24220 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Rules and Regulations

1 12 U.S.C. 371c(d)(6). By its terms, section 23A

only applies to member banks. The Federal Deposit

Insurance Act extends the coverage of section 23A

to all FDIC-insured 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 that the bank’s purchase be consistent with

safe and sound banking practices. 12 U.S.C.

371c(a)(4).

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: Final rule.

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 adopting an

interpretation that would expand the

types of asset purchases that are eligible

for the exemption in section 23A(d)(6),

which exempts the purchase from an

affiliate of an asset that has a readily

identifiable and publicly available

market quotation. This interpretation

would expand the ability of an insured

depository institution to purchase

securities from its registered brokerdealer affiliates, while ensuring that the

transactions are conducted in a manner

that is consistent with safe and sound

banking practices.

EFFECTIVE DATE: June 11, 2001.

FOR FURTHER INFORMATION CONTACT:

Pamela G. Nardolilli, Senior Counsel

(202/452–3289), or Mark E. Van Der

Weide, Counsel (202/452–2263), Legal

Division; or Molly S. Wassom, Associate

Director, Division of Banking

Supervision and Regulation (202/452–

2305), Board of Governors of the Federal

Reserve System, 20th and C Streets,

NW., Washington, DC 20551.

SUPPLEMENTARY INFORMATION:

Background

The Board is adopting an

interpretation of section 23A(d)(6) of the

Federal Reserve Act to expand the types

of securities that an insured depository

institution (‘‘depository institution’’)

can purchase on an exempt basis from

a registered broker-dealer affiliate.1

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. Section 23A limits

covered transactions between a member

bank and an affiliate to 10 percent of the

bank’s capital stock and surplus, and

limits the aggregate amount of all

transactions between a member bank

and all of its affiliates to 20 percent of

capital stock and surplus. The purchase

of assets by a bank from its affiliates is

included in the definition of covered

transaction and is subject to the statute’s

quantitative limits.

Section 23A also contains several

exemptions from the statute’s

quantitative limits and collateral

requirements. 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 the past, institutions

have been advised that the (d)(6)

exemption was available only for the

purchase of assets, the price of which

was recorded in a widely disseminated

publication that was readily available to

the general public. Such assets included

obligations of the United States,

securities traded on exchanges, foreign

exchange, certain mutual fund shares,

and precious metals. Other marketable

assets could not meet this standard.

In 1997, the Board removed certain

prohibitions on transactions between a

bank and its section 20 affiliates

(‘‘section 20 firewalls’’). Because of the

changes to the section 20 firewalls, the

Board received several requests from

organizations (‘‘Petitioners’’) regarding

the interpretation of the (d)(6)

exemption as it related to the purchase

of assets from section 20 affiliates.

Several Petitioners stated that, although

the removal of the firewall was

welcomed, section 23A continued to

limit certain transactions with section

20 affiliates. Petitioners argued that

certain prohibited transactions do not

raise significant safety and soundness

issues and that the prohibition impeded

the efficient operations of the insured

depository institution and the section 20

affiliate. In particular, Petitioners were

concerned about the ability of an

insured depository institution to

purchase securities under the (d)(6)

exemption because of the Board’s

narrow reading of the exemption, which

prevented the purchase of otherwise

marketable assets.

Summary of Comments and Description

of the Rule

Because of Petitioners’ requests, the

Board proposed to expand the ability of

a bank to purchase from a registered

broker-dealer affiliate securities that,

although not so widely traded as to

warrant the inclusion of their prices in

publications of general circulation, are

actively traded and whose prices can be

verified by independent reliable sources

(‘‘1998 Proposal’’). Under the 1998

Proposal, a purchase of securities by an

insured depository institution from its

broker-dealer affiliate would meet the

(d)(6) exemption if the transaction met

the following criteria:

(1) The broker-dealer from which the

securities were purchased was

registered with the Securities and

Exchange Commission (‘‘SEC’’);

(2) The securities had a ‘‘ready

market,’’ as defined by the SEC in its

regulation codified at 17 CFR 240.15c3–

1(c)(11)(i);

(3) The securities had received an

investment grade rating from a

nationally recognized statistical rating

organization (‘‘NRSRO’’), and no

NRSRO had stated that the rating was

under review for a possible downgrade

to below investment grade;

(4) The securities were not purchased

during an underwriting or within 30

days of an underwriting if an affiliate

was an underwriter of the security;

(5) The price paid for the securities

could be verified by

(i) A widely disseminated news

source;

(ii) An electronic service that

provided indicative data from real-time

financial networks; or

(iii) Two or more actual independent

dealer quotes on the exact securities to

be purchased, where the price paid was

not higher than the average of the price

quotes obtained from the unaffiliated

broker-dealers; and

(6) The securities were not issued by

an affiliate, unless the securities were

obligations of the United States or fully

guaranteed by the United States or its

agencies as to principal and interest.

The Board received thirteen

comments on the proposed

interpretation: nine from banks and

bank holding companies, three from

trade associations and one from a

clearing house. In addition, comments

were received from eight Federal

Reserve Banks. Commenters generally

supported the Board’s proposed

interpretation. The commenters

concurred with the Board that a broader

interpretation of the (d)(6) exemption, as

proposed, would promote operational

efficiencies in a banking organization

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Rules and Regulations 24221

3 17 CFR 240.15c3–1(c)(11)(i). The SEC defines a

ready market as including a recognized established

securities market: (i) In which there exist

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 (ii) where

payment will be received in settlement of a sale at

such price within a relatively short time conforming

to trade custom.

4 12 CFR 1.2(f)(4).

while still ensuring that transactions are

conducted in a safe and sound manner.

Although the commenters uniformly

supported the Board’s proposal to

expand its interpretation of the (d)(6)

exemption, a number of commenters

expressed concerns about the specific

qualifying criteria proposed by the

Board. The commenters’ views

regarding each of the criteria and the

Board’s response are discussed below.

(1) The Securities Must Be Purchased

From a Broker-Dealer Registered With

the SEC

In order for a purchase of securities to

meet the expanded (d)(6) exemption, the

Board proposed that the purchase of

securities must be from a broker-dealer

registered with the SEC.

One commenter specifically

supported the Board’s proposed

requirement that the broker-dealer

affiliate be registered with the SEC.

Several other commenters, however,

urged the Board to loosen the

requirement. One commenter argued

that the Board should allow depository

institutions to buy securities under the

exemption from broker-dealers

registered with foreign authorities.

Several other commenters argued that

there is no reason to limit the exemption

to broker-dealers. These commenters

expressed the view that non-brokerdealers may hold securities that would

qualify under the terms of the 1998

Proposal, and these commenters argued

that there is no policy reason for

prohibiting these non-broker-dealer

affiliates from using the proposed

interpretation.

Broker-dealers that are registered with

the SEC are subject to supervision and

examination by the SEC and are

required by SEC regulations to keep and

maintain detailed records concerning

each securities transaction conducted by

the broker-dealer. In addition, SECregistered broker-dealers have

experience in determining whether a

security has a ‘‘ready market’’ under

SEC regulations, as described below.

The Board believes that these factors

will help ensure that banks satisfy the

requirements of the expanded

exemption and will assist the Federal

banking agencies in monitoring such

compliance.

The Board does not believe it is

appropriate at this time to expand the

exemption to include securities

purchases from foreign broker-dealers

because such entities may be subject to

different levels of supervision and

regulation and because of the increased

difficulties associated with monitoring

compliance by foreign entities. An

insured depository institution can,

however, request that the Board exempt

securities purchases from a foreign

broker-dealer, and the Board would

consider these requests on a case-bycase basis in light of all the facts and

circumstances.

In addition, although the proposed

expanded (d)(6) exemption is limited to

purchases from registered brokerdealers, the Board notes that a purchase

of securities or other assets from other

types of affiliates would continue to be

exempt under section 23A(d)(6) if the

price of the asset is routinely quoted in

a widely disseminated news source and

the asset was purchased at or below its

current market price. The Board, in any

event, expects to evaluate the continued

need for the requirement as insured

depository institutions and the Board

gain experience with this expanded

exemption.

(2) The Securities Must Have a ‘‘Ready

Market’’ as Defined by the SEC

The 1998 Proposal provided that, in

order to meet the expanded (d)(6)

exemption, the assets must have a

‘‘ready market,’’ as defined by the SEC.3

Based on public comments, the Board

considered various alternative

marketability definitions. Some

commenters noted that the Office of the

Comptroller of the Currency (‘‘OCC’’)

defines ‘‘marketable’’ under its

Investment Securities regulations to

include those securities that can be sold

with reasonable promptness at a price

that corresponds reasonably to fair

value.4 The commenters submitted that

banks would be comfortable with this

alternative definition of ‘‘ready market.’’

One commenter argued that the SEC’s

‘‘ready market’’ concept was not

appropriate for the (d)(6) exemption.

The commenter contended that the

SEC’s ‘‘ready market’’ concept is used in

the context of determining the liquidity

of a broker-dealer’s portfolio, and the

commenter argued that the concept of

liquidity is not analogous to the

question raised in the context of the

(d)(6) exemption as to whether the

security was purchased at a fair market

price. The commenter argued that a

more appropriate standard is set forth in

the ‘‘fair market price’’ definition in

National Association of Securities

Dealers (‘‘NASD’’) Rule 2730. The

commenter noted that the NASD’s ‘‘fair

market price’’ definition is one with

which broker-dealers are already

familiar.

In the proposed interpretation, the

Board employed the ‘‘ready market’’ test

because it believed that this definition

would help ensure that a ready,

competitive market exists for the

securities that the bank purchases.

Under the SEC’s net capital rules, 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

assets. The purpose of the ‘‘ready

market’’ test is to identify securities

with a liquid market to ensure that a

broker-dealer promptly can sell a

security and receive its value. The types

of securities that meet this definition

include obligations of the United States

and its agencies, as well as many assetbacked, corporate debt, and sovereign

debt securities. It is a standard

understood by SEC-registered brokerdealers and monitored by the SEC, and

if the bank is unsure of the status of a

security, it can determine the status by

asking how the security is treated by the

broker-dealer affiliate for its own capital

purposes.

The Board believes that the ‘‘ready

market’’ test provides the best standard

that is well understood by the banking

and securities industries. Because a

broker-dealer must adjust its capital

daily—and therefore must confirm daily

that its assets meet the ‘‘ready market’’

definition—the liquidity of purchased

securities is confirmed by an

independent standard on a regular basis.

The Board believes that the ‘‘ready

market’’ standard provides more

specific guidance to banks than either

the OCC’s ‘‘marketable’’ definition or

NASD Rule 2730.

In addition, the Board does not

believe that NASD Rule 2730 is

appropriate for the exemption because

the rule is concerned primarily with the

price at which a security is bought. The

Board disagrees with commenters who

stated that only price, not liquidity, is

critical under the (d)(6) exemption. The

(d)(6) exemption, by its terms, applies

only to assets with a ‘‘market’’

quotation. The Board believes that

inherent in the concept of a market

quotation is the idea that the asset can

be bought and sold on a regular basis.

Moreover, this proposal deals primarily

with assets that are too thinly traded to

warrant listing of their price in a widely

disseminated publication, and this

criterion helps support the validity of

the market quote mechanism discussed

below. In addition, section 23A requires

24222 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Rules and Regulations

5 12 U.S.C. 335.

6 12 U.S.C. 335.

7 12 U.S.C. 24(7).

8See 12 CFR 1.1(e). State member banks also are

permitted to invest up to 5 percent of their capital

and surplus in securities that may not be the credit

equivalent of investment-grade securities, but only

if the bank concludes that the obligors will be able

to satisfy their obligations under the securities and

that the securities may be sold with reasonable

promptness at a price that corresponds reasonably

to their fair value. See 12 CFR 1.3(i). 9See 12 CFR 1.3.

that all covered transactions, whether or

not they meet an exemption, be on

terms and conditions that are consistent

with safe and sound banking practices.

The Board believes that it would be

inconsistent with safe and sound

banking practices to allow a depository

institution to purchase from an affiliate

unlimited amounts of a security for

which no ‘‘ready market’’ exists.

(3) The Securities Must Be Eligible for

Purchase by a State Member Bank and

Must Not Be Low-Quality Assets

In the 1998 Proposal, the Board

proposed that a purchase of a security

would be eligible for the expanded

(d)(6) exemption only if the security

were rated investment grade by a

nationally recognized statistical rating

organization (‘‘NRSRO’’). In light of

comments received on the proposal,

however, the Board now proposes

replacing the investment-grade

requirement with requirements that the

security be eligible for direct purchase

by a State member bank under section

9 of the Federal Reserve Act, as

determined by the Board,5 and that the

security not be a low-quality asset (as

defined in section 23A).

The Board received one comment

supporting the Board’s proposed

requirement that the security being

purchased under the expanded (d)(6)

exemption have an investment grade

rating from an NRSRO. The commenter

argued that this requirement would help

ensure bank safety and soundness.

Approximately ten commenters,

however, opposed or proposed

modifications to this requirement.

Several commenters argued that this

condition is unnecessary and overly

restrictive, especially in light of the

protections afforded by the Board’s

other proposed criteria. One commenter

noted that the focus of the (d)(6)

exemption is liquidity and market

information, and the commenter argued

that a security can have substantial

liquidity and be the subject of

significant market information even if it

is not investment grade. Several

commenters also contended that section

23A separately addresses the question of

depository institution purchases of lowquality assets from affiliates, and they

contended that there is no statutory

basis for importing the investment grade

requirement into the (d)(6) exemption.

Other commenters proposed

alternative standards. Some of them

argued that non-rated securities could

satisfy the Board’s concerns, provided

that the purchasing depository

institution conducts an independent

evaluation of the security. Another

commenter noted that the OCC’s

regulations allow national banks to

purchase securities that are rated

investment grade or, if not rated, are the

‘‘credit equivalent’’ of a security rated

investment grade. Two commenters also

argued that the Board’s proposed

requirement of an investment grade

rating is superfluous given the OCC’s

restrictions on what types of securities

national banks can purchase. Several

commenters also argued that, at a

minimum, the investment grade rating

requirement should be expanded to

include high yield securities traded on

the NASD’s Fixed Income Pricing

System (‘‘FIPS’’), because the NASD

carefully reviews a security’s volume

and pricing, and the issuer’s name

recognition and research following,

before approving a security for FIPS

quotation.

The Board originally proposed that a

security must be rated by an NRSRO

because it believed that such a rating

ensured the marketability of a security

and that the security would not be the

equivalent of a ‘‘low-quality asset,’’ the

purchase of which is prohibited by

section 23A. In light of the comments,

however, the Board has decided to

eliminate the requirement that a

security receive an investment grade

rating from an NRSRO. Instead, the

security will be eligible for the

expanded (d)(6) exemption if it is

eligible for purchase by a State member

bank under section 9 of the Federal

Reserve Act and is not a low-quality

asset, as defined by section 23A.6

Section 9 of the Federal Reserve Act

permits a State member bank to

purchase securities that a national bank

may own pursuant to paragraph 7 of

section 5136 of the Revised Statutes.7

This provision permits the purchase of

a variety of securities, including

obligations of State and local

governments and asset-backed and

corporate debt securities, that may not

be rated. State member banks can

purchase unrated corporate debt

securities and asset-backed securities,

however, only if the securities generally

are the credit equivalent of a security

rated investment grade.8 Moreover, a

State member bank’s purchases of

corporate debt securities of any one

obligor are limited to 10 percent of the

bank’s capital and surplus; and

purchases of asset-backed securities,

except certain highly rated mortgagebacked securities, are limited to 25

percent of capital and surplus.9

Institutions using this exemption would

be subject to the restrictions described

above and all other terms and

conditions that govern the investment

activities of State member banks.

The Board believes that the statutory

and other restrictions placed on a State

member bank’s ownership of securities

also are appropriate limits on the

securities eligible for this interpretation

of the (d)(6) exemption. The Board

further believes that the purchase must

be recorded by the insured depository

institution as a security purchased, and

not as a loan, pursuant to the

instructions of the Call Report.

The Board also proposes to restrict the

availability of this interpretation of the

(d)(6) exemption to purchases of assets

that are not low-quality assets (as

defined in section 23A). Because of the

inherent volatility of low-quality assets

and section 23A’s special concern with

respect to purchases of low-quality

assets, it is inappropriate to allow banks

to purchase an unlimited amount of

low-quality assets from an affiliate

pursuant to this interpretation.

These two replacement requirements

should increase the types of securities

eligible for purchase under the new

(d)(6) exemption, as compared with the

investment grade requirement, while

ensuring that purchases are consistent

with section 23A’s injunction that

covered transactions, even exempt

covered transactions, must be consistent

with safe and sound banking practices.

(4) No Purchases During an

Underwriting Period and for Thirty Days

Thereafter

The Board’s proposed interpretation

would disqualify from the expanded

(d)(6) exemption an insured depository

institution’s purchase of a security from

an affiliate during the underwriting

period for the security and for 30 days

thereafter. Approximately 11

commenters expressed opposition to

this criterion. The commenters believed

that a 30-day underwriting exclusion is

unnecessary. The commenters believed

that the proposed restriction was based

on misperceptions on the part of the

Board about pricing volatility and

conflicts of interest in the underwriting

of securities.

Several commenters also argued that

the Board’s concerns regarding potential

conflicts of interest between

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Rules and Regulations 24223

underwriting affiliates and depository

institutions were unfounded.

Commenters argued that the Board had

not identified any conflicts and could

not demonstrate that conflicts were

sufficiently serious to require the

proposed 30-day underwriting

exclusion.

A number of commenters argued that

the Board’s proposed limitation could

not be supported by the language of

section 23A, which does not contain

any restriction on purchases of

securities during an underwriting

period. Commenters also noted that

section 23B does contain a provision

that prohibits a depository institution

from purchasing securities during the

existence of any underwriting or selling

syndicate if a principal underwriter of

the securities is an affiliate of the

depository institution. The prohibition

in section 23B, however, contains an

exception if the purchase or acquisition

of securities has been approved by a

majority of the directors of a depository

institution before such securities are

initially offered for sale to the public.

The commenters contended that, if the

Board decides to adopt the proposed

restriction, the Board also should add a

similar exception for purchases

receiving prior director approval.

A number of commenters argued that,

at a minimum, the 30-day waiting

period after the underwriting should not

be required. Some commenters argued

that the 30-day buffer should be deleted,

if in no other circumstances, in those

situations in which an affiliate has been

able to sell all of its allotted securities

to third parties during the underwriting.

Commenters also urged the Board to

eliminate the 30-day waiting period for

investment-grade securities.

Two commenters noted that, in the

preamble to the proposed exemption,

the Board stated that the proposed 30-

day underwriting exclusion applies to

bank-ineligible securities. The

commenters noted, however, that the

text of the proposed rule would appear

to cover all securities, eligible and

ineligible. The commenters urged the

Board to clarify that the restriction

would apply only to bank-ineligible

securities.

The Board proposes to maintain the

30-Day Restriction in its final rule with

one exception, because of uncertain

market values of securities during and

shortly after an underwriting period and

because of the conflicts of interest that

may arise during and after an

underwriting period, especially if an

affiliate has difficulty selling its

allotment.

The Board believes that the 30-Day

Restriction should not apply to

purchases of obligations of, or

obligations fully guaranteed as to

principal and interest by, the United

States or its agencies. The markets for

these instruments generally do not

require substantial market stabilization

by the underwriters, and therefore it is

less likely that the risks of stabilization

efforts could be transferred from the

securities affiliate to the depository

institution.

The Board also has reviewed the

restriction imposed by section 23B and

its relationship to the (d)(6) exemption.

As noted above, the requirements of

section 23B are in addition to the

requirements of section 23A. Section

23B requires the approval of a majority

of the insured depository institution’s

directors prior to the purchase of

securities for which an affiliate is a

principal underwriter. Even with the

directors’ vote, however, the insured

depository institution’s purchase would

be subject to the quantitative limits of

section 23A. If the securities are exempt

under (d)(6), however, there is no

quantitative limit imposed on the

insured depository institution. The

Board believes that given the expansion

of the types of securities that insured

depository institutions can purchase

under this interpretation of the (d)(6)

exemption, a vote of the directors is not

sufficient protection to the insured

depository institution if it is permitted

to purchase unlimited amounts of a

security before it has even been offered

for sale to the public.

(5) Price Verification Methods

Several commenters concurred with

the Board’s requirement for the

verification of the price of each security

purchased by a depository institution

from an affiliated broker-dealer. At least

two commenters supported the Board’s

inclusion of three alternative price

verification methods—(1) A widely

disseminated news source; (2) an

electronic service that provides

indicative data from real-time financial

networks; and (3) two independent

dealer quotes on the exact security

purchased. These commenters believed

use of the two independent dealer

quotes would ensure that the securities

in question are readily marketable and

have a price that is verifiable, which

may not be the case if only one price

quote were obtained.

Approximately ten commenters

expressed concerns about the price

verification methods proposed by the

Board. One commenter suggested the

Board eliminate the detailed

requirements for price verification. The

commenter suggested that these price

verification conditions are redundant in

light of the ‘‘ready market’’ condition

discussed above.

Several commenters argued that, in

addition to indicative data from realtime networks, the Board should permit

the use of pricing matrices proposed by

the bank or its affiliate, which the

commenters claimed are widely used by

dealers and institutional investors and

relied upon in setting prices for actual

trades. The commenters noted that

matrices are updated daily and are

based on actual trades and dealer marksto-market involving securities having

substantially similar characteristics. The

commenters stated that, so long as a

security meets the credit, liquidity, and

other criteria of the proposed rule, a

depository institution is as assured of

obtaining the security at fair market

value when using a matrix as the

institution is when using any of the

other pricing verification methods

proposed by the Board.

A number of commenters suggested

that, with respect to the third proposed

method of verification (verification by

two independent dealer bids on the

same security), the Board also should

permit verification by independent bids

on closely comparable securities. The

commenters argued that requiring

quotes on the exact security purchased

was needlessly burdensome. Several

commenters also contended that

permitting quotes on comparable

securities would recognize that, as a

practical matter, it is often difficult to

get quotes on the particular security

being purchased.

One commenter argued that there

should be a mechanism that allows

Board staff to evaluate the use of

comparable securities on a case-by-case

basis. Such a procedure, the commenter

noted, would allow depository

institutions to present the comparability

question in the context of a specific

security. Another commenter suggested

that the Board adopt a method by which

Board staff may consider the

permissibility of new dependable

pricing mechanisms as they become

available. The commenter noted that

rapid developments and enhancements

of information systems may produce

equally dependable price verification

methods in the future, which, the

commenter argued, should then be

included in the scope of the

interpretation.

The 1998 Proposal included a price

verification test because of the statutory

requirement that the asset have a

‘‘readily identifiable and publicly

available market quotation’’ and the

Board’s belief that the proposed criteria

would meet the statutory requirement.

Prior to publication of the proposal, the

24224 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Rules and Regulations

10The final (d)(6) interpretation also does not

include the ‘‘widely disseminated news source’’

pricing option because the old (d)(6) exemption

remains as a separate, stand-alone exemption.

Board reviewed the use of matrices and

the use of comparable securities and did

not believe that those price verification

methods would meet the statutory

standard that the quotation be ‘‘publicly

available.’’ In addition, the Board

believed that the value of a security

should be independently determined

and not by a method that was subject to

manipulation by the insured depository

institution or its affiliated broker-dealer.

The Board has reviewed its position

in light of the comments received on the

1998 Proposal and further analysis of

the reliability of various pricing

methodologies set forth in the 1998

Proposal. The Board continues to

believe that the use of matrices and

comparable securities to determine the

price of a security may indicate a lack

of liquidity in the market for that

security, and the purchase of unlimited

amounts of such a security from an

affiliate raises safety and soundness

concerns. Moreover, if a securities

purchase could meet the (d)(6)

exemption by the use of a matrix or

comparable securities, the limitations

Congress imposed in the (d)(6)

exemption would be meaningless

because an insured depository

institution could always develop a price

for a security using its own

methodology. The Board believes that

the use of third-party networks helps

ensure that a market for the security

exists and that the price the insured

depository institution pays for the

security is a fair market price.

Moreover, the Board has concluded

that it would not be appropriate to use

independent dealer quotations to

establish a market price for a security

under the expanded (d)(6) exemption.

The Board also is concerned that a

security that is not quoted routinely in

a widely disseminated news source or a

third-party electronic financial network

may not trade in a sufficiently liquid

market to justify allowing an insured

depository institution to purchase

unlimited amounts of such security

from an affiliate.10

The exemption also provides that a

depository institution that is taking

advantage of the new (d)(6) exemption

must pay a price for the relevant

security that is no higher than the

current market quotation for the security

and must ensure that the size of the

transaction executed by the depository

institution does not cast material doubt

on the appropriateness of relying on the

current market quotation for the

security.

The Board agrees with commenters

that there should be procedures in place

for the Board to review new dependable

market pricing mechanisms as they

become available. The Board will

continue to assess the appropriateness

of new methodologies.

(6) The Securities Must Not Be Issued by

an Affiliate

Finally, the proposed interpretation

provided that the exemption would not

apply to securities issued by an affiliate

unless those securities were backed by

a guarantee of the U.S. government.

Several commenters specifically

supported the Board’s decision to

exclude from the (d)(6) exemption those

securities issued by an affiliate,

including asset-backed securities issued

by an affiliate and shares of a mutual

fund advised by the depository

institution or affiliate, unless such

securities are guaranteed by the United

States government. One commenter

noted that inclusion of these securities

within the interpretation could lead to

potential self-dealing and could double

capital exposure from the underwriting

activity of the affiliate and the treatment

of the security as an asset of the

depository institution.

Two commenters argued that advised

mutual funds should not be treated like

other affiliates under section 23A. The

commenters argued that, because a

mutual fund’s profits do not accrue to

its advisor but to the fund’s investors,

there is little risk that a depository

institution’s purchase of shares of an

advised mutual fund could contribute to

the unlimited funding of the affiliated

fund. The commenters noted that

certain mutual fund shares are

permissible investments for national

banks under the OCC’s regulations,

mutual fund share prices are subject to

comprehensive regulation under the

Investment Company Act, and mutual

fund share prices are published daily in

The Wall Street Journal. The

commenters contended that, in light of

these facts, there is no justification for

a blanket prohibition on depository

institution purchases of affiliated

mutual fund shares under the (d)(6)

exemption.

Several commenters requested that

the Board confirm that the sale of assetbacked securities, where the underlying

assets were on the depository

institution’s books immediately prior to

the securities offering, would be outside

the scope of section 23A. The

commenters argued that the Board’s

proposal should not be interpreted to

extend section 23A limits to the

investments of insured depository

institutions in a securitization of their

own loans or other assets merely

because the securitization is

underwritten or traded by their

affiliated broker-dealer.

The proposed regulation prohibits the

applicability of the (d)(6) exemption to

most affiliate-issued securities because a

contrary determination would permit a

bank to acquire an unlimited credit

exposure to an affiliate in contradiction

to the purposes of section 23A. In

addition, if a purchase of assets from an

affiliate is also a purchase of affiliateissued securities (if, for example, a bank

purchases securities issued by one

affiliate from the inventory of another

affiliate), the bank has engaged in two

types of covered transaction. Although

the (d)(6) exemption may apply to the

one-time asset purchase component of

the transaction, it should not apply to

exempt the ongoing investment in

securities issued by an affiliate.

The Board continues to believe that

safety and soundness requires

restrictions on a bank’s ability to

purchase securities issued by an

affiliate. Such restrictions help prevent

a bank from acquiring an unlimited

credit exposure to its affiliates, and are

consistent with other provisions of

section 23A, which limit the bank’s

ability to lend to an affiliate or accept

the affiliate’s securities as collateral.

In light of the comments, the Board

will continue to review the

appropriateness of making the purchase

of affiliate-issued asset-backed securities

and affiliate-advised mutual funds

eligible for the (d)(6) exemption.

(7) Document Retention

Five commenters expressed concerns

about the Board’s proposed requirement

that pricing information be retained in

the insured depository institution’s files

for five years. One commenter requested

that the Board change the requirement

to allow documents to be retained only

for two years. The commenter noted that

depository institutions are examined

every one or two years and, accordingly,

it does not make sense to require

retention of documents beyond an

examination cycle.

Another commenter requested that

Board staff consult and work with

market participants regarding what

information can be made available

without imposing an undue

administrative burden. Other

commenters requested that the Board

clarify that the requirement applies to

documentation concerning the actual

price paid; the commenters believed

that a simple notation of the price paid

and source of price verification should

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Rules and Regulations 24225

be sufficient. The commenters argued

that otherwise this requirement would

be overly burdensome for depository

institutions, especially in light of the

fact that historical pricing data are

available from other sources.

The Board proposed a five-year

standard because it believed that it

would provide examiners a basis to

review how the exemption was applied

over time by insured depository

institutions. The Board has determined

to shorten the period of time necessary

for the insured depository institution to

retain the price verification information

to two years. The Board concurs with

the commenters that this period of time

is consistent with the exam schedules of

the institutions in question and that

further information retention is not

necessary in order to ensure compliance

with the law. The Board does not

believe that the documentation

requirements are substantial, and

insured depository institutions should

contact their primary regulators to

determine what documentation is

required. At a minimum, however, the

Board believes that an institution’s

records should clearly show the security

purchased, the seller, price and date of

purchase, and evidence of the method

used to determine the price.

(8) Other Issues

Failure to meet the conditions for

availability of this interpretation of the

(d)(6) exemption does not prevent an

insured depository institution from

purchasing securities or other assets. A

depository institution, of course, can

continue to buy securities and other

assets from an affiliate subject to the

quantitative limits of section 23A and

can buy such securities and other assets

from unaffiliated parties without any

section 23A limit, so long as the

purchase is otherwise authorized by

law. In addition, this interpretation of

the (d)(6) exemption does not interfere

with the ability of a depository

institution to purchase securities and

other assets from affiliates pursuant to

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

prices of such assets are recorded in a

widely disseminated publication that is

readily available to the general public.

Regulatory Flexibility Act

The Board certifies that adoption of

this final rule 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, most small bank holding

companies would not be affected by this

final rule. In addition, the rule would

expand the types of transactions that an

insured depository institution may

engage in with its broker-dealer

affiliates. Accordingly, the rule does not

impose more burdensome requirements

on depository institutions, their holding

companies, or their affiliates than are

currently applicable.

Administrative Procedure Act

Subject to certain exceptions, 12

U.S.C. 4801(b)(1) provides that new

regulations and amendments to

regulations prescribed by a Federal

banking agency that impose additional

reporting, disclosure, or other new

requirements on an insured depository

institution must take effect on the first

day of a calendar quarter that begins on

or after the date on which the

regulations are published in final form.

This rule is not subject to this delayed

effective date requirement because the

rule imposes no new requirements on

existing operations of depository

institutions. The rule only exempts

transactions that were previously

subject to the restrictions of section

23A.

Paperwork Reduction Act

The Board has determined that the

final rule 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

Banks, banking, Federal Reserve

System.

For the reasons set forth in the

preamble, the Board amends 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(f).

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

a security by an insured depository

institution from an affiliate.

(a) The purchase of a security by an

insured depository institution from an

affiliate that is a broker-dealer registered

with the Securities and Exchange

Commission is exempt from section 23A

of the Federal Reserve Act (12 U.S.C.

371c) under paragraph (d)(6) of that

statute if:

(1) The security has a ‘‘ready market,’’

as defined in 17 CFR 240.15c3–

1(c)(11)(i);

(2) The security is eligible for a State

member bank to purchase directly,

subject to the same terms and

conditions that govern the investment

activities of a State member bank, and

the institution records the transaction as

a purchase of securities for purposes of

the bank Call report, consistent with the

requirements for a State member bank;

(3) The security is not a low-quality

asset;

(4) The security is not purchased

during an underwriting, or within 30

days of an underwriting, if an affiliate

is an underwriter of the security, unless

the security is purchased as part of an

issue of obligations of, or obligations

fully guaranteed as to principal and

interest by, the United States or its

agencies;

(5) The security’s price is quoted

routinely on an unaffiliated electronic

service that provides indicative data

from real-time financial networks,

provided that:

(i) The price paid by the insured

depository institution is at or below the

current market quotation for the

security; and

(ii) The size of the transaction

executed by the insured depository

institution does not cast material doubt

on the appropriateness of relying on the

current market quotation for the

security; and

(6) The security is not issued by an

affiliate, unless the security is an

obligation fully guaranteed by the

United States or its agencies as to

principal and interest.

(b) The purchase of the security must

comply with paragraph (a)(4) of section

23A, which requires that any covered

transactions between an insured

depository institution and an affiliate be

on terms and conditions that are

consistent with safe and sound banking

practices.

By order of the Board of Governors of the

Federal Reserve System, May 3, 2001.

Jennifer J. Johnson,

Secretary of the Board.

[FR Doc. 01–11609 Filed 5–10–01; 8:45 am]

BILLING CODE 6210–01–P