Sullivan & Cromwell LLP
125 Broad Street
New York, New York 10004-2498
October 17, 2003
VIA E-MAIL: firstname.lastname@example.org
Mr. Jonathan G. Katz,
Securities and Exchange Commission,
450 Fifth Street, N.W.,
Washington, D.C. 20549-0609.
Re: Proposed Foreign Bank Exemption from the Insider Lending Prohibition of Exchange Act 13(k) - (File No. S7-15-03)
Dear Mr. Katz:
We appreciate the opportunity to comment on proposed Rule 13k-1 (Release No. 34-48481, International Series Release No. 1272).
We strongly support the Commission's efforts to address the discriminatory impact of Section 402 of the Sarbanes-Oxley Act on non-U.S. banks.1 The principle of "national treatment" of non-U.S. banks has long been a fundamental tenet of U.S. Federal banking law, and we commend the Commission for proposing to extend that principle to Section 402.
We are, however, concerned that laws of many countries having internationally recognized, sophisticated, bank-regulatory regimes will not meet the preconditions of the Proposed Rule. As a result, the Proposed Rule would have only limited effect in achieving national treatment, and the discriminatory impact of Section 402 would largely continue. Our principal comment, therefore, is to suggest that the Commission revise the Proposed Rule to accommodate the diversity of regimes governing insider lending outside the United States.
1. The laws of many countries having internationally recognized, sophisticated, bank-regulatory regimes will not satisfy Proposed Rule 13k-1(b)(2).
We believe that the most restrictive element of the Commission's proposal is Proposed Rule 13k-1(b)(2). Proposed Rule 13k-1(b)(2) conditions the proposed exemption on a requirement that the "laws or regulations" of a non-U.S. bank's home country prohibit the bank from making loans to its executive officers and directors or those of its parent company unless it extends the loan in one of the three following ways:
- on substantially the same terms as those prevailing at the time for comparable transactions by the bank with other persons;
- pursuant to a benefit or compensation program that is widely available to the employees of the bank or its parent company and that does not give preference to any of the executive officers or directors; or
- following express approval of the loan by the bank's home-country bank regulator.
We are concerned that many countries will not satisfy this condition. This is the case not because these countries lack protection against abusive insider lending, but because they did not choose to regulate insider loans in the very specific ways required by the condition.
Although we have not surveyed foreign jurisdictions to assess whether their laws or regulations satisfy Proposed Rule 13k-1(b)(2), we have been advised that the laws of Australia, Canada, Germany, Ireland, the Netherlands and the United Kingdom do not appear to do so, and many other jurisdictions may be in a similar position.2 To the extent that the Proposed Rule would exclude banks in many jurisdictions that the Federal Reserve has determined have comprehensive, consolidated supervision, we believe it leads to a result that the Commission did not intend.
In this regard, the Commission may have underestimated the diversity of regimes governing insider lending outside the United States. To illustrate this diversity, we briefly describe the differing regimes of Australia, Canada and Germany below. Each country regulates insider lending by its banks, but does so under a different approach that may not satisfy Proposed Rule 13k-1(b)(2).
The Australian Prudential Regulation Authority, or APRA, supervises the domestic and off-shore operations of Australian banks and their subsidiaries. Aspects of Australia's regulatory regime include that (1) each regulated bank must submit specific financial and statistical reports to APRA; (2) each bank's external auditors report directly to APRA for certain matters, must bring certain matters to APRA's attention and must provide an annual opinion to APRA regarding the bank's compliance with prudential regulation; (3) APRA conducts formal annual prudential consultations with a bank's executive management; and (4) APRA has statutory authority to exercise enforcement powers.3
Australian banking law does not specifically regulate insider lending. Instead, all public Australian companies are subject to Chapter 2E of the Australian Corporations Act of 2001. Chapter 2E prohibits any public Australian company, including any public bank, from providing "financial benefits" to "related parties"4 unless (1) it does so on terms and conditions that would be reasonable in the circumstances in an arm's-length transaction, (2) the shareholders approve the transaction or (3) the benefit falls within a category of transactions which do not need to be referred to shareholders for approval.5 In addition, insider transactions are also subject to the general supervision of APRA, which has the capacity to control related-party lending through its prudential standards, and as part of its on-site and off-site examination process.6 APRA has noted previously that it includes specific related-party lending requests and questions as part of its on-site examination process.7
Through the combination of comprehensive, consolidated supervision of banks and restrictions on insider transactions by any Australian public company, insider lending by public Australian banks is narrowly constrained and the potential for abusive insider loans is limited to an extent that justifies an exemption from Section 402. However, Proposed Rule 13k-1(b)(2) would preclude any Australian bank from taking advantage of the proposed exemption. For example, under Australian law (1) shareholders may approve transactions that are not arm's length and (2) the definition of "related parties" does not include non-director executive officers.
Canadian banks are regulated and supervised by the Office of the Superintendent of Financial Institutions, or the OSFI. As part of its supervisory process, the OSFI conducts an annual on-site examination of each bank, including a review of the bank's compliance with applicable law.8
Canadian banking law strictly limits the circumstances and terms of loans to bank insiders and is in some respects more restrictive than U.S. law. Canadian law prohibits personal loans and other commercial transactions between a bank and any "related party", including directors and executive officers,9 unless (1) the loan is made on "market terms and conditions",10 (2) the amount of credit extended to an insider, even on market terms, does not exceed certain limits,11 and (3) the bank's board of directors approves by a vote of two-thirds any loan to an insider that would bring the sum of all outstanding loans to the recipient (excluding mortgages and certain other loans) above 2% of the bank's regulatory capital.12 Despite this general prohibition, however, Canadian law permits a Canadian bank to make a loan (other than a margin loan) to a senior officer on terms and conditions more favorable than those offered by the bank to the public, upon prior approval of the terms and conditions by the conduct review committee of its Board of Directors.13 The exercise of this authority is subject to the supervision of (but not pre-approval by) the OSFI.
As we have noted, Proposed Rule 13k-1(b)(2) does not appear to contemplate exceptions in addition to those it specifically sets forth. As a result, notwithstanding the framework outlined above, the exception under Canadian law for loans on favorable terms appears to be inconsistent with Proposed Rule 13k-1(b)(2), because it could result in a loan being extended otherwise than in compliance with any of the three circumstances provided for in Proposed Rule 13k-1(b)(2).
German banks are supervised by the Banking Supervision directorate of the Federal Financial Supervisory Authority, or the BaFin. The BaFin's supervision is supplemented by the Deutsche Bundesbank, Germany's central bank, which also routinely holds prudential discussions with banks and monitors their regulatory and financial reports.
The German Banking Act does not specifically require that loans to bank directors or executive officers be on market terms. Instead, German corporate law takes a more principle-based approach and limits loans to insiders through fiduciary duty of care principles. In addition, Section 15 of the German Banking Act requires unanimous approval by each of a bank's management and supervisory boards for loans to any member of either board, or any of their spouses or minor children. Insider loans are also subject to the supervision of the BaFin.
Basle Core Principle 10
In the release accompanying the Proposed Rule, the Commission states that it does not believe that Proposed Rule 13k-1(b)(2) "should pose an undue burden on many foreign banks."14 This expectation appears to be based at least in part on Principle 10 of the "core principles" for banking supervision developed by the Basle Committee on Banking Supervision of the Bank for International Settlements.15
We believe, however, that Principle 10 accommodates a wider variety of regulatory schemes for insider lending than Proposed Rule 13k-1(b)(2). For example, Principle 10 contemplates that countries may have different methods for defining who constitutes a "related party"16 and different exceptions to the arm's length requirement in the case of compensation packages.17 A jurisdiction therefore may satisfy the essential criteria of Principle 10 but not satisfy Proposed Rule 13k-1(b)(2). We note that representatives of the central banks of Canada, Germany, the Netherlands and the United Kingdom are members of the Basle Committee on Banking Supervision that developed the Core Principles, and we believe each would be viewed as complying with Principle 10. Similarly, APRA has concluded that Australia is "largely compliant" with Principle 10.18
2. We respectfully suggest that the Commission revise the Proposed Rule to accommodate the diversity of regimes governing insider lending outside the United States.
The Proposed Rule recognizes that some differences exist between U.S. and non-U.S. bank regimes governing insider lending. We believe, however, that the Commission should expand the Proposed Rule to further accommodate the diversity of non-U.S. regimes.
We support the proposal by the Institute of International Bankers that any bank that is organized in a jurisdiction that the Federal Reserve has concluded has comprehensive, consolidated supervision should be exempt from Section 402.19 A CCS determination is required for a non-U.S. bank to do business in the United States, and we believe it represents an appropriate standard for an exemption from Section 402.20
The CCS standard reflects a basic international and U.S. policy that a bank's home country regulator should be primarily responsible for the bank's overall regulation and safety and soundness. At the international level, this policy is embodied in the Basle Concordat of 1983, which sets forth the fundamental principles of international bank regulation and has been endorsed by the U.S. and about 85 other countries.21 At the domestic level, it has been embodied most recently in the Gramm-Leach-Bliley Act of 1999, which requires that the Federal Reserve give "due regard to the principle of national treatment and equality of competitive opportunity" in establishing standards for non-U.S. banks desiring to become "financial holding companies" in the U.S.22
Lending is a fundamental part of banking, 23 and one of the primary sources of a bank's risk. Under the principle of home country consolidated supervision, a local jurisdiction should not regulate the manner in which a bank lends in its home country. Consistent with this policy, the Federal Reserve has specifically refrained from extending its insider lending requirements to non-U.S. banks doing business in the U.S.24 Instead, it defers regulation of insider lending to the non-U.S. bank's home country, just as we believe the Federal Reserve expects other jurisdictions to defer to its regulation of lending by U.S. banks.
In our view, Proposed Rule 13k-1(b)(2) is inconsistent with these basic principles in that it proposes to extend U.S. insider lending requirements to non-U.S. financial institutions. This is the case notwithstanding that the Federal Reserve has considered whether to extend these same limits to non-U.S. banks actually engaging in business in the United States and has chosen not to do so. As noted above, however, the Federal Reserve must make a CCS determination before it allows the bank to engage in such business.
We believe it would be inconsistent with Congressional intent for the Commission to expand the regulation of lending by non-U.S. banks beyond the limits established by the Federal banking regulators. Section 402 specifically defers to Federal bank regulatory standards in limiting insider lending by U.S. banks. We therefore believe the Commission would be consistent with the intent of Section 402 if it refers to those same regulatory standards in limiting insider lending by non-U.S. banks. Although the Commission notes in the release accompanying the Proposed Rule that the legislative history of Section 402 contains "nothing to indicate that Congress intended to treat foreign banks differently than domestic banks",25 we note that the legislative history of this provision, which was added at the very end of the legislative process, is very sparse.26 Accordingly, we believe it is appropriate to refer to the Congressional intent embodied in the statutes that were specifically designed to regulate non-U.S. banks, such as the International Banking Act and the Gramm-Leach-Bliley Act.
Compliance in Fact
If the Commission determines not to exempt loans by banks from CCS jurisdictions, we recommend that it revise Proposed Rule 13k-1(b)(2) to permit extensions of credit that comply in fact with one of the three standards - without regard to the requirements of local law or regulation. This revision would permit the Proposed Rule to substantially accommodate the diversity of insider lending regimes outside the United States and would ease the discriminatory impact of Section 402, without undermining the basic objective of Section 402.
This revision would address fully the Commission's stated intent in proposing Proposed Rule 13k-1(b)(2), because it would continue to require non-U.S. banks to adhere to the main insider lending restrictions the Commission has identified as significant.27 Whether or not the bank's home country laws or regulations include such restrictions does not seem relevant once the loan complies in fact. The end result is identical, and we see no principled reason to end the inquiry at the law if the bank's actual program is even more restrictive.
This revision also would be consistent with the other exemptions built into Section 402. As the Commission notes, Section 402 exempts certain loans if they are (1) made in the ordinary course of the issuer's consumer credit business, (2) of a type generally made available to the public by the issuer and (3) on terms no more favorable than those offered to the public. These exemptions require only that the loan complies in fact with these requirements. Requiring compliance in fact under Proposed Rule 13k-1(b)(2) would be consistent with this approach. Moreover, the potential for abuse by non-U.S. banks is limited by either CCS or home-country regulation under the applicable deposit insurance scheme.
For these reasons, we also recommend that compliance in fact be adopted for non-CCS jurisdictions.
3. We respectfully suggest that the Commission revise the Proposed Rule in the following other respects.
Scope of the Proposed Rule
The Proposed Rule exempts only loans to directors and executive officers of the non-U.S. bank or the parent company of the bank. It therefore appears that loans to directors and executive officers of issuers that are sister companies or subsidiaries of the non-U.S. bank would not be exempt.
We do not believe that excluding sister companies or subsidiaries from the Proposed Rule is consistent with the Commission's goal of parity. Section 402 exempts "any loan" by a U.S. bank if the loan is subject to the Federal Reserve's insider lending restrictions. Accordingly, loans by a U.S. bank to the directors or executive officers of any sister company would be permitted.28 We believe that parity requires comparable treatment for non-U.S. banks under the Proposed Rule.
We also do not believe that the Commission's purpose in adopting the Proposed Rule requires the exclusion of sister companies or subsidiaries. If a proposed loan complies with the various conditions of the Proposed Rule, the possibility of insider abuse is appropriately circumscribed.
In light of the preceding, we recommend that the Commission revise the Proposed Rule to exempt loans by a non-U.S. bank to either its own insiders or the insiders of any of its affiliates.
The Commission solicits comment on whether the proposed exemption should be available to a bank if its home country is also the home country of at least one bank that has received a favorable CCS determination. We recommend that the Commission adopt this approach subject to the condition that the non-U.S. bank concludes in good faith that it is regulated on substantially the same basis as a bank in the jurisdiction that has received a CCS determination.
The fact that one bank from a jurisdiction may have a favorable CCS determination while another does not is likely to be completely unrelated to the level of home-country supervision. A non-U.S. bank is required to request a CCS determination in connection with opening a U.S. branch or agency, acquiring a U.S. bank or commercial lending company or becoming a financial holding company for U.S. law purposes. Historically, the fact that one bank from a country may have a CCS determination while another bank does not reflects only the differing U.S. activities of the two banks and not differing home country supervision. We are unaware of a single instance in which the Federal Reserve has determined that a bank is not subject to CCS once it has determined that another bank from the same jurisdiction is subject to CCS.
Whether a non-U.S. bank has had occasion to seek a CCS determination also is unrelated to whether the bank is subject to Section 402 - a non-U.S. bank may be subject to Section 402 even if it conducts no banking business in the United States. Moreover, although the Federal Reserve may be willing to provide a CCS determination in the absence of a transaction or business proposal that requires a determination, we do not believe it has ever done so. The anomalous result of the Proposed Rule could be that, for any jurisdiction, only foreign banks not doing business in the United States would be required to comply with Section 402.
We believe that the Commission can avoid this result by treating CCS determinations on a country-by-country basis so long as any non-U.S. bank that has not received a specific CCS determination concludes in good faith that it is regulated on substantially the same basis as a bank in the jurisdiction that has received a CCS determination. Requiring such a good faith determination would limit the possibility that an issuer that is not appropriately supervised could take advantage of the Proposed Rule, and is consistent with Federal Reserve process.29
The Commission also solicits comment on whether the Proposed Rule should require prior Board approval for loans to an insider that exceed a certain amount. We recommend that the Commission not include such a requirement. On the one hand, we believe it is appropriate to defer to home country supervisory requirements with respect to insider lending for the reasons we described. On the other hand, to the extent the Commission does not adopt our approach, the Proposed Rule requires that the extension of credit be made on terms that eliminate the potential for insider abuse.30 In either case, Board approval is not required to achieve the Commission's purpose and increases the extraterritorial effect of the Proposed Rule.31 We also note that the extraterritorial effect of the Proposed Rule is heightened by the fact that many, if not most, ordinary-course mortgage loans to directors or executive officers would exceed the $500,000 threshold (requiring Board approval for any subsequent extension of credit, regardless of size).
* * *
We appreciate the opportunity to comment on the Proposed Rule and would be pleased to discuss any of the points raised in this letter in more detail. Questions may be directed to H. Rodgin Cohen (212-558-3534), Michael M. Wiseman (212-558-3846) or Marc. R. Trevino (212-558-4239).
Very truly yours,
SULLIVAN & CROMWELL LLP
cc: Giovanni P. Prezioso
Alan L. Beller
Director, Division of Corporation Finance
Paul M. Dudek
Chief, Office of International Corporate Finance
|1|| Section 402 of the Sarbanes-Oxley Act of 2002 added Section 13(k) of the Securities Exchange Act of 1934.
|2|| The Federal Reserve has determined that banks in each of these countries are subject to comprehensive, consolidated supervision. Australian banks that have obtained a favorable CCS determination include Australia & New Zealand Banking Group Limited and National Australia Bank Ltd. Canadian banks include Bank of Montreal, Canadian International Bank of Commerce, Royal Bank of Canada, The Toronto-Dominion Bank and National Bank of Canada. German banks include Bayerische Hypo- und Vereinsbank Aktiengesellschaft, Commerzbank AG, Deutsche Bank AG, Dresdner Bank AG and Eurohypo Aktiengesellschaft. Irish banks include Allied Irish Banks plc, Anglo Irish Bank Corporation plc and Bank of Ireland. Dutch banks include ABN AMRO Bank N.V., Cooperatieve Centrale Raiffeisen-Boerenleenbank B.A., Rabobank Nederland and ING Bank N.V. British banks include Abbey National plc, HSBC Holdings plc and The Royal Bank of Scotland Group plc.
|3|| See, e.g., National Australia Bank Ltd., 81 Fed. Res. Bull. 1153 (1995) (discussing nature and extent of supervision provided by the Reserve Bank of Australia, whose bank supervisory functions were subsequently assumed by APRA); Australia & New Zealand Banking Group Limited, 86 Fed. Res. Bull. 695 (2000) (determining that applicant bank is supervised in substantially the same manner as National Australia Bank Ltd.).
|4|| The term "financial benefit" is defined very broadly and includes indirect financial benefits. Related parties include the directors of the public company, a person or an entity that controls the public company and the directors of that entity, and the spouses, de facto spouses, parents and children of these directors and persons. The term "related party" does not include an executive officer who is not a director, but the annual directors' report from a public company listed on the Australian Stock Exchange must include details of the nature and amount of each director's emoluments and each of the five named officers receiving the highest emoluments.
|5|| Under the Australian Corporations Act, these categories are: (1) payment of reasonable remuneration and expenses to officers, (2) gifts of less than A$2,000, (3) financial benefits given within a closely held group, (4) reasonable indemnities, exemptions and insurance policies and payment for reasonable legal costs for officers, (5) benefits given to related parties as members of the public company (provided that the benefits are provided on a non-discriminatory basis) and (6) financial benefits given under a court order.
|6|| APRA, Core Principles for Effective Banking Supervision: Self-Assessment For Australia 24 (Apr. 2001), available at http://www.apra.gov.au/RePEc/RePEcDocs/Archive/information_papers/ifp0002.pdf.
|8|| See, e.g., Bank of Montreal, 80 Fed. Res. Bull. 925 (1994) (discussing nature and extent of supervision provided by the OSFI); Royal Bank of Canada, 89 Fed. Res. Bull. 139 (2003) (determining that applicant bank is subject to comprehensive, consolidated supervision by the OSFI in the same manner as other Canadian banks were in previous determinations by the Federal Reserve Board).
|9|| See Bank Act, as amended, § 489(1) (Can.). The term "related party" includes directors, senior officers (a term that is broader than "executive officer" under Section 402 of the Sarbanes-Oxley Act), spouses, common law partners and children under the age of 18 of such persons, and companies controlled by any of the foregoing.
|10|| In the case of a loan facility offered to the public in the ordinary course of business, "market terms and conditions" means terms "no more or less favorable" than those offered to the public in the ordinary course of business. In the case of other loans, this provision requires terms and conditions (including interest rates) that might reasonably be expected to apply in a similar transaction in an arm's-length transaction or, if the loan is not one that would reasonably be expected to occur in an open-market, arm's-length transaction, terms and conditions (including interest rates) that would reasonably be expected to provide the bank with fair value. Id. at § 501.
|11|| A bank's aggregate loans to any senior officer (excluding mortgages and margin loans) may not exceed the greater of CN$100,000 and twice the officer's annual salary. See id. at § 496(2).
|12|| Id. at § 497(1).
|13|| Id. at § 496(4).
|14|| 86 Fed. Reg. 54589, 54593 (Sept. 17, 2003).
|15|| Principle 10 provides that:
"[B]anking supervisors must have in place requirements that banks lend to related companies and individuals on an arm's-length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks."
Basle Committee on Banking Supervision, Core Principles for Effective Banking Supervision 26 (1997).
|16|| See Basle Committee on Banking Supervision, Core Principles Methodology 25 (1999) (Essential Criterion 1 to Core Principle 10).
|17|| See id. at 25, n.7 (Essential Criterion 2 to Core Principle 10).
|18|| See APRA, Core Principles for Effective Banking Supervision: Self-Assessment For Australia 23 (Apr. 2001), available at http://www.apra.gov.au/RePEc/RePEcDocs/Archive/information_papers/ifp0002.pdf.
|19|| See Letter from Cleary, Gottlieb, Steen & Hamilton, to Martin Dunn, Deputy Director, and Paul M. Dudek, Chief, Office of International Corporate Finance, Division of Corporation Finance, Securities and Exchange Commission (Aug. 16, 2002).
|20|| Since 1991, the Federal Reserve has been required to make a CCS determination before a non-U.S. bank can establish a branch or agency in the United States or acquire a U.S. bank or commercial lending company. See Section 7(d) of the International Banking Act of 1978, 12 U.S.C. § 3105(d).
|21|| This Concordat summarizes the concept of consolidated supervision as follows:
"The principle of consolidated supervision is that parent banks and parent supervisory authorities monitor the risk exposure - including a perspective of concentrations of risk and of the quality of assets - of the banks or banking groups for which they are responsible, as well as the adequacy of their capital, on the basis of the totality of their business wherever conducted. This principle does not imply any lessening of host authorities' responsibilities for supervising foreign bank establishments that operate in their territories, although it is recognised that the full implementation of the consolidation principle may well lead to some extension of parental responsibility."
Basle Committee on Banking Supervision, Principles for the Supervision of Banks' Foreign Establishments 4 (1983). See also Basle Committee on Banking Supervision, Minimum Standards for the Supervision of International Banking Groups and Their Cross-Border Establishments (1992).
|22|| 12 U.S.C. § 1843(l)(3). The Federal Reserve has implemented this requirement by assessing regulatory capital requirements on the basis of the capital adequacy rules of the home country. See 12 C.F.R. § 225.90(b)(1).
|23|| The Commission recognizes this concept by proposing to include lending as one of the three required elements of the definition of "business of banking" in Proposed Rule 13k-1(a)(3).
|24|| See 44 Fed. Reg. 12959, 12961 (Mar. 9, 1979) (adopting final rules amending Regulation O).
|25|| 86 Fed. Reg. 54589, 54591 (Sept. 17, 2003).
|26|| As a consequence, there has been substantial uncertainty and confusion about the application of Section 402.
|27|| 86 Fed. Reg. 54589, 54593 (Sept. 17, 2003). ("This second provision of Rule 13k-1(b) would be consistent with Section 402 by conditioning the exemption on a foreign bank's adherence to one of the main insider lending restrictions of Regulation O.").
|28|| See 12 C.F.R. § 215.4 (restricting loans to insiders of a U.S. bank or any of its affiliates).
|29|| See Joseph J. Norton & Christopher D. Olive, A By-product of the Globalization Process: The Rise of Cross-Border Bank Mergers and Acquisitions-The U.S. Regulatory Framework, 56 The Bus. Lawyer 591, 607 (2001) ("The [Federal Reserve Board] usually requires subsequent applicants [from a single country] to describe the extent to which bank supervision previously evaluated applies to them and whether that system has changed since the FRB earlier reviewed it.").
|30|| This would be the case if the Commission does not revise Proposed Rule 13k-1(b)(2) or revises it to permit extensions of credit that comply in fact with one of the three standards.
|31|| We note that the other exemptions built into Section 402 do not require prior Board approval.