Request for Comment on Statement Concerning Complex Structured Finance  Activities - District Notice
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Request for Comment on Statement Concerning Complex Structured Finance Activities - District Notice

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Learn all about the services we offer
14 Pages
English

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ll★KFederal Reserve Bank of Dallas2200 N. PEARL ST.DALLAS, TX 75201-2272May 21, 2004Notice 04-28TO: The Chief Executive Officer of eachfinancial institution and others concernedin the Eleventh Federal Reserve DistrictSUBJECTRequest for Comment on Statement ConcerningComplex Structured Finance ActivitiesDETAILSThe Board of Governors, Office of the Comptroller of the Currency, Office of ThriftSupervision, Federal Deposit Insurance Corporation, and Securities and Exchange Commissionhave requested public comment on a proposed interagency statement concerning the complexstructured finance activities of financial institutions (national and state banks; bank holdingcompanies; federal and state savings associations; savings and loan holding companies; andSEC-registered broker-dealers and investment advisors) supervised by the agencies.As recent events have highlighted, a financial institution may assume substantialreputational and legal risk if the institution enters into a complex structured finance transactionwith a customer and the customer uses the transaction to circumvent regulatory or financialreporting requirements, evade tax liabilities, or further other illegal or improper behavior. Theproposed interagency statement describes the types of internal controls and risk managementprocedures that the agencies believe are particularly effective in assisting financial institutions toidentify and address the reputational, legal, and other risks ...

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ll★K
Federal Reserve Bank of Dallas
2200 N. PEARL ST.
DALLAS, TX 75201-2272
May 21, 2004
Notice 04-28
TO: The Chief Executive Officer of each
financial institution and others concerned
in the Eleventh Federal Reserve District
SUBJECT
Request for Comment on Statement Concerning
Complex Structured Finance Activities
DETAILS
The Board of Governors, Office of the Comptroller of the Currency, Office of Thrift
Supervision, Federal Deposit Insurance Corporation, and Securities and Exchange Commission
have requested 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 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
•t o identify those complex structured finance transactions that may involve
heightened reputational and legal risk,
For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal
Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012;
Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.- 2 -
•t o ensure that these transactions receive enhanced scrutiny by the institution, and
•t o ensure that the institution does not participate in illegal or inappropriate
transactions.
The Board must receive comments regarding the statement on or before June 18,
2004. Comments regarding the information collections contained in the statement should be
received on or before July 19, 2004. Please address comments to Jennifer J. Johnson, Secretary,
Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W.,
Washington, DC 20551. Also, you may mail comments electronically to
regs.comments@federalreserve.gov. All comments should refer to Docket No. OP-1189.
The public can also view and submit comments on proposals by the Board and other
federal agencies from the www.regulations.gov web site.
AT TACHMENT
A copy of the Board’s notice as it appears on pages 28980–91, Vol. 69, No. 97 of the
Federal Register dated May 19, 2004, is attached.
MORE INFORMATION
For more information, please contact Bobby Coberly, (214)-922-6209 or Randy
Steinley, (713) 652-9117, Banking Supervision Department. Paper copies of this notice or previ-
ous Federal Reserve Bank notices can be printed from our web site at www.dallasfed.org/
banking/notices/index.html.28980 Federal Register/Vol. 69, No. 97/Wednesday, May 19, 2004/Notices
place to identify those complex document number. All comments DEPARTMENT OF THE TREASURY
structured finance transactions that may received will be posted without change
Office of the Comptroller of the involve heightened reputational and to http://www.ots.treas.gov/
Currency legal risk, to ensure that these pagehtml.cfm?catNumber=67&an=1,
transactions receive enhanced scrutiny including any personal information
[Docket No. 04–12]
by the institution, and to ensure that the provided.
Docket: For access to the docket to institution does not participate in illegal Office of Thrift Supervision
read background documents or or inappropriate transactions.
[No. 2004–27] comments received, go to http://DATES: Comments regarding the
www.ots.treas.gov/Statement should be received on or FEDERAL RESERVE SYSTEM
pagehtml.cfm?catNumber=67&an=1. In before June 18, 2004. Comments
[Docket No. OP–1189] addition, you may inspect comments at regarding the information collections
the Public Reading Room, 1700 G Street, contained in the Statement should be
FEDERAL DEPOSIT INSURANCE NW., by appointment. To make an received on or before July 19, 2004.
CORPORATION appointment for access, call (202) 906–
ADDRESSES:
5922, send an e-mail to OCC: You may submit comments,
SECURITIES AND EXCHANGE public.info@ots.treas.gov, or send a identified by Docket number 04–12 by
COMMISSION facsimile transmission to (202) 906–any of the following methods:
7755. (Prior notice identifying the [Release No. 34–49695; File No. S7–22–04] E-mail address: http://
materials you will be requesting will www.regs.comments@occ.treas.gov.
Interagency Statement on Sound assist us in serving you.) We schedule Fax: (202) 874–4448.
Practices Concerning Complex appointments on business days between Mail: Office of the Comptroller of the
Structured Finance Activities 10 a.m. and 4 p.m. In most cases, Currency, 250 E Street, SW., Public
appointments will be available the next Reference Room, Mail Stop 1–5,
AGENCIES: Office of the Comptroller of
business day following the date we Washington, DC 20219. the Currency, Treasury (OCC); Office of
Hand Delivery/Courier: 250 E Street, receive a request.
Thrift Supervision, Treasury (OTS); Board: You may submit comments, SW., Attn: Public Reference Room,
Board of Governors of the Federal identified by Docket No. OP–1189, by MailStop 1–5, Washington, DC 20219.
Reserve System (Board); Federal Deposit any of the following methods: You may review the comments received
Insurance Corporation (FDIC); and
• Board’s Web Site: http://by the OCC and other related materials
Securities and Exchange Commission www.federalreserve.gov. Follow the by any of the following methods:
(SEC). instructions for submitting comments at Viewing Comments Personally: You
ACTION: Notice of interagency statement http://www.federalreserve.gov/may personally inspect and photocopy
with request for public comment. generalinfo/foia/ProposedRegs.cfm. comments received at the OCC’s Public
• Federal eRulemaking Portal: http//Reference Room, 250 E Street, SW.,
SUMMARY: The OCC, OTS, Board, FDIC, www.regulations.gov. Follow the Washington, DC. You can make an and SEC (collectively, the Agencies) are instructions for submitting comments. appointment to inspect comments by requesting public comment on a
• E-mail: calling (202) 874–5043. proposed interagency statement regs.comments@federalreserve.gov. Viewing Comments Electronically:
concerning the complex structured Include docket number in the subject You may request copies of comments
finance activities of financial line of the message. received for a particular docket via e-
institutions (national and state banks; Fax: (202) 452–3819 or (202) 452–mail or CD-ROM by contacting the
bank holding companies; federal and 3102. OCC’s Public Reference Room at
state savings associations; savings and
• Mail: Jennifer J. Johnson, Secretary, http://www.foia-pa@occ.treas.gov.
loan holding companies; and SEC- Board of Governors of the Federal OTS: You may submit comments,
registered broker-dealers and Reserve System, 20th Street and identified by No. 2004–27, by any of the
investment advisors) supervised by the Constitution Avenue, NW., Washington, following methods:
Agencies. As recent events have DC 20551.
• Federal eRulemaking Portal: http://
highlighted, a financial institution may All public comments are available www.regulations.gov. Follow the
assume substantial reputational and from the Board’s Web site at http://instructions for submitting comments.
legal risk if the institution enters into a www.federalreserve.gov/generalinfo/
• E-mail:
complex structured finance transaction foia/ProposedRegs.cfm as submitted, regs.comments@ots.treas.gov. Please
with a customer and the customer uses except as necessary for technical include No. 2004–27 in the subject line
the transaction to circumvent regulatory reasons. Accordingly, your comments of the message, and include your name
or financial reporting requirements, will not be edited to remove any and telephone number in the message.
evade tax liabilities, or further other identifying or contact information.
• Fax: (202) 906–6518.
illegal or improper behavior. The Public comments also may be viewed
• Mail: Regulation Comments, Chief
proposed interagency statement electronically or in paper form in Room Counsel’s Office, Office of Thrift
(Statement) describes the types of MP–500 of the Board’s Martin Building Supervision, 1700 G Street, NW.,
internal controls and risk management (C and 20th Streets, NW.) between 9 Washington, DC 20552, Attention: No.
procedures that the Agencies believe are a.m. and 5 p.m. on weekdays. 2004–27.
particularly effective in assisting FDIC: Written comments should be
• Hand Delivery/Courier: Guard’s
financial institutions to identify and addressed to Robert E. Feldman, Desk, East Lobby Entrance, 1700 G
address the reputational, legal, and Executive Secretary, Attention: Street, NW., from 9 a.m. to 4 p.m. on
other risks associated with complex Comments/OES, Federal Deposit business days, Attention: Regulation
structured finance transactions. The Insurance Corporation, 550 17th Street, Comments, Chief Counsel’s Office,
Statement, among other things, provides NW., Washington, DC 20429. Comments Attention: No. 2004–27.
that financial institutions should have Instructions: All submissions received may be hand delivered to the guard
effective policies and procedures in must include the agency name and station at the rear of the 550 17th Street
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Building (located on F Street), on Assistant Director (202) 452–5264, or markets. In the vast majority of cases,
business days between 7:00 a.m. and Sabeth I. Siddique, Manager (202) 452– structured finance products and the role
5:00 p.m. (Fax number: (202) 898–3838; 3861, Division of Banking Supervision played by financial institutions with
Internet address: comments@fdic.gov). and Regulation; or Kieran J. Fallon, respect to these products have served
Comments may be inspected and Managing Senior Counsel (202) 452– the legitimate business purposes of
photocopied in the FDIC Public 5270, Legal Division, Board of customers. This has allowed structured
Information Center, Room 100, 801 17th Governors of the Federal Reserve finance products to become an essential
Street, NW., Washington, DC, between 9 System, 20th Street and Constitution part of U.S. and international capital
a.m. and 4:30 p.m. on business days. Avenue, NW., Washington, DC 20551. markets.
SEC: Comments may be submitted by The more complex variations of Users of Telecommunication Device for
any of the following methods: Deaf (TTD) only, call (202) 263–4869. structured finance products, however,
Electronic comments: FDIC: William A. Stark, Associate have placed pressure on the
• Use the Commission’s Internet Director, Capital Markets Branch, (202) interpretations of accounting and tax
comment form (http://www.sec.gov/ 898–6972, Jason C. Cave, Chief, Policy rules, and, in turn, have given rise to
rules/policy); or Section, Capital Markets Branch, (202) significant concerns about the legality
• Send an e-mail to rule- 898–3548, Division of Supervision and and appropriateness of certain
comments@sec.gov. Please include File Consumer Protection; or Mark G. individual transactions. Importantly, a
Number S7–22–04 on the subject line; Flanigan, Counsel, Supervision and limited number of complex structured
or Legislation Branch, Legal Division, (202) finance transactions appear to have been
• Use the Federal eRulemaking Portal 898–7426, Federal Deposit Insurance used to alter the appearance of a
(http://www.regulations.gov). Follow the Corporation, 550 17th Street, NW., customer’s public financial statements
instructions for submitting comments. Washington, DC 20429. in ways that are not consistent with the
Paper comments: SEC: Mary Ann Gadziala, Associate economic reality of the transactions or
• Send paper comments in triplicate Director, or Juanita Bishop, Supervisory to inappropriately reduce a customer’s
to Jonathan G. Katz, Secretary, Accountant at (202) 942–7400, Office of tax liabilities. In the most extreme cases,
Securities and Exchange Commission, Compliance Inspections and structured finance transactions appear
450 Fifth Street, NW., Washington, DC Examinations, or Catherine McGuire, to have been used in fraudulent
20549–0609. Chief Counsel, Linda Stamp Sundberg, schemes to misrepresent the financial
All submissions should refer to File Attorney Fellow, or Randall W. Roy, condition of public companies or evade
Number S7–22–04. This file number Special Counsel, at (202) 942–0073, taxes.
should be included on the subject line Division of Market Regulation, Financial institutions must conduct
if e-mail is used. To help us process and Securities and Exchange Commission, their operations in compliance with
review your comments more efficiently, 450 Fifth Street, NW., Washington, DC applicable law and regulations, and
please use only one method. The 20549–1001. institutions that do not may be subject
Commission will post all comments on to enforcement actions by the Agencies SUPPLEMENTARY INFORMATION:
the Commission’s Internet Web site and lawsuits by private parties. As
I. Background (http://www.sec.gov/rules/policy). recent events have highlighted, financial
Comments are also available for public Financial markets have grown rapidly institutions may face substantial legal
inspection and copying in the over the past decade and innovations in risk to the extent they participate in
Commission’s Public Reference Room, financial instruments have facilitated complex structured finance transactions
450 Fifth Street, NW., Washington, DC the structuring of cash flows and the that are used by customers to
20549. All comments received will be allocation of risk among borrowers and circumvent regulatory or financial
posted without change; we do not edit investors in more efficient ways. This reporting requirements, evade tax
personal identifying information from innovation has led to the development liabilities, or further other illegal or
submissions. You should submit only of a wide array of structured finance improper behavior by the customer.
information that you wish to make products, including financial Involvement in such transactions also
available publicly. derivatives for market and credit risk, may damage an institution’s reputation
asset-backed securities with customized and franchise value. Reputational risk FOR FURTHER INFORMATION CONTACT:
OCC: Kathryn E. Dick, Deputy cash flow features, and specialized poses a major threat to financial
Comptroller, (202) 874–4660, Risk financial conduits that manage pools of institutions because the nature of their
Evaluation, Grace E. Dailey, Deputy purchased assets. business requires maintaining the
National and state banks, bank –4610, Large confidence of customers, creditors, and
holding companies, and SEC-registered Bank Supervision, Ellen Broadman, the general marketplace. Importantly,
broker-dealers and investment advisers Director, (202) 874–5210, Securities and reputational risks may arise even where
have played an active and important Corporate Practices Division, Office of the transactions involved are structured
role in the development of structured the Comptroller of the Currency, 250 E to technically comply with existing laws
finance products and markets. In this and regulations. Street, SW., Washington, DC 20219.
OTS: John C. Price, Jr., Director, regard, financial institutions often play The events associated with Enron
Supervision Policy, Examinations and an important role in structuring, Corp. demonstrate the potential for the
abusive use of complex structured Supervision Policy, (202) 906–5745; arranging or participating in complex
finance transactions, as well as the Debbie Merkle, Project Manager, Credit structured finance transactions for their
substantial legal and reputational risks Risk, Supervision Policy, (202) 906– own use and to facilitate the needs of
that financial institutions face when 5688; David A. Permut, Senior Attorney, customers.
As financial intermediaries, financial they participate in complex structured Business Transactions Division, (202)
institutions play a critical role in finance transactions that are designed or 906–7505, Office of Thrift Supervision,
ensuring the integrity of financial used for improper purposes. After 1700 G Street, NW., Washington, DC
markets and maintaining the trust and conducting investigations, the OCC, 20552.
Board: Michael G. Martinson, Senior public confidence essential to the Federal Reserve System, and the SEC
Adviser (202–452–3640), Walt H. Miles, proper functioning of the capital took strong and coordinated civil and
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administrative enforcement actions with complex structured finance on both a per transaction and
against certain financial institutions that transactions. These assessments relationship basis, with all customers
participated in complex structured indicated that many financial (including corporate entities,
finance transactions with Enron Corp. institutions have already taken government entities, and individuals)
that appeared to have been designed or meaningful steps to improve their and in all jurisdictions where the
used to shield the company’s true control infrastructures relating to financial institution operates.
1financial health from the public. These complex structured finance products in The board of directors of a financial
actions involved significant financial light of the control weaknesses institution has ultimate responsibility
penalties on the institutions and evidenced by recent events. The for establishing the institution’s risk
required the institutions to take several Agencies also have focused attention on tolerances for complex structured
the complex structured finance measures to strengthen their risk finance transactions and ensuring that a
management practices for complex activities of financial institutions in the sufficiently strong risk control
structured finance activities. The normal course of our supervisory framework is in place to guide the
structured finance relationships process. actions of the financial institution’s
between some financial institutions and personnel. The board of directors and II. Proposed Statement on Sound
Enron Corp. also sparked an senior management also should send a Practices Concerning the Complex
investigation by the Permanent strong message to others in the financial Structured Finance Activities of
Subcommittee on Investigations of the institution about the importance of Financial Institutions
U.S. Senate Committee on integrity, compliance with the law, and
2 In order to help ensure that financial Governmental Affairs, as well as overall good business ethics, which may
institutions have and maintain adequate numerous lawsuits by private litigants. be implemented through a Code of
control infrastructures for complex The Agencies have long expected Professional Conduct.
structured finance transactions, the financial institutions to develop and
• As described further in the Agencies have developed, and are maintain robust control infrastructures
Statement, an institution’s policies and seeking public comment on, the enabling them fully to identify, evaluate
procedures should define what attached Statement included at the end and control all dimensions of risk
constitutes a complex structured finance 3of this notice. The Statement describes associated with their business activities.
transaction and should, among other a number of internal controls and risk In the area of complex structured
things— management procedures that the finance transactions, it is critical that
• Define the process that financial Agencies believe are particularly useful financial institutions have effective risk
institution personnel must follow to in assisting financial institutions to management and internal controls to
obtain approval for complex structured ensure that their complex structured ensure that the institutions’ activities
finance transactions; financial activities are conducted in comply with the law and that all of the
accordance with applicable law and that
• Establish a control process for the risks associated with a transaction—
institutions effectively manage the full approval of all new complex structured including legal and reputational risks—
range of risks associated with these finance products; are identified and appropriately
activities, including legal and addressed. • Ensure that the reputational and
reputational risks. The Statement In light of recent events, the OCC, legal risks associated with a complex
reflects the ‘‘lessons learned’’ from Board, and SEC conducted special structured finance transaction, or series
recent events, as well as what the reviews of several banking and of transactions, are identified and
Agencies believe to be sound practices securities firms that are significant evaluated in both the transaction and
in this area based on supervisory participants in the market for complex new product approval process and
reviews and experience. Financial structured finance products. These appropriately managed by the
institutions should consider the reviews were designed to evaluate the institution;
Statement in developing and evaluating product approval, transaction approval,
• Ensure that financial institution
the institution’s risk controls for and other internal controls and staff appropriately reviews and
complex structured finance activities. processes used by these institutions to documents the customers’ proposed
The following provides a brief overview identify and manage the legal, accounting treatment of complex
of the key aspects of the Statement.reputational, and other risks associated structured finance transactions, As a general matter, the Statement
financial disclosures relating to the indicates that financial institutions 1 See Exchange Act Release No. 48230 (July 28, transactions, and business objectives for
2003), Written Agreement by and between Citibank, offering complex structured finance
entering into the transactions; N.A. and the Office of the Comptroller of the transactions should maintain a
Currency, No. 2003–77 (July 28, 2003) (pertaining
• Provide for the generation, comprehensive set of formal, firm-wide
to transactions entered into by Citibank, N.A. with collection and retention of appropriate policies and procedures that provide for Enron Corp.), and Written Agreement by and
documentation relating to all complex between Citigroup, Inc. and the Federal Reserve the identification, documentation,
structured finance transactions; Bank of New York, dated July 28, 2003 (pertaining evaluation, and control of the full range
to transactions involving Citigroup Inc. and its
• Ensure that senior management and of credit, market, operational, legal, and
subsidiaries and Enron Corp. and Dynegy Inc.); SEC the board of directors of the institution reputational risks that may be associated Litigation Release No. 18252 (July 28, 2003) and
receive appropriate and timely reports with these transactions. These policies Written Agreement by and among J.P. Morgan
Chase & Co., the Federal Reserve Bank of New York, concerning the institution s complex and procedures should be designed to
and the New York State Banking Department, dated structured finance activities;ensure that the financial institution
July 28, 2003 (pertaining to transactions involving
consistently and appropriately manages • Provide for periodic independent J.P. Morgan Chase & Co. and its subsidiaries and
its complex structured finance activities reviews of the institution’s complex Enron Corp.).
2 See Fishtail, Bacchus, Sundance, and Slapshot: structured finance activities to ensure
3Four Enron Transactions Funded and Facilitated by For institutions supervised by the Board, the that the institution’s policies and
U.S. Financial Institutions, Report Prepared by the OCC, the OTS, and the FDIC the statement will controls are being implemented
Permanent Subcomm. on Investigations, Comm. on represent supervisory guidance. For institutions
effectively and to identify potential Governmental Affairs, United States Senate, S. Rpt. registered with the SEC, the statement will
107–82 (2003). represent a policy statement. compliance issues;
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• Ensure effective internal audit its complex structured finance Statement will be submitted to the OMB
coverage of the institution’s complex activities. in accordance with the Paperwork
structured finance activities; and The Agencies request comment on all Reduction Act of 1995 (44 U.S.C. Ch.
aspects of the Statement and will revise 35). The OCC will use any comments
• Ensure that financial institution
the Statement as appropriate after a received to evaluate the collections and personnel receive appropriate training
review of public comments. verify its burden estimates. The OCC concerning the institution’s policies and
believes that only the largest national procedures governing its complex III. Paperwork Reduction Act
banks and U.S. branches of foreign structured finance activities.
The Board, the FDIC, the OTS, and banks are involved in these activities. An institution should establish a clear
the OCC have determined that the Further, as a matter of usual and process for identifying those complex
Statement, which will represent customary business practice and in light structured finance transactions that
supervisory guidance for institutions of recent events, involved institutions involve heightened legal and
supervised by the Board, the FDIC, the already have installed policies and reputational risks. Once a transaction is
OTS, and the OCC, contains collections procedures similar to those envisioned identified as involving potentially
of information for purposes of the in the Statement. However, institutions heightened legal or reputational risk, the
Paperwork Reduction Act of 1995 (44 will have to verify and update their institution should ensure that these
U.S.C. Ch. 35). The OCC, the FDIC, the policies and procedures periodically to transactions receive an elevated and
OTS, and Board request public ensure that they are adequate and thorough review. If, after conducting
comment on all aspects of the current. this review, the financial institution
collections of information contained in Comments on the collections of determines that a proposed transaction
the Statement. Also, the OCC, FDIC, information should be sent to John may result in the customer filing
OTS, and Board request comment on Ference or Camille Dixon, Office of the materially misleading financial
whether institutions involved in Comptroller of the Currency, 250 E statements, the financial institution
Street, SW., Mail Stop 8–4, Attention: complex structured finance transactions should decline to participate in the
Docket Number 04–12 (1557–CSFA), currently are in compliance with the transaction, condition its participation
Washington, DC 20219. You may also Statement and the information upon the customer making express and
send comments by electronic mail to collections therein. accurate disclosures regarding the
The OCC, FDIC, OTS, and Board also camille.dixon@occ.treas.gov. You nature and financial impact of the
invite comment on: should also send a copy of your transaction on the customer’s financial
(1) Whether the collections of comments to OMB Desk Officer, Mark condition, or take other steps to ensure
information contained in the Statement Menchik, Office of Information and that the financial institution does not
are necessary for the proper Regulatory Affairs, Office of participate in an inappropriate
performance of each agency’s functions, Management and Budget, Paperwork transaction.
including whether the information has Reduction Project (1557–CSFA),
The Statement includes examples of
practical utility; Washington, DC 20503. Alternatively,
characteristics that may indicate that a (2) The accuracy of each agency’s you may e-mail your comments to
transaction or series of transactions estimate of the burden of the proposed mmenchik@omb.eop.gov, or fax them to
involves elevated levels of legal or information collections; (202) 395–6974.
reputational risk and, thus, should be (3) Ways to enhance the quality, The potential respondents are the
subject to heightened review by the utility, and clarity of the information to largest national banks and U.S. branches
institution. The examples included in be collected; of foreign banks.
the Statement are not exclusive and (4) Ways to minimize the burden of Estimated number of respondents: 21.
institutions may differ in the sets of the information collections on Estimated average annual burden
characteristics they use in identifying respondents, including the use of hours per respondent: 100 hours.
transactions that may involve Estimated total annual burden: 2,100 automated collection techniques or
heightened risks. Institutions, however, burden hours.other forms of information technology;
should be conservative when FDIC: The collection of information and
establishing these characteristics and requirements contained in the (5) Estimates of capital or start-up
the ultimate goals of all institutions Statement will be submitted to the OMB costs and costs of operation,
should remain the same—to identify in accordance with the Paperwork maintenance, and purchases of services
those transactions that require Reduction Act of 1995 (44 U.S.C. Ch. to provide information.
additional scrutiny at inception and to 35). The FDIC will use any comments Respondents/record keepers are not
ensure that transactions receive a level received to evaluate the collections and required to respond to these collections
of review that is commensurate with the verify its burden estimates. The FDIC of information unless the Board, the
legal and reputational risks associated believes that only the largest state FDIC, the OTS, and OCC display a
with the transaction. nonmember banks are involved in these currently valid Office of Management
Because the Statement discusses activities. Further, as a matter of usual and Budget (OMB) control number. The
sound practices related to complex and customary business practice and in OCC, FDIC, and OTS currently are
structured finance activities—activities light of recent events, involved requesting approval of these information
that typically are conducted only by institutions already have installed collections from OMB, and the Board is
larger financial institutions—the policies and procedures similar to those processing this collection under its
Statement would not be relevant and, envisioned in the Statement. However, delegated authority.
therefore, would not apply to most The OCC, FDIC, OTS, and Board institutions will have to verify and
small institutions. Moreover, an estimates of the total annual burden of update their policies and procedures
institution’s policies and procedures the collections of information contained periodically to ensure that they are
concerning complex structured finance in the Statement on the financial adequate and current.
activities should be tailored to, and Comments on the collections of institutions they supervise follow.
appropriate in light of, the institution’s OCC: The collection of information information should be sent to Thomas
size and the nature, scope, and risk of requirements contained in the Nixon, Legal Division, Federal Deposit
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Insurance Corporation, 550 17th Street Washington, DC 20503. Alternatively, the structuring of cash flows and
NW., Washington, DC 20429. Comments you may e-mail your comments to allocation of risk among creditors,
may be hand-delivered to the guard mmenchik@omb.eop.gov, or fax them to borrowers and investors in more
station at the rear of the 17th Street (202) 395–6974. efficient ways. Financial derivatives for
Building (located on F Street), on The potential respondents are the market and credit risk, asset-backed
business days between 7 a.m. and 5 p.m. largest savings associations and savings securities with customized cash flow
Comments should also be submitted to and loan holding companies. features, specialized financial conduits
the OMB desk officer for the FDIC: Mark Estimated number of respondents: 5. that manage pools of purchased assets,
Menchik, Office of Information and Estimated average annual burden along with other structured transactions
Regulatory Affairs, Office of hours per respondent: 100 hours. have usually served the legitimate
business purposes of the customers of Management and Budget, New Estimated total annual burden: 500
Executive Office Building, Washington, financial institutions and are an burden hours.
DC 20503. Alternatively, you may e- essential part of U.S. and international Board: In accordance with section
mail your comments to capital markets. 3506 of the Paperwork Reduction Act of
Financial institutions have played an mmenchik@omb.eop.gov, or fax them to 1995 (44 U.S.C. Ch. 35; 5 CFR 1320,
active and important role in the (202) 395–6974. appendix A.1), the Board reviewed the
The potential respondents are the development of structured finance Statement under the authority delegated
largest state nonmember banks. products and markets. Structured to the Board by the OMB. The Board
Estimated number of respondents: 5. finance transactions are often employed believes that only the largest state
Estimated average annual burden to manage risk or for other legitimate member banks, bank holding
hours per respondent: 100 hours. business purposes, such as diversifying companies, and U.S. branches and
Estimated total annual burden: 500 risks, allocating cash flows, and agencies of foreign banks are involved
burden hours. reducing cost of capital. The more in complex structured finance activities.
OTS: The collection of information complex variations of selected Further, as a matter of usual and
requirements contained in the structured finance transactions have, customary business practice and in light Statement will be submitted to OMB in however, placed pressure on the of recent events, involved institutions accordance with the Paperwork interpretations of accounting and tax already have adopted policies and Reduction Act of 1995 (44 U.S.C. Ch. rules, and this has given rise to procedures similar to those envisioned 35). OTS will use any comments significant concerns about the risks in the Statement. However, the received to evaluate the collections and associated with certain individual institutions will have to verify and verify its burden estimates. The OTS transactions. More so, a limited number update their policies and procedures assumes that only the largest savings of transactions appear to have been used periodically to ensure that they are associations and savings and loan primarily to alter the appearance of a adequate and current. holding companies could be involved in customer’s public financial statements Comments on the collections of these activities. Further, as a matter of in ways that are not consistent with the information should be sent to Michelle usual and customary business practice economic reality of the transactions or Long, Acting Federal Reserve Board and in light of recent events, involved to inappropriately reduce a customer’s Clearance Officer, Division of Research institutions already have installed tax liabilities. In the most extreme cases, and Statistics, Mail Stop 41, Board of policies and procedures similar to those structured finance transactions appear Governors of the Federal Reserve envisioned in the Statement. However, to have been used in fraudulent System, Washington, DC 20551. You institutions will have to verify and schemes primarily to misrepresent the should also send a copy of your update their policies and procedures financial condition of public companies comments to OMB Desk Officer, Mark periodically to ensure that they are or evade taxes. Some financial Menchik, Office of Information and adequate and current. institutions have been subject to
Regulatory Affairs, Office of Send comments, referring to the criminal sanctions, and civil and
Management and Budget, Paperwork collection by title of the proposal, to administrative enforcement actions by
Reduction Project (1557—To Be Information Collection Comments, Chief the regulatory agencies, for participating
Determined), Washington, DC 20503. Counsel’s Office, Office of Thrift in complex structured finance
Alternatively, you may e-mail your Supervision, 1700 G Street, NW., transactions used by a public company
comments to mmenchik@omb.eop.gov, Washington, DC 20552; send a facsimile in reporting false or misleading
or fax them to (202) 395–6974. transmission to (202) 906–6518; or send financial statements.
The potential respondents are the an e-mail to Financial institutions are in a unique
largest state member banks, bank infocollection.comments@ots.treas.gov. position given their role in structuring,
holding companies, and U. S. branches OTS will post comments and the related arranging or participating in complex
and agencies of foreign banks. index on the OTS Internet Site at http:/ structured finance transactions for their
Estimated number of respondents: 20. /www.ots.treas.gov. In addition, own use and to facilitate the needs of
Estimated average annual burden interested persons may inspect their customers. When a financial
hours per respondent: 100 hours. comments at the Public Reading Room, institution provides advice on, arranges
Estimated total annual burden: 2,000 1700 G Street, NW., by appointment. To or actively participates in a complex
hours. make an appointment, call (202) 906– structured finance transaction, it
The proposed Statement follows. 5922, send an e-mail to assumes the usual market, credit, and
publicinfo@ots.treas.gov, or send a operational risks and also may assume Interagency Statement on Sound
facsimile transmission to (202) 906– substantial reputational and legal risk to Practices Concerning Complex
7755. You should also send a copy of the extent that an end-user enters into Structured Finance Activities
your comments to OMB Desk Officer, the transaction for improper purposes.
I. Introduction Mark Menchik, Office of Information Considering the inherent complexity of
and Regulatory Affairs, Office of Financial markets have grown rapidly many structured finance transactions
Management and Budget, Paperwork over the past decade and innovations in and the many risks associated with
Reduction Project (1550–NEW), financial instruments have facilitated these transactions, it is critical that
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financial institutions have effective risk II. Definition and Key Risks of Complex of their business requires maintaining
Structured Finance Transactions the confidence of customers, creditors management and internal controls
and the general marketplace. relating to these products to ensure Structured finance transactions
Importantly, reputational risks may compliance with the law and to encompass a broad array of products
arise even where the transactions effectively monitor and control the risks with varying levels of complexity. This
involved are structured to technically associated with these transactions. guidance addresses complex structured
comply with existing laws and Financial institutions may not engage in finance transactions, which usually
regulations and accounting standards.complex structured finance transactions share several common characteristics.
Accordingly, financial institutions in violation of the law and institutions First, they typically result in a final
need to have strong controls to ensure that violate the law may be subject to product that is often non-standard and
that their actions with respect to enforcement action and civil or criminal structured to meet the specific financial
complex structured finance penalties. objectives of a customer. Second, they
transactions—including structuring, often involve professionals from The regulatory agencies have long
marketing, sales, funding and trading multiple disciplines within the financial expected financial institutions to
activities—are conducted in accordance institution and may have significant fees develop and maintain robust control
with applicable laws and regulations, or high returns in relation to the market infrastructures enabling them to fully
and to ensure that the institution and credit risks associated with the identify, evaluate and control all
identifies and appropriately addresses transaction. Third, they may be dimensions of risk associated with their
the potential reputational risks involved associated with the creation or use of business activities. In the wake of recent
in these transactions. As discussed one or more special purpose entities developments, the Office of the
further under ‘‘Reputational and Legal (SPEs) designed to address the Comptroller of the Currency, the Office Risk,’’ an institution’s policies and economic, legal, tax or accounting of Thrift Supervision, the Board of procedures should identify those objectives of the customer and/or the Governors of the Federal Reserve complex structured finance transactions combination of cash and derivative System, the Federal Deposit Insurance that may warrant enhanced scrutiny due products. Finally, and perhaps most Corporation, and the U.S. Securities and to factors related specifically to importantly, they may expose the Exchange Commission are issuing this reputational and legal risk. financial institution to elevated levels of guidance to financial institutions that Although the foregoing (and this
market, credit, operational, legal or we supervise (‘‘financial institutions’’ or document more generally) highlights
1 reputational risks. These criteria are not ‘‘institutions’’) to describe a number of some of the most significant risks
exclusive and institutions should internal controls and risk management associated with complex structured
supplement or modify these criteria as procedures that we believe are useful to finance transactions, it is not intended
appropriate to reflect the institution’s effectively manage the risks associated to present a full exposition of the risks
business activities and changes in the with complex structured finance associated with these transactions.
marketplace. transactions. Financial institutions are encouraged to Financial risks include, among other
refer to other supervisory information Because many of the core elements of things, market and credit risks. Due to
prepared by the agencies for further an effective control infrastructure are their inherent complexity, financial
information concerning market, credit, the same regardless of the business line institutions participating in complex
operational, legal and reputational risks. involved, this guidance draws heavily structured finance transactions also may
on controls and procedures that our face heightened reputational or legal III. Guidelines for Incorporating
agencies previously have found to be risk. Financial institutions have been Structured Finance Transactions Into
effective in managing and controlling sued due to their involvement in Existing Management Procedures,
risks and identifies ways in which these complex structured finance transactions Controls and Systems
controls and procedures can effectively that allegedly facilitated the deceptive
Role of Board and Management be applied to the institution’s complex accounting or financial reporting
structured finance activities. Financial The board of directors (the Board) of practices of certain public companies.
institutions should consider this a financial institution is elected by and Legal risk also may arise in other
guidance in developing, or evaluating accountable to shareholders, and is the situations if the financial institution is
existing, risk controls for complex focal point of the corporate governance involved in transactions that are used by
structured finance activities. These risk system. Effective oversight by the boards customers to circumvent regulatory or
controls should supplement the of directors of public institutions is financial reporting requirements, evade
financial institution’s more general fundamental to preserving the integrity tax liabilities, or further other illegal or
internal controls and risk management 2 of capital markets. The board of improper behavior by the customer.
systems, as appropriate. directors, in its oversight role, is Besides creating legal risks, these
ultimately responsible for the financial transactions may create substantial
1 These institutions are national banks in the case well being of the institutions they reputational risk for the institution.
of the Office of the Comptroller of the Currency; oversee, as well as ensuring that the Reputational risk poses a major threat to
federal and state savings associations and savings risks associated with the firm’s business financial institutions because the nature and loan holding companies in the case of the
activities, including those activities Office of Thrift Supervision; state member banks
2and bank holding companies in the case of the For additional guidance concerning when a associated with the offering and
Federal Reserve Board; state nonmember banks in financial institution’s participation in a complex delivery of complex structured finance
the case of the Federal Deposit Insurance structured finance transaction may violate the transactions, are appropriately
Corporation; and registered broker-dealers and Federal securities laws, and the bases for such
identified, evaluated and controlled by investment advisers in the case of the Securities potential liability, see Letter from Annette L.
and Exchange Commission. The U.S. branches and Nazareth, Director, Division of Market Regulation, management. The Board should
agencies of foreign banks supervised by the Federal Securities and Exchange Commission, to Richard establish the financial institution’s
Reserve Board, the Office of the Comptroller, and Spillenkothen and Douglas W. Roeder, dated threshold for the risks associated with
the Federal Deposit Insurance Corporation also are December 4, 2003 (available at http://
complex structured finance products considered to be financial institutions for purposes www.federalreserve.gov/boarddocs/srletters/2004/
of this guidance. and http://www.occ.treas.gov). and ensure that a sufficiently strong risk
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control framework is in place to guide Accordingly, these policies and procedures should encourage personnel
the actions of the financial institution’s to elevate ethical concerns regarding a procedures should address
personnel. The Board should ensure complex structured finance transaction responsibilities of personnel from sales
that the financial institution has a risk or series of transactions to appropriate and trading, relationship management,
control framework for complex levels of management. Establishing a market risk, credit risk, operations,
structured finance transactions that culture that encourages financial accounting, legal, compliance, audit and
includes comprehensive policies that institution personnel to elevate senior line management. The financial
address the elements described below. concerns to appropriate levels of institution’s policies and procedures
Using guidance provided by the management may require mechanisms should provide a clear framework for
Board, senior management should to protect personnel by permitting the approval and monitoring of complex
implement a risk control framework for structured finance transactions. Policies confidential disclosure in appropriate
4complex structured finance transactions circumstances. Additionally, the Board for relevant personnel should describe
that includes comprehensive policies, and senior management should ensure responsibilities for working with
defined roles and responsibilities and that incentive plans are not structured relationship managers, advising and
approval authorities, detailed in a way that encourages transactors to counseling customers, disclosing
management reporting, required cross ethical boundaries when executing information to customers, and providing
documentation, and ongoing complex structured finance relevant information to control areas.
independent monitoring and testing of The institution’s policies should transactions.
policy compliance. In order to manage ensure that the market, credit, and
Policies and Procedures the risks associated with complex operational risk associated with
Financial institutions offering structured finance transactions, some individual complex structured
complex structured finance transactions institutions have established a senior transactions are appropriately
should maintain a comprehensive set of management committee that is designed identified, aggregated, and managed. A
formal, firm-wide policies and financial institution should, at a to ensure that all of the relevant control
functions within the financial procedures that provide for the minimum, also have procedures,
institution, including independent risk identification, documentation, controls and systems for complex
management, accounting policy, legal, evaluation, and control of the full range structured finance activities that address
and financial control, are involved in of credit, market, operational, legal, and the following: (1) Transaction approval,
the oversight of complex structured reputational risks that may be associated (2) new product approval, (3)
finance transactions. The goal of such a with these transactions. These policies reputational and legal risk, (4)
senior-level risk control committee is to should start with the financial accounting and disclosure by the
ensure that those complex structured institution’s definition of what customer, (5) documentation, (6)
finance activities that may expose the constitutes a complex structured finance reporting, (7) independent monitoring,
analysis and compliance with internal financial institution to higher levels of transaction and be designed to ensure
financial, legal and reputational risk are policies, (8) audit, and (9) training. that the financial institution
comprehensively and consistently appropriately manages its complex Transaction Approval
managed and controlled on a company- structured finance activities on both an
The policies and procedures of a wide basis. This senior management individual transaction and a
financial institution should define the committee regularly reviews trends in relationship basis, with all customers
process that personnel must follow to new products and complex structured (including corporate entities,
obtain approval for a complex transaction activity, including overall government entities and individuals)
structured finance transaction. Policies risk exposures from such transactions, and in all jurisdictions where the
5 for approving complex structured and typically provides final approval of financial institution operates. These
finance transactions should clearly the most complicated or controversial policies may be developed specifically
articulate the roles and responsibilities complex structured finance for complex structured finance
of both transactors (e.g. personnel from transactions. The agencies believe that transactions or included in the set of
origination, structuring, execution, sales such a senior-level committee can serve broader policies governing the
and trading areas) and independent as an important part of an effective institution generally.
control staff (e.g. personnel from risk control infrastructure for complex To be most effective, the institution’s
3 management, accounting policy, legal, structured finance activities. policies and procedures relating to
and financial control) in analyzing, The Board and senior management complex structured finance transactions
approving, and documenting proposed also should send a strong message to should specifically set forth the
transactions. Policies should guide front others in the financial institution about particular responsibilities of the
office personnel in meeting their the importance of integrity, compliance personnel involved in the origination,
responsibilities to provide information with the law, and overall good business structuring, trading, review, approval,
on customer objectives and key risk ethics, which may be implemented documentation, verification, and
issues (including those described below) through a Code of Professional Conduct. execution of these transactions.
to the appropriate approving personnel.
Furthermore, it is imperative that the should strive to create a firm-wide 4 The agencies note that the Sarbanes-Oxley Act
approving authority includes corporate culture that is sensitive to of 2002 requires companies listed on a national
securities exchange or inter-dealer quotation system representatives from appropriate control ethical issues as well as the potential
of a national securities association to establish areas that are independent of the risks to the financial institution. The
procedures that enable employees to submit
transactors. Approving personnel financial institution’s culture and concerns regarding questionable accounting or
should have appropriate experience and auditing matters on a confidential, anonymous
3 basis. See 15 U.S.C. 78j–1(m).Financial institutions should ensure that the stature in the financial institution to
5control processes established for complex In the case of U.S. branches and agencies of ensure proper consideration of elements
structured finance activities comply with any foreign banks, these policies should be coordinated or factors that may expose the
informational barriers established by the institution with the group-wide policies developed in
institution to higher levels of credit, to manage potential conflicts of interest, insider accordance with the rules of the foreign bank’s
trading or other concerns. home supervisor. market, operational, legal or
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reputational risk. While acknowledging Reputational and Legal Risk review complex structured finance
transactions as part of the approval its ultimate responsibility for the The policies and procedures
process. Legal personnel may be approval of complex structured finance established by a financial institution for
assigned to business units or areas transactions, the organization’s policies complex structured finance activities
where complex structured transactions also should clearly outline when third- should ensure that the legal and
originate to ensure the legal party legal professionals should be reputational risks associated with a
department’s involvement throughout engaged to review and opine on transaction, or series of transactions, are
the transaction’s development, or transactions, and when third-party identified and evaluated in both the
financial institutions may assign accounting or tax professionals should transaction and new product approval
specific legal personnel to each complex be engaged to consult on transactions. processes and effectively and
structured finance transaction.
appropriately managed by the New Product Policies Independent monitoring by a risk
institution. A financial institution
control group or compliance unit should
Complex structured finance should have effective policies,
ensure that all complex structured
transactions also should be incorporated procedures and controls for assessing
transactions receive appropriate legal
the customer’s business objectives for into a financial institution’s new review, including review by outside
entering into a transaction or series of product policies. In this regard, a counsel where appropriate.
transactions and the economic financial institution’s policies should Areas for legal review include
substance of the transaction(s), include a definition of what constitutes financial institution permissibility,
evaluating the appropriateness of the a ‘‘new’’ complex structured finance disclosure by the customer, regulatory
transaction(s), and preventing the product and should establish a control capital requirements, the enforceability
financial institution from participating process for the approval of each new of any netting and collateral agreements
in inappropriate transactions. product. In determining whether or not associated with the transaction,
Policies should ensure that the a complex structured finance suitability or appropriateness
customer understands the risk and transaction is ‘‘new,’’ a financial assessments, customer assurances,
return profile of the transaction. In institution should consider a variety of insurance considerations and tax issues.
instances where the financial institution factors, including any structural Because transactions may involve
is designing the transaction and variations from existing products, multiple counterparties located in
advising the customer, the disclosures whether the product is targeted at a new different jurisdictions, the financial
to the customer should include an class of customers, pricing variations institution should establish review and
adequate description of the risks in the from existing products, whether the documentation procedures that are
complex structured finance transaction product raises additional or new legal, designed to ensure that each
as well as disclosure of any conflicts of compliance or regulatory issues, and counterparty has the authority to enter
interest associated with the financial deviations from standard market into the transaction and that each
institution’s participation in the practices. When in doubt as to whether counterparty’s obligations are reduced
transaction. Policies should also to legally enforceable contracts. a complex structured finance
articulate when a proposed transaction Financial institutions should ensure transaction requires vetting through the
requires acknowledgement by the that any legal reviews are conducted by new product approval process, financial
customer that the transaction has been qualified in-house or outside counsel institution personnel should err on the
reviewed and approved by higher levels and that these professionals are side of conservatism and route the
of the customer’s management. provided the documentation and other proposed product through the process
Notwithstanding a customer’s information needed to properly evaluate dictated in the new product approval
sophistication and structure of a the transaction. policy. The new product policies for
complex structured finance transaction, Careful evaluations of the complex structured finance activities
the financial institution should evaluate consequences of a transaction are should address the roles and
the impact a transaction may have on particularly important when the responsibilities of all relevant parties,
the financial institution’s reputation or transaction is designed to achieve a including the front office, credit risk,
franchise value. customer’s financial reporting or market risk, operations, accounting,
Policies should outline complex tax objectives. Policies should legal, compliance, audit and senior line
responsibilities of the sales force, front clearly define the types of management. In addition, it is
office, credit and other risk control circumstances where the approval of imperative that the institution’s policies
personnel for analyzing and transactions or patterns of transactions require that new products receive the
documenting the customer’s objectives should be elevated to higher levels of approval of all relevant control areas
and customer-related accounting, financial institution management for that are independent of the profit center
regulatory, or tax issues. In addition, a reasons specific to legal or reputational before the product is offered to
financial institution’s policies and risk. In creating procedures for elevating
customers. procedures should establish criteria or certain transactions to higher levels,
A financial institution also should factors for when concerns related to a financial institutions should identify the
have in place controls that are designed particular structured finance transaction characteristics of those transactions, or
to ensure that new complex structured will necessitate a comprehensive series of transactions, that increase
finance products are, in fact, subjected evaluation of the institution’s entire reputational and legal risk. Institutions
to the institution’s established approval relationship with a customer. should be conservative when
process. Moreover, subsequent to the Policies should ensure that complex identifying these characteristics. While
new product approval, the financial structured finance transactions are institutions may differ in the sets of
institution should monitor new complex reviewed on a consistent basis by the characteristics they identify, the goals
structured finance products to ensure financial institution’s legal department should remain the same—to identify the
that they are effectively incorporated and, where appropriate, by independent transactions that require additional
into the institution’s risk control outside counsel. In general, the financial scrutiny at inception and to ensure that
systems. institution’s legal department should transactions receive a level of review
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