United States: Financial Services Alert

The likelihood of so-called financial modernization legislation emerging from ongoing Congressional conference deliberations to be enacted this year remains uncertain. However, the three chairmen of the relevant committees, Senator Phil Gramm (R-TX) and Representatives Jim Leach (R-IA) and Tom Bliley (R-VA), have completed their work on drafting a consolidated proposal for consideration and further amendment by the Conference Committee. A markup of the new version of the bill is scheduled for this Thursday. The Conference is intended to be completed in time to allow votes in both chambers for passage prior to the anticipated adjournment of the Congressional session later this month. Disputes over several controversial issues, including the Community Reinvestment Act, activities of bank subsidiaries, insurance and securities provisions, and so-called unitary thrift holding companies, as well as recently surfaced concerns over privacy, have dominated the Conferees’ deliberations. Notably, the new version of the bill sets May 4, 1999 as the cut off date for the filing of new unitary thrift holding company applications. Issues as to transferability of existing unitary thrift holding companies will be decided by the Conference Committee through the amendment process. Accusations by the minority that the Republican leadership has deliberately delayed and foreclosed open discussion of the issues suggest a seemingly growing partisan rift between Conferees that could scuttle a final bill or might foreshadow a threatened Presidential veto. Indications of compromise by the three Chairmen have nevertheless bolstered optimism among some industry representatives that a bill, that would be acceptable to the Administration, may yet be enacted. The Chairmen’s Mark can be viewed at http://www.house.gov/banking/s900conf.htm.

Audit Committee. In response to recommendations made by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, as well as concerns about "earnings management" by companies, the SEC proposed new rules intended to improve disclosure relating to the functioning of corporate audit committees and to enhance the reliability of public company financial statements. The proposal would require that a company’s interim financial statements be reviewed (but not audited) by an independent public accountant prior to their filing with the SEC. The proposal also would require the audit committee to include a report in the company’s proxy statement disclosing whether it has discussed the audited financial statements with management and discussed certain other matters with the independent auditors. In addition, the proposal would require the audit committee to set forth in the proxy statement report whether, based on its review, anything came to its attention that caused it to believe that the year-end audited financial statements contain an untrue statement of a material fact or omit to state a material fact necessary to make the statements therein not misleading. Moreover, the proposal would require companies to disclose in their proxy statements whether their audit committee is governed by a charter. If so, that charter would have to be included as an appendix to the proxy statement at least every 3 years. The proposal also would mandate that companies whose securities are not listed on the NYSE or AMEX, or quoted on Nasdaq, disclose in their proxy statements whether the members of their audit committee are "independent". Finally, to seek to alleviate concerns of increased liability as a result of the additional disclosures required, the disclosures would not have to be considered "soliciting material," "filed" with the SEC, or subject to Regulation 14A or 14C or liability under Section 18 of the Exchange Act.

Rule 10b-18. The SEC finalized amendments to its Exchange Act Rule 10b-18, which provides a safe harbor for liability from manipulation for a company’s repurchase of its common stock in compliance with the rule’s conditions. The rule was developed in response to a petition by the NYSE asserting that expanding the Rule 10b-18 safe harbor to cover issuer repurchases effected during the trading session following a severe market decline could offer an important source of liquidity and provide balance to selling activity. Accordingly, the Rule 10b-18 timing conditions have been amended to permit issuers to bid for or purchase securities either: (1) from the reopening of trading on the same day as a market-wide trading suspension until the scheduled close of trading; or (2) at the opening of trading the next day, if the trading halt is in effect at the close of trading. The Rule 10b-18 conditions governing the manner, price and volume of market purchases would continue to apply. The amendments become effective October 29, 1999.

Foreign Issuer. The SEC also adopted new disclosure requirements for foreign companies. The rule changes reflect the international standards endorsed in 1998 by the International Organization of Securities Commissions (IOSCO). The amendments are expected to simplify capital-raising transactions that take place in multiple countries by allowing companies to prepare a core disclosure document that would be generally acceptable in many countries. The new disclosure standards will change most of the disclosure requirements (other than financial statements) of Form 20-F, the basic disclosure document for foreign private issuers; the SEC will make similar changes in the registration statements used by foreign issuers. The rule changes do not affect the accounting requirements for financial statements, nor will they affect disclosure areas that are not included in the IOSCO protocol (such as market risk disclosure) or the SEC’s review of filings. The new requirements generally will be starting September 30, 2000, depending on the filing.

The Basel Committee on Banking Supervision and the Technical Committee of IOSCO issued updated guidance to banks and securities firms on public disclosures in the trading and derivatives areas. The guidance recommends both qualitative and quantitative disclosures. As to qualitative disclosures, the report recommends that institutions address whether derivatives are used primarily for trading or non-trading purposes, as well as whether the institution primarily uses exchange-traded or OTC derivatives. For trading activities, general disclosures should include whether the institution is a wholesale market maker, engages in proprietary trading, or takes positions merely as an accommodation to customers. In addition, the report recommends that institutions summarize policies regarding market risk, credit risk, and liquidity risk, as well as their approach to income recognition. As to quantitative disclosures, the guidance recommends that institutions provide summary information about the composition of trading portfolios and the use of derivatives for non-trading activities. Institutions should provide, among other things, summary quantitative information on their exposure to market-risk based on the methods they use for internal risk-management purposes, and information on the earnings impact of non-trading derivative activities and other items.

The Massachusetts Division of Banks proposed amendments to its National Bank Parity Regulations (209 C.M.R. 47.00). The proposal would permit Massachusetts-chartered banks to hold minority or non-controlling investments in entities subject to the same four investment limitations as are applicable to national banks, namely: (1) the activities of the enterprise must be limited to activities that are part of or incidental to the business of banking; (2) the bank must be able to prevent the enterprise from engaging in impermissible activities or be able to withdraw its investment; (3) the bank’s loss must be limited as both a legal and an accounting matter; and (4) the investment must be convenient and useful to the bank and not a mere passive investment. The proposal also would permit Massachusetts banks to: invest in a small business investment corporation prior to its obtaining a license from the Small Business Administration; sell, provide or deliver alternate media, including such things as postage, transit fares or passes, event tickets and gift certificates; and sell, provide, or deliver Internet access to customers and non-customers directly or indirectly through the bank. The proposal also would permit a bank to purchase, participate in, or service loans originated by other banks or creditors without regard to the standard requirements of Massachusetts General Law Chapter 167E, Sections 2-12, provided that the bank: perform an independent credit analysis prior to purchase; have capital levels commensurate with the level of risk present in any purchase; maintain adequate loan loss reserves; maintain and implement appropriate risk management; and not advance any new funds to a borrower under a purchased loan if the advance exceeds the single borrower lending limits. A hearing on the proposal is expected October 25, 1999.

If you would like anyone else to receive issues of the Financial Services Alert, would like to receive any past issues, or would like the background materials for any of the matters discussed above, please contact Greg Lyons by telephone: Boston - (617) 570-1329 or DC - (202) 974-1032; facsimile: Boston - (617) 523-1231 or DC - (202) 331-9330; mail (Boston or DC office) or email (glyons@gph.com ).

The contents of this publication are intended for informational purposes only and should not be construed as legal advice or legal opinion, which can be rendered properly only when related to specific facts. This document may be considered advertising under the rules of the Supreme Judicial Court of Massachusetts. ©GPH LLP 1999