Credit Suisse Settles OFAC Charges for $536 million

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The Credit Suisse Group has reached a settlement with U.S. authorities related to U.S. dollar payments involving parties subject to U.S. sanctions. The $536 million global settlement with Credit Suisse represents by far the largest sanctions settlement in the history of US Treasury’s Office of Foreign Assets Control.

The settlement arises out of Credit Suisse’s processing of thousands of transactions over a 20 year period that concealed the involvement of sanctioned parties. Credit Suisse approached OFAC in early April 2006 about an internal investigation it was conducting related to U.S. securities transactions executed on behalf of an entity subject to U.S. sanctions. In early 2007, after the New York County District Attorney’s Office began looking into several suspicious wire transfers, Credit Suisse also informed OFAC of a separate internal investigation related to its activities as a U.S. dollar correspondent for payments involving Iran, Sudan, Burma, Cuba, North Korea.

The settlement agreement lays out the decades long history of bad behavior at Credit Suisse.

“Credit Suisse in Zurich had a standard procedure of structuring payments to avoid disclosing the sanctions nexus of transactions passed through the United States, deleting or omitting certain information when transactions were to be processed through the United States, and providing incorrect information in wire transfer instructions executed through the United States on behalf of U.S. sanctioned individuals and entities. This standard procedure was embodied in internal directives, memoranda, and e-mails involving, among others, a Credit Suisse Bank Payments sector head, Credit Suisse’s Treasury and Trade Finance departments, the head of Credit Suisse’s Iran desk, as well as in e-mails between Credit Suisse and its Iranian bank clients.

Specifically, from on or about August 19,2003, to on or about November 1,2006, Credit Suisse processed 4,775 electronic funds transfers, in the aggregate amount of USD 480,072,032.00, through financial institutions located in the United States to the benefit of the Government of Iran and/or persons in Iran, including various Iranian financial institutions, in apparent violation of the prohibition against the “exportation, … directly or indirectly, from the United States, … of any … services to Iran or the Government of Iran,” 31 C.F.R. § 560.204.”

Credit Suisse is making the $536 million payment pursuant to a settlement agreement with OFAC and deferred prosecution agreements with the New York Country District Attorney’s Office and the United States Department Justice.

I would expect that a shareholder class action suit will be filed shortly as well. We have seen these shareholder suits result from FCPA settlements.

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SEC Approves New Custody Rule

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The Securities and Exchange Commission adopted the proposed Custody Rule for investment advisers originally proposed last May. (See: SEC Releases Proposed Custody Rules for Investment Advisers)

As is typical with the SEC, they announced the rule was approved before they made the final version of rule available. The rule amendments will be effective 60 days after their publication in the Federal Register.

The SEC press release highlights the two biggest changes:

Surprise Exam

“The adviser is now required to engage an independent public accountant to conduct an annual “surprise exam” to verify that client assets exist. Such a surprise examination would provide another set of eyes on the client’s assets, and provide additional protection against theft or misuse. The accountants would have to contact the SEC if they discovered client assets were missing.”

Custody Controls Review

“When the adviser or an affiliate serves as custodian of client assets, the adviser is now required to obtain a written report — prepared by an accountant that is registered with and subject to regular inspection by the PCAOB — that, among other things, describes the controls in place at the custodian, tests the operating effectiveness of those controls and provides the results of those tests. These reports are commonly known as SAS-70 reports. Requiring that the accountant be registered with and subject to inspection by the PCAOB provides greater confidence regarding the quality of these reports.”

The rules are amendments to Rule 206(4)-2 [17 CFR 275.206(4)-2], Rule 204-2 [17 CFR 275.204-2] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] (the “Advisers Act” or “Act”), to Form ADV [17 CFR 279.1], and to Form ADV-E [17 CFR 279.8].

References:

SEC Historical Society

November 1, 1974 - "We're Moving Right Along," Herblock, Copyright by The Herb Block Foundation
November 1, 1974 - "We're Moving Right Along," Herblock, Copyright by The Herb Block Foundation

The Securities and Exchange Commission Historical Society has launched a new gallery exploring the SEC during the mid to late 1970s: In the Midst of Revolution: The SEC, 1973-1981.

“From 1973 to 1981, the securities industry and the SEC experienced revolutionary change that created enormous upheaval, provided new economic opportunity and made the task of the SEC to respond to the new demands wrought by the rapid changes in the market increasingly more difficult.”

I was surprised to discover that the SEC’s Historical Society existed. I was even more surprised to see the wealth of information in its archives and virtual museum.

There is also a great history of the SEC’s regulation of insider trading.

Computer Files for Employees in France

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France has strict laws on the ability of a company to monitor its employees’ computers. But a recent French decision found that files created by an employee on a computer issued by the company for work purposes are presumed professional unless the employee identified them clearly as personal. So the company can open these files without the employee being present and without telling the employee in advance.

At least that is according to recent post in Proskauer’s Privacy Law Blog. The decision is in French so I am assuming that Ms. Martin’s French is better than mine. (Google’s translation of the case is not very good.)

“Until this case, the case law was unclear on whether folders or files located on an employee’s work computer but titled with the employee’s name or initials would be afforded privacy protection under workplace privacy laws. However in this ruling, the French Supreme Court made clear that all files created by an employee on an employer’s computer belong to the employer unless they are expressly identified as personal. By adopting this position, the French Supreme Court was consistent with the French Data Protection Agency (CNIL) which, since 2002, has advised that employees should be cautious when using their work computers for personal purposes.”

References:

Supreme Court to Hear Case on Employer Access to Worker Messages

supreme court

How much privacy do workers have when they send text messages from company accounts?

Users of text-messaging services “have a reasonable expectation of privacy” regarding messages stored on the service provider’s network, 9th Circuit Judge Kim Wardlaw said in Quon v. Arch Wireless Operating Company, Inc., 529 F.3d 892 (9th Cir. 2008).

In that case the court found that a police department had violated the Fourth Amendment and state constitutional rights of employees and the people they exchanged text messages with, when they reviewed “personal” text messages created on devices owned and issued by the police department. It also found that the text messaging provider, Arch Wireless, violated the Stored Communications Act (SCA), 18 U.S.C. §§2701-2711, by providing transcripts of these messages to the employer.

Supreme Court

The U.S. Supreme Court agreed to hear an appeal of the case: City of Ontario, California, et al., Petitioners v. Jeff Quon, et al. (08-1332). The Justices could add some new law to the ability of companies to monitor and access their employees’ use of a company’s computer system.

Limitations

Although it sounds interesting, the case has some limitations that will likely make the decision underwhelming. The employees at issue are government employees, so the Constitution is implicated. You don’t have this issue with private employees. Second, the governmental employer accessed the information from the third party provider of the text-messaging system. The information was not on the government’s computer system itself. Third, the governmental employer did not have a clear policy on the use of the equipment and whether the messages were private or accessible by the government employer.

Background

The case originated when police officers claimed thier rights were violated when messages on department devices were read by their chief. Quon and the other officers had signed a statement declaring “users should have no expectation of privacy or confidentiality” when using devices furnished by the city. But shortly after text pagers were distributed, the officers were told by a supervisor they could use them to send messages, as long as they paid for messages that exceeded the monthly limit. It was understood that some of these messages would be personal and unrelated to police work. When the police chief learned that some officers were regularly exceeding the monthly limit, he asked for an audit and read the messages.

After Quon and the other officers learned their messages had been read, they sued. They lost in the Los Angeles Federal District Court, but won in front of the 9th Circuit.

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COBRA Subsidy Expiring

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Congress continues to health care reform while the emergency COBRA subsidy is set to expire.

To help out the wave of workers laid-off, downsized and outsourced, Congress included a health insurance subsidy as part of the American Recovery and Reinvestment Act of 2009. The government would pay 65 percent of the COBRA premium for eligible workers who lost their jobs between September 1, 2008 and December 31, 2009.

If you lost your job between September 1, 2008 and March 1, 2009, the subsidy is set to expire. The law provided for nine months of the subsidy. If you lost your job after March 1, 2009, the subsidy is in place for nine months after you lost your job.

When this benefit expires, the employee will not lose the COBRA coverage. But the subsidy will expire and the employee will be bear the full cost of the insurance coverage.

There have been a few bills in Congress to extend the subsidy (Extended COBRA Continuation Protection Act of 2009 (H.R. 3930) and COBRA Subsidy Extension and Enhancement Act (S. 2730)) but they do not seem to be moving forward.

That means that employers will need to go back their old COBRA notice in January 2010. For those of you who had the benefit of the COBRA subsidy, the amount you pay for health insurance will go up.

References:

House Passes Far-Reaching Bill Tightening Financial Rules

I'm just a bill from Schoolhouse Rock

Today, the House passed the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173 ), a week after it was introduced.

It looks it is a mashup of other bills that were being tossed around in the House to regulate the financial industry. According to Carl Husle of the New York Times, “After three days of floor debate, the House voted 223 to 202 to approve the measure. It creates a new agency to oversee consumer lending, establishes new rules for transactions that contributed to the meltdown, and seeks to reduce the threat that one or two huge companies on the verge of collapse could bring down the economy.”

Most likely, this bill will go up against the Dodd bill (in whatever form it ends up) in Congressional committee.

I looked at Title V of Wall Street Reform and Consumer Protection Act of 2009and found the Private Fund Investment Advisers Registration Act tucked neatly inside. It looks like it kept the all the Amendments to the Private Fund Investment Advisers Registration Act as it was passed by the House Financial Services Committee.

———————————–

TITLE V–CAPITAL MARKETS

Subtitle A–Private Fund Investment Advisers Registration Act

SEC. 5001. SHORT TITLE.

This subtitle may be cited as the ‘Private Fund Investment Advisers Registration Act of 2009’.

SEC. 5002. DEFINITIONS.

Section 202(a) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)) is amended by adding at the end the following new paragraphs:

‘(29) PRIVATE FUND- The term ‘private fund’ means an issuer that would be an investment company under section 3(a) of the Investment Company Act of 1940 (15 U.S.C. 80a-3(a)) but for the exception provided from that definition by either section 3(c)(1) or section 3(c)(7) of such Act.

‘(30) FOREIGN PRIVATE FUND ADVISER- The term ‘foreign private fund adviser’ means an investment adviser who–

‘(A) has no place of business in the United States;

‘(B) during the preceding 12 months has had–

‘(i) fewer than 15 clients in the United States; and

‘(ii) assets under management attributable to clients in the United States of less than $25,000,000, or such higher amount as the Commission may, by rule, deem appropriate in the public interest or for the protection of investors; and

‘(C) neither holds itself out generally to the public in the United States as an investment adviser, nor acts as an investment adviser to any investment company registered under the Investment Company Act of 1940, or a company which has elected to be a business development company pursuant to section 54 of the Investment Company Act of 1940 (15 U.S.C. 80a-53) and has not withdrawn such election.’.

SEC. 5003. ELIMINATION OF PRIVATE ADVISER EXEMPTION; LIMITED EXEMPTION FOR FOREIGN PRIVATE FUND ADVISERS; LIMITED INTRASTATE EXEMPTION.

Section 203(b) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3(b)) is amended–

(1) in paragraph (1), by inserting ‘, except an investment adviser who acts as an investment adviser to any private fund,’ after ‘any investment adviser’;

(2) by amending paragraph (3) to read as follows:

‘(3) any investment adviser that is a foreign private fund adviser;’;

(3) in paragraph (5), by striking ‘or’ at the end;

(4) in paragraph (6)–

(A) in subparagraph (A), by striking ‘or’;

(B) in subparagraph (B), by striking the period at the end and adding ‘; or’; and

(C) by adding at the end the following new subparagraph:

‘(C) a private fund; or’; and

(5) by adding at the end the following:

‘(7) any investment adviser who solely advises–

‘(A) small business investment companies licensed under the Small Business Investment Act of 1958;

‘(B) entities that have received from the Small Business Administration notice to proceed to qualify for a license, which notice or license has not been revoked; or

‘(C) applicants, related to one or more licensed small business investment companies covered in subparagraph (A), that have applied for another license, which application remains pending.’.

SEC. 5004. COLLECTION OF SYSTEMIC RISK DATA.

Section 204 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-4) is amended–

(1) by redesignating subsections (b) and (c) as subsections (c) and (d), respectively; and

(2) by inserting after subsection (a) the following new subsection:

‘(b) Records and Reports of Private Funds-

‘(1) IN GENERAL- The Commission is authorized to require any investment adviser registered under this Act to maintain such records of and file with the Commission such reports regarding private funds advised by the investment adviser as are necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk as the Commission determines in consultation with the Board of Governors of the Federal Reserve System. The Commission is authorized to provide or make available to the Board of Governors of the Federal Reserve System, and to any other entity that the Commission identifies as having systemic risk responsibility, those reports or records or the information contained therein. The records and reports of any private fund, to which any such investment adviser provides investment advice, maintained or filed by an investment adviser registered under this Act, shall be deemed to be the records and reports of the investment adviser.

‘(2) REQUIRED INFORMATION- The records and reports required to be maintained or filed with the Commission under this subsection shall include, for each private fund advised by the investment adviser–

‘(A) the amount of assets under management;

‘(B) the use of leverage (including off-balance sheet leverage);

‘(C) counterparty credit risk exposures;

‘(D) trading and investment positions;

‘(E) trading practices; and

‘(F) such other information as the Commission, in consultation with the Board of Governors of the Federal Reserve System, determines necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.

‘(3) OPTIONAL INFORMATION- The Commission may require the reporting of such additional information from private fund advisers as the Commission determines necessary. In making such determination, the Commission, taking into account the public interest and potential to contribute to systemic risk, may set different reporting requirements for different classes of private fund advisers, based on the particular types or sizes of private funds advised by such advisers.

‘(4) MAINTENANCE OF RECORDS- An investment adviser registered under this Act is required to maintain and keep such records of private funds advised by the investment adviser for such period or periods as the Commission, by rule or regulation, may prescribe as necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.

‘(5) EXAMINATION OF RECORDS-

‘(A) PERIODIC AND SPECIAL EXAMINATIONS- All records of a private fund maintained by an investment adviser registered under this Act shall be subject at any time and from time to time to such periodic, special, and other examinations by the Commission, or any member or representative thereof, as the Commission may prescribe.

‘(B) AVAILABILITY OF RECORDS- An investment adviser registered under this Act shall make available to the Commission or its representatives any copies or extracts from such records as may be prepared without undue effort, expense, or delay as the Commission or its representatives may reasonably request.

‘(6) INFORMATION SHARING- The Commission shall make available to the Board of Governors of the Federal Reserve System, and to any other entity that the Commission identifies as having systemic risk responsibility, copies of all reports, documents, records, and information filed with or provided to the Commission by an investment adviser under this subsection as the Board, or such other entity, may consider necessary for the purpose of assessing the systemic risk of a private fund. All such reports, documents, records, and information obtained by the Board, or such other entity, from the Commission under this subsection shall be kept confidential in a manner consistent with confidentiality established by the Commission pursuant to paragraph (8).

‘(7) DISCLOSURES OF CERTAIN PRIVATE FUND INFORMATION- An investment adviser registered under this Act shall provide such reports, records, and other documents to investors, prospective investors, counterparties, and creditors, of any private fund advised by the investment adviser as the Commission, by rule or regulation, may prescribe as necessary or appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.

‘(8) CONFIDENTIALITY OF REPORTS- Notwithstanding any other provision of law, the Commission shall not be compelled to disclose any report or information contained therein required to be filed with the Commission under this subsection. Nothing in this paragraph shall authorize the Commission to withhold information from the Congress or prevent the Commission from complying with a request for information from any other Federal department or agency or any self-regulatory organization requesting the report or information for purposes within the scope of its jurisdiction, or complying with an order of a court of the United States in an action brought by the United States or the Commission. For purposes of section 552 of title 5, United States Code, this paragraph shall be considered a statute described in subsection (b)(3)(B) of such section.’.

SEC. 5005. ELIMINATION OF DISCLOSURE PROVISION.

Section 210 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-10) is amended by striking subsection (c).

SEC. 5006. EXEMPTION OF AND REPORTING BY VENTURE CAPITAL FUND ADVISERS.

Section 203 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3) is amended by adding at the end the following new subsection:

‘(l) Exemption of and Reporting by Venture Capital Fund Advisers- The Commission shall identify and define the term ‘venture capital fund’ and shall provide an adviser to such a fund an exemption from the registration requirements under this section (excluding any such fund whose adviser is exempt from registration pursuant to paragraph (7) of subsection (b)). The Commission shall require such advisers to maintain such records and provide to the Commission such annual or other reports as the Commission determines necessary or appropriate in the public interest or for the protection of investors.’.

SEC. 5007. EXEMPTION OF AND REPORTING BY CERTAIN PRIVATE FUND ADVISERS.

Section 203 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3), as amended by section 5006, is further amended by adding at the end the following new subsections:

‘(m) Exemption of and Reporting by Certain Private Fund Advisers-

‘(1) IN GENERAL- The Commission shall provide an exemption from the registration requirements under this section to any investment adviser of private funds, if each of such private funds has assets under management in the United States of less than $150,000,000.

‘(2) REPORTING- The Commission shall require investment advisers exempted by reason of this subsection to maintain such records and provide to the Commission such annual or other reports as the Commission determines necessary or appropriate in the public interest or for the protection of investors.

‘(n) Registration and Examination of Mid-sized Private Fund Advisers- In prescribing regulations to carry out the requirements of this section with respect to investment advisers acting as investment advisers to mid-sized private funds, the Commission shall take into account the size, governance, and investment strategy of such funds to determine whether they pose systemic risk, and shall provide for registration and examination procedures with respect to the investment advisers of such funds which reflect the level of systemic risk posed by such funds.’.

SEC. 5008. CLARIFICATION OF RULEMAKING AUTHORITY.

Section 211 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-11) is amended–

(1) by amending subsection (a) to read as follows:

‘(a) The Commission shall have authority from time to time to make, issue, amend, and rescind such rules and regulations and such orders as are necessary or appropriate to the exercise of the functions and powers conferred upon the Commission elsewhere in this title, including rules and regulations defining technical, trade, and other terms used in this title. For the purposes of its rules and regulations, the Commission may–

‘(1) classify persons and matters within its jurisdiction based upon, but not limited to–

‘(A) size;

‘(B) scope;

‘(C) business model;

‘(D) compensation scheme; or

‘(E) potential to create or increase systemic risk;

‘(2) prescribe different requirements for different classes of persons or matters; and

‘(3) ascribe different meanings to terms (including the term ‘client’, except the Commission shall not ascribe a meaning to the term ‘client’ that would include an investor in a private fund managed by an investment adviser, where such private fund has entered into an advisory contract with such adviser) used in different sections of this title as the Commission determines necessary to effect the purposes of this title.’; and

(2) by adding at the end the following new subsection:

‘(e) The Commission and the Commodity Futures Trading Commission shall, after consultation with the Board of Governors of the Federal Reserve System, within 12 months after the date of enactment of the Private Fund Investment Advisers Registration Act of 2009, jointly promulgate rules to establish the form and content of the reports required to be filed with the Commission under sections 203(l) and 204(b) and with the Commodity Futures Trading Commission by investment advisers that are registered both under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1 et seq.) and the Commodity Exchange Act (7 U.S.C. 1 et seq.).’.

SEC. 5009. GAO STUDY.

(a) Study Required- The Comptroller General of the United States shall carry out a study to assess the annual costs on industry members and their investors due to the registration requirements and ongoing reporting requirements under this subtitle and the amendments made by this subtitle.

(b) Report to the Congress- Not later than the end of the 2-year period beginning on the date of the enactment of this title, the Comptroller General of the United States shall submit a report to the Congress containing the findings and determinations made by the Comptroller General in carrying out the study required under subsection (a).

SEC. 5010. EFFECTIVE DATE; TRANSITION PERIOD.

(a) Effective Date- This subtitle, and the amendments made by this subtitle, shall take effect with respect to investment advisers after the end of the 1-year period beginning on the date of the enactment of this title.

(b) Transition Period- The Securities and Exchange Commission shall prescribe rules and regulations to permit an investment adviser who will be required to register with the Securities and Exchange Commission by reason of this subtitle with the option of registering with the Securities and Exchange Commission before the date described under subsection (a).

SEC. 5011. QUALIFIED CLIENT STANDARD.

Section 205(e) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-5(e)) is amended by adding at the end the following: ‘With respect to any factor used by the Commission in making a determination under this subsection, if the Commission uses a dollar amount test in connection with such factor, such as a net asset threshold, the Commission shall, not later than one year after the date of the enactment of the Private Fund Investment Advisers Registration Act of 2009, and every 5 years thereafter, adjust for the effects of inflation on such test. Any such adjustment that is not a multiple of $1,000 shall be rounded to the nearest multiple of $1,000.’.

Compliance Bits and Pieces for December 11

Here are some interesting stories from the past week.

Tis the Season! Where are the gifts from vendors?? from Kathleen Edmond, Best Buy’s Chief Ethics Officer

This time every year we send out reminders to our employees that we do not accept gifts from vendors. At the same time we send letters to our vendors asking that they don’t send our employees any gifts. I usually get questions from employees, and even some vendors, about why we we have this policy.

Second Circuit Defines Employers’ Obligations in Sexual Harassment Claim by Daniel Schwartz on the Connecticut Employment Law Blog

The Second Circuit’s decision in Duch v. Jakubek (decided on Friday, December 4th)… discusses what to do with a supervisor who purposely ignores evidence of sexual harassment. And the court concludes that the supervisor should have known that a female subordinate was being sexually harassed and should’ve done something about it.

Magyar’s Magnum Opus from the FCPA Blog

Magyar Telekom’s SEC disclosure last week about its internal investigation into fraudulent contracting practices could have been short and bland and very ordinary. A typical corporate blank wall. Instead it was abundant in length and detail  — one of the most rewarding public disclosures about an internal investigation we’ve ever read. It appeared in the company’s SEC Form 6-K, Report of Foreign Private Issuer, filed December 3, 2009 here.

Did An FCPA Enforcement Action Contribute to a Foreign Coup? by Mike Koehler in the FCPA Professor

In April 2009, DOJ announced (see here) that Latin Node, Inc. (a privately-held telecommunication services company headquartered in Miami) pled guilty to violating the FCPA’s anti-bribery provisions in connection with improper payments made to officials in Honduras and Yemen in order to obtain and retain business. The criminal information (see here) details Latin Node’s efforts to obtain and retain business with Hondutel (the Honduran government-owned telecommunications company) and charges that despite recognized “financial weaknesses” in Latin Node’s proposal, Hondutel ultimately selected Latin Node for the agreement because of various improper payments Latin Node made or authorized to various Honduran “foreign officials.”

FCPA Ending its ‘Most Dynamic Single Year’ With a Bang By Dionne Searcey for The Wall Street Journal Law Blog

Two Florida executives of a Miami-Dade County-based telecommunications company, the president of Florida-based Telecom Consulting Services Corp., and two former Haitian government officials were charged in an indictment unsealed yesterday for their alleged roles in a foreign bribery, wire fraud and money laundering scheme, DOJ has announced.

Why You Shouldn’t Take it Hard If a Judge Rejects Your Friend Request by Ashby Jones on the Wall Street Journal Law Blog

Late last month, the Florida Judicial Ethics Advisory Committee issued an advisory opinion on the use of social networking sites by Florida judges. (Hat tip: Legal Profession Blog.) This little rhetorical appears early in the opinion:

Whether a judge may add lawyers who may appear before the judge as “friends” on a social networking site, and permit such lawyers to add the judge as their “friend.”

ANSWER: No.

Carried Interest Tax Legislation Suddenly Appears and Moves Forward

Tucked into the Tax Extenders Act of 2009 (H.R. 4213), is a provision targeted at partnership interests held by partners providing services.

This proposal seems to be the same proposal offered by Congressman Sandy Levin from the 12th District of Michigan in H.R. 1935 which has been sitting in Committee [See prior post: Carried Interest Tax Legislation.

H.R. 4213 flew through the legislative process of the House of Representatives. It was introduced on December 7, 2009 and passed by the House on December 9, mostly along party lines. The Carried Interest Tax is one of several dozen changes to the tax code included in the bill.

The text of the relevant section of the bill:

TITLE VI–OTHER REVENUE PROVISIONS

Subtitle A–Partnership Interests Held by Partners Providing Services

SEC. 601. PARTNERSHIP INTERESTS TRANSFERRED IN CONNECTION WITH PERFORMANCE OF SERVICES.

(a) Modification to Election To Include Partnership Interest in Gross Income in Year of Transfer- Subsection (c) of section 83 is amended by redesignating paragraph (4) as paragraph (5) and by inserting after paragraph (3) the following new paragraph:

‘(4) PARTNERSHIP INTERESTS- Except as provided by the Secretary, in the case of any transfer of an interest in a partnership in connection with the provision of services to (or for the benefit of) such partnership–

‘(A) the fair market value of such interest shall be treated for purposes of this section as being equal to the amount of the distribution which the partner would receive if the partnership sold (at the time of the transfer) all of its assets at fair market value and distributed the proceeds of such sale (reduced by the liabilities of the partnership) to its partners in liquidation of the partnership, and

‘(B) the person receiving such interest shall be treated as having made the election under subsection (b)(1) unless such person makes an election under this paragraph to have such subsection not apply.’.

(b) Conforming Amendment- Paragraph (2) of section 83(b) is amended by inserting ‘or subsection (c)(4)(B)’ after ‘paragraph (1)’.

(c) Effective Date- The amendments made by this section shall apply to interests in partnerships transferred after the date of the enactment of this Act.

SEC. 602. INCOME OF PARTNERS FOR PERFORMING INVESTMENT MANAGEMENT SERVICES TREATED AS ORDINARY INCOME RECEIVED FOR PERFORMANCE OF SERVICES.

(a) In General- Part I of subchapter K of chapter 1 is amended by adding at the end the following new section:

‘SEC. 710. SPECIAL RULES FOR PARTNERS PROVIDING INVESTMENT MANAGEMENT SERVICES TO PARTNERSHIP.

‘(a) Treatment of Distributive Share of Partnership Items- For purposes of this title, in the case of an investment services partnership interest–

‘(1) IN GENERAL- Notwithstanding section 702(b)–

‘(A) any net income with respect to such interest for any partnership taxable year shall be treated as ordinary income, and

‘(B) any net loss with respect to such interest for such year, to the extent not disallowed under paragraph (2) for such year, shall be treated as an ordinary loss.

All items of income, gain, deduction, and loss which are taken into account in computing net income or net loss shall be treated as ordinary income or ordinary loss (as the case may be).

‘(2) TREATMENT OF LOSSES-

‘(A) LIMITATION- Any net loss with respect to such interest shall be allowed for any partnership taxable year only to the extent that such loss does not exceed the excess (if any) of–

‘(i) the aggregate net income with respect to such interest for all prior partnership taxable years, over

‘(ii) the aggregate net loss with respect to such interest not disallowed under this subparagraph for all prior partnership taxable years.

‘(B) CARRYFORWARD- Any net loss for any partnership taxable year which is not allowed by reason of subparagraph (A) shall be treated as an item of loss with respect to such partnership interest for the succeeding partnership taxable year.

‘(C) BASIS ADJUSTMENT- No adjustment to the basis of a partnership interest shall be made on account of any net loss which is not allowed by reason of subparagraph (A).

‘(D) PRIOR PARTNERSHIP YEARS- Any reference in this paragraph to prior partnership taxable years shall only include prior partnership taxable years to which this section applies.

‘(3) NET INCOME AND LOSS- For purposes of this section–

‘(A) NET INCOME- The term ‘net income’ means, with respect to any investment services partnership interest for any partnership taxable year, the excess (if any) of–

‘(i) all items of income and gain taken into account by the holder of such interest under section 702 with respect to such interest for such year, over

‘(ii) all items of deduction and loss so taken into account.

‘(B) NET LOSS- The term ‘net loss’ means, with respect to such interest for such year, the excess (if any) of the amount described in subparagraph (A)(ii) over the amount described in subparagraph (A)(i).

‘(b) Dispositions of Partnership Interests-

‘(1) GAIN- Any gain on the disposition of an investment services partnership interest shall be treated as ordinary income and shall be recognized notwithstanding any other provision of this subtitle.

‘(2) LOSS- Any loss on the disposition of an investment services partnership interest shall be treated as an ordinary loss to the extent of the excess (if any) of–

‘(A) the aggregate net income with respect to such interest for all partnership taxable years, over

‘(B) the aggregate net loss with respect to such interest allowed under subsection (a)(2) for all partnership taxable years.

‘(3) DISPOSITION OF PORTION OF INTEREST- In the case of any disposition of an investment services partnership interest, the amount of net loss which otherwise would have (but for subsection (a)(2)(C)) applied to reduce the basis of such interest shall be disregarded for purposes of this section for all succeeding partnership taxable years.

‘(4) DISTRIBUTIONS OF PARTNERSHIP PROPERTY- In the case of any distribution of property by a partnership with respect to any investment services partnership interest held by a partner–

‘(A) the excess (if any) of–

‘(i) the fair market value of such property at the time of such distribution, over

‘(ii) the adjusted basis of such property in the hands of the partnership,

shall be taken into account as an increase in such partner’s distributive share of the taxable income of the partnership (except to the extent such excess is otherwise taken into account in determining the taxable income of the partnership),

‘(B) such property shall be treated for purposes of subpart B of part II as money distributed to such partner in an amount equal to such fair market value, and

‘(C) the basis of such property in the hands of such partner shall be such fair market value.

Subsection (b) of section 734 shall be applied without regard to the preceding sentence.

‘(5) APPLICATION OF SECTION 751- In applying section 751(a), an investment services partnership interest shall be treated as an inventory item.

‘(c) Investment Services Partnership Interest- For purposes of this section–

‘(1) IN GENERAL- The term ‘investment services partnership interest’ means any interest in a partnership which is held (directly or indirectly) by any person if it was reasonably expected (at the time that such person acquired such interest) that such person (or any person related to such person) would provide (directly or indirectly) a substantial quantity of any of the following services with respect to assets held (directly or indirectly) by the partnership:

‘(A) Advising as to the advisability of investing in, purchasing, or selling any specified asset.

‘(B) Managing, acquiring, or disposing of any specified asset.

‘(C) Arranging financing with respect to acquiring specified assets.

‘(D) Any activity in support of any service described in subparagraphs (A) through (C).

For purposes of this paragraph, the term ‘specified asset’ means securities (as defined in section 475(c)(2) without regard to the last sentence thereof), real estate held for rental or investment, interests in partnerships, commodities (as defined in section 475(e)(2)), or options or derivative contracts with respect to any of the foregoing.

‘(2) EXCEPTION FOR CERTAIN CAPITAL INTERESTS-

‘(A) IN GENERAL- In the case of any portion of an investment services partnership interest which is a qualified capital interest, all items of income, gain, loss, and deduction which are allocated to such qualified capital interest shall not be taken into account under subsection (a) if–

‘(i) allocations of items are made by the partnership to such qualified capital interest in the same manner as such allocations are made to other qualified capital interests held by partners who do not provide any services described in paragraph (1) and who are not related to the partner holding the qualified capital interest, and

‘(ii) the allocations made to such other interests are significant compared to the allocations made to such qualified capital interest.

‘(B) SPECIAL RULE FOR NO OR INSIGNIFICANT ALLOCATIONS TO NONSERVICE PROVIDERS- To the extent provided by the Secretary in regulations or other guidance, in any case in which the requirements of subparagraph (A)(ii) are not satisfied, items of income, gain, loss, and deduction shall not be taken into account under subsection (a) to the extent that such items are properly allocable under such regulations or other guidance to qualified capital interests.

‘(C) SPECIAL RULE FOR DISPOSITIONS- In the case of any investment services partnership interest any portion of which is a qualified capital interest, subsection (b) shall not apply to so much of any gain or loss as bears the same proportion to the entire amount of such gain or loss as–

‘(i) the distributive share of gain or loss that would have been allocable to the qualified capital interest under subparagraph (A) if the partnership sold all of its assets immediately before the disposition, bears to

‘(ii) the distributive share of gain or loss that would have been so allocable to the investment services partnership interest of which such qualified capital interest is a part.

‘(D) QUALIFIED CAPITAL INTEREST- For purposes of this paragraph, the term ‘qualified capital interest’ means so much of a partner’s interest in the capital of the partnership as is attributable to–

‘(i) the fair market value of any money or other property contributed to the partnership in exchange for such interest (determined without regard to section 752(a)) ,

‘(ii) any amounts which have been included in gross income under section 83 with respect to the transfer of such interest, and

‘(iii) the excess (if any) of–

‘(I) any items of income and gain taken into account under section 702 with respect to such interest for taxable years to which this section applies, over

‘(II) any items of deduction and loss so taken into account.

The qualified capital interest shall be reduced by distributions from the partnership with respect to such interest for taxable years to which this section applies and by the excess (if any) of the amount described in clause (iii)(II) over the amount described in clause (iii)(I).

‘(E) TREATMENT OF CERTAIN LOANS-

‘(i) PROCEEDS OF PARTNERSHIP LOANS NOT TREATED AS QUALIFIED CAPITAL INTEREST OF SERVICE PROVIDING PARTNERS- For purposes of this paragraph, an investment services partnership interest shall not be treated as a qualified capital interest to the extent that such interest is acquired in connection with the proceeds of any loan or other advance made or guaranteed, directly or indirectly, by any other partner or the partnership (or any person related to any such other partner or the partnership).

‘(ii) REDUCTION IN ALLOCATIONS TO QUALIFIED CAPITAL INTERESTS FOR LOANS FROM NONSERVICE PROVIDING PARTNERS TO THE PARTNERSHIP- For purposes of this paragraph, any loan or other advance to the partnership made or guaranteed, directly or indirectly, by a partner not providing services described in paragraph (1) to the partnership (or any person related to such partner) shall be taken into account in determining the qualified capital interests of the partners in the partnership.

‘(3) RELATED PERSONS- A person shall be treated as related to another person if the relationship between such persons would result in a disallowance of losses under section 267 or 707(b).

‘(d) Other Income and Gain in Connection With Investment Management Services-

‘(1) IN GENERAL- If–

‘(A) a person performs (directly or indirectly) investment management services for any entity,

‘(B) such person holds (directly or indirectly) a disqualified interest with respect to such entity, and

‘(C) the value of such interest (or payments thereunder) is substantially related to the amount of income or gain (whether or not realized) from the assets with respect to which the investment management services are performed,

any income or gain with respect to such interest shall be treated as ordinary income. Rules similar to the rules of subsection (c)(2) shall apply for purposes of this subsection.

‘(2) DEFINITIONS- For purposes of this subsection–

‘(A) DISQUALIFIED INTEREST-

‘(i) IN GENERAL- The term ‘disqualified interest’ means, with respect to any entity–

‘(I) any interest in such entity other than indebtedness,

‘(II) convertible or contingent debt of such entity,

‘(III) any option or other right to acquire property described in subclause (I) or (II), and

‘(IV) any derivative instrument entered into (directly or indirectly) with such entity or any investor in such entity.

‘(ii) EXCEPTIONS- Such term shall not include–

‘(I) a partnership interest,

‘(II) except as provided by the Secretary, any interest in a taxable corporation, and

‘(III) except as provided by the Secretary, stock in an S corporation.

‘(B) TAXABLE CORPORATION- The term ‘taxable corporation’ means–

‘(i) a domestic C corporation, or

‘(ii) a foreign corporation substantially all of the income of which is–

‘(I) effectively connected with the conduct of a trade or business in the United States, or

‘(II) subject to a comprehensive foreign income tax (as defined in section 457A(d)(2)).

‘(C) INVESTMENT MANAGEMENT SERVICES- The term ‘investment management services’ means a substantial quantity of any of the services described in subsection (c)(1).

‘(e) Regulations- The Secretary shall prescribe such regulations or other guidance as is necessary or appropriate to carry out the purposes of this section, including regulations or other guidance to–

‘(1) provide modifications to the application of this section (including treating related persons as not related to one another) to the extent such modification is consistent with the purposes of this section,

‘(2) prevent the avoidance of the purposes of this section, and

‘(3) coordinate this section with the other provisions of this title.

‘(f) Cross Reference- For 40 percent penalty on certain underpayments due to the avoidance of this section, see section 6662.’.

(b) Income From Investment Services Partnership Interests Not Treated as Qualifying Income of Publicly Traded Partnerships- Subsection (d) of section 7704 is amended by adding at the end the following new paragraph:

‘(6) INCOME FROM INVESTMENT SERVICES PARTNERSHIP INTERESTS NOT QUALIFIED-

‘(A) IN GENERAL- Items of income and gain shall not be treated as qualifying income if such items are treated as ordinary income by reason of the application of section 710 (relating to special rules for partners providing investment management services to partnership).

‘(B) SPECIAL RULES FOR CERTAIN PARTNERSHIPS-

‘(i) CERTAIN PARTNERSHIPS OWNED BY REAL ESTATE INVESTMENT TRUSTS- Subparagraph (A) shall not apply in the case of a partnership which meets each of the following requirements:

‘(I) Such partnership is treated as publicly traded under this section solely by reason of interests in such partnership being convertible into interests in a real estate investment trust which is publicly traded.

‘(II) 50 percent or more of the capital and profits interests of such partnership are owned, directly or indirectly, at all times during the taxable year by such real estate investment trust (determined with the application of section 267(c)).

‘(III) Such partnership meets the requirements of paragraphs (2), (3), and (4) of section 856(c).

‘(ii) CERTAIN PARTNERSHIPS OWNING OTHER PUBLICLY TRADED PARTNERSHIPS- Subparagraph (A) shall not apply in the case of a partnership which meets each of the following requirements:

‘(I) Substantially all of the assets of such partnership consist of interests in one or more publicly traded partnerships (determined without regard to subsection (b)(2)).

‘(II) Substantially all of the income of such partnership is ordinary income or section 1231 gain (as defined in section 1231(a)(3)).

‘(C) TRANSITIONAL RULE- In the case of a partnership which is a publicly traded partnership on the date of the enactment of this paragraph, subparagraph (A) shall not apply to any taxable year of the partnership beginning before the date which is 10 years after the date of the enactment of this paragraph.’.

(c) Imposition of Penalty on Underpayments-

(1) IN GENERAL- Subsection (b) of section 6662, as amended by section 512, is amended by inserting after paragraph (6) the following new paragraph:

‘(7) The application of subsection (d) of section 710 or the regulations prescribed under section 710(e) to prevent the avoidance of the purposes of section 710.’.

(2) AMOUNT OF PENALTY-

(A) IN GENERAL- Section 6662, as amended by section 512, is amended by adding at the end the following new subsection:

‘(j) Increase in Penalty in Case of Property Transferred for Investment Management Services- In the case of any portion of an underpayment to which this section applies by reason of subsection (b)(7), subsection (a) shall be applied with respect to such portion by substituting ‘40 percent’ for ‘20 percent’.’.

(B) CONFORMING AMENDMENTS- Subparagraph (B) of section 6662A(e)(2) is amended–

(i) by striking ‘section 6662(h)’ and inserting ‘subsection (h) or (i) of section 6662’, and

(ii) by striking ‘GROSS VALUATION MISSTATEMENT PENALTY’ in the heading and inserting ‘CERTAIN INCREASED UNDERPAYMENT PENALTIES’.

(3) SPECIAL RULES FOR APPLICATION OF REASONABLE CAUSE EXCEPTION- Subsection (c) of section 6664 is amended–

(A) by redesignating paragraphs (2) and (3) as paragraphs (3) and (4), respectively,

(B) by striking ‘paragraph (2)’ in paragraph (4), as so redesignated, and inserting ‘paragraph (3)’, and

(C) by inserting after paragraph (1) the following new paragraph:

‘(2) SPECIAL RULE FOR UNDERPAYMENTS ATTRIBUTABLE TO INVESTMENT MANAGEMENT SERVICES-

‘(A) IN GENERAL- Paragraph (1) shall not apply to any portion of an underpayment to which this section applies by reason of subsection (b)(7) unless–

‘(i) the relevant facts affecting the tax treatment of the item are adequately disclosed,

‘(ii) there is or was substantial authority for such treatment, and

‘(iii) the taxpayer reasonably believed that such treatment was more likely than not the proper treatment.

‘(B) RULES RELATING TO REASONABLE BELIEF- Rules similar to the rules of subsection (d)(3) shall apply for purposes of subparagraph (A)(iii).’.

(d) Income and Loss From Investment Services Partnership Interests Taken Into Account in Determining Net Earnings From Self-Employment-

(1) INTERNAL REVENUE CODE- Section 1402(a) is amended by striking ‘and’ at the end of paragraph (16), by striking the period at the end of paragraph (17) and inserting ‘; and’, and by inserting after paragraph (17) the following new paragraph:

‘(18) notwithstanding the preceding provisions of this subsection, in the case of any individual engaged in the trade or business of providing services described in section 710(c)(1) with respect to any entity, any amount treated as ordinary income or ordinary loss of such individual under section 710 with respect to such entity shall be taken into account in determining the net earnings from self-employment of such individual.’.

(2) SOCIAL SECURITY ACT- Section 211(a) of the Social Security Act is amended by inserting after paragraph (16) the following new paragraph:

‘(17) Notwithstanding the preceding provisions of this subsection, in the case of any individual engaged in the trade or business of providing services described in section 710(c)(1) of the Internal Revenue Code of 1986 with respect to any entity, any amount treated as ordinary income or ordinary loss of such individual under section 710 of such Code with respect to such entity shall be taken into account in determining the net earnings from self-employment of such individual.’.

(e) Conforming Amendments-

(1) Subsection (d) of section 731 is amended by inserting ‘section 710(b)(4) (relating to distributions of partnership property),’ after ‘to the extent otherwise provided by’.

(2) Section 741 is amended by inserting ‘or section 710 (relating to special rules for partners providing investment management services to partnership)’ before the period at the end.

(3) The table of sections for part I of subchapter K of chapter 1 is amended by adding at the end the following new item:

‘Sec. 710. Special rules for partners providing investment management services to partnership.’.

(f) Effective Date-

(1) IN GENERAL- Except as otherwise provided in this subsection, the amendments made by this section shall apply to taxable years ending after December 31, 2009.

(2) PARTNERSHIP TAXABLE YEARS WHICH INCLUDE EFFECTIVE DATE- In applying section 710(a) of the Internal Revenue Code of 1986 (as added by this section) in the case of any partnership taxable year which includes December 31, 2009, the amount of the net income referred to in such section shall be treated as being the lesser of the net income for the entire partnership taxable year or the net income determined by only taking into account items attributable to the portion of the partnership taxable year which is after such date.

(3) DISPOSITIONS OF PARTNERSHIP INTERESTS- Section 710(b) of the Internal Revenue Code of 1986 (as added by this section) shall apply to dispositions and distributions after December 31, 2009.

(4) OTHER INCOME AND GAIN IN CONNECTION WITH INVESTMENT MANAGEMENT SERVICES- Section 710(d) of such Code (as added by this section) shall take effect on January 1, 2010.

(5) PUBLICLY TRADED PARTNERSHIPS- The amendment made by subsection (b) shall apply to taxable years beginning after December 31, 2009.