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

Letter

Background

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.

Bankruptcy Proceedings

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.

Orderly Liquidation Authority under the Dodd- Frank Act

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.

Resolution Plans and Other Financial Stability Provisions under the Dodd-Frank Act

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.

Additional Rulemaking Authorities under the Dodd-Frank Act

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.

D.C. District Court Revised Its Rule for Judicial Review under OLA

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.

Although Regulators Have Issued Rules Related to OLA, Some Clarifications Remain Outstanding

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.

Federal Regulators Have Issued Final Rules for OLA and Resolution Plans

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.

Concerns Have Been Raised about FDIC’s Limited Experience with Resolving Large, Complex Institutions

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.

International Coordination Remains a Key Challenge, Although Regulators Have Made Progress on a Universal Identifier

International Coordination Efforts

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.

Financial Company Bankruptcies Remain Difficult to Track and Several Major Cases Move Forward

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.

Data on Financial Company Bankruptcies Are Limited

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.

Agency Comments and Our Evaluation

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.

Appendix I: Objectives, Scope, and Methodology

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.

Appendix II: Status of Selected Rules Related to the Orderly Liquidation Authority and Resolution Planning under the Dodd-Frank Act

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.

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

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.