Troubled Asset Relief Program and Related Measures Enacted into Law SUMMARY President Bush on Friday signed into law the of 2008 (the Act ). The Act seeks to restore stability and liquidity to the financial markets by addressing some of the major stresses currently affecting the U.S. financial system, particularly in the mortgage and credit markets. The primary feature of the Act is its establishment of a new $700 billion troubled asset relief program (the TARP ), under which the Treasury Department will have broad authority to purchase, and to make and fund commitments to purchase, mortgages, mortgage-related securities and certain other troubled assets from a wide range of financial institutions through December 31, 2009, subject to extension. The Act was immediately effective, but policies and procedures must still be developed. The Act also authorizes a guaranty program for troubled assets (the Troubled Assets Insurance Program ), to be funded by premiums paid by participating financial institutions. A Troubled Assets Insurance Financing Fund will be established to hold insurance premiums paid to, and fulfill claims made under, the Troubled Assets Insurance Program. In addition, the Act: requires financial institutions participating in the TARP to provide warrants or senior debt instruments to the Treasury Department; imposes limitations on executive compensation of participating financial institutions, including certain prohibitions on golden parachutes and reductions in the tax deductibility of officers compensation; permits the Treasury Department to award contracts for asset managers, servicers, property managers and other service providers for the TARP; codifies the recently announced program to provide federal guaranties for money market funds; New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com
gives the SEC the authority to suspend the application of Statement Number 157 (Fair Value Measurements) of the Financial Accounting Standards Board, relating to fair value accounting; increases, through December 31, 2009, FDIC deposit insurance from its current level of $100,000 to $250,000; offers limited relief for homeowners including potential rate reductions and term extensions for residential mortgages acquired by the Treasury Department; establishes a Congressional Oversight Board and a Special Inspector General to prevent waste, fraud and abuse in connection with the TARP and the Troubled Assets Insurance Program; extends numerous tax incentive and tax relief provisions that would otherwise expire, including a one-year patch of the alternative minimum tax; and includes a variety of tax incentives promoting the production and use of alternative energy sources and energy conservation. The Act also accelerated a previously codified authorization for the Federal Reserve to pay interest on required and excess reserve balances held by or on behalf of depository institutions. This change had previously been scheduled to commence on October 1, 2011. The Federal Reserve announced on October 6, 2008, that it will begin paying such interest. According to the Treasury Secretary, the Treasury Department will move rapidly to implement the new authorities under the Act, in conjunction with the Federal Reserve and the FDIC. The Treasury Department yesterday announced solicitations for several types of financial agents under the TARP, and interested parties must submit requests by 5 p.m. on October 8, 2008. Following the enactment of the Act, the SEC announced that its emergency order prohibiting short sales of the securities of financial institutions will expire at 11:59 p.m. on October 8, 2008. ELIGIBILITY TO PARTICIPATE IN THE TARP AND TROUBLED ASSETS INSURANCE PROGRAM The TARP and the Troubled Assets Insurance Program will be available to financial institutions, broadly defined to include any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company that (1) is established and regulated under U.S. federal or state law (including territories and possessions) and (2) has significant operations in the United States. The Act does not clarify the extent of U.S. regulation to which an institution must be subject in order to fall within this definition. The definition would include retirement plans, but excludes any central bank of, or institution owned by, a non-u.s. government. The definition of financial institution would appear to include branches and agencies of non-u.s. banks established and regulated, and with significant operations, in the United States. Although sovereign wealth funds and non-u.s. central banks are expressly excluded, the Act elsewhere provides that troubled assets held by such entities qualify for purchase under the TARP if the assets are held as a -2-
result of the non-u.s. authorities extending financing to financial institutions that have failed or defaulted on such financing. Notwithstanding any particular institution s eligibility for the TARP and the Troubled Assets Insurance Program, the Treasury Department will retain discretion as to whether to acquire troubled assets from, or provide insurance to, such institution. The Treasury Department is charged with considering how to ensure that all financial institutions are eligible to participate in the TARP, without discrimination based on size, geography or form of organization, or the size, type or number of troubled assets eligible for purchase. The Treasury Department must also consider providing financial assistance to financial institutions serving low- and moderate-income populations and other underserved communities, as well as financial institutions with assets of less than $1 billion that were well or adequately capitalized on June 30, 2008, but whose capital position was adversely affected as a result of the devaluation of the preferred stock of Fannie Mae and Freddie Mac. However, the Treasury Department must also consider the long-term viability of a financial institution before purchasing troubled assets from it directly. THE TROUBLED ASSET RELIEF PROGRAM AUTHORITY FOR PURCHASES The Treasury Department is authorized to purchase troubled assets from any financial institution on terms and conditions determined by the Treasury Department. 1 The Treasury Department will develop and implement policies and procedures to shape the exercise of its discretion under the TARP. The Treasury Department s authority to purchase and insure troubled assets under the Act expires on December 31, 2009, but the Treasury Department may extend this deadline up to October 3, 2010. TYPES OF ASSETS ELIGIBLE TO BE PURCHASED Only troubled assets whose purchase the Treasury Department determines will promote financial market stability are eligible for purchase under the TARP. The primary category of troubled assets eligible for purchase are mortgages and mortgage-related securities or instruments originated or issued on or before March 14, 2008. 2 The Treasury Department also has authority, after consultation with the Chairman of the Board of Governors of the Federal Reserve System and upon submission of a determination to certain Congressional committees, to acquire any other financial instrument whose purchase is necessary, in the Treasury Department s view, to promote financial market stability. 1 In exercising authority with respect to the TARP, the Act requires the Treasury Department to consult with the Board of Governors of the Federal Reserve System, the FDIC, the Comptroller of the Currency, the Director of the Office of Thrift Supervision, the Chairman of the National Credit Union Administration Board, and the Secretary of Housing and Urban Development. 2 March 14, 2008, was also the valuation date for assets covered by the Federal Reserve s backstop in connection with the acquisition of Bear Stearns by J.P. Morgan. -3-
The Treasury Department is required to consider the utility of purchasing other real estate owned and instruments backed by mortgages on multifamily properties. The effect of this consideration is unclear, because real estate is not included in the definition of troubled assets eligible for purchase under the TARP. LIMITS ON THE TREASURY DEPARTMENT S PURCHASING AUTHORITY Funds will be available to the Treasury Department for purchases under the TARP in graduated amounts. Initially, troubled assets held under the program may not exceed $250 billion at any time. This amount may be increased at any time to $350 billion upon a written certification by the President to Congress. The limit can be further increased by an additional $350 billion, to $700 billion, upon provision of a written report from the President to Congress, unless within 15 days after receiving such report Congress enacts a joint resolution disapproving of the increase. For purposes of these limits, the relevant measure of the amount of troubled assets purchased under the TARP at any time will be the aggregate purchase price of all troubled assets held at such time. As a result, the amount of troubled assets purchased during the existence of the TARP may exceed $700 billion, so long as the aggregate purchase price of the assets held at any time does not exceed that amount. Amounts available under the TARP will be reduced by the value of the outstanding guaranteed obligations under the Troubled Assets Insurance Program, less the amount of premiums from financial institutions taking advantage of that program held in the Troubled Assets Insurance Financing Fund. CONSIDERATIONS IN PURCHASING TROUBLED ASSETS In performing its duties under the Act, including purchasing decisions, the Treasury Department must consider a number of public policy objectives, including: protecting the interests of taxpayers by maximizing returns and minimizing the impact on the national debt; providing stability to the financial markets; preserving homeownership; protecting retirement security (by purchasing troubled assets held by eligible retirement plans); and promoting stability for state and local public instrumentalities that may have suffered increased costs or losses in the current market. The Act does not require a particular purchase or pricing mechanism for troubled assets. The Treasury Department is, however, required to acquire assets in a manner that will minimize any potential long-term negative impact on the taxpayer. The Act generally encourages the use of market mechanisms, including auctions or reverse auctions, where appropriate. If market mechanisms are not feasible or appropriate, and the purposes of the Act are best served through the direct purchase of troubled assets from a financial institution, the Treasury Department may engage in direct purchases for prices that are reasonable and reflect the underlying value of the asset. -4-
One constraint on the Treasury Department s pricing authority is that it must prevent unjust enrichment of participating financial institutions, including by preventing the sale of a troubled asset to the Treasury Department at a price higher than the seller s purchase price. There are two exceptions to this limitation: it does not apply to troubled assets acquired in a merger or acquisition or to purchases of assets from a financial institution in conservatorship, receivership or Chapter 11 bankruptcy proceedings. The Treasury Department will publish guidelines detailing the mechanisms for purchasing troubled assets, the methods for pricing and valuing troubled assets, the procedures for selecting asset managers, and the criteria for identifying troubled assets for purchase. TREASURY DEPARTMENT MUST OBTAIN WARRANTS OR DEBT INSTRUMENTS PRIOR TO PURCHASE Prior to purchasing or making a commitment to purchase troubled assets (whether through a direct purchase or an auction), the Treasury Department must receive: for financial institutions whose securities are traded on a national securities exchange, warrants for non-voting common or preferred stock, or voting stock with respect to which the Treasury Department agrees not to vote, as the Treasury Department determines appropriate; 3 and for all other financial institutions, warrants for common or preferred stock, or a senior debt instrument. The warrants and debt instruments acquired from financial institutions must meet certain criteria, including the following: a reasonable participation in any equity appreciation (in the case of warrants or other equity securities) or a reasonable interest rate premium (in the case of debt instruments); the Treasury Department must have the ability to sell, exercise or surrender the warrants or debt instruments; any warrants must convert to senior debt (or contain alternative compensating protections) in the event that the financial institution s securities are no longer listed or traded on a national securities exchange; any warrants must contain customary anti-dilution provisions that protect the value of the securities upon the occurrence of events affecting the issuer, such as mergers, stock splits and stock distributions; and the exercise price of any warrants will be set by the Treasury Department. The Act directs the Treasury Department to establish two exceptions to the requirement to deliver warrants or debt instruments: a de minimis exception for financial institutions whose sales to the 3 Any financial institution issuing warrants must guarantee that it has sufficient authorized shares available to fulfill its obligations. If the financial institution does not have sufficient authorized shares and a shareholder vote to authorize issuance of the necessary shares cannot be obtained, the Treasury Department may accept a senior debt instrument of an equivalent value. -5-
Treasury Department of troubled assets do not exceed a threshold (to be established by the Treasury Department, of not more than $100 million), and an exception for financial institutions that are legally prohibited from issuing securities and debt instruments (although the Treasury Department must establish appropriate alternative requirements for those institutions). HOLDING AND SELLING TROUBLED ASSETS; PRIVATE SECTOR PARTICIPATION The Act directs the Treasury Department to hold troubled assets purchased under the TARP until maturity or for resale at a time when the Treasury Department determines that the market is optimal for selling such assets. Troubled assets are to be sold at a price that the Treasury Department determines, based on available financial analysis, will maximize return on investment. The Treasury Department is also permitted to enter into securities loans, repurchase transactions and other financial transactions in respect of purchased troubled assets. The Act gives the Treasury Department broad authority to manage troubled assets through a newly established Office of Financial Stability. The Treasury Department may award contracts for asset managers, servicers, property managers and other service providers pursuant to streamlined government contracting procedures. The Act requires the Treasury Department to consider the FDIC when selecting asset managers for residential mortgage loans and residential mortgage-backed securities. On October 6, 2008, the Treasury Department announced solicitations for financial agents under the TARP to provide (1) custodian, accounting, auction management and other infrastructure services, (2) securities asset management services, and (3) whole loan asset management services. Interested parties must submit requests by 5 p.m. on October 8, 2008, and the initial selections are to be announced the following week. 4 The Treasury Department is required to develop and implement regulations, standards and procedures to ensure, to the maximum extent possible, the inclusion of minorities and women, and minority-owned and women-owned businesses, and to manage or prohibit conflicts of interest, including in the hiring of contractors and the purchase and management of troubled assets. PUBLIC DISCLOSURES REGARDING PURCHASE, TRADE AND SALE OF TROUBLED ASSETS Within two business days of purchasing, trading or otherwise disposing of troubled assets, the Treasury Department must publicly disclose a description of the transaction, including amounts and pricing. This disclosure requirement is designed to ensure market transparency and, presumably, to help set prices in non-functioning markets for the benefit of other potential market participants. The Treasury Department also must conduct an evaluation of the public disclosures of financial institutions that sell assets into the TARP. Specifically, the Treasury Department must determine whether 4 For detailed notices describing the services sought by the Treasury Department, see http://www.treasury.gov/press/releases/hp1185.htm. -6-
the public disclosure required of each type of participating financial institution with respect to off-balance sheet transactions, derivatives instruments, contingent liabilities, and similar sources of potential exposure is adequate to provide the public with sufficient information as to the institution s true financial position. If the disclosure is not adequate, the Treasury Department must make recommendations to the relevant regulators for additional disclosure requirements. The Act does not explicitly require the Treasury Department publicly to identify participating financial institutions by name or for those financial institutions to disclose sales of troubled assets under the TARP, although neither does the Act prohibit identification of those institutions. In the case of financial institutions that are publicly traded companies, however, applicable securities laws might mandate disclosure in some circumstances. RECOUPING TARP LOSSES If, after five years, there is a shortfall in the net amount within the TARP, the President must submit a legislative proposal to recoup from the financial industry an amount equal to that shortfall in order to ensure that the TARP does not add to the deficit or the national debt. Neither financial industry nor net amount within the TARP is defined, but it appears that financial industry is intended to extend beyond those financial institutions that participated in the TARP. EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE Financial institutions that sell troubled assets to the Treasury Department are subject to certain corporate governance requirements under the Act, including limitations on the compensation of the top five highly paid executives of a public company, whose compensation is required to be disclosed under the proxy rules, and non-public company counterparts (the top executives ). These provisions apply to financial institutions from which the Treasury Department: directly purchases troubled assets and in which the Treasury Department receives a meaningful equity or debt position ; or acquires troubled assets through an auction process in an aggregate amount that (including any direct purchases) exceeds $300 million. Direct Purchases from Financial Institutions In the case of direct purchases, during the period the Treasury Department holds an equity or debt position in the financial institution, the Act requires the Treasury Department to prescribe executive compensation and corporate governance standards for financial institutions that include: limits on compensation for the top executives that exclude incentives to take unnecessary and excessive risks that threaten the value of the financial institution ; a clawback providing for recovery by the institution of bonuses or incentive compensation paid to top executives if they are later proven to be based on materially inaccurate statements of earnings or other financial results; and a prohibition on golden parachute payments. -7-
Auction Purchases from Financial Institutions For institutions that participate in auction purchases, if the Treasury Department purchases troubled assets exceeding $300 million (through auctions and any direct purchases) from such institutions, the Act: prohibits any new employment contract with top executives that provides for a golden parachute in the event of an involuntary termination of employment or corporate bankruptcy filing, insolvency or receivership; with respect to an institution s chief executive officer, chief financial officer and the three other highest-paid officers (not necessarily the same top five highly paid executives referred to above), extends the current golden parachute tax rules (limiting deductibility to the institution and imposing a 20% excise tax on the officer) to apply to payments to such officers in the event of their involuntary severance from employment (whether or not contingent on a corporate change in control) by reason of involuntary termination by the employer or in connection with the employer s bankruptcy, liquidation or receivership; and reduces the executive compensation (including performance-based compensation and stock options) that is tax-deductible by the financial institution from $1 million to $500,000 per year for each individual referred to in the preceding bullet point. These restrictions will apply so long as the Treasury Department has authority to acquire troubled assets under the Act. Offshore Deferred Compensation Restrictions Other provisions of the Act, not connected to the TARP, impose current taxation on offshore deferred compensation, largely to prevent hedge fund managers from avoiding tax on their compensation through the use of offshore arrangements. The executive compensation provisions of the Act are more fully described in a separate memorandum that the Firm has prepared. 5 EXCHANGE STABILIZATION FUND As described in an earlier memorandum, 6 the Treasury Department previously commenced the operation and announced the terms of a Temporary Guarantee Program for Money Market Funds, to be funded out of the assets of the Exchange Stabilization Fund, which was initially established by the Gold Reserve Act of 1934. The Act requires the Treasury Department to reimburse the Exchange Stabilization Fund with funds made available under the Act, and prohibits use of the Exchange Stabilization Fund for the establishment of any future guaranty programs for the U.S. money market mutual fund industry. 5 Financial Bailout Legislation Restricts Executive Compensation,. 6 U.S. Treasury Establishes Money Market Fund Guarantee Program, September 29, 2008. -8-
TROUBLED ASSETS INSURANCE PROGRAM The Act requires the Treasury Department to establish a troubled assets insurance program in conjunction with the TARP. As under the TARP, eligible troubled assets are those originated or issued on or before March 14, 2008. Upon a request from a financial institution, the Treasury Department may agree to guarantee timely payment of principal and interest on troubled assets. The Treasury Department has discretion as to the terms of the guarantee, including the guarantee premiums; however, premiums must provide sufficient reserves to meet anticipated claims, based on an actuarial analysis, and the Treasury Department must publish the methodology for setting premiums for each class of troubled assets guaranteed. A Troubled Assets Insurance Financing Fund ( TAIFF ) will be established to hold insurance premiums paid to, and fulfill claims made under, the Troubled Assets Insurance Program. The Act does not expressly cap the amount of troubled assets that may be insured, but an amount equal to the difference between the outstanding guaranteed obligations and the balance in the TAIFF will be counted against the TARP purchase authority limit. AMENDMENTS TO THE FEDERAL DEPOSIT INSURANCE ACT The Act includes several amendments to the Federal Deposit Insurance Act ( FDIA ) administered by the FDIC. First, the Act temporarily increases deposit insurance from $100,000 to $250,000, ending on December 31, 2009. This increase will not be taken into account by the FDIC for purposes of setting assessments for insured depository institutions. The Act makes a corresponding change for deposits insured under the Federal Credit Union Act. The Act also includes a provision addressing the enforceability of certain agreements in the context of transactions involving the FDIC. This provision has been invoked by Wachovia, Wells Fargo and Citigroup in their pending litigation. The Act further amends the FDIA to allow civil penalties for the misuse of the FDIC name and logo and for false representations of insured deposit status, and provides enforcement authority to appropriate federal banking agencies. The FDIC is also given the authority to take enforcement action against any person or institution for misuse and misrepresentation if the appropriate banking agency does not take action within 30 days. HOMEOWNER PROTECTIONS The Act includes certain homeowner protections. Where the Treasury Department or other federal agencies, including the Federal Housing Finance Agency, acquire mortgages, mortgage-backed securities and other assets secured by residential real estate, the agencies will be obligated to implement a plan that seeks to maximize assistance for homeowners, including rate reductions, term -9-
extensions, principal write-downs, loan guarantees, and encouraging mortgage servicers to minimize foreclosures. The Act provides that, except as established in any contract, a servicer of pooled residential mortgages will be deemed to act in the best interests of all investors in the investment if the servicer implements a workout plan involving reasonable loss-mitigation measures, including partial payments. The Act also includes amendments to the HOPE for Homeowners Program to expand eligibility for the program and provide additional tools to avoid foreclosures. FAIR VALUE ACCOUNTING On September 30, 2008, the SEC Office of the Chief Accountant and the FASB staff jointly issued clarifying guidance under Statement Number 157 of the Financial Accounting Standards Board (the FASB ), relating to fair value accounting. 7 The guidance, which was intended to help determine carrying values for assets under current market conditions, stated in part that management can rely on internal assumptions when relevant market data are unavailable, and that the results of distressed sales are not determinative when measuring fair value. The Act goes further and clarifies that the SEC has the authority to suspend the application of Statement Number 157 for any issuer or with respect to any class or category of transaction if the SEC determines that suspension is necessary or appropriate in the public interest and is consistent with the protection of investors. In addition, by January 1, 2009, the SEC is required to complete a study and report to Congress on the effects of mark-to-market accounting on financial institutions balance sheets, its impact on bank failures in 2008, the impact of mark-to-market accounting on the quality of financial information available to investors, the process used by the FASB in developing accounting standards, and the advisability and feasibility of modifying, and potential alternatives to, the current mark-to-market accounting standards. TAX PROVISIONS The Act contains a variety of tax provisions, only a few of which are directly related to the current financial market developments. The other provisions came from a bill that had been recently passed by the Senate. Those provisions include revenue raisers, extensions of current tax relief and incentive provisions for individuals and businesses, energy incentives, natural disaster tax relief, and others. 7 See http://www.sec.gov/news/press/2008/2008-234.htm. -10-
GAINS AND LOSSES ON PREFERRED STOCK IN FANNIE MAE OR FREDDIE MAC If an applicable financial institution 8 ( AFI ) held preferred stock in Fannie Mae or Freddie Mac on September 6, 2008, or sold or exchanged such stock on or after January 1, 2008 and before September 7, 2008, any gain or loss on the sale or exchange of the stock will be treated as ordinary gain or loss (rather than capital gain or loss) if certain requirements are met. As a result, any such losses could be used to offset ordinary income. An AFI may take advantage of this change: if it sold or exchanged the stock on or after January 1, 2008, and before September 7, 2008, provided that the taxpayer was an AFI at the time of the sale or exchange; or if it sold or exchanged the stock after September 6, 2008, provided that the taxpayer was an AFI at all times from September 6, 2008, until the date of the sale or exchange. The Act authorizes the Treasury Department to extend this provision to two additional types of situations: where the AFI did not hold the stock on September 6, 2008, but acquired it after that date in a carry-over basis transaction from a transferor who held the stock on September 6, 2008; and where the AFI is a partner in a partnership that held the stock on September 6, 2008. TAX RELIEF FOR INDIVIDUALS WHO HAVE CANCELLATION OF INDEBTEDNESS INCOME The Act also extends the expiration date of a special tax relief rule relating to cancellation of indebtedness income. 9 Under this special rule, enacted in 2007, if an individual recognizes such income upon a default or renegotiation of indebtedness incurred by the individual to acquire the individual s principal residence, the cancellation of indebtedness income is not taxable. This special rule, which was set to expire at the end of 2009, is extended by the Act until the end of 2012. REVENUE RAISERS The revenue-raising provisions include: Modifying the Section 199 domestic production deduction. Section 199 provides a deduction for a percentage of receipts from certain domestic qualified production activities. The deduction percentage is currently 6% but is scheduled to increase to 9% in 2010. The Act freezes the rate at 6% for receipts from the sale, exchange or other disposition of oil, natural gas or any primary product thereof. Maintaining the additional 0.2% FUTA tax through 2009. Congress has added an additional 0.2% to the basic federal unemployment insurance tax rate since 1976. The additional 0.2% was set to expire at the end of 2008, and the Act extends it by one additional year. 8 An applicable financial institution is (1) a financial institution referred to in Internal Revenue Code ( IRC ) Section 582(c)(2) or (2) a depositary institution holding company as defined in Section 3(w)(1) of the Federal Deposit Insurance Act. 9 IRC Section 108(a)(1)(E). -11-
Combining FOGEI and FORI under IRC Section 907. The Act modifies IRC Section 907 so that non-u.s. oil and gas extraction income and non-u.s. oil related income are subject to a single non-u.s. tax credit limitation, instead of two separate limitations. EXTENSION OF BUSINESS TAX INCENTIVES The Act generally extends to the end of 2009 various business tax credits (including the research and development credit, the new markets credit, and credits for investments in outlying areas and Indian reservations). The Act also extends to the end of 2009 the exclusions from subpart F income of: active financing income of a controlled foreign corporation ( CFC ) engaged in an active financing business ; and interest, dividends, rents and royalties received by a CFC from a related CFC (whether or not operating in the same non-u.s. country as the recipient) to the extent attributable or allocable to that related person s active income (the so-called related person look-through rule ). The Act also extends to the end of 2009 two types of relief from U.S. taxes for non-u.s. investors in U.S. regulated investment companies ( RICs ), of which mutual funds are the most common type: the exemption from U.S. withholding on interest-related dividends and short-term capital gain dividends from a RIC; and the exemption from FIRPTA tax on capital gains recognized on the disposition of stock in a RIC if the RIC is (i) publicly traded and the non-u.s. shareholder owns 5% or less of the relevant class of stock, or (ii) domestically controlled. ENERGY: CONSERVATION, PRODUCTION AND EFFICIENCY INCENTIVES The energy provisions of the Act create and extend a variety of tax incentives intended to promote conservation and the efficient production and use of energy, including, among many others: tax credits for generating certain types of energy and from investing in properties that generate certain types of energy; authorization of tax-favorable bonds to fund various energy-efficiency and conservationrelated projects; deductions for the costs of installing energy-efficient property in commercial buildings and accelerated deductions for the costs of certain recycling equipment; and various credits for homes and vehicles, including a provision that permits employers to provide employees who commute by bicycle with a tax-free fringe benefit to offset the costs of such commuting. EXTENSION OF TAX RELIEF PROVISIONS FOR INDIVIDUALS The Act extends to the end of 2009 a variety of individual tax relief measures, including: the itemized deduction for state and local sales tax in lieu of state and local income taxes; the extension of the tax-free transfer from IRAs to charitable organizations; the above-the-line deduction for qualified higher-education expenses; -12-
the above-the-line deduction for certain expenses of elementary and secondary school teachers; and the additional standard deduction for real estate taxes for non-itemizers. At the end of 2007, a one-year alternative minimum tax patch was enacted for the 2007 year. The patch modified the alternative minimum tax with the intention of limiting the number of individuals to which it applied. The Act provides a similar one-year patch for 2008. DISASTER RELIEF The Act establishes and extends various tax relief measures for individuals and businesses in areas affected by natural disasters such as Hurricanes Katrina and Ike. MISCELLANEOUS Broker Basis Reporting Now Required for Covered Securities The Act adds a new reporting requirement under which brokers must report, on any informational return with respect to the gross proceeds of the sale of a covered security, the customer s adjusted basis in such security and whether any gain or loss is long-term or short-term. A covered security is generally a security acquired through an account maintained with the broker, or transferred to such account from another account in which such security was a covered security, but only if the broker received the necessary informational statement with respect to such transfer. Tax Preparer Penalty Standards: Conformed to Taxpayer Standards The Act includes the much-hoped-for amendments to the tax return preparer penalty rules in IRC Section 6694. The amendments generally conform the preparer penalty standards to those applicable to taxpayers under IRC Sections 6662, 6664 and 6662A. Accordingly, a preparer of a position that gives rise to an understatement is subject to a penalty unless one of the following applies: there is or was substantial authority for the position; there is a reasonable basis for the position and the position was adequately disclosed in the tax return; or the position is supported by a reasonable belief that it would more likely than not be sustained on its merits ( MLTN ). If the position arises from a tax shelter (as defined in IRC Section 6662(d)(2)(C)(ii)) or a reportable transaction to which IRC Section 6662A applies, then only the MLTN defense appears to be available. The amendments also retain the reasonable cause and good faith defense that exists under current law. The amendments are effective for returns prepared after May 25, 2007, except that in the case of tax shelters and reportable transactions, the amendments are effective only for returns prepared for taxable years ending after the date of enactment of the Act. Although not clear, this seems to mean that for -13-
returns prepared for prior years, the current law rule (requiring either MLTN or reasonable basis plus adequate disclosure) would apply. ENFORCEMENT, OVERSIGHT AND REPORTING REQUIREMENTS The Act includes a number of provisions intended to determine the causes of the current market difficulties, recommend improvements in the regulatory system, promote accountability and efficiency in the administration of the TARP, and enhance enforcement of laws relating to financial products. DETERMINING THE CAUSES OF THE DIFFICULTIES IN THE U.S. FINANCIAL SYSTEM The Act requires a series of studies from various federal agencies intended to identify the causes of the current difficulties in the U.S. financial system and possible legislative responses. The U.S. Comptroller General must report to Congress, no later than June 1, 2009, on the extent to which leverage and sudden deleveraging of financial institutions was a factor in the financial crisis. The study must include an analysis of the roles of federal regulatory agencies and recommendations for any changes that should be made to the existing authority of the Federal Reserve. The Act also requires the Treasury Department to provide a Regulatory Modernization Report regarding the current state of the financial markets and the regulatory system to Congress by April 30, 2009. This report is to include recommendations from the Treasury Department regarding enhancement of the clearing and settlement of over-the-counter swaps and whether any participants in the financial markets that are currently outside the regulatory system should become subject to the regulatory system. The Blueprint for a Modernized Financial Regulatory Infrastructure, issued by the Treasury Department in March 2008, 10 may serve as a basis for the Regulatory Modernization Report and any upcoming legislative and regulatory reform. The Congressional Oversight Panel (the COP ), established by the Act, will prepare a special report on potential regulatory reform no later than January 20, 2009. The COP, which will sit within the legislative branch, will consist of five individuals appointed by Congressional leaders. OVERSIGHT OF THE TREASURY DEPARTMENT AND THE TARP The Act establishes three new entities to monitor the Treasury Department s actions under the Act: the Financial Stability Oversight Board ( FSOB ), the COP (described above) and the Office of the Special Inspector General for the TARP. The FSOB will review and make recommendations regarding the Treasury Department s exercise of authority under the Act, including evaluating the efficacy of policies implemented by the Treasury Department and the OFS in preserving home ownership, stabilizing financial 10 See http://www.treasury.gov/press/releases/reports/blueprint.pdf. -14-
markets and protecting taxpayers. In addition, the FSOB will report suspected fraud, misrepresentation and malfeasance. The FSOB will be composed of the Chairman of the Board of Governors of the Federal Reserve System, the Treasury Secretary, the Director of the Federal Housing Finance Agency, the Chairman of the SEC, and the Secretary of Housing and Urban Development, and must report to Congress at least quarterly. The COP will submit monthly reports to Congress on the use and impact of the Act. The Special Inspector General for the TARP will conduct, supervise and coordinate audits and investigations of the purchase, management and sale of troubled assets by the Treasury Department, and the management of the Troubled Assets Insurance Program. The Special Inspector General will collect detailed information on these programs. The Special Inspector General will report to Congress on a quarterly basis. The Treasury Department also has various reporting obligations, including a report to Congress on the Troubled Assets Insurance Program no later than January 1, 2009, and other periodic reports. The U.S. Comptroller General is required to engage in ongoing oversight of the TARP and its agents and representatives, including with respect to the program s efficacy, efficiency and financial condition. The Comptroller General must audit the TARP s financial statements annually in accordance with generally accepted auditing standards and is required to report at least once every 60 days to Congress and the Special Inspector General. The Act requires the Office of Management and Budget and the Congressional Budget Office to provide periodic reports. The Act also requires the Federal Reserve to report to Congress on the use of its authority under Federal Reserve Act Section 13(3) (relating to discounts of notes, drafts and bills), with updates at least every 60 days while the loan is outstanding. ENFORCEMENT OF LAWS; JUDICIAL REVIEW The Act directs federal financial regulatory agencies to cooperate with the Federal Bureau of Investigation and other law enforcement agencies in investigating fraud, misrepresentation and malfeasance with respect to the development, advertising and sale of financial products. With respect to private civil litigation, the Act permits some narrow legal challenges to the Treasury Department s actions, but limits injunctive relief with respect to the Treasury Department s principal actions under the Act to Constitutional violations and ensures that any requests for temporary restraining orders, injunctions and other claims will be addressed quickly. * * * Copyright Sullivan & Cromwell LLP 2008-15-
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