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Nutter Bank Report, January 2008

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01.31.2008 | Legal Update

Headlines

1.  FDIC Discontinues MERIT Examination Program
2.  Trust Advisory Fees Subject to 2% Floor on Deductions
3.  Massachusetts Regulator Proposes Data Security Standards
4.  OTS Expands Permissible Activities for Holding Companies
5.  Other Developments: CRA and HMDA Asset-Size Thresholds Increased

Full Reports

1.  FDIC Discontinues MERIT Examination Program

The FDIC has decided to end its MERIT (Maximum Efficiency, Risk-Focused, Institution Targeted) Examination Program, the streamlined examination program created in 2002 for small, well-managed banks.  Reports of the program’s termination earlier this month were confirmed by Chairman Bair on January 7.  The decision to end the MERIT program was reportedly a reaction to the results of a survey of FDIC employees compiled late last year which revealed wide-spread dissatisfaction among examiners with the restrictions placed on them by the MERIT guidelines.  In response to community banks’ concerns that the elimination of the program will lead to intrusive and burdensome safety and soundness examinations, Ms. Bair has sought to reassure low-risk institutions that the FDIC will continue to base examination activities on institution risk, and she has said banks should notice little change in terms of the duration of on-site examinations.  “We recognize that the examination process can be burdensome to bank management and staff and agree with you that the FDIC needs to continue building on policies that make the process more efficient,” she said.  She also emphasized the FDIC’s commitment to using risk-focused procedures, off-site monitoring and technology as much as possible to minimize the burden of examinations.

Nutter Notes:  Well capitalized institutions with total assets of $1 billion or less, and a 1 or 2 composite Camels rating for the two most recent examinations qualified for the MERIT program.  Under MERIT guidelines, FDIC examiners used procedures that focused on determining the adequacy of an insured depository institution’s internal control systems, and that focused on an overall assessment of an institution’s risk-management processes.  The guidelines directed examiners to review an institution’s lower-risk activities primarily through discussions with management and by using off-site monitoring programs.  The goal of the MERIT program was to allow examiners to spend less time conducting on-site reviews of small, well-managed banks.  If an institution maintained an effective internal asset review program, for example, examiners could significantly reduce the time spent reviewing individual credits.  Examiners also engaged in a reduced level of loan portfolio transaction testing under MERIT guidelines.  The FDIC expects its examiners will continue to emphasize overall risk and employ available technology to minimize the disruption of on-site examinations for well-managed institutions.  Ms. Bair suggested that the elimination of the program will allow the FDIC more flexibility to concentrate its resources where there is heightened risk.

2.  Trust Advisory Fees Subject to 2% Floor on Deductions

Investment advisory fees paid by a trust are subject to the 2 percent floor on tax deductible expenses according to a recent U.S. Supreme Court decision.  The January 16 ruling in Knight v. Commissioner means that a trust may deduct investment advisory fees only to the extent that the aggregate of such fees and other miscellaneous itemized deductions exceeds 2 percent of the trust’s adjusted gross income under Section 67 of the Internal Revenue Code.  Under Section 67, costs paid or incurred in connection with the administration of a trust that would not have been incurred if the property were not held in the trust are not subject to the 2 percent floor and are fully deductible.  The trustee argued that he was compelled to engage an investment advisor to satisfy his fiduciary duties under the Connecticut Uniform Prudent Investor Act, so the advisory fees would not have been incurred if the property were not held in the trust.  The Court explained that the test for whether a trust expense is subject to the 2 percent floor requires determining whether the cost is of a type that would not “customarily or commonly” be incurred if the trust property were held by an individual.  Since it is not unusual or uncommon for an individual investor to hire an investment advisor, the trust’s advisory fees are subject to the 2 percent floor.

Nutter Notes:  In July 2007, the IRS released a proposed rule to clarify the application of Section 67 to certain fiduciary expenses.  The proposed rule would allow costs incurred by estates or non-grantor trusts that are unique to an estate or non-grantor trust to be fully deductible.  The proposal was issued to address a split among United States courts of appeals on the interpretation of Section 67, the result of which is that the deductions of similarly situated taxpayers may or may not be subject to the 2 percent floor, depending upon the jurisdiction in which the executor or the trustee is located.  Under the proposed rule, an expense would be unique to an estate or non-grantor trust if an individual holding the trust or estate property could not have incurred the expense.  The Supreme Court did concede in the Knight opinion that there may be trust-related investment advisory fees that are fully deductible to the extent that such fees are imposed by an investment advisor only on its fiduciary accounts.  Fees that apply only to fiduciary accounts would not “customarily or commonly” be incurred if the trust property were held by an individual.  The comment period for the proposed IRS rule closed in October 2007, but the IRS has not yet issued a final rule and may need to revise the proposal in light of the Knight opinion.

3.  Massachusetts Regulator Proposes Data Security Standards

Banks and thrift institutions, among other companies in Massachusetts, will be required to develop and maintain comprehensive, written information security programs consistent with industry standards to ensure the safe storage and proper use of all electronic and paper records containing personal information about consumers under proposed data security regulations.  The data security rule, proposed by the Office of Consumer Affairs and Business Regulation on December 14 to implement Chapter 93H of the General Laws, would require that security programs, among other things, identify an employee or employees to have overall responsibility for the program, identify and assess internal and external risks, develop security policies for employees who telecommute taking into account their access to data outside the office, prevent terminated employees from accessing data, require due diligence on third party service providers, and require regular monitoring and auditing of employee access to data.  The proposed regulation provides that the following factors would be taken into account to determine whether a particular information security program is in compliance with the standards: the size and scope of the particular business, the amount of resources available, the amount and nature of the personal data stored, and the need for security and confidentiality of the stored information.  The deadline for comments on the proposed regulations was January 25.

Nutter Notes:  The proposal would also require that every person that owns, licenses, stores or maintains personal information about Massachusetts residents, and electronically stores or transmits the information, must include in its written, comprehensive information security program plans for security for its computers, including any wireless system, that must provide for, among other things, secure user authentication protocols, secure access control measures, encryption of all transmitted records and files containing personal information, including those in wireless environments, that will travel across public networks, periodic monitoring of networks and systems for unauthorized use of or access to personal information, firewall protection with up-to-date patches, including operating system security patches, the most current version of system security agent software, which must include anti-spyware and anti-virus software, education and training of employees, and restricted physical access to computerized records containing personal information.  Chapter 93H became effective on October 31, 2007 and is one of two recent information security bills approved to prevent the unauthorized disclosure of personal information of Massachusetts residents.

4.  OTS Expands Permissible Activities for Holding Companies

The OTS has issued a final rule to expand the activities that are permissible for a Savings and Loan Holding Company (SLHC) to the full extent allowed under the Home Owners’ Loan Act.  The revised regulation published on December 20 permits SLHCs to engage in the same activities that are permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act.  Although the Home Owners’ Loan Act authorizes SLHCs to engage in any activity determined by the Federal Reserve to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act, the OTS had previously limited the permissible activities for SLHCs under that authority to activities the Federal Reserve has permitted for bank holding companies under Section 4(c)(8) (certain permissible nonbanking activities under the Federal Reserve’s Regulation Y).  Activities that will now be permissible for SLHCs include engaging in foreign activities under Sections 4(c)(9) and 4(c)(13) of the Bank Holding Company Act, such as investments in foreign companies that transact business in the United States.

Nutter Notes:  Certain activities described in parts of Section 4(c) of the Bank Holding Company Act are already permissible for SLHCs under other authority.  For example, Section 4(c)(1) authorizes bank holding companies to hold or operate properties used wholly or substantially by any banking subsidiary of the holding company, and to liquidate assets acquired from a bank subsidiary.  SLHCs may engage in these activities with regard to savings association subsidiaries under the Home Owners’ Loan Act without prior OTS approval.  SLHCs that seek to exercise powers that the Federal Reserve has granted to bank holding companies will be subject to the terms and conditions the Federal Reserve has applied to them.  The final rule will also permit an SLHC, with the prior approval of the OTS, to acquire more than 5 percent of the voting shares of a savings association that is not the acquiring SLHC’s subsidiary, or more than 5 percent of the voting shares of another SLHC that is not a subsidiary.  The change brings OTS regulations in line with an earlier amendment to the Home Owners’ Loan Act, which removed the absolute prohibition against a SLHC acquiring more than 5 percent of a non-subsidiary savings association or SLHC.

5.  Other Developments: CRA and HMDA Asset-Size Thresholds Increased

  • CRA Asset-Size Thresholds Increased

The federal banking agencies announced the annual adjustment to the CRA asset-size thresholds for “small” and “intermediate small” institutions last month.  The amendment of the CRA asset-size thresholds became effective as of January 1 and reflects a 2.7 percent increase in the Consumer Price Index for the twelve months ended in November 2007. 

Nutter Notes:  Institutions that had assets of less than $1.061 billion as of December 31 of either of the prior two years qualify as small institutions for CRA purposes.  Intermediate-small institutions are those with assets of at least $265 million as of December 31 of both of the prior two years, and less than $1.061 billion for either of the prior two years.

  • HMDA Asset-Size Exemption Threshold Increased

The Federal Reserve increased the asset-size exemption threshold under its Home Mortgage Disclosure Act rule, Regulation C, in December as a result of the increase in the Consumer Price Index.  The amendment of the CRA asset-size thresholds became effective as of January 1.

Nutter Notes:  Depository institutions with assets of $37 million or less as of December 31, 2007 are exempt from home mortgage lending data collection and reporting requirements of the Home Mortgage Disclosure Act, which represents a $1 million increase from the prior threshold.

Nutter Bank Report

Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP.  Chambers and Partners, the international law firm rating service, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation in the 2007 Chambers and Partners U.S. rankings.  The “well known and well-versed” Nutter team “excels” at corporate and regulatory banking advice, according to the 2007 Chambers Guide.  Visit the 2007 U.S. rankings at ChambersandPartners.com.  The Nutter Bank Report is edited by Matthew D. Hanaghan.  Assistance in the preparation of this issue was provided by Lisa M. Jentzen.  The information in this publication is not legal advice.  For further information, contact:

Gene A. Blumenreich   
gblumenreich@nutter.com  
Tel: (617) 439-2889  

Kenneth F. Ehrlich   
kehrlich@nutter.com  
Tel: (617) 439-2989  

Michael K. Krebs
mkrebs@nutter.com

Tel: (617) 439-2288

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