This section of the FEDERAL REGISTER

contains notices to the public of the proposed

issuance of rules and regulations. The

purpose of these notices is to give interested

persons an opportunity to participate in the

rule making prior to the adoption of the final

rules.

Proposed Rules Federal Register

32766

Vol. 63, No. 115

Tuesday, June 16, 1998

1 12 U.S.C. 371c. Although section 23A originally

applied only to member banks, Congress has since

applied the section to insured nonmember banks

and savings associations in the same manner as it

applies to member banks. See 12 U.S.C. 1828(j); 12

U.S.C. 1468.

2 ‘‘Capital and surplus’’ has been defined by the

Board as tier 1 and tier 2 capital plus the balance

of an institution’s allowance for loan and lease

losses not included in tier 2 capital. 12 CFR

250.242.

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

4 12 U.S.C. 371c(a)(2). Section 23A defines an

affiliate to include ‘‘any company that controls the

member bank and any other company that is

controlled by the company that controls the

member bank.’’ 12 U.S.C. 371c(b)(1).

5See A Discussion of Amendments to Section

23A of the Federal Reserve Act Proposed by the

Board of Governors of the Federal Reserve System

36 n.1 (September 1981) (attached as an appendix

to correspondence from Chairman Paul Volcker to

the Chairman and Ranking Members of the House

and Senate Committees on Banking, Housing and

Urban Affairs, October 2, 1981).

6See, e.g., Letter from J. Virgil Mattingly, General

Counsel of the Board, to Ms. Charla Jackson (August

26, 1996) (crop-production loan to farmer who

leases farm land from a bank’s affiliate is covered

by section 23A); F.R.R.S. ¶ 3–1146.5 (bank loan to

finance a prospective purchaser’s acquisition of an

affiliate covered by section 23A); F.R.R.S. ¶ 3–

1167.3 (bank loan to finance the purchase of shares

issued by an affiliate deemed a covered transaction

subject to section 23A).

FEDERAL RESERVE SYSTEM

12 CFR Part 250

[Miscellaneous Interpretations; Docket R–

1016]

Applicability of Section 23A of the

Federal Reserve Act to Loans and

Extensions of Credit Made by a

Member Bank to a Third Party

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 direct investments, loans, or

certain other transactions (covered

transactions). Section 23A deems

transactions between a member bank

and a nonaffiliated third party as

covered transactions between the bank

and its affiliate to the extent that

proceeds of the transactions are used for

the benefit of or transferred to the

affiliate. The Board is proposing to grant

two exemptions from section 23A for

certain loans and extensions of credit

made by an insured depository

institution to customers that use the

proceeds to purchase certain securities

from or through the depository

institution’s registered broker-dealer

affiliate. The first exemption would

apply when the affiliate is acting solely

as a broker or riskless principal in the

securities transaction. The second

exemption would apply when the

extension of credit is made pursuant to

a pre-existing line of credit that was not

established for the purpose of buying

securities from or through an affiliate.

The Board proposes to grant these

exemptions from section 23A to permit

customers to gain more flexible use of

the services of insured depository

institutions and their registered brokerdealer affiliates, while still ensuring that

the credit transactions are conducted in

a manner that is consistent with safe

and sound banking practices.

DATES: Comments must be submitted on

or before July 21, 1998.

ADDRESSES: Comments, which should

refer to Docket No. R–1016, 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 section 261.12 of

the Board’s Rules Regarding Availability

of Information.

FOR FURTHER INFORMATION CONTACT:

Thomas M. Corsi, Senior Counsel (202/

452–3275), 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 for the Deaf (TDD), Diane Jenkins

(202/452–3254).

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 To

achieve this purpose, section 23A

establishes both quantitative limits and

qualitative restrictions on transactions

by a member bank with its affiliates.

The statute places limits on ‘‘covered

transactions’’ between a member bank

and any single affiliate to no more than

10 percent of the bank’s capital and

surplus and limits aggregate covered

transactions with all affiliates to no

more than 20 percent of the bank’s

capital and surplus.2 Covered

transactions include extensions of

credit, investments, and certain other

transactions that expose the member

bank to risk. Section 23A also requires

that credit exposures to an affiliate be

secured by collateral, the amount of

which is statutorily defined.3

In addition to regulating direct

transactions between a bank and its

affiliates, section 23A deems any

transaction between a member bank and

any person to be a transaction between

a member bank and an affiliate to the

extent that the proceeds of the

transaction are ‘‘used for the benefit of,

or transferred to,’’ that affiliate.4 This

provision of the statute, commonly

referred to as the ‘‘attribution rule,’’ is

designed to prevent an evasion of the

quantitative limits and collateral

requirements of section 23A through the

use of a third party that serves as a

conduit for the flow of funds from the

bank to its affiliates.5

Both the Board and Board staff have

taken the position that, by means of the

attribution rule, section 23A applies to

loans made by a bank to a third party,

where the proceeds of the loans are used

to purchase various types of assets from

the bank’s affiliate.6 In transactions in

which a bank provides funds to a

borrower to finance the purchase of

assets from an affiliate of the bank, the

Board and its staff have been concerned

that the affiliate’s need for cash or need
Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 / Proposed Rules 32767

7 12 U.S.C. 371c(e)(2).

8See 62 FR 45295, 45307 (1997) (codified at 12

CFR 225.200). Section 20 subsidiaries are

companies that underwrite and deal in, to a limited

extent, bank-ineligible securities. A bank-ineligible

security is a security in which a member bank may

not underwrite or deal.

9For example, commenters noted that a bank

making a loan for the purchase of securities from

its section 20 affiliate would need to monitor (1)

whether the stocks being purchased by its

customers were issues in which its section 20

affiliate was making a market, (2) the appropriate

amount of collateral, (3) the length of time the

collateral would need to be posted, and (4) whether

there was room for the loan under the bank’s

section 23A quantitative limit on covered

transactions.

10 ‘‘Riskless principal’’ is the term used in the

securities business to refer to a transaction in which

a broker-dealer, after receiving an order to buy (or

sell) a security for a customer, purchases (or sells)

the security for its own account to offset a

contemporaneous sale to (or purchase from) the

customer. A broker-dealer acting as a riskless

principal is not obligated to buy (or sell) a security

for its customer until after the broker-dealer

executes the offsetting purchase (or sale) for its own

account. See, e.g., 12 CFR 225.28(b)(7)(ii); The Bank

of New York Company, Inc., 82 Fed. Res. Bull. 748

(1996). Accordingly, riskless principal transaction

are an alternative means for executing buy or sell

orders on behalf of customers in a manner

equivalent to an agency transaction.

to sell assets may improperly influence

the bank’s decision to extend credit.

Section 23A also gives the Board

broad authority to grant exemptions

from the statute’s restrictions.

Specifically, the statute permits the

Board to exempt transactions or

relationships, by regulation or by order,

if such exemptions are ‘‘in the public

interest and consistent with the

purposes of this section.’’ 7

Section 20 Operating Standards and

Application of Section 23A

In August 1997, the Board revised the

prudential limitations governing the

activities of section 20 subsidiaries of

bank holding companies and adopted

Operating Standards to replace the

existing firewalls.8 One of the firewalls

had prohibited a bank holding company

and its subsidiaries (other than the

underwriting subsidiary) from

knowingly extending credit to

customers to purchase (a) a bankineligible security underwritten by a

section 20 subsidiary during the period

of the underwriting or for 30 days

thereafter, or (b) a bank-ineligible

security in which the section 20

subsidiary makes a market.

In place of this firewall, the Board

adopted Operating Standard # 6, which

prohibits a bank from knowingly

extending credit to a customer to

purchase bank-ineligible securities that

a section 20 subsidiary is underwriting

or has underwritten within the past 30

days. The Operating Standard, however,

allows an extension of credit to be made

by a bank to a customer to purchase

securities from a section 20 affiliate

during the underwriting period,

pursuant to a pre-existing line of credit

not entered into in contemplation of the

purchase of affiliate-underwritten

securities. Operating Standard #6 does

not otherwise prohibit a bank from

lending to a customer to purchase

securities from a section 20 affiliate.

At the same time that it adopted the

Operating Standards, the Board affirmed

that section 23A would apply to the

types of credit transactions that

Operating Standard #6 does not prohibit

to the extent that the proceeds of the

transactions would be used for the

benefit of, or transferred to, an affiliate.

Several commenters on the Board’s

proposal to adopt the Operating

Standards raised concerns about the

compliance and economic burdens

associated with applying section 23A to

the extensions of credit now permitted

under Operating Standard #6.9 The

commenters argued that these burdens

would cause banks to avoid making the

types of loans permitted by the new

Operating Standard, thereby minimizing

the practical effect of eliminating the

firewall. In response, the Board stated

that it would consider whether an

exemption from section 23A for those

transactions to which the Operating

Standard does not apply would be

appropriate.

Proposal

The Board is proposing to grant two

exemptions from the quantitative

limitations and collateral restrictions of

section 23A for certain loans and

extensions of credit made by an insured

depository institution, the proceeds of

which are used to buy securities from a

registered broker-dealer affiliate of the

depository institution. The first

proposed exemption from section 23A

would apply when an insured

depository institution lends to its

customers for the purpose of purchasing

third-party securities through a

registered broker-dealer affiliate that is

acting solely as broker (but not as

principal) in the securities transaction

with the customer or as riskless

principal in the transaction with the

customer.10 In such circumstances, the

customer would be purchasing

securities through the depository

institution’s affiliated broker-dealer,

which would be acting only on an

agency or agency-equivalent basis, and

the seller of the securities would be

required to be a nonaffiliated thirdparty. The exemption would be

applicable even if the broker-dealer

affiliate of the insured depository

institution retained part of the loan

proceeds as a brokerage commission or,

in the case of a riskless principal

transaction, a mark-up for effecting the

securities transaction.

The second proposed exemption

would apply to extensions of credit that

are made pursuant to a pre-existing line

of credit, the proceeds of which are used

to purchase securities from or through

an affiliate that is a registered-broker

dealer. Under the proposed exemption,

the extensions of credit must be made

by an insured depository institution

pursuant to a pre-existing line of credit

that (1) was not entered into in

contemplation of the purchase of

securities from or through an affiliate,

and (2) is either unrestricted or the

extension of credit is clearly consistent

with any restrictions imposed. (For

example, if the customer had a preexisting line of credit limited to

purchases of rated securities from an

unaffiliated party, then the exemption

would not apply to an extension of

credit used to purchase unrated

securities from or through an affiliate.)

In determining whether the line of

credit is truly pre-existing, examiners

will consider the timing of the line of

credit, the conditions imposed on the

line of credit, and whether the line of

credit has been used for purposes other

than the purchase of securities from an

affiliate.

The Board believes that the two

proposed exemptions from the

restrictions of section 23A are consistent

with the purposes of the Federal

Reserve Act. The exemptions would

pose minimal risk to insured depository

institutions. Under the first exemption,

there is negligible risk that loans made

would be used as a source of funding

from an insured depository institution

to its affiliates. The exemption may be

used only when the depository

institution’s broker-dealer affiliate acts

as a broker or riskless principal in a

securities transaction. Accordingly, the

securities being sold through the

registered broker-dealer would not be

carried in the inventory of the brokerdealer or an affiliate, and the loan

proceeds, which would be initially

transferred to the affiliate to purchase

the securities, would be transferred in

turn to the seller of the securities, which

also would not be an affiliate of the

insured depository institution.

The second exemption also presents

little opportunity for a depository

institution to benefit its affiliates. In

circumstances in which there is a preexisting line of credit that has been

established for a purpose other than

buying securities from or through an

affiliate, there is little risk that the
32768 Federal Register / Vol. 63, No. 115 /Tuesday, June 16, 1998 / Proposed Rules

depository institution either will be

using a credit transaction to direct

money to its affiliates in violation of

section 23A or will ease its credit

standards to benefit its affiliate.

The Board also believes that the

proposed exemptions from section 23A

are consistent with the public interest.

The two exemptions would provide

greater convenience to customers to gain

more flexible use of the services of

insured depository institutions and their

registered broker-dealer affiliates, while

still ensuring that the safety and

soundness concerns of section 23A are

met. In addition, the exemption that

applies to pre-existing lines of credit

would alleviate the compliance burdens

associated with applying section 23A to

extensions of credit that were not made

in contemplation of a purchase of

securities from a depository institution’s

section 20 affiliate.

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).