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388
BOARD OF GOVERNORS
OF THE
X•9539
FEDERAL RESERVE SYSTEM
WASHINGTON
ADDRESS OFFII;:IAL CORRESPONDENCE
TO THE BOARD
April 4, 1956.
SUBJECT:
Interpretation of Comptroller's
Regulation re Investment Securities.
Dear Sir:
There are inclosed herewith a cop,y of a letter dated Februar,y 28, 1956, from the President of the Federal Reserve Bank of New
York, a copy of a letter dated March 2, 1956, from the Assistant
Federal Reserve Agent at Cleveland, and a
COP.Y
of a telegram dated
March 6, 1956, from the Assistant Federal Reserve Agent at San Francisco, each of which presents certain questions arising under the
provisions of the regulation of the Comptroller of the Currency governing the purchase of investment securities.
Copies of these inquiries were referred to the Comptroller
for a statement of his views concerning the questions presented
therein.
There are inclosed herewith copies of the Comptroller's
replies and of the Board's letters to the President of the Federal
Reserve Bank of New York, to the Federal Reserve Agent at Cleveland,
and to the Assistant Federal Reserve Agent at San Francisco, inclosing copies of such replies.
Very truly yours,
Chester Morrill,
Secretar,y.
Inclosures.
http://fraser.stlouisfed.org/ ALL FEDERAL
TO
Federal Reserve Bank of St. Louis
RES.:!>RVE AGENTS.
389
COPY
FEDERAL RESERVE BANK
OF NEW YORK
X-9559-a
February 28, 1956.
Dear Governor Broderick:
Referring to my conversation over the telephone yesterday,
there appears to be some confusion among member banks as to the interpretation and effect of the "Regulations Governing the Purchase of
Investment Securities, and Further Defining the Term 'Investment Securities' as Used in Section 5156 of the Re:vised Statutes as Amended
by the 'Banking Act of 1955 1 ", promulgated by the Comptroller of the
Currency on February 15, 1956. We received copies of these regulations from the Board on F'ebruary 26, 1956, and in accordance with the
Board's request on that day we mailed copies to all State member
banks in this district, copies having previously been sent to all
national banks by the Comptroller of the Currency.
Judging from the inquiries which we have received, the confusion in regard to these regulations relates principally to the
following points:
1. ~fuether the regulations prohibit the purchase by
member banks of certain municipal obligations which are not
readily "market.:'lble" as that term is defined in the regulations.
2. ~fuether member banks may continue to hold securities which were purchased prior to thc:3 issuance of the
present regulations and which do not meet the test of "investment socurities 11 as laid down in such regulations, but
which the banks were permitted to acquire under the terms
of the regulations in effect at the time of purchase.
5. v1:hether or not the ratings of securitios by recognized rating manuals conclusively· establish the sto.tus of
securities as bGing, or not being, securities "in which the
investment cha.racteristics are distinctly or predominantly
speculative" within tho meaning of subdivision (:3) of Section
II of the regulations; and, if so, at what point in such
scale of ratings are securities to be conclusively deemed to
be "distinctly or predominantly speculative"-, or, ln other
words, how many of the highest grades of securities as so
rated may be considE~red not to be "distinctly or predominantly
·speculative", The section in question, and the footnote
thereto, read as follows:
3BO
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X-9539-a
"(3) The purchase of 1 investmEmt securities' in
which the investment chal:'actoristics are distinctly
or predominantly speculative, or 'investment securities'
of a lower designated standctrd than those which are
distinctly or predominantly speculative, is prohibi ted.-l~
The purchase of securities which are in default, either
as to principal or intorest, is also prohibited.
~'t
The terms employed herein· may be found in
recognized rating manuals, and where there
is doUbt as to the eligibility of a security for pttrchase, such eligibility must be
supported by not less than two rating
manuals."
4. Whether all so-called "convertible" bonds are ineligible for purchasE;. by member banks by reason of subdivision (5) of Soction II which reads: "Purchase of securities
convertible into stock at tho option of the issuer is
prohibited."
It would be helpful if these points could be clarified and
I am therefore calling the ~atter to your attention in the hope that
it may be possible to discuss these questions with tho Comptroller's
office with a view to such clarification.
With respect to the first point, it is our understanding
that as a matter of law neither Section 5156 of the Revised Statutes,
nor ru1y regulation of the Comptroller issued thereunder, can apply
to "general obligations of any state or of ar..y political subdivision
thereof", which would include most municipal securities.
With res·pect to the second point, it is our understanding
that while the present regulations are silent on the question, they
do not in fact prohibit a member bank from holding securities which
the bank purchased prior to the issuance of such regulations and
which the bank was permitted to acquire under the terms of the
regulations in effect ct tho time of purchase.
With respect to the third point, we question the advisability of making the manual ratings the conclusive test of whether
or not securities are "distinctly or predominantly" speculative.
'l'his is particularly true in the case of new issues which have not
yet received ratings and which arc often offered to banks on the
original issue at a few points below the retail price. Many of
these new issues mo.y be entirely sound, and we believe the bank
officers should be permitted to exercise their discretion in the
391
X-9539-a
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purchase of them when they are honestly believed to be sound investments and otherwise comply with the legal requirements. If, however,
it is the Comptroller's purpose to make manual ratings the conclusive
test, it would seem to us that the regulations should be more definite as to which grades include, or may include, eligible securities
and which are necessarily considered ineligible as speculative. We
construe the regulations as now drawn as permitting the purchase of
securities in any of the four highest grades, since the definitions
in the manuals of the fourth highest grade, that is, the highest of
the three grades in the B group, indicate that in general the· securities included therein are in the investment class, although in some
instances having speculative elements. It appears that there has
been considerable confusion on this point, however, as we understand
that conflicting views have been expressed as to whether the securities eligible for purchase under the terms of the regulations as now
drawn are limited to the three or fol~ highest grades.
With respect to the fourth point, subdivision (5) of Section II in terms prohibits the purchase only of securities convertible
into stock "at the option of the issuer" and would not appear to apply to securities convertible only at the option of the holder. Most,
if not all, of what are commonly referred to as "convertible" bonds,
are comrerti ble only at the option of the holder. These undoubtedly
include some entirely sound issues which can be purchased on an investment yield basis without paying any substantial premium for the
conversion pri~iloge.
Very truly yours,
(Signed)
George L. Harrison
George L. Harrison,
Governor.
Hon. Joseph A. Broderick,
Board of Governors of the
Federal Reserve System,
Washington, D. C.
FEDERAL RESERVE BANK
X-9559-b
OF CLEVELAND
March 2, 1936.
Board of Governors of the
Federal Reserve System,
Washington, D. c.
Gentlemen:
In order that we may make prompt and accurate replies to
concerning the interpretation of the Comptroller's regulation dated February 15, 1956, governing the purchase of investment
securities and further defining the term "investment securities" as
used in section 5136 of the Revised Statutes, as amended, we should
appreciate it if our understanding of the following items is confirmed.
inqu~nes
(l)
That investment securities lawfully acquired prior to February 15, 1936, need not be disposed of if such obligations do not
conform to terms of the regulation made effective as of that date.
(2)
That under the Moody classification bonds rated Baa, defined as those "in which speculative elements begin distinctly to
appear," may lawfully be purchased since they may scarcely be classed
as investments whose characteristics are "distinctly or predominantly
speculative".
(3)
Under the Standard Statistics classification, bonds rated
B, which are classed as "semi-speculative" are in the twilight zone,
their eligibility for purchase being dependent upon the degree to which
speculative elements appear.
(4)
In Fitch's ratings it is our impression that bonds rated
to and including BB may be regarded as proper investments under tho
terms of the regulation.
(5)
Under the Poor classification it is our impression that all
bonds rated to and including B* meet the requirements of the regulation.
It is assumed in all cases that bonds are otherwise legally
purchasable.
Very truly yours,
(Signed)
J. B, Anderson
Assistant Federal Reserve Agent.
393
X-9539-c
FEDERAL RESERVE SYSTEM
TELEGRAM
265gc
San Francisco Mar 6 338p
Board
Washn
Reference is made to the Comptrollers regulations Governing the purchase of investment securities referred to in the Board's telegram
No. 2379.
Some State bank members have informed us that prior to
receiving the subject regulations they had invested in some instances
in non excepted bonds in amounts permitted under State law but in axcess of limit prescribed under Section 5136, and wish to be advised
whether, in the circumstances, immediate reduction to conform to the
provisions of said Section and regulations will be required.
It would
seem equitable that if reductions are to be req11irod, an orderly liquidation to avoid loss to the bank should be permitted.
The Board's
advice as to requirements and policy to be followed in the circumstances
will be appreciated
Sargent
649p
394
X-9539-d
TREASURY DEPAR'rMEHT
Comptroller of the Currency
Wra.sh.l.ngton
March 18, 1936.
Board of Governors,
Federal Reserve System,
V/ashington, D. C.
Dear Sir:
Reference is had to yours of March 5, enclosing a
copy of a letter received by you from the Governor of the
Federal Reserve Bank of New York, dated February 28, 1936,
presenting various questions rising under the regulations
issued b:.r this office February 15, 1956, ,;overninb the purchase of investment securities.
With respect to the questions raised, our position
is as follows:
(1) The regulations do not prohibit the purchase
by Member Banks of municipal oblig&tions which are not readily
"marketable" as defined by the regulations, i.f such municipal
obligations are in fact "ge:n£:ral oblig~.tions" as uistine:,>Uishcd from limited or special obligations, and further provided
that such ob.Ligations are in fact obligations of L'- "political
subdivision" of the State. This question sometimes becomes
important, as, for example, bond issues for the improvement
of a municipal electric light plant, whelre the issue is not
by its terms an obligation of the municipal1ty but some unit,
board or entity within the municipality.
It '\ilrill be understood that even thou.::h a "municipal"
obligation is not a "general obligation" an<i HVen though the
entity issuing it is not a political subaivision of the State,
such obligation may still be e1igiblu for investment provided
it meets with all the requiroments of th6 regulations.
(2) The regulations do not rc-:quiro th0 banks to
dispose of securities which are nevi inoligiblG uncer the present
regt.llations but which 'Nere purchased 1
;rior to the issuanc0 of
the regulations, if th0y were otherwise lawfully acquire<i at
the time of thoir purchase.
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X-9559-d
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(5) On the question as to -;>hether or not eligibility
from a non-speculative standpoint under the re~ulations is to
be conclusively determined by the ratings of rating manuals,
we have dealt with this question at length in a separate communication of this date addressed to you, in reply to an inquiry submitted by the Assistant Federal Reserve Agent at Cleveland. Governor Harrison does reise one point not discussed in
the above referred to separate comrrmnication, namely: the fact
that now issues which have not yet received rc.tings are often
offered to the banks, which issues are entirely sound; the
query being whether or not absence of a rating in such·cases
would operate to prevent the acquisition of such securities.
The absence of a rating in no inst~nce is conclusive
and if any issue of securities otherwise meets the requirements
of the regulations, and if its investment characteristics are
not distinctly or predominately speculative, as judged by
whatever means are available for determining such question,
then the purchase of such a security would be permissible.
(4) With regard to the provision "Purchase of
securities convertible into stock at the option of the issuer
is prohibited", it was not intended that such provision should
operate to prohibit th<:J purchase of securities convertible only
at the option of the holder.
Very truly yours,
(Signed)
J. F. T. O'Connor
J. F. T. O'CONNOR,
Comptroller.
•
396
X-9559-e!
ThEASURY LEPMiTMENT
Comptroller of the Currency
Washington
March 18, 1936.
Board of Governors,
Federal Reserve System,
Washington, D. c.
Dear Sirs:
This acknowledges yours of Harch 10, enclosing a copy of
a letter dated March 2, 1936, received by you from the Assistant
Federal Reserve Agent at Cleveland, ru1d a copy of a telegram dated
March 6, 1956, from the Assistant Federal Reserve Agent at San
Francisco, both of which raise certain questions of interpretation
under the regulations recently issued by this office relative to
investment securities.
As respects the letter from the Assistant F'edoral Reserve
Agent at Cleveland, the questions ra:i.sed therein are as follows:
(l) Vihether or not ~i.nvestment securities lawfully acquired prior to February 15, 1936, need to b~ disposnG. of if such
obligations do not conform to the ter;as of the re£;ulations.
If the investment :::;ccuri tit~s \Wre lawfull.z acquired prior
to the issuance of the rcgulatiom~, there is no obll~;ation under the
regulations to dispose of sc:cmc.
Unaor questions (2), (5), (4) and (5) the inquiry is made
as to 'Nhether bonds classified unci.er Certain rating symbols by the
various rating services are to be considered as within tho eligible
classification defined in Section II (5) of the rt:gul&tions.
This office has had nu:nc;rous inquiries of a similar nature
from banks and from the public, ann ;·ie have consi6tently rcfraim~d
from specifically advising "ihether or not a security under n specific
rating classification of a specific rating service is oli~Sible. This
position has boon taken for the reason that such information may
operate to C[tusc thosu responsible for ·the investmt:;nts of the bank to
assume that their responsibility hGs been borne <vhen they determine
that n particular security fall~; v;ithin L sp.:.::cific rating cla;3Bificntion, with the result th[it the jud;;:,mcnt of the r;:~ting service eupplants
397
X-9559-e
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the responsibHities of those primarily charged with properly investing the bank funds. Furthermore, .it is not possible to araw a definite line that would operate satisfactorily in t..he case of all rated
securities. In individual cases a security of a :eating one class belmv what would be gen:.;ralLy considered satisfactor;;; might for particular reasons still. bE: eligible, uno vice versa.
It was intended that reference t.o the~ ratin; manuals ;as
not to be the excludvl; guide; on tlw quec;ti~m of o1i.:;ibi1it:r but that
the usc of such manuals was to be porinissible a:::: r.:..n aid in determining
eligibility, particularly in the case of banks ~hich do not have the
facilities for making an indepen<.ient investigation of the: history and
prospects of an issuer.
You will appreciate from the foregoinc considerations that
we cannot s.t~ate that. a security havin.; a :::\pecific rating is necessarily viithin the eligible class.
The question raised by telegram from ;{our Assistant Federal Reserve Agent at San Francisco involves a situation v~here the
State banks, prior to receiv..;.ng the regu.l.ations, ha<i invested in nonexcepted bonds in amounts permit te<i under StL te 1r~.\. but in excess of
the limit prescribed undor .Section 51:-56, ana thE C.(Uestion i~3 ruisod
as 7,o ·.:hether l.n the circumstances immediate; re<iuction to conform to
the limitations will. be required, i.t being sug,;ested that if reductions are to be required, an orderly liquidation :o avoici loss to the
bank shoul<i be permitted.
Inasmuch as the limitations as to ~Jmount pr<;;scribed ln
Section 5156 of the Revised Statutes nere macie effective as to State
f;lemLer Banks by the Banking Act of 1933, as of June l6, 19;)5, the
limitations }lrescribed by Section 5136 as amended from time to time
naturally operated from that date. Cons<;quently, securities purchased in excess of the J.imi tations subst:)c:uerrt to June 16, 1933, by
the State !Vldnber Banks were helC:. in violation of l&w independent of
our regulations, and it would S<.'em to follow that such hol~C.~in;ss should
be reduced in conformity to the li:~;itations. 1\s to ·,hether or not
such reduction must be immc:diato Ol· .,.;radual in orc.~cr to avoi.d loss,
that is a matter of policy, und as resp;:cts Nationc.l Lanks >hich may
have excess holdings of securities, tl [;radual .liqui<. <ation in most
cases would be ~::;ermissiblc if immediate liquidation ·Nou1<i involve loss
to the bank.
Very tru.Ly yours,
~.
.
( ::,~gm;ct )
J. F. T. O'Connor
J. F. T.
O'CON~OR,
Comptroller,
COPY
X-9539-f
April 4, 1936.
Mr. George L, Harrison, President,
Federal Reserve Bank of New York,
New York, New York.
Dear Mr. Harrison:
This refers to your letter to Mr. Broderick
dated February 28, 1956, regarding the interpretation of the
regulation issued under the provisions of section 5136 of the
Revised Statutes by the Comptroller of the Currency, governing the purchase of investment securities.
Your letter was referred to the Comptroller
for an expression of his views upon the questions presented
therein. There is inclosed herewith a copy of a reply from
the Comptroller, which was received by the Board on March 25,
1936, setting forth his views concerning the questions presented in your letter.
A copy of the letter referred to in paragraph
numbered (5) of the Comptroller's letter is also inclosed
herewith.
Very truly yours,
(Signed) Chester Morrill
Chester Morrill,
Secretary.
Inclosures
3S9
COPY
X-9539-g
April 4, 1936
Mr. E. S. Burke, Jr.,
Federal Reserve Agent,
Federal Reserve Bank of Cleveland,
Cleveland, Ohio.
Dear Mr. Burke:
This refers to Mr. Anderson's letter of March 2,
1936, presenting certain questions concerning the interpretation of the Comptroller1s regulation governing the purchase
of investment securities which was promulgated under the authority of section 5136 of the Revised Statutes.
A copy of Mr. Anderson's letter together with a copy
of a telegram from the Assistant Federal Reserve Agent at
San Francisco was submitted to the Comptroller of the Currency with a request for an expression of his views thereon.
A copy of the Comptroller's reply, which was received
by the Board on March 25, 1936, is inclosed herewith.
Very truly yours,
(Signed) Chester Morrill
Chester Morrill,
Secretary.
Inclosuru.
COPY
X-9539-h
April 4, 1936.
Mr. S. G. Sargent,
Assistant Federal Reserve Agent,
Federal Reserve Bank of San Francisco,
San Francisco, California.
Dear Mr. Sargent;
This refers to your telegram dated March 6, 1956, presenting
a question regarding the interpretation of the Comptroller's regulation
governing the purchase of investment securities which was promulgated
under the authority of section 5136 of the Revised Statutes.
A copy of your telegram, together with a copy of a letter from
the Assistant Federal Reserve Agent at Cleveland, was submitted to the
Comptroller of the Currency with a request for an expression of his views
thereon. There is inclosed herewith a copy of the Comptroller's reply,
which was received by the Board on March 25, 1936.
It will be observed that the Comptroller has stated that, in
the case of national banks which hold securities in excess of the limitations prescribed by section 5136, a gradual liquidation in most cases
would be permissible if immediate liquidation would involve loss to the
bank.
Likewise, it is the viev; of the Board that, in cases of the
kind described in your telegram where a State member bank holds investment securities in excess of the limitations prescribed by section 5136,
a gradual liquidation is permissible if immediate liquidation would
involve loss to the bank.
Inclosure.
Very truly yours,
(Signed) Chester Morrill
Chester Morrill,
Secretary.
400
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