not Required to Comply with FTC’s Privacy Rules under GLBA

5. SEC Staff Responds to ABA Subcommittee on Private Investment Entities Regarding New Private (Hedge) Fund Adviser Registration Requirements and Related Advisers Act Compliance Issues

The SEC issued a formal release (the "Release") proposing amendments to the proxy rules under Section 14 of the Securities Exchange Act of 1934, as amended (the "1934 Act"), that would allow persons soliciting proxies, including persons other than an issuer, to satisfy the requirements of Rule 14a-3 under the 1934 Act to furnish proxy materials by means of a "notice and access" model for the delivery of proxy materials that uses a website to post the materials and a "Notice of Electronic Proxy Materials" ("Notice") sent to shareholders alerting them to the materials’ website availability. Proxy materials deliverable under the notice and access model would include proxy statements, proxy cards, information statements, additional soliciting materials and any amendments to the foregoing. The amendments would also allow use of the notice and access model to deliver (i) annual reports for issuers not subject to the shareholder report requirements of the Investment Company Act of 1940, as amended, and (ii) shareholder meeting notices, so long as reliance on the notice and access model for delivery of a notice of meeting is consistent with applicable state law. The amendments would not permit the use of the notice and access model for business combination transactions as defined in Rule 165 under the Securities Exchange Act of 1933, as amended (the "1933 Act"), which would include registered investment company reorganizations and exchange offers involving the use of Form N-14 under the 1933 Act. The amendments generally would not affect the use of other methods of delivering proxy materials.

Notice of Electronic Proxy Materials. A Notice would have to include (a) a specified legend in bold-face type, (b) information relating to the meeting and the availability of proxy materials on a specified website and in paper form and (c) a clear and impartial description of the matters to be considered at the meeting along with the issuer’s recommendation regarding those matters. A Notice could present only the required information except that the notice of meeting typically included by issuers in proxy materials could be combined with the Notice, consistent with applicable state law requirements. No other shareholder communications, except for a proxy card (and return envelope), could accompany a Notice. An issuer would have to send a Notice to shareholders 30 days or more prior to the shareholder meeting date, or if no meeting were to be held, 30 days or more prior to the date the votes, consents or authorizations could be used to effect the corporate action.

Website Access to Proxy Materials. Under the proposed amendment, the EDGAR website could not be used to provide website access to proxy materials under the notice and access model. The website address for proxy materials would need to be specific enough to lead shareholders directly to those materials, rather than to a homepage or other section of a website where the materials might be accessed. In addition, the proxy materials presented on the website would need to be in a format that provides a version of those materials, including all charts, tables, graphics, and similarly formatted information, that is substantially identical to what would otherwise be furnished in a different medium such as paper. An issuer would have to post proxy materials on the website on or before the time shareholders received the related Notice, and the proxy materials would have to remain available through the time of the shareholder meeting. An issuer would have to post any additional soliciting materials on the same website no later than the date on which the additional soliciting materials were first sent to shareholders or made public, although the issuer would be free to disseminate those additional materials through other means (e.g., direct mail, e-mail, newspaper publication, etc.).

Procedural Requirements. Use of the notice and access model would be subject to certain procedural requirements. The proxy card would have to be delivered along with, and through the same medium (paper or electronic) as, either the Notice or the proxy statement. An issuer would have to send a paper copy of proxy materials within two business days of a shareholder request for those materials using first class mail (or any other reasonably prompt means of delivery). The proposed amendments would not affect state law obligations regarding proxy solicitation or the holding of annual meetings.

Intermediaries. Under the proposed amendments, brokers, banks, or other intermediaries that are recordholders of an issuer’s shares would use the notice and access model at the issuer’s request, but could not elect to do so otherwise. An intermediary requested to use the notice and access model would be subject to the following general requirements: (a) the intermediary would have to forward the issuer’s Notice to beneficial owners, unless it prepares its own Notice; (b) if the issuer posts its proxy card on the proxy materials website, the intermediary would have to supplement the issuer’s Notice or create and send its own Notice to clarify how beneficial owners should provide their voting instructions; (c) the intermediary may choose to post its request for voting instructions on a website, but would have to maintain the website for posting both those instructions, and the issuer’s proxy materials (other than the proxy card); (d) if the intermediary chooses not to post its request for voting instructions on a website, it would have to prepare and send, with the Notice, a copy of the intermediary’s request for voting instructions; and (e) the intermediary would have to request and forward a copy of the proxy materials from the issuer in response to requests from its beneficial shareholder customers. Under the proposed amendments, a beneficial owner could request a copy of proxy materials either from the intermediary or the issuer.

Use of the "Notice and Access" Model By Persons Other than an Issuer. Persons other than an issuer soliciting proxies would be able to rely on the notice and access model in much the same way as an issuer, with appropriate changes to the information required in the Notice and subject to a delivery deadline of the later of (i) 30 days before the meeting or (ii) 10 days after the issuer files its proxy materials. The proposed amendments would continue to permit a soliciting person conducting a proxy solicitation to limit its solicitation, e.g., to shareholders willing to access the soliciting person’s proxy materials electronically. Under such a limited solicitation, the soliciting person would have no obligation to deliver paper or e-mail copies of the proxy materials to anyone.

Public Comment and Final Effectiveness. The Release requests comment on a wide range of issues. A 60 day period for public comment on the proposed amendments will commence when the Release appears in the Federal Register. At the open meeting where proposal of the amendments was approved, the SEC staff indicated that even if the rulemaking process were to move forward to adoption without any departures from the usual timetable, they did not expect the notice and access model to be available for the 2006 proxy season.

Bies Discussion. On December 6, 2005 FRB Governor Bies spoke about the linkage between internal capital measures and regulatory capital requirements. As to the relation of risk to capital, Governor Bies discussed the manner in which economic models of capital are tied to unexpected losses, that risk capital should be related to risk management, and that, in almost all cases, banks should hold capital above the regulatory minimum. She also discussed controls and oversight, stating that such mechanisms are vital to assessing capital needs, and that banks need to keep up with the latest innovations in risk measurement. Governor Bies then noted that Basel II for the first time creates a link between regulatory capital and risk management, and "by design, the Basel II framework allows for flexibility and leaves open the possibility to include risk-management improvements not yet discovered".

Governor Bies further discussed the results from Basel II’s QIS4 (see the May 25, 2005 Alert for a detailed analysis of QIS4). She stated that the interagency analysis of QIS4 is essentially complete, and the significant drop in required minimum risk-based capital evidenced in QIS4 was due in large part to the favorable part of the business cycle which it reflected. As to the significant dispersion of regulatory capital between banks participating in the study, Governor Bies said that this difference was principally "due to the varying risk parameters and methodologies they used, permissible in the QIS4 exercise." She said that one of the challenges the agencies will face as Basel II is implemented is how to define the range of acceptable practice in implementing the Basel II inputs, and how to communicate that to the affected banking institutions.

Governor Bies also spoke about the home-host issues in Basel II (see the December 6, 2006 Alert for the most recent discussion of home-host issues). She stated that although some industry participants may have concerns about the US delay in rolling out and implementing Basel II, the US agencies were committed to working with other countries to make the transition as smooth as possible. She noted that home-host issues have existed prior to Basel II, and that the international governments involved will continue to work to decrease the burden on the banking industry as much as possible. Nonetheless, although the international agencies can try to reduce differences in treatment of international banks, "at the end of the day we must realize that national jurisdictions still matter."

RMA Alternative to US Basel IA ANPR. At a December 8, 2005 webinar co-sponsored with Goodwin Procter, members of the RMA and of this firm discussed the RMA’s proposed alternative to the Basel IA ANPR published by the US banking agencies (that ANPR is summarized in the October 11, 2005 Alert). Whereas the US banking agencies published a single framework in the ANPR to cover all US banking institutions (approximately 9,000) not subject to the Basel II advanced framework (i.e., a single framework for all but the 10-20 largest, internationally active US banking organizations), the RMA proposed a 4 tiered approach.

Tier I would be the current risk capital framework, resulting in institutions choosing this tier effectively "opting out" of any revisions in the risk capital process. Tier 2 would most closely resemble the ANPR issued by the banking agencies, but also would incorporate qualitative risk management techniques. Tier 3 would incorporate quantitative measures of risk (e.g., probability of default) into the risk capital framework. Finally, Tier 4 would be the Basel II advanced approach promoted for the largest, internationally active US banks.

Participants in the webinar emphasized that each tier would be an option for US banks, and "there is absolutely no intent for any bank to be forced or persuaded to go into any particular tier." The participants also emphasized that the appropriate tier for a particular institution would not be based on asset size, but rather on the institution’s business and risk management systems. This webinar, as well as the November 4, 2005 RMA/Goodwin Procter webinar focusing on the shortcomings of the ANPR, is available at http://www.goodwinprocter.com/webinar_basel_12_8_05.asp.

The FDIC’s Winter 2005 issue of Supervisory Insights includes an article (the "Article") concerning financial institution ("FI") governance of risks associated with the use of financial models. Such models are being increasingly used by FIs to manage credit risk and interest rate risk and to measure regulatory capital and derivative pricing, among other things. The Article points out that these models themselves create a new source of risk, "the potential for model output to incorrectly inform [and thereby influence FI] management decisions." The Article states that while model governance procedures will vary with the complexity of the model, four governance principles typically apply at all FIs: (1) the Board of the FI should establish policies providing oversight throughout the FI commensurate with overall reliance on models; (2) management should provide adequate controls over use of each model, based on the criticality and complexity of the model; (3) FI staff or outside vendors with appropriate independence and expertise should periodically validate that the model is working in the manner intended; and (4) internal audit should test model control practices and model validation procedures to confirm compliance with FI policies and procedures. The Article states that examiners will generally review controls and validation procedures used by the FI for some selected, but not all, models. As part of the supervisory process examiners are typically also reviewing model governance policies and the accuracy and completeness of the FI’s model inventory. An FI’s failure to adequately oversee and govern its financial model inventory is likely to adversely affect its "sensitivity to market risk", "management" and/or other supervisory ratings related to a specific inadequately governed model.

The U.S. Court of Appeals for the District of Columbia (the "Court") upheld a lower court ruling that the Federal Trade Commission ("FTC") does not have the authority to require lawyers to comply with the FTC’s financial privacy rules issued pursuant to the Gramm-Leach-Bliley Act ("GLBA"). American Bar Association v. Federal Trade Commission, No. 04-5257 (Dec. 6, 2005). The Court, in its opinion, said that Congress in passing GLBA did not evidence any intent to permit the FTC to regulate lawyers and that the agency could not infer ambiguity in the statute simply because the law was silent on whether lawyers or law firms engaged in certain financial activities were "financial institutions" subject to the GLBA privacy provisions. The Court also held that the FTC was not entitled to deference in its interpretation in the statute. Finally, the Court stated that "The states have regulated the practice of law throughout the history of the country; the federal government has not. . . .[I]t is not reasonable for an agency to decide that Congress has chosen such a course of action in language that is, even charitably viewed, at most ambiguous." It is not yet known whether the FTC will appeal the decision.

The staff of the SEC’s Division of Investment Management responded to a letter submitted by the Chair and Vice Chair of the Subcommittee on Private Investment Entities of the Committee on Federal Regulation of Securities of the Business Law Section of the American Bar Association regarding issues raised by Rule 203(b)(3)-2 under the Investment Advisers Act of 1940, as amended (the "Advisers Act"), and related rule amendments that require advisers to certain unregistered funds ("private funds") to register under the Advisers Act. The Subcommittee’s letter also addressed various issues regarding compliance with the Advisers Act that would affect newly registered private fund advisers. The Subcommittee had previously queried the staff in 1999 regarding a variety of interpretive issues relating to rules adopted by the SEC to implement provisions of the National Securities Markets Improvement Act of 1996 relating to certain types of privately offered funds (American Bar Ass’n., SEC No-Action Letter (pub. avail. April 22, 1999) (the "ABA Letter")). As with the ABA Letter, the staff’s responses to the issues raised in the Subcommittee’s June 23, 2005 letter were somewhat mixed, reflecting both favorable and unfavorable reactions to the interpretive positions the Subcommittee suggested the staff adopt. Topics addressed by the staff include (a) the redemption period element of the "private fund" definition as it applies to certain owners, transfers and withdrawals, (b) the treatment of offshore subadvisers, (c) registration of a private fund adviser’s affiliated entities and (d) compliance with the Adviser Act’s principal transactions and custody requirements. In its response, the staff indicated that it had not addressed certain issues raised by the Subcommittee (e.g., proxy voting). A Hedge Fund Alert discussing the staff’s responses and related issues in detail will be forthcoming; its availability will be announced in the Alert.

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