(The news featured below is a selection from the news covered in Federal Securities Law Reporter, which is distributed to subscribers of Federal Securities Law Reporter.)

ISDA, SIA Support Revised Guidance on Structured Transactions

In a joint comment letter, the International Swaps and Derivatives Association and the Securities Industry Association expressed strong support for the interagency statement on complex structured finance transactions, but asked that the requirement to document the reasons for approving or disapproving an elevated risk transaction be dropped. ISDA and the SIA said that financial institutions should not be saddled with the duty and expense of creating documents they may not otherwise create and that are not necessary for purposes of evaluating their compliance with regulatory guidance or internal policies. The trade groups also refuted a position taken by a group of law professors urging withdrawal of the guidance because it lists characteristics strongly suggestive of fraud and then requires that banks and securities firms do nothing to avoid participating in deals like those listed. The Bond Market Association also joined in the comments.

As financial derivatives and asset-backed securities have gone from somewhat esoteric instruments to a central feature of the markets, the SEC and the federal banking regulators have developed guidance for banks and securities firms that engage in complex structured transactions. Continuing a process that began in 2004, the agencies recently issued revised guidance on managing the risk of derivatives and other instruments issued in connection with complex transactions. The SEC and the banking agencies continue to believe that it is important for financial institutions engaged in complex structured transactions to design procedures to effectively manage the associated risks.

The associations praised the guidance for providing a clear and flexible set of principles that will enable financial institutions to design internal controls for the review and approval of complex transactions posing heightened levels of legal or reputational risk. However, they believe that the decision of whether to document the reasoning behind approval or disapproval of an elevated risk transaction should be left to the judgment of senior management based on the circumstances and the nature of the issues considered. While the obligation to record the reasons for approval or disapproval may appear innocuous, the associations said it would actually create potentially significant risks and burdens for financial institutions that would not be outweighed by any benefits.

The associations specifically questioned the regulatory basis for requiring a financial institution to justify a determination to reject a complex transaction since such a determination, by its nature, does not require the level of confidence in a legal or accounting conclusion that would be appropriate in the context of a transaction that is executed. In addition, they contended that the production of a document that includes the legal analysis underlying approval or disapproval of a transaction could compromise the attorney-client privilege.

The associations predicted that, to protect themselves, financial institutions would generate a demand for documentation of their legal or accounting analysis of a transaction that bears little relation to what management believes is appropriate under the circumstances. The associations concluded that the attendant expense was not justified, would increase the costs of elevated risk transactions and could have a chilling effect by tipping the balance of costs and potential revenues.

The associations offered a point-by-point refutation of the law professors' comments. Describing the professors' comments as more sensational than substantive, the trade groups noted that their fear of reckless indifference by financial institutions to fraudulent transactions is contradicted by the considerable steps banks and firms have taken to better manage the legal or reputational dangers presented by elevated risk transactions. In particular, financial institutions have significantly increased the resources allocated to their legal, compliance and control functions.

Contrary to the professors' contention, the associations said the guidance is unequivocal that financial institutions should subject transactions presenting heightened risk to enhanced scrutiny. Nothing in the guidance creates incentives for financial institution to ignore warning signs of potential improprieties that could lead to liability, emphasized the associations.