[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