DAVIS POLK & WARDWELLOctober 17, 2003
Securities and Exchange Commission
Ladies and Gentlemen: We are pleased to submit this comment letter on behalf of the European banking organizations set forth below (the "European Bank Group" or the "Group") in support of the Commission's proposal to exempt qualified foreign banks from the insider lending prohibition of Section 13(k) of the Securities Exchange Act of 1934 (the "Exchange Act").
I. Executive Summary The Group strongly supports the proposal to grant foreign banks an exemption from Section 13(k), agrees that the standard for the proposed exemption should be the comparability of its scope and conditions with the scope and conditions of the statutory exemption for U.S. domestic banks, and views the proposed exemption as a positive step in developing an exemption that satisfies the comparability standard. Indeed, the Group previously submitted a letter to the Commission urging it to provide an exemption to foreign banks subject to comprehensive consolidated supervision ("CCS"), a home country deposit insurance scheme and home country insider lending restrictions.1 The Group also submitted an alternative proposal based on compliance with the fundamental elements of Regulation O.2 The Group is in agreement with most of the proposed exemption as written. The Group agrees that the first condition of the proposed exemption - that a foreign bank must be subject either to CCS or to a home country deposit insurance program - is comparable to the federal deposit insurance requirement of the U.S. bank exemption in Section 13(k). The Group also agrees that the second and third conditions of the proposed exemption are comparable to the insider lending restriction requirement of the U.S. bank exemption to the extent they condition the availability of the proposed exemption to foreign banks on their being subject to home jurisdiction insider lending restrictions (without specifying any minimum content requirements) or the fundamental elements of Regulation O, or both. The Group believes, however, that conditioning the proposed exemption on home country insider lending restrictions containing the fundamental elements of Regulation O (i.e., a home country minimum content requirement) will entangle the Commission in the very delicate process of exporting U.S. insider lending restrictions in a way that is virtually certain to intrude into legitimate areas of exclusive foreign regulatory and supervisory discretion and that is unnecessary to achieve the goal of making the foreign bank exemption comparable to the domestic bank exemption. The Group therefore urges the Commission to drop the requirement that foreign insider lending restrictions satisfy any minimum content requirement. II. Discussion The Commission has broad discretion to provide an exemption from Section 13(k) for foreign banks to the extent the exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.3 The Group agrees that it is in the public interest and consistent with the protection of investors - and with both the letter and spirit of Section 13(k) - for the Commission to provide an exemption for foreign banks based on conditions that are comparable to the conditions of the statutory exemption for U.S. domestic banks. A. Comparability Standard Section 13(k) contains a statutory exemption for U.S. banks that is subject to only two conditions: (i) the bank's deposits must be insured by the Federal Deposit Insurance Corporation ("FDIC") and (ii) the bank's insider loans must be subject to the federal insider lending restrictions contained in Section 22(h) of the Federal Reserve Act, which is implemented by Regulation O promulgated by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board" or the "Board"). 1. CCS or Deposit Insurance Condition The Group agrees that the first condition of the proposed exemption - that a foreign bank must be subject either to CCS or a home country deposit insurance program - is comparable to the FDIC insurance requirement of the U.S. bank exemption. The home country deposit insurance requirement is directly comparable to the FDIC insurance requirement, and the CCS condition is a reasonable substitute for the only purpose the deposit insurance requirement could possibly serve - as a reliable indicator that a bank is subject to extensive supervision and regulation. The Commission requested comment on whether one or the other of the CCS or home country deposit insurance requirements should be the exclusive screening condition, or whether the two requirements should be alternative screening conditions as proposed. Although each member of the European Bank Group is subject to a deposit insurance program in its home country, and all but one have been specifically determined by the Federal Reserve Board to be subject to CCS,4 the Group agrees with the Commission that the two conditions should be alternative conditions as proposed.5 The purpose of the deposit insurance condition cannot be that it has any direct bearing on the proper regulation of insider lending; deposit insurance is designed to protect insured depositors from the insolvency risk of the bank and to prevent runs on banks during times of financial crises.6 Instead, the Group agrees with the Commission that the purpose of the deposit insurance condition is to serve as a reliable indicator that a bank is subject to extensive supervision and regulation. Indeed, legislatures and banking supervisors around the world typically justify the extensive supervision and regulation of insured banks as a trade-off for the implicit subsidy received by such banks from deposit insurance, to prevent moral hazard and to protect deposit insurance funds or taxpayers from financial losses.7 CCS is a concept that was developed by the Basle Committee on Bank Supervision in the Basle Concordat in 19838 and elaborated on in the Basle Committee's Core Principles in 1997.9 Its key features are that a bank must be subject to comprehensive supervision and regulation, and such supervision and regulation must be conducted on a groupwide basis. It is typically equal to or greater than the level of supervision and regulation implied by the presence of deposit insurance. As a result, satisfaction of the CCS condition should be an alternative to satisfaction of the deposit insurance condition. The Commission also requested comment on whether a foreign bank should be allowed to satisfy the CCS condition solely by a specific CCS determination as proposed, or whether it should be allowed to satisfy the CCS condition by showing that one or more other banks from its home country have been found to be subject to CCS. The Group believes that a foreign bank should be able to meet the CCS condition by (i) obtaining a specific determination from the Federal Reserve Board that it is subject to CCS or (ii) furnishing a certificate to the Commission attaching a Federal Reserve Board determination that a bank from the foreign bank's home jurisdiction is subject to CCS and certifying that the foreign bank is subject to substantially the same regulation and supervision in all material respects. There could be a large number of foreign banks that are or become subject to Section 13(k) that do not have and may never establish the type of operations in the United States that would result in the Federal Reserve Board being required to make a specific CCS determination about them. The Board generally makes a CCS determination when approving the application of a foreign bank to acquire a U.S. bank or commercial lending subsidiary, to open a branch or agency office in the United States or to elect to be treated as a financial holding company, although it is required to make such a determination only when a foreign bank acquires a U.S. bank.10 It is not required to make a CCS determination when a foreign bank becomes a reporting company or otherwise becomes subject to Section 13(k). Moreover, because the Board was not required to make CCS determinations until enactment of the Foreign Bank Supervision Enhancement Act of 1991, other foreign banks may have established their U.S. operations before the Federal Reserve Board became obligated to make CCS determinations and may never change their U.S. operations in a way that would result in the Board being required to make a CCS determination. Requiring foreign banks to show that the Board has made a specific CCS determination about them would therefore exclude all such foreign banks from the proposed exemption even if they are subject to CCS. In addition, because foreign banks organized under the laws of a particular jurisdiction are likely to be subject to substantially identical supervision and regulation as other banks organized under the same laws, the Group believes that a foreign bank should be able to meet the CCS condition by furnishing a certificate to the Commission attaching a Federal Reserve Board determination that a bank from the foreign bank's home jurisdiction is subject to CCS and certifying that the foreign bank is subject to substantially the same regulation and supervision in all material respects. This approach is consistent with the Board's own practice in making CCS determinations when the Board has previously determined that another bank from the same jurisdiction was subject to CCS.11 2. Insider Lending Condition The Group also agrees that the second and third conditions of the proposed exemption in paragraph (b) are comparable to the federal insider lending rule condition of the U.S. bank exemption to the extent they condition the availability of the proposed exemption on foreign banks being subject to home country insider lending restrictions (without specifying their minimum contents) or the fundamental elements of Regulation O, or both. The Commission expressly or (in the case of the third and fourth bullet points) effectively requested comment on whether the second condition should require compliance:
The Group believes that any of the first four alternatives would satisfy the comparability standard. Although the fifth alternative may appear to satisfy the comparability standard, it is broader than necessary to ensure that foreign banks comply with home country insider lending restrictions or the fundamental elements of Regulation O, or both, and would almost certainly intrude into legitimate areas of exclusive foreign regulatory and supervisory discretion. a. The First Four Alternatives. The first alternative would be directly comparable to the federal insider lending rule condition of the U.S. domestic bank exemption. Although the details of home country insider lending restrictions can be different from those of Regulation O, the first alternative gives appropriate recognition to the observation that insider lending by foreign banks has not caused any losses to U.S. investors in the past, there is more than one way to regulate insider lending appropriately, and there is no reason to presume that home country bank supervisors cannot be trusted to regulate insider lending in a way that properly addresses the investor protection and corporate governance goals of Section 13(k). To the extent there is any residual concern about deferring to home country insider lending restrictions without a sufficient understanding of the contents of those restrictions, the Group believes that the issue could be addressed through disclosure. For example, to the extent that a foreign bank made insider loans pursuant to home country insider lending restrictions that are materially different from the fundamental elements of Regulation O, the foreign bank could be required to disclose in its annual report on Form 20-F or 40-F what those material differences are. In this way, U.S. investors could make their own assessment about the quality of a foreign bank's corporate governance or regulatory regime with respect to insider lending. The second alternative is also comparable to the federal insider lending condition by requiring foreign banks to comply with the fundamental elements of Regulation O. The Group agrees with the Commission that subsections (b)(2) and (3) reflect all of the fundamental elements of Regulation O that are necessary to ensure that the proposed exemption reflects comparable criteria to those contained in the statutory exemption for U.S. insured depository institutions. Other elements of Regulation O - such as the limits on the amount of loans to one borrower and recordkeeping requirements - would almost certainly be duplicative of home country supervision and regulation, have little to do with the investor protection and corporate governance purposes of Section 13(k) and are unnecessary to ensure that the proposed exemption is consistent with the letter and spirit of Section 13(k). The third alternative satisfies the comparability condition if the first two alternatives do. It has the additional advantage of being more inclusive than either of the first two alternatives standing alone. It would allow a foreign bank to qualify for the proposed exemption not only if it complied with its home country insider lending restrictions, but also if it was willing to comply with the fundamental elements of Regulation O in the absence of any home country insider lending restrictions. The fourth alternative is essentially the same as the second alternative, except that in addition to requiring compliance with the fundamental elements of Regulation O, it would also require compliance with home country insider lending restrictions. In essence, it would require foreign banks that are subject to Section 13(k) to comply with the more restrictive of the two insider lending restrictions in order to qualify for the proposed exemption. Although the Group believes that each of these first four alternatives satisfies the comparability standard, it believes that the third alternative is the most desirable. It is consistent with both the letter and the spirit of Section 13(k). It gives appropriate recognition to the observation that insider lending by foreign banks has not caused any losses to U.S. investors in the past, there is more than one way to regulate insider lending appropriately, and there is no reason to presume that home country bank supervisors cannot be trusted to regulate insider lending in a way that properly addresses the investor protection and corporate governance goals of Section 13(k). And it is the most inclusive alternative, since it would allow a foreign bank to qualify for the proposed exemption not only if it complied with its home country insider lending restrictions, but also if it was willing to comply with the fundamental elements of Regulation O in the absence of any home country insider lending restrictions. b. The Minimum Content Requirement. Although the fifth alternative may appear to satisfy the comparability standard, the Group believes that it is broader than necessary to ensure that foreign banks that are subject to Section 13(k) comply with the fundamental elements of Regulation O, and would almost certainly intrude into legitimate areas of exclusive foreign regulatory and supervisory discretion. Although many foreign insider lending restrictions and procedures are broadly consistent with the fundamental elements of Regulation O, as reflected in subsections (b)(2) and (3) of the proposed exemption, there are important differences in many jurisdictions. For example, some foreign insider lending restrictions distinguish between directors and executive officers in terms of the applicable restrictions. Other foreign insider lending restrictions use other words such as "managing director" for the term "executive officer" or may not define the equivalent term in precisely the same way as the Commission does for purposes of Section 13(k).13 Some require board or shareholder approval; others do not. Some require approval by the foreign bank's home country bank supervisor; others do not. There may also be other subtle differences between home country insider lending restrictions and the fundamental elements of Regulation O, as reflected in subsections (b)(2) and (3) of the proposed exemption. Under the minimum content approach, any foreign bank whose home country insider lending restrictions do not reflect precisely every element of the minimum content requirement would be excluded from the proposed exemption, even if the foreign bank was otherwise willing to conform its insider lending practices to the fundamental elements of Regulation O, as reflected by subsections (b)(2) and (3) of the proposed exemption, and to whatever home country insider lending restrictions required. In other words, foreign banks would not be able to benefit from the proposed exemption unless and until they persuaded their home country legislatures or supervisors to amend their home country insider lending restrictions to reflect the minimum content requirements of the proposed exemption. Because of the legal and practical difficulties of crafting one home country insider lending rule for banks that are subject to Section 13(k) and another for banks that are not subject to Section 13(k), a minimum content requirement would effectively mean that any such amendments would have to apply to all home country banks, including those that are not subject to Section 13(k). This will entangle the Commission in the very delicate process of exporting U.S. insider lending restrictions in a way that interferes with the foreign regulation of insider loans by banks that are not even subject to Section 13(k). Such a sweeping requirement will therefore intrude into a legitimate area of exclusive foreign concern and is not necessary to achieve the goal of making the foreign bank exemption comparable to the domestic bank exemption in terms of compliance with home country insider lending restrictions or the fundamental elements of Regulation O, or both. That goal can be achieved by requiring foreign banks to comply with the fundamental elements of Regulation O independently of whether any of those elements are incorporated into home country insider lending restrictions. The Group therefore requests the Commission to drop the requirement that foreign insider lending restrictions satisfy any minimum content requirement as a condition to the proposed foreign bank exemption from Section 13(k). B. Miscellaneous Comments The Group also wishes to respond to certain miscellaneous comments requested by the Commission. 1. Specific Approval by Home Country Supervisor The Commission requested comment on whether to "permit a foreign bank to qualify for the exemption if its insider loans are subject to prior approval by the bank supervisor in its home jurisdiction, as proposed." The Group agrees that foreign banks should be permitted to make insider loans that are specifically approved by their home country bank supervisors. The legislative history and statutory exemptions of Section 13(k) reveal that its primary purpose was to prohibit unregulated companies not generally engaged in the lending business from making large extensions of credit to their executive officers and directors, without proper board or regulatory oversight. If a foreign bank's insider loans are both subject to the prior approval by the bank's home country bank supervisor and, if over a certain size, subject to prior approval by a majority of the bank's board of directors without the interested insider voting, as in proposed subsections (b)(2)(iii) and (3), the letter and spirit of Section 13(k) has been satisfied and the criteria for the foreign bank exemption is comparable to the criteria for the statutory exemption for U.S. insured depository institutions. 2. Prior Board Approval Requirement The Commission requested comments on whether to "require prior board approval for an insider loan that, when aggregated with all other loans to that insider, exceeds a certain amount" and, "[i]f so, should the amount be $500,000, as proposed" or "[s]hould it be an amount less than or greater than $500,000 and, if so, why." The $500,000 threshold was derived from Section 215.4(b)(2) of Regulation O, which requires prior board approval of insider loans by U.S. banks in excess of $500,000 if the bank has capital and surplus of more than $10 million. Each of the members of the European Bank Group has, and virtually any other foreign bank that is likely to become subject to Section 13(k) is likely to have, capital and surplus far in excess of that amount. As a result, the threshold for board approval should not be lower than $500,000. The $500,000 threshold established by Section 215.4(b)(2) of Regulation O has not been adjusted for inflation since 1983. Thus, the Commission should adjust this amount upward for purposes of the proposed exemption to reflect inflation. At a minimum, the prior board approval requirement in the proposed exemption should be modified to replace the $500,000 figure with a cross-reference to the amount set forth from time to time in Section 215.4(b)(2) of Regulation O (or any successor). This would allow the threshold amount in the proposed exemption to be automatically adjusted for inflation whenever the Federal Reserve Board sees fit to do so in Section 215.4(b)(2) of Regulation O (or any successor). The Commission also requested comments on whether to "require a two-thirds vote or a unanimous vote of approval by the board" and "[f]or a foreign bank that has a two-tier board, [whether] majority approval of the insider loan by either board suffices to satisfy the prior board approval requirement." The Group agrees with the Commission that the prior board approval requirement in subsection (b)(3) should be based on the approval of a simple majority of a foreign bank's board of directors and, in the case of a foreign bank with a two-tiered board structure, the approval of a simple majority of either the managing board or the supervisory board, provided that the affected insider does not participate in the voting process. The Group believes that the proposed foreign bank exemption would not be comparable to the statutory exemption for U.S. insured depository institutions if subsection (b)(3) required any supermajority voting requirement, such as a two-thirds or unanimous vote. The prior board approval requirements in Regulation O require only a simple majority to approve an insider loan.14 * * * * * * * We hope these comments will be helpful to the Commission in finalizing its proposed foreign bank exemption to be comparable with the statutory exemption applicable to U.S. insured depository institutions, while making reasonable accommodation for foreign circumstances. Attached as Exhibit A are suggested revisions to the proposed Rule 13k-1 to implement the Group's comments. Please feel free to call the undersigned if you would like to discuss anything discussed in this comment letter with any representative of the European Bank Group.
Exhibit A Proposed Revisions to Rule 13k-1 (Proposed revisions are in bold) (b) . . . (1) Either: . . . (ii) (A) The Board of Governors of the Federal Reserve System (the "Board") has determined that the foreign bank is subject to comprehensive supervision or regulation on a consolidated basis ("CCS") by the bank supervisor in the foreign bank's home jurisdiction as provided in 12 C.F.R. 211.24(c)(1)(ii) (or any successor) or (B) the foreign bank has furnished a certificate to the Commission attaching a copy of a Board determination that a bank incorporated under the laws of the foreign bank's home jurisdiction is subject to CCS and certifying that the foreign bank is subject to substantially the same regulation and supervision in all material respects;15 and (2) Either: (i) The laws or regulations of the foreign bank's home jurisdiction restrict the foreign bank from making loans to its executive officers and directors (or their equivalent) or those of its parent company; [or] [and] (ii) Each loan to any of its executive officers or directors or those of its parent company is made: (A) On substantially the same terms as those prevailing at the time for comparable transactions by the foreign bank with other persons who are not executive officers, directors or employees of the foreign bank or its parent company; (B) Pursuant to a benefit or compensation program that is widely available to the employees of the foreign bank or its parent company and does not give preference to any of the executive officers or directors of the foreign bank or its parent company over any other employees of the foreign bank or its parent company; or (C) Following the express approval of the loan by the bank supervisor in the foreign bank's home jurisdiction; and (3) For any loan that, when aggregated with the amount of all other outstanding loans to a particular executive officer or director, exceeds the amount set forth in 12 C.F.R. 215.4(b)(2) (or any successor)16: . . . ____________________________
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