Regulatory Updates

2006 Executive Summaries Final ALLL Policy Statement Final CRE Guidelines FDIC Risk-Based Premiums Deposit Insurance Reform Interagency Guidance on Nontraditional Mortgages and CRE Lending 2005 Executive Summaries Basel II & Basel IA GSE Reform Identity Theft Protection Act Data Security & Identity Theft Home Equity Lending Guidelines The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 The Sarbanes-Oxley Act 2006 Executive Summary: Final ALLL Policy Statement December 2006 The OCC, the FDIC, the Federal Reserve, the OTS, and the NCUA recently published a revised version of the banking agencies' 1993 policy statement regarding the allowance for loan and lease losses (ALLL). All revisions were meant to bring policy in line with current generally accepted accounting principles (GAAP) and supervisory guidance (published in 2001 and 2004), while continuing to allow management to exercise discretion. Unlike previous statements, this policy statement will be applicable to credit unions as well as banks and thrifts. The policy reemphasizes that institutions must have a structured and well-documented methodology to determine reserve requirements. The statement stresses that reserve estimates should take into account all available information, including industry, geographic, economic, and political factors. The agencies state that all institutions have a responsibility to develop, maintain, and document a "comprehensive, systematic, and consistently-applied process" for determining both the amount of ALLL and provisions for loan and lease losses (PLLL). Regulators do not want banks to rely upon agency benchmarks for estimating losses. Instead, individual institutions will be held responsible for both maintaining an appropriate ALLL model and documenting all related analyses. ALLL-related policies should include a comprehensive portfolio analysis, an effective loan review system, adequate data capture and reporting systems, and the evaluation of loss estimate models. Estimates of losses should reflect all factors that may affect collectibility. These include changes in lending policies, changes in loan terms, changes in economic conditions, and other external factors. The guidance also allows for "unallocated" loan loss allowances when such allowances reflect estimates of probable losses and are properly supported. Management should evaluate the ALLL at the end of each quarter (at a minimum). This evaluation is subject to review by examiners. In addition, the board should review all ALLL-related policies and procedures at least once a year. return to top Executive Summary: Final CRE Guidelines December 2006 In January 2006, the Fed, the FDIC, the OCC, and the OTS proposed guidelines for nontraditional mortgages and commercial real estate (CRE) lending (See Executive Summary: Interagency Guidance on Nontraditional Mortgages and CRE Lending). Two sets of final guidelines were published this month: one for thrifts and another for banks and BHCs. The OTS decided not to specify concentrations thresholds for thrifts, as these institutions are already subject to limits on their CRE lending activities. With the exception of the thresholds, the two sets of guidelines are basically the same. The final guidance specifies that its focus is on CRE loans "where the cash flow from the real estate collateral is the primary source of repayment" as opposed to loans where "the real estate is a secondary source of repayment or is taken as collateral through an abundance of caution." Call reports will be amended in 2007 to show each of these types of CRE loans as a separate line item. Institutions should be capable of assessing the concentration risk in their own portfolios and should be able to identify concentrations within their own portfolios using detailed information to identify loans with common risk characteristics (i.e., loans for higher-risk property types, loans in higher-risk geographic areas, etc.) or common sensitivities to economic or business developments. The board and senior management should monitor concentrations, and institutions should set internal concentration limits. Risk management processes at all institutions should be consistent with their level of risk. The specific guidance offered with regard to risk management varied little from what had been proposed and included: Greater board management and oversight, including periodic assessments of the portfolio and the institution's CRE-related policies. Management of portfolio risk as well as individual loan risk. MIS capable of supporting the management of portfolio risk, the identification/aggregation of an exposure to a particular borrower, and the stratification of the portfolio by property type, geographic market, tenant characteristics, developer concentrations, risk rating, loan structure, loan purpose, LTV limits, debt service coverage and affiliated loans. Market analysis to support the assessment of specific CRE market conditions. The establishment of strong underwriting standards, with limited exceptions. Regular portfolio stress testing and sensitivity analysis. Regular credit risk review. As demonstrated by the above provisions, the final guidelines emphasize the need for an institution to assess its own level of risk. The regulators have, however, retained two general concentration thresholds in order to allow examiners to identify institutions with a potential exposure. The guidelines note that these thresholds will be used as a preliminary screen and that greater scrutiny will depend on additional factors. These thresholds are as follows: Total reported loans for construction, land development, and other land represent 100% or more of total risk-based capital Total commercial real estate loans (CRE, CLD, multifamily, and unsecured CRE loans) represent 300% or more of total risk-based capital and the outstanding balance of the CRE loan portfolio has increased by 50% or more during the prior 36 months In general, any institution that recently has experienced a significant increase in their CRE portfolio can expect to be subject to greater scrutiny. All institutions will be expected to hold adequate capital relative to their level of concentration risk. return to top Executive Summary: FDIC Risk-Based Premiums October 2006 The FDIC Deposit Insurance Reform Act of 2005 required that the FDIC provide final regulations for deposit insurance assessments by November 5, 2006. Proposed revised rules for the assessment of risk-based premiums for deposit insurance were published in the Federal Register on July 24, 2006. The comment period ended on September 22, 2006. The proposed rules would revise the Federal Deposit Insurance Act to create different risk differentiation frameworks for smaller and larger well-capitalized/well-managed institutions, establish a common risk framework for all other institutions, and establish a base assessment rate schedule. The Reform Act allows the FDIC's Board of Directors to price deposit insurance according to risk, regardless of the level of the fund's reserve ratio. Proposed Revisions The FDIC's current risk-based assessment system places institutions into one of nine categories based on capital levels and supervisory ratings. The proposed rules would consolidate these nine categories into four: Risk Category I: CAMELS 1 or 2 and well-capitalized Risk Category II: CAMELS 1 or 2 and only adequately capitalized or CAMELS 3 and at least adequately capitalized Risk Category III: CAMELS 1, 2, or 3 and under-capitalized; CAMELS 4 or 5 and at least adequately capitalized Risk Category IV: CAMELS 4 or 5 and under-capitalized Category I would correspond to the present highest rating of 1A and would probably contain 95% of all institutions (based on the number of institutions currently rated 1A). Ratings within Category I would be different for large and small institutions. For small institutions, the assessment rate would be calculated using CAMELS ratings and current financial ratios, such as: Tier 1 Leverage Ratio Loans Past Due 30-89 Days/Gross Assets Nonperforming Loans/Gross Assets Net Loan Charge-Offs/Gross Assets Net Income (before taxes)/Gross Risk-Weighted Assets Volatile Liabilities/Gross Assets A weighted average of the components of the CAMELS rating Comments were requested on whether or not additional ratios should be included and whether or not a financial-ratios-only approach would be preferred. For larger institutions (those with $10 billion or more in assets), long-term debt issuer ratings would be used, in addition to CAMELS ratings. CAMELS ratings would account for 50% of the assessment. The other half would be split between debt issuer ratings and financial ratios. The weight given to debt issuer ratings would increase with bank size; for example, ratings at institutions with less than $15 million would receive no weight while at institutions with more than $30 billion, this data would receive a weight of up to 50%. As the weight assigned to debt issuer ratings increased, the weight given to financial ratios would decrease. Financial ratios would therefore only be used in some cases. Large institutions would then be assigned to one of four subgroups and the FDIC would have the authority to move an institution among those subgroups based on new market information. All new institutions (those established within the past seven years) in Risk Category I would be treated identically, regardless of size and would be assessed the maximum rate applicable to Category I institutions, or four basis points. The FDIC's proposal included a proposed schedule of rates. The minimum annual rate assessed for Category I institutions would be two basis points; the maximum (as stated above) would be four basis points. Category II institutions would be assessed an annual rate of seven basis points, Category III institutions a rate of 25 basis points, and Category IV institutions a rate of 40 basis points. Some groups, such as the ABA, believe that the two-basis-point base rate is too high. Since the system is untested, they argue, the lowest rate assessed initially should be one basis point to avoid unnecessary costs to banks. The ABA also believes that the proposed system places too great an emphasis on healthy institutions and does not focus adequately on institutions that have received lower CAMELS ratings. Finally, the ABA argues in its comments that de novo institutions should not all be charged the same rate, especially since these institutions are generally well-capitalized and are subject to greater regulatory scrutiny than others. return to top Executive Summary: Deposit Insurance Reform May 2006 On February 8, 2006, the Federal Deposit Insurance Reform Act was signed into law by President Bush as part of the Deficit Reduction Act of 2005. A companion bill, the Federal Deposit Insurance Reform Conforming Amendments Act of 2005, became law a few days later on February 15th. Combining Deposit Funds and Increasing Coverage The first provision of the bill - the combination of the deposit funds - was implemented in March 2006. The existing Bank Insurance Fund (BIF) and Savings Association Insurance Fund (SAIF) have been combined into a single Deposit Insurance Fund (DIF) that both types of institutions may access. The bill also raised the insurance limit for retirement accounts to $250,000 and stated that insurance for these accounts will be considered separate from that given to deposit accounts held at the same institution. The general insurance limit will remain at $100,000 until January 1, 2012. Both insurance limits will be indexed to the Personal Consumption Expenditures Index and will be adjusted in 2010. Additional adjustments are scheduled to occur every five years and will be made based on the FDIC and NCUA's joint assessment of economic conditions, potential problems with banks, and on the probability that the proposed adjustment would reduce reserves below 1.15%. Distribution of Credits and Dividends The bill contained two provisions to allow the FDIC to distribute credits and dividends to insured institutions. Banks that paid into the fund before 1996 will receive a one-time credit that reflects contributions to the capitalization of the fund. This credit will amount to 10½ basis points of the combined BIF/SAIF assessment bases as of year-end 2001 and may be applied against future premium payments (within certain limits). A total of $4.7 billion in credits will be issued. Half of the excess above a 1.35% DIF reserve ratio and all of the excess above a 1.50% DIF reserve ratio will be declared by the FDIC as cash dividends, awarded on a historical basis. This provision is meant to slow the upward growth of the fund and protect against increased premiums. The FDIC may temporarily suspend or limit dividends, if needed, when there is a "significant risk" to the DIF over the next year. Changes to the Reserve Ratio and Assessment Rates The law removes previous provisions that limited the FDIC to biannual changes in assessment rates and prohibited it from charging the best risk-rated banks when the reserve ratio was above 1.25%. It also eliminates the 1.25% deposit reserve ratio and the requirement that the FDIC maintain that ratio by charging up to 23 basis points. Instead, the FDIC is required to establish a restoration plan within 90 days of determining that the DIF has or will fall below 1.15% within six months. At such a time, the FDIC must charge premiums to restore the fund within five years and can restrict the use of credits to no more than 3 basis points. Provisions of the new law allow the FDIC to set the DIF's reserve ratio at any point between 1.15% and 1.50% of insured deposits. The reserve ratio will be set annually prior to the beginning of each year. This would allow the FDIC to forgo the imposition of higher premiums if it believes a decline is temporary. Implications The increase in the level of insurance for retirement accounts is expected to help banks & thrifts in competing for these products with nontraditional financial services providers. Many small banks argue that the level of insurance on other deposit accounts should receive a more permanent and fixed increase rather than simply being indexed to inflation. They believe that leaving the cap at $100,000 gives customers with high balances incentive to move their funds to the relative safety of a "too big to fail" institution. The bill gives the FDIC more flexibility with regard to the reserve ratio of the combined fund. It no longer requires banks to pay a 23-basis-point premium if the reserve ratio falls below 1.25% of insured deposits. The application of the one-time credit will mean that only new entrants or banks that have experienced high levels of deposit growth will be required to pay deposit insurance premiums over the next few years. Because the funds have been adequately capitalized for the past decade, many newer banks have not yet been required to pay for deposit insurance. return to top Executive Summary: Interagency Guidance on Nontraditional Mortgages and CRE Lending January 2006 The Fed, the FDIC, the OCC, and the OTS continue to express concern with regards to the increased level of risk being taken on by institutions through current lending practices. Proposed guidelines for two new areas - nontraditional mortgages and commercial real estate (CRE) lending - were published recently in the Federal Register. Both sets of guidelines are open for comment, and final guidance is expected in late 2006. The main sources of risk for both areas of lending are the recent increases in demand for these loans and the increased competition within these two markets. Greater demand has resulted in increasing concentrations of these loans, while higher levels of competition have led some institutions to apply weaker qualification and underwriting standards. The recommendations and best practices contained in these guidelines are fairly similar and are consistent with previous guidance. Both emphasize the following best practices: Institutions should assess adequately a borrower's ability to repay. Institutions should tighten qualification and underwriting standards and should ensure that all exceptions to these standards are well documented. Portfolios should be managed actively and analyzed frequently. Stress tests should be performed regularly. To aid in this analysis, MIS should be improved. Institutions should be sure to hold capital at levels above the regulatory minimum. In addition, the nontraditional mortgage guidelines also recommend increased transparency in marketing and all other communications with consumers. This clarity is especially important in instances where negative amortization could occur. The CRE guidelines call for increased board oversight and improved documentation of current and future CRE lending strategies (especially with regard to the adjustments needed if market conditions change). Guidelines for nontraditional mortgages would apply to all institutions that offer these products, which include interest-only loans, payment-option ARMs, low-doc loans, and simultaneous second-lien mortgages. These institutions will have to continue with improvements to MIS and credit analytics undertaken in response to earlier retail lending guidance. The regulatory agencies have noted that they expect the level of documentation associated with a loan to correspond directly to a loan's level of risk. This guideline is open to interpretation by examiners as a requirement for higher levels of documentation, which could lead to a decrease in the number of low-doc loans that are offered. The CRE lending guidelines would apply to institutions for which construction and development loans represent 100% or more of total equity capital or those for which multifamily, nonfarm/nonresidential, and construction and development loans combined represent 300% or more of total equity capital. Under these definitions, roughly a quarter of all banks and thrifts would be required to apply these guidelines, according to the American Banker. The FDIC has estimated that CRE loans account for 400% or more of equity capital at 35% of all FDIC-insured institutions. The final CRE guidelines will have the most impact on community banks, which have recently been relying on CRE lending for growth and are more likely to have portfolios that are concentrated in a particular geographic area or industry. return to top 2005 Executive Summary: Basel II & Basel IA November 2005 After meetings with Congress in late September, the Fed announced that it would publish a Notice of Proposed Rulemaking for Basel II in the first quarter of 2006 and would delay the phase-in of the new risk-based capital standards by one year. A 12-month trial period will begin in 2008. If the trial goes well, the standards will be phased in gradually beginning in 2009, with final implementation occurring in 2012. In all phases, implementation at adopting institutions will be assessed on a case-by-case basis and will not progress without the approval of an institution's primary regulator. Legislators grew concerned after the results of the fourth Quantitative Impact Study were released in May. At 13 of the 26 institutions participating in this study, adopting Basel II would result in a 26% decrease in capital levels. This drop is due, in part, to the large number of mortgages on the books of these institutions (under Basel II, capital held against mortgages would be halved). The delay is viewed as good news for small banks (who are worried about the competitive implications of Basel II), but is a set-back for larger institutions, who have already invested a considerable amount in data collection and other preparations. All institutions are concerned about the effect that the delay will have on the competitiveness of US institutions relative to foreign banks. On October 7th, an Advance Notice of Proposed Rulemaking (ANPR) for Basel IA was published. Basel IA is a set of revisions that would be applied to the current Basel I system and implemented by non-Basel II-adopting banks. It would change capital standards but would be less complex than Basel II. Proposed rules include: The addition of four new risk weights; Splitting residential mortgages into four risk categories based on LTVs; Using debt-to-income ratios in determining the risk weighting of mortgages; Permitting greater use of external risk weighting; Expanding the types of guarantors and collateral that may be recognized; Increasing the amount of capital held against CRE, construction, and past-due loans and against loans with a maturity of less than one year; Decreasing the amount of capital held against small business loans. The Fed is debating whether or not to allow some smaller, well-capitalized banks to opt out of both Basel II and Basel IA. return to top Executive Summary: GSE Reform November 2005 The Federal Housing Finance Reform Act of 2005 (H.R. 1461) was passed by the House on October 27, 2005 by a vote of 331 to 90. The bill's affordable housing provision was altered to prohibit housing advocacy groups and other organizations involved in voter registration and election activities from receiving funds. Areas affected by natural disasters are expected to take precedent over others. This alteration allowed H.R. 1461 to overcome the Republican opposition that it originally faced. Further action by the Senate has been delayed, however, due to a lack of support from the administration and from Senate Democrats. The administration believes that, without strict limits on the asset portfolios of GSEs, the bill does not adequately address any systemic risk posed by these holdings. Democrats are mainly concerned with the alterations that were made to the affordable housing provision. An amendment that would have accomplished the administration's goal of strict portfolio limits was rejected by the House (by a vote of 346 to 73). Though H.R. 1461 allows any new regulator to establish portfolio limits when necessary, opponents are concerned that the regulator would be hesitant to exert this power due to the political power of the GSEs themselves. Originally introduced in April, the current version of the bill that will go to the floor contains the following provisions: A new regulator would be established with the ability to adjust minimum capital requirements, impose limits on portfolios, and put the GSEs into receivership if they were in financial crisis. The new regulator would also have the power to require that GSEs divest or acquire assets for safety and soundness reasons. It would be required to review the on-balance and off-balance assets and liabilities of the GSEs before directing the GSEs to either divest or acquire assets. This was considered to be a reasonable alternative to a specific cap on the mortgage portfolios, as it would allow the regulator to set a limit that reflected the needs of the market at a given point in time. The regulator would also be required to establish standards for 11 areas, including internal controls, internal audits, and asset/portfolio management; as well as anything else that it deems to be appropriate. Once a year, this regulator would be required to report to Congress about the size and risk implications of the GSEs' portfolios and justify the size of these holdings. It would also be required to define the difference between primary and secondary market activities before approving any new products offered by the GSEs. A Housing Finance Oversight Board would be created to advise the regulator. The GSEs themselves would see the maximum size of mortgages eligible for purchase in high-cost areas increased by 50% to $540,000 or the area's median home price, whichever was lower. The GSEs could continue to use their automated underwriting systems, but mortgage originations would be specifically defined in the bill as a primary market activity, and would be off limits. Presidential appointees would be removed from the boards of Fannie Mae and Freddie Mac. Fannie and Freddie would also be required to publicly disclose their charitable contributions and study the amount of sub-prime loans that they purchase. The GSEs would also be required to set aside a portion of their after-tax income for affordable housing over the next five years. In the next two years, 3.5% of income would be set aside; this would increase to 5% for the last three years. Finally, the Government Accountability Office would be required to study guarantee fees. return to top Executive Summary: Identity Theft Protection Act September 2005 Increased Emphasis on Data Security and Protection Against Identity Theft In the wake of the dozen security breaches in the first half of 2005, legislation on the issue of data security has been in the works in both houses of Congress and at the state level. Several bills intended to supplement existing legislation have been introduced in Congress. Only one, the Senate’s Identity Theft Protection Act, has moved out of committee. Further action is not expected until late September. A new federal law is considered highly likely, and it will most likely include a threshold for notification, preemption of state laws, and data-broker-specific security standards. During its development, the prospect of new legislation has raised two key issues for financial services institutions: Data Ownership: It is not clear if a final federal law will allow consumers to freeze their credit reports and to exert more control over their personal data. Currently, ten states allow this, and the Identity Theft Protection Act would make this a national practice. Credit bureaus oppose any such provision, because this action would potentially hurt revenues by shifting control over access to these reports to the consumer. This would also potentially lessen the ability of lenders to pre-approve individuals for credit products. Increased Compliance Costs: Legislation would most likely raise operating costs for data brokers and thus result in higher fees for banks. This would have an impact on compliance costs, as banks and other financial institutions use these brokers a great deal to verify data and fulfill the Customer Identification Program (CIP) requirements of the USA PATRIOT Act. New notification requirements could also raise costs for institutions in general. This would have the greatest impact on small lenders, who do not have the scale of operations required to defray such costs. return to top Executive Summary: Data Security and Identity Theft August 2005 There were twelve instances of disclosure problems during the first half of 2005. These security breaches - and the adverse publicity that ensued - have prompted a response by all institutions and their regulators, as well as a bipartisan legislative effort in both houses of Congress. Currently, the FACT Act, FTC regulations, and Section 501(b) of the Gramm-Leach-Bliley Act (GLB) address the security of customer information at the federal level. GLB required that the various regulatory agencies issue guidelines on information security, which were first published in February 2001. Additional interagency guidelines were issued in March 2005. These guidelines require that every institution implement a comprehensive security program and notify customers of unauthorized access to information in instances where that data has been or will be misused. At the state level, California currently has the most comprehensive laws, with stricter notification requirements, as well as provisions that allow a consumer to freeze their credit report. Nine other states also let consumers freeze their data. Several bills addressing this issue have been introduced in both the House and Senate in the past few months; however the slow speed at which Congress is moving has prompted 23 states to draft bills of their own concerning customer notification. All proposed legislation extends existing rules for banks and thrifts to data brokers, and would require customer notification in the instance of "reasonable" or "significant" risk. One House bill would preempt any existing state laws, while the Senate bills would preempt only those that were inconsistent with their provisions. The Identity Theft Protection Act, the only bill in the Senate to have moved out of committee, would allow consumers nationwide to freeze their credit reports. Outlook A new federal law is considered highly likely, even though further action will not come before September. Regulators argue that a new federal law for institutions under their jurisdiction is unnecessary, as existing law contains sufficient guidelines for financial services companies, and simply lacks comprehensive rules for data brokers. Final legislation will most likely include a threshold for notification, preemption of state laws, and data-broker-specific security standards. Due to PR concerns and a wish to avoid a "patchwork" of state laws, most financial services institutions support the implementation of national data security rules. Credit bureaus currently oppose the Identity Theft Protection Act, as provisions allowing consumers to freeze their credit reports would potentially limit the revenues they gain from controlling access to these reports. Legislation would most likely raise operating costs for data brokers, and thus result in higher fees for banks. This would have an impact on expenses, as banks and other financial institutions use these brokers a great deal to verify data and fulfill the Customer Identification Program (CIP) requirements of the USA PATRIOT Act. Tighter data security in general would increase expenses, as the average cost of notification is $30 to $50 per customer, accompanied by an additional $25 per customer in monitoring costs. return to top Executive Summary: Home Equity Lending Guidelines July 2005 In their continuing efforts to alert financial institutions to risks embedded in loan portfolios, the Fed, the OCC, the FDIC, the OTS, and the NCUA issued interagency guidelines on managing credit risk in home equity lending on May 16, 2005. As with the residential mortgage lending guidance released in February, the home equity guidelines stressed the importance of assessing a borrower’s ability to repay, especially given a change in the interest rate environment or the value of collateral. The agencies recommended that all institutions take greater care in marketing, dealing with third-party brokers or originators, and the use of automatic valuation models. The last was deemed to be especially important, as differences between such models can often be used for “value-shopping,” which results in the overvaluation of properties. For lenders, these guidelines imply a need to enhance risk measurement, risk monitoring, and management information systems capabilities and higher compliance costs. return to top Executive Summary: The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 May 2005 This bill was signed into law on April 20, 2005. Most provisions will not take effect until October 17, 2005. It is the first significant reform of bankruptcy laws since the 1970s. Currently, individuals can choose to file under either Chapter 7 or Chapter 13 of bankruptcy law. Chapter 7 filers have almost all of their debt discharged, even if they are capable of repaying it, while Chapter 13 filers repay all or part of their debt in installments over 3-5 years. The reform introduces a needs-based test for Chapter 7 filers with incomes greater than the state median. The provisions of this law also include new requirements for consumer lenders, such as disclosures regarding minimum payments, introductory rates, late payment deadlines and penalties for open-end lines of credit, and the tax consequences of certain home equity loans. Creditors will also be prohibited from closing open-end loan accounts solely because a customer had not incurred finance charges. In the short-term, the number of filings could increase, resulting in an increase in non-performing credits and charge-offs. Filings have consistently increased in the quarter following the introduction of reform legislation as individuals try to take advantage of the old system. Less is known about the possible long-term effects of these reforms. This legislation was supported by the financial industry in general. It was opposed by various consumer groups, who argued that it would result in unnecessary costs for low-income individuals, and that it does not address the real problem - the ease with which individuals can obtain credit. return to top Executive Summary: The Sarbanes-Oxley Act February 2005 Signed into law on July 30, 2002, this act was meant to address audits, financial reporting and disclosure, conflicts of interest, and corporate governance at all public companies. It also established a new supervisory agency for accountants, the Public Company Accounting Oversight Board (PCAOB). Banks are directly subject to this act if they have a class of securities registered, or if they are required to file reports under the SEC Act of 1934 (in short, if they are a public banking organization). Banks with $500 million or more in assets that are subject to certain portions of the FDIC Act that were amended by Sarbanes-Oxley must also comply with the portions of the act that relate to auditor independence. The majority of the regulations laid out in Sarbanes-Oxley require more disclosure and greater auditor independence. For example, auditors can no longer provide audit and non-audit services to a company at the same time, unless such non-audit services have been pre-approved by an independent audit committee. Most attention has been paid to Section 404, which consists of the following: Companies must now verify that they have the proper internal reporting controls in place. Management must issue a report on its responsibility over internal controls, the framework used to evaluate those controls, and an assessment of their effectiveness. The company's external auditor then has to verify management's report of internal controls. There are two main concerns associated with this act: the increase in compliance costs and the increase in liability for banks. For small public banks, these additional compliance costs could be high enough to drive them into M&As, or to force them to consider going private. They could also find themselves at a competitive disadvantage compared with small private banks. Liability becomes an issue, because under Sarbanes-Oxley, banks no longer have to be the primary actor in securities fraud in order to be considered at fault, even though they may not have perfect knowledge of their customers and their behavior. return to top For more information contact Vanessa Mambrino at 202/337-1507 or vmambrino@capitalperfom.com.

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