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A bank filed a second-tier appeal with the ombudsman regarding the appropriate accounting and legal treatment of certain intercompany transactions, sometimes referred to as "round trip dividends." The transactions represent a series of substantially simultaneous events between the bank and its parent companies in accordance with a preexisting regulatory commitment. The transactions facilitate amortization of a note payable from a subsidiary corporation to the parent holding company. The parent holding company owns 100 percent of the subsidiary corporation, which owns 100 percent of the bank. At issue was whether the funds could be returned to the bank as undivided profits or as surplus and whether they reduce the bank's dividend-paying capacity under 12 USC 56 and 60.
Bank management questioned whether the bank should treat each intercompany transfer as a separate payment or whether it could view the payments together at their net amount. In the latter case, the substance of the transaction would be a nonevent for accounting purposes, and thus, for legal dividend purposes as well. The OCC agreed to allow the bank to treat future payment as a net transaction for accounting and legal purposes under the following conditions:
The statute (12 USC 60(b)) requires a national bank to obtain prior OCC approval if the total of all dividends declared in any one calendar year exceeds the total of its net income of that year plus the retained net income (net income less dividends) for the preceding two years. The legislative history of the statute indicates that its intent was to protect the capital of national banks. It provides the OCC with a legal mechanism to prevent national banks from dissipating their capital through dividend payment.
Bank management claims they never considered these intercompany payments to be dividends. In order to provide the fullest possible disclosure of intercompany transactions to their regulators, the bank reported the payments from the bank as cash dividends and their return to the bank as "other transactions with parent holding company." In reality, however, these transactions constituted a series of substantially simultaneous events fully in accord with a preexisting regulatory commitment. Consequently, the capital accounts on the bank's book are not affected.
Generally accepted accounting principles do not specifically address the treatment of these intercompany payments. The Financial Accounting Standards Board's "Statements of Concepts," however, give preference to economic substance over legal form. The bank's external accountants, a "big six" accounting firm, provided a letter stating that the substances and economics of the transactions should be viewed together as a nonevent for accounting purposes. The related transactions, therefore, should be accounted for on a net basis without affecting the bank's undivided profits account.
In this case, the accounting largely drives the legal question regarding the applicability of 12 USC 60. If the intercompany payments are not dividends, the dividend statutes do not apply.
The ombudsman concurs with the chief national bank examiners that future payments and receipts of the same amounts made under the escrow arrangement represents a net transaction for accounting and legal purposes. These payments do not meet the basic elements of a dividend payment in that the funds effectively do not leave the bank. From a safety and soundness perspective, the ombudsman believes the escrow arrangement provides a reasonable safeguard against the potential dissipation of bank capital.
The ombudsman also concurs with the chief national bank examiner that the previous intercompany payments made before the bank established the escrow arrangement should normally be treated as dividends. The proper handling would have been to use the escrow arrangement for these payments. In this rather unusual case, however, the ombudsman is willing to allow these historical payments to be treated as a net transaction for accounting and legal purposes. The ombudsman bases this exception on four primary factors: 1) the bank's initial perspective that these payments did not represent dividends in the normal sense of the term; 2) the economic substances of the transaction; 3) the bank's demonstration that the parent companies immediately returned the funds to the bank according to plan; and 4) the existence of a formal commitment to ensure return of the payments. Also, because of the unusual nature of these transactions, the bank was unaware of the necessity of the escrow arrangements and acted in good faith to accomplish the objective of not dissipating the bank's capital. The ombudsman granted this exception on the condition that the banks amend previously filed call reports that reflected these payments as dividends, if significant in amount.
