FDIC Federal Register Citations

[[Page 28980]]

-----------------------------------------------------------------------

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.

-----------------------------------------------------------------------

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://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.
---------------------------------------------------------------------------

\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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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;

[[Page 28983]]

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.
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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.treas.gov).

---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\7\ Of course, financial institutions also should ensure that
the institution's own accounting for transactions complies with
applicable accounting standards, consistently applied.

---------------------------------------------------------------------------

[[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\
---------------------------------------------------------------------------

\8\ Of course, financial institutions must continue to comply
with all applicable laws and regulations governing the making and
keeping of records and reports.
---------------------------------------------------------------------------

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