Banking and Finance Law Report : Banking & Finance Lawyer & Attorney : Porter Wright Morris & Arthur Law Firm : Bankruptcy, Commercial Lending

On February 23, 2010, the Securities and Exchange Commission began what may become radical revisions to the regulation of money market funds when it adopted a number of significant changes to its rules governing money market funds. The changes were accompanied by a statement from the SEC chairman that indicated more regulatory change is on the way. SEC Release No. IC-29132 (Feb. 23, 2010) is online.

The new rules are generally intended to increase investor protections by increasing regulatory oversight of money market funds. For example, among other things, the new rules establish:

• liquidity requirements for money market funds (a daily cash or equivalent requirement of 10 per cent);
• a new restriction on the ability of funds to acquire illiquid securities;shorter maturity limits for securities held by money market funds;
• “know your investor” procedures requiring funds to hold liquid securities to meet foreseeable redemptions;
• a requirement for periodic stress testing to assess ability of a fund to maintain a stable net asset value upon the occurrence of events such as a sudden increase in interest rates;
• andnew disclosure requirements including a monthly report of holdings to the Commission and a monthly posting of holdings online.

In many of these areas there previously was little or no regulation. The rules are effective May 5, 2010, but a number of the new requirements are phased in over two years, including a new requirement that funds be able, as a matter of processing capability, to process transactions at prices other than a stable net asset value.

SEC Chairman Mary Schapiro’s statement on the new rules is online.

Ms. Schapiro’s remarks indicate that the SEC is continuing to study the possibility of floating net asset value money market funds, among other changes. She indicated the market place should expect further changes when she characterized the current regulatory changes as “important initial steps toward making money market funds less vulnerable to ‘runs’.” (Italics supplied.) One further change under study is the establishment of a private liquidity facility for money market funds in times of stress.

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January 21, 2010, President Obama proposed reforms to the financial system designed to ensure no bank, or financial institution that contains a bank, will own, invest in, or sponsor a hedge fund, private equity fund, or proprietary trading operation for the bank’s own profit. The new reforms, known as the Volcker Rule after former chair of the Federal Reserve Board, Paul Volcker, are intended to prevent banks from engaging in what are now perceived as risky investments.

How the Volcker Rule will be drafted and applied is unclear. At a minimum it seems that banks may have to halt investments that use solely the bank’s capital. Banks may therefore have to divest their proprietary trading desks, although most banks have significantly smaller proprietary trading desks than they did prior to the economic crisis.

What constitutes proprietary trading operations under the Volcker Rule is unknown. For example, do such activities include the practice of facilitating trading for clients and investing alongside clients? Additionally, it is unclear whether only wholly-owned bank funds would be prohibited or any bank involvement in a hedge fund or private equity fund above a certain threshold. One approach, which would be a broad interpretation of the Volcker Rule, would be to prohibit any trading activity that could affect a bank’s balance sheet.

President Obama has pledged to work with Congress to implement the Volcker Rule as part of a comprehensive financial reform bill. The dynamics of the bill should have a direct effect on whether some banks will be willing to cease being a bank holding company in order to keep their trading and investment business.

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In November the House Financial Services Committee passed an amendment to the proposed Investor Protection Act, H.R. 3817, that would exempt non-accelerated filers from providing auditor attestation of internal control over financial reporting. Public holding companies for some community banks may be affected. If passed, the bill as amended would provide significant relief for smaller reporting companies which are, generally speaking, companies with a public float of less than $75 million.

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For bankers, November 2, 2009, is a key date to remember in conjunction with unlimited FDIC deposit insurance on noninterest-bearing transaction accounts. By that date, bankers must decide to opt out of the program, or not. For bank customers, November 16, 2009, is a key date because by that date banks that opt out must post notices to that effect.

You will remember the origins of this program: The Transaction Account Guarantee (TAG) program was established in October 2008 in the midst of a severe disruption in the credit market. The TAG program is one of two elements of the FDIC’s Temporary Liquidity Guarantee Program. The other element is the Debt Guarantee Program that provides a guarantee for bank-issued senior debt. The ability to issue debt under that program was scheduled to expire on June 30, 2009 and has been generally extended for four months.

On August 26, 2009, the Board of Directors of FDIC approved its Final Rule on the extension of unlimited deposit insurance for transaction accounts under TAG, and the rule is effective October 1, 2009. The program has been extended to June 30, 2010 (from December 31, 2009). 

Each financial institution that participates will be subject to certain FDIC fees during the extension. The Final Rule provides that financial institutions can opt out of the program by November 2, 2009, and it describes the procedures required for a financial institution to make an election to opt out. The fees to be paid by participating institutions are based on the entity’s Risk Category under the FDIC’s risk-based premium system and range from 15 basis points to 25 basis points (annualized) multiplied by the amounts held in noninterest-bearing accounts that exceed the current deposit insurance limit of $250,000.

The rule also contains requirements for financial institutions to provide notices to customers with respect to the financial institution’s participation in TAG. In summary, the notices must be prominent and must be posted in the lobby of the main office, in each branch office and on the financial institution’s website if it offers internet deposit services. The notice must state whether the institution is participating in the transaction guarantee program and, if so, that the funds held in noninterest-bearing transaction accounts are guaranteed in full by the FDIC. 

In addition, the rule requires certain disclosures of institutions that use sweep arrangements or other actions that result in funds being transferred or reclassified to an account that is not guaranteed under TAG. For example, funds swept into an interest bearing account would not be covered. These disclosures must advise customers that such arrangements would void the FDIC’s insurance guarantee with respect to the swept, transferred, or reclassified funds.

The FDIC’s Final Rule is available here.

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The FDIC has updated its regulatory advice concerning changes for insurance coverage of sweep accounts. Bankers, corporate treasurers and CFO’s should carefully consider the impact on sweep accounts of recent changes in the FDIC’s deposit insurance of these accounts. 

On July 6, the FDIC issued a Financial Institution Letter (FIL-39-2009) consisting of frequently asked questions to update the rule change that was final in January 2009 and published here. The new Letter, intended to answer common questions from bankers, covers:

• The types of sweep accounts covered by the disclosure requirements,
• The disclosures required by the rule.
• The frequency of required disclosures.
• The principles used to determine how swept funds will be treated in the event of failure.
• The requirements for a properly structured repo sweep.

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The Board of Governors of the Federal Reserve recently approved a final rule amending Regulation Z (Truth in Lending) and the Home Ownership Equity Protection Act (HOEPA).   The purpose of the new rule, according to Federal Reserve Chairman Ben Bernanke, is to "protect consumers from unfair or deceptive acts and practices in mortgage lending, while keeping credit available to qualified borrowers and supporting home ownership."  The highlights of the new rule are as follows:

The final rule imposes certain restrictions on lenders in relation to "higher priced mortgages."  This term is broadly defined to capture virtually all loans in the subprime market while at the same time excluding loans in the prime market.  Lenders are prohibited from making a loan without verifying the borrowers' ability to repay the loan from income and assets other than the mortgaged property.  Targeted directly at the practice of offering adjustable rate mortgages (ARMs) with low initial payments, compliance with this regulation requires lenders to assess repayment ability based on the highest scheduled payments in the first seven years of the loan.  In a similar vein, prepayment penalties are prohibited when payments may change within the initial four years of the loan.  More importantly, lenders may incur liability for violating these standards on a case-by-case basis, as borrowers will not have to demonstrate that any violations are part of a larger pattern or practice. 

Advertising for all mortgage loans, regardless of type, priority or the nature of the collateral, must contain additional information about rates, monthly payments and other loan features, such as the effect of discounted rates, the existence of a balloon payment, deductibility of certain kinds of interest for tax purposes, and the extent of promotional or introductory rates.  Certain specific advertising practices thought to be misleading or deceptive are also banned. 

Compliance with this final rule becomes mandatory on October 1, 2009.

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