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5000 - Statements of Policy
{{8-17-92 p.5359}}
STATEMENT OF POLICY ON FORECLOSURE CONSENT AND
REDEMPTION
RIGHTS
Background
12 U.S.C. 1825(b), the
codification of section 15(b) of the Federal Deposit Insurance Act
(FDIA), was added by section 219 of FIRREA. Section 1825(b) dealt with
the immunity from state taxation enjoyed by the FDIC under section 15
of the FDIA applied when the FDIC acted in its receivership capacity.
The section also protected receivership property from both involuntary
alienation as well as involuntary liens.
Since the passage of FIRREA, the Corporation has received many
requests for consent to foreclosure, waivers of the right to consent,
interpretation of the scope of section 1825(b)(2) and its
applicability, and specific explication of the Corporation's policy.
After analysis, the Corporation has determined that in the interests of
promoting efficiency in the Corporation's operations, providing
certainty as to title upon foreclosure, and minimizing the impact the
statute has on the secondary mortgage market in general, with respect
to voluntary liens, the Corporation would, pursuant to its statement of
policy, grant the consent required pursuant to section 1825(b) and, as
to any property to which section 1825(b)(2) applies, state it will not
assert any rights to which it may have been entitled pursuant to 28
U.S.C. 2410(c). The Corporation also has determined that it will
continue to require holders of involuntary liens to obtain the
Corporation's consent prior to foreclosing pursuant to an involuntary
lien, provided the interest of the FDIC in the liened property is of
record.
Scope and Applicability
The policy statement applies to the Corporation in its corporate and
receivership capacities. It confirms that section 1825(b) applies to
all property held by the Corporation acting as receiver or in its
corporate capacity, including property of the financial institutions
for which the Corporation has been appointed receiver or property which
the Corporation holds for liquidation.
The policy statement further confirms that property of the
Corporation encompasses any interest in real and personal property held
by the Corporation, including security and equity interests. This is
consistent with the Corporation's Policy Statement on the Payment of
State and Local Property Taxes, which holds that section 1825(b)(2)
covers both the Corporation's fee and lien interests in property. The
statement of policy also makes clear that section 1825(b)(2) applies to
both tax and non-tax liens.
The policy statement does not authorize, and shall not be construed
as authorizing the waiver of the prohibitions in 12 U.S.C. 1825(b)(2)
against levy, attachment, garnishment, or sale of property of the
Corporation, nor does it authorize or shall it be construed as
authorizing the attachment of any involuntary lien upon the property of
the Corporation.
Policy and Guidelines
Section 4.a.(ii)(A) of the policy statement provides that where the
Corporation holds a lien interest as a result of a mortgage, deed of
trust or other similar security instrument, consent is granted to the
holder of a consensual security interest which is senior to the
Corporation's interest. Similarly, consent is also granted where the
Corporation holds a title interest.
Section 4.a.(ii)(B) of the policy statement is a specific case of
the general policy set forth in section 4.a.(ii)(A). Subsection (B)
does not expand the consent granted under subsection (A), but, in light
of the large number of mortgages insured or held by the Federal Housing
Administration, the Department of Veterans Affairs, the Farmers Home
Administration and the Secretary of Housing and Urban Development, the
policy specifically refers to these organizations in order to make
clear that it applies to interests they hold.
The statement of policy is explicitly limited to the application of
12 U.S.C. 1825(b)(2). The consents granted under the statement of
policy do not act to waive or relinquish any rights granted to the
Corporation, in any capacity, pursuant to any other applicable law
or
{{8-17-92 p.5360}}any agreement or contract. By way of
example without limitation, if any local law requires notice to a
property owner prior to foreclosure, or if a loan agreement provides
notice shall be given, the consent granted under the policy statement
will not act to excuse such requirement to give notice.
Statement of Policy Regarding 12 U.S.C. 1825(b)(2) and 28
U.S.C. 2410(c)
1. Purpose
To establish a uniform policy for determining when the Federal
Deposit Insurance Corporation (the "Corporation"), in its various
capacities, will consent, pursuant to
12 U.S.C 1825(b)(2), to
permit third parties to foreclose upon mortgages and other liens where
title to the affected property is held by the Corporation or the
property is encumbered by a security interest held by the Corporation;
to provide the consent of the Corporation pursuant to 12 U.S.C.
1825(b)(2) in certain specified instances; to establish a uniform
policy regarding the assertion of the one year right of redemption and
other rights which may be applicable to the Corporation, in its various
capacities, pursuant to 28 U.S.C. 2410(c); and to modify, to the extent
inconsistent herewith, the Corporation's Statement of Policy Regarding
the Payment of State and Local Property Taxes.
2. Scope and Applicability
This policy addresses the application of 12 U.S.C. 1825(b)(2) to the
Corporation in its corporate and receivership capacities, and provides
that with regard to foreclosures under bona fide mortgages
and other security instruments, the Corporation will not assert its
rights under that section when acting as conservator, or on behalf of
subsidiary corporations of receiverships and conservatorships. This
policy also indicates that the Corporation will not assert any rights
under 28 U.S.C. 2410(c).
This policy is limited in scope to the right of the Corporation to
consent under 12 U.S.C. 1825(b)(2) to permit foreclosure actions, and
the rights of the Corporation under 28 U.S.C. 2410(c). This policy
shall not be construed as authorizing the waiver of the prohibitions in
12 U.S.C. 1825(b)(2) that no property of the Corporation shall be
subject to levy, attachment, or garnishment, or as permitting any sale
not specifically authorized in accordance with this policy, without the
consent of the Corporation; nor does it authorize waiver of 12 U.S.C.
1825(b)(2)'s prohibition against any involuntary lien attaching upon
the property of the Corporation.
3. Background
12 U.S.C. 1825(b)(2) provides that no property of the Corporation
shall be subject to levy, attachment, garnishment, foreclosure, or sale
without the consent of the Corporation. The Corporation has received
many requests for consents to foreclosure, waivers of the right to
consent to foreclosure, and specific statements of the Corporation's
policy with respect to that provision.
In addition, 28 U.S.C. 2410(c) provides certain protections when a
federal lien or mortgage interest in property is to be extinguished
through foreclosure, condemnation, partition or quiet title action. In
particular, 28 U.S.C. 2410(c) provides that a sale to satisfy a lien
inferior to one of the United States shall be made subject to and
without disturbing the lien of the United States, unless the United
States consents; and, the United States has a one year right of
redemption in the case of any sale of real estate made to satisfy a
lien prior to that of the United States.
4. Policy and Guidelines Regarding 12 U.S.C.
1825(b)(2)
a. Receivership and Corporate Capacities
(i) Generally. The provisions of 12 U.S.C. 1825(b)
apply to all property held by the Corporation acting as receiver or in
its corporate capacity, including property of the financial
institutions for which the Corporation has been appointed receiver.
Property of the Corporation encompasses any interest in real and
personal property held by the Corporation, including security interests
as well as equity interests. Therefore, no property
{{8-17-92 p.5361}}of the Corporation shall be subject
to levy, attachment, garnishment, foreclosure, or sale without the
consent of the Corporation.
(ii) Voluntary Liens Affecting Property Interests of the
Corporation. It is the policy of the Corporation that it will
grant its consent to permit foreclosure actions in certain instances as
contemplated by 12 U.S.C. 1825(b)(2). The consent of the Corporation is
granted in this policy for certain specific matters, and the
Corporation will endeavor to consider other appropriate consent
requests in a timely manner. More specifically:
(A) Property Interests. Where the Corporation has an
interest in real or personal property, whether a lien interest as a
result of a mortgage, deed of trust or other similar security
instrument, or a title interest, the Corporation hereby grants its
consent under 12 U.S.C. 1825(b)(2) as to any foreclosure by the holder
of a consensual security interest in such property, pursuant to any
bona fide mortgage, deed of trust, pledge (with respect to
personalty) or other similar security instrument which is senior to the
Corporation's interest.
(B) Real Property Encumbered by Government-Related
Mortgage. In accordance with paragraph 4.a(ii)(A) above, where the
Corporation holds title to a single family residence encumbered by a
bona fide mortgage insured or guaranteed by the Federal
Housing Administration, the Department of Veterans Affairs, or the
Farmers Home Administration, or a mortgage held by the Secretary of
Housing and Urban Development, the Corporation hereby grants its
consent under 12 U.S.C. 1825(b)(2) as to any foreclosure by the holder
of such mortgage, deed of trust or other similar security instrument
which encumbers such property.
(iii) Involuntary Liens. This policy does not permit
the attachment, garnishment, execution, levy or distraint of property
held by the Corporation. In accordance with 12 U.S.C. 1825(b)(2),
holders of mechanics' and materialmen's claims, tax liens and other
non-consensual, involuntary liens must obtain the consent of the
Corporation to permit foreclosure actions affecting property in which
the Corporation's interest is of record. If the Corporation's interest
is not of record, the Corporation hereby grants its consent under 12
U.S.C. 1825(b)(2) as to any foreclosure by the holder of any bona
fide lien which encumbers such property.
The consent of the Corporation under 12 U.S.C. 1825(b)(2) may be
requested in accordance with the procedures (the "Procedures")
set forth in, and as otherwise established by the Director, Division of
Liquidation, pursuant to, paragraph 6 below, with the understanding
that consent may be granted or withheld in the sole and absolute
discretion of the Corporation.
For purposes of this policy, the interest of the Corporation shall
be considered "of record" if, as of the notice date (as defined
below): First, for real property, such interest appears vested in the
Corporation in its corporate capacity or as receiver for a financial
institution in the public land records in accordance with local law, or
such interest appears vested in a financial institution for which the
Corporation has been appointed receiver in the public land records in
accordance with local law and the Corporation has published notice in
the Federal Register that it has been appointed receiver for that
financial institution; and second, for personal property, the property
is in the possession of the Corporation, or the lien interest has been
perfected in accordance with applicable law. Financial institutions
shall include any predecessors identified in the notice published in
the Federal Register. For purposes of this policy, the "notice
date" shall be for judicial foreclosure actions, the date on which
service of notice of the foreclosure sale has been perfected on all
persons required to be provided with notice in accordance with
applicable law, and for nonjudicial foreclosure actions, the date on
which notice of the foreclosure sale has been given to all persons
required to be provided with notice in accordance with applicable law.
(iv) Limited Effect. The effect of consents to
foreclosure under 12 U.S.C. 1825(b)(2) as described above, shall be
limited solely to the application of 12 U.S.C. 1825(b)(2). Such
consents shall not act to waive or relinquish the rights granted to the
Corporation, in any capacity, pursuant to any other applicable law
(including any rights
{{8-17-92 p.5362}}under local foreclosure statutes),
or with respect to (A) any note, indebtedness, claim or other
obligation that has been secured by the property, or (B) the terms of
any mortgage, guaranty, security agreement or other document relating
to any obligation.
Any foreclosure actions by the lienholder must still be effectuated
in accordance with all other applicable laws.
Failure to obtain the consent of the Corporation where required
shall not render the subject foreclosure action void or voidable, so
long as the interest of the Corporation survives and is not
extinguished by such foreclosure action.
b. Conservatorships and Subsidiary Corporations
The Corporation will not assert any right to consent under 12 U.S.C.
1825(b)(2) with regard to a foreclosure action relating to any property
interest held by a conservatorship or a subsidiary corporation of a
receivership or conservatorship. In accordance with this position, when
a Corporation conservatorship, or a subsidiary of an institution, has
an interest in property, foreclosure actions undertaken in accordance
with applicable state law may proceed without the consent of the
Corporation. In the event an interest has economic value,
conservatorships and subsidiary corporations must take appropriate
actions to protect their interest in the property under local
foreclosure law.
c. Successors
It is the policy of the Corporation that in no event shall the right
to consent under 12 U.S.C. 1825(b)(2) be assigned or transferred to any
purchaser of property from the Corporation.
5. Policy Regarding 28 U.S.C. 2410(c)
As to any property to which section 1825(b) applies, the
Corporation, in its various capacities, shall not assert any rights it
might possess under 28 U.S.C. 2410(c). In no event shall any rights
under 28 U.S.C. 2410(c) be assigned or transferred to any purchaser of
property from the Corporation.
6. Procedures
Where the consent of the Corporation is required hereunder,
lienholders, or their authorized designee(s), shall submit to the
Corporation a written request for the consent of the Corporation to the
foreclosure. The request for consent shall be in writing, in the form
attached hereto as Exhibit A (as it may be amended from time to time),
delivered to the Corporation at the place and address specified in the
Federal Register, by certified mail or as otherwise specified in the
Federal Register notice. The place and address specified and the means
of delivery may be subject to change from time-to-time. All amendments
and changes shall be published in the Federal Register. The Director of
the Division of Liquidation is hereby authorized and directed to
establish and make publicly available such other procedures as the
Director deems appropriate to implement this policy.
Consent requests will be ruled upon after the Corporation has
gathered the necessary information, analyzed such information, and made
a decision as to an appropriate course of action.
If a consent is to be granted, those parties with Power of Attorney
may execute the Consent to Foreclosure form. Appearing as Exhibit B is
a sample Consent to Foreclosure form for the Corporation acting as
receiver. This form should be modified appropriately to reflect the
Corporation's capacity or ownership interest.
7. Limitation of Actions
Consents to be granted under this policy are to be provided solely
at the discretion of the Corporation. No person shall have any right to
bring any action to direct or compel the granting of any consent under
this policy, or to pursue any claim or cause of action based on the
alleged failure of the Corporation or any person acting on its behalf
to take any action whatsoever under this policy.
{{8-17-92 p.5363}}
8. Retroactivity
Subject to the limitations of paragraph 4.a.(iii) above, the
Corporation will not assert any right under either 12 U.S.C. 1825(b)(2)
or 28 U.S.C. 2410(c) to which it may have been entitled (in either its
receivership or corporate capacity) which it agreed not to assert
hereunder, with respect to any foreclosure action completed prior to
the effective date of this policy. A nonjudicial foreclosure action
shall be considered completed upon recordation of the trustee's deed
conveying property to the purchaser at a foreclosure sale. A judicial
foreclosure shall be considered completed upon entry of a final,
nonappealable judgment.
This policy is not retroactive with respect to any matters in
litigation on the date hereof, the continuation of which will be
reviewed on a case by case basis.
Exhibit A
Request and Information Form
[To accompany Request for Consent to Foreclose]
Instructions: This form is to be used by the holder of an
involuntary or nonconsensual lien when requesting consent to foreclose
in accordance with 12 U.S.C. 1825(b)(2) and Paragraph 4.a.(iii) of the
FDIC Statement of Policy regarding 12 U.S.C. 1825(b)(2) and 28 U.S.C.
2410(c) (the "Policy"). In order for a Request to be valid and
proper, all information must be completed (unless the form indicates
that the information may be completed as available). All forms must be
typewritten.
Name of Requesting Party: ____________________________________________
Address of Requesting Party: ____________________________________________
Telephone Number: ____________________________________________
(Area Code) (Number)
Relationship to Lienholder: ____________________________________________
The above named Requesting Party hereby requests the consent of the
Federal Deposit Insurance Corporation, in the appropriate capacity, to
the foreclosure of the property more particularly identified below.
Failed Institution Name: ____________________________________________
Failed Institution Information:
(Reference Number) ____________________________________________
________________________________________________________
(City) (State)
Property Address: ____________________________________________
(Street)
________________________________________________________
(City) (County) (State) (Zip Code)
Legal Description of Property: ____________________________________________
(Use extra sheet if necessary)
Legal Owner of Property: ____________________________________________
Lien Information
Lienholder (Foreclosing Party): ____________________________________________
Face Amount Lien/Outstanding Amount
________________________________________________________
Date of Lien
________________________________________________________
Recording Information
(e.g., Folio and Liber or Instrument Number)
Failed Institution Lien:
Face Amount Lien ____________________________________________
________________________________________________________
{{8-17-92 p.5364}}
Date of Mortgage/Deed of Trust
________________________________________________________
Name of Trustee
________________________________________________________
Beneficiary
________________________________________________________
Recording Information (e.g., Folio, Liber or Instrument Number)
Foreclosure Sale Information (If applicable)
Date of Sale: ____________________________________________
Place of Sale: ____________________________________________
Manner of Sale: ____________________________________________
Telephone Number of Contact Person: ____________________________________________
Appraised Value of Property: $ ____________________________________________
(If Available)
as of ____________________________________________
Date
Appraiser: ____________________________________________
Name
________________________________________________________
ID Number
________________________________________________________
Address
For FDIC Use Only
Date Received: ____________________________________________
(Month) (Day) (Year)
Assigned Account Officer: ____________________________________________
Date Response Mailed: ____________________________________________
Disposition: ____________________________________________
Approved
________________________________________________________
Disapproved
________________________________________________________
Other
Attach copy of response and Consent to Foreclosure (as applicable).
Exhibit B
Consent to Foreclosure
In accordance with its rights pursuant to 12 U.S.C. 1825(b)(2) and
29 U.S.C. 2410(c), the FEDERAL DEPOSIT INSURANCE CORPORATION
("FDIC"), in its capacity as [insert capacity] does
hereby consent to foreclosures by _______ ("Lienholder"),
pursuant to that certain lien dated _______ , and recorded at
_______ [city/county], among the land records in
_______ _______ [state], which encumbers certain real
property more particularly described in Exhibit "A"
attached to and incorporated in this Consent (the
"Property").
This consent is limited to the consent to foreclosures set forth
above pursuant to the provisions of 12 U.S.C. 1825(b)(2) and 28 U.S.C.
2410(c), only in connection with the above-described foreclosure
action. This consent does not affect the rights of the FDIC, in any
capacity, pursuant to any other applicable law (including local
foreclosure statutes) or with respect to (i) any note, indebtedness,
claim or other obligation ("Obligation") which has been secured
by the Property or (ii) the terms of any mortgage, guaranty, or
agreement or other document relating to any Obligation.
{{2-28-06 p.5364.01}}
Federal Deposit Insurance Corporation, as [insert capacity]
________________________________________________________
________________________________________________________
By: ____________________________________________
Print Name: _____________________
Title or Capacity: ____________________________________________
[Add Appropriate Notarial Acknowledgement]
By order of the Board of Directors, June 16, 1992.
[Source: 57 Fed. Reg. 29491, July 2, 1992]
{{2-28-06 p.5365}}
INTERAGENCY ADVISORY ON THE UNSAFE AND UNSOUND USE OF LIMITATION
OF LIABILITY PROVISIONS IN EXTERNAL AUDIT
ENGAGEMENT LETTERS
Purpose
This Advisory, issued jointly by the Office of Thrift Supervision
(OTS), the Board of Governors of the Federal Reserve System (Board),
the Federal Deposit Insurance Corporation (FDIC), the National Credit
Union Administration (NCUA), and the Office of the Comptroller of the
Currency (OCC) (collectively, the "Agencies"), alerts financial
institutions, 1
boards of directors, audit committees, management, and external
auditors to the safety and soundness implications of provisions that
limit external auditors' liability in audit engagements.
Limits on external auditors' liability may weaken the external
auditors' objectivity, impartiality, and performance and, thus, reduce
the Agencies' ability to rely on Audits. Therefore, certain limitation
of liability provisions (described in this Advisory and Appendix A) are
unsafe and unsound. In addition, such provisions may not be consistent
with the auditor independence standards of the U.S. Securities and
Exchange Commission (SEC), the Public Company Accounting Oversight
Board (PCAOB), and the American Institute of Certified Public
Accountants (AICPA). Scope
This Advisory applies to engagement letters between financial
institutions and external auditors with respect to financial statement
audits, audits of internal control over financial reporting, and
attestations on management's assessment of internal control over
financial reporting (collectively, "Audit" or "Audits").
This Advisory does not apply to:
• Non-Audit services that may be performed by financial
institutions' external auditors;
• Audits of financial institutions' 401K plans, pension plans,
and other similar audits;
• Services performed by accountants who are not engaged to
perform financial institutions' Audits (e.g., outsourced
internal audits, loan reviews); and
• Other service providers (e.g., software consultants,
legal advisors).
While the Agencies have observed several types of limitation of
liability provisions in external Audit engagement letters, this
Advisory applies to any agreement that a financial institution enters
into with its external auditor that limits the external auditor's
liability with respect to Audits in an unsafe and unsound manner.Background
A properly conducted audit provides an independent and objective
view of the reliability of a financial institution's financial
statements. The external auditor's objective in an audit is to form an
opinion on the financial statements taken as a whole. When planning and
performing the audit, the external auditor considers the financial
institution's internal control over financial reporting. Generally,
the external auditor communicates any identified deficiencies in
internal control to management, which enables management to take
appropriate corrective action. In addition, certain financial
institutions are required to file audited financial statements and
internal control audit/attestation reports with one or
more
{{2-28-06 p.5365.01}}of the Agencies. The Agencies
encourage financial institutions not subject to mandatory audit
requirements to voluntarily obtain audits of their financial
statements. The Federal Financial Institutions Examination Council's
(FFIEC) Interagency Policy Statement on External Auditing
Programs of Banks and Savings
Associations 2
notes, "[a]n institution's internal and external audit programs
are critical to its safety and soundness." The Policy also states
that an effective external auditing program "can improve the safety
and soundness of an institution substantially and lessen the risk the
institution poses to the insurance funds administered by the Federal
Deposit Insurance Corporation (FDIC).
Typically, a written engagement letter is used to establish an
understanding between the external auditor and the financial
institution regarding the services to be performed in connection with
the financial institution's audit. The engagement letter commonly
describes the objective of the audit, the reports to be prepared, the
responsibilities of management and the external auditor, and other
significant arrangements (e.g., fees and billing). The
Agencies encourage boards of directors, audit committees, and
management to closely review all of the provisions in the audit
engagement letter before agreeing to sign. As with all agreements that
affect a financial institution's legal rights, legal counsel should
carefully review audit engagement letters to help ensure that those
charged with engaging the external auditor make a fully informed
decision.
While the Agencies have not observed provisions that limit an
external auditor's liability in the majority of external audit
engagement letters reviewed, they have observed a significant increase
in the types and frequency of these provisions. These provisions take
many forms, making it impractical to provide an all-inclusive list.
This Advisory describes the types of objectionable limitation of
liability provisions and provides
examples. 3
Financial institutions' boards of directors, audit committees, and
management should also be aware that certain insurance policies (such
as error and omission policies and director and officer liability
policies) might not cover losses arising from claims that are precluded
by limitation of liability provisions.
Limitation of Liability Provisions
The provisions the Agencies deem unsafe and unsound can be generally
categorized as an agreement by a financial institution that is a client
of an external auditor to:
• Indemnify the external auditor against claims made by third
parties;
• Hold harmless or release the external auditor from liability
for claims or potential claims that might be asserted by the client
financial institution, other than claims for punitive damages; or
• Limit the remedies available to the client financial
institution, other than punitive damages.
Collectively, these categories of provisions are referred to in this
Advisory as "limitation of liability provisions."
Provisions that waive the right of financial institutions to seek
punitive damages from their external auditor are not treated as unsafe
and unsound under this Advisory. Nevertheless, agreements by clients to
indemnify their auditors against any third party damage awards,
including punitive damages, are deemed unsafe and unsound under this
Advisory. To enhance transparency and market discipline, public
financial institutions that agree to waive claims for punitive damages
against their external auditors may want to disclose annually the
nature of these arrangements in their proxy statements or other public
reports.
Many financial institutions are required to have their financial
statements audited while others voluntarily choose to undergo such
audits. For example, banks, savings associations, and credit unions
with $500 million or more in total assets are required to have
annual
{{2-28-06 p.5365.02}}independent
audits. 4
Certain savings associations (for example, those with a CAMELS rating
of 3, 4, or 5) and savings and loan holding companies are also required
by OTS regulations to have annual independent
audits. 5
Furthermore, financial institutions that are public
companies 6
must have annual independent audits. The Agencies rely on the results
of Audits as part of their assessment of the safety and soundness of a
financial institution.
In order for Audits to be effective, the external auditors must be
independent in both fact and appearance, and must perform all necessary
procedures to comply with auditing and attestation standards
established by either the AICPA or, if applicable, the PCAOB. When
financial institutions execute agreements that limit the external
auditors' liability, the external auditors' objectivity,
impartiality, and performance may be weakened or compromised, and the
usefulness of the Audits for safety and soundness purposes may be
diminished.
By their very nature, limitation of liability provisions can remove
or greatly weaken external auditors' objective and unbiased
consideration of problems encountered in audit engagements and may
diminish auditors' adherence to the standards of objectivity and
impartiality required in the performance of Audits. The existence of
such provisions in external audit engagement letters may lead to the
use of less extensive or less thorough procedures than would otherwise
be followed, thereby reducing the reliability of Audits. Accordingly,
financial institutions should not enter into external audit
arrangements that include unsafe and unsound limitation of liability
provisions identified in this Advisory, regardless of (1) The size of
the financial institution, (2) whether the financial institution is
public or not, or (3) whether the external audit is required or
voluntary.
Auditor Independence
Currently, auditor independence standard-setters include the SEC,
PCAOB, and AICPA. Depending upon the audit client, an external auditor
is subject to the independence standards issued by one or more of these
standard-setters. For all credit unions under the NCUA's regulations,
and for other non-public financial institutions that are not required
to have annual independent audits pursuant to either Part 363 of the
FDIC's regulations or § 562.4 of the OTS's regulations, the
Agencies' rules require only that an external auditor meet the AICPA
independence standards; they do not require the financial
institution's external auditor to comply with the independence
standards of the SEC and the PCAOB.
In contrast, for financial institutions subject to the audit
requirements either in Part 363 of the FDIC's regulations or in
§ 562.4 of the OTS's regulations, the external auditor should be in
compliance with the AICPA's Code of Professional Conduct and meet the
independence requirements and interpretations of the SEC and its
staff. 7
In this regard, in a December 13, 2004, Frequently Asked Question (FAQ)
on the application of the SEC's auditor independence rules, the SEC
staff reiterated its long-standing position that when an accountant and
his or her client enter into an agreement which seeks to provide the
accountant immunity from liability for his or her own negligent acts,
the accountant is not independent. The FAQ also states that including
in engagement letters a clause that would release, indemnify, or hold
the auditor harmless from any liability and costs resulting from
knowing misrepresentations by management would impair the auditor's
independence. 8
The
{{2-28-06 p.5365.03}}SEC's FAQ is consistent with
Section 602.02.f.i. (Indemnification by Client) of the SEC's
Codification of Financial Reporting Policies. (Section 602.02.f.i. and
the FAQ are included in Appendix B.)
Based on the SEC guidance and the Agencies' existing regulations,
certain limits on auditors' liability are already inappropriate in
audit engagement letters entered into by:
• Public financial institutions that file reports with the SEC or
with the Agencies;
• Financial institutions subject to Part 363; and
• Certain other financial institutions that OTS regulations (12
CFR 562.4) require to have annual independent audits.
In addition, certain of these limits on auditors' liability may
violate the AICPA independence standards. Notwithstanding the potential
applicability of auditor independence standards, the limitation of
liability provisions discussed in this Advisory present safety and
soundness concerns for all financial institution Audits.
Alternative Dispute Resolution Agreements and Jury Trial
Waivers
The Agencies have observed that some financial institutions have
agreed in engagement letters to submit disputes over external audit
services to mandatory and binding alternative dispute resolution,
binding arbitration, other binding non-judicial dispute resolution
processes (collectively, "mandatory ADR") or to waive the right
to a jury trial. By agreeing in advance to submit disputes to mandatory
ADR, financial institutions may waive the right to full discovery,
limit appellate review, or limit or waive other rights and protections
available in ordinary litigation proceedings.
The Agencies recognize that mandatory ADR procedures and jury trial
waivers may be efficient and cost-effective tools for resolving
disputes in some cases. Accordingly, the Agencies believe that
mandatory ADR or waiver of jury trial provisions in external Audit
engagement letters do not present safety and soundness concerns,
provided that the engagement letters do not also incorporate limitation
of liability provisions. The Agencies encourage institutions to
carefully review mandatory ADR and jury trial provisions in engagement
letters, as well as any agreements regarding rules of procedure, and to
fully comprehend the ramifications of any agreement to waive any
available remedies. Financial institutions should ensure that any
mandatory ADR provisions in Audit engagement letters are commercially
reasonable and:
• Apply equally to all parties;
• Provide a fair process (e.g., neutral
decision-makers and appropriate hearing procedures); and
• Are not imposed in a coercive manner.
Conclusion
Financial institutions' boards of directors, audit committees, and
management should not enter into any agreement that incorporates
limitation of liability provisions with respect to Audits. In addition,
financial institutions should document their business rationale for
agreeing to any other provisions that limit their legal rights.
This Advisory applies to engagement letters executed on or after
February 9, 2006. The inclusion of limitation of liability provisions
in external Audit engagement letters and other agreements that are
inconsistent with this Advisory will generally be considered an unsafe
and unsound practice. The Agencies' examiners will consider the
policies, processes, and personnel surrounding a financial
institution's external auditing program in determining whether (1) the
engagement letter covering external auditing activities raises any
safety and soundness concerns, and (2) the external auditor maintains
appropriate independence regarding relationships with the financial
institution under relevant professional standards. The Agencies may
take appropriate supervisory action if unsafe and unsound limitation of
liability provisions are included in external Audit engagement letters
or other agreements
{{2-28-06 p.5365.04}}related to Audits that are executed
(accepted or agreed to by the financial institution) on or after
February 9, 2006.
Appendix A
Examples of Unsafe and Unsound Limitation of Liability
Provisions
Presented below are some of the types of limitation of liability
provisions (with an illustrative example of each type) that the
Agencies observed in financial insitutions' external audit engagement
letters. The inclusion in external Audit engagement letters or
agreements related to Audits of any of the illustrative provisions
(which do not represent an all-inclusive list) or any other language
that would produce similar effects is considered an unsafe and unsound
practice.
1. "Release From Liability for Auditor Negligence" Provision
In this type of provision, the financial institution agrees not to
hold the audit firm liable for any damages, except to the extent
determined to have resulted from willful misconduct or fraudulent
behavior by the audit firm.
Example: In no event shall [the audit firm] be
liable to the Financial Institution, whether a claim in tort, contract
or otherwise, for any consequential, indirect, lost profit, or similar
damages relating to [the audit firm's] services provided under this
engagement letter, except to the extent finally determined to have
resulted from the willful misconduct or fraudulent behavior of [the
audit firm] relating to such services.
2. "No Damages" Provision
In this type of provision, the financial institution agrees that in
no event will the external audit firm's liability include
responsibility for any compensatory (incidental or consequential)
damages claimed by the financial institution.
Example: In no event will [the audit firm's]
liability under the terms of this Agreement include responsibility for
any claimed incidental or consequential damages.
3. "Limitation of Period To File Claim" Provision
In this type of provision, the financial institution agrees that no
claim will be asserted after a fixed period of time that is shorter
than the applicable statute of limitations, effectively agreeing to
limit the financial institution's rights in filing a claim.
Example: It is agreed by the Financial Institution and
[the audit firm] or any successors in interest that no claim arising
out of services rendered pursuant to this agreement by, or on behalf
of, the Financial Institution shall be asserted more than two years
after the date of the last audit report issued by [the audit firm].
4. "Losses Occurring During Periods Audited" Provision
In this type of provision, the financial institution agrees that the
external audit firm's liability will be limited to any losses
occurring during periods covered by the external audit, and will not
include any losses occurring in later periods for which the external
audit firm is not engaged. This provision may not only preclude the
collection of consequential damages for harm in later years, but could
preclude any recovery at all. It appears that no claim of liability
could be brought against the external audit firm until the external
audit report is actually delivered. Under such a clause, any claim for
liability thereafter might be precluded because the losses did not
occur during the period covered by the external audit. In other words,
it might limit the external audit firm's liability to a period before
there could be any liability. Read more broadly, the external audit
firm might be liable for losses that arise in subsequent years only if
the firm continues to be engaged to audit the client's financial
statements in those years.
Example: In the event the Financial Institution is
dissatisfied with [the audit firm's] services, it is understood that
[the audit firm's] liability, if any, arising from this engagement
will be limited to any losses occurring during the periods covered by
[the audit
{{2-28-06 p.5365.05}}firm's] audit, and shall not
include any losses occurring in later periods for which [the audit
firm] is not engaged as auditors.
5. "No Assignment or Transfer" Provision
In this type of provision, the financial institution agrees that it
will not assign or transfer any claim against the external audit firm
to another party. This provision could limit the ability of another
party to pursue a claim against the external auditor in a sale or
merger of the financial institution, in a sale of certain assets or a
line of business of the financial institution, or in a supervisory
merger or receivership of the financial institution. This provision may
also prevent the financial institution from subrogating a claim against
its external auditor to the financial institution's insurer under its
directors' and officers' liability or other insurance coverage.
Example: The Financial Institution agrees that it will
not, directly or indirectly, agree to assign or transfer ay claim
against [the audit firm] arising out of this engagement to anyone.
6. "Knowing Misrepresentations by Management" Provision
In this type of provision, the financial institution releases and
indemnifies the external audit firm from any claims, liabilities, and
costs attributable to any knowing misrepresentation by management.
Example: Because of the importance of oral and written
management representations to an effective audit, the Financial
Institution releases and indemnifies [the audit firm] and its
personnel from any and all claims, liabilities, costs, and expenses
attributable to any knowing misrepresentation by management.
7. "Indemnification for Management Negligence" Provision
In this type of provision, the financial institution agrees to
protect the external auditor from third party claims arising from the
external audit firm's failure to discover negligent conduct by
management. It would also reinforce the defense of contributory
negligence in cases in which the financial institution brings an action
against its external auditor. In either case, the contractual defense
would insulate the external audit firm form claims for damages even if
the reason the external auditor failed to discover the negligent
conduct was a failure to conduct the external audit in accordance with
generally accepted auditing standards or other applicable professional
standards.
Example: The Financial Institution shall indemnify,
hold harmless and defend [the audit firm] and its authorized agents,
partners and employees from and against any and all claims, damages,
demands, actions, costs and charges arising out of, or by reason of,
the Financial Institution's negligent acts or failure to act
hereunder.
8. "Damages Not to Exceed Fees Paid" Provision
In this type of provision, the financial institution agrees to limit
the external auditor's liability to the amount of audit fees the
financial institution paid the external auditor, regardless of the
extent of damages. This may result in a substantial unrecoverable loss
or cost to the financial institution.
Example: [The audit firm] shall not be liable for
any claim for damages arising out of or in connection with any services
provided herein to the Financial Institution in an amount greater than
the amount of fees actually paid to [the audit firm] with respect to
the services directly relating to and forming the basis of such claim.
Note: The Agencies also observed a similar
provision that limited damages to a predetermined amount not related to
fees paid.
{{2-28-06 p.5365.06}}
Appendix B
SEC's Codification of Financial Reporting Policies, Section
602.02.f.i and the SEC's December 13, 2004, FAQ on Auditor
Independence
Section 602.02.f.i--Indemnification by Client, 3 Fed. Sec. L. (CCH)
¶ 38,335, at 38,603--17 (2003)
Inquiry was made as to whether an accountant who certifies financial
statements included in a registration statement or annual report filed
with the Commission under the Securities Act or the Exchange Act would
be considered independent if he had entered into an indemnity agreement
with the registrant. In the particular illustration cited, the board of
directors of the registrant formally approved the filing of a
registration statement with the Commission and agreed to indemnify and
save harmless each and every accountant who certified any part of such
statement, "from any and all losses, claims, damages or liabilities
arising out of such act or acts to which they or any of them may become
subject under the Securities Act, as amended, or at common law,'
other than for their willful misstatements or omissions."
When an accountant and his client, directly or through an affiliate,
have entered into an agreement of indemnity which seeks to assure to
the accountant immunity from liability for his own negligent acts,
whether of omission or commission, one of the major stimuli to
objective and unbiased consideration of the problems encountered in a
particular engagement is removed or greatly weakened. Such condition
must frequently induce a departure from the standards of objectivity
and impartiality which the concept of independence implies. In such
difficult matters, for example, as the determination of the scope of
audit necessary, existence of such an agreement may easily lead to the
use of less extensive or thorough procedures than would otherwise be
followed. In other cases it may result in a failure to appraise with
professional acumen the information disclosed by the examination.
Consequently, the accountant cannot be recognized as independent
for the purpose of certifying the financial statements of the
corporation. (Emphasis added.)
U.S. Securities and Exchange Commission; Office of the Chief
Accountant: Application of the Commission's Rules on Auditor
Independence Frequently Asked Questions; Other Matters--Question 4
(issued December 13, 2004)
Q: Has there been any change in the Commission's long standing view
(Financial Reporting Policies--Section 600--602.02.f.i.
"Indemnification by Client") that when an accountant enters into
an indemnity agreement with the registrant, his or her independence
would come into question?
A: No. When an accountant and his or her client, directly or through
an affiliate, enter into an agreement of indemnity that seeks to
provide the accountant immunity from liability for his or her own
negligent acts, whether of omission or commission, the accountant
is not independent. Further, including in engagement letters a
clause that a registrant would release, indemnify or hold harmless from
any liability and costs resulting from knowing misrepresentations
by management would also impair the firm's independence.
(Emphasis added.)
By order of the Board of Directors February 1, 2006.
[Source: 71 Fed. Reg. 6852, February 9, 2006, the Advisory is
effective for engagement letters executed on or after February 9,
2006]
[The page following this is 5367.]
1As used in this document, the term financial
institutions includes banks, bank holding companies, savings
associations, savings and loan holding companies, and credit unions. Go Back to Text
2Published in the Federal Register on September 28,
1999 (64 FR 52319). The NCUA, a member of the FFIEC, has not adopted
the policy statement. Go Back to Text
3Examples of auditor limitation of liability provisions are
illustrated in Appendix A. Go Back to Text
4For banks and savings associations, see Section 36 of the
Federal Deposit Insurance Act (FDI Act) (12 U.S.C. 1831m) and Part 363
of the FDIC's regulations (12 CFR Part 363). For credit unions, see
Section 202(a)(6) of the Federal Credit Union Act (12 U.S.C.
1782(a)(6)) and Part 715 of the NCUA's regulations (12 CFR Part
715). Go Back to Text
5See OTS regulation at 12 CFR 562.4. Go Back to Text
6Public companies are companies subject to the reporting
requirements of the Securities Exchange Act of 1934. Go Back to Text
7See FDIC Regulation 12 CFR Part 363, Appendix
A--Guidelines and Interpretations, Guideline 14, Role of the
Independent Public Accountant--Independence; and OTS Regulation 12
CFR 562.4(d)(3)(i), Qualifications for independent public
accountants. Go Back to Text
8In contrast to the SEC's position, AICPA Ethics Ruling 94 (ET
§ 191.188--189) currently concludes that indemnification for
"knowing misrepresentations by management" does not impair
independence. On September 15, 2005, the AICPA published for comment
its proposed interpretation of its auditor independence standards. In
that proposal the AICPA specifically identified limitation of liability
provisions that impair auditor independence under the AICPA's
standards. Most of the provisions cited in this Advisory were deemed to
impair independence in the AICPA's proposed interpretation. At this
writing, the AICPA has not issued a final interpretation. Go Back to Text
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