FRB Interprets Application of Deposit Regs to ABCP Conduits in Light of FIN 46.

The FRB published an interpretation (the "Interpretation") regarding the application of its Regulation D requirements concerning deposit reserve requirements, as well as its Regulation Q requirements prohibiting payment of interest on demand deposits, to asset backed commercial paper conduits ("ABCP Conduits") in light of the implementation of FASB FIN 46, which concerns the consolidation of variable interest entities (a detailed discussion of FIN 46 appears in the February 4, 2003 and November 11, 2003 Alerts). The issue arises because FIN 46 has caused banks to consolidate many ABCP Conduits onto their balance sheets. Because the FRB has viewed the receipt of cash by a bank for the sale of an instrument with an option of the buyer to force the bank to repurchase or provide cash with respect to the instrument as a "deposit" under certain circumstances, Regulations D and Q are implicated. In this instance, however, the Interpretation highlighted that, although perhaps consolidated by FIN 46 for accounting purposes, the ABCP Conduit remains a bankruptcy remote vehicle from the bank. Moreover, a holder of the commercial paper issued by the ABCP Conduit has no right to force the bank to repurchase any of the paper. As a result, because of this lack of a direct relationship to the bank, the commercial paper issued by the ABCP Conduit would not be a deposit for purposes of Regulations D or Q.

Federal Banking Agencies Issue Guidance on Allowance for Loan and Lease Losses

The FDIC, FRB, OCC, OTS and NCUA (the "Agencies") jointly issued guidance (the "Guidance") to financial institutions ("FIs") reminding FIs that they are required to determine their allowance for loan and lease losses ("ALLL") using generally accepted accounting principles and that the ALLL must be at a level "that is appropriate to absorb estimated credit losses inherent in the [FI's] loan and lease portfolio." In the Guidance, the Agencies also updated FIs on the status of a Statement of Position, "Accounting for Credit Losses" of the Accounting Standards Executive Committee ("AcSEC") of the American Institute of Certified Public Accountants. AcSEC has decided to focus its efforts on providing guidance as to how FIs should improve their disclosure regarding their ALLL methodology and has decided not to proceed with the issuance of additional guidance concerning loss recognition and ALLL measurement. Accordingly, FIs are advised by the Agencies to continue to determine the appropriateness of their ALLL in accordance with existing guidance and the Agencies provide a list in the Guidance of the current sources of ALLL accounting and regulatory guidance.

SEC Issues the Adopting Release on Shareholder Report and Quarterly Fund Holdings Disclosure Requirements

The SEC issued a release describing rule and form amendments adopted at its February 11, 2004 meeting (as discussed in the February 17, 2004 Alert) that (i) require registered open-end funds ("mutual funds") to include additional fund expense disclosure in shareholder reports, (ii) permit mutual funds and registered closed-end funds (collectively, "funds") to include only a summary portfolio schedule of investments in shareholder reports and exempt money market funds from shareholder report portfolio schedule requirements, provided that in each case a complete portfolio schedule is filed with the SEC and is provided to shareholders upon request, (iii) require fund shareholder reports to include a tabular or graphic presentation of portfolio holdings in identifiable categories, (iv) require funds to disclose their complete portfolio schedule in SEC filings on a quarterly basis, and (v) require Management's Discussion of Fund Performance ("MDFP") to appear in mutual fund annual shareholder reports.

Fund Expense Disclosure. Mutual fund shareholder reports for periods ending on or after July 9, 2004 will be required to include an expense example that shows (1) the dollar cost associated with an investment of $1,000 based on the fund's actual expenses and return for the period covered by the report; (2) the dollar cost associated with an investment of $1,000 based on the fund's actual expenses for the period and an assumed return of 5 percent per year; and (3) the fund's expense ratio and the end of period account values in each of the foregoing $1,000 investment scenarios.

Portfolio Information in Shareholder Reports. In shareholder reports for periods ending on or after July 9, 2004, funds may include a summary portfolio schedule in lieu of a complete schedule of holdings in unaffiliated issuers, and money market funds will be exempt from the requirement to include a portfolio schedule in shareholder reports, provided, in each case, that the complete portfolio schedule, subject to certain exceptions, is filed with the SEC on Form N-CSR and is provided without charge to shareholders upon request. The summary portfolio schedule will include each of the fund's 50 largest holdings in unaffiliated issuers and each investment in unaffiliated issuers that exceeds one percent of the fund's net asset value. The investments shown in the summary portfolio schedule must be categorized by type of investment (e.g., common stock, fixed-income security), and further by their related industry, country or geographic region. Shareholder reports must also include a tabular or graphic presentation of the fund's entire portfolio by identifiable categories (e.g., industry sector, geographic region, credit quality or maturity). A fund will have the flexibility to select the categories to be used, the format (table, chart, graph) and the basis of presentation (net asset value vs. total investments), provided that the selection is "reasonably designed to depict clearly the types of investments made by the fund, given its investment objectives."

Quarterly Portfolio Holdings Filings. Open-end and closed-end funds will be required to file their complete portfolio schedule for the 2 nd and 4 th fiscal quarters on Form N-CSR and for the 1 st and 3 rd quarters on Form N-Q within 60 days of each quarter end. Filings on new Form N-Q will be under both the Investment Company Act of 1940, as amended (the "1940 Act"), and the Securities Exchange Act of 1934, as amended, and subject to certification by the fund's principal executive and financial officers in the manner currently required by Form N-CSR. A fund's disclosure controls and procedures under 1940 Act Rule 30a-3 will now need to include controls and procedures with respect to Form N-Q filings. Form N-Q filings will be publicly available on EDGAR, and funds are required to notify shareholders of their availability. Funds are required to file Form N-Q beginning with the first fiscal quarter ending on or after July 9, 2004, with delayed compliance for certain certification provisions consistent with existing transition periods for corresponding provisions in Form N-CSR.

MDFP. The MDFP, which formerly could appear in either a mutual fund's prospectus or annual shareholder report, will be required to appear in annual shareholder reports beginning with each fund's report for its first fiscal year ending after July 9, 2004. The SEC has asked its staff to focus on the sufficiency of MDFP disclosure in its review of fund shareholder reports and identify instances where mutual funds have failed to provide substantive discussion of the factors that affected fund performance during the reporting period.

FDIC Chairman Suggests Regulators Should Consider Tightening Definition of Tier 1 Capital

FDIC Chairman Donald E. Powell made a presentation to the Institute of International Bankers in which he suggested that times of economic expansion and growth in FI earnings should be used by an FI as an opportune moment to strengthen the FI's balance sheet and remove any "questionable items" from the FI's balance sheet. Bank regulators, said Mr. Powell, should "clean up our definition of capital" and consider whether a variety of hybrid capital instruments that "have significant attributes of debt (e.g., trust preferred securities, real estate investment trust preferred securities) should continue to qualify as Tier 1 capital. Under current banking regulations trust preferred securities can account for up to 25% of an FI's Tier 1 capital. Noting that recent changes to generally accepted accounting principles are causing some of these hybrid instruments to be counted as liabilities rather than equity for accounting purposes, Mr. Powell stated that regulators should take advantage of the external stimulus of the change in the accounting rules and allow into the definition of Tier 1 capital "only those instruments that are available to absorb unanticipated loss on a going concern basis."

SEC Proposes Mandatory Redemption Fees on Mutual Fund Shares

The SEC proposed new Rule 22c-2 (the "Proposed Rule") under the 1940 Act that would require registered open-end investment companies ("funds") to impose a mandatory 2% redemption fee on the redemption of shares held five business days or less (although funds could designate a longer holding period), as determined on a first-in, first-out basis. The 2% redemption fee would apply to all fund shares, including those held through financial intermediaries, such as broker-dealers, banks and retirement plans, but would be subject to certain exceptions noted below. Under the Proposed Rule, funds would be able to select one of three methods for ensuring that redemption fees are imposed as required. Under the first method, the financial intermediary would transmit to the fund at the time of a transaction the account number the intermediary uses to identify the underlying shareholder, thereby permitting the fund to match the current transaction with any previous transactions by the same account. Under the second method, the intermediary would (a) identify redemptions that trigger the redemption fee and (b) transmit holdings and transaction information to the fund so that it could assess the amount of the redemption fee. Under the third method, the financial intermediary would impose the redemption fee and remit the proceeds to the fund. Under either of the latter two methods, the fund would be responsible for ensuring that the intermediaries are properly determining or assessing the fee, as the case may be. Regardless of the method used to collect redemption fees, a fund would have to require each financial intermediary, at least weekly, to provide the amount and dates of all fund share purchases and redemptions by the intermediary's accountholders during the period covered by the report along with accountholder taxpayer identification information. V

The Proposed Rule would include certain exceptions to the mandatory redemption fee. First, funds could waive the redemption fee on redemptions of $2,500 or less. A fund would be required to waive the redemption fee upon written request from a shareholder in the event of a shareholder financial emergency if the amount of the redemption were $10,000 or less; if the amount of the redemption were greater than $10,000, waiver of the redemption fee under these circumstances would be at the fund's discretion. The Proposed Rule would not apply to redemptions of shares of (a) money market funds, (b) funds traded on national exchanges (ETFs) or (c) any fund that (i) adopts a fundamental policy to permit short-term trading in its shares and (ii) clearly and prominently discloses in its prospectus that it permits short-term trading of its shares and that such trading may result in additional costs for the fund. The SEC requested comment on numerous aspects of the Proposed Rule as well as on fair value pricing as it relates to abusive market timing. Comments on the Proposed Rule are due by May 10, 2004.

OCC Provides Guidance on Consumer Complaints Referred by State Officials

The OCC published an advisory letter ("AL 2004-2") regarding the proper handling by a national bank of consumer complaints referred by state officials. AL 2004-2 provides that the OCC expects national banks to resolve consumer complaints fairly and expeditiously, regardless of the source of the compliant. In most cases, the national bank need not notify the OCC about the issue. However, if a state authority seeks to direct the bank's conduct, or if an issue about the applicability of a state law arises, then the bank should involve the OCC. If a state believes a national bank is engaging in illegal activities, then AL 2004-2 declares that the state should notify the OCC for a resolution of the issue. If a state requests that the national bank inform it of how an issue is resolved, AL 2004-2 encourages the national bank to do so.

Other Items of Note

Proposed Regulations on Tax Treatment of Contingent Nonperiodic Swap Payments

The Treasury Department and the Internal Revenue Service proposed regulations regarding the taxation of contingent nonperiodic payments under swap transactions and other notional principal contracts. The proposed regulations would require taxpayers to either (i) reasonably project the expected amount of contingent nonperiodic payments under a swap transaction and accrue the appropriate portion in each taxable year, or (ii) elect to mark to market the value of the swap at the end of each year. Further information on the proposed regulations will be provided in a future edition of the Alert.

Goodwin Procter Chairs Bank Charter Conference

Goodwin Procter is pleased to announce that it is chairing a conference, "Broadening Opportunities with the Banking Charter" on May 10-11, 2004 at the Metropolitan Hotel in New York. The conference discusses in depth the advantages a bank or a thrift charter can provide to various types of financial services firms, including mortgage companies, securities firms, investment advisory firms, and insurance companies, and also the possible benefits to existing banking institutions of having more than one charter The conference will feature leading members of the various bank and securities regulatory agencies and of the financial services industry. Topics include preemption, innovative products and services, the bank broker-dealer rules, and maximizing efficiencies, including through outsourcing. The brochure can be found at: www.srinstitute.com/ci290.

This article, which may be considered advertising under the ethical rules of certain jurisdictions, is provided with the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin Procter LLP or its attorneys. [c] 2004 Goodwin Procter LLP. All rights reserved.Goodwin Procter LLP, a firm of 500 lawyers, has one of the largest financial services practices in the United States.

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