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CLEARING HOUSE
July 19, 2004
Office of the Comptroller of the Currency
250 E Street, SW
Public Reference Room
Mail Stop 1-5
Washington, DC 20219
Attention: Docket No. 04-12
Ms. Jennifer J. Johnson
Secretary
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW
Washington, DC 20551
Attention: Docket No. OP-1189
Mr. Robert E. Feldman
Executive Secretary
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429
Attention: Comments/OES
Regulation Comments
Chief Counsel’s Office
Office of Thrift Supervision
1700 G Street, NW
Washington, DC 20552
Attention: No. 2004-27
Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Attention: File No. S7-22-04
Re: Proposed Interagency Statement on Sound Practices Concerning
Complex Structured Finance Activities
Ladies and Gentlemen:
The member banks of The Clearing House Association L.L.C. (“The
Clearing House”)1 appreciate the opportunity to comment on
the proposed Interagency Statement on Sound Practices Concerning Complex
Structured Finance Activities issued by the Office of the Comptroller of
the Currency, the Office of Thrift Supervision, the Board of Governors
of the Federal Reserve System (the “Board”), the Federal Deposit
Insurance Corporation and the Securities and Exchange Commission
(collectively, the “Agencies”). 69 Fed. Reg. 28980-28991 (2004) (the
“Proposed Statement”).2
We appreciate and support the Agencies’ proposal to provide guidance
to financial institutions in developing internal controls and risk
management procedures to help identify and address the reputational,
legal and other risks associated with complex structured finance
transactions (“CSFTs”). We agree with the Agencies that financial
institutions should have effective policies and procedures in place to
identify CSFTs that may involve heightened reputational and legal risk,
to provide for a level of review that is commensurate with those risks,
and to protect the institution from participating in illegal or
questionable transactions.
We are deeply concerned, however, about a number of aspects of the
Proposed Statement. We have summarized immediately below our principal
comments, which are discussed in greater detail in the sections that
follow.
First, particularly given the current legal and political climate,
the Proposed Statement could be improperly construed as creating new
rights of action or theories of civil liability of financial
institutions to third parties. We believe that it is crucial that the
final Interagency Statement clarify that it is not intended to suggest
any right of action or theory of liability that does not currently
exist; rather, it is intended to help financial institutions conduct
complex structured finance activities consistent with safe and sound
banking practices and to help financial institutions protect themselves
against unscrupulous customers. We also urge the Agencies to modify or
delete certain specific language that exacerbates this concern.
Second, with respect to regulatory compliance, we believe it is
essential that financial institutions not be required to police their
customers’ compliance with the federal securities laws or accounting,
tax or regulatory requirements. Appropriate securities disclosure and
proper accounting, tax and regulatory treatment are the obligations of
the issuer, its accountants and its counsel, and securities disclosure
is subject to review by the Securities and Exchange Commission.
Financial institutions lack the information and the access to perform
this role. This situation is different from the Bank Secrecy Act, where
Congress has imposed due diligence and reporting responsibility on
financial institutions with respect to their customers.
Third, it is essential that the final Interagency Statement recognize
the differences among both institutions and transactions by utilizing a
principles-based approach. The Interagency Statement should not become
an examiner’s checklist, with a prescribed list of requirements for all
institutions and all transactions. The final Interagency Statement
should explicitly acknowledge that financial institutions will need
flexibility as they implement the Interagency Statement, and it should
modify or delete certain specific suggestions and other language that
could encourage a checklist approach.
Fourth, we believe that several key revisions should be made in the
Proposed Statement to avoid creating unattainably high standards,
unreasonable responsibilities and unwarranted exposure.
Fifth, we are concerned that certain statements in the Proposed
Statement impose an unduly high standard on the board of directors of
financial institutions and may discourage qualified individuals from
serving as directors.
As the Proposed Statement recognizes, structured finance products
“[i]n the vast majority of cases . . . have served the legitimate
business purposes of customers” and are “an essential part of U.S. and
international capital markets”. Id. at 28981. Only in “a limited
number” of cases have these transactions been used to circumvent
regulatory or financial reporting requirements, evade tax liabilities or
further illegal or improper behavior. Id. It is, therefore,
essential that the final Interagency Statement both provide enough
flexibility and avoid creating additional liability so that the vast
majority of structured finance transactions that are legitimate are not
rendered inefficient or even precluded, and that financial innovation is
not discouraged.3
I. The Agencies Should Clarify that the Proposed Statement Is Not
Intended to Create New Rights of Action or Theories of Liability of
Financial Institutions to Third Parties
We are deeply concerned that the Proposed Statement could be
improperly construed as creating new rights of action or theories of
civil liability of financial institutions to third parties, particularly
given the current legal and political climate. Absent a specific
disclaimer to the contrary in the final Interagency Statement, there is
a risk that third parties will use the Interagency Statement against
financial institutions in support of a negligence claim or to attempt to
establish the scienter element of an aiding and abetting claim.
They will assert that a financial institution either failed to adopt
policies and procedures as required by the Interagency Statement or
failed to comply with those policies and procedures. The potential for
third-party claims based on the alleged inadequacy of a financial
institution’s policies and procedures is increased by the inability to
define precisely what transactions constitute CSFTs and which of those
transactions require special scrutiny.
Although, as we stated at the outset, The Clearing House supports
supervisory guidance on CSFTs, it is essential that this guidance not
actually increase the risk to the safety and soundness of the banking
system. Yet, that risk will be significantly increased if the Proposed
Statement provides new causes of action for the plaintiffs’ bar. Such a
result would be inconsistent with the ultimate objective of the Proposed
Statement of protecting financial institutions from legal and
reputational risk.
We therefore respectfully request that the Agencies include an
explicit statement, at the beginning of the final Interagency Statement,
clarifying that the Interagency Statement is in no way intended to
suggest any rights of action or theories of liability of financial
institutions to third parties that do not currently exist. Rather, its
purpose is to help financial institutions conduct complex structured
finance activities consistent with safe and sound banking practices and
to help financial institutions protect themselves against unscrupulous
customers. Such a statement would be consistent with the Supreme Court’s
decision in Central Bank that there is no private right of action
for aiding and abetting liability in civil cases under Rule 10b-5 under
the Securities Exchange Act of 1934. (Central Bank of Denver, N.A.
v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994)).4
We are not suggesting that financial institutions be absolved of any
and all responsibility for transactions with their customers. It is
important, however, to recognize, as acknowledged in the SEC Memorandum,
that liability generally requires scienter – which is defined by the
Supreme Court as “a mental state embracing intent to deceive,
manipulate, or defraud”. Ernst & Ernst v. Hochfelder, 425
U.S. 185, 193 n.12 (1976). It is also important to recognize that very
few financial products are inherently deceptive. If there is deception,
it is in their usage rather than their origin.
Our concerns in this regard are heightened by the SEC Memorandum. It
refers repeatedly to “deceptive structured finance product”, without
distinguishing between a structured finance product that is inherently
deceptive, which we believe is unusual, and a structured finance product
that is used in a deceptive manner.
There are two specific terms in the Proposed Statement that
exacerbate the risk of third party liability, and we urge the Agencies
to modify or eliminate them. The first is “ensure”, which is frequently
used in the Proposed Statement. See, e.g., 69 Fed. Reg. at
28982, 28983, 28985, 28986. We believe that the use of the word “ensure”
– whether in connection with the policies and procedures themselves, the
role of the board of directors5 or the role of management –
may incorrectly suggest that the financial institution, or its directors
and officers, have strict liability as guarantors of legal and
regulatory compliance by the financial institution or its counterparty.
To avoid any confusion, we believe it is critical that the final
Interagency Statement use a different term or consistently modify
“ensure” with “strive to” (see id. at 28986).6
The second term that could increase the risk of liability is
“conservatism”, e.g., “financial institution personnel should err on the
side of conservatism”. Id. at 28987. With the benefit of
hindsight, virtually every decision that ultimately proves to have been
wrong could be regarded as not meeting this standard. We believe that
this term should be deleted. A financial institution should be neither
overly conservative nor overly aggressive in responding to the needs of
its customers.
We support and appreciate the effort in the Proposed Statement to
assist financial institutions in managing existing legal risk.
The final Interagency Statement must, however, be revised so that this
effort does not result in creating new legal risk.
II. The Agencies Should Clarify that the Proposed Statement Is Not
Intended to Create a Policing Obligation for Securities Disclosure
Violations or Improper Accounting, Tax or Regulatory Treatment
We strongly urge that the final Interagency Statement draw a clear
distinction between a financial institution’s obligation to deal with
its own reputational and legal risks and an obligation to police its
customers’ compliance with the federal securities laws or accounting,
tax or regulatory requirements. As the Sarbanes-Oxley Act of 2002 (Pub.
L. No. 107-204) makes clear, proper disclosure is the responsibility of
the issuer, its accountants and its counsel. The Securities and Exchange
Commission has been given enhanced powers and resources to review,
monitor and enforce disclosure requirements. Similarly, a company’s
compliance with applicable accounting, tax and regulatory requirements
is the responsibility of the issuer, its accountants and its counsel.
Financial institutions lack both the information and the authority to
assume an investigatory and policing obligation. In most cases, the
proper disclosure of and accounting for a transaction cannot be
determined from the “four corners” of the transaction itself. Rather,
the appropriate accounting and disclosure depend on the customer’s use
of the transaction and a variety of other factors relating to the
customer’s specific circumstances. The financial institution does not
have access to this information from the customer, and it has no ability
to compel the customer’s advisors to provide the information (even if
they have it).
Our concern here is that a disclosure violation or a violation of an
accounting, tax or regulatory requirement by the customer will create a
presumption, or at least an inference, of a violation by the financial
institution of a regulatory obligation. That should not be the result,
but we believe that an explicit disclaimer in the final Interagency
Statement is necessary to protect against such a result.
III. The Final Interagency Statement Should More Clearly Provide
Financial Institutions with Flexibility in Implementing the Proposed
Statement
We believe that the Proposed Statement provides useful supervisory
guidance on the types of internal controls and risk management
procedures that a financial institution should consider in managing the
risks associated with CSFTs. Although the Proposed Statement asserts
that it represents guidance rather than mandates, we are very concerned
that bank examiners may use the more specific suggestions in the
Proposed Statement as a compliance “checklist” in the examination
process. We believe that the final Interagency Statement should
eliminate a number of specific suggestions as not being consistent with
a flexible, principles-based approach, explicitly disclaim a checklist
approach and generally acknowledge that financial institutions will
require flexibility as they implement the Interagency Statement. The
following areas are of particular concern.
1. Definition of CSFT.
The Proposed Statement does not define what constitutes a “complex
structured finance transaction”, leaving it by implication to each
institution to establish its own process for identifying CSFTs. See
id. at 28986. We are concerned, however, that the four criteria
listed in the Proposed Statement will become a mandatory “checklist”.
The Proposed Statement does suggest that the criteria are not exclusive,
but this only reinforces the idea that they are mandatory. See
id. at 28985.
We believe that the final Interagency Statement should state
explicitly that the absence of a precise definition of “complex
structured finance transaction” is designed to provide financial
institutions with discretion in determining what transactions come
within the scope of their special procedures for CSFTs. Specifically, we
urge that the final Interagency Statement make clear that the presence
of one or more of the listed criteria does not create a presumption of
the existence of a CSFT.
Our concern is generated in large part because these criteria are so
broad that they have the potential of capturing numerous routine and
well-established transactions that incorporate some of these criteria,
but do not raise the legal and reputational risks to which the Agencies’
guidance is directed. By subjecting an unnecessarily large number of
transactions to the recommended procedures, such a broad definition
creates excessive burden. Moreover, it may have the unintended
consequence of diverting an institution’s efforts from those
transactions that have the potential for the greatest risks.
Accordingly, we recommend that the first three criteria be modified by
adding the phrase “and is purposefully designed in order to achieve a
specific tax, accounting or regulatory goal of the customer”. Otherwise,
such criteria as “non-standard” and “specific financial objectives of a
customer” are far too sweeping. See id. Many transactions
have non-standard features because they are directed to the customers’
specific objectives. Arguably, all transactions are designed to meet the
customers’ specific financial objectives.
We also note that the fourth CSFT criterion – that the transaction
exposes the financial institution to elevated levels of market, credit,
operational, legal or reputational risks – does not define a CSFT, but
merely identifies the risks that may be associated with CSFTs. See
id. To avoid any confusion on this point, we recommend that the
fourth criterion be eliminated.
2. “Heightened Risk” CSFTs.
A similar concern arises with respect to the Proposed Statement’s
list of twelve types of transaction characteristics that should be
considered in determining whether a CSFT requires additional scrutiny.
See id. at 28988. Many of these characteristics are
individually and collectively very broad and could describe a large
number of ordinary course transactions at large financial institutions.
It should be recognized that the adverse consequences of an unduly
broad concept of heightened risk CSFTs are not limited to the burden
imposed on financial institutions, as substantial as that would be. Such
a concept could actually increase risk because it would divert attention
from those transactions on which the control processes should focus. It
would also reduce the efficiency of structured finance products that
create only limited risk. Finally, the categorization of a structured
finance product as a “heightened risk” CSFT has implications beyond
requiring heightened review and scrutiny. It would discourage use of
that product without regard to its economic value or other merits.
Although a number of the twelve characteristics listed in the
Proposed Statement clearly raise “red flags”, others do not. Perhaps
most troublesome is the suggestion that the “use of SPEs or limited
partnerships” is suspect because they “involv[e] multiple obligors or
otherwise lack[ ] transparency”. Id. Another area of concern is
the reference to transactions “with unusually short time horizons”,
particularly when combined with the reference to transactions that are
“executed at year end or at the end of a reporting period”. Id.
It is very commonplace for customers to borrow on a short-term basis
over a quarter-end or year-end date.
Accordingly, we urge that the final Interagency Statement include an
explicit disclaimer to the effect that the existence of one or more of
these twelve characteristics will not create a presumption of heightened
risk or require heightened scrutiny by the financial institution.
3. Different Roles.
One important aspect of the flexibility that financial institutions
need relates to the wide variety of relationships that a financial
institution may have with respect to a CSFT.7 We accept that
special scrutiny is often appropriate where a financial institution
originates and structures a CSFT, but a lesser degree of scrutiny may be
appropriate where the financial institution plays a more limited role.
For example, a financial institution’s only involvement in a particular
CSFT may be to act as a custodian or perform some other largely
administrative function. In that instance, we would expect that a
financial institution would normally not be required to conduct the same
level of review of the transaction as would be required if the financial
institution were actively involved in the development of the deal
structure. Furthermore, we believe that a financial institution should
be required to conduct a lesser level of review when it is providing the
financing for a transaction that has been structured and developed by
the customer or an independent third party.
In order to deal with this issue, we request that the final
Interagency Statement explicitly acknowledge that the policies and
procedures relating to CSFTs may incorporate different standards of
review based on the financial institution’s role or the degree of the
financial institution’s involvement in a particular CSFT. Likewise, the
final Interagency Statement should permit a financial institution that
is participating in a limited part of a transaction to conclude that the
duty of investigation need not extend to the entire transaction,
depending on the particular facts and circumstances.
4. Syndicated Loans.
A specific variant of the different roles issue is presented in the
case of syndicated loans. Where the financing in connection with a CSFT
is provided by a syndicate of financial institutions, it would be
totally inefficient for each member of the syndicate to investigate the
transaction. Indeed, only in the rare case would each lender have access
to the information required for such investigation.
5. Document Retention.
The document retention requirements set forth in the Proposed
Statement are very detailed. See id. at 28989. Although
the Proposed Statement uses the phrase “as appropriate” in describing
these requirements (id.), we are once again concerned that bank
examiners may use the list of documents included in the Proposed
Statement as a compliance “checklist”. Certain types of documents may be
relevant to one type of transaction, or to a financial institution’s
role in that transaction, but not to another type of a transaction or
different role. In addition, some of these documents may not be material
to a transaction, such that retention of the document would not serve
any purpose.
We believe that the document retention policy should be limited to
the generation, distribution and retention of those documents necessary
to evaluate and control the legal and reputational risks associated with
CSFTs. As the Proposed Statement recognizes, the guiding principle in
documentation standards should be to “minimiz[e] legal and credit risks,
as well as [to] reduc[e] unwarranted exposures to the financial
institution’s reputation”. Id. As part of this process, the final
Interagency Statement should explicitly acknowledge that the scope of
the documentation standards will vary with the institution, the
transaction, the institution’s role in the transaction and the
materiality of the document. In addition, institutions should be
explicitly authorized to determine for themselves an appropriate
document retention timeframe.
We also have two specific concerns about the Proposed Statement’s
discussion of document retention. First, the Proposed Statement would
require retention of “comprehensive documentation” for “disapproved
transactions with controversial elements”. Id. If a transaction
is “controversial”, it may be disapproved at an early stage before there
is comprehensive documentation. In addition, a transaction might be
controversial for a number of reasons, including the credit of the
customer or the efficacy of the product. We believe that the
“controversial” predicate should be limited to controversy because of
legal or reputational risk.
Second, we strongly urge that the references to minutes be deleted,
particularly because of the view of some that minutes should approximate
verbatim transcripts. See id. We believe that any direct
or indirect requirements to maintain minutes will significantly increase
the risk to financial institutions without offsetting benefits.
6. Transactions with Private Companies and Individuals.
We believe that the Proposed Statement should generally not apply to
CSFTs that are undertaken with individuals and private companies, as
they do not present the same legal and reputational risks as public
companies, particularly with regard to disclosure. If the Proposed
Statement is to apply to CSFTs undertaken with individuals and private
companies, however, we would request that the Agencies explicitly
acknowledge that transactions with such counterparties need not be
subject to all the same processes as CSFTs with public companies.
7. Significance of the Transaction.
We request that the Agencies explicitly acknowledge that CSFTs that
are of minor significance to the counterparty do not present the level
of legal and reputational risks that would require the enhanced scrutiny
for which the policies and procedures are designed. In addition, we
believe that the final Interagency Statement should utilize a
“significance” standard for the type and nature of review by management
of CSFTs and the retention of documents.
8. Minimization of Specific Suggestions.
As mentioned, The Clearing House strongly believes that the Proposed
Statement should incorporate a flexible, principles-based approach. Such
an approach is particularly appropriate here because most of the large
financial institutions that conduct CSFTs already have policies and
procedures in place regarding CSFTs that have been reviewed by the
Agencies. We are concerned, however, that the numerous specific
suggestions on policies and procedures in the Proposed Statement are
inconsistent with this approach.
Accordingly, we recommend that the final Interagency Statement
eliminate the following specific suggestions: (1) the description of
“areas of legal review” of CSFTs that includes suitability, tax
considerations, insurance considerations, and regulatory capital
requirements (see id. at 28987)8; (2) the
recommendations that policies “clearly define” or “articulate” when the
retention of external legal, accounting or tax advisors or review by
higher level management at the financial institution or at the customer
is necessary (see, e.g., id. at 28987, 28988)9 ;
(3) the bullet-point list under the section entitled “Independent
Monitoring, Analysis, and Compliance with Internal Policies”, which
suggests, among other things, on-site compliance coverage for each
traded product or business line and “compliance” review of CSFT
documentation (see id. at 28990); and (4) the statement
that SPEs, including those that are client-sponsored, should be subject
to a separate approval process and that a database of all such SPEs
should be maintained (see id. at 28989).
Further, we respectfully request that the Agencies consider whether
additional specific suggestions in the Preliminary Statement with
respect to policies and procedures may be eliminated, which would
further encourage a more flexible, principles-based approach. The
specific suggestions in the Preliminary Statement are likely to
encourage a checklist approach by examiners, and are seemingly
inconsistent with the Agencies’ acknowledgement that policies and
procedures concerning CSFTs “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”. Id. at 28983.
9. Additional Observations.
We have not attempted, nor would it be possible, to identify every
circumstance in which financial institutions will need to be given
flexibility as they implement the Interagency Statement. We respectfully
request that the final Interagency Statement contain explicit general
acknowledgement of the need of financial institutions to implement the
Interagency Statement in a practical and flexible way so as not to
stifle legitimate structured finance activity.
The concept of flexibility needs to take into account that some of
the guidance, although perhaps theoretically unobjectionable, may be
impracticable in the current environment. For example, our member banks
have found that their customers’ accountants and counsel, fearful about
their own liability risks, are refusing to provide any written
confirmation of their advice regarding a particular transaction. Indeed,
in some cases, they are refusing even to talk to the lending banks about
the transaction, or are requiring indemnities.
We recognize that the need for flexibility versus the need for
guidance creates tension regarding the breadth of the Interagency
Statement. Resolution of this tension is highly dependent upon the
potential level of liability resulting from the Interagency Statement
(either from examiners or from third-party plaintiffs). If it were clear
that the Interagency Statement represents supervisory guidance within
the parameters of which financial institutions have flexibility to
create their own policies and procedures, then the breadth of certain
sections may be appropriate to encourage flexibility. However, if the
guidance is to be a prescriptive “checklist” (or enforced as such by
examiners or plaintiffs), then the breadth of the Interagency Statement
needs to be curtailed significantly and the recommended procedures need
to be tailored to only what is necessary.
In addition, in view of the ambiguity and uncertainty surrounding
what transactions constitute CSFTs and which of those transactions
require heightened scrutiny, there will unquestionably be some level of
disagreement between the regulators and the financial institutions, at
least initially. The supervisory staff of the Agencies should be
prepared to confer with financial institutions in a meaningful way as
they implement the Interagency Statement. Except in egregious cases, we
urge the Agencies to allow one full examination cycle to pass before a
financial institution is subject to any significant criticism as a
result of its policies and procedures under the new guidance.
IV. Appropriate Standards
The Clearing House believes that a number of specific standards in
the Proposed Statement are inappropriate in that they create
unreasonable and even unachievable responsibilities and risk creating
unwarranted liability.
1. “Appropriateness” of a Transaction.
The Proposed Statement establishes a broad new responsibility for
financial institutions to evaluate the “appropriateness” of
transactions. See id. at 28987. Not only is this standard
vague and subjective, and a radical departure from current law, but it
is not possible for a financial institution to determine what is
appropriate for another organization. Such a requirement would impose
upon a financial institution the responsibility for making difficult
qualitative judgments as to whether a particular transaction is
appropriate for a particular company. The appropriateness of a
transaction is the responsibility of the counterparty’s management and
advisors based on a number of factors and considerations, many of which
are unknown to the financial institution. We recommend that this
obligation be deleted.
2. Legally Enforceable Contracts.
The Proposed Statement requires that each counterparty’s obligations
be “reduced to legally enforceable contracts”. Id. A counterparty
may assume various obligations upon which a financial institution relies
even though they are not legally binding. We appreciate the specific
exception for “traditional, non-binding ‘comfort letters’” (id.
at 28988, n.6), but are concerned that this exception furthers the idea
that all other non-binding obligations are improper. We recommend that
the “in writing” requirement be eliminated or limited to situations
where the financial institution is aware that the failure to document
the obligation is likely to alter the views of the counterparty’s
accountants.
3. “Complete and Accurate” Standard.
We accept that a financial institution should obtain and document
information about a customer’s proposed accounting treatment of a
transaction subject to heightened scrutiny. See id. We do
not believe, however, that the standard should be “complete and
accurate”. Id. This is a very high standard and would probably
require financial institutions to call upon their own external
accountants. Yet, the accountants may be unable to express a view
because they do not have sufficient knowledge of the financial
institution’s customer. In addition, where the financial institution is
acting as a counterparty, rather than as an independent advisor, in a
CSFT, it may not have complete, unfettered access to a customer’s
auditors, to nonpublic customer information, or to analyses prepared by
the customer’s outside legal counsel or accountants. Accountants and
other advisors to the customer may not be prepared to divulge
information to the financial institution because of their own liability
concerns, because they believe their advice is privileged or because
they may have a conflict of interest in advising on both sides of the
transaction. We believe that the final Interagency Statement should
explicitly acknowledge that a financial institution need only obtain
information on a customer’s proposed accounting treatment of a
transaction that is reasonably available given the nature of the
counterparty relationship.
4. “Independent” Review.
There are frequent references to “independent” review in the Proposed
Statement. See, e.g., id. at 28989. Although, in a number
of cases, the Proposed Statement makes clear that the financial
institution’s own employees in a separate unit, such as compliance, can
satisfy this independence requirement, that is not always clear. We are
particularly concerned that the specific reference to use of “outside”
professionals to review structured product use will be treated by
examiners as a requirement. See id. at 28990.
We recommend that the final Interagency Statement explicitly reject
such a position. The decision whether to use external advisors should be
related to the novelty or uncertainty of the issues involved and should
be highly dependent on the expertise of internal resources.
5. Assumption of Risk.
The Proposed Statement asserts that a financial institution “assumes”
various risks when it “provides advice on, arranges or actively
participates in” a CSFT. Id. at 28984. We agree that active
participation in a CSFT creates greater exposure to risk, but we do not
believe that the risk is “assumed” in the sense that the financial
institution has automatic liability. We recommend that the Proposed
Statement be modified to delete this term.
V. Certain Statements in the Proposed Statement Impose an Unduly
High Standard on the Board of Directors and May Discourage Qualified
Individuals From Serving as Directors of Financial Institutions
At a time when the demands for higher standards and greater
accountability is discouraging many individuals from serving in director
positions, it is essential that the role and responsibility of directors
be carefully articulated. We agree with the statement in the Proposed
Statement that the “board of directors . . . is the focal point of the
corporate governance system”. Id. at 28985. It is precisely
because of this responsibility that it is essential for financial
institutions to obtain and retain the most qualified directors.
We are concerned that certain statements in the Proposed Statement
may discourage qualified individuals from serving as directors of
financial institutions, particularly if they appear to impose a higher
standard than exists for directors of other companies. The Proposed
Statement states that the board of directors is “ultimately responsible
for the financial well being of the institutions they oversee” and has
“ultimate responsibility for establishing the institution’s risk
tolerances”. Id. at 28985, 28982. To the extent that “ultimate
responsibility” is intended to be synonymous with liability, we strongly
disagree with this statement. Such a standard of liability is
inconsistent with the state law standards that govern the duties and
responsibilities of directors and cannot, we believe, be justified by
federal statute.
In addition, as noted in Part I above, we are concerned with the
repeated use of the word “ensure” in describing the board’s
responsibilities, particularly in connection with the identification,
evaluation and control of risk, because this word can be read to suggest
directors have strict liability as guarantors of a financial
institution’s legal and regulatory compliance. See id. at
28985-86. As the Proposed Statement recognizes, the board’s
responsibility is one of oversight, and not management, and oversight
cannot legitimately be expected to provide a guarantee. As mentioned
above, we recommend that the final Interagency Statement consistently
modify “ensure” with “strive to”. Alternatively, the final Interagency
Statement should clarify, as regulatory enforcement orders often do,
that “ensure” in the context of the role of the board of directors means
(i) authorizing necessary action by the institution, (ii) requiring
timely reporting by the management, (iii) following up on non-compliance
and (iv) requiring management to take corrective action.
VI. Summary
As the Agencies recognize, CSFTs play a productive role in
diversifying and minimizing risks and creating more efficient financing
opportunities. It is essential that the Proposed Statement’s valid
effort to prevent abuse not be expanded by others – whether private
litigants, other governmental authorities or the Agencies’ own examiners
– into restrictions that reduce the value of CSFTs in our economy. We
urge that the final Interagency Statement be modified, as discussed
above, to minimize this risk.
* * *
The Clearing House appreciates the opportunity to comment on the
Proposed Statement and would be pleased to discuss any of the points
raised in this letter in more detail. Should you have any questions,
please contact Norman R. Nelson, General Counsel of The Clearing House,
at (212) 612-9205.
Sincerely yours,
Jeffery P. Neubert
The Clearing House
100 Broad Street
New York, NY 10004
1 The member banks of The Clearing House are: Bank of
America, National Association; The Bank of New York; Citibank, N.A.;
Deutsche Bank Trust Company Americas; HSBC Bank USA, National
Association; JPMorgan Chase Bank; LaSalle Bank National Association; U.S
Bank National Association; Wachovia Bank, National Association; and
Wells Fargo Bank, National Association.
2 The Clearing House believes that the coordination among
the Agencies in formulating guidance on this important issue is very
constructive. We recommend that there also be coordination with
financial supervisors in other countries because of the global nature of
CSFTs.
3 As Board Governor Bies recently noted: “The improvements
in technology, the quick pace of financial innovation, and the evolving
risk-management techniques almost ensure that businesses will
increasingly use almost limitless configurations of products and
services and sophisticated financial structures.” Remarks at the
Financial Executives International 2004 Summit (San Diego, California),
April 27, 2004.
4 Without commenting on any specific situation, we believe
that various settlements of enforcement actions cited in the attachment
to the Board’s SR 04-7 (the Securities and Exchange Commission’s
memorandum of December 4, 2003 (the “SEC Memorandum”)) do not constitute
valid precedent on the question of liability under the federal
securities laws. In none of the settlements did the settling parties
admit the allegations of the complaint. Moreover, in today’s
environment, parties subject to proposed regulatory or law enforcement
actions often have little option but to settle on the best possible
terms.
5 We address the role of the board of directors further in
Part III below.
6 As one example of the need for this modification, the
Proposed Statement provides that “the Board and senior management should
ensure that incentive plans are not structured in a way that encourages
transactors to cross ethical boundaries ….” Id. Such a subjective
determination cannot be “ensured”.
7 Our concern about this issue is reinforced by the SEC
Memorandum’s repeated joinder of the “offer[ing]” of and the “participa[tion]”
in a deceptive structured finance product, without distinction between
the two or among various levels or types of participation.
8 These matters are addressed primarily or solely at most
financial institutions by functions other than the legal function.
9 These decisions are inherently case-specific
determinations that are best made by the independent participants in the
review process.
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