Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations 45295

period in the future, if deemed

necessary. The committee wants to

ensure that consistent accounting and

administrative procedures can be

implemented simultaneously in the

future.

There is unanimous committee

support to reduce the time periods

specified for timely payment of

assessments owed by handlers to 30

days of invoice for both types of

inspections.

Currently, the time lapse between the

date the fruit is shipped and the date

assessments are due is between 60–90

days. Handlers normally receive

payment for shipments within 30 days

of shipment. Therefore, the impact of

this action will not be significant as

payments for shipments are normally

received 30–60 days before assessments

are due.

For the 1997–98 season, handlers will

pay assessments of $.0225 per tray or

tray equivalent and have 60 days from

date of invoice for in-line inspected

kiwifruit and have 45 days from date of

invoice for block inspected kiwifruit to

pay their assessments before their

assessments are considered delinquent.

If handlers pay their assessments in a

timely manner, they are not charged the

simple interest rate of 1.5 percent per

month nor the 10 percent late charge.

Under this rule, handlers will have 30

days from the invoice date before their

assessments will be considered

delinquent. This 30-day reduction in the

time period for handlers receiving inline inspection and 15-day reduction in

the time period for handlers receiving

block inspection will have no impact on

handlers who pay their assessments in

a timely manner. Even for those who do

not pay in a timely manner, the impact

will not be significant. For example, if

a handler is delinquent in paying

assessments, a simple interest rate of 1.5

percent interest per month and an

assessment of $.0225 per tray or tray

equivalent will apply. During the peak

month of March 1996, less than 1.6

million trays or tray equivalents were

shipped. This equates to an approximate

average of 26,667 trays for each of the

60 handlers, which when assessed at

$.0225 per tray generates a $600

assessment per handler. If an account is

30 days delinquent, the handler is

charged a 1.5 percent interest charge in

the amount of $9.00 and a 10 percent

late charge in the amount of $60.00 over

the assessment. This action does not

change the interest rate nor the late

charge percentage, but reduces the time

period specified for timely payment to

30 days. If amounts are paid in a timely

manner, no additional charges are

incurred. The majority of assessments

owed by handlers are paid within the

specified time periods.

This change will reduce the

administrative and accounting burden

for handlers and for the committee staff

by making the committee’s and the

commission’s time periods consistent.

While no specific alternatives were

suggested during the public meeting, the

committee’s recommendation and the

rule finalized herein do provide for

built-in alternatives and flexibility.

Allowing the committee to further

revise this time period to a later time

period in the future, if deemed

necessary, will ensure that consistent

accounting and administrative

procedures can be implemented

simultaneously in the future. This rule

will be applied uniformly to all

handlers and was viewed by the

committee as the best solution.

This action will not impose any

additional reporting or recordkeeping

requirements on either small or large

kiwifruit handlers. As with all Federal

marketing order programs, reports and

forms are periodically reviewed to

reduce information requirements and

duplication by industry and public

sector agencies.

The Department has not identified

any relevant Federal rules that

duplicate, overlap or conflict with this

final rule.

In addition, the committee’s meeting

was widely publicized throughout the

kiwifruit industry and all interested

persons were invited to attend the

meeting and participate in committee

deliberations on all issues. Like all

committee meetings, the April 16, 1997,

meeting was a public meeting and all

entities, both large and small, were able

to express views on this issue.

A proposed rule concerning this

action was issued by the Department on

June 30, 1997, and published in the

Federal Register on Monday, July 7,

1997 (62 FR 36231). Copies of the rule

were mailed to all Committee members

and kiwifruit handlers. The rule was

also made available through the Internet

by the Office of the Federal Register. No

comments were received.

After consideration of all relevant

matter presented, including the

information and recommendations

submitted by the committee and other

available information, it is hereby found

that this rule, as hereinafter set forth,

will tend to effectuate the declared

policy of the Act.

It is further found that good cause

exists for not postponing the effective

date of this rule until 30 days after

publication in the Federal Register (5

U.S.C. 553) because this change should

apply to all kiwifruit shipped during the

season. Such shipments can begin as

early as September. Further, handlers

are aware of this rule, which was

recommended at a public meeting. Also,

a 30-day comment period was provided

for in the proposed rule and no

comments were received.

List of Subjects in 7 CFR Part 920

Kiwifruit, Marketing agreements.

For the reasons set forth in the

preamble, 7 CFR part 920 is amended as

follows:

PART 920—KIWIFRUIT GROWN IN

CALIFORNIA

1. The authority citation for 7 CFR

part 920 continues to read as follows:

Authority: 7 U.S.C. 601–674.

2. Section 920.112 is revised to read

as follows:

§ 920.112 Late payments.

Pursuant to § 920.41(a), interest will

be charged at a 1.5 percent monthly

simple interest rate. Assessments for

kiwifruit shall be deemed late if not

received within 30 days of invoice, or

such other later time period as specified

by the committee. A 10 percent late

charge will be assessed when payment

becomes 30 days late. Interest and late

payment charges shall be applied only

to the overdue assessment.

Dated: August 21, 1997.

Robert C. Keeney,

Director, Fruit and Vegetable Division.

[FR Doc. 97–22710 Filed 8–26–97; 8:45 am]

BILLING CODE 3410–02–P

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

AGENCY: Board of Governors of the

Federal Reserve System.

ACTION: Final Conditions to Board

Orders.

SUMMARY: The Board is modifying the

prudential limitations established in its

decisions under the Bank Holding

Company Act and section 20 of the

Glass-Steagall Act permitting a nonbank

subsidiary of a bank holding company

to underwrite and deal in securities.

The Board is eliminating those

restrictions that have proven to be

unduly burdensome or unnecessary in

light of other laws or regulations, and
45296 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations

1 12 U.S.C. 377.

2See, e.g., J.P. Morgan & Co. Inc., The Chase

Manhattan Corp., Bankers Trust New York Corp.,

Citicorp, and Security Pacific Corp., 75 Federal

Reserve Bulletin 192 (1989) (hereafter, 1989 Order);

Citicorp, J.P. Morgan & Co., and Bankers Trust New

York Corp., 73 Federal Reserve Bulletin 473 (1987)

(hereafter, 1987 Order); see also Canadian Imperial

Bank of Commerce, The Royal Bank of Canada,

Barclays PLC and Barclays Bank PLC, 76 Federal

Reserve Bulletin 158 (1990) (applying earlier orders

to section 20 subsidiaries of foreign banks)

(hereafter, 1990 Order).

3 12 U.S.C. 4803.

4The other adverse commenter did not address

the proposal but generally opposed the affiliation of

commercial and investment banking.

5The commenter noted that five other restrictions

were being rescinded because they were largely

duplicated by sections 23A and 23B of the Federal

Reserve Act (12 U.S.C. 371c and 371c–1) or other

statutes. The commenter stressed that it supported

elimination so long as eliminating the firewalls did

not change the substance of how transactions could

occur.

consolidating the remaining restrictions

in a series of eight operating standards.

The Board has concluded that the

narrower set of restrictions will be fully

consistent with safety and soundness

and should improve operating

efficiencies at section 20 subsidiaries

and increase options for their

customers.

EFFECTIVE DATE: October 27, 1997.

FOR FURTHER INFORMATION CONTACT:

Gregory Baer, Managing Senior Counsel

(202) 452–3236, Thomas Corsi, Senior

Attorney (202) 452–3275, Legal

Division; Michael J. Schoenfeld, Senior

Supervisory Financial Analyst (202)

452–2781, Division of Banking

Supervision and Regulation; for the

hearing impaired only,

Telecommunications Device for the Deaf

(TDD), Diane Jenkins (202) 452–3544.

SUPPLEMENTARY INFORMATION:

I. Background

Section 20 of the Glass-Steagall Act

prohibits a member bank of the Federal

Reserve System from being affiliated

with a company that is ‘‘engaged

principally’’ in underwriting and

dealing in securities not eligible for

underwriting and dealing by a member

bank.1 Beginning in 1987, the Board has

issued a series of orders authorizing

bank holding companies to establish

‘‘section 20 subsidiaries’’ to engage in

underwriting and dealing within the

limits of the Act.2

In those orders, the Board has

established a series of prudential

restrictions as conditions for approval

under the Bank Holding Company Act.

Most of the firewalls were adopted in

the Board’s initial 1987 Order

authorizing bank holding companies to

underwrite and deal in commercial

paper, municipal revenue bonds,

mortgage-backed securities, and

consumer-receivable-related securities.

Others were added in 1989 when the

Board authorized underwriting and

dealing in all types of debt and equity

securities. The restrictions are designed

to prevent securities underwriting and

dealing risks from being passed from a

section 20 subsidiary to an affiliated

insured depository institution, and thus

to the federal safety net, and to mitigate

the potential for conflicts of interest,

unfair competition, and other adverse

effects that may arise from the affiliation

of commercial and investment banks.

On January 8, 1997, the Board

proposed to rescind many of the

firewalls and consolidate the remainder

in a series of operating standards to be

published in the Code of Federal

Regulations. The proposal was

developed through the Board’s

comprehensive review of its regulations

and written policies that was required

by section 303 of the Riegle Community

Development and Regulatory

Improvement Act of 1994.3 That statute

directs the Board and other banking

agencies to streamline their regulations

to improve efficiency, reduce

unnecessary costs, and eliminate

unwarranted constraints on credit

availability. In the proposal, the Board

stated that in its experience the risks of

securities underwriting and dealing had

proven to be manageable in a bank

holding company framework, and that

bank holding companies and banks had

successfully undertaken and managed

activities posing similar risks for which

no firewalls were erected. The Board

noted that the purposes of the firewalls

are often duplicated by other statutes or

regulations that are more narrowly

tailored to addressing the perceived risk

or conflict.

II. Summary of Comments

The Board received twenty-nine

public comments on its proposal, and

comments were overwhelmingly

favorable. Only two commenters

opposed the Board’s proposed

elimination of firewalls. The remaining

commenters supported the Board’s

proposal, though almost all of those

commenters urged the Board to go

further to rescind all or at least more of

the firewalls.

The comments generally expressed

support for the proposal in a summary

fashion, reserving specific comment for

the four firewalls on which the Board

sought comment and two others that

proved controversial. Those comments

are discussed below in the context of

each relevant firewall.

One trade association representing

community banks expressed concerns

about the proposal.4 The commenter

stated that the Board may be acting too

quickly in eliminating some of the

firewalls and urged a careful approach.

The commenter urged the Board to

retain the requirement that a bank

holding company deduct from its

regulatory capital any investment in a

section 20 subsidiary, arguing that

elimination would allow a bank holding

company to lodge all of its capital (other

than bank capital) at its section 20

subsidiary, which would mean that no

capital would be available at the

holding company level if the holding

company were called upon to serve as

a source of strength to its insured

depository institution subsidiaries. The

commenter also urged the Board to

maintain capital requirements for a

section 20 subsidiary that mirror the net

capital rule of the Securities and

Exchange Commission (SEC), as the SEC

could revise or eliminate its regulation.

The same commenter urged the Board

to retain restrictions on a bank

extending credit to customers of a

section 20 affiliate or offering credit

enhancements for securities

underwritten by the section 20 affiliate.

The commenter urged the Board to

delay final action on the proposal

because one bill pending in Congress

would continue to impose such

restrictions. The commenter also

expressed concern that conflicts of

interest would be present when 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 investment banks are

addressed by general bank and bank

holding company 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

investment bank—the Board has

determined that there are unique risks

of affiliation not addressed by other
Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations 45297

6The only exception is Firewall #1 of the Board’s

1987 Order, which set forth the types of securities

to which companies operating under that order

must limit their underwriting and dealing. 1987

Order at 502–03. That restriction will continue to

apply.

7Footnotes to the orders are omitted. Description

of the firewalls conforms to the 1989 Order. The

Board’s request for comment describes the

differences among the firewalls in the 1989 Order

(allowing debt and equity underwriting), the 1987

Order (allowing underwriting and dealing in only

four types of debt securities), and the 1990 Order

(applicable to foreign banks).

8 62 FR 2622 (Jan. 17, 1997). As with the earlier

notice, references to banks include thrifts. In

addition, to the extent that the operating standards

apply to banks and thrifts, they also apply to the

U.S. branches and agencies of foreign banks. 9 12 CFR 225.4(a)(1).

10 12 U.S.C. 1831o.

11Two commenters opposed this change because

it could lead to a substantial disruption of the

business of a section 20 subsidiary when affiliated

banks experience capital difficulty. However, the

Board would expect to reimpose these restrictions

only if they addressed problems in the organization

or diminished resulting risks to its insured

depository institutions.

laws. The operating standards being

adopted by the Board address those

risks.

Compliance with the operating

standards will 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 summary of

each of the firewalls established in the

Board’s orders; 7 (2) the Board’s proposal

with 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 which it is

based:

Operating standard Firewall

1. Capital requirement for

bank holding company and

section 20 subsidiary.

1, 3 and 4.

2. Internal controls ................. 11.

3. Interlocks restriction ........... 13.

4. Customer disclosure .......... 14.

5. Credit for clearing purposes 21(a) & (b).

6. Funding of securities purchases from a section 20

affiliate.

6.

7. Reporting requirement ....... 24.

8. Application of sections 23A

and 23B to foreign banks.

21(a).

Those wishing 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

IV. Analysis of Each Firewall

A. Capital Adequacy 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 maintain adequate

capital after deducting (1) any

investment 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 manner and to the same extent as

would be required under section 23A(c)

of the Federal Reserve Act (Firewall

1(b)).

Proposal. The Board proposed to

rescind the capital deduction required

by this firewall, but retain the

requirement that a bank holding

company maintain adequate capital on

a fully consolidated basis as a condition

for operating a section 20 subsidiary.

Final action. The Board is retaining

the requirement 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 will condition the operation of a

section 20 subsidiary on a bank holding

company’s maintaining adequate

capital.

The Board is eliminating the required

capital deductions. The capital

deductions (and resulting

deconsolidation for regulatory capital

purposes) are inconsistent with

generally accepted accounting

principles (GAAP) and have therefore

created confusion and imposed costs by

requiring bank holding companies to

prepare financial statements on two

bases.

However, as one commenter noted,

elimination of the capital deductions

would 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 upon 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

maintain 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, with the elimination of many

of the firewalls, particularly the funding

and credit enhancement firewalls, a

bank’s potential exposure to its section

20 affiliate will 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

enhancements 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 bank’s capital ratios fell to the

adequately capitalized level (where

prompt 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

immediately to limit the damage.11 The

Board is adopting this proposal but also

conditioning its approval of relief from

the existing firewalls on a requirement

that a bank holding company maintain

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 company failed to recapitalize

it, the Board could order the bank

holding company to divest its section 20

subsidiary. The Board would 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 within 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 maintain 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 maintain capital at

a level that is comparable to that of a
45298 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations

12See 17 CFR 240.17a–11.

13A bank-ineligible security is one that a member

bank is prohibited from underwriting or dealing in

by section 16 of the Glass-Steagall Act. 12 U.S.C.

24(Seventh); 12 U.S.C. 335.

U.S. banking organization, for which

different capital requirements 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 requirement

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

well above the applicable minimums.

Consequently, and in the interests of

national treatment, the Board has

decided that foreign banks should

maintain a strong capital position, above

the minimum levels of the Basle Capital

Accord. The Board believes that this

standard will provide substantial

equivalence in the maintenance 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 company investments 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 submit to the

Board a plan to raise additional capital

or demonstrate that it is strongly

capitalized and will remain so after

making authorized capital adjustments.

Proposal. The Board proposed to

rescind this firewall, which was applied

in the 1989 Order granting authority to

engage in underwriting 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 modified form. The

Board analyzes the capital adequacy,

financial condition, and business plan

of each applicant before approving its

application to engage in underwriting

and dealing pursuant to section 20. The

Board expects that any bank holding

company filing a notice with 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

underwriting and dealing in all types of

debt and equity securities shall also

remain strongly capitalized, and the

Board has not permitted applicants to

commence underwriting and dealing in

all types of debt and equity securities

until they have demonstrated that they

can meet this standard. Accordingly, the

Board is retaining this requirement in

Operating Standard # 1. Consistent with

the discussion above, the Board will

require that the bank holding company

be strongly capitalized on a fully

consolidated basis, and thus will not

deduct from its capital the bank holding

company’s investment in, or extensions

of credit to, its section 20 subsidiary.

Firewall 4 (Capital Adequacy

Requirement)

Existing firewall. Requires a section

20 subsidiary to maintain capital

adequate to support its activities and

cover reasonably expected expenses and

losses in accordance with industry

norms.

Proposal. The Board sought comment

on whether 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

maintain capital above ‘‘early warning’’

levels contained in SEC capital rules.

The purpose of this capital

requirement 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

competitive advantage over other

broker-dealers. The Board has

concluded, however, that the firewall is

not an effective tool for addressing this

concern, primarily because there is no

defined ‘‘industry norm.’’

Although the SEC imposes ‘‘haircut’’

and capital requirements on all brokerdealers (including section 20

subsidiaries), these minimum capital

levels cannot be considered ‘‘industry

norms.’’ Because broker-dealers that fail

to meet SEC minimum capital

requirements are liquidated, and brokerdealers that fall below somewhat higher

‘‘early warning’’ levels are required to

notify the SEC, broker-dealers ordinarily

do not operate near these minimums.

One commenter also explained that

significant underwriters must maintain

capital greatly in excess of SEC

minimums so that they can draw down

on their excess capital when a

significant underwriting arises.

Commenters also stated that any

attempt to determine the ‘‘average’’

capital actually held by the industry (as

opposed to the minimum capital

required by the SEC) and specify it as

the industry norm would 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

must meet capital requirements at the

bank and holding company 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 requirement for section

20 subsidiaries, their ability to leverage

themselves will be constrained.

The Board has decided to require a

section 20 subsidiary to notify the Board

as well as the SEC of any failure to

maintain capital above ‘‘early warning’’

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 will be required to be filed

concurrently with the relevant Federal

Reserve Bank. The Board would then

have the authority to take appropriate

action to maintain safety and

soundness.

B. Credit Extensions to Customers of 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,

indemnity, guarantee, insurance or

other facility that might be viewed as

enhancing the creditworthiness or

marketability of a bank-ineligible

securities issue underwritten or

distributed by the underwriting

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 enhancements in tandem

with a section 20 affiliate, the firewall

hampers the ability of bank holding

companies to serve as full-service
Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations 45299

14 12 U.S.C. 84; 12 CFR 32.2.

15 12 U.S.C. 371c–1(a)(2)(E)(ii).

16 12 U.S.C. 1972(1).

17This operating standard does not apply when

a section 20 subsidiary is acting only as a selling

group member. Although a selling group member

may be engaged in the public sale or distribution

of securities for purposes of the Glass-Steagall Act,

a selling group member is not considered an

underwriter.

18Rule 2110 of the NASD’s Conduct Rules

(Standards of Commercial Honor and Principles of

Trade); Rule 2310 of the NASD’s Conduct Rules

(Recommendations to Customers (suitability));

NYSE Rule 405 (‘‘know your customer’’); SEC Rule

15g–9 (sales practice rules for certain low-price

securities).

19Section 23B applies to ‘‘any transaction or

series of transactions with a third party * * * if an

affiliate is a participant in such transaction or series

of transactions.’’ 12 U.S.C. 371c–1(a)(2)(E).

financial services providers and reduces

options for their customers. For

example, existing corporate customers

of a bank may wish 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

enhancements even though it is the

institution best suited to perform a

credit analysis—and, with smaller

customers, perhaps the only institution

willing to perform a credit analysis. The

bank is precluded from providing a

credit enhancement even if it reached

an independent credit decision prior to

referring the customer to its section 20

affiliate.

Moreover, significant safety and

soundness protections will remain in

the absence of the firewall. First, a bank

will be required to hold capital against

all credit enhancements extended to

customers of its section 20 affiliate—

something that was not the case at the

time the firewall was adopted. Second,

the amount of credit that a bank may

extend to an issuer of securities

underwritten by an affiliated section 20

will be limited by loan-to-one borrower

rules.14 Third, section 23B of the

Federal Reserve Act will require that all

credit enhancements of securities being

underwritten by a section 20 affiliate be

on market terms—that is, the same

terms that would be offered to a third

party of equal creditworthiness.15 Thus,

for example, a bank could not offer such

credit enhancements at less than market

terms, or to customers who were poor

credit risks, in order to generate

underwriting business for a section 20

affiliate. Similarly, section 106 of the

Bank Holding Company Act

Amendments of 1970 would prohibit a

bank from offering discounted credit

enhancements on the condition that an

issuer obtain investment banking

services from a section 20 affiliate.16

Finally, Operating Standard #2,

discussed below, will require that the

bank conduct an independent and

thorough credit evaluation before

offering any credit enhancement in

tandem with a section 20 affiliate, and

maintain documentation of that

evaluation sufficient to allow examiners

to assess compliance with 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

credit to a customer to fund the

purchase of a bank-ineligible security

that is being underwritten by a section

20 subsidiary during the period of the

underwriting or for 30 days thereafter,

or to purchase from the underwriting

subsidiary any bank-ineligible security

in which the underwriting subsidiary

makes a market. The limitation 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 whether existing protections were

sufficient to address the primary

concern of Firewall 6: the possibility

that a bank would extend credit below

market rates in order to induce

customers to purchase securities

underwritten by its section 20 affiliate

or to facilitate its market 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 will be induced by easy

credit into purchasing risky securities,

thereby harming 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

with respect to any extension of credit

during the underwriting 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

which a section 20 affiliate makes a

market.

Commenters supported elimination of

the firewall. Commenters stressed that it

would make little sense for a bank to

expose itself to the losses associated

with unsound loans so that its section

20 affiliate could earn a fraction of those

potential losses on the sale of securities.

One commenter 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 would have been

entered into based on the customer’s

creditworthiness and the value of the

security, not the identity of the

underwriter of any potential securities

purchases, and could also be subject to

the margin requirements imposed by the

Board’s Regulation U. Commenters also

stressed that a section 20 subsidiary, as

a registered broker-dealer, is responsible

under NASD, NYSE, and SEC ‘‘know

your customer’’ and suitability rules for

ensuring that the securities purchased

by a customer are suitable investments

for that particular customer.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

underwriter from extending or arranging

for credit to customers purchasing the

newly issued securities during the

underwriting period and for 30 days

after the underwriting period. Thus, a

section 20 subsidiary acting as

underwriter would be prohibited from

arranging for an affiliated bank to make

loans to customers for purchases during

an underwriting period.

Commenters also noted that section

23B of the Federal Reserve Act would

apply to loans to fund purchases by

customers of securities from a section 20

affiliate during the existence of the

underwriting or selling syndicate, and

to any loan to purchase a security from

the inventory of the section 20 affiliate,

including securities in which the

section 20 affiliate makes a market.19

Section 23B would 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 underwriting

period, when the market 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 when

a bank lends during the underwriting

period or for 30 days thereafter.

However, the Board will 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 contemplation of the purchase of
45300 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations

20 In determining whether the line of credit is

truly preexisting, examiners will consider the

timing of the line of credit and the underwriting,

the conditions imposed on the line of credit, and

whether the line of credit has been used for

purposes other than the purchase of affiliateunderwritten securities. 21 12 U.S.C. 371c(a)(2).

22 12 U.S.C. 371c–1(a)(3).

23 12 U.S.C. 1468(a)(1).

affiliate-underwritten securities,20 and

(2) either the line of credit is

unrestricted or the extension of credit is

clearly consistent with any restrictions

imposed. (For example, if a customer

had a preexisting line of credit limited

to purchases of rated securities, then the

bank would continue to be prohibited

from lending to purchase unrated

securities underwritten by an affiliate.)

The Board has concluded that these

transactions do not present the same

risks as other loans made during an

underwriting. Such lines of credit are

routinely used by institutional and other

sophisticated customers, and are based

on the customer’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 customer 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 affiliateunderwritten securities.

The Board has also concluded that the

potential conflicts of interest associated

with extending securities credit are

lessened, and the protections more

effective, when the section 20 affiliate is

making a secondary market 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

underwriter. Second, especially because

there is generally more than one firm

making a market in a given security,

compliance with the market terms

requirement of section 23B should be

easier to determine than in the

underwriting 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

which a broker-dealer makes a market,

broker-dealers (including section 20

subsidiaries) are already permitted 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 Wall’’

procedures should help to ensure that a

bank lending officer is unaware of the

section 20 affiliate’s market making role.

The Board recognizes that section 23A

of the Federal Reserve Act would apply

to both types of transactions being

exempted from the firewall to the extent

that the proceeds of the transaction

would be ‘‘used for the benefit of, or

transferred to’’ the affiliate.21 Section

23A limits transactions with any one

affiliate to 10 percent of the bank’s

capital, and transactions with 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 amount of such credit but raise

interpretive and compliance questions

concerning how a bank should monitor

compliance with the statute. However,

for the same reasons that the Board has

decided to exempt these transactions

from the firewall, the Board is

considering whether 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 Underwritten

Securities)

Existing firewall. Prohibits a bank

holding company or any of its

subsidiaries from extending credit to an

issuer of bank-ineligible securities

previously underwritten 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

unwise loans to improve the financial

condition of companies whose

securities were underwritten 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 when credit is extended during

the underwriting period, as the financial

and reputational risks to the section 20

affiliate are lessened once the

underwriting is successfully completed.

The firewall also has proven

burdensome and has had unintended

effects. For example, banks face

compliance problems renewing a

company’s revolving line of credit if a

section 20 subsidiary has underwritten

an offering by that company since the

credit was first extended; the bank must

either recruit other lenders to

participate in the renewal or amend the

line of credit in order to specify its

purpose.

Finally, in the absence of this firewall,

section 23B of the Federal Reserve Act

will require that extensions of credit for

the purpose of payment 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 maintenance of necessary

documentary records, to ensure that any

extension of credit by it or any of its

subsidiaries to issuers of bank-ineligible

securities underwritten or dealt in by a

section 20 subsidiary are on an arm’slength basis for purposes other than

payment of principal, interest, or

dividends on the issuer’s bank-ineligible

securities being underwritten or dealt in

by the underwriting 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 with an

issuance of securities underwritten by a

section 20 affiliate to be on market

terms. Although the firewall also

includes extensions of credit by

nonbank subsidiaries, those extensions

of credit do not directly implicate 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

company or any other nonbank lender,

and the Board sees no reason to reverse

that judgment in this context.

Firewall 9 (Restriction on Thrifts)

Existing firewall. Requires thrifts to

observe the limitations of sections 23A

and 23B of the Federal Reserve Act in

any dealings with 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 Owners’ Loan Act has since

been amended to apply sections 23A

and 23B of the Federal Reserve Act to

a thrift as if it were a member bank.23
Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations 45301

24As the Board noted in a recent order, this

limitation does not apply to interlocks between a

section 20 subsidiary and a subsidiary of an

affiliated bank. See Bankers Trust New York, 83

Federal Reserve Bulletin ll (July 21, 1997). 25Federal Reserve Regulatory Service 3–1579.51.

Firewall 10 (Restriction on Industrial

Revenue Bonds)

Existing firewall. Applies the

requirements 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 Documentation 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

underwritten or arranged by a section 20

affiliate. They shall also ensure that loan

documentation is available for review

by the Reserve Banks to ensure that an

independent and thorough credit

evaluation has been undertaken in

connection with bank or thrift

participation in such financing packages

and that such lending complies with the

firewalls and section 23B of the Federal

Reserve Act.

Proposal. The Board proposed to

include this firewall in slightly

amended 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 will thereby be

imposing this restriction for the first

time on section 20 subsidiaries

operating under the 1987 Order.

Several commenters objected to

retention of this requirement as

redundant in view of the current federal

banking agency examination 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

important in light of the risks of

affiliation between 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 companies establish

appropriate policies, procedures, and

limitations regarding exposure of the

holding company on a consolidated

basis to any single customer whose

securities are underwritten or dealt in

by the section 20 subsidiary.

Proposal. The Board sought comment

on whether 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 company with respect to any

one issuer whose securities are

underwritten 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 company is not

exposed unduly to any single issuer.

Bank holding companies have

successfully operated section 20

subsidiaries under the Board’s 1987

Order without being subject to this

requirement. Finally, unlike the banks

for whom exposure limits are required

by Operating Standard #2, bank holding

companies are not federally insured.

C. Limitations to Maintain Separateness

of an Underwriting Affiliate’s Activity

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

bank. 24 Requires the underwriting

subsidiary to have offices separate from

any affiliated bank.

Proposal. The Board proposed no

changes to the interlocks restrictions,

which it recently amended. 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

expense. Second, for sales to retail

customers, the Board intends to rely on

the Interagency Statement on Retail

Sales of Nondeposit Investment

Products, which largely duplicates this

restriction.25 According to the

Interagency Statement, sales or

recommendations of non-deposit

investment 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

elimination of or modifications to the

interlocks restriction, on which 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 with a special disclosure

statement describing the difference

between 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

must also state that securities sold,

offered, or recommended by the

underwriting 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 will be used

to repay outstanding indebtedness to

affiliates.

Proposal. The Board proposed to

amend this firewall to follow the

Interagency Statement on Retail Sales of

Nondeposit 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
45302 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations

26For purposes of this operating standard, a retail

customer is any customer that is not an ‘‘accredited

investor’’ as defined in 17 CFR 230.501(a).

27NASD Notice to Members 96–3, NASD Files

with the SEC Proposed Rule Governing Members

Operating on Bank Premises, (January 1996) and

NASD Notice to Members 97–26, NASD Regulation

Files Amendment to Bank Broker-Dealer Rule (May

1997).

28 1989 Order at 209–210.

29 12 U.S.C. 371c–1(c).

30 61 FR 57679, 57683 (1996).

31Any dual employee engaged in the investment

banking or securities business of an NASD member

must be registered as a representative with the

NASD and comply with its rules. NASD Rule

1031(a), 0115(a). The NASD consistently has taken

the position in published interpretations that it is

improper for a member or a person associated with

a member to make payments of ‘‘finders’’ or referral

fees to third parties who introduce or refer

prospective brokerage customers to the firm, unless

the recipient is registered as a representative of an

NASD member firm. Although the NASD has a

limited exception for ‘‘one-time fees,’’ the exception

does not include fees tied to the completion of a

transaction or the opening of an account.

customers the same disclosures that the

Interagency Statement mandates for

retail customers of banks, even when it

is operating off bank premises. 26 The

disclosures of the Interagency Statement

are only slightly different from those

required by the existing firewall,

however, and the amendment will allow

the same form to be used for both. The

operating standard is narrower than the

firewall it replaces because it no longer

requires disclosures to institutional

customers (who should be aware of

whether 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.

While commenters favored limiting

customer disclosure requirements 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, which

is to prevent customer confusion

regarding whether 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 with 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

will be required only at the time that a

customer opens an account with the

section 20 subsidiary, and therefore

should not be unduly burdensome to

obtain. Thus, this disclosure provides

some benefit at minimal cost. The Board

notes that when it rejected a suggestion

that a section 20 subsidiary be required

to have a different name or logo from a

banking affiliate, it relied in part on the

disclosures that would be given to

customers.28

E. Marketing Activities on Behalf of 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. Investment Advice by Bank/Thrift

Affiliates

Firewall 17 (Expressing an Opinion 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

underwritten or dealt in by a section 20

affiliate unless the bank notifies the

customer that the section 20 affiliate is

underwriting, making a market,

distributing or dealing in the security.

Proposal. The Board proposed to

retain this restriction but sought

comment on whether it should only

prohibit expressing an opinion when

the employee has knowledge of the

affiliate’s role.

Final action. The Board is retaining

this restriction, with a knowledge

requirement added, as Operating

Standard # 4. SEC Rule 10b–10 and

NASD Rule 2250 already require a

broker-dealer to provide written

disclosure to a customer that it is a

market maker in a security at or before

completion 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 would have a

similar financial incentive to give

advice that would benefit its affiliate.

Commenters argued for either

elimination of the firewall or addition of

a knowledge standard. Several

commenters stressed that the existing

firewall essentially requires routine,

widespread disclosure of securitiesrelated information throughout a bank

holding company system in order to

ensure that employees provide the

required disclosure whenever a section

20 affiliate has a role in the transaction.

This approach is fundamentally

inconsistent with the ‘‘Chinese Wall’’

procedures prevalent throughout the

investment banking industry, which

address the same conflict-of-interest

problem by narrowly restricting the flow

of information 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 disseminated to every area in the

holding company 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 requirement with a knowledge

standard added. Thus, when the bank

employee providing the investment

advice knows of a section 20 affiliate’s

role in an underwriting—as might be the

case with a dual employee—the

employee must give the required

disclosure. Regardless of the employee’s

knowledge, the Board notes that any

potential for a conflict of interest is

diminished because any dual employee

is generally prohibited from receiving

compensation for recommending an

affiliate’s securities.31

One commenter asked the Board to

clarify that an opinion on the value of

a security provided by the custodial

department of the bank is not covered.

Rather, the operating standard should be

limited 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 investment advisory
Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations 45303

32 12 U.S.C. 371c–1(b)(1)(B).

33 29 U.S.C. 1002(21), 1104.

34 15 U.S.C. 80a–10, 80a–17.

35 12 U.S.C. 24 (Seventh), 335.

36 J.P. Morgan & Co., 76 Federal Reserve Bulletin

26, 28 (1990).

37Exemption for the Acquisition of Securities

During the Existence of an Underwriting or Selling

Syndicate, SEC Investment Company Act Release

No. 22775 (July 31, 1997). In addition to limiting

the amount of such purchases, the SEC requires that

the securities be purchased ‘‘prior to the end of the

first day on which any sales are made, at a price

that is not more than the price paid by each other

purchaser of securities in that offering or in any

concurrent offering of the securities.’’ This standard

is akin to the market-terms requirement of section

23B of the Federal Reserve Act.

subsidiaries from purchasing, as a

trustee or in any other fiduciary

capacity, for accounts over which they

have investment discretion, bankineligible securities (a) underwritten by

a section 20 affiliate as lead underwriter

or syndicate member during the period

of any underwriting or selling syndicate,

and for a period of 60 days after the

termination thereof, and (b) from the

section 20 affiliate if it makes a market

in that security, unless such purchase is

specifically authorized under the

instrument creating the fiduciary

relationship, by court order, or by the

law of the jurisdiction under which 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)(1)(B) of the Federal Reserve Act

duplicates the restrictions of Firewall 18

when 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 which a section 20 is a

principal underwriter during the

existence of the underwriting 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 must be permitted by the

instrument 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 underwriting 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 when 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 imposed

by ERISA.33 If the purchase is on behalf

of a mutual fund, then sections 10 and

17 of the Investment Company Act of

1940 restrict the ability of the mutual

fund to purchase securities from an

affiliate of the investment advisor.34 The

Board has concluded that these

protections, in addition to state laws,

are sufficient in the bank holding

company context as well.

G. Extensions of Credit and Purchases

and Sales of Assets

Firewall 19 (Restrictions on Purchases

as Principal During Underwriting Period

or From Market Maker)

Existing firewall. Generally prohibits a

bank holding company and any of its

subsidiaries from purchasing, as

principal, bank-ineligible securities that

are underwritten by a section 20

subsidiary during the period of the

underwriting and for 60 days after the

close of the underwriting period, or

purchasing from the section 20

subsidiary any bank-ineligible security

in which the section 20 subsidiary

makes a market.

Proposal. The Board proposed to

rescind this firewall.

Final action. The Board is rescinding

this firewall, which was intended to

prevent a section 20 affiliate from

selling unattractive issues to its

affiliates. In practice, the firewall has

prevented bank and nonbank

subsidiaries of a bank holding company

subsidiary from obtaining attractive

issues underwritten or dealt in by a

section 20 affiliate. Other restrictions

provide sufficient protection to the

bank. As noted above with respect to

Firewall 18, section 23B prohibits a

bank from purchasing any security for

which a section 20 affiliate is a

principal underwriter during the

existence of the underwriting 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 the bank or any affiliate.

Section 23B also requires purchases to

be on market terms, and section 23A

will apply if the bank purchases the

security as principal directly from the

section 20 affiliate. The bank would also

be required to hold capital against these

exposures. Moreover, member banks are

limited to purchasing only investment

securities, generally investment grade

debt where compliance with section

23B will be readily determinable.35

Finally, since 1989, the Board has

authorized bank holding companies

engaged in private placement activities

to place up to 50 percent of an issue of

securities with their nonbank affiliates

and no supervisory concerns have

arisen from this practice.36 The SEC has

recently permitted investment

companies to purchase limited amounts

of securities for which an affiliate is

acting as a principal underwriter.37

Firewall 20 (Restriction on underwriting

and dealing in affiliates’ securities)

Existing firewall (as amended).

Generally prohibits a section 20 affiliate

from underwriting or dealing in any

bank-ineligible securities issued by its

affiliates or representing an interest in,

or secured by, obligations originated or

sponsored by its affiliates, unless they

are (1) rated by an unaffiliated,

nationally recognized statistical rating

organization, or (2) issued or guaranteed

by FNMA, FHLMC or GNMA (or

represent interests in securities issued

or guaranteed by FNMA, FHLMC, or

GNMA).

Proposal. The Board proposed to

rescind this firewall.

Final action. The Board is rescinding

this firewall. NASD Rule 2720 already

imposes substantially the same

restriction. Rule 2720, to which section

20 subsidiaries are subject, provides that

if a member of the NASD proposes to

underwrite, participate as a member of

the underwriting syndicate or selling

group, or otherwise assist in the

distribution of a public offering of its

own or an affiliate’s securities, then

either (1) the securities must be rated by

a qualified, independent rating agency,

(2) the price or yield of the issue must

be set by a qualified independent

underwriter who shall also participate

in the preparation of the registration

statement and prospectus, offering

circular, or similar document, exercising

due diligence, or (3) in the case of

equity securities only, there must be an

independent market in the security. The

Board has concluded that this

protection is sufficient in the bank

holding company context.

Firewall 21(a) (Prohibition on

Extensions of Credit to Section 20

Subsidiary)

Existing firewall. Requires a bank

holding company to ensure that no bank

subsidiary extends credit in any manner
45304 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations

38Although the funding firewall will permit a

bank lending securities to issue a guarantee or

indemnification in case of a section 20 affiliate’s

non-performance, any such transaction will be

subject to sections 23A and 23B of the Federal

Reserve Act.

39With respect to foreign banks operating under

the 1990 Order, the proposal represents relief from

a restriction. Although this proposal would impose

new requirements on foreign banks operating under

the 1987 Order, the Board specifically reserved its

right to impose new restrictions should

circumstances change to make such requirements

appropriate. See Sanwa Bank, Ltd., 76 Federal

Reserve Bulletin 568, 570 (1990).

40 61 FR 57679, 57683.

to an affiliated underwriting 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,

imposed 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

will thereby be imposing this restriction

for the first time on section 20

subsidiaries operating under the 1987

Order.

Commenters strongly supported

elimination of the funding restriction.

As for the remaining restriction on intraday credit, several commenters opposed

requiring that intra-day credit be fully

secured even when market practice is

less stringent. One commenter stressed

that such loans are intended to be intraday transactions to finance the purchase

of securities, and historically have been

extremely low-risk. The commenter

argued that the proposed operating

standard would continue to put 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 limit on intra-day

credit for clearing purposes would

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 demand deposit accounts

that an affiliated bank may maintain as

a settlement bank for a section 20

company 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

would not apply to intra-day overdrafts

in deposit accounts maintained at an

affiliated bank as a settlement bank for

a section 20 company that is engaged in

clearing futures, options on futures,

options traded on a nationally

recognized securities exchange as a

futures commission merchant or as a

broker-dealer. Lastly, the commenter

asked the Board to clarify whether

removal of the funding firewall would

allow a bank lending securities to a

section 20 affiliate to issue a guarantee

or indemnity to protect its customers

against losses in the event of the section

20 company’s nonperformance.

The Board is rescinding the general

prohibition on funding.38 A bank’s

funding of an affiliate will continue to

be limited by sections 23A and 23B of

the Federal Reserve Act. Thus, a bank

will be subject to the quantitative

limitations of section 23A, will have to

deal with the section 20 affiliate on

market terms, will be prohibited from

purchasing low-quality assets from the

affiliate, and will be prohibited from

purchasing securities underwritten by a

section 20 affiliate during the existence

of the underwriting or selling syndicate

unless a majority of the bank’s outside

board of directors approves. These

restrictions have been sufficient with

respect to the fourteen companies

operating under the 1987 Order that

have not been subject to this firewall.

The Board will continue to prohibit

intra-day extensions of credit for

clearing or other purposes unless they

are on market terms consistent with

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 requirements 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

detriment of the bank and the section 20

affiliate’s competitors. However, the

Board will not require that intra-day

extensions of credit be fully secured

when 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 Elimination 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 would 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 with 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 with 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 who are both

located outside the U.S. and are not

officers or employees of any U.S. branch

or agency of the foreign bank.

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 firewall (as amended).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 limitation does not apply to
Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations 45305

41 12 U.S.C. 371c(a)(3), (b)(10).

42 62 FR 9336 (1997) (amending 12 CFR

225.28(b)(7)(i)). 43 12 U.S.C. 1972(1).

the purchase and sale of assets having

a readily identifiable and publicly

available market quotation and

purchased at that market 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, which 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 which

the Board has relied in permitting direct

funding will still require that all such

purchases be made on market terms,

and section 23A of the Federal Reserve

Act will 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

investment securities that a national

bank may hold, generally to investment

grade debt securities.

Elimination 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 would have to be consistent

with sections 23A and 23B, however,

and market terms generally require overcollateralization with 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 with an affiliated bank as its

sole funding source.

H. Limitations on Transfers of

Information

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 creditworthiness of an

issuer or other customer of that bank, or

underwriting subsidiary) without 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

commenters objected to retention of this

restriction. These commenters argued

that although the restriction was

initially implemented 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 with bank holding

companies increasingly have access to

financial information of issuers through

participation in syndicated and other

commercial lending transactions, yet

they may share that information with

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, which

will 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 would impede 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

investment advice or full-service

brokerage.42 Finally, one commenter

noted that many customers, particularly

large institutional customers, simply

assume the sharing of information will

occur consistent with applicable law.

After considering these comments, the

Board has decided not to adopt this

operating standard, as the chances for a

bank holding company to gain a

competitive advantage or harm a

customer through the sharing of

information 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 companies to submit quarterly

to the appropriate Federal Reserve Bank

copies of FOCUS reports filed with the

NASD or other self-regulatory

organizations, and detailed information

breaking down the section 20

subsidiary’s business with respect to

eligible and bank-ineligible securities.

Proposal. The Board proposed to

retain this requirement in modified form

as one of the operating standards.

Final action. The Board is retaining

this requirement as Operating Standard

#7, as it wishes the filing of these

reports to be a condition of section 20

approval and enforceable as such.

J. Transfer of Activities and Formation

of Subsidiaries of an Underwriting

Subsidiary to Engage in Underwriting

and Dealing

Firewall 25 (Scope of Order)

Existing firewall. Clarifies that

approval of a section 20 application

extends only to the subsidiaries for

which approval has been sought in the

instant application. Also prohibits any

corporate reorganization without 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. Limitations on Reciprocal

Arrangements and Discriminatory

Treatment

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 which 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 with, or on behalf of, the

first bank holding company (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 Amendments of 1970.43

The Board will rely on the examination

process to identify any evasions of the

proposed operating standards.
45306 Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations

44National Securities Markets Improvement Act

of 1996, Pub. L. 104–290 (1996) (amending 15

U.S.C. 78h(a)(1995)) .

1Firewalls 5–8, 19, 21 and 22 of J.P. Morgan &

Co., The Chase Manhattan Corp., Bankers Trust

New York Corp., Citicorp, and Security Pacific

Corp., 75 Federal Reserve Bulletin 192, 214–16

(1989).

2Firewalls 5–8, 19, 21 and 22 of Canadian

Imperial Bank of Commerce, The Royal Bank of

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 would 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 with 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 that arises

when a bank is dealing with competitors

of its section 20 affiliate. However, other

laws adequately address or diminish the

potential for conflict of interest. First,

the Board notes that whereas securities

firms had been restricted by section 8(a)

of the Securities Exchange Act of 1934

in the types of lenders from which 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 eliminated.44 Thus, the

possibility that a bank would be able to

enforce unfavorable credit terms on a

competitor of a section 20 affiliate is

remote. Second, section 106 of the Bank

Holding Company Act Amendments 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 competitor of

the bank or its affiliates.

L. Requirement for Supervisory Review

Before Commencement of Activities

Firewall 28 (Infrastructure Review)

Existing firewall. Requires a review of

a bank holding company’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

underwriting 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

continue to conduct an inspection prior

to allowing commencement of

underwriting 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

completed before the application is

considered by the Board. Thus, the precommencement 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 will 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).

List of Subjects 12 CFR Part 225

Administrative practice and

procedure, Banks, Banking, Federal

Reserve System, Holding companies,

Reporting and recordkeeping

requirements, Securities.

For the reasons set out in the

preamble, the Board amends 12 CFR

Part 225 as follows:

PART 225—BANK HOLDING

COMPANIES AND CHANGE IN BANK

CONTROL (REGULATION Y)

1. The authority citation for Part 225

continues to read as follows:

Authority: 12 U.S.C. 1817(j)(13), 1818,

1831i, 1831p–1, 1843(c)(8), 1844(b), 1972(l),

3106, 3108, 3310, 3331–3351, 3907, 3908,

and 3909.

2. An undesignated center heading

and § 225.200 would be added to read

as follows:

Conditions to Orders

§ 225.200 Conditions to Board’s section 20

orders.

(a) Introduction. Under section 20 of

the Glass-Steagall Act (12 U.S.C. 377)

and section 4(c)(8) of the Bank Holding

Company Act (12 U.S.C. 1843(c)(8)), a

nonbank subsidiary of a bank holding

company may to a limited extent

underwrite and deal in securities for

which underwriting and dealing by a

member bank is prohibited. Pursuant to

the Securities Act of 1933 and the

Securities Exchange Act of 1934, these

so-called section 20 subsidiaries are

required to register with the SEC as

broker-dealers and are subject to all the

financial reporting, anti-fraud and

financial responsibility rules applicable

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–1). The Board

expects a section 20 subsidiary, like any

other subsidiary of a bank holding

company, to be operated prudently.

Doing so would include observing

corporate formalities (such as the

maintenance of separate accounting and

corporate records), and instituting

appropriate risk management, including

independent trading and exposure

limits consistent with parent company

guidelines.

(b) Conditions. As a condition of each

order approving establishment of a

section 20 subsidiary, a bank holding

company shall comply with the

following conditions.

(1) Capital. (i) A bank holding

company shall maintain adequate

capital on a fully consolidated basis. If

operating a section 20 authorized to

underwrite and deal in all types of debt

and equity securities, a bank holding

company shall maintain strong capital

on a fully consolidated basis.

(ii) In the event that a bank or thrift

affiliate of a section 20 subsidiary shall

become less than well capitalized (as

defined in section 38 of the Federal

Deposit Insurance Act, 12 U.S.C. 1831o),

and the bank holding company shall fail

to restore it promptly to the well

capitalized level, the Board may, in its

discretion, reimpose the funding, credit

extension and credit enhancement

firewalls contained in its 1989 order

allowing underwriting and dealing in

bank-ineligible securities,1 or order the

bank holding company to divest the

section 20 subsidiary.

(iii) A foreign bank that operates a

branch or agency in the United States

shall maintain strong capital on a fully

consolidated basis at levels above the

minimum levels required by the Basle

Capital Accord. In the event that the

Board determines that the foreign bank’s

capital has fallen below these levels and

the foreign bank fails to restore its

capital position promptly, the Board

may, in its discretion, reimpose the

funding, credit extension and credit

enhancement firewalls contained in its

1990 order allowing foreign banks to

underwrite and deal in bank-ineligible

securities,2 or order the foreign bank to

divest the section 20 subsidiary.
Federal Register / Vol. 62, No. 166 / Wednesday, August 27, 1997 / Rules and Regulations 45307

Canada, Barclays PLC and Barclays Bank PLC, 76

Federal Reserve Bulletin 158, (1990).

3The terms ‘‘branch’’ and ‘‘agency’’ refer to a U.S.

branch and agency of a foreign bank.

4For purposes of this operating standard, a retail

customer is any customer that is not an ‘‘accredited

investor’’ as defined in 17 CFR 230.501(a).

1Section 2(5) of the Home Owners’ Loan Act

defines ‘‘federal savings associations’’ to include

federal savings associations and federal savings

banks. Accordingly, references herein to federal

savings associations include federal savings banks.

2 12 CFR 552.2–7.

3 12 CFR 552.2–6.

(2) Internal controls. (i) Each bank

holding company 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

underwritten 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 with participation by a bank,

thrift, or branch or agency in such

transactions, and that adequate

documentation of that evaluation is

maintained 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

manager of a branch or agency may act

as a director of the underwriting

subsidiary.

(iii) For purposes of this standard, the

manager of a branch or agency of a

foreign bank generally will 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 written

and oral disclosures, and obtain the

same customer acknowledgment,

required by the Interagency Statement

on Retail Sales of Nondeposit

Investment Products as if it were a

depository institution.

(ii) Disclosures accompanying

investment 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

underwritten or dealt in by a section 20

affiliate unless he or she notifies the

customer of the affiliate’s role.

(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 with section 23B of the

Federal Reserve Act.

(6) Restriction on funding purchases

of 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 underwriting

or has underwritten within the past 30

days, unless:

(i) The extension of credit is made

pursuant to, and consistent with any

conditions imposed in a preexisting line

of credit that was not established in

contemplation of the underwriting; or

(ii) The extension of credit is made in

connection with clearing transactions

for the section 20 affiliate.

(7) Reporting requirement. (i) Each

bank holding company or foreign bank

shall submit quarterly to the appropriate

Federal Reserve Bank any FOCUS report

filed with the NASD or other selfregulatory organizations, and any

information required by the Board to

monitor compliance with 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 240.17a–11, a copy

of the notice shall be filed concurrently

with 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 which a

section 20 affiliate is a principal

underwriter, 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 order of the Board of Governors of the

Federal Reserve System, August 22, 1997.

William W. Wiles,

Secretary of the Board.

[FR Doc. 97–22840 Filed 8–26–97; 8:45 am]

BILLING CODE 6210–01–P

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 543

[No. 97–83]

RIN 1550–AB06

Incorporation, Organization, and

Conversion of Federal Mutual

Associations

AGENCY: Office of Thrift Supervision,

Treasury.

ACTION: Final rule.

SUMMARY: The Office of Thrift

Supervision (OTS) is issuing a final rule

amending its regulations governing

conversions to federal mutual savings

associations. The final rule permits the

direct conversion of all types of mutual

depository institutions into federal

mutual savings associations. This final

rule simplifies the conversion process.

EFFECTIVE DATE: August 27, 1997.

FOR FURTHER INFORMATION CONTACT:

David A. Permut, Counsel (Banking and

Finance) Business Transactions Division

(202/906–7505); Scott Ciardi, Senior

Analyst, Corporate Activities Division

(202/906–6960); or Kevin A. Corcoran,

Assistant Chief Counsel for Business

Transactions (202/906–6962), Business

Transactions Division, Chief Counsel’s

Office, Office of Thrift Supervision,

1700 G Street, NW., Washington, D.C.

20552.

SUPPLEMENTARY INFORMATION:

I. Background

The OTS is issuing a final regulation

that permits all types of mutual

depository institutions to convert

directly to a federal mutual savings

association charter.1 The regulation is

consistent with OTS’s long-standing

position that depository institutions

should be free to operate under

whatever charter best suits their

business needs, consistent with safety

and soundness. The OTS previously has

granted federal savings associations

explicit authority to convert directly to

a bank charter,2 and has promulgated

regulations enabling stock depository

institutions to convert directly to a

federal stock savings association

charter.3

The OTS published a notice of

proposed rulemaking regarding direct