banking, investment banking and securities
TRANSCRIPT
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F I N A N C I A L S E R V I C E S
T H E S T A T E O F
T H E B A N K I N G I N D U S T R Y
B a n k i n g a n d
I n v e s t m e n t B a n k i n g & S e c u r i t i e
A p r i l 1 J u n e 3 0 , 2 0 0 3
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A p r i l 1 t h r o u g h J u n e 3 0 , 2 0 0 3
P u b l i s h e d A u g u s t 2 0 0 3
The State of the Banking Industry is published by KPMGs Banking practice for members of the Banking
and Investment Banking and Securities Industries. Information and statistics contained in this document
were obtained from publicly available materials. The information provided here is of a general nature and
is not intended to address the circumstances of any particular individual or entity. Although we endeavor
to provide accurate and timely information, there can be no guarantee that such information is accurate as
of the date it is received or that it will continue to be accurate in the future. No one should act upon such
information without the appropriate professional advice after a thorough examination of the facts of the
particular situation.
For additional information on KPMG, please go to our Web site at www.us.kpmg.com.
F I N A N C I A L S E R V I C E S
T H E S T A T E O F T H E B A N K I N G I N D U S T R Y
B a n k i n g a n d I n v e s t m e n t B a n k i n g & S e c u r i t i e s
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
All rights reserved.
BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG International
or any KPMG member firm.
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2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
All rights reserved.
BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG International
or any KPMG member firm.
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T A B L E O F C O N T E N T S
Q uar ter l y U pdates
General Highlights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Accounting Standards and Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Market Forces
Broker/Dealers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Consolidation and Convergence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
International Focus and Globalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
e-Business and Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Risk Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
KPMGs Ban k i n g I n s i d er
Analysis and Commentary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.All rights reserved.
BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG International
or any KPMG member firm.
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2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
All rights reserved.
BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG Internationalor any KPMG member firm.
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Q U A R T E R L Y U P D A T E S
G e n e r a l H i g h l i g h t s
On May 8, 2003, the Public Company Accounting
Oversight Board announced that Thomas Ray is joining
the Boards staff as Deputy Chief Auditor who will work
closely with Chief Auditor Douglas R. Carmichael. Mr.
Ray, a partner in KPMG LLPs Department of
Professional Practice Assurance, has been the
chairman of the International Auditing Standards
Subcommittee of the AICPA, a member of the AICPA
Internal Control Reporting Task Force, and a member of
the International Auditing and Assurance Standards
Board Quality Control Task Force. (PCAOB press
release, May 8, 2003)
On June 2, 2003, NASD announced that it has agreed to
principle terms to sell the American Stock Exchange to
GTCR Golder Rauner LLC, a Chicago based private
equity firm for approximately $110 million, subject to
completion of definitive sale documents and various
approvals. In line with NASDs key goals to exit
ownership of exchanges and focus on its core mission as
a regulator to promote market integrity and protect
investors, NASD began the process by spinning off
Nasdaq in 2000. (NASD press release, June 2, 2003)
The final report and recommendations of the
NYSE/NASD IPO Advisory Committee was issued on
May 29, 2003 and proposes 20 steps to enhance public
confidence in the integrity of the IPO process. The
Committee, formed in October 2002 by the New York
Stock Exchange and NASD at the request of the SEC,
included corporate, financial and academic leaders.
Recommendations of the Committee are intended to
complement the numerous recent legislative and
regulatory initiatives, including the Global Settlement
among regulators and major investment banks. Overall:
The IPO process must promote transparency in
pricing and avoid aftermarket distortions.
Abusive allocation practices must be eliminated.
The flow of, and access to, information regarding
IPOs must be improved.
(NASD/NYSE press release, May 29, 2003)
On June 5, the NYSEs board of directors adopted initial
recommendations of its Special Committee on
Governance of the NYSE that would annually disclose
director and senior executive compensation, prohibit
NYSE officers from serving on the boards of listed
companies, and provide that the NYSEs compensation
committee consist only of non-securities industry
directors. These were among ten initial steps to be put
into effect immediately to ensure that the NYSEs
governance structure and practices best serve the 85million people who invest, directly or indirectly, through
the NYSE. (NYSE press release, June 5, 2003)
New Tillinghast-Towers Perrin research indicates that
there is going to be a considerable increase in the sale of
financial services products through the workplace,
particularly in the areas of critical illness, health
insurance, and banking products such as personal loans,
credit cards and mortgages. Reasons behind the expected
growth include the relatively low customer acquisition
costs; the increasing interest in flexible benefit schemesof employers as they look to reduce their costs while
adding choice; the need to educate consumers on
financial issues as the Government seeks ways in which
to reduce the retirement savings gap; and the potential
change from occupational pension schemes to individual
plans. (Tillinghast press release, June 2, 2003)
Weiss Ratings, Inc. noted that in 2002 the banking
industry set a new record for profits, earning $105.3
billion, outpacing its previous record of $87.5 billion in
2001. With interest rates at near record lows, the surgein consumer demand for loans more than offset the
decline in commercial lending. Banks saw more
profitable net interest margins, higher values for bond
holdings and increased consumer demand for mortgages,
home equity and credit card loans and other consumer
borrowing. There was a 9.7 percent increase in both
home mortgage lending and consumer loans and a 39.1
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
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BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG Internationalor any KPMG member firm.
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Q U A R T E R L Y U P D A T E S
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percent increase in home equity loans in 2002, while
commercial and industrial lending saw a decline of 5.3
percent for the year. For the week ended June 27, 2003,the U.S. 30-year fixed rate mortgage averaged 5.24
percent vs. 6.55 percent a year ago; 15-year rates
averaged 4.63 percent vs. 5.99 percent at this time last
year; and one-year adjustable rate mortgages averaged
3.45 percent vs. 4.61 percent a year ago. (Weiss Ratings,
Inc. press release, May 12, 2003; Freddie Mac press
release, June 26, 2003)
The Office of Federal Housing Enterprise Oversight
reports in its latest quarterly House Price Index that
average prices for U.S. homes increased 6.48 percent
from the first quarter of 2002 through the first quarter of
2003. At the same time, the quarterly national average
price appreciation continued deceleration at 0.94 percent
from 1.3 percent last quarter. In the current quarter, all
U.S. states experienced positive growth, with California
continuing to dominate the ranks of the Top 20. (Office
of Federal Housing Enterprise Oversight press release,
June 9, 2003)
On July 16th Sanford I. Weill announced his decision to
step down as head of Citigroup, effective in January
2004. Charles O. Prince will become Citigroups new
Chief Executive Officer and Robert B. Willumstad,
President, will become Chief Operating Officer. Mr.
Weill will remain Chairman of the Board until the 2006
Annual Meeting of Citigroup shareholders. (Citigroup
press release, July 16, 2003)
Earnings
U.S . Ba nk Ea rning s
Bank of America Corp.: With a strongperformance in most product lines such as mortgage,
debit and credit cards, deposits and loans, Bank of
America reported record earnings of $2.74 billion in the
second quarter of 2003, compared to $2.22 billion for
the same quarter a year ago. Net income for Bank of
America's consumer and commercial banking segment
was $1.87 billion, compared to $1.59 billion in the
second quarter of 2002. Total revenue for BofA's credit
card operation in the second quarter of 2003 was $1.04billion, compared to $806 million a year earlier. Return
on assets was 1.42 percent, compared to 1.38 percent in
the second quarter 2002, while return on equity was
21.86 percent, compared to 18.47 percent for the year-
earlier quarter. Assets on June 30 were $769 billion.
Bank of New York: The closing of Pershing
lowered Bank of New Yorks reported net income to
$295 million for the second quarter, compared to $361
million in the second quarter of 2002. Return on assets
was 1.30 percent, compared to 1.82 percent a year
earlier, while return on equity was 15.56 percent,
compared to 22.59 percent a year ago. The bank's non-
interest income was $996 million, compared to $855
million in the second quarter last year, while net interest
income was $398 million, compared to $423 million a
year earlier. Assets on June 30 were $99.8 billion.
Bank One Corp.: Reported 2003 second-quarter
net income of $856 million, compared to $803 million in
the second quarter of 2002 (excluding a $40 million
after-tax benefit from a restructuring charge reversal in
the second quarter of 2002). Bank One's retail line of
business recorded net income of $373 million (excluding
$11 million after-tax benefit from a restructuring charge
reversal a year earlier), compared to $371 million a year
earlier, while its commercial banking business had net
income of $249 million (excluding the $3 million after-
tax benefit from a restructuring charge reversal in the
prior year), compared to $147 million in the second
quarter of 2002. Return on assets totaled 1.24 percent,
compared to 1.32 percent a year earlier, while return on
equity was 15.3 percent, compared to 15.7 percent in the
year-ago quarter. Reported total assets on June 30 were$299 billion.
Citigroup: Helped by its strong consumer business,
the nation's largest financial services company reported
second-quarter operating earnings of $4.3 billion,
compared to $3.83 billion a year earlier. Net income was
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
All rights reserved.
BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG Internationalor any KPMG member firm.
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Q U A R T E R L Y U P D A T E S
earnings for J.P. Morgan's investment bank operation was
$1.09 billion, up 114 percent from second quarter 2002,
and its Chase Financial Services business reported recordoperating earnings of $883 million, an increase of 36
percent from 2002's second quarter. Return on assets was
0.96 percent, compared to 0.56 percent in the year-ago
quarter, and second-quarter return on equity was 17
percent, compared to 10 percent a year ago. Assets on
June 30 were $803 billion.
Mellon Financial Corp.: Reported second
quarter operating income of $173 million, compared to
$106 million for the second quarter last year. Net income
was $175 million, compared to $109 million in the year-ago quarter. Total non-interest revenue was $874 million,
compared to $923 million in the second quarter of 2002;
investment management fee revenue was $334 million in
the quarter, compared to $355 million a year earlier.
Return on equity was 19.5 percent, compared to 12.6
percent in 2002's second quarter. Assets on June 30 were
$38.9 billion.
Merri l l Lynch: Reported second quarter 2003 net
earnings of $1.02 billion, compared to $634 million for
the comparable quarter in 2002, an increase of 61 percent
mainly due to strong bond trading, cutting costs and
increasing profit margins. The earnings per diluted share
were $1.05 compared to $0.66 in last years quarter. Non-
interest expenses declined by 3.7 percent or $150 million
in the quarter. The Global Markets and Investment
Banking group produced quarterly pre-tax earnings of
$1.11 billion, 72 percent over last years second quarter.
Return on average common equity was 17.0 percent in the
second quarter 2003, compared to 12.0 percent a year
earlier.
Morgan Stanley 1: Reported second quarter 2003
net income of $599 million, including a pre-tax asset
impairment charge of $287 million from Morgan
Stanleys aircraft financing business, compared to $797
million for the comparable quarter in 2002, a decrease of
25 percent. The earnings per diluted share were $0.55
also $4.3 billion, compared to $4.08 billion a year earlier.
Citi's consumer cards operation had income of $768
million for the quarter, compared to $722 million a yearago, while its retail banking operations had income of
$1.05 billion, compared to $645 million in 2002's second
quarter. Income for Citigroup's total global corporate and
investment bank was $1.34 billion, compared to $1.32
billion a year earlier. Return on equity was 19.2 percent,
compared to 19.5 percent in the second quarter of 2002.
Assets on June 30 were $1.19 trillion.
FleetBoston Financial: Reported net income of
$624 million for the second quarter of 2003, compared to
a net loss of $386 million for the second quarter last year,
mainly due to the banks position of becoming more
consumer-oriented after suffering losses from its
Argentine business and reducing its risk. Net chargeoffs to
average loans was 1.59 percent, compared to 3.29 percent
in the second quarter of 2002. Return on average assets
was 1.27 percent and return on equity was 14.47 percent.
Assets on June 30 were $197.1 billion.
Goldman Sachs1
: Reported second-quarter 2003
net earnings of $695 million, compared to $563 million
for the comparable quarter in 2002, an increase of 23
percent resulting from solid operations from the Fixed
Income, Currency and Commodities franchise. The
earnings per diluted share were $1.36 compared to $1.06
in last years quarter. According to Goldman Sachs, Fixed
Income, Currency and Commodities (FICC) produced
quarterly net revenues of $1.59 billion, 39 percent over
last years second quarter. Annualized return on average
tangible shareholders equity was 18.7 percent, and
annualized return on average shareholdersequity 14.1
percent for second quarter 2003. Total capital as of May
30 was approximately $71.3 billion.
J.P. Morgan Chase & Co.: Boosted by bond
trading and consumer banking, J.P. Morgan Chase
reported operating earnings and net income of $1.8 billion
in the second quarter, compared to operating earnings of
$1.18 billion and net income of $1.0 billion a year earlier
that included merger and restructuring costs. Operating1
First quarter ended May 31, 2003
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
All rights reserved.
BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG Internationalor any KPMG member firm.
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quarter. Net chargeoffs to average loans was 0.44
percent, compared to 0.62 percent in the second quarter
of 2002. Return on average assets was 1.11 percent,compared to 1.29 percent in the same quarter last year,
and return on equity was 14.95 percent, compared to
15.77 percent in 2002's second quarter. Assets on June
30 were $120.9 billion.
U.S . Ba nco rp: Reported second-quarter net
income of $954 million, compared to $823 million a
year ago. Net interest income in the second quarter was
$1.81 billion, compared to $1.69 billion in the same
quarter last year; non-interest income was $1.67 billion,
compared to $1.44 billion in 2002's second quarter.Return on assets was 2.04 percent, compared to 1.95 a
year earlier, while return on equity was 20.0 percent,
compared to 20.0 percent in the second quarter of 2002.
Assets on June 30 were $195 billion.
Wachovia Corp.: Reported second-quarter net
income of $1.03 billion, compared to $849 million for
the same quarter a year ago. Non-performing assets as a
percentage of total loans was 1.04 percent for the
quarter, compared to 1.24 percent a year earlier;
chargeoffs were 0.43 percent, compared to 0.97 percent
in the second quarter of 2002. Average core deposits
were $179 billion during the second quarter, compared
to $165 billion a year ago. Return on assets was 1.21
percent, compared to 1.09 percent in the year-ago
quarter; return on equity was 12.78 percent, compared to
11.52 percent in the second quarter of 2002. Assets on
June 30 were $364 billion.
Washington Mutual Inc.: Boosted by branch
growth and mortgage lending, Washington Mutual
reported net income in 2003's second quarter of $1.02
billion, compared to $990 million for the same quarter a
year ago. Net interest income after provisions for loan
and lease losses was $1.91 billion for the quarter,
compared to $1.94 billion in the second quarter of 2002.
Wamu's non-interest income was $1.63 billion for the
second quarter of 2003, compared to $1.21 billion a year
earlier. Return on assets was 1.44 percent, compared to
compared to $0.72 in last years quarter. Institutional
Securities posted quarterly net income of $298 million,
33 percent below last years second quarter. The FixedIncome Sales & Trading net revenues increased year-
over-year by 48 percent to $1.3 billion. Return on
average common equity was 10.6 percent in the second
quarter 2003, compared to 15.1 percent a year earlier.
Total capital as of May 31, 2003 was $78.7 billion.
National City Corp.: Helped by a strong core
deposit, consumer loan and mortgage results, National
City Corp. reported net income of $617 million for the
second quarter, compared to $393 million for the same
period a year earlier. Net interest income after provisionsfor loan losses was $919 million, compared to $806
million in 2002's second quarter, and fees and other
income totaled $1.03 billion, compared to $729 million
for the year-ago quarter. Return on assets was 2.08
percent, compared to 1.61 percent a year ago, and return
on equity was 28.10 percent, compared to 19.98 percent
for the second quarter of 2002. Assets on June 30 were
$123.4 billion.
State Street Corp.: State Street reported net
loss of $23 million on revenue of $1.1 billion that
included pre-tax restructuring charges of $292 million
from its expense-reduction program, a $13 million pre-
tax charge relating to an agreement to sell some real
estate in suburban Boston and a $18 million pre-tax
merger and integration cost related to the business it
acquired from Deutsche Bank. State Street also finished
a tax issue relating to its REIT with the Massachusetts
Department of Revenue that produced a tax benefit of
$13 million. For second quarter 2002, net income was
$178 million, and revenue was $1.0 billion. Assets on
June 30 were $83.1 billion.
SunTrust Banks Inc.: SunTrust reported net
income of $330 million for the second quarter of 2003,
compared to net income of $344 million for the second
quarter of 2002. The bank holding company reported net
interest income after loan loss provisions of $717
million, compared to $702 million in the year-ago
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
All rights reserved.
BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG Internationalor any KPMG member firm.
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Q U A R T E R L Y U P D A T E S
1.48 percent in 2002's second quarter, while return on
equity was 19.25 percent, compared to 20.37 percent for
the same quarter a year ago. Assets on June 30 were$283 billion.
Wells Fargo & Co.: With strong results in
consumer lending, Wells Fargo reported net income of
$1.53 billion in the second quarter of 2003, compared to
net income of $1.42 billion for the same quarter a year
ago. Return on assets was 1.63 percent, compared to
1.83 percent a year ago, while return on equity was
19.60 percent, compared to 19.72 percent in 2002's
second quarter. Net interest income after loan losses was
$3.62 billion, compared to $3.23 billion a year earlier,while non-interest income was $2.71 billion in the
second quarter, up from $2.38 billion in the second
quarter of 2002. Assets on June 30 were $370 billion.
Canadian Bank Earnings*
Bank of Montreal announced a second quarter
net income of $409 million compared to $301 million
during the same period a year ago. Revenues for the
quarter decreased by 1 percent over the second quarter
of 2002 to $2.2 billion due to the fact that volume
growth and improved net interest margins in Canadian
retail and business banking were offset by the effects of
low client transaction volumes in other operating groups
and the weaker U.S. dollar. Net interest income after
provision of credit losses was $1.09 billion. Return on
equity was 15.2 percent, compared to 11.6 percent in the
year-ago quarter. Assets on April 30, 2003 were
$258 billion.
CIBC announced a second quarter net income of $320
million compared to $227 million during the same
period a year ago. Total revenues reported on a taxequivalent basis were $2.7 billion in the quarter. Net
interest income rose to $1.36 billion in the second
quarter of 2003 from $1.32 billion in the same quarter of
2002 due to increases in loan volume, residential
mortgages and volume growth and improved spreads in
cards and Presidents Choice Financial which were
moderately counteracted by lower West Indies revenue
as a result of the change to equity accounting and lower
trading revenue. Return on equity was 11.9 percent,compared to 8.0 percent in the year-ago quarter. Assets
on April 30, 2003 were $280 billion.
Royal Bank of Canada announced second
quarter record net income of $689 million compared to
$710 million during the same period a year ago. Net
income from U.S. acquisitions (RBC Centura, RBC
Dain Rauscher and RBC Liberty Insurance) was $58
million. Total revenues dropped by 4 percent in the
quarter to $3.75 billion from $3.91 billion in the second
quarter of 2002, due to a net gain on credit derivativesthat was recorded in last years second quarter, and a
decline in revenue this quarter due to the appreciation of
the Canadian dollar in comparison to the U.S. dollar.
Interest income was $1.70 billion for the quarter down
from prior years quarter of $1.72 billion. Return on
equity was 15.4 percent, compared to 16.8 percent in the
year-ago quarter. Assets on April 30, 2003 were
$398 billion.
Scotiabankannounced second quarter net income
of $596 million compared with $598 million during the
same period a year ago. Revenues for the quarter were
$2.57 billion compared to $2.77 billion in the second
quarter of 2002. This decline mainly resulted from lower
securities gains and foreign currency funding spread as
well as the sales of Scotiabank Quilmes and the Banks
merchant acquirer business last year. Net interest income
was $1.54 billion compared to $1.65 billion in the prior
years quarter. Return on equity was17.2 percent,
compared to 18.3 percent in the year-ago quarter. Assets
on April 30, 2003 were $292 billion.
TD Bank Financial Group reported a netincome on operating cash basis loss of $146 million in
the second quarter of 2003, compared to net income on
an operating cash basis of $316 million in the same
quarter of 2002 which reflects the steps the Bank is
taking to restructure its wealth management business
outside North America and the U.S. equity option arm of
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
All rights reserved.
BearingPoint, Inc., formerly KPMG Consulting Inc., is an independent consulting firm and is not affiliated with KPMG Internationalor any KPMG member firm.
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is the subject of the lease stripping transaction. The fact
that parties that were unrelated up to and including the
time of a transaction engage in that transaction in anattempt to arbitrarily shift income or deductions among
themselves does not by itself evidence the type of
control necessary to satisfy the acting in concert or with
a common goal or purpose requirement of section
1.482-1(i)(4).
The IRS also noted that it will challenge lease stripping
transactions on other legal grounds. Rev. Rul. 2003-96
will appear in Internal Revenue Bulletin 2003-34, dated
August 25, 2003.
(KPMGs TaxNewsFlash, No. 2003-234, July 21, 2003)
IRS Identifies Lease Stripping Transactions as
"Listed Transactions"
On July 21, 2003, the IRS released an advance copy of
Notice 2003-55, relating to lease strips and other
stripping transactions. With this notice, the IRS stated
that transactions that are the same as or substantially
similar to the lease strips described in the notice are
"listed transactions" for purposes of the tax shelter
regulations.
Listed Transaction - The IRS concluded that lease
strips improperly separate income from related
deductions and generally do not produce the tax
consequences desired by the participants.
Therefore, transactions that are the same as, or
substantially similar to, the lease strips described in
Notice 2003-55 are "listed transactions" for purposes of
Reg. sections 1.6011-4(b)(2), 301.6111-2(b)(2), and
301.6112-1(b)(2). Moreover, according to the notice,
these transactions may already be subject to the
disclosure requirements, the tax shelter registration
requirements, or the list maintenance requirements under
the regulations. Finally, the IRS warns that accuracy-
related penalties may be imposed on participants in lease
strip transactions.
its wholesale banking operation. Net interest income
(TEB) grew from $1.37 billion in the second quarter of
2002 to $1.47 billion in this years second quarter.Return on equity on an operating cash basis was negative
6.0 percent, compared to 9.7 percent in the year-ago
quarter. Assets on April 30, 2003 were $322 billion.
* Canadian financial information reported in Canadian currency.
Second quarter ended April 30, 2003.
(Source: Company financial reports)
The information contained in this Earnings section was obtained from
the individual company financial statements. KPMG LLP has not
verified any information stated herein and does not endorse any of the
numerical information provided.
Taxation
IRS Rules Section 482 Cannot Be Used to Allocate
Income, Deductions From Lease Stripping
Transactions
On July 21, 2003, the IRS released an advance copy of
Rev. Rul. 2003-96, concerning whether the transfer
pricing rules can be used to allow allocations of incomeand deductions under a lease stripping arrangement
entered into among unrelated parties, under a plan
promoted to realize tax benefits for one or more of the
parties, solely on the basis that at the time the parties
entered into the transaction, they had a common goal to
shift income or deductions among themselves.
The IRS ruled that under the facts presented, section 482
could not be used to allow the allocation of income and
deductions arising from property that is the subject of a
lease stripping transaction. According to the IRS, the
facts in the revenue ruling:
. . . described up to and including the time the income is
stripped from the leases do not support the application of
section 482 to allow the allocation among the parties of
the income and deductions arising from the property that
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(1) A book method, under which the inducement fee
is recognized for federal income tax purposes in
the same amounts and over the same period inwhich that fee is included in income by the
taxpayer for financial reporting purposes
(provided that period is not shorter than the period
over which the REMIC is expected to generate
taxable income).
(2) A method under which the inducement fee is
recognized for federal income tax purposes ratably
over the remaining anticipated weighted average
life of the REMIC determined as of the time the
noneconomic residual interest is transferred to thetaxpayer.
Provide a rule that applies if a holder of a residual
interest sells or otherwise disposes of the residual
interest.
Include a rule clarifying that an inducement fee is
income from sources within the United States.
If the regulations are finalized as proposed, the timing
for including inducement fees in income would apply
for tax years ending on or after the publication of finalregulations in the Federal Register. Comments are
requested.
The proposed rules also note that a taxpayer may not
change its method of accounting for inducement fees
without securing the prior consent of the Commissioner.
Treasury and the IRS request comments as to how best
to effect any change in method of accounting under
these regulations.
REG-162625-02 is scheduled to be published in the
Federal Register, July 21, 2003.
(KPMGs TaxNewsFlash, No. 2003-230, July 18, 2003)
The IRS further stated that it was currently evaluating
other situations in which tax benefits are claimed as a
result of transactions in which the ownership of propertyhas been separated from the right to income from the
property. For example, the IRS reported that it is
evaluating situations in which, in exchange for
consideration, one participant assigns its interest in
property but retains the right to income from the
property, and, by allocating all of its basis to the
transferred property and none to the retained future
payments, the transferor claims a loss on the transfer.
Notice 2003-55 modifies and supersedes Notice 95-53,
and will appear in Internal Revenue Bulletin 2003-34,
dated August 25, 2003.
(KPMGs TaxNewsFlash, No. 2003-233, July 21, 2003)
Proposed Accounting Rules for REMIC
Inducement Fees
On July 18, 2003, the Treasury Department and IRS
released proposed regulations (REG-162625-02) with
accounting rules for taking into income any fees received
to induce the acquisition of noneconomic residual
interests in real estate mortgage investment conduits(REMICs). Under the proposed accounting rules,
inducement fees would be taken into income over a
period that is related to the period during which the
applicable REMIC is expected to generate taxable
income or net loss allocable to the holder of the
noneconomic residual interest. In general, the proposed
regulations:
Provide that an inducement fee may not be taken into
account in a single tax year, but must be included in
income over a period that is reasonably related to theperiod during which the REMIC is expected to
generate taxable income or net loss allocable to the
holder of the noneconomic residual interest.
Establish two safe harbor methods of accounting for
inducement fees:
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procedure is effective for leases in effect or entered into
on or after January 1, 2001, and will appear in Internal
Revenue Bulletin 2003-33, dated August 18, 2003.
(KPMGs TaxNewsFlash, No. 2003-223, July 16, 2003)
IRS Establishes Safe Harbor for Loan by REIT to Be
Treated as Real Estate Asset
On July 11, 2003, the IRS released an advance copy of
Rev. Proc. 2003-65, establishing a safe harbor for a loan
made by a real estate investment trust (REIT) to be
treated as a real estate asset for purposes of sections
856(c)(4)(A) and 856(c)(5)(B), even though the loan isnot directly secured by a mortgage on real property. In
addition, if the criteria for the safe harbor are satisfied,
the IRS states that interest on such loans will be treated
as interest on an obligation secured by a mortgage on
real property or on an interest in real property for
purposes of section 856(c)(3)(B).
Background - Many REITs invest in real estate by
making loans that are secured by real property. In certain
cases, because of financing arrangements and restrictive
loan covenants, REITs make loans to the owners of
entities that hold real property, instead of making loans
that are secured directly by real property. The loans are
secured by a pledge of the borrowers' ownership
interests in the property-owning entities.
Section 856, however, requires that certain tests must be
met for the entity to qualify as a REIT. These tests
include requirements that:
75 percent of the value of the REIT's total assets is
represented by real estate assets (including mortgages
on real property), cash and cash items, andgovernment securities.
75 percent of the REIT's gross income is derived
from certain items including interest on obligations
secured by mortgages on real property or on interests
in real property.
IRS Issues Guidance for REITs and Taxable REIT
Subsidiaries
On July 16, 2003, the IRS released the following
guidance concerning real estate investment trusts
(REITs):
Rev. Rul. 2003-86 addresses whether a joint venture
partnership between a taxable REIT subsidiary and a
corporation that qualifies as an independent
contractor of the REIT can provide noncustomary
services to tenants of the REIT without causing the
rents paid to the REIT to fail to qualify as rents from
real property under section 856(d).
Rev. Proc. 2003-66 describes the conditions under
which payments to a REIT from a joint venture
between a taxable REIT subsidiary and an unrelated
third party for space at property owned by the REIT
will be treated as rents from property under section
856(d).
Rev. Rul. 2003-86 - Under the facts considered in the
July 16th revenue ruling, the IRS ruled that the joint
venture partnership between the unrelated independent
contractor and the taxable REIT subsidiary may provide
certain noncustomary services (primarily for the
convenience of the REIT tenants) to such tenants without
causing the related rents paid to the REIT to fail to
qualify as rents from real property.
Rev. Rul. 2003-86 will appear in Internal Revenue
Bulletin 2003-32, dated August 11, 2003.
Rev. Proc. 2003-66provides the rules under which the
IRS will treat rents from a qualifying joint venture as
rents from real property, where the amounts paid to the
REIT by the joint venture are substantially comparable torents paid by other tenants at the REIT's property for
comparable space and at least 90 percent of the leased
space of the REIT's property is rented to persons other
than (1) taxable REIT subsidiaries and (2) related parties
as described in section 856(d)(2)(B). The revenue
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Rev. Proc. 2003-65 - With the July 11th revenue
procedure, the IRS provides a safe harbor for treating a
loan as a qualified real estate asset under the REITqualification rules, even though the loan is not directly
secured by a mortgage on real property. To qualify for
the safe harbor, the following requirements must be met:
The borrower is either a partner or a partnership, or
the sole member of an eligible entity that has not
elected to be treated as a corporation for federal tax
purposes (and therefore is disregarded as an entity
separate from its owner).
The loan is nonrecourse.
The lender has a first priority security interest in the
pledged ownership interest.
On default and foreclosure of the secured loan, the
lender will replace the borrower as a partner in the
partnership or as the sole member of the disregarded
entity.
On the date that the lender's commitment to make the
loan is binding, the partnership or disregarded entity
holds real property and if any of this property is sold
or transferred, the loan is immediately due andpayable.
On each testing date, the value of the subject real
property is at least 85 percent of the value of all of the
assets of the partnership or disregarded entity.
The loan value of the real property owned by the
partnership or disregarded entity equals or exceeds
the amount of the loan as determined under Reg.
section 1.856-5(c)(2).
Interest on the loan includes only an amount that
constitutes compensation for the use or forbearance of
money.
A loan that satisfies these eight requirements will be
treated as a real estate asset for purposes of sections
856(c)(4)(A) and 856(c)(5)(B), and the interest on the
loan will be treated as interest on an obligation secured
by a mortgage on real property or on an interest in real
property for purposes of section 856(c)(3)(B).
Rev. Proc. 2003-65 is effective August 11, 2003, and will
appear in Internal Revenue Bulletin 2003-32, dated
August 11, 2003.
(KPMGs TaxNewsFlash, No. 2003-219, July 11, 2003)
Final IRS Guidance on Withholding Rules for
Foreign Partnerships and Foreign Trusts
On July 10, 2003, the IRS issued Rev. Proc. 2003-64,
concerning the withholding and reporting obligations for
payments of income made to foreign partnerships and
foreign simple or grantor trusts. The IRS stated that the
purpose of this guidance is to simplify these withholding
and reporting obligations. Accordingly, Rev. Proc. 2003-64:
Provides final withholding foreign partnership (WP)
and withholding foreign trust (WT) agreements, as
described in Reg. section 1.1441-5(c)(2)(ii) and
(e)(5)(v), and the application procedures for entering
into such agreements.
Amends the Qualified Intermediary (QI) withholdingagreement of Rev. Proc. 2000-12 by including new
section 4A -i.e., additional rules for QIs for
withholding and reporting on certain small or related
foreign partnerships and foreign simple or grantor
trusts that do not enter into WP or WT agreements.
Similar rules are part of the final WP and WT
agreements. Rev. Proc. 2003-64 provides that a WP or
WT agreement entered into during a calendar year may
be made effective as of the first day of that calendar
year. Therefore, a QI may apply the provisions of section
4A as of the beginning of the 2003 calendar year.
Background - In Notice 2001-4, the IRS provided
important transitional relief and guidance related to the
section 1441 regulations (as amended in May 2000) for
foreign partnerships for calendar year 2001 (see
KPMGs TaxNewsFlash 2000-207). The transitional
relief was extended through calendar year 2002.
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In Notice 2002-41, the IRS proposed WP and WT
agreements with streamlined procedures designed to
simplify documentation and reporting (see KPMGsTaxNewsFlash 2002-120). As proposed, a WP or
WT was to provide the withholding agent with a
Form W-8IMY as a WP or WT without attached
documentation from partners, beneficiaries, or owners.
The WP or WT would receive gross payments from the
withholding agent, and then withhold and deposit tax (if
any) based on the Forms W-8 or W-9 received from the
partners, beneficiaries, or owners. The WP or WT would
report payments to, and tax withheld from, its direct
foreign partners, beneficiaries, or owners on Form 1042-
S on an individual basis or, by election, on a pooled
basis. Thus, a WP or WT would be relieved of having to
disclose to a withholding agent any documentation and
payment information for partners, beneficiaries, or
owners. A withholding agent would be relieved of the
responsibility for collecting documentation, withholding,
and reporting payment information for partners,
beneficiaries, or owners of a WP or WT.
Rev. Proc. 2003-64 - According to the July 10th revenue
procedure, no further extensions of the transitional relief
for foreign partnerships are required. With respect to the
documentation and reporting relief for foreign simple
and grantor trusts, comprehensive guidance is included
in the revenue procedure; however, for the year 2003, a
QI may apply the earlier rules of Notice 2001-4 or the
rules of this revenue procedure.
Concerning WP and WT agreements, several provisions
of the WP and WT agreements have been amended, and
a new set of provisions for certain smaller foreign
partnerships and trusts and for certain foreign
partnerships and trusts that are related to a QI, WP, or
WT have been developed. Other changes concern the::
Term of the Agreement: The six-year renewable term
is still available, but the WP or WT may elect to use a
longer non-renewable term of up to 15 years.
Automatic Termination: The final WP or WT
agreements (1) extend the date for curing
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documentation failures from January 31 to March 15
and (2) add an alternative method for curing failure.
Withholding on Distributions: The WP or WT may
compute the amount of withholding on a distribution
by using a reasonable estimate of the partner,
beneficiary, or owner's distributive share of income
subject to withholding for the year.
Application to Direct Partners, Beneficiaries, or
Owner: The final WP and WT agreements contain
two new provisions for application to indirect
partners, beneficiaries, or owners (1) that are small
partnerships and trusts (streamlined rules similar to
the U.S. rules for joint account holders) and (2) thatare partnerships or trusts that are related to the WP or
WT (rules similar to those for private arrangement
intermediaries (PAIs) under the QI agreement)
Frequency of Audit: The WP and WT agreements
have been amended to conform the audit cycle for the
six-year agreement to the audit cycle under the QI
agreement. If the WP or WT elects pooled reporting
and a six-year term, it must agree to have the external
auditor conduct an audit of the second and fifth full
calendar year that the agreement is in effect. The two-
year audit cycle is retained for a WP or WT that
elects pooled reporting and a non-renewable term of
up to 15 years.
Yet, for the most part, the final WP and WT agreements
are substantially the same as originally proposed in
Notice 2002-41. For example, the WP and WT
agreements continue to require payments to partners,
beneficiaries, or owners to be documented solely with
Forms W-8 and W-9 and do not permit reliance on the
presumption rules. Rev. Proc. 2003-64 also includes new
rules for:
A small foreign partnership or simple or grantor trust
that is an account holder of a QI.
A foreign partnership or trust that is related to a QI,
WP, or WT to provide information necessary for the
QI, WP, or WT to withhold and report on reportable
amounts.
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Rev. Proc. 2003-64 is effective, July 10, 2003, and will
appear in Internal Revenue Bulletin 2002-32, dated
August 11, 2003.
(KPMGs TaxNewsFlash, No. 2003-217, July10, 2003)
New Regulations Governing Section 338(h)(10)
Elections and Multi-Step Transactions -
A Brave New World
On July 8, 2003, the Treasury Department and IRS
released an advance copy of final and temporary
regulations (T.D. 9071) and, by cross reference, proposed
regulations (REG-143679-02), giving effect to section
338(h)(10) elections in certain multi-step transactions as
contemplated by Rev. Rul. 2001-46.
The regulations provide that the step-transaction doctrine
will not be applied if a taxpayer makes a valid section
338(h)(10) election with respect to a step in a multi-step
transaction, even if the transaction would otherwise
qualify as a reorganization, if the step, viewed
independently, is a qualified stock purchase.
Background - Rev. Rul. 2001-46 applied the step-
transaction doctrine to treat a series of transactionsoccurring pursuant to a single plan - encompassing a
first step acquisition merger of a subsidiary of Acquiring
into Target that would otherwise constitute a qualified
stock purchase, followed by a second step upstream
merger of Target into Acquiring - as a single statutory
merger of Target into Acquiring (see KPMGs
TaxNewsFlash 2001-187).
Final and Temporary Regulations - As contemplated
by Rev. Rul. 2001-46, the July 8th release adopts new
final and temporary regulations to give effect to section
338(h)(10) elections in multi-step transactions where the
purchasing corporation's acquisition of the target's stock,
viewed independently, constitutes a qualified stock
purchase.
The regulations provide that if a section 338(h)(10)
election is made in these circumstances, the purchasing
corporation's acquisition of target's stock will be treated
as a qualified stock purchase for all federal tax purposes,
even if the overall transaction would be integrated andtreated as a single reorganization qualifying under
section 368(a) in the absence of a section 338(h)(10)
election.
Effective Date - The final and temporary regulations are
applicable to acquisitions of stock occurring on or after
the date of publication of the regulations in the Federal
Register (scheduled to be July 9, 2003).
KPMG Observation - The regulations provide
taxpayers flexibility in structuring and planning the tax
consequences of an acquisition, and represent a novel
approach by the Treasury in which tax-free
reorganization treatment is, in certain circumstances,
elective. One may wonder if this may be an initial foray
into a check-the-box regime for tax-free reorganization
treatment.
(KPMGs TaxNewsFlash, No. 2003-214, July 8, 2003)
For electronic versions of the releases mentioned above or for additionaltax-related information, see KPMGs TaxNewsFlash publications at
www.kpmgtax.com.
Regulat ion
FinCEN and the SEC issued joint final rules that require
broker-dealers and mutual funds to take steps to verify
the identities of their customers. They became effective
on June 9. These institutions must fully implement their
customer identification programs (CIPs) by October 1.
These rules were issued concurrently with other final
regulations affecting banks, savings associations, credit
unions, and certain non-federally regulated banks, as
well as futures commission merchants and introducing
brokers. Collectively, the rules are intended to be
uniform throughout the financial services industry.
FinCEN and the SEC collaborated on the broker-dealer
and mutual fund CIP rules, which are intended to
implement Section 326 of the United and Strengthening
America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (USA
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on Sound Practices to Strengthen the Resilience of the
U.S. Financial System. The paper identifies three new
business continuity objectives that are of specialimportance to financial institutions in the post-
September 11 environment, and four sound practices
which are intended to strengthen the resilience of critical
U.S. financial markets by minimizing the immediate
systemic effects of a wide-scale disruption. The paper
applies most directly to core clearing and settlement
organizations and firms that play significant roles in
critical financial markets. The agencies expect these
institutions to adopt the sound practices discussed in the
paper within designated time frames.
The SEC issued a notice that it approved an order to
extend the temporary exemption of banks, savings
associations and savings banks from the definitions of
broker under Section 3(a)(4) of the Securities and
Exchange Act of 1934 (Exchange Act) until November
12, 2004.
The SEC adopted an amendment to Rule 15c3-3(b)(3)
under theExchange Act, which provides that broker-
dealers must provide full collateral consisting of certain
specified financial instruments or cash when theyborrow fully paid and excess margin securities from
customers. The rule change will allow firms to pledge
other collateral as the SEC designates as permissible by
order of the SECs Division of Market Regulation. The
change became effective on April 16.
The SEC issued an interpretive release regarding its
books and records regulations (Rules 17a-3 and 17a-4
under theExchange Act) in order to clarify certain issues
raised by industry participants. Amendments to these
rules, which were adopted on October 26, 2001, recentlybecame effective on May 2. The interpretation became
effective on May 29.
NASD announced a proposal to amend Rule 3010 to
require the Chief Executive Officer and Chief
Compliance Officer of each member firm to make
annual, joint certifications regarding the adequacy of
PATRIOT Act). They aim to strengthen ongoing efforts by
these agencies to prevent, detect and prosecute money
laundering and the financing of terrorism.
FinCEN issued a notice of proposed rulemaking that
would amendBank Secrecy Act (BSA) rules to add
futures commission merchants and introducing brokers
in commodities to the regulatory definition of financial
institution, and require that they report suspicious
transactions to FinCEN. These institutions are considered
at risk for certain money laundering activities due to
their respective business activities and importance in the
global economy. The proposal is intended to implement
provisions of theBSA in order to further the efforts ofTreasury and other financial regulators to prevent, detect
and prosecute money laundering and the financing of
terrorism. In developing the proposed and amended
rules, FinCEN consulted extensively with the Chicago
Futures Trading Commission, which, with designated
self regulatory organizations, would be responsible for
oversight and enforcement of the rules. The changes
would become effective 180 days after the final version
of the rule is adopted.
The SEC, New York Attorney General, North AmericanSecurities Administrators Association, NASD, NYSE,
and state securities regulators jointly announced the
finalization of an approximate $1.4 billion settlement
with ten large broker-dealers, in connection with
allegations of conflicts of interest between research and
investment banking interests at these firms, supervisory
deficiencies and allegations of spinning. The action
represents finalization of the so-called global
settlement that was reached in principle in December
2002. The terms require payments of penalties,
disgorgement and funds for independent research and
investment education, as well as significant structural
reforms to increase the integrity of equity research.
The SEC, the Board of Governors of the Federal Reserve
System (Fed), and the Office of the Comptroller of the
Currency (OCC), in cooperation with the Federal
Reserve Bank of New York, issued anInteragency Paper
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the firms compliance and supervisory procedures.
NASD also proposed the adoption of related
interpretive material to describe the purpose of theproposed rule and provide clarification regarding the
obligations and liabilities associated with the
certification requirement.
The SEC requested public comment on a petition
filed by The Nasdaq Stock Market, Inc., relative to
trading in Nasdaq-listed securities. Nasdaq has asked
the SEC to take multiple actions in order to address
unequal and inadequate regulation by various
national and regional exchanges that trade these
securities.
NASD established a one-time global extension for
all firms subject to the requirement to complete a
self-assessment of front-end load mutual fund
transactions. This review was required in connection
with recent regulatory, Congressional and industry
attention to potential problems in this area.
Sources: KPMGs Compliance & Regulatory Focus, April-July 2003;
KPMGs Washington Report, March-July 2003. Federal Register and Web
sites of the issuing agencies including: www.treas.gov/fincen,
www.sec.gov, www.nasd.com, www.nyse.com, www.nasaa.org and
www.gao.gov.
KPMG hostsRegulatory Perspectives, a quarterly teleconference
briefing for clients on important legislative and regulatory activities
specific to the financial services industry. For more information about
Regulatory Perspectives, or to register for future teleconferences, please
send an e-mail to [email protected]. The e-mail should include your
name, title, company name, and your e-mail address.You will be
notified via e-mail regarding future teleconferences.
Legis lat ion
Basel Bill Passes House Subcommittee
The House Financial Services Subcommittee on
Financial Institutions passes H.R. 2043, the United
States Financial Policy Committee For Fair Capital
Standards Act, by voice vote on July 16.
The bill would create an interagency financial policy
committee that would include the Treasury secretary as
chairman, the chairman of the Board of Governors of the
Federal Reserve System, the comptroller of the currency,the chairman of the Federal Deposit Insurance
Corporation, and the chairman of the Office of Thrift
Supervision.
The Financial Policy Committee would be responsible
for constructing uniform United States positions on
proposals made to, and issues before, the Basel
Committee on Banking Supervision that may affect U.S.
financial institutions.
If the bill passed tomorrow, it would force regulators to
form a uniform policy on the Basel II accord. According
to a committee press release, several members of the
Committee questioned the wisdom of making
operational risk a mandatory capital charge under Pillar I
of the Basel Accord a provision which is included
under the current Basel proposal. Several members also
expressed their desire for continued Congressional
oversight of the Basel process.
The House Committee on Financial Services has yet to
schedule a markup on the bill. Further, there is no
companion legislation in the Senate as of yet.
The text of H.R. 2043 is available on the Library of
Congress Web site.
(KPMGs Washington Report, July 21, 2003)
FACT Act Passes House Financial Services
Committee
The House Committee on Financial Services passed
H.R. 2622, theFair and Accurate Credit Transactions
Act(FACT), by a 61-3 vote. H.R. 2622 would renewpreemption provisions in theFair Credit Reporting Act
(FCRA) that allow financial and retail firms to share
certain customer data among their affiliates. These
provisions are set to expire on January 1, 2004. The bill
also strengthens rules to fight identity theft. The
Committee passed a number of amendments to the bill
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that would:
Require consumer reporting agencies to employ afraud alert system to help victims of identity theft to
ensure that credit is not extended to identity thieves.
Ban businesses from sharing negative information
about a consumer if they have received a copy of a
police report indicating an illegal transaction
following an identity theft.
Require the General Accounting Office to conduct a
study on the role of race and gender in the credit
granting process.
Require credit bureaus to notify users of consumer
reports when discrepancies exist in connection with
addresses.
Require federal bank regulators to issue guidance on
how lenders should treat credit reports when there is
confusion about a consumers address.
Ban the passing on of consumer information to credit
bureaus if the information furnisher has substantial
doubts about the accuracy of the information.
Permit consumers to reinvestigate consumer disputesdirectly through resellers of credit reporting
information.
Define a fraud alert as a statement that notified users
of the file that the consumer does not want credit
offered without permission through a preauthorized
procedure.
The fraud alert system created by the bill is composed of
three tiers: an initial alert; an extended alert; and a
special military alert.
When a consumer reporting agency creates an alert, it
would automatically be communicated to other consumer
reporting agencies and would exclude the consumer from
pre-screened offers of credit or insurance. Further, no
user of a consumer report with a fraud alert in it may
issue or extend credit in the name of the consumer to a
Q U A R T E R L Y U P D A T E S
person other than the consumer without first attempting
to obtain the authorization or preauthorization of the
consumer in the manner contained in the fraud alert.
The FACT Act now heads to the House Floor for
consideration. Congressman Oxley (R-OH), Chairman
of the House Committee on Financial Services, would
like the House to complete action on the bill before the
end of September. Congressman Frank (D-MA)
predicted the bill would pass the Senate before
January 1, 2004.
The text of H.R. 2622 is available on the Library of Congress
Web site at http://thomas.loc.gov.
(KPMGs Washington Report, July 28, 2003)
To subscribe to KPMGs regulatory and legislative reports, please
send an e-mail message to [email protected] for any of the
following publications:
Washington Reports
Regulatory Practice Letters
Legislative Practice Letters
Compliance and Regulatory Focus
These reports can also be accessed through KPMGs Web site at
www.us.kpmg.com (Financial Services industry). Back issues may be
obtained by sending an e-mail message to [email protected].
Accounting Standards and
Developments
Financial Accounting Standards Board (FASB)
The FASB has issued for public comment an Exposure
Draft, Qualifying Special-Purpose Entities and Isolation
of Transferred Assets, which would amend FASB
Statement No. 140,Accounting for Transfers and
Servicing of Financial Assets and Extinguishments ofLiabilities. The purpose of the proposal is to provide
more specific guidance on the accounting for transfers
of financial assets from a company to an off-balance
sheet structure known as a qualifying special-purpose
entity (QSPE).
The Boards objective is to improve the accounting for
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
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QSPEs in several key respects. First, it would prohibit an
entity from being a QSPE if a company that transfers
assets to the entity enters into a commitment (such as afinancial guarantee, liquidity commitment or total return
swap) to provide additional cash or other assets to fulfill
the QSPEs obligations to its beneficial interest holders.
Second, if an entity can reissue beneficial interests, the
proposed Statement would prohibit that entity from
being a QSPE if any party involved with the entity has
certain risks or combinations of risks and decision-
making abilities. Third, the proposed Statement would
prohibit an entity from being a QSPE if it holds equity
instruments, such as shares or partnership interests.
Finally, the proposed Statement would clarify certain of
the requirements in Statement 140 related to legally
isolating assets and surrendering control of assets. The
comment period ends July 31, 2003.
FASB has issued Statement No. 150,Accounting for
Certain Financial Instruments with Characteristics of
both Liabilities and Equity. The Statement improves the
accounting for certain financial instruments that, under
previous guidance, issuers could account for as equity.
The new Statement requires that those instruments be
classified as liabilities (or, in certain circumstances, as
assets) in statements of financial position.
Statement 150 affects the issuers accounting for
mandatorily redeemable shares that the issuing company
is obligated to buy back in exchange for cash or other
assets, instruments that do or may require issuers to buy
back shares in exchange for cash or other assets, and
obligations that can be settled with shares, the monetary
value of which is fixed, tied solely or predominantly to a
variable such as a market index, or varies inversely with
the value of the issuers shares. Statement 150 does not
apply to features embedded in a financial instrument that
is not a derivative in its entirety.
Most of the guidance in Statement 150 is effective for
financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003,
except that for private companies, mandatorily
redeemable financial instruments are subject to the
provisions of this Statement for the fiscal periodbeginning after December 15, 2003.
FASB issued Statement No. 149,Amendment of
Statement 133 on Derivative Instruments and Hedging
Activities. The Statement amends and clarifies
accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and
for hedging activities under Statement No. 133,
Accounting for Derivative Instruments and Hedging
Activities.
The amendments set forth in Statement 149 are intended
to improve financial reporting by requiring that contracts
with comparable characteristics be accounted for
similarly. In particular, this Statement: (1) clarifies under
what circumstances a contract with an initial net
investment meets the characteristic of a derivative as
discussed in paragraph 6(b) of Statement 133;
(2) clarifies when a derivative contains a financing
component; (3) clarifies the definition of an underlying
to conform it to language used in FASB Interpretation
No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others; and (4) amends
certain other existing pronouncements. In addition to
other changes, this Statement:
Removes from the scope of Statement 133 contracts
for the purchase or sale of securities referred to as
when-issuedsecurities or other securities that do not
yet exist if the contracts meet all three criteria in
paragraph 59(a) of Statement 133.
Significantly modifies DIG Issue C13 by excludingfrom the exemption from Statement 133, as well as
from the automatic inclusion, commitments to
purchase loans. Holders and issuers of commitments
to purchase loans now will need to evaluate the terms
of the contracts to conclude whether they otherwise
meet the characteristics of a derivative.
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
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Clarifies the use of the short-cut method by requiring
that the interest rate swap has a fair value of zero at
inception of the hedging relationship if the hedginginstrument is solely an interest rate swap. If the
hedging instrument is a compound derivative, that is
when the hedged item is callable, the premium for
the mirror-image call option compounded with the
swap must be paid or received in the same manner as
the premium on the call option embedded in the
hedged item.
Clarifies the accounting for option-based contracts
used as hedging instruments in a cash flow hedge of
the variability of the functional-currency-equivalent
cash flows for a recognized foreign-currency-
denominated asset or liability that is remeasured at
spot exchange rates.
Clarifies those financial guarantee contracts within
the scope exception.
This Statement is effective for contracts entered into or
modified after June 30, 2003, except as stated below and
for hedging relationships designated after June 30, 2003.
The guidance should be applied prospectively.
The provisions of this Statement that relate to Statement
133 Implementation Issues that have been effective for
fiscal quarters that began prior to June 15, 2003, should
continue to be applied in accordance with their
respective effective dates. In addition, certain provisions
relating to forward purchases or sales of when-issued
securities or other securities that do not yet exist, should
be applied to existing contracts as well as new contracts
entered into after June 30, 2003.
The FASB decided on April 22, 2003 to require allcompanies to expense the value of employee stock
options. Companies will be required to measure the cost
according to the fair value of the options.
At the May 7, 2003 Board meeting, the Board decided
that: (1) compensation cost would be recognized over
the service period; (2) stock-based compensation awards
would be accounted for using the modified grant-date
measurement approach in FASB Statement No. 123,Accounting for Stock-Based Compensation; therefore,
compensation cost would be adjusted to reflect actual
forfeitures and outcomes of performance conditions;
(3) the method of attribution would be consistent with
the approach presented in Statement 123 which requires
attribution over the period the employee provides the
service; and (4) for awards with service conditions, an
enterprise would base accruals of compensation cost on
the best available estimate of the number of equity
instruments that are expected to vest and to revise that
estimate, if necessary, if subsequent information
indicates that actual forfeitures are likely to differ from
initial estimates.
Securities and Exchange Commission (SEC)
Companies will be delisted if they fail to comply with
the audit committee requirements of the Sarbanes-Oxley
Actand implementing SEC regulations, according to a
recent release that mandates changes in the listing
standards. The release contains new audit committee
requirements; conforming provisions by the national
securities exchanges and the national securities
association must be approved by the SEC by December
1, 2003; and listed issuers other than small-business and
foreign-private issuers must be in compliance with the
new provisions by the date of their first shareholders
meeting after January 15, 2004, but in any event no later
than October 31, 2004. Foreign-private and small-
business issuers are given more time.
The exchanges and securities association will be
obligated to delist companies that are not in compliance
with several sets of requirements and do not successfully
cure violations. The requirements cover audit
committees independence; responsibilities with respect
to public accounting firms; procedures for handling
complaints on auditing, accounting, and control matters;
authority to engage independent counsel and other
advisors; and funding.
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
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The SEC has released final rules governing
managements report on internal control over financial
reporting and revisions to certifications of disclosure inExchange Actperiodic reports. The rules pertaining to
Section 302 and Section 906 certifications, including
changes relative to registered investment companies,
become effective on August 14, 2003 (the due date for
June 30, 2003 quarterly filings). The Commission staff
has indicated their intent to apply the revised Section
302 certification to all quarterly filings for the quarter
ended June 30, 2003, regardless of the date actually
filed. Section 302 certifications may temporarily omit
certain references to internal control over financial
reporting until the compliance date for managements
report on internal control over financial reporting.
Managements report on internal control over financial
reporting will be required by issuers, other than foreign
private issuers, that meet the definition of an
accelerated filer inExchange ActRule 12b-2, for
fiscal years ending on or after June 15, 2004 (December
31, 2004, for calendar-year accelerated filers).
Accelerated filers are generally U.S. companies that have
public float over $75 million and have filed an annual
report with the Commission. All other issuers, including
small-business and foreign-private issuers, will be
required to comply with the requirements of Section 404
for their fiscal years ending on or after April 15, 2005
(December 31, 2005, for calendar-year issuers).
Voluntary early compliance is permitted.
On April 24, 2003, the SEC voted to require that reports
by insiders disclosing their securities holdings be filed
electronically with the SEC. The Commission also voted
to adopt rules prohibiting company officials from
improperly influencing auditors of financial statements.
These new rules and amendments will become effective
on June 30, 2003.
American Institute of Certified Public
Accountants (AICPA)
The AICPAs Accounting Standards Executive
Committee has issued an exposure draft of a proposed
Statement of Position (SOP), Allowance for Credit
Losses. The proposed SOP addresses the recognition and
measurement by creditors of the allowance for credit
losses related to all loans, as that term is defined in
FASB Statement of Financial Accounting Standards No.
114,Accounting by Creditors for Impairment of a Loan,
with certain exceptions. The proposed SOP would apply
to all creditors other than state and local governmental
entities and federal governmental entities.
The provisions of the proposed SOP would be effective
for financial statements for fiscal years beginning after
December 15, 2003, with earlier application permitted.
The effect of initially applying the provisions of the
proposed SOP would be reported as a change in
accounting estimate.
Federal Financial Institutions Examination Council
(FFIEC)
James E. Gilleran, Director of the Office of Thrift
Supervision, has been named Chairman of the FFIEC
for a two-year term beginning April l, 2003. Director
Gilleran succeeds Donald E. Powell, Chairman of the
Federal Deposit Insurance Corporation. The Council also
named NCUA Chairman Dennis Dollar, as its new Vice
Chairman.
The FFIEC announced several appointments to its State
Liaison Committee. The Council has appointed Richard
C. Houseworth, Superintendent of Banks, Arizona, to fillthe vacancy created by the resignation of Elizabeth
McCaul, former Superintendent of Banking, New York.
The National Association of State Credit Union
Supervisors appoints Jerrie J. Lattimore, Credit Union
Division, North Carolina Commerce Department to the
Committee to replace Iowa Superintendent of Credit
Unions James E. Forney. The American Council of State
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Savings Supervisors has appointed Jonathan Smith,
Review Examiner, State Banking Department,
Delaware, to replace Texas Savings & LoanCommissioner James L. Pledger.
(Sources: FASB, SEC, AICPA, and FFIEC Websites)
KPMGs Audit Committee Institute (ACI) has been serving audit
committee members, interacting with thousands of directors and
officers, since its inception two years ago.ACIs initiatives include
semiannual roundtables, conference and board presentations, a toll-
free hotline, theAudit Committee Quarterly Update, periodic
distribution of time-sensitive information and its Web site. ACI has
received positive feedback from directors and officers who have used
the Web site, which is dedicated to providing tools to meet the needs of
audit committee members. ACIs Web site address is
http://www.us.kpmg.com/auditcommittee.ACI can be reached at 877-
KPMG-ACI (877-576-4224) or via e-mail at
2003 KPMG LLP, the U.S. member firm of KPMG International, a Swiss nonoperating association.
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M A R K E T F O R C E S
Broker /Dealers
Thomson Financial announced on June 4th theintroduction of a suite of brokerage solutions designed to
add transparency to the research process and facilitate
broker compliance with the recently announced Global
Analyst Settlement. The solutions, which can be grouped
together and customized to meet individual
requirements, include the newly created Thomson
proprietary In Context reports that are designed to
educate individual investors and add context to
brokerage and boutique research, broker infrastructure
outsourcing opportunities and Thomsons independent
analyst rankings and monitoring services. (Thomsonpress release, June 4, 2003)
On May 13th, Charles Schwab & Co., Inc. announced
public disclosure of performance reporting on all its
stock ratings. The company launched its Schwab Equity
Ratings on May 6, 2002, and with one year of
performance data available the public can now have
access to the performance of Schwabs equity ratings
during rolling 52-week periods through the companys
Web site. A survey sponsored by Schwab found that the
majority of those polled want objective research
combined with performance information. According to
the results of the survey, research conducted by
independent research firms is more valuable than
research conducted by Wall Street firms that are
financially tied to the companies they evaluate. Also, the
majority surveyed said they would like to know how
well stock analysts recommendations compare to
subsequent stock performance. (Charles Schwab & Co.,
Inc. press release, May 13, 2003)
Charles Schwabs newly launched Charles Schwab Bank
has entered into the home mortgage loan area for clients
and clients of independent investment advisors.
Responding to consumers requests for greater
transparency in mortgage rates and terms, the bank is
offering three guarantees. First, Schwab will top any