The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
Federal reserve Bank of Dallas RO B ERT D. M cTEER , JR. DALLAS, TEXAS 75265-5906 P R E S ID E N T AN D C H IE F E X E C U T IV E O F F IC E R September 10, 1997 Notice 97-78 TO: The Chief Executive Officer of each bank holding company and others concerned in the Eleventh Federal Reserve District SUBJECT Final Amendments to Regulation Y (Bank Holding Companies and Change in Bank Control) DETAILS The Board of Governors of the Federal Reserve System has announced modifica tions to the prudential limits or firewalls that currently apply to bank holding companies engaged in securities underwriting and dealing activities through section 20 subsidiaries. The Board is eliminating those restrictions that have proven to be unduly burdensome or unnecessary in light of other laws or regulations. The remaining restrictions are being consolidated in a series of eight operating standards. The new operating standards will cover the following areas: • capital requirement for a bank holding company and section 20 subsidiary; • internal controls; • interlocks restriction; • customer disclosure; • credit for clearing purposes; • funding of securities purchases from a section 20 affiliate; • reporting requirement; and • application of sections 23A and 23B to foreign banks. For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012; Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810. This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) The narrower set of restrictions will be consistent with safety and soundness and should improve operating efficiencies at section 20 subsidiaries and increase options for their customers. ATTACHMENT A copy of the Board’s notice as it appears on pages 45295-307, Vol. 62, No. 166 of the Federal Register dated August 27, 1997, is attached. MORE INFORMATION For more information, please contact Bob Coberly at (214) 922-6209. For addi tional copies of this Bank’ notice, please contact the Public Affairs Department at (214) 922-5254. Sincerely yours, Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations 45295 FEDERAL RESERVE SYSTEM 12 CFR Part 225 [Regulation Y; Docket No. R-0958] Bank Holding Companies and Change in Bank Control (Regulation Y); Amendments to Restrictions in the Board’s Section 20 Orders Board of Governors of the Federal Reserve System. ACTION: Final Conditions to Board Orders. AGENCY: SUMMARY: The Board is modifying the prudential limitations established in its decisions u nder the Bank Holding Company Act and section 20 of the Glass-Steagall Act perm itting a nonbank subsidiary of a bank holding company to underw rite and deal in securities. The Board is elim inating those restrictions that have proven to be unduly burdensom e or unnecessary in light of other laws or regulations, and 45296 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations consolidating the rem aining restrictions in a series of eight operating standards. The Board has concluded that the narrow er set of restrictions w ill be fully consistent w ith safety and soundness and should improve operating efficiencies at section 20 subsidiaries and increase options for their customers. EFFECTIVE DATE: October 27, 1997. to the federal safety net, and to mitigate the potential for conflicts of interest, unfair competition, and other adverse effects that m ay arise from the affiliation of commercial and investm ent banks. On January 8, 1997, the Board proposed to rescind m any of the firewalls and consolidate the rem ainder in a series of operating standards to be published in the Code of Federal Regulations. The proposal was FOR FURTHER INFORMATION CONTACT: developed through the Board’s Gregory Baer, Managing Senior Counsel com prehensive review of its regulations (202) 452-3236, Thomas Corsi, Senior and w ritten policies that was required Attorney (202) 452-3275, Legal by section 303 of the Riegle Community Division; M ichael J. Schoenfeld, Senior Development and Regulatory Supervisory Financial Analyst (202) Im provem ent Act of 1994.3 That statute 452-2781, Division of Banking directs the Board and other banking Supervision and Regulation; for the agencies to streamline their regulations hearing im paired only, Telecomm unications Device for the Deaf to improve efficiency, reduce unnecessary costs, and eliminate (TDD), Diane Jenkins (202) 452-3544. unw arranted constraints on credit SUPPLEMENTARY INFORMATION: availability. In the proposal, the Board stated that in its experience the risks of I. Background securities underw riting and dealing had Section 20 of the Glass-Steagall Act proven to be manageable in a bank prohibits a member bank of the Federal holding com pany framework, and that Reserve System from being affiliated bank holding com panies and banks had w ith a company that is “engaged successfully undertaken and managed principally” in underw riting and activities posing similar risks for w hich dealing in securities not eligible for no firewalls were erected. The Board underw riting and dealing by a member noted that the purposes of the firewalls bank.1 Beginning in 1987, the Board has are often duplicated by other statutes or issued a series of orders authorizing regulations that are more narrowly bank holding com panies to establish tailored to addressing the perceived risk “section 20 subsidiaries” to engage in or conflict. underw riting and dealing w ithin the II. Summary of Comments limits of the Act.2 In those orders, the Board has The Board received twenty-nine established a series of prudential public comments on its proposal, and restrictions as conditions for approval comments were overwhelmingly under the Bank Holding Company Act. favorable. Only two commenters Most of the firewalls were adopted in opposed the Board’s proposed the Board’s initial 1987 Order elim ination of firewalls. The remaining authorizing bank holding companies to commenters supported the Board’s underw rite and deal in commercial proposal, though almost all of those paper, m unicipal revenue bonds, commenters urged the Board to go mortgage-backed securities, and further to rescind all or at least more of consumer-receivable-related securities. the firewalls. Others were added in 1989 w hen the The comments generally expressed Board authorized underw riting and support for the proposal in a summary dealing in all types of debt and equity fashion, reserving specific comment for securities. The restrictions are designed the four firewalls on w hich the Board to prevent securities underw riting and sought comment and two others that dealing risks from being passed from a proved controversial. Those comments section 20 subsidiary to an affiliated are discussed below in the context of insured depository institution, and thus each relevant firewall. One trade association representing >12 U.S.C. 377. com m unity banks expressed concerns 2 See, e.g., J.P. M organ & Co. Inc., T h e C hase about the proposal.4 The commenter M a n h a tta n C orp., B a n k e rs T ru st N e w Y o rk Corp., stated that the Board may be acting too C iticorp, a n d S e c u r ity P a cific Corp., 75 F ed e ra l R eserve B u lle tin 192 (1989) (hereafter, 1989 Order); quickly in eliminating some of the C iticorp, J.P. M organ & Co., a n d B a n k e rs T ru st N ew firewalls and urged a careful approach. Y o rk Corp., 73 F e d e ra l R eserve B u lle tin 473 (1987) The comm enter urged the Board to (hereafter, 1987 O rder); see a lso C a nad ia n Im p eria l B a n k o f C om m erce, T h e R o y a l B a n k o f C anada, B arcla ys PLC a n d B arclays B a n k PLC, 76 F ed eral R eserve B u lle tin 158 (1990) (ap p ly in g e arlie r o rders to s ec tio n 20 su b sid ia rie s o f fo reig n ban ks) (hereafter, 1990 O rder). 3 12 U.S.C. 4803. 4 T h e o th e r a d v erse c o m m e n te r d id n o t a d d re ss th e p ro p o sa l b u t g e n erally o p p o s e d th e a ffiliatio n of c o m m e rc ia l a n d in v e stm e n t banking. retain the requirem ent that a bank holding company deduct from its regulatory capital any investm ent in a section 20 subsidiary, arguing that elim ination w ould allow a bank holding company to lodge all of its capital (other than bank capital) at its section 20 subsidiary, w hich w ould m ean that no capital w ould be available at the holding com pany level if the holding com pany were called upon to serve as a source of strength to its insured depository institution subsidiaries. The commenter also urged the Board to m aintain capital requirem ents for a section 20 subsidiary that mirror the net capital rule of the Securities and Exchange Commission (SEC), as the SEC could revise or elim inate its regulation. The same com m enter urged the Board to retain restrictions on a bank extending credit to customers of a section 20 affiliate or offering credit enhancem ents for securities underw ritten by the section 20 affiliate. The commenter urged the Board to delay final action on the proposal because one bill pending in Congress w ould continue to impose such restrictions. The comm enter also expressed concern that conflicts of interest w ould be present w hen a bank lent to customers of a section 20 affiliate, and that customers needed the firewall for protection.5 III. Final Notice The Board is adopting the proposed operating standards, and the corresponding rescission of the existing firewalls, substantially as proposed. Based on its experience supervising section 20 subsidiaries and the comments received on the proposal, the Board has concluded that the great majority of risks of affiliation of commercial and investm ent banks are addressed by general bank and bank holding com pany regulations, and by the securities laws and regulations of the SEC, National Association of Securities Dealers (NASD) and securities exchanges that apply to a section 20 subsidiary just like any other broker-dealer. However, in certain areas—for example, the potential for a customer to confuse the financial products of a commercial and investm ent bank—the Board has determ ined that there are unique risks of affiliation not addressed by other 5 T h e c o m m e n te r n o te d th a t five o th e r re stric tio n s w e re b e in g re s c in d e d b e ca u se th e y w e re largely d u p lic a te d b y sec tio n s 23A a n d 23B of th e F e d e ra l R eserve A ct (12 U.S.C. 371c a n d 3 7 1 c - l) o r oth e r statu tes. T h e c o m m e n te r stre sse d th a t it s u p p o rte d elim in a tio n so lo ng as e lim in a tin g th e firew alls d id n o t ch ang e th e s u b sta n c e of h o w tra n s a c tio n s c o u ld occur. Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations laws. The operating standards being adopted by the Board address those risks. Compliance w ith the operating standards w ill be a condition of the continued operation of any existing section 20 subsidiary and, unless modified in the authorizing order, a condition of the operation of any section 20 subsidiary approved in the future. For purposes of existing section 20 subsidiaries, the operating standards replace the Board’s existing section 20 firewalls.6 Set forth below are: (1) A sum mary of each of the firewalls established in the Board’s orders;7 (2) the Board’s proposal w ith respect to the firewall; and (3) the Board’s final action and the reasons for that action, including a discussion of any comments received. Each of the proposed operating standards is discussed in the context of the firewall from the 1989 Order on w hich it is based: Operating standard 1. Capital requirement for bank holding company and section 20 subsidiary. 2. Internal controls ................. 3. Interlocks restriction ........... 4. Customer disclosure .......... 5. Credit for clearing purposes 6. Funding of securities pur chases from a section 20 affiliate. 7. Reporting requirement 8. Application of sections 23A and 23B to foreign banks. Firewall 1, 3 and 4. 11. 13. 14. 21(a) & (b). 6. 24. 21(a). Those w ishing a more detailed description of the firewalls should refer to the request for comment on the Board’s proposal, where each of the firewalls was set forth verbatim.8 6 T h e o n ly e x c e p tio n is F irew a ll #1 o f th e B o ard ’s 1987 O rd er, w h ic h set fo rth th e ty p e s o f secu rities to w h ic h c o m p a n ie s o p e ra tin g u n d e r th a t o rder m u s t lim it th e ir u n d e rw ritin g a n d d ealin g. 1987 O rd e r at 5 0 2 -0 3 . T h a t re stric tio n w ill c o n tin u e to apply. 7 F o o tn o tes to th e o rd e rs are o m itted . D e sc rip tio n o f th e firew a lls co n fo rm s to th e 1989 O rder. T he B o ard ’s re q u e st for c o m m e n t d e sc rib e s th e differen ces am o n g th e firew a lls in th e 1989 O rder (allo w in g d e b t a n d e q u ity u n d e rw ritin g ), th e 1987 O rd e r (allow ing u n d e rw ritin g a n d d e alin g in o n ly four ty p e s o f de b t sec u rities), a n d th e 1990 O rd er (a p p lic a b le to foreign banks). 8 62 FR 2622 (Jan. 17, 1997). As w ith th e earlier n o tice, re fe re n c es to b a n k s in c lu d e th rifts. In a d d itio n , to th e e x te n t th a t th e o p e ra tin g sta n d a rd s a p p ly to b a n k s a n d th rifts, th e y also a p p ly to th e U.S. b ra n c h es a n d agen cies o f foreign ban ks. IV. Analysis of Each Firewall A. Capital A dequacy Conditions Firewall 1(a) (Deduction of Investment in Subsidiary From Bank Holding Company Capital) Firewall 1(b) (Deduction of Extensions of Credit From Bank Holding Company Capital) Existing firewalls. Requires a bank holding company to m aintain adequate capital after deducting (1) any investm ent in a section 20 subsidiary that is treated as capital in the subsidiary (Firewall 1(a)), and (2) any credit that it or a nonbank subsidiary extends to a section 20 subsidiary, unless the credit is fully secured by U.S. Treasury securities or other marketable securities and is collateralized in the same m anner and to the same extent as w ould be required under section 23A(c) of the Federal Reserve Act (Firewall Kb)). Proposal. The Board proposed to rescind the capital deduction required by this firewall, b ut retain the requirem ent that a bank holding com pany m aintain adequate capital on a fully consolidated basis as a condition for operating a section 20 subsidiary. Final action. The Board is retaining the requirem ent that any bank holding company operating a section 20 subsidiary be adequately capitalized. Although bank holding companies are also subject to the Board’s risk-based capital guidelines, Operating Standard #1 w ill condition the operation of a section 20 subsidiary on a bank holding com pany’s maintaining adequate capital. The Board is eliminating the required capital deductions. The capital deductions (and resulting deconsolidation for regulatory capital purposes) are inconsistent w ith generally accepted accounting principles (GAAP) and have therefore created confusion and im posed costs by requiring bank holding companies to prepare financial statements on two bases. However, as one commenter noted, elim ination of the capital deductions w ould allow a bank holding company to lodge its capital (other than bank capital) at the section 20 subsidiary, leaving less capital available at the holding company level if the holding company were called upo n to serve as a source of strength to its insured depository institution subsidiaries.9 Reflecting this concern, the Board in its section 20 orders has consistently required bank holding companies to 9 12 CFR 225.4(a)(1). 45297 m aintain their ability to serve as a source of strength to their subsidiary banks, and has satisfied itself that the subsidiary banks of applicants, and any foreign bank applicants, were strongly capitalized before granting approval. Moreover, w ith the elim ination of m any of the firewalls, particularly the funding and credit enhancem ent firewalls, a bank’s potential exposure to its section 20 affiliate w ill increase, thereby increasing the importance of maintaining strong bank capital levels. As a protection for the bank, the Board proposed to retain the discretion to restrict funding and credit enhancem ents by a bank in the event the bank failed to qualify as well capitalized, as defined in section 38 of the Federal Deposit Insurance Act.10 Thus, if a b ank’s capital ratios fell to the adequately capitalized level (where prom pt corrective action did not yet engage), and the drop in capital ratios were attributable to poor credit decisions relating to its section 20 affiliate, the Board could act im m ediately to lim it the damage.11 The Board is adopting this proposal but also conditioning its approval of relief from the existing firewalls on a requirem ent that a bank holding com pany m aintain the capital of its subsidiary banks at the well-capitalized level. Thus, in the event that a subsidiary bank fell below the well-capitalized level and the bank holding com pany failed to recapitalize it, the Board could order the bank holding com pany to divest its section 20 subsidiary. The Board w ould expect to do so only if the subsidiary were causing harm to the bank (and other steps such as restricting bank funding of the section 20 affiliate were ineffective), or if the divestiture of the section 20 affiliate was the only available source of funds w ithin the organization to recapitalize the bank. The Board notes that Glass-Steagall reform legislation pending in the Congress also requires a bank holding company to m aintain its subsidiary banks at the well-capitalized level as a condition of conducting securities activities. In applying this condition to foreign banks, the Board has decided that a foreign bank should m aintain capital at a level that is comparable to that of a 1012 U .S.C. 18310. 11 T w o c o m m e n te rs o p p o s e d th is ch an g e b ecau se it c o u ld le a d to a su b sta n tia l d is ru p tio n of th e b u s in e s s o f a s ec tio n 20 su b sid ia ry w h e n affiliated b a n k s e x p erie n ce c a p ita l difficulty . H ow ever, th e B oard w o u ld e x p ec t to re im p o se th e se re stric tio n s o n ly if th e y a d d re ss e d p ro b le m s in th e o rg an iz a tio n or d im in ish e d re s u ltin g risk s to its in s u re d d e p o sito ry in stitu tio n s. 45298 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations U.S. banking organization, for w hich different capital requirem ents apply to the bank and the bank holding company. As noted in the 1990 Order, foreign banks operate in the United States as both banks and bank holding companies, and the capital requirem ent for a foreign bank should take account of this fact. As noted above, in acting on applications by foreign banks to establish section 20 subsidiaries, the Board relied on the fact that each foreign bank was capitalized at levels w ell above the applicable minimums. Consequently, and in the interests of national treatment, the Board has decided that foreign banks should m aintain a strong capital position, above the m inim um levels of the Basle Capital Accord. The Board believes that this standard w ill provide substantial equivalence in the m aintenance of capital by both domestic and foreign banking organizations that operate section 20 subsidiaries. Firewall 2 (Prior Approval Requirement for Investments in Subsidiary) This firewall was repealed by the Board at the time it published its • request for comment. The firewall had required Board approval for any bank holding com pany investm ents in a section 20 subsidiary subsequent to its formation. Firewall 3 (Requirement of Capital Plan) Existing firewall. Requires that, before establishing a section 20 subsidiary, a bank holding company subm it to the Board a plan to raise additional capital or demonstrate that it is strongly capitalized and w ill rem ain so after making authorized capital adjustments. Proposal. The Board proposed to rescind this firewall, w hich was applied in the 1989 Order granting authority to engage in underw riting and dealing in all types of debt and equity securities, but not in the 1987 Order. Final action. The Board is retaining this firewall in m odified form. The Board analyzes the capital adequacy, financial condition, and business plan of each applicant before approving its application to engage in underw riting and dealing pursuant to section 20. The Board expects that any bank holding com pany filing a notice w ith the Board to acquire and/or operate a section 20 subsidiary should have a strong capital position. Therefore, the Board has concluded that an operating standard setting forth the contents of a capital plan is unnecessary. The firewall also provides, however, that applicants seeking authority to engage in underw riting and dealing in all types of debt and equity securities shall also rem ain strongly capitalized, and the Board has not perm itted applicants to commence underw riting and dealing in all types of debt and equity securities until they have dem onstrated that they can meet this standard. Accordingly, the Board is retaining this requirem ent in Operating Standard # 1. Consistent w ith the discussion above, the Board will require that the bank holding company be strongly capitalized on a fully consolidated basis, and thus w ill not deduct from its capital the bank holding com pany’s investm ent in, or extensions of credit to, its section 20 subsidiary. Firewall 4 (Capital Adequacy Requirement) Existing firewall. Requires a section 20 subsidiary to m aintain capital adequate to support its activities and cover reasonably expected expenses and losses in accordance w ith industry norms. Proposal. The Board sought comment on w hether to retain this firewall. Final action. The Board is rescinding this firewall, but modifying the operating standards to require the section 20 subsidiary to notify the Board as well as the SEC of any failure to m aintain capital above “early w arning” levels contained in SEC capital rules. The purpose of this capital requirem ent was to prevent a section 20 subsidiary from operating below industry capital standards by trading on the reputation and resources of its affiliated bank, thereby gaining a com petitive advantage over other broker-dealers. The Board has concluded, however, that the firewall is not an effective tool for addressing this concern, prim arily because there is no defined “industry norm .” Although the SEC imposes “h aircut” and capital requirements on all brokerdealers (including section 20 subsidiaries), these m inim um capital levels cannot be considered “industry norm s.” Because broker-dealers that fail to m eet SEC m inim um capital requirem ents are liquidated, and brokerdealers that fall below somewhat higher “early w arning” levels are required to notify the SEC, broker-dealers ordinarily do not operate near these minimums. One commenter also explained that significant underw riters m ust m aintain capital greatly in excess of SEC m inim um s so that they can draw down on their excess capital w hen a significant underw riting arises. Commenters also stated that any attem pt to determ ine the “average” capital actually held by the industry (as opposed to the m inim um capital required by the SEC) and specify it as the industry norm w ould be unwise. Capital varies significantly depending on the activities and risk profile of the individual firm. Furthermore, commenters noted that whereas SEC capital requirements allow all capital to be concentrated in the broker-dealer and dedicated to meeting capital requirements, a bank holding company m ust m eet capital requirem ents at the bank and holding com pany levels as well. Finally, the Board already measures bank holding company capital on a consolidated basis, including the capital and assets of the section 20 subsidiary. Therefore, even in the absence of a special capital requirem ent for section 20 subsidiaries, their ability to leverage themselves w ill be constrained. The Board has decided to require a section 20 subsidiary to notify the Board as w ell as the SEC of any failure to m aintain capital above “ early w arning” levels contained in SEC capital rules.12 If a section 20 subsidiary is required to file a warning notice advising the SEC that the section 20 subsidiary is experiencing financial distress, a copy of the notice w ill be required to be filed concurrently w ith the relevant Federal Reserve Bank. The Board w ould then have the authority to take appropriate action to m aintain safety and soundness. B. Credit Extensions to Customers o f the Underwriting Subsidiary Firewall 5 (Restriction on Credit Enhancement) Existing firewall. Prohibits a section 20 affiliate from extending credit or issuing or entering into a stand-by letter of credit, asset purchase agreement, indem nity, guarantee, insurance or other facility that might be viewed as enhancing the creditw orthiness or marketability of a bank-ineligible securities issue underw ritten or distributed by the underw riting subsidiary.13 Proposal. The Board proposed to rescind this firewall. Final action. The Board is rescinding this firewall because other protections adequately serve its purposes, and its burden on section 20 subsidiaries and their customers therefore is not warranted. Commenters stressed that by prohibiting banks from providing routine credit enhancem ents in tandem w ith a section 20 affiliate, the firewall ham pers the ability of bank holding companies to serve as full-service 12 See 17 CFR 2 4 0 .1 7 a - ll. 13 A ba n k -in e lig ib le sec u rity is o n e th a t a m em b er b a n k is p ro h ib ite d from u n d e rw ritin g o r d e alin g in b y sec tio n 16 o f th e G lass-Steagall Act. 12 U.S.C. 24(S eventh); 12 U.S.C. 335. Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations financial services providers and reduces options for their customers. For example, existing corporate customers of a bank may w ish to issue commercial paper or issue debt in some other form. Although the bank may refer the customer to its section 20 affiliate, the bank is prohibited from providing credit enhancem ents even though it is the institution best suited to perform a credit analysis—and, w ith smaller customers, perhaps the only institution w illing to perform a credit analysis. The bank is precluded from providing a credit enhancem ent even if it reached an independent credit decision prior to referring the custom er to its section 20 affiliate. Moreover, significant safety and soundness protections w ill rem ain in the absence of the firewall. First, a bank w ill be required to hold capital against all credit enhancem ents extended to customers of its section 20 affiliate— something that was not the case at the time the firewall was adopted. Second, the am ount of credit that a bank may extend to an issuer of securities underw ritten by an affiliated section 20 w ill be lim ited by loan-to-one borrower rules.14 Third, section 23B of the Federal Reserve Act w ill require that all credit enhancem ents of securities being underw ritten by a section 20 affiliate be on market terms—that is, the same terms that w ould be offered to a third party of equal creditw orthiness.15 Thus, for example, a bank could not offer such credit enhancem ents at less than market terms, or to customers who were poor credit risks, in order to generate underw riting business for a section 20 affiliate. Similarly, section 106 of the Bank Holding Company Act A m endm ents of 1970 w ould prohibit a bank from offering discounted credit enhancem ents on the condition that an issuer obtain investm ent banking services from a section 20 affiliate.16 Finally, Operating Standard #2, discussed below, w ill require that the bank conduct an independent and thorough credit evaluation before offering any credit enhancem ent in tandem w ith a section 20 affiliate, and m aintain docum entation of that evaluation sufficient to allow examiners to assess com pliance w ith its credit policies. Firewall 6 (Restriction on Funding Purchases of Securities) Existing firewall. This firewall prohibits a bank holding company or its subsidiary from knowingly extending 1412 U.S.C. 84; 12 CFR 32.2. 1 = 1 2 U.S.C. 371c— l(a)(2)(E)(ii). 1612 U.S.C. 1972(1). credit to a customer to fund the purchase of a bank-ineligible security that is being underw ritten by a section 20 subsidiary during the period of the underw riting or for 30 days thereafter, or to purchase from the underw riting subsidiary any bank-ineligible security in w hich the underw riting subsidiary makes a market. The lim itation does not include lending to a broker-dealer for the purchase of securities where an affiliated bank is the clearing bank for such broker-dealer. Proposal. The Board sought comment on w hether existing protections were sufficient to address the primary concern of Firewall 6: the possibility that a bank w ould extend credit below market rates in order to induce customers to purchase securities underw ritten by its section 20 affiliate or to facilitate its m arket making activities. The primary risks of such action are threefold: that such extensions of credit may not be repaid, thereby harming the bank; that customers w ill be induced by easy credit into purchasing risky securities, thereby harm ing the customer; and that a section 20 affiliate could reap a competitive advantage over competitors that do not have a federally subsidized affiliate to provide credit to their customers. Final action. The Board is retaining this firewall as Operating Standard #6 w ith respect to any extension of credit during the underw riting period or for 30 days thereafter, subject to an exception for preexisting lines of credit.17 The Board is removing the restriction on lending for purchases of securities in w hich a section 20 affiliate makes a market. Commenters supported elim ination of the firewall. Commenters stressed that it w ould make little sense for a bank to expose itself to the losses associated w ith unsoun d loans so that its section 20 affiliate could earn a fraction of those potential losses on the sale of securities. One com menter explained that a bank may have a pre-existing line of credit for a customer for the purchase of securities on margin. Such a line w ould have been entered into based on the custom er’s creditworthiness and the value of the security, not the identity of the underw riter of any potential securities purchases, and could also be subject to the margin requirements im posed by the Board’s Regulation U. Commenters also 17 T h is o p e ra tin g s ta n d a rd d oes n o t a p p ly w h e n a sec tio n 20 su b sid ia ry is actin g o n ly as a selling g ro u p m em b er. A lth o u g h a s ellin g g ro u p m e m b e r m a y be eng ag ed in th e p u b lic s ale or d is trib u tio n o f sec u rities for p u rp o s e s of th e G lass-Steagall Act, a sellin g g ro u p m e m b e r is n o t c o n sid e re d an u n d e rw rite r. 45299 stressed that a section 20 subsidiary, as a registered broker-dealer, is responsible under NASD, NYSE, and SEC “know your custom er” and suitability rules for ensuring that the securities purchased by a customer are suitable investments for that particular custom er.18 Commenters noted that section 11(d) of the Securities Exchange Act of 1934 addresses some of the same concerns as Firewall 6. Section 11(d) prohibits a broker-dealer (including a section 20 subsidiary) that is acting as an underw riter from extending or arranging for credit to customers purchasing the new ly issued securities during the underw riting period and for 30 days after the underw riting period. Thus, a section 20 subsidiary acting as underw riter w ould be prohibited from arranging for an affiliated bank to make loans to customers for purchases during an underw riting period. Commenters also noted that section 23B of the Federal Reserve Act w ould apply to loans to fund purchases by customers of securities from a section 20 affiliate during the existence of the underw riting or selling syndicate, and to any loan to purchase a security from the inventory of the section 20 affiliate, including securities in w hich the section 20 affiliate makes a m arket.19 Section 23B w ould require the loan to be on market terms. The Board has concluded, however, that these protections do not address all the concerns behind the firewall. Section 11(d) does not apply to a bank loan unless the loan is arranged by an affiliated broker-dealer, and although section 23B requires the loan to be on market terms, the Board has some concern that during an underw riting period, w hen the m arket value of the securities is uncertain, section 23B may not be an adequate protection. In sum, the Board has concluded that existing law is not a complete protection against the conflicts of interest that arise w hen a bank lends during the underw riting period or for 30 days thereafter. However, the Board w ill revise the restriction to allow an extension of credit to be made pursuant to a preexisting line of credit, provided that (1) the line of credit was not entered into in contem plation of the purchase of 18 R ule 2110 o f th e N A SD ’s C o n d u ct R ules (S tan d a rd s o f C o m m ercial H o n o r a n d P rin c ip le s o f T rade); R ule 2310 o f th e N A SD ’s C o n d u ct R ules (R eco m m en d atio n s to C u sto m ers (suitability)); NYSE R ule 405 (“ k n o w y o u r c u sto m e r” )', SEC R ule 1 5 g -9 (sales p ra c tic e ru le s for c erta in lo w -p rice securities). 19 S ec tio n 23B a p p lie s to “ a n y tra n s a c tio n or series o f tra n s a c tio n s w ith a th ir d p a rty * * * if an affiliate is a p a rtic ip a n t in s u c h tra n s a c tio n o r series o f tra n s a c tio n s .” 12 U.S.C. 371c— (a)(2)(E). 1 45300 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations affiliate-underwritten securities,20 and (2) either the line of credit is unrestricted or the extension of credit is clearly consistent w ith any restrictions imposed. (For example, if a customer had a preexisting line of credit limited to purchases of rated securities, then the bank w ould continue to be prohibited from lending to purchase unrated securities underw ritten by an affiliate.) The Board has concluded that these transactions do not present the same risks as other loans m ade during an underw riting. Such lines of credit are routinely used by institutional and other sophisticated customers, and are based on the custom er’s overall creditworthiness as well as margin required for any purchase; although any security purchased using the line of credit is taken as collateral, there are other assurances of repayment. In such cases, the custom er is not being induced by an offer of bank credit to purchase an affiliate-underwritten security, as the customer is free to use the line of credit to purchase other securities of the same type. Finally, for purposes of section 23B, the pricing of the line of credit can be compared to other, similar lines that are not used to purchase affiliateunderw ritten securities. The Board has also concluded that the potential conflicts of interest associated w ith extending securities credit are lessened, and the protections more effective, w hen the section 20 affiliate is making a secondary m arket in the securities. First, the section 20 affiliate’s potential exposure as market maker should be substantially less and more manageable than its exposure as underw riter. Second, especially because there is generally more than one firm making a market in a given security, com pliance w ith the m arket terms requirem ent of section 23B should be easier to determ ine than in the underw riting context, where there may be no secondary market. Third, because section 11(d) does not apply to loans for the purpose of purchasing securities in w hich a broker-dealer makes a market, broker-dealers (including section 20 subsidiaries) are already perm itted to lend in this context, and lending by banks does not appear to present any greater conflict of interest that would justify excluding them from this credit market. Fourth, as described more fully below, existing “Chinese W all” procedures should help to ensure that a 20 In d e te rm in in g w h e th e r th e lin e of c re d it is tru ly p re e x istin g , ex am in ers w ill c o n sid e r th e tim in g of th e lin e o f c re d it a n d th e u n d e rw ritin g , th e c o n d itio n s im p o s e d o n th e lin e of cred it, a n d w h e th e r th e lin e o f c re d it h a s b e e n u s e d for p u rp o s e s o th e r th a n th e p u rc h a se o f affiliateu n d e rw ritte n securities. bank lending officer is unaw are of the section 20 affiliate’s m arket making role. The Board recognizes that section 23A of the Federal Reserve Act w ould apply to both types of transactions being exempted from the firewall to the extent that the proceeds of the transaction w ould be “used for the benefit of, or transferred to ” the affiliate.21 Section 23A limits transactions w ith any one affiliate to 10 percent of the bank’s capital, and transactions w ith all affiliates to 20 percent of capital, and also requires that collateral be pledged to a bank for any extension of credit. As several commenters noted, application of section 23A could not only restrict the am ount of such credit but raise interpretive and com pliance questions concerning how a bank should monitor compliance w ith the statute. However, for the same reasons that the Board has decided to exem pt these transactions from the firewall, the Board is considering w hether an exemption from section 23A may also be appropriate. The Board expects to seek comment on this and other issues arising under sections 23A and 23B in the near future. Firewall 7 (Restriction on Extensions of Credit for Repayment of U nderw ritten Securities) Existing firewall. Prohibits a bank holding company or any of its subsidiaries from extending credit to an issuer of bank-ineligible securities previously underw ritten by a section 20 affiliate for the purpose of the payment of principal, interest or dividends on such securities. Proposal. The Board proposed to rescind this firewall. Final action. The Board is rescinding this firewall. The Board stated in 1987 that it was adopting this firewall in order to prevent a bank from making unw ise loans to improve the financial condition of com panies whose securities were underw ritten by the section 20 affiliate, either to assist in the marketing of the securities or to prevent the customers of the section 20 affiliate from incurring losses on securities sold by the subsidiary. However, this conflict of interest is more attenuated than those present w hen credit is extended during the underw riting period, as the financial and reputational risks to the section 20 affiliate are lessened once the underw riting is successfully completed. The firewall also has proven burdensom e and has had unintended effects. For example, banks face compliance problems renewing a com pany’s revolving line of credit if a section 20 subsidiary has underw ritten 12 U.S.C. 371c(a)(2). an offering by that com pany since the credit was first extended; the bank m ust either recruit other lenders to participate in the renew al or am end the line of credit in order to specify its purpose. Finally, in the absence of this firewall, section 23B of the Federal Reserve Act w ill require that extensions of credit for the purpose of paym ent of principal, interest or dividends be made on market terms if the section 20 affiliate is a participant in the transaction.22 Firewall 8 (Procedures for Extensions of Credit) Existing firewall. Requires a bank holding company to adopt procedures, including m aintenance of necessary docum entary records, to ensure that any extension of credit by it or any of its subsidiaries to issuers of bank-ineligible securities underw ritten or dealt in by a section 20 subsidiary are on an arm ’slength basis for purposes other than paym ent of principal, interest, or dividends on the issuer’s bank-ineligible securities being underw ritten or dealt in by the underw riting subsidiary. Proposal. The Board proposed to rescind this firewall. Final action. The Board is rescinding this firewall as superfluous. Section 23B, enacted since this firewall was initially adopted, requires extensions of credit by a bank in conjunction w ith an issuance of securities underw ritten by a section 20 affiliate to be on market terms. Although the firewall also includes extensions of credit by n onbank subsidiaries, those extensions of credit do not directly im plicate the federal safety net. In amending section 23A in 1982 and adopting section 23B in 1987, Congress chose not to apply them to the parent bank holding com pany or any other nonbank lender, and the Board sees no reason to reverse that judgm ent in this context. Firewall 9 (Restriction on Thrifts) Existing firewall. Requires thrifts to observe the lim itations of sections 23A and 23B of the Federal Reserve Act in any dealings w ith a section 20 affiliate. Proposal. The Board proposed to rescind this provision. Final action. The Board is rescinding this firewall as superfluous, given that the Home O w ners’ Loan Act has since been am ended to apply sections 23A and 23B of the Federal Reserve Act to a thrift as if it were a member bank.23 2212 U.S.C. 371c— 1(a)(3). 2312 U.S.C. 1468(a)(1). Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations Firewall 10 (Restriction on Industrial Revenue Bonds) Existing firewall. Applies the requirem ents relating to credit extensions to issuers noted in paragraphs 5-9 above to extensions of credit to parties that are major users of projects that are financed by industrial revenue bonds. Proposal. As the Board proposed to rescind the incorporated restrictions, the Board proposed to rescind this restriction as well. Final action. As the Board is rescinding all of the incorporated restrictions relating to credit extensions to issuers, the Board is rescinding this restriction as well. Firewall 11 (Loan Docum entation and Exposure Limits) Existing firewall. Requires bank holding companies to cause their subsidiary banks to adopt policies and procedures, including appropriate limits on exposure, to govern their participation in financing transactions underw ritten or arranged by a section 20 affiliate. They shall also ensure that loan docum entation is available for review by the Reserve Banks to ensure that an independent and thorough credit evaluation has been undertaken in connection w ith bank or thrift participation in such financing packages and that such lending complies w ith the firewalls and section 23B of the Federal Reserve Act. Proposal. The Board proposed to include this firewall in slightly am ended form in its operating standards for all section 20 subsidiaries. Final action. The Board is retaining this restriction as part of Operating Standard 2. The Board w ill thereby be imposing this restriction for the first time on section 20 subsidiaries operating u n der the 1987 Order. Several commenters objected to retention of this requirem ent as red und an t in view of the current federal banking agency exam ination standards for risk management. These commenters noted that this restriction was initially adopted in the context of highly leveraged transactions, and that additional internal control restrictions are not placed on bank activities with respect to other nonbank subsidiaries. However, the Board has concluded that this operating standard remains im portant in light of the risks of affiliation betw een a section 20 subsidiary and a depository institution, particularly in view of the Board’s removal of other restrictions on such affiliation. Firewall 12 (Procedures for Limiting Exposure to One Customer) Existing firewall. Mandates that bank holding com panies establish appropriate policies, procedures, and limitations regarding exposure of the holding com pany on a consolidated basis to any single customer whose securities are underw ritten or dealt in by the section 20 subsidiary. Proposal. The Board sought comment on w hether to include this restriction in its operating standards for section 20 subsidiaries. Final action. The Board is rescinding this firewall. The firewall mandates consolidated exposure limits for a bank holding com pany w ith respect to any one issuer w hose securities are underw ritten or dealt in by a section 20 subsidiary. The Board has the authority to review bank holding company policies on exposure through the examination process and believes that an examination is adequate to ensure that a bank holding com pany is not exposed undu ly to any single issuer. Bank holding companies have successfully operated section 20 subsidiaries under the Board’s 1987 Order w ithout being subject to this requirement. Finally, unlike the banks for w hom exposure limits are required by Operating Standard #2, bank holding com panies are not federally insured. C. Lim itations to M aintain Separateness o f an Underwriting A ffilia te’s A ctivity Firewall 13 (Interlocks Restriction) Existing firewall. Prohibits directors, officers or employees of a bank from serving as a majority of the board of directors or the chief executive officer of an affiliated section 20 subsidiary, and directors, officers or employees of a section 20 subsidiary from serving as a majority of the board of directors or the chief executive officer of an affiliated b an k .24 Requires the underw riting subsidiary to have offices separate from any affiliated bank. Proposal. The Board proposed no changes to the interlocks restrictions, w hich it recently am ended. The Board proposed to rescind the separate office requirement. Final action. The Board is rescinding the separate office requirement. First, in the Board’s experience, maintaining separate offices for functions that do not involve retail customers—for example, back-office functions—serves no purpose and represents a needless 24 A s th e B oard n o te d in a re c en t o rd er, th is lim ita tio n does n o t a p p ly to in te rlo c k s b e tw e e n a s ec tio n 20 su b sid ia ry a n d a su b sid ia ry of an affiliated b an k . S e e B a n kers T ru st N e w York, 83 F e d e ra l R eserve B u lle tin ____(July 21, 1997). 45301 expense. Second, for sales to retail customers, the Board intends to rely on the Interagency Statement on Retail Sales of Nondeposit Investment Products, w hich largely duplicates this restriction.25 According to the Interagency Statement, sales or recom m endations of non-deposit investm ent products on the premises of a depository institution—including sales by a section 20 affiliate—should be conducted in a physical location distinct from the area where retail deposits are taken. Several commenters suggested elim ination of or modifications to the interlocks restriction, on w hich the Board did not seek comment. The Board continues to view the interlocks restriction as helping to ensure the corporate separateness of a bank and a section 20 affiliate, and thereby as helping to prevent a piercing of the bank’s corporate veil by creditors of the section 20 affiliate. D. Disclosure by the Underwriting Subsidiary Firewall 14 (Customer Disclosures) Existing firewall. Requires a section 20 affiliate to provide each of its customers w ith a special disclosure statem ent describing the difference betw een itself and its bank affiliates, pointing out that an affiliated bank could be a lender to an issuer, and referring the customer to the disclosure documents for details. The statement m ust also state that securities sold, offered, or recom m ended by the underw riting subsidiary are not deposits, are not insured by the Federal Deposit Insurance Corporation, are not guaranteed by an affiliated bank or thrift, and are not otherwise an obligation or responsibility of such a bank or thrift (unless such is the case). The section 20 affiliate should also disclose any material lending relationship between the issuer and a bank or lending affiliate of the section 20 affiliate as required under the securities laws and in every case where the proceeds of the issue w ill be used to repay outstanding indebtedness to affiliates. Proposal. The Board proposed to am end this firewall to follow the Interagency Statement on Retail Sales of N ondeposit Investment Products that applies to sales by bank employees or on bank premises. Final action. The Board has decided to adopt this operating standard as proposed. A section 20 subsidiary will be required to provide each of its retail 25F ed e ra l R eserve R egulatory S erv ice 3— 1579.51. 45302 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations customers the same disclosures that the Interagency Statem ent m andates for retail customers of banks, even w hen it is operating off bank prem ises.26 The disclosures of the Interagency Statement are only slightly different from those required by the existing firewall, however, and the am endm ent w ill allow the same form to be used for both. The operating standard is narrow er than the firewall it replaces because it no longer requires disclosures to institutional customers (who should be aware of w hether a product is federally insured or bank guaranteed) but broader than the existing firewall because it requires an acknowledgment of the disclosure by retail customers. W hile commenters favored limiting customer disclosure requirem ents to retail customers, they objected to extending the reach of the Interagency Statement to activities conducted off bank premises, and thereby to requiring retail customers to sign and return an acknowledgment in those circumstances. Commenters contended that requiring the disclosures to be made off bank premises does not further the purpose of the requirement, w hich is to prevent customer confusion regarding w hether products offered by a section 20 subsidiary are federally insured or guaranteed by an affiliated bank. One commenter noted that the NASD has sought SEC approval of a new rule that is designed to require disclosures consistent w ith those required by the Interagency Statement.27 The Board continues to believe that it is appropriate for a section 20 subsidiary to provide the disclosures required by the Interagency Statement to all of its retail customers. As set forth in the Interagency Statement, customer acknowledgment of these disclosures w ill be required only at the time that a custom er opens an account w ith the section 20 subsidiary, and therefore should not be und uly burdensom e to obtain. Thus, this disclosure provides some benefit at m inim al cost. The Board notes that w hen it rejected a suggestion that a section 20 subsidiary be required to have a different nam e or logo from a banking affiliate, it relied in part on the disclosures that w ould be given to custom ers.28 26F o r p u rp o s e s o f th is o p e ra tin g sta n d a rd , a retail c u sto m e r is a n y c u sto m e r th a t is n o t an “ a c c re d ite d in v e sto r” as d e fin e d in 17 CFR 230.501(a). 27 NASD N otice to M em b ers 9 6 -3 , N A S D F iles w ith th e SEC P ropo sed R u le G overning M em b ers O p era tin g on B a n k P rem ises, (January 1996) a n d N A SD N o tic e to M em b ers 97— N A S D R eg u la tio n 26, F iles A m e n d m e n t to B a n k B roker-D ealer R u le (M ay 1997). 28 1989 O rd e r at 2 0 9-2 10 . E. M arketing A ctivities on B ehalf o f an Underwriting Subsidiary Firewall 15 (Restriction on Advertising Bank Connection) Existing firewall. Prohibits a section 20 affiliate and any affiliated bank from engaging in advertising or entering into an agreement stating or suggesting that the bank is responsible for the section 20 affiliate’s obligations. Proposal. The Board proposed to rescind this firewall as superfluous. Final action. This firewall is now duplicated by section 23B(c) of the Federal Reserve Act,29 and therefore the Board is rescinding it. Firewall 16 (Cross-Marketing and Agency Activities by Banks) This firewall was rescinded in 1996.30 F. Investm ent A dvice by B ank/Thrift A ffiliates Firewall 17 (Expressing an O pinion on Securities) Existing firewall. Prohibits a bank from expressing an opinion on the value or the advisability of the purchase or the sale of bank-ineligible securities underw ritten or dealt in by a section 20 affiliate unless the bank notifies the custom er that the section 20 affiliate is underw riting, making a market, distributing or dealing in the security. Proposal. The Board proposed to retain this restriction but sought com m ent on w hether it should only prohibit expressing an opinion w hen the employee has knowledge of the affiliate’s role. Final action. The Board is retaining this restriction, w ith a knowledge requirem ent added, as Operating Standard # 4. SEC Rule 10b-10 and NASD Rule 2250 already require a broker-dealer to provide w ritten disclosure to a customer that it is a market maker in a security at or before com pletion of a transaction in the security. These restrictions are based on the conflict of interest between the broker-dealer’s duty to advise its customers and its financial interest in selling its security. The operating standard extends these restrictions to an affiliated bank because it w ould have a similar financial incentive to give advice that w ould benefit its affiliate. Commenters argued for either elim ination of the firewall or addition of a knowledge standard. Several commenters stressed that the existing firewall essentially requires routine, w idespread disclosure of securitiesrelated information throughout a bank 2912 U.S.C. 371c— 1(c). 3061 FR 57679, 57683 (1996). holding company system in order to ensure that employees provide the required disclosure w henever a section 20 affiliate has a role in the transaction. This approach is fundam entally inconsistent w ith the “Chinese W all” procedures prevalent throughout the investm ent banking industry, w hich address the same conflict-of-interest problem by narrow ly restricting the flow of inform ation to those whose possession of such information could not create a conflict of interest. One commenter also noted that the existing firewall is difficult to enforce for large, diversified bank holding companies because it requires that information on all securities “ dealt in ” by the company be dissem inated to every area in the holding com pany system where “an opinion on the value or the advisability” of a securities transaction might be expressed. The Board has concluded that these concerns can be abated, and the potential conflict of interest raised by such advice still addressed, by retaining the requirem ent w ith a knowledge standard added. Thus, w hen the bank employee providing the investm ent advice knows of a section 20 affiliate’s role in an underw riting—as might be the case w ith a dual employee—the employee m ust give the required disclosure. Regardless of the em ployee’s knowledge, the Board notes that any potential for a conflict of interest is dim inished because any dual employee is generally prohibited from receiving com pensation for recom m ending an affiliate’s securities.31 One comm enter asked the Board to clarify that an opinion on the value of a security provided by the custodial departm ent of the bank is not covered. Rather, the operating standard should be lim ited to expressing an opinion on the advisability of purchasing or selling a security. The Board agrees. Firewall 18 (Restriction on Fiduciary Purchases During Underwriting Period or From Market Maker) Existing firewall. Prohibits a bank holding company and any of its bank, thrift, trust or investm ent advisory 31 A n y d u a l e m p lo y e e engaged in th e in v e stm e n t b a n k in g or s ec u rities b u sin e ss o f a n N A SD m em ber m u s t b e re g iste re d as a re p re s e n ta tiv e w ith the NASD a n d c o m p ly w ith its ru le s. NASD R ule 1031(a), 0115(a). T h e N A SD c o n siste n tly h a s ta k e n th e p o s itio n in p u b lis h e d in te rp re ta tio n s th a t it is im p ro p e r fo r a m e m b e r o r a p e rs o n a sso c iated w ith a m e m b e r to m ak e p a y m e n ts o f “ fin d e rs ” o r referral fees to th ir d p a rtie s w h o in tro d u c e or refer p ro sp e c tiv e bro kerag e cu sto m ers to th e firm , u n le ss th e re c ip ie n t is re g iste re d as a re p re s e n ta tiv e o f an N A SD m e m b e r firm . A lth o u g h th e N A SD h a s a lim ite d e x ce p tio n for “ o n e-tim e fees,” th e e x ce p tio n d oes n o t in c lu d e fees tie d to th e c o m p le tio n o f a tra n s a c tio n or th e o p e n in g of an accou nt. Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations subsidiaries from purchasing, as a trustee or in any other fiduciary capacity, for accounts over w hich they have investm ent discretion, bankineligible securities (a) underw ritten by a section 20 affiliate as lead underw riter or syndicate member during the period of any underw riting or selling syndicate, and for a period of 60 days after the term ination thereof, and (b) from the section 20 affiliate if it makes a market in that security, unless such purchase is specifically authorized u nd er the instrum ent creating the fiduciary relationship, by court order, or by the law of the jurisdiction under w hich the trust is administered. Proposal. The Board proposed to rescind this firewall. Final notice. The Board is rescinding this firewall as superfluous. Section 23B(b)(l)(B) of the Federal Reserve Act duplicates the restrictions of Firewall 18 w hen a bank or thrift is making the purchase.32 Indeed, in its 1987 order first imposing this firewall, the Board noted that section 23B was pending as proposed legislation. Section 23B explicitly prohibits a bank from purchasing, as principal or fiduciary, any security for w hich a section 20 is a principal underw riter during the existence of the underw riting or selling syndicate, unless such a purchase has been approved by a majority of the bank’s board of directors who are not officers of any bank or any affiliate. If the purchase is as fiduciary, the purchase m ust be perm itted by the instrum ent creating the fiduciary relationship, court order, or state law. Firewall 18 is broader than section 23B in that it applies for 60 days after the underw riting period. However, the Board is not aware of any evidence to justify imposing a restriction that Congress apparently decided was unnecessary in the same context, and commenters did not urge it to do so. Firewall 18 is also broader than section 23B in that the firewall also applies w hen a bank holding company or its nonbank subsidiary (and not just a bank) purchases the securities as fiduciary. However, nonbank affiliates of broker-dealers outside of a bank holding company are not subject to such a firewall. Rather, potential conflicts of interest are addressed by other statutes or regulations. If the purchase is on behalf of a pension plan, then the fiduciary is subject to the standard of care im posed by ERISA.33 If the purchase is on behalf of a m utual fund, then sections 10 and 17 of the Investment Company Act of 3212 U.S.C. 371c— 1(b)(1)(B). 3329 U.S.C. 1002(21), 1104. 1940 restrict the ability of the m utual fund to purchase securities from an affiliate of the investm ent advisor.34 The Board has concluded that these protections, in addition to state laws, are sufficient in the bank holding com pany context as well. 45303 arisen from this practice.36 The SEC has recently perm itted investm ent com panies to purchase lim ited amounts of securities for w hich an affiliate is acting as a principal underw riter.37 Firewall 20 (Restriction on underw riting and dealing in affiliates’ securities) G. Extensions o f Credit and Purchases and Sales o f A ssets Existing firew all (as am ended). Generally prohibits a section 20 affiliate from underw riting or dealing in any Firewall 19 (Restrictions on Purchases as Principal During U nderw riting Period bank-ineligible securities issued by its affiliates or representing an interest in, or From Market Maker) or secured by, obligations originated or Existing firewall. Generally prohibits a sponsored by its affiliates, unless they bank holding company and any of its are (1) rated by an unaffiliated, subsidiaries from purchasing, as nationally recognized statistical rating principal, bank-ineligible securities that organization, or (2) issued or guaranteed are underw ritten by a section 20 by FNMA, FHLMC or GNMA (or subsidiary during the period of the represent interests in securities issued underw riting and for 60 days after the or guaranteed by FNMA, FHLMC, or close of the underw riting period, or GNMA). purchasing from the section 20 Proposal. The Board proposed to subsidiary any bank-ineligible security rescind this firewall. in w hich the section 20 subsidiary Final action. The Board is rescinding makes a market. this firewall. NASD Rule 2720 already Proposal. The Board proposed to imposes substantially the same rescind this firewall. restriction. Rule 2720, to w hich section Final action. The Board is rescinding 20 subsidiaries are subject, provides that this firewall, w hich was intended to if a member of the NASD proposes to prevent a section 20 affiliate from underw rite, participate as a member of selling unattractive issues to its the underw riting syndicate or selling affiliates. In practice, the firewall has group, or otherwise assist in the prevented bank and nonbank distribution of a public offering of its subsidiaries of a bank holding company own or an affiliate’s securities, then subsidiary from obtaining attractive either (1) the securities m ust be rated by issues underw ritten or dealt in by a a qualified, independent rating agency, section 20 affiliate. Other restrictions (2) the price or yield of the issue m ust provide sufficient protection to the be set by a qualified independent bank. As noted above w ith respect to underw riter w ho shall also participate Firewall 18, section 23B prohibits a in the preparation of the registration bank from purchasing any security for statement and prospectus, offering w hich a section 20 affiliate is a circular, or similar document, exercising principal underw riter during the due diligence, or (3) in the case of existence of the underw riting or selling equity securities only, there m ust be an syndicate, unless such a purchase has independent market in the security. The been approved by a majority of the Board has concluded that this bank’s board of directors who are not protection is sufficient in the bank officers of the bank or any affiliate. holding company context. Section 23B also requires purchases to be on market terms, and section 23A Firewall 21(a) (Prohibition on Extensions of Credit to Section 20 w ill apply if the bank purchases the security as principal directly from the Subsidiary) section 20 affiliate. The bank w ould also Existing firewall. Requires a bank be required to hold capital against these holding company to ensure that no bank exposures. Moreover, member banks are subsidiary extends credit in any m anner lim ited to purchasing only investment securities, generally investm ent grade 36J.P. M organ & Co., 76 F e d e ra l R eserve B u lle tin debt where compliance w ith section 26, 28 (1990). 37 E x e m p tio n fo r th e A c q u is itio n o f S e c u ritie s 23B w ill be readily determ inable.35 D urin g th e E x iste n c e o f a n U n derw riting or S e llin g Finally, since 1989, the Board has S y n d ic a te, SEC In v e stm e n t C o m p an y A ct R elease authorized bank holding companies N o. 22775 (July 31, 1997). In a d d itio n to lim itin g engaged in private placem ent activities th e a m o u n t o f s u c h p u rc h a se s, th e SEC re q u ire s th a t th e sec u rities b e p u rc h a s e d “ p rio r to th e e n d o f th e to place up to 50 percent of an issue of first day o n w h ic h a n y sales are m a d e , at a p rice securities w ith their nonbank affiliates th a t is n o t m o re th a n th e p ric e p a id b y e ac h o th e r and no supervisory concerns have p u rc h a s e r of s ec u rities in th a t offering or in an y 3415 U.S.C. 80a— 8 0 a -1 7 . 10, 3512 U.S.C. 24 (Seventh), 335. c o n c u rre n t offering o f th e s e c u ritie s .” T his s ta n d a rd is a k in to th e m a rk e t-te rm s re q u ire m e n t o f sec tio n 23B of th e F e d e ra l R eserve Act. 45304 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations to an affiliated underw riting subsidiary or a subsidiary thereof, or issues a guarantee, acceptance, or letter of credit for the benefit of a section 20 affiliate or a subsidiary thereof. Proposal. The Board proposed to rescind this restriction except insofar as it applies to intra-day extensions of credit for clearing purposes, requiring that such intra-day extensions of credit be: (1) on market terms consistent with section 23B of the Federal Reserve Act, and (2) fully secured, even if the bank’s general policy (and section 23B) does not require the bank to be fully secured in clearing. Final action. The Board is rescinding the blanket prohibition on funding, im posed by this firewall but retaining as Operating Standard #5 the restriction on intra-day funding in modified form. Because the operating standards apply to all section 20 subsidiaries, the Board w ill thereby be imposing this restriction for the first tim e on section 20 subsidiaries operating u nd er the 1987 Order. Commenters strongly supported elim ination of the funding restriction. As for the remaining restriction on intra day credit, several commenters opposed requiring that intra-day credit be fully secured even w hen m arket practice is less stringent. One commenter stressed that such loans are intended to be intra day transactions to finance the purchase of securities, and historically have been extremely low-risk. The commenter argued that the proposed operating standard w ould continue to pu t section 20 companies at a competitive disadvantage to dealers outside of bank holding companies. Finally, the commenter noted that although the Board has previously encouraged clearing banks to obtain collateral to secure daylight overdrafts, it has not required them to obtain collateral. Another commenter asked the Board to clarify that any lim it on intra-day credit for clearing purposes w ould apply only to intra-day overdrafts related to the bank’s clearing of securities trades for the affiliated section 20 company, and not to daylight overdrafts in dem and deposit accounts that an affiliated bank may m aintain as a settlement bank for a section 20 com pany that is a clearing member on an exchange (whether the product being cleared is a security or a commodity.) The commenter also asked the Board to clarify that the proposed standard w ould not apply to intra-day overdrafts in deposit accounts m aintained at an affiliated bank as a settlem ent bank for a section 20 com pany that is engaged in clearing futures, options on futures, options traded on a nationally recognized securities exchange as a futures commission m erchant or as a broker-dealer. Lastly, the comm enter asked the Board to clarify w hether removal of the funding firewall w ould allow a bank lending securities to a section 20 affiliate to issue a guarantee or indem nity to protect its customers against losses in the event of the section 20 com pany’s nonperformance. The Board is rescinding the general prohibition on funding.38 A bank’s funding of an affiliate w ill continue to be lim ited by sections 23A and 23B of the Federal Reserve Act. Thus, a bank w ill be subject to the quantitative limitations of section 23A, w ill have to deal w ith the section 20 affiliate on market terms, w ill be prohibited from purchasing low-quality assets from the affiliate, and w ill be prohibited from purchasing securities underw ritten by a section 20 affiliate during the existence of the underw riting or selling syndicate unless a majority of the bank’s outside board of directors approves. These restrictions have been sufficient w ith respect to the fourteen companies operating under the 1987 Order that have not been subject to this firewall. The Board w ill continue to prohibit intra-day extensions of credit for clearing or other purposes unless they are on market terms consistent w ith section 23B of the Federal Reserve Act. In effect, the Board is requiring that the bank apply to a section 20 affiliate the same internal exposure limits and collateral requirem ents for intra-day credit that it applies to third parties. The Board believes that the application of section 23B to all intra-day extensions of credit to a section 20 affiliate is appropriate to ensure that such credit is not subsidizing the activities of the section 20 affiliate to the detrim ent of the bank and the section 20 affiliate’s competitors. However, the Board w ill not require that intra-day extensions of credit be fully secured w hen market practice does not. Finally, the operating standard being adopted by the Board applies sections 23A and 23B of the Federal Reserve Act to U.S. branches and agencies of foreign banks for purposes of extensions of credit to a section 20 affiliate. Under the current firewall, lending to a section 20 affiliate by a U.S. branch and agency of a foreign bank is prohibited, as is lending by a U.S. bank.39 Elim ination of the firewall and adoption of this operating standard will liberalize the funding restriction for U.S. branches and agencies of foreign banks to the same extent that the restriction is liberalized for U.S. banking organizations. Commenters sought clarification on how certain provisions of sections 23A and 23B w ould apply to U.S. branches and agencies of foreign banks. In applying the quantitative limitations of sections 23A and 23B, a U.S. branch or agency of a foreign bank shall refer to the capital of its foreign bank parent as calculated under its home country capital standards if the home country supervisor of the foreign bank has adopted capital standards consistent in all respects w ith the Capital Accord of the Basle Committee on Banking Supervision (Basle Accord). If the home country supervisor has not adopted capital standards consistent in all respects w ith the Basle Accord, the branch or agency shall refer to the capital of its foreign bank parent as calculated under standards applicable to U.S. banking organizations. Furthermore, in applying the provisions of section 23B that require outside director approval for certain transactions, a foreign bank may, at its option, seek approval for a transaction from a majority of the senior executive officers of the foreign bank w ho are both located outside the U.S. and are not officers or employees of any U.S. branch or agency of the foreign bank. 38 A lth o u g h th e fu n d in g firew a ll w ill p e rm it a b a n k le n d in g sec u rities to issu e a g u a ra n te e or in d e m n ific a tio n in case of a s ec tio n 20 affiliate’s n o n -p e rfo rm a n ce , a n y s u c h tra n s a c tio n w ill be su bject to sec tio n s 23A a n d 23B of th e F ederal R eserve Act. 39 W ith re sp ec t to foreign b a n k s o p e ra tin g u n d e r th e 1990 O rder, th e p ro p o s a l re p re s e n ts re lie f from a re stric tio n . A lth o u g h th is p ro p o s a l w o u ld im p o se n e w re q u ire m e n ts o n foreign b a n k s op e ra tin g u n d e r th e 1987 O rd er, th e B oard sp ec ifica lly re serv ed its rig h t to im p o se n e w re stric tio n s s h o u ld c irc u m stan c e s ch an g e to m a k e s u c h re q u ire m e n ts a p p ro p ria te . See S a n w a B ank, Ltd., 76 F ed e ra l R eserve B u lle tin 568, 570 (1990). 40 61 FR 57679, 57683. Firewall 21(b) Existing firewall. Established an exception to Firewall 21(a) for clearing purposes. Proposal. If Firewall 21(a) were rescinded, the Board proposed to rescind Firewall 21(b) as moot. Final action. The Board is rescinding this firewall. Firewall 22 (Financial Assets Restriction). Existing firew all (as am ended).40 Prohibits a bank (or U.S. branch or agency of a foreign bank) from purchasing for its own account any financial assets of a section 20 affiliate or a subsidiary thereof, or selling from its own account such assets to the section 20 affiliate or a subsidiary thereof. The lim itation does not apply to Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations the purchase and sale of assets having a readily identifiable and publicly available m arket quotation and purchased at that m arket quotation (and therefore exempt from section 23A of the Federal Reserve Act), provided that those assets are not subject to a repurchase or reverse repurchase agreement. Proposal. The Board proposed to rescind this firewall. Final action. The Board is rescinding this firewall, w hich was designed to prevent a bank from using purchases and sales as a means of evading Firewall 21 and indirectly funding a section 20 affiliate. The same protections on w hich the Board has relied in permitting direct funding w ill still require that all such purchases be m ade on m arket terms, and section 23A of the Federal Reserve Act w ill impose quantitative limits. Section 23A also generally prohibits a bank from purchasing a low-quality asset from an affiliate.41 Moreover, the National Bank Act limits the type of investm ent securities that a national bank may hold, generally to investm ent grade debt securities. Elim ination of this restriction will allow repurchase and reverse repurchase agreements as a funding vehicle between a section 20 subsidiary and its affiliated banks. Such agreements w ould have to be consistent w ith sections 23A and 23B, however, and m arket terms generally require over collateralization w ith government securities. The Board notes that as a safety and soundness matter, it generally emphasizes that section 20 subsidiaries should develop diverse funding sources. Thus, a section 20 company should not rely on repurchase agreements w ith an affiliated bank as its sole funding source. H. Lim itations on Transfers o f Inform ation Firewall 23 (Disclosure of Nonpublic Information) Existing firewall. Prohibits a bank from disclosing to a section 20 affiliate or a section 20 affiliate from disclosing to an affiliated bank, any nonpublic customer information (including an evaluation of the creditw orthiness of an issuer or other customer of that bank, or underw riting subsidiary) w ithout the consent of that customer. Proposal. The Board proposed to include this firewall as an operating standard. Final action. The Board is rescinding this firewall and not adopting the proposed operating standard. Many 4112 U.S.C. 371c(a)(3), (b)(10). commenters objected to retention of this restriction. These commenters argued that although the restriction was initially im plem ented to prevent a section 20 subsidiary from gaining an unfair competitive advantage through access to its affiliated bank’s credit files, it now places section 20 subsidiaries at a competitive disadvantage. Investment banks not affiliated w ith bank holding com panies increasingly have access to financial information of issuers through participation in syndicated and other commercial lending transactions, yet they may share that inform ation w ith their affiliates. These commenters also noted that the restriction is at odds with, and impracticable in light of, the Board’s recent removal of the cross-marketing and dual employee restrictions, w hich w ill entail sharing of nonpublic information. Commenters also contended that existing statutory and regulatory provisions such as the Fair Credit Reporting Act and state consumer privacy statutes are adequate to protect retail customers, and that retention of the restriction w ould im pede customer convenience. Commenters noted that the Board has recently removed restrictions on the sharing of customer information between a bank and an affiliate engaged in providing investm ent advice or full-service brokerage.42 Finally, one commenter noted that many customers, particularly large institutional customers, simply assume the sharing of information w ill occur consistent w ith applicable law. After considering these comments, the Board has decided not to adopt this operating standard, as the chances for a bank holding com pany to gain a competitive advantage or harm a customer through the sharing of inform ation appear to be remote. The Board will continue to monitor this area to determine if abuses do occur. I. Reports Firewall 24 (Reports to Federal Reserve) Existing firewall. Requires bank holding com panies to subm it quarterly to the appropriate Federal Reserve Bank copies of FOCUS reports filed w ith the NASD or other self-regulatory organizations, and detailed information breaking dow n the section 20 subsidiary’s business w ith respect to eligible and bank-ineligible securities. Proposal. The Board proposed to retain this requirem ent in m odified form as one of the operating standards. Final action. The Board is retaining this requirem ent as Operating Standard 42 62 FR 9336 (1997) (a m e n d in g 12 CFR 225.28(b)(7)(i)). 45305 #7, as it wishes the filing of these reports to be a condition of section 20 approval and enforceable as such. /. Transfer o f A ctivities and Formation o f Subsidiaries o f an Underwriting Subsidiary to Engage in Underwriting a nd Dealing Firewall 25 (Scope of Order) Existing firewall. Clarifies that approval of a section 20 application extends only to the subsidiaries for w hich approval has been sought in the instant application. Also prohibits any corporate reorganization w ithout prior Board approval. Proposal. The Board proposed to rescind this firewall. Final action. The Board is rescinding this information, as each order approving section 20 activities makes plain the scope and organizational structure of the activities approved. K. Lim itations on Reciprocal Arrangem ents and Discriminatory Treatm ent Firewall 26 (Prohibition on Reciprocity Arrangements) Existing firewall. Prohibits a bank holding company or any subsidiary from entering into any reciprocity arrangement. A reciprocity arrangement means any agreement, understanding, or other arrangement under w hich one bank holding company (or subsidiary thereof) agrees to engage in a transaction with, or on behalf of, another bank holding company (or subsidiary thereof), in exchange for the agreement of the second bank holding company (or any subsidiary thereof) to engage in a transaction w ith, or on behalf of, the first bank holding com pany (or any subsidiary thereof) for the purpose of evading the firewalls or any prohibition on transactions between, or for the benefit of, affiliates of banks established pursuant to federal banking law or regulation. Proposal. The Board proposed to rescind this firewall. Final action. The Board is rescinding this firewall. Anti-competitive reciprocity arrangements are prohibited by the antitrust laws, and reciprocity arrangements involving a bank are subject to a special per se prohibition in section 106 of the Bank Holding Company Act A m endm ents of 1970 43 The Board w ill rely on the exam ination process to identify any evasions of the proposed operating standards. 4312 U.S.C. 1972(1). 45306 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations Firewall 27 (Prohibition on Discriminatory Treatment) Existing firewall. Prohibits a bank from: (a) Extending or denying credit or services (including clearing services), or varying the terms or conditions thereof, if the effect of such action w ould be to treat an unaffiliated securities firm less favorably than its section 20 affiliate; or (b) Extending or denying credit or services or varying the terms or conditions thereof w ith the intent of creating a competitive advantage for a section 20 affiliate. Proposal. The Board proposed to rescind this firewall. Final action. The Board is rescinding this firewall. This firewall addresses a potential conflict of interest th at arises w hen a bank is dealing w ith competitors of its section 20 affiliate. However, other laws adequately address or dim inish the potential for conflict of interest. First, the Board notes th at whereas securities firms had been restricted by section 8(a) of the Securities Exchange Act of 1934 in the types of lenders from w hich they could obtain loans secured by securities collateral—generally, to banks and other broker-dealers—section 8(a) was recently repealed, and such restriction thereby elim inated.44 Thus, the possibility that a bank w ould be able to enforce unfavorable credit terms on a com petitor of a section 20 affiliate is remote. Second, section 106 of the Bank Holding Company Act A m endm ents of 1970 prohibits a bank from, among other things, restricting the availability of, or offering discounts on, its products on the condition that the customer not obtain products from any com petitor of the bank or its affiliates. L. Requirem ent fo r Supervisory Review Before C om m encem ent o f A ctivities Firewall 28 (Infrastructure Review) Existing firewall. Requires a review of a bank holding com pany’s policies and procedures—including computer, audit and accounting systems, internal risk management controls and the necessary operational and managerial infrastructure—before approval to commence corporate debt and equity underw riting and dealing activities. Proposal. The Board proposed to require an infrastructure review in the context of each application rather than including it as an operating standard for section 20 subsidiaries. Final action. The Board is rescinding the firewall. The Board generally will '“ N a tio n a l S e c u ritie s M ark ets Im p ro v e m e n t A ct o f 1996, Pub. L. 1 0 4 -2 9 0 (1996) (a m e n d in g 15 U.S.C. 7 8 h (a )(1 9 9 5 )). to broker-dealers. In addition, transactions between insured depository institutions and their section 20 affiliates are restricted by sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c and 371c-l). The Board expects a section 20 subsidiary, like any other subsidiary of a bank holding company, to be operated prudently. Doing so w ould include observing corporate formalities (such as the m aintenance of separate accounting and corporate records), and instituting appropriate risk management, including independent trading and exposure limits consistent w ith parent company guidelines. (b) Conditions. As a condition of each order approving establishm ent of a section 20 subsidiary, a bank holding com pany shall comply w ith the following conditions. (1) Capital, (i) A bank holding com pany shall m aintain adequate capital on a fully consolidated basis. If operating a section 20 authorized to List of Subjects 12 CFR Part 225 underw rite and deal in all types of debt Adm inistrative practice and and equity securities, a bank holding procedure, Banks, Banking, Federal com pany shall m aintain strong capital Reserve System, Holding companies, on a fully consolidated basis. (ii) In the event that a bank or thrift Reporting and recordkeeping affiliate of a section 20 subsidiary shall requirements, Securities. become less than well capitalized (as For the reasons set out in the defined in section 38 of the Federal preamble, the Board amends 12 CFR Deposit Insurance Act, 12 U.S.C. 1831o), Part 225 as follows: and the bank holding com pany shall fail PART 225— BANK HOLDING to restore it prom ptly to the well COMPANIES AND CHANGE IN BANK capitalized level, the Board may, in its CONTROL (REGULATION Y) discretion, reimpose the funding, credit extension and credit enhancem ent 1. The authority citation for Part 225 firewalls contained in its 1989 order continues to read as follows: allowing underw riting and dealing in Authority: 12 U.S.C. 1817(j)(13), 1818, bank-ineligible securities,1 or order the 1831i, 1831p— 1843(c)(8), 1844(b), 1972(1), 1, bank holding company to divest the 3106, 3108, 3310, 3 3 31 -3 3 51 , 3907, 3908, section 20 subsidiary. a n d 3909. (iii) A foreign bank that operates a 2. An undesignated center heading branch or agency in the United States and § 225.200 w ould be added to read shall m aintain strong capital on a fully as follows: consolidated basis at levels above the m inim um levels required by the Basle Conditions to Orders Capital Accord. In the event that the §225.200 Conditions to Board’s section 20 Board determines that the foreign bank’s orders. capital has fallen below these levels and (a) Introduction. U nder section 20 of the foreign bank fails to restore its the Glass-Steagall Act (12 U.S.C. 377) capital position prom ptly, the Board and section 4(c)(8) of the Bank Holding may, in its discretion, reim pose the Company Act (12 U.S.C. 1843(c)(8)), a funding, credit extension and credit nonbank subsidiary of a bank holding enhancem ent firewalls contained in its company may to a lim ited extent 1990 order allowing foreign banks to underw rite and deal in securities for underw rite and deal in bank-ineligible w hich underw riting and dealing by a securities,2 or order the foreign bank to member bank is prohibited. Pursuant to divest the section 20 subsidiary. the Securities Act of 1933 and the Securities Exchange Act of 1934, these 1F irew a lls 5 -8 , 19, 21 a n d 22 o f J.P. M organ Sr Co., T h e C hase M a n h a tta n Corp., B a n kers T ru st so-called section 20 subsidiaries are N e w Y o rk C orp., C iticorp, a n d S e c u r ity P acific required to register w ith the SEC as C orp., 75 F e d e ra l R eserve B u lle tin 192, 214— 16 broker-dealers and are subject to all the (1989). financial reporting, anti-fraud and 2F irew a lls 5 -8 , 19, 21 a n d 22 o f C anadian Im p e ria l B a n k o f C om m erce, T h e R o y a l B a n k o f financial responsibility rules applicable continue to conduct an inspection prior to allowing com m encem ent of underw riting and dealing in corporate debt or equity securities pursuant to the 1989 Order. Such inspections now frequently begin shortly after the filing of an application, and may be com pleted before the application is considered by the Board. Thus, the pre com m encem ent examination generally does not create a substantial delay beyond the application processing period. In special cases, such as an acquisition of a going concern, the inspection w ill occur as soon as possible after consummation. For the foregoing reasons, the Board is (1) rescinding conditions 2-20 in its 1987 Order (and any other order incorporating those conditions), conditions 1-28 in its 1989 Order (and any other order incorporating those conditions), and conditions 1-28 in its 1990 Order (and any other order incorporating those conditions). Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations (2) Internal controls, (i) Each bank holding com pany or foreign bank shall cause its subsidiary banks, thrifts, branches or agencies 3 to adopt policies and procedures, including appropriate limits on exposure, to govern their participation in transactions underw ritten or arranged by a section 20 affiliate. (ii) Each bank holding company or foreign bank shall ensure that an independent and thorough credit evaluation has been undertaken in connection w ith participation by a bank, thrift, or branch or agency in such transactions, and that adequate docum entation of that evaluation is m aintained for review by examiners of the appropriate federal banking agency and the Federal Reserve. (3) Interlocks restriction, (i) Directors, officers or employees of a bank or thrift subsidiary of a bank holding company, or a bank or thrift subsidiary or branch or agency of a foreign bank, shall not serve as a majority of the board of directors or the chief executive officer of an affiliated section 20 subsidiary. (ii) Directors, officers or employees of a section 20 subsidiary shall not serve as a majority of the board of directors or the chief executive officer of an affiliated bank or thrift subsidiary or branch or agency, except that the m anager of a branch or agency may act as a director of the underw riting subsidiary. (iii) For purposes of this standard, the manager of a branch or agency of a foreign bank generally w ill be considered to be the chief executive officer of the branch or agency. (4) Customer disclosure—(i) Disclosure to section 20 customers. A section 20 subsidiary shall provide each of its retail customers 4 the same w ritten and oral disclosures, and obtain the same customer acknowledgment, required by the Interagency Statement on Retail Sales of N ondeposit Investm ent Products as if it were a depository institution. (ii) Disclosures accom panying investm ent advice. A director, officer, or employee of a bank, thrift, branch or agency may not express an opinion on the value or the advisability of the purchase or the sale of a bank-ineligible security that he or she knows is being underw ritten or dealt in by a section 20 affiliate unless he or she notifies the custom er of the affiliate’s role. C anada, B arcla ys PLC a n d B arclays B a n k PLC, 76 F e d e ra l R eserve B u lle tin 158, (1990). 3 T h e te rm s “b ra n c h ” a n d “ ag en c y ” re fe r to a U.S. b ra n c h a n d agency of a foreign bank. 4 F or p u rp o s e s o f th is o p e ra tin g s ta n d a rd , a retail c u sto m e r is an y c u sto m e r th a t is n o t a n “ a c c re d ite d in v e sto r” as d e fin e d in 17 CFR 230.501(a). (5) Intra-day credit. Any intra-day extension of credit to a section 20 subsidiary by an affiliated bank, thrift, branch or agency shall be on market terms consistent w ith section 23B of the Federal Reserve Act. (6) Restriction on fu n d in g purchases o f securities during underwriting period. No bank, thrift, branch or agency shall knowingly extend credit to a customer secured by, or for the purpose of purchasing, any bank-ineligible security that a section 20 affiliate is underw riting or has underw ritten w ithin the past 30 days, unless: (i) The extension of credit is made pursuant to, and consistent w ith any conditions im posed in a preexisting line of credit that was not established in contem plation of the underwriting; or (ii) The extension of credit is m ade in connection w ith clearing transactions for the section 20 affiliate. (7) Reporting requirem ent, (i) Each bank holding company or foreign bank shall submit quarterly to the appropriate Federal Reserve Bank any FOCUS report filed w ith the NASD or other selfregulatory organizations, and any information required by the Board to m onitor compliance w ith these operating standards and section 20 of the Glass-Steagall Act, on forms provided by the Board. (ii) In the event that a section 20 subsidiary is required to furnish notice concerning its capitalization to the Securities and Exchange Commission pursuant to 17 CFR 2 4 0 .1 7 a -ll, a copy of the notice shall be filed concurrently w ith the appropriate Federal Reserve Bank. (8) Foreign banks. A foreign bank shall ensure that any extension of credit by its branch or agency to a section 20 affiliate, and any purchase by such branch or agency, as principal or fiduciary, of securities for w hich a section 20 affiliate is a principal underw riter, conforms to sections 23A and 23B of the Federal Reserve Act, and that its branches and agencies not advertise or suggest that they are responsible for the obligations of a section 20 affiliate, consistent with section 23B(c) of the Federal Reserve Act. By o rd e r of th e B oard of G overnors of the F ed eral Reserve System , A u gu st 22, 1997. W illiam W. Wiles, Secretary of the Board. [FR Doc. 9 7 -2 2 8 4 0 F iled 8 -2 6 -9 7 ; 8:45 am] BILLING CODE 6 210 -01 -P 45307
@FedFRASER