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FED ER A L R ESER VE BANK O F NEW YORK [Circular No. 71091 L March 6, 1973 J INTERPRETATION OF REGULATION K To Alt Member Banks, and Others Concerned, in the Second Federal Reserve District: Printed below is an excerpt from the Federal Register o f March 5, containing the text of an interpre tation o f Regulation K, issued February 22 by the Board o f Governors o f the Federal Reserve System. The interpretation provides that foreign subsidiaries o f Edge Act corporations may engage in international joint account arbitrage as an incident to their dealings in securities abroad. Additional copies o f this circular will be furnished upon request. Alfred Hayes, President. Title 12— Banks and Banking CHAPTER II— FEDERAL RESERVE SYSTEM SUBCHAPTER A— BOARD OF GOVERNORS OF TH E FEDERAL RESERVE SYSTEM [Reg. K ] PART 211— CORPORATIONS ENGAGED IN FOREIGN BANKING AND FINANCING UNDER THE FEDERAL RESERVE ACT Dealing in Securities The Board o f Governors has ruled that a foreign subsidiary of an Edge Act cor poration that engages in the business of buying and selling securities outside the United States may participate, as an in cident to that business, in international arbitrage under a joint arrangement with a member firm of the New York Stock Exchange, in accordance with Rule 437 o f the exchange. International arbitrage involves the business of buying and sell ing securities in one market with the intent of reversing such transactions in a market in a country different from that in which the original transaction has taken place, in order to profit from price differences between such markets, and which business is not casual, but contains the element o f continuity. The B oard’s ruling relates to the Edge A ct (section 25(a ) of the Federal Reserve A ct) and the B oard’s Regulation K . It sets forth special restrictions on the fo r eign subsidiary’s participation intended to limit the activity to bona fide arbitrage (b) The foreign subsidiary on whose behalf the inquiry was m ade was a fo r eign bank that is engaged in the business of dealing in securities outside the United States, including securities that are is sued by corporations chartered in the United States and are listed on the New § 2 1 1 .1 0 9 In tern a tion al jo in t a ccou n t York Stock Exchange. The international a rb itrag e in ciden tal to securities b u si arbitrage joint account will be operated ness a b roa d . in accordance with the rules of the New (a) A question has been raised withYork Stock Exchange. The foreign bank the Board as to whether a foreign sub would post to the joint account trans sidiary of a corporation organized under actions executed by it in foreign markets section 25 (a) of the Federal Reserve Act in securities listed on the Exchange. Pur (an Edge corporation) m ay participate chases and sales in foreign markets would with a m em ber firm o f the New York be made primarily from or to foreignStock Exchange in the operation of an owned financial institutions dealing in international arbitrage joint account of securities. The member firm of the E x the kind authorized by rule 437 of the change would execute orders on the E x change reversing those transactions on New York Stock Exchange with permis the same business day, thereby elim inat sion of the Exchange. The Edge corpora tion’s investment in the foreign subsidi ing long or short positions in the joint ary was made subject to the Board’s account before the end of the New York standard condition that the subsidiary trading day. The foreign bank and the should not engage in any activities that member firm would share equally in profits and losses on the operations of would not be permissible if it were a cor the account. poration organized under section 25(a) not “ engaged in banking” within the (c) The question posed involves an in m ean in g of § 211.2(d) of this part (reg terpretation of paragraph 10 of section ulation K ) . For the reasons hereinafter 25 (a ) and § 211.5(b) of regulation K . stated, the Board believes that, under Paragraph 10 of section 25(a ) prohibits appropriate conditions, such participa an Edge corporation from carrying on tion in an international arbitrage account any part of its business in the United is not prohibited by either section 25(a) States except such as, in the B oard’s of the Federal Reserve Act or regulation judgm ent, shall be incidental to its in K. ternational or foreign business. (W ith incidental to a foreign securities busi ness, as well as special reporting require m ents to monitor activities undertaken pursuant to such ruling. T o publish its ruling, the Board has issued the follow ing interpretation: (Over) regard to the permissible operations of foreign subsidiary of an Edge corpora tion in an international arbitrage joint foreign subsidiaries of Edge corporations, the effect of paragraph 10, under the account, as described above, with a mem Board’s standard condition mentioned ber firm of the New York Stock Exchange above, is to duplicate the prohibition con would not place that foreign subsidiary in the business of selling or distributing se tained in paragraph 8 of section 25(a) curities in the United States, or involve against investment by an Edge corpora it in carrying on any part of its business tion in any corporation transacting any business in the United States except such in the United States except such as may as, in the Board’s judgment, may be inci be incidental to its international or for dental to its international or foreign eign business, if the account is operated business.) Section 211.5(b) of regulation subject to the following restrictions: (1) K prohibits an Edge corporation, with Transactions in the United States shall certain exceptions not material to this be confined to those that reverse prior ruling, from engaging in the business of transactions initiated in foreign markets, selling or distributing securities in the (2) purchases and sales of securities out United States or underwriting any por side the United States shall be made only from or to foreign residents not con tion thereof so sold or distributed. (d) International arbitrage involvestrolled by any U.S. company, (3) trans engaging in the business of buying or actions shall be confined to bona fide ar selling securities in one market with the bitrage as defined for purposes of rule 437 intent of reversing such transactions in of the New York Stock Exchange, (4) the a market in a country different from that joint account shall be regularly settled in which the original transaction has betwe'en the participants at no greater taken place, in order to profit from price than quarterly intervals, and (5) in no differences between such markets. In the event will orders be placed for the joint account in securities being underwritten Boards’ judgment, the participation by by the foreign subsidiary. Under such circumstances, the Board is of the opin ion that a foreign subsidiary of an Edge corporation may engage in international joint account arbitrage as an incident to its dealings in securities outside the United States consistently with section 25(a) and regulation K. (e) Full information concerning the volume and the nature of the transac tions in such an account and enabling as sessment of compliance with the forego ing restrictions shall be available and will be reviewed during examinations of an Edge corporation whose foreign subsid iary participates in an international ar bitrage joint account. Such information shall be retained in the Edge corpora tion’s records for at least 3 years after such transactions are executed. [Interprets and applies 12 U.S.C. 015] By order of the Board of Governors of the Federal Reserve System, February 22, 1973.
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