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federal reserve

Bank

of

Dallas

DALLAS, TEXAS 75222

Circular No. 81-117
June 11, 1981

POLICY STATEMENT
Sale of Third Party Commercial Paper

TO ALL MEMBER BANKS IN THE
ELEVENTH FEDERAL RESERVE DISTRICT:
The Board of Governors of the Federal Reserve System has adopted
a policy statem ent setting forth guidelines governing the sale by a sta te member
bank of commercial paper of issuers not related to the bank ("third party com­
mercial paper").
The guidelines concern the type and amount of commercial
paper that should be sold, the kind of records that should be maintained, and
the purchasers to which such paper may be sold.
Although the policy statem ent is effective immediately, interested
parties are encouraged to submit comments, for Board review, by July 31, 1981.
Comments should refer to Docket No. R-0360 and should be mailed to the Sec­
retary, Board of Governors of the Federal Reserve System, 20th and Constitution
Avenue, N.W., Washington, D.C. 20551.
Printed on the following pages are copies of the Board's press re­
lease and the material submitted for publication in the Federal Register. These
pages more fully explain the Board's action.
Any questions concerning the policy statem ent should be directed to
Marvin C. McCoy, Ext. 6657, or Earl Anderson, Ext. 6275, of this Bank's Bank
Supervision and Regulations Department.
Sincerely yours,
William H. Wallace
First Vice President

Banks and others are encouraged to use the following incoming W A T S numbers in contacting this Bank:
1-800-442-7140 (intrastate) and 1-800-527-9200 (interstate). For calls placed locally, please use 651 plus the
extension referred to above.

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

FEDERALRESERVEpressrelease

For immediate release

May 28, 1981

The Federal Reserve Board has adopted a policy statement providing
guidelines to govern the sale by State member banks of commercial paper issued by
firms not related to the bank.
The Board's guidelines concerning the sale of such third party
commercial paper

(promissory notes of corporations) are intended to assure safe

and sound banking practices.

The Board said it would monitor activity in this

area closely and would modify or supplement its guidelines as indicated by
experience.
The policy statement is effective immediately.

However, the Board

will accept comment, for review by the Board, through July 31, 1981.
The policy statement calls for:
— Limitation of sales to prime quality commercial
paper meeting specifications in the statement.
— Careful analysis and monitoring by the seller of the
creditworthiness of the issuer.
— Adoption by the selling bank of rules limiting the
amount of commercial paper that may be sold for
single or related issuers.
— Extensive record keeping and maintenance of records.
— No sales to fiduciary accounts over which the bank has
investment discretion, or to the bank's parent
bankholding company (unless it is a bank) or to a
nonbank affiliate of the bank.
— Certain notices to buyers.
These guidelines are spelled out in the attached statement.

Attachment

FEDERAL RESERVE SYSTEM
POLICY STATEM
ENT CONCERNING THE SALE
OF THIRD PARTY COM ERCIAL PAPER B
M
Y
STATE M BER BANKS
EM
[DOCKET NO. R-0360]
AGENCY:

Board of Governors of the Federal Reserve System.

ACTION:

Policy Statement

SUM ARY: Pursuant to i t s a u th o r ity to r e s t r a i n unsafe or unsound banking
M
p r a c t i c e s by S ta te member banks, the Board of Governors of th e Federal
Reserve System adopts a policy statement s e t t i n g f o r t h g u id elin es
governing th e s a l e by a S t a te member bank of commercial paper of i s s u e r s
not r e l a t e d t o th e bank ( " t h i r d pa rty commercial p a per" ). The guidelines
r e f l e c t th e Board's judgment t h a t c e r t a i n p r a c t i c e s may develop in the
sa le by a bank of t h i r d party commercial paper t h a t may not be c o n s i s te n t
with th e p r i n c i p l e s of sa fe and sound banking. The guidelines concern
the type and amount of commercial paper t h a t should be s o l d , t h e kinds
of records t h a t should be maintained, and the purchasers t o which such
paper may be sold. The Board intends to monitor clo s e ly th e a c t i v i t i e s
of S ta t e member banks in t h i s area and may modify or supplement t h i s
policy statement based on the Board's review of th e experience of S tate
member banks in conducting th ese a c t i v i t i e s .
EFFECTIVE DATE: May 26, 1981. I n t e r e s te d p a r t i e s may submit comments
on th e policy statement that will be reviewed by the Board. Comments must
be received on or before July 31, 1981.
ADDRESS: Comments should include reference to Docket No. R-0360 and
should be mailed to th e S ecretary , Board of Governors of th e Federal
Reserve System, 20th and C ons titution Avenue, N. W., Washington, D. C.
20551, or de li ver ed t o Room B-2223, 20th and C o ns titution Avenue, N. W.,
Washington, D. C. between 8:45 a.m. and- 5:15 p.m. Comments may be
inspected in Room B-1122 between 8:45 a.m. and 5:15 p.m.
FOR FURTHER INFORM
ATION CONTACT: Robert S. P lo tk in , A s s is ta n t D ir e c to r,
Division of Banking Supervision and Regulation, (202) 452-2782, or
Richard Ashton, Senior Counsel, Legal Divisio n, (202) 452-3750, Board of
Governors of the Federal Reserve System, Washington, D. C. 20551.
SUPPLEM
ENTAL INFORMATION: On September 26, 1980, the Board took action
with respect to th e p e t i t i o n s of th e S e c u r i t i e s Industry As sociation (the
"SIA") and of A. G. Becker Incorporated ("A. G. Becker") t h a t th e Board
p r o h i b i t Bankers Trust Company, New York, New York ("Bankers T r u s t " ) , a
S t a te member bank, from s e l l i n g t h i r d pa rty commercial paper. The Board
denied th e p e t i t i o n s t o th e extent they alleged t h a t Bankers T r u s t ' s
commercial paper a c t i v i t i e s v i o l a t e th e Glass-Steagall Act or should be
p r o h ib it e d by general co ns idera tions of public policy . The Board also

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s t a t e d t h a t th e s a l e of t h i r d pa rty commercial paper by a commercial
bank could in volv e, a t l e a s t in some circumstances, p o te n tia l unsafe or
unsound p r a c t i c e s . The Board thus took no a ctio n on th e p e t i t i o n s ' a l l e ­
gations of dangers to Bankers Trust or p o t e n tia l c o n f l i c t s of i n t e r e s t
pending development of general supervisory guideli nes designed t o avoid
p o t e n tia l unsafe or unsound p r a c t i c e s in t h e s a le of t h i r d par ty commer­
c i a l paper by S ta te member banks.
In developing the guideli n es t h a t ar e s e t f o r th in th e following
policy statem en t, th e Board has consulted with th e s t a f f s of th e other
federal banking agencies and has considered th e a l l e g a t i o n s of unsafe prac ­
t i c e s made by t h e SIA and A. G. Becker and the comments of the S e c u r i t i e s
and Exchange Commission.
With respect t o t h e p o s s i b i l i t y t h a t a bank's commercial paper
s e l l i n g a c t i v i t i e s may lead the bank i n to in v e s tin g i t s funds in imprudent
investments, th e Board recognizes t h a t a bank's s e l l i n g a c t i v i t y may r e s u l t
in th e purchase of some commercial paper with th e bank's own funds. How­
e v e r , t h e Board notes t h a t banks have t r a d i t i o n a l l y been permitted to
purchase commercial paper f o r t h e i r own account and such purchases have
been t r e a t e d f o r supervisory purposes as commercial loans. In a d d i t i o n ,
sinc e only la r g e , well-known corp orations with e s t a b l i s h e d c r e d i t ra t in g s
are able t o market unsecured o b i i gat ions, commercial paper i s g enerally a
low-risk instrum ent, even r e l a t i v e to some commercial loans.Jiy F u rth e r ­
more, t h e Board's g uid elines provide t h a t a bank should s e l l only prime
q u a l i t y paper and make a thorough c r e d i t a n a ly s is of each i s s u e r and t h a t
a l l commercial paper sold by th e bank should be f u l l y supported by a v a i l ­
able l i n e s of c r e d i t . 2 / These gu idel ines would a ls o minimize the danger
t h a t a bank s e l l i n g commercial paper might be tempted to make unsound
loans t o an i s s u e r which is encountering f i n a n c i a l d i f f i c u l t i e s in order
to p r o t e c t the bank's r e p u ta t io n .
The SIA, A. G. Becker, and th e SEC have also rai se d th e p o s s i b i l i t y
of loans by a s e l l i n g bank t o f a c i l i t a t e purchase of commercial paper being
sold by the bank. However, because r a t e s on commercial paper are us ually
lower than r a t e s charged on bank loans, the use of borrowed funds t o pur­
chase commercial paper would be u n p r o fita b le and thus u n l ik e l y . According­
l y , t h e r e does not appear t o be any p r a c t i c a l substance t o t h i s concern. -

T7 The Board notes t h a t , a t l e a s t on some occa sions, s i g n i f i c a n t loss es
Tiave been su ffere d by commercial paper pur chase rs, f o r example, th e 1970
coll aps e of Penn Central Trans portation Company. However, banking func­
t i o n s , such as commercial lending, a l s o involve some degree of r i s k and
losses can and do occuur.

2/ A s e l l i n g bank could only p a r t i c i p a t e in th e l i n e of c r e d i t up to the
amount of i t s legal lending l i m i t .

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Another p o t e n t i a l hazard c i t e d in connection with bank sa les of
commercial paper is t h e p o s s i b i l i t y t h a t th e bank's salesman's i n t e r e s t
might impair i t s e x i s t i n g o b li g a ti o n s to i t s customers and might conse­
quently damage th e bank's good will and r e p u t a t i o n . In p a r t i c u l a r , i t i s
claimed t h a t bank dep o s ito r s might s u f f e r loss es on paper purchased from
th e bank, t h a t "the bank's r e p uta tion f o r prudence and r e s t r a i n t would
be abused," t h a t th e bank would lose i t s a b i l i t y to provide d i s i n t e r e s t e d
investment advice , and t h a t th e bank might "unload" worthless commercial
paper in i t s t r u s t department.
Under the Board's g u i d e lin e s , however, a bank may s e l l
commercial paper only t o f i n a n c i a l l y s o p h i s t i c a t e d purchasers and may not
a d v e r t i s e commercial paper f o r s a le to th e general p u b lic . Thus, th e r e
appears t o be l i t t l e lik e lih o o d t h a t any but a small f r a c t i o n of a bank's
d e p o s ito r s would even consider purchasing commercial paper being sold by
the bank. For th e same reason, th e p o t e n t i a l f o r a bank abusing i t s repu­
t a t i o n f o r "prudence and r e s t r a i n t " in s e l l i n g commercial paper does not
appear s i g n i f i c a n t . F i n a l l y , with respec t t o p o t e n t i a l i n a b i l i t y to
provide d i s i n t e r e s t e d investment advice and "unloading" of worthless com­
mercial paper in th e bank's t r u s t accounts, th e guidelines provide t h a t
th e bank should not s e l l commercial paper to f i d u c i a r y accounts over
which the bank has investment d i s c r e t i o n .
The Board intends to monitor clo s e ly th e s e l l i n g a c t i v i t i e s of
Bankers Trust and any o th e r S t a t e member bank t h a t may i n i t i a t e such
s e r v i c e s . Based on f u r t h e r experience in t h i s a r e a , t h e Board may modify
or supplement th e s e guid elines t o as su re t h a t such a c t i v i t i e s ar e
conducted in accordance with p r i n c i p l e s of safe and sound banking.
Accordingly, a c tin g pursuant to i t s supervisory a u t h o r i t y over
S t a t e member banks contained in se ction 9 (12 U.S.C. 321, e t seq. ) and
se ction 11 (12 U.S.C. 248) of th e Federal Reserve Act and th e Financial
I n s t i t u t i o n s Supervisory Act of 1966 (12 U.S.C. 1818(b)) and r e l a t e d
provisions of law, th e Board of Governors adopts th e following policy
statement.
POLICY STATEM
ENT CONCERNING
SALE OF THIRD PARTY COM ERCIAL PAPER
M
B STATE M BER BANKS
Y
EM
The Board of Governors has r e c e n tly determined t h a t th e s a l e of
commercial paper by a S t a t e member bank f o r u n a f f i l i a t e d i s s u e r s ( " th ir d
party commercial pa pe r" */) did not v i o l a t e th e Glass-Steagall Act (12
U.S.C. §§ 24, Seventh, "378). The Board was concerned however, t h a t the
*/ Excluding commercial paper issued by a parent bank holding company;
the Board has prev iously advised bank holding companies concerning sa le s
of bank holding company commercial paper ( l e t t e r dated June 27, 1980).

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s a l e of t h i r d par ty commercial paper**/ might, in some cir cum stances, i n ­
volve unsafe or unsound p r a c t i c e s . Tfccordingly, in th e i n t e r e s t of safe
and sound banking, th e Board believe s t h a t any S t a t e member bank t h a t may
decide to engage in t h e s a le of t h i r d par ty commercial paper should adhere
t o th e following g u id e li n e s .* * * /
1. A S ta te member bank should s e l l only prime q u a l i t y commercial
paper t h a t q u a l i f i e s f o r th e exemption provided by s e ction 3( a )( 3 ) of
th e S e c u r i t i e s Act of 1933 (15 U.S.C. 7 7 c ( a ) ( 3 ) ) . The bank should take
a pp r o p ri a te precaution t o as su re i t s e l f t h a t t h e se c t io n 3 ( a )( 3 ) exemption
a pplies t o th e commercial paper i t proposes t o s e l l . In t h i s regard,
( i ) th e bank should determine t h a t th e commercial paper i t proposes to
s e l l i s of prime q u a l i t y ; ( i i ) the bank may r e l y on r e p r e s e n t a ti o n s of
th e i s s u e r with resp ec t t o the use of proceeds; ( i i i ) except as f u r t h e r
limited by paragraphs 7 and 8, th e bank*should s e l l commercial paper only
to f i n a n c i a l l y s o p h i s t i c a t e d customers, such as customers t h a t re gularl y
purchase a v a r i e t y of sh or t-term c r e d i t inst rum en ts, and should not adver­
t i s e commercial paper f o r s a le t o the general p u b li c ; (iv) th e bank
should obtain p e r i o d i c a l l y , and maintain in t h e bank's rec o rd s, a cu rre nt
legal opinion of counsel t h a t th e se ction 3( a)( 3 ) exemption i s a v a i l a b l e .
In a d d i t i o n , th e bank should s e l l commercial paper in minimum denominations
t h a t ar e c o n s i s t e n t with app li c a b le law and, in no ev ent, should s e l l
commercial paper in minimum denominations of l e s s than $100,000.
2. The s e l l i n g bank should maintain a complete c r e d i t a n a ly s is of
th e i s s u e r a t a l l times and should ex e r c ise due d ili g e n c e in i n v e s t i g a t i n g th e
f i n a n c i a l a f f a i r s of the i s s u e r . P a r t i c u l a r a t t e n t i o n should be given to
th e l i q u i d i t y p o sitio n of the i s s u e r and i t s l i n e s of c r e d i t . All commer­
c ia l paper sold by the bank should be f u l l y supported by a v a i l a b l e lin e s
of c r e d i t . Any p a r t i c i p a t i o n by th e s e l l i n g bank in such l i n e s of c r e d i t
should be made only a f t e r co nsidera tion of th e bank's legal lending l i m i t .
3. Senior management should adopt i n te r n a l l i m i t s f o r the
amount(s) of commercial paper t h a t may be sold by th e bank f o r a s i n g le
or r e l a t e d i s s u e r ( s ) . In determining t h e i n t e r n a l l i m i t s , se n io r management
should consider the f in a n c ia l condition of th e i s s u e r , a l l l i n e s of c r e d i t
a v a i l a b l e to the i s s u e r , and th e bank's p a r t i c i p a t i o n in the li n e s of

**/ Banks have t r a d i t i o n a l l y purchased commercial paper upon th e o r d er,
and f o r th e account of, customers, whereas here the bank i s e s s e n t i a l l y
a cti n g f o r th e i s s u e r ; the former a c t i v i t y i s not subject to th e guide­
li n e s s e t f o r th in t h i s Policy Statement.
***/ The Board does not expect to take enforcement action to r e s t r a i n
unsafe or unsound banking p r a c t i c e s with res pec t t o t h i r d - p a r t y commer­
cia l paper s e l l i n g a c t i v i t i e s of any S t a t e member bank t h a t conducts such
a c t i v i t i e s within th ese g u id eli n es .

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c r e d i t and any o t h e r extensions of c r e d i t or commitments to th e i s s u e r by
th e bank (including commercial paper purchased by th e bank f o r i t s own
account.)
4. Chronological records of o r ig in a l en try should be maintained
t h a t con tain an itemized d a ily record of a l l s a le s and purchases of
commercial paper. The records should a ls o contain :
.

A des ignation of th e commercial paper,

.

nature of th e t r a n s a c t i o n , e . g . purchase or s a l e ,

.

t r a d e and se ttle ment d a te s ,

.

c o n t r a - p a r t y name or d e s ig n a tio n ,

.

net proceeds, discount r a t e , or y i e l d to maturity.

5. Account records should be maintained for each i s s u e r t h a t r e f l e c t
.

All s a l e s and purchases of commercial paper placed by the
bank f o r t h a t i s s u e r ,

.

a l l l i n e s of c r e d i t a v a i l a b l e to the i s s u e r ,

.

the amount of the bank's p a r t i c i p a t i o n in the l i n e s of c r e d i t ,

.
a c u r re n t balance of a l l extensions of c r e d i t and a
d e s c r i p t i o n of other commitments to th e i s s u e r .
6. Account records should be maintained f o r each purchaser
t h a t r e f l e c t a l l s a l e s and purchases of commercial paper f o r th e account
of t h a t customer.
7. Commercial paper should not be sold t o f i d u c ia r y accounts
over which the bank has investment d i s c r e t i o n .
8. Commercial paper should not be sold to th e bank's parent
holding company (unless i t i s a bank) or any nonbank a f f i l i a t e of the bank.
9. The bank should f u rn is h to a l l purchasers of commercial
paper w r i t te n advice in connection with a l l purchases t h a t (1) the commer­
cia l paper i s not an oblig a tio n of th e bank, and i s not insured by the
FDIC, (2) the bank has no o b li g a t io n t o repurchase any of the paper sold,
(3) the bank i s under no o b ligation to lend funds to the i s s u e r (except

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pursuant t o e x i s t i n g c r e d i t l i n e s , or o th e r commitments, i f an y) , and
(4) copies of th e i s s u e r ' s most recently published f i n a n c i a l statements
will be furnished upon reque st.
By ord er of th e Board of Governors, May 26, 1981.
(signed) James McAfee

James McAfee
A s s i s t a n t Secr etary of th e Board
(SEAL)


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102