[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