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Federal Reserve Bank of Dallas ROBERT D. McTEER, 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 July 6, 1998 Notice 98-58 TO: The Chief Executive Officer of each financial institution and others concerned in the Eleventh Federal Reserve District SUBJECT Request for Public Comment on the Applicability of Section 23A to Loans and Extensions of Credit Made by a Member Bank to a Third Party and the Applicability of Section 23A to the Purchase of Securities From Certain Affiliates DETAILS The Board of Governors of the Federal Reserve System has requested public com ment on a proposal to grant two exemptions from section 23A for certain loans and extensions of credit made by an insured depository institution to customers who use the proceeds to purchase certain securities from or through the depository institution’s registered broker-dealer affiliate. The exemptions would permit customers to gain more flexible use of the services of insured depository institutions and their registered broker-dealer affiliates while still ensuring that the credit transactions are conducted in a manner consistent with safe and sound banking practices. The Board has also requested public comment on expanding the types of asset pur chases eligible for the exemption in section 23A(d)(6), which permits asset purchases where the assets have a readily identifiable and publicly available market quotation. This proposal would expand the ability of an insured depository institution to purchase securities from its registered broker-dealer affiliates while still ensuring that the transactions are conducted in a manner consistent with safe and sound banking practices. The Board must receive comments by July 21, 1998. Please address comments to Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W., Washington, DC 20551. All comments should refer to Docket No. R-1016 (for the first proposal) and Docket No. R-1015 (for the second proposal). 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) ATTACHMENTS Copies of the Board’s notices as they appear on pages 32766-70, Vol. 63, No. 115 of the Federal Register dated June 16, 1998, are attached. MORE INFORMATION For more information, please contact Jane Anne Schmoker at (214) 922-5101. For additional copies of this Bank’s notice, contact the Public Affairs Department at (214) 922-5254. Sincerely yours, Tuesday June 16,1998 0) DC Federal Reserve System 12CFR Part 250 Applicability of Section 23A of the Federal Reserve Act to Loans and Extensions of Credit Made by a Member Bank to a Third Party (Docket No. R-1016) Applicability of Section 23A of the Federal Reserve Act to the Purchase of Securities from Certain Affiliates (Docket No. R-1015) 32766 Proposed Rules Federal Register Vol. 63, No. 115 T u esd ay , Ju n e 16, 1998 Comments must be submitted on more than 20 percent of the bank’s capital and surplus.2 Covered or before July 21,1998. transactions include extensions of ADDRESSES: Comments, which should credit, investments, and certain other refer to Docket No. R-1016, may be mailed to Jennifer J. Johnson, Secretary, transactions that expose the member bank to risk. Section 23A also requires Board of Governors of the Federal that credit exposures to an affiliate be Reserve System, 20th Street and secured by collateral, the amount of Constitution Avenue, N.W., which is statutorily defined.3 Washington, D.C. 20551. Comments In addition to regulating direct addressed to Ms. Johnson also may be transactions between a bank and its delivered to the Board’s mail room affiliates, section 23A deems any between 8:45 a.m. and 5:15 p.m. and to transaction between a member bank and the security control room outside of those hours. Both the mail room and the any person to be a transaction between a member bank and an affiliate to the security control room are accessible extent that the proceeds of the from the courtyard entrance on 20th Street between Constitution Avenue and transaction are “used for the benefit of, or transferred to,” that affiliate.4 This C Street, N.W. Comments may be provision of the statute, commonly inspected in Room MP-500 between referred to as the “attribution rule,” is 9:00 a.m. and 5:00 p.m. weekdays, designed to prevent an evasion of the except as provided in section 261.12 of the Board’s Rules Regarding Availability quantitative limits and collateral requirements of section 23A through the of Information. use of a third party that serves as a FOR FURTHER INFORMATION CONTACT: conduit for the flow of funds from the Thomas M. Corsi, Senior Counsel (202/ 452-3275), Pamela G. Nardolilli, Senior bank to its affiliates.5 Both the Board and Board staff have Counsel (202/452-3289), or Satish M. taken the position that, by means of the Kini, Senior Attorney (202/452-3818), attribution rule, section 23A applies to Legal Division; or Molly S. Wassom, loans made by a bank to a third party, Deputy Associate Director, Banking where the proceeds of the loans are used Supervision and Regulation (202/452to purchase various types of assets from 2305), Board of Governors of the Federal the bank’s affiliate.6 In transactions in Reserve System. For the hearing which a bank provides funds to a impaired only, Telecommunications borrower to finance the purchase of Device for the Deaf (TDD), Diane Jenkins assets from an affiliate of the bank, the (202/452-3254). Board and its staff have been concerned SUPPLEMENTARY INFORMATION: that the affiliate’s need for cash or need DATES: FEDERAL RESERVE SYSTEM 12CFR Part 250 [Miscellaneous Interpretations; Docket R - 1016] Applicability of Section 23A of the Federal Reserve Act to Loans and Extensions of Credit Made by a Member Bank to a Third Party Board of Governors of the Federal Reserve System. ACTION: Notice of proposed rulemaking. AGENCY: SUMMARY: Section 23A of the Federal Reserve Act restricts the ability of a member bank to fund its affiliates through direct investments, loans, or certain other transactions (covered transactions). Section 23A deems transactions between a member bank and a nonaffiliated third party as covered transactions between the bank and its affiliate to the extent that proceeds of the transactions are used for the benefit of or transferred to the affiliate. The Board is proposing to grant two exemptions from section 23A for certain loans and extensions of credit made by an insured depository institution to customers that use the proceeds to purchase certain securities from or through the depository institution’s registered broker-dealer affiliate. The first exemption would apply when the affiliate is acting solely as a broker or riskless principal in the securities transaction. The second exemption would apply when the extension of credit is made pursuant to a pre-existing line of credit that was not established for the purpose of buying securities from or through an affiliate. The Board proposes to grant these exemptions from section 23A to permit customers to gain more flexible use of the services of insured depository institutions and their registered brokerdealer affiliates, while still ensuring that the credit transactions are conducted in a manner that is consistent with safe and sound banking practices. Background Restrictions o f Section 23A Section 23A of the Federal Reserve Act, originally enacted as part of the Banking Act of 1933, is designed to prevent the misuse of a member bank’s resources through “non-arm’s length” transactions with its affiliates.1 To achieve this purpose, section 23A establishes both quantitative limits and qualitative restrictions on transactions by a member bank with its affiliates. The statute places limits on “covered transactions” between a member bank and any single affiliate to no more than 10 percent of the bank’s capital and surplus and limits aggregate covered transactions with all affiliates to no 1 12 U.S.C. 371c. Although section 23A originally applied only to m em ber banks, Congress has since applied the section to insured nonm em ber banks and savings associations in the same m anner as it applies to m em ber banks. See 12 U.S.C. 1828(j); 12 U.S.C. 1468. 2 “Capital and su rp lu s” has been defined by the Board as tier 1 and tier 2 capital plus the balance of an in stitu tio n ’s allowance for loan and lease losses not included in tier 2 capital. 12 CFR 250.242. 312 U.S.C. 371c(c). 4 12 U.S.C. 371c(a)(2). Section 23A defines an affiliate to include “ any com pany that controls the mem ber bank and any other com pany that is controlled by the com pany that controls the mem ber bank.” 12 U.S.C. 371c(b)(l). 5 See A D iscussion o f A m en d m en ts to Section 23A o f the Federal Reserve A c t Proposed by the Board o f Governors o f the Federal Reserve System 36 n .l (September 1981) (attached as an appendix to correspondence from Chairm an Paul Volcker to the Chairm an and Ranking Members of th e House and Senate Committees on Banking, Housing and Urban Affairs, October 2,1981). 6 See, e.g., Letter from J. Virgil M attingly, General Counsel of the Board, to Ms. Charla Jackson (August 26,1996) (crop-production loan to farmer who leases farm land from a bank’s affiliate is covered by section 23A); F.R.R.S. f 3-1146.5 (bank loan to finance a prospective purchaser’s acquisition of an affiliate covered by section 23A); F.R.R.S. *[[ 3 1167.3 (bank loan to finance the purchase of shares issued by an affiliate deem ed a covered transaction subject to section 23A). Federal Register/Vol. 63, No. 115/Tuesday, June 16, 1998/Proposed Rules to sell assets may improperly influence the bank’s decision to extend credit. Section 23A also gives the Board broad authority to grant exemptions from the statute’s restrictions. Specifically, the statute permits the Board to exempt transactions or relationships, by regulation or by order, if such exemptions are “in the public interest and consistent with the purposes of this section.” 7 Section 20 Operating Standards and Application o f Section 23A In August 1997, the Board revised the prudential limitations governing the activities of section 20 subsidiaries of bank holding companies and adopted Operating Standards to replace the existing firewalls.8 One of the firewalls had prohibited a bank holding company and its subsidiaries (other than the underwriting subsidiary) from knowingly extending credit to customers to purchase (a) a bankineligible security underwritten by a section 20 subsidiary during the period of the underwriting or for 30 days thereafter, or (b) a bank-ineligible security in which the section 20 subsidiary makes a market. In place of this firewall, the Board adopted Operating Standard #6, which prohibits a bank from knowingly extending credit to a customer to purchase bank-ineligible securities that a section 20 subsidiary is underwriting or has underwritten within the past 30 days. The Operating Standard, however, allows an extension of credit to be made by a bank to a customer to purchase securities from a section 20 affiliate during the underwriting period, pursuant to a pre-existing line of credit not entered into in contemplation of the purchase of affiliate-underwritten securities. Operating Standard #6 does not otherwise prohibit a bank from lending to a customer to purchase securities from a section 20 affiliate. At the same time that it adopted the Operating Standards, the Board affirmed that section 23A would apply to the types of credit transactions that Operating Standard #6 does not prohibit to the extent that the proceeds of the transactions would be used for the benefit of, or transferred to, an affiliate. Several commenters on the Board’s proposal to adopt the Operating Standards raised concerns about the compliance and economic burdens 712 U.S.C. 371c(e)(2). 8 See 62 FR 45295, 45307 (1997) (codified at 12 CFR 225.200). Section 20 subsidiaries are com panies that underw rite and deal in, to a lim ited extent, bank-ineligible securities. A bank-ineligible security is a security in w hich a m em ber bank may not underw rite or deal. associated with applying section 23A to the extensions of credit now permitted under Operating Standard #6.9 The commenters argued that these burdens would cause banks to avoid making the types of loans permitted by the new Operating Standard, thereby minimizing the practical effect of eliminating the firewall. In response, the Board stated that it would consider whether an exemption from section 23A for those transactions to which the Operating Standard does not apply would be appropriate. Proposal The Board is proposing to grant two exemptions from the quantitative limitations and collateral restrictions of section 23A for certain loans and extensions of credit made by an insured depository institution, the proceeds of which are used to buy securities from a registered broker-dealer affiliate of the depository institution. The first proposed exemption from section 23A would apply when an insured depository institution lends to its customers for the purpose of purchasing third-party securities through a registered broker-dealer affiliate that is acting solely as broker (but not as principal) in the securities transaction with the customer or as riskless principal in the transaction with the customer.10 In such circumstances, the customer would be purchasing securities through the depository institution’s affiliated broker-dealer, which would be acting only on an agency or agency-equivalent basis, and the seller of the securities would be required to be a nonaffiliated thirdparty. The exemption would be applicable even if the broker-dealer affiliate of the insured depository 9 For exam ple, com m enters noted that a bank making a loan for the purchase of securities from its section 20 affiliate w ould need to m onitor (1) w hether the stocks being purchased by its custom ers w ere issues in w hich its section 20 affiliate w as m aking a market, (2) th e appropriate am ount of collateral, (3) the length of tim e the collateral w ould need to be posted, and (4) w hether there was room for the loan u n d er the bank’s section 23A quantitative lim it on covered transactions. 10 “Riskless p rin cip al” is the term used in the securities business to refer to a transaction in w hich a broker-dealer, after receiving an order to b uy (or sell) a security for a customer, purchases (or sells) the security for its own account to offset a contem poraneous sale to (or purchase from) the customer. A broker-dealer acting as a riskless principal is not obligated to buy (or sell) a security for its custom er un til after the broker-dealer executes the offsetting purchase (or sale) for its own account. See, e.g., 12 CFR 225.28(b)(7)(ii); The B ank o f N ew Y ork Company, Inc., 82 Fed. Res. Bull. 748 (1996). Accordingly, riskless principal transaction are an alternative m eans for executing buy or sell orders on behalf of custom ers in a m anner equivalent to an agency transaction. 32767 institution retained part of the loan proceeds as a brokerage commission or, in the case of a riskless principal transaction, a mark-up for effecting the securities transaction. The second proposed exemption would apply to extensions of credit that are made pursuant to a pre-existing line of credit, the proceeds of which are used to purchase securities from or through an affiliate that is a registered-broker dealer. Under the proposed exemption, the extensions of credit must be made by an insured depository institution pursuant to a pre-existing line of credit that (1) was not entered into in contemplation of the purchase of securities from or through an affiliate, and (2) is either unrestricted or the extension of credit is clearly consistent with any restrictions imposed. (For example, if the customer had a pre existing line of credit limited to purchases of rated securities from an unaffiliated party, then the exemption would not apply to an extension of credit used to purchase unrated securities from or through an affiliate.) In determining whether the line of credit is truly pre-existing, examiners will consider the timing of the line of credit, the conditions imposed on the line of credit, and whether the line of credit has been used for purposes other than the purchase of securities from an affiliate. The Board believes that the two proposed exemptions from the restrictions of section 23A are consistent with the purposes of the Federal Reserve Act. The exemptions would pose minimal risk to insured depository institutions. Under the first exemption, there is negligible risk that loans made would be used as a source of funding from an insured depository institution to its affiliates. The exemption may be used only when the depository institution’s broker-dealer affiliate acts as a broker or riskless principal in a securities transaction. Accordingly, the securities being sold through the registered broker-dealer would not be carried in the inventory of the brokerdealer or an affiliate, and the loan proceeds, which would be initially transferred to the affiliate to purchase the securities, would be transferred in turn to the seller of the securities, which also would not be an affiliate of the insured depository institution. The second exemption also presents little opportunity for a depository institution to benefit its affiliates. In circumstances in which there is a pre existing line of credit that has been established for a purpose other than buying securities from or through an affiliate, there is little risk that the 32768 Federal Register/Vol. 63, No. 115/Tuesday, June 16, 1998/Proposed Rules depository institution either will be using a credit transaction to direct money to its affiliates in violation of section 23A or will ease its credit standards to benefit its affiliate. The Board also believes that the proposed exemptions from section 23A are consistent with the public interest. The two exemptions would provide greater convenience to customers to gain more flexible use of the services of insured depository institutions and their registered broker-dealer affiliates, while still ensuring that the safety and soundness concerns of section 23A are met. In addition, the exemption that applies to pre-existing lines of credit would alleviate the compliance burdens associated with applying section 23A to extensions of credit that were not made in contemplation of a purchase of securities from a depository institution’s section 20 affiliate. 2. Section 250.244 is added to read as follows: 12 CFR Part 250 §250.244 Exemption from section 23A of the Federal Reserve Act for certain loans and extensions of credit made by an insured depository institution to a third party to purchase securities from an affiliate. (a) Section 23A of the Federal Reserve Act (12 U.S.C. 371c) shall not apply to a loan or extension of credit by an insured depository institution to any person other than an affiliate if— (1) The terms of the loan or extension of credit are consistent with safe and sound banking practices; and (2) The proceeds of the loan or extension of credit are used to purchase securities through an affiliate that is a broker-dealer registered with the Securities and Exchange Commission, where (i) The affiliate is acting solely as Regulatory Flexibility Act Analysis broker (but not as principal) in the securities transaction or as riskless The Board certifies that adoption of principal in the securities transaction; this proposal is not expected to have a and significant economic impact on a substantial number of small business (ii) The securities are not issued or entities within the meaning of the sold by companies that are affiliates of Regulatory Flexibility Act (5 U.S.C. 601 the insured depository institution. et seq.). Many small bank holding (b) This grant of exemption is companies do not have registered applicable to a loan or extension of broker-dealer affiliates. Many small credit even if a portion of the proceeds banking organizations, therefore, would are used by a borrower to pay brokerage not be affected by the proposed rule. commissions or, in the case of riskless In addition, the proposed rule would principal transactions, mark-ups to the create an exemption from section 23A of affiliate. the Federal Reserve Act for bank 3. Section 250.245 is added to read as holding companies and insured follows: depository institutions that have registered broker-dealer affiliates. § 250.245 Exemption from section 23A of the Federal Reserve Act for certain Accordingly, the proposal may be extensions of credit by an insured expected to alleviate (rather than depository institution to a third party made increase) compliance for affected small pursuant to a pre-existing line of credit. bank holding companies and their affiliates. Section 23A of the Federal Reserve Act (12 U.S.C. 371c) shall not apply to Paperwork Reduction Act an extension of credit by an insured The Board has determined that the depository institution to any person proposed rules do not involve the other than an affiliate if— collection of information pursuant to (a) The proceeds of the extension of the provisions of the Paperwork credit are used to purchase securities Reduction Act of 1995, 44 U.S.C. 3501 from or through an affiliate that is a et seq. registered broker-dealer; and (b) The extension of credit is made List of Subjects in 12 CFR Part 250 pursuant to, and consistent with any Federal Reserve System. conditions imposed in, a pre-existing For the reasons set forth in the line of credit that was not established in preamble, the Board proposes to amend contemplation of the purchase of 12 CFR part 250 as follows: securities from or through an affiliate. PART 250— MISCELLANEOUS INTERPRETATIONS By o rd er of th e B oard of G overnors of th e F e d e ral Reserve System , June 1 0 ,1 9 9 8 . Jennifer J. Johnson, 1. The authority citation for part 250 Secretary o f the Board. continues to read as follows: [FR Doc. 9 8 -1 5 9 3 4 F iled Authority: 12 U.S.C. 78, 248(i) a n d 371c(e). FEDERAL RESERVE SYSTEM BILLING CODE 6210 -01 -P 6 -1 5 -9 8 ; 8:45 am] [Miscellaneous Interpretations; Docket R 1015] Applicability of Section 23A of the Federal Reserve Act to the Purchase of Securities From Certain Affiliates Board of Governors of the Federal Reserve System. ACTION: Notice of proposed rulemaking. AGENCY: Section 23A of the Federal Reserve Act restricts the ability of a member bank to fund its affiliates through asset purchases, loans, or certain other transactions (covered transactions). The Board is proposing to expand the types of asset purchases that are eligible for the exemption in section 23A(d)(6), which permits asset purchases where the assets have a readily identifiable and publicly available market quotation. This proposal would expand the ability of an insured depository institution to purchase securities from its registered broker-dealer affiliates, while still ensuring that the transactions are conducted in a manner that is consistent with safe and sound banking practices. DATES: Comments must be submitted on or before July 21,1998. ADDRESSES: Comments, which should refer to Docket No. R-1015, may be mailed to Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue, N.W., Washington, D.C. 20551. Comments addressed to Ms. Johnson also may be delivered to the Board’s mail room between 8:45 a.m. and 5:15 p.m. and to the security control room outside of those hours. Both the mail room and the security control room are accessible from the courtyard entrance on 20th Street between Constitution Avenue and C Street, N.W. Comments may be inspected in Room MP-500 between 9:00 a.m. and 5:00 p.m. weekdays, except as provided in § 261.12 of the Board’s Rules Regarding Availability of Information. SUMMARY: FOR FURTHER INFORMATION CONTACT: Pamela G. Nardolilli, Senior Counsel (202/452-3289) or Satish M. Kini, Senior Attorney (202/452-3818), Legal Division; or Molly S. Wassom, Deputy Associate Director, Banking Supervision and Regulation (202/452-2305), Board of Governors of the Federal Reserve System. For the hearing impaired only, Telecommunications Device of the Deaf (TDD), Diane Jenkins (202/452-3254). Federal Register/Vol. 63, No. 115/Tuesday, June 16, 1998/Proposed Rules 32769 which had prohibited many transactions including agency-issued securities, as well as many asset-backed, corporate between an insured depository debt, and sovereign debt securities. institution and its affiliated section 20 Restrictions o f Section 23A In addition to meeting the “ready subsidiary. Several Petitioners have market” standard, the Board proposes stated that, although the removal of the Section 23A of the Federal Reserve that any security that is purchased as firewall was welcomed, section 23A Act, originally enacted as part of the exempt under (d)(6) receive an continues to limit certain transactions Banking Act of 1933, is designed to investment grade rating from a with their section 20 subsidiaries. prevent the misuse of a member bank’s Petitioners argue that certain prohibited nationally recognized statistical rating resources through “non-arm’s length” organization (NRSRO). Ratings that are transactions with its affiliates.1 Section transactions do not raise significant stated by an NRSRO to be “under 23A limits covered transactions between safety and soundness issues and review” for a possible downgrade to a member bank and its subsidiaries and impedes the efficient operations of the below investment grade would not be an affiliate to 10 percent of the insured depository institution and the institution’s capital stock and surplus, viewed as “investment grade for section 20 affiliate. In particular, and limits the aggregate amount of all meeting this requirement.” Petitioners were concerned about the In addition to requiring that a security transactions between a member bank ability of the insured depository and its subsidiaries and all of its have a ready market, the Board believes institution to purchase securities under that the price of each security must be affiliates to 20 percent of capital stock the (d)(6) exemption because of the established from sources other than the and surplus. The purchase of assets by narrow reading that had been imposed a bank from its affiliates, including purchasing bank and its affiliates. Thus, on the exemption, which prevented the assets subject to repurchase, is included purchase of otherwise marketable assets. in addition to demonstrating that the in the definition of covered transactions security has a ready market and is rated In light of technological and market and is subject to the statute’s by an NRSRO, the Board believes that changes and to address concerns of the quantitative limitation. the bank must be able to demonstrate Petitioners, the Board is proposing to Section 23A also contains several that the price paid by the bank for the expand the kind of assets that may be exemptions from the statute’s security was a competitive price that eligible for the (d)(6) exemption to quantitative and collateral limitations. examiners can verify. include other securities that, although One exemption is contained in section Securities that meet the “ready not so widely traded as to warrant 23A(d)(6), which exempts from the market” standard may not always be publication of their activity in statute’s quantitative limits, a purchase verifiable through a widely publications of general circulation, are of an asset that has “a readily disseminated news source, however. actively traded and whose price can be identifiable and publicly available Accordingly, the Board proposes to obtained from independent reliable market quotation” ((d)(6) exemption).2 allow alternative reliable pricing sources, if the securities are purchased In addition, section 23A gives the Board from a registered broker-dealer. The sources, such as electronic services from broad authority to issue regulations and Board is proposing that this test can be real-time financial networks that orders as may be necessary to provide indicative data to determine met for certain assets that are treated as administer and carry out the purposes of having a “ready market,” as defined by that the price that the bank pays is on section 23A.3 market terms. Such pricing services the Securities and Exchange In the past, institutions have been could be used to qualify a bank’s Commission (SEC), and where such advised that the (d)(6) exemption was purchase from a registered broker-dealer assets are purchased at publicly available for the purchase of assets, the under the (d)(6) exemption so long as available market quotations from a price of which were recorded in widely the bank is able to obtain a quote on the registered broker-dealer.4 disseminated publications that were This “ready market” definition exact security it wishes to purchase. In readily available to the general public. ensures that a ready, competitive market the alternative, if a security was so Such assets included obligations of the exists for that asset. In addition, the thinly traded that a quote from a United States, securities traded on marketability of the asset meets a “screen” or other similar source was not exchanges, foreign exchange, certain standard already used by registered available, the Board is proposing to mutual share funds, and precious broker-dealers and that is monitored by adopt a standard that an insured metals. Other marketable assets could the SEC. Under the SEC net capital depository institution could purchase not meet this standard, however. requirements, a registered broker-dealer the security as an exempt transaction if must deduct 100 percent of the carrying the insured depository institution Proposal value of securities and certain other obtained at least two actual The Board has received several independent dealer quotes for the requests from organizations (Petitioners) assets if there is not a “ready market” particular security from unaffiliated regarding the interpretation of the (d)(6) for the asset. The purpose of the ready market test is to identify securities with registered broker-dealers, which must be exemption. These requests were a liquid market to ensure that a brokerbased, in part, on the amount of the prompted, in part, by the Board’s dealer can liquidate a security and security that the bank proposes to removal of the section 20 firewalls, receive its value. The type of securities purchase. The insured depository that meet this definition include institution could purchase the security 1By its term s, section 23A only applies to obligations of the United States, from the registered broker-dealer at a m em ber banks. The Federal Deposit Insurance Act extended the coverage of section 23A to all FDICprice no higher than the average of the insured nonm em ber banks. 12 U.S.C. 1828(j). The 4 17 CFR 240.15c3-l(c)(ll)(i). The SEC defines a prices obtained from the unaffiliated Financial Institutions Reform, Recovery, and ready m arket as including a recognized established broker-dealers. To assist examiners in Enforcement Act of 1989 applies section 23A to securities m arket in w hich there exists independent FDIC-insured savings associations. 12 U.S.C. 1468. verifying the price paid, documentation bona fid e offers to buy and sell so that a price 2 12 U.S.C. 371c(d)(6). A lthough such asset for (d)(6) transactions must be reasonably related to the last sales price or current purchases are exem pt from the quantitative bona fid e com petitive bid and offer quotations can maintained in the insured depository restrictions of section 23A, the (d)(6) exem ption be determ ined for a particular security almost institution’s file for five years. requires the b an k ’s purchase be consistent w ith safe instantaneously and w here paym ent w ill be The Board’s proposal would not and sound banking practices. 12 U.S.C. 371c(a)(4). received in settlem ent of a sale at such price w ithin 3 12 U.S.C. 371c(e)(l). allow, however, an insured depository a relatively short tim e conforming to trade custom. SUPPLEMENTARY INFORMATION: Background 32770 Federal Register /Vol. 63, No. 115/Tuesday, June 16, 1998/Proposed Rules institution to purchase certain securities under the (d)(6) exemption even if the proposed criteria are met. The proposed interpretations would prohibit the purchase under the (d)(6) exemption of any securities issued by an affiliate, which would include the capital stock of an affiliate, asset-backed securities issued by an affiliate, of shares of mutual funds advised by the bank or an affiliate, unless those instruments are obligations of the United States or fully guaranteed by the United States or its agencies as to principal and interest. The Board believes that safety and soundness requires restrictions on an insured depository institution’s ability to purchase an affiliate’s securities to help prevent the unlimited funding of its affiliates, and the restriction is consistent with other provisions of section 23A, which limit the insured depository institution’s ability to lend to an affiliate or accept the affiliate’s securities as collateral.5 In addition, bank-ineligible securities that are underwritten by an affiliate would not qualify for the (d)(6) exemption during the period of the underwriting or for 30 days thereafter. This restriction is similar to Operating Standard 6 that the Board has imposed on section 20 subsidiaries, which prohibits an insured depository institution from extending credit to a customer secured by, or for the purpose of purchasing, any bank-ineligible security that a section 20 affiliate is underwriting or has underwritten within the past 30 days.6 The Board believes that the market value of securities may be uncertain during the underwriting period and that the conflicts of interest that may arise during the underwriting period cause enough concern to require this limitation. Banks, of course, could continue to buy nonexempt securities from an affiliate subject to the quantitative limits of section 23A and could buy such securities from unaffiliated parties without any section 23A limit, so long as the purchase was otherwise authorized by law. In addition, this interpretation of (d)(6) does not interfere with the ability of an insured depository institution to purchase assets from affiliates other 5 For exam ple, if the restriction on the purchase of an affiliate’s securities is not im posed, an insured depository institution could purchase the debt securities of an affiliate w ithout lim it, but a collateralized loan to the affiliate w ould be lim ited to 10 percent of the institu tio n ’s capital and surplus. 6 Am endm ents to Restrictions in the B oard’s Section 20 Orders num ber 6, 62 F.R. 45295, 45307 (1997) (to be codified at 12 CFR 225.200). A bankineligible security is a security th at a m em ber bank m ay n ot deal in or underw rite. than the registered broker-dealer so long as the price of such assets are recorded in widely disseminated publications that are readily available to the general public. The Board understands that these criteria are more restrictive than the criteria proposed by some Petitioners in their request for the Board’s review of the (d)(6) exemption. For example, it has been proposed that if the bank cannot obtain a quote on the exact security, the bank should be able to rely on quotes for “comparable securities”— securities with the same rating and other similar characteristics—to determine the correct price and to permit the bank to exclude the purchase from its quantitative limits. The purchase of such securities, which would be without any type of quantitative limit if purchased as a (d)(6) exempt asset, would raise significant safety and soundness concerns, however, because it would be difficult for examiners to verify compliance with the (d)(6) exemption requirement that the price paid was determined by reference to a competitive market for the security. Although the Board believes that the expansion of the types of assets that are eligible for the (d)(6) exemption is warranted, the Board believes it is prudent to limit expansion at this time. The Board, as part of its review of the public comments on this proposal, will consider other suggested pricing mechanisms if such mechanisms can meet the statutory standards. Regulatory Flexibility Act Analysis The Board certifies that adoption of this proposal is not expected to have a significant economic impact on a substantial number of small business entities within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et seq.) because most small bank holding companies and insured depository institutions do not have registered broker-dealer affiliates. For this reason, small bank holding companies would not be affected by the proposed rule. In addition, the proposed rule would expand the type of transactions that an insured depository institution may engage in with its affiliate. Accordingly, the proposal does not impose more burdensome requirements on depository institutions, their holding companies, and their affiliates than are currently applicable. Paperwork Reduction Act The Board has determined that the proposal does not involve the collection of information pursuant to the provisions of the Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq. List o f Subjects in 12 C F R Part 250 Federal Reserve System. For the reasons set forth in the preamble, the Board proposes to amend 12 CFR part 250 as follows: PART 250— MISCELLANEOUS INTERPRETATIONS 1. The authority citation for part 250 continues to read as follows: Authority: 12 U.S.C. 78, 248(i) a n d 371c(e). 2. Section 250.246 is added to read as follows: § 250.246 Applicability of section 23A of the Federal Reserve Act to the purchase of securities by an insured depository institution. The purchase of securities by an insured depository institution from an affiliate that is a broker-dealer is exempt under section 23A(d)(6) of the Federal Reserve Act (12 U.S.C. 317 c(d)(6)) if: (a) The broker-dealer is registered with the Securities and Exchange Commission; (b) The securities have a “ready market,” as defined by 17 CFR 240.15c3—l(c)(ll)(i); (c) The securities have received an investment grade rating from a nationally recognized statistical rating organization (NRSRO), and a NRSRO has not stated that the rating is under review for a possible downgrade to below investment grade; (d) The securities are not purchased during an underwriting or within 30 days of an underwriting if an affiliate is an underwriter of the security; (e) The price paid for the security can be verified by (1) A widely disseminated news source; (2) An electronic service that provides indicative data from real-time financial networks; or (3) Two or more actual independent dealer quotes on the exact security to be purchased, where the price paid is no higher than the average of the price quotes obtained from the unaffiliated broker-dealers; (f) The securities are not issued by an affiliate, unless the securities are obligations of the United States or fully guaranteed by the United States or its agencies as to principal and interest. By o rd er of th e B oard o f G overnors of th e F ed eral R eserve System , Ju ne 1 0 ,1 9 9 8 . Jennifer J. Johnson, Secretary o f the Board. [FR Doc. 9 8-1 5 9 3 3 F iled 6 -1 5 -9 8 ; 8:45 am] BILLING CODE 6210 -01 -P
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