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Nutter Bank Report, February 2008

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1.  Guidance Issued on Massachusetts Subprime ARM Requirements
2.  FDIC Clarifies Internal Control Attestation Requirements
3.  SEC Proposes Sarbanes-Oxley Section 404 Extension
4.  Treasury to Release Blueprint for New Financial Services Regulation
5.  Other Developments: OTS on Trust Referral Fees and OCC Notarial Seal Requirements

1.  Guidance Issued on Subprime ARM Opt-In and Counseling Requirements

The Massachusetts Division of Banks has adopted standards for determining when an adjustable rate mortgage loan made to a first-time home loan borrower qualifies as a “subprime” loan for purposes of new counseling and opt-in requirements under state law.  Regulatory Bulletin 1.3-104 issued on January 30 defines a number of terms used in a new law that prohibits lenders in Massachusetts from making a subprime adjustable rate mortgage loan to a first-time home loan borrower unless the borrower affirmatively opts in writing for the adjustable rate loan.  The law also requires that a lender receive a certification from an approved credit counselor that the borrower has received counseling, in person, on the advisability of the mortgage loan transaction before closing the loan.  Under Regulatory Bulletin 1.3-104, an adjustable rate mortgage loan to a first-time home buyer secured by a first lien is considered to be “subprime” if the loan amount falls within Fannie Mae’s or Freddie Mac’s conforming loan limit but for any reason fails to meet their underwriting guidelines or, if the amount exceeds the conforming loan limit, the annual percentage rate is greater than 2.5 percentage points above the yield on United States Treasury securities having a comparable period of maturity.  An adjustable rate mortgage loan secured by a simultaneous second lien is deemed to be “subprime” if the annual percentage rate is more than 5 percentage points above the yield on United States Treasury securities having a comparable maturity.

Nutter Notes:  The Regulatory Bulletin implements Section 17B½ of Chapter 184 of the General Laws of Massachusetts, which was included in the mortgage reform legislation approved in November 2007 and became effective on January 31.  The statute applies to all Massachusetts mortgage lenders, including banks.  If a lender makes a subprime adjustable rate mortgage loan to a first-time borrower in violation of the statute, the adjustable rate terms of the loan are not enforceable and the interest rate becomes the lesser of the original interest rate, including any discounted rate, or the applicable adjusted rate throughout the life of the loan.  In addition to defining the term “subprime,” the Regulatory Bulletin specifies certain requirements for the written opt-in statement, and defines the terms “first-time home loan borrower” and “simultaneous second lien” among others.  The Massachusetts Predatory Home Loan Practices Act, Chapter 183C, Section 3 of the General Laws, imposes a counseling requirement similar to that of Chapter 184, Section 17B½.  Chapter 183C, however, applies to high cost home mortgage loans, which are defined differently than subprime mortgage loans and institutions should be mindful of both the differences in scope and potential overlap between the two statutes.  The Division of Banks accepted public comments on the Regulatory Bulletin through February 20.

2.  FDIC Clarifies Internal Control Attestation Requirements

The FDIC has issued guidance on the internal control attestation standards that auditors are advised to follow to comply with the audit and reporting requirements under Part 363 of the FDIC’s regulations.  The Guidance on Part 363 Internal Control Attestation Standards for Independent Auditors released on February 1 describes the types of internal control reports that will satisfy the requirements of Part 363 for public institutions and for nonpublic institutions.  Part 363 requires both the management and independent auditors of institutions with total assets of $1 billion or more to assess the effectiveness of the institution’s internal control structure and procedures for financial reporting.  The requirement for assessment of internal controls is similar to that imposed on public companies by Section 404 of the Sarbanes-Oxley Act.  On May 24, 2007, the Public Company Accounting Oversight Board adopted Auditing Standard No. 5, which establishes requirements and provides direction to auditors performing an audit of management’s assessment of the effectiveness of internal control over financial reporting pursuant to Section 404 for public companies.  The FDIC’s guidance was issued in response to recent questions about whether the internal control report of auditors following Auditing Standard No. 5 will satisfy the requirements of Part 363.  The FDIC’s guidance confirms that institutions may satisfy the Part 363 requirements by following Auditing Standard No. 5.  Alternatively, public companies that are not accelerated filers and nonpublic institutions may follow the American Institute of Certified Public Accountants’ AT-501 rules.

Nutter Notes:  Public institutions that are not accelerated filers may rely on the AICPA’s AT-501 rules for fiscal years ending before December 15, 2008 or until AICPA revises those standards, but the use of Auditing Standard No. 5 will be required for fiscal years ending on or after December 15.  There are significant differences between Auditing Standard No. 5 and AT-501 that may impact the auditor’s attestation report.  For example, the AICPA included in AT-501 the definition of “material weakness” from Auditing Standard No. 2, which was eliminated from Auditing Standard No. 5.  The AICPA’s AT-501 defines material weakness to mean “a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.”  The definition in Auditing Standard No. 5 instead uses the phrase “reasonable possibility that a material misstatement” of the financial statements will not be prevented or detected “on a timely basis.”  The FDIC guidance also reminds institutions that the FDIC (and the other federal banking agencies) agreed with the SEC that insured depository institutions that are subject to both Part 363 and the SEC’s rules implementing Section 404 can prepare a single report on internal control over financial reporting that satisfies both the FDIC’s and SEC’s requirements instead of preparing two separate reports on the institution’s internal control over financial reporting to satisfy the Part 363 requirements and the SEC’s Section 404 requirements.

3.  SEC Proposes Sarbanes-Oxley Section 404 Extension

The SEC has issued a proposed rule that would extend for an additional one-year period the deadline for compliance with the auditor attestation requirement relating to internal control over financial reporting for public companies that are not accelerated filers under Section 404(b) of the Sarbanes-Oxley Act.  The proposal, published on February 7, would permit a smaller public company to provide the attestation report of its independent auditor on internal control over financial reporting in annual reports for fiscal years ending on or after December 15, 2009 rather than December 15, 2008.  The proposal to extend the compliance date for nonaccelerated filers was made in recognition of the additional actions the SEC and PCAOB intend to take in connection with the approval of PCAOB’s Auditing Standard No. 5.  PCAOB intends to issue final staff guidance on auditing internal control over financial reporting of smaller public companies.  The SEC is also undertaking a study to determine whether the Section 404(b) auditor attestation requirement is being implemented in a cost-effective manner for smaller public companies.  Comments on the proposed extension should be submitted to the SEC on or before March 10.

Nutter Notes:  The PCAOB issued preliminary staff guidance on the auditing of internal control over financial reporting for smaller public companies on October 17, 2007.  The preliminary guidance addresses how auditors can apply the principles described in Auditing Standard No. 5, along with examples.  The preliminary guidance discusses entity-level controls, risk of management override, segregation of duties and alternative controls, information technology controls, financial reporting competencies and testing controls.  The public comment period for the PCAOB’s preliminary guidance for smaller public companies ended on December 17, 2007.  The SEC is also concerned about the costs to smaller companies of implementing the auditor attestation requirements before it has an opportunity to consider whether further action to improve the efficiency of the Section 404(b) implementation is warranted.  Despite the SEC’s proposed extension of the smaller public company compliance date under Section 404(b), institutions with total assets of $1 billion or more that are nonaccelerated filers are still required to comply with the FDIC’s auditor attestation requirements under Part 363 of the FDIC’s rules.

4.  Treasury to Release New Blueprint for Financial Services Regulation

The Treasury Department is expected to issue its new blueprint for financial services regulation by March 31.  Robert Steel, Under Secretary for Domestic Finance, announced the impending release of Treasury’s proposal to modernize the regulation of financial services in the United States during a speech before the New York Society of Securities Analysts on February 8.  Steel did not provide details about Treasury’s new blueprint, but did indicate that the proposed structure will be different from the current regulatory structure.  He mentioned that Treasury considered the unitary model of the United Kingdom, where nine regulatory bodies were consolidated into the Financial Services Authority and monetary policy was separated from bank supervision.  He compared that unitary model with the so-called “twin peaks” model adopted in other countries where one regulatory body is responsible for prudential financial regulation of entities and the other body is responsible for business conduct and consumer protection in connection with financial products offered to consumers and investors.

Nutter Notes:  Steel emphasized that the goal of financial services regulation is to facilitate the efficient functioning of capital markets—“connecting suppliers of capital with users of capital”—while providing strong protections for investors and consumers, market integrity and risk mitigation.  He also discussed Treasury’s recognition that regulatory protection of market participants should range along a continuum from the highest levels (e.g., deposit insurance) for retail consumers to lower levels for large, sophisticated investors who understand market risks.  Steel cited among the deficiencies of the current system the multiple regulators with overlapping authority and inconsistently applied standards.  Steel’s comments echoed criticisms leveled against the Federal Reserve, OTS and SEC in a March 2007 Government Accountability Office report examining their approaches to consolidated supervision of financial conglomerates and an October 2007 GAO study that suggested consolidation of regulatory agencies and principles-based regulation should be key elements of any plan to modernize the U.S. financial regulatory system.

5.  Other Developments: OTS on Trust Referral Fees and OCC Notarial Seal Requirements

  • ·OTS Revises Policy on Fees for Referrals of Trust Business

The OTS has revised its policy on the payment of fees for referrals of trust business.  Thrift Bulletin 76-1a, issued on February 20, states that the OTS permits the payment of such referral fees by federal savings associations, and does not arbitrarily impose limits on the size of the fees.  Under the new policy, the association, not the referring party, is responsible for providing a written disclosure document to the prospective trust customer prior to payment of the referral fee.

Nutter Notes:  The Thrift Bulletin rescinds and replaces Thrift Bulletin 76-1.  The required content of the written disclosure to the prospective customer is similar to that required by the old guidelines, but there is a new requirement that the disclosure be delivered by the association prior to the payment of the referral fee.  Also new is a requirement that such fees be subject to a referral fee program approved by the board of directors and reviewed annually by management.

  • OCC Removes Notarial and Bank Seal Requirements

National banks will no longer be required to affix notary stamps or bank seals to a number of corporate applications and notices.  The OCC announced on February 8 that, after an internal review, it found such requirements prevent many documents from being submitted through its electronic application system.

Nutter Notes:  The OCC’s electronic filing system, e-Corp., was introduced in 2002 and allows national banks to electronically file documents such as branch applications and licensing filings.  Among the documents that will no longer require notarization are notices of debt issuance, notices of change of par value and applications to establish an initial or additional federal branch or agency.

Nutter Bank Report

Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP.  Chambers and Partners, the international law firm rating service, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation in the 2007 Chambers and Partners U.S. rankings.  The “well known and well-versed” Nutter team “excels” at corporate and regulatory banking advice, according to the 2007 Chambers Guide.  Visit the 2007 U.S. rankings at  The Nutter Bank Report is edited by Matthew D. Hanaghan.  Assistance in the preparation of this issue was provided by Lisa M. Jentzen.  The information in this publication is not legal advice.  For further information, contact:

Gene A. Blumenreich                                         
Tel: (617) 439-2889                                                   

Kenneth F. Ehrlich  
Tel: (617) 439-2989

Michael K. Krebs
Tel: (617) 439-2288

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