The State of the Banking Industry


Published on

  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

The State of the Banking Industry

  1. 1. BANKING & FINANCE The State of the Banking Industry Banking and Investment Banking & Securities Winter 2005
  2. 2. SOBI Winter 2005 BANKING & FINANCE The State of the Banking Industry Banking and Investment Banking & Securities Winter 2005 The State of the Banking Industry is published by KPMG LLP’s Banking & Finance Industry Sector for members of the Banking and Investment Banking & Securities Industries. Information and statistics contained in this document were obtained from materials available to the public. 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 LLP, please go to our Web site at © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  3. 3. SOBI Winter 2005 Contents Page Changes & Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 General Highlights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Regulatory and Legislative Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Accounting Standards and Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Market Forces . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Broker/Dealers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11 Consolidation and Convergence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 International Focus and Globalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Risk Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 e-Business and Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 KPMG Banking Insider . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Analysis and Commentary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 KPMG Contacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 © 2004 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. 23680NYGR © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  4. 4. SOBI Winter 2005 1 Changes & Trends General Highlights – The net purchases of U.S. securities • Commercial banks and savings by foreigners has brought the total institutions insured by the Federal • According to the Securities Industry value of their U.S. portfolios to $5.8 Deposit Insurance Corporation (FDIC) Association’s “Key Trends in the trillion in mid-2004 — a new high. reported net income of $32.5 billion for Securities Industry,” the U.S. securities the third quarter of 2004, surpassing industry continued to raise trillions of – Seventy-three percent of Americans’ the first quarter high of $31.8 billion. dollars for new and expanding liquid financial assets are invested in According to the FDIC, the profits were businesses as individuals, both U.S.- securities-related products, such as fueled in part by increased lending to and foreign-based investors, increased stocks, bonds, and mutual funds. consumers and businesses and higher their ownership of equities. Other key This represents a large shift in gains on sales of securities and other trends, based on nine-months’ investments over the past 30 years assets. Profits for the third quarter annualized data, include: — in 1975, 55 percent of the surpassed the total for the same period American public’s assets were in in 2003 by 6.9 percent. The numbers – The securities industry raised an bank deposits. are from the FDIC’s “Quarterly Banking estimated $2.9 trillion of capital for – Pre-tax profits for all broker-dealers Profile,” released on November 23, U.S. business in 2004 through doing a public business in the United 2004. Major findings in the third quarter corporate underwriting activity in the States are forecast to reach report include: net interest income grew United States, the second straight $18.9 billion in 2004, representing the strongly while noninterest income year at this level. fourth most profitable year ever for declined; the $198 billion increase in – IPOs are projected to raise $42 billion the industry. Total revenues are loans and leases was the second in 2004, a strong rebound from the forecast to reach $216.3 billion (up largest quarterly increase ever reported $16 billion achieved in 2003. 1.7 percent from 2003). by the industry; growth in consumer loans remained robust, while – Average daily share volume on the – The M&A market remains stagnant, commercial and industrial loan demand NYSE and NASDAQ remains strong. but will show a modest improvement showed signs of picking up Average daily volume on the NYSE over 2003. The value of announced momentum. Also according to the was 1.44 billion shares. NASDAQ’s deals is expected to reach FDIC, should interest rates increase, the average daily volume was 1.78 billion $757 billion in 2004, still far from the industry’s ability to realize gains on shares. These figures are roughly $1.741 trillion in 2000. securities sales would be limited. (FDIC twice the daily average traded five Press Release, November 23, 2004) – The securities industry’s employment years ago. levels apparently bottomed-out in • The Federal Open Market Committee, – International trading and investments May 2003. Since then the industry on December 14, 2004, raised its target in foreign securities are booming. The has gained 35,800 jobs through for the federal funds rate by 25 basis September 2004. (Securities Industry total value of U.S. holdings of foreign points to 24 percent. Despite this Association Press Release, securities was $1.9 trillion in mid- increase, the Committee believes that November 4, 2004) 2003, and by mid-2004 the value had the stance of monetary policy remains grown to $2.5 trillion (peak value was accommodative and, coupled with $2.5 trillion in 1999). robust underlying growth in productivity, © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  5. 5. 2 SOBI Winter 2005 is providing ongoing support to Almost half of the respondents said that refinance mortgages will account for economic activity. The Committee said credit availability from their current only 32 percent of the mortgage market the upside and downside risks to the lender has increased during the year, in 2005 and 26 percent in 2006. (Press attainment of both sustainable growth and the majority of the companies Releases: OFHEO, December 1; and price stability for the next few surveyed purchased at least one Mortgage Bankers Association, quarters are roughly equal. With financial product in addition to the credit October 27, 2004) underlying inflation expected to be facility. (Press Releases: Business • The Bank Administration Institute’s relatively low, the Committee believes Roundtable, December 1; Bank of Check 21 readiness survey revealed that policy accommodation can be America, December 6, 2004) that many bankers believe their financial removed at a pace that is likely to be • Average U.S. home prices increased institutions have a long way to go measured. In a related action, the Board 12.97 percent from the third quarter of before they will be able to maximize the of Governors unanimously approved a 2003 through the third quarter of 2004. potential of Check 21, but a majority are 25 basis point increase in the discount Appreciation was 4.62 percent, or an expected to be able to meet the rate to 3-1/4 percent. (Federal Reserve annualized rate of 18.48 percent. The minimum requirements by October 28, Press Release, December 14, 2004) figures were released on December 1 2004. Sixty-four percent of those • Business Roundtable’s December 2004 by the Office of Federal Housing responding place their institutions in CEO Economic Outlook Survey shows Enterprise Oversight (OFHEO), as part one of the top two overall readiness that America’s leading CEOs expect the of OFHEO’s House Price Index (HPI). categories, but fewer than one in 20 U.S. economy to continue to grow at a Several factors could be playing a role in expressed doubt that their companies healthy pace in the first half of 2005, the large house price increases in the would be able to receive and process with a slight easing from the strong third quarter, OFHEO notes. With the substitute checks, make consumers growth of 2004. The responses led to a slight decrease in long-term interest aware of the law and their rights under CEO Economic Outlook Index of 98.9, rates, purchasing a house has been less it, and provide expedited recredit as the second-highest index level for the expensive. Also, refinancing volume fell required by the Check Clearing for the survey. A majority of the respondents last quarter substantially below levels in 21st Century Act. In a separate report, expect sales to continue to increase, recent quarters. During the previous Celent estimates that paper check and half of the CEOs expect to increase period of intense refinancing, HPI processing should nearly disappear by capital expenditures. In the annual increases may have been held down as the end of the decade. According to its question about challenges to growth, appraised values used for refinancing report, “The Future of Check CEOs cited health care costs as the mortgages with low loan-to-value ratios Processing in the US,” image exchange greatest cost pressure to corporate may not have kept up with recent of transit checks will grow from more America, followed by litigation costs and market price increase. According to the than 14 percent in 2005 to 61 percent energy prices. The percentage of CEOs Mortgage Bankers Association’s (MBA) by 2007. By 2010, more than 93 per- who cited energy cost pressures is long-term forecasts for the housing cent of transit items will be image- nearly three times higher than a year finance market for 2005 and 2006, exchanged. (Press Releases: Bank ago. A separate manufacturing sector purchase mortgage originations should Administration Institute, October 2004; “CFO Outlook” survey, released on remain near the record levels of 2004. Celent, October 27, 2004) December 6, 2004 by Bank of America, MBA predicts that purchase originations saw almost the same results. CFOs will decline from an expected Regulatory and surveyed also were bullish about the $1.48 trillion in 2004 to $1.45 trillion in Legislative Issues economy in 2005 and expect to 2005 and $1.44 trillion in 2006. The Important actions during recent months increase their capital expenditures. Also, refinance market is expected to decline by federal agencies, including the almost a quarter of CFOs expect to from $1.19 trillion in 2004 to Securities and Exchange Commission participate in a merger or acquisition in $0.68 trillion in 2005 and $0.46 trillion in (SEC) and other regulatory bodies and 2005, up substantially from last year. 2006. As a result, according to MBA, industry groups such as NASD (formerly © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  6. 6. SOBI Winter 2005 3 known as the National Association of and expectations under related inter- • The SEC voted to propose amendments Securities Dealers, Inc.), the New York pretive material in Notice to Members to Regulation M under the Securities Stock Exchange, Inc. (NYSE), and the 04-71 and Notice to Members 04-79. Exchange Act of 1934, the anti- Municipal Securities Rulemaking Board The NYSE has communicated the manipulation rule concerning securities (MSRB) are referenced below. All dates same information to its members via offerings, which applies to broker- refer to the year 2004, unless otherwise Information Memo 04-38. (CRF, October dealers and their activities relative to noted. For more information on select and December; WR, November 8, the promotion of sales of initial public topics, please see the publications 2004; and RPL 04-06) offerings. The changes would curtail referenced including KPMG’s The certain market activities that undermine • The SEC adopted rule amendments Washington Report (WR) and KPMG’s the integrity and fairness of this under Regulation S-P to require financial Compliance & Regulatory Focus (CRF) process, as well as enhance the institutions to adopt policies and available at transparency of underwriters’ procedures regarding the safeguarding aftermarket activities. (CRF, November; Rulemaking Initiatives and disposal of certain customer WR, October 11 and 18, 2004) • In a series of related rulemaking information as per section 216 of the initiatives, the SEC approved Fair and Accurate Credit Transactions • The SEC approved an order to delay the complementary NASD and NYSE rules Act of 2003. The rules apply to most Regulation SHO (Short Sales) pilot and amendments that form a broker-dealers, investment companies, period to suspend the operation of short comprehensive regulatory scheme and investment advisers, among others. sale price provisions. (CRF, January designed to strengthen the supervisory (CRF, January 2005; WR, December 6, 2005; WR, December 6, 2004) procedures and internal controls of 2004) broker-dealers. New NASD Rule 3013 Enforcement Actions • The SEC voted to propose new rules • The NYSE announced that it reached an and related interpretive material require and rule and form amendments that agreement in principle with a broker- the designation of a chief compliance would impact the current structure dealer to settle an action that resulted in officer by December 1, and annual and function of the self-regulatory a censure and $19 million fine, among certifications by the chief executive organization (SRO) paradigm. The other things, for allegedly failing to officer relative to the state of a firm’s proposals address the areas of deliver prospectuses to customers in internal compliance systems, among governance, transparency, SRO registered offerings. (CRF, October; WR, other things. Effective January 31, reporting, SRO ownership, and SRO October 4, 2004) 2005, amendments to NASD Rule 3010 self-listing activities. In a related action, and new NASD Rule 3012 will require the SEC issued a concept release to • NASD censured and fined 29 broker- firms to establish procedures to test explore issues relating to the efficacy dealers over $9.2 million in connection their supervisory internal controls, of the self-regulatory system. (CRF, with widespread late disclosures of among other things. The NYSE has December; WR, November 15, 2004) reportable information about firm promulgated requirements under Rule registered representatives, including 342, effective December 17, 2004, that • The SEC voted to propose new and customer complaints, regulatory actions are substantially similar to the NASD amended rules and form changes to and criminal charges and convictions. regulations. Further, there are certain modify the registration, communi- Two of the firms were also prohibited additional new requirements relating to cations, and offering processes under from registering new brokers for a the transmission of customer funds and the Securities Act of 1933 that would period of time, due to the number of securities, customer changes in facilitate the ability of a company that violations and their previous disciplinary addresses, changes in customer plans to issue shares of its stock in an histories. (CRF, December; WR, investment objectives, time and price initial public offering to communicate December 6, 2004) discretionary limits, and recordkeeping accurate information to investors and under NASD Rule 3110 and NYSE Rules potential investors in the weeks before • The SEC announced a $2 million 401, 408(d), 410. NASD has set forth the sale. (CRF, November; WR, settlement with a broker-dealer that elements of its new rules, amendments November 1, 2004) allegedly made undisclosed cash © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  7. 7. 4 SOBI Winter 2005 payments to three investment advisers inappropriate sales literature that discussed its reception by the public. in return for encouraging the advisers to included unsubstantiated claims and (CRF, November; WR, October 11, direct their clients’ brokerage business inadequate risk disclosure. (CRF, 2004) to the firm. The SEC initiated and December 2004) • Before the Investment Company subsequently settled related fraud • NASD announced that it exercised, for Institute’s 2004 Equity Markets actions against the advisers. (CRF, the first time, its temporary cease and Conference, Annette L. Nazareth, October; WR, October 4, 2004) desist authority. (CRF, October; WR, Director of the SEC’s Division of Market • NASD censured and fined 18 broker- September 13, 2004) Regulation, spoke primarily about dealers over $1.2 million in connection proposed Regulation NMS and the with findings of widespread trade SEC Agenda substance of comments received reporting violations to NASD’s Order • At the Securities Industry Association’s relative to this rulemaking initiative. Audit Trail System. Multiple firms annual meeting, SEC Chairman William (CRF, October; WR, September 27, were also cited for related supervisory H. Donaldson discussed well-publicized 2004) deficiencies. (CRF, November; WR, industry events of the last year, initiatives undertaken by his agency and • Stephen M. Cutler, Director of the October 11, 2004) the industry to meet the related SEC’s Division of Enforcement, • In a NASD action, a broker-dealer was challenges of the current business delivered a speech entitled “The fined $156,000, ordered to disburse climate, and the corresponding progress Themes of Sarbanes-Oxley as Reflected over $1 million in restitution to made in many areas to date. (CRF, in the Commission’s Enforcement customers, and required to retain an December; WR, November 29, 2004) Program” at the UCLA School of Law. independent consultant and pre-file (CRF, October; WR, September 27, advertising material with NASD for • SEC Chairman Donaldson delivered 2004) one year. The allegations related to remarks before the Annual Conference advertising, markup/down, and of Independent Sector regarding the Regulatory Issues supervisory and other deficiencies. issue of the erosion of investor • NASD’s Mutual Fund Task Force (CRF, November 2004) confidence in the non-profit sector of submitted a report to the SEC con- U.S. business and the corresponding taining its first set of recommendations • NASD fined a broker-dealer $1 million opportunity for independent sector regarding soft dollars and portfolio for allegedly providing misleading institutions to work to restore the trust transaction costs. (CRF, December; WR, information as to the nature of the of donors, the public, and Congress. November 22, 2004) variable life insurance products at (CRF, December; WR, November 29, sales seminars for its agents. (CRF, • The SEC recently published interpretive 2004) December 2004) guidance relative to issues regarding • Remarks by Lori A. Richards, Director of Addendum A of the Global Research • NASD censured and fined a broker- the SEC’s Office of Compliance Analyst Settlement. (CRF, December; dealer $700,000 in connection with Inspections and Examinations, at the WR, November 15, 2004) allegations that it failed to prevent Financial Services Institute’s First market timing in three mutual funds • NASD issued Notice to Members 04-66 Annual Public Policy Day, centered on a offered by an affiliate. The firm was to remind member firms of their discussion of developments in the also cited for related supervisory obligations under NASD supervisory SEC’s examination program. (CRF, failures. (CRF, November; WR, regulations to ensure that their November; WR, October 25, 2004) October 18, 2004) supervisory systems and written • SEC Commissioner Cynthia A. supervisory procedures are adequate to • In the largest enforcement action to Glassman spoke before the Council of ensure the proper entry of orders into date involving hedge fund sales by Institutional Investors on proposed new trading systems. (CRF, October; WR, broker-dealers, NASD fined a firm Regulation National Market System September 20, 2004) $250,000 for allegedly disseminating (NMS) governing market structure, and © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  8. 8. SOBI Winter 2005 5 (Sources: The Federal Register and Web sites of the issuing Statement 123 allowed companies a Issues Relevant to the agencies including:,,,,, choice between the fair value method Financial Services Industry,,,, and and the intrinsic value method. The • The SEC adopted new rules that require revised statement does not specify certain hedge funds to register as To receive KPMG’s regulatory and legislative reports electronically, please send an e-mail what type of valuation model should investment advisers under the message to for any of be used to determine fair value. The Investment Advisers Act of 1940. The the following: classification of a share-based award new rules will also subject these – The Washington Report entities to inspection and examination will affect compensation cost – Regulatory Practice Letters by the SEC, require that registered recognized. Liability-classified awards – Legislative Practice Letters hedge funds adopt basic compliance are remeasured to fair value at each – Compliance & Regulatory Focus controls, and mandate certain balance-sheet date until the award is These reports can also be accessed through disclosures, among other things. KPMG’s Web site at settled. Equity-classified awards are (Financial Services industry). Compliance with the new regulations measured at grant-date fair value and KPMG hosts Regulatory Perspectives, a is expected by February 1, 2006. (CRF, are not subsequently remeasured. The quarterly teleconference briefing for clients October and November; WR, on important legislative and regulatory statement is effective for most public activities specific to the financial services December 12, November 11, and companies’ interim or annual periods industry. For more information about October 25) Regulatory Perspectives, or to register for beginning after June 15, 2005 and is future teleconferences, please send an e-mail effective for nonpublic companies for message to, and • The Government Accountability Office annual periods beginning after include your name, title, company name, and issued a report recommending that e-mail address. You will be notified via e-mail December 15, 2005. regarding future teleconferences. Congress consider improvements to the current U.S. financial services regulatory • Following the issuance of Statement structure, particularly with respect to 123(R), Share-Based Payment, as the oversight of complex, internationally Accounting Standards noted above, the FASB approved the active firms. (CRF, December; WR, and Developments resulting revisions to Statement 133 November 15, 2004) • FASB Statement No. 123(R), Share- (Accounting for Derivative Instruments Based Payment, issued in December and Hedging Activities) Implementation • The SEC extended, until March 31, 2004, sets accounting requirements Issues. The FASB amended Statement 2005, the compliance dates for banks for “share-based” compensation to 133 Implementation Issue No. C3 relative to the temporary exemption employees, including employee stock (Exception Related to Stock-Based from the definition of “broker” under purchase plans. It does not affect the Compensation Arrangements) to clarify the Gramm-Leach-Bliley Act of 1999. accounting for awards to non- that equity-based compensation (CRF, December; WR, November 8, employees nor does it affect the instruments issued to non-employees 2004) accounting for employee stock only receive the scope exception • On December 17, President Bush ownership plan transactions, which provided in paragraph 11(b) of signed the “National Intelligence will still follow SOP 93-6, Employers’ Statement 133 while the instrument Reform Act of 2004” into law. The new Accounting for Employee Stock is subject to the requirements of law is intended to: disrupt the financing Ownership Plans. Awards to non- Statement 123(R). The FASB also of terrorism; strengthen the country’s employee directors, however, do fall noted that Statement 133 anti-money laundering laws; and under the scope of the newly revised Implementation Issue No. G1 (Hedging improve the tools with which the statement. The statement requires an SAR Obligation) was updated to government can stop the flow of companies to recognize as income the reflect the changes in the underlying terrorist funds. (WR, December 20, grant-date fair value of stock options accounting for non-vested stock 2004) and other equity-based compensation appreciation rights (SARs) under issued to employees. Previously, Statement 123(R), and noted that they © 2004 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. 23680NYGR © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  9. 9. 6 SOBI Winter 2005 are still considering the need for consensus in EITF 04-8 would have for the Foreign Earnings Repatriation specific transition guidance or whether coincided with the effective date of a Provision within the American Jobs the current guidance in Statement 133, proposed amendment to FASB Creation Act of 2004,” allows paragraph 31 is sufficient. Additionally, Statement No. 128, Earnings per companies additional time to evaluate the FASB noted that there were no Share. However, at the November whether foreign earnings will be substantive changes to Statement 133 2004 meeting, due to an anticipated repatriated under the repatriation Implementation Issue No. E19, delay in the issuance of that provisions of the new tax law and Methods of Assessing Hedge amendment, the Task Force de-linked requires specified disclosures for Effectiveness When Options Are the effective date of EITF 04-8 from companies needing the additional time Designated as the Hedging the effective date of the proposed to complete the evaluation. Instruments. amendment to Statement 128 and (Source: KPMG’s Defining Issues; FASB Web site) specified that the consensus in EITF • The FASB is reconsidering in its KPMG's Audit Committee Institute 04-8 should be applied for reporting Recognizing the challenge that audit entirety Emerging Issues Task Force periods ending after December 15, committees face in meeting their demanding (EITF) and all other guidance on responsibilities, KPMG created the Audit 2004. Committee Institute (ACI) in 1999 to serve as a disclosing, measuring, and recognizing resource for audit committee members and other-than-temporary impairments of • Corporate accounting for income taxes senior management. Our primary mission is to debt and equity securities. Until new communicate with audit committee members will be affected by the American Jobs and enhance their awareness, commitment, and guidance is issued, companies must Creation Act of 2004, signed into law ability to implement effective audit committee continue to comply with the disclosure during October 2004. The new law processes. ACI's initiatives include semiannual roundtables, publication of Audit Committee requirements of EITF Issue No. 03-1, allows domestic entities to repatriate Quarterly, conference and board presentations, “The Meaning of Other-Than- foreign earnings at a reduced rate, a toll-free hotline, periodic distribution of time- sensitive information, and our Web site. During Temporary Impairment and Its subject to certain limitations. The law’s the past five years, ACI has conducted active Application to Certain Investments,” outreach among thousands of audit committee incentive to repatriate foreign earnings members and we have sponsored hundreds of and all relevant measurement and will affect evaluations of whether workshops, presentations, and issue-oriented recognition requirements in other meetings. some or all of those earnings qualify accounting literature. In September, ACI's Web site address is for Statement 109’s exception from ACI can be reached the FASB delayed the guidance on recognizing deferred tax liabilities. In toll-free at 877-576-4224 or via e-mail at impairment losses under EITF 03-1, but December 2004, the FASB issued two the delay did not include the disclosure Staff Positions on the accounting provisions, which will remain in effect until the full reconsideration of the treatment of the tax change. FSP FAS Taxation 109-1, “Application of FASB Statement EITF 03-1 guidance is completed. • Withholding Taxes Under Internal No. 109, Accounting for Income Taxes, New measurement and recognition Revenue Code Section 1441 to the Tax Deduction on Qualified guidance had been expected to be in Production Activities Provided by the In September of 2004, the IRS place by the end of 2004. However, American Jobs Creation Act of 2004,” announced a new Section 1441 the FASB is expected to present requires companies that qualify for Voluntary Compliance Program (VCP) recommendations on its full the recent tax law’s deduction for under which eligible withholding reconsideration of EITF 03-1 and the domestic production activities to agents may essentially be able to related literature in early 2005. account for the deduction as a special perform a self-evaluation of their • The effective date has been adjusted deduction under Statement 109 and documentation, withholding and for EITF Issue No. 04-8, “The Effect of reduce their tax expense in the period reporting obligations, identify areas of Contingently Convertible Instruments or periods the amounts are deductible noncompliance, and pay any on Diluted Earnings per Share.” on the tax return. FSP FAS 109-2, underwithholding. This VCP is not an Originally, the effective date of the “Accounting and Disclosure Guidance amnesty, but a temporary opportunity © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  10. 10. SOBI Winter 2005 7 for withholding agents to avail which the World Trade Organization domestic reinvestment plan themselves of an attractive alternative had found to be an “illegal trade (“Plan”) approved by company to an IRS audit. Taxpayers have until subsidy.” The key provisions of the management before the funds are December 31, 2005 to file their VCP legislation are highlighted below. repatriated. application with the IRS. – International Tax Reform On January 13, 2005, the Treasury To encourage withholding agents to Department and IRS released an The Act contains significant changes come in under VCP, the IRS has advance copy of Notice 2005-10 to the international tax law regime. announced that it intends to achieve and a Fact Sheet providing 100 percent coverage, whether by o Repatriation of Foreign Earnings guidance on repatriation of foreign traditional IRS audit or voluntary earnings under the Act. According disclosures under VCP, for the top 500 Under section 965 of the Act, to a related Treasury Department Form 1042 filers. The IRS has further certain actual and deemed release, Notice 2005-10 and the indicated that it does not intend to dividends received by a U.S. Fact Sheet are the first in a series impose penalties on those withholding corporation from controlled foreign of notices that will provide agents that come in voluntarily. More- corporations in which it is a U.S. guidance for U.S. companies over, it has also agreed to entertain shareholder, are eligible for an planning to repatriate earnings individual proposals for the allowance 85 percent dividends-received from overseas subsidiaries subject of lower documentation standards deduction (DRD). At the taxpayer’s to the temporary reduced tax rate (i.e., faxed forms, and forms with election, this deduction is available available under the Act. inconsequential errors permissible to for dividends received either: Notice 2005-10 provides detailed support reduced rates of withholding) » During the taxpayer’s last tax guidance regarding the para- as long as the withholding agent year beginning before meters for a Plan and the types of proposes and implements a remedial October 22, 2004 (the date of investments in the United States plan to correct the problem(s) in the enactment); or for which repatriated funds may future. The IRS has indicated that it will be used under this provision. The not afford either benefit to withholding » During the taxpayer’s first tax notice also provides guidance on agents that opt for the traditional IRS year, which begins during the the requirement that the repatri- audit. (IRS Web site, September and one-year period beginning on ation be in the form of a cash October 2004) the date of enactment. dividend. In addition, Notice 2005- The DRD applies only to certain 10 provides guidance on electing • The American Jobs Creation Act of extraordinary repatriations in application of the provision and on 2004 required information reporting excess of the taxpayer’s “average The American Jobs Creation Act of regarding repatriated dividends repatriation level” in recent tax 2004 (Pub. L. No. 108-357, hereinafter and associated U.S. investments, years. Special rules apply for the the Act) that was signed into law by and provides a safe harbor computation of the repatriated the president on October 22, 2004, is mechanism for taxpayers to use amount eligible for the DRD. the culmination of a multiyear effort to in establishing that the Plan resolve a number of controversial tax Section 965 contains several requirement is satisfied. (KPMG’s and international trade issues. Its limitations on the repatriated TaxNewsFlash-United States Nos. primary objective, which has been dividends that are eligible for the 2005-12 and 2005-13) accomplished, was the repeal of the reduced tax rate. One key require- foreign sales corporation regime and ment is that the repatriated funds the repeal of its replacement, the must be invested by the company exclusion for extraterritorial income, in the United States pursuant to a © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  11. 11. 8 SOBI Winter 2005 o Foreign Tax Credits U.S. corporation hold 80 percent o Financial “triggers” based on the or more of the stock of the health of the company are not The Act makes a number of foreign-incorporated entity, the allowed. (Under the Act, plan changes to the foreign tax credit foreign entity is deemed to be triggers are treated as property regime, including: a domestic U.S. corporation for transfers.) » Reducing from nine to two tax purposes. If the entity is Elections of “initial deferral” must be the number of categories 60 percent owned, the top-tier made in the preceding tax year (with (“baskets”) by which income corporation is respected as a a performance-based compensation must be classified foreign corporation, but a number deferral election possible later). of corporate-level “toll charges” » Extending the period of time “Subsequent deferral” elections are imposed upon the over which foreign tax credits cannot be made less than 12 months establishment of the structure. may be carried forward (from 5 prior to the first scheduled payment, years to 10 years), but reducing – Deferred Compensation Rules cannot take effect for 12 months, the carryback period (from 2 Effective in 2005 and must result in a deferral of at years to 1 year) least five additional years. As a result of changes to the tax » Modifying the calculation of the characterization of unfunded These rules also may apply to stock foreign tax credit by permitting deferred compensation under the appreciation rights or discounted deductible interest to be Act, virtually all such plans will need stock options. determined on a worldwide to be examined — and most will In addition, deferred compensation basis and providing a rule that need to be changed — to conform assets in foreign trusts (rabbi trusts) redresses an inequity with to the new rules. When these rules are taxed upon vesting, with the regard to how domestic income become effective in 2005, any exception of assets in foreign following a domestic loss may attempt to defer compensation will jurisdictions where “substantially all” be allocated to enhance the be deemed “ineffective” — and services were performed. Many U.S. foreign tax credit. the deferred element of the taxpayers working overseas and compensation will be immediately o Deferral of Taxation of Foreign- covered under foreign deferred taxable and subject to significant Sourced Income compensation arrangements (even if additional penalties — unless the unfunded) may not be in compliance The Act makes a number of following conditions are met: with these rules. specific, but relatively limited, o Distributions are payable only changes to the regime governing In a taxpayer-friendly provision, the upon an employee’s separation the extent to which the foreign Act specifies that the “spread” upon from service, death, or disability; a earnings of a controlled foreign the exercise of rights under an change in control of the company; corporation are taxed currently in incentive stock option or employee an “unforeseeable emergency”; the United States. stock ownership plan will not or a specific date in the future. constitute wages for employment o Inversions o The timing and schedule of tax purposes. The Act imposes a new tax payments cannot be accelerated – New Disclosure and Penalty regime on companies that (unless in accordance with certain Regimes for Reportable “invert” — i.e., become the sub- regulatory exceptions). Thus, Transactions (Tax Shelters) sidiary of a foreign-incorporated “haircut” provisions and “board entity — after March 4, 2003. If discretion” distributions are Taxpayers should take particular note the former shareholders of the prohibited. of new disclosure and penalty © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR
  12. 12. SOBI Winter 2005 9 regimes that the Act establishes Commissioner can rescind the – Conclusion with respect to reportable penalty for failing to disclose a The American Jobs Creation Act transactions. These provisions — nonlisted reportable transaction of 2004 provides significant which are generally applicable to all but must submit an annual report opportunities for U.S. businesses companies — include the following: to Congress describing each to improve their tax positions. At penalty and explaining why it was o Disclosure of Reportable the same time, however, it presents rescinded. Transactions a host of new hurdles and risks, SEC reporting companies must including stricter reporting require- The Act imposes a strict liability inform shareholders, via their SEC ments, increased penalties, and, penalty for the failure to disclose filing, in the event that this penalty potentially, new tax costs. In addition “listed transactions.” It also is imposed on the company for to the provisions highlighted in this imposes a penalty on nonlisted failure to disclose a listed executive brief, the Act affects a reportable transactions. Nonlisted transaction. broad spectrum of business reportable transactions include activities, transactions, and entities. those that: o Understatements Businesses, tax professionals, regu- » Result in certain large losses or lators, lawmakers, and third parties The Act created a new accuracy- book/tax differences in excess will have to devote significant time related penalty for listed trans- of $10 million per year; and resources to analyzing this new actions, and other reportable law to gain a better understanding » Are offered under conditions of transactions if a significant of the implications of the Act and confidentiality; purpose of the other reportable provisions that are pertinent to their transaction is the avoidance or interests. (The American Jobs » Are subject to contingent fee evasion of federal income tax Creation Act of 2004 unless arrangements or refunds if the (reportable avoidance transaction). otherwise stated above) intended tax results are not This penalty affects returns for tax achieved; years ending after October 22, • IRS Administrative Procedures for 2004. Automatic Consent to Change » Result in tax credits (including Method of Accounting Under foreign tax credits) in excess of The understatement penalty is "INDOPCO Regulations" for Second $250,000 when the taxpayer 20 percent in the case of Tax Year Ending After 2003 has held the underlying asset disclosed listed or reportable for less than 45 days. On December 13, 2004, the IRS avoidance transactions and 30 per- cent if the transaction was not released an advance copy of Rev. Proc. The penalty is $50,000 ($10,000 disclosed. The 20 percent penalty 2005-9, that sets forth the exclusive for a natural person) with respect may be mitigated in the case of administrative procedures that a to nonlisted reportable trans- taxpayer must use to obtain automatic actions, and $200,000 ($100,000 disclosed transactions by consent to change its method of for a natural person) with respect “reasonable cause” (although an accounting for the second tax year to listed transactions. This penalty opinion from a disqualified tax ending on or after 2003, under the regime, which affects tax returns adviser cannot be used to final section 263(a) regulations on and statements due after establish reasonable cause). capitalizing costs incurred in acquiring October 22, 2004, applies solely Companies that are penalized at or creating intangible assets. (KPMG’s to the issue of nondisclosure; it is the 30 percent rate under this TaxNewsFlash-United States, No. not in lieu of other penalties and is provision must disclose the action 2004-303) applicable even if the taxpayer in their SEC filing. An additional prevails on the underlying merits $200,000 penalty may be imposed of the position. However, the for failure to do so. © 2005 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Printed in the U.S.A. A13954NYGR