Financial Services Alert

Goodwin, Procter & Hoar LLP, a firm of over 400 lawyers, has one of the largest financial services practices in the United States. We have created the Financial Services Alert as a service to advise our clients and other financial services institutions to news of importance to the industry in a timely manner. Some issues of the Alert, such as this one, will principally summarize significant recent developments in financial services law and regulation. Other issues will provide more indepth analysis about specific areas of financial services law. We hope that you will find the Financial Services Alert to be helpful. We welcome your suggestions for future topics of interest.

Developments of Note

FASB Votes to Eliminate Pooling, Proposes Stock Compensation Interpretation

The Financial Accounting Standards Board ("FASB") voted to eliminate "pooling of interests" as a method of accounting for business combinations. The pooling of interests method entails two combining companies simply adding together the book value of their net assets. This is contrasted with the purchase method, in which one company is identified as the buyer. The excess (if any) of the purchase price over the fair market value of the acquired assets then represents goodwill, which is charged to the buyer's earnings over time. FASB is expected to issue a proposal to implement this change in the third quarter of 1999, with a final standard expected to be issued by the end of 2000. Business combinations initiated prior to the issuance of the final standard will be grandfathered, with FASB declaring that paragraph 46 of FASB Opinion 16 (Business Combinations) will be the reference to determine whether a business combination has been "initiated" prior to a particular date.

In addition, FASB issued a proposed interpretation concerning accounting for stock options, which is covered by FASB Opinion 25 (Accounting for Stock Issued to Employees). The proposed interpretation declares, among other things, that: once an option is repriced, the option must be accounted for as a variable plan from the time it is repriced to the time it is exercised; employees are defined by the common law; Opinion 25 does not apply to outside directors because they are not employees; plans with a "look back" option (i.e., those that permit employees to purchase an employer's stock at the lesser of 85% of the stock price at the date of grant or 85% of the stock price at the date of exercise) do not create a compensatory plan; and a subsidiary may account for parent company stock in separately issued financial statements, provided the subsidiary is part of the parent's consolidated financials. Comments on this proposal are due June 30, 1999.

FDIC, FRB and OCC Finalize Market Risk-Based Capital Revisions

The FDIC, FRB and OCC adopted as a final rule their interim rule amending the risk-based capital standards for market risk applicable to banks and bank holding companies with significant trading activities. The market risk rules require institutions to hold capital for exposure to both general market risk (i.e., changes in the market value of on-and-off - balance-sheet items resulting from broad market movements) and specific risk (i.e., changes in the market value of individual debt and equity positions due to factors other than broad market movements). Prior to the interim rule, an institution that measured specific risk with an internal model was subject to a minimum capital charge, which had to be at least 50% of a specific risk charge calculated using an agency developed "standarized" approach. The interim rule and the final rule eliminate this minimum charge. However, as with the interim rule, if an institution's internal risk model does not adequately capture all aspects of specific risk, including event and default risk, a "specific risk add-on" will be added. The rule becomes effective July 1, 1999.

NASD Issues Guidance on Variable Annuity Sales

The NASD issued a Notice to Members (99-35) regarding their responsibilities with sales of variable annuities. Because certain components of variable annuities will fluctuate in response to market changes, variable annuities generally must be registered under the Securities Act of 1933 and funds that hold annuities often must be registered under the Investment Company Act of 1940. The NASD notes that many of the features available in a variable annuity make the suitability analysis required under the NASD rules particularly complex. The Notice provides industry guidelines (which are not mandatory) which declare, among other things, that prior to recommending a variable annuity NASD members should: obtain customer information (including the customer's occupation, marital status, tax status, and annual income) and as well as discuss penalties, fees, and other charges associated with these investments; provide to the customer product information, including a current prospectus; and ensure that the customer recognizes the lack of liquidity in this investment. The Notice also discusses suitability issues with purchases of variable annuities in tax qualified plans (such as 401(k) plans). Finally, the Notice highlights that members may want to develop compliance systems to review variable annuity replacements, including systems that highlight member representatives whose clients have an unusually high number of variable annuity replacements or rollovers.

Massachusetts Application of Sales and Use Tax to Sales of Database

The Massachusetts Department of Revenue released a Letter Ruling (99-2) concerning the application of state sales and use tax to sales of database and computer hardware to the financial services industry. The ruling declares that a vendor's sale of database access and electronic retrieval of financial information and computer generated models is not subject to sales or use tax. Separately stated charges for computer hardware, such as modems and routers, as well as "canned" software sold to Massachusetts customers, are taxable. A vendor's purchase or use of telecommunications services in connection with providing nontaxable information service to Massachusetts customers is also taxable.

FDIC Expedites Certain Aspects of Mutual-to-Stock Conversions

In 1994, the FDIC finalized regulations governing mutual-to-stock conversions of state nonmember banks, which, among other things, require the proposed conversion to be approved by a vote of at least a majority of the bank's depositors. These rules also apply to mutual holding company formations. Waivers of this requirement could be granted only by an action of the full Board of Directors of the FDIC. The FDIC notes that since its conversion regulations were promulgated it has received many depositor voting waiver requests from mutual savings institutions, including those of Massachusetts and other New England states, which have laws permitting corporator voting in lieu of voting by all eligible depositors, or prohibit proxy voting by depositors. As a result of its experience in this area, the FDIC has determined that it can delegate the authority to waive the depositor voting request to a lower level of the agency, permitting the FDIC to further expedite final actions regarding such waiver requests. [QQ]
The focus of the FDIC when it reviews waiver requests from mutual savings institutions whose corporators are authorized to vote on mutual-to-stock conversions will continue to be whether a sufficient number of independent corporators voted in favor of the proposed conversion. In the case of states with prohibitions on proxy voting by depositors, the focus will continue to be the efforts to encourage in-person depositor voting and the number of depositors with no apparent conflict of interest who attended the special meeting and voted for the conversion. The delegation becomes effective May 26, 1999.

Year 2000 Legal Audits for Banking Clients

The FFIEC has issued a field manual for its examiners to use in assessing the Year 2000 readiness of financial institutions. The manual contains a list of criteria that form the basis of the examination. One of those criteria is to "[d]etermine if the institution's legal counsel has performed a legal audit that includes a review of insurance policies, public documents, and new and existing contracts or warranties to ensure that they contain appropriate Year 2000 language." Not only will an audit assist the client in identifying Year 2000-related risks that may still exist, but it will also provide additional evidence of the client's diligence. The GP&H Year 2000 Practice Group has performed legal audits for both banking and non-banking clients. An outline of the elements prepared by the Practice Group for such an audit is available upon request.

U.S.-E.U. Privacy/Safe Harbor Negotiations

The Department of Commerce has released revised so-called "safe harbor" principles for U.S. companies that choose to adhere to certain standards to comply with the "adequacy" requirements of the European Union's Directive on Data Protection regarding personal data transfers from E.U. countries to the U.S. The U.S. remains in negotiations with the European Commission over possible adoption of safe harbor principles and procedures to be followed. The Department has requested further public comments, to be filed by May 10, 1999, on the various newly released safe harbor documents, which include (1) revised safe harbor principles; (2) frequently asked questions and answers on access; and (3) a draft European Commission document on complaint procedures.

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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. (c)GPH LLP 1999