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Treasury Outlines Overhaul Proposal

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The Obama administration’s plans to seek authority to take over troubled non-bank financial services companies create “tremendous concerns” for the state regulatory and guaranty fund system, an industry lawyer said today.

The administration is expected to give details about the plans Thursday, when Treasury Secretary Timothy Geithner testifies before the House Financial Services Committee.

After reviewing an outline of the plans released today by the U.S. Treasury Department, Francine Semaya, a lawyer in the New York office of Nelson Levin de Luca & Horst L.L.C., said the proposal likely would give the federal government the authority to regulate the underlying operating insurance subsidiaries of a troubled insurance holding company.

“It is hard to tell from the outline if they plan to regulate only the holding company of a troubled insurance company, or the underlying insurance assets as well,” Semaya says.

“If they do seek authority that will give them the power to deal with the underlying insurance subsidiaries, this bill would be an attempt to usurp the current state receivership and guaranty fund system,” says Semaya, who is president of the International Association of Insurance Receivers, New York.

Under the Obama administration proposal, she says, the new resolving authority, likely the Federal Deposit Insurance Corp., would have the authority to sell assets, terminate contracts and regulate the underlying state-insurance regulated entities.

Under current law, the holding company of an insolvent insurance company comes under the authority of the federal bankruptcy court system, while the underlying insurance company subsidiaries are dealt with through the state receivership and guaranty fund system.

Semaya says her interpretation of the Obama administration proposal is that it would supersede the federal bankruptcy code in resolving the parent company of a insurance holding company system, giving a federal agency authority over the underlying insurance subs.

The trustee of the conservatorship or receivership would have broad powers, including the authority to sell or transfer the assets or liabilities of the institution in question, to renegotiate or repudiate the institution’s contracts (including with its employees), and to deal with a derivatives book, according to the Treasury Department outline.

Treasury officials say in the outline that the conservator also would have the power to fundamentally restructure an institution by, for example, replacing its board of directors and its senior officers.

“None of these actions would be subject to the approval of the institution’s creditors or other stakeholders,” officials say.

The federal agency with resolving authority could act if the financial institution in question were “in danger of becoming insolvent”; its insolvency “would have serious adverse effects on economic conditions or financial stability in the United States”; and taking emergency action “as provided for in the law would avoid or mitigate those adverse effects,” officials say in the outline.

Geithner testified Tuesday before the House Financial Services Committee that there would be limits on the ability of the Treasury secretary to order that a non-bank entity, such as an insurance holding company, be placed in conservatorship or receivership.

The secretary would act “upon the positive recommendations of both the Federal Reserve Board and the appropriate federal regulatory agency and in consultation with the president,” Geithner testified.

A copy of the Treasury outline is available here.