United States: FinCEN Issues Final Rule Regarding Mutual Fund Reporting of Suspicious Transactions
(Financial Services Alert – Developments of Note)

Developments of Note

1. FinCEN Issues Final Rule Regarding Mutual Fund Reporting of Suspicious Transactions

2. NYSE Issues Guidance on Compliance Reporting Lines

3. NASD and NYSE Issue Joint Guidance Regarding the Solicitation of Substantial Charitable Contributions by Employees or Agents of Certain Customers

4. SEC Publishes Semiannual Regulatory Agenda

5. U.S. Senate Banking Committee Approves Regulatory Relief Legislation

6. Goodwin Procter to Co-Host Compliance Seminar; Host Pre-conference Cocktail Party

The Financial Crimes Enforcement Network ("FinCEN") issued a final rule (the "Rule") that requires all mutual funds (open-end management investment companies as described in the Investment Company Act of 1940, "Mutual Funds" and each a "Mutual Fund") to report suspicious transactions to FinCEN. The Rule requires a Mutual Fund to report to FinCEN on a Form SAR-SF any transaction conducted or attempted by, at, or through a Mutual Fund and that involves at least $5,000 in cash or other assets (whether or not the transaction involves currency) and that the Mutual Fund knows, suspects or has reason to suspect falls within any one of four categories: (1) transactions involving funds derived from illegal activity or intended or conducted in order to hide or disguise funds derived from illegal activity; (2) transactions disguised (through structuring or otherwise) to evade the requirements of the Bank Secrecy Act; (3) transactions that appear to serve no business or other lawful purpose, or are atypical for the customer and for which the Mutual Fund knows of no reasonable explanation after examining the available facts; or (4) transactions involving the use of the Mutual Fund to facilitate criminal activity. Mutual Funds may voluntarily file suspicious activity reports involving amounts of less than $5,000. Implementation of the Rule will make Mutual Funds subject to suspicious transaction reporting requirements that have previously been imposed on banks, broker-dealers and certain other "financial institutions" as defined under the Bank Secrecy Act.

Suspicious Activity Reports ("SARs") must be filed with FinCEN within 30 days after the Mutual Fund initially detects the suspicious transaction (or within 60 days after initial detection by the Mutual Fund of the suspicious activity in the event no suspect is identified at the time of the initial detection). Mutual Funds are required to adopt policies and procedures for identifying and reporting suspicious transactions under the anti-money laundering compliance program requirements of Section 352 of the USA Patriot Act and NASD rules (See, the April 23, 2002 Alert). The release adopting the Rule clarifies that a Mutual Fund can contract out its SAR reporting obligations to a transfer agent or other service provider, but the Mutual Fund remains responsible for compliance and must "actively monitor" the performance of the service provider. The Rule requires reporting by Mutual Funds, but not by certain affiliates, e.g., investment advisers, principal underwriters, administrators and others who provide Mutual Fund-related services.

The Rule points out that Mutual Funds are frequently a part of a fund complex and that more than one Mutual Fund may be required to report the same transaction. Under the Rule, all of such Mutual Funds (as well as other "financial institutions" under the Bank Secrecy Act) may file a joint SAR, but only one should be identified as the "filer" and the narrative section of the SAR should state that it is a "joint filing" and identify the other filers. The Rule also makes it clear when Mutual Funds and other financial institutions exchange information to determine whether a SAR should be filed or which financial institution should file the SAR, such sharing of information does not violate the prohibition on disclosure of information concerning the filing of SARs. Moreover, in situations involving suspected terrorist financing, ongoing money laundering schemes or that otherwise require immediate attention, Mutual Funds must contact law enforcement authorities immediately by telephone as well as filing a Form SAR-SF. Mutual Funds, in such situations, may also, but are not required to, contact the SEC. The Rule is effective June 5, 2006 and will apply to transactions occurring after October 31, 2006.

A number of financial organizations with multiple functionally regulated subsidiaries have centralized their compliance activities in their parent holding companies in order to integrate their compliance systems more efficiently and effectively. In some cases, the chief compliance officers ("CCOs") for the regulated subsidiaries report directly to the CCO, general counsel, or other executive of the parent holding company.

The New York Stock Exchange issued guidance concerning such arrangements involving securities broker-dealers that are members of the Exchange. In an Information Memo, the Exchange reminded its members that the chief executive officer ("CEO") of each member firm is responsible for all functions of the member firm, including compliance, and must exercise direct oversight of the compliance function notwithstanding any reporting lines outside of the member firm. NYSE Regulation, Inc., Information Memo Number 06-26 (the "Memo").

When the CCO of a member firm reports outside of the member firm, the Memo states that the firm’s CEO must adopt measures to avoid potential conflicts of interest that may subordinate the member organization’s compliance efforts to other priorities of the holding company. Although the Memo does not state what these conflicts of interest entail, they presumably refer to the level of funding and senior management attention to compliance matters affecting the member firm. The Memo advises that each member firm CEO should interact with parent company officers to whom the CCO reports on a regular basis to discuss staffing, budgeting, hiring, and disciplinary matters, and should participate in the performance appraisal of the CCO, including salary and bonus decisions.

It is important to note that the NYSE is not telling member firms that their CCOs cannot report to holding company officials. Rather, it is cautioning them against relinquishing ultimate responsibility for their own compliance function to the parent holding company.

The NYSE appears to be the only regulator that has addressed this issue as of this date. The FRB, which regulates financial holding companies, has not addressed the supervisory implications of consolidated compliance systems, although FRB governors have emphasized the importance of enterprise-wide compliance risk-management. See "Enterprise-Wide Compliance Risk-Management," Remarks by FRB Governor Mark Olson to the Fiduciary and Investment Risk Management Association, April 10, 2006; Remarks by FRB Governor Susan Schmidt Bies at the Enterprise Wide Management Roundtable, North Carolina State University, April 28, 2006.

The NASD and NYSE issued joint guidance (the "Joint Guidance") encouraging their respective members to establish written procedures that address charitable giving, particularly situations where a member firm is solicited by employees or agents of a customer (a "Fiduciary Customer") acting in a fiduciary capacity (e.g., employees of an investment company, pension fund or investment manager). The Joint Guidance notes that many of the concerns that have driven recent NASD and NYSE rulemaking with respect to gifts, gratuities and business entertainment are present in situations where substantial charitable contributions are sought from a firm by employees or agents of Fiduciary Customers with whom the firm conducts or intends to conduct business; in these situations, the person making the solicitation may be motivated to act in a manner contrary to the interests of that person’s employer. To comply with the Joint Guidance, a firm’s written procedures should take into account the firm’s structure and its manner of charitable giving, e.g., procedures appropriate for firms with a practice of decentralized charitable giving may not be necessary for firms in which all charitable giving is centralized.

The Joint Guidance suggests that a firm’s procedures could require that charitable contributions exceeding specific dollar or frequency thresholds, or made by an associated person on behalf of the firm, receive appropriate approval. Dollar and frequency thresholds could distinguish customary and minor charitable contributions from substantial contributions that could, by their size or frequency, create potential conflicts of interest. Dollar thresholds should be based on the nature of a firm’s business and its customary practice of charitable giving, and under no circumstances should they be tied to the level of actual or anticipated business from the particular Fiduciary Customer whose employee or agent is soliciting a charitable contribution. The Joint Guidance goes on to suggest that if a firm establishes a dollar threshold for contributions, it may wish to adopt additional procedures for any request that exceeds the specified thresholds, including obtaining specific approval from an appropriate representative of the Fiduciary Customer (i.e., a person who is not involved in soliciting the contribution or conducting business with the firm), and reviewing business subsequently received from the Fiduciary Customer for indications that the person who made the solicitation is acting in a manner contrary to the Fiduciary Customer’s interests. The Joint Guidance cautions that a firm’s procedures should also recognize that there is a greater potential for a conflict of interest when solicitations are made on behalf of a charity that is closely aligned with the employee making the request (e.g., the employee serves as an officer of, or sponsors, the charity) as compared to organizations aligned with the Fiduciary Customer. The Joint Guidance notes that it does not address (a) customary charitable giving initiated by firms or their foundations or (b) charitable giving by persons in their individual capacities, provided that in each instance the giving does not give rise to the conflicts of interest addressed in the Joint Guidance and is not intended to circumvent the firm’s procedures for addressing those types of conflicts. In addition, the Joint Guidance doe snot deal with solicitations received directly from charitable organizations.

In April 2006, the SEC published its Semiannual Regulatory Agenda (the "Agenda") which, in compliance with the Regulatory Flexibility Act, identifies anticipated rulemaking activity that is likely to have a significant economic impact on a substantial number of small entities. In large part, on matters affecting the investment management industry, the Agenda reflects postponements of target dates (of from four months up to a year) for SEC action on initiatives listed in the immediately preceding SEC Semiannual Regulatory Agenda (the "Prior Agenda"), which was discussed in the January 24, 2006 Alert. A notable exception to this trend is the SEC’s investment company disclosure reform initiative, which still has the September 2006 action date for a rulemaking proposal reflected in the Prior Agenda. The principal changes from the Prior Agenda aside from the postponement of action dates are new entries reflecting (a) the ongoing rulemaking activity under the Investment Company Act of 1940 (the "1940 Act") Rule 22c-2 relating to information sharing agreements and (b) consideration of a proposal to amend 1940 Act Rule 19b-1’s requirements regarding the frequency of capital gain distributions. It is important to note that publication of the Agenda does not preclude the SEC from engaging in rulemaking activities with respect to other matters. Nor is the SEC required to act on matters that appear in the Agenda, or act on them within the indicated timeframes. In this instance, the value of the Agenda as a predictor of future SEC rulemaking activity is further qualified by the significant likelihood that the Agenda does not reflect the priorities of incoming Director of Investment Management, Andrew Donahue. His appointment was announced April 10, 2006 while the Agenda speaks as of February 24, 2006.

The U.S. Senate Banking Committee approved a regulatory relief bill (the "Senate Bill") that avoided certain controversial issues (approved in a previous House version of the legislation), but that is given a good chance of being enacted. The Senate Bill, among other things, would: give thrifts parity with banks under federal securities law; require the banking agencies to simplify privacy notices within 180 days after enactment; let financial institutions earn interest on reserves deposited with the FRB; and direct the SEC to consult with the federal banking agencies in implementing Regulation B, the SEC rule that will implement the Gramm-Leach-Bliley Act of 1999 "push-out" provisions with respect to the definition of "broker." After a vote by the full Senate, the Senate Bill is expected to be considered by a House-Senate Conference and the legislation is given a reasonable chance of being enacted before the end of 2006. If and when enacted into law, the Alert will provide an expanded discussion of the key provisions of the legislation.

On May 16, 2006 at the St. Regis Hotel in Washington, D.C., Goodwin Procter will join with The Financial Services Roundtable and the Boston University School of Law Morin Center for Banking & Financial Law Studies in presenting "The Compliance Challenge: How To Structure and Manage the Compliance Function in a Diversified Financial Services Organization." This seminar will help financial institutions better structure and manage their compliance programs to be more effective and efficient. Panels of banking and securities regulators will discuss how financial institutions can meet supervisory expectations, while bank compliance professionals will share their experiences with different approaches to compliance management and structure. For further information or to register, please see the attached brochure.

Attendees and speakers are also invited to a welcome reception at Goodwin Procter’s offices in Washington, DC on May 15. Details on the reception will be forwarded to all registrants.

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.