[Federal Register Volume 66, Number 92 (Friday, May 11, 2001)]
[Rules and Regulations]
[Pages 24220-24225]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-11609]



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

[[Page 24220]]


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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.

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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 broker-dealer 
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of the Federal Reserve Act, originally enacted as part of the Banking 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.
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    \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.
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    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.
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    \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).
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    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

[[Page 24221]]

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-broker-
dealers 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, 
SEC-registered 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-by-case basis in light of all the 
facts and circumstances.
    In addition, although the proposed expanded (d)(6) exemption is 
limited to purchases from registered broker-dealers, 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\
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    \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.
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    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.''
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    \4\ 12 CFR 1.2(f)(4).
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    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 asset-backed, corporate debt, and sovereign 
debt securities. It is a standard understood by SEC-registered broker-
dealers 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

[[Page 24222]]

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).
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    \5\ 12 U.S.C. 335.
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    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 low-quality 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\
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    \6\ 12 U.S.C. 335.
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    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 mortgage-backed 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.
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    \7\ 12 U.S.C. 24(7).
    \8\ See 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).
    \9\ See 12 CFR 1.3.
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    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

[[Page 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 
real-time 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 marks-to-
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

[[Page 24224]]

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\
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    \10\ The 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.
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    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 asset-backed 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 affiliate-issued 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

[[Page 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:


Sec. 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