Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities, 1372-1380 [07-55]
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Federal Register / Vol. 72, No. 7 / Thursday, January 11, 2007 / Notices
as fixed guideway miles for purposes of
FTA’s funding formulas.
Issued on January 8, 2007.
James S. Simpson,
Administrator.
[FR Doc. E7–263 Filed 1–10–07; 8:45 am]
BILLING CODE 4910–57–P
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
[Docket No. 06–17]
Office of Thrift Supervision
[Docket No. 2006–55]
FEDERAL RESERVE SYSTEM
[Docket No. OP–1254]
FEDERAL DEPOSIT INSURANCE
CORPORATION
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–55043; File No. S7–08–06]
Interagency Statement on Sound
Practices Concerning Elevated Risk
Complex Structured Finance Activities
Office of the Comptroller of
the Currency, Treasury (‘‘OCC’’); Office
of Thrift Supervision, Treasury (‘‘OTS’’);
Board of Governors of the Federal
Reserve System (‘‘Board’’); Federal
Deposit Insurance Corporation
(‘‘FDIC’’); and Securities and Exchange
Commission (‘‘SEC’’) (collectively, the
‘‘Agencies’’).
ACTION: Notice of final interagency
statement.
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AGENCIES:
SUMMARY: The Agencies are adopting an
Interagency Statement on Sound
Practices Concerning Elevated Risk
Complex Structured Finance Activities
(‘‘Final Statement’’). The Final
Statement pertains to national banks,
state banks, bank holding companies
(other than foreign banks), federal and
state savings associations, savings and
loan holding companies, U.S. branches
and agencies of foreign banks, and SECregistered broker-dealers and
investment advisers (collectively,
‘‘financial institutions’’ or
‘‘institutions’’) engaged in complex
structured finance transactions
(‘‘CSFTs’’). In May 2004, the Agencies
issued and requested comment on a
proposed interagency statement (‘‘Initial
Proposed Statement’’). After reviewing
the comments received on the Initial
Proposed Statement, the Agencies in
May 2006 issued and requested
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comment on a revised proposed
interagency statement (‘‘Revised
Proposed Statement’’). The
modifications to the Revised Proposed
Statement, among other things, made
the statement more principles-based and
focused on the identification, review
and approval process for those CSFTs
that may pose heightened levels of legal
or reputational risk to the relevant
institution (referred to as ‘‘elevated risk
CSFTs’’). After carefully reviewing the
comments on the Revised Proposed
Statement, the Agencies have adopted
the Final Statement with minor
modifications designed to clarify, but
not alter, the principles set forth in the
Revised Proposed Statement. The Final
Statement describes some of the internal
controls and risk management
procedures that may help financial
institutions identify, manage, and
address the heightened reputational and
legal risks that may arise from elevated
risk CSFTs. As discussed further below,
the Final Statement will not affect or
apply to the vast majority of financial
institutions, including most small
institutions, nor does it create any
private rights of action.
The Final Statement is
effective January 11, 2007.
EFFECTIVE DATE:
FOR FURTHER INFORMATION CONTACT:
OCC: Kathryn E. Dick, Deputy
Comptroller, Credit and Market Risk,
(202) 874–4660; Grace E. Dailey, Deputy
Comptroller, Large Bank Supervision,
(202) 874–4610; or Ellen Broadman,
Director, Securities and Corporate
Practices Division, (202) 874–5210,
Office of the Comptroller of the
Currency, 250 E Street, SW.,
Washington, DC 20219.
OTS: Fred J. Phillips-Patrick, Director,
Credit Policy, (202) 906–7295, and
Deborah S. Merkle, Project Manager,
Credit Policy, (202) 906–5688,
Examinations and Supervision Policy;
or David A. Permut, Senior Attorney,
Business Transactions Division, (202)
906–7505, Office of Thrift Supervision,
1700 G Street, NW., Washington, DC
20552.
Board: Sabeth I. Siddique, Assistant
Director, (202) 452–3861, or Virginia
Gibbs, Senior Supervisory Financial
Analyst, (202) 452–2521, Division of
Banking Supervision and Regulation; or
Kieran J. Fallon, Assistant General
Counsel, (202) 452–5270, or Anne B.
Zorc, Senior Attorney, (202) 452–3876,
Legal Division, Board of Governors of
the Federal Reserve System, 20th Street
and Constitution Avenue, NW.,
Washington, DC 20551. Users of
Telecommunication Device for Deaf
(TTD) only, call (202) 263–4869.
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FDIC: Jason C. Cave, Associate
Director, (202) 898–3548; Division of
Supervision and Consumer Protection;
or Mark G. Flanigan, Counsel,
Supervision and Legislation Branch,
Legal Division, (202) 898–7426, Federal
Deposit Insurance Corporation, 550 17th
Street, NW., Washington, DC 20429.
SEC: Mary Ann Gadziala, Associate
Director, Office of Compliance
Inspections and Examinations, (202)
551–6207; Catherine McGuire, Chief
Counsel, Linda Stamp Sundberg, Senior
Special Counsel (Banking and
Derivatives), or Randall W. Roy, Branch
Chief, Division of Market Regulation,
(202) 551–5550, Securities and
Exchange Commission, 100 F Street,
NE., Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Background
Financial markets have grown rapidly
over the past decade, and innovations in
financial instruments have facilitated
the structuring of cash flows and
allocation of risk among creditors,
borrowers, and investors in more
efficient ways. Financial derivatives for
market and credit risk, asset-backed
securities with customized cash flow
features, specialized financial conduits
that manage pools of assets, and other
types of structured finance transactions
serve important purposes, such as
diversifying risk, allocating cash flows
and reducing cost of capital. As a result,
structured finance transactions,
including the more complex variations
of these transactions, now are an
essential part of U.S. and international
capital markets.
When a financial institution
participates in a CSFT, it bears the usual
market, credit, and operational risks
associated with the transaction. In some
circumstances, a financial institution
also may face heightened legal or
reputational risks due to its involvement
in a CSFT. For example, a financial
institution involved in a CSFT may face
heightened legal or reputational risk if
the customer’s regulatory, tax or
accounting treatment for the CSFT, or
disclosures concerning the CSFT in its
public filings or financial statements, do
not comply with applicable laws,
regulations or accounting principles.1
In some cases, certain CSFTs appear
to have been used in illegal schemes
1 For a memorandum on the potential liability of
a financial institution for securities laws violations
arising from participation in a CSFT, see Letter from
Annette L. Nazareth, Director, Division of Market
Regulation, Securities and Exchange Commission,
to Richard Spillenkothen and Douglas W. Roeder,
dated December 4, 2003 (available at https://
www.federalreserve.gov/boarddocs/srletters/2004/
and https://www.occ.treas.gov).
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that misrepresented the financial
condition of public companies to
investors and regulatory authorities.
After conducting investigations, the
OCC, Federal Reserve System and SEC
took strong and coordinated civil and
administrative enforcement actions
against certain financial institutions that
engaged in CSFTs that appeared to have
been designed or used to shield their
customers’ true financial health from
the public. These actions involved the
assessment of significant financial
penalties on the institutions and
required the institutions to take several
measures to strengthen their risk
management procedures for CSFTs.2
The complex structured finance
relationships involving these financial
institutions also sparked an
investigation by the Permanent
Subcommittee on Governmental Affairs
of the United States Senate,3 as well as
numerous lawsuits by private litigants.
The OCC, Federal Reserve System and
SEC also conducted special reviews of
several large financial institutions
engaged in CSFTs, and the Agencies
have focused attention on the CSFT
activities of financial institutions in the
normal course of the supervisory
process. These reviews and activities
indicate that many of the large financial
institutions engaged in CSFTs have
taken meaningful steps in recent years
to improve their control infrastructure
relating to CSFTs.
II. Initial and Revised Proposed
Statements
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To assist financial institutions in
identifying, managing, and addressing
the risks that may be associated with
CSFTs, the Agencies developed and
requested public comment on the Initial
Proposed Statement.4 The Initial
Proposed Statement described the types
2 See, e.g., In the Matter of Citigroup, Inc.,
Securities Exchange Act Release No. 48230 (July 28,
2003), Written Agreement by and between Citibank,
N.A. and the Office of the Comptroller of the
Currency, No. 2003–77 (July 28, 2003) (pertaining
to transactions entered into by Citibank, N.A. with
Enron Corp.) and Written Agreement by and
between Citigroup, Inc. and the Federal Reserve
Bank of New York, dated July 28, 2003 (pertaining
to transactions involving Citigroup Inc. and its
subsidiaries and Enron Corp. and Dynegy Inc.); SEC
v. J.P. Morgan Chase, SEC Litigation Release No.
18252 (July 28, 2003) and Written Agreement by
and among J.P. Morgan Chase & Co., the Federal
Reserve Bank of New York, and the New York State
Banking Department, dated July 28, 2003
(pertaining to transactions involving J.P. Morgan
Chase & Co. and its subsidiaries and Enron Corp.).
3 See Fishtail, Bacchus, Sundance, and Slapshot:
Four Enron Transactions Funded and Facilitated by
U.S. Financial Institutions, Report Prepared by the
Permanent Subcomm. on Investigations, Comm. on
Governmental Affairs, United States Senate, S. Rpt.
107–82 (2003).
4 See 69 FR 28980, May 19, 2004.
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of policies and procedures that a
financial institution engaged in CSFTs
should have in place to allow the
institution to identify, document,
evaluate, and control the full range of
credit, market, operational, legal, and
reputational risks that may arise from
CSFTs. The agencies collectively
received comments from more than 40
commenters on the Initial Proposed
Statement. Although commenters
generally supported the Agencies’
efforts to describe the types of risk
management procedures and internal
controls that may help institutions
manage the risks associated with CSFTs,
virtually all of the commenters
recommended changes to the Initial
Proposed Statement.
After carefully reviewing the
comments on the Initial Proposed
Statement, the Agencies issued and
requested comment on a Revised
Proposed Statement.5 The Revised
Proposed Statement was modified in
numerous respects to clarify the
purpose, scope and effect of the
statement; make the statement more
risk-focused and principles based; and
focus the statement on those CSFTs that
may pose elevated levels of legal or
reputational risk to the relevant
institution.6
III. Overview of Comments on the
Revised Proposed Statement
The Agencies collectively received
written comments from 19 commenters
on the Revised Proposed Statement,
although many commenters submitted
identical comments to multiple
Agencies. Commenters included
banking organizations, financial services
trade associations, and individuals.
Commenters generally expressed strong
support for the Revised Proposed
Statement, including its principlesbased structure and focus on elevated
risk CSFTs. Many commenters also
asserted that the Revised Proposed
Statement provides a financial
institution appropriate flexibility to
develop internal controls and risk
management procedures that are
tailored to the institution’s own
business activities and organizational
structure.
Several commenters requested that
the Agencies clarify or revise the
Revised Proposed Statement in certain
respects. For example, some
commenters asked the Agencies to
5 See
71 FR 28326, May 16, 2006.
more detailed summary of the comments on
the Initial Proposed Statement, as well as the
changes made in response to those comments, is
contained in the Federal Register notice
accompanying the Revised Proposed Statement (71
FR 28326, 28328–29 (May 16, 2006)).
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further streamline the provisions in the
statement pertaining to documentation
of elevated risk CSFTs, or clarify how
the U.S. branches or agencies of foreign
banks might implement risk
management systems, policies or
controls consistent with the statement’s
principles. In addition, some
commenters asked the Agencies to set
forth or clarify the legal standards
governing the potential liability of
financial institutions for CSFTs or
provide ‘‘safe harbors’’ from such
potential liability. One group of
commenters also argued that the
Revised Proposed Statement should not
be implemented because it allegedly
would encourage or condone illegal
conduct by financial institutions. The
comments received on the Revised
Proposed Statement are further
discussed below.
IV. Overview of Final Statement
After carefully reviewing the
comments on the Revised Proposed
Statement, the Agencies have made
minor modifications to the Revised
Proposed Statement in response to
comments and to clarify the principles,
scope, and intent of the Final Statement.
The Final Statement has been adopted
as supervisory guidance by the Board,
OCC, FDIC and OTS and as a policy
statement by the SEC. The Agencies will
use the Final Statement going forward
in reviewing the internal controls and
risk management policies, procedures
and systems of financial institutions
engaged in CSFTs as part of the
Agencies’ ongoing supervisory process.
The Agencies continue to believe that
it is important for a financial institution
engaged in CSFTs to have policies and
procedures that are designed to allow
the institution to effectively manage and
address the full range of risks associated
with its CSFT activities, including the
elevated legal or reputational risks that
may arise in connection with certain
CSFTs. For this reason, the Final
Statement describes the types of risk
management principles that the
Agencies believe may help a financial
institution to identify elevated risk
CSFTs and to evaluate, manage, and
address these risks within the
institution’s internal control
framework.7 These policies and
procedures should, among other things,
be designed to allow the institution to
identify elevated risk CSFTs during its
7 As noted in the Final Statement, financial
institutions are encouraged to refer to other
supervisory guidance and materials prepared by the
Agencies for further information concerning market,
credit and operational risk, as well as for further
information on legal and reputational risk, internal
audit and internal controls.
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transaction and new product approval
processes, and should provide for
elevated risk CSFTs to be reviewed by
appropriate levels of control and
management personnel at the
institution, including personnel from
control areas that are independent of the
business line(s) involved in the
transaction.
The Final Statement—like the Revised
Proposed Statement—applies to
financial institutions that are engaged in
CSFT activities and focuses on those
CSFTs that may create heightened levels
of legal or reputational risks for a
participating financial institution.
Because CSFTs typically are conducted
by a limited number of large financial
institutions, the Final Statement will
not affect or apply to the vast majority
of financial institutions, including most
small institutions.
As the Final Statement recognizes,
structured finance transactions
encompass a broad array of products
with varying levels of complexity. Most
structured finance transactions, such as
standard public mortgage-backed
securities and hedging-type transactions
involving ‘‘plain vanilla’’ derivatives or
collateralized debt obligations, are
familiar to participants in the financial
markets, have well-established track
records, and typically would not be
considered CSFTs for purposes of the
Final Statement. Some commenters
requested that the Agencies provide a
more extensive list of structured finance
transactions that typically would not be
considered CSFTs. The Agencies note
that the types of non-complex
transactions listed in the Final
Statement are only examples of the
types of transactions that typically
would not be considered CSFTs and
that any list of examples would not, and
could not, be all inclusive given the
changing nature of the structured
finance market. Consistent with the
principles-based approach of the Final
Statement, the Agencies believe the
statement appropriately highlights the
hallmarks of a non-complex
transaction—i.e., a well established
track record and familiarity to
participants in the financial markets—
that may guide institutions and
examiners in considering whether a
particular type of transaction should be
considered a CSFT now or in the future.
A. Identification, Due Diligence, and
Approval Processes for Elevated Risk
CSFTs
As noted above, a financial institution
should establish and maintain policies,
procedures and systems that are
designed to identify elevated risk CSFTs
as part of the institution’s transaction or
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new product approval processes, and to
ensure that transactions or new
products identified as elevated risk
CSFTs are subject to heightened
review.8 In general, a financial
institution should conduct the level and
amount of due diligence for an elevated
risk CSFT that is commensurate with
the level of risks identified. A financial
institution’s policies and procedures
should provide that CSFTs identified as
potentially having elevated legal or
reputational risk are reviewed and
approved by appropriate levels of
management. The Agencies continue to
believe that the designated approval
process for elevated risk CSFTs should
include the institution’s representatives
from the relevant business line(s) and/
or client relationship management, as
well as from appropriate control areas
that are independent of the business
line(s) involved in the transaction. An
institution’s policies should provide
that new complex structured finance
products receive the approval of all
relevant control areas that are
independent of the profit center before
the product is offered to customers.9
The Final Statement—like the Revised
Proposed Statement—provides
examples of transactions that may
warrant additional scrutiny by an
institution. These examples include,
among other things, transactions that
appear to the institution to:
• Lack economic substance or
business purpose;
• Be designed or used primarily for
questionable accounting, regulatory, or
tax objectives, particularly when the
transactions are executed at year-end or
8 In response to comments, the Agencies have
modified the Final Statement to clarify that a U.S.
branch or agency of a foreign bank is not necessarily
expected to establish or adopt separate U.S.-based
risk management structures or policies for its CSFT
activities. In addition, the Agencies believe the
Final Statement provides U.S. branches and
agencies of foreign banks sufficient flexibility to
develop controls, risk management and reporting
structures, and lines of authority that are consistent
with the internal management structure of U.S.
branches and agencies. However, the risk
management structure and policies used by a U.S.
branch or agency, whether adopted or implemented
on a group-wide or stand-alone basis, should be
effective in allowing the branch or agency to
manage the risks associated with its CSFT activities.
9 One commenter sought clarification regarding
when during the new product approval process a
new complex structured finance product should
receive the approval of relevant control areas. The
Agencies note that the Final Statement is not
intended to prevent institutions from engaging in
initial or preliminary discussions or negotiations
with potential customers about a new complex
structured finance product. However, an institution
should obtain the necessary approvals for a new
complex structured finance product from
appropriate control areas before the institution
enters into, or becomes obligated to enter into, a
transaction with the customer.
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at the end of a reporting period for the
customer; or
• Raise concerns that the client will
report or disclose the transaction in its
public filings or financial statements in
a manner that is materially misleading
or inconsistent with the substance of the
transaction or applicable regulatory or
accounting requirements.
A few commenters contended that the
examples of elevated risk CSFTs
contained in the Revised Proposed
Statement have characteristics that are
signals, if not conclusive proof, of
fraudulent activity, and recommended
that the Agencies inform financial
institutions that transactions or
products with any of these
characteristics should be considered
presumptively prohibited. The
commenters also argued that the
statement encourages or condones
illegal conduct by financial institutions.
The Agencies believe that CSFTs that
initially appear to an institution, during
the ordinary course of its new product
or transaction approval process, to have
one or more of the characteristics
identified in the Final Statement should
generally be identified as an elevated
risk CSFT, and the institution should
conduct due diligence for the
transaction that is commensurate with
the level of identified, potential risks.
The Agencies, however, do not believe
it is appropriate to provide that all
transactions initially identified as
potentially creating elevated legal or
reputational risks for an institution
should be considered presumptively
prohibited. For example, an institution,
after conducting additional due
diligence for a transaction initially
identified as an elevated risk CSFT, may
determine that the transaction does not,
in fact, have the characteristics that
initially triggered the review.
Alternatively, the institution may take
steps to address the legal or reputational
risks that initially triggered the review.
In this regard, the Final Statement
expressly provides that, if after
evaluating an elevated risk CSFT, a
financial institution determines that its
participation in the transaction would
create significant legal or reputational
risks for the institution, the financial
institution should take appropriate steps
to manage and address these risks. Such
steps may include modifying the
transaction or conditioning the
institution’s participation in the
transaction upon the receipt of
representations or assurances from the
customer that reasonably address the
heightened risks presented by the
transaction.
Importantly, the Final Statement
continues to provide that a financial
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institution should decline to participate
in an elevated risk CSFT if, after
conducting appropriate due diligence
and taking appropriate steps to address
the risks from the transaction, the
institution determines that the
transaction presents unacceptable risks
to the institution or would result in a
violation of applicable laws, regulations
or accounting principles.10 The Final
Statement also expressly notes that
financial institutions must conduct their
activities in accordance with applicable
statutes and regulations. The Agencies
believe the Final Statement should
assist financial institutions engaged in
CSFTs in managing the risks associated
with these activities and complying
with the law, and does not, as some
commenters alleged, encourage or
condone illegal conduct.
Some commenters also requested that
the Agencies enunciate, clarify or
modify the legal standards governing
the potential liability of a financial
institution for participating in a CSFT
that is used for fraudulent or illegal
purposes. For example, some
commenters asked the Agencies to
declare that institutions do not have a
duty to ensure the accuracy of a client’s
public filings or accounting. Other
commenters asked that the Agencies
state that an institution will not be held
liable or responsible for a CSFT if the
institution has a reasonable degree of
confidence that the customer will report
or account for the transactions properly.
Other commenters expressed concern
that the Revised Proposed Statement, or
the comments submitted on that
document, attempted to alter the current
legal standards under which a financial
institution may be held liable for
fraudulent activity or criminally
responsible under the Federal securities
law or other laws.
As events in recent years have
highlighted, institutions may in certain
circumstances bear significant legal or
reputational risk from participating in a
CSFT. In light of these risks, the Final
Statement describes the types of risk
10 Some commenters asked the Agencies to clarify
that the Final Statement does not necessarily
prevent a financial institution from proceeding with
a CSFT simply because there may be some
ambiguity in how the transaction might be viewed
under the law or applicable accounting principles.
The Agencies recognize that in certain
circumstances ambiguities may exist as to how the
law or accounting principles apply to a CSFT,
particularly in light of the inherent complexity and
rapidly evolving nature of CSFTs. Nevertheless, as
discussed in the Final Statement, a financial
institution should maintain strong and effective
processes and controls designed to determine
whether any such ambiguities may create
significant legal or reputational risks for the
institution and to manage and address those risks
as appropriate.
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management systems and internal
controls that may help a financial
institution engaged in CSFTs to identify
those CSFTs that may pose heightened
legal or reputational risk to the
institution, and to evaluate, manage,
and address those risks. Because the
Final Statement represents guidance on
the part of the Banking Agencies and a
policy statement on the part of the SEC,
it does not, by itself, establish any
legally enforceable requirements or
obligations. Moreover, as the Final
Statement expressly provides, it does
not create any private rights of action,
nor does it alter or expand the legal
duties and obligations that a financial
institution may have to a customer, its
shareholders or other parties under
applicable law. Accordingly, the
Agencies do not believe it is appropriate
or possible to address in the Final
Statement these legal concerns
expressed by commenters.
B. Documentation
The Final Statement states that a
financial institution should create and
collect sufficient documentation to,
among other things, verify that the
institution’s policies and procedures
related to elevated risk CSFTs are being
followed and allow the internal audit
function to monitor compliance with
those policies and procedures. The
Final Statement also provides that,
when an institution’s policies and
procedures require an elevated risk
CSFT to be submitted for approval to
senior management, the institution
should maintain the transaction-related
documentation provided to senior
management as well as other
documentation that reflect
management’s approval (or disapproval)
of the transaction, any conditions
imposed by senior management, and the
reasons for such action.
Several commenters strongly
suggested that the Agencies should
eliminate or modify the portions of the
statement that provide for a financial
institution to maintain certain
documentation related to elevated risk
CSFTs that are submitted to the
institution’s senior management for
approval (or denial). For example, some
commenters argued that institutions
should not be required to maintain any
documentation for declined
transactions. Other commenters
expressed concern that this provision
was inconsistent with the current
practice of financial institutions, would
require financial institutions to create
new and potentially extensive
documentation to memorialize all
aspects of the institution’s analytical
and decision-making process with
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respect to an elevated risk CSFT, or
would require institutions to create or
maintain extensive documentation even
for transactions that are approved or
rejected by junior staff.
As an initial matter, the Agencies note
that the Final Statement’s provisions
regarding documentation for elevated
risk CSFTs submitted to senior
management for approval (or
disapproval) do not apply to
transactions that may be reviewed and
acted on by more junior personnel in
accordance with the institution’s
policies and procedures. Rather, these
provisions apply only to those elevated
risk CSFTs that are identified by the
institution as potentially involving the
greatest degree of risk to the institution
and, for this reason, are required to be
reviewed by the institution’s senior
management. The Agencies believe that
it is important for institutions to
maintain documentation for this
category of elevated risk CSFTs,
whether approved or declined, that
reflects the factors considered by senior
management in taking such action. The
Agencies believe this type of
documentation may be of significant
benefit to the institution and to the
Agencies in reviewing the effectiveness
of the institution’s CSFT-related
policies, procedures, and internal
controls. However, to help address the
commenter’s concern about potential
burden, the Agencies have modified the
Final Statement to recognize that the
minutes of an institution’s reviewing
senior management committee may
have the information described and to
clarify that the documentation for a
transaction should reflect the factors
considered by senior management in
taking action, but does not have to detail
every aspect of the institution’s legal or
business analysis of the transaction.11
C. General Risk Management Principles
for Elevated Risk CSFTs
The Final Statement—like the Revised
Proposed Statement—also describes
some of the other key risk management
policies and internal controls that
financial institutions should have in
place for elevated risk CSFTs. For
example, the Final Statement provides
that the board of directors and senior
management of an institution should
establish a ‘‘tone at the top’’ through
both actions and formalized policies
that sends a strong message throughout
11 In light of comments, the Agencies have
modified the Documentation section of the
Statement to clarify that an institution should retain
sufficient documentation to establish that it has
provided the customer any disclosures concerning
an elevated risk CSFT that the institution is
otherwise required to provide to the customer.
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the financial institution about the
importance of compliance with the law
and overall good business ethics. The
Final Statement also describes the types
of training, reporting mechanisms, and
audit procedures that institutions
should have in place with respect to
elevated risk CSFTs. The Final
Statement also provides that a financial
institution should conduct periodic
independent reviews of its CSFT
activities to verify and monitor that its
policies and controls relating to elevated
risk CSFTs are being implemented
effectively and that elevated risk CSFTs
are accurately identified and receive
proper approvals.
In response to comments, the
Agencies have modified the Final
Statement to clarify that the
independent reviews conducted by a
financial institution may be performed
by the institution’s audit department or
an independent compliance function
within the institution. One commenter
also asked the Agencies to state that the
proper role of an institution’s
independent review function is only to
confirm that the institution’s policies
and procedures for elevated risk CSFTs
are being followed and that the function
should not assess the quality of the
decisions made by institution
personnel. The Agencies believe that an
institution’s audit or compliance
department should have the flexibility,
in appropriate circumstances, to review
the decisions made by institution
personnel during the review and
approval process for elevated risk
CSFTs and for this reason have not
made the recommended change.
V. Paperwork Reduction Act
In accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. 3506;
5 CFR Part 1320, Appendix A.1), the
Agencies reviewed the Final Statement.
The Agencies may not conduct or
sponsor, and an organization is not
required to respond to, this information
collection unless it displays a currently
valid OMB control number. The
Agencies previously determined that
certain provisions of the Revised
Proposed Statement contained
information collection requirements.
OMB reviewed and approved the
information collections contained in the
Revised Proposed Statement for the
FDIC, OTS, OCC and SEC; and the
Board reviewed the Revised Proposed
Statement under the authority delegated
to the Board by OMB (5 CFR Part 1320,
Appendix A.1).
OMB control numbers:
OCC: 1557–0229.
OTS: 1550–0111.
FRB: 7100–0311.
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FDIC: 3064–0148.
SEC: 3235–0622.
Burden Estimates
OCC
Number of Respondents: 21.
Estimated Time per Response: 25
hours.
Total Estimated Annual Burden: 525
hours.
OTS
Number of Respondents: 5.
Estimated Time per Response: 25
hours.
Total Estimated Annual Burden: 125
hours.
Board
Number of Respondents: 20.
Estimated Time per Response: 25
hours.
Total Estimated Annual Burden: 500
hours.
FDIC
Number of Respondents: 5.
Estimated Time per Response: 25
hours.
Total Estimated Annual Burden: 125
hours.
SEC
Number of Respondents: 5.
Estimated Time per Response: 25
hours.
Total Estimated Annual Burden: 125
hours.
No commenters addressed the
Agencies’ information collection
estimates. The Agencies do not believe
that the clarifications included in this
Final Statement impact the burden
estimates previously developed and
approved for these information
collections. The Agencies have a
continuing interest in the public’s
opinions of our collections of
information. At any time, comments
regarding the burden estimate, or any
other aspect of this collection of
information, including suggestions for
reducing the burden, may be sent to:
OCC: You should direct your
comments to:
Communications Division, Office of
the Comptroller of the Currency, Public
Information Room, Mailstop 1–5,
Attention: 1557–0229, 250 E Street,
SW., Washington, DC 20219. In
addition, comments may be sent by fax
to (202) 874–4448, or by electronic mail
to regs.comments@occ.treas.gov. You
can inspect and photocopy the
comments at the OCC’s Public
Information Room, 250 E Street, SW.,
Washington, DC 20219. You can make
an appointment to inspect the
comments by calling (202) 874–5043.
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Additionally, you should send a copy of
your comments to OCC Desk Officer,
1557–0229, by mail to U.S. Office of
Management and Budget, 725 17th
Street, NW., #10235, Washington, DC
20503, or by fax to (202) 395–6974.
You can request additional
information or a copy of the collection
from Mary Gottlieb, OCC Clearance
Officer, or Camille Dickerson, (202)
874–5090, Legislative and Regulatory
Activities Division, Office of the
Comptroller of the Currency, 250 E
Street, SW., Washington, DC 20219.
OTS: Information Collection
Comments, Chief Counsel’s Office,
Office of Thrift Supervision, 1700 G
Street, NW., Washington, DC 20552;
send a facsimile transmission to (202)
906–6518; or send an e-mail to
infocollection.comments@ots.treas.gov.
OTS will post comments and the related
index on the OTS Internet site at https://
www.treas.gov. In addition, interested
persons may inspect the comments at
the Public Reading Room, 1700 G Street,
NW., by appointment. To make an
appointment, call (202) 906–5922, send
an e-mail to public.info@ots.treas.gov, or
send a facsimile transmission to (202)
906–7755.
To obtain a copy of the submission to
OMB, contact Marilyn K. Burton at
marilyn.burton@ots.treas.gov, (202)
906–6467, or fax number (202) 906–
6518, Chief Counsel’s Office, Office of
Thrift Supervision, 1700 G Street, NW.,
Washington, DC 20552
Board: You may submit comments,
identified by FR 4022, by any of the
following methods:
• Agency Web site: https://
www.federalreserve.gov. Follow the
instructions for submitting comments at
https://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
• Federal eRulemaking Portal: https://
www.regulations.gov. Follow the
instructions for submitting comments.
• E-mail:
Regs.comments@federalreserve.gov.
Include docket number in the subject
line of the message.
• Fax: (202) 452–3819 or (202) 452–
3102.
• Mail: Michelle Long, Federal
Reserve Board Clearance Officer (202)
452–3829, Division of Research and
Statistics, Board of Governors of the
Federal Reserve System, Washington,
DC 20551. Telecommunications Device
for the Deaf (TDD) users may contact
(202) 263–4869, Board of Governors of
the Federal Reserve System,
Washington, DC 20551.
All public comments are available
from the Board’s Web site at https://
www.federalreserve.gov/generalinfo/
foia/ProposedRegs.cfm as submitted,
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unless modified for technical reasons.
Accordingly, your comments will not be
edited to remove any identifying or
contact information. Public comments
may also be viewed electronically or in
paper in Room MP–500 of the Board’s
Martin Building (20th and C Streets,
NW.) between 9 a.m. and 5 p.m. on
weekdays.
FDIC: Interested parties are invited to
submit written comments to the FDIC
concerning the Paperwork Reduction
Act implications of this proposal. Such
comments should refer to ‘‘Complex
Structured Finance Transactions, 3064–
0148.’’ Comments may be submitted by
any of the following methods:
• https://www.FDIC.gov/regulations/
laws/federal/propose.html.
• E-mail: comments@FDIC.gov.
Include Complex Structured Financial
Transactions, 3064–0148 in the subject
line of the message.
• Mail: Steven F. Hanft (202) 898–
3907, Federal Deposit Insurance
Corporation, 550 17th Street, NW.,
Washington, DC 20429.
• Hand Delivery: Comments may be
hand-delivered to the guard station at
the rear of the 17th Street Building
(located on F Street), on business days
between 7 a.m. and 5 p.m.
SEC: You should direct your
comments to: Office of Management and
Budget, Attention Desk Officer for the
Securities and Exchange Commission,
Office of Information and Regulatory
Affairs, Room 10102, New Executive
Office Building, Washington, DC 20503,
with a copy sent to Nancy M. Morris,
Secretary, Securities and Exchange
Commission, 100 F Street, NE.,
Washington, DC 20549–1090 with
reference to File No. S7–08–06.
The Final Statement follows:
Interagency Statement on Sound
Practices Concerning Elevated Risk
Complex Structured Finance Activities
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I. Introduction
Financial markets have grown rapidly
over the past decade, and innovations in
financial instruments have facilitated
the structuring of cash flows and
allocation of risk among creditors,
borrowers and investors in more
efficient ways. Financial derivatives for
market and credit risk, asset-backed
securities with customized cash flow
features, specialized financial conduits
that manage pools of assets and other
types of structured finance transactions
serve important business purposes, such
as diversifying risks, allocating cash
flows, and reducing cost of capital. As
a result, structured finance transactions
now are an essential part of U.S. and
international capital markets. Financial
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institutions have played and continue to
play an active and important role in the
development of structured finance
products and markets, including the
market for the more complex variations
of structured finance products.
When a financial institution
participates in a complex structured
finance transaction (‘‘CSFT’’), it bears
the usual market, credit, and operational
risks associated with the transaction. In
some circumstances, a financial
institution also may face heightened
legal or reputational risks due to its
involvement in a CSFT. For example, in
some circumstances, a financial
institution may face heightened legal or
reputational risk if a customer’s
regulatory, tax or accounting treatment
for a CSFT, or disclosures to investors
concerning the CSFT in the customer’s
public filings or financial statements, do
not comply with applicable laws,
regulations or accounting principles.
Indeed, in some instances, CSFTs have
been used to misrepresent a customer’s
financial condition to investors,
regulatory authorities and others. In
these situations, investors have been
harmed, and financial institutions have
incurred significant legal and
reputational exposure. In addition to
legal risk, reputational risk poses a
significant threat to financial
institutions because the nature of their
business requires them to maintain the
confidence of customers, creditors and
the general marketplace.
The Office of the Comptroller of the
Currency, the Office of Thrift
Supervision, the Board of Governors of
the Federal Reserve System, the Federal
Deposit Insurance Corporation, and the
Securities and Exchange Commission
(the ‘‘Agencies’’) have long expected
financial institutions to develop and
maintain robust control infrastructures
that enable them to identify, evaluate
and address the risks associated with
their business activities. Financial
institutions also must conduct their
activities in accordance with applicable
statutes and regulations.
II. Scope and Purpose of Statement
The Agencies are issuing this
Statement to describe the types of risk
management principles that we believe
may help a financial institution to
identify CSFTs that may pose
heightened legal or reputational risks to
the institution (‘‘elevated risk CSFTs’’)
and to evaluate, manage and address
these risks within the institution’s
internal control framework.12
12 As used in this Statement, the term ‘‘financial
institution’’ or ‘‘institution’’ refers to national banks
in the case of the Office of the Comptroller of the
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1377
Structured finance transactions
encompass a broad array of products
with varying levels of complexity. Most
structured finance transactions, such as
standard public mortgage-backed
securities transactions, public
securitizations of retail credit cards,
asset-backed commercial paper conduit
transactions, and hedging-type
transactions involving ‘‘plain vanilla’’
derivatives and collateralized loan
obligations, are familiar to participants
in the financial markets, and these
vehicles have a well-established track
record. These transactions typically
would not be considered CSFTs for the
purpose of this Statement.
Because this Statement focuses on
sound practices related to CSFTs that
may create heightened legal or
reputational risks—transactions that
typically are conducted by a limited
number of large financial institutions—
it will not affect or apply to the vast
majority of financial institutions,
including most small institutions. As in
all cases, a financial institution should
tailor its internal controls so that they
are appropriate in light of the nature,
scope, complexity and risks of its
activities. Thus, for example, an
institution that is actively involved in
structuring and offering CSFTs that may
create heightened legal or reputational
risk for the institution should have a
more formalized and detailed control
framework than an institution that
participates in these types of
transactions less frequently. The
internal controls and procedures
discussed in this Statement are not all
inclusive, and, in appropriate
circumstances, an institution may find
that other controls, policies, or
procedures are appropriate in light of its
particular CSFT activities.
Because many of the core elements of
an effective control infrastructure are
the same regardless of the business line
involved, this Statement draws heavily
on controls and procedures that the
Agencies previously have found to be
effective in assisting a financial
institution to manage and control risks
and identifies ways in which these
controls and procedures can be
Currency; federal and state savings associations and
savings and loan holding companies in the case of
the Office of Thrift Supervision; state member
banks and bank holding companies (other than
foreign banking organizations) in the case of the
Federal Reserve Board; state nonmember banks in
the case of the Federal Deposit Insurance
Corporation; and registered broker-dealers and
investment advisers in the case of the Securities
and Exchange Commission. The U.S. branches and
agencies of foreign banks supervised by the Office
of the Comptroller, the Federal Reserve Board and
the Federal Deposit Insurance Corporation also are
considered to be financial institutions for purposes
of this Statement.
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effectively applied to elevated risk
CSFTs. Although this Statement
highlights some of the most significant
risks associated with elevated risk
CSFTs, it is not intended to present a
full exposition of all risks associated
with these transactions. Financial
institutions are encouraged to refer to
other supervisory guidance prepared by
the Agencies for further information
concerning market, credit, operational,
legal and reputational risks as well as
internal audit and other appropriate
internal controls.
This Statement does not create any
private rights of action, and does not
alter or expand the legal duties and
obligations that a financial institution
may have to a customer, its shareholders
or other third parties under applicable
law. At the same time, adherence to the
principles discussed in this Statement
would not necessarily insulate a
financial institution from regulatory
action or any liability the institution
may have to third parties under
applicable law.
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III. Identification and Review of
Elevated Risk Complex Structured
Finance Transactions
A financial institution that engages in
CSFTs should maintain a set of formal,
written, firm-wide policies and
procedures that are designed to allow
the institution to identify, evaluate,
assess, document, and control the full
range of credit, market, operational,
legal and reputational risks associated
with these transactions. These policies
may be developed specifically for
CSFTs, or included in the set of broader
policies governing the institution
generally. A financial institution
operating in foreign jurisdictions may
tailor its policies and procedures as
appropriate to account for, and comply
with, the applicable laws, regulations
and standards of those jurisdictions.13
A financial institution’s policies and
procedures should establish a clear
framework for the review and approval
of individual CSFTs. These policies and
procedures should set forth the
responsibilities of the personnel
involved in the origination, structuring,
trading, review, approval,
documentation, verification, and
execution of CSFTs. Financial
institutions may find it helpful to
13 In the case of U.S. branches and agencies of
foreign banks, these policies, including
management, review and approval requirements,
should be coordinated with the foreign bank’s
group-wide policies developed in accordance with
the rules of the foreign bank’s home country
supervisor and should be consistent with the
foreign bank’s overall corporate and management
structure as well as its framework for risk
management and internal controls.
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incorporate the review of new CSFTs
into their existing new product policies.
In this regard, a financial institution
should define what constitutes a ‘‘new’’
complex structured finance product and
establish a control process for the
approval of such new products. In
determining whether a CSFT is new, a
financial institution may consider a
variety of factors, including whether it
contains structural or pricing variations
from existing products, whether the
product is targeted at a new class of
customers, whether it is designed to
address a new need of customers,
whether it raises significant new legal,
compliance or regulatory issues, and
whether it or the manner in which it
would be offered would materially
deviate from standard market practices.
An institution’s policies should require
new complex structured finance
products to receive the approval of all
relevant control areas that are
independent of the profit center before
the product is offered to customers.
A. Identifying Elevated Risk CSFTs
As part of its transaction and new
product approval controls, a financial
institution should establish and
maintain policies, procedures and
systems to identify elevated risk CSFTs.
Because of the potential risks they
present to the institution, transactions
or new products identified as elevated
risk CSFTs should be subject to
heightened reviews during the
institution’s transaction or new product
approval processes. Examples of
transactions that an institution may
determine warrant this additional
scrutiny are those that (either
individually or collectively) appear to
the institution during the ordinary
course of its transaction approval or
new product approval process to:
• Lack economic substance or
business purpose;
• Be designed or used primarily for
questionable accounting, regulatory, or
tax objectives, particularly when the
transactions are executed at year end or
at the end of a reporting period for the
customer;
• Raise concerns that the client will
report or disclose the transaction in its
public filings or financial statements in
a manner that is materially misleading
or inconsistent with the substance of the
transaction or applicable regulatory or
accounting requirements;
• Involve circular transfers of risk
(either between the financial institution
and the customer or between the
customer and other related parties) that
lack economic substance or business
purpose;
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• Involve oral or undocumented
agreements that, when taken into
account, would have a material impact
on the regulatory, tax, or accounting
treatment of the related transaction, or
the client’s disclosure obligations; 14
• Have material economic terms that
are inconsistent with market norms
(e.g., deep ‘‘in the money’’ options or
historic rate rollovers); or
• Provide the financial institution
with compensation that appears
substantially disproportionate to the
services provided or investment made
by the financial institution or to the
credit, market or operational risk
assumed by the institution.
The examples listed previously are
provided for illustrative purposes only,
and the policies and procedures
established by financial institutions may
differ in how they seek to identify
elevated risk CSFTs. The goal of each
institution’s policies and procedures,
however, should remain the same—to
identify those CSFTs that warrant
additional scrutiny in the transaction or
new product approval process due to
concerns regarding legal or reputational
risks.
Financial institutions that structure or
market, act as an advisor to a customer
regarding, or otherwise play a
substantial role in a transaction may
have more information concerning the
customer’s business purpose for the
transaction and any special accounting,
tax or financial disclosure issues raised
by the transaction than institutions that
play a more limited role. Thus, the
ability of a financial institution to
identify the risks associated with an
elevated risk CSFT may differ
depending on its role.
B. Due Diligence, Approval and
Documentation Process for Elevated
Risk CSFTs
Having developed a process to
identify elevated risk CSFTs, a financial
institution should implement policies
and procedures to conduct a heightened
level of due diligence for these
transactions. The financial institution
should design these policies and
procedures to allow personnel at an
appropriate level to understand and
evaluate the potential legal or
reputational risks presented by the
transaction to the institution and to
manage and address any heightened
14 This item is not intended to include traditional,
non-binding ‘‘comfort’’ letters or assurances
provided to financial institutions in the loan
process where, for example, the parent of a loan
customer states that the customer states that the
customer (i.e., the parent’s subsidiary) is an integral
and important part of the parent’s operations.
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legal or reputational risks ultimately
found to exist with the transaction.
Due Diligence. If a CSFT is identified
as an elevated risk CSFT, the institution
should carefully evaluate and take
appropriate steps to address the risks
presented by the transaction with a
particular focus on those issues
identified as potentially creating
heightened levels of legal or
reputational risk for the institution. In
general, a financial institution should
conduct the level and amount of due
diligence for an elevated risk CSFT that
is commensurate with the level of risks
identified. A financial institution that
structures or markets an elevated risk
CSFT to a customer, or that acts as an
advisor to a customer or investors
concerning an elevated risk CSFT, may
have additional responsibilities under
the federal securities laws, the Internal
Revenue Code, state fiduciary laws or
other laws or regulations and, thus, may
have greater legal and reputational risk
exposure with respect to an elevated
risk CSFT than a financial institution
that acts only as a counterparty for the
transaction. Accordingly, a financial
institution may need to exercise a
higher degree of care in conducting its
due diligence when the institution
structures or markets an elevated risk
CSFT or acts as an advisor concerning
such a transaction than when the
institution plays a more limited role in
the transaction.
To appropriately understand and
evaluate the potential legal and
reputational risks associated with an
elevated risk CSFT that a financial
institution has identified, the institution
may find it useful or necessary to obtain
additional information from the
customer or to obtain specialized advice
from qualified in-house or outside
accounting, tax, legal, or other
professionals. As with any transaction,
an institution should obtain satisfactory
responses to its material questions and
concerns prior to consummation of a
transaction.15
In conducting its due diligence for an
elevated risk CSFT, a financial
institution should independently
analyze the potential risks to the
institution from both the transaction
and the institution’s overall relationship
with the customer. Institutions should
not conclude that a transaction
identified as being an elevated risk
CSFT involves minimal or manageable
risks solely because another financial
institution will participate in the
15 Of course, financial institutions also should
ensure that their own accounting for transactions
complies with applicable accounting standards,
consistently applied.
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transaction or because of the size or
sophistication of the customer or
counterparty. Moreover, a financial
institution should carefully consider
whether it would be appropriate to rely
on opinions or analyses prepared by or
for the customer concerning any
significant accounting, tax or legal
issues associated with an elevated risk
CSFT.
Approval Process. A financial
institution’s policies and procedures
should provide that CSFTs identified as
having elevated legal or reputational
risk are reviewed and approved by
appropriate levels of control and
management personnel. The designated
approval process for such CSFTs should
include representatives from the
relevant business line(s) and/or client
management, as well as from
appropriate control areas that are
independent of the business line(s)
involved in the transaction. The
personnel responsible for approving an
elevated risk CSFT on behalf of a
financial institution should have
sufficient experience, training and
stature within the organization to
evaluate the legal and reputational risks,
as well as the credit, market and
operational risks to the institution.
The institution’s control framework
should have procedures to deliver the
necessary or appropriate information to
the personnel responsible for reviewing
or approving an elevated risk CSFT to
allow them to properly perform their
duties. Such information may include,
for example, the material terms of the
transaction, a summary of the
institution’s relationship with the
customer, and a discussion of the
significant legal, reputational, credit,
market and operational risks presented
by the transaction.
Some institutions have established a
senior management committee that is
designed to involve experienced
business executives and senior
representatives from all of the relevant
control functions within the financial
institution (including such groups as
independent risk management, tax,
accounting, policy, legal, compliance,
and financial control) in the oversight
and approval of those elevated risk
CSFTs that are identified by the
institution’s personnel as requiring
senior management review and approval
due to the potential risks associated
with the transactions. While this type of
management committee may not be
appropriate for all financial institutions,
a financial institution should establish
processes that assist the institution in
consistently managing the review and
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1379
approval of elevated risk CSFTs on a
firm-wide basis.16
If, after evaluating an elevated risk
CSFT, the financial institution
determines that its participation in the
CSFT would create significant legal or
reputational risks for the institution, the
institution should take appropriate steps
to address those risks. Such actions may
include declining to participate in the
transaction, or conditioning its
participation upon the receipt of
representations or assurances from the
customer that reasonably address the
heightened legal or reputational risks
presented by the transaction. Any
representations or assurances provided
by a customer should be obtained before
a transaction is executed and be
received from, or approved by, an
appropriate level of the customer’s
management. A financial institution
should decline to participate in an
elevated risk CSFT if, after conducting
appropriate due diligence and taking
appropriate steps to address the risks
from the transaction, the institution
determines that the transaction presents
unacceptable risk to the institution or
would result in a violation of applicable
laws, regulations or accounting
principles.
Documentation. The documentation
that financial institutions use to support
CSFTs is often highly customized for
individual transactions and negotiated
with the customer. Careful generation,
collection and retention of documents
associated with elevated risk CSFTs are
important control mechanisms that may
help an institution monitor and manage
the legal, reputational, operational,
market, and credit risks associated with
the transactions. In addition, sound
documentation practices may help
reduce unwarranted exposure to the
financial institution’s reputation.
A financial institution should create
and collect sufficient documentation to
allow the institution to:
• Document the material terms of the
transaction;
• Enforce the material obligations of
the counterparties;
• Confirm that the institution has
provided the customer any disclosures
concerning the transaction that the
institution is otherwise required to
provide; and
• Verify that the institution’s policies
and procedures are being followed and
allow the internal audit function to
16 The control processes that a financial
institution establishes for CSFTs should take
account of, and be consistent with, any
informational barriers established by the institution
to manage potential conflicts of interest, insider
trading or other concerns.
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monitor compliance with those policies
and procedures.
When an institution’s policies and
procedures require an elevated risk
CSFT to be submitted for approval to
senior management, the institution
should maintain the transaction-related
documentation provided to senior
management as well as other
documentation, such as minutes of the
relevant senior management committee,
that reflect senior management’s
approval (or disapproval) of the
transaction, any conditions imposed by
senior management, and the factors
considered in taking such action. The
institution should retain documents
created for elevated risk CSFTs in
accordance with its record retention
policies and procedures as well as
applicable statutes and regulations.
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C. Other Risk Management Principles
for Elevated Risk CSFTs
General Business Ethics. The board
and senior management of a financial
institution also should establish a ‘‘tone
at the top’’ through both actions and
formalized policies that sends a strong
message throughout the financial
institution about the importance of
compliance with the law and overall
good business ethics. The board and
senior management should strive to
create a firm-wide corporate culture that
is sensitive to ethical or legal issues as
well as the potential risks to the
financial institution that may arise from
unethical or illegal behavior. This kind
of culture coupled with appropriate
procedures should reinforce businessline ownership of risk identification,
and encourage personnel to move
ethical or legal concerns regarding
elevated risk CSFTs to appropriate
levels of management. In appropriate
circumstances, financial institutions
may also need to consider implementing
mechanisms to protect personnel by
permitting the confidential disclosure of
concerns.17 As in other areas of
financial institution management,
compensation and incentive plans
should be structured, in the context of
elevated risk CSFTs, so that they
provide personnel with appropriate
incentives to have due regard for the
legal, ethical and reputational risk
interests of the institution.
Reporting. A financial institution’s
policies and procedures should provide
17 The agencies note that the Sarbanes-Oxley Act
of 2002 requires companies listed on a national
securities exchange or inter-dealer quotation system
of a national securities association to establish
procedures that enable employees to submit
concerns regarding questionable accounting or
auditing matters on a confidential, anonymous
basis. See 15 U.S.C. 78j–1(m).
VerDate Aug<31>2005
15:52 Jan 10, 2007
Jkt 211001
for the appropriate levels of
management and the board of directors
to receive sufficient information and
reports concerning the institution’s
elevated risk CSFTs to perform their
oversight functions.
Monitoring Compliance with Internal
Policies and Procedures. The events of
recent years evidence the need for an
effective oversight and review program
for elevated risk CSFTs. A financial
institution’s program should provide for
periodic independent reviews of its
CSFT activities to verify and monitor
that its policies and controls relating to
elevated risk CSFTs are being
implemented effectively and that
elevated risk CSFTs are accurately
identified and received proper
approvals. These independent reviews
should be performed by appropriately
qualified audit, compliance or other
personnel in a manner consistent with
the institution’s overall framework for
compliance monitoring, which should
include consideration of issues such as
the independence of reviewing
personnel from the business line. Such
monitoring may include more frequent
assessments of the risk arising from
elevated risk CSFTs, both individually
and within the context of the overall
customer relationship, and the results of
this monitoring should be provided to
an appropriate level of management in
the financial institution.
Audit. The internal audit department
of any financial institution is integral to
its defense against fraud, unauthorized
risk taking and damage to the financial
institution’s reputation. The internal
audit department of a financial
institution should regularly audit the
financial institution’s adherence to its
own control procedures relating to
elevated risk CSFTs, and further assess
the adequacy of its policies and
procedures related to elevated risk
CSFTs. Internal audit should
periodically validate that business lines
and individual employees are
complying with the financial
institution’s standards for elevated risk
CSFTs and appropriately identifying
any exceptions. This validation should
include transaction testing for elevated
risk CSFTs.
Training. An institution should
identify relevant personnel who may
need specialized training regarding
CSFTs to be able to effectively perform
their oversight and review
responsibilities. Appropriate training on
the financial institution’s policies and
procedures for handling elevated risk
CSFTs is critical. Financial institution
personnel involved in CSFTs should be
familiar with the institution’s policies
and procedures concerning elevated risk
PO 00000
Frm 00072
Fmt 4703
Sfmt 4703
CSFTs, including the processes
established by the institution for
identification and approval of elevated
risk CSFTs and new complex structured
finance products and for the elevation of
concerns regarding transactions or
products to appropriate levels of
management. Financial institution
personnel involved in CSFTs should be
trained to identify and properly handle
elevated risk CSFTs that may result in
a violation of law.
IV. Conclusion
Structured finance products have
become an essential and important part
of the U.S. and international capital
markets, and financial institutions have
played an important role in the
development of structured finance
markets. In some instances, however,
CSFTs have been used to misrepresent
a customer’s financial condition to
investors and others, and financial
institutions involved in these
transactions have sustained significant
legal and reputational harm. In light of
the potential legal and reputational risks
associated with CSFTs, a financial
institution should have effective risk
management and internal control
systems that are designed to allow the
institution to identify elevated risk
CSFTs, to evaluate, manage and address
the risks arising from such transactions,
and to conduct those activities in
compliance with applicable law.
Dated: December 12, 2006.
John C. Dugan,
Comptroller of the Currency.
Dated: December 21, 2006.
By the Office of Thrift Supervision.
Scott M. Polakoff,
Deputy Director & Chief Operating Officer.
By order of the Board of Governors of the
Federal Reserve System, December 20, 2006.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, DC, the 22nd day of
December, 2006.
By order of the Federal Deposit Insurance
Corporation.
Robert E. Feldman,
Executive Secretary.
Dated: January 5, 2007.
By the Securities and Exchange
Commission.
Nancy M. Morris,
Secretary.
[FR Doc. 07–55 Filed 1–10–07; 8:45 am]
BILLING CODE 4810–33–P; 6720–01–P; 6210–01–P;
6714–01–P; 8011–01–P
E:\FR\FM\11JAN1.SGM
11JAN1
]]>Agencies
[Federal Register Volume 72, Number 7 (Thursday, January 11, 2007)]
[Notices]
[Pages 1372-1380]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 07-55]
=======================================================================
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
[Docket No. 06-17]
Office of Thrift Supervision
[Docket No. 2006-55]
FEDERAL RESERVE SYSTEM
[Docket No. OP-1254]
FEDERAL DEPOSIT INSURANCE CORPORATION
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-55043; File No. S7-08-06]
Interagency Statement on Sound Practices Concerning Elevated Risk
Complex Structured Finance Activities
AGENCIES: Office of the Comptroller of the Currency, Treasury
(``OCC''); Office of Thrift Supervision, Treasury (``OTS''); Board of
Governors of the Federal Reserve System (``Board''); Federal Deposit
Insurance Corporation (``FDIC''); and Securities and Exchange
Commission (``SEC'') (collectively, the ``Agencies'').
ACTION: Notice of final interagency statement.
-----------------------------------------------------------------------
SUMMARY: The Agencies are adopting an Interagency Statement on Sound
Practices Concerning Elevated Risk Complex Structured Finance
Activities (``Final Statement''). The Final Statement pertains to
national banks, state banks, bank holding companies (other than foreign
banks), federal and state savings associations, savings and loan
holding companies, U.S. branches and agencies of foreign banks, and
SEC-registered broker-dealers and investment advisers (collectively,
``financial institutions'' or ``institutions'') engaged in complex
structured finance transactions (``CSFTs''). In May 2004, the Agencies
issued and requested comment on a proposed interagency statement
(``Initial Proposed Statement''). After reviewing the comments received
on the Initial Proposed Statement, the Agencies in May 2006 issued and
requested comment on a revised proposed interagency statement
(``Revised Proposed Statement''). The modifications to the Revised
Proposed Statement, among other things, made the statement more
principles-based and focused on the identification, review and approval
process for those CSFTs that may pose heightened levels of legal or
reputational risk to the relevant institution (referred to as
``elevated risk CSFTs''). After carefully reviewing the comments on the
Revised Proposed Statement, the Agencies have adopted the Final
Statement with minor modifications designed to clarify, but not alter,
the principles set forth in the Revised Proposed Statement. The Final
Statement describes some of the internal controls and risk management
procedures that may help financial institutions identify, manage, and
address the heightened reputational and legal risks that may arise from
elevated risk CSFTs. As discussed further below, the Final Statement
will not affect or apply to the vast majority of financial
institutions, including most small institutions, nor does it create any
private rights of action.
EFFECTIVE DATE: The Final Statement is effective January 11, 2007.
FOR FURTHER INFORMATION CONTACT:
OCC: Kathryn E. Dick, Deputy Comptroller, Credit and Market Risk,
(202) 874-4660; Grace E. Dailey, Deputy Comptroller, Large Bank
Supervision, (202) 874-4610; or Ellen Broadman, Director, Securities
and Corporate Practices Division, (202) 874-5210, Office of the
Comptroller of the Currency, 250 E Street, SW., Washington, DC 20219.
OTS: Fred J. Phillips-Patrick, Director, Credit Policy, (202) 906-
7295, and Deborah S. Merkle, Project Manager, Credit Policy, (202) 906-
5688, Examinations and Supervision Policy; or David A. Permut, Senior
Attorney, Business Transactions Division, (202) 906-7505, Office of
Thrift Supervision, 1700 G Street, NW., Washington, DC 20552.
Board: Sabeth I. Siddique, Assistant Director, (202) 452-3861, or
Virginia Gibbs, Senior Supervisory Financial Analyst, (202) 452-2521,
Division of Banking Supervision and Regulation; or Kieran J. Fallon,
Assistant General Counsel, (202) 452-5270, or Anne B. Zorc, Senior
Attorney, (202) 452-3876, Legal Division, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, NW.,
Washington, DC 20551. Users of Telecommunication Device for Deaf (TTD)
only, call (202) 263-4869.
FDIC: Jason C. Cave, Associate Director, (202) 898-3548; Division
of Supervision and Consumer Protection; or Mark G. Flanigan, Counsel,
Supervision and Legislation Branch, Legal Division, (202) 898-7426,
Federal Deposit Insurance Corporation, 550 17th Street, NW.,
Washington, DC 20429.
SEC: Mary Ann Gadziala, Associate Director, Office of Compliance
Inspections and Examinations, (202) 551-6207; Catherine McGuire, Chief
Counsel, Linda Stamp Sundberg, Senior Special Counsel (Banking and
Derivatives), or Randall W. Roy, Branch Chief, Division of Market
Regulation, (202) 551-5550, Securities and Exchange Commission, 100 F
Street, NE., Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Background
Financial markets have grown rapidly over the past decade, and
innovations in financial instruments have facilitated the structuring
of cash flows and allocation of risk among creditors, borrowers, and
investors in more efficient ways. Financial derivatives for market and
credit risk, asset-backed securities with customized cash flow
features, specialized financial conduits that manage pools of assets,
and other types of structured finance transactions serve important
purposes, such as diversifying risk, allocating cash flows and reducing
cost of capital. As a result, structured finance transactions,
including the more complex variations of these transactions, now are an
essential part of U.S. and international capital markets.
When a financial institution participates in a CSFT, it bears the
usual market, credit, and operational risks associated with the
transaction. In some circumstances, a financial institution also may
face heightened legal or reputational risks due to its involvement in a
CSFT. For example, a financial institution involved in a CSFT may face
heightened legal or reputational risk if the customer's regulatory, tax
or accounting treatment for the CSFT, or disclosures concerning the
CSFT in its public filings or financial statements, do not comply with
applicable laws, regulations or accounting principles.\1\
---------------------------------------------------------------------------
\1\ For a memorandum on the potential liability of a financial
institution for securities laws violations arising from
participation in a CSFT, see Letter from Annette L. Nazareth,
Director, Division of Market Regulation, Securities and Exchange
Commission, to Richard Spillenkothen and Douglas W. Roeder, dated
December 4, 2003 (available at https://www.federalreserve.gov/
boarddocs/srletters/2004/ and https://www.occ.treas.gov).
---------------------------------------------------------------------------
In some cases, certain CSFTs appear to have been used in illegal
schemes
[[Page 1373]]
that misrepresented the financial condition of public companies to
investors and regulatory authorities. After conducting investigations,
the OCC, Federal Reserve System and SEC took strong and coordinated
civil and administrative enforcement actions against certain financial
institutions that engaged in CSFTs that appeared to have been designed
or used to shield their customers' true financial health from the
public. These actions involved the assessment of significant financial
penalties on the institutions and required the institutions to take
several measures to strengthen their risk management procedures for
CSFTs.\2\ The complex structured finance relationships involving these
financial institutions also sparked an investigation by the Permanent
Subcommittee on Governmental Affairs of the United States Senate,\3\ as
well as numerous lawsuits by private litigants.
---------------------------------------------------------------------------
\2\ See, e.g., In the Matter of Citigroup, Inc., Securities
Exchange Act Release No. 48230 (July 28, 2003), Written Agreement by
and between Citibank, N.A. and the Office of the Comptroller of the
Currency, No. 2003-77 (July 28, 2003) (pertaining to transactions
entered into by Citibank, N.A. with Enron Corp.) and Written
Agreement by and between Citigroup, Inc. and the Federal Reserve
Bank of New York, dated July 28, 2003 (pertaining to transactions
involving Citigroup Inc. and its subsidiaries and Enron Corp. and
Dynegy Inc.); SEC v. J.P. Morgan Chase, SEC Litigation Release No.
18252 (July 28, 2003) and Written Agreement by and among J.P. Morgan
Chase & Co., the Federal Reserve Bank of New York, and the New York
State Banking Department, dated July 28, 2003 (pertaining to
transactions involving J.P. Morgan Chase & Co. and its subsidiaries
and Enron Corp.).
\3\ See Fishtail, Bacchus, Sundance, and Slapshot: Four Enron
Transactions Funded and Facilitated by U.S. Financial Institutions,
Report Prepared by the Permanent Subcomm. on Investigations, Comm.
on Governmental Affairs, United States Senate, S. Rpt. 107-82
(2003).
---------------------------------------------------------------------------
The OCC, Federal Reserve System and SEC also conducted special
reviews of several large financial institutions engaged in CSFTs, and
the Agencies have focused attention on the CSFT activities of financial
institutions in the normal course of the supervisory process. These
reviews and activities indicate that many of the large financial
institutions engaged in CSFTs have taken meaningful steps in recent
years to improve their control infrastructure relating to CSFTs.
II. Initial and Revised Proposed Statements
To assist financial institutions in identifying, managing, and
addressing the risks that may be associated with CSFTs, the Agencies
developed and requested public comment on the Initial Proposed
Statement.\4\ The Initial Proposed Statement described the types of
policies and procedures that a financial institution engaged in CSFTs
should have in place to allow the institution to identify, document,
evaluate, and control the full range of credit, market, operational,
legal, and reputational risks that may arise from CSFTs. The agencies
collectively received comments from more than 40 commenters on the
Initial Proposed Statement. Although commenters generally supported the
Agencies' efforts to describe the types of risk management procedures
and internal controls that may help institutions manage the risks
associated with CSFTs, virtually all of the commenters recommended
changes to the Initial Proposed Statement.
---------------------------------------------------------------------------
\4\ See 69 FR 28980, May 19, 2004.
---------------------------------------------------------------------------
After carefully reviewing the comments on the Initial Proposed
Statement, the Agencies issued and requested comment on a Revised
Proposed Statement.\5\ The Revised Proposed Statement was modified in
numerous respects to clarify the purpose, scope and effect of the
statement; make the statement more risk-focused and principles based;
and focus the statement on those CSFTs that may pose elevated levels of
legal or reputational risk to the relevant institution.\6\
---------------------------------------------------------------------------
\5\ See 71 FR 28326, May 16, 2006.
\6\ A more detailed summary of the comments on the Initial
Proposed Statement, as well as the changes made in response to those
comments, is contained in the Federal Register notice accompanying
the Revised Proposed Statement (71 FR 28326, 28328-29 (May 16,
2006)).
---------------------------------------------------------------------------
III. Overview of Comments on the Revised Proposed Statement
The Agencies collectively received written comments from 19
commenters on the Revised Proposed Statement, although many commenters
submitted identical comments to multiple Agencies. Commenters included
banking organizations, financial services trade associations, and
individuals. Commenters generally expressed strong support for the
Revised Proposed Statement, including its principles-based structure
and focus on elevated risk CSFTs. Many commenters also asserted that
the Revised Proposed Statement provides a financial institution
appropriate flexibility to develop internal controls and risk
management procedures that are tailored to the institution's own
business activities and organizational structure.
Several commenters requested that the Agencies clarify or revise
the Revised Proposed Statement in certain respects. For example, some
commenters asked the Agencies to further streamline the provisions in
the statement pertaining to documentation of elevated risk CSFTs, or
clarify how the U.S. branches or agencies of foreign banks might
implement risk management systems, policies or controls consistent with
the statement's principles. In addition, some commenters asked the
Agencies to set forth or clarify the legal standards governing the
potential liability of financial institutions for CSFTs or provide
``safe harbors'' from such potential liability. One group of commenters
also argued that the Revised Proposed Statement should not be
implemented because it allegedly would encourage or condone illegal
conduct by financial institutions. The comments received on the Revised
Proposed Statement are further discussed below.
IV. Overview of Final Statement
After carefully reviewing the comments on the Revised Proposed
Statement, the Agencies have made minor modifications to the Revised
Proposed Statement in response to comments and to clarify the
principles, scope, and intent of the Final Statement. The Final
Statement has been adopted as supervisory guidance by the Board, OCC,
FDIC and OTS and as a policy statement by the SEC. The Agencies will
use the Final Statement going forward in reviewing the internal
controls and risk management policies, procedures and systems of
financial institutions engaged in CSFTs as part of the Agencies'
ongoing supervisory process.
The Agencies continue to believe that it is important for a
financial institution engaged in CSFTs to have policies and procedures
that are designed to allow the institution to effectively manage and
address the full range of risks associated with its CSFT activities,
including the elevated legal or reputational risks that may arise in
connection with certain CSFTs. For this reason, the Final Statement
describes the types of risk management principles that the Agencies
believe may help a financial institution to identify elevated risk
CSFTs and to evaluate, manage, and address these risks within the
institution's internal control framework.\7\ These policies and
procedures should, among other things, be designed to allow the
institution to identify elevated risk CSFTs during its
[[Page 1374]]
transaction and new product approval processes, and should provide for
elevated risk CSFTs to be reviewed by appropriate levels of control and
management personnel at the institution, including personnel from
control areas that are independent of the business line(s) involved in
the transaction.
---------------------------------------------------------------------------
\7\ As noted in the Final Statement, financial institutions are
encouraged to refer to other supervisory guidance and materials
prepared by the Agencies for further information concerning market,
credit and operational risk, as well as for further information on
legal and reputational risk, internal audit and internal controls.
---------------------------------------------------------------------------
The Final Statement--like the Revised Proposed Statement--applies
to financial institutions that are engaged in CSFT activities and
focuses on those CSFTs that may create heightened levels of legal or
reputational risks for a participating financial institution. Because
CSFTs typically are conducted by a limited number of large financial
institutions, the Final Statement will not affect or apply to the vast
majority of financial institutions, including most small institutions.
As the Final Statement recognizes, structured finance transactions
encompass a broad array of products with varying levels of complexity.
Most structured finance transactions, such as standard public mortgage-
backed securities and hedging-type transactions involving ``plain
vanilla'' derivatives or collateralized debt obligations, are familiar
to participants in the financial markets, have well-established track
records, and typically would not be considered CSFTs for purposes of
the Final Statement. Some commenters requested that the Agencies
provide a more extensive list of structured finance transactions that
typically would not be considered CSFTs. The Agencies note that the
types of non-complex transactions listed in the Final Statement are
only examples of the types of transactions that typically would not be
considered CSFTs and that any list of examples would not, and could
not, be all inclusive given the changing nature of the structured
finance market. Consistent with the principles-based approach of the
Final Statement, the Agencies believe the statement appropriately
highlights the hallmarks of a non-complex transaction--i.e., a well
established track record and familiarity to participants in the
financial markets--that may guide institutions and examiners in
considering whether a particular type of transaction should be
considered a CSFT now or in the future.
A. Identification, Due Diligence, and Approval Processes for Elevated
Risk CSFTs
As noted above, a financial institution should establish and
maintain policies, procedures and systems that are designed to identify
elevated risk CSFTs as part of the institution's transaction or new
product approval processes, and to ensure that transactions or new
products identified as elevated risk CSFTs are subject to heightened
review.\8\ In general, a financial institution should conduct the level
and amount of due diligence for an elevated risk CSFT that is
commensurate with the level of risks identified. A financial
institution's policies and procedures should provide that CSFTs
identified as potentially having elevated legal or reputational risk
are reviewed and approved by appropriate levels of management. The
Agencies continue to believe that the designated approval process for
elevated risk CSFTs should include the institution's representatives
from the relevant business line(s) and/or client relationship
management, as well as from appropriate control areas that are
independent of the business line(s) involved in the transaction. An
institution's policies should provide that new complex structured
finance products receive the approval of all relevant control areas
that are independent of the profit center before the product is offered
to customers.\9\
---------------------------------------------------------------------------
\8\ In response to comments, the Agencies have modified the
Final Statement to clarify that a U.S. branch or agency of a foreign
bank is not necessarily expected to establish or adopt separate
U.S.-based risk management structures or policies for its CSFT
activities. In addition, the Agencies believe the Final Statement
provides U.S. branches and agencies of foreign banks sufficient
flexibility to develop controls, risk management and reporting
structures, and lines of authority that are consistent with the
internal management structure of U.S. branches and agencies.
However, the risk management structure and policies used by a U.S.
branch or agency, whether adopted or implemented on a group-wide or
stand-alone basis, should be effective in allowing the branch or
agency to manage the risks associated with its CSFT activities.
\9\ One commenter sought clarification regarding when during the
new product approval process a new complex structured finance
product should receive the approval of relevant control areas. The
Agencies note that the Final Statement is not intended to prevent
institutions from engaging in initial or preliminary discussions or
negotiations with potential customers about a new complex structured
finance product. However, an institution should obtain the necessary
approvals for a new complex structured finance product from
appropriate control areas before the institution enters into, or
becomes obligated to enter into, a transaction with the customer.
---------------------------------------------------------------------------
The Final Statement--like the Revised Proposed Statement--provides
examples of transactions that may warrant additional scrutiny by an
institution. These examples include, among other things, transactions
that appear to the institution to:
Lack economic substance or business purpose;
Be designed or used primarily for questionable accounting,
regulatory, or tax objectives, particularly when the transactions are
executed at year-end or at the end of a reporting period for the
customer; or
Raise concerns that the client will report or disclose the
transaction in its public filings or financial statements in a manner
that is materially misleading or inconsistent with the substance of the
transaction or applicable regulatory or accounting requirements.
A few commenters contended that the examples of elevated risk CSFTs
contained in the Revised Proposed Statement have characteristics that
are signals, if not conclusive proof, of fraudulent activity, and
recommended that the Agencies inform financial institutions that
transactions or products with any of these characteristics should be
considered presumptively prohibited. The commenters also argued that
the statement encourages or condones illegal conduct by financial
institutions. The Agencies believe that CSFTs that initially appear to
an institution, during the ordinary course of its new product or
transaction approval process, to have one or more of the
characteristics identified in the Final Statement should generally be
identified as an elevated risk CSFT, and the institution should conduct
due diligence for the transaction that is commensurate with the level
of identified, potential risks. The Agencies, however, do not believe
it is appropriate to provide that all transactions initially identified
as potentially creating elevated legal or reputational risks for an
institution should be considered presumptively prohibited. For example,
an institution, after conducting additional due diligence for a
transaction initially identified as an elevated risk CSFT, may
determine that the transaction does not, in fact, have the
characteristics that initially triggered the review. Alternatively, the
institution may take steps to address the legal or reputational risks
that initially triggered the review. In this regard, the Final
Statement expressly provides that, if after evaluating an elevated risk
CSFT, a financial institution determines that its participation in the
transaction would create significant legal or reputational risks for
the institution, the financial institution should take appropriate
steps to manage and address these risks. Such steps may include
modifying the transaction or conditioning the institution's
participation in the transaction upon the receipt of representations or
assurances from the customer that reasonably address the heightened
risks presented by the transaction.
Importantly, the Final Statement continues to provide that a
financial
[[Page 1375]]
institution should decline to participate in an elevated risk CSFT if,
after conducting appropriate due diligence and taking appropriate steps
to address the risks from the transaction, the institution determines
that the transaction presents unacceptable risks to the institution or
would result in a violation of applicable laws, regulations or
accounting principles.\10\ The Final Statement also expressly notes
that financial institutions must conduct their activities in accordance
with applicable statutes and regulations. The Agencies believe the
Final Statement should assist financial institutions engaged in CSFTs
in managing the risks associated with these activities and complying
with the law, and does not, as some commenters alleged, encourage or
condone illegal conduct.
---------------------------------------------------------------------------
\10\ Some commenters asked the Agencies to clarify that the
Final Statement does not necessarily prevent a financial institution
from proceeding with a CSFT simply because there may be some
ambiguity in how the transaction might be viewed under the law or
applicable accounting principles. The Agencies recognize that in
certain circumstances ambiguities may exist as to how the law or
accounting principles apply to a CSFT, particularly in light of the
inherent complexity and rapidly evolving nature of CSFTs.
Nevertheless, as discussed in the Final Statement, a financial
institution should maintain strong and effective processes and
controls designed to determine whether any such ambiguities may
create significant legal or reputational risks for the institution
and to manage and address those risks as appropriate.
---------------------------------------------------------------------------
Some commenters also requested that the Agencies enunciate, clarify
or modify the legal standards governing the potential liability of a
financial institution for participating in a CSFT that is used for
fraudulent or illegal purposes. For example, some commenters asked the
Agencies to declare that institutions do not have a duty to ensure the
accuracy of a client's public filings or accounting. Other commenters
asked that the Agencies state that an institution will not be held
liable or responsible for a CSFT if the institution has a reasonable
degree of confidence that the customer will report or account for the
transactions properly. Other commenters expressed concern that the
Revised Proposed Statement, or the comments submitted on that document,
attempted to alter the current legal standards under which a financial
institution may be held liable for fraudulent activity or criminally
responsible under the Federal securities law or other laws.
As events in recent years have highlighted, institutions may in
certain circumstances bear significant legal or reputational risk from
participating in a CSFT. In light of these risks, the Final Statement
describes the types of risk management systems and internal controls
that may help a financial institution engaged in CSFTs to identify
those CSFTs that may pose heightened legal or reputational risk to the
institution, and to evaluate, manage, and address those risks. Because
the Final Statement represents guidance on the part of the Banking
Agencies and a policy statement on the part of the SEC, it does not, by
itself, establish any legally enforceable requirements or obligations.
Moreover, as the Final Statement expressly provides, it does not create
any private rights of action, nor does it alter or expand the legal
duties and obligations that a financial institution may have to a
customer, its shareholders or other parties under applicable law.
Accordingly, the Agencies do not believe it is appropriate or possible
to address in the Final Statement these legal concerns expressed by
commenters.
B. Documentation
The Final Statement states that a financial institution should
create and collect sufficient documentation to, among other things,
verify that the institution's policies and procedures related to
elevated risk CSFTs are being followed and allow the internal audit
function to monitor compliance with those policies and procedures. The
Final Statement also provides that, when an institution's policies and
procedures require an elevated risk CSFT to be submitted for approval
to senior management, the institution should maintain the transaction-
related documentation provided to senior management as well as other
documentation that reflect management's approval (or disapproval) of
the transaction, any conditions imposed by senior management, and the
reasons for such action.
Several commenters strongly suggested that the Agencies should
eliminate or modify the portions of the statement that provide for a
financial institution to maintain certain documentation related to
elevated risk CSFTs that are submitted to the institution's senior
management for approval (or denial). For example, some commenters
argued that institutions should not be required to maintain any
documentation for declined transactions. Other commenters expressed
concern that this provision was inconsistent with the current practice
of financial institutions, would require financial institutions to
create new and potentially extensive documentation to memorialize all
aspects of the institution's analytical and decision-making process
with respect to an elevated risk CSFT, or would require institutions to
create or maintain extensive documentation even for transactions that
are approved or rejected by junior staff.
As an initial matter, the Agencies note that the Final Statement's
provisions regarding documentation for elevated risk CSFTs submitted to
senior management for approval (or disapproval) do not apply to
transactions that may be reviewed and acted on by more junior personnel
in accordance with the institution's policies and procedures. Rather,
these provisions apply only to those elevated risk CSFTs that are
identified by the institution as potentially involving the greatest
degree of risk to the institution and, for this reason, are required to
be reviewed by the institution's senior management. The Agencies
believe that it is important for institutions to maintain documentation
for this category of elevated risk CSFTs, whether approved or declined,
that reflects the factors considered by senior management in taking
such action. The Agencies believe this type of documentation may be of
significant benefit to the institution and to the Agencies in reviewing
the effectiveness of the institution's CSFT-related policies,
procedures, and internal controls. However, to help address the
commenter's concern about potential burden, the Agencies have modified
the Final Statement to recognize that the minutes of an institution's
reviewing senior management committee may have the information
described and to clarify that the documentation for a transaction
should reflect the factors considered by senior management in taking
action, but does not have to detail every aspect of the institution's
legal or business analysis of the transaction.\11\
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\11\ In light of comments, the Agencies have modified the
Documentation section of the Statement to clarify that an
institution should retain sufficient documentation to establish that
it has provided the customer any disclosures concerning an elevated
risk CSFT that the institution is otherwise required to provide to
the customer.
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C. General Risk Management Principles for Elevated Risk CSFTs
The Final Statement--like the Revised Proposed Statement--also
describes some of the other key risk management policies and internal
controls that financial institutions should have in place for elevated
risk CSFTs. For example, the Final Statement provides that the board of
directors and senior management of an institution should establish a
``tone at the top'' through both actions and formalized policies that
sends a strong message throughout
[[Page 1376]]
the financial institution about the importance of compliance with the
law and overall good business ethics. The Final Statement also
describes the types of training, reporting mechanisms, and audit
procedures that institutions should have in place with respect to
elevated risk CSFTs. The Final Statement also provides that a financial
institution should conduct periodic independent reviews of its CSFT
activities to verify and monitor that its policies and controls
relating to elevated risk CSFTs are being implemented effectively and
that elevated risk CSFTs are accurately identified and receive proper
approvals.
In response to comments, the Agencies have modified the Final
Statement to clarify that the independent reviews conducted by a
financial institution may be performed by the institution's audit
department or an independent compliance function within the
institution. One commenter also asked the Agencies to state that the
proper role of an institution's independent review function is only to
confirm that the institution's policies and procedures for elevated
risk CSFTs are being followed and that the function should not assess
the quality of the decisions made by institution personnel. The
Agencies believe that an institution's audit or compliance department
should have the flexibility, in appropriate circumstances, to review
the decisions made by institution personnel during the review and
approval process for elevated risk CSFTs and for this reason have not
made the recommended change.
V. Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3506; 5 CFR Part 1320, Appendix A.1), the Agencies reviewed the Final
Statement. The Agencies may not conduct or sponsor, and an organization
is not required to respond to, this information collection unless it
displays a currently valid OMB control number. The Agencies previously
determined that certain provisions of the Revised Proposed Statement
contained information collection requirements. OMB reviewed and
approved the information collections contained in the Revised Proposed
Statement for the FDIC, OTS, OCC and SEC; and the Board reviewed the
Revised Proposed Statement under the authority delegated to the Board
by OMB (5 CFR Part 1320, Appendix A.1).
OMB control numbers:
OCC: 1557-0229.
OTS: 1550-0111.
FRB: 7100-0311.
FDIC: 3064-0148.
SEC: 3235-0622.
Burden Estimates
OCC
Number of Respondents: 21.
Estimated Time per Response: 25 hours.
Total Estimated Annual Burden: 525 hours.
OTS
Number of Respondents: 5.
Estimated Time per Response: 25 hours.
Total Estimated Annual Burden: 125 hours.
Board
Number of Respondents: 20.
Estimated Time per Response: 25 hours.
Total Estimated Annual Burden: 500 hours.
FDIC
Number of Respondents: 5.
Estimated Time per Response: 25 hours.
Total Estimated Annual Burden: 125 hours.
SEC
Number of Respondents: 5.
Estimated Time per Response: 25 hours.
Total Estimated Annual Burden: 125 hours.
No commenters addressed the Agencies' information collection
estimates. The Agencies do not believe that the clarifications included
in this Final Statement impact the burden estimates previously
developed and approved for these information collections. The Agencies
have a continuing interest in the public's opinions of our collections
of information. At any time, comments regarding the burden estimate, or
any other aspect of this collection of information, including
suggestions for reducing the burden, may be sent to:
OCC: You should direct your comments to:
Communications Division, Office of the Comptroller of the Currency,
Public Information Room, Mailstop 1-5, Attention: 1557-0229, 250 E
Street, SW., Washington, DC 20219. In addition, comments may be sent by
fax to (202) 874-4448, or by electronic mail to
regs.comments@occ.treas.gov. You can inspect and photocopy the comments
at the OCC's Public Information Room, 250 E Street, SW., Washington, DC
20219. You can make an appointment to inspect the comments by calling
(202) 874-5043. Additionally, you should send a copy of your comments
to OCC Desk Officer, 1557-0229, by mail to U.S. Office of Management
and Budget, 725 17th Street, NW., 10235, Washington, DC 20503,
or by fax to (202) 395-6974.
You can request additional information or a copy of the collection
from Mary Gottlieb, OCC Clearance Officer, or Camille Dickerson, (202)
874-5090, Legislative and Regulatory Activities Division, Office of the
Comptroller of the Currency, 250 E Street, SW., Washington, DC 20219.
OTS: Information Collection Comments, Chief Counsel's Office,
Office of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552;
send a facsimile transmission to (202) 906-6518; or send an e-mail to
infocollection.comments@ots.treas.gov. OTS will post comments and the
related index on the OTS Internet site at https://www.treas.gov. In
addition, interested persons may inspect the comments at the Public
Reading Room, 1700 G Street, NW., by appointment. To make an
appointment, call (202) 906-5922, send an e-mail to
public.info@ots.treas.gov, or send a facsimile transmission to (202)
906-7755.
To obtain a copy of the submission to OMB, contact Marilyn K.
Burton at marilyn.burton@ots.treas.gov, (202) 906-6467, or fax number
(202) 906-6518, Chief Counsel's Office, Office of Thrift Supervision,
1700 G Street, NW., Washington, DC 20552
Board: You may submit comments, identified by FR 4022, by any of
the following methods:
Agency Web site: https://www.federalreserve.gov. Follow the
instructions for submitting comments at https://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: https://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: Regs.comments@federalreserve.gov. Include docket
number in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Michelle Long, Federal Reserve Board Clearance
Officer (202) 452-3829, Division of Research and Statistics, Board of
Governors of the Federal Reserve System, Washington, DC 20551.
Telecommunications Device for the Deaf (TDD) users may contact (202)
263-4869, Board of Governors of the Federal Reserve System, Washington,
DC 20551.
All public comments are available from the Board's Web site at
https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted,
[[Page 1377]]
unless modified for technical reasons. Accordingly, your comments will
not be edited to remove any identifying or contact information. Public
comments may also be viewed electronically or in paper in Room MP-500
of the Board's Martin Building (20th and C Streets, NW.) between 9 a.m.
and 5 p.m. on weekdays.
FDIC: Interested parties are invited to submit written comments to
the FDIC concerning the Paperwork Reduction Act implications of this
proposal. Such comments should refer to ``Complex Structured Finance
Transactions, 3064-0148.'' Comments may be submitted by any of the
following methods:
https://www.FDIC.gov/regulations/laws/federal/propose.html.
E-mail: comments@FDIC.gov. Include Complex Structured
Financial Transactions, 3064-0148 in the subject line of the message.
Mail: Steven F. Hanft (202) 898-3907, Federal Deposit
Insurance Corporation, 550 17th Street, NW., Washington, DC 20429.
Hand Delivery: Comments may be hand-delivered to the guard
station at the rear of the 17th Street Building (located on F Street),
on business days between 7 a.m. and 5 p.m.
SEC: You should direct your comments to: Office of Management and
Budget, Attention Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Room 10102,
New Executive Office Building, Washington, DC 20503, with a copy sent
to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100
F Street, NE., Washington, DC 20549-1090 with reference to File No. S7-
08-06.
The Final Statement follows:
Interagency Statement on Sound Practices Concerning Elevated Risk
Complex Structured Finance Activities
I. Introduction
Financial markets have grown rapidly over the past decade, and
innovations in financial instruments have facilitated the structuring
of cash flows and allocation of risk among creditors, borrowers and
investors in more efficient ways. Financial derivatives for market and
credit risk, asset-backed securities with customized cash flow
features, specialized financial conduits that manage pools of assets
and other types of structured finance transactions serve important
business purposes, such as diversifying risks, allocating cash flows,
and reducing cost of capital. As a result, structured finance
transactions now are an essential part of U.S. and international
capital markets. Financial institutions have played and continue to
play an active and important role in the development of structured
finance products and markets, including the market for the more complex
variations of structured finance products.
When a financial institution participates in a complex structured
finance transaction (``CSFT''), it bears the usual market, credit, and
operational risks associated with the transaction. In some
circumstances, a financial institution also may face heightened legal
or reputational risks due to its involvement in a CSFT. For example, in
some circumstances, a financial institution may face heightened legal
or reputational risk if a customer's regulatory, tax or accounting
treatment for a CSFT, or disclosures to investors concerning the CSFT
in the customer's public filings or financial statements, do not comply
with applicable laws, regulations or accounting principles. Indeed, in
some instances, CSFTs have been used to misrepresent a customer's
financial condition to investors, regulatory authorities and others. In
these situations, investors have been harmed, and financial
institutions have incurred significant legal and reputational exposure.
In addition to legal risk, reputational risk poses a significant threat
to financial institutions because the nature of their business requires
them to maintain the confidence of customers, creditors and the general
marketplace.
The Office of the Comptroller of the Currency, the Office of Thrift
Supervision, the Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation, and the Securities and Exchange
Commission (the ``Agencies'') have long expected financial institutions
to develop and maintain robust control infrastructures that enable them
to identify, evaluate and address the risks associated with their
business activities. Financial institutions also must conduct their
activities in accordance with applicable statutes and regulations.
II. Scope and Purpose of Statement
The Agencies are issuing this Statement to describe the types of
risk management principles that we believe may help a financial
institution to identify CSFTs that may pose heightened legal or
reputational risks to the institution (``elevated risk CSFTs'') and to
evaluate, manage and address these risks within the institution's
internal control framework.\12\
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\12\ As used in this Statement, the term ``financial
institution'' or ``institution'' refers to national banks in the
case of the Office of the Comptroller of the Currency; federal and
state savings associations and savings and loan holding companies in
the case of the Office of Thrift Supervision; state member banks and
bank holding companies (other than foreign banking organizations) in
the case of the Federal Reserve Board; state nonmember banks in the
case of the Federal Deposit Insurance Corporation; and registered
broker-dealers and investment advisers in the case of the Securities
and Exchange Commission. The U.S. branches and agencies of foreign
banks supervised by the Office of the Comptroller, the Federal
Reserve Board and the Federal Deposit Insurance Corporation also are
considered to be financial institutions for purposes of this
Statement.
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Structured finance transactions encompass a broad array of products
with varying levels of complexity. Most structured finance
transactions, such as standard public mortgage-backed securities
transactions, public securitizations of retail credit cards, asset-
backed commercial paper conduit transactions, and hedging-type
transactions involving ``plain vanilla'' derivatives and collateralized
loan obligations, are familiar to participants in the financial
markets, and these vehicles have a well-established track record. These
transactions typically would not be considered CSFTs for the purpose of
this Statement.
Because this Statement focuses on sound practices related to CSFTs
that may create heightened legal or reputational risks--transactions
that typically are conducted by a limited number of large financial
institutions--it will not affect or apply to the vast majority of
financial institutions, including most small institutions. As in all
cases, a financial institution should tailor its internal controls so
that they are appropriate in light of the nature, scope, complexity and
risks of its activities. Thus, for example, an institution that is
actively involved in structuring and offering CSFTs that may create
heightened legal or reputational risk for the institution should have a
more formalized and detailed control framework than an institution that
participates in these types of transactions less frequently. The
internal controls and procedures discussed in this Statement are not
all inclusive, and, in appropriate circumstances, an institution may
find that other controls, policies, or procedures are appropriate in
light of its particular CSFT activities.
Because many of the core elements of an effective control
infrastructure are the same regardless of the business line involved,
this Statement draws heavily on controls and procedures that the
Agencies previously have found to be effective in assisting a financial
institution to manage and control risks and identifies ways in which
these controls and procedures can be
[[Page 1378]]
effectively applied to elevated risk CSFTs. Although this Statement
highlights some of the most significant risks associated with elevated
risk CSFTs, it is not intended to present a full exposition of all
risks associated with these transactions. Financial institutions are
encouraged to refer to other supervisory guidance prepared by the
Agencies for further information concerning market, credit,
operational, legal and reputational risks as well as internal audit and
other appropriate internal controls.
This Statement does not create any private rights of action, and
does not alter or expand the legal duties and obligations that a
financial institution may have to a customer, its shareholders or other
third parties under applicable law. At the same time, adherence to the
principles discussed in this Statement would not necessarily insulate a
financial institution from regulatory action or any liability the
institution may have to third parties under applicable law.
III. Identification and Review of Elevated Risk Complex Structured
Finance Transactions
A financial institution that engages in CSFTs should maintain a set
of formal, written, firm-wide policies and procedures that are designed
to allow the institution to identify, evaluate, assess, document, and
control the full range of credit, market, operational, legal and
reputational risks associated with these transactions. These policies
may be developed specifically for CSFTs, or included in the set of
broader policies governing the institution generally. A financial
institution operating in foreign jurisdictions may tailor its policies
and procedures as appropriate to account for, and comply with, the
applicable laws, regulations and standards of those jurisdictions.\13\
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\13\ In the case of U.S. branches and agencies of foreign banks,
these policies, including management, review and approval
requirements, should be coordinated with the foreign bank's group-
wide policies developed in accordance with the rules of the foreign
bank's home country supervisor and should be consistent with the
foreign bank's overall corporate and management structure as well as
its framework for risk management and internal controls.
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A financial institution's policies and procedures should establish
a clear framework for the review and approval of individual CSFTs.
These policies and procedures should set forth the responsibilities of
the personnel involved in the origination, structuring, trading,
review, approval, documentation, verification, and execution of CSFTs.
Financial institutions may find it helpful to incorporate the review of
new CSFTs into their existing new product policies. In this regard, a
financial institution should define what constitutes a ``new'' complex
structured finance product and establish a control process for the
approval of such new products. In determining whether a CSFT is new, a
financial institution may consider a variety of factors, including
whether it contains structural or pricing variations from existing
products, whether the product is targeted at a new class of customers,
whether it is designed to address a new need of customers, whether it
raises significant new legal, compliance or regulatory issues, and
whether it or the manner in which it would be offered would materially
deviate from standard market practices. An institution's policies
should require new complex structured finance products to receive the
approval of all relevant control areas that are independent of the
profit center before the product is offered to customers.
A. Identifying Elevated Risk CSFTs
As part of its transaction and new product approval controls, a
financial institution should establish and maintain policies,
procedures and systems to identify elevated risk CSFTs. Because of the
potential risks they present to the institution, transactions or new
products identified as elevated risk CSFTs should be subject to
heightened reviews during the institution's transaction or new product
approval processes. Examples of transactions that an institution may
determine warrant this additional scrutiny are those that (either
individually or collectively) appear to the institution during the
ordinary course of its transaction approval or new product approval
process to:
Lack economic substance or business purpose;
Be designed or used primarily for questionable accounting,
regulatory, or tax objectives, particularly when the transactions are
executed at year end or at the end of a reporting period for the
customer;
Raise concerns that the client will report or disclose the
transaction in its public filings or financial statements in a manner
that is materially misleading or inconsistent with the substance of the
transaction or applicable regulatory or accounting requirements;
Involve circular transfers of risk (either between the
financial institution and the customer or between the customer and
other related parties) that lack economic substance or business
purpose;
Involve oral or undocumented agreements that, when taken
into account, would have a material impact on the regulatory, tax, or
accounting treatment of the related transaction, or the client's
disclosure obligations; \14\
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\14\ This item is not intended to include traditional, non-
binding ``comfort'' letters or assurances provided to financial
institutions in the loan process where, for example, the parent of a
loan customer states that the customer states that the customer
(i.e., the parent's subsidiary) is an integral and important part of
the parent's operations.
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Have material economic terms that are inconsistent with
market norms (e.g., deep ``in the money'' options or historic rate
rollovers); or
Provide the financial institution with compensation that
appears substantially disproportionate to the services provided or
investment made by the financial institution or to the credit, market
or operational risk assumed by the institution.
The examples listed previously are provided for illustrative
purposes only, and the policies and procedures established by financial
institutions may differ in how they seek to identify elevated risk
CSFTs. The goal of each institution's policies and procedures, however,
should remain the same--to identify those CSFTs that warrant additional
scrutiny in the transaction or new product approval process due to
concerns regarding legal or reputational risks.
Financial institutions that structure or market, act as an advisor
to a customer regarding, or otherwise play a substantial role in a
transaction may have more information concerning the customer's
business purpose for the transaction and any special accounting, tax or
financial disclosure issues raised by the transaction than institutions
that play a more limited role. Thus, the ability of a financial
institution to identify the risks associated with an elevated risk CSFT
may differ depending on its role.
B. Due Diligence, Approval and Documentation Process for Elevated Risk
CSFTs
Having developed a process to identify elevated risk CSFTs, a
financial institution should implement policies and procedures to
conduct a heightened level of due diligence for these transactions. The
financial institution should design these policies and procedures to
allow personnel at an appropriate level to understand and evaluate the
potential legal or reputational risks presented by the transaction to
the institution and to manage and address any heightened
[[Page 1379]]
legal or reputational risks ultimately found to exist with the
transaction.
Due Diligence. If a CSFT is identified as an elevated risk CSFT,
the institution should carefully evaluate and take appropriate steps to
address the risks presented by the transaction with a particular focus
on those issues identified as potentially creating heightened levels of
legal or reputational risk for the institution. In general, a financial
institution should conduct the level and amount of due diligence for an
elevated risk CSFT that is commensurate with the level of risks
identified. A financial institution that structures or markets an
elevated risk CSFT to a customer, or that acts as an advisor to a
customer or investors concerning an elevated risk CSFT, may have
additional responsibilities under the federal securities laws, the
Internal Revenue Code, state fiduciary laws or other laws or
regulations and, thus, may have greater legal and reputational risk
exposure with respect to an elevated risk CSFT than a financial
institution that acts only as a counterparty for the transaction.
Accordingly, a financial institution may need to exercise a higher
degree of care in conducting its due diligence when the institution
structures or markets an elevated risk CSFT or acts as an advisor
concerning such a transaction than when the institution plays a more
limited role in the transaction.
To appropriately understand and evaluate the potential legal and
reputational risks associated with an elevated risk CSFT that a
financial institution has identified, the institution may find it
useful or necessary to obtain additional information from the customer
or to obtain specialized advice from qualified in-house or outside
accounting, tax, legal, or other professionals. As with any
transaction, an institution should obtain satisfactory responses to its
material questions and concerns prior to consummation of a
transaction.\15\
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\15\ Of course, financial institutions also should ensure that
their own accounting for transactions complies with applicable
accounting standards, consistently applied.
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In conducting its due diligence for an elevated risk CSFT, a
financial institution should independently analyze the potential risks
to the institution from both the transaction and the institution's
overall relationship with the customer. Institutions should not
conclude that a transaction identified as being an elevated risk CSFT
involves minimal or manageable risks solely because another financial
institution will participate in the transaction or because of the size
or sophistication of the customer or counterparty. Moreover, a
financial institution should carefully consider whether it would be
appropriate to rely on opinions or analyses prepared by or for the
customer concerning any significant accounting, tax or legal issues
associated with an elevated risk CSFT.
Approval Process. A financial institution's policies and procedures
should provide that CSFTs identified as having elevated legal or
reputational risk are reviewed and approved by appropriate levels of
control and management personnel. The designated approval process for
such CSFTs should include representatives from the relevant business
line(s) and/or client management, as well as from appropriate control
areas that are independent of the business line(s) involved in the
transaction. The personnel responsible for approving an elevated risk
CSFT on behalf of a financial institution should have sufficient
experience, training and stature within the organization to evaluate
the legal and reputational risks, as well as the credit, market and
operational risks to the institution.
The institution's control framework should have procedures to
deliver the necessary or appropriate information to the personnel
responsible for reviewing or approving an elevated risk CSFT to allow
them to properly perform their duties. Such information may include,
for example, the material terms of the transaction, a summary of the
institution's relationship with the customer, and a discussion of the
significant legal, reputational, credit, market and operational risks
presented by the transaction.
Some institutions have established a senior management committee
that is designed to involve experienced business executives and senior
representatives from all of the relevant control functions within the
financial institution (including such groups as independent risk
management, tax, accounting, policy, legal, compliance, and financial
control) in the oversight and approval of those elevated risk CSFTs
that are identified by the institution's personnel as requiring senior
management review and approval due to the potential risks associated
with the transactions. While this type of management committee may not
be appropriate for all financial institutions, a financial institution
should establish processes that assist the institution in consistently
managing the review and approval of elevated risk CSFTs on a firm-wide
basis.\16\
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\16\ The control processes that a financial institution
establishes for CSFTs should take account of, and be consistent
with, any informational barriers established by the institution to
manage potential conflicts of interest, insider trading or other
concerns.
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If, after evaluating an elevated risk CSFT, the financial
institution determines that its participation in the CSFT would create
significant legal or reputational risks for the institution, the
institution should take appropriate steps to address those risks. Such
actions may include declining to participate in the transaction, or
conditioning its participation upon the receipt of representations or
assurances from the customer that reasonably address the heightened
legal or reputational risks presented by the transaction. Any
representations or assurances provided by a customer should be obtained
before a transaction is executed and be received from, or approved by,
an appropriate level of the customer's management. A financial
institution should decline to participate in an elevated risk CSFT if,
after conducting appropriate due diligence and taking appropriate steps
to address the risks from the transaction, the institution determines
that the transaction presents unacceptable risk to the institution or
would result in a violation of applicable laws, regulations or
accounting principles.
Documentation. The documentation that financial institutions use to
support CSFTs is often highly customized for individual transactions
and negotiated with the customer. Careful generation, collection and
retention of documents associated with elevated risk CSFTs are
important control mechanisms that may help an institution monitor and
manage the legal, reputational, operational, market, and credit risks
associated with the transactions. In addition, sound documentation
practices may help reduce unwarranted exposure to the financial
institution's reputation.
A financial institution should create and collect sufficient
documentation to allow the institution to:
Document the material terms of the transaction;
Enforce the material obligations of the counterparties;
Confirm that the institution has provided the customer any
disclosures concerning the transaction that the institution is
otherwise required to provide; and
Verify that the institution's policies and procedures are
being followed and allow the internal audit function to
[[Page 1380]]
monitor compliance with those policies and procedures.
When an institution's policies and procedures require an elevated
risk CSFT to be submitted for approval to senior management, the
institution should maintain the transaction-related documentation
provided to senior management as well as other documentation, such as
minutes of the relevant senior management committee, that reflect
senior management's approval (or disapproval) of the transaction, any
conditions imposed by senior management, and the factors considered in
taking such action. The institution should retain documents created for
elevated risk CSFTs in accordance with its record retention policies
and procedures as well as applicable statutes and regulations.
C. Other Risk Management Principles for Elevated Risk CSFTs
General Business Ethics. The board and senior management of a
financial institution also should establish a ``tone at the top''
through both actions and formalized policies that sends a strong
message throughout the financial institution about the importance of
compliance with the law and overall good business ethics. The board and
senior management should strive to create a firm-wide corporate culture
that is sensitive to ethical or legal issues as well as the potential
risks to the financial institution that may arise from unethical or
illegal behavior. This kind of culture coupled with appropriate
procedures should reinforce business-line ownership of risk
identification, and encourage personnel to move ethical or legal
concerns regarding elevated risk CSFTs to appropriate levels of
management. In appropriate circumstances, financial institutions may
also need to consider
