Financial Institutions Executive Briefing
Nov. 13, 2013
The Financial Institutions Executive Briefing offers updates on financial reporting, governance, and risk management topics from Crowe Horwath LLP. In each issue of this electronic newsletter, you will find abstracts of recent standard-setting activities and regulatory developments affecting financial institutions.
From the Federal Financial Institution Regulators
TDR Guidance Issued
On Oct. 24, 2013, the Board of Governors of the Federal Reserve System (Fed), the Federal Deposit Insurance Corp. (FDIC), the National Credit Union Administration (NCUA), and the Office of the Comptroller of the Currency (OCC) jointly issued “Interagency Supervisory Guidance Addressing Certain Issues Related to Troubled Debt Restructurings.” The agencies aim to clarify certain issues related to the accounting treatment and regulatory classification of commercial and residential real estate loans that have undergone troubled debt restructurings (TDRs). The guidance reiterates important aspects of previously issued guidance. In addition, it includes information about the definition of collateral-dependent loans and the classification and charge-off treatment for impaired loans, including TDRs.
Crowe Horwath LLP has published an article discussing additional details of the guidance.
FDIC Concerns About Sensitivity to Interest-Rate Risk Addressed
On Oct. 8, 2013, the FDIC issued to financial institutions a letter expressing concern about banks’ sensitivity to interest-rate risk. In the letter, the FDIC emphasized the importance of prudent interest-rate risk oversight and effective risk management processes to help institutions prepare for a period of rising interest rates. The FDIC re-emphasized that a comprehensive asset-liability and interest-rate risk management process should include:
- Effective board and management oversight
- An appropriate policy framework and prudent exposure limits
- Effective measurement and monitoring of interest-rate risk
- Proactive risk mitigation strategies
Stress-Test Tool Issued by FDIC
The FDIC has announced the release of a template for company-run annual stress testing for institutions with total consolidated assets of $10 billion to $50 billion. The FDIC will use the data collected through the templates to assess the reasonableness of the institution’s stress-test results. The completed template reports are to be submitted electronically through Reporting Central, the Federal Reserve Board’s electronic reports submission application.
Guidance on Third-Party Relationships Released by OCC
The OCC on Oct. 30, 2013, issued updated guidance on risk management related to third-party relationships. The guidance continues to emphasize that the use of third parties does not diminish the responsibility of the board and management to ensure that the activity conforms to safe and sound banking practices and complies with applicable laws. The OCC advises banks to adopt risk management processes commensurate with the risk and complexity levels of their third-party relationships. There should be more comprehensive oversight and management of third-party relationships that involve critical bank activities.
To manage risks from third-party relationships, the OCC advises banks to do the following:
- Develop a plan that outlines the bank’s strategy, identifies the inherent risks of the activity, and details how the bank will select, assess, and oversee the third party.
- Perform proper due diligence to identify risks and select a third-party provider.
- Negotiate written contracts that clearly outline the rights and responsibilities of all parties.
- Conduct ongoing monitoring of the third party’s activities and performance.
- Execute a plan to terminate the relationship in a manner that allows the bank to transition the activities to another third party, bring the activities in-house, or discontinue the activities.
- Assign clear roles and responsibilities for overseeing and managing third-party relationships and the risk management process.
- Maintain proper documentation and reporting to facilitate oversight, accountability, monitoring, and risk management.
- Conduct independent reviews of the risk management process to enable management to assess that the bank’s process aligns with its strategy and effectively manages the risks from third-party relationships.
Rule Proposed to Strengthen Liquidity Positions of Large Institutions
The Fed, the FDIC, and the OCC have proposed a rule to create a standardized minimum liquidity requirement for large financial institutions. The proposed rule is generally consistent with the liquidity coverage ratio standard established by the Basel Committee on Banking Supervision. Each covered institution would be required to hold liquidity in an amount equal to or greater than its projected cash outflows minus its projected cash inflows during a short-term stress period.
The rule would apply to all internationally active banking organizations with more than $250 billion in total assets or more than $10 billion in on-balance-sheet foreign exposure and to systemically important nonbank financial institutions. Bank holding companies and savings and loan holding companies that are not active internationally but have more than $50 billion in total assets would be subject to less stringent liquidity coverage ratio requirements.
Comments on the proposed rule are due Jan. 31, 2014.
Standards Proposed for Assessing Diversity Policies and Practices
Section 342 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) requires each federal financial regulatory agency to develop standards for assessing diversity policies and practices in the institutions they regulate. On Oct. 23, 2013, the Fed – along with the Consumer Financial Protection Bureau, the FDIC, the NCUA, the OCC, and the Securities and Exchange Commission (SEC) – announced the proposal of joint standards addressing this requirement.
The agencies intend for the proposed assessment standards to facilitate greater awareness and transparency of the diversity policies and practices of regulated entities. The proposed standards address four key areas: organizational commitment to diversity and inclusion, workforce profile and employment practices, procurement and business practices and supplier diversity, and practices to promote transparency of organizational diversity and inclusion. According to the agencies, the proposed standards take into account individual entity circumstances such as size, number of employees, governance structure, income, geographic location, and community characteristics.
Once the proposed standards have been published in the Federal Register, there will be a 60-day comment period.
From the Consumer Financial Protection Bureau (CFPB)
Remittance Transfer Examination Procedures Issued
On Oct. 22, 2013, the CFPB published the procedures it will use to examine institutions that make remittance transfers for consumers. A remittance transfer is an electronic transfer of money from a consumer in the United States to a person or business in a foreign country. In February 2012, the CFPB issued a final rule (subpart B of Regulation E) outlining how providers of these remittance transfers should treat consumers. That rule, which subsequently has been amended to address some implementation challenges, goes into effect on Oct. 28, 2013. The examination procedures are intended to help institutions understand how CFPB examiners will review compliance with the rule’s provisions about required disclosures, error resolution procedures, and refund and cancellation rights.
In conjunction with the release of the examination procedures, the CFPB also launched its eRegulations platform, which is intended to make regulations easier to find, read, and understand. Regulation E is the first regulation to be included in this new Web-based tool. Using the eRegulations tool, users can identify and display definitions for specific terms in the text of a regulation, easily access current and previous versions of a regulation, and navigate among regulation text, official interpretations, appendices, and certain section-by-section analyses contained in Federal Register notices.
HMDA Enforcement Actions Announced
The CFPB announced on Oct. 9, 2013, enforcement actions against two financial institutions for violating the Home Mortgage Disclosure Act (HMDA). Examiners had determined during their HMDA reviews that the institutions’ compliance systems were inadequate and that their reported 2011 mortgage lending data contained significant errors. Both of the institutions were ordered to pay a civil penalty, correct and resubmit 2011 HMDA data, and develop and implement effective HMDA compliance management systems to prevent future violations.
In addition, the bureau released a bulletin reminding mortgage lenders about the importance of submitting correct mortgage loan information and effective HDMA compliance management. The bulletin discusses the components of an effective HMDA compliance management system, including employee training, internal audits of information accuracy, and the assignment of responsibility for timely and accurate reporting. The bulletin discusses the factors the CFPB may consider when evaluating whether to pursue a public enforcement action for HMDA violations. The bulletin also announces the release of the CFPB’s “HMDA Resubmission Schedule and Guidelines,” which lists the error thresholds that CFPB examination teams will use to determine when institutions should correct and resubmit their HMDA data.
From the Financial Accounting Standards Board (FASB)
Board Votes to Move Forward With a New Revenue Recognition Standard
The FASB voted on Nov. 6, 2013, to continue to move toward the issuance of new guidance on revenue recognition. The FASB staff was directed to prepare a ballot draft to be submitted to the board for final approval. If approved, an Accounting Standards Update (ASU) is expected to be issued in early 2014. The new rules are expected to be effective for public companies in 2017 and for private companies in 2018.
Issuance of an ASU on revenue recognition will mark the completion of one of the FASB’s major joint projects with the International Accounting Standards Board. The project was started with the objectives of clarifying the principles for recognizing revenue and developing common revenue standards for U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). The goals of the joint project were to establish a new revenue standard that would:
- Eliminate inconsistencies and weaknesses from existing revenue requirements
- Provide a more robust framework for addressing revenue issues
- Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets
- Improve disclosure requirements to provide more useful information to users of financial statements
- Reduce the number of requirements to which an entity must refer in order to simplify the preparation of financial statements
Q&A About Disclosure Framework Project Published
The FASB published a question-and-answer (Q&A) fact sheet on Oct. 10, 2013, about its disclosure framework project, which focuses on finding ways to improve the effectiveness of disclosures made in financial statements. The fact sheet, which describes the FASB’s and the reporting entity’s decision-making processes, is a response to questions stakeholders frequently ask about the project, including:
- Is the primary goal of the project to reduce the volume of the notes to financial statements?
- Will the board’s decision-making process require financial statement preparers to disclose predictions and forecasts of future cash flows?
- Will it eliminate disclosure overlap among U.S. GAAP, SEC rules, and other regulatory requirements?
- How does the disclosure framework project relate to private companies?
Exposure Draft Addressing Stock Compensation Issued
On Oct. 23, 2013, the FASB issued for comment an exposure draft of a proposed ASU, “Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period.” The proposed guidance addresses the diverse accounting treatments for stock compensation in various situations, such as when an employee is eligible to retire or to terminate employment before the end of the period in which a performance target could be achieved and still be eligible to benefit from the award if and when the performance target is met. A performance target that could be achieved after the requisite service period would be treated as a performance condition that affects the vesting of the award. Compensation cost would be recognized if it is probable that the performance condition will be achieved. The total amount of compensation cost recognized during and after the requisite service period would reflect the number of awards that are expected to vest and would be adjusted to reflect the awards that ultimately do vest.
Comments on the proposal are due Dec. 23, 2013.
Embedded Derivative Clarification Proposed
A proposed ASU, “Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity,” also issued on Oct. 23, 2013, is intended to clarify how existing U.S. GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument issued in the form of a share. The proposed guidance would require an entity to consider the economic characteristics and risks of the entire financial instrument, including the embedded derivative that is being evaluated for separate accounting from the host contract. In evaluating the stated and implied substantive terms, the existence or omission of any single feature – including a fixed-price, noncontingent redemption feature – would not necessarily determine the economic characteristics and risks of the host contract.
Comments on the proposal are due Dec. 23, 2013.
From the Securities and Exchange Commission (SEC)
New SEC Appointments Announced
The SEC announced on Oct. 10, 2013, that Mark Kronforst has been named chief accountant of the commission’s Division of Corporation Finance (Corp Fin). Kronforst was previously an associate director for disclosure operations at Corp Fin.
In addition, on Oct. 11, 2013, the SEC announced the appointment of Daniel Murdock as a deputy chief accountant in the Office of the Chief Accountant (OCA). Murdock will serve as the head of the OCA’s accounting group.
Financial Reporting Manual Updated
The staff of Corp Fin published a new version of the “Financial Reporting Manual” (FRM), dated Oct. 29, 2013. The new edition reflects changes through June 30, 2013 – including updates of issues related to FRM requirements for the JOBS Act, the age of financial statements, acquisition of selected parts of an entity that may result in less than full financial statements, requirements in reporting a disposition, and measuring significance for equity method investees.
The manual is intended as an internal reference document for SEC staff, but preparers and others might find it a useful reference for financial reporting matters.
From the Public Company Accounting Oversight Board (PCAOB)
Staff Audit Practice Alert Issued on Deficiencies Observed in Audits of ICFR
The PCAOB issued on Oct. 24, 2013, Staff Audit Practice Alert No. 11, “Considerations for Audits of Internal Control Over Financial Reporting.” The PCAOB publishes staff audit practice alerts to highlight new or otherwise noteworthy circumstances that could affect how auditors work under the existing requirements of PCAOB standards and relevant laws.
This alert is a response to issues observed in the past three years related to audits of internal control over financial reporting (ICFR). It highlights certain requirements of the auditing standards of the PCAOB in aspects of audits of internal control in which PCAOB inspection reports have frequently cited significant auditing deficiencies. The alert discusses:
- The auditor’s risk assessment and the audit of internal control
- Selecting controls to test
- Testing management review controls
- IT considerations, including system-generated data and reports
- Roll-forward of control testing performed at an interim date
- The auditor’s use of the work of others
- Evaluating identified control deficiencies
Standards Issued for Audits of Brokers and Dealers
On Oct. 10, 2013, the PCAOB adopted several new standards pertaining to the audits of brokers and dealers. Dodd-Frank gave the PCAOB the authority to oversee audits of brokers-dealers, including inspections, standard setting, investigations, and disciplinary proceedings. In July 2013, the SEC amended its Rule 17a-5 to require that broker-dealers file with the SEC annual financial reports that are audited in accordance with PCAOB standards. In addition, the SEC adopted requirements for new compliance and exemption reports that are covered by an auditor’s report prepared in accordance with PCAOB standards. To implement these new rules, the PCAOB adopted two new attestation standards (contained in PCAOB Release No. 2013-007): “Examination Engagements Regarding Compliance Reports of Brokers and Dealers” and “Review Engagements Regarding Exemption Reports of Brokers and Dealers.”
The PCAOB also adopted a new standard for auditing the supplemental information that accompanies financial statements, “Auditing Supplemental Information Accompanying Audited Financial Statements” (contained in PCAOB Release No. 2013-008).
Subject to SEC approval, these new standards will become effective for audits of financial statements for fiscal years ending on or after June 1, 2014, to coincide with the effective date for the SEC’s broker-dealer reporting requirements issued in its Rule 17a-5 amendments.
The PCAOB also published a fact sheet, a brief description of the requirements of the new standards.
Standard-Setting Agenda Published
The PCAOB’s Office of the Chief Auditor published its updated standard-setting agenda as of Sept. 30, 2013. The agenda indicated that during the last quarter of 2013 and first quarter of 2014, the PCAOB plans to:
- Adopt a final standard on audits of brokers and dealers (issued Oct. 10, 2013; see previous item)
- Adopt a final standard on related parties
- Issue a revised exposure draft, “Audit Transparency: Identification of the Engagement Partner and Other Public Accounting Firms or Persons That Are Not Employed by the Auditor but Participate in the Audit”
- Issue an exposure draft, “Auditor’s Responsibilities With Respect to Other Accounting Firms, Individual Accountants, and Specialists”
- Issue an exposure draft, “Framework for Reorganization of PCAOB Standards – Phase 2
From the American Institute of Certified Public Accountants (AICPA)
Comparison of Two Proposals for Auditor’s Report Enhancements Published
Last month, the AICPA published a Financial Reporting Center Brief, “Proposals to Enhance the Auditor’s Report,” which includes a side-by-side comparison of the important aspects of two proposals for new standards intended to make the auditor’s report more relevant to investors. One of the proposals for enhancements to the report is from the International Auditing and Assurance Standards Board (IAASB); the other is from the PCAOB.
Comments on the IAASB proposal, “Reporting on Audited Financial Statements: Proposed New and Revised International Standards on Auditing (ISAs),” are due Nov. 22, 2013.
Comments on the PCAOB proposal, PCAOB Release No. 2013-005, “The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion; the Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report; and Related Amendments to PCAOB Standards,” are due Dec. 11, 2013.
For More Information
Sydney K. Garmong
Dennis M. Hild