Chapter 2- Legal And Regulatory Environment Flashcards
Office of foreign assets control (OFAC)
Office of the us treasury that administers and enforces economic and trade sanctions against targeted foreign countries, terrorist sponsoring organizations and drug traffickers
Secret service
Created in 1865 to suppress counterfeit currency. Deals with check fraud, credit card fraud and identity theft
Securities and exchange commission (SEC)
Federal agency designed to maintain a fair and orderly market for investors by regulating and supervising securities sales
Responsibilities:
- registering public offerings
- setting financial disclosure standards for corporations
- requiring public companies to file financial reports (annual and quarterly)
- regulating mutual funds and investment advisors
- monitoring insider trading
Focused on protecting investors
Federal reserve act of 193
Established the Fed
Glass-Steagall Act (banking act of 1933)
Passed to deal with banking issues coming out of the Great Depression
- prohibited commercial banks from underwriting securities except for government issues
- prohibited securities firms from engaging in bank like activities such as deposit gathering
- required the Fed to establish IR ceilings and prohibit the payment of interest on demand deposits
- created the FDIC
Tying
The act of requiring an organization or individual to purchase a product or service in order to be allowed to obtain a separate product or service
Gramm-leach-Bliley Act 1999
Eliminates most of glass-steagall
Specifically eliminating the barriers between commercial and investment banks and insurance
- permits the creation of financial holding companies (FHC)
- allows easier entry of foreign banks into the us
- allows for key provisions relating to consumer protections
establishes the Fed as the primary regulator of FHCs
Dodd-Frank 2010
Created in response to the 2007-2009 financial crisis
Overall goal to bring more transparency and accountability to the derivatives markets
- closes regulatory gaps
- require central clearing and exchange trading
- require market transparency
- adds financial safeguards
- sets higher standards of conduct
Volcker Rule
Part of Dodd frank
Limits an FI’s ability to engage in proprietary trading for its own portfolio
Prohibits FI’s from owning or sponsoring hedge funds or private equity funds
Electronic fund transfer act (EFTA) 1978
Defines the rights and responsibilities of customers using all electronic funds transfer services except wires
Limits customer liability for unauthorized banking transactions, provides the customer notices the bank or other institution who issued the card
Depository institutions deregulation and monetary control act (DIDMCA) 1989
- requires all deposit-taking institutions to maintain reserves at the fed
- makes the Fed services such as discount window and check clearing available to all deposit-taking institutions
- mandates the fed to reduce and/or price payment system float and price previously free fed services according to standards of tax paying vendor
Electronic structures in global and national commerce act (E-sign Act) 2000
Grant digital signatures the same legal status as handwritten ink signatures
Check clearing for the 21st century act (Check 21) 2003
Basis for electronic clearing of checks by allowing the substitution of a copy or image of a check for the original document in the clearing process
Bank secrecy act (BSA) and money laundering control act (MLCA) 1986
Purpose is to control the flow of illegal money when money is laundered to conceal illegal activity
BSA requires all FIs to report any suspicious financial transactions, a paper trail is created to assist in detection
Makes money laundering a federal crime and FIs are liable if they fail to comply the record keeping and anti money liam front provisions
Requires KYC stuff
Report and monitor:
- activity inconsistent with customer’s business
- attempts by customers to avoid reporting or record-keeping requirements
- unusual or multiple funds transfer activities
- customers who provide insufficient or suspicious information
Financial Institutions (FI)
- provide a mechanism for savers of capital to transfer that capital to others that need capital
- commercial bank is the most common type (provides both deposits and loans )
Net Interest Margin
- the difference between the interest rate at which the bank lends to borrowers and the interest rate that the bank pays to depositors for funds on deposit
- primary way banks make money
Primary Job of Regulators
To monitor the credit and liquidity risks relating to potential bank failures and to implement safeguards that can reduce the overall risk of systemic failure
5 Main areas of financial regulation
1) monitoring and managing the overall safety ans soundness of the banking system
2) setting and implementing monetary policy
3) determining guidelines for the chartering of banks and other depository institutions
4) allocating credit toward certain economic segments and protecting consumers
5) protecting investors purchasing securities through FIs
Minimum capital levels
-regulatory approach applied to create safety in the system
-requires bank owners to contribute equity aka capital to the business
-Key ratio:
Bank’s capital/ At risk assets
at risk assets include loans and other investments
higher the ratio the less the risk
Impairment of Capital Rules
- regulatory approach applied to create safety in the system
- regulators will monitor the quality of the loan and investment portfolio, restricting how much can be loaned or invested in a particular company or industry sector
Regulatory approaches to monitoring and managing the overall safety and soundness of the banking system
1) Minimum Capital Levels
2) Impairment of Capital Requirements
3) Deposit Insurance
4) regulatory monitoring and surveillance ( onsite examiners)
Deposit Insurance (Deposit Guarantee)
- regulatory approach applied to create safety in the system
- intended to protect the deposits of smaller deposit customers
- increases overall confidence in the banking system
- Moral Hazard
- Depositors have little incentive to investigate banks since the government will cover defaults
- banks have limited incentive to be cautious since if they fail, the government will bail out depositors (makes the banks take more risks)
Monetary Policy
Action taken by the central bank to control money supply and interest rates
Chartering Process
The establishment or opening of banks and other deposit institutions along with the guidelines regarding the types of financial services they are allowed to offer
tend to specify the amount of capital needed to open banks
Typical central Bank Responsabilities
1) Monetary Policy
2) Currency Issuance
3) Supervision and Regulation
4) Government Services
5) Depository Institution Services
Discount Rate
the rate for lending to FIs set by the FED
Financial Stability Board (FSB)
- based in Basel, Switzerland
- Established to provide international coordination of national financial authorities and international standard-setting bodies
FSB Goals
1) maintain financial stability
2) promote the openness and transparency of the financial sector
3) implement international financial standards
4) conduct periodic peer reviews
Bank for International Settlements (BAS)
- established in 1930 after WWI, oldest international financial institution
- aims to foster cooperation among central banks and increasingly other agencies in pursuit of monetary and financial stability
History
- focused on the implementation and defense of Bretton Woods Agreement
- helped manage cross-border capital flow following oil crisis
- Basel Accords (all 3)
- acts as a traditional bank, funding the bank community (gold and FX transactions)
Group of Governors and Heads of Supervision (GHOS)
- committee that is part of BIS
- is the governing body of the Basel Committee and is comprised of central bank governors and non central bank heads of supervision from member countries
Committee on the Global Financial System (CGFS)
- committee that is part of BIS
- is a central bank forum for the monitoring and examination of broad issues relating to financial markets and systems
Committee on payment and settlement systems (CPSS)
- committee that is part of BIS
- is a BIS hosted standard setting body for payment and securities settlement systems
Basel Committee on Banking Supervision (BCBS)
- committee that is part of BIS
- Established in 1974
- is a standard setting body that provides a forum for regular cooperation on banking supervisory matters. goal is to reduce systemic risk, enhance understanding of key supervisory issues, improve quality of banking supervision worldwide
- this is the group that publish the Basel Accords which set minimum capital ratios for large banks based on credit risk of various assets
Herstatt Risk
foreign exchange settlement risk, especially between bank counterparties
-named after the Herstatt bank failure in 1974
Basel Capital Accords
Issues by the BCBS
-first set Basel I, issued in 1988 and set minimum capital ratios for large banks based on credit risk of various assets
- Basel II: set in 2004, expanded risk rantings of Basel I and added an assessment of operation risk to the existing credit risk evaluation in establishing core capital requirements for major banks. Was based on three pillars:
1) Minimum capital requirements to address credit and operational risk
2) supervisory review, which provided a framework for dealing with and evaluating risk
3) market discipline, which focused on disclosure requirements regarding risk metrics and capital adequacy
Basel III: developed in 2011,in response to the global financial crisis of 2007-2009. Extended Basel II to address stress testing and market liquidity risk as well as capital adequacy. Scheduled to be implemented in 2018
Basel III Goals:
1) improve the banking sector’s ability to absorb shocks arising from financial and economic stress
2) improve risk management and governance
3) strengthen banks’ transparency and disclosures
European Payments Council (EPC)
the coordination and decision making body of the European banking industry in relation to payments.
The purpose of the EPC is to support and promote the single euro payments area
Single Euro Payments Area (SEPA)
establishes minimum standards and common pricing for payments processing within the EU
- seeks to incentivize increased use of electronic payments by standardizing practices
- create single standard for payments
European Securities and Market Authority (ESMA)
an independent EU authority that contributes to safeguarding the stability of the EU’s financial system by ensuring the integrity, transparency, efficiency, and orderly functioning of securities markets, as well as enhancing investor protection.
Partially responsible for the implementation and administration of the EMIR
European Market Infrastructure Regulation (EMIR)
adopted by European Parliament in 2012
-is intended to increase the stability of OTC derivatives market throughout Europe and implements reporting and clearing obligations for OTC derivatives (similar to Dodd Frank)
International Association of Deposit Insurers (IADI)
-goal is to enhance the effectiveness of deposit insurance systems by promoting guidance and international cooperation
International Organization of Securities Commissions (IOSCO)
International standard setter for securities markets
Financial Action Task Force (FATF)
Primary purpose is the development and promotion of policies nationally and internationally that combat money laundering and terrorist financing
Money Laundering
Any financial transaction which generates an asset or a value as a result of an illegal act, which may involve actions such as tax evasion or false accounting
Three Stages of Money Laundering
1) Placement: the physical deposit of cash proceeds from illegal activities into an FI
2) Layering: A series of financial transactions designed to separate cash proceeds from their criminal or terrorist origins
3) Integration: Creating what appears to be a legitimate explanation for the source of funds (e.g showing that funds were donated for a charitable purpose)
International Association of Insurance Supervisors (IAIS)
A standard setting group that represents insurance regulators and supervisory entities of some 190 jurisdictions in 140 countries
objective is to encourage cooperation among the members on both the international and domestic levels
helps to ensure the maintenance of efficient, fair, safe, and stable insurance markets, ultimately benefiting and protecting policy holders
International Swaps and Derivatives Association (ISDA)
Purpose is to improve the safety and efficiency of the world’s swaps and derivatives markets
Dual Banking System
The US has a dual banking system meaning that banks are either federally or stat chartered
Commodity Futures Trading Commission (CFTC)
created in 1874 with the mandate to regulate commodity futures and options markets in the US
post Dodd-Frank works with SEC to regulate OTC derivatives
Consumer Financial Protection Bureau (CFPB)
Independent consumer protection entity with in the Fed that was created in 2010 by Dodd-Frank to consolidate and strengthen consumer protection responsibilities and oversee the enforcement of federal laws intended to ensure fair and equitable access to credit for individuals and communities
Department of Justice (DOJ)
reviews and approves proposed bank mergers and holding company acquisitions. plays role in investigating FI Fraud and theft as well as enforcing key money laundering legislation.
Federal Deposit Insurance Corporation (FDIC)
established in 1933 as part of Glass-Steagall. primary role is to protect depositors from losses caused by insolvency
Responsibilities include:
1) providing deposit insurance for all insured FIs
2) supervising selected depository institutions
3) Acting as a trustee in the event of bank failures
administered the Deposit Insurance Fund (DIF)
Financial Crimes Enforcement Network (FinCEN)
Serves as the US financial intelligence unit (FIU) primary agency that oversees and implements polices to prevent and detect money laundering
Financial Industry Regulatory Authority (FINRA)
is the largest independent regulator for all securities firms and registered securities representatives doing business in the US
involved in most aspects of securities:
- Registering and educating industry participants
- examining brokerage firms
- writing and enforcing rules related to federal securities laws
- informing and educating the investing public
- providing trade reporting and other industry utilities
- administering the primary dispute resolution forum for investors and registered firms
Financial Stability Oversight Council (FSOC)
FSOC responsibility is to prevent systemic risk from threatening the financial system by identifying threats to financial stability and gaps in regulations and facilitating coordination across federal and state agencies
was created by Dodd frank and has authority of the Fed’s board of governors
National Credit Union Administration (NCUA)
independent federal agency that charters and supervises federal credit unions
Patriot act 2001
After 9/11 increased latitude in intelligence gathering activities intended to make it easier to prevent, detect and prosecute money laundering
Some provisions:
- imposes significant obligations upon nonbank FIs
- makes all foreign banks with accounts in the US subject to US jurisdiction
- prohibits US banks from maintaining either directly or indirectly, correspondent accounts for any shell banks
- prevents us credit card system operators from authorizing foreign banks to issue or accept us credit cards without taking steps to prevent usage by terrorists
- requires banks to know their customers, resulting in increased due diligence before creating new accounts
Foreign shell bank
A foreign bank without physical presence in any country
Sarbanes-Oxley Act (SOX) 2002
Purpose is to improve disclosure and financial reporting
Firms must:
- disclose in annual reports the code of ethics applicable to senior financial officers
- disclose in annual reports whether the audit committee has a financial expert
- establish and maintain adequate internal controls for financial reporting
- require audit committees to preapprove all audit and non audit services provided by the auditor
SEC Reg G implements SOX and requires public companies to reconcile pro forms financial info to financial statements
The Red Flags Rule
Refers to regulations that require FIs and creditors to develop and implement written identity theft prevention programs as part of the Fair and Accurate Credit Transactions Act of 2003 (FACT)
Foreign Account Tax Compliance Act (FATCA) 2010 and the report of foreign bank and financial accounts (FBAR)
FATCA was implemented to address tax and non compliance by US taxpayers with foreign bank accounts.
Requires US tax payers to file an annual report of all foreign financial accounts and offshore assets. Also requires foreign financials institutions to report financial accounts held by us taxpayers
Regulation D -Fed Regs
Implements reserve requirements for deposit institutions
Fed uses this to control money supply
Regulation E -Fed Reg
Implements provisions of the Electronic Fund Transfer Act of 1978, which establishes the rights, responsibilities and liabilities of parties engaged in consumer-related EFTs. Protects consumers using ATMs, ACH and credit cards
Regulation J-Fed Regs
Implements check collection and settlement provisions through the Fed
Regulation Q -Fed Regs
Implemented the interest-bearing account restriction of the Glass-Steagall Act and barred the paying of interest on any corporate demand deposit accounts (for profit Cos)
Regulation Y-Fed Regs
Implements provisions of Bank Holding Company Act of 1956. Covers the acquisition of control of banks and bank holding companies and defines and regulates non banking activities
Regulation Z -Fed Regs
Applies to the Truth in Lending Act of 1968 (TILA) which is concerned with promoting informed use of credit by consumers.
Was updated on feb ‘10 to implement the Credit Card Accountability responsibility and Disclosure Act of 2009 (Credit CARD Act)
- protects co summers for unexpected increases in credit card interest rates, by generally prohibiting rate increases in the first year
- prohibits creditors from issuing a credit card to a consumer who is under the age of 21 unless the consumer can make required payments
- requires creditors to obtain consumer’s consent before charging fees for transactions that exceed the credit limit
- limits high fees associated with subprime ccs
- band creditors from using two cycle billing to impose interest charges
- prohibits creditors for allocating payments in ways that maximize interest charges
Regulation BB -Fed Regs
Implements provisions of the Community Reinvestment Act of 1977 ad revised in 95.
Requires banks to meet the credit needs of the entire community in which they do business
Regulation CC - Fed Regs
Implements part of Expedited Funds Availability Act of 1987 which establishes rules designed to speed the collection and return of checks
Fair Disclosure, Regulation FD
Provides when an issuer discloses material non public information to certain individuals or entities, generally, securities market professionals such as analysts or others who could trade on the info- the issuer must make that info available to the public
SEC Rule 2a-7
Governs Money Market Funds. stipulates what securities can be held by an MMF with the goal of insuring adequate diversity in the portfolio. post 2016 rules were expanded to include the ability for MMF redemption to be suspended if liquidity is in question
Article 3: Negotiable Instruments
how bank’s handle unauthorized signatures and who can be liable should one be used
Article 4: Bank Deposits and Collections
Include rights, responsibility and definition of the parties involved in deposit and collection processes. Addresses the relationship between a bank and its customers.
Defines:
- when a bank may charge a customer’s account
- The bank’s liability to a customer for failing to honor a good check
- The customer’s right to stop payment
- The bank’s option not to pay an item more than six months old
- A customer’s duty to report an unauthorized signature or alternation
Article 4A: Funds Transfers
provides a legal framework that outlines the risks, rights and obligations of parties in connection with electronic funds transfers.
Article 5: Letters of Credit
Covers US commercial letters of credit
Article 9: Secured Transactions
Under this article any business that requires such a security interest must file a UCC-1 financing statement with its state’s office of assessments and taxation
Unclaimed Property (Escheatment) Legislation
impacts banks or companies that hold unclaimed assets of customers or employees. for non banks this is the process of turning over assets to a state authority
Unitary Tax
A tax on a corporation’s global income
Foreign tax credit
to relieve the effect of double taxation, US tax law grants a US company a credit against its total US income tax liability for foreign income taxes paid by the company and any subs
Capital Tax
a tax assessed on a initial capital used to establish the new venture and on subsequent incoming capital or repatriated capital
purpose can be to slow foreign direct investment
Asset Tax
taxes on the value of accumulated real property or business equipment or on the value of a financial portfolio
Turnover Tax
a sales tax on goods and services
Withholding Tax
taxes levied when companies move funds outside a foreign country
Sales Tax
charged at the point of purchase for certain goods and services
Use Tax
imposed directly on the consumer of goods that were purchased without paying sales tax
Value Add Tax (VAT)
a type of sales tax. a separate tax is charged at each discrete stage of production
Bondholders’ Rights - Bankruptcy
normally senior to those of equity holders. creditors have the right to force a company into bankruptcy
Involuntary Bankruptcy
When three or more creditors of the firm petition the federal bankruptcy court to force a company into bankruptcy
Shareholders’ Rights - Bankruptcy
tended to have junior or limited rights
Types of Bankruptcy
Chapter 7, chapter 9, Chapter 11, Chapter 13, chapter 15
Chapter 7 - Bankruptcy
Liquidation of a firm
Designed to accomplish 3 objectives
1) provide safeguards against the withdrawal of assets by the owners of the bankrupt firm
2) Provide for an equitable distribution of the assets among creditors
3) Allow insolvent debtors to discharge all of their obligations and start over unhampered by the burden of prior debt
Chapter 9 - Bankruptcy
Financially distressed municipalities (City, State Govt)
Chapter 11 - Bankruptcy
Business reorganization
- existing management remains in control
- firm must adopt a reorganization plan (cram down procedure or unanimous)
Chapter 13 - Bankruptcy
Adjustment of debts for individuals with regular income (Personal Bankruptcy)
Chapter 15 - Bankruptcy
Establishment of bankruptcy trustees for bankruptcies that involve companies, assets or individuals in more than one country
Chapter 11- Unanimous Consent Procedure
all classes of creditors and equity holders must consent to the reorganization plan, with 2/3 vote of all members in each class consenting.
Management is in strong bargaining position. Only management can propose a plan in the first four months of filing. Only after all parties have voted on management’s initial plan can other parties propose plans
Chapter 11 - Cram Down Procedure
Generally executed by secured creditors
comes into play when a reorg fails
if at least one class of creditors has voted in favor of the plan then the court can confirm the plan as long as each dissenting class is treated fairly
higher transaction costs
Chapter 7 Asset Distribution - Absolute Priority Rule
1) Secured creditors are entitled to the proceeds of the sale of specific property pledged for a lien or a mortgage
2) Trustee’s costs to administer and operate the bankrupt firm are reimbursed next
3) Expenses incurred after an involuntary liquidation has begun but before a trustee is appointment
4) wages to workers if earned within three months prior to filing
5) claims for unpaid contributions to employee benefit plans that should have been paid within six months prior to filling
6) Unsecured claims for customer deposits
7) taxes
8) unfunded pension plan liabilities up to 30% of the book value of the common and preferred equity
9) General, unsecured creditors
10) Preferred stock
11) common stock
Formal Bankruptcy
case is filed and taken before a bankruptcy court
Types of formal procedures
Free-Fall:
-a firm files or is forced into bankruptcy and has no structured plan for coming out
Prearranged:
management has arranged a tentative deal with some of the creditors
Prepackaged:
management files with the SEC a formal plan that all classes of creditors have voted on and accepted
