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Trading and Capital-Markets Activities Manual

Capital-Markets Activities: Investment Securities and End-User Activities (Continue)
Source: Federal Reserve System 
(The complete Activities Manual (pdf format) can be downloaded from the Federal Reserve's web site)

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Institutions should categorize each of their security activities as trading, available-for-sale, or held-to-maturity consistent with GAAP (that is, Statement of Financial Accounting Standards No. 115, ''Accounting for Certain Investments in Debt and Equity Securities,'' as amended) and regulatory reporting standards. Management should reassess the categorizations of its securities periodically to ensure that they remain appropriate.

Securities that are intended to be held principally for the purpose of selling in the near term should be classified as trading assets. Trading activity includes the active and frequent buying and selling of securities for the purpose of generating profits on short-term fluctuations in price. Securities held for trading purposes must be reported at fair value, with unrealized gains and losses recognized in current earnings and regulatory capital. The proper categorization of securities is important to ensure that trading gains and losses are promptly recognized- which will not occur when securities intended to be held for trading purposes are categorized as held-to-maturity or available-for-sale. 

It is an unsafe and unsound practice to report securities held for trading purposes as available-for-sale or held-to-maturity securities. A close examination of an institution's actual securities activities will determine whether securities it reported as available-for-sale or held-to-maturity are, in reality, held for trading. When the following securities activities are conducted in available-for-sale or held-to-maturity accounts, they should raise supervisory concerns. The first five practices below are considered trading activities and should not occur in available-for-sale or held-to-maturity securities portfolios, and the sixth practice is wholly unacceptable under all circumstances. 

Gains Trading 

Gains trading is the purchase of a security and the subsequent sale of that security at a profit after a short holding period. However, at the same time, securities acquired for gains trading that cannot be sold at a profit are retained in the available-for-sale or held-to-maturity portfolio; unrealized losses on debt securities in these two categories do not directly affect regulatory capital and are not reported in income until the security is sold. Examiners should note institutions that exhibit a pattern or practice of reporting significant amounts of realized gains on sales of non-trading securities (typically, available-for-sale securities) after short holding periods, while continuing to hold other non-trading securities with significant amounts of unrealized losses. In these situations, examiners may designate some or all of the securities reported outside of the trading category as trading assets. 

When-Issued Securities Trading 

When-issued securities trading is the buying and selling of securities in the period between the announcement of an offering and the issuance and payment date of the securities. A purchaser of a when-issued security acquires all of the risks and rewards of owning a security and may sell this security at a profit before having to take delivery and pay for it. These transactions should be regarded as trading activities. 


Pair-offs are security purchases that are closed out or sold at or before settlement date. In a pair-off, an institution commits to purchase a security. Then before the predetermined settlement date, the institution will pair off the purchase with a sale of the same security. Pair-offs are settled net when one party to the transaction remits the difference between the purchase and sale price to the counterparty. Other pair-off transactions may involve the same sequence of events using swaps, options on swaps, forward commitments, options on forward commitments, or other off-balance-sheet derivative contracts.

Extended Settlements 

Regular-way settlement for U.S. government and federal-agency securities (except mortgage-backed securities and derivative contracts) is one business day after the trade date. Regular-way settlement for corporate and municipal securities is three business days after the trade date, and settlement for mortgage-backed securities can be up to 60 days or more after the trade date. Using a settlement period that exceeds the regular-way settlement periods to facilitate speculation is considered a trading activity. 

Short Sales 

A short sale is the sale of a security that is not owned. Generally, the purpose of a short sale is to speculate on a fall in the price of the security. Short sales should be conducted in the trading portfolio. A short sale that involves the delivery of the security sold short by borrowing it from the depository institution's available-for-sale or held-to-maturity portfolio should not be reported as a short sale. Instead, it should be reported as a sale of the underlying security with gain or loss recognized. Short sales are not permitted for federal credit unions. 

Adjusted Trading 

Adjusted trading involves the sale of a security to a broker or dealer at a price above the prevailing market value and the simultaneous purchase and booking of a different security, frequently a lower-grade issue or one with a longer maturity, at a price above its market value. Thus, the dealer is reimbursed for its losses on the initial purchase from the institution and ensured a profit. Adjusted-trading transactions inappropriately defer the recognition of losses on the security sold and establish an excessive reported value for the newly acquired security. Consequently, these transactions are prohibited and may be in violation of 18 USC 1001 (False Statements or Entries) and 1005 (False Entries). 

Investment Securities and End-User Activities 

Examination Objectives 

1. To determine if policies, practices, procedures, and internal controls for investments are adequate. 

2. To determine if bank officers are operating in conformance with the established guidelines. 

3. To determine the scope and adequacy of the audit function. 

4. To determine the overall quality of the investment portfolio and how that quality relates to the soundness of the bank. 

5. To determine compliance with laws and regulations. 

6. To initiate corrective action when policies, practices, procedures, or internal controls are deficient or when violations of laws or regulations have been noted.

Investment Securities and End-User Activities 

Examination Procedures 

These procedures represent a list of processes and activities that may be reviewed during a full-scope examination. The examiner-in-charge will establish the general scope of examination and work with the examination staff to tailor specific areas for review as circumstances warrant. As part of this process, the examiner reviewing a function or product will analyze and evaluate internal audit comments and previous examination work papers to assist in designing the scope of examination. In addition, after a general review of a particular area to be examined, the examiner should use these procedures, to the extent they are applicable, for further guidance. Ultimately, it is the seasoned judgment of the examiner and the examiner-in-charge as to which procedures are warranted in examining any particular activity. 

1. Based on the evaluation of internal controls and the work performed by internal and external auditors, determine the scope of the examination. 

2. Test for compliance with policies, practices, procedures, and internal controls in conjunction with performing the examination procedures. Also, obtain a listing of any deficiencies noted in the latest review conducted by internal and external auditors and determine if corrections have been accomplished. Determine the extent and effectiveness of investment-policy supervision by- 

a. reviewing the abstracted minutes of board of directors meetings and minutes of appropriate committee meetings; 
b. determining that proper authorizations have been made for investment officers or committees; 
c. determining any limitations or restrictions on delegated authorities; 
d. evaluating the sufficiency of analytical data used by the board or investment committee; 
e. reviewing the reporting methods used by department supervisors and internal auditors to ensure compliance with established policy; and 
f. preparing a memo for the examiner who is assigned to review the duties and responsibilities of directors and for the examiner responsible for the international examination, if applicable. This memo should state conclusions on the effectiveness of directors' supervision of the domestic and international-division investment policy. All conclusions should be documented. 

3. Obtain the following: 
a. trial balances of investment-account holdings, money market instruments, and end-user derivative positions including commercial paper, banker's acceptances, negotiable certificates of deposit, securities purchased under agreements to resell, and federal funds sold (Identify any depository instruments placed through money brokers.) 
b. a list of any assets carried in loans and any discounts on which interest is exempt from federal income taxes and which are carried in the investment account on call reports 
c. a list of open purchase-and-sale commitments 
d. a schedule of all securities, forward placement contracts, and derivative contracts including contracts on exchange-traded puts and calls, option contracts on futures puts and calls, and standby contracts purchased or sold since the last examination 
e. a maturity schedule of securities sold under repurchase agreements 
f. a list of pledged assets and secured liabilities 
g. a list of the names and addresses of all securities dealers doing business with the bank 
h. a list of the bank's personnel authorized to trade with dealers 
i. a list of all U.S. government-guaranteed loans which are recorded and carried as an investment-account security 
j. for international division and overseas branches, a list of investments- 

  held to comply with various foreign governmental regulations requiring such investments, 
  used to meet foreign reserve requirements, 
  required as stock exchange guarantees or used to enable the bank to provide securities services, 
  representing investment of surplus funds, 
  used to obtain telephone and telex services, 
  representing club and school memberships, 
  acquired through debts previously contracted, 
  representing minority interests in non-affiliated companies, 
  representing trading-account securities, 
  representing equity interests in Edge Act and agreement corporations and in foreign banks, and 
  held for other purposes. 

4. Using updated data available from reports of condition, UBPR printouts, and investment advisor and correspondent bank portfolio analysis reports, obtain or prepare an analysis of investment, money market, and end-user derivative holdings that includes- 

a. a month-by-month schedule of par, book, and market values of issues maEagle Tradersg in one year; 
b. schedules of par, book, and market values of holdings in the investment portfolio (these schedules should be indexed by maturity date, and the schedule should be detailed by maturity dates over the following time periods: over 1 through 5 years, over 5 through 10 years, and over 10 years); 
c. book value totals of holdings by obligor or industry, related obligors or industries, geographic distribution, yield, and special characteristics, such as moral obligations, conversion, or warrant features; 
d. par value schedules of type I, II, and III investment holdings, by those legally defined types; and 
e. for the international division, a list of international investment holdings (foreign-currency amounts and U.S. dollar equivalents) to include- 

  descriptions of securities held (par, book, and market values), 
  names of issuers, 
  issuers' countries of domicile, 
  interest rates, and 
  pledged securities. 

5. Review the reconcilement of the trial balances investment and money market accounts to general-ledger control accounts. 

6. Using either an appropriate sampling technique or the asset-coverage method, select from the trial balances the international investments, municipal investments, and money market and derivative holdings for examination. If transaction volume permits, include in the population of items to be reviewed all securities purchased since the last general examination. 

7. Perform the following procedures for each investment and money market holding selected in step 6. 
a. Check appropriate legal opinions or published data outlining legal status. 
b. If market prices are provided to the bank by an independent party (excluding affiliates and securities dealers selling investments to the bank), or if they are independently tested as a documented part of the bank's audit program, those prices should be accepted. If the independence of the prices cannot be established, test market values by referring to one of the following sources: 

  published quotations, if available 
  appraisals by outside pricing services, if performed 

c. For investments and money market obligations in the sample that are rated, compare the ratings provided to the most recent published ratings. 

Before continuing, refer to steps 15 through 17. They should be performed in conjunction with steps 8 through 14. International-division holdings should be reviewed with domestic holdings to ensure compliance, when combined, with applicable legal requirements. 

8. To the extent practicable under the circumstances, test that the institution has analyzed the following: 
a. the obligors on securities purchased under agreements to resell, when the readily marketable value of the securities is not sufficient to satisfy the obligation b. all international investments, non-rated securities, derivatives, and money market instruments selected in step 6 or acquired since the last examination 
c. all previously detailed or currently known speculative issues 
d. all defaulted issues 
e. any issues in the current Interagency Country Exposure Review Committee credit schedule (obtained from the international loan portfolio manager): 

  compare the schedule to the foreign securities trial balance obtained in step 3 to ascertain which foreign securities are to be included in Interagency Country Exposure Review Committee credits 
  for each security so identified, transcribe the following appropriate information to a separate examiner's line sheet or a related examiner's credit line sheet: 

- amount (and U.S. dollar equivalent if a foreign currency) to include par, book, and market values
- how and when acquired 
- maturity dates
- default date, if appropriate 
- any pertinent comments 

  return the schedule and appropriate examiner's line sheets to the examiner who is assigned to international-loan portfolio management. 

9. Review the most recent reports of examination of the bank's Edge Act and agreement corporation affiliates and foreign subsidiaries to determine their overall conditions. Also, compile data on Edge Act and agreement corporations and foreign subsidiaries that are necessary for the commercial report of examination (such as asset criticisms, transfer risk, and other material examination findings). 

10. Classify speculative and defaulted issues according to the following standards (except those securities in the Interagency Country Exposure Review and other securities on which special instructions have been issued): 

a. The entire book value of speculative grade municipal general obligation securities which are not in default will be classified substandard. Market depreciation on other speculative issues should be classified doubtful. The remaining book value usually is classified substandard. 
b. The entire book value of all defaulted municipal general obligation securities will be classified doubtful. Market depreciation on other defaulted bonds should be classified loss. The remaining book value usually is classified substandard. 
c. Market depreciation on non-exempt stock should be classified loss. 
d. Report comments should include: 

  description of issue 
  how and when each issue was acquired 
  default date, if appropriate 
  date interest was paid to the issue 
  rating at time of acquisition 
     comments supporting the classification 

11. Review the bank's maturity program. 
a. Review the maturity schedules by- 

  comparing book and market values and, after considering the gain or loss on year-to-date sales, determine if the costs of selling intermediate and long-term issues appear prohibitive, and 
  determine if recent acquisitions show a trend toward lengthened or shortened maturities. Discuss such trends with management, particularly with regard to investment objectives approved by the investment committee. 

b. Review the pledged-asset and secured-liability schedules and isolate pledged securities by maturity segment, then determine the market value of securities pledged in excess of net secured liabilities. 
c. Review the schedule of securities sold under repurchase agreement and determine- 

  if financing for securities purchases is provided via repurchase agreement by the securities dealer who originally sold the security to the bank, 
  if funds acquired through the sale of securities under agreement to repurchase are invested in money market assets or if short-term repurchase agreements are being used to fund longer-term, fixed-rate assets, 
  the extent of matched-asset repo and liability repo maturities and the overall effect on liquidity resulting from unmatched positions, 
  if the interest rate paid on securities sold under agreement to repurchase is   appropriate relative to current money market rates, and 
  if the repurchase agreement is at the option of the buying or selling bank. 

d. Review the list of open purchase-and-sale commitments and determine the effect of their completion on maturity scheduling. 
e. Submit investment portfolio information regarding the credit quality and practical liquidity of the investment portfolio to the examiner who is assigned to asset/liability management.

12. Consult with the examiner responsible for the asset/liability management analysis to determine what information is needed to assess the bank's sensitivity to interest-rate fluctuations and its ability to meet short-term funding requirements. If requested, compile the information using bank records or other appropriate sources. (See the Instructions for the Report of Examination section of this manual for factors to be taken into account when compiling this information.) Information which may be required to be furnished includes- 

a. the market value of un-pledged government and federal-agency securities maEagle Tradersg within one year; 
b. the market value of other un-pledged government and federal-agency securities which would be sold without loss; 
c. the market value of un-pledged municipal securities maEagle Tradersg within one year; 
d. the book value of money market instruments, such as banker's acceptances, commercial paper, and certificates of deposit (provide amounts for each category); and 
e. commitments to purchase and sell securities, including futures, forward, and standby contracts. (Provide a description of the security contract, the purchase or sales price, and the settlement or expiration date.) 

13. Determine whether the bank's investment policies and practices are balancing earnings and risk satisfactorily. 
a. Use UBPR or average call report data to calculate investments as a percentage of total assets and average yields on U.S. government and non-taxable investments. 

  Compare results to peer-group statistics. 
  Determine the reasons for significant variances from the norm. 
  Determine if trends are apparent and the reasons for such trends. 

b. Calculate current market depreciation as a percentage of gross capital funds. c. Review the analysis of municipal and corporate issues by rating classification. 

  Determine the total in each rating class and the total of non-rated issues. 
  Determine the total of non-rated investment securities issued by obligors located outside of the bank's service area (exclude U.S. government- guaranteed issues). 
  Review acquisitions since the prior examination and ascertain reasons for trends that may suggest a shift in the rated quality of investment holdings. 

d. Review coupon rates or yields (when available) and compare those recently acquired investments and money market holdings with coupon rates or yields that appear high or low to similarly acquired instruments of analogous types, ratings, and maturity characteristics. Discuss significant rate or yield variances with management. 
e. Review the schedule of securities, futures, forward, and standby contracts purchased and sold since the last examination and determine whether the volume of trading is consistent with policy objectives. If the bank does not have a separate trading account, determine whether such an account should be established, including appropriate recordkeeping and controls. 
f. If the majority of sales resulted in gains, determine if profit-taking is consistent with stated policy objectives or is motivated by anxiety for short-term income. 
g. Determine whether the bank has discounted or has plans to discount future investment income by selling interest coupons in advance of interest-payment dates. 
h. Review the list of commitments to purchase or sell investments or money market investments. Determine the effect of completion of these contracts on future earnings. 

14. Review the bank's federal income tax position. 
a. Determine, by discussion with appropriate officers, if the bank is taking advantage of procedures to minimize tax liability in view of other investment objectives. 
b. Review or compute the bank's actual and budgeted tax-exempt holdings as a percentage of total assets and its applicable income taxes as a percentage of net operating income before taxes. 
c. Discuss with management the tax implications of losses resulting from securities sales. 

15. Determine that proper risk diversification exists within the portfolio. 
a. Review totals of holdings by single obligor or industry, related obligors or industries, geographic distribution, yields, and securities that have special characteristics (include individual due from bank accounts from the list received from the bank or from the examiner who is assigned to due from banks and all money market instruments). 

  Detail, as concentrations, all holdings equaling 25 percent or more of capital funds. 
  List all holdings equaling at least 10 percent but less than 25 percent of capital funds and submit that information to the examiner who is assigned to loan portfolio management. These holdings will be combined with any additional advances in the lending areas. 

b. Perform a credit analysis of all non-rated holdings determined to be a concentration (if not performed in step 8). 

16. If the bank is engaged in financial futures, exchange-traded puts and calls, forward placements, or standby contracts, determine the following. 
a. The policy is specific enough to outline permissible contract strategies and their relationships to other banking activities. 
b. Recordkeeping systems are sufficiently detailed to permit a determination of whether operating personnel have acted in accordance with authorized objectives. 
c. The board of directors or its designee has established specific contract-position limits and reviews contract positions at least monthly to ascertain conformance with those limits. 
d. Gross and net positions are within authorized positions and limits, and trades were executed by persons authorized to trade futures. 
e. The bank maintains general-ledger memorandum accounts or commitment registers which, at a minimum, include- 

  the type and amount of each contract, 
  the maturity date of each contract, 
  the current market price and cost of each contract, and 
  the amount held in margin accounts, including- 

- all futures contracts and forward, standby, and options contracts revalued on the basis of market or the lower of cost or market at each month-end; 
- securities acquired as the result of completed contracts valued at the lower of cost or market upon settlement; 
- fee income received by the bank on standby contracts accounted for properly; - financial reports disclosing futures, forwards, options, and standby activity; 
- a bank-instituted system for monitoring credit-risk exposure in forward and standby contract activity; and 
- the bank's internal controls, management reports, and audit procedures to ensure adherence to policy. 

17. If the bank is engaged in financial futures, forward placement, options, or standby contracts, determine if the contracts have a reasonable correlation to the bank's business needs (including gap position) and if the bank fulfills its obligations under the contracts. 
a. Compare the contract commitment and maturity dates to anticipated offset. 
b. Report significant gaps to the examiner who is assigned to asset/liability management (see step 12). 
c. Compare the amounts of outstanding contracts to the amounts of the anticipated offset. 
d. Ascertain the extent of the correlation between expected interest-rate movements on the contracts and the anticipated offset. 
e. Determine the effect of the loss recognition on future earnings, and, if significant, report it to the examiner who is assigned to analytical review and income and expense. 

18. On the basis of the pricings, ratings, and credit analyses performed above, and using the investments selected in step 6 or from lists previously obtained, test for compliance with applicable laws and regulations. 
a. Determine if the bank holds type II or III investments that are predominantly speculative or if it holds securities that are not marketable (12 CFR 1.3(b)). 
b. Review the recap of investment securities by legal types, as defined by 12 CFR1, on the basis of the legal restrictions of 12 USC 24 and competent legal opinions. 
c. For those investment securities that are convertible into stock or which have stock purchase warrants attached- 

  determine if the book value has been written down to an amount that represents the investment value of the security, independent of the conversion or warrant provision (12 CFR 1.10) and 
  determine if the par values of other securities that have been ruled eligible for purchase are within specified capital limitations. 

d. Review pledge agreements and secured liabilities and determine that- 

  proper custodial procedures have been followed, 
  eligible securities are pledged,  
  securities pledged are sufficient to secure the liability that requires securing, 
  Treasury tax and loan remittance options and note options are properly secured, and 
  private deposits are not being secured. 

(Information needed to perform the above steps will be in the pledge agreement; Treasury circulars 92 and 176, as amended.) 

e. Review accounting procedures to determine that- 

  investment premiums are being extinguished by maturity or call dates (12 CFR 1.11); 
  premium amortization is charged to operating income (12 CFR 1.11); 
  accretion of discount is included in current income for banks required to use accrual accounting for reporting purposes; 
  accretion of bond discount requires a concurrent accrual of deferred income tax payable; and  
  securities gains or losses are reported net of applicable taxes, and net gains or losses are reflected in the period in which they are realized. 

f. Determine if securities purchased under agreement to resell are in fact securities (not loans), are eligible for investment by the bank, and are within prescribed limits (12 USC 24 and 12 CFR 1). If not, determine whether the transaction is within applicable legal lending limits in the state. 
g. Review securities sold under agreement to repurchase and determine whether they are, in fact, deposits (Regulation D, 12 CFR 204.2(a)(1)). 
h. Determine that securities and money market investments held by foreign branches comply with section 211.3 of Regulation K-Foreign Branches of Member Banks (12 CFR 211.3) as to- 

  acquiring and holding securities (section 211.3(b)(3)) and 
  underwriting, distributing, buying, and selling obligations of the national government of the country in which the branch is located (section 211.3(b)(4)). 

(Further considerations relating to the above are in other sections of Regulation K. Also review any applicable sections of Regulation T-Credit by Brokers and Dealers (12 CFR 220), Regulation X-Borrowers of Securities Credit (12 CFR 224), and Board interpretations 6150 (regarding securities issued or guaranteed by the International Bank for Reconstruction and Development) and 6200 (regarding borrowing by a domestic broker from a foreign broker). Edge Act and agreement corporations are discussed in the bank-related organizations section. 

i. Determine that the bank's equity investments in foreign banks comply with the provisions of section 25 of the Federal Reserve Act and section 211.5 of Regulation K as to- 

  investment limitations (section 211.5(b)) and 
  investment procedures (section 211.5(c)). 

19. Test for compliance with other laws and regulations as follows. a. Review lists of affiliate relationships and lists of directors and principal officers and their interests. 
  Determine if the bank is an affiliate of a firm that is primarily engaged in underwriting or selling securities (12 USC 377). 
  Determine if directors or officers are engaged in or employed by firms that are engaged in similar activities (12 USC 78, 377, and 378). (It is an acceptable practice for bank officers to act as directors of securities companies not doing business in the United States, the stock of which is owned by the bank as authorized by the Board of Governors of the Federal Reserve System.) 
  Review the list of federal funds sold, securities purchased under agreements to resell, interest-bearing time deposits, and commercial paper, and determine if the bank is investing in money market instruments of affiliated banks or firms (section 23A, Federal Reserve Act and 12 USC 371(c)). 
  Determine if transactions involving affiliates, insiders, or their interests have terms that are less favorable to the bank than transactions involving unrelated parties (sections 23A and 22 of the Federal Reserve Act (12 USC 371c, 375, 375a, and 375b)). 

b. Determine if Federal Reserve stock equals 3 percent of the subject bank's booked capital and surplus accounts (Regulation I and 12 CFR 209). 
c. Review the nature and duration of federal funds sales to determine if term federal funds are being sold in an amount exceeding the limit imposed by state legal lending limits. 

20. With regard to potential unsafe and unsound investment practices and possible violations of the Securities Exchange Act of 1934, review the list of securities purchased and/or sold since the last examination. 
a. Determine if the bank engages one securities dealer or salesperson for virtually all transactions. If so- 

  evaluate the reasonableness of the relationship on the basis of the dealer's location and reputation and 
  compare purchase and sale prices to independently established market prices as of trade dates, if appropriate. 

b. Determine if investment-account securities have been purchased from the bank's own trading department. If so- 

  independently establish the market price as of trade date, 
  review trading-account purchase and sale confirmations and determine if the security was transferred to the investment portfolio at market price, and 
  review controls designed to prevent dumping. 

c. Determine if the volume of trading activity in the investment portfolio appears unwarranted. If so- 

  review investment-account daily ledgers and transaction invoices to determine if sales were matched by a like amount of purchases, 
  determine whether the bank is financing a dealer's inventory, 
  compare purchase and sale prices with independently established market prices as of trade dates, if appropriate (the carrying value should be determined by the market value of the securities as of the trade date), and 
  cross reference descriptive details on investment ledgers and purchase confirmations to the actual bonds or safekeeping receipts to determine if the bonds delivered are those purchased. 

21. Discuss with appropriate officers and prepare report comments on- 
a. defaulted issues; 
b. speculative issues; 
c. incomplete credit information; 
d. the absence of legal opinions; 
e. significant changes in maturity scheduling; 
f. shifts in the rated quality of holdings; 
g. concentrations; 
h. unbalanced earnings and risk considerations; 
i. unsafe and unsound investment practices; 
j. apparent violations of laws, rulings, and regulations and the potential personal liability of the directorate; 
k. significant variances from peer-group statistics; 
l. market-value depreciation, if significant; 
m. weaknesses in supervision; 
n. policy deficiencies; and 
o. material problems being encountered by the bank's Edge Act and agreement corporation affiliates and other related international concerns that could affect the condition of the bank. 

22. The following guidelines are to be implemented while reviewing securities participations, purchases and sales, swaps, or other transfers. The guidelines are designed to ensure that securities transfers involving state member banks, bank holding companies, and non-bank affiliates are carefully evaluated to determine if they were carried out to avoid classification and to determine the effect of the transfer on the condition of the institution. In addition, the guidelines are designed to ensure that the primary regulator of the other financial institution involved in the transfer is notified. 
a. Investigate any situations in which securities were transferred before the date of examination to determine if any were transferred to avoid possible criticism during the examination. 
b. Determine whether any of the securities transferred were nonperforming at the time of transfer, classified at the previous examination, depreciated or sub-investment-grade, or for any other reason considered to be of questionable quality. 
c. Review the bank's policies and procedures to determine whether securities purchased by the bank are given an independent, complete, and adequate credit evaluation. If the bank is a holding company subsidiary or a member of a chain banking organization, review securities purchases or participations from affiliates or other known members of the chain to determine if the securities purchases are given an arm's-length and independent credit evaluation by the purchasing bank. d. Determine whether bank purchases of securities from an affiliate are in conformance with section 23A, which generally prohibits purchases of low-quality assets from an affiliate. 
e. Determine that any securities purchased by the bank are properly reflected on its books at fair market value (fair market value should at a minimum reflect both the rate of return being earned on such assets and an appropriate risk premium). Determine that appropriate write-offs are taken on any securities sold by the bank at less than book value. 
f. Determine that transactions involving transfers of low-quality securities to the parent holding company or a non-bank affiliate are properly reflected at fair market value on the books of both the bank and the holding company affiliate. 
g. If poor-quality securities were transferred to or from another financial institution for which the Federal Reserve is not the primary regulator, prepare a memorandum to be submitted to Reserve Bank supervisory personnel. The Reserve Bank will then inform the local office of the primary federal regulator of the other institution involved in the transfer. The memorandum should include the following information, as applicable: 

  names of originating and receiving institutions 
  the type of securities involved and type of transfer (such as participation, purchase or sale, or swap) 
  dates of transfer 
  the total number and dollar amount of securities transferred 
  the status of the securities when transferred (for example, rating, depreciation, nonperforming, or classified) 
  any other information that would be helpful to the other regulator 

23. Evaluate the quality of department management. Communicate your conclusion to the examiner who is assigned to management assessment and the examiner responsible for the international examination, if applicable. 

24. Update work-papers with any information that will facilitate future examinations. If the bank has overseas branches, indicate those securities that will require review during the next overseas examination and the reasons for the review.

Investment Securities and End-User Activities 

Internal Control Questionnaire 

Review the bank's internal controls, policies, practices, and procedures regarding purchases, sales, and servicing of the investment portfolio. The bank's system should be documented completely and concisely, and should include, where appropriate, narrative descriptions, flow charts, copies of forms used, and other pertinent information. Items in the questionnaire marked with an asterisk require substantiation by observation or testing. 

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