Swiss Bankers Association
By E-Mail: firstname.lastname@example.org
Basel, October 17, 2003
Re: Proposed Foreign Bank Exemption from the Insider Lending Prohibition of Exchange Act Section 13(k) (File No. S7-15-03)
Ladies and Gentlemen:
The Swiss Bankers Association (the "SBA") appreciates the opportunity to comment on the regulations proposed by the Securities and Exchange Commission (the "SEC") to exempt certain foreign banks from the provisions of section 402 of the Sarbanes-Oxley Act ("Section 402").1
We commend the SEC for responding to the requests of the SBA and other representatives of foreign banks to address the apparently unintended inequitable treatment accorded foreign bank issuers under Section 402.2 The proposal recognizes that, like domestic bank issuers, foreign bank issuers did not and do not engage in the type of practices that gave rise to Section 402. In the U.S. context, this is attributable to "safety and soundness" supervision of banks, including the specific restrictions on insider lending imposed under the Federal Reserve Act and Regulation O. In the international context, it is attributable to comparable, strong systems of supervision applicable to a significant percentage of bank issuers and certified as such by the Federal Reserve. The proposed regulation provides a sound starting point for fair and comparable treatment of U.S. and non-U.S. bank issuers under Section 402, while minimizing any unnecessary extraterritorial impact on the latter.
Although the SBA regards the proposed regulation as a substantial step in the right direction, it would like to express its views on some of the issues on which the SEC invited specific comment. The SBA notes that it has reviewed the comment letter submitted by the Institute of International Bankers ("IIB") in connection with this proposal and aligns itself with the overall views expressed in that letter, particularly the definitional issues that it comprehensively addresses. Accordingly, this letter focuses on issues of special concern to the SBA and its members.
The SBA's principal recommendations are as follows:
Each of these recommendations is discussed in greater detail below.
I. Satisfaction of the CCS Element of the Proposal Should be Sufficient to Qualify for an Exemption from Section 402
The proposal requires satisfaction of each component of the proposed exemption before a foreign bank issuer would qualify for the exemption from Section 402. Linking these requirements as a condition of the exemption, particularly for institutions that satisfy the "comprehensive consolidated supervision" or "CCS" standard, is inconsistent with international standards of bank supervision and does not accord appropriate deference to foreign supervisory regimes that the Federal Reserve has found to constitute comprehensive supervision and regulation on a consolidated basis for banks headquartered in their countries.
The Federal Reserve's CCS standard is embodied in the Basel Committee's minimum standards of banking supervision as elaborated in several issuances of the Basel Committee, including the "Principles for the Supervision of Banks' Foreign Establishments" and "The Supervision of Cross-Border Banking."3 One of the requirements of the standards is that "[a]ll international banking groups and international banks should be supervised by a home country authority that capably performs consolidated supervision."4 In the Basel Committee's "Core Principles for Effective Bank Supervision," the tenth core principle of effective bank supervision states:
In order to prevent abuses arising from connected lending, banking 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.5
As part of its CCS determination made in the context of its consideration of foreign bank regulatory applications, the Federal Reserve routinely reviews information regarding home jurisdiction restrictions on and disclosures of insider lending.6 Once the Federal Reserve determines that a foreign regulatory regime applies CCS, it should not be necessary to further find that the regulation of insider lending in that country is essentially the same as that in the United States. As the preamble acknowledges, "many jurisdictions have adopted insider lending restrictions similar to those of Regulation O."7 Requiring an additional level of evaluation for foreign bank issuers as a condition of extending to them an exemption that applies to U.S. banks is inconsistent with the deference that is customarily accorded to regulators in jurisdictions that adhere to recognized international standards of bank supervision and is not required as a matter of competitive equity.8
When it passed the Sarbanes-Oxley Act, Congress necessarily found that pre-existing U.S. safety and soundness regulation applicable to U.S. bank issuers (the Federal Reserve's Regulation O) satisfactorily addressed Section 402's corporate governance objectives. It follows from this that the safety and soundness regulation of non-U.S. bank issuers that have received Federal Reserve approval (as part of CCS determinations) also should satisfy these Section 402 objectives. Today domestic banks are subject to the same insider lending restrictions as they were before the enactment of the Sarbanes-Oxley Act, yet, read literally, Section 402 prohibits foreign banks and their parent companies from making loans to their insiders, although the legislative history does not indicate that Congress intended such a result. While the proposed regulation would mitigate this unfair result, it would still impose additional restrictions on non-U.S. bank issuers (even where the Federal Reserve has made CCS determinations) that are not necessary to address corporate governance or safety and soundness concerns.
For the foregoing reasons, the SBA respectfully recommends that the proposal be amended so that the exemption would apply once a foreign bank issuer is determined by the Federal Reserve to be subject to CCS without additional conditions.9 The SBA also recommends that this exemption be extended to apply to all banks from a country once one bank from that country achieves the CCS designation because no sound policy objective would be served by requiring future bank issuers from home jurisdictions that have been found to subject similarly regulated banks to CCS to achieve their own specific CCS designation. Indeed, without a need to submit an application to the Federal Reserve, there may be no means for such an institution to obtain a CCS designation.10
II. At a Minimum, the Second Condition Should Take Into Account Differing Systems of Regulation That Ensure an Effective Level of Supervision and Enforcement of Insider Lending Restrictions
As discussed above, the SBA believes that if a bank satisfies the CCS component, it should qualify for the exception to Section 402 on that basis alone. Consistent with this approach, the SBA recommends that the second component of the proposed exemption should only come into play as an alternative test for foreign bank issuers that are located in countries that have not been determined to be CCS jurisdictions. Under these circumstances, where the U.S. supervisory authorities are unable to confirm that the global operations of a bank are subject to broad and robust regulation by a home country supervisor, it would be appropriate for the SEC to provide an alternative basis for other banks to qualify for the Section 402 exemption.
As proposed, however, the second condition could be construed too narrowly and, in this regard, could create compliance difficulties for banks from countries that do not have the tradition of implementing insider lending restrictions through laws or codified regulations, as is the case in the United States. Read literally, the second component of the proposed exemption can only be satisfied if "the laws or regulations" of the bank's home country restrict insider lending in the manner specified in the proposed second component of the proposed regulation.
In many jurisdictions, including Switzerland, recognized and enforceable requirements that apply to banking operations are not necessarily specified in formal regulations. Indeed, in many jurisdictions, acceptable banking practices have evolved over time through, and are understood as part of, recognized custom and practice. In such jurisdictions, the competent authority can take enforcement action against institutions that engage in activities that are not consistent with established custom and practice. In Switzerland, for example, the relevant statute, Article 4ter, provides:
Article 4ter provides the Swiss Federal Banking Commission ("SFBC") with its authority for imposing a body of insider lending restrictions that are consistent with those required by the first and second components of the second condition of the SEC's proposal. However, because the SFBC has not codified its insider lending restrictions in a "regulation," it is possible that, despite a bank's conformity with Swiss insider lending standards and the potential for the SFBC to take enforcement action for violations of such standards, such a framework may not qualify under the proposed exemption. We are confident that the SEC does not intend to prevent banks that are subject to such supervisory regimes from qualifying for the proposed exemption simply because the standards, while recognized and enforceable, are not specified in "law or regulation."11
The SBA recommends, therefore, that the language of proposed Section 240.13k-1(b)(2) be amended so that, in addition to laws or regulations, it also permits the exemption to apply where recognized supervisory standards, while not codified, embody the types of requirements that are specified in subparagraphs (i) and (ii) and are enforced by the home country supervisor.
III. The Regulation Should Permit a Board to Delegate its Approval Authority for Loan Arrangements That Exceed $500,000
The third condition requires that when aggregate loans to a particular executive officer or director exceed $500,000, a majority of the foreign bank's board of directors must approve the loan in advance, and the loan's intended recipient must abstain from participating in the vote regarding the loan. Again, the SBA recommends that this requirement be deleted for banks from countries that meet CCS for the reasons discussed above.
The SBA appreciates that the SEC has proposed granting flexibility to banks with two-tiered board systems to obtain the approval of either board and supports the inclusion of such flexibility in the final rule. In addition, however, given the large size of foreign bank issuers in the U.S., even the approval of the home jurisdiction management board for each such loan could be unnecessarily burdensome and produce unintended difficulties for banks insiders in need of a credit decision that does not correspond to a board meeting schedule.
Accordingly, the SBA respectfully recommends that this aspect of the proposal be amended in one of several ways. First, boards of directors should be permitted to delegate the approval obligation to a committee of the board of directors such as a committee of either the supervisory board or the management board, or with respect to loans to insiders in the U.S., to local U.S. management. Of course, if delegation is permitted, the person with an interest in the loan should be prohibited from participating in the decision in any way.
In addition, the requirement of board approval for loans to insiders in excess of $500,000 is inappropriate in that the amount that triggers the requirement for such approval is low under current conditions. Ordinary mortgage lending to insiders in many locations would routinely exceed this limit. The SBA recognizes that the proposed $500,000 limit mirrors a requirement of Regulation O of the Federal Reserve. However, Regulation O must strike a balance among all insured domestic institutions regardless of asset size and locale, whereas foreign bank issuers in the U.S. are large sophisticated institutions usually based in high cost-of-living areas.
Rather than fixing the board approval requirement at $500,000, the SEC should consider requiring board approval only if the amount loaned is clearly substantial or would be material to the borrower. One possible formulation would be to increase the amount, which triggers the board approval requirement, for example, to $2,000,000, as recommended by the IIB. As an alternative, another formulation would be to require board approval if the amount of the loan, when aggregated with other outstanding debt of the borrower, exceeds 75 percent of the borrower's total net worth. This approach has the advantage of causing boards of directors or the appropriate delegatees to be informed of the indebtedness of their insiders before any substantial loans are made to them. Moreover, rather than fixing an arbitrary trigger for board approval, the approval requirement would depend on the creditworthiness of the insider and his or her ability to shoulder additional debt.12
IV. Disclosure Requirements
The proposed regulation would require foreign bank issuers to disclose on Form 20-F the identity and relationship with the bank of any insider whose loans have become problematic or otherwise ineligible for disclosure as ordinary non-problematic loans.
This proposed amendment to Form 20-F would directly conflict with laws of Switzerland and other countries that protect individual privacy of bank customers. For banks in such jurisdictions, this requirement could effectively prohibit loans to insiders because, should the loan become problematic, the bank would either be put in the position of violating the proposed disclosure requirement or be in violation of home jurisdiction privacy laws. Even assuming that a borrower could effectively waive his or her statutory privacy protection, deference should be given to the insider loan reporting requirements of CCS jurisdictions, and supervision and monitoring of insider loans should be conducted by the home jurisdiction regulator. For example, in Switzerland, if the external auditor discovers insider loans that do not meet the requirements of Swiss law, they must be reported to the SFBC, which will take enforcement action to remedy such problems.
The SBA respectfully requests that the SEC remove this disclosure requirement from the proposed rule. This aspect of the proposal is not required by Section 402, and there is no evidence that suggests that the existing reporting obligations, as they apply to foreign banks, have been insufficient.
If the SEC decides to impose the proposed reporting obligation on all institutions, the SBA recommends that, at a minimum, the rule should be amended to incorporate a threshold below which such reports would not be required. In the case of foreign bank issuers, the SBA recommends tying such threshold to the same level that would require board approval of credit extensions to insiders. In addition to symmetry, this approach has the advantage of only requiring reporting when a problematic loan is more likely to be material to the borrower and, therefore, of greater relevance to shareholders.
V. The Scope of the Exemption Should be Broadened
A. Loans by Subsidiaries and Affiliates of Foreign Banks Should be Permitted
The proposed regulation only provides an exemption for an issuer that is a foreign bank or the parent company of a foreign bank that maintains, arranges for, or renews credit in the form of a personal loan from the foreign bank to or for any of its directors or executive officers. An affiliate or subsidiary of a foreign bank could not rely on this exemption to make a loan to a director or executive officer of the foreign bank or its parent company because the loans are required to be "made by the foreign bank."13
The SBA accordingly recommends that loans made by a subsidiary of a foreign bank or the subsidiary of the parent company of the foreign bank be permitted to rely on the exemption from Section 402. Foreign banking organizations may "book" such loans in different subsidiaries of the foreign bank or its parent company for a number of reasons, including regulatory requirements in their home jurisdictions. Because these subsidiaries of foreign banks and parent companies of foreign banks are subject to consolidated supervision under the CCS standard in CCS jurisdictions, there should be no reason why such lending should not be permitted as if made directly by the foreign bank.
B. Loans to Insiders of Issuers that are Subsidiaries and Affiliates of Foreign Banks Should be Permitted
Because the proposed regulation only exempts loans to the insiders of an issuer that is a foreign bank or the parent company of a foreign bank, loans by a foreign bank to the directors and executive officers of a non-bank issuer that is an affiliate or subsidiary of the foreign bank would not be permitted by the proposed regulation. In contrast, similar loans to insiders of an affiliate of a domestic bank are permitted. The SBA would recommend expanding the exemption to treat these loans like loans by a foreign bank to the insiders of its parent company.
The SBA thanks the SEC for the opportunity to comment on the proposed regulations. If you need any additional information concerning issues addressed in this letter, please contact our U.S. counsel, Thomas J. Delaney (202.663.8045) or Marc R. Cohen (202.663.8017) at Shaw Pittman, LLP.
Swiss Bankers Association
C.-A. Margelisch A. Hubschmid