[Federal Register Volume 61, Number 116 (Friday, June 14, 1996)]
[Proposed Rules]
[Pages 30190-30197]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-14000]
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DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Parts 545, 556, 560, 563, and 571
[No. 96-48]
RIN 1550-AA89
Conflicts of Interest, Corporate Opportunity and Hazard Insurance
AGENCY: Office of Thrift Supervision, Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Office of Thrift Supervision (OTS or agency) is proposing
to update and substantially streamline its regulations and policy
statements concerning conflicts of interest, usurpation of corporate
opportunity and hazard insurance. This notice of proposed rulemaking is
based on a detailed staff review of each pertinent regulation and
policy statement to determine whether they are necessary, impose the
least possible burden consistent with safety and soundness and
statutory requirements and are written in a clear, straightforward
manner. Today's proposal is being made pursuant to the Regulatory
Reinvention Initiative of the Vice President's National Performance
Review and section 303 of the Community Development and Regulatory
Improvement Act of 1994.
DATES: Comments must be received on or before August 13, 1996.
ADDRESSES: Send comments to Manager, Dissemination Branch, Records
Management and Information Policy, Office of Thrift Supervision, 1700 G
Street, NW., Washington, DC 20552, Attention Docket No. 96-48. These
submissions may be hand-delivered to 1700 G Street, NW., from 9:00 a.m.
to 5:00 p.m. on business days; they may be sent by facsimile
transmission to FAX Number (202) 906-7755. Comments will be available
for inspection at 1700 G Street, NW., from 9:00 a.m. until 4:00 p.m. on
business days.
FOR FURTHER INFORMATION CONTACT: Robyn Dennis, Program Manager, (202)
906-5751; or Francis Raue, Policy Analyst, (202) 906-5750, Supervision
Policy; or Dorene Rosenthal, Counsel (Banking and Finance), (202) 906-
7268, Regulations and Legislation Division, Chief Counsel's Office.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background of the Proposal
II. Objectives III. Description of the Proposal
A. Conflicts of Interest
B. Corporate Opportunity
C. Hazard Insurance
IV. Proposed Disposition of Conflicts of Interest, Corporate
Opportunity and Hazard Insurance Regulations and Policy Statements
V. Executive Order 12866
VI. Unfunded Mandates Act of 1995
VII. Regulatory Flexibility Act Analysis
I. Background of the Proposal
In a comprehensive review of the agency's regulations in the spring
of 1995, OTS identified numerous obsolete or redundant regulations that
could be quickly repealed. OTS also identified several key regulatory
areas for a more intensive, systematic regulatory burden review. These
areas--lending and investment authority, subsidiaries and equity
investments, corporate governance, conflicts of interest, corporate
opportunity and hazard insurance--were selected because they have a
significant impact on thrift operations, and have not been developed on
an interagency basis or been comprehensively reviewed for many years.
Today's proposal presents the results of an intensive review of OTS's
regulations and policy statements on conflicts of interest, corporate
opportunity and hazard insurance.
Since commencing its reinvention initiative in the spring of 1995,
OTS has already repealed eight percent of its regulations. In addition,
in January of 1996, OTS issued a comprehensive proposal on its lending
and investment regulations.1 Burden reduction proposals regarding
corporate governance and subsidiaries and equity investments will be
issued in the near future.
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\1\ 61 FR 1162 (January 17, 1996).
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Today's proposal regarding conflicts of interest, corporate
opportunity and hazard insurance will also result in significant
regulatory burden reduction. The proposal affects the following
regulatory sections:
Section 545.126--Referral of insurance business
Section 556.16--Insurance agencies--usurpation of corporate opportunity
Section 563.35--Restrictions involving loan services
Section 563.40--Restrictions on loan procurement fees, kickbacks and
unearned fees
Section 563.44--Loans involving mortgage insurance
Section 571.4--Hazard insurance
Section 571.7--Conflicts of interest
Section 571.9--Corporate opportunity in savings associations
OTS is proposing to repeal five of these provisions in their
entirety. The remaining three provisions--loan procurement fees,
conflicts of interest, and corporate opportunity--will be retained in
the form of regulations, but streamlined and clarified. The proposed
changes will, if adopted in final form, reduce the amount of CFR text
devoted to conflicts, corporate opportunity and hazard insurance from
six pages to half a page.
In developing this proposal, we have consulted with those who use
the regulations on a daily basis, including OTS regional staff and
representatives of the thrift industry. A focus group of five thrift
institutions and an industry trade association discussed staff's
initial recommendations. We have also reviewed the other federal
banking agencies' regulations and policy statements concerning
conflicts, corporate opportunity and hazard insurance.
II. Objectives
The overarching goal of OTS's reinvention initiative is to reduce
regulatory burden on savings associations to the greatest extent
possible consistent with statutory requirements and safety and
soundness. In the context of conflicts, corporate opportunity and
hazard insurance, we believe maximum burden reduction can be achieved
by pursuing three specific objectives.
First, we are attempting to eliminate duplication and overlap. The
conflicts, corporate opportunity and hazard insurance regulations have
existed essentially unchanged for over 20 years. During this time,
there have been significant statutory and regulatory advances,
including enactment of the Real Estate Settlement Procedures Act of
1974 (RESPA),2 amendments to the Home Owners' Loan Act of 1933
[[Page 30191]]
(HOLA) 3 and promulgation of the Interagency Real Estate Lending
Guidelines.4 As a result, much of OTS's conflicts of interest,
corporate opportunity and hazard insurance regulations and policy
statements have become outdated or obsolete. For example, the policy
statement regarding hazard insurance (Sec. 571.4) has been largely
superseded by the Interagency Real Estate Lending Guidelines.
Similarly, the regulatory provisions prohibiting a savings association
from conditioning the extension of credit on the borrower obtaining
certain other services from the institution (tying arrangements)
(Sec. 563.35) have been superseded by tying prohibitions in HOLA
section 5(q). Additionally, the regulatory provisions governing kick-
backs and unearned fees for loans (Sec. 563.40) are largely duplicative
of RESPA. Redundant regulatory coverage causes confusion and wastes
both industry and government resources. Today's proposal eliminates
duplication wherever possible.
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\2\ Pub. L. 93-533, 88 Stat. 1724, Dec. 22, 1974.
\3\ 12 U.S.C. 1461, et seq.
\4\ 57 FR 62890 (December 31, 1992).
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Second, as part of its reinvention effort, OTS is seeking to move
away from regulations that micromanage thrift operations. Our goal is
to focus the regulations on issues that are truly vital to safe and
sound operations, leaving other matters for handbook guidance. For
example, the regulations currently include three detailed provisions,
which occupy three pages of CFR text, governing when federal thrifts
can refer customers to affiliates that sell insurance. Although
insurance referrals were thought to be an important issue 20 years ago
when thrift service corporations were first authorized to sell
insurance, insurance referrals clearly do not lie at the heart of
safety and soundness today. Nor do they present issues distinct from
the general questions that arise whenever a thrift refers many other
types of business to affiliates. Accordingly, OTS is proposing to
repeal the insurance referral provisions in their entirety, leaving
insurance referrals to be handled in the same way as other corporate
opportunity issues. (See discussion of corporate opportunity below.)
Third, in its reinvention effort, OTS is seeking to enhance the
conciseness and clarity of its regulations. Accordingly, the three
provisions slated for retention in today's proposal are being revised
to remove ambiguous and imprecise language. For example, the current
306-word policy statement on conflicts of interest (Sec. 571.7) is
being converted to a 53-word regulation. The oblique reference to
actions that may create the ``appearance of a conflict of interest'' is
being removed. Instead, there will be a simple statement of a
fiduciary's common law duty ``not [to] advance [his or her] personal
interests, or those of others, at the expense of [his or her]
institution.''
Similarly, the corporate opportunity policy statement (Sec. 571.9)
is being converted to a regulation containing a simple statement of a
fiduciary's common law duty not to ``take advantage of corporate
opportunities belonging to [his or her] savings association.'' A second
sentence describes when an opportunity will be deemed to ``belong'' to
a savings association. The new regulation will be about one-third the
length of the current policy statement.
Each of the provisions being retained have been redrafted using
plain language techniques pioneered by the Department of Interior and
promoted by the Vice President's Regulatory Reinvention Initiative.
Plain language drafting emphasizes the use of informative headings,
short sentences, paragraphs and sections, non-technical language
(including the use of ``you''), and sentences in the active voice. The
goal of plain language drafting is to enhance clarity, thereby
decreasing industry frustration, inadvertent violations, the need to
seek clarification in correspondence and phone calls, and the amount of
time institutions must devote to understanding the regulations.
OTS is hopeful that the foregoing reforms will result in a
significant decrease in regulatory burden in the areas of conflicts,
corporate opportunity and hazard insurance.
III. Description of the Proposal
For each area covered by today's proposal--conflicts of interest,
corporate opportunity and hazard insurance--this section provides
historical background, an analysis of the disposition of the current
rules and a description of the proposed rules.
A. Conflicts of Interest
1. Historical Background
The Federal Home Loan Bank Board (FHLBB), the predecessor to OTS,
adopted the conflicts of interest policy statement (Sec. 571.7) in
1970. The FHLBB stated that the principles enunciated there are basic
to the continued viability and public acceptance of the thrift industry
in contemporary society.5 The policy statement, which prohibits
insiders from engaging in conflicts of interest that adversely affect
savings associations, has remained unchanged for over 25 years.
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\5\ FHLBB Memorandum to The Management of Each Insured
Institution from Chairman Martin (November 19, 1970).
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In 1974, Congress enacted RESPA to effect certain changes in
settlement procedures for residential real estate loans. It was
designed, among other things, to eliminate kickbacks or referral fees
that tend to increase unnecessarily the costs of certain settlement
services. Such kickbacks and fees also can create a conflict between an
officer or director's personal interests and those of his or her
association.
The following year, in response to abuses involving certain loan
practices, the FHLBB issued another rulemaking intended ``to delineate,
and prohibit or control, transactions which are, or are likely to be,
conflicts of interest'' and ``to prohibit financial, lending or
managerial policies or practices of insured institutions which are
detrimental to, or inconsistent with, sound and economic home-
financing.'' 6 The FHLBB revised the regulations prohibiting the
tying of loans and certain related services (Sec. 563.35) and
promulgated a new regulation prohibiting loan procurement fees,
kickbacks and unearned fees (Sec. 563.40). This regulation reiterated
and expanded upon the RESPA prohibitions on kickbacks and fees. A
separate regulation was promulgated to limit the potential for abuse
and risk as a result of self-dealing business practices relating to
mortgage insurance (Sec. 563.44). Basically, this regulation prohibits
a savings association from insuring any loan with an affiliated
mortgage insurance company.
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\6\ 40 FR 43832, 43842 (September 23, 1975).
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The Garn-St Germain Depository Institutions Act of 1982 7 also
addressed concerns about self-dealing practices related to lending.
This Act added a new HOLA section 5(q) prohibiting certain tying
arrangements.
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\7\ Pub. L. 97-320, 96 Stat. 1469, Oct. 15, 1982.
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Thus, the statutes, regulations and policy guidance concerning
conflicts of interest have evolved in a manner that results in a
significant amount of duplication and overlap.
2. Disposition of Current Rules
a. Section 571.7 Conflicts of interest. This policy statement says,
in essence, that directors, officers and other affiliated persons
8 have a fundamental duty to avoid placing themselves in a
position which creates, or which leads
[[Page 30192]]
to or could lead to, a conflict of interest or appearance of a conflict
of interest between their personal financial interests and the
interests of their association, where the interests of the association
are adversely affected.
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\8\ The terms ``director,'' ``officer'' and ``affiliated
person'' are defined below under the description of the Conflicts of
interest Proposed Rule.
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OTS proposes to codify this policy statement as a regulation, after
making modifications to clarify and simplify the language. OTS believes
this statement serves as an important reminder to thrift insiders of
their fiduciary duties to avoid conflicts of interest. (See description
of the Proposed Rule below.)
As noted above in the discussion of objectives, OTS believes that
its regulations should focus on issues vital to safety and soundness.
Fiduciary duties lie at the heart of safety and soundness. The thrift
crisis of the 1980s provided numerous examples of how fiduciary
breaches can undermine the stability of an institution. Thus, we
believe it is appropriate for the regulations to contain a brief
statement regarding the importance of avoiding conflicts of
interest.9 To eliminate any mention of conflicts of interest from
the CFR would not accurately reflect current OTS policy.
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\9\ We are aware that none of the other federal banking agencies
has specific regulations regarding fiduciary duties, except the
Office of the Comptroller of the Currency (OCC), which has a
regulation on conflicts of interest. 12 CFR 2.5. Recently, the OCC
proposed repeal of this provision, 60 FR 47498, 47500 (September 13,
1995), on grounds that it merely restates common law and a provision
in the National Bank Act requiring national bank directors to take
an oath to perform their duties diligently, honestly, and lawfully
(12 U.S.C. 73). Savings associations do not operate under a
statutory provision equivalent to 12 U.S.C. 73. For the reasons
stated above, OTS believes that a brief regulation on conflicts is
important.
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b. Section 563.35 Restrictions involving loan services. Paragraph
(a) enumerates specific services typically involved in real estate
lending that cannot be ``tied'' to the granting of a loan: insurance
services (except insurance or a guarantee provided by a government
agency or private mortgage insurance); building materials or
construction services; borrower legal services; real estate or
brokerage services; and real estate property management services.
OTS proposes to delete this paragraph because it is redundant of
HOLA section 5(q), which prohibits a savings association from
conditioning the extension of credit on the borrower obtaining certain
other services from the institution. To the extent the regulatory
language provides useful illustrations of the type of conduct HOLA
prohibits, OTS will include this guidance in the Thrift Activities
Handbook.
Paragraphs (b) and (c) relate to hazard insurance. These paragraphs
and their proposed disposition will be discussed below in Part III.C.,
``Hazard insurance.''
Paragraph (d) provides that a savings association must give
residential borrowers a written itemization of fees in excess of $100
to be paid by the borrower for the lender's attorney. This requirement
was promulgated to protect the borrower from hidden subsidization of
legal services provided to the lender that are unrelated to the
borrower's particular loan.10
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\10\ See FHLBB Letter of Tumler, Congressional Affairs (Sept.
18, 1978).
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OTS proposes to delete this provision because borrowers' interests
are adequately protected by RESPA, which prohibits kickbacks and
unearned fees (12 U.S.C. 2607).11
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\11\ In addition, RESPA also protects an institution's interest
in selecting its own settlement attorney. The law provides that an
arrangement requiring a borrower to pay the services of an attorney
chosen by the lender to represent the lender's interest in a real
estate transaction is not a violation of the general prohibition
against requiring the use of any particular provider of settlement
services (12 U.S.C. 2607(c)).
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c. Section 563.40 Restrictions on loan procurement fees, kickbacks
and unearned fees. Paragraph (a) provides that no affiliated person of
a savings association may receive, either directly or indirectly, from
the association (or any other source) any fee in connection with the
procurement of a loan from the association or a subsidiary of the
association.
Under this provision, loan procurement fees (i.e., fees for finding
loan applicants) are prohibited, regardless of whether they are earned
or unearned. The term ``loan procurement fee'' does not include
payments for loan origination services (such as title examination,
appraisals, credit reports, drawing up of papers, loan closings, and
other services necessary and incident to loan origination).
OTS believes that loan procurement fees pose the risk that insiders
may approve bad loans in order to obtain fees. Thus, we propose to
retain this provision but to make clarifying amendments to more
precisely tailor the scope of the regulation to the practices we wish
to prohibit. (See description of Proposed Rule below.)
Paragraph (b) prohibits the payment of unearned fees for loan
origination and settlement services, but this does not prohibit savings
associations and third parties from paying fees for loan origination
services actually rendered. This paragraph extends the RESPA
prohibition on kickbacks and unearned fees in connection with
``federally related mortgage loans'' (i.e., loans secured by a 1-4
family home) to any loan on real property. This rule was promulgated by
the FHLBB to standardize the initial loan charges restrictions
applicable to all types of real property loans.12
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\12\ Before RESPA was enacted, the FHLBB had proposed a
regulation that would have imposed restrictions with respect to
initial loan charges on all real estate loans. 39 FR 42382 (December
5, 1974). These restrictions were different than RESPA's
restrictions with respect to federally related mortgage loans. The
FHLBB decided not to adopt its proposed restrictions and instead
applied RESPA's restrictions to all loans. 40 FR 43832, 43839
(September 23, 1975).
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OTS proposes to delete this paragraph because the regulation
extends the RESPA consumer protection provisions to commercial real
estate loans. We do not believe this protection is necessary for
commercial borrowers. None of the other banking agencies imposes a
similar restriction on banks. Thus, removing this provision will
establish parity with banks. To the extent paragraph (b) protects
thrifts from insiders engaging in prohibited conflicts of interest,
these conflicts would be covered by the new conflicts of interest
regulation.
d. Section 563.44 Mortgage insurance. Paragraph (a) contains
definitions used in this section. Paragraph (b) prohibits a savings
association (or service corporation affiliate) from insuring any loan
with a mortgage insurance company if certain affiliations are present.
The affiliations deemed to give rise to harmful conflicts of interest
are: the mortgage insurance company maintains a deposit account at the
association;13 there is an interrelationship of insiders or
employees; the association, affiliate or insiders have an ownership
interest in the mortgage company above specified limits; or the
mortgage insurance company pays a fee or commission to the association,
an affiliate or insiders.
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\13\ The rationale for this provision was to ensure that a
mortgage company was not forced to maintain an account at the
association as a condition for the placement or renewal of mortgage
insurance with the company. 41 FR 7497, 7498 (February 19, 1976).
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Paragraph (c) provides an exception to grandfather investments made
by savings associations in the Pennsylvania Mortgage Insurance Company
prior to promulgation of Sec. 563.44. See 43 FR 60571, 60572 (December
28, 1978).
OTS proposes to repeal Sec. 563.44 since prohibited tying of
products is now covered by the statutory anti-tying provisions in HOLA
section 5(q). In addition, RESPA requires a lender to make disclosure
to a borrower when it has an interest in a mortgage insurance company
and to inform the borrower that services need not be obtained from
[[Page 30193]]
that particular company. Common law fiduciary duties, the statutory
rules governing transactions with affiliates, and OTS's new conflicts
of interest regulation will cover conflicts of interest related to
mortgage insurance companies. Thus, Sec. 563.44 adds an unnecessary
additional layer of regulation.
3. Proposed Rules
a. Conflicts of interest. As indicated above, OTS proposes to
convert its general policy statement on conflicts of interest
(Sec. 571.7) to a regulation (proposed Sec. 563.200). Proposed
Sec. 563.200 prohibits directors,14 officers,15 employees,
persons having the power to control the management or policies of
savings associations, and other persons who owe fiduciary duties to
savings associations from advancing their own personal or business
interests, or those of others, at the expense of the institutions they
serve.16
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\14\ The term ``director'' is defined in OTS regulations as: any
director, trustee or person performing similar functions with
respect to an organization. (Sec. 561.18.)
\15\ The term ``officer'' is defined in OTS regulations as: the
president, vice-president (but not an assistant vice-president or
second vice-president, or other vice-president with similar
authority to an assistant or second vice-president), the secretary,
the treasurer, the comptroller, any person performing similar
functions with respect to any organization, and the chairman of the
board of directors if the chairman participates in the management of
the organization. (Sec. 561.35.) The term ``officer'' would include
``senior executive officer,'' defined in OTS regulations as: chief
executive officer, chief operating officer, chief financial officer,
chief lending officer, chief investment officer and any other
individual who exercises significant influence over, or participates
in major policy decisions of the savings association or a savings
and loan holding company. (Sec. 574.9(a)(2).)
\16\ This statement reiterates the current common law fiduciary
duty these individuals and entities owe to their institutions. See,
e.g., E. Brodsky & M.P. Adamski, Law of Corporate Officers and
Directors: Rights, Duties and Liabilities, ch. 3 and 4 (1984 and
Supp. 1995) (directors and officers have fiduciary duties to avoid
conflicts of interest and corporate usurpation); and H. Henn & J.
Alexander, Laws of Corporations, Secs. 235-238 (3d ed. 1983)
(controlling shareholders may owe fiduciary duties to corporations).
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The proposed rule differs from the current OTS policy statement on
conflicts of interest (Sec. 571.7) in several respects. First, today's
proposal removes an ``appearance of a conflict of interest'' from the
scope of the rule. The OTS continues to urge fiduciaries to avoid even
the appearance of a conflict of interest as a matter of good business
practice. However, OTS intends to focus its supervisory efforts on
actual conflicts.
Second, the proposal simplifies the language used to describe
prohibited conflicts. This should make it easier for persons covered by
the rule to understand what conduct is prohibited. The language of the
proposed rule tracks the language of OTS's 1992 ``Statement Concerning
Responsibilities of Officers and Directors,'' which clarified OTS
policy and reiterated general common law standards on the duty of
loyalty and the duty of care that directors and officers owe their
institutions.17 This statement is much shorter and clearer than
the current policy statement and is the same standard employed by the
Federal Deposit Insurance Corporation (FDIC).18
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\17\ CEO Letter from Director Ryan (November 18, 1992).
\18\ FDIC Financial Institutions Letter 87-92 (December 17,
1992).
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Third, the current policy statement covers ``affiliated persons.''
19 The term affiliated person does not precisely match the scope
of persons who at common law owe fiduciary duties to institutions. For
example, immediate family members are included within the definition of
affiliated person but they generally do not owe fiduciary duties under
the common law.
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\19\ The term ``affiliated person'' is defined in OTS
regulations to include: officers, directors, controlling persons of
savings associations; immediate family members of officers,
directors and controlling persons; and corporations and trusts with
common ownership or control with the association. (Sec. 561.5.)
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The proposed regulation refers specifically to directors, officers,
employees, persons having the power to control the management or
policies of savings associations and other persons who owe fiduciary
duties to savings associations. No reference is made to affiliated
persons.
As indicated above, ``directors'' and ``officers'' are defined in
OTS regulations. ``Employee'' is not defined, but this term is intended
to have its common meaning. OTS believes that coverage of employees is
important because there have been instances where employees' conflicts
of interest have harmed savings associations.
Persons having the power to control the management or policies of
savings associations would include both natural persons and companies.
Generally, a shareholder of a savings association controls the
management or policies of a savings association if the shareholder owns
twenty-five percent or more of the voting stock of the
institution.20 Any other shareholder or other person who makes
significant policy decisions for the institution would also be covered
by the proposed regulation.
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\20\ See 12 U.S.C. 1817(j) and 1467a.
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OTS does not attempt to define in this regulation who else (besides
directors, officers, employees and persons who control management) owes
fiduciary duties to savings associations. If a person owes a fiduciary
duty under common law to a savings association, then that person must
not advance his or her own interests at the expense of the institutions
he or she serves.
b. Prohibition on loan procurement fees. OTS is moving the
prohibition on loan procurement fees (Sec. 563.40(a)) to a new section
(Sec. 560.130) in its proposed Part 560 on Lending and Investment and
is narrowing the scope of the rule.
The current rule covers ``affiliated persons.'' Today's proposal
will apply only to directors, officers 21 and natural persons
having the power to control the management or policies of savings
associations. OTS continues to believe that loan procurement fees paid
to these persons pose a threat to the safety and soundness of savings
associations. Such fees provide incentives to these individuals to
bring loans into the association and to press for their approval,
without giving proper consideration to whether they are a good
investment for the institution. This is a classic example of a conflict
of interest: the person's interest in financial gain from a loan
procurement fee would be adverse to the institution's interest in
making only high quality loans.
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\21\ The proposed rule, like the current rule, would not apply
to loan officers and branch managers who do not make significant
policy decisions for the institution. However, any loan procurement
bonus or incentive system for employees who are not senior executive
officers must be consistent with the safe and sound operation of the
savings association. For illustrative examples of what compensation
provisions OTS may consider unsafe and unsound, see OTS Regulatory
Bulletin 27a, ``Executive Compensation.'' This bulletin does not
specifically apply to incentive programs for employees who are not
senior executive officers, but it does provide general guidance in
this area.
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However, by eliminating the reference to ``affiliated person,'' the
rule will no longer apply to holding companies and holding company
affiliates of savings associations. OTS believes that loan procurement
fees paid to corporate affiliates pose less risk for several reasons.
First, these fees, unlike fees paid to officers and directors, are
subject to section 23B of the Federal Reserve Act (FRA).22 Under
section 23B, all payments to corporate affiliates must be on arms-
length terms for services actually rendered. Second, as a practical
matter, an individual officer or director generally would have greater
ability to directly or indirectly influence a loan approval than a
corporate affiliate because of direct reporting relationships.
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\22\ 12 U.S.C. 371c-1.
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With the proposed change, affiliates of thrifts that are mortgage
brokers will
[[Page 30194]]
be able to receive an arms-length fee when acting as agent soliciting
loans for affiliated thrifts.
B. Corporate Opportunity
1. Historical Background
In 1974, the FHLBB adopted a general corporate opportunity policy
statement to apprise savings association officers, directors and
controlling persons of their fiduciary duty not to appropriate business
opportunities that belong to the association.23 The policy
statement was not intended to impose new legal duties, but simply to
codify existing common law fiduciary principles.24
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\23\ 37 FR 6696 (February 22, 1974).
\24\ Id.
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The following year, the FHLBB promulgated Secs. 545.126, 556.16,
and 571.9(b). Taken together, these provisions describe in elaborate
detail when federal thrifts can refer insurance business to insurance
agencies that affiliated persons control without raising concerns about
usurpation of corporate opportunity. As structured, these provisions
impose a general ban on referral of insurance business to affiliated
persons, but then carve out numerous exceptions (e.g. when the thrift
is located in a state that prohibits insurance sales by thrifts).
The FHLBB developed these rules to apply general corporate
opportunity law to the operation of insurance agencies by management of
federal associations, and to avoid case-by-case determinations. The
rules focused on the insurance business because insurance brokerage had
recently been added to the list of preapproved activities for savings
association service corporations. These rules were designed to
eliminate opportunities for insider abuse and to protect insurance
business opportunities for savings associations and their subsidiaries.
2. Disposition of Current Rules
a. Section 545.126 Referral of Insurance Business. This section
prohibits a federal savings association from referring any insurance
business to an agency owned by officers or directors of the
association, or by individuals having the power to direct its
management, subject to certain exceptions. The exceptions are: (i) a
state statute or regulation prohibits a federal savings association's
service corporation (or wholly owned subsidiary thereof) from engaging
in the insurance business; (ii) the state regulator has denied the
association's application to engage in the insurance business; (iii)
the state regulator has an established and well-known policy of denying
such applications; (iv) the referral takes place within a reasonable
time after a change in state law, regulation or policy; and (v) an
application to establish or acquire an insurance business is pending
with OTS or the appropriate state agency.
OTS proposes to delete this provision. This regulation was enacted
over 20 years ago to control the perceived risks of usurpation of
corporate opportunity related to the insurance agency business. In the
agency's experience, insurance referrals have not presented risks that
differ either in degree or kind from the risks presented by referrals
of other types of business. Accordingly, insurance referrals, like
other referrals, will be reviewed under the proposed general corporate
opportunity regulation. (See description of the Proposed Rule below.)
b. Section 556.16 Insurance agencies--usurpation of corporate
opportunities. This section, which substantially duplicates
Sec. 545.126, provides that a federal savings association's corporate
opportunity to engage in the insurance business is usurped if it refers
any insurance business to an agency owned by officers or directors of
the association, or by individuals having the power to direct its
management, subject to certain exceptions. The policy statement
contains a number of exceptions to this general rule. Exceptions apply
if the referral takes place: (i) while an application to establish or
acquire an insurance business is pending with OTS or the appropriate
state agency; (ii) while a state statute or regulation prohibits a
federal savings association's service corporation (or wholly owned
subsidiary thereof) from engaging in the insurance business; (iii)
while the state licensing authority or regulator has an established and
well-known policy of refusing to accept or process applications by
federal savings associations to engage in the insurance business; or
(iv) within a reasonable time after a change in state law, regulation
or policy. Additional exceptions apply for referrals where (i) the
referral took place before May 20, 1971; (ii) the association's
application to obtain necessary state approval to engage in the
insurance business was denied; (iii) a disinterested majority of the
association's board of directors votes for sound business reasons to
reject the opportunity; or (iv) there is no economic justification for
the association to engage in the insurance business. This section also
provides that if a corporate opportunity is usurped, the association is
entitled to the benefit of the transaction.
Section 556.16 was published in 1975 at the same time the FHLBB
promulgated Sec. 545.126. It appears that the FHLBB may have intended
for Sec. 556.16 to state the standards applicable to insurance
referrals that had already occurred and for Sec. 545.126 to state the
standards applicable to all subsequent insurance referrals. However,
Sec. 556.16 is not worded in a manner that limits it to retrospective
application. Thus, OTS has traditionally read both sections together.
OTS proposes repealing Sec. 556.16 for the reasons discussed above
under Sec. 545.126.
c. Section 571.9 Corporate opportunity in savings associations.
Paragraph (a) of this policy statement states that it is a breach of
fiduciary duty for a director, officer or person having the power to
direct the management of an institution to take advantage of a business
opportunity for his or her own or another person's personal profit or
benefit when the opportunity is within the corporate powers of the
association or its service corporation and when the opportunity is of
present or potential practical advantage to the association. Any of
these persons who usurps a corporate opportunity is liable to the
association or its service corporation for the benefit of the
transaction or business.
This paragraph further provides that in determining whether an
opportunity is of present or potential practical advantage to the
association, OTS will consider, among other things, the financial,
managerial and technical resources of the association and its service
corporation, and the reasonable ability of the association directly or
through a service corporation to acquire such resources.
OTS proposes to codify this policy statement as a regulation, with
modifications to shorten and simplify the regulatory language. (See
description of the Proposed Rule below.) A general regulation
concerning usurpation of corporate opportunity will serve as an
important reminder to thrift insiders of their fundamental duty to
protect the interests of their institution. OTS believes that avoiding
corporate usurpation is as essential to safety and soundness as
avoiding conflicts of interest. Thus, the OTS believes it is
appropriate for the regulations to contain a brief statement regarding
corporate usurpation.
Paragraph (b) provides that a usurpation of corporate opportunity
to engage in the insurance business is an unsafe and unsound practice.
For the reasons set forth above under Sec. 545.126, OTS proposes
deleting this paragraph.
[[Page 30195]]
Insurance referrals will be treated the same as other types of
referrals. They will be subject to the general standards in the
proposed corporate opportunity regulation.
3. Proposed Rule
Paragraph (a) of OTS's proposed corporate opportunity regulation
prohibits directors or officers of savings associations, persons having
the power to control the management or policies of savings associations
and other persons who owe a fiduciary duty to savings associations from
taking advantage of corporate opportunities belonging to their savings
association or its subsidiaries. Paragraph (b) of the proposed rule,
like the current policy statement on corporate opportunity, indicates
that a corporate opportunity will be deemed to belong to the savings
association if: (a) It is within the corporate powers of the savings
association or its subsidiary; and (b) the opportunity is of present or
potential practical advantage to the savings association, directly or
through its subsidiary.
OTS intends for common law standards governing usurpation of
corporate opportunity to be applied in determining when an opportunity
would be of present or potential practical advantage to an institution.
Examples of the types of issues that fiduciaries should consider under
this standard include, without limitation, an institution's financial
condition and management resources, the level of risk presented by the
business, and potential profit from the business weighed against any
profits that might arise from transfer of the business. Prior OTS
interpretations have indicated that a usurpation of corporate
opportunity does not occur when an institution receives fair market
value consideration for transfer of a line of business. By definition,
an institution that receives fair market value receives as much as it
conveys.
The scope of the proposed regulation on corporate opportunity
differs from the scope of the current policy statement in one small
respect. The current policy statement refers to directors, officers and
other persons having power to direct management of savings associations
which includes both natural persons and companies. To this OTS proposes
to add a reference to ``other persons who owe fiduciary duties to
savings associations.'' 25 This will ensure that the scope of the
regulation equates to the scope of common law fiduciary duties.
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\25\ Employees are specifically mentioned in the proposed
conflicts regulation, but not in the proposed corporate opportunity
regulation. OTS has encountered a number of instances in which
employee conflicts have been problematic. Similar problems have not
arisen in the usurpation area. In those rare instances where an
employee breaches a common law duty regarding usurpation of
corporate opportunity, the employee will be covered by the general
reference in the corporate opportunity regulation to ``other persons
who owe fiduciary duties to savings associations.''
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In the past questions have arisen regarding the extent to which the
corporate opportunity doctrine applies to dealings between savings
associations and their holding companies. The reference in the proposed
regulation to persons having power to direct management or policies of
savings associations includes holding companies. Thus, under the
proposed regulation, the dealings of holding companies with their
subsidiary thrifts will be subject to the doctrine of usurpation of
corporate opportunity to the same extent as provided by common law.
OTS realizes, however, that there is not a great deal of common law
guidance regarding the nature of a controlling shareholder's duties to
the depositors of a wholly-owned thrift or bank, especially with
respect to the usurpation doctrine. OTS also believes that the
transactions with affiliates provisions of sections 23A and 23B of the
FRA,26 as well as general principles of safety and soundness,
generally provide an adequate basis for regulating dealings between
thrifts and their holding companies. Thus, barring egregious
circumstances or instances where a thrift is undercapitalized or
unprofitable, OTS supervisors and examiners will generally defer to
holding company decisions regarding where to allocate lines of business
within a holding company structure, provided there is no violation of
FRA sections 23A and 23B or general principles of safety and soundness.
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\26\ 12 U.S.C. 371c and 371c-1.
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C. Hazard Insurance
1. Historical Background
The FHLBB published a 1966 policy statement providing for the
maintenance of hazard insurance policies on real property securing
loans made or purchased by savings associations (Sec. 571.4).27
The FHLBB's regulation on restrictions involving loan services
(Sec. 563.35), published in 1975, contains additional hazard insurance
requirements.
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\27\ 31 FR 9539 (July 14, 1966). In 1959 the FHLBB published a
policy statement requiring federally chartered associations to
maintain hazard insurance on the property securing loans
(Sec. 556.4). As part of Phase I of OTS's Regulatory Review, this
provision was deleted because it imposed duplicative requirements to
those set forth in Sec. 571.4. 61 FR 66866, 66869 (December 27,
1995).
---------------------------------------------------------------------------
Over the past several years, the safety and soundness restrictions
on thrifts' lending have been substantially revised. The Federal
Deposit Insurance Corporation Improvement Act of 1991 28 required
the federal banking agencies to develop uniform real estate lending
standards. In 1992, OTS, Board of Governors of the Federal Reserve
System, FDIC and OCC adopted a uniform rule on real estate lending and
developed Interagency Guidelines for Real Estate Lending Policies.
These rules and guidelines generally require that institutions adopt
real estate lending policies consistent with safety and soundness and
that such policies include prudent underwriting standards. Among other
things, prudent underwriting standards include guidelines regarding
insurance coverage of security property.
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\28\ Pub. L. 102-242, 105 Stat. 2236, Dec. 19, 1991.
---------------------------------------------------------------------------
2. Disposition of Current Rules
a. Section 571.4 Hazard insurance. Paragraph (a) of this policy
statement provides that all savings associations should include in
their loan contracts provisions requiring borrowers to maintain hazard
insurance in a sufficient amount to protect the savings association
from loss in the event of damage to or destruction of the real estate
securing the savings association's loans.
Paragraph (b) requires the insurance policy to name and protect the
savings association as mortgagee in an amount at least equal to its
insurable interest in the security. The policy also must cover perils
commonly included in ``Standard Fire and Extended Coverage,'' as well
as other perils commonly required by institutional lenders operating in
the same area.
Paragraph (c) stipulates that examiners will review loan files for
evidence that appropriate hazard insurance is in force.
Details regarding hazard insurance are unnecessary in light of the
general safety and soundness requirements set forth in the Interagency
Real Estate Lending Guidelines and standard business practices in the
mortgage lending industry. OTS proposes to delete this section. As
noted in the objectives section, OTS does not believe its regulations
should micromanage thrift operations. OTS examiners will review the
sufficiency of thrifts' lending standards and practices during
examinations.
[[Page 30196]]
b. Section 563.35 Restrictions involving loan services. Paragraphs
(b) and (c) contain additional hazard insurance requirements. Paragraph
(b) requires a savings association to inform borrowers of their right
to freely select providers of insurance services. Paragraph (c) says a
savings association may refuse to make a loan if the borrower's choice
of insurance services would provide insufficient coverage.
OTS proposes to repeal Sec. 563.35 (b) and (c). Savings
associations have authority to refuse to make loans in the absence of
adequate insurance coverage with or without paragraph (c). As for
paragraph (b), OTS believes that RESPA provides an adequate safety net
regarding loan origination practices. Eliminating paragraphs (b) and
(c) will establish parity with banks.
IV. Proposed Disposition of Conflicts of Interest, Corporate
Opportunity and Hazard Insurance Regulations and Policy Statements
The following chart displays the proposed disposition of OTS's
existing conflicts of interest, corporate opportunity and hazard
insurance regulations and policy statements. OTS intends to review all
the regulations and policy statements that it is proposing to repeal to
determine which are appropriate to convert into guidance in the Thrift
Activities Handbook.
------------------------------------------------------------------------
Original New
provision provision Comment
------------------------------------------------------------------------
Sec. 545.1
26........ ......... Removed.
Sec. 556.1
6......... ......... Removed.
Sec. 563.3
5......... ......... Removed.
Sec. 563.4
0(a)...... Sec. 560
.130 Modified.
Sec. 563.4
0(b)...... ......... Removed.
Sec. 563.4
4......... ......... Removed.
Sec. 571.4 ......... Removed.
Sec. 571.7 Sec. 563
.200 Modified.
Sec. 571.9
(a)....... Sec. 563
.201 Modified.
Sec. 571.9
(b)....... ......... Removed.
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V. Executive Order 12866
The Director of OTS has determined that this proposed rule does not
constitute a ``significant regulatory action'' for the purposes of
Executive Order 12866.
VI. Unfunded Mandates Act of 1995
Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. L.
104-4 (Unfunded Mandates Act), requires that an agency prepare a
budgetary impact statement before promulgating a rule that includes a
federal mandate that may result in expenditure by state, local, and
tribal governments, in the aggregate, or by the private sector, of $100
million or more in any one year. If a budgetary impact statement is
required, section 205 of the Unfunded Mandates Act also requires an
agency to identify and consider a reasonable number of regulatory
alternatives before promulgating a rule. As discussed in the preamble,
this proposed rule reduces regulatory burden and clarifies the
fiduciary duties that directors, officers and other fiduciaries owe to
savings associations. OTS has determined that the proposed rule will
not result in expenditures by state, local, or tribal governments or by
the private sector of $100 million or more. Accordingly, this
rulemaking is not subject to section 202 of the Unfunded Mandates Act.
VII. Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, OTS
certifies that this proposed rule will not have a significant economic
impact on a substantial number of small entities.
List of Subjects
12 CFR Part 545
Accounting, Consumer protection, Credit, Electronic funds
transfers, Investments, Manufactured homes, Mortgages, Reporting and
recordkeeping requirements, Savings associations.
12 CFR Part 556
Savings associations.
12 CFR Part 560
Consumer protection, Investments, Manufactured homes, Mortgages,
Reporting and recordkeeping requirements, Savings associations,
Securities.
12 CFR Part 563
Accounting, Advertising, Crime, Currency, Flood insurance,
Investments, Mortgages, Reporting and recordkeeping requirements,
Savings associations, Securities, Surety bonds.
12 CFR Part 571
Hazard insurance, Conflict of interests, Corporate opportunity.
Accordingly, the Office of Thrift Supervision proposes to amend
chapter V, title 12, Code of Federal Regulations, as set forth below.
PART 545--OPERATIONS
1. The authority citation for part 545 continues to read as
follows:
Authority: 12 U.S.C. 1462a, 1463, 1464, 1828.
Sec. 545.126 [Removed]
2. Section 545.126 is removed.
PART 556--STATEMENTS OF POLICY
3. The authority citation for part 556 continues to read as
follows:
Authority: 5 U.S.C. 552, 559; 12 U.S.C. 1464, 1701j-3; 15 U.S.C.
1693-1693r.
Sec. 556.16 [Removed]
4. Section 556.16 is removed.
PART 560--LENDING AND INVESTMENT
5. Part 560 as proposed to be added at 61 FR 1177 is amended as
follows:
a. The authority citation for part 560 is revised to read as
follows:
Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1701j-3, 1828,
3803, 3806; 42 U.S.C. 4106
b. Section 560.130 is added to read as follows:
Sec. 560.130 Prohibition on loan procurement fees.
If you are a director, officer, or other natural person having the
power to direct the management or policies of a savings association,
you must not receive, either directly or indirectly, any commission,
fee, or other compensation in connection with the procurement of any
loan made by the association or a subsidiary of the association.
PART 563--OPERATIONS
6. The authority citation for part 563 continues to read as
follows:
Authority: 12 U.S.C. 375b, 1462, 1462a, 1463, 1464, 1467a, 1468,
1817, 1828, 3806; 42 U.S.C. 4106.
Sec. 563.35 [Removed]
7. Section 563.35 is removed.
Sec. 563.40 [Removed]
8. Section 563.40 is removed.
Sec. 563.44 [Removed]
9. Section 563.44 is removed.
10. Section 563.200 is added to read as follows:
Sec. 563.200 Conflicts of interest.
If you are a director, officer, or employee of a savings
association, or have the power to direct its management or policies, or
otherwise owe a fiduciary duty to a savings association, you must not
advance your own personal or business interests, or those of others, at
the expense of the savings association.
11. Section 563.201 is added to read as follows:
Sec. 563.201 Corporate opportunity.
(a) If you are a director or officer of a savings association, or
have the power to direct its management or policies, or otherwise owe a
fiduciary duty to a
[[Page 30197]]
savings association, you must not take advantage of corporate
opportunities belonging to the savings association.
(b) A corporate opportunity belongs to a savings association if:
(1) The opportunity is within the corporate powers of a savings
association or a subsidiary of the savings association; and
(2) The opportunity is of present or potential practical advantage
to the savings association, either directly or through its subsidiary.
PART 571--STATEMENTS OF POLICY
12. The authority citation for part 571 continues to read as
follows:
Authority: 5 U.S.C. 552, 559; 12 U.S.C. 1462a, 1463, 1464.
Secs. 571.4, 571.7, 571.9 [Removed]
13. Sections 571.4, 571.7 and 571.9 are removed.
Dated: May 29, 1996.
By the Office of Thrift Supervision.
Jonathan L. Fiechter,
Acting Director.
[FR Doc. 96-14000 Filed 6-13-96; 8:45 am]
BILLING CODE 6720-01-P