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Home > News & Events > Financial Institution Letters




Financial Institution Letters
 
[Federal Register: May 19, 2004 (Volume 69, Number 97)]
[Notices]               
[Page 28980-28991]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr19my04-107]                         


[[Page 28980]]

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

[Docket No. 04-12]

Office of Thrift Supervision

[No. 2004-27]

FEDERAL RESERVE SYSTEM

[Docket No. OP-1189]

FEDERAL DEPOSIT INSURANCE CORPORATION

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49695; File No. S7-22-04]

 
Interagency Statement on Sound Practices Concerning 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).

ACTION: Notice of interagency statement with request for public 
comment.

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SUMMARY: The OCC, OTS, Board, FDIC, and SEC (collectively, the 
Agencies) are requesting public comment on a proposed interagency 
statement concerning the complex structured finance activities of 
financial institutions (national and state banks; bank holding 
companies; federal and state savings associations; savings and loan 
holding companies; and SEC-registered broker-dealers and investment 
advisors) supervised by the Agencies. As recent events have 
highlighted, a financial institution may assume substantial 
reputational and legal risk if the institution enters into a complex 
structured finance transaction with a customer and the customer uses 
the transaction to circumvent regulatory or financial reporting 
requirements, evade tax liabilities, or further other illegal or 
improper behavior. The proposed interagency statement (Statement) 
describes the types of internal controls and risk management procedures 
that the Agencies believe are particularly effective in assisting 
financial institutions to identify and address the reputational, legal, 
and other risks associated with complex structured finance 
transactions. The Statement, among other things, provides that 
financial institutions should have effective policies and procedures in 
place to identify those complex structured finance transactions that 
may involve heightened reputational and legal risk, to ensure that 
these transactions receive enhanced scrutiny by the institution, and to 
ensure that the institution does not participate in illegal or 
inappropriate transactions.

DATES: Comments regarding the Statement should be received on or before 
June 18, 2004. Comments regarding the information collections contained 
in the Statement should be received on or before July 19, 2004.

ADDRESSES:
    OCC: You may submit comments, identified by Docket number 04-12 by 
any of the following methods:
    E-mail address: http://www.regs.comments@occ.treas.gov">http://www.regs.comments@occ.treas.gov.
    Fax: (202) 874-4448.
    Mail: Office of the Comptroller of the Currency, 250 E Street, SW., 
Public Reference Room, Mail Stop 1-5, Washington, DC 20219.
    Hand Delivery/Courier: 250 E Street, SW., Attn: Public Reference 
Room, MailStop 1-5, Washington, DC 20219. You may review the comments 
received by the OCC and other related materials by any of the following 
methods:
    Viewing Comments Personally: You may personally inspect and 
photocopy comments received at the OCC's Public Reference 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 copies of comments 
received for a particular docket via e-mail or CD-ROM by contacting the 
OCC's Public Reference Room at http://www.foia-pa@occ.treas.gov">http://www.foia-pa@occ.treas.gov.
    OTS: You may submit comments, identified by No. 2004-27, 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. 
2004-27 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. 2004-27.
     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. 2004-27.
    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-1189, 
by any of the following methods:
     Board's Web Site: http://www.federalreserve.gov Follow the instructions for submitting comments at http://.

http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.

     Federal eRulemaking Portal: http//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: 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, except as necessary 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

[[Page 28981]]

Building (located on F Street), on business days between 7:00 a.m. and 
5:00 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:
    Electronic comments:
     Use the Commission's Internet comment form (http://www.sec.gov/rules/policy
); or

     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-22-04 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov
). Follow the instructions for submitting comments.

    Paper comments:
     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number S7-22-04. 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). 

Comments are also available for public inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street, NW., 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, (202) 874-4660, Risk 
Evaluation, Grace E. Dailey, Deputy Comptroller, (202) 874-4610, Large 
Bank Supervision, Ellen Broadman, Director, (202) 874-5210, Securities 
and Corporate Practices Division, Office of the Comptroller of the 
Currency, 250 E Street, SW., Washington, DC 20219.
    OTS: John C. Price, Jr., Director, Supervision Policy, Examinations 
and Supervision Policy, (202) 906-5745; Debbie Merkle, Project Manager, 
Credit Risk, Supervision Policy, (202) 906-5688; David A. Permut, 
Senior Attorney, Business Transactions Division, (202) 906-7505, Office 
of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552.
    Board: Michael G. Martinson, Senior Adviser (202-452-3640), Walt H. 
Miles, Assistant Director (202) 452-5264, or Sabeth I. Siddique, 
Manager (202) 452-3861, Division of Banking Supervision and Regulation; 
or Kieran J. Fallon, Managing Senior Counsel (202) 452-5270, 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: William A. Stark, Associate Director, Capital Markets Branch, 
(202) 898-6972, Jason C. Cave, Chief, Policy Section, Capital Markets 
Branch, (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, or Juanita Bishop, 
Supervisory Accountant at (202) 942-7400, Office of Compliance 
Inspections and Examinations, or Catherine McGuire, Chief Counsel, 
Linda Stamp Sundberg, Attorney Fellow, or Randall W. Roy, Special 
Counsel, at (202) 942-0073, Division of Market Regulation, Securities 
and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-
1001.

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 the allocation of risk among borrowers and investors 
in more efficient ways. This innovation has led to the development of a 
wide array of structured finance products, including financial 
derivatives for market and credit risk, asset-backed securities with 
customized cash flow features, and specialized financial conduits that 
manage pools of purchased assets.
    National and state banks, bank holding companies, and SEC-
registered broker-dealers and investment advisers have played an active 
and important role in the development of structured finance products 
and markets. In this regard, financial institutions often play an 
important role in structuring, arranging or participating in complex 
structured finance transactions for their own use and to facilitate the 
needs of customers.
    As financial intermediaries, financial institutions play a critical 
role in ensuring the integrity of financial markets and maintaining the 
trust and public confidence essential to the proper functioning of the 
capital markets. In the vast majority of cases, structured finance 
products and the role played by financial institutions with respect to 
these products have served the legitimate business purposes of 
customers. This has allowed structured finance products to become an 
essential part of U.S. and international capital markets.
    The more complex variations of structured finance products, 
however, have placed pressure on the interpretations of accounting and 
tax rules, and, in turn, have given rise to significant concerns about 
the legality and appropriateness of certain individual transactions. 
Importantly, a limited number of complex structured finance 
transactions appear to have been used to alter the appearance of a 
customer's public financial statements in ways that are not consistent 
with the economic reality of the transactions or to inappropriately 
reduce a customer's tax liabilities. In the most extreme cases, 
structured finance transactions appear to have been used in fraudulent 
schemes to misrepresent the financial condition of public companies or 
evade taxes.
    Financial institutions must conduct their operations in compliance 
with applicable law and regulations, and institutions that do not may 
be subject to enforcement actions by the Agencies and lawsuits by 
private parties. As recent events have highlighted, financial 
institutions may face substantial legal risk to the extent they 
participate in complex structured finance transactions that are used by 
customers to circumvent regulatory or financial reporting requirements, 
evade tax liabilities, or further other illegal or improper behavior by 
the customer. Involvement in such transactions also may damage an 
institution's reputation and franchise value. Reputational risk poses a 
major threat to financial institutions because the nature of their 
business requires maintaining the confidence of customers, creditors, 
and the general marketplace. Importantly, reputational risks may arise 
even where the transactions involved are structured to technically 
comply with existing laws and regulations.
    The events associated with Enron Corp. demonstrate the potential 
for the abusive use of complex structured finance transactions, as well 
as the substantial legal and reputational risks that financial 
institutions face when they participate in complex structured finance 
transactions that are designed or used for improper purposes. After 
conducting investigations, the OCC, Federal Reserve System, and the SEC 
took strong and coordinated civil and

[[Page 28982]]

administrative enforcement actions against certain financial 
institutions that participated in complex structured finance 
transactions with Enron Corp. that appeared to have been designed or 
used to shield the company's true financial health from the public.\1\ 
These actions involved significant financial penalties on the 
institutions and required the institutions to take several measures to 
strengthen their risk management practices for complex structured 
finance activities. The structured finance relationships between some 
financial institutions and Enron Corp. also sparked an investigation by 
the Permanent Subcommittee on Investigations of the U.S. Senate 
Committee on Governmental Affairs,\2\ as well as numerous lawsuits by 
private litigants.
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    \1\ See 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 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.).
    \2\ 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).
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    The Agencies have long expected financial institutions to develop 
and maintain robust control infrastructures enabling them fully to 
identify, evaluate and control all dimensions of risk associated with 
their business activities. In the area of complex structured finance 
transactions, it is critical that financial institutions have effective 
risk management and internal controls to ensure that the institutions' 
activities comply with the law and that all of the risks associated 
with a transaction--including legal and reputational risks--are 
identified and appropriately addressed.
    In light of recent events, the OCC, Board, and SEC conducted 
special reviews of several banking and securities firms that are 
significant participants in the market for complex structured finance 
products. These reviews were designed to evaluate the 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 complex structured finance transactions. 
These assessments indicated that many financial institutions have 
already taken meaningful steps to improve their control infrastructures 
relating to complex structured finance products in light of the control 
weaknesses evidenced by recent events. The Agencies also have focused 
attention on the complex structured finance activities of financial 
institutions in the normal course of our supervisory process.

II. Proposed Statement on Sound Practices Concerning the Complex 
Structured Finance Activities of Financial Institutions

    In order to help ensure that financial institutions have and 
maintain adequate control infrastructures for complex structured 
finance transactions, the Agencies have developed, and are seeking 
public comment on, the attached Statement included at the end of this 
notice.\3\ The Statement describes a number of internal controls and 
risk management procedures that the Agencies believe are particularly 
useful in assisting financial institutions to ensure that their complex 
structured financial activities are conducted in accordance with 
applicable law and that institutions effectively manage the full range 
of risks associated with these activities, including legal and 
reputational risks. The Statement reflects the ``lessons learned'' from 
recent events, as well as what the Agencies believe to be sound 
practices in this area based on supervisory reviews and experience. 
Financial institutions should consider the Statement in developing and 
evaluating the institution's risk controls for complex structured 
finance activities. The following provides a brief overview of the key 
aspects of the Statement.
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    \3\ For institutions supervised by the Board, the OCC, the OTS, 
and the FDIC the statement will represent supervisory guidance. For 
institutions registered with the SEC, the statement will represent a 
policy statement.
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    As a general matter, the Statement indicates that financial 
institutions offering complex structured finance transactions should 
maintain a comprehensive set of formal, firm-wide policies and 
procedures that provide for the identification, documentation, 
evaluation, and control of the full range of credit, market, 
operational, legal, and reputational risks that may be associated with 
these transactions. These policies and procedures should be designed to 
ensure that the financial institution consistently and appropriately 
manages its complex structured finance activities on both a per 
transaction and relationship basis, with all customers (including 
corporate entities, government entities, and individuals) and in all 
jurisdictions where the financial institution operates.
    The board of directors of a financial institution has ultimate 
responsibility for establishing the institution's risk tolerances for 
complex structured finance transactions and ensuring that a 
sufficiently strong risk control framework is in place to guide the 
actions of the financial institution's personnel. The board of 
directors and senior management also should send a strong message to 
others in the financial institution about the importance of integrity, 
compliance with the law, and overall good business ethics, which may be 
implemented through a Code of Professional Conduct.
     As described further in the Statement, an institution's 
policies and procedures should define what constitutes a complex 
structured finance transaction and should, among other things--
     Define the process that financial institution personnel 
must follow to obtain approval for complex structured finance 
transactions;
     Establish a control process for the approval of all new 
complex structured finance products;
     Ensure that the reputational and legal risks associated 
with a complex structured finance transaction, or series of 
transactions, are identified and evaluated in both the transaction and 
new product approval process and appropriately managed by the 
institution;
     Ensure that financial institution staff appropriately 
reviews and documents the customers' proposed accounting treatment of 
complex structured finance transactions, financial disclosures relating 
to the transactions, and business objectives for entering into the 
transactions;
     Provide for the generation, collection and retention of 
appropriate documentation relating to all complex structured finance 
transactions;
     Ensure that senior management and the board of directors 
of the institution receive appropriate and timely reports concerning 
the institution s complex structured finance activities;
     Provide for periodic independent reviews of the 
institution's complex structured finance activities to ensure that the 
institution's policies and controls are being implemented effectively 
and to identify potential compliance issues;

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     Ensure effective internal audit coverage of the 
institution's complex structured finance activities; and
     Ensure that financial institution personnel receive 
appropriate training concerning the institution's policies and 
procedures governing its complex structured finance activities.
    An institution should establish a clear process for identifying 
those complex structured finance transactions that involve heightened 
legal and reputational risks. Once a transaction is identified as 
involving potentially heightened legal or reputational risk, the 
institution should ensure that these transactions receive an elevated 
and thorough review. If, after conducting this review, the financial 
institution determines that a proposed transaction may result in the 
customer filing materially misleading financial statements, the 
financial institution should decline to participate in the transaction, 
condition its participation upon the customer making express and 
accurate disclosures regarding the nature and financial impact of the 
transaction on the customer's financial condition, or take other steps 
to ensure that the financial institution does not participate in an 
inappropriate transaction.
    The Statement includes examples of characteristics that may 
indicate that a transaction or series of transactions involves elevated 
levels of legal or reputational risk and, thus, should be subject to 
heightened review by the institution. The examples included in the 
Statement are not exclusive and institutions may differ in the sets of 
characteristics they use in identifying transactions that may involve 
heightened risks. Institutions, however, should be conservative when 
establishing these characteristics and the ultimate goals of all 
institutions should remain the same--to identify those transactions 
that require additional scrutiny at inception and to ensure that 
transactions receive a level of review that is commensurate with the 
legal and reputational risks associated with the transaction.
    Because the Statement discusses sound practices related to complex 
structured finance activities--activities that typically are conducted 
only by larger financial institutions--the Statement would not be 
relevant and, therefore, would not apply to most small institutions. 
Moreover, an institution's policies and procedures concerning complex 
structured finance activities should be tailored to, and appropriate in 
light of, the institution's size and the nature, scope, and risk of its 
complex structured finance activities.
    The Agencies request comment on all aspects of the Statement and 
will revise the Statement as appropriate after a review of public 
comments.

III. Paperwork Reduction Act

    The Board, the FDIC, the OTS, and the OCC have determined that the 
Statement, which will represent supervisory guidance for institutions 
supervised by the Board, the FDIC, the OTS, and the OCC, contains 
collections of information for purposes of the Paperwork Reduction Act 
of 1995 (44 U.S.C. Ch. 35). The OCC, the FDIC, the OTS, and Board 
request public comment on all aspects of the collections of information 
contained in the Statement. Also, the OCC, FDIC, OTS, and Board request 
comment on whether institutions involved in complex structured finance 
transactions currently are in compliance with the Statement and the 
information collections therein.
    The OCC, FDIC, OTS, and Board also invite comment on:
    (1) Whether the collections of information contained in the 
Statement are necessary for the proper performance of each agency's 
functions, including whether the information has practical utility;
    (2) The accuracy of each agency's estimate of the burden of the 
proposed information collections;
    (3) Ways to enhance the quality, utility, and clarity of the 
information to be collected;
    (4) Ways to minimize the burden of the information collections on 
respondents, including the use of automated collection techniques or 
other forms of information technology; and
    (5) Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchases of services to provide information.
    Respondents/record keepers are not required to respond to these 
collections of information unless the Board, the FDIC, the OTS, and OCC 
display a currently valid Office of Management and Budget (OMB) control 
number. The OCC, FDIC, and OTS currently are requesting approval of 
these information collections from OMB, and the Board is processing 
this collection under its delegated authority.
    The OCC, FDIC, OTS, and Board estimates of the total annual burden 
of the collections of information contained in the Statement on the 
financial institutions they supervise follow.
    OCC: The collection of information requirements contained in the 
Statement will be submitted to the OMB in accordance with the Paperwork 
Reduction Act of 1995 (44 U.S.C. Ch. 35). The OCC will use any comments 
received to evaluate the collections and verify its burden estimates. 
The OCC believes that only the largest national banks and U.S. branches 
of foreign banks are involved in these activities. Further, as a matter 
of usual and customary business practice and in light of recent events, 
involved institutions already have installed policies and procedures 
similar to those envisioned in the Statement. However, institutions 
will have to verify and update their policies and procedures 
periodically to ensure that they are adequate and current.
    Comments on the collections of information should be sent to John 
Ference or Camille Dixon, Office of the Comptroller of the Currency, 
250 E Street, SW., Mail Stop 8-4, Attention: Docket Number 04-12 (1557-
CSFA), Washington, DC 20219. You may also send comments by electronic 
mail to camille.dixon@occ.treas.gov. You should also send a copy of 
your comments to OMB Desk Officer, Mark Menchik, Office of Information 
and Regulatory Affairs, Office of Management and Budget, Paperwork 
Reduction Project (1557-CSFA), Washington, DC 20503. Alternatively, you 
may e-mail your comments to mmenchik@omb.eop.gov, or fax them to (202) 
395-6974.
    The potential respondents are the largest national banks and U.S. 
branches of foreign banks.
    Estimated number of respondents: 21.
    Estimated average annual burden hours per respondent: 100 hours.
    Estimated total annual burden: 2,100 burden hours.
    FDIC: The collection of information requirements contained in the 
Statement will be submitted to the OMB in accordance with the Paperwork 
Reduction Act of 1995 (44 U.S.C. Ch. 35). The FDIC will use any 
comments received to evaluate the collections and verify its burden 
estimates. The FDIC believes that only the largest state nonmember 
banks are involved in these activities. Further, as a matter of usual 
and customary business practice and in light of recent events, involved 
institutions already have installed policies and procedures similar to 
those envisioned in the Statement. However, institutions will have to 
verify and update their policies and procedures periodically to ensure 
that they are adequate and current.
    Comments on the collections of information should be sent to Thomas 
Nixon, Legal Division, Federal Deposit

[[Page 28984]]

Insurance Corporation, 550 17th Street NW., Washington, DC 20429. 
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. Comments should also be submitted to the OMB desk 
officer for the FDIC: Mark Menchik, Office of Information and 
Regulatory Affairs, Office of Management and Budget, New Executive 
Office Building, Washington, DC 20503. Alternatively, you may e-mail 
your comments to mmenchik@omb.eop.gov, or fax them to (202) 395-6974.
    The potential respondents are the largest state nonmember banks.
    Estimated number of respondents: 5.
    Estimated average annual burden hours per respondent: 100 hours.
    Estimated total annual burden: 500 burden hours.
    OTS: The collection of information requirements contained in the 
Statement will be submitted to OMB in accordance with the Paperwork 
Reduction Act of 1995 (44 U.S.C. Ch. 35). OTS will use any comments 
received to evaluate the collections and verify its burden estimates. 
The OTS assumes that only the largest savings associations and savings 
and loan holding companies could be involved in these activities. 
Further, as a matter of usual and customary business practice and in 
light of recent events, involved institutions already have installed 
policies and procedures similar to those envisioned in the Statement. 
However, institutions will have to verify and update their policies and 
procedures periodically to ensure that they are adequate and current.
    Send comments, referring to the collection by title of the 
proposal, to 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 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 publicinfo@ots.treas.gov, or send a 
facsimile transmission to (202) 906-7755. You should also send a copy 
of your comments to OMB Desk Officer, Mark Menchik, Office of 
Information and Regulatory Affairs, Office of Management and Budget, 
Paperwork Reduction Project (1550-NEW), Washington, DC 20503. 
Alternatively, you may e-mail your comments to mmenchik@omb.eop.gov, or 
fax them to (202) 395-6974.
    The potential respondents are the largest savings associations and 
savings and loan holding companies.
    Estimated number of respondents: 5.
    Estimated average annual burden hours per respondent: 100 hours.
    Estimated total annual burden: 500 burden hours.
    Board: In accordance with section 3506 of the Paperwork Reduction 
Act of 1995 (44 U.S.C. Ch. 35; 5 CFR 1320, appendix A.1), the Board 
reviewed the Statement under the authority delegated to the Board by 
the OMB. The Board believes that only the largest state member banks, 
bank holding companies, and U.S. branches and agencies of foreign banks 
are involved in complex structured finance activities. Further, as a 
matter of usual and customary business practice and in light of recent 
events, involved institutions already have adopted policies and 
procedures similar to those envisioned in the Statement. However, the 
institutions will have to verify and update their policies and 
procedures periodically to ensure that they are adequate and current.
    Comments on the collections of information should be sent to 
Michelle Long, Acting Federal Reserve Board Clearance Officer, Division 
of Research and Statistics, Mail Stop 41, Board of Governors of the 
Federal Reserve System, Washington, DC 20551. You should also send a 
copy of your comments to OMB Desk Officer, Mark Menchik, Office of 
Information and Regulatory Affairs, Office of Management and Budget, 
Paperwork Reduction Project (1557--To Be Determined), Washington, DC 
20503. Alternatively, you may e-mail your comments to 
mmenchik@omb.eop.gov, or fax them to (202) 395-6974.

    The potential respondents are the largest state member banks, bank 
holding companies, and U. S. branches and agencies of foreign banks.
    Estimated number of respondents: 20.
    Estimated average annual burden hours per respondent: 100 hours.
    Estimated total annual burden: 2,000 hours.
    The proposed Statement follows.

Interagency Statement on Sound Practices Concerning 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 purchased 
assets, along with other structured transactions have usually served 
the legitimate business purposes of the customers of financial 
institutions and are an essential part of U.S. and international 
capital markets.
    Financial institutions have played an active and important role in 
the development of structured finance products and markets. Structured 
finance transactions are often employed to manage risk or for other 
legitimate business purposes, such as diversifying risks, allocating 
cash flows, and reducing cost of capital. The more complex variations 
of selected structured finance transactions have, however, placed 
pressure on the interpretations of accounting and tax rules, and this 
has given rise to significant concerns about the risks associated with 
certain individual transactions. More so, a limited number of 
transactions appear to have been used primarily to alter the appearance 
of a customer's public financial statements in ways that are not 
consistent with the economic reality of the transactions or to 
inappropriately reduce a customer's tax liabilities. In the most 
extreme cases, structured finance transactions appear to have been used 
in fraudulent schemes primarily to misrepresent the financial condition 
of public companies or evade taxes. Some financial institutions have 
been subject to criminal sanctions, and civil and administrative 
enforcement actions by the regulatory agencies, for participating in 
complex structured finance transactions used by a public company in 
reporting false or misleading financial statements.
    Financial institutions are in a unique position given their role in 
structuring, arranging or participating in complex structured finance 
transactions for their own use and to facilitate the needs of their 
customers. When a financial institution provides advice on, arranges or 
actively participates in a complex structured finance transaction, it 
assumes the usual market, credit, and operational risks and also may 
assume substantial reputational and legal risk to the extent that an 
end-user enters into the transaction for improper purposes. Considering 
the inherent complexity of many structured finance transactions and the 
many risks associated with these transactions, it is critical that

[[Page 28985]]

financial institutions have effective risk management and internal 
controls relating to these products to ensure compliance with the law 
and to effectively monitor and control the risks associated with these 
transactions. Financial institutions may not engage in complex 
structured finance transactions in violation of the law and 
institutions that violate the law may be subject to enforcement action 
and civil or criminal penalties.
    The regulatory agencies have long expected financial institutions 
to develop and maintain robust control infrastructures enabling them to 
fully identify, evaluate and control all dimensions of risk associated 
with their business activities. In the wake of recent developments, 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 U.S. Securities and 
Exchange Commission are issuing this guidance to financial institutions 
that we supervise (``financial institutions'' or ``institutions'')\1\ 
to describe a number of internal controls and risk management 
procedures that we believe are useful to effectively manage the risks 
associated with complex structured finance transactions.
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    \1\ These institutions are 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 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 Federal 
Reserve Board, the Office of the Comptroller, and the Federal 
Deposit Insurance Corporation also are considered to be financial 
institutions for purposes of this guidance.
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    Because many of the core elements of an effective control 
infrastructure are the same regardless of the business line involved, 
this guidance draws heavily on controls and procedures that our 
agencies previously have found to be effective in managing and 
controlling risks and identifies ways in which these controls and 
procedures can effectively be applied to the institution's complex 
structured finance activities. Financial institutions should consider 
this guidance in developing, or evaluating existing, risk controls for 
complex structured finance activities. These risk controls should 
supplement the financial institution's more general internal controls 
and risk management systems, as appropriate.

II. Definition and Key Risks of Complex Structured Finance Transactions

    Structured finance transactions encompass a broad array of products 
with varying levels of complexity. This guidance addresses complex 
structured finance transactions, which usually share several common 
characteristics. First, they typically result in a final product that 
is often non-standard and structured to meet the specific financial 
objectives of a customer. Second, they often involve professionals from 
multiple disciplines within the financial institution and may have 
significant fees or high returns in relation to the market and credit 
risks associated with the transaction. Third, they may be associated 
with the creation or use of one or more special purpose entities (SPEs) 
designed to address the economic, legal, tax or accounting objectives 
of the customer and/or the combination of cash and derivative products. 
Finally, and perhaps most importantly, they may expose the financial 
institution to elevated levels of market, credit, operational, legal or 
reputational risks. These criteria are not exclusive and institutions 
should supplement or modify these criteria as appropriate to reflect 
the institution's business activities and changes in the marketplace.
    Financial risks include, among other things, market and credit 
risks. Due to their inherent complexity, financial institutions 
participating in complex structured finance transactions also may face 
heightened reputational or legal risk. Financial institutions have been 
sued due to their involvement in complex structured finance 
transactions that allegedly facilitated the deceptive accounting or 
financial reporting practices of certain public companies. Legal risk 
also may arise in other situations if the financial institution is 
involved in transactions that are used by customers to circumvent 
regulatory or financial reporting requirements, evade tax liabilities, 
or further other illegal or improper behavior by the customer. \2\ 
Besides creating legal risks, these transactions may create substantial 
reputational risk for the institution. Reputational risk poses a major 
threat to financial institutions because the nature of their business 
requires maintaining the confidence of customers, creditors and the 
general marketplace. Importantly, reputational risks may arise even 
where the transactions involved are structured to technically comply 
with existing laws and regulations and accounting standards.
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    \2\ For additional guidance concerning when a financial 
institution's participation in a complex structured finance 
transaction may violate the Federal securities laws, and the bases 
for such potential liability, 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.gov).

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    Accordingly, financial institutions need to have strong controls to 
ensure that their actions with respect to complex structured finance 
transactions--including structuring, marketing, sales, funding and 
trading activities--are conducted in accordance with applicable laws 
and regulations, and to ensure that the institution identifies and 
appropriately addresses the potential reputational risks involved in 
these transactions. As discussed further under ``Reputational and Legal 
Risk,'' an institution's policies and procedures should identify those 
complex structured finance transactions that may warrant enhanced 
scrutiny due to factors related specifically to reputational and legal 
risk.
    Although the foregoing (and this document more generally) 
highlights some of the most significant risks associated with complex 
structured finance transactions, it is not intended to present a full 
exposition of the risks associated with these transactions. Financial 
institutions are encouraged to refer to other supervisory information 
prepared by the agencies for further information concerning market, 
credit, operational, legal and reputational risks.

III. Guidelines for Incorporating Structured Finance Transactions Into 
Existing Management Procedures, Controls and Systems

Role of Board and Management

    The board of directors (the Board) of a financial institution is 
elected by and accountable to shareholders, and is the focal point of 
the corporate governance system. Effective oversight by the boards of 
directors of public institutions is fundamental to preserving the 
integrity of capital markets. The board of directors, in its oversight 
role, is ultimately responsible for the financial well being of the 
institutions they oversee, as well as ensuring that the risks 
associated with the firm's business activities, including those 
activities associated with the offering and delivery of complex 
structured finance transactions, are appropriately identified, 
evaluated and controlled by management. The Board should establish the 
financial institution's threshold for the risks associated with complex 
structured finance products and ensure that a sufficiently strong risk

[[Page 28986]]

control framework is in place to guide the actions of the financial 
institution's personnel. The Board should ensure that the financial 
institution has a risk control framework for complex structured finance 
transactions that includes comprehensive policies that address the 
elements described below.
    Using guidance provided by the Board, senior management should 
implement a risk control framework for complex structured finance 
transactions that includes comprehensive policies, defined roles and 
responsibilities and approval authorities, detailed management 
reporting, required documentation, and ongoing independent monitoring 
and testing of policy compliance. In order to manage the risks 
associated with complex structured finance transactions, some 
institutions have established a senior management committee that is 
designed to ensure that all of the relevant control functions within 
the financial institution, including independent risk management, 
accounting policy, legal, and financial control, are involved in the 
oversight of complex structured finance transactions. The goal of such 
a senior-level risk control committee is to ensure that those complex 
structured finance activities that may expose the financial institution 
to higher levels of financial, legal and reputational risk are 
comprehensively and consistently managed and controlled on a company-
wide basis. This senior management committee regularly reviews trends 
in new products and complex structured transaction activity, including 
overall risk exposures from such transactions, and typically provides 
final approval of the most complicated or controversial complex 
structured finance transactions. The agencies believe that such a 
senior-level committee can serve as an important part of an effective 
control infrastructure for complex structured finance activities.\3\
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    \3\ Financial institutions should ensure that the control 
processes established for complex structured finance activities 
comply with any informational barriers established by the 
institution to manage potential conflicts of interest, insider 
trading or other concerns.
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    The Board and senior management also should send a strong message 
to others in the financial institution about the importance of 
integrity, compliance with the law, and overall good business ethics, 
which may be implemented through a Code of Professional Conduct. The 
Board and senior management should strive to create a firm-wide 
corporate culture that is sensitive to ethical issues as well as the 
potential risks to the financial institution. The financial 
institution's culture and procedures should encourage personnel to 
elevate ethical concerns regarding a complex structured finance 
transaction or series of transactions to appropriate levels of 
management. Establishing a culture that encourages financial 
institution personnel to elevate concerns to appropriate levels of 
management may require mechanisms to protect personnel by permitting 
confidential disclosure in appropriate circumstances.\4\ Additionally, 
the Board and senior management should ensure that incentive plans are 
not structured in a way that encourages transactors to cross ethical 
boundaries when executing complex structured finance transactions.
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    \4\ 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).
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Policies and Procedures

    Financial institutions offering complex structured finance 
transactions should maintain a comprehensive set of formal, firm-wide 
policies and procedures that provide for the identification, 
documentation, evaluation, and control of the full range of credit, 
market, operational, legal, and reputational risks that may be 
associated with these transactions. These policies should start with 
the financial institution's definition of what constitutes a complex 
structured finance transaction and be designed to ensure that the 
financial institution appropriately manages its complex structured 
finance activities on both an individual transaction and a relationship 
basis, with all customers (including corporate entities, government 
entities and individuals) and in all jurisdictions where the financial 
institution operates.\5\ These policies may be developed specifically 
for complex structured finance transactions or included in the set of 
broader policies governing the institution generally.
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    \5\ In the case of U.S. branches and agencies of foreign banks, 
these policies should be coordinated with the group-wide policies 
developed in accordance with the rules of the foreign bank's home 
supervisor.
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    To be most effective, the institution's policies and procedures 
relating to complex structured finance transactions should specifically 
set forth the particular responsibilities of the personnel involved in 
the origination, structuring, trading, review, approval, documentation, 
verification, and execution of these transactions. Accordingly, these 
policies and procedures should address responsibilities of personnel 
from sales and trading, relationship management, market risk, credit 
risk, operations, accounting, legal, compliance, audit and senior line 
management. The financial institution's policies and procedures should 
provide a clear framework for the approval and monitoring of complex 
structured finance transactions. Policies for relevant personnel should 
describe responsibilities for working with relationship managers, 
advising and counseling customers, disclosing information to customers, 
and providing relevant information to control areas.
    The institution's policies should ensure that the market, credit, 
and operational risk associated with individual complex structured 
transactions are appropriately identified, aggregated, and managed. A 
financial institution should, at a minimum, also have procedures, 
controls and systems for complex structured finance activities that 
address the following: (1) Transaction approval, (2) new product 
approval, (3) reputational and legal risk, (4) accounting and 
disclosure by the customer, (5) documentation, (6) reporting, (7) 
independent monitoring, analysis and compliance with internal policies, 
(8) audit, and (9) training.
Transaction Approval
    The policies and procedures of a financial institution should 
define the process that personnel must follow to obtain approval for a 
complex structured finance transaction. Policies for approving complex 
structured finance transactions should clearly articulate the roles and 
responsibilities of both transactors (e.g. personnel from origination, 
structuring, execution, sales and trading areas) and independent 
control staff (e.g. personnel from risk management, accounting policy, 
legal, and financial control) in analyzing, approving, and documenting 
proposed transactions. Policies should guide front office personnel in 
meeting their responsibilities to provide information on customer 
objectives and key risk issues (including those described below) to the 
appropriate approving personnel. Furthermore, it is imperative that the 
approving authority includes representatives from appropriate control 
areas that are independent of the transactors. Approving personnel 
should have appropriate experience and stature in the financial 
institution to ensure proper consideration of elements or factors that 
may expose the institution to higher levels of credit, market, 
operational, legal or

[[Page 28987]]

reputational risk. While acknowledging its ultimate responsibility for 
the approval of complex structured finance transactions, the 
organization's policies also should clearly outline when third-party 
legal professionals should be engaged to review and opine on 
transactions, and when third-party accounting or tax professionals 
should be engaged to consult on transactions.
New Product Policies
    Complex structured finance transactions also should be incorporated 
into a financial institution's new product policies. In this regard, a 
financial institution's policies should include a definition of what 
constitutes a ``new'' complex structured finance product and should 
establish a control process for the approval of each new product. In 
determining whether or not a complex structured finance transaction is 
``new,'' a financial institution should consider a variety of factors, 
including any structural variations from existing products, whether the 
product is targeted at a new class of customers, pricing variations 
from existing products, whether the product raises additional or new 
legal, compliance or regulatory issues, and deviations from standard 
market practices. When in doubt as to whether a complex structured 
finance transaction requires vetting through the new product approval 
process, financial institution personnel should err on the side of 
conservatism and route the proposed product through the process 
dictated in the new product approval policy. The new product policies 
for complex structured finance activities should address the roles and 
responsibilities of all relevant parties, including the front office, 
credit risk, market risk, operations, accounting, legal, compliance, 
audit and senior line management. In addition, it is imperative that 
the institution's policies require that new products receive the 
approval of all relevant control areas that are independent of the 
profit center before the product is offered to customers.
    A financial institution also should have in place controls that are 
designed to ensure that new complex structured finance products are, in 
fact, subjected to the institution's established approval process. 
Moreover, subsequent to the new product approval, the financial 
institution should monitor new complex structured finance products to 
ensure that they are effectively incorporated into the institution's 
risk control systems.

Reputational and Legal Risk

    The policies and procedures established by a financial institution 
for complex structured finance activities should ensure that the legal 
and reputational risks associated with a transaction, or series of 
transactions, are identified and evaluated in both the transaction and 
new product approval processes and effectively and appropriately 
managed by the institution. A financial institution should have 
effective policies, procedures and controls for assessing the 
customer's business objectives for entering into a transaction or 
series of transactions and the economic substance of the 
transaction(s), evaluating the appropriateness of the transaction(s), 
and preventing the financial institution from participating in 
inappropriate transactions.
    Policies should ensure that the customer understands the risk and 
return profile of the transaction. In instances where the financial 
institution is designing the transaction and advising the customer, the 
disclosures to the customer should include an adequate description of 
the risks in the complex structured finance transaction as well as 
disclosure of any conflicts of interest associated with the financial 
institution's participation in the transaction. Policies should also 
articulate when a proposed transaction requires acknowledgement by the 
customer that the transaction has been reviewed and approved by higher 
levels of the customer's management. Notwithstanding a customer's 
sophistication and structure of a complex structured finance 
transaction, the financial institution should evaluate the impact a 
transaction may have on the financial institution's reputation or 
franchise value.
    Policies should outline responsibilities of the sales force, front 
office, credit and other risk control personnel for analyzing and 
documenting the customer's objectives and customer-related accounting, 
regulatory, or tax issues. In addition, a financial institution's 
policies and procedures should establish criteria or factors for when 
concerns related to a particular structured finance transaction will 
necessitate a comprehensive evaluation of the institution's entire 
relationship with a customer.
    Policies should ensure that complex structured finance transactions 
are reviewed on a consistent basis by the financial institution's legal 
department and, where appropriate, by independent outside counsel. In 
general, the financial institution's legal department should review 
complex structured finance transactions as part of the approval 
process. Legal personnel may be assigned to business units or areas 
where complex structured transactions originate to ensure the legal 
department's involvement throughout the transaction's development, or 
financial institutions may assign specific legal personnel to each 
complex structured finance transaction. Independent monitoring by a 
risk control group or compliance unit should ensure that all complex 
structured transactions receive appropriate legal review, including 
review by outside counsel where appropriate.
    Areas for legal review include financial institution 
permissibility, disclosure by the customer, regulatory capital 
requirements, the enforceability of any netting and collateral 
agreements associated with the transaction, suitability or 
appropriateness assessments, customer assurances, insurance 
considerations and tax issues. Because transactions may involve 
multiple counterparties located in different jurisdictions, the 
financial institution should establish review and documentation 
procedures that are designed to ensure that each counterparty has the 
authority to enter into the transaction and that each counterparty's 
obligations are reduced to legally enforceable contracts. Financial 
institutions should ensure that any legal reviews are conducted by 
qualified in-house or outside counsel and that these professionals are 
provided the documentation and other information needed to properly 
evaluate the transaction.
    Careful evaluations of the consequences of a transaction are 
particularly important when the transaction is designed to achieve a 
customer's financial reporting or complex tax objectives. Policies 
should clearly define the types of circumstances where the approval of 
transactions or patterns of transactions should be elevated to higher 
levels of financial institution management for reasons specific to 
legal or reputational risk. In creating procedures for elevating 
certain transactions to higher levels, financial institutions should 
identify the characteristics of those transactions, or series of 
transactions, that increase reputational and legal risk. Institutions 
should be conservative when identifying these characteristics. While 
institutions may differ in the sets of characteristics they identify, 
the goals should remain the same--to identify the transactions that 
require additional scrutiny at inception and to ensure that 
transactions receive a level of review

[[Page 28988]]

that is commensurate with the legal and reputational risks associated 
with the transaction. Examples of characteristics that should be 
considered in determining whether or not a transaction or series of 
transactions might need additional scrutiny include:
     Transactions with questionable economic substance or 
business purpose or designed primarily to exploit accounting, 
regulatory or tax guidelines), (particularly when executed at year end 
or at the end of a reporting period);
     Transactions that require an equity capital commitment 
from the financial institution;
     Transactions with terms inconsistent with market norms 
(e.g., deep ``in the money'' options, non-standard settlement dates, 
non-standard forward-rate rolls);
     Transactions using non-standard legal agreements (e.g., 
customer insists on using its own documents that deviate from market 
norms);
     Transactions involving multiple obligors or otherwise 
lacking transparency (e.g., use of SPEs or limited partnerships);
     Transactions with unusual profits or losses or 
transactions that give rise to compensation that appears 
disproportionate to the services provided or to the risk assumed by the 
institution;
     Transactions that raise concerns about how the client will 
report or disclose the transaction (e.g., derivatives with a funding 
component, restructuring trades with mark to market losses);
     Transactions with unusually short time horizons or 
potentially circular transfers of risk (either between the financial 
institution and customer or between the customer and other related 
parties);
     Transactions with oral or undocumented agreements, which, 
if documented, could have material legal, reputational, financial 
accounting, financial disclosure, or tax implications; \6\
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    \6\ This item is not intended to include traditional, non-
binding ``comfort'' letters 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 subsidiary) is an 
integral and important part of the parent's operations.
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     Transactions that cross multiple geographic or regulatory 
jurisdictions, making processing and oversight difficult;
     Transactions that cannot be processed via established 
operations systems; and
     Transactions with significant leverage.
    Having developed a process to identify transactions that may pose 
higher levels of legal and reputational risk, financial institutions 
should implement procedures to address these risks. These procedures 
should, among other things:
     Ensure that staff approving each transaction fully 
understands the scope of the institution's relationship with the 
customer and has evaluated and documented the customer's business 
objectives for entering into the transaction, the economic substance of 
the transaction, and the potential legal and reputational risks to the 
financial institution;
     Ensure a thorough review and evaluation of whether credit 
exceptions, accounting issues, rating agency disclosures, law suits 
against the customer, or other factors expose the financial institution 
to unwarranted legal or reputational risks;
     Develop and implement effective internal communication 
procedures to ensure that all financial institution personnel 
responsible for transaction approval and monitoring receive, and 
document in a timely manner, complete and accurate information about 
the transaction, the customer's purpose(s) for entering into the 
particular transaction, and the materiality of the transaction to the 
customer;
     Ensure sufficient time is allowed for a detailed, thorough 
review of the transaction by the relevant personnel;
     Ensure that complex structured finance transactions 
identified as having heightened risks receive a thorough review by 
senior management for an evaluation of credit, market, operation, legal 
and reputational risks to the financial institution;
     Ensure that complex structured finance transactions that 
are determined to present unacceptable risk to the financial 
institution are declined;
     Ensure that the Board and senior management periodically 
assess the financial institution's tolerance for risks associated with 
complex structured finance transactions; and
     Ensure that the institution provides the customer with 
appropriate information concerning the structure and risks of the 
transaction, and articulate when a proposed transaction requires 
acknowledgement of review by higher levels of a customer's management.
Accounting and Disclosure by Customers
    As noted above, transactions designed primarily to achieve 
financial reporting or complex tax objectives may require greater 
scrutiny due to possible legal and reputational risk implications. For 
transactions identified as involving elevated risks, the financial 
institution's procedures should ensure that staff approving the 
transactions obtain and document complete and accurate information 
about the customer's proposed accounting treatment of the transaction, 
financial disclosures relating to the transaction, as well as the 
customer's objectives for entering into the transaction. The 
institution's policies should ensure that this information is assessed 
by appropriate personnel in the approval process and that these 
personnel consider the information in light of financial, accounting, 
rating agency disclosure, or other information associated with the 
transaction that may raise legal or reputational risks for the 
financial institution.
    The financial institution's policies also should address when third 
party accounting professionals should be engaged to review 
transactions. Moreover, there may be circumstances where the financial 
institution or the third-party accounting professionals it engages will 
wish to communicate directly with the customer's independent auditors 
to discuss the transaction. Independent monitoring of the approval 
process (discussed below) should ensure that personnel adhere to 
established requirements for obtaining a review by third party 
accountants or communicating with the customer's independent auditor.
    In any instance where the financial institution determines that a 
proposed transaction may result in the customer filing materially 
misleading financial statements, the financial institution should take 
appropriate actions. Such actions may include declining to participate 
in the transaction or conditioning its participation upon the customer 
making express and accurate disclosures regarding the nature and 
financial impact of the transaction on the customer's financial 
condition. The ultimate objective is to take steps to ensure that the 
financial institution does not participate in an inappropriate 
transaction. As part of this process, financial institutions should 
consider seeking representations and warranties from the customer 
stating the purpose of the transaction, how the customer will account 
for the transaction, and that the customer will account for the 
transaction in accordance with applicable accounting standards, 
consistently applied.\7\
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    \7\ Of course, financial institutions also should ensure that 
the institution's own accounting for transactions complies with 
applicable accounting standards, consistently applied.

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[[Page 28989]]

    The financial institution also should develop procedures to address 
the creation, acquisition, and use of institution and client-sponsored 
SPEs. When a structured transaction requires the establishment of such 
an entity, the financial institution should implement an SPE approval 
process that permits the risk control groups to evaluate the 
accounting, legal, and tax issues. Effective review may protect the 
financial institution against accounting, legal, tax, and reputational 
risks. Financial institutions should also monitor the use of SPEs by 
providing periodic updates to executive management and maintaining a 
database of all SPEs created to facilitate structured finance 
transactions.
Documentation Standards
    The documentation that financial institutions use to support 
complex structured finance transactions is often highly customized and 
negotiated. Careful generation, collection and retention of documents 
associated with complex structured finance transactions are important 
control mechanisms in minimizing legal and credit risks, as well as 
reducing unwarranted exposures to the financial institution's 
reputation. Policies and procedures should ensure that transaction 
documentation is appropriately detailed and transparent for review by 
all control or approval functions. When in doubt, financial 
institutions should err on the side of conservatism and retain 
documents associated with transaction due diligence, approval and 
monitoring. Financial institutions should maintain comprehensive 
documentation for all transactions approved, as well as disapproved 
transactions with controversial elements (e.g., denied in the final 
stages of approval or due to customer requests for particular terms 
requiring additional scrutiny).
    The documentation policies of a financial institution should seek 
to ensure that all counterparty obligations are reduced to legally 
enforceable written contracts. This would include the use of term 
sheets, confirmations, master agreements, netting agreements, and 
collateral agreements or comparable documents. An institution should 
have systems in place to track the status of documentation on a deal-
by-deal basis to ensure that counterparties execute and return all 
necessary contractual documents. The responsibility for drafting 
transaction documents, or selecting appropriate templates, should be 
assigned to personnel who can identify legal issues (e.g., enforcing 
collateral or netting agreements in foreign jurisdictions), and have 
been given guidance on when to escalate issues involving the drafting 
process to higher level legal staff or management. Financial 
institutions that engage in a significant number of complex structured 
finance transactions may find it beneficial to establish a specialized 
documentation unit.
    The financial institution's documentation standards also should 
clearly assign accountability and strive for transparency in the 
approval process and ongoing monitoring of exposures associated with 
complex structured finance transactions. Such standards should include 
appropriate guidance on: \8\
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    \8\ Of course, financial institutions must continue to comply 
with all applicable laws and regulations governing the making and 
keeping of records and reports.
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     Generation, distribution and retention of documents 
associated with individual transactions. In addition to standard legal 
documents, such documentation should include, as appropriate:

--Deal summary, including a list of deal terms
--Analysis or opinions (both formal and informal), prepared internally 
or by third parties, regarding legal considerations, tax and accounting 
treatments, market viability and regulatory capital requirements for 
any and all parties
--Marketing materials and other key documents provided to the customer
--Internal and external correspondence, including electronic 
communications, regarding transaction development and due diligence
--Transaction and credit approvals (including any documentation of 
actions taken to mitigate initial concerns, such as providing 
additional client disclosures or changing deal structures)
--Minutes of critical meetings with the client
--Disclosures provided to the customer (including side letters or other 
documents addressing terms or conditions of the transactions), 
including disclosures of all conflicts of interest and descriptions of 
the terms of the complex structured finance transactions
--Acknowledgements received from the customer concerning the 
accounting, tax, or regulatory implications associated with the 
transaction

     Generation, distribution and retention of documents such 
as minutes of meetings of committees and control groups prepared in 
sufficient detail to indicate issues raised, approval or rejection of a 
transaction, rationale or factors considered in approving or rejecting 
a transaction and contingencies or items to be resolved pending final 
approval. It may be practical to assign a specific coordinator or 
central location for the maintenance of committee and control group 
minutes.
     Generation, distribution and retention of information 
demonstrating final resolution of items still pending at time of 
transaction approval.
     Generation, distribution and retention of key documents 
associated with ongoing communications with the customer.
     Generation, distribution and retention of key documents 
showing the financial institution's monitoring of exposures and 
periodic assessment of reputational and legal risk considerations.
Reporting
    Regardless of the approval structure, the financial institution 
should define the complex structured finance transaction reporting 
requirements appropriate for various levels of management and the 
Board. Financial institutions should develop and ensure that reports 
summarizing pending and contemplated complex structured finance 
transactions are disseminated to appropriate levels of management for 
their review and further distribution. At a minimum, the financial 
institution should establish an independent risk function that prepares 
a periodic summary of trends in complex structured finance transactions 
and a brief summary of each deal determined to involve heightened 
risks. In addition, management should establish a process for reporting 
transactions viewed as possessing higher risk.
Independent Monitoring, Analysis, and Compliance With Internal Policies
    The events of recent years evidence the need for a strong 
compliance function in those financial institutions engaged in complex 
structured finance transactions. Financial institutions should develop 
and enforce procedures to conduct periodic independent reviews of 
complex structured finance business activity to ensure that policies 
and controls are being implemented effectively and to identify complex 
structured transactions that may have been executed without proper 
approvals or which may indicate problematic trends. These reviews 
should cover all the processes involved in creating, analyzing, 
offering and marketing

[[Page 28990]]

complex structured finance products. Procedures should identify 
departments and personnel responsible for conducting reviews and 
surveillance. Generally, compliance management oversees this monitoring 
and analysis, with considerable assistance from personnel in finance 
and operations.
    The establishment of an independent monitoring and analysis program 
often requires considerable work, as unique reports often need to be 
set up for specialized products. Elevated monitoring should be directed 
to those transactions or relationships that the financial institution 
has identified as presenting heightened legal or reputational risks, 
based on the factors and considerations discussed above under 
``Reputational and Legal Risks,'' or where the transaction or patterns 
of transactions pose greater credit or market risk. Such monitoring may 
include more frequent assessments of customer exposures and elevation 
of findings to a higher level of management in the financial 
institution.
    Compliance functions often are organized along product lines, and 
this structure may prove challenging when offering complex structured 
finance transactions that cross product lines. Practices that may 
assist financial institutions in establishing proactive compliance 
functions include, but are not limited to:
     Assigning onsite compliance officers for each traded 
product or business line and establishing a process for communication 
across product lines, legal entities, or regions
     Developing comprehensive compliance programs that address 
responsibilities for risk assessment, identifying and managing 
conflicts of interest, and require policy implementation, training, 
monitoring and testing
     Establishing clear policies that govern product and 
transaction approval, require the pre-approval of higher risk 
transactions, and define standards for marketing materials
     Conducting periodic reviews of derivatives and complex 
structured transaction documentation and policy compliance
     Reviewing trading activity to identify off market trades, 
synthetic funding transactions, unusually profitable trades and 
customer relationships and trades that present reputational concerns
     Conducting a periodic assessment of the supervision of 
sales and trading personnel and policy compliance.
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. These are all areas 
of concern with respect to complex structured finance activities. The 
complexity and relative profitability of these activities may add to 
the difficulty of analysis and increase the incentives for risk taking. 
For these reasons, the internal audit department in conducting its 
review of complex structured finance activities should audit the 
financial institution's adherence to its own control procedures, and 
further assess the adequacy of its policies and procedures given the 
nature of its complex structured finance business.
    Effective internal audit coverage of complex structured finance 
transactions requires a comprehensive independent audit program that is 
staffed with personnel that have the necessary skills and experience to 
identify and report on compliance with financial institution policy and 
procedures. These necessary skills and experience should include an 
understanding of the nature and risks of structured transactions, as 
well as a detailed understanding of the institution's policies and 
procedures. Internal audit should validate that all business lines and 
individual desks are complying with the financial institution's 
standards for complex structured finance transactions and appropriately 
identify any exceptions. This validation should include transaction 
testing that confirms policy compliance, the existence of proper 
approvals, the adequacy of documentation, and the integrity of 
management reporting. Internal audit should have well-articulated 
procedures for when to expand the scope of audit activities. Further, 
internal audit should have procedures for reporting audit findings 
directly to the financial institution's audit committee and senior 
management of the audited area. Internal audit should implement follow-
up procedures to ensure that audit findings have been resolved and the 
business unit or department has implemented audit recommendations in a 
timely manner.
    In addition, the complexity of the structured finance activities 
may cause financial institutions to retain outside consultants, 
accountants, or lawyers to review the structured product area. The 
retention of such independent expertise may be a prudent method to 
fully grasp and control the overall risk resulting from such 
activities. For example, financial institutions may employ external 
auditors to test the structured transactions approval process and 
ensure compliance with its policies and procedures.
    The resulting reports and memoranda can provide valuable insight to 
the financial institution in improving its risk controls and oversight.
Training
    Appropriate training on the financial institution's policies and 
procedures for handling complex structured finance transactions is 
critical. At the inception of a complex structured finance transaction, 
financial institution personnel should be aware of the required 
approval process needed for transaction implementation. The financial 
institution should retain documentation to support the initial and 
ongoing training of personnel involved in complex structured finance 
transactions.

Summary

    Financial institutions play a critical role in ensuring the 
integrity of our financial markets. The ability of financial 
institutions to fulfill this role and operate in a prudent manner 
depends on a foundation built upon trust and public confidence and 
compliance with all applicable legal requirements. The regulatory 
agencies expect financial institutions involved in structured finance 
transactions to build and implement enhanced risk management and 
internal controls systems that effectively ensure compliance with the 
law and control the risks associated with complex structured finance 
transactions.


[[Page 28991]]


    Dated: May 13, 2004.
John D. Hawke, Jr.,
Comptroller of the Currency.
    Dated: May 12, 2004.

    By the Office of Thrift Supervision.
James E. Gilleran,
Director.
    By order of the Board of Governors of the Federal Reserve 
System.

    Dated: May 13, 2004.
Jennifer J. Johnson,
Secretary of the Board.
    Dated at Washington, DC, this 11th day of May, 2004.

    By order of the Board of Directors.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
    By the Commission.

    Dated: May 13, 2004.
Jonathan G. Katz,
Secretary.
[FR Doc. 04-11270 Filed 5-18-04; 8:45 am]
BILLING CODE 4810-33-P; 6720-01-P; 6210-01-P; 8010-01-P






Last Updated 5/20/2004 communications@fdic.gov