December 16 – More than 400 such failures since 2007 have cost the fund, which is fed by banks and backstopped by taxpayers, an estimated $88 billion. That volume shows the need for more transparency in bank regulation, which is largely conducted in the dark, said Paul Atkins, a former Republican commissioner at the Securities and Exchange Commission.

“Transparency is vital,” said Atkins, the managing director at Patomak Partners LLC, a financial services consulting firm in Washington. “It helps make regulators accountable and helps taxpayers better judge what their liabilities might be.”

At least 1,400 times last year, federal examiners told a bank to fix a problem that could imperil its health, according to data from the three agencies that regulate banks. The agencies didn’t reveal the names of the troubled banks or the nature and severity of their concerns. That information is kept from investors, customers and the public unless securities laws force the bank itself to disclose.  Such secrecy is needed to prevent panic that might result in bank runs or investor sell-offs, making problems far worse.

“Ninety-five percent of the corrective action we want to get from an institution, we get seamlessly and efficiently, and sometimes it involves nothing more than a bank examiner whispering in the ear of a compliance officer,” said Dan Stipano, deputy chief counsel at the OCC. “That kind of thing unfortunately for us is invisible and not necessarily measurable. You don’t see scalps on the wall.”

Examiners weren’t always as tough as they needed to be from 2006 through the third quarter of 2010, according to a June report by the Government Accountability Office, an investigative arm of Congress. “Regulators generally were successful in identifying early warning signs of bank distress, but the presence and timeliness of subsequent enforcement actions were often inconsistent,” according to the report.

Enforcement has gotten tougher since the 2008 credit crisis, said Ralph “Chip” MacDonald III, a partner at the Jones Day law firm in Atlanta who represents banks.

“Regulators are doing a good job, they are pretty much on top of their game,” MacDonald said. “The bias is toward acting quicker, as opposed to holding off.”

Most public oversight of bank examiners takes the form of post-mortem reviews: Inspectors general for the three regulatory agencies are required by law to audit any bank failure that costs the FDIC’s insurance fund more than $200 million. While that fund has a $100 billion line of credit with the U.S. Treasury, the FDIC can increase assessments on banks to keep it solvent.

Regulators’ main job is to ensure lenders’ safety and soundness through on-site examinations that involve looking through their books, assessing the risk they’ve taken on and monitoring their capital reserves. Examiners also gauge the acumen of the firms’ management teams. The largest banks have examiners on premises full time. Some banks are also reviewed by state authorities.

The Fed supervised 829 state member banks last year, along with more than 5,000 bank holding companies. The OCC oversees about 1,400 national banks, 631 federal savings associations and 48 branches of foreign banks. The FDIC regulates 4,715 institutions.  [see Bloomberg for additional text]

Source: Bloomberg

Posted by Steven Maimes, The Trust Advisor.

Permalink: http://thetrustadvisor.com/headlines/bank-failures

On July 21, the Office of Thrift Supervision ceased to exist and about 700 trust banks, thrifts and other institutions entered a brave new regulatory world.

The good news is that their new watchdog, the Office of the Comptroller of the Currency, has so far vowed to let them continue with business as usual.

The bad news? Nobody expects the status quo to last very long — maybe a year or two — and there are still some big question marks.

“What I’m getting is that at this point nobody is going to go in and tell anyone, ‘The OTS said you can do this, but this is a new regime and you can’t,’” says Bernard Garbo, publisher of Trust Regulatory News.

“That’s simply not going to happen, at least initially.”

Voting with their feet?

It’s clear that plenty of thrifts have not been eager to hang around and find out. There were 745 institutions under OTS supervision back in January. Now there are barely 700.

In what some considered a final show of force, the traditionally laissez-faire OTS shut down five of its charges over the last six months.

Another 40 transferred their charters to the FDIC or state regulators.

But the remaining 700 institutions now under the OCC’s eye include nationally known independent trust companies like Montana-based Davidson Trust and National Advisors Trust Co., as well as giant Northern Trust.

Many of the big brokerage houses, insurance carriers and money managers also have OTS charters:  Edward Jones, Fidelity, Franklin Templeton, MassMutual, TIAA-CREF.

For these giants, the OCC is probably still the only game in town unless they really want to get into the banking business or swap the state regulators with branching applications.

State charters are an option for the non-giants, says attorney James Rockett, who helped Davidson set up its OTS charter in the first place.

“The states definitely have certain levels of consistency to them compared to the questions around the OCC,” he explains.

“They might be an appropriate course of action while the dust settles.”

Picking through the gray areas

Rockett says one of the biggest mysteries right now is what happens to institutions that were formerly under the OTS but might now see their operating units move to the OCC while the holding company actually shifts to Federal Reserve supervision.

“Limited purpose trust companies can easily fall into this category,” he says. “There’s just no clear guidance on that.”

Bernard Garbo sees the potential headaches getting even bigger if these former thrifts have depositary arms that now need to get their insurance from the FDIC.

“That’s probably the area of most discomfort, dealing with three regulators,” he says. “Even if everything works absolutely smoothly, moving from one entity regulating you to three is a big shift.”

And not even the OCC knows yet what will happen when its mandate contradicts the legacy OTS rules.

So far, government lawyers have been busy enough simply combing through the two sets of regulations and deleting everything that the OTS was doing exactly the same way that the OCC already does.

“Blended” examinations and ultimate convergence

There are no formal plans to migrate any OTS-chartered institutions to OCC rules immediately, so everyone is effectively grandfathered into their current way of doing business for an unspecified period of time.

But down the road, the people I talked to is sure that there will be a slow consolidation around OCC policies — and that’s a matter of attrition as much as inter-agency politics.

As institutions get bought out, shift business models or simply fail, their thrift charters will likely vanish over time. And no new thrift charters will be issued.

Eventually, Garbo suspects, there might be “subtle suggestions” to the remaining thrifts that the OCC would rather see them adopt a normal national bank charter instead.

One thing we do know: the examination system will definitely take its cues from the OCC side, which has a reputation for being more exacting than the OTS was.

The honeymoon will be relatively brief, Rockett says.

“My view is that the OCC will work toward integrating the examination process as quickly as possible,” he says.

“It may take longer than they might like, but the OCC processes will definitely be those that are implemented going forward.”

On the positive side, Rockett dismisses fears that the OCC will say no to regulated trust companies trying to branch out across state lines.

As he points out, the regulator has already lost friends in jurisdictions like Missouri and Texas for overruling state statutes prohibiting out-of-state trust and other fiduciary activities.

Garbo agrees that the OCC has a track record of being friendlier toward branching than some might think.

But he admits that it’s still too early to tell.

“Be careful if you are fully relying on the old OTS regulations,” he warns Trust Advisor readers.

“Things may be okay now, but it might be like a tax audit: you do something this year and don’t hear back from the IRS for two years.”

Scott Martin, senior editor, The Trust Advisor Blog. Jerry Cooper and Steven Maimes contributed to the research.

Permalink: http://thetrustadvisor.com/news/ots-2

President Obama signed sweeping changes to  federal financial regulation this week, signaling perhaps the Democrats’ last major legislative victory before the midterm elections in November.

After over a year of bickering about everything from toasters to options trading, the financial reform bill is now a reality and the 20-year-old Office of Thrift Supervision’s days are numbered.

Starting next summer, the OTS will fold into the Office of the Comptroller of the Currency, which will take over supervision of about 745 thrift-structured lenders, trust companies and other institutions. Click here to request an Excel listing of all 745 OTS thrift institutions.

But, what won’t be folding anywhere are the existing powers thrifts have to operate in all 50 states.  They will, however, have to comply with new, more stringent capital rules regarding problem loans.

According to the OTS and the new rules,  no new national thrift charters will be issued anymore.

“We are changing regulators but still have a valid thrift charter,” explains Art Sims, president of Davidson Trust, which got an OTS charter in 2000. “That is not going away.”

With a year to consider their options, holders of national thrift charters are mulling their next moves carefully, Sims says. Some are considering asking the OCC to convert them into banks, but Davidson at least will probably stay right where it is.

No reason to change?

As Sims points out, these institutions went down the thrift route in the first place because the distinct advantages that operating model offered outweighed the downside.

Everyone I talked to while putting this story together told me that the OTS unified holding company rules made it easier to branch out. As long as you didn’t break any state statutes, all you really needed was a national thrift charter and you could set up remote offices instantaneously.

“It was a distinct advantage,” says Scott Walshaw, regulatory advisor of Advisors Institutional Services. “Presuming the regulatory provisions those charters are operating under right now are grandfathered, it will continue to be an advantage.”

One reason Davidson Trust went with the OTS when it was picking a charter was because the thrift system let it operate under the same rules wherever it chose to do business.

That uniformity has saved endless headaches as the company serves the customers of its corporate parent, the Davidson Companies, which does business in 15 states beyond its native Montana.

If anything, people who have worked with both OTS and OCC charters say that the national thrift charter is now not only an endangered species but a hot commodity.

“The people who are holding those federal charters will have a distinct valuable asset,” Walshaw says.

State charters are in play

Other OTS-chartered trust companies are weighing their choice as well.

One source close to an OTS trust bank–talking on condition of confidentiality–tells me that the institution started making plans to move to a state trust charter back in June in order to avoid having to deal with the overhaul.

For industry giants that, like Northern Trust, already have both thrift and banking charters, there is no reason to switch. If anything, having one less regulator to deal with simply streamlines the compliance process.

More locally focused players may find the idea of dealing with the OCC a little daunting, especially if rumors that the bank regulators are going to get stricter on thrifts come true.

Right or wrong, the OTS had a reputation for being a bit more lenient with reserves and the way it priced non-performing assets.

Since the old savings & loans had most of their portfolios tied up in real estate, a more flexible regulatory model made sense—at least in theory. But a lot of today’s thrift-chartered lenders are carrying a lot of bad debt on their books that might have passed OTS muster but not the OCC.

These lenders may be looking at converting to a state charter. In the new environment, the FDIC will still regulate state thrifts and the various state watchdogs will supervise trust companies.

Scott Walshaw wouldn’t be surprised if state thrift charters make a comeback as both new and established lenders opt for local regulation. For trust companies, of course, leverage and non-performing loans are both non-issues.

A nationally chartered trust company would probably find moving to state regulation to be more of a step backward than just going across to the OCC, Art Sims believes.

“A state charter can entail more effort and more cost to keep up with the state regulator, much less rethink what a change would mean for every location where you do business,” he explains. “It is less likely that people who have already committed to a national charter are going to want to go back to a state charter.”

When the rubber hits the road

As anyone who deals with regulators knows, all of this is still largely hypothetical.

OTS spokeswoman Janet Frank was able to point The Trust Advisor readers to the two sections of the 2,300-page Dodd-Frank rules that affect trust companies (here and here), but she admits that as yet nothing is set in stone.

“So much is up in the air right now and there are so many moving parts,” she says. “Guidance will be coming out as appropriate to tell our trust companies how the transfer will work, but I don’t know how or when that guidance will move.”

While the OTS is currently scheduled to disappear next July, Congress has the option to extend its life another six months if the transition bogs down. This means that an institution may not even deal with the OCC until 2012 at the earliest.

By that point, the OCC, OTS and the Federal Reserve should have had plenty of time to sit down and come up with a system for affected trust companies to follow.

“Naturally, I would hope they do it soon in order to eliminate uncertainty and give people time to rethink their business plan,” Scott Walshaw says. “But it could take two years for the dust to settle, and in the meantime it’s anybody’s guess.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and the editing.

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Bank examiners have started checking on trust companies to make sure that everyone can either demonstrate that they’re obeying Regulation R, even though the specifics still perplex industry veterans.

Regulation R mandates that non-SEC-regulated institutions “push out” or refer most securities sales—and the commissions they generate—to broker-dealers. Fiduciaries can get a pass if they can prove that no more than 30% of their revenue comes from commissions.

Because this is a new requirement, not all trust companies are sure they’ll have what it takes to convince the Office of the Comptroller of the Currency’s examiners that they’re exempt when compliance testing starts on January 1.

“We’re all still waiting on record-keeping guidance,” Sally Miller, who chairs the American Bankers Association’s banking law committee, told me.

“I understand it has been drafted, but with everything else going on right now in the regulatory world, review has been slow,” she added. “It just hasn’t been a top priority.”

Caught in the middle

On the surface, the rules are clear. A fiduciary can book up to 30% of its revenue (calculated on a two-year rolling basis) from trading fees that it earns in the course of exercising its duties. All other stock and mutual fund trading needs to be pushed out.

“You don’t want to make any mistakes on this one,” warns securities lawyer Melanie Fein, who wrote the Securities & Exchange Commission’s Reg R compliance manual.

Fein acknowledges that a lot of the confusion out there stems from the fact that trust companies—especially those with state charters—occupy a somewhat nebulous position on the national regulatory map.

While trust departments affiliated with FDIC-insured banks are clearly under the OCC eye, an independent trust company operating under state jurisdiction may normally consider itself aloof from the banking world.

Fein says that’s not really an issue here. State-chartered trust companies may not be OCC-regulated banking entities, but it’s the SEC they ultimately need to convince that they’re operating on the right side of the line. And all trust companies look alike as far as the securities regulators are concerned.

“The term ‘bank’ at the SEC includes the term ‘trust company,’” Fein told me. “What a Reg R exemption means is that you are exempt from their regulation. They are not really concerned with who regulates your other activities.”

This is the real danger of failing the compensation test, Fein says. A trust company that does too much commission-based business actually loses its exemption from SEC oversight.

“If it turns out you are not exempt, you would be operating as an unregistered broker-dealer and would be liable for your customers’ losses,” she explains.

Plenty of questions remain…

In theory, a bank can get around the 30% rule by making sure all employees maintain a strict “two-hat” separation between commission-based and relationship-based business. As long as a securities-licensed bank employee takes off the “bank” hat to trade, the bank can avoid from SEC oversight.

While this may look feasible on a superficial level, every securities lawyer I talked to warned me that keeping the hats separate is an operational and supervisory nightmare for banks and broker-dealers alike.

As a result, some compliance departments on both sides of the bank/broker divide take a more restrictive position than advisors might like. That’s their perogative, but it can be frustrating.

“Our broker-dealer takes the position that independent trust companies are not exempted under Reg R,” Jim Farmer, a wealth manager at First Bankers in Quincy, Illinois, told me. “They will pay commissions to the bank, but not the trust company. I understand the two-headed issue, but sometimes I still feel stuck.”

Most banks and trust companies will simply pass the business to a favored broker and collect a fee. Sally Miller at the ABA says most of the Reg R questions she gets revolve around how the examiners will look at these referral fees.

“This is the tougher nut to crack for some of the banks out there,” she told me. “Is this commission-based or relationship-based income? And what will the OCC think is fair?”

Red-flag referrals

Miller says there are a few practices out there that trust companies should avoid if they want to keep their Reg R exemption.

Referral compensation should not be tied to either the size of the account or trade at stake or the broker-dealer’s success in getting the business. Doing this raises the odds that a payment may actually be a commission in disguise, Miller told me.

These fees should also never be tied to any kind of incentive program. The rationale here is that pushing out securities business is supposed to be a sacrifice, not a business opportunity for trust companies to chase.

“Staying exempt under Reg R means proving that you’re primarily interested in lending, cash management, trust administration or other traditional banking activities,” Miller says. “If you tell your employees they’ll get a bonus for turning over prospects to broker-dealers, it doesn’t look good.”

Although the OCC has yet to issue concrete guidance, examiners have been actively working with banks and trust companies to make sure everything is going well. If a trust company still has any questions about what it will need to pass the test, there’s plenty of time to find out, Miller says.

Melanie Fein emphatically agrees.

“Confer with your regulator and clarify your status,” she told me. “Whether you’re FDIC-insured, state-chartered, OCC-regulated, go ahead and make the call. This is very definitely serious business.”

For follow-up, we suggest reading an excellent article on compliance, published by the Federal Reserve Bank of Philadelaphia, “Regulation R: Is Your Bank in Compliance?.”

Scott Martin, contributing editor, The Trust Advisor Blog, Jerry Cooper contributed to the reporting, Steven Maimes  contributed to the research and editing

Permalink: http://thetrustadvisor.com/news/regr

“The SEC can’t get into the bank, but I can get into the advisors. It’s important for me to see if the banks are using their exemption properly … or merely renting a space [to advisors] inside a trust company,” says SEC’s Andrew “Buddy” Donohue, head of the SEC’s investment management unit.

Donohue fired a warning shot at bank regulators by threatening to go after the advisors who sell collective investment trusts. Experts say a move like that may just be saber rattling, but it pits the SEC against bank regulators over oversight of about $1.6 trillion in the collective funds market.

On the surface, these vehicles—also known as collective trusts, commingled funds or common trust funds—look a lot like institutional mutual funds and invest in all the conventional asset classes. Advisors do brisk business selling them to retirement plans.

But while mutual funds are SEC-registered, collective investment trusts are managed by a bank trust department and so falls under the jurisdiction of the Office of the Comptroller of the Currency, which is part of the Treasury Department.

If Donohue gets his way, that may change. In a speech at Practicing Law Institute’s Investment Management Institute in New York, he said he’s got his eye on these bank products. If he decides they need tighter regulation, he’ll make it happen, one way or another.

“I can’t get into the bank,” he reportedly elaborated in an off-script comment after the speech. “But I can get into the advisors.”

The OCC has refused to rise to the bait so far. All I got out of them was a terse “we’re aware of it and no comment.”

Rattling the Chains

Longtime agency watchers are a lot more expansive, but on the whole they’re a little mystified at what you could read as an SEC power grab.

“Collective investment trusts used to be considered a settled matter,” Maureen Young, a partner at high-powered law firm Bingham McCutchen, told me.

“If the SEC is really concerned about these products, maybe they’re hoping that they can get some response by rattling the chains and going after the brokers,” she added.

George Washington University law professor Arthur Wilmarth filled me in on the long struggle over who would regulate these products following the repeal of the Glass-Steagall Act over a decade ago.

“As they say, nothing is as precious in Washington as a bit of turf,” he told me. “They fought for years and just couldn’t agree,” he added. “It took Congress basically threatening to bang the agencies’ heads together to get the job done.”

By the time the last dust settled, it was already 2007 and the once-obscure collective investment trust was becoming big business in retirement plans.

There’s about $1.6 trillion invested in these trusts now, according to Morningstar data. About half of it is in traditional pension funds; the other $800 billion—the real growth market—is in 401(k)s and other defined contribution accounts.

Getting Tough

Some of the people I interviewed for this story suspect that the size of this marketplace is the factor that brought it to the SEC’s attention after years of letting the OCC tend its own knitting.

Others wonder whether the SEC is looking for ways to prove that it’s indispensable in a world where the Obama Administration seems intent on reshuffling the regulatory deck and all the agencies have made mistakes.

In any event, Donohue isn’t alone in talking tough.

“We simply show up,” said Gene Gohlke, associate director of the SEC’s Office of Compliance, Inspections and Examination, speaking at the same conference as Donohue.

“If there are allegations of wrongdoing, we don’t want to give firms a good deal of lead time to clean up,” he added.

But while statements like this paint a tough picture of the commission as a sort of rapid-deployment vigilante regulator, it’s going to be tough to put that rhetoric into practice, former Nevada banking commissioner L. Scott Walshaw told me.

“From a bank regulator’s perspective, the OCC or whoever else is being stepped on is going to have something to say about this,” Walshaw, now a regulatory advisor at Advisors Institutional, says.

“Common sense would dictate that it makes more sense to just sit down with the OCC and maybe see if they can express their concerns without infringing on anybody’s turf,” he added.

Headed for the Mainstream

Meanwhile, there are already 1,200 collective investment trusts in Morningstar’s database and more launching all the time.

“We talk to established money managers about these vehicles every week,” says Steve Deutsch, who leads the company’s research in this area.

Deutsch sees collective trusts heading for the mainstream of the asset management marketplace very quickly. That’s probably why the SEC is getting involved, he says.

“If you want to be mainstream, you’ve got to have all the features of a mainstream product, and I think that’s what the SEC is concerned about,” he added.

As Deutsch notes, these trusts already walk and talk a lot like mainstream investment products. Improved record-keeping capabilities allow them to report NAV on a daily basis. They trade on Fund/SERV. And since Morningstar tracks them, there’s third-party transparency.

Last but not least, they are already strictly regulated—not only by the OCC, but in so far as collective trusts are essentially retirement plan options, by the IRS, ERISA and the Labor Department.

For example, Victory Capital Management is a substantial player in this space with about $3 billion in collective trust assets under management.

“It’s not like there’s no oversight,” says John Kutz, the head of the company’s retirement plan business.

“There’s tremendous oversight. There’s a lot of auditing. These are fiduciary products. The OCC makes sure every ‘i’ is dotted and every ‘t’ is crossed, at least where we’re concerned.”

Victory is still bullish on the business, expecting its AUM to double in the next few years. Evidently, a little oversight is worth the effort.

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research.

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