Last week the bank regulators and the Securities and Exchange Commission jointly released 28 pages of provisional, heavily principles-based guidelines for identifying and establishing control policies aimed at "complex structured finance activities."

The sentiment is hardly new, though a commentary authored by both the SEC and the Federal Financial Institutions Examinations Council (FFIEC) is something of a novelty.

This latest call for accountability on Wall Street, titled Interagency Statement on Sound Practices Concerning Complex Structured Finance Activities, will be open for comments for 30 days after it is officially published in the Federal Register.

As usual, market participants are concerned about the absence of specific guidelines, tests and identifiers. Rather, the agencies believe the banks should bear the burden of establishing their own internal controls. "It's clear that this is meant to forestall the Enron-type transaction," said one source. "What is unnerving is the vagueness or lack of specific definitions."

The agencies seem to home in on a financial institution's "reputational risk" as a key ingredient for identifying structures and transactions that while perhaps technically legal may be designed to circumvent tax liabilities or disclosure requirements to the extent that a client's true financial condition is not represented in its public financial statements. Thus, if an investment bank believes its own integrity could be questioned in its association with a structured finance transaction, this transaction should be subject to a set of cautionary internal controls.

While there are no bright lines presented, the agencies do offer a list of characteristics that may indicate a structure is adequately complex and shady to warrant additional scrutiny:

* Transactions with questionable economic substance or business purpose or designed primarily to exploit accounting, regulatory or tax guidelines (particularly when executed at year-end or at the end of a reporting period);

* Transactions that require an equity capital commitment from the financial institution;

* Transactions with terms inconsistent with market norms (e.g., deep "in the money" options, non-standard settlement dates, non-standard forward-rate rolls);

* Transactions using non-standard legal agreements (e.g., customer insists on using its own documents that deviate from market norms);

* Transactions involving multiple obligors or otherwise lacking transparency (e.g. use of SPEs or limited partnerships);

* Transactions with unusual profits or losses, or transactions that give rise to compensation that appears disproportionate to the services provided or to the risk assumed by the institution;

* Transactions that raise concerns about how the client will report or disclose the transaction (e.g. derivatives with a funding component, restructuring trades with mark to market losses);

* Transactions with unusually short time horizons or potentially circular transfers of risk (either between the financial institution and customer or between the customer and other related parties);

* Transactions with oral or undocumented agreements, which, if documented, could have material legal, reputational, financial accounting, financial disclosure, or tax implications;

* Transactions that cross multiple geographic or regulatory jurisdictions, making processing and oversight difficult;

* Transactions that cannot be processed via established operations systems; and

* Transactions with significant leverage.

Jason Kravitt, of Mayer Brown Rowe & Maw, identified a few areas of potential concern. In addition to being perhaps overly broad, there is a "meaningful amount of ambiguity" in some of the concepts and definitions in the proposal that will need to be clarified.

Also, there may a point at which the administrative and procedural processes accompanying structured finance will outweigh its benefits. "When you put it all together, is there a proper balance between the administrative and procedure burden and economic efficiency?" Kravitt asked.

Further, Kravitt questions whether the rules will have the potential to create aiding and abetting liabilities where they had not existed before.

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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