1372 Federal Register / Vol. 72, No. 7 / Thursday, January 11, 2007 / Notices 

1For a memorandum on the potential liability of 

a financial institution for securities laws violations 

arising from participation in a CSFT, 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). 

as fixed guideway miles for purposes of 

FTA’s funding formulas. 

Issued on January 8, 2007. 

James S. Simpson, 

Administrator. 

[FR Doc. E7–263 Filed 1–10–07; 8:45 am] 

BILLING CODE 4910–57–P 

DEPARTMENT OF THE TREASURY 

Office of the Comptroller of the 

Currency 

[Docket No. 06–17] 

Office of Thrift Supervision 

[Docket No. 2006–55] 

FEDERAL RESERVE SYSTEM 

[Docket No. OP–1254] 

FEDERAL DEPOSIT INSURANCE 

CORPORATION 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–55043; File No. S7–08–06] 

Interagency Statement on Sound 

Practices Concerning Elevated Risk 

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’’) (collectively, the 

‘‘Agencies’’). 

ACTION: Notice of final interagency 

statement. 

SUMMARY: The Agencies are adopting an 

Interagency Statement on Sound 

Practices Concerning Elevated Risk 

Complex Structured Finance Activities 

(‘‘Final Statement’’). The Final 

Statement pertains to national banks, 

state banks, bank holding companies 

(other than foreign banks), federal and 

state savings associations, savings and 

loan holding companies, U.S. branches 

and agencies of foreign banks, and SECregistered broker-dealers and 

investment advisers (collectively, 

‘‘financial institutions’’ or 

‘‘institutions’’) engaged in complex 

structured finance transactions 

(‘‘CSFTs’’). In May 2004, the Agencies 

issued and requested comment on a 

proposed interagency statement (‘‘Initial 

Proposed Statement’’). After reviewing 

the comments received on the Initial 

Proposed Statement, the Agencies in 

May 2006 issued and requested 

comment on a revised proposed 

interagency statement (‘‘Revised 

Proposed Statement’’). The 

modifications to the Revised Proposed 

Statement, among other things, made 

the statement more principles-based and 

focused on the identification, review 

and approval process for those CSFTs 

that may pose heightened levels of legal 

or reputational risk to the relevant 

institution (referred to as ‘‘elevated risk 

CSFTs’’). After carefully reviewing the 

comments on the Revised Proposed 

Statement, the Agencies have adopted 

the Final Statement with minor 

modifications designed to clarify, but 

not alter, the principles set forth in the 

Revised Proposed Statement. The Final 

Statement describes some of the internal 

controls and risk management 

procedures that may help financial 

institutions identify, manage, and 

address the heightened reputational and 

legal risks that may arise from elevated 

risk CSFTs. As discussed further below, 

the Final Statement will not affect or 

apply to the vast majority of financial 

institutions, including most small 

institutions, nor does it create any 

private rights of action. 

EFFECTIVE DATE: The Final Statement is 

effective January 11, 2007. 

FOR FURTHER INFORMATION CONTACT: 

OCC: Kathryn E. Dick, Deputy 

Comptroller, Credit and Market Risk, 

(202) 874–4660; Grace E. Dailey, Deputy 

Comptroller, Large Bank Supervision, 

(202) 874–4610; or Ellen Broadman, 

Director, Securities and Corporate 

Practices Division, (202) 874–5210, 

Office of the Comptroller of the 

Currency, 250 E Street, SW., 

Washington, DC 20219. 

OTS: Fred J. Phillips-Patrick, Director, 

Credit Policy, (202) 906–7295, and 

Deborah S. Merkle, Project Manager, 

Credit Policy, (202) 906–5688, 

Examinations and Supervision Policy; 

or David A. Permut, Senior Attorney, 

Business Transactions Division, (202) 

906–7505, Office of Thrift Supervision, 

1700 G Street, NW., Washington, DC 

20552. 

Board: Sabeth I. Siddique, Assistant 

Director, (202) 452–3861, or Virginia 

Gibbs, Senior Supervisory Financial 

Analyst, (202) 452–2521, Division of 

Banking Supervision and Regulation; or 

Kieran J. Fallon, Assistant General 

Counsel, (202) 452–5270, or Anne B. 

Zorc, Senior Attorney, (202) 452–3876, 

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: Jason C. Cave, Associate 

Director, (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, Office of Compliance 

Inspections and Examinations, (202) 

551–6207; Catherine McGuire, Chief 

Counsel, Linda Stamp Sundberg, Senior 

Special Counsel (Banking and 

Derivatives), or Randall W. Roy, Branch 

Chief, Division of Market Regulation, 

(202) 551–5550, Securities and 

Exchange Commission, 100 F Street, 

NE., Washington, DC 20549. 

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 

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 assets, and other 

types of structured finance transactions 

serve important purposes, such as 

diversifying risk, allocating cash flows 

and reducing cost of capital. As a result, 

structured finance transactions, 

including the more complex variations 

of these transactions, now are an 

essential part of U.S. and international 

capital markets. 

When a financial institution 

participates in a CSFT, it bears the usual 

market, credit, and operational risks 

associated with the transaction. In some 

circumstances, a financial institution 

also may face heightened legal or 

reputational risks due to its involvement 

in a CSFT. For example, a financial 

institution involved in a CSFT may face 

heightened legal or reputational risk if 

the customer’s regulatory, tax or 

accounting treatment for the CSFT, or 

disclosures concerning the CSFT in its 

public filings or financial statements, do 

not comply with applicable laws, 

regulations or accounting principles.1

In some cases, certain CSFTs appear 

to have been used in illegal schemes 


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Federal Register / Vol. 72, No. 7 / Thursday, January 11, 2007 / Notices 1373 

2See, e.g., In the Matter of Citigroup, Inc., 

Securities 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 

v. J.P. Morgan Chase, 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.). 

3See 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). 

4See 69 FR 28980, May 19, 2004. 

5See 71 FR 28326, May 16, 2006. 

6A more detailed summary of the comments on 

the Initial Proposed Statement, as well as the 

changes made in response to those comments, is 

contained in the Federal Register notice 

accompanying the Revised Proposed Statement (71 

FR 28326, 28328–29 (May 16, 2006)). 

7As noted in the Final Statement, financial 

institutions are encouraged to refer to other 

supervisory guidance and materials prepared by the 

Agencies for further information concerning market, 

credit and operational risk, as well as for further 

information on legal and reputational risk, internal 

audit and internal controls. 

that misrepresented the financial 

condition of public companies to 

investors and regulatory authorities. 

After conducting investigations, the 

OCC, Federal Reserve System and SEC 

took strong and coordinated civil and 

administrative enforcement actions 

against certain financial institutions that 

engaged in CSFTs that appeared to have 

been designed or used to shield their 

customers’ true financial health from 

the public. These actions involved the 

assessment of significant financial 

penalties on the institutions and 

required the institutions to take several 

measures to strengthen their risk 

management procedures for CSFTs.2

The complex structured finance 

relationships involving these financial 

institutions also sparked an 

investigation by the Permanent 

Subcommittee on Governmental Affairs 

of the United States Senate,3 as well as 

numerous lawsuits by private litigants. 

The OCC, Federal Reserve System and 

SEC also conducted special reviews of 

several large financial institutions 

engaged in CSFTs, and the Agencies 

have focused attention on the CSFT 

activities of financial institutions in the 

normal course of the supervisory 

process. These reviews and activities 

indicate that many of the large financial 

institutions engaged in CSFTs have 

taken meaningful steps in recent years 

to improve their control infrastructure 

relating to CSFTs. 

II. Initial and Revised Proposed 

Statements 

To assist financial institutions in 

identifying, managing, and addressing 

the risks that may be associated with 

CSFTs, the Agencies developed and 

requested public comment on the Initial 

Proposed Statement.4 The Initial 

Proposed Statement described the types 

of policies and procedures that a 

financial institution engaged in CSFTs 

should have in place to allow the 

institution to identify, document, 

evaluate, and control the full range of 

credit, market, operational, legal, and 

reputational risks that may arise from 

CSFTs. The agencies collectively 

received comments from more than 40 

commenters on the Initial Proposed 

Statement. Although commenters 

generally supported the Agencies’

efforts to describe the types of risk 

management procedures and internal 

controls that may help institutions 

manage the risks associated with CSFTs, 

virtually all of the commenters 

recommended changes to the Initial 

Proposed Statement. 

After carefully reviewing the 

comments on the Initial Proposed 

Statement, the Agencies issued and 

requested comment on a Revised 

Proposed Statement.5 The Revised 

Proposed Statement was modified in 

numerous respects to clarify the 

purpose, scope and effect of the 

statement; make the statement more 

risk-focused and principles based; and 

focus the statement on those CSFTs that 

may pose elevated levels of legal or 

reputational risk to the relevant 

institution.6

III. Overview of Comments on the 

Revised Proposed Statement 

The Agencies collectively received 

written comments from 19 commenters 

on the Revised Proposed Statement, 

although many commenters submitted 

identical comments to multiple 

Agencies. Commenters included 

banking organizations, financial services 

trade associations, and individuals. 

Commenters generally expressed strong 

support for the Revised Proposed 

Statement, including its principlesbased structure and focus on elevated 

risk CSFTs. Many commenters also 

asserted that the Revised Proposed 

Statement provides a financial 

institution appropriate flexibility to 

develop internal controls and risk 

management procedures that are 

tailored to the institution’s own 

business activities and organizational 

structure. 

Several commenters requested that 

the Agencies clarify or revise the 

Revised Proposed Statement in certain 

respects. For example, some 

commenters asked the Agencies to 

further streamline the provisions in the 

statement pertaining to documentation 

of elevated risk CSFTs, or clarify how 

the U.S. branches or agencies of foreign 

banks might implement risk 

management systems, policies or 

controls consistent with the statement’s 

principles. In addition, some 

commenters asked the Agencies to set 

forth or clarify the legal standards 

governing the potential liability of 

financial institutions for CSFTs or 

provide ‘‘safe harbors’’ from such 

potential liability. One group of 

commenters also argued that the 

Revised Proposed Statement should not 

be implemented because it allegedly 

would encourage or condone illegal 

conduct by financial institutions. The 

comments received on the Revised 

Proposed Statement are further 

discussed below. 

IV. Overview of Final Statement 

After carefully reviewing the 

comments on the Revised Proposed 

Statement, the Agencies have made 

minor modifications to the Revised 

Proposed Statement in response to 

comments and to clarify the principles, 

scope, and intent of the Final Statement. 

The Final Statement has been adopted 

as supervisory guidance by the Board, 

OCC, FDIC and OTS and as a policy 

statement by the SEC. The Agencies will 

use the Final Statement going forward 

in reviewing the internal controls and 

risk management policies, procedures 

and systems of financial institutions 

engaged in CSFTs as part of the 

Agencies’ ongoing supervisory process. 

The Agencies continue to believe that 

it is important for a financial institution 

engaged in CSFTs to have policies and 

procedures that are designed to allow 

the institution to effectively manage and 

address the full range of risks associated 

with its CSFT activities, including the 

elevated legal or reputational risks that 

may arise in connection with certain 

CSFTs. For this reason, the Final 

Statement describes the types of risk 

management principles that the 

Agencies believe may help a financial 

institution to identify elevated risk 

CSFTs and to evaluate, manage, and 

address these risks within the 

institution’s internal control 

framework.7 These policies and 

procedures should, among other things, 

be designed to allow the institution to 

identify elevated risk CSFTs during its 


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8 In response to comments, the Agencies have 

modified the Final Statement to clarify that a U.S. 

branch or agency of a foreign bank is not necessarily 

expected to establish or adopt separate U.S.-based 

risk management structures or policies for its CSFT 

activities. In addition, the Agencies believe the 

Final Statement provides U.S. branches and 

agencies of foreign banks sufficient flexibility to 

develop controls, risk management and reporting 

structures, and lines of authority that are consistent 

with the internal management structure of U.S. 

branches and agencies. However, the risk 

management structure and policies used by a U.S. 

branch or agency, whether adopted or implemented 

on a group-wide or stand-alone basis, should be 

effective in allowing the branch or agency to 

manage the risks associated with its CSFT activities. 

9One commenter sought clarification regarding 

when during the new product approval process a 

new complex structured finance product should 

receive the approval of relevant control areas. The 

Agencies note that the Final Statement is not 

intended to prevent institutions from engaging in 

initial or preliminary discussions or negotiations 

with potential customers about a new complex 

structured finance product. However, an institution 

should obtain the necessary approvals for a new 

complex structured finance product from 

appropriate control areas before the institution 

enters into, or becomes obligated to enter into, a 

transaction with the customer. 

transaction and new product approval 

processes, and should provide for 

elevated risk CSFTs to be reviewed by 

appropriate levels of control and 

management personnel at the 

institution, including personnel from 

control areas that are independent of the 

business line(s) involved in the 

transaction. 

The Final Statement—like the Revised 

Proposed Statement—applies to 

financial institutions that are engaged in 

CSFT activities and focuses on those 

CSFTs that may create heightened levels 

of legal or reputational risks for a 

participating financial institution. 

Because CSFTs typically are conducted 

by a limited number of large financial 

institutions, the Final Statement will 

not affect or apply to the vast majority 

of financial institutions, including most 

small institutions. 

As the Final Statement recognizes, 

structured finance transactions 

encompass a broad array of products 

with varying levels of complexity. Most 

structured finance transactions, such as 

standard public mortgage-backed 

securities and hedging-type transactions 

involving ‘‘plain vanilla’’ derivatives or 

collateralized debt obligations, are 

familiar to participants in the financial 

markets, have well-established track 

records, and typically would not be 

considered CSFTs for purposes of the 

Final Statement. Some commenters 

requested that the Agencies provide a 

more extensive list of structured finance 

transactions that typically would not be 

considered CSFTs. The Agencies note 

that the types of non-complex 

transactions listed in the Final 

Statement are only examples of the 

types of transactions that typically 

would not be considered CSFTs and 

that any list of examples would not, and 

could not, be all inclusive given the 

changing nature of the structured 

finance market. Consistent with the 

principles-based approach of the Final 

Statement, the Agencies believe the 

statement appropriately highlights the 

hallmarks of a non-complex 

transaction—i.e., a well established 

track record and familiarity to 

participants in the financial markets—

that may guide institutions and 

examiners in considering whether a 

particular type of transaction should be 

considered a CSFT now or in the future. 

A. Identification, Due Diligence, and 

Approval Processes for Elevated Risk 

CSFTs 

As noted above, a financial institution 

should establish and maintain policies, 

procedures and systems that are 

designed to identify elevated risk CSFTs 

as part of the institution’s transaction or 

new product approval processes, and to 

ensure that transactions or new 

products identified as elevated risk 

CSFTs are subject to heightened 

review.8 In general, a financial 

institution should conduct the level and 

amount of due diligence for an elevated 

risk CSFT that is commensurate with 

the level of risks identified. A financial 

institution’s policies and procedures 

should provide that CSFTs identified as 

potentially having elevated legal or 

reputational risk are reviewed and 

approved by appropriate levels of 

management. The Agencies continue to 

believe that the designated approval 

process for elevated risk CSFTs should 

include the institution’s representatives 

from the relevant business line(s) and/ 

or client relationship management, as 

well as from appropriate control areas 

that are independent of the business 

line(s) involved in the transaction. An 

institution’s policies should provide 

that new complex structured finance 

products receive the approval of all 

relevant control areas that are 

independent of the profit center before 

the product is offered to customers.9

The Final Statement—like the Revised 

Proposed Statement—provides 

examples of transactions that may 

warrant additional scrutiny by an 

institution. These examples include, 

among other things, transactions that 

appear to the institution to: 

• Lack economic substance or 

business purpose; 

• Be designed or used primarily for 

questionable accounting, regulatory, or 

tax objectives, particularly when the 

transactions are executed at year-end or 

at the end of a reporting period for the 

customer; or 

• Raise concerns that the client will 

report or disclose the transaction in its 

public filings or financial statements in 

a manner that is materially misleading 

or inconsistent with the substance of the 

transaction or applicable regulatory or 

accounting requirements. 

A few commenters contended that the 

examples of elevated risk CSFTs 

contained in the Revised Proposed 

Statement have characteristics that are 

signals, if not conclusive proof, of 

fraudulent activity, and recommended 

that the Agencies inform financial 

institutions that transactions or 

products with any of these 

characteristics should be considered 

presumptively prohibited. The 

commenters also argued that the 

statement encourages or condones 

illegal conduct by financial institutions. 

The Agencies believe that CSFTs that 

initially appear to an institution, during 

the ordinary course of its new product 

or transaction approval process, to have 

one or more of the characteristics 

identified in the Final Statement should 

generally be identified as an elevated 

risk CSFT, and the institution should 

conduct due diligence for the 

transaction that is commensurate with 

the level of identified, potential risks. 

The Agencies, however, do not believe 

it is appropriate to provide that all 

transactions initially identified as 

potentially creating elevated legal or 

reputational risks for an institution 

should be considered presumptively 

prohibited. For example, an institution, 

after conducting additional due 

diligence for a transaction initially 

identified as an elevated risk CSFT, may 

determine that the transaction does not, 

in fact, have the characteristics that 

initially triggered the review. 

Alternatively, the institution may take 

steps to address the legal or reputational 

risks that initially triggered the review. 

In this regard, the Final Statement 

expressly provides that, if after 

evaluating an elevated risk CSFT, a 

financial institution determines that its 

participation in the transaction would 

create significant legal or reputational 

risks for the institution, the financial 

institution should take appropriate steps 

to manage and address these risks. Such 

steps may include modifying the 

transaction or conditioning the 

institution’s participation in the 

transaction upon the receipt of 

representations or assurances from the 

customer that reasonably address the 

heightened risks presented by the 

transaction. 

Importantly, the Final Statement 

continues to provide that a financial 


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10Some commenters asked the Agencies to clarify 

that the Final Statement does not necessarily 

prevent a financial institution from proceeding with 

a CSFT simply because there may be some 

ambiguity in how the transaction might be viewed 

under the law or applicable accounting principles. 

The Agencies recognize that in certain 

circumstances ambiguities may exist as to how the 

law or accounting principles apply to a CSFT, 

particularly in light of the inherent complexity and 

rapidly evolving nature of CSFTs. Nevertheless, as 

discussed in the Final Statement, a financial 

institution should maintain strong and effective 

processes and controls designed to determine 

whether any such ambiguities may create 

significant legal or reputational risks for the 

institution and to manage and address those risks 

as appropriate. 

11 In light of comments, the Agencies have 

modified the Documentation section of the 

Statement to clarify that an institution should retain 

sufficient documentation to establish that it has 

provided the customer any disclosures concerning 

an elevated risk CSFT that the institution is 

otherwise required to provide to the customer. 

institution should decline to participate 

in an elevated risk CSFT if, after 

conducting appropriate due diligence 

and taking appropriate steps to address 

the risks from the transaction, the 

institution determines that the 

transaction presents unacceptable risks 

to the institution or would result in a 

violation of applicable laws, regulations 

or accounting principles.10 The Final 

Statement also expressly notes that 

financial institutions must conduct their 

activities in accordance with applicable 

statutes and regulations. The Agencies 

believe the Final Statement should 

assist financial institutions engaged in 

CSFTs in managing the risks associated 

with these activities and complying 

with the law, and does not, as some 

commenters alleged, encourage or 

condone illegal conduct. 

Some commenters also requested that 

the Agencies enunciate, clarify or 

modify the legal standards governing 

the potential liability of a financial 

institution for participating in a CSFT 

that is used for fraudulent or illegal 

purposes. For example, some 

commenters asked the Agencies to 

declare that institutions do not have a 

duty to ensure the accuracy of a client’s 

public filings or accounting. Other 

commenters asked that the Agencies 

state that an institution will not be held 

liable or responsible for a CSFT if the 

institution has a reasonable degree of 

confidence that the customer will report 

or account for the transactions properly. 

Other commenters expressed concern 

that the Revised Proposed Statement, or 

the comments submitted on that 

document, attempted to alter the current 

legal standards under which a financial 

institution may be held liable for 

fraudulent activity or criminally 

responsible under the Federal securities 

law or other laws. 

As events in recent years have 

highlighted, institutions may in certain 

circumstances bear significant legal or 

reputational risk from participating in a 

CSFT. In light of these risks, the Final 

Statement describes the types of risk 

management systems and internal 

controls that may help a financial 

institution engaged in CSFTs to identify 

those CSFTs that may pose heightened 

legal or reputational risk to the 

institution, and to evaluate, manage, 

and address those risks. Because the 

Final Statement represents guidance on 

the part of the Banking Agencies and a 

policy statement on the part of the SEC, 

it does not, by itself, establish any 

legally enforceable requirements or 

obligations. Moreover, as the Final 

Statement expressly provides, it does 

not create any private rights of action, 

nor does it alter or expand the legal 

duties and obligations that a financial 

institution may have to a customer, its 

shareholders or other parties under 

applicable law. Accordingly, the 

Agencies do not believe it is appropriate 

or possible to address in the Final 

Statement these legal concerns 

expressed by commenters. 

B. Documentation 

The Final Statement states that a 

financial institution should create and 

collect sufficient documentation to, 

among other things, verify that the 

institution’s policies and procedures 

related to elevated risk CSFTs are being 

followed and allow the internal audit 

function to monitor compliance with 

those policies and procedures. The 

Final Statement also provides that, 

when an institution’s policies and 

procedures require an elevated risk 

CSFT to be submitted for approval to 

senior management, the institution 

should maintain the transaction-related 

documentation provided to senior 

management as well as other 

documentation that reflect 

management’s approval (or disapproval) 

of the transaction, any conditions 

imposed by senior management, and the 

reasons for such action. 

Several commenters strongly 

suggested that the Agencies should 

eliminate or modify the portions of the 

statement that provide for a financial 

institution to maintain certain 

documentation related to elevated risk 

CSFTs that are submitted to the 

institution’s senior management for 

approval (or denial). For example, some 

commenters argued that institutions 

should not be required to maintain any 

documentation for declined 

transactions. Other commenters 

expressed concern that this provision 

was inconsistent with the current 

practice of financial institutions, would 

require financial institutions to create 

new and potentially extensive 

documentation to memorialize all 

aspects of the institution’s analytical 

and decision-making process with 

respect to an elevated risk CSFT, or 

would require institutions to create or 

maintain extensive documentation even 

for transactions that are approved or 

rejected by junior staff. 

As an initial matter, the Agencies note 

that the Final Statement’s provisions 

regarding documentation for elevated 

risk CSFTs submitted to senior 

management for approval (or 

disapproval) do not apply to 

transactions that may be reviewed and 

acted on by more junior personnel in 

accordance with the institution’s 

policies and procedures. Rather, these 

provisions apply only to those elevated 

risk CSFTs that are identified by the 

institution as potentially involving the 

greatest degree of risk to the institution 

and, for this reason, are required to be 

reviewed by the institution’s senior 

management. The Agencies believe that 

it is important for institutions to 

maintain documentation for this 

category of elevated risk CSFTs, 

whether approved or declined, that 

reflects the factors considered by senior 

management in taking such action. The 

Agencies believe this type of 

documentation may be of significant 

benefit to the institution and to the 

Agencies in reviewing the effectiveness 

of the institution’s CSFT-related 

policies, procedures, and internal 

controls. However, to help address the 

commenter’s concern about potential 

burden, the Agencies have modified the 

Final Statement to recognize that the 

minutes of an institution’s reviewing 

senior management committee may 

have the information described and to 

clarify that the documentation for a 

transaction should reflect the factors 

considered by senior management in 

taking action, but does not have to detail 

every aspect of the institution’s legal or 

business analysis of the transaction.11

C. General Risk Management Principles 

for Elevated Risk CSFTs 

The Final Statement—like the Revised 

Proposed Statement—also describes 

some of the other key risk management 

policies and internal controls that 

financial institutions should have in 

place for elevated risk CSFTs. For 

example, the Final Statement provides 

that the board of directors and senior 

management of an institution should 

establish a ‘‘tone at the top’’ through 

both actions and formalized policies 

that sends a strong message throughout 


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the financial institution about the 

importance of compliance with the law 

and overall good business ethics. The 

Final Statement also describes the types 

of training, reporting mechanisms, and 

audit procedures that institutions 

should have in place with respect to 

elevated risk CSFTs. The Final 

Statement also provides that a financial 

institution should conduct periodic 

independent reviews of its CSFT 

activities to verify and monitor that its 

policies and controls relating to elevated 

risk CSFTs are being implemented 

effectively and that elevated risk CSFTs 

are accurately identified and receive 

proper approvals. 

In response to comments, the 

Agencies have modified the Final 

Statement to clarify that the 

independent reviews conducted by a 

financial institution may be performed 

by the institution’s audit department or 

an independent compliance function 

within the institution. One commenter 

also asked the Agencies to state that the 

proper role of an institution’s 

independent review function is only to 

confirm that the institution’s policies 

and procedures for elevated risk CSFTs 

are being followed and that the function 

should not assess the quality of the 

decisions made by institution 

personnel. The Agencies believe that an 

institution’s audit or compliance 

department should have the flexibility, 

in appropriate circumstances, to review 

the decisions made by institution 

personnel during the review and 

approval process for elevated risk 

CSFTs and for this reason have not 

made the recommended change. 

V. Paperwork Reduction Act 

In accordance with the Paperwork 

Reduction Act of 1995 (44 U.S.C. 3506; 

5 CFR Part 1320, Appendix A.1), the 

Agencies reviewed the Final Statement. 

The Agencies may not conduct or 

sponsor, and an organization is not 

required to respond to, this information 

collection unless it displays a currently 

valid OMB control number. The 

Agencies previously determined that 

certain provisions of the Revised 

Proposed Statement contained 

information collection requirements. 

OMB reviewed and approved the 

information collections contained in the 

Revised Proposed Statement for the 

FDIC, OTS, OCC and SEC; and the 

Board reviewed the Revised Proposed 

Statement under the authority delegated 

to the Board by OMB (5 CFR Part 1320, 

Appendix A.1). 

OMB control numbers: 

OCC: 1557–0229. 

OTS: 1550–0111. 

FRB: 7100–0311. 

FDIC: 3064–0148. 

SEC: 3235–0622. 

Burden Estimates 

OCC 

Number of Respondents: 21. 

Estimated Time per Response: 25 

hours. 

Total Estimated Annual Burden: 525 

hours. 

OTS 

Number of Respondents: 5. 

Estimated Time per Response: 25 

hours. 

Total Estimated Annual Burden: 125 

hours. 

Board 

Number of Respondents: 20. 

Estimated Time per Response: 25 

hours. 

Total Estimated Annual Burden: 500 

hours. 

FDIC 

Number of Respondents: 5. 

Estimated Time per Response: 25 

hours. 

Total Estimated Annual Burden: 125 

hours. 

SEC 

Number of Respondents: 5. 

Estimated Time per Response: 25 

hours. 

Total Estimated Annual Burden: 125 

hours. 

No commenters addressed the 

Agencies’ information collection 

estimates. The Agencies do not believe 

that the clarifications included in this 

Final Statement impact the burden 

estimates previously developed and 

approved for these information 

collections. The Agencies have a 

continuing interest in the public’s 

opinions of our collections of 

information. At any time, comments 

regarding the burden estimate, or any 

other aspect of this collection of 

information, including suggestions for 

reducing the burden, may be sent to: 

OCC: You should direct your 

comments to: 

Communications Division, Office of 

the Comptroller of the Currency, Public 

Information Room, Mailstop 1–5, 

Attention: 1557–0229, 250 E Street, 

SW., Washington, DC 20219. In 

addition, comments may be sent by fax 

to (202) 874–4448, or by electronic mail 

to regs.comments@occ.treas.gov. You 

can inspect and photocopy the 

comments at the OCC’s Public 

Information Room, 250 E Street, SW., 

Washington, DC 20219. You can make 

an appointment to inspect the 

comments by calling (202) 874–5043. 

Additionally, you should send a copy of 

your comments to OCC Desk Officer, 

1557–0229, by mail to U.S. Office of 

Management and Budget, 725 17th 

Street, NW., #10235, Washington, DC 

20503, or by fax to (202) 395–6974. 

You can request additional 

information or a copy of the collection 

from Mary Gottlieb, OCC Clearance 

Officer, or Camille Dickerson, (202) 

874–5090, Legislative and Regulatory 

Activities Division, Office of the 

Comptroller of the Currency, 250 E 

Street, SW., Washington, DC 20219. 

OTS: 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.treas.gov. In addition, interested 

persons may inspect the 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 public.info@ots.treas.gov, or 

send a facsimile transmission to (202) 

906–7755. 

To obtain a copy of the submission to 

OMB, contact Marilyn K. Burton at 

marilyn.burton@ots.treas.gov, (202) 

906–6467, or fax number (202) 906–

6518, Chief Counsel’s Office, Office of 

Thrift Supervision, 1700 G Street, NW., 

Washington, DC 20552 

Board: You may submit comments, 

identified by FR 4022, by any of the 

following methods: 

• Agency Web site: http:// 

www.federalreserve.gov. Follow the 

instructions for submitting comments at 

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: Michelle Long, Federal 

Reserve Board Clearance Officer (202) 

452–3829, Division of Research and 

Statistics, Board of Governors of the 

Federal Reserve System, Washington, 

DC 20551. Telecommunications Device 

for the Deaf (TDD) users may contact 

(202) 263–4869, Board of Governors of 

the Federal Reserve System, 

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, 


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12As used in this Statement, the term ‘‘financial 

institution’’ or ‘‘institution’’ refers to 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 (other than 

foreign banking organizations) 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 Office 

of the Comptroller, the Federal Reserve Board and 

the Federal Deposit Insurance Corporation also are 

considered to be financial institutions for purposes 

of this Statement. 

unless modified for technical reasons. 

Accordingly, your comments will not be 

edited to remove any identifying or 

contact information. Public comments 

may also be viewed electronically or in 

paper in Room MP–500 of the Board’s 

Martin Building (20th and C Streets, 

NW.) between 9 a.m. and 5 p.m. on 

weekdays. 

FDIC: Interested parties are invited to 

submit written comments to the FDIC 

concerning the Paperwork Reduction 

Act implications of this proposal. Such 

comments should refer to ‘‘Complex 

Structured Finance Transactions, 3064–

0148.’’ Comments may be submitted by 

any of the following methods: 

• http://www.FDIC.gov/regulations/ 

laws/federal/propose.html. 

• E-mail: comments@FDIC.gov. 

Include Complex Structured Financial 

Transactions, 3064–0148 in the subject 

line of the message. 

• Mail: Steven F. Hanft (202) 898–

3907, Federal Deposit Insurance 

Corporation, 550 17th Street, NW., 

Washington, DC 20429. 

• Hand Delivery: 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. 

SEC: You should direct your 

comments to: Office of Management and 

Budget, Attention Desk Officer for the 

Securities and Exchange Commission, 

Office of Information and Regulatory 

Affairs, Room 10102, New Executive 

Office Building, Washington, DC 20503, 

with a copy sent to Nancy M. Morris, 

Secretary, Securities and Exchange 

Commission, 100 F Street, NE., 

Washington, DC 20549–1090 with 

reference to File No. S7–08–06. 

The Final Statement follows: 

Interagency Statement on Sound 

Practices Concerning Elevated Risk 

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 assets and other 

types of structured finance transactions 

serve important business purposes, such 

as diversifying risks, allocating cash 

flows, and reducing cost of capital. As 

a result, structured finance transactions 

now are an essential part of U.S. and 

international capital markets. Financial 

institutions have played and continue to 

play an active and important role in the 

development of structured finance 

products and markets, including the 

market for the more complex variations 

of structured finance products. 

When a financial institution 

participates in a complex structured 

finance transaction (‘‘CSFT’’), it bears 

the usual market, credit, and operational 

risks associated with the transaction. In 

some circumstances, a financial 

institution also may face heightened 

legal or reputational risks due to its 

involvement in a CSFT. For example, in 

some circumstances, a financial 

institution may face heightened legal or 

reputational risk if a customer’s 

regulatory, tax or accounting treatment 

for a CSFT, or disclosures to investors 

concerning the CSFT in the customer’s 

public filings or financial statements, do 

not comply with applicable laws, 

regulations or accounting principles. 

Indeed, in some instances, CSFTs have 

been used to misrepresent a customer’s 

financial condition to investors, 

regulatory authorities and others. In 

these situations, investors have been 

harmed, and financial institutions have 

incurred significant legal and 

reputational exposure. In addition to 

legal risk, reputational risk poses a 

significant threat to financial 

institutions because the nature of their 

business requires them to maintain the 

confidence of customers, creditors and 

the general marketplace. 

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 

Securities and Exchange Commission 

(the ‘‘Agencies’’) have long expected 

financial institutions to develop and 

maintain robust control infrastructures 

that enable them to identify, evaluate 

and address the risks associated with 

their business activities. Financial 

institutions also must conduct their 

activities in accordance with applicable 

statutes and regulations. 

II. Scope and Purpose of Statement 

The Agencies are issuing this 

Statement to describe the types of risk 

management principles that we believe 

may help a financial institution to 

identify CSFTs that may pose 

heightened legal or reputational risks to 

the institution (‘‘elevated risk CSFTs’’) 

and to evaluate, manage and address 

these risks within the institution’s 

internal control framework.12

Structured finance transactions 

encompass a broad array of products 

with varying levels of complexity. Most 

structured finance transactions, such as 

standard public mortgage-backed 

securities transactions, public 

securitizations of retail credit cards, 

asset-backed commercial paper conduit 

transactions, and hedging-type 

transactions involving ‘‘plain vanilla’’

derivatives and collateralized loan 

obligations, are familiar to participants 

in the financial markets, and these 

vehicles have a well-established track 

record. These transactions typically 

would not be considered CSFTs for the 

purpose of this Statement. 

Because this Statement focuses on 

sound practices related to CSFTs that 

may create heightened legal or 

reputational risks—transactions that 

typically are conducted by a limited 

number of large financial institutions—

it will not affect or apply to the vast 

majority of financial institutions, 

including most small institutions. As in 

all cases, a financial institution should 

tailor its internal controls so that they 

are appropriate in light of the nature, 

scope, complexity and risks of its 

activities. Thus, for example, an 

institution that is actively involved in 

structuring and offering CSFTs that may 

create heightened legal or reputational 

risk for the institution should have a 

more formalized and detailed control 

framework than an institution that 

participates in these types of 

transactions less frequently. The 

internal controls and procedures 

discussed in this Statement are not all 

inclusive, and, in appropriate 

circumstances, an institution may find 

that other controls, policies, or 

procedures are appropriate in light of its 

particular CSFT activities. 

Because many of the core elements of 

an effective control infrastructure are 

the same regardless of the business line 

involved, this Statement draws heavily 

on controls and procedures that the 

Agencies previously have found to be 

effective in assisting a financial 

institution to manage and control risks 

and identifies ways in which these 

controls and procedures can be 


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1378 Federal Register / Vol. 72, No. 7 / Thursday, January 11, 2007 / Notices 

13 In the case of U.S. branches and agencies of 

foreign banks, these policies, including 

management, review and approval requirements, 

should be coordinated with the foreign bank’s 

group-wide policies developed in accordance with 

the rules of the foreign bank’s home country 

supervisor and should be consistent with the 

foreign bank’s overall corporate and management 

structure as well as its framework for risk 

management and internal controls. 

14This item is not intended to include traditional, 

non-binding ‘‘comfort’’ letters or assurances 

provided to financial institutions in the loan 

process where, for example, the parent of a loan 

customer states that the customer states that the 

customer (i.e., the parent’s subsidiary) is an integral 

and important part of the parent’s operations. 

effectively applied to elevated risk 

CSFTs. Although this Statement 

highlights some of the most significant 

risks associated with elevated risk 

CSFTs, it is not intended to present a 

full exposition of all risks associated 

with these transactions. Financial 

institutions are encouraged to refer to 

other supervisory guidance prepared by 

the Agencies for further information 

concerning market, credit, operational, 

legal and reputational risks as well as 

internal audit and other appropriate 

internal controls. 

This Statement does not create any 

private rights of action, and does not 

alter or expand the legal duties and 

obligations that a financial institution 

may have to a customer, its shareholders 

or other third parties under applicable 

law. At the same time, adherence to the 

principles discussed in this Statement 

would not necessarily insulate a 

financial institution from regulatory 

action or any liability the institution 

may have to third parties under 

applicable law. 

III. Identification and Review of 

Elevated Risk Complex Structured 

Finance Transactions 

A financial institution that engages in 

CSFTs should maintain a set of formal, 

written, firm-wide policies and 

procedures that are designed to allow 

the institution to identify, evaluate, 

assess, document, and control the full 

range of credit, market, operational, 

legal and reputational risks associated 

with these transactions. These policies 

may be developed specifically for 

CSFTs, or included in the set of broader 

policies governing the institution 

generally. A financial institution 

operating in foreign jurisdictions may 

tailor its policies and procedures as 

appropriate to account for, and comply 

with, the applicable laws, regulations 

and standards of those jurisdictions.13

A financial institution’s policies and 

procedures should establish a clear 

framework for the review and approval 

of individual CSFTs. These policies and 

procedures should set forth the 

responsibilities of the personnel 

involved in the origination, structuring, 

trading, review, approval, 

documentation, verification, and 

execution of CSFTs. Financial 

institutions may find it helpful to 

incorporate the review of new CSFTs 

into their existing new product policies. 

In this regard, a financial institution 

should define what constitutes a ‘‘new’’

complex structured finance product and 

establish a control process for the 

approval of such new products. In 

determining whether a CSFT is new, a 

financial institution may consider a 

variety of factors, including whether it 

contains structural or pricing variations 

from existing products, whether the 

product is targeted at a new class of 

customers, whether it is designed to 

address a new need of customers, 

whether it raises significant new legal, 

compliance or regulatory issues, and 

whether it or the manner in which it 

would be offered would materially 

deviate from standard market practices. 

An institution’s policies should require 

new complex structured finance 

products to receive the approval of all 

relevant control areas that are 

independent of the profit center before 

the product is offered to customers. 

A. Identifying Elevated Risk CSFTs 

As part of its transaction and new 

product approval controls, a financial 

institution should establish and 

maintain policies, procedures and 

systems to identify elevated risk CSFTs. 

Because of the potential risks they 

present to the institution, transactions 

or new products identified as elevated 

risk CSFTs should be subject to 

heightened reviews during the 

institution’s transaction or new product 

approval processes. Examples of 

transactions that an institution may 

determine warrant this additional 

scrutiny are those that (either 

individually or collectively) appear to 

the institution during the ordinary 

course of its transaction approval or 

new product approval process to: 

• Lack economic substance or 

business purpose; 

• Be designed or used primarily for 

questionable accounting, regulatory, or 

tax objectives, particularly when the 

transactions are executed at year end or 

at the end of a reporting period for the 

customer; 

• Raise concerns that the client will 

report or disclose the transaction in its 

public filings or financial statements in 

a manner that is materially misleading 

or inconsistent with the substance of the 

transaction or applicable regulatory or 

accounting requirements; 

• Involve circular transfers of risk 

(either between the financial institution 

and the customer or between the 

customer and other related parties) that 

lack economic substance or business 

purpose; 

• Involve oral or undocumented 

agreements that, when taken into 

account, would have a material impact 

on the regulatory, tax, or accounting 

treatment of the related transaction, or 

the client’s disclosure obligations; 14

• Have material economic terms that 

are inconsistent with market norms 

(e.g., deep ‘‘in the money’’ options or 

historic rate rollovers); or 

• Provide the financial institution 

with compensation that appears 

substantially disproportionate to the 

services provided or investment made 

by the financial institution or to the 

credit, market or operational risk 

assumed by the institution. 

The examples listed previously are 

provided for illustrative purposes only, 

and the policies and procedures 

established by financial institutions may 

differ in how they seek to identify 

elevated risk CSFTs. The goal of each 

institution’s policies and procedures, 

however, should remain the same—to 

identify those CSFTs that warrant 

additional scrutiny in the transaction or 

new product approval process due to 

concerns regarding legal or reputational 

risks. 

Financial institutions that structure or 

market, act as an advisor to a customer 

regarding, or otherwise play a 

substantial role in a transaction may 

have more information concerning the 

customer’s business purpose for the 

transaction and any special accounting, 

tax or financial disclosure issues raised 

by the transaction than institutions that 

play a more limited role. Thus, the 

ability of a financial institution to 

identify the risks associated with an 

elevated risk CSFT may differ 

depending on its role. 

B. Due Diligence, Approval and 

Documentation Process for Elevated 

Risk CSFTs 

Having developed a process to 

identify elevated risk CSFTs, a financial 

institution should implement policies 

and procedures to conduct a heightened 

level of due diligence for these 

transactions. The financial institution 

should design these policies and 

procedures to allow personnel at an 

appropriate level to understand and 

evaluate the potential legal or 

reputational risks presented by the 

transaction to the institution and to 

manage and address any heightened 


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15Of course, financial institutions also should 

ensure that their own accounting for transactions 

complies with applicable accounting standards, 

consistently applied. 

16The control processes that a financial 

institution establishes for CSFTs should take 

account of, and be consistent with, any 

informational barriers established by the institution 

to manage potential conflicts of interest, insider 

trading or other concerns. 

legal or reputational risks ultimately 

found to exist with the transaction. 

Due Diligence. If a CSFT is identified 

as an elevated risk CSFT, the institution 

should carefully evaluate and take 

appropriate steps to address the risks 

presented by the transaction with a 

particular focus on those issues 

identified as potentially creating 

heightened levels of legal or 

reputational risk for the institution. In 

general, a financial institution should 

conduct the level and amount of due 

diligence for an elevated risk CSFT that 

is commensurate with the level of risks 

identified. A financial institution that 

structures or markets an elevated risk 

CSFT to a customer, or that acts as an 

advisor to a customer or investors 

concerning an elevated risk CSFT, may 

have additional responsibilities under 

the federal securities laws, the Internal 

Revenue Code, state fiduciary laws or 

other laws or regulations and, thus, may 

have greater legal and reputational risk 

exposure with respect to an elevated 

risk CSFT than a financial institution 

that acts only as a counterparty for the 

transaction. Accordingly, a financial 

institution may need to exercise a 

higher degree of care in conducting its 

due diligence when the institution 

structures or markets an elevated risk 

CSFT or acts as an advisor concerning 

such a transaction than when the 

institution plays a more limited role in 

the transaction. 

To appropriately understand and 

evaluate the potential legal and 

reputational risks associated with an 

elevated risk CSFT that a financial 

institution has identified, the institution 

may find it useful or necessary to obtain 

additional information from the 

customer or to obtain specialized advice 

from qualified in-house or outside 

accounting, tax, legal, or other 

professionals. As with any transaction, 

an institution should obtain satisfactory 

responses to its material questions and 

concerns prior to consummation of a 

transaction.15

In conducting its due diligence for an 

elevated risk CSFT, a financial 

institution should independently 

analyze the potential risks to the 

institution from both the transaction 

and the institution’s overall relationship 

with the customer. Institutions should 

not conclude that a transaction 

identified as being an elevated risk 

CSFT involves minimal or manageable 

risks solely because another financial 

institution will participate in the 

transaction or because of the size or 

sophistication of the customer or 

counterparty. Moreover, a financial 

institution should carefully consider 

whether it would be appropriate to rely 

on opinions or analyses prepared by or 

for the customer concerning any 

significant accounting, tax or legal 

issues associated with an elevated risk 

CSFT. 

Approval Process. A financial 

institution’s policies and procedures 

should provide that CSFTs identified as 

having elevated legal or reputational 

risk are reviewed and approved by 

appropriate levels of control and 

management personnel. The designated 

approval process for such CSFTs should 

include representatives from the 

relevant business line(s) and/or client 

management, as well as from 

appropriate control areas that are 

independent of the business line(s) 

involved in the transaction. The 

personnel responsible for approving an 

elevated risk CSFT on behalf of a 

financial institution should have 

sufficient experience, training and 

stature within the organization to 

evaluate the legal and reputational risks, 

as well as the credit, market and 

operational risks to the institution. 

The institution’s control framework 

should have procedures to deliver the 

necessary or appropriate information to 

the personnel responsible for reviewing 

or approving an elevated risk CSFT to 

allow them to properly perform their 

duties. Such information may include, 

for example, the material terms of the 

transaction, a summary of the 

institution’s relationship with the 

customer, and a discussion of the 

significant legal, reputational, credit, 

market and operational risks presented 

by the transaction. 

Some institutions have established a 

senior management committee that is 

designed to involve experienced 

business executives and senior 

representatives from all of the relevant 

control functions within the financial 

institution (including such groups as 

independent risk management, tax, 

accounting, policy, legal, compliance, 

and financial control) in the oversight 

and approval of those elevated risk 

CSFTs that are identified by the 

institution’s personnel as requiring 

senior management review and approval 

due to the potential risks associated 

with the transactions. While this type of 

management committee may not be 

appropriate for all financial institutions, 

a financial institution should establish 

processes that assist the institution in 

consistently managing the review and 

approval of elevated risk CSFTs on a 

firm-wide basis.16

If, after evaluating an elevated risk 

CSFT, the financial institution 

determines that its participation in the 

CSFT would create significant legal or 

reputational risks for the institution, the 

institution should take appropriate steps 

to address those risks. Such actions may 

include declining to participate in the 

transaction, or conditioning its 

participation upon the receipt of 

representations or assurances from the 

customer that reasonably address the 

heightened legal or reputational risks 

presented by the transaction. Any 

representations or assurances provided 

by a customer should be obtained before 

a transaction is executed and be 

received from, or approved by, an 

appropriate level of the customer’s 

management. A financial institution 

should decline to participate in an 

elevated risk CSFT if, after conducting 

appropriate due diligence and taking 

appropriate steps to address the risks 

from the transaction, the institution 

determines that the transaction presents 

unacceptable risk to the institution or 

would result in a violation of applicable 

laws, regulations or accounting 

principles. 

Documentation. The documentation 

that financial institutions use to support 

CSFTs is often highly customized for 

individual transactions and negotiated 

with the customer. Careful generation, 

collection and retention of documents 

associated with elevated risk CSFTs are 

important control mechanisms that may 

help an institution monitor and manage 

the legal, reputational, operational, 

market, and credit risks associated with 

the transactions. In addition, sound 

documentation practices may help 

reduce unwarranted exposure to the 

financial institution’s reputation. 

A financial institution should create 

and collect sufficient documentation to 

allow the institution to: 

• Document the material terms of the 

transaction; 

• Enforce the material obligations of 

the counterparties; 

• Confirm that the institution has 

provided the customer any disclosures 

concerning the transaction that the 

institution is otherwise required to 

provide; and 

• Verify that the institution’s policies 

and procedures are being followed and 

allow the internal audit function to 


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1380 Federal Register / Vol. 72, No. 7 / Thursday, January 11, 2007 / Notices 

17The 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). 

monitor compliance with those policies 

and procedures. 

When an institution’s policies and 

procedures require an elevated risk 

CSFT to be submitted for approval to 

senior management, the institution 

should maintain the transaction-related 

documentation provided to senior 

management as well as other 

documentation, such as minutes of the 

relevant senior management committee, 

that reflect senior management’s 

approval (or disapproval) of the 

transaction, any conditions imposed by 

senior management, and the factors 

considered in taking such action. The 

institution should retain documents 

created for elevated risk CSFTs in 

accordance with its record retention 

policies and procedures as well as 

applicable statutes and regulations. 

C. Other Risk Management Principles 

for Elevated Risk CSFTs 

General Business Ethics. The board 

and senior management of a financial 

institution also should establish a ‘‘tone 

at the top’’ through both actions and 

formalized policies that sends a strong 

message throughout the financial 

institution about the importance of 

compliance with the law and overall 

good business ethics. The board and 

senior management should strive to 

create a firm-wide corporate culture that 

is sensitive to ethical or legal issues as 

well as the potential risks to the 

financial institution that may arise from 

unethical or illegal behavior. This kind 

of culture coupled with appropriate 

procedures should reinforce businessline ownership of risk identification, 

and encourage personnel to move 

ethical or legal concerns regarding 

elevated risk CSFTs to appropriate 

levels of management. In appropriate 

circumstances, financial institutions 

may also need to consider implementing 

mechanisms to protect personnel by 

permitting the confidential disclosure of 

concerns.17 As in other areas of 

financial institution management, 

compensation and incentive plans 

should be structured, in the context of 

elevated risk CSFTs, so that they 

provide personnel with appropriate 

incentives to have due regard for the 

legal, ethical and reputational risk 

interests of the institution. 

Reporting. A financial institution’s 

policies and procedures should provide 

for the appropriate levels of 

management and the board of directors 

to receive sufficient information and 

reports concerning the institution’s 

elevated risk CSFTs to perform their 

oversight functions. 

Monitoring Compliance with Internal 

Policies and Procedures. The events of 

recent years evidence the need for an 

effective oversight and review program 

for elevated risk CSFTs. A financial 

institution’s program should provide for 

periodic independent reviews of its 

CSFT activities to verify and monitor 

that its policies and controls relating to 

elevated risk CSFTs are being 

implemented effectively and that 

elevated risk CSFTs are accurately 

identified and received proper 

approvals. These independent reviews 

should be performed by appropriately 

qualified audit, compliance or other 

personnel in a manner consistent with 

the institution’s overall framework for 

compliance monitoring, which should 

include consideration of issues such as 

the independence of reviewing 

personnel from the business line. Such 

monitoring may include more frequent 

assessments of the risk arising from 

elevated risk CSFTs, both individually 

and within the context of the overall 

customer relationship, and the results of 

this monitoring should be provided to 

an appropriate level of management in 

the financial institution. 

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. The internal 

audit department of a financial 

institution should regularly audit the 

financial institution’s adherence to its 

own control procedures relating to 

elevated risk CSFTs, and further assess 

the adequacy of its policies and 

procedures related to elevated risk 

CSFTs. Internal audit should 

periodically validate that business lines 

and individual employees are 

complying with the financial 

institution’s standards for elevated risk 

CSFTs and appropriately identifying 

any exceptions. This validation should 

include transaction testing for elevated 

risk CSFTs. 

Training. An institution should 

identify relevant personnel who may 

need specialized training regarding 

CSFTs to be able to effectively perform 

their oversight and review 

responsibilities. Appropriate training on 

the financial institution’s policies and 

procedures for handling elevated risk 

CSFTs is critical. Financial institution 

personnel involved in CSFTs should be 

familiar with the institution’s policies 

and procedures concerning elevated risk 

CSFTs, including the processes 

established by the institution for 

identification and approval of elevated 

risk CSFTs and new complex structured 

finance products and for the elevation of 

concerns regarding transactions or 

products to appropriate levels of 

management. Financial institution 

personnel involved in CSFTs should be 

trained to identify and properly handle 

elevated risk CSFTs that may result in 

a violation of law. 

IV. Conclusion 

Structured finance products have 

become an essential and important part 

of the U.S. and international capital 

markets, and financial institutions have 

played an important role in the 

development of structured finance 

markets. In some instances, however, 

CSFTs have been used to misrepresent 

a customer’s financial condition to 

investors and others, and financial 

institutions involved in these 

transactions have sustained significant 

legal and reputational harm. In light of 

the potential legal and reputational risks 

associated with CSFTs, a financial 

institution should have effective risk 

management and internal control 

systems that are designed to allow the 

institution to identify elevated risk 

CSFTs, to evaluate, manage and address 

the risks arising from such transactions, 

and to conduct those activities in 

compliance with applicable law. 

Dated: December 12, 2006. 

John C. Dugan, 

Comptroller of the Currency. 

Dated: December 21, 2006. 

By the Office of Thrift Supervision. 

Scott M. Polakoff, 

Deputy Director & Chief Operating Officer. 

By order of the Board of Governors of the 

Federal Reserve System, December 20, 2006. 

Jennifer J. Johnson, 

Secretary of the Board. 

Dated at Washington, DC, the 22nd day of 

December, 2006. 

By order of the Federal Deposit Insurance 

Corporation. 

Robert E. Feldman, 

Executive Secretary. 

Dated: January 5, 2007. 

By the Securities and Exchange 

Commission. 

Nancy M. Morris, 

Secretary. 

[FR Doc. 07–55 Filed 1–10–07; 8:45 am] 

BILLING CODE 4810–33–P; 6720–01–P; 6210–01–P; 

6714–01–P; 8011–01–P 


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