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05.28.2010 | Legal Update

Headlines

1.  FASB Proposes Mark-to-Market Requirements for Financial Instruments
2.  Senate Approves Comprehensive Financial Regulatory Reform Bill
3.  FDIC Proposes Requirements for Securitization Transactions
4.  Compliance Guidance Issued for Internet Gambling Rules
5.  Other Developments: Correspondent Risks and OTS Card Rules

Full Reports

1.  FASB Proposes Mark-to-Market Requirements for Financial Instruments

The Financial Accounting Standards Board on May 26 issued an Exposure Draft of a proposed Accounting Standards Update (ASU) entitled “Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities,” intended to improve financial statement reporting by incorporating both amortized cost and fair value information about financial instruments held for collection or payment of cash flows. The proposal would require (1) presentation of both amortized cost and fair value on an entity’s statement of financial position for most financial instruments held for collection or payment of contractual cash flows and (2) the inclusion of both amortized cost and fair value information for these instruments in determining net income and comprehensive income. The proposal would require that financial instruments held for sale or settlement (primarily derivatives and trading financial instruments) be recognized and measured at fair value with all changes in fair value recognized in net income. The proposal would provide nonpublic entities with less than $1 billion in total assets with four years to implement the new requirements as they relate to loans, loan commitments, and core deposit liabilities that meet certain criteria.

Nutter Notes: All entities that hold financial instruments would be affected by the proposed requirements. The extent of the effect would depend on the relative significance of financial instruments to an entity’s operations and financial position as well as the entity’s business strategy. The proposal acknowledges that traditional banks, which currently measure a large number of financial assets at amortized cost, would be affected to a greater extent than brokers and dealers in securities and investment companies that currently measure most financial assets at fair value. Insurance companies would be affected to varying degrees depending on their asset mix, with companies that invest more heavily in equity securities being the most affected. Some specific types of financial instruments, such as pension obligations and leases, would be exempt from the proposed guidance. Also, short-term receivables and payables would continue to be measured at amortized cost (plus or minus fair value hedging adjustments). Comments on the proposed ASU must be submitted by September 30, 2010. The FASB intends to hold public roundtable meetings immediately following the close of the comment period in October to collect further input.

2.  Senate Approves Comprehensive Financial Regulatory Reform Bill

The U.S. Senate has approved its version of comprehensive financial regulatory reform legislation, the Restoring American Financial Stability Act of 2010, which must now be reconciled with a similar bill that was approved by the U.S. House of Representatives on December 11, 2009, the Wall Street Reform and Consumer Protection Act of 2009. The Senate bill approved on May 20 would, among other things, establish a new Bureau of Consumer Financial Protection, eliminate the OTS, create a mechanism for the orderly liquidation of failing systemically significant financial institutions and impose new regulatory burdens on depository institutions, some of which are summarized below. The Bureau of Consumer Financial Protection would consolidate regulatory authority for all consumer financial products and services under a single agency housed within the Federal Reserve. The authority of the OTS to oversee existing savings and loan holding companies would be transferred to the Federal Reserve, and oversight of existing federal savings associations would be transferred to the OCC. However, the OCC would not be permitted to charter any new federal savings associations under the Senate bill. Provisions of the bill intended to end so-called “too big to fail” bailouts of large non-bank financial institutions would empower the FDIC to unwind financial firms whose failure would have a serious adverse effect on financial stability.

Nutter Notes: Among the new regulatory burdens that would be imposed by the Senate bill is a provision that would apply the national bank lending limit to all state-chartered banks, which would reduce the lending limit applicable to Massachusetts-chartered banks and those chartered by other states that currently have higher lending limits. A similar requirement was stricken from a version of the House bill before it was approved late last year. The Senate bill would authorize the Federal Reserve to require all publicly traded bank holding companies with less than $10 billion in assets to have a new “risk committee.” The committee would be required to have a minimum number of independent directors, as determined by the Federal Reserve, and would also be required to have at least one risk management expert who has experience in “identifying, assessing, and managing risk exposures of large, complex firms.” Bank holding companies would be subject to new capital requirements and new source of strength rules to be established by the Federal Reserve under the Senate bill. The Senate bill would also roll back federal preemption. The OCC would not be permitted to preempt a state law under the bill unless there is substantial evidence of a conflict and the OCC finds that there is a “substantive standard” in place that regulates the activity in question. Preemption would be unavailable to subsidiaries of national banks.

3.  FDIC Proposes Requirements for Securitization Transactions

An amendment proposed by the FDIC to a safe harbor available to banks in conservatorship or receivership would impose new requirements on banks engaged in securitization transactions. The proposed amendment issued on May 11 clarifies the circumstances in which the FDIC as conservator or receiver would refrain from using its statutory authority to disaffirm or repudiate contracts to reclaim, recover or re-characterize financial assets transferred by an insured depository institution in connection with a securitization transaction. In order to qualify for the safe harbor under the FDIC proposal, an institution would be required to establish a 5% reserve fund for residential mortgage-backed securities in order to cover potential put backs during the first year of the securitization, any competing ownership interests held by the servicer, or its affiliates, in other loans secured by the same property would be required to be disclosed, and a portion of the compensation paid to rating agencies would have to be deferred. The proposed amendments would also require institutions to retain at least 5% of each credit tranche in any securitization transaction or a representative sample of the securitized financial assets equal to at least 5% of the principal amount of the financial assets at the time of transfer, net of hedging for credit risk (the proposal would not restrict hedging for other types of risk, such as interest rate risk).

Nutter Notes: The need to amend the FDIC’s safe harbor rule for transferred financial assets in connection with securitizations was triggered by changes adopted by the Financial Accounting Standards Board in June 2009 to the accounting standards that determine whether a transfer of financial assets qualifies as a sale under GAAP. Under the current rule, a transfer of financial assets in a securitization or participation qualifies for the safe harbor if the transfer qualifies as a sale under GAAP. The additional safe harbor requirements that the FDIC proposes to add to the rule reflect those proposed in April by the SEC for asset-backed securities issued under the SEC’s Regulation AB. The FDIC proposal also includes additional disclosure requirements about the credit and payment performance of the assets in any securitization that reflect the SEC’s Regulation AB proposal. Unlike the SEC’s proposal, the FDIC’s requirements would apply to any securitization transaction regardless of whether the issuance of the asset-back securities were registered under Regulation AB. The comprehensive regulatory reform bill recently approved by the Senate, described below, also includes new sponsor risk retention and disclosure requirements for asset-back securities that differ from the SEC and FDIC proposals.

4.  Compliance Guidance Issued for Internet Gambling Rules

The Federal Reserve, OCC and OTS have issued interagency guidance for compliance with the regulations that implement the Unlawful Internet Gambling Enforcement Act of 2006 (UIGEA). The interagency guidance released on May 20 reminds financial institutions that the regulations require participants in five designated payment systems to establish policies and procedures that are “reasonably designed to identify and block or otherwise prevent or prohibit” transactions related to unlawful Internet gambling. Compliance with the UIGEA regulations is required by June 1. The five designated payment systems are the automated clearing house (ACH) systems, payment card systems, check collection systems, money transmitting businesses and wire transfer systems. The interagency examination guidance includes an overview of the UIGEA regulations, applicable exemptions and safe harbors for compliance. The regulations generally exempt all participants in each designated payment system from the requirement to have policies and procedures in place unless the participant is specifically listed as “non-exempt.” The beneficiary’s bank for wire transfers and the depositary bank for check collections are non-exempt, so such banks must have UIGEA-compliant policies and procedures in place by June 1.

Nutter Notes: The UIGEA regulations require all non-exempt participants in each designated payment system to establish and implement policies and procedures reasonably designed to identify and block or otherwise prevent or prohibit restricted transactions. Non-exempt participants are permitted to design and implement policies and procedures tailored to their operations and may use different policies and procedures with respect to different business lines. The UIGEA regulations provide models of reasonably designed policies and procedures that would meet the requirements of the rule for each designated payment system. While these model policies and procedures are not the exclusive means of compliance, use of the models will provide a safe harbor for purposes of regulatory compliance. Beneficiaries’ banks and depositary banks will be considered in compliance with the regulations if their policies and procedures apply appropriate due diligence procedures to commercial accounts or relationships and provide notice to all commercial accountholders of the prohibition on conducting restricted transactions, apply such due diligence requirements if the bank has actual knowledge that a commercial customer engages in an Internet gambling business, and address instances in which the bank has actual knowledge of restricted transactions.

5.  Other Developments: Correspondent Risks and OTS Card Rules

• Federal Banking Agencies Issue Guidance on Correspondent Concentration Risks

The federal banking agencies issued joint guidance on April 30 addressing the agencies’ expectations for financial institutions relating to identifying, monitoring, and managing risks associated with funding and credit concentrations arising from correspondent relationships. A correspondent relationship occurs when a financial organization provides another financial organization with services related to deposits, lending, or other activities.

Nutter Notes: The guidance highlights the need for institutions to identify, monitor, and manage correspondent concentration risk on a stand-alone and organization-wide basis. The guidance also reinforces the supervisory view that financial institutions should perform appropriate due diligence on all credit exposures to, and funding transactions with, other financial institutions as part of their risk management policies and procedures.

• OTS Amends Rule on Unfair Credit Card Account Practices

To avoid confusion and duplication with provisions of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit CARD Act) and certain amendments to the Federal Reserve’s Regulation Z, the OTS announced on May 13 that it is removing a part of its rules that deal with unfair consumer credit card account practices.

Nutter Notes: Specifically, the OTS is removing subpart C and the related official commentary from its rule on Unfair or Deceptive Acts or Practices originally adopted in January 2009 under authority granted by the Federal Trade Commission Act and the Home Owners’ Loan Act. The consumer protections contained in the OTS rule are subsumed within the Credit CARD Act and changes to Regulation Z.

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