March 2012


Stress Testing Comment Period Extended

The Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) extended the comment period on a proposal to implement annual stress testing requirements of Section 165 of the Dodd-Frank Act.  This also coincides with the Federal Reserve’s proposed rules to implement the enhanced prudential standards of Dodd-Frank Section 165 which also includes stress test requirements.  The comment period for all three regulators is now April 30, 2012.

The Federal Advisory Council, which is composed of twelve representatives of the banking industry, consults with and advises the FRB on all matters within the FRB jurisdiction.  The Council met with the Board of Governors and in its written views expressed that the proposed stress testing disclosure requirement goes well beyond the statutory mandate of Dodd-Frank and should be modified.  The Council believed that the level and specificity of disclosure for the baseline scenario is the equivalent of requiring those banks covered by the Federal Reserve to provide earnings guidance every six months and detailed P&L forecasts for the following nine quarters and would create significant and unnecessary risks for banks and the banking sector.  The Council also expressed concern that the required disclosures would become “checklists” and would likely compel banks to prioritize the achievement of short-term results to meet checklist expectations over more appropriate longer-term risk management and sustained long-term results.  The Council advised that the Federal Reserve should focus on high-level, cumulative, summary information rather than detailed expectations and de facto guidance.  The Council also proposed allowing banks to coordinate stress-test disclosures with disclosures of quarterly financial results.

Some of the public comments included the following suggestions to regulators: changing the public disclosure from 90 days from the report to 30 days; moving the testing cycle such that the deadline to submit reports would be September 30th to avoid the influx of bank activity during the 4th quarter; tightening the requirements for the covered institutions to have to publish the test results on the institution’s website to keep them from purposefully being posted in an unnoticeable or inaccessible portion of their website – the proposed solution was to either require the banks to include the results or the direction on how to obtain the report in its annual report or annual letter to clients; for the regulators to include a “good faith effort” clause to allow for leniency for any bank conducting its initial stress test if the report is not furnished on time but is nearing completion; to lower the capital required to qualify for the stress testing to cover more financial institutions; that only the general terms of the scenarios to be tested and whether the bank in question passed the test or not should be the only publicly disclosed information as opposed to any detailed results and financial information.


FRB’s Comprehensive Capital Analysis and Review (CCAR) Results

On March 13, the Federal Reserve announced summary results of the latest round of bank stress tests, which showed that the majority of the largest U.S. banks would continue to meet supervisory expectations for capital adequacy despite large projected losses in an extremely adverse hypothetical economic scenario.  The Comprehensive Capital Analysis and Review (CCAR) evaluates the capital planning processes and capital adequacy of the 19 largest bank holding companies.  Reflecting the severity of the stress scenario – which included a peak unemployment rate of 13 percent, a 50 percent drop in equity prices, and a 21 percent decline in housing prices – losses at the 19 bank holding companies are estimated to total $534 billion during the nine quarters of the hypothetical stress scenario.  Despite the significant projected capital declines, 15 of the 19 bank holding companies were estimated to maintain capital ratios above all four of the regulatory minimum levels under the hypothetical stress scenario.

MetLife Chairman and CEO Steve Kandarian issued a statement regarding its participation in the 2012 CCAR and the Federal Reserve’s objection of its incremental capital distribution plan: “MetLife is financially strong and well positioned for both the current environment and a potential further economic downturn.  We are deeply disappointed with the Federal Reserve’s announcement.  We do not believe that the bank-centric methodologies used under the CCAR are appropriate for insurance companies, which operate under a different business model than banks….  The established ratios used to measure insurance company capital adequacy, such as the NAIC’s risk-based capital ratio, show that MetLife is financially strong.  At year-end 2011, MetLife had a consolidated risk-based capital ratio of 450%, well in excess of regulatory minimums.

MetLife is the only bank holding company with predominate business activities in the insurance sector.  MetLife has been very public about its intention to cease being a bank holding company by the end of the second quarter of 2012.


Senate Hearing on International Harmonization of Wall Street Reform

On March 22, the Senate banking committee held a hearing entitled, “International Harmonization of Wall Street Reform: Orderly Liquidation, Derivatives, and the Volcker Rule.”  The banking regulators reviewed the initiatives their respective agencies were undertaking as well as those being addressed in collaboration with other domestic and foreign regulators.  The regulators expressed that many of the initiatives allowed for international harmonization within financial reform.  However, it was also noted that there are areas where policy makers in individual countries have chosen to tailor standards to their country’s specific circumstances rather than adopt the totality of an international approach.  One U.S. example of this tailoring is the “Collins Amendment,” which requires the same generally applicable minimum capital requirements to be applied to bank holding companies as apply to banks and places a floor under the capital requirements of large banks applying Basel’s advanced approaches capital framework.  Another is Section 939A of Dodd-Frank which requires all federal agencies to remove references to, and reliance on, credit ratings from their regulations and replace them with appropriate alternatives for evaluating creditworthiness.  Basel III, in contrast continues to rely on credit ratings in many areas so implementation of those provisions of Basel III will differ from international standards, and generally be more stringent in the U.S.

However, arguably the most notable difference is the Volcker Rule’s prohibitions on proprietary trading and private equity and hedge fund investments, which unlike capital and liquidity requirements, currently are not the subject of international harmonization efforts.  Concerns surrounding the Volcker Rule difference in treatment include regulatory arbitrage, regulatory uncertainty, and unfair competition.  Also foreign sovereignties have expressed concern of the extraterritorial impact the Volcker Rule regulations may have which may conflict with foreign laws and may be inconsistent with the regulatory approach adopted by foreign regulators.  Another international concern is the preferential treatment afforded to U.S. government obligations as compared to obligations issued by foreign governments.



House Republicans FY2013 Budget Proposal

On March 20, House republicans released a FY2013 Budget Proposal entitled “The Path to Prosperity: A Blueprint for American Renewal” and on March 29, the House voted 228-191 to approve the budget.  All Democrats and 10 Republicans voted against the proposal.  The budget consolidates the current six individual income tax brackets into two brackets of 10 and 25 percent and repeals the Alternative Minimum Tax.  It would reduce the corporate rate to 25 percent and move to the so-called “territorial” system of international taxation, whereby businesses earning income abroad are subject only to the tax system of the country where the income is earned.  The budget would also cut government spending, cut the size of government to 20 percent of the economy, repeal the Obama’s federal health reform law, and alter Medicaid and Medicare among other things.

Democrats largely targeted their criticism on the budget’s plan to overhaul Medicare while not raising taxes for high-income U.S. residents.  They also charged that the budget’s proposal to cap Medicare spending growth would fail to keep up with the program’s costs, imposing an even larger burden on beneficiaries.  Rep. David McKinley (R-W. Va.), one of the 10 Republicans who voted against the budget, noted that he has supported cuts amounting to more than $5 trillion in government spending but said that he found the House budget to be unacceptable.  “I can’t support a plan that cuts Medicare, removes widely-used tax credits for homeowners and health care, and still doesn’t balance the budget for 28 years.”



Congressional Report on Income Tax Reform and Tax Base Broadening

On March 22, the Congressional Research Service (CRS) issued a report entitled, “The Challenge of Individual Income Tax Reform: An Economic Analysis of Tax Base Broadening.”  The report analyzes congressional interest in major reform of the individual income tax and evaluates the possibilities to repeal or substantially trim most special tax deductions, credits, exclusions, and special rates, also known as tax expenditures.  According to the report, for FY2014, individual income tax expenditures, which account for most of the potential base broadening provisions, are projected to total over $1.1 trillion.

However, the CRS authors conclude that it appears unlikely that a significant fraction of this potential revenue could be realized.  Instead of the more than $1 trillion that could be gained if all tax expenditures were eliminated–which would support substantial marginal tax rate reductions including reducing the top rate from 39.6% to 23%–they believe it may prove difficult to gain more than $100 billion to $150 billion in additional tax revenues through base broadening.  Some reasons offered include the fact that some large tax expenditures, notably the exclusion of employer health insurance and the exclusion of Medicare, which account for 20% of the total revenue loss of all tax expenditures ($240.4 billion), are also in-kind benefits that are not easily valued.  Other impediments are that tax expenditures are viewed as serving an important purpose, are important for distributional reasons, are technically difficult to change, are broadly used by the public and quite popular.  The CRS is the nonpartisan public policy research arm of Congress that works exclusively for congressional members, their committees and their staffs.



Cowboy Athletics, Inc. v. Lincoln Nat’l Life Insurance

On March 9, a federal district court judge ended the two year litigation between Cowboy Athletics Inc., a nonprofit organization formed to support athletics at Oklahoma State University (OSU) and OSU alumnus T. Boone Pickens, against Lincoln National Life Insurance Company.  In 2007, Cowboy Athletics adopted a charitable life insurance program entitled “The Gift of a Lifetime.”  Under the program, an annual $16 million premium payment for the policies would be covered by a premium finance loan, which in turn would be repaid using the death benefits from the policies with the excess of any such benefits becoming a stream of future income to Cowboy Athletics projected somewhere between $100 million and $350 million.  In 2009, facing a third premium with no offsetting death benefits (no alumnus had died), Cowboy Athletics requested the physical policies to be delivered and a few days after the physical delivery, requested Lincoln to cancel the policies and return all premium payments.  At that time, Cowboy Athletics did not make any subsequent premium payments.  Lincoln maintained that the policies were delivered in 2007 and the free look period had expired.  In January 2010, Cowboy Athletics and Mr. Pickens filed a suit in state court seeking rescission of each of the twenty-seven $10 million life insurance policies that Cowboy Athletics had purchased on the lives of OSU alumni, claiming breach of contract arguing that Lincoln was required to physically deliver the policies to Cowboy Athletics for the free look period to begin.

Lincoln countersued Mr. Pickens and Cowboy Athletics in federal court, seeking a declaratory judgment preventing the rescission.  The countersuit also alleged that Mr. Pickens tortuously interfered with Lincoln’s contract with Cowboy Athletics by encouraging that organization to breach its contract with Lincoln.  The federal judge found that the policies were constructively delivered when the authorized official signed the policy delivery receipts, and were valid despite Cowboy Athletics not taking physical possession of the policies until two years after the contracts were executed.  The judge noted that the fund could have obtained the physical policies at any time and that the fund treated them as valid policies evidenced by the payment of premiums.  The judge also disagreed that the fund or Mr. Pickens were victims of fraud finding that there was evidence that the fund, Mr. Pickens and the insurance brokers created the program and that the officials at the athletic fund had gotten their own due diligence report.  In addition to Lincoln being able to keep the $33.3 million premium payments, Cowboy Athletics will also have to cover the litigation costs by Lincoln and the other defendants. The state court matter is still open and Cowboy Athletics may decide to appeal the federal court decision.



NY Producer Compensation Disclosure Rule Upheld

In January 2010, the New York Insurance Department (now part of the New York Department of Financial Services) issued its final rule, Insurance Regulation 194, requiring insurance producers to disclose their role within the sale of insurance, compensation received as a result of the sale and all other factors that contribute to their compensation.  Some trade associations and insurance groups, lead by the Council of Insurance Brokers of Greater New York (CIBGNY) and the Independent Insurance Agents & Brokers of New York (IIABNY), challenged the ruling claiming that the state’s insurance superintendent acted outside the scope of his authority.  In a March 8 decision, the appellate court upheld the regulation as lawful.  The court relied on precedent that provided that a regulation promulgated by the superintendent, if not irrational or unreasonable, will be upheld in deference to his special competence and expertise with respect to the insurance industry, unless it runs counter to the clear wording of a statutory provision.  This matter was an appeal from a judgment of the NY Supreme Court entered November 2010 which dismissed the trade associations’ application in a proceeding pursuant to CPLR article 78 to annul Insurance Regulation 194.