Bankruptcy: Agencies Continue Rulemakings for Clarifying Specific Provisions of Orderly Liquidation Authority
Released: 2012-07-12T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: The Dodd-Frank Act created OLA for resolving failed, systemically important financial companies. Since the act was passed in 2010, regulators have been developing regulations to implement this authority and avoid disorderly resolutions that create substantial losses for the financial system. In July 2011, GAO issued the first of its statutorily mandated reports on the effectiveness of the Bankruptcy Code for resolving or liquidating complex, internationally active financial companies. Among the topics examined in this second report, GAO reviewed: (1) federal rules or regulations relating to OLA and the resolution of financial institutions, including living wills; and (2) status of efforts to improve coordination on international resolutions, data collection efforts, and the outcomes of financial institutions that were in the bankruptcy process.

To address these objectives, GAO reviewed agencies’ draft and final rules related to OLA and comment letters submitted. GAO continued to monitor developments related to the Lehman Brothers and Washington Mutual bankruptcies, and began monitoring a recent bankruptcy filing by MF Global. GAO also studied available data on the number of financial company bankruptcies and met with relevant agency and court officials.

GAO makes no new recommendations in this report. GAO provided a draft for comment to AOUSC, the Department of the Treasury, and federal financial regulators. None provided written comments and technical comments have been incorporated, as appropriate.

section_title: What GAO Found
paragraphs: The federal financial regulators have issued certain final rules for resolving large, complex financial companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act’s (Dodd-Frank Act) established Orderly Liquidation Authority (OLA). Under OLA, the Federal Deposit Insurance Corporation (FDIC) could serve as receiver of a failing financial company instead of the company entering the bankruptcy process. Regulators continue to address a number of issues related to FDIC’s new authority, including how creditors will ensure that they receive no less than they would under a Chapter 7 bankruptcy liquidation; how certain assets and liabilities would be treated in a new company created by FDIC under OLA; and what role the Securities Investor Protection Corporation would play in the resolution of a broker-dealer under OLA. Regulatory officials reported that they were continuing to draft rules to clarify how OLA would be used. FDIC and the Board of Governors of the Federal Reserve (Federal Reserve) also have issued final rules requiring certain financial companies to file resolution plans or “living wills” that must detail how companies would resolve their operations through an orderly bankruptcy. Regulators told GAO that the plans also would help FDIC plan for the exercise of its resolution authority, including OLA. The filing dates for these plans are phased in over the next year and a half, with the first group of financial companies filing their first plans on July 1, 2012. However, “nonbank financial companies” that also will need to provide plans have yet to be designated.

International coordination remains a critical component in resolving the failure of a large, complex financial company and regulators have been taking steps to address this and are testing new data collection efforts. Specifically, efforts are under way to develop a universal legal entity identifier that allows companies to identify and manage risks from companies with which they are engaged in financial transactions. This additional information could help regulators in resolving internationally active financial companies. Data to identify financial institutions filing for bankruptcy protection as well as their outcomes are limited. Since neither FDIC nor federal judicial agencies have a database that tracks financial companies in bankruptcy, the Administrative Office of the U.S. Courts (AOUSC) and the Federal Judicial Center have begun a new effort to track financial company bankruptcies, but reported court data are untested for this purpose. Several large financial institution bankruptcies are still in progress. Two of the largest financial company bankruptcies, Lehman Brothers Holdings Inc. (Lehman Brothers) and Washington Mutual, Inc.—both of which filed in September 2008—recently had their reorganization plans confirmed by creditors and approved by the courts. However, these cases are not yet fully resolved. In the Lehman Brothers case, international litigation could take several years to resolve. The October 2011 bankruptcy of MF Global Holdings Ltd., a holding company with a securities and commodities broker, has raised concerns about how commodity customers are treated under a liquidation regime and also involves international litigation over customer property. These financial company bankruptcies highlight the challenges FDIC and other regulators would face in resolving large, complex financial companies under the OLA process.

section_title: Letter
paragraphs: The 2008 financial crisis and the failures of large, complex financial  institutions led some experts to question the effectiveness of the United  States Bankruptcy Code (Code) for resolving or liquidating these  institutions without causing further harm to the financial system. In  response, Congress created the Orderly Liquidation Authority (OLA) as  part of the Dodd-Frank Wall Street Reform and Consumer Protection Act  (Dodd-Frank Act). Under OLA, the Secretary of the Treasury may  appoint the Federal Deposit Insurance Corporation (FDIC) as a receiver  for certain insolvent financial companies that pose a risk to the financial  stability of the United States. The Dodd-Frank Act requires FDIC to  liquidate certain financial companies to maximize the value of the  companies’ assets, minimize losses, mitigate systemic risk, and minimize  moral hazard. OLA created a new process for resolving large, complex  financial companies, but policymakers, academic experts, and industry  participants have raised questions about whether this process would  achieve the stated goals more effectively than the established bankruptcy  process.

As well as creating OLA, the Dodd-Frank Act requires financial  companies to file periodic resolution plans describing how they could be  resolved in an orderly manner in the event of material financial distress or  failure. These “living wills” are intended to allow companies and  regulators to anticipate possible challenges to their resolution under the  Code. Some policymakers and other experts have questioned the usefulness of the resolution plans because of the range of scenarios that  could lead to a financial institution’s failure.

In July 2011, we issued the first of our statutorily mandated reports on the  effectiveness of the Code for resolving or liquidating complex,  internationally active, financial institutions. Although OLA has not been  invoked, we have been monitoring the development of rules and  regulations related to OLA as well as the bankruptcies of large financial  institutions. Specifically, this report examines: (1) actions the U.S. District  Court for the District of Columbia (D.C. District Court) has taken in  response to the judicial review provision of OLA, including any revisions  to local civil rule 85; (2) federal rules or regulations relating to OLA and  efforts to improve international coordination, including living wills, in  resolving financial companies; and (3) data collection efforts and  outcomes of financial institutions that were in the bankruptcy process.

We also studied the reports related to the section 202(e) and section 216 mandates. See  Administrative Office of the United States Courts, Report Pursuant to Section 202(e) of the  Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Washington, D.C.:  July 2011) and Board of Governors for the Federal Reserve System, Study of the  Resolution of Financial Companies Under the Bankruptcy Code (Washington, D.C.: July  2011). Pursuant to Dodd-Frank Act § 215, the Financial Stability Oversight Council  (FSOC) in July 2011 published Report to Congress on Secured Creditor Haircuts, which  examined allowing regulators to treat a portion of fully secured creditors’ claims as  unsecured in a resolution proceeding. institutions from January 1, 2010, through December 31, 2011. Finally,  we met with officials from the Administrative Office of the U.S. Courts  (AOUSC), D.C. District Court, the Commodity Futures Trading  Commission (CFTC), FDIC, the Board of Governors of the Federal  Reserve System (Federal Reserve), Federal Judicial Center, Department  of Justice (Justice), Securities and Exchange Commission (SEC),  Securities Investor Protection Corporation (SIPC), and the Department of  the Treasury (Treasury), including the Office of Financial Research. See  appendix I for more information on our scope and methodology.

We conducted this performance audit from August 2011 to July 2012 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Bankruptcy is a federal court procedure conducted under the Code. The  goal of bankruptcy is to give individuals and businesses a “fresh start” by  eliminating or restructuring debts they cannot repay and help creditors  receive some payment in an equitable manner. The filing of a bankruptcy  petition operates as an “automatic stay” that stops most lawsuits,  foreclosures, and most other collection activities against the debtor.  Under the Code, secured creditors—those with liens or other secured  claims against the debtor’s property—are more likely to get some debt  repaid than unsecured creditors. Creditors typically receive payment of  their debts before shareholders receive any return of their equity in the  failed company.
subsections: section_title: Bankruptcy Proceedings
paragraphs: Business debtors that are eligible for protection under the Code may  qualify for liquidation, governed primarily by Chapter 7 of the Code, or  reorganization, governed by Chapter 11. Proceedings under both  Chapters 7 and 11 can be voluntary (initiated by the debtor) or involuntary  (generally initiated by at least three creditors).

A liquidation proceeding—under Chapter 7—is a court-supervised  procedure by which a trustee takes over the assets of the debtor’s  estate, reduces them to cash, and makes distributions to creditors in  accordance with the Code’s priority scheme.

A reorganization proceeding—under Chapter 11—allows debtors that  are commercial enterprises to continue to operate some or all of the  debtor’s operations as a way to satisfy creditor claims. The debtor  typically remains in control of its assets under a Chapter 11  proceeding, and is called a debtor-in-possession (DIP). However, if  the court determines that there is cause or it is in the best interest of  creditors, the court can direct the U.S. Trustee to appoint a Chapter  11 trustee to take over the affairs of the debtor. A debtor (or other  interested party) may file a reorganization plan, which ultimately may  be confirmed by the court. The plan includes details on the operations  of the reorganization, including disposition or retention of property,  mergers, and issuance of securities. The plan also divides creditors  into classes and directs how the creditor classes will be paid. The  debtor can terminate burdensome contracts and leases, recover  assets, and rescale its operations to return to profitability. To continue  operations, a debtor may obtain additional financing, which could be  paid before other debts.under Chapter 11 or transfer to a Chapter 7 liquidation, which may  provide a greater return to creditors.

A debtor also may file a plan of liquidation  The U.S. bankruptcy system involves multiple federal entities. While  bankruptcy courts are located in 90 federal judicial districts, the Southern  District of New York (which includes Manhattan) and the District of  Delaware adjudicate a majority of larger corporate or business bankruptcy  cases, many of which constitute “megacases.” The Judicial Conference of the United States recommends national policies and legislation for all  aspects of federal judicial administration. AOUSC serves as the central  administrative support entity for the Judicial Conference and the federal  courts, including bankruptcy courts. For example, AOUSC provides  administrative, legal, financial, management, and information technology  support functions for the federal courts. The Federal Judicial Center, an  education and research agency for the federal courts, assists bankruptcy  courts with education relating to case administration and management,  while the majority of Federal Judicial Center research helps inform policy  decisions of the Judicial Conference of the United States. In addition, the  Trustee Program at Justice and the Bankruptcy Administrator Program  oversee bankruptcy trustees and the administration of bankruptcy  estates, respectively.

It is important to note that certain financial institutions may not file as  debtors under the Code and other entities face special restrictions in  using the Code:  Insured depository institutions: Under the Federal Deposit Insurance  Act, FDIC serves as the conservator or receiver for the insured  depository institutions placed into conservatorship or receivership  under applicable law.

Insurance companies: Insurers generally are subject to oversight by  state insurance commissioners, who have the authority to place them  into conservatorship, rehabilitation, or receivership.

Broker-dealers: Broker-dealers can be liquidated under the Securities  Investor Protection Act (SIPA) or under a special provision of Chapter   7 of the Code. However, broker-dealers may not file for reorganization  under Chapter 11.

Commodity brokers: Commodity brokers, also known as futures  commission merchants, are restricted to using only a special provision  of Chapter 7 for bankruptcy relief.

section_title: Orderly Liquidation Authority under the Dodd- Frank Act
paragraphs: Bank Holding Company Act of 1956, 12 U.S.C. § 1841 et seq. nonbank financial companies supervised by the Federal Reserve; any company that is predominantly engaged in activities that the  Federal Reserve has determined to be financial in nature or incidental  thereto for purposes of section 4(k) of the Bank Holding Company Act  (including broker-dealers that are registered with SEC and are  members of SIPC); or any subsidiary of a company described in the bullets above that is  predominantly engaged in activities that the Federal Reserve has  determined to be financial in nature or incidental thereto for purposes  of section 4(k) of the Bank Holding Company Act (except for insured  depository institutions and insurance companies).

In addition to the evaluation of whether the financial company fits within  one of the categories described above, federal regulators recommending  whether the Secretary of the Treasury should appoint FDIC as receiver  must include: an evaluation of whether the financial company is in default or in  danger of default; a description of the effect that the default of the financial company  would have on the financial stability in the United States; a description of the effect that the default of the financial company  would have on economic conditions or financial stability for low- income, minority, or underserved communities; a recommendation on the nature and extent of actions to be taken  under Title II of the Dodd-Frank Act regarding the financial company; an evaluation of the likelihood of a private-sector alternative to prevent  the default of the financial company; an evaluation of why a case under the Code is not appropriate for the an evaluation of the effects on creditors, counterparties, and  shareholders of the financial company and other market participants.

Upon recommendation, the Secretary of the Treasury, must invoke OLA if  the Secretary, in consultation with the President, determines that:  the financial company is in default or in danger of default; the failure of the financial company and its resolution under otherwise  applicable federal or state law would have serious adverse effects on  the financial stability of the United States; no viable private-sector alternative is available to prevent the default;  the effect on the claims or interests of creditors, counterparties, and  shareholders of the financial company and other market participants  of proceedings under Title II of the Dodd-Frank Act is appropriate,  given the impact that any action under Title II would have on the  financial stability of the United States; an orderly liquidation would avoid or mitigate such adverse effects;  and  the company meets the definition of financial company as described  above.

By a two-thirds vote, the Federal Reserve and FDIC (or relevant  regulator) must agree to make the recommendation to the Secretary of  the Treasury to place the financial company into receivership. The  Secretary consults with the President and then makes a determination to  place the company in receivership, and notifies the company’s board of  directors (or equivalent). If the company consents or acquiesces to the  recommendation, FDIC becomes receiver. If the company does not  consent, the Secretary through Justice must petition the D.C. District  Court for an order authorizing the appointment of FDIC as receiver. The  D.C. District Court has 24 hours to determine whether the Secretary’s  determination was arbitrary and capricious, in which case FDIC would not  become receiver. If the D.C. District Court failed to act within 24 hours,  then FDIC would become receiver. The financial company can appeal the  D.C. District Court’s determination, but the receivership would not be  stayed (or postponed) if it did so. If the D.C. District Court did not uphold  the Secretary’s determination, the Secretary could amend and refile or  appeal within 30 days. Upon appointment as receiver, FDIC becomes  successor to and legal custodian of the financial company, including  assets and operations.

Under authority provided by Title II of the Dodd-Frank Act, when FDIC is  appointed receiver of the financial company it may take over and manage  the assets of the company. FDIC must liquidate and wind up the affairs of  the financial company, and may sell or transfer the assets to a bridge  financial company, which is a temporary company used to maintain the  failed company’s operations. A bridge financial company may purchase  assets, assume liabilities, and undertake other functions of the financial  company. FDIC also has authority to determine the validity of creditor  claims against the company and pay creditor claims. The Dodd-Frank Act  generally requires that all creditors of a financial company with similar  priority be treated similarly; however, in certain circumstances FDIC may  treat similarly situated creditors differently. In some cases, FDIC may  repudiate contracts to which a financial company is a party or may  enforce certain contracts that otherwise could have been terminated  because of the financial company’s insolvency.

section_title: Resolution Plans and Other Financial Stability Provisions under the Dodd-Frank Act
paragraphs: Among its provisions, Title I of the Dodd-Frank Act requires certain  financial companies to provide regulators with periodic reports on their  plans for rapid and orderly resolution in the event of “material financial  distress or failure” under the Code. The resolution plan must include the  following:  information on the manner and extent to which any insured depository  institution affiliated with the company is adequately protected from  risks arising from the activities of any nonbank subsidiaries of the  company; full descriptions of the ownership structure, assets, liabilities, and  contractual obligations of the company; identification of the cross-guarantees tied to different securities,  identification of major counterparties, and a process for determining to  whom the collateral of the company is pledged; and any other information that the Federal Reserve and FDIC jointly  require by rule or order.

The Federal Reserve and FDIC must review the information in these  resolution plans. If they jointly determine and notify a company that its  plan is not credible or would not facilitate an orderly resolution under the  Code, the financial company would have to submit a revised plan. A  revised plan must discuss in detail revisions that address the deficiencies  jointly identified by the Federal Reserve and FDIC. The revised plan must  also address changes, if any, in its business operations or corporate  structure that the company proposes to make to facilitate implementation  of the plan. If the company fails to submit a satisfactory revised plan, the  Federal Reserve and FDIC could impose stricter requirements such as   If the company  higher capital or liquidity requirements on the company. fails to submit a satisfactory revised plan within 2 years of the imposition  of stricter requirements, the Federal Reserve and FDIC, in consultation  with the Financial Stability Oversight Council (FSOC), may jointly direct a  company to divest certain assets or operations jointly identified by the  Federal Reserve and FDIC as necessary to facilitate an orderly resolution  under the Code in the event of failure of the company.

section_title: Additional Rulemaking Authorities under the Dodd-Frank Act
paragraphs: The Dodd-Frank Act requires certain regulators to develop and issue  rules to implement OLA and resolution plan requirements. For some  rules, the regulators must consult with FSOC, a new entity established by  the Dodd-Frank Act. FDIC—in consultation with FSOC—has primary  responsibility for developing and issuing rules and regulations related to  its authority as receiver of a failed financial company. Other sections of  Title II of the Dodd-Frank Act also contain specific requirements for FDIC  to coordinate with the Federal Reserve, SEC, and other banking  regulators on key aspects of OLA. Under Title I, the Federal Reserve and  FDIC must issue joint rules on resolution plans. FSOC has the authority  to designate nonbank financial companies (including foreign nonbank  financial companies) for Federal Reserve supervision if FSOC determines  that such companies could pose a threat to the financial stability of the  United States. These nonbank financial companies would have to file  resolution plans. Appendix II lists the primary rules related to OLA and  resolution plans and their status as of May 15, 2012.

section_title: D.C. District Court Revised Its Rule for Judicial Review under OLA
paragraphs: As we previously reported, the D.C. District Court issued Local Civil Rule  85 on January 19, 2011, to implement its judicial review requirements  under OLA. Generally, the rule reiterated the procedural requirements in  the Dodd-Frank Act. It provided for a 24-hour review, and the financial  company has the right to oppose the Secretary’s petition to invoke an  FDIC receivership under OLA. If the court did not rule on the petition  within 24 hours, or ruled in favor of the Secretary, the receivership would  proceed immediately. As the rule was originally written, the Secretary of  the Treasury would have had to notify the D.C. District Court under seal  at least 48 hours before the filing of a petition, which would give the court  time to prepare for the review. In addition, the original rule did not  specifically address Rule 6 of the Federal Rules of Civil Procedure  regarding the 24-hour period. Rule 6 states that if a time period ends on a  weekend or holiday, the period would be extended to the next business  day. Court officials told us that they included the original 48-hour notice  because they were concerned about receiving advance notice before an  OLA filing. Court officials also told us that the D.C. District Court was a  smaller court that did not hear many business cases and few large  bankruptcies and therefore they needed the advance notice.

In letters dated March 2011, FDIC and Treasury objected to notification  requirements in the rule that required Treasury to provide an additional  48-hour notification to the court before filing a petition to invoke OLA. In  addition, they were concerned about the possible use of Rule 6 of the  Federal Rules of Civil Procedure to extend the 24-hour period for the  court to rule and the 48-hour notification period. The agencies said that  Treasury may not always be able to provide the 48-hour notice because  of the speed with which a financial company could become insolvent.  FDIC and Treasury were concerned that the use of Rule 6 to calculate the  timing of filings and decisions effectively would expand the court’s 24- hour time frame to rule on the petition and the 48-hour notice period. For  example, if the Secretary’s 48-hour notice period or the court’s 24-hour  review period ended on a weekend or holiday, Rule 6 calculations would  move the ends of those periods to the next business day. According to  agency officials, this delay could have serious adverse effects on U.S  financial stability. As a result, the agencies thought the court should be  prepared to make rulings over the weekend.

On July 6, 2011, the court issued a revised final rule, which added “to the  extent feasible” to the requirement that the Secretary of the Treasury  notify the court 48 hours before filing a petition. In addition the revised  rule added a section stating that the 48-hour notice period and the 24- hour decision period were not subject to Rule 6, meaning that the time  limit would apply without regard to whether the time periods ended on a  weekend or holiday. FDIC and Treasury officials told us that the revisions  to the court’s rule addressed their concerns. The court has not yet tested  the effectiveness of the rule because, as of May 1, 2012, the Secretary  had not sought the appointment of FDIC as receiver in an OLA  proceeding.

section_title: Although Regulators Have Issued Rules Related to OLA, Some Clarifications Remain Outstanding
paragraphs: Federal regulators have issued separate final rules for OLA and  resolution plans, as required by the Dodd-Frank Act. FDIC plans to issue  additional rules to clarify its use of OLA, such as a joint rule with SEC for  the resolution of broker-dealers. Because the first financial companies will  not begin filing resolution plans until July 2012, it is too soon to determine  the effectiveness of the plans. Despite the issuance of rules, academics  and other experts have questioned FDIC’s ability to resolve large,  systemically important financial institutions under OLA because of the  complexity of the firms involved and challenges relating to international  coordination. Regulators have reported progress on developing a  universal identifier for financial companies that would help them identify  and manage companies’ counterparty exposures.
subsections: section_title: Federal Regulators Have Issued Final Rules for OLA and Resolution Plans
paragraphs: Final Rules for OLA. On July 15, 2011, FDIC published a final rule  (referred to as the Orderly Liquidation Authority Final Rule) under  rulemaking authority provided by Section 209 of the Dodd-Frank Act. In  its discussion of the final rule, FDIC noted that the rule represented the  results of its initial phase of rulemaking for its OLA authority. FDIC staff  also told us that this final rule included topics addressed in an earlier  interim final rule and two notices of proposed rulemakings.

More specifically, the final rule covers topics under three broad  categories: (1) the definition of terms in a receivership under OLA and  other general provisions of an FDIC receivership; (2) the priority of  payments, including those for administrative expenses and to unsecured  creditors; and (3) the process for administering claims against the failed  financial company. The rule also covers other aspects of the receivership.  For example, the final rule addresses FDIC’s ability to recover  compensation from a current or former senior executive who is found  substantially responsible for the failure of the financial company. In  addition, the rule addresses the payment for services performed under  personal service agreements after FDIC is appointed receiver or for the  acceptance of services by a bridge financial company. FDIC’s final rule  also discusses the distribution of assets in the liquidation of a  noninsurance company subsidiary of an insurance company. FDIC has  indicated that it believes it now has in place the regulations necessary to  accomplish a resolution under OLA, even though it intends to adopt  several additional regulations over the next year.

In addition, FDIC published a final rule (the Mutual Insurance Holding  Company Treated as Insurance Company Rule) concerning the treatment  of mutual insurance holding companies on April 30, 2012. Mutual  insurance holding companies are owned by policyholders, not  stockholders, and generally have been subject to state insurance  insolvency regimes. In its final rule, FDIC sought to make the resolution of  mutual insurance companies conform to state insurance statutes for the  resolution of such companies.

Proposed Rules Related to OLA. FDIC, in consultation with FSOC, also  has issued two proposed rules related to OLA to clarify certain technical  issues. First, FDIC and Treasury jointly issued a notice of proposed  rulemaking on November 25, 2011, governing the calculation of the  maximum obligation FDIC could incur as receiver under OLA, as required  by the Dodd-Frank Act. The proposed rule (the Maximum Obligation  Limitation Rule) outlines a calculation that limits the total outstanding  obligations that FDIC can incur in connection with the liquidation of a  financial company under OLA and defines terms such as “obligations.”  FDIC issued a second proposed rule on March 20, 2012, which relates to  its enforcement of subsidiary and affiliate contracts as the receiver of a  covered financial company. The proposed rule (Enforcement of  Subsidiary and Affiliate Contracts by the FDIC as Receiver of a Covered  Financial Company Proposed Rule) clarifies FDIC’s authority to preserve  the value of a failed financial company’s assets and business lines by  enforcing certain contracts of subsidiaries and affiliates of the financial  company. FDIC as receiver has authority to enforce contracts guaranteed  by the financial company even though the counterparty has the  contractual right to terminate or accelerate the contract based on the  insolvency of the financial company. FDIC must transfer the guarantee  and all related assets to a bridge financial company or third party or  provide adequate protection for the obligations. According to FDIC, this  authority will help enable it to place a financial company at the holding  company level into receivership without placing solvent subsidiaries into  receivership, while also helping to mitigate systemic risk and maintain  financial stability.

Final Rule on Resolution Plans. On November 1, 2011, FDIC and the  Federal Reserve published a final rule (the Resolution Plans Final Rule)  implementing the Dodd-Frank Act requirement under section 165(d).  Under this requirement, bank holding companies with at least $50 billion  in total consolidated assets (including foreign banking organizations that  are treated as bank holding companies) and nonbank financial companies  supervised by the Federal Reserve must periodically submit resolution  plans. Although this rule requires these types of financial institutions to  submit plans describing how they would be resolved through the  bankruptcy process, regulators reported that having companies file  resolution plans would help FDIC in planning for the exercise of the  possible use of its resolution authorities, including OLA. Regulators  anticipate the plans also would provide additional insights on these  companies’ structure and complexity, including funding sources and  counterparties. In addition, the Federal Reserve noted that the plans will  assist in its supervisory efforts to ensure that companies operate in a  manner that is both safe and sound and do not pose risks to financial  stability generally. The final rule addresses information required in the  plans, steps for submitting the plans, requirements for updating plans,  and steps regulators may take for addressing inadequate plans. Under  the rule, a company’s resolution plan must take into account different  economic scenarios provided to the company by the Federal Reserve; the  scenarios will be developed in the Federal Reserve’s rules on stress  testing. As shown in table 1, the deadlines for resolution plans are  staggered by company size. Plans for the largest bank holding companies  are due in July 2012.

FDIC and other regulators noted in our discussions that although they  completed a final rule for OLA and drafted several other rules, regulators  are working on, but have not yet issued, certain mandated rules. In  addition, the final rule does not address a number of important issues.  Most of the outstanding rules related to OLA are required under the  Dodd-Frank Act. Three of these are rules FDIC must issue jointly with  other regulators:

Orderly liquidation of broker-dealers (no statutory deadline);

Recordkeeping for qualified financial contracts (due July 21, 2012);

Source of strength (due July 21, 2012).

FDIC officials reported that each of these three rules was in a different  stage of development, with the recordkeeping rule for qualified financial  contracts closest to being issued, potentially as an interim rule before the  statutory deadline in July.

Besides addressing the complexity of OLA, regulators told us that  coordination and reaching consensus with different regulators  represented a challenge in drafting and issuing OLA-related rules,  particularly given the number of rulemakings required of some regulators  and resource constraints. As part of the OLA rule development process,  FDIC must consult with different members of FSOC and in some cases is  statutorily mandated to work with specific regulators or agencies.  Regulators also have had to address how certain rules would avoid  conflicts with other rules and help ensure consistency with other  requirements mandated under the Dodd-Frank Act.

Dodd-Frank Act § 616(d); 12 U.S.C. § 1831o-1. dealers that are subject to OLA. Under OLA, FDIC, as receiver of a  failed broker-dealer, or in a case in which the largest U.S. subsidiary of a  financial company is a broker-dealer, would appoint SIPC as trustee for  the liquidation. However, in our earlier discussions with FDIC, SEC, and  SIPC officials, they noted that the Dodd-Frank Act did not clearly  delineate SIPC’s role in a broker-dealer resolution under OLA, which may  pose challenges in such a case. For instance, if FDIC as the receiver of a  broker-dealer put the broker-dealer into a bridge institution, the agencies  would need to determine what SIPC’s role would be and how creditor and  customer claims would be handled.would govern the relationship between FDIC and SIPC. Although there is  no statutory deadline for this rule, SIPC officials emphasized the  importance of the rule to clarify SIPC’s participation so as to avoid  confusion in any future resolution under OLA. FDIC and SIPC officials  told us that they met together with SEC for the first time on May 3, 2012,  to discuss developing this rule. FDIC officials reported that they anticipate  issuing a final rule by the end of 2012.

FDIC officials told us that this rule  SEC officials told us that other Dodd-Frank requirements were a  complicating factor in the development of the required rule on  recordkeeping for qualified financial contracts. Under FDIC’s proposal,  financial companies would have to provide FDIC with information on  swaps and other contracts similar to the information that they would  provide regulators under other Dodd-Frank requirements. FDIC officials told us that they are actively working with other regulators on the rule,  which is due in July 2012. In another example, Federal Reserve staff told  us that rulemaking related to the source of strength rule involved  significant policy decisions, including to which bank holding companies  the rule would apply, and how this requirement relates to other  requirements for bank holding companies.they have reached out to the Federal Reserve and Office of the  Comptroller of the Currency to start developing this rule (also due in July  2012) but do not have an estimated issuance date.

FDIC officials told us that other OLA-related rules—either mandated by  the Dodd-Frank Act or recommended by others—detailing key aspects of  FDIC’s authority as receiver, as well as the treatment of creditors, were  still in the design phase or had not been drafted. First, the final rule on  FDIC’s general authority under OLA does not fully define the universe of  financial companies for which FDIC could be receiver. proposed rule, FDIC included a definition of financial companies (under  its authority under Title II of the Dodd-Frank Act) but in the final rule, the  agency deferred finalizing this definition until the Federal Reserve issued  its final rule on the definition of nonbank financial companies (under its  authority for enhanced supervision under Title I of the Dodd-Frank Act).  The Federal Reserve has issued two proposed rules on the definition of  financial companies and officials from FDIC and the Federal Reserve told us that they have been coordinating to make their definitions consistent.FDIC officials told us that they anticipated issuing a final rule defining  financial companies by the end of 2012.

As discussed earlier, FDIC’s authority under OLA would extend to those companies  “predominantly engaged in activities that the Federal Reserve has determined are  financial in nature or incidental thereto for purposes of section 4(k) of the Bank Holding  Company Act.” The final OLA rule did not define how FDIC would make this  determination. the proposed rule, industry groups and a federal regulator called for  greater clarification about how FDIC would do its assessment. FDIC  officials told us that they have started to develop a “minimum recovery”  rule to respond to these concerns and clarify how creditors would receive  no less than they would under a Chapter 7 bankruptcy proceeding.

Martin J Gruenberg. “Remarks to the Federal Reserve Bank of Chicago Bank Structure  Conference” (Chicago, Ill.: May 10, 2012).

Dodd-Frank Act allows for a bridge financial company to be established  for 2 years, with the ability to extend it for 1 year (up to three times).

The Dodd-Frank Act specifically states OLA is not a bailout to individual firms. Section  214 provides that all financial companies put into OLA must be liquidated and all funds  expended in the liquidation shall be recovered through disposition of assets or  assessments on the financial sector. 12 U.S.C. § 5394, Section 1101 amended the  section 13(3) of the Federal Reserve Act to prohibit the Federal Reserve Board from  authorizing direct loans for the purpose of assisting a single and specific company to avoid  bankruptcy, as it did in the 2008 financial crisis. 12 U.S.C. § 343. under OLA. FDIC faces no statutory deadline for completing these rules,  and FDIC officials told us that they considered them to be of lower  priority. Lastly, FDIC may issue additional rulemakings through its general  authority under Title II of the Dodd-Frank Act, in consultation with  FSOC. FDIC plans to issue a rule about the orderly liquidation of a  commodity broker, but officials told us that they would coordinate any  rulemaking with changes CFTC might make to its rule related to  commodity broker bankruptcies.

section_title: Concerns Have Been Raised about FDIC’s Limited Experience with Resolving Large, Complex Institutions
paragraphs: Although FDIC and other regulatory officials noted that resolution plans  could help prepare for the possible failure of a large financial company,  not enough time has passed to determine the effectiveness of the living  will requirement in assisting financial companies to prepare for  bankruptcy (as discussed earlier) as well as aiding FDIC in the use of its  Title II authority. As mentioned previously, the largest bank holding  companies are required to submit resolution plans by July 1, 2012. As of  May 2012, FSOC had not yet designated the systemically important  nonbank financial companies, and the resolution plan final rule states that  these companies do not have to file earlier than 270 days from their date  of designation. Federal Reserve and FDIC staff told us that they  anticipated that 9 or 10 bank holding companies would file in the first  wave of submissions. Federal Reserve officials told us that they have  been in discussions with the largest bank holding companies since the   Although entities commenting on the draft rule for  rule was finalized.resolution plan requirements brought up concerns about the definition of  government support to financial companies and the confidentiality of  proprietary data, regulatory officials believe that they have largely  addressed these issues in the final rule. As of May 2012, details on the  credit exposure reporting requirements had not been specified. Federal  Reserve officials told us that the requirement for credit exposure reports  will be included in a separate rulemaking related to single-party credit  exposure limitation.

In the bankruptcy process, the resolution or liquidation of large, complex,  internationally active financial firms involves multiple challenges. As we  discussed in our 2011 report, these challenges include identifying funding  sources and counterparties and dealing with complex corporate   Financial and legal experts structures across international jurisdictions. have noted that resolution plans might not be as helpful as hoped during  times of financial distress because of the need for current information— much of a company’s contracts, assets, and liabilities could change  dramatically from day to day. The final rule for resolution plans under Title  I requires financial companies to stress test their portfolios under multiple  scenarios to identify the financial firm’s risks. However, the scenarios may  not anticipate the type of financial crisis that could eventually lead to a  firm’s insolvency. Because of these challenges and the reported burden  associated with developing the plans, some industry and academic  experts have questioned the merits of the plans. FDIC noted their  expectation that the plans, when complete, would provide important  information for its advance planning to facilitate any necessary liquidation  of a firm, irrespective of the cause of the firm’s failure.

Furthermore, although FDIC has been working to further clarify its  authority under OLA, several academic and other experts have raised  concerns about FDIC’s overall ability to effectively initiate the resolution of  large and complex firms without causing broader market disruption. As  we discussed in our 2011 report, FDIC has issued an analysis of how it  would have handled the failure of Lehman under OLA; some criticized the  analysis for its assumptions about Barclays Capital Inc.(Barclays)’s ability  to obtain regulatory approval to purchase Lehman’s distressed assets at  a time of widespread weakness in the financial markets. According to  Lehman’s bankruptcy examiner, Barclays was interested in acquiring  Lehman prior to Lehman’s bankruptcy and did purchase certain assets of  Lehman’s following bankruptcy. According to FDIC, its willingness to  absorb the first $40 billion in Lehman’s losses would have addressed  concerns of Barclays’ U.K. regulators. FDIC officials told us that they  have been given sufficient powers to resolve such firms in order to limit  further market disruption. FDIC officials reported that having access to  funding would allow the receiver to make payments to creditors shortly  after the time of failure and would help to maintain financial stability. In  addition, they noted that the receiver would be able to establish a bridge  financial company, as discussed earlier, to maintain the operations of the  company without engaging in a bailout of stockholders of the failed firm.  FDIC reported it received strong support for its proposals under OLA  during a public forum with academic experts in January 2012.

Others have noted FDIC’s lack of experience in resolving financial  companies as complex as Lehman with multiple international  subsidiaries. As one SIPC official told us, Lehman collapsed within 24  hours—a much shorter planning period than that to which FDIC is  accustomed when resolving failed banks. In response, FDIC officials  noted that they likely would have reviewed a firm’s resolution plan and  been kept abreast of actions taken by the firm’s supervisor. As FDIC  notes in its paper on the hypothetical liquidation of Lehman under OLA,  FDIC would have been engaged for months prior to the failure of the firm.  In addition, we noted in our 2011 report, there have been few large scale  bankruptcies of complex, internationally active financial firms.

However, others have noted that today’s largest financial companies have  structures and asset sizes that dwarf those of Lehman, which remains the  largest Chapter 11 debtor in U.S. history. FDIC also could be limited in its  ability to manage the failure of an internationally active financial institution  because it would be responsible for resolving the domestic subsidiaries of  a failed company. Certain subsidiaries, assets, and creditors would be  subject to separate insolvency regimes in various countries.

section_title: International Coordination Remains a Key Challenge, Although Regulators Have Made Progress on a Universal Identifier
subsections: section_title: International Coordination Efforts
paragraphs: As discussed in our 2011 report, cross-border resolutions of  internationally active financial institutions such as Lehman Brothers  remain a challenge, due to the manner in which different countries’  insolvency proceedings interact. In comments on the proposed resolution  plan rules, several entities called for international coordination on the  submission and approval of resolution plan requirements, as many  internationally active financial institutions will be subject to resolution  regimes in multiple countries. U.S. and international regulators have  recognized this challenge and in July 2011 the Financial Stability Board  issued a consultative document that proposed a requirement to mandate  that all designated global systemically important financial institutions  (SIFI) have recovery and resolution plans.called for cross-border cooperation agreements to enable countries’  resolution authorities to act collectively to resolve internationally active  financial institutions in an orderly and less-costly way.

In addition, the document  After receiving comments on its proposal, the Financial Stability Board  released an updated list of key attributes of effective regimes for resolving  failed SIFIs in October 2011. These attributes addressed issues such as  the scope and independence of the country’s resolution authority, the  essential powers and authorities of the resolution authority, and how  jurisdictions can facilitate cross-border cooperation in resolutions of SIFIs.  Members of the G20 endorsed the attributes in November 2011. FDIC  and Federal Reserve officials report that the Dodd-Frank Act’s Title II  authority for FDIC to resolve systemically important financial institutions  and its Title I requirement for these institutions to file periodic resolution  plans follow the key attributes designated by the Financial Stability Board.  Federal Reserve staff told us that the United States was ahead of some  jurisdictions in adopting these provisions. In a November 2011 update  (the latest available), the Financial Stability Board wrote that many  jurisdictions had not implemented adequate legal frameworks for  resolving global SIFIs and substantial further work on recovery and  resolution plans as well as cross-border cooperation was needed.

FDIC, the Federal Reserve, and other international regulators that are  members of the Financial Stability Board have formed “crisis  management groups” to review the recovery and resolution plans for  global SIFIs. Officials from both U.S. agencies told us that the crisis- management groups for five of the U.S. global SIFIs have met with their  international regulatory counterparts during the past year. In particular,  they discussed progress for the planning efforts of these institutions.  FDIC also has reported starting bilateral discussions with the foreign  regulators of U.S.-based global SIFIs to identify any impediments to  orderly resolution and implement any changes to address those  challenges. FDIC noted that these discussions have led to the drafting of  several memorandums of understanding with international regulators.  FDIC further reported in January 2012 that their analysis has shown that  in a crisis the U.S.-based global SIFIs would have a limited number of  international regulators with which to work. For these financial institutions,  more than 90 percent of the “total reported foreign activity” was located in  from one to three foreign jurisdictions and more than 80 percent of this  activity came from legal entities in the United Kingdom.

However, Federal Reserve staff told us developing plans for cross-border  resolution under the Bankruptcy Code remains a challenge. While the  United States is requiring companies to file resolution plans that must  detail how companies would resolve themselves under the Code, in some  countries, regulators complete a resolution plan that discusses resolving  the company without further market disruptions. In contrast, financial  companies in those countries only have to complete a recovery plan that  discusses ways to restore strength to a company under financial stress.  Therefore, foreign banking organizations, which must file resolution plans  in the United States, could face a different set of requirements in their  home countries.

U.S. and international regulators have cited the development of the Legal  Entity Identifier (LEI) as a code for financial institutions and regulators to  better identify and manage institutions’ relationships with other  institutions—allowing them to more effectively measure and monitor  systemic risk. In addition, FDIC officials told us that the use of an LEI  should help regulators in resolving a financial company during the OLA  process because its adoption would allow large, systemically important  financial companies to identify their many component entities, which  generally are organized along business rather than legal lines. As we  discussed in our 2011 report, the resolution of these companies involves  unwinding the complex interrelationships among the entities in order to  address creditor claims.

Currently, a single financial institution may be identified or coded in  different ways by a firm doing business with that institution. For example,  JP Morgan Chase, Inc. may be referred to as JPMC, Chase, and  JPMorgan. Regulators have cited a universal identifier for financial  institutions as particularly helpful in the identification of parties in  transactions involving over-the-counter derivatives. collapsed in 2008, other financial institutions struggled to determine their  counterparty exposure to the firm, causing further market disruptions.

Over-the-counter derivatives refer to derivatives not traded on a formal exchange.

The financial industry has been exploring a universal identifier for  decades, but recently regulators have pushed for a global mandate. The  Dodd-Frank-created Office of Financial Research issued a policy  statement in 2010 seeking comment on the development of an LEI.  Since then, the Office of Financial Research and the Financial Stability  Board have held roundtables and the financial industry has convened  panels on the development of an LEI. In January 2012, the Financial  Stability Board convened an expert group of regulators (supported by an  industry advisory panel of experts) to provide recommendations on the  governance framework for the LEI with a goal of endorsement by the G20  summit in June 2012. On May 30, the Financial Stability Board endorsed  the expert group’s recommendations for a governance and operational  framework for an LEI. In addition, the Financial Stability Board’s  specification for an LEI standard is derived from the technical standard for  a 20-digit alphanumeric code published in May 2012 by the International  Organization for Standardization.

Global acceptance of an LEI requires determining its governance and  regulatory oversight. An Office of Financial Research official told us that  the Financial Stability Board’s LEI Expert Group has broken into  committees to discuss issues including governance, operating model,  reference data and confidentiality, funding, and implementation. The  official said that the governance committee also has been considering a  model in which a nonprofit entity would administer the process. According  to Treasury, the Financial Stability Board published a report in mid-June  2012 including recommendations for the appropriate governance  framework for a global LEI. U.S. regulators reported that the first iteration  of LEI structure will be limited to the code itself and a minimal set of  reference data, not information about ownership hierarchies, because of  confidentiality concerns. In its commodity swap reporting rule (which goes  into effect July 16, 2012), CFTC became the first U.S. regulator to require  financial companies to use LEIs.securities swap reporting rule that requires the use of an LEI provided by   SEC also has published a proposed  an international organization when available.Board has recommended a target for global implementation of the LEI  standard by March 2013.

section_title: Financial Company Bankruptcies Remain Difficult to Track and Several Major Cases Move Forward
paragraphs: In the 2011 report, we found that comprehensive data on the number of  financial companies in bankruptcy are not readily available. Bankruptcy  data are collected for provisions relevant to the Code and for  management of cases. While federal agencies currently do not collect  information to identify certain bankrupt entities, the Federal Judicial  Center is starting to assemble a specialized database of financial  company bankruptcies from the past 10 years. Two large cases we began  tracking in our 2011 report, Lehman Brothers and Washington Mutual, are  moving forward, but these cases along with the more recent bankruptcy  of MF Global illustrate the challenges in resolving large, complex financial  institutions.
subsections: section_title: Data on Financial Company Bankruptcies Are Limited
paragraphs: As we reported last year, tracking financial company bankruptcies is  difficult because data are limited. Specifically, data on the number of  financial company bankruptcies and their outcomes have been difficult to  obtain. Neither AOUSC, the Trustees’ Office in Justice, nor FDIC collect  information on the number of financial companies in bankruptcy. We  previously reported that AOUSC collects some data on bankruptcy  outcomes, such as the closing date for large cases. However, AOUSC  does not specifically include information on bankruptcy cases involving  financial institutions, or track outcomes such as the value of creditor  returns or the value of firms emerging from bankruptcy. The bankruptcy  courts only collect data on the type of business in which an institution is  engaged if the data are pertinent to provisions of the Code (for example if  the business was a broker-dealer subject to a SIPA proceeding) and  these data are used for case processing rather than overall study.  AOUSC officials told us they have been considering having the  bankruptcy courts include the North American Industry Classification  System code when a company files for bankruptcy. However, AOUSC  and Federal Judicial Center officials told us that this new requirement  would require a modification to the Official Bankruptcy Forms. These  officials told us that this process generally takes 2 years and follows the  process for amending the Federal Rules of Bankruptcy Procedure, except  the process does not require approval by the Supreme Court or an  opportunity for review by Congress.

AOUSC provides the Trustee Program’s bankruptcy filing data. Officials  told us these data include whether the debtor is a person or a corporation,  whether it is a small business, the case number, the name and address of  the debtor, and the status of the case (that is, whether a plan has been  filed or if the case has been dismissed), and other types of information.  However, officials told us they do not flag financial companies and cannot  track them separately. FDIC officials told us that although they track  individual cases of bank holding companies in bankruptcy, such as  Washington Mutual, Inc. and Colonial Bank, they do not have a database  that aggregates these case records.

Although AOUSC officials told us that they currently were not routinely  collecting any data that would allow the identification and tracking of  financial company bankruptcies, AOUSC and the Federal Judicial Center  have undertaken a collaborative effort to create a specialized database of  financial companies that have filed for bankruptcy protection from 2000 to  2010, but they have concerns about the reliability of these data as they  are untested for this purpose. According to a Federal Judicial Center  official, the purpose of the database is to compile information useful in  understanding the effectiveness of Chapter 7 and Chapter 11 of the Code  in facilitating the orderly liquidation or reorganization of financial  companies. Officials told us developing such a database has been   A  challenging, due to the resources needed and coding concerns.Federal Judicial Center official told us they had developed an online  coding form to document more information about each case and held a  training session for the student coders. One of the items researchers  must code is the type of financial company, which is not information the  courts currently collect. Some outcomes included in the database, such  as details about the sale of all assets, are more difficult to find in court  dockets. In addition, the official told us determining the level of detail on  each case to include in the database has been a challenge. For example,  the official told us they attempted to limit the complexity of information for  staff to code, while still documenting the necessary data for further study.  To address this issue, the official told us that the Federal Judicial Center  is undertaking various data verification processes, including a process by  which two independent coders will code the same information and a third,  more experienced researcher will reconcile any differences between  them. Despite these efforts, AOUSC officials told us that they currently  are not able to determine how effective this database will be in allowing  them to track large financial company bankruptcies, partly because of  concerns over using data reported by the companies filing for bankruptcy.

As in our 2011 report, to examine the number of large financial  companies filing for bankruptcy protection, we matched AOUSC data on  Chapter 11 megacases with data from a private firm on financial company  bankruptcies to determine the number of financial companies in  bankruptcy during the past decade. Table 2 describes both the total  megacase filings and those megacases that are financial companies.

We continued to monitor two financial megacases, Washington Mutual,  Inc. (Washington Mutual) and Lehman Brothers Holdings, Inc. (Lehman)  and began monitoring a third, MF Global Holdings Ltd. (MF Global).  Washington Mutual and Lehman are making progress in their bankruptcy  proceedings, with several issues outstanding. Both financial institutions  filed for Chapter 11 protection in September 2008. A new case involves  MF Global, a holding company with a broker-dealer and commodity  broker, which filed for Chapter 11 protection in October 2011. Each case  illustrates the complexities of liquidating large financial institutions.

Washington Mutual. As we discussed in our 2011 report, the parties to  the bankruptcy had agreed to a revised settlement report in late 2010, but  confirmation of that plan was delayed due to various claims by  shareholders and some creditors. These delays continued throughout  2011 because of additional hearings to discuss allegations of insider  trading by hedge funds. Shareholders alleged that several hedge funds  had access to discussions about the settlement plan through their  attorneys and later bid on creditor claims. The parties entered mediation  in October 2011 and reached a settlement and submitted a plan on  December 12, 2011. A Delaware bankruptcy court judge confirmed the  plan on February 17, 2012. As discussed in the 2011 report, the plan set  forth the allocation of the tax refund among all of the parties: up to $2.2  billion to Washington Mutual’s holding company; up to $2.2 billion to J.P.  Morgan Chase, Inc. (the new owner of the depository bank); up to $850  million to FDIC; and $335 million to the bank’s bondholders. As of May  2012, the judge told us that she had been advised that the majority of the  claims had been resolved. Further payouts will be distributed through a  liquidating trust. Washington Mutual, Inc. is being reorganized as a  reinsurance company that will be funded by capital contributions from  new bondholders, not by the creditors from the original debtor.

Lehman Brothers. On June 29, 2011, Lehman filed a disclosure  statement that set out the plan for distribution of assets to the creditors of  23 Lehman debtor entities. This plan was made after extensive  negotiations with representatives of major creditor groups, including those  that supported substantive consolidation and those that did not. This plan  represents a compromise between the parties by providing for  adjustments in payments to creditors. In November 2011, creditors  approved Lehman’s reorganization plan. The bankruptcy court confirmed  the plan in December 2011. The plan included numerous settlements  between the holding company and other counterparties, including a series  of bilateral settlements with foreign affiliates and creditors. As a result,  creditors reduced the amount of claims asserted against Lehman by more  than $295 billion. According to Lehman, distributions to creditors totaling  $22.5 billion began on April 17, 2012. A second distribution is planned for  September 2012.

The resolution of Lehman’s broker-dealer, Lehman Brothers Inc.,  continues through the SIPC process. According to SIPC officials, almost  all of the 100,000 claims had been satisfied as of May 2012. However,  some of the remaining claims are among the largest and involve complex  litigation over who meets the definition of “customer” under SIPA.  According to the SIPA Trustee, there are over 2,100 claims with a total  value of nearly $42 billion that are still unresolved. One of the largest of  these claims involves Lehman’s overseas affiliate—Lehman Brothers  International, Europe (LBIE)—which is pursuing two types of claims  against Lehman Brothers Inc. The first is an “omnibus customer claim”  on behalf of approximately 1,100 LBIE clients against Lehman Brothers  Inc., of which $6 billion in claims for securities and $2 billion in claims for  cash have been allowed by the SIPA Trustee. A remaining $6.7 billion  remains under dispute. The second is a “house claim” on its own behalf  against Lehman Brothers Inc., of which $8.9 billion remains under  dispute. The trustee said he does not recognize LBIE as a “customer” of  Lehman Brothers Inc. because it does not meet the definition of  “customer” under SIPA. According to SIPC officials, Lehman Brothers Inc.  never held reserves on behalf of LBIE. These issues remain in litigation  and may go to trial in 2013.

The SIPA Trustee for Lehman Brothers Inc. has initiated litigation against  other counterparties over payment distribution, which also remains  ongoing. In the first case, the SIPA Trustee is in litigation with Barclays  involving issues surrounding its purchase of assets of Lehman Brothers  Inc., immediately after Lehman filed for bankruptcy. According to the  SIPA Trustee’s report, the dispute centers on competing interpretations of  the Asset Purchase Agreement (defining the terms of the sale of certain  Lehman Brothers Inc. assets to Barclays) between Lehman, Barclays,  and Lehman Brothers, Inc. and involves contested claims to  approximately $7 billion of “disputed assets.” This case is currently on  appeal.

In a second case, SIPC officials told us the SIPA Trustee has filed an  adversary proceeding against Citibank seeking the return of a $1 billion  deposit Lehman Brothers Inc. made with Citibank during Lehman  Brothers Inc.’s last week in operation. The case involves Citibank’s setoff  of Lehman Brothers Inc.’s obligations against Lehman Brothers Inc.’s  deposits at Citibank and affiliated entities. Citibank claims it set off the deposit shortly before Lehman Brothers Inc.’s SIPA liquidation process  began in September 2008. The SIPA Trustee also has been seeking the  turnover of approximately $300 million deposited in Lehman Brothers Inc.  accounts at various Citibank locations around the world. According to the  SIPA Trustee, Citibank has been attempting to set off these deposits  against a component of the Lehman Brothers Inc. obligations  (approximately $1.26 billion) that are related to a settlement service  provided by Citibank.

In addition, the SIPA Trustee has been pursuing claims against LBIE on  behalf of the broker-dealer’s customers. The SIPA Trustee alleges that  LBIE has assets that belong to Lehman Brothers Inc. customers.  According to the SIPA Trustee, due to the hundreds of thousands of  transactions between Lehman Brothers Inc. and LBIE, the final outcome  and amounts available for SIPC’s customer distribution are heavily  dependent on LBIE’s own resolution in the United Kingdom. The SIPA  Trustee has filed claims against LBIE totaling almost $16 billion.  According to the SIPA Trustee, he and his advisers have been engaged  in discussions with LBIE about the extent to which LBIE will allow the  SIPA Trustee’s claim. The SIPA Trustee said the result of this process will  have a major impact on the resolution of the U.S.-based Lehman Brothers  Inc. estate and the SIPA Trustee’s ability to satisfy claims of customers  and other creditors of the broker-dealer.

MF Global. MF Global has been in the bankruptcy process since October  31, 2011, and has faced challenges due to missing customer funds and  property. MF Global was a large, globally active company with a  commodity and securities broker-dealer. The firm was based in the United  States, with operations in multiple countries, including Australia, Canada,  Hong Kong, India, Japan, Singapore, and the United Kingdom. As of mid- 2011, the holding company had total assets of almost $46 billion. MF  Global’s stock price declined during 2011, falling from about $8 a share at  the start of the year to below $4 in early October and below $2 by late  October. According to the SIPA Trustee, MF Global’s exposure to  European debt and poor earnings reports led to credit downgrades and  increased demands for collateral from MF Global’s counterparties. This in  turn led to an increased loss of confidence in MF Global as customers  began to close their accounts and withdraw funds.

According to CFTC, the failure of the MF Global commodity broker (MF  Global Inc.) is unprecedented in the size and scope of missing customer  funds. Ordinarily, the designated self-regulatory organization, in  coordination with CFTC, would have arranged for the sale of a failed  commodity broker to another commodity broker, but in the case of MF  Global Inc., the missing customer funds and possible fraud prevented this  from occurring, according to CFTC officials. These officials said they  increased their involvement in the MF Global case after the company was  downgraded by credit rating agencies on October 27, 2011. Despite  repeated inquiries, MF Global Inc. was not able to provide supporting  records for its calculations of segregated customer accounts. Because  CFTC lacks authority to put the commodity broker into bankruptcy, when  customer money was found missing, SEC and CFTC determined that a  SIPC-led bankruptcy was the appropriate course of action to protect  customer accounts and assets.

The MF Global bankruptcy has highlighted issues related to resolving an  international broker-dealer and commodity broker and the effect on  customer payments. According to SIPC officials, for the securities estate,  the SIPA Trustee is using SIPA, and for the commodities estate, the  Trustee is applying subchapter IV of Chapter 7 of the Code to the extent  consistent with SIPA, as well as applicable commodities law. While a  SIPA proceeding and the bankruptcy process for a commodity broker are  similar, there are important differences. Under the bankruptcy process for  a commodity broker, to the extent that the debtor’s general estate is  insufficient to pay for the estate’s administrative expenses, these  expenses are paid from customer property ahead of the claims of  customers. However, under the SIPA process, customer property is used  to pay customers, and is available to pay estate expenses only if all  customers have been satisfied in full. These differences could have a  distinct effect on the funds available to customers, depending on the  amount of the administrative expenses being paid compared to the  amount of the general estate and the amount of the customer claims. In  addition, SIPC may advance up to $500,000 for each customer holding  securities (and a maximum of $250,000 for customers holding cash) while  the liquidation is ongoing, which enables the trustee to provide some  relief to securities customers relatively quickly. SIPC has no authority to  make advances to satisfy commodities claims and the liquidation process  for a commodity broker has no such provision. In MF Global, more than  30,000 commodity customer claims were filed compared with  approximately 300 securities customer claims.

Because different customer estates are available to securities and  commodity customers, each type of customer is receiving a different  recovery percentage. CFTC officials told us they have been working to  identify customer property for these estates, and SIPC officials told us the  CFTC has closely cooperated with the SIPA Trustee.  However, SIPC  officials said the CFTC’s regulations that implement bankruptcies for  commodity brokers have been cumbersome to follow. In addition,  according to SIPC officials, the SIPA Trustee’s authority to conduct bulk  transfers from the insolvent commodity broker-dealer to other broker- dealers is vague.

According to the SIPA Trustee, a large volume of transactions occurred in  the final week of MF Global’s operations. The SIPA Trustee’s report  stated that the company’s information technology system could not  handle this increased volume, leading to transactions that were not  recorded or recorded incorrectly. The report estimated that “fail  transactions” (in which a counterparty fails to deliver cash or securities)  were five times the normal volume in the final week. Following the  bankruptcy filing, the SIPA Trustee conducted an investigation examining  840 cash transactions in excess of $10 million that totaled $327 billion  and 20,000 cash transfers below $10 million that totaled $9 billion. In  addition the SIPA Trustee has been examining securities transactions  valued at more than $100 billion. The SIPA Trustee has sought to  connect cash transfers from counterparties to the transfers of securities  from MF Global to locate more customer funds.

The resolution of MF Global Inc. also has been hampered by differences  in laws of various jurisdictions and the location of foreign assets.  According to the SIPA Trustee, differences in insolvency laws and a lack  of legal precedent have contributed to significant gaps in commodity  customer protection between the United States and foreign jurisdictions.  SIPC officials and the SIPA Trustee said customers who had accounts for  trading on domestic exchanges and customers who had accounts to take  physical delivery of commodities received an 80 percent return on their  account from the first interim distribution; however, the customers with  accounts for trading on foreign exchanges will receive only a 10 percent  return from this distribution. The officials explained that most of the  property for customers on foreign exchanges is in the United Kingdom  and according to the SIPA Trustee, these assets are now under the  control of foreign bankruptcy trustees, similar to other international  bankruptcies. The SIPA Trustee said that recovery of foreign assets was  uncertain and would take time, adding that these issues were usually the  last to be resolved and only after litigation. At a June 1, 2012, hearing, a  target date of April 9, 2013, was set by the U.K. court.

The recent bankruptcy cases involving large complex financial institutions  illustrate the potential challenges FDIC will have in an OLA proceeding,  including resolving a securities and commodity broker, a company with  significant international presence, and cases involving complex litigation.  As described previously, MF Global customer property may be located in  other countries, complicating the trustee’s efforts to obtain it. The trustee  for Lehman’s broker-dealer has been involved in litigation with one of  Lehman’s foreign affiliates for several years. Because OLA will only apply  to domestic entities, international coordination and voluntary cooperation  with foreign regulators will be essential for the resolution of a global  company. As discussed earlier, FDIC and other regulators have been  taking steps to improve international coordination of the resolution of  large, systemically important financial institutions but challenges remain.  Regulators have yet to clarify the roles and responsibilities of FDIC and  SIPC during the liquidation of a broker-dealer under OLA, including the  treatment of securities customers, commodity customers, and general  creditors. On May 3, 2012, FDIC conducted an exercise with SEC and  CFTC simulating a hypothetical failure of a systemically important  financial institution with both a securities broker and commodity broker to  better understand gaps in the OLA process and assist in their rulemaking  process.

section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to AOUSC, CFTC, Departments of  Justice and the Treasury, FDIC, Federal Judicial Center, Federal  Reserve, National Association of Insurance Commissioners, SEC, and  SIPC for review and comment. The National Association of Insurance  Commissioners did not provide comments. We received technical  comments from the remaining agencies, which we incorporated as  appropriate.

We are sending copies of this report to the appropriate congressional  committees, the Director of the Administrative Office of the U.S. Courts,  the Chairman of the Commodity Futures Trading Commission, the  Assistant Attorney General for Administration at the Department of  Justice, the Secretary of the Treasury, the Chairman of the Federal  Deposit Insurance Corporation, the Director of the Federal Judicial  Center, the Chairman of the Board of Governors of the Federal Reserve  System, the Chief Executive Officer of the National Association of  Insurance Commissioners, the Chairman of the Securities and Exchange  Commission, and the Chairman of the Securities Investor Protection  Corporation, and other interested parties. The report also is available at  no charge on the GAO website at http://www.gao.gov.

If you or your staff members have any questions about this report, please  contact Alicia Puente Cackley at (202) 512-8678 or cackleya@gao.gov.  Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this report. Major contributors to  this report are listed in appendix III.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: As required under section 202 of the Dodd-Frank Wall Street Reform and  Consumer Protection Act (Dodd-Frank Act), this report examines: (1)  actions the U.S. District Court for the District of Columbia (D.C. District  Court) has taken in response to the judicial review provision of Orderly  Liquidation Authority (OLA), including any revisions to Local Civil Rule 85;  (2) federal rules or regulations relating to OLA and efforts to improve  international coordination, including living wills, in resolving financial  companies; and (3) data collection efforts and the outcomes of financial  institutions that were in the bankruptcy process.

Generally to address our objectives, we reviewed the Dodd-Frank Wall  Street Reform and Consumer Protection Act (Dodd-Frank Act) of 2010  and its rulemaking requirements. We also conducted interviews with  officials at the Administrative Office of the U.S. Courts (AOUSC);  Commodity Futures Trading Commission; Federal Deposit Insurance  Corporation (FDIC); Board of Governors of the Federal Reserve System  (Federal Reserve); Federal Judicial Center; Securities and Exchange  Commission; Securities Investor Protection Corporation; Department of  the Treasury (Treasury); and the U.S. District Court for the District of  Columbia (D.C. District Court). We reviewed relevant literature and  reports issued since our last report, including those written by AOUSC  and the Federal Reserve in response to mandates in the Dodd-Frank Act.

Specifically to address the first objective on actions the D.C. District Court  took in response to the judicial review provision of the OLA, we monitored  the website for the D.C. District Court for changes in Local Civil Rule 85.  We interviewed the Chief Judge and other officials from the court to  discuss how the rule would be implemented in case of a petition under  OLA and the changes made to the rule in response to comments from  FDIC and Treasury. We also discussed these changes with officials from  FDIC and Treasury to obtain their views on the amended rule and how  they expected the rule to be implemented.

To address the second objective on federal regulations relating to OLA  and the resolution of financial institutions, we searched the Federal  Register and monitored the websites of FDIC and the Federal Reserve to  determine if relevant rules related to FDIC’s authority under Title II and  resolution planning had been issued. We also monitored the development  of other related rules, including the Federal Reserve’s rule related to the  definition of nonbank financial companies and the Financial Stability  Oversight Council’s designation of systemically important financial  institutions. We reviewed proposed, interim final, and final rules under  these authorities; they are presented in appendix II. We reviewed  comment letters on the rules, testimonies by regulatory officials,  roundtable discussions held by FDIC, legal opinions and law firm client  updates, and seminars conducted by law firms on FDIC’s new authority  under Title II. We reviewed updates from the Financial Stability Board on  international coordination of related resolution and recovery planning and  monitored the websites of the Financial Stability Board and Treasury’s  Office of Financial Research for developments on the Legal Entity  Identifier. We also participated in financial industry presentations on the  development and challenges of adoption of the Legal Entity Identifier.

To address the third objective on data collection and the status of  financial institutions in the bankruptcy process, we spoke to officials from  AOUSC, the Federal Judicial Center, and the Trustee Program at the  Department of Justice to learn more about potential sources of financial  company bankruptcy data. However, as discussed in our report, we found  that no single source for financial company bankruptcy data is available.  To provide some background information on the number of bankruptcies  of large financial institutions from January 1, 2010, through December 31,  2011, we used data (as we did for last year’s report) on Chapter 11  megacases collected by AOUSC and compared these cases with  bankruptcy data from New Generations Research, Inc. New Generations,  Inc., is a private company that takes data from U.S. bankruptcy filings and  augments it with industry-specific data, including the type of industry of  the debtor. We spoke with federal officials familiar with New Generations,  Inc., and they consider it to be reliable for tracking bankruptcy cases. We  also spoke to representatives from New Generations, Inc. regarding their  data collection and reliability methods. We concluded that the data were  reliable for tracking bankruptcy cases. AOUSC provided lead case data  on megacases (involving assets of more than $100 million and more than  1,000 creditors) that included date and location of filing and some  information on how closed cases were concluded (such as by sale,  liquidation, or reorganization). By matching data on bankruptcies of  financial institutions from New Generations with the AOUSC-provided  megacase data, we were able to provide some context on the number of  Chapter 11 megacases that represented financial institutions. We decided  the data were sufficiently reliable for that purpose because there was a  reasonable match between cases in the two data sets. As with our  previous report, AOUSC provided only data on Chapter 11 cases and not  Chapter 7. According to AOUSC officials, virtually all megacases were  originally filed as Chapter 11 cases.

In addition to our general tracking of financial institution bankruptcies, we  continued to monitor two major financial company bankruptcies—Lehman  Brothers Holdings, Inc. and Washington Mutual, Inc.—on which we  reported as case studies in 2011. We also began monitoring a new  major financial company bankruptcy, MF Global Holdings, Inc., that filed  for Chapter 11 protection in October 2011. For each of these cases, we  reviewed court documents such as court orders, trustee reports, and  reorganization plans. We also interviewed federal officials on their  involvement in these cases. We reviewed these data to provide illustrative  examples of some of the challenges and complexities of financial  company megacases; for example, challenges in resolving an  internationally active company or cases involving complex legal issues.  We verified information about these cases with federal officials. We  concluded that the information in these sources was sufficiently reliable  for our purposes.

We conducted this performance audit from August 2011 to July 2012, in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

section_title: Appendix II: Status of Selected Rules Related to the Orderly Liquidation Authority and Resolution Planning under the Dodd-Frank Act
paragraphs: The following are rules either mandated by the Dodd-Frank Wall Street  Reform and Consumer Protection Act (Dodd-Frank Act) or initiated by the  Federal Deposit Insurance Corporation (FDIC) or other agencies. As  discussed in the report, FDIC has been considering additional rules under  its Title II authority. Table 3 includes a list of rules and actions that have  been completed by the regulators and the courts related to the orderly  liquidation authority (OLA), resolution planning, or bankruptcy.

See table 4 for the status of various rules that have yet to be finalized.

Finally, table 5 provides the status of selected required rules that have yet  to be proposed or had any action taken.

section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Debra Johnson, Assistant  Director; Nancy Barry; Rachel DeMarcus; Katherine Bittinger Eikel;  William R. Chatlos; Dean P. Gudicello; Jonathan M. Kucskar; Marc W.  Molino; Barbara M. Roesmann; and Jessica Sandler made major  contributions to this report. Technical assistance was provided by JoAnna  Berry and David Martin.


Question-summary annotations: questions: question: What is the purpose of OLA?
answer: The federal financial regulators have issued certain final rules for resolving large, complex financial companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act’s (Dodd-Frank Act) established Orderly Liquidation Authority (OLA). Under OLA, the Federal Deposit Insurance Corporation (FDIC) could serve as receiver of a failing financial company instead of the company entering the bankruptcy process.
child_questions: question: What issues need to be resolved with regards to FDIC?
answer: Regulators continue to address a number of issues related to FDIC’s new authority, including how creditors will ensure that they receive no less than they would under a Chapter 7 bankruptcy liquidation; how certain assets and liabilities would be treated in a new company created by FDIC under OLA; and what role the Securities Investor Protection Corporation would play in the resolution of a broker-dealer under OLA.
child_questions: question: What actions have stakeholders taken already?
answer: Regulatory officials reported that they were continuing to draft rules to clarify how OLA would be used. FDIC and the Board of Governors of the Federal Reserve (Federal Reserve) also have issued final rules requiring certain financial companies to file resolution plans or “living wills” that must detail how companies would resolve their operations through an orderly bankruptcy.

question: What did regulators tell GAO about their plans?
answer: Regulators told GAO that the plans also would help FDIC plan for the exercise of its resolution authority, including OLA. The filing dates for these plans are phased in over the next year and a half, with the first group of financial companies filing their first plans on July 1, 2012. However, “nonbank financial companies” that also will need to provide plans have yet to be designated.

questions: question: What are regulators trying to address with their new data collection efforts?
answer: International coordination remains a critical component in resolving the failure of a large, complex financial company and regulators have been taking steps to address this and are testing new data collection efforts.
child_questions: question: What efforts are being made?
answer: Specifically, efforts are under way to develop a universal legal entity identifier that allows companies to identify and manage risks from companies with which they are engaged in financial transactions.
child_questions: question: Why is this information important?
answer: This additional information could help regulators in resolving internationally active financial companies. Data to identify financial institutions filing for bankruptcy protection as well as their outcomes are limited. Since neither FDIC nor federal judicial agencies have a database that tracks financial companies in bankruptcy, the Administrative Office of the U.S. Courts (AOUSC) and the Federal Judicial Center have begun a new effort to track financial company bankruptcies, but reported court data are untested for this purpose.

question: What is the current status of ongoing bankruptcies?
answer: Several large financial institution bankruptcies are still in progress. Two of the largest financial company bankruptcies, Lehman Brothers Holdings Inc. (Lehman Brothers) and Washington Mutual, Inc.—both of which filed in September 2008—recently had their reorganization plans confirmed by creditors and approved by the courts. However, these cases are not yet fully resolved. In the Lehman Brothers case, international litigation could take several years to resolve.
child_questions: question: What issues have these bankruptcies revealed?
answer: The October 2011 bankruptcy of MF Global Holdings Ltd., a holding company with a securities and commodities broker, has raised concerns about how commodity customers are treated under a liquidation regime and also involves international litigation over customer property. These financial company bankruptcies highlight the challenges FDIC and other regulators would face in resolving large, complex financial companies under the OLA process.

questions: question: Why was OLA created?
answer: The Dodd-Frank Act created OLA for resolving failed, systemically important financial companies.
child_questions: question: What actions have been taken since the Dodd-Frank Act with OLA was passed?
answer: Since the act was passed in 2010, regulators have been developing regulations to implement this authority and avoid disorderly resolutions that create substantial losses for the financial system.

question: What was GAO's role in this process?
answer: In July 2011, GAO issued the first of its statutorily mandated reports on the effectiveness of the Bankruptcy Code for resolving or liquidating complex, internationally active financial companies.
child_questions: question: What did GAO review?
answer: Among the topics examined in this second report, GAO reviewed: (1) federal rules or regulations relating to OLA and the resolution of financial institutions, including living wills; and (2) status of efforts to improve coordination on international resolutions, data collection efforts, and the outcomes of financial institutions that were in the bankruptcy process.