As reported in the July LRA, the banking agencies issued three notices of proposed rulemaking that would revise and replace the agencies’ current capital rules. The original comment period was set to expire on September 7, but has been extended to October 22.
As proposed, insurers that operate thrifts would be subject to the same capital standards as banks at the holding company level except for certain unique insurance activities (e.g., separate accounts, deferred acquisition costs and insurance underwriting). This could affect AIG, Prudential and MassMutual among others. A number of insurers have indicated a desire to divest of their banking units primarily due to regulatory burden.
Many commenters, including some members of Congress, requested that the comment period be extended for an additional 90 days or longer. One item that received a lot of comments is the proposal to include unrealized gains and losses accumulated from available for sale securities recorded in accumulated other comprehensive income/loss (AOCI) in regulatory capital measurements. Concerns include that removing the AOCI filter will 1) overstate capital in low rate environments and understate caption when rates are higher, 2) discourage investments in liquid securities with appropriate interest rate durations, 3) compel U.S. banks to maintain substantial “uncertainty buffers” over stated regulatory requirements to avoid adverse consequences, and 4) disadvantage U.S. firms because of differing accounting standards abroad. Another common topic was concern of the impact the proposed rules would have on small and community banks.
On August 16, the OCC published a notice of a proposed information collection in the Federal Register. The Dodd-Frank Act §165(i)(2) requires certain financial companies with total consolidated assets over $10 billion, including national banks and federal savings associations, to conduct annual stress tests and requires the primary financial regulatory agency of those financial companies to issue regulations implementing the stress test requirements. On January 24, 2012, the OCC published a notice of proposed rulemaking implementing the section 165(i)(2) annual stress test requirement. The August 16 notice describes the reports required in order for covered institutions with consolidated assets of $50 billion or more to meet the reporting requirements of section 165(i)(2).
The notice includes a 65-page sample reporting template. The comment period will close on October 15, 2012. The OCC is considering a delay in implementation for covered institutions with total consolidated assets between $10 billion and $50 billion until September 2013. Institutions with assets greater than $50 billion would begin conducting annual stress tests under the rule this year, although the OCC would delay implementation on a case-by-case basis where warranted. The OCC will publish a separate proposal addressing the reports required to be filed by covered institutions with assets between $10 and $50 billion.
The joint CFTC/SEC rules further defining the terms “swap,” “security-based swap,” and “security-based swap agreement” have been published in the Federal Register. The product definition rules, as they are generally known, also provide interpretive guidance regarding mixed swaps. Insurance products issued by insurance companies are largely exempted from swap classification. The effective date of the rules is October 12, 2012.
On August 22, SEC Chairman Mary Shapiro released a statement that three of the five SEC Commissioners have told her that they would not support the staff proposal to reform the structure of money market funds. As a result, Shapiro will not submit the proposal for a Commissioner vote and it therefore cannot be published for public comment. According to the statement, some Commissioners suggested a concept release; however, it seems Shapiro is unwilling to go that route. She stated: “Other policymakers now have clarity that the SEC will not act to issue a money market fund reform proposal and can take this into account in deciding what steps should be taken to address the issue.”
Shapiro pointed to SEC Rule 2a-7, which allows money market funds to seek to maintain a stable $1 NAV, as a source of systemic risk to US financial markets because money market funds have insufficient ability to absorb losses above a certain amount without “breaking the buck” and, if that were to occur, there would be massive withdrawals from money market funds which could create or further exacerbate a financial crisis. The two proposed reform alternatives were that money market funds float the NAV and use mark-to-market valuation like every other mutual fund or, alternatively, implement a tailored capital buffer of less than 1% of fund assets, adjusted to reflect the risk characteristics of the money-market fund.
On August 6, the Federal Advisory Committee on Insurance (FACI) held its second public meeting in Washington, D.C. Federal Insurance Office (FIO) Director Michael McRaith reported on his ongoing involvement in international insurance matters. An issue was raised as to whether the FIO would adopt the views of state insurance regulators with respect to the Common Framework for Supervision of Internationally Active Insurance Groups (ComFrame). ComFrame is a major project of the International Association of Insurance Supervisors (IAIS) that will be a framework that lays out how supervisors around the globe can work together to supervise the largest, most complex insurance entities. A FACI member expressed concern that the FIO and state regulators might take diametrically opposing views regarding approaches for prudential supervision. At the meeting a new subcommittee was formed and tasked with reviewing international regulatory standards currently under development, such as ComFrame. The next meeting of the FACI will be scheduled for October 2012.
On August 27, the United States Tax Court entered a ruling related to the termination of split-dollar arrangements. The matter was consolidated and was regarding six life insurance policies taken on the lives of two employees as part of split-dollar arrangements (SDAs) created in 2002. The primary issue for decision was whether the equity split-dollar arrangements were terminated and whether, when, and to what extent the employees received taxable income thereon.
Under the life insurance policies and the SDAs from March 2002 through the end of December 2003, the employer paid ~$842 thousand in premiums. In light of 409A regulations, the parties sought to terminate the SDAs. The employees’ legal counsel and tax professionals applied a present value discount for the ~$842 thousand using an assumed life expectancy for each petitioner of 85 and an interest rate of 6%. The advisers calculated the present value of the employer’s ~$842 thousand reimbursement rights at ~$132 thousand. In an audit, the IRS determined that the employees should have included ~$710 thousand (the difference between the premium the employer paid (~$842k) and the amount the employees reimbursed the employer (~$132k) as compensation income in 2003. The IRS asserted that the employees failed to pay the appropriate amount of income tax and assessed penalties. In tax court, the employees argued that they did not terminate the SDAs, but at most “a freeze” occurred. The tax court disagreed and found that they employees should have included the ~$710 thousand as income. However, since the employees appeared to act in good faith and relied on professionals, the court did not award penalties.