In the last issue of the Financial Services Regulatory Report, we addressed the concern that, despite the issuance by the FFIEC of Y2K guidance for the last two years, many bank Y2K compliance efforts have been inadequate or non-existent (see "Y2K Compliance Examinations: Are You Ready for Your Regulator?" Vol. 5 No. 6). Specifically, we reported on the assertive guidance issued by the FFIEC on October 15, 1998, "Interagency Guidelines Establishing Year 2000 Standards for Safety and Soundness" (the "October Guidelines"), which contains the first specific discussion of regulatory enforcement actions that might be taken in response to inadequate Y2K preparations, including the requirement that an institution submit an acceptable compliance plan to its regulator.

As forewarned, the Federal Reserve Board ("FRB") has now issued releases detailing the strict supervisory requirements the FRB has imposed on two of its state member banks. While each bank's situation is unique, these two recent enforcement actions provide some general lessons for all banks.

On December 14, 1998, the FRB issued a Cease and Desist Order ("Order") against the Zia New Mexico Bank in Tucumcari, New Mexico ("Zia Bank"). The Order focused exclusively on Y2K concerns, and stated that it was issued in recognition of the common goal of the FRB and Zia Bank to "maintain the integrity of the records and information systems" of Zia Bank, and to "ensure that all mission-critical systems of the Bank will continue to be fully functional before, on, and after January 1, 2000...." The Order focused on three general areas of Y2K concern, including mission critical systems, business resumption contingency planning, and the compliance responsibilities of the Zia Bank board.

  1. Mission Critical Systems. With respect to ensuring that internal and external mission critical systems are Y2K compliant, Zia Bank was ordered to take the following actions:
    1. To appoint a senior manager, acceptable to the regional Federal Reserve Bank ("Reserve Bank") and accountable to the board of directors, who will oversee the Bank's Y2K readiness efforts.
    2. To identify and allocate financial and other resources necessary to achieve Y2K compliance.
    3. To submit to the Reserve Bank an acceptable plan for the renovation of all internal and external mission-critical systems.
    4. To submit to the Reserve Bank acceptable test plans for all renovated or modified internal and external mission-critical systems.
    5. To (i) identify all customers (including funds takers and funds providers) that represent "material risk" to Zia Bank, (ii) evaluate the Y2K preparedness of such customers, (iii) assess the existing and potential Y2K risk to Zia Bank by such customers, and (iv) implement appropriate risk controls to manage and mitigate such risk.
    6. To submit to the Reserve Bank an acceptable remediation contingency plan that describes how Zia Bank will mitigate the risks associated with failure to complete successfully its renovation, testing, and implementation of internal and external mission-critical systems.
  2. Business Resumption Contingency Planning. With respect to ensuring that Zia Bank has created an adequate business resumption contingency plan ("Contingency Plan"), and has the ability to execute the Contingency Plan, Zia Bank was ordered to complete the following measures:
          1. To designate a senior manager, acceptable to the Reserve Bank and accountable to the board of directors, who will be responsible for supervising the creation and execution of the Contingency Plan.
          2. To submit to the Reserve Bank an acceptable written program for the development of the Contingency Plan to mitigate operational risks that may be caused by failures of Zia Bank's core business processes. The program must, at minimum, include and address the following four phases of the planning process and provide for the periodic update of the plan as necessary:
                  1. the establishment of organizational planning guidelines that define Zia Bank's business continuity planning strategy;
                  2. the development of a business impact analysis to assess the potential impact of mission-critical system failures on Zia Bank's core business processes;
                  3. the identification of circumstances and trigger dates under which the business resumption contingency plan will be activated; and iv. the establishment of a method of validating the plan for effectiveness and viability.
  3. Board Monitoring and Approval. To ensure adequate managerial oversight, the Order requires the Zia Bank board of the directors to meet at least once every two weeks to review and monitor Zia Bank's Y2K compliance efforts. Minutes of the board meetings which detail the Y2K compliance efforts must be submitted to the Reserve Bank.
  4. Monthly Status Reports. Zia Bank is required to provide the Reserve Bank with written progress reports, "detailing the form and manner of all actions taken to secure compliance," within five days after the end of each month.
  5. Reserve Bank Approval. Any plans or programs required by the Order are required to be pre-approved by the Reserve Bank. The Zia Bank board is required to adopt formally all approved plans within 10 days of such approval.

    6. On December 22, 1998, similar requirements were imposed by the FRB as part of a written agreement ("Agreement") with Adairsville Bancshares, Inc. of Adairsville, Georgia, a registered bank holding company, the Bank of Adairsville, Adairsville, Georgia ("Adairsville"), the Federal Reserve Bank of Atlanta (the "Reserve Bank") and the Banking Commissioner of the State of Georgia (the "Commissioner"). The Agreement with Adairsville was broader than the Order issued to Zia Bank and addressed other safety and soundness concerns in addition to Y2K matters. Nonetheless, the Y2K-specific requirements imposed on Adairsville under the Agreement were similar to those imposed on Zia Bank.

    As evidenced by the situations of Zia Bank and Adairsville, but no surprise to readers of the Financial Services Regulatory Report, the areas of particular FRB concern include:

            1. the identification of all internal and external mission critical systems;
            2. the creation of adequate remediation and business resumption contingency plans;
            3. the identification of material customers that pose "material" risk to the institution; and
            4. appropriate monitoring of Y2K compliance efforts by both the bank board and appropriate regulator.

In response, the FRB is requiring institutions that are behind in their Y2K efforts to accomplish several tasks under strict time deadlines:

  1. Appoint a senior manager with responsibility for supervising Y2K readiness efforts who shall have the power to appoint any additional staff necessary to achieve Y2K readiness. This person must be directly answerable to the bank board and appropriate regulator. [Note that in the case of Adairsville, the FRB required the hiring of an independent consultant to assist with the bank's efforts.]
  2. Commit to allocating whatever financial resources are necessary to achieve Y2K compliance.
  3. Submit mission critical testing plans, renovation plans, remediation contingency plans, and business resumption contingency plans to the appropriate regulator for preapproval before implementation.
  4. Identify all material customers and corresponding material risk posed by such customers to the bank.
  5. Appoint a senior manager with responsibility for supervising the creation and execution of the business resumption contingency plan who shall have the power to appoint any additional staff necessary to prepare and execute the plan. This person must be directly answerable to the bank board and appropriate regulator.

In addition, bank boards are being required to meet every two weeks and progress reports must be generated every month for submission to the appropriate regulatory bodies.

With only eleven months remaining, banks which have not been closely following FFIEC guidance may be unable to avoid similar regulatory criticisms and strict regulatory oversight. By now, regulated banks should have contingency plans in place for all core business functions and mission-critical systems, complete with trigger dates for implementing alternative solutions. Contingency plans must contain (i) a business risk assessment that identifies potential disruptions and the effects of such disruptions on the bank's business operations, (ii) the minimum acceptable level of outputs and services, (iii) an analysis of strategies and resources available to restore a system or business operations, and (iv) a recovery program that identifies resources (financial, human, and equipment, both external and internal) necessary for the institution to function at an adequate level.

As the situations of Zia Bank and Adairsville demonstrate, it is clear that the agencies are taking an increasingly strict position on Y2K matters. In light of the fact that the final Y2K examination for all regulated financial institutions will occur no later than mid-1999, the Fed's most recent releases likely represent only the beginning of similar supervisory actions specific to Y2K. Accordingly, it is critical for banks to prepare their strategy for pending regulatory examinations in order to demonstrate satisfactory Y2K progress. Those banks forced to work towards Y2K compliance under the watchful eye of their supervisor will face an increased likelihood of being subject to further, harsher enforcement actions, which may include cease and desist orders, civil money penalties, and ultimately, a forced sale.

Prepared by Joseph E. Yesutis, Esq. of the Washington, D.C. Office

This article was first published in the December/January 1999 Issue of Mayer, Brown & Platt's Financial Services Regulatory Report. The Financial Services Regulatory Report is edited by Melody A. Chestnut of the Washington, DC Office

Copyright © 1999 Mayer, Brown & Platt. This Mayer, Brown & Platt article provides information and comments on legal issues and developments of interest to our clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.