Financial Services Alert

Type of Investments Covered. The capital charge rules would apply only to investments (under the applicable authorities cited above) in nonfinancial entities. Moreover, the proposal and the associated capital charge would not apply to: (1) securities held in a trading account as part of market making activities; (2) investments held in community development corporations or investments to promote the public welfare; and (3) of particular interest to New England banks, any publicly-held securities and registered investment company shares held under the so-called "grandfather" provisions of a 1991 federal law. Furthermore, whereas the earlier proposal would have generally applied the capital charge to all debt held by a banking institution if the institution also held at least 15% of the nonfinancial company’s equity, the new proposal only applies to equity features of debt (i.e., warrants) and to debt convertible into equity that is held under one of the above-cited authorities. Finally, as to funds controlled by a banking organization (e.g., by being a general partner), the capital charge would apply only to the institution’s proportionate share of a fund’s investments.

Capital Treatment of General Investments. Rather than the general 50% deduction that the March, 2000 proposal would have required, the modified proposal establishes a marginal capital structure that is different and, on average, lower. The proposed capital charge would be applied by deducting from Tier 1 capital the "adjusted carrying value" (the "ACV") of covered investments. In applying this deduction, SBIC’s would receive preferred treatment, as there would be no capital charge so long as the aggregate ACV of covered investments held by an SBIC does not exceed 15% of its parent bank’s Tier 1 capital (a slightly different approach would apply if the SBIC is held directly by the BHC). As to all other covered investments, an 8% Tier 1 capital charge would apply so long as the ACV of all covered investments (including all SBIC investments) represents less than 15% of Tier 1 capital; for that portion between 15% and 24.99% of Tier 1 capital, a 12% marginal charge would apply; and for any portion equal to or greater than 25% of Tier 1 capital, a 25% marginal capital charge would apply.

The SEC adopted changes to its rules and forms that generally will require mutual funds to disclose standardized after-tax returns in prospectuses and, under certain circumstances, in sales materials. The standardized after-tax returns are (i) a pre-liquidation after-tax return designed to reflect the tax effects on shareholders of portfolio management activity; and (ii) a post-liquidation after-tax return which also reflects the effect of a shareholder’s decision to sell fund shares. These after-tax returns must accompany before-tax returns in the risk/return summary section of most fund prospectuses. In addition, mutual funds are generally required to include standardized after-tax returns in sales materials that include (a) after-tax returns or (b) other performance information together with representations that the fund is managed to limit taxes. Standardized after-tax returns are calculated using the highest applicable individual federal income tax rate.

Money market funds are exempt from the after-tax return disclosure requirements. In addition, a fund may omit after-tax return information in a prospectus used exclusively to offer the fund as an option for 401(k) plans and other similar tax-deferred arrangements or to entities that are not subject to individual taxation (e.g., tax-exempt foundations). The new requirements generally apply to post-effective amendments and profiles filed on or after February 15, 2002. Fund sales materials must comply with the new requirements no later than October 1, 2001

The FRB, OCC, FDIC and OTS jointly adopted final guidelines (the "Guidelines") for safeguarding confidential customer information. The Guidelines are required by sections 501 and 505(b) of the Gramm-Leach-Bliley Act, and substantially resemble the proposed guidelines discussed in the July 4, 2000 Alert. Similar to the proposal, the final Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors, to create a comprehensive written information security program designed to ensure the security and confidentiality of customer information; protect against any anticipated threats or hazards to the security or integrity of such information; and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The Guidelines establish standards for the above goals, but provide flexibility for financial institutions in implementing the standards, depending upon the sensitivity of the information as well as the complexity and scope of the financial institution’s activities.

A notable change from the guidelines proposed earlier, however, is the provision in the Guidelines that requires financial institutions to have a contract with each of its service providers pursuant to which each service provider must implement appropriate measures designed to meet the objectives of the Guidelines. Contracts in existence on or before the date that will be thirty days after the Guidelines are published in the Federal Register will not have to include such a contractual provision before July 1, 2003. The Guidelines are effective as of July 1, 2001.

The SEC, FTC and NCUA are also required to issue comparable standards to safeguard customer information. The SEC’s final guidelines were included in its final privacy regulation, Regulation S-P, and the NCUA’s final guidelines were released last week. The FTC issued an advanced notice of proposed rulemaking in September regarding information safeguards, but has not issued a proposal yet.

The SEC adopted a new rule that (a) prohibits fund names that suggest guarantee or approval by the U.S. government and (b) imposes portfolio composition requirements on any fund whose name suggests investment in (i) certain types of securities or industries or (ii) certain countries or geographic regions. The new rule, which has a compliance date of July 31, 2002, applies to open-end and closed-end funds and certain unit investment trusts.

Under the new rule, a fund whose name indicates an emphasis on certain investments or industries, must have a policy that, under normal circumstances, 80% of its assets be in the type of investments suggested by its name. A fund whose name suggests an investment emphasis on certain countries or regions (a) must adopt a policy that, under normal circumstances, at least 80% of its assets be in investments that are tied economically to the particular country or geographic region and (b) disclose the criteria for meeting this test. A fund whose name suggests that its distributions are exempt from federal income tax or both federal and state income tax (a "Tax Exempt Fund") must adopt a policy that, under normal circumstances, it will (a) invest at least 80% of its assets in investments the income from which is exempt from federal or federal and state income tax, as applicable, or (b) invest its assets so that at least 80% of the income distributed will be exempt from federal or federal and state income tax, as applicable.

A fund may comply with the new rule by adopting a fundamental policy (i.e., one requiring shareholder approval of any amendment) that satisfies the applicable 80% test. A fund other than a Tax-Exempt Fund may also comply with the new rule by adopting a non-fundamental policy that satisfies the applicable 80% test, provided shareholders are entitled to at least 60 days prior notice of any amendment to the policy.