United States: NYSE Proposes New Business Entertainment Rule
(Financial Services Alert (Developments of Note)

1. U.S. District Court Denies Bundled Service Provider’s Motion for Summary Judgment of Claims Regarding Revenue Sharing Arrangements

2. FDIC Adopts Interim Final Rule Increasing Deposit Insurance Coverage for Certain Retirement Accounts

3. OCC Clarifies National Bank Authority to Invest in Minority-and Women-Owned Banks and Thrifts

4. NYSE Proposes New Business Entertainment Rule

5. IRS Issues Final Withholding Regulations for Qualified Interest Income and Short-Term Gain Distributions by RICs

6. FRB Amends Regulations K to Expand Reach of Bank Secrecy Act to Edge and Agreement Corporations

7. Federal Banking Agencies Issue Advisory Concerning Management of Risks Related to Pandemic Flu

The U.S. District Court for the District of Connecticut recently denied the defendant bundled service provider’s motion for summary judgment to dismiss plaintiffs’ claims that certain revenue sharing arrangements violated the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). In Haddock v. Nationwide Fin. Servs., No. 3:01cv1522 (D. Conn. March 7, 2006), the court allowed the plaintiffs to proceed with claims for breach of fiduciary duty and violation of the prohibited transaction rules under ERISA, against Nationwide Financial Services, Inc. ("Nationwide"). The court found that a reasonable fact-finder could conclude that (i) Nationwide acted as a fiduciary by selecting the investment option line-up offered to plan sponsors, (ii) Nationwide breached its alleged fiduciary duty and engaged in prohibited self-dealing by selecting investment options that favored Nationwide, including funds that provided Nationwide with higher revenue sharing payments, and (iii) Nationwide breached its alleged fiduciary duty by accepting revenue sharing payments (which the court concluded may be plan assets). The plaintiffs are seeking class-action certification. This case could potentially have broad implications for the bundled service business.

The FDIC approved an interim final rule (the "Interim Final Rule") that increases the deposit insurance coverage on certain retirement accounts at a bank or thrift to $250,000 from $100,000. Accounts that will receive the increased insurance coverage are traditional and Roth IRAs, self-directed Keogh accounts, "457 Plan" accounts for state government employees and employer-sponsored "defined contribution plan" accounts that are self-directed – which the FDIC states are primarily 401(k) accounts. Moreover, the retirement accounts that are insured up to $250,000 under the Interim Final Rule are insured separately from a customer’s other accounts at the applicable bank or thrift. Insurance coverage for all other deposit accounts remain at the $100,000 level.

The Interim Final Rule also eliminates a restriction that a bank or thrift must satisfy certain capital requirements as a precondition to the availability at the bank or thrift of pass-through insurance coverage for employee benefit accounts. The FDIC states that insurance coverage limits for all types of accounts may be adjusted, in the future, to reflect inflation, but not prior to 2011. The Interim Final Rule will be open for comment for 60 days after its publication in the Federal Register, but will become effective on April 1, 2006.

The OCC amended (the "Amendment") its "Common Part 24 Questions" to add a new section specifically clarifying that it is permissible for a national bank to invest in minority- and women-owned banks and thrifts pursuant to the authority to engage in public welfare investments set forth in 12 CFR Part 24 ("Part 24"). The Amendment states that, when evaluating a national bank’s Community Reinvestment Act ("CRA") performance a 1992 CRA amendment authorizes consideration of capital investments in cooperation with minority- and women-owned banks, provided that these activities help meet the credit needs of the local communities in which the minority- and women-owned banks are chartered. As a result, the Amendment states that national banks may invest in minority- and women-owned banks pursuant to Part 24 if such banks serve the local communities in which they are chartered. Moreover, national banks may make a Part 24 investment in minority- and women-owned banks that are certified as Community Development Financial Institutions, or are community development focus national banks chartered by the OCC.

The New York Stock Exchange ("NYSE") proposed new Rule 350A (the "Rule") which would address business entertainment provided by its members to representatives of customers (including prospective customers). In proposing the Rule, the NYSE cited concern over whether business entertainment provided by members might be influencing customer representatives’ decisions to direct business to members in potential violation of SEC and NYSE rules. (In this regard, the NYSE’s proposal notes that "[a]lthough not explicitly defined by the SEC, when acting as an agent for its customers, a broker-dealer owes such customers a duty of best execution"; the proposal also cites NYSE Rule 123A.401, "which provides that a broker handling a market order is to use due diligence to execute their [sic] order at the best price or prices available under the published market procedures of the Exchange.") As discussed in its proposal, the NYSE initially contemplated an approach to regulating member business entertainment practices that would have established specific quantitative dollar standards applicable to all members. Instead, consistent with the approach taken by the NASD in its own recent proposed rulemaking regarding business entertainment (see the January 31, 2006 Alert), the Rule would require members to establish written policies and procedures relating to business entertainment practices, along with related supervisory practices, training, testing and recordkeeping. Unlike the NASD proposal, however, the Rule would require an NYSE member to provide notice to customers (including prospective customers) that have a fiduciary duty to public customers or shareholders (such as a mutual fund or advisory client) that upon written request the member will provide information on business entertainment provided to the customer’s employees.

Business Entertainment. The proposed Rule defines business entertainment as any social event, hospitality, sporting event, entertainment event, meal, leisure activity or event of like nature or purpose, including entertainment offered in connection with a charitable event or educational conference, as well as any associated transportation or lodging provided in connection with the entertainment, where a person associated with a member accompanies an employee, agent or other representative of a customer (a "customer representative"). If a customer representative is not accompanied by a person associated with the member organization, expenses associated with the entertainment are considered a gift or a gratuity under NYSE Rule 350, unless exigent circumstances make it impracticable for an associated person to attend. The exception for exigent circumstances would be subject to various documentation and approval requirements.

General Standard Regarding Business Entertainment. The Rule would prescribe a general standard regarding member business entertainment practices. Under this standard, an NYSE member could not provide, in a "business entertainment" context, anything of value to a customer representative during the course of, or pursuant to the establishment of, a business relationship that is intended or designed to cause, or otherwise would be reasonably judged to have the likely effect of causing, the customer representative to act in a manner inconsistent with the best interest of, or fiduciary responsibility to, the customer.

Written Policies and Supervisory Procedures. The proposed Rule would require each NYSE member to adopt written policies and supervisory procedures reasonably designed to define forms of business entertainment that are "appropriate" and "inappropriate" using quantitative and/or qualitative venue, nature, and frequency standards. A member’s policies governing business entertainment would also have to impose specific dollar limits, or require written supervisory approval at specified dollar thresholds. In its proposal, the NYSE indicates an expectation that the process of setting dollar limits would likely encourage firms to compare their standards with those of similarly situated firms, which may enable "unofficial" industry standards to evolve.

Under the proposed Rule, a member’s written supervisory procedures would also have to include policies and procedures designed to detect and prevent business entertainment that is intended as, or could reasonably be perceived to be intended as, an improper quid pro quo or inducement for obtaining customer business, The NYSE’s proposal notes that this provision (whose standard differs somewhat from the Rule’s general standard discussed above) is designed to make clear that members should take a proactive approach to policing their business entertainment practices. The Rule would also require (1) detailed recordkeeping regarding business entertainment expenses, (2) appropriate education and training (which could be provided as part of the "Firm Element" requirement of NYSE Rule 345A) and (3) periodic verification and testing pursuant to NYSE Rule 342.23. The proposed Rule would expressly allow specifically tailored standards for business entertainment deemed to be primarily educational in nature or closely associated with a charitable event or philanthropic cause.

Considerations in Establishing Written Policies. The NYSE indicates in its proposal that it intends to issue an information memo in conjunction with approval of the proposed Rule that would set forth factors to be considered when a member establishes the criteria in its written policies and procedures used to evaluate the propriety of business entertainment in various contexts. The factors fall in three categories: entertainment, client and business purpose. Factors with respect to entertainment would include consistency with the nature of the business relationship, industry custom, member organization custom and comparability within a particular location. Factors with respect to a client would be whether the recipient has fiduciary duties that are implicated by the receipt of business entertainment, the frequency of entertainment provided to the representative and the frequency of firm contact with the client in the ordinary course of business. Factors with respect to business purpose would be whether the entertainment is in recognition of a completed deal and whether the entertainment is educational or philanthropic in nature, or strictly recreational.

Public Comment and Effectiveness. Public comment may be submitted on the NYSE’s proposal no later than the 21st day following publication of notice of the proposal in the Federal Register. The proposal will become effective within 35 days of the publication of the notice, subject to SEC action to extend the period for consideration of the proposal or institute proceedings to disapprove the proposed Rule.

The IRS has issued final regulations clarifying withholding tax obligations for distributions of short-term capital gains and qualified interest income ("QII"). Pursuant to the American Jobs Creation Act of 2004, regulated investment companies ("RICs") are permitted to designate distributions of short-term capital gains and QII as exempt from U.S. withholding tax when paid to foreign investors. The final regulations extend the "reasonable estimate rules" currently applicable to long-term capital gain and exempt-interest dividends to QII and short-term gains. They generally provide that if the amount designated by a RIC as short-term gain or QII exceeds the amount that may be designated under the Internal Revenue Code, no penalties will be imposed for any related underwithholding, provided that the designation was based on a "reasonable estimate" and adjustments to the amount withheld are made within a certain time period (generally, prior to the due date of Form 1042). The final regulations became effective on March 14, 2006.

The FRB approved a final rule (the "Rule") amending Regulation K to require Edge and Agreement Corporations and uninsured, state-licensed U.S. branches, agencies, and representative offices of foreign banks supervised by the FRB to establish and maintain procedures reasonably designed to ensure and monitor compliance with the Bank Secrecy Act (the "BSA") and related regulations. Domestic financial institutions subject to the FRB’s Regulation H (as well as state nonmember banks, national banks, broker-dealers, mutual funds and other "financial institutions" under the BSA) are already required to maintain programs to ensure compliance with the BSA. The BSA requires that a financial institution doing business in the U.S. keep records and make reports that have a high degree of usefulness in criminal, tax, or regulatory proceedings. For a discussion of the minimum components of a compliance program that "financial institutions" covered by the BSA are required to implement and maintain see the April 23, 2002 Alert. The FRB has also stated that, as with other "financial institutions" covered by the BSA, Edge and Agreement Corporations should adopt BSA programs tailored to address the risks posed by their specific business operations and customer base. The Rule becomes effective on April 19, 2006.

The FRB, FDIC, OCC and OTS (the "Agencies") issued a joint advisory (the "Advisory") to financial institutions ("FIs") and their technology service providers concerning the risks to FIs posed by a pandemic influenza outbreak and the need for FIs to reflect and plan for addressing these risks in FIs’ event-response and contingency strategies, e.g., by planning for greater numbers of employees to work off-site during a period of outbreak of pandemic flu and by taking steps to reduce risks to employee safety and business continuity. The Advisory was issued by the Agencies in accordance with the White House’s "National Strategy for Pandemic Influenza" issued on November 1, 2005. The Agencies note that FIs with a global presence and those considered critical to the financial system may require greater preparation than smaller FIs, but that a potential pandemic outbreak is a threat to all FIs regardless of size and location.

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