32768 Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 / Proposed Rules

depository institution either will be

using a credit transaction to direct

money to its affiliates in violation of

section 23A or will ease its credit

standards to benefit its affiliate.

The Board also believes that the

proposed exemptions from section 23A

are consistent with the public interest.

The two exemptions would provide

greater convenience to customers to gain

more flexible use of the services of

insured depository institutions and their

registered broker-dealer affiliates, while

still ensuring that the safety and

soundness concerns of section 23A are

met. In addition, the exemption that

applies to pre-existing lines of credit

would alleviate the compliance burdens

associated with applying section 23A to

extensions of credit that were not made

in contemplation of a purchase of

securities from a depository institution’s

section 20 affiliate.

Regulatory Flexibility Act Analysis

The Board certifies that adoption of

this proposal is not expected to have a

significant economic impact on a

substantial number of small business

entities within the meaning of the

Regulatory Flexibility Act (5 U.S.C. 601

et seq.). Many small bank holding

companies do not have registered

broker-dealer affiliates. Many small

banking organizations, therefore, would

not be affected by the proposed rule.

In addition, the proposed rule would

create an exemption from section 23A of

the Federal Reserve Act for bank

holding companies and insured

depository institutions that have

registered broker-dealer affiliates.

Accordingly, the proposal may be

expected to alleviate (rather than

increase) compliance for affected small

bank holding companies and their

affiliates.

Paperwork Reduction Act

The Board has determined that the

proposed rules do not involve the

collection of information pursuant to

the provisions of the Paperwork

Reduction Act of 1995, 44 U.S.C. 3501

et seq.

List of Subjects in 12 CFR Part 250

Federal Reserve System.

For the reasons set forth in the

preamble, the Board proposes to amend

12 CFR part 250 as follows:

PART 250—MISCELLANEOUS

INTERPRETATIONS

1. The authority citation for part 250

continues to read as follows:

Authority: 12 U.S.C. 78, 248(i) and 371c(e).

2. Section 250.244 is added to read as

follows:

§ 250.244 Exemption from section 23A of

the Federal Reserve Act for certain loans

and extensions of credit made by an

insured depository institution to a third

party to purchase securities from an

affiliate.

(a) Section 23A of the Federal Reserve

Act (12 U.S.C. 371c) shall not apply to

a loan or extension of credit by an

insured depository institution to any

person other than an affiliate if—

(1) The terms of the loan or extension

of credit are consistent with safe and

sound banking practices; and

(2) The proceeds of the loan or

extension of credit are used to purchase

securities through an affiliate that is a

broker-dealer registered with the

Securities and Exchange Commission,

where

(i) The affiliate is acting solely as

broker (but not as principal) in the

securities transaction or as riskless

principal in the securities transaction;

and

(ii) The securities are not issued or

sold by companies that are affiliates of

the insured depository institution.

(b) This grant of exemption is

applicable to a loan or extension of

credit even if a portion of the proceeds

are used by a borrower to pay brokerage

commissions or, in the case of riskless

principal transactions, mark-ups to the

affiliate.

3. Section 250.245 is added to read as

follows:

§ 250.245 Exemption from section 23A of

the Federal Reserve Act for certain

extensions of credit by an insured

depository institution to a third party made

pursuant to a pre-existing line of credit.

Section 23A of the Federal Reserve

Act (12 U.S.C. 371c) shall not apply to

an extension of credit by an insured

depository institution to any person

other than an affiliate if—

(a) The proceeds of the extension of

credit are used to purchase securities

from or through an affiliate that is a

registered broker-dealer; and

(b) The extension of credit is made

pursuant to, and consistent with any

conditions imposed in, a pre-existing

line of credit that was not established in

contemplation of the purchase of

securities from or through an affiliate.

By order of the Board of Governors of the

Federal Reserve System, June 10, 1998.

Jennifer J. Johnson,

Secretary of the Board.

[FR Doc. 98–15934 Filed 6–15–98; 8:45 am]

BILLING CODE 6210–01–P

FEDERAL RESERVE SYSTEM

12 CFR Part 250

[Miscellaneous Interpretations; Docket R–

1015]

Applicability of Section 23A of the

Federal Reserve Act to the Purchase of

Securities From Certain Affiliates

AGENCY: Board of Governors of the

Federal Reserve System.

ACTION: Notice of proposed rulemaking.

SUMMARY: Section 23A of the Federal

Reserve Act restricts the ability of a

member bank to fund its affiliates

through asset purchases, loans, or

certain other transactions (covered

transactions). The Board is proposing to

expand the types of asset purchases that

are eligible for the exemption in section

23A(d)(6), which permits asset

purchases where the assets have a

readily identifiable and publicly

available market quotation. This

proposal would expand the ability of an

insured depository institution to

purchase securities from its registered

broker-dealer affiliates, while still

ensuring that the transactions are

conducted in a manner that is consistent

with safe and sound banking practices.

DATES: Comments must be submitted on

or before July 21, 1998.

ADDRESSES: Comments, which should

refer to Docket No. R–1015, may be

mailed to Jennifer J. Johnson, Secretary,

Board of Governors of the Federal

Reserve System, 20th Street and

Constitution Avenue, N.W.,

Washington, D.C. 20551. Comments

addressed to Ms. Johnson also may be

delivered to the Board’s mail room

between 8:45 a.m. and 5:15 p.m. and to

the security control room outside of

those hours. Both the mail room and the

security control room are accessible

from the courtyard entrance on 20th

Street between Constitution Avenue and

C Street, N.W. Comments may be

inspected in Room MP–500 between

9:00 a.m. and 5:00 p.m. weekdays,

except as provided in § 261.12 of the

Board’s Rules Regarding Availability of

Information.

FOR FURTHER INFORMATION CONTACT:

Pamela G. Nardolilli, Senior Counsel

(202/452–3289) or Satish M. Kini,

Senior Attorney (202/452–3818), Legal

Division; or Molly S. Wassom, Deputy

Associate Director, Banking Supervision

and Regulation (202/452–2305), Board

of Governors of the Federal Reserve

System. For the hearing impaired only,

Telecommunications Device of the Deaf

(TDD), Diane Jenkins (202/452–3254).
Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 / Proposed Rules 32769

1By its terms, section 23A only applies to

member banks. The Federal Deposit Insurance Act

extended the coverage of section 23A to all FDICinsured nonmember banks. 12 U.S.C. 1828(j). The

Financial Institutions Reform, Recovery, and

Enforcement Act of 1989 applies section 23A to

FDIC-insured savings associations. 12 U.S.C. 1468.

2 12 U.S.C. 371c(d)(6). Although such asset

purchases are exempt from the quantitative

restrictions of section 23A, the (d)(6) exemption

requires the bank’s purchase be consistent with safe

and sound banking practices. 12 U.S.C. 371c(a)(4).

3 12 U.S.C. 371c(e)(1).

4 17 CFR 240.15c3–1(c)(11)(i). The SEC defines a

ready market as including a recognized established

securities market in which there exists independent

bona fide offers to buy and sell so that a price

reasonably related to the last sales price or current

bona fide competitive bid and offer quotations can

be determined for a particular security almost

instantaneously and where payment will be

received in settlement of a sale at such price within

a relatively short time conforming to trade custom.

SUPPLEMENTARY INFORMATION:

Background

Restrictions of Section 23A

Section 23A of the Federal Reserve

Act, originally enacted as part of the

Banking Act of 1933, is designed to

prevent the misuse of a member bank’s

resources through ‘‘non-arm’s length’’

transactions with its affiliates.1 Section

23A limits covered transactions between

a member bank and its subsidiaries and

an affiliate to 10 percent of the

institution’s capital stock and surplus,

and limits the aggregate amount of all

transactions between a member bank

and its subsidiaries and all of its

affiliates to 20 percent of capital stock

and surplus. The purchase of assets by

a bank from its affiliates, including

assets subject to repurchase, is included

in the definition of covered transactions

and is subject to the statute’s

quantitative limitation. Section 23A also contains several

exemptions from the statute’s

quantitative and collateral limitations.

One exemption is contained in section

23A(d)(6), which exempts from the

statute’s quantitative limits, a purchase

of an asset that has ‘‘a readily

identifiable and publicly available

market quotation’’ ((d)(6) exemption).2

In addition, section 23A gives the Board

broad authority to issue regulations and

orders as may be necessary to

administer and carry out the purposes of

section 23A.3

In the past, institutions have been

advised that the (d)(6) exemption was

available for the purchase of assets, the

price of which were recorded in widely

disseminated publications that were

readily available to the general public.

Such assets included obligations of the

United States, securities traded on

exchanges, foreign exchange, certain

mutual share funds, and precious

metals. Other marketable assets could

not meet this standard, however.

Proposal

The Board has received several

requests from organizations (Petitioners)

regarding the interpretation of the (d)(6)

exemption. These requests were

prompted, in part, by the Board’s

removal of the section 20 firewalls,

which had prohibited many transactions

between an insured depository

institution and its affiliated section 20

subsidiary. Several Petitioners have

stated that, although the removal of the

firewall was welcomed, section 23A

continues to limit certain transactions

with their section 20 subsidiaries.

Petitioners argue that certain prohibited

transactions do not raise significant

safety and soundness issues and

impedes the efficient operations of the

insured depository institution and the

section 20 affiliate. In particular,

Petitioners were concerned about the

ability of the insured depository

institution to purchase securities under

the (d)(6) exemption because of the

narrow reading that had been imposed

on the exemption, which prevented the

purchase of otherwise marketable assets.

In light of technological and market

changes and to address concerns of the

Petitioners, the Board is proposing to

expand the kind of assets that may be

eligible for the (d)(6) exemption to

include other securities that, although

not so widely traded as to warrant

publication of their activity in

publications of general circulation, are

actively traded and whose price can be

obtained from independent reliable

sources, if the securities are purchased

from a registered broker-dealer. The

Board is proposing that this test can be

met for certain assets that are treated as

having a ‘‘ready market,’’ as defined by

the Securities and Exchange

Commission (SEC), and where such

assets are purchased at publicly

available market quotations from a

registered broker-dealer.4

This ‘‘ready market’’ definition

ensures that a ready, competitive market

exists for that asset. In addition, the

marketability of the asset meets a

standard already used by registered

broker-dealers and that is monitored by

the SEC. Under the SEC net capital

requirements, a registered broker-dealer

must deduct 100 percent of the carrying

value of securities and certain other

assets if there is not a ‘‘ready market’’

for the asset. The purpose of the ready

market test is to identify securities with

a liquid market to ensure that a brokerdealer can liquidate a security and

receive its value. The type of securities

that meet this definition include

obligations of the United States,

including agency-issued securities, as

well as many asset-backed, corporate

debt, and sovereign debt securities.

In addition to meeting the ‘‘ready

market’’ standard, the Board proposes

that any security that is purchased as

exempt under (d)(6) receive an

investment grade rating from a

nationally recognized statistical rating

organization (NRSRO). Ratings that are

stated by an NRSRO to be ‘‘under

review’’ for a possible downgrade to

below investment grade would not be

viewed as ‘‘investment grade for

meeting this requirement.’’

In addition to requiring that a security

have a ready market, the Board believes

that the price of each security must be

established from sources other than the

purchasing bank and its affiliates. Thus,

in addition to demonstrating that the

security has a ready market and is rated

by an NRSRO, the Board believes that

the bank must be able to demonstrate

that the price paid by the bank for the

security was a competitive price that

examiners can verify.

Securities that meet the ‘‘ready

market’’ standard may not always be

verifiable through a widely

disseminated news source, however.

Accordingly, the Board proposes to

allow alternative reliable pricing

sources, such as electronic services from

real-time financial networks that

provide indicative data to determine

that the price that the bank pays is on

market terms. Such pricing services

could be used to qualify a bank’s

purchase from a registered broker-dealer

under the (d)(6) exemption so long as

the bank is able to obtain a quote on the

exact security it wishes to purchase. In

the alternative, if a security was so

thinly traded that a quote from a

‘‘screen’’ or other similar source was not

available, the Board is proposing to

adopt a standard that an insured

depository institution could purchase

the security as an exempt transaction if

the insured depository institution

obtained at least two actual

independent dealer quotes for the

particular security from unaffiliated

registered broker-dealers, which must be

based, in part, on the amount of the

security that the bank proposes to

purchase. The insured depository

institution could purchase the security

from the registered broker-dealer at a

price no higher than the average of the

prices obtained from the unaffiliated

broker-dealers. To assist examiners in

verifying the price paid, documentation

for (d)(6) transactions must be

maintained in the insured depository

institution’s file for five years.

The Board’s proposal would not

allow, however, an insured depository
32770 Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 / Proposed Rules

5For example, if the restriction on the purchase

of an affiliate’s securities is not imposed, an insured

depository institution could purchase the debt

securities of an affiliate without limit, but a

collateralized loan to the affiliate would be limited

to 10 percent of the institution’s capital and

surplus.

6Amendments to Restrictions in the Board’s

Section 20 Orders number 6, 62 F.R. 45295, 45307

(1997) (to be codified at 12 CFR 225.200). A bankineligible security is a security that a member bank

may not deal in or underwrite.

institution to purchase certain securities

under the (d)(6) exemption even if the

proposed criteria are met. The proposed

interpretations would prohibit the

purchase under the (d)(6) exemption of

any securities issued by an affiliate,

which would include the capital stock

of an affiliate, asset-backed securities

issued by an affiliate, of shares of

mutual funds advised by the bank or an

affiliate, unless those instruments are

obligations of the United States or fully

guaranteed by the United States or its

agencies as to principal and interest.

The Board believes that safety and

soundness requires restrictions on an

insured depository institution’s ability

to purchase an affiliate’s securities to

help prevent the unlimited funding of

its affiliates, and the restriction is

consistent with other provisions of

section 23A, which limit the insured

depository institution’s ability to lend to

an affiliate or accept the affiliate’s

securities as collateral.5

In addition, bank-ineligible securities

that are underwritten by an affiliate

would not qualify for the (d)(6)

exemption during the period of the

underwriting or for 30 days thereafter.

This restriction is similar to Operating

Standard 6 that the Board has imposed

on section 20 subsidiaries, which

prohibits an insured depository

institution from extending credit to a

customer secured by, or for the purpose

of purchasing, any bank-ineligible

security that a section 20 affiliate is

underwriting or has underwritten

within the past 30 days.6 The Board

believes that the market value of

securities may be uncertain during the

underwriting period and that the

conflicts of interest that may arise

during the underwriting period cause

enough concern to require this

limitation. Banks, of course, could

continue to buy nonexempt securities

from an affiliate subject to the

quantitative limits of section 23A and

could buy such securities from

unaffiliated parties without any section

23A limit, so long as the purchase was

otherwise authorized by law. In

addition, this interpretation of (d)(6)

does not interfere with the ability of an

insured depository institution to

purchase assets from affiliates other

than the registered broker-dealer so long

as the price of such assets are recorded

in widely disseminated publications

that are readily available to the general

public.

The Board understands that these

criteria are more restrictive than the

criteria proposed by some Petitioners in

their request for the Board’s review of

the (d)(6) exemption. For example, it

has been proposed that if the bank

cannot obtain a quote on the exact

security, the bank should be able to rely

on quotes for ‘‘comparable securities’’—

securities with the same rating and

other similar characteristics—to

determine the correct price and to

permit the bank to exclude the purchase

from its quantitative limits. The

purchase of such securities, which

would be without any type of

quantitative limit if purchased as a

(d)(6) exempt asset, would raise

significant safety and soundness

concerns, however, because it would be

difficult for examiners to verify

compliance with the (d)(6) exemption

requirement that the price paid was

determined by reference to a

competitive market for the security.

Although the Board believes that the

expansion of the types of assets that are

eligible for the (d)(6) exemption is

warranted, the Board believes it is

prudent to limit expansion at this time.

The Board, as part of its review of the

public comments on this proposal, will

consider other suggested pricing

mechanisms if such mechanisms can

meet the statutory standards.

Regulatory Flexibility Act Analysis

The Board certifies that adoption of

this proposal is not expected to have a

significant economic impact on a

substantial number of small business

entities within the meaning of the

Regulatory Flexibility Act (5 U.S.C. 601

et seq.) because most small bank

holding companies and insured

depository institutions do not have

registered broker-dealer affiliates. For

this reason, small bank holding

companies would not be affected by the

proposed rule.

In addition, the proposed rule would

expand the type of transactions that an

insured depository institution may

engage in with its affiliate. Accordingly,

the proposal does not impose more

burdensome requirements on depository

institutions, their holding companies,

and their affiliates than are currently

applicable.

Paperwork Reduction Act

The Board has determined that the

proposal does not involve the collection

of information pursuant to the

provisions of the Paperwork Reduction

Act of 1995, 44 U.S.C. 3501 et seq.

List of Subjects in 12 CFR Part 250

Federal Reserve System.

For the reasons set forth in the

preamble, the Board proposes to amend

12 CFR part 250 as follows:

PART 250—MISCELLANEOUS

INTERPRETATIONS

1. The authority citation for part 250

continues to read as follows:

Authority: 12 U.S.C. 78, 248(i) and 371c(e).

2. Section 250.246 is added to read as

follows:

§ 250.246 Applicability of section 23A of

the Federal Reserve Act to the purchase of

securities by an insured depository

institution.

The purchase of securities by an

insured depository institution from an

affiliate that is a broker-dealer is exempt

under section 23A(d)(6) of the Federal

Reserve Act (12 U.S.C. 317 c(d)(6)) if:

(a) The broker-dealer is registered

with the Securities and Exchange

Commission;

(b) The securities have a ‘‘ready

market,’’ as defined by 17 CFR

240.15c3–1(c)(11)(i);

(c) The securities have received an

investment grade rating from a

nationally recognized statistical rating

organization (NRSRO), and a NRSRO

has not stated that the rating is under

review for a possible downgrade to

below investment grade;

(d) The securities are not purchased

during an underwriting or within 30

days of an underwriting if an affiliate is

an underwriter of the security;

(e) The price paid for the security can

be verified by

(1) A widely disseminated news

source;

(2) An electronic service that provides

indicative data from real-time financial

networks; or

(3) Two or more actual independent

dealer quotes on the exact security to be

purchased, where the price paid is no

higher than the average of the price

quotes obtained from the unaffiliated

broker-dealers;

(f) The securities are not issued by an

affiliate, unless the securities are

obligations of the United States or fully

guaranteed by the United States or its

agencies as to principal and interest.

By order of the Board of Governors of the

Federal Reserve System, June 10, 1998.

Jennifer J. Johnson,

Secretary of the Board.

[FR Doc. 98–15933 Filed 6–15–98; 8:45 am]

BILLING CODE 6210–01–P