06-4510

28326

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
[Docket No. 06–06]

Office of Thrift Supervision
[No. 2006–20]

FEDERAL RESERVE SYSTEM
[Docket No. OP–1254]

FEDERAL DEPOSIT INSURANCE
CORPORATION
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–53773; 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 revised interagency
statement with request for public
comment.

sroberts on PROD1PC70 with NOTICES

AGENCIES:

SUMMARY: On May 19, 2004, the
Agencies issued and requested comment
on a proposed Interagency Statement on
Sound Practices Concerning Complex
Structured Finance Activities (‘‘Initial
Statement’’) of national banks, state
banks, bank holding companies, 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’’). The Initial Statement
described 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 certain complex structured
finance transactions (‘‘CSFTs’’). After
reviewing the comments received on the
Initial Statement, the Agencies are
requesting comment on a revised
proposed interagency statement
(‘‘Revised Statement’’). The Revised
Statement has been modified in
numerous respects to address issues and
concerns raised by commenters, clarify
the purpose, scope and effect of the
statement, and make the statement more
principles-based. These changes include
reorganizing and streamlining the

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

document to reduce redundancies and
to focus the statement on those CSFTs
that may pose heightened levels of legal
or reputational risk to the relevant
institution (referred to as ‘‘elevated risk
CSFTs’’). In addition, the Agencies have
modified the examples of transactions
that may present elevated risk to make
these examples more risk-focused, and
have recognized more explicitly that an
institution’s review and approval
process for elevated risk CSFTs should
be commensurate with, and focus on,
the potential risks presented by the
transaction to the institution. As
discussed below, the Revised Statement
will not affect or apply to the vast
majority of small financial institutions,
nor does it create any private rights of
action.
DATES: Comments on the Revised
Statement should be received on or
before June 15, 2006.
ADDRESSES:
OCC: You should include OCC and
Docket Number 06–06 in your comment.
You may submit comments by any of
the following methods:
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.
• OCC Web site: http://
www.occ.treas.gov. Click on ‘‘Contact
the OCC,’’ scroll down and click on
‘‘Comments on Proposed Regulations.’’
• E-mail address:
regs.comments@occ.treas.gov.
• Fax: (202) 874–4448.
• Mail: Office of the Comptroller of
the Currency, 250 E Street, SW., Mail
Stop 1–5, Washington, DC 20219.
• Hand Delivery/Courier: 250 E
Street, SW., Attn: Public Information
Room, Mail Stop 1–5, Washington, DC
20219.
Instructions: All submissions received
must include the agency name (OCC)
and docket number or Regulatory
Information Number (RIN) for this
notice of proposed rulemaking. In
general, OCC will enter all comments
received into the docket without
change, including any business or
personal information that you provide.
You may review comments and other
related materials by any of the following
methods:
• Viewing Comments Personally: You
may personally inspect and photocopy
comments at the OCC’s Public
Information Room, 250 E Street, SW.,
Washington, DC. You can make an
appointment to inspect comments by
calling (202) 874–5043.
• Viewing Comments Electronically:
You may request e-mail or CD–ROM
copies of comments that the OCC has
received by contacting the OCC’s Public

PO 00000

Frm 00031

Fmt 4703

Sfmt 4703

Information Room at:
regs.comments@occ.treas.gov.
• Docket: You may also request
available background documents and
project summaries using the methods
described above.
OTS: You may submit comments,
identified by No. 2006–20 by any of the
following methods:
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.
• E-mail:
regs.comments@ots.treas.gov. Please
include No. 2006–20 in the subject line
of the message, and include your name
and telephone number in the message.
• Fax: (202) 906–6518.
• Mail: Regulation Comments, Chief
Counsel’s Office, Office of Thrift
Supervision, 1700 G Street, NW.,
Washington, DC 20552, Attention: No.
2006–20.
• Hand Delivery/Courier: Guard’s
Desk, East Lobby Entrance, 1700 G
Street, NW., from 9 a.m. to 4 p.m. on
business days, Attention: Regulation
Comments, Chief Counsel’s Office,
Attention: No. 2006–20.
Instructions: All submissions received
must include the agency name and
document number. All comments
received will be posted without change
to http://www.ots.treas.gov/
pagehtml.cfm?catNumber=67&an=1,
including any personal information
provided.
Docket: For access to the docket to
read background documents or
comments received, go to http://
www.ots.treas.gov/
pagehtml.cfm?catNumber=67&an=1. In
addition, you may inspect comments at
the Public Reading Room, 1700 G Street,
NW., by appointment. To make an
appointment for access, call (202) 906–
5922, send an e-mail to
public.info@ots.treas.gov, or send a
facsimile transmission to (202) 906–
7755. (Prior notice identifying the
materials you will be requesting will
assist us in serving you.) We schedule
appointments on business days between
10 a.m. and 4 p.m. In most cases,
appointments will be available the next
business day following the date we
receive a request.
Board: You may submit comments,
identified by Docket No. OP–1254, by
any of the following methods:
• Board’s Web site: http://
www.federalreserve.gov. Follow the
instructions for submitting comments at
http://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
• Federal eRulemaking Portal: http//
www.regulations.gov. Follow the
instructions for submitting comments.

E:\FR\FM\16MYN1.SGM

16MYN1

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices
• 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: Jennifer J. Johnson, Secretary,
Board of Governors of the Federal
Reserve System, 20th Street and
Constitution Avenue, NW., Washington,
DC 20551.
All public comments are available
from the Board’s Web site at http://
www.federalreserve.gov/generalinfo/
foia/ProposedRegs.cfm as submitted,
unless modified for technical reasons.
Accordingly, your comments will not be
edited to remove any identifying or
contact information. Public comments
also may be viewed electronically or in
paper form in Room MP–500 of the
Board’s Martin Building (C and 20th
Streets, NW.) between 9 a.m. and 5 p.m.
on weekdays.
FDIC: Written comments should be
addressed to Robert E. Feldman,
Executive Secretary, Attention:
Comments/OES, Federal Deposit
Insurance Corporation, 550 17th Street,
NW., Washington, DC 20429. Comments
may be hand delivered to the guard
station at the rear of the 550 17th Street
Building (located on F Street), on
business days between 7 a.m. and 5 p.m.
(Fax number: (202) 898–3838; Internet
address: comments@fdic.gov.)
Comments may be inspected and
photocopied in the FDIC Public
Information Center, Room 100, 801 17th
Street, NW., Washington, DC, between 9
a.m. and 4:30 p.m. on business days.
SEC: Comments may be submitted by
any of the following methods:

sroberts on PROD1PC70 with NOTICES

Electronic Comments
• Use the Commission’s Internet
comment form (http://www.sec.gov/
rules/policy.shtml;) or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number S7–08–06 on the subject line.
Paper Comments
• Send paper comments in triplicate
to Nancy M. Morris, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090.
All submissions should refer to File
Number S7–08–06. This file number
should be included on the subject line
if e-mail is used. To help us process and
review your comments more efficiently,
please use only one method. The
Commission will post all comments on
the Commission’s Internet Web site
(http://www.sec.gov/rules/policy.shtml).
Comments are also available for public
inspection and copying in the

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

Commission’s Public Reference Room,
100 F Street, NE., Washington, DC
20549. All comments received will be
posted without change; we do not edit
personal identifying information from
submissions. You should submit only
information that you wish to make
available publicly.
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, Examinations and
Supervision Policy, (202) 906–7295;
Deborah S. Merkle, Project Manager,
Credit Policy, Examinations and
Supervision Policy, (202) 906–5688; 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, 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, Anne B. Zorc,
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

PO 00000

Frm 00032

Fmt 4703

Sfmt 4703

28327

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 risks, 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 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.
In some cases, certain CSFTs appear
to have been used in illegal schemes
that misrepresented the financial
condition of public companies to
investors and regulatory authorities.
Those cases highlight the substantial
legal and reputational risks that
financial institutions may face when
they participate in a CSFT that is used
by the institution’s customer to
circumvent regulatory or financial
reporting requirements or further other
illegal behavior.1 After conducting
investigations, the OCC, Federal Reserve
System and the 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
significant financial penalties on the
institutions and required the
institutions to take several measures to
strengthen their risk management
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 http://
www.federalreserve.gov/boarddocs/srletters/2004/
and http://www.occ.treas.gov).

E:\FR\FM\16MYN1.SGM

16MYN1

28328

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices

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.
Following these investigations, the
OCC, Board and SEC also conducted
special reviews of several large banking
and securities firms that are significant
participants in the market for CSFTs.
These reviews were designed to
evaluate the new product approval,
transaction approval, and other internal
controls and processes used by these
institutions to identify and manage the
legal, reputational and other risks
associated with CSFTs. These
assessments indicated that many of the
large financial institutions engaged in
CSFTs already had taken meaningful
steps to improve their control
infrastructure relating to CSFTs. The
Agencies also focused attention on the
complex structured finance activities of
financial institutions in the normal
course of the supervisory process.
II. Initial Statement

sroberts on PROD1PC70 with NOTICES

To further 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 Statement.4 As
a general matter, the Initial Statement
provided that financial institutions
engaged in CSFTs should have and
maintain a comprehensive set of formal,
firm-wide policies and procedures that
are designed 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 Initial
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.

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

Statement also described the types of
policies and procedures that financial
institutions should have for CSFTs in
the following specific areas: (1)
Transaction approval; (2) approval of
new complex structured finance
products; (3) identification and
management of the potential
reputational and legal risk associated
with CSFTs; (4) review of the customer’s
proposed accounting and disclosures for
CSFTs; (5) documentation of CSFTs; (6)
management reporting for CSFTs; (7)
independent monitoring and analysis of
the institution’s compliance with its
internal policies regarding CSFTs; (8)
role of internal audit; and (9) training of
personnel involved in CSFTs.
Among other things, the Initial
Statement provided that financial
institutions should establish a clear
process for identifying those CSFTs that
may create heightened legal or
reputational risk for the institution, and
included a list of transaction
characteristics that may indicate that a
CSFT (or series of CSFTs) creates
elevated levels of legal or reputational
risk for the institution. The Initial
Statement also provided that an
institution should ensure that
transactions identified as being elevated
risk CSFTs are thoroughly reviewed by
the institution’s control functions and
management during the institution’s
transaction or new product approval
processes. As part of this review, the
Initial Statement indicated that the
institution should obtain and document
complete and accurate information
about the customer’s business objectives
for entering into the transaction, as well
as about the customer’s proposed
accounting treatment and financial
disclosures relating to the transaction.
III. Overview of Comments
The Agencies collectively received
comments on the Initial Statement from
more than 40 persons, although many
commenters submitted multiple
comments or submitted identical
comments to multiple Agencies.
Commenters included banking
organizations, trade associations,
investment banks, consulting firms,
public accounting firms, law firms, an
association of state officials, and
individuals. In addition to submitting
written comments, some commenters
also met with Agency representatives to
discuss their views of the Initial
Statement.
Commenters generally supported the
Agencies’ efforts to describe the types of
risk management procedures and
internal controls that may help financial
institutions identify and mitigate the
legal and reputational risks associated

PO 00000

Frm 00033

Fmt 4703

Sfmt 4703

with CSFTs. In this regard, many
commenters recognized that financial
institutions need a robust risk
management and control framework to
help institutions avoid becoming
involved in CSFTs that are used for
illegal or abusive purposes and to
manage the risks associated with CSFTs.
Virtually all of the commenters,
however, recommended changes to the
Initial Statement. For example, many
commenters argued that the
characteristics of CSFTs in general and
of elevated risk CSFTs in particular
identified in the Initial Statement were
too broad and would encompass many
structured finance products that are not
novel or complex and that do not
present heightened legal or reputational
risks for participating financial
institutions. These commenters argued,
for example, that the Initial Statement
could be read as requiring financial
institutions to identify any structured
finance transaction that involves a
special purpose entity (‘‘SPE’’) or crossborder elements as an elevated risk
CSFT.
Many commenters also asserted that
the internal controls and risk
management processes described in the
Initial Statement for CSFTs and elevated
risk CSFTs were overly prescriptive and
burdensome. For example, many
commenters expressed concern that the
Initial Statement could be read as
requiring a financial institution to
conduct a detailed and extensive pretransaction review of all CSFTs
regardless of the role that the institution
played in the transaction, and regardless
of whether the transaction’s
characteristics suggested that it may
create significant legal, reputational or
other risks for the institution. Similarly,
many commenters argued that the Initial
Statement imposed new and
inappropriate obligations on financial
institutions to confirm the validity of a
customer’s financial disclosures or
accounting or tax treatment for a CSFT,
and would establish new and extensive
documentation requirements for CSFTs.
Commenters asserted that, in light of
these and other concerns, the Initial
Statement had the potential to increase
the legal risks faced by financial
institutions participating in CSFTs. In
addition, commenters argued that the
Initial Statement, if implemented,
would disrupt the market for legitimate
structured finance products and place
U.S. financial institutions at a
competitive disadvantage in the market
for CSFTs both in the United States and
abroad.
As a general matter, commenters
recommended that the Agencies modify
the Initial Statement to make it more

E:\FR\FM\16MYN1.SGM

16MYN1

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices

sroberts on PROD1PC70 with NOTICES

principles-based and focused on
transactions that may create elevated
risks for a participating financial
institution. For example, many
commenters recommended that the
Agencies modify the list of
characteristics of elevated risk CSFTs to
focus on factors that are likely
indicators that a transaction may, in
fact, create heightened legal or
reputational risks for a participating
institution. In addition, commenters
recommended that the Agencies provide
financial institutions greater flexibility
to design internal controls and risk
management procedures for CSFTs that
are tailored to the size, activities and
general internal control framework of
the institution. Finally, many
commenters recommended that the
Agencies republish a revised statement
for a new round of public comment.
IV. Overview of Revised Statement
The Agencies have substantially
revised the Initial Statement in light of
the comments. In particular, the Revised
Statement has been shortened and
reorganized to be more principles-based
and to focus on elevated risk CSFTs.
Because these revisions are substantial,
and the Revised Statement is an
important explanation of the key
principles and best practices governing
CSFT activities, the Agencies invite
public comment on the Revised
Statement.
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 risks associated with its
CSFT activities. These policies and
procedures should, among other things,
be designed to allow the institution to
identify during its transaction and new
product approval processes those CSFTs
that may present elevated legal or
reputational risks to the institution. In
addition, an institution’s policies and
procedures should provide that CSFTs
identified as potentially having elevated
legal or reputational risks are 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 level and amount of
due diligence conducted by an
institution for an elevated risk CSFT
should be commensurate with the
transaction’s potential risk to the
institution. In conducting this due
diligence, the institution may find it
useful or necessary to obtain additional
information from the customer or to
obtain specialized advice from qualified

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

in-house or outside accounting, tax,
legal or other professionals.
If, after evaluating an elevated risk
CSFT, a financial institution determines
that its participation in the CSFT 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. 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 risks to the institution or
would result in a violation of applicable
laws, regulations or accounting
principles.
With these broad principles in mind,
the Agencies have made a number of
changes to the Initial Statement to
address the issues and concerns raised
by commenters, to clarify the purpose,
scope and effect of the Revised
Statement, and to make the document
more risk-focused. The Agencies believe
that, with these changes, the Revised
Statement promotes sound risk
management principles while providing
an individual financial institution
greater flexibility to develop
implementing policies, procedures and
systems that are appropriately tailored
to the nature, scope, complexity and
risks of its CSFT activities and to the
institution’s general internal control
framework. In particular, the Agencies
have, among other things:
• Focused the statement more clearly
on those CSFTs that may present
heightened legal or reputational risks to
a participating institution;
• Clarified that the statement does not
apply to structured finance transactions,
such as standard public mortgagebacked securities transactions, that are
familiar to participants in the financial
markets and have well-established track
records and, for this reason, will not
affect or apply to the vast majority of
small financial institutions;
• Modified the examples of CSFTs
that may warrant additional scrutiny by
an institution to focus on transactions
that are more likely to present elevated
levels of legal or reputational risk to an
institution (e.g., transactions that raise
concerns that the client will report or
disclose the transaction in its public

PO 00000

Frm 00034

Fmt 4703

Sfmt 4703

28329

filings or financial statements in a
manner that is materially misleading);
• Clarified that the due diligence
conducted by a financial institution for
an elevated risk CSFT should focus on
those issues identified by the institution
as potentially creating heightened levels
of legal or reputational risk for the
institution;
• Recognized that the role a financial
institution plays in a CSFT may affect
both the amount of information it has
concerning the transaction and the level
of legal or reputational risks presented
by the transaction to the institution;
• Streamlined and modified the
documentation and general control
portions of the statement to focus on the
proper goals of an institution s policies
and procedures in these areas; and
• Provided that 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 foreign
jurisdictions.
Because many of the core elements of
an effective control infrastructure are
the same regardless of the business line
involved, the Revised Statement
continues to draw 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 applied effectively to
elevated risk CSFTs. Moreover, as noted
above, many of the large financial
institutions that are actively involved in
CSFT-related activities have taken steps
in recent years to bolster and improve
their risk management and internal
control processes for CSFTs. Based on
the Agencies’ supervisory experience,
the Agencies believe that the Revised
Statement generally is consistent with
the controls and processes used by large
financial institutions to manage the
risks arising from their CSFT activities.
The Agencies propose to adopt the
Revised Statement as supervisory
guidance (in the case of the Federal
banking agencies) or a policy statement
(in the case of the SEC) and to use the
Revised Statement in reviewing the
internal controls and risk management
systems of those financial institutions
that are engaged in CSFTs as part of the
Agencies’ supervisory processes.
Accordingly, the Revised Statement
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 third
parties under applicable law. The

E:\FR\FM\16MYN1.SGM

16MYN1

28330

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices

Agencies have added a statement to this
effect in the Revised Statement.
The Agencies request comment on all
aspects of the Revised Statement.

sroberts on PROD1PC70 with NOTICES

V. Paperwork Reduction Act
The Agencies have determined that
certain provisions of the Revised
Statement contain collection of
information requirements as defined in
the Paperwork Reduction Act of 1995
(44 U.S.C. 3501 et seq.) (PRA). An
Agency may not conduct or sponsor,
and a respondent is not required to
respond to, an information collection
unless it displays a currently valid
Office of Management and Budget
(OMB) control number.
OMB has reviewed and approved the
proposed information collections for the
FDIC, OTS, and OCC; the SEC is
submitting their proposed information
collection to OMB for review and
approval; and the Board has reviewed
the Revised Statement under the
authority delegated to the Board by
OMB (5 CFR 1320, appendix A.1).
OMB control numbers:
OCC: 1557–0229.
OTS: 1550–0111.
FRB: 7100–0311.
FDIC: 3064–0148.
SEC: 3235–0xxx (to be assigned).
Comment was requested on the
proposed information collections
contained in the Initial Statement
published for comment on May 19,
2004. As discussed above, many
commenters asserted that the Initial
Statement in general, and its
documentation provisions in particular,
were unduly burdensome and
prescriptive. For this reason, some
commenters asserted that the estimates
of the burden (100 hours per
respondent) were too low.
In light of this and the modifications
made to the Initial Statement, the
Agencies have reconsidered the burden
estimates previously published and are
once again requesting comment before
finalizing this statement. In response to
the comments, the Agencies have made
significant modifications to make the
Revised Statement more principlesbased and risk-focused than the Initial
Statement, and to provide an individual
institution greater flexibility in
developing policies, procedures, and
systems that are appropriate and
tailored to the nature of the institution’s
CSFT activities and general internal
control framework. The Agencies
believe that the information collection
requirements contained in the Revised
Statement, as discussed earlier in the
notice, are generally consistent with the
types of policies and procedures that the

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

large financial institutions actively
involved in CSFTs have already
developed and implemented as a matter
of usual and customary business
practices. Therefore, the information
collections contained in the Revised
Statement are significantly less
burdensome than those estimated in the
Initial Statement and, thus, the Agencies
have revised the hourly estimate down
from 100 hours per response to an
average of 25 hours per response.
New 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.
Comments continue to be invited on:
(a) Whether the collections of
information contained in the Revised
Statement are necessary for the proper
performance of the Agencies’ functions,
including whether the information has
practical utility;
(b) The accuracy of the estimates of
the burden of the information
collection, including the validity of the
methodology and assumptions used;
(c) Ways to enhance the quality,
utility, and clarity of the information to
be collected;
(d) Ways to minimize the burden of
the information collection on
respondents, including through the use
of automated collection techniques or
other forms of information technology;
and

PO 00000

Frm 00035

Fmt 4703

Sfmt 4703

(e) Estimates of capital or start up
costs and costs of operation,
maintenance, and purchase of services
to provide information.
Comments on the information
collections contained in the Revised
Statement should be addressed 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 http://
www.ots.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 Docket No. OP–1254, by
any of the following methods:
• Agency Web site: http://
www.federalreserve.gov. Follow the
instructions for submitting comments at

E:\FR\FM\16MYN1.SGM

16MYN1

sroberts on PROD1PC70 with NOTICES

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices
http://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
• Federal eRulemaking Portal: http://
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 http://
www.federalreserve.gov/generalinfo/
foia/ProposedRegs.cfm as submitted,
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 Financial Transactions,
3064–0148.’’ Comments may be
submitted by any of the following
methods:
• http://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 of 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.,

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

Washington, DC 20549–1090 with
reference to File No. S7–08–06.
The proposed Revised 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 concerning
the CSFT in its public filings or
financial statements, do not comply
with applicable laws, regulations or
accounting principles. Indeed, some
financial institutions have incurred
significant legal costs and liability and
suffered reputational harm due to their
role in certain transactions that were
used by customers to misrepresent the
customers’ financial condition to
investors, regulatory authorities or
others. 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

PO 00000

Frm 00036

Fmt 4703

Sfmt 4703

28331

Deposit Insurance Corporation, and the
Securities and Exchange Commission
(the regulatory 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 regulatory 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.5
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
5 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.

E:\FR\FM\16MYN1.SGM

16MYN1

28332

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices

sroberts on PROD1PC70 with NOTICES

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
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,
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

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

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.6
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
6 In the case of U.S. branches and agencies of
foreign banks, the institution should coordinate
these policies with the foreign bank’s group-wide
policies developed in accordance with the rules of
the foreign bank’s home country supervisor. In
addition, the U.S. branches and agencies of foreign
banks should implement a control infrastructure for
CSFTs, including management, review and
approval requirements, that is consistent with the
institution’s overall corporate and management
structure as well as its framework for risk
management and internal controls.

PO 00000

Frm 00037

Fmt 4703

Sfmt 4703

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; 7
• 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
7 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 (i.e., the parent’s
subsidiary) is an integral and important part of the
parent’s operations.

E:\FR\FM\16MYN1.SGM

16MYN1

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices

sroberts on PROD1PC70 with NOTICES

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
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

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

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.8
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
8 Of course, financial institutions also should
ensure that their own accounting for transactions
complies with applicable accounting standards,
consistently applied.

PO 00000

Frm 00038

Fmt 4703

Sfmt 4703

28333

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,
accounting, policy, legal, compliance,
and financial control, in the oversight
and approval of CSFTs identified as
having elevated risks. 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 its elevated risk
CSFTs on a firm-wide basis.9
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 transaction. In addition, sound
9 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 manager potential
conflicts of interests, insider trading or other
concerns.

E:\FR\FM\16MYN1.SGM

16MYN1

28334

Federal Register / Vol. 71, No. 94 / Tuesday, May 16, 2006 / Notices

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 customers have
received any required disclosures
concerning the transaction; and
• Verify that the institution s policies
and procedures are being followed and
allow the internal audit function to
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 that reflect
management’s approval (or disapproval)
of the transaction, any conditions
imposed by senior management, and the
reasons for 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.

sroberts on PROD1PC70 with NOTICES

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.10 As in other areas of
10 The agencies note that the Sarbanes-Oxley Act
of 2002 requires companies listed on a national
securities exchange or inter-dealer quotation system

VerDate Aug<31>2005

16:06 May 15, 2006

Jkt 208001

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.
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. Financial
institutions should conduct periodic
independent reviews of their CSFT
activities to verify that their policies and
controls relating to elevated risk CSFTs
are being implemented effectively and
that elevated risk CSFTs are accurately
identified and receive proper approvals.
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.
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
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 should be trained to identify
and properly handle elevated risk
CSFTs that may result in a violation of
law.
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
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).

PO 00000

Frm 00039

Fmt 4703

Sfmt 4703

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.
Reporting. A financial institution’s
policies and procedures should provide
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.
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: May 4, 2006.
John C. Dugan,
Comptroller of the Currency.
Dated: May 8, 2006.
By the Office of Thrift Supervision.
John M. Reich,
Director.
By order of the Board of Governors of the
Federal Reserve System, May 9, 2006.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, DC, the 9th day of
May, 2006.
By order of the Federal Deposit Insurance
Corporation.
Robert E. Feldman,
Executive Secretary.
Dated: May 9, 2006.
By the Securities and Exchange
Commission.
Nancy M. Morris,
Secretary.
[FR Doc. 06–4510 Filed 5–15–06; 8:45 am]
BILLING CODE 4810–33–P, 6720–01–P, 6210–01–P,
6714–10–P, 8010–01–P

E:\FR\FM\16MYN1.SGM

16MYN1