United States: Financial Services Alert

As we highlighted in a Special Alert distributed last Friday, the federal financial modernization legislation, more formally known as the Gramm-Leach-Bliley Act (the "Modernization Act"), has become law. The Modernization Act makes sweeping changes to the financial services landscape, permitting for the first time the affiliation of banks, securities firms, and insurance companies. The Modernization Act also addresses privacy, insurance, Community Reinvestment Act ("CRA"), and other issues. On Friday, we distributed to clients for whom we had e-mail addresses a summary of the Modernization Act prepared by this firm, which contains hyperlinks for easier navigation through the 50 page document. If you would like to receive a copy of the summary, either in electronic or hard copy form, please contact Gregory Lyons. Please also note that the effective date for bank compliance with the privacy provisions is the 1 year period stated in the summary, rather than the 2 year time-frame referenced in last week’s Alert.

The SEC finalized rules regarding householding of prospectuses and certain shareholder reports and proposed rules regarding householding of proxy and information statements.

Final Rules. The SEC adopted new Rule 154 under the Securities Act of 1933 along with certain rule amendments to permit "householding" of prospectuses and shareholder reports. Householding is the delivery of one prospectus or shareholder report to investors who share the same address. Under new Rule 154, delivery (including delivery by electronic means) of a single prospectus or prospectus supplement to the shared address of several persons is considered delivery to each of them for purposes of the federal securities laws, provided those persons consent in writing to the method of delivery and the prospectus is addressed to the persons as a group or to each of them individually. The Rule also permits householding to a residential street address or P.O. Box based on implied consent provided certain conditions, which relate primarily to notice, are met. Rule 154 as adopted differs from the SEC’s original 1997 proposal in several respects, including coverage under the final rule of householding with respect to investors who are not natural persons and householding of new investors based on implied as well as written consent. Rule 154 does not apply to any prospectus delivered in connection with a business combination transaction, exchange offer or reclassification of securities. The SEC also adopted amendments to Rules 30d-1 and 30d-2 under the Investment Company Act of 1940 (the "Investment Company Act") and Rules 14a-3, 14c-3 and 14c-7 under the Securities Exchange Act of 1934 (the "Exchange Act") to permit householding of annual and semi-annual reports under substantially the same conditions as those for householding under Rule 154. Funds relying on no action relief to household shareholder reports may continue to do so for existing householded investors without complying with the notice and consent requirements of the amended rules but must observe the revocation provisions of the new rules in the event a current householded investor revokes householding consent. Rule 154 and the Investment Company Act and Exchange Act rule amendments are effective December 20, 1999.

Proposed Rules. In a companion release, the SEC proposed amendments to the Exchange Act rules regarding the delivery of proxy and information statements to permit householding of these documents under conditions similar to those applicable under Rule 154 (although a separate proxy card would need to be provided for each shareholder account solicited). These proposals would also permit intermediaries such as banks and broker-dealers acting on their own initiative to household proxy and information statements and would extend newly adopted Rule 154 to allow householding of combined proxy statement-prospectuses delivered for business combinations, exchange offers or reclassifications. The SEC has requested comment on a variety of matters in connection with the proposed amendments, including whether state law requirements regarding the delivery of notice of shareholder meetings make proxy statement householding unfeasible and whether householding, with or without consent, should be permitted to parties vested with voting authority (e.g., investment advisors, investment managers for ERISA plans and trustees). Because the written notice of intent to household required in all final and proposed rules governing householding must include specific mention of each document to be householded, the SEC suggested that persons intending to household consider waiting until the conclusion of SEC initiatives in this area before mailing any householding notices in order to avoid the possible expense of a second circulation following the conclusion of rulemaking. The SEC must receive comments on the proposed rule by January 18, 2000.

In response to a bank holding company’s ("BHC") request to engage in data processing activities offshore pursuant to 12 C.F.R. § 211.5(d)(10) of Regulation K without any restrictions on the type of data processing being conducted, the FRB issued an interpretation that clarifies that Regulation K does not permit a broader range of data processing activities outside the US than is permissible under Regulation Y (e.g., no more than 30% of its revenue may be nonfinancial) without specific FRB approval. If a BHC wishes to engage in a broader range of data processing activities offshore than is permitted under Regulation Y, it must apply for the FRB’s specific approval under Section 211.5(d)(20) of Regulation K. The interpretation also notes that if a BHC already has commenced data processing activities offshore beyond those permissible under Regulation Y, it should consult with FRB staff to determine whether such activities may be continued. This interpretation is significant because the Modernization Act generally permits financial holding companies ("FHC") to conduct the same activities in the US as offshore. A determination that Regulation K permitted data processing activities without restriction thus could have been imported into the US for the benefit of FHCs.

The SEC proposed new Advisers Act Rule 202(a)(11)-1, which is designed to avoid the application of the Advisers Act of 1940 (the "Advisers Act") to a broker-dealer that provides investment advice incidental to its brokerage services solely because (1) the broker-dealer receives compensation on a basis other than traditional brokerage commissions, or (2) the broker-dealer provides execution-only services in addition to full-service brokerage. Under the proposed rule, a broker-dealer providing incidental investment advice to its brokerage customers will not be required to treat those customer accounts as subject to the Advisers Act solely because of the form of its compensation from those accounts if the broker-dealer satisfies 3 conditions: (1) the broker-dealer does not exercise investment discretion over the customer accounts; (2) any investment advice provided to customers is incidental to the brokerage service provided; and (3) advertisements for and contracts or agreements governing the accounts contain a prominent statement that they are brokerage accounts. The proposed rule would also not treat a broker-dealer as receiving "special compensation" (which would subject the broker-dealer to the Advisers Act) solely because the broker or dealer charges a commission, mark-up, mark-down or similar fee for brokerage services that is greater or less than one it charges another customer. Until the SEC takes final action on the proposal, the Division of Investment Management will not recommend, based on the form of compensation received, that the SEC take any action against a broker-dealer for failure to treat any account over which the broker-dealer does not exercise investment discretion as subject to the Advisers Act. Comments on the proposal are due by January 14, 2000.

The OCC amended its interpretative rulings located at 12 CFR Part 7, as well as to other provisions of the OCC regulations. The amendments to Part 7 are principally intended to codify recent OCC interpretative rulings, and include:

Messenger Services. Modification of the authority concerning messenger services to provide that whereas an affiliated service must continue to show that it is both providing services to the public and retaining discretion to determine which customers and geographic areas it will serve, a non-affiliated service need demonstrate only that it has discretion to determine whom it will serve and where.

Directors. An amendment expressly permitting a director’s qualifying shares to be subject to buyback or repurchase agreements, and permitting a director to assign the right to receive dividends or distributions on the shares back to the original shareholder and to execute an irrevocable proxy authorizing the original shareholder to vote the shares. The rule also amends the current provision to make clear that banks should file the original executed director oaths with the OCC and retain copies.

Treasury Shares. Codification of many of the recent rulings addressing when a national bank may, with OCC approval, acquire outstanding shares and hold them as treasury stock, defining legitimate bases to include: holding shares in connection with a stock plan, holding shares for sale to a potential director to meet the qualifying share requirements, purchasing a director’s shares upon resignation or death when there is no publicly available market, reducing the number of shareholders so as to qualify as an S corporation, and reducing the number of shareholders to lower the bank’s administrative costs.

Visitorial Powers. Clarification that the exclusive visitorial powers of the OCC generally include the inspection, regulation and control of the operations of a bank. As limited exceptions to this standard for which states do have visitorial powers, the preamble cites state escheat laws and insurance, particularly in light of the Modernization Act.

RSUs. Clarification that automated teller machines and remote service units ("RSUs") established and operated by a national bank are not subject to any state-imposed geographic or operational restrictions or licensing laws, codification of its 1995 interpretation that a deposit production office which merely assists bank customers to make deposits is not a branch, and express declaration that a facility does not become a branch merely by combining the nonbranch functions of a loan production office, a deposit production office, and a RSU (even a RSU that can receive deposits, pay withdrawals, and loan money). As to the last point, the preamble acknowledges that these nonbranch offices raise CRA and other issues which must be addressed. The rule becomes effective December 6, 1999.

The FRB issued Orders permitting BHCs to engage in operating a securities exchange, as well as acting as a certification authority ("CA") in connection with financial and nonfinancial and other related activities. CA involves identity authentication and related services. These Orders were issued prior to the day prior to the enactment of the Modernization Act, and thus these activities will be permitted for a BHC whether or not it elects FHC status.

Securities Exchange. The FRB approved the Regulation Y application of a number of BHCs to acquire significant interests in a company that operates an electronic exchange for the secondary trading of listed equity and equity-related securities. The exchange is a screen-based electronic market that provides securities trade matching, execution, and related services to US and foreign market-makers, broker-dealers, and institutional investors. The exchange would not take a principal position in securities, clear or settle the securities transactions executed on the exchange, or assume any principal risks for securities trades executed on the exchange. The Order states that operating a securities exchange is closely related to banking, as its principal function is to provide a centralized facility for the execution, clearance, and settlement of securities transactions. The Order also notes that operating an exchange is a proper incident to banking, as all of the entities were well capitalized and would remain so after the consummation of the proposal. The Order specifically provides that because the clearance and settlement of securities transactions involve risks that are materially different from the risks associated with the execution of securities transactions, the notificants would have to seek separate FRB approval if the exchange proposed to clear or settle transactions.

CA. The FRB also permitted a number of BHCs to make significant investments in a company that acts as a CA in the US in connection with financial and nonfinancial transactions and other related activities. The company would act as the global rulemaking coordinating body for a number of financial institutions that would act as CAs and therefore provide services designed to verify or authenticate the identity of customers conducting financial and nonfinancial transactions over the Internet and other "open" networks. The Order states that the FRB has previously authorized organizations to act as CAs in connection with financial transactions conducted over electronic networks, but not in connection with nonfinancial transactions. However, applying the National Courier test, the Order determined that banks and BHCs have provided similar services, such as by providing notary services to customers. The Order also notes that state banks and national banks recently were authorized by their bank regulatory authorities to act as CAs and provide identity authentication services in connection with financial and nonfinancial transactions.

The four federal banking agencies issued a Web Site Privacy Survey Report, pursuant to which they examined 314 web sites selected randomly, plus those of the 50 largest banks and thrifts with web sites. A copy of the report is available upon request.

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.

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