The SEC recently published its formal release (the “Adopting Release”) adopting significant amendments (the “Amendments”) to Rule 2a-7 and other rules under the Investment Company Act of 1940 (the “1940 Act”) that affect money market funds.  The SEC approved the Amendments at its January 27, 2010 open meeting.  This special edition of the Alert discusses the Amendments in detail.  It reviews the principal changes to the 1940 Act’s money market fund rules, and discusses the new obligations the Amendments impose on money market fund boards of directors as well as the new policies the Amendments require funds to adopt.  It also reviews the various compliance dates for the Amendments.

Summary of the Amendments

The Amendments reflect three categories of changes to the rules governing money market funds: (a) changes to Rule 2a-7’s risk limiting conditions governing a fund portfolio’s: (i) maturity, (ii) credit quality, (iii) diversification and (iv) liquidity, (b) changes relating to operational aspects of money market funds, and (c) new disclosure requirements. [Read more →]

As it makes its way through the legislative process, the EU’s Alternative Investment Fund Managers Directive continues to include elements that would significantly affect non-EU funds and managers that want to market to investors in the EU. For commentary and analysis from our colleagues at SJ Berwin LLP on amendments to the Directive recently proposed in the European Parliament and proposals put forward by the new Spanish Presidency of the EU, click here.

The SEC issued the adopting release for amendments to Regulation SHO that impose an alternative uptick rule on short selling in a security covered by the rules once trading in the security trips a “circuit breaker” by causing the security to experience a price decline of at least 10 percent from the prior day’s close. Under the alternative uptick rule, short selling is permitted only if the price of the security is above the current national best bid. The restriction applies to short sale orders in that security for the remainder of the day on which the circuit breaker is tripped and on the following day. The alternative uptick rule generally applies to all equity securities that are listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market. This new requirement will be implemented by requiring trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale. The compliance date for the amendments is November 10, 2010.

The Technical Committee of the International Organization of Securities Commissions (“IOSCO”) has released a template designed to allow securities regulators to gather comparable and consistent data from hedge fund managers and advisers to facilitate international supervisory cooperation in identifying possible systemic risks in the hedge fund sector. The template was released in view of planned legislative changes being considered in various jurisdictions, with a recommendation that the first gathering of data be carried out on a best efforts basis in September 2010. SEC Commissioner Kathleen Casey chairs the Technical Committee. As discussed in a November 20, 2009 Goodwin Procter Client Alert, the various U.S. financial regulatory reform proposals to date would grant the SEC considerable rulemaking power to require advisers to privately offered funds to report on their activities and those of their funds.

The federal banking agencies (the “Agencies”) clarified the risk weights for claims on or guaranteed by the FDIC for purposes of banking organizations’ risk-based capital requirements. Direct claims on and claims unconditionally guaranteed by the FDIC (such as FDIC-insured deposits, prepaid assessments of deposit insurance premiums and debt guaranteed under the Temporary Liquidity Guarantee Program) may be assigned a zero percent risk weight. Recent loss-sharing agreements entered into by the FDIC, though, are considered conditional guarantees for risk-based capital purposes due to contractual conditions that acquirers must meet, and therefore are not eligible for a zero percent risk weight. Instead, the guaranteed portion of assets subject to such a loss-sharing agreement may be assigned a 20 percent risk weight. The Agencies also advised banking organizations to consult with their primary federal regulator to determine the appropriate risk-based capital treatment for specific loss-sharing agreements, as the specific terms of each agreement may vary.

In actions designed to bring borrowing from the FRB’s discount window closer to terms and conditions that prevail in a normal, stable economic environment the FRB announced that it would: (i) increase the primary credit rate at the FRB discount window to 0.75% from 0.50% effective February 19, 2010; (2) reduce the maximum maturity of most discount window loans to overnight (from maturities of 28 days) as of March 18, 2010; and (3) raise the minimum bid rate for the FRB’s Term Auction Facility (“TAF”) from 0.25% to 0.50%.  The FRB also announced that its final TAF auction will be held on March 8, 2010.  Primary credit is short-term funding provided by the FRB on a fully secured basis to depository institutions that are in a “generally sound condition.”  The FRB intends that primary credit be used by borrowing depository institutions as a backup source of funding.

The FRB said that it was able to make these changes to discount window practices because of “continued improvement in financial market conditions.”  The FRB also noted in its announcement that is expects that as a result of these changes, depository institutions will use private funding sources (rather than the discount window) for normal short term credit needs.  Morever, the FRB stated that its changes in discount window rates and maturities are not expected to lead to tighter financial conditions for households and businesses “and do not signal any changes in the FRB’s outlook for the economy or for monetary policy.”

In written testimony to the House Financial Services Committee, FRB Chairman Ben Bernanke outlined the FRB’s exit strategy from the extraordinary lending and monetary policies it established in response to the financial crisis and recession which have caused the FRB’s balance sheet to grow to more than $2.2 trillion.  “As a result of the very large volume of reserves in the banking system, the level of activity and liquidity in the federal funds market has declined considerably, raising the possibility that the federal funds rate could for a time become a less reliable indicator than usual of conditions in short-term money markets,” Chairman Bernanke stated.  Instead, Chairman Bernanke indicated that the FRB is turning to the interest rate paid on reserves – currently at 0.25%   as an alternative short term interest rate.  The FRB was granted the authority to pay interest on reserves in October 2008.  As of February 3, 2010, U.S. banks had more than $1.1 trillion on deposit with the Federal Reserve Banks.  An increase in the interest rate paid on reserves would encourage banks to increase their reserve deposits, which would result in less money in the banking system. [Read more →]

Senate Banking Committee Chairman Christopher Dodd and Ranking Member Richard Shelby announced that they have reached an impasse in their bipartisan efforts to craft a comprehensive financial markets regulatory reform bill.  It is believed that their talks fell apart over whether an independent consumer protection division within a regulatory agency could have rule-making authority.  Senator Dodd had previously agreed to scrap a proposal for a new independent agency the Consumer Financial Protection Agency, in favor of an independent consumer protection division within a financial regulatory agency.  In December 2009, the House of Representatives passed the Wall Street Reform and Consumer Protection Act of 2009, which would establish an independent Consumer Financial Protection Agency.  No Republican members of the House voted for the bill.

The Senate Banking Committee had formed four bipartisan working groups to address specific regulatory reform subjects.  Senators Dodd and Shelby worked on consumer protection and prudential banking regulation; Senators Jack Reed and Judd Gregg worked on derivatives and credit-rating agencies; Senators Mark Warner and Bob Corker worked on the resolution of major financial institutions; and Senators Charles Schumer and Michael Crapo worked on executive compensation and corporate governance.  Senators Dodd and Corker have announced they will continue to work on the bipartisan legislation, setting aside for the moment consumer protection issues.  Senator Corker stated that he was willing to be the lone Republican vote for financial markets regulatory reform, but that he believes the Senate Banking Committee will draft a bill that other Republicans would be comfortable supporting.

The SEC announced that it has adopted amendments (the “Amendments”) to its rules relating to money market funds, principally to Rule 2a-7 under the Investment Company Act of 1940, as amended.  The Amendments were proposed in June 2009, as discussed in the July 7, 2009 Alert.  The Amendments have not yet been published.  The following description of the Amendments is based on the SEC’s announcement regarding the Amendments and related statements prepared by the Staff of the SEC’s Division of Investment Management. [Read more →]

The Basel Committee on Banking Supervision of the Bank for International Settlements (the “Basel Committee”) issued guidance on “Compensation Principles and Standards Assessment Methodology” (the “Guidance”).  The Guidance is designed to assist national financial supervisory agencies in assessing a bank’s compensation practices.  The Basel Committee said that the Guidance “will contribute to ongoing implementation of” nine “Principles for Sound Compensation Practices” (the “Principles”) adopted by the Financial Stability Board (the predecessor of the Financial Statutory Forum (the “FSF”)) that the Basel Committee believes are appropriate standards to use in implementing banks’ compensation practices.

The Guidance covers all nine Principles, which are organized into three sections and address: (1) governance of compensation; (2) alignment of compensation with prudent risk taking; and (3) supervisory oversight of compensation practices and engagement by stakeholders.  The Principles were proposed by the FSF as standards to reduce individuals’ incentives to take excessive risks present in banks’ compensation arrangements.

The Guidance recognizes that the Principles are designed to be internationally agreed upon objectives and high level principles with only a few specific benchmarks.  The Basel Committee also acknowledges that the translation of the Principles and Guidance into national (rather than international) rules is key and that “in many countries, domestic rules represent the key reference point for supervisors, both in practice and in a legal sense.”  In addition, the Basel Committee stated that the Guidance is targeted at “significant financial institutions, particularly large, systematically important firms.” [Read more →]

The OCC approved the first use of a “shelf charter,” a new mechanism that makes it easier for nonbank investors to buy failed banks without first owning a bank.

The shelf charter program, which was established by the OCC in November 2008, enables private equity firms to obtain conditional preliminary approval of a national bank shelf charter.  The OCC stated that the approval process for a shelf process can be just as demanding as the approval process for a regular charter.  During its initial review, the OCC evaluates “the qualifications of the proposed management team, the sources and amount of capital that would be available to the bank, and a streamlined business plan that describes how the acquired bank will be operated.”  If the OCC gives its conditional preliminary approval of the shelf charter, the shelf charter remains inactive until the private equity firm is ready to acquire a troubled banking institution.  The private equity firm then must meet certain conditions specified in the OCC’s conditional preliminary approval, be cleared to view the FDIC’s list of troubled institutions and to bid for those institutions, and have its bid for such an institution approved by the FDIC.  Since the beginning of the shelf charter program, the OCC has granted only four shelf charters, and prior to January 22, 2010, no shelf charter has been used to successfully bid for a failed bank. [Read more →]

President Obama proposed two new restrictions designed to limit the size and scope of financial institutions.  One restriction would limit the scope of a financial institution’s activities by barring any insured depository institution, or any financial firm which owns an insured depository institution, from owning, investing in or sponsoring a hedge fund or private equity fund and from engaging in proprietary trading operations unrelated to serving the institution’s customers.  The proposal did not provide a definition of proprietary trading, which some commentators have asserted may be difficult to distinguish from trading that relates to business conducted for customers.

The other restriction would limit the size of a financial institution through a cap on an institution’s nondeposit liabilities.  Depository institutions are currently prevented from acquiring another depository institution if such transaction would result in the resulting institution holding more than 10 percent of aggregate U.S.-insured deposits.  Financial institutions are allowed to exceed the 10 percent limitation through organic growth.  The proposed restriction would supplement the deposit cap and would include such liabilities as non-insured deposits and wholesale funding.  The level of the proposed cap has not yet been determined.  This restriction is designed to limit the future growth of the largest U.S. financial institutions. [Read more →]

The FDIC and the Bank of England signed a memorandum of understanding (“MOU”) under the terms of which they have agreed to expand their cooperation when they act to resolve troubled depository institutions that have activities in both the United States and the United Kingdom.  In the MOU, the FDIC and the Bank of England stressed the importance of “close and effective communication about the operations of financial institutions [subject to differing national laws], consultation on developing issues, cooperative contingency planning … and supporting the development of appropriate recovery (going concern) and resolution (gone concern) plans.”

Under the MOU the FDIC and the Bank of England also agree to work closely with other regulatory authorities in the U.S. and the U.K. in connection with the resolution of troubled cross-border financial institutions.  FDIC Chairman Bair stated that the MOU is an important step toward implementing the recommendations of the Basel Committee’s Cross Border Resolution Group.

The agenda for the SEC’s open meeting on Wednesday, January 27, 2010 includes action on new rules, rule amendments, and a new form under the Investment Company Act of 1940 governing money market funds.

The FDIC’s Board of Directors, by a 3-to-2 vote, approved the issuance of an advance notice of proposed rulemaking (“ANPR”) concerning whether an insured depository institution (“IDI”) compensation program should be incorporated as a factor into the FDIC’s determination of the risk-based deposit insurance premium to be charged to the IDI.  The FDIC requested public comment on the ANPR and posed 15 specific questions for comment that are noted below.  Under Section 7 of the Federal Deposit Insurance Act, the FDIC is supposed to establish a risk-based assessment system for IDIs that incorporates the factors the FDIC believes are relevant in assessing the probability that the Deposit Insurance Fund (“DIF”) will incur a loss because of an IDI.  The FDIC states in the ANPR that it has concluded that IDI compensation practices led to excessive risk-taking by IDI management that contributed to the recent financial crisis.

The FDIC stresses in the ANPR that it does not seek to limit compensation of IDIs, but rather it seeks to adjust risk-based deposit insurance assessment rates to adequately compensate the DIF “for the risks inherent in the design of certain compensation programs.”  The FDIC says that it seeks to provide incentives for IDIs and their holding companies to adopt compensation programs that “align employees’ interests with the long term interests” of the IDI, the FDIC and the IDI’s other stockholders.  The FDIC also wants to promote the use of compensation programs that reward employees for focusing on risk management.  The FDIC does not propose specific minimum compensation standards in the ANPR. [Read more →]