[Federal Register Volume 61, Number 151 (Monday, August 5, 1996)]
[Notices]
[Pages 40640-40642]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-19867]
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FEDERAL RESERVE SYSTEM
[Docket No. R-0701]
Review of Restrictions on Director and Employee Interlocks,
Cross-Marketing Activities and the Purchase and Sale of Financial
Assets
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice; request for comment.
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SUMMARY: The Board is providing a second opportunity for public comment
on proposed revisions to three of the prudential limitations
established in its decisions under the Bank Holding Company Act and
section 20 of the Glass-Steagall Act permitting a nonbank subsidiary of
a bank holding company to underwrite and deal in securities. The Board
is proposing to ease or eliminate 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).
DATES: Comments should be received on or before September 3, 1996.
ADDRESSES: Comments should refer to Docket No. R-0701, and may be
mailed to William W. Wiles, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, N.W.,
Washington, DC 20551. Comments also may be delivered to Room B-222 of
the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to the
guard station in the Eccles Building courtyard on 20th Street, N.W.
(between Constitution Avenue and C Street, N.W.) at any time. Comments
received will be available for inspection in Room MP-500 of the Martin
Building between 9:00 a.m. and 5:00 p.m. weekdays, except as provided
in 12 CFR 261.8 of the Board's rules regarding availability of
information.
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:
Background
In its orders authorizing bank holding companies to operate section
20 subsidiaries, the Board has established a series of prudential
restrictions (commonly referred to as firewalls) designed to prevent
securities underwriting and dealing risk from being passed from a
section 20 subsidiary to an affiliated insured depository institution,
and thus to the federal safety net. The firewalls also mitigate the
potential for conflicts of interest, unfair competition, and other
adverse effects that may arise from the conduct of bank-ineligible
securities activities. 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).1 In adopting these restrictions, the Board stated
that it would continue to review their appropriateness in the light of
its experience in supervising section 20 subsidiaries.
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\1\ The 1989 Order and the 1987 Order are referred to
collectively as the ``section 20 Orders.''
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The Board originally sought comment on changes to the interlocks,
cross-marketing and financial assets restrictions on July 10, 1990. 55
FR 28,295 (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
[[Page 40641]]
affecting the section 20 firewalls was introduced shortly after the
Board sought comment, and has been introduced intermittently in the
years since, the Board has deferred further action.
Given the passage of time since the original notice, the Board has
decided to reopen these three firewalls for comment. All comments
received on the original notice will be considered by the Board before
taking final action, but commenters may wish to update their earlier
submissions.
Proposed Changes
Introduction
The interlocks and cross-marketing restrictions were intended to
insulate a bank or thrift from the underwriting and dealing risks borne
by an affiliated section 20 subsidiary by ensuring that each company is
operated independently and is perceived as such by its customers. The
Board is considering possible alternatives to these restrictions that
would maintain the intended insulation while allowing each company to
draw on management expertise at its affiliates, operate more
efficiently, and serve its customers more effectively.
Similarly, the financial assets restriction was a prophylactic
measure designed to insulate a bank or thrift from the risks of an
affiliated section 20 subsidiary by limiting one means by which a bank
or thrift could fund an affiliated section 20 subsidiary. The Board is
now considering whether that restriction is overbroad to the extent
that it covers purchases and sales where the bank or thrift assumes no
credit or liquidity risk.
Interlocks
The interlocks restriction currently prohibits all director,
officer, and employee interlocks between a section 20 subsidiary and
its bank or thrift affiliates.2 The restriction seeks to ensure
that customers will not be confused about which company they are
dealing with, and that in the event of troubles at the section 20
subsidiary, the two entities will continue to operate independently and
be ruled to have done so in the event that creditors of the section 20
subsidiary attempt to recover against the bank or thrift.
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\2\ 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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By prohibiting bank or thrift employees from serving at the section
20 subsidiary, the interlocks restriction imposes considerable costs on
bank holding companies operating a section 20 subsidiary and serves as
a barrier to entry for those considering doing so. This cost may be
prohibitive for some smaller bank holding companies that cannot afford
to pay separate staffs to perform similar functions. Accordingly, the
Board believes that this firewall should be reviewed in order to
determine whether the burdens it imposes serve functions important to
safety and soundness.
With respect to directors, the Board is seeking comment on whether
to eliminate the current blanket prohibition entirely or instead to
prohibit: (1) A majority of the board of directors of a section 20
subsidiary from being composed of directors, officers or employees of
affiliated banks or thrifts, and (2) a majority of the board of
directors of a bank or thrift from being composed of directors,
officers or employees of an affiliated section 20 subsidiary. The Board
believes that a prohibition on majority representation would help to
ensure corporate separateness, while allowing personnel costs to be
reduced and operating efficiencies to be exploited.
In addition, the Board originally requested comment on replacing
the prohibition on officer and employee interlocks with a requirement
that the section 20 subsidiary not be managed or controlled by its
affiliated banks or thrifts and that there not be a substantial
identity of personnel between the entities. Commenters strongly opposed
this proposal as vague and impractical, and the Board agrees. The Board
now seeks comment on whether the prohibition on officer and employee
interlocks should be eliminated altogether or, alternatively, limited
to only the senior executive officer or senior executive officers of
the section 20 subsidiary.
The Board believes that if the restriction on officer and employee
interlocks were eliminated or modified, existing firewalls and the
Interagency Policy Statement on the Sale of Uninsured Investment
Products would be sufficient to prevent customers from being confused
about which company they are dealing with, and consequently whether any
product they are obtaining is federally insured. For example, the
Board's section 20 Orders 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 and
thrift 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 or thrift, and
not otherwise an obligation or responsibility of such bank or thrift.
E.g. 1989 Order at 215. The Board seeks comment on whether existing
disclosure requirements are sufficient to prevent customer confusion
and potential liability of a bank or thrift.
The Board also seeks comment on whether concerns about corporate
separateness, even given a restriction on director interlocks, warrant
maintaining some restriction on officer interlocks. In particular, the
Board seeks comment on whether it should generally allow such
interlocks but prohibit (1) any senior executive officer of the section
20 subsidiary from serving as an officer or employee of an affiliated
bank or thrift, and (2) any senior executive officer of a bank or
thrift from serving as an officer or employee of an affiliated section
20 subsidiary.3 Alternatively, the Board seeks comment on whether
the officer or employee interlock should be limited only to the chief
executive officer.
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\3\ Under 12 CFR 225.71, a senior executive officer is defined
to include a person who ``without regard to title, exercises the
authority of one or more of the following positions: chief executive
officer, chief operating officer, chief financial officer, chief
lending officer, or chief investment officer. Senior executive
officer also includes any other person with significant influence
over major policymaking decisions.'' The Board seeks comment on
whether, if adopted, this definition should be amended to clarify
its coverage of interlocks between U.S. branches and agencies of
foreign banks and their affiliated section 20 subsidiaries.
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Cross-marketing
The Board's section 20 Orders also prohibit a bank or thrift
affiliate of a section 20 subsidiary from acting as agent for, or
engaging in marketing activities on behalf of, the section 20
subsidiary.4 The Board is requesting comment on whether to
eliminate this
[[Page 40642]]
restriction. As noted above, the Board believes that the disclosure
requirements contained in the section 20 Orders and the Interagency
Statement on Retail Sales of Nondeposit Investment Products may be a
more narrowly tailored and less burdensome method of protecting against
customer confusion as to whether the customer is dealing with a section
20 subsidiary or an affiliated bank or thrift.
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\4\ The cross-marketing restriction does not serve as a
complete bar on marketing activities by a bank or thrift on behalf
of an affiliated section 20 subsidiary. Pursuant to certain
conditions, the Board has allowed a bank affiliate of a section 20
subsidiary to: (1) send materials describing the section 20
subsidiary and the section 20 subsidiary's services to retail and
commercial customers directly or as a stuffer to bank statements;
(2) have its officers and employees send materials and letters on
bank letterhead describing the section 20 subsidiary and the section
20 subsidiary's services to the bank's retail and commercial
customers; (3) sponsor or co-sponsor with the section 20 subsidiary
educational seminars to inform retail and commercial customers about
investment opportunities, investment strategies, and the section 20
subsidiary's services; and (4) have its officers and employees send
invitations on bank letterhead inviting their customers to attend
the educational seminars sponsored or co-sponsored by the banks.
Letter Interpreting Section 20 Orders, 81 Federal Reserve Bulletin
198 (1995).
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The Board notes that the Glass-Steagall reform legislation passed
at various times by the Senate and reported by the House Banking
Committee has not prohibited cross-marketing and agency activities.
That legislation would have relied instead on disclosures regarding the
uninsured status of securities affiliates to prevent customer
confusion.
Purchase of Financial Assets
The Board is also seeking comment on amending the financial assets
restriction, which generally prohibits a bank or thrift 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 or thrift affiliates. See, e.g.,
1989 Order at 216; Canadian Imperial Bank of Commerce, The Royal Bank
of Canada, Barclays PLC and Barclays Bank PLC, 76 Federal Reserve
Bulletin 158, 172 (1990).
In establishing the exception for U.S. Treasury securities, the
Board cited the breadth and liquidity of the market for such
instruments, which make evident the ``market terms'' on which the sale
must be transacted and ensure that the bank will be able to resell any
asset it purchases. In its 1990 Notice, the Board sought comment on
extending this exception to include those U.S. Government agency
securities and U.S. Government-sponsored agency securities for which
there is a market with a breadth and liquidity comparable to that for
U.S. Treasury securities.
The Board now seeks 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 and that the bank is not incurring credit or liquidity
risk through the purchase of assets. The Board notes that the 1987
Order did not contain a financial assets firewall. In the Board's
experience, banks and thrifts whose holding companies operate free of
the financial assets restriction have not experienced adverse effects
from purchasing assets from, or selling assets to, their affiliated
section 20 subsidiaries.
The Board does intend to retain for now the financial assets
restriction to the extent that it prohibits a purchase or sale of
illiquid assets and any purchase or sale of assets subject to a
repurchase or reverse repurchase agreement. The Board believes that any
further changes to the financial assets restriction should 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 and thrifts.
By order of the Board of Governors of the Federal Reserve
System, July 31, 1996.
William W. Wiles,
Secretary of the Board.
[FR Doc. 96-19867; Filed 8-2-96; 8:45 am]
BILLING CODE: 6210-01-P
