[Federal Register Volume 61, Number 217 (Thursday, November 7, 1996)]
[Notices]
[Pages 57679-57683]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-28619]
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FEDERAL RESERVE SYSTEM
[Docket No. R-0701]
Review of Restrictions on Director, Officer and Employee
Interlocks, Cross-Marketing Activities, and the Purchase and Sale of
Financial Assets Between a Section 20 Subsidiary and an Affiliated Bank
or Thrift
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice.
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SUMMARY: The Board is amending three of the prudential limitations
established in its decisions under the Bank Holding Company Act and the
Glass-Steagall Act permitting a nonbank subsidiary of a bank holding
company to underwrite and deal in securities. The Board is easing or
eliminating the following restrictions on these so-called section 20
subsidiaries: the prohibition on director, officer and employee
interlocks between a section 20 subsidiary and its affiliated banks or
thrifts (the interlocks restriction); the restriction on a bank or
thrift acting as agent for, or engaging in marketing activities on
behalf of, an affiliated section 20 subsidiary (the cross-marketing
restriction); and the restriction on the purchase and sale of financial
assets between a section 20 subsidiary and its affiliated bank or
thrift (the financial assets restriction).
EFFECTIVE DATE: January 7, 1997.
FOR FURTHER INFORMATION CONTACT: Gregory Baer, Managing Senior Counsel
(202) 452-3236, Thomas Corsi, Senior Attorney (202) 452-3275, Legal
Division; Michael J. Schoenfeld, Senior Securities Regulation Analyst
(202) 452-2781, Division of Banking Supervision and Regulation; for the
hearing impaired only, Telecommunications Device for the Deaf (TDD),
Dorothea Thompson (202) 452-3544.
SUPPLEMENTARY INFORMATION:
I. Background
In its section 20 orders, the Board has established a series of
firewalls designed to prevent securities underwriting and dealing risk
from being passed from a section 20 subsidiary to an affiliated insured
depository institution, and to prevent the federal safety net from
being extended to subsidize this activity.1 The firewalls also
reduce the potential for conflicts of interest, unfair competition, and
other adverse effects that may arise from securities underwriting and
dealing. In adopting these restrictions, the Board stated that it would
continue to review their appropriateness in the light of its experience
supervising section 20 subsidiaries.
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\1\ See, e.g., J.P. Morgan & Co., The Chase Manhattan Corp.,
Bankers Trust New York Corp., Citicorp, and Security Pacific Corp.,
75 Federal Reserve Bulletin 192, 202-03 (1989) (hereafter, 1989
Order); Citicorp, J.P. Morgan & Co., and Bankers Trust New York
Corp., 73 Federal Reserve Bulletin 473, 492 (1987) (hereafter, 1987
Order).
The interlocks and cross-marketing restrictions were included in
the Board's 1987 Order authorizing certain section 20 subsidiaries
to underwrite and deal in four limited types of debt securities, and
were repeated in the Board's 1989 Order authorizing certain section
20 subsidiaries to underwrite and deal in all types of debt and
equity securities. See 1987 Order at 503, 504 (Firewalls #10 and
#13); 1989 Order at 215 (Firewalls #13 and #16). The financial
assets restriction was included in the 1989 Order but not the 1987
Order. See 1989 Order at 216 (Firewall #22). All three have since
been applied to foreign banks operating section 20 subsidiaries.
Canadian Imperial Bank of Commerce, The Royal Bank of Canada,
Barclays PLC and Barclays Bank PLC, 76 Federal Reserve Bulletin 158,
172 (1990) (hereafter, 1990 Order) (Firewalls #13, #16, and #22).
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The Board originally sought comment on changes to the interlocks,
cross-marketing and financial assets restrictions on July 10, 1990. The
Board received forty responses to its notice, with comments coming from
banks, securities firms, trade associations and other members of the
public. However, because legislation affecting the section 20 firewalls
was introduced shortly after the Board sought comment, and has been
introduced intermittently in the years since, the Board deferred
further action.2
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\2\ These older comments, many of which have been superseded by
a subsequent comment or mooted by changes to the amendments
proposed, are not discussed in detail below but were considered by
the Board.
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On July 31, 1996, the Board announced that it was reopening the
three firewalls for comment, and broadening the changes proposed. An
additional 41 public comments were received. Commenters included 20
bank holding companies, eight bank trade associations, seven foreign
banks, one securities trade association, and four members of the
public.
Commenters expressed strong support for the three proposed
amendments. Of 41 public commenters, only four opposed one or more of
the proposals. Many commenters suggested that they be expanded.
Commenters stated that adoption of the Board's proposals was vital to
the ability of section 20 subsidiaries to compete with other providers
of financial services and to provide bank holding company customers
with the array of financial products and services they require.
Commenters stressed that the firewalls were not required by the Glass-
Steagall Act and imposed substantial costs that could not be justified
by any corresponding benefit.
Three commenters made general objections to this proposal and those
concerning the section 20 revenue test. A securities trade association
urged the Board to defer action indefinitely in order to allow Congress
to undertake comprehensive reform of the financial services system. An
individual commenter argued that recent examples of malfeasance in the
securities markets argued against allowing bank holding companies to
expand their securities activities. Another individual argued that any
action that allows bank holding companies to engage in more investment
banking creates an opportunity for huge losses, and that re-regulation
rather than deregulation is in order.
II. Final Order
After considering the comments, the Board has decided to repeal the
cross-marketing restriction as proposed, and amend the interlocks and
financial assets restrictions in ways similar to those proposed. The
Board has concluded that with these amendments, limited underwriting
and dealing in securities would remain closely related to banking and a
proper incident thereto, and thus permissible under section 4(c)(8) of
the Bank Holding Company Act, because substantial benefits to
efficiency, convenience and competition from these amendments outweigh
any minimal costs.
As detailed below, the Board's experience administering these
firewalls indicates that the existing restrictions are more restrictive
than necessary to serve their intended purposes. Furthermore, their
repeal or constriction
[[Page 57680]]
should lower operating costs for existing section 20 subsidiaries and
eliminate significant barriers to entry for smaller bank holding
companies considering the establishment of a section 20 subsidiary. The
amendments should also benefit customers. Bank holding companies will
be able to serve their customers needs more effectively and should be
able to pass along cost savings derived from improved efficiency; new
entrants should provide better service for small and mid-size issuers,
and increased competition may lower costs.
A. Interlocks Restriction
1. Background
The interlocks restriction currently prohibits all director,
officer and employee interlocks between a section 20 subsidiary and an
affiliated bank.3 The restriction seeks to ensure that the risks
of underwriting and dealing are not passed from a section 20 subsidiary
to an affiliated bank.4
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\3\ Hereafter, references to banks include thrifts.
\4\ In specific cases, the Board has authorized limited officer
or director interlocks between a section 20 subsidiary and its
affiliated banks. See, e.g., National City Corporation, 80 Federal
Reserve Bulletin 346, 348-9; Synovus Financial Corp., 77 Federal
Reserve Bulletin 954, 955-56 (1991); Banc One Corporation, 76
Federal Reserve Bulletin 756, 758 (1990).
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The Board proposed to eliminate the firewall entirely or replace it
with a more narrow restriction. With respect to directors, the Board
sought comment on whether to prohibit a majority of the board of
directors of a section 20 subsidiary from being composed of directors,
officers or employees of an affiliated bank, and a majority of the
board of directors of a bank from being composed of directors, officers
or employees of an affiliated section 20 subsidiary. The Board also
sought comment on whether it should limit the prohibition on officer
interlocks to only the chief executive officer or senior executive
officers of each company.
2. Summary of Comments
Commenters devoted the majority of their comments to this
restriction, stressing that its elimination would increase the
operational efficiency of bank holding companies and allow entry by
smaller organizations that otherwise could not bear the costs of
staffing a section 20 subsidiary. Commenters also stated that there was
no need for an interlocks restriction to prevent risk from being passed
from a section 20 subsidiary to an affiliated bank.
More specifically, commenters stated that the existing interlocks
restriction causes redundant staffing and operational inefficiencies by
precluding functional reporting, supervision and coordination between
complementary section 20 and bank business units. For example, one
large bank holding company commenter noted that if the restriction were
eliminated, senior personnel who oversee the treasury function in a
bank could oversee the related businesses in an affiliated section 20
subsidiary; similarly, a senior officer serving as the global head of a
particular business, such as Fixed Income or Emerging Markets, could
participate in the management of each of the entities involved in those
businesses. Another large bank holding company commenter explained that
it had been forced to move its project finance business out of its
section 20 subsidiary because of the interlocks restriction; instead,
the company has placed virtually all offshore employees, including
project finance employees, in its lead bank or its subsidiaries.
Many commenters stressed that by preventing a centralized
management structure, the interlocks restriction makes it more
difficult for bank holding companies to control and manage risk.
Indeed, commenters argued that restricting interlocks may actually
increase risks to the bank holding company by preventing the most
experienced and responsible members of the organization from monitoring
risk.
Commenters also noted that the Glass-Steagall Act does not require
an interlocks restriction, and that the Board has not restricted
interlocks between a bank and any type of affiliate other than a
section 20 subsidiary. Commenters stated that customer confusion and
challenges to corporate separateness have not arisen with respect to
these other affiliates. Commenters also argued that, with respect to
section 20 subsidiaries, any such concerns are adequately addressed by
other restrictions.
Commenters stated that SEC and Federal Reserve capitalization
requirements for section 20 companies and the restrictions on inter-
affiliate transactions contained in sections 23A and 23B of the Federal
Reserve Act would be sufficient to ensure that the companies are
operated independently, and that disclosures would be sufficient to
prevent customer confusion.
Commenters generally opposed the Board's proposed alternatives to
eliminating the restriction. The suggested restriction on officer
interlocks was more frequently and deeply criticized, with commenters
arguing that interlocks at the senior level were most necessary for
effective management. Although commenters also generally opposed any
restriction on director interlocks, a few commenters noted that it was
neither as great an impediment to sound management nor as great a
compliance burden as the restriction on officer interlocks.
3. Final Order
The Board is adopting the amendments substantially as proposed, and
thereby substantially reducing the scope of the interlocks restriction.
The Board has concluded that a blanket prohibition on director, officer
and employee interlocks is an unnecessary restraint under section
4(c)(8) of the Bank Holding Company Act. Nonetheless, for the reasons
set forth below, the Board has concluded that a narrow interlocks
restrictions would further ensure corporate separateness at minimal
cost. Accordingly, the Board is prohibiting directors, officers or
employees of a bank from serving as a majority of the board of
directors or the chief executive officer of an affiliated section 20
subsidiary, and prohibiting directors, officers or employees of a
section 20 subsidiary from serving as a majority of the board of
directors or the chief executive officer of an affiliated bank. The
Board is imposing no restriction on employee interlocks. The Board
intends to review these restrictions after these changes to the
firewalls, and any subsequent changes made after a more comprehensive
review, have been implemented.
a. Officer and director interlocks/Corporate separateness. Courts
generally prefer to honor the corporate form and recognize corporations
as legal entities separate from their shareholders. ``Piercing the
corporate veil'' refers to the judicially imposed exception to this
principle by which courts disregard corporate separateness and impose
liability on an individual or corporate shareholder or corporate
sibling. In deciding whether one company should be held liable for the
liabilities of another, courts generally require 1. that the corporate
form be used to commit a fraud or injustice on the plaintiff; and 2.
that one company so dominate another that they should be considered,
and held liable, as one.5
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\5\ In making the latter determination, courts consider a
multitude of factors. These factors include: (1) the absence of the
formalities that are part and parcel of corporate existence; (2)
inadequate capitalization; (3) overlap in ownership, officers,
directors, and personnel; (4) common office space, address and
telephone numbers of corporate entities; (5) the amount of business
discretion displayed by the allegedly dominated corporation; (7)
whether the dominated corporation is dealt with at arms length; (8)
whether the corporations are treated as independent profit centers;
(9) the payment or guarantee of debts of the dominated corporation
by other corporations in the group; and (10) whether the corporation
in question has property that was used by other of the corporations
as if it were its own. See, e.g., W. Passalacqua Builders v. Resnick
Developers, 933 F.2d 131 (2d Cir. 1991) (applying New York common
law).
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[[Page 57681]]
Repeal of the interlocks and cross marketing restrictions would
allow increased synergies in the operation of a section 20 subsidiary
and its bank affiliates. Persons may be employed by both companies, and
the trend toward common management of like business functions could
accelerate, with reporting lines running between companies. While such
coordinated management and commonality of personnel generally are not
sufficient to justify disregarding the corporate form, they are
sometimes combined with other factors to justify such a decision.
On the other hand, SEC rules and other Board firewalls require that
a section 20 subsidiary be adequately capitalized, and the examination
process ensures that the corporate formalities are maintained and that
holding company affiliates deal with each other on arm's-length terms,
as required by section 23B of the Federal Reserve Act.6 These are
important factors considered by courts in deciding whether to pierce
the corporate veil.
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\6\ 12 U.S.C. 371c-1.
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After weighing these considerations, the Board has concluded that a
restriction on interlocks at the most senior level might provide some
further assurance of corporate separateness. The director interlocks
restriction should clarify that the goals of the section 20 subsidiary,
while they may be intertwined with an affiliated bank, are independent
of the bank. The chief executive officer interlocks restriction should
clarify that control of the day-to-day activities of each company is
independent of the other.
Of equal note, these minimal restrictions should not impose
significant costs to the bank holding company. Finding qualified
directors who are not connected to an affiliate (and who could be drawn
from the holding company) should not burden a section 20 subsidiary or
a bank. Prohibiting a section 20 subsidiary or a bank from designating
a director, officer or employee of an affiliate as its chief executive
officer is a minimal burden, as the job of chief executive officer
should be a full-time occupation.
b. Employee interlocks/Vicarious liability. While employee
interlocks could be considered in a decision about whether to pierce
the corporate veil, the employee interlocks restriction serves
primarily to prevent customer confusion about the identity of the
customer's counterparty, and potential vicarious liability of the bank
for the actions of an affiliated section 20 subsidiary. Thus, the
employee interlocks restriction is more closely related to the cross-
marketing restriction, which has the same aim.
A bank could be held vicariously liable for the actions of an
affiliate's employee if a customer reasonably believed that the
employee were acting under the actual or apparent authority of the
bank. Clearly, if a section 20 employee were also an employee of the
bank (as elimination of the employee interlocks restriction would
allow) and was also selling bank products (as elimination of the cross-
marketing restriction would allow), the potential for such liability
might increase.
However, for the reasons discussed below in connection with the
cross-marketing restriction, the Board has concluded that current
disclosure requirements and practices should be sufficient insurance
against vicarious liability. The Board emphasizes that supervision by
federal and state banking agencies will need to continue with increased
vigilance in order to ensure that the disclosures are adequate and are
provided whenever appropriate.
4. Continued Supervisory Concerns
Although the Board has concluded that a broad interlocks
restriction is unnecessary to ensure corporate separateness or prevent
customer confusion, proper risk management may require further
restriction of interlocks on a case-by-case basis. For example, an
employee responsible for custodial services at a bank generally should
not be involved in trading at an affiliated section 20 subsidiary. In
such cases, the problem is not with the dual employment per se, but
rather with the potential for conflicts of interest or other risks
arising from the nature of the employee's duties (be they conducted at
the bank or the section 20 subsidiary). These matters will continue to
be addressed in the supervisory process by ensuring prudent internal
controls--for example, proper segregation of duties--to manage
conflicts of interest and prevent violations of law.
B. Cross-marketing Restriction
1. Background
The Board's section 20 orders prohibit a bank from acting as agent
for, or engaging in marketing activities on behalf of, an affiliated
section 20 subsidiary.7 This restriction was intended to prevent
customers from being confused about the identity of their counterparty,
and perhaps attempting to hold the bank liable for actions of an
affiliated section 20 subsidiary. Such liability could arise under a
variety of legal theories, most notably vicarious liability (or
respondeat superior), where a company can be liable for the actions of
its agent, regardless of whether the company itself was at fault.8
The Board sought comment on whether to eliminate this restriction.
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\7\ The Board has allowed a few limited exceptions to the cross-
marketing restriction. See Letter Interpreting Section 20 Orders, 81
Federal Reserve Bulletin 198 (1995).
\8\ One of the commenters to the 1990 notice cautioned that
liability could arise not only under the legal theory of vicarious
liability but also under secondary liability as a controlling person
under Section 20(a) of the Securities Exchange Act of 1934, aiding
and abetting, and conspiracy.
To be liable under the Securities Exchange Act for the actions
of an employee, a bank would have to control the actions of the
employee at the section 20 subsidiary. However, the Act specifically
provides that no liability can be imposed if the controlling person
can show that it acted in good faith and did not directly or
indirectly induce the act or acts constituting the violation, see 15
U.S.C. Sec. 78(t)(a), and courts have held that a bank may
demonstrate its good faith under section 20(a) through maintenance
and enforcement of ``a reasonable and proper system of supervision
and internal control.'' See Hollinger v. Titan Capital Corp., 914
F.2d 1564, 1576 (9th Cir. 1990).
In order to be liable for vicarious liability based on civil
conspiracy, a defendant must have knowingly and substantially
assisted in the fraud. Aiding and abetting liability, which in 1990
required a showing akin to civil conspiracy, was eliminated as a
private cause of action in Central Bank v. First Interstate Bank,
511 U.S. 164 (1994). The SEC may still bring an action for civil
money penalties for aiding and abetting, with penalties determined
by statute. See 15 U.S.C. 78u(d)(1), (d)(3).
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2. Summary of Comments
Commenters stated that the existing restriction prevents bank
holding companies from serving their customers effectively. One
commenter explained that if a customer wishes to purchase a security
from a section 20 subsidiary and also enter into a related contract
with a bank affiliate for the purposes of managing the risks of that
security, the cross-marketing restriction requires the customer to deal
and communicate separately with bank and section 20 company
representatives. Another commenter explained that the restriction
complicates the client calling efforts of its relationship managers.
The commenter found this restriction particularly unjustifiable in the
wholesale market, where section 20 subsidiaries do the majority of
their business and where the role of each company is well understood.
Finally,
[[Page 57682]]
another commenter noted that its customers had frequently expressed
frustration with the multiplicity of contacts and communications
required by the current firewall.
Commenters stated that repeal would eliminate these inefficiencies.
One commenter explained that repeal would enable a single officer--
whether in a bank or a section 20 subsidiary--to market the full range
of products offered by the holding company group, and better tailor the
group's products to the needs of the customer. Bank holding company
commenters also stated that repeal of the cross-marketing restriction
would eliminate a competitive inequality between them and their
investment banking competitors, who market their products without
restrictions. One commenter noted that investment banks have expanded
beyond traditional financial advisory and securities underwriting
services into bank loan syndications, bridge financings and private
equity investment.
Commenters also stated that existing disclosure requirements--most
notably the Interagency Statement on Retail Sales of Nondeposit
Products--were sufficient to address any concerns about customer
confusion. One commenter observed that clients for sophisticated
financial products are unlikely to be confused about the structure of a
proposed transaction or the corporate identity of the counterparties
involved, and that where the insured status of a counterparty may have
significance, such disclosure requirements are sufficient to ensure
that the necessary information is available to the customer.
Three commenters raised specific objections to repeal of the cross-
marketing firewall. A securities trade association stated that while it
was aware that safety and soundness and investor protection concerns
were the paramount issues causing the Board to impose the various
firewalls, the cross-marketing restriction has at least partially
maintained a level of competitive fairness between section 20
subsidiaries and other securities firms by limiting a section 20
subsidiary's ability to market its products and services through an
affiliated bank's retail branch system--an opportunity not available to
other securities firms. A bank trade association urged the Board to
allow cross-marketing only on a case-by-case basis in order to avoid
the danger that products or services could be packaged in a way that
would give bank holding companies an unfair competitive advantage.
Another commenter stated that repeal of the cross-marketing restriction
would pose risks to the public, citing a study showing that some
consumers mistakenly believe that money market mutual funds are
insured.
3. Final Order
The Board has decided to repeal the cross-marketing restriction. As
noted by the commenters, existing disclosure requirements adequately
address concerns about customer confusion. The Interagency Statement on
Retail Sales of Nondeposit Products states that, for any sale of a non-
deposit product by a bank employee or on bank premises, the customer
must receive and acknowledge a written statement that the product being
sold is not federally insured, is not a deposit or other obligation of
the bank and is not guaranteed by the bank, and is subject to
investment risks including loss of principal.9 Although the
Interagency Statement does not apply to sales to institutional
customers, the Board understands that, while obtaining acknowledgements
may be infeasible, disclosures are sometimes provided. The Board
believes that this is good practice, particularly in the case of
individual investors. See 12 CFR 225.2(g)(3).
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\9\ Compliance with the Interagency Statement is examined for
by the federal banking agencies.
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Furthermore, other firewalls require a section 20 subsidiary to
provide each of its customers with a special disclosure statement
describing the difference between the underwriting subsidiary and its
bank affiliates, and stating that securities sold, offered or
recommended by the section 20 subsidiary are not deposits, not
federally insured, not guaranteed by an affiliated bank, and not
otherwise an obligation or responsibility of such bank.10 Although
the disclosure firewall does not require that a section 20 subsidiary
obtain an acknowledgement, the Interagency Statement would require an
acknowledgement if the sale were on bank premises, and the Board
understands that section 20 subsidiaries generally obtain an
acknowledgement even when operating off bank premises. The Board
believes that this represents good practice. Once again, supervisory
efforts by the Board and other agencies will need to be emphasized in
this area.
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\10\ E.g. 1989 Order at 215.
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Finally, the Board notes that no serious problems of respondeat
superior liability have arisen with subsidiaries engaged in
underwriting eligible securities, despite the absence of a cross-
marketing firewall.
The concerns raised by commenters do not argue for retaining the
cross-marketing restriction. First, although banks could in theory
package their products in order to gain an unfair competitive
advantage, this danger is addressed specifically by the antitrust laws,
most notably the Sherman Act, and by a special anti-tying restriction
contained in section 106 of the Bank Holding Company Act Amendments of
1970. 12 U.S.C. 1972(1). Second, even assuming that the cross-marketing
firewall helps to create competitive equality between section 20
subsidiaries and other securities firms, as one commenter stated, the
Board does not believe that keeping customers ignorant of business
opportunities is an effective or appropriate way to maintain
competitive equality.
4. Continued Compliance Concerns
Furthermore, member banks should be aware that repeal of the cross-
marketing firewall does not relieve them of their obligation to comply
with sections 16 and 21 of the Glass-Steagall Act. 12 U.S.C. 24
(Seventh); 12 U.S.C. 378a. Although the Board will no longer impose a
blanket prohibition on a member bank's acting as agent for an
affiliated section 20 subsidiary, the bank will still be prohibited
from distributing securities underwritten by the section 20 subsidiary.
C. Restriction on Purchase and Sale of Financial Assets
1. Background
The Board sought comment on amending the financial assets
restriction, which generally prohibits a bank from purchasing financial
assets from, or selling such assets to, an affiliated section 20
subsidiary. An existing exception to this restriction allows the
purchase or sale of U.S. Treasury securities or direct obligations of
the Canadian federal government at market terms, provided that they are
not subject to repurchase or reverse repurchase agreements between the
underwriting subsidiary and its bank affiliates. The Board sought
comment on whether it should expand this exception to include the
purchase or sale of any assets with a sufficiently broad and liquid
market to ensure that the transaction is on market terms.
2. Summary of Comments
Commenters strongly favored an expanded exception to the
restriction on the purchase and sale of financial assets, though many
commenters favored eliminating the restriction altogether. Several
commenters argued that the financial assets restriction was unduly
broad to the extent it prohibits a bank from purchasing and selling
securities
[[Page 57683]]
that it is permitted by statute to purchase and sell for its own
account. Commenters noted that sections 16 and 21 of the Glass-Steagall
Act, and regulations adopted pursuant thereto, require that a bank
determine that ``there is adequate evidence that the obligor will be
able to perform all that it undertakes to perform in connection with
the security, including all debt service requirements, and that the
security is marketable'' before purchasing a security.\11\ Commenters
contended that these restrictions fully address the issues of credit
quality and liquidity in bank investments.
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\11\ 12 CFR 1.5(a).
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Another commenter stressed that regional bank holding companies
have legitimate reasons for asset transactions between a section 20
company and its affiliated bank. Because the securities distribution
side of regional section 20 companies tends to be dominated by
individual investors and smaller institutional and corporate investors,
a bank holding company might find it economically advantageous for its
section 20 subsidiary to acquire securities which can both be sold to
the bank for its investment portfolio and distributed by the section 20
subsidiary to its investor clients. The commenter stated that such
commingled transactions enable the institution to obtain securities in
the open market at more favorable terms than would otherwise be
available at lower volume.
A securities trade association objected to the proposal on the
grounds that it would permit banks to sell financial assets to, or
purchase such assets from, affiliated section 20 subsidiaries on terms
or under conditions that would not be available to other securities
firms, in effect subsidizing the activities of their affiliated section
20 subsidiaries. The commenter also expressed concern that banks could
provide their section 20 affiliates with access to certain financial
assets either earlier, or in greater amounts, than other securities
firms.
3. Final Order
The Board is expanding the exception to the financial assets
restriction, but using a more definite standard than that proposed.
Rather than allowing the purchase or sale of any security with a
``broad and liquid market,'' the Board is extending the exception to
``assets having a readily identifiable and publicly available market
quotation and purchased at that market quotation.'' Asset purchases
meeting this price availability standard are already exempt from the
quantitative and qualitative restrictions on inter-affiliated funding
contained in sections 23A and 23B of the Federal Reserve Act. 12 U.S.C.
371c(d)(6); 12 U.S.C. 371c-1(d)(3). Use of the same standard is
appropriate here. First, the same policy is being served: ensuring that
an inter-affiliate transaction is so verifiably arm's-length so as not
to require federal regulation of its terms. Second, use of the same
standard will ease compliance burden for banks, who are experienced in
administering it. Indeed, for any purchase of assets by a bank from an
affiliated section 20 subsidiary, the bank will already be required to
ensure compliance with this standard for purposes of sections 23A and
23B. Third, compliance with this standard would ensure that section 20
affiliates would not gain a competitive advantage over other securities
firms through asset sales to their affiliated banks.
The Board has decided to retain for now the financial assets
restriction to the extent that it prohibits a purchase or sale of less
liquid assets and any purchase or sale of assets subject to a
repurchase or reverse repurchase agreement. Any further changes to the
financial assets restriction will be considered in conjunction with
other funding firewalls, as part of a more comprehensive review of all
the remaining firewalls between a section 20 subsidiary and its
affiliated banks.
Revised Amendment to Firewalls
The Board is amending the section 20 firewalls as follows:
Interlocks Restriction
1987 and 1989 Orders (Domestic Bank Holding Companies)
Directors, officers or employees of a bank or thrift shall not
serve as a majority of the board of directors or the chief executive
officer of an affiliated section 20 subsidiary, and directors, officers
or employees of a section 20 subsidiary shall not serve as a majority
of the board of directors or the chief executive officer of an
affiliated bank or thrift. The underwriting subsidiary will have
separate offices from any affiliated bank or thrift.***
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\***\ An underwriting subsidiary may have offices in the same
building as a bank or thrift affiliate if the underwriting
subsidiary's offices are clearly distinguished from those of the
bank or thrift affiliate.
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1990 Order (Foreign Banks)
Directors, officers or employees of Applicant's U.S. bank or thrift
subsidiaries, branches or agencies shall not serve as a majority of the
board of directors or the chief executive officer of an affiliated
section 20 subsidiary, and directors, officers or employees of a
section 20 subsidiary shall not serve as a majority of the board of
directors or the chief executive officer +++ of an affiliated U.S.
bank or thrift subsidiary, branch or agency of Applicant, except that
the manager of a branch or agency may act as a director of the
underwriting subsidiary. The underwriting subsidiary will have separate
offices from any bank or thrift subsidiary or branch or agency of
Applicant.###
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\+++\ For purposes of this firewall, the manager of a U.S.
branch or agency of a foreign bank normally will be considered to be
the chief executive officer of the branch or agency.
\\## An underwriting subsidiary may have offices
in the same building as a bank or thrift subsidiary or branch or
agency of Applicant if the underwriting subsidiary's offices are
clearly distinguished from those of the bank, thrift, branch or
agency.
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Cross-Marketing Restriction
1987, 1989 and 1990 Orders
The cross-marketing restriction is removed.
Financial Assets Restriction
1989 and 1990 Orders
No bank or thrift (or U.S. branch or agency of a foreign bank)
shall, directly or indirectly, for its own account, purchase financial
assets of an affiliated underwriting subsidiary or a subsidiary thereof
or sell such assets to the underwriting subsidiary or subsidiary
thereof. This limitation shall not apply to the purchase and sale of
assets having a readily identifiable and publicly available market
quotation and purchased at that market quotation for purposes of
section 23A of the Federal Reserve Act, 12 U.S.C. 371c(d)(6), provided
that those assets are not subject to a repurchase or reverse repurchase
agreement between the underwriting subsidiary and its bank or thrift
affiliate.
By order of the Board of Governors of the Federal Reserve
System, November 1, 1996.
William W. Wiles,
Secretary of the Board.
[FR Doc. 96-28619 Filed 11-6-96; 8:45 am]
BILLING CODE 6210-01-P
