[Federal Register Volume 69, Number 108 (Friday, June 4, 2004)]
[Proposed Rules]
[Pages 31541-31551]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-12514]


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FARM CREDIT ADMINISTRATION

12 CFR Parts 611, 612, 614, 615, and 620

RIN 3052-AC21


Organization; Standards of Conduct and Referral of Known or 
Suspected Criminal Violations; Loan Policies and Operations; Funding 
and Fiscal Affairs, Loan Policies and Operations, and Funding 
Operations; Disclosure to Shareholders; Preferred Stock

AGENCY: Farm Credit Administration.

ACTION: Proposed rule.

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SUMMARY: The Farm Credit Administration (FCA or agency) proposes to 
change its regulatory capital treatment for preferred stock issued by 
Farm Credit System (FCS or System) banks, associations, and service 
corporations and place certain restrictions on the retirement of 
preferred stock. Additionally, this proposal would require greater 
board involvement and oversight in the retirement of preferred stock, 
enhance the current standards of conduct regulations to specifically 
address insider preferred stock transactions, and require disclosure of 
senior officer and director preferred stock transactions. We also 
propose to modify and streamline our process for reviewing and clearing 
disclosure for certain issuances of FCS equities. Lastly, we propose to 
add a new provision to control investments by FCS banks, associations, 
and service corporations in preferred stock of other FCS institutions, 
including the Federal Agricultural Mortgage Corporation (Farmer Mac).

DATES: Please send your comments to us by August 3, 2004.

ADDRESSES: You may send comments by electronic mail to [email protected], through the Pending Regulations section of FCA's Web 
site, www.fca.gov, or through the Governmentwide www.regulations.gov 
portal. You may also send comments to S. Robert Coleman, Director, 
Regulation and Policy Division, Office of Policy and Analysis, Farm 
Credit Administration, 1501 Farm Credit Drive, McLean, Virginia 22102-
5090 or by fax to (703) 734-5784. You may review copies of all comments 
we receive at our office in McLean, Virginia.

FOR FURTHER INFORMATION CONTACT:

    Laurie A. Rea, Senior Policy Analyst, Office of Policy and 
Analysis, Farm Credit Administration, McLean, VA 22102-5090, (703) 
883-4479; TTY (703) 883-4434;

or

    Howard Rubin, Senior Attorney, Office of General Counsel, Farm 
Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY 
(703) 883-2020.

SUPPLEMENTARY INFORMATION:

I. Objectives

    Through this rulemaking we strive to:
     Ensure the stability and quality of capital at FCS 
institutions by establishing safety and soundness parameters on the 
issuance of preferred stock;
     Place restrictions on preferred stock issued by FCS 
institutions that can be continually redeemed and has limited 
attributes of equity;
     Ensure fair and equitable treatment of all shareholders of 
FCS preferred stock and minimize the potential for insider abuse;
     Modify and streamline our review and clearance process for 
issuances of nonborrower equities; and
     Require disclosure of senior officer and director 
preferred stock purchases and retirements.
    The agency believes additional regulatory guidance and requirements 
will help ensure consistent treatment for all FCS institutions seeking 
to issue preferred stock.

II. Background

A. Informational Memorandum

    FCA recently experienced an increase in requests from FCS 
institutions to review new preferred stock issuances. In reviewing 
submissions where associations sought to offer preferred stock to 
borrowers, we identified a number of policy and safety and soundness 
issues that led to a review of our capital adequacy regulations. In the 
fall of 2003, we outlined our concerns in an informational memorandum 
to all FCS institutions, which indicated that the FCA Board planned to 
consider modifications to FCA regulations to address these policy and 
safety and soundness issues.\1\
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    \1\ See Informational Memorandum, Roland E. Smith, Issuance of 
Preferred Stock, September 9, 2003.
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    We noted that questions exist about the stability (``permanency'') 
and quality of preferred stock that an institution plans to redeem 
routinely with few limitations or without direct involvement or 
consideration by the institution's board of directors. In particular, 
we highlighted our concerns about the risk associated with the capital 
and earnings volatility that may result from fluctuations in purchases 
and retirements that may occur daily. Preferred stock programs may be 
an especially volatile source of capital under adverse credit or 
interest rate

[[Page 31542]]

conditions when the likelihood of requests for redemption is increased.
    Stock that lacks permanence and other attributes of equity may not 
be available to absorb unforeseen losses, support growth, meet 
liquidity demands, or build financial strength. Overreliance on such 
programs as a source of capital may result in unsafe and unsound 
conditions and lessen incentives to procure more stable forms of 
capital. Therefore, it is necessary to take appropriate action to 
ensure that each FCS institution's capital continues to be primarily 
composed of equities that are likely to be a long-term feature of the 
institution's capital base. For this reason, we believe additional 
regulatory parameters and limits on certain types of preferred stock 
programs are warranted.
    In 1997, FCA adopted new surplus and collateral requirements in 
order to better measure and ensure the adequacy of FCS institution 
capital.\2\ However, many FCS stockholders and others still regard 
``permanent capital'' to be a meaningful measure of an FCS 
institution's financial stability. Therefore, including certain types 
of preferred stock that lack qualities of ``permanence'' in an 
institution's permanent capital ratio may give stockholders an 
inaccurate or misleading impression about the institution's true 
financial condition. FCS institutions need to ensure that stockholders 
receive complete information regarding the components of their 
institution's capital base and the long-term stability of those 
components. Fair, accurate, and complete disclosure about preferred 
stock programs in all written materials (including marketing materials, 
Web page advertisements, and other written information) is another 
critical issue of concern for FCA. Therefore, we are soliciting public 
input on what additional disclosures or additional regulatory guidance 
would be helpful to FCS institutions and benefit potential investors. 
We are also proposing regulatory changes to help streamline our 
clearance and review process for certain nonborrower equities. We 
believe changes can be made to expedite the processing of requests for 
applications that do not, for example, raise any novel or significant 
legal, policy or safety and soundness issues.
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    \2\ See 62 FR 4429 (January 30, 1997).
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    Lastly, we noted in the informational memorandum that certain 
preferred stock programs may raise the concern that an institution's 
board and management may not treat all preferred stockholders equitably 
regarding stock retirement, or that insiders could become aware of 
financial difficulties of the FCS institution and retire their stock 
before other shareholders. Thus, the agency is also proposing 
additional conflict of interest provisions specifically directed to 
preferred stock issuances.

B. Mission and Policy

    In addition to the safety and soundness concerns outlined above, we 
are proposing new restrictions to address mission and policy concerns 
regarding preferred stock issued by FCS institutions that is 
continually redeemed by the institution or otherwise has limited 
attributes of equity.
    FCS institutions have statutory authority to issue debt and equity 
securities (subject to FCA regulation) to fulfill their mission of 
serving the needs of farmers, ranchers, and rural residents. Preferred 
stock can be a valuable tool for FCS institutions to increase their 
capital and generate additional loanable funds to meet the credit needs 
of their borrowers. Additionally, preferred stock issued to borrowers 
provides FCS associations a mechanism for members to invest and 
participate in their cooperative beyond minimum borrower stock 
purchases.
    However, we question whether Congress intended FCS institutions to 
issue equities that have many characteristics of deposit or money 
market instruments. FCS institutions do not have authority to accept 
deposits except for limited circumstances specifically authorized by 
statute. Preferred stock securities that are structured so that a 
holder can reasonably expect redemption upon request have many features 
in common with comparably structured demand debt instruments (such as 
commercial bank deposits) under normal circumstances. Because the 
holder of such preferred stock can expect to receive principal and 
interest to the date of redemption, the preferred stock is functionally 
similar to a deposit or money market instrument under normal 
circumstances.
    On balance, unlike a commercial bank deposit, FCS preferred stock 
is an ``at-risk'' equity investment and a preferred stockholder 
ordinarily does not have an enforceable right to demand redemption. The 
holder of a deposit instrument, such as a demand deposit, time deposit, 
certificate of deposit, or a ``money market'' deposit has an 
enforceable legal right to demand payment. By contrast, the holder of 
preferred stock (a form of equity security) does not have an 
enforceable right to demand payment. Further, the deposit holder (a 
creditor) has priority in liquidation over the preferred stockholder 
(an equity holder). This important distinction makes preferred stock at 
risk (meaning the shareholder can lose some or all of its principal 
investment) and is, therefore, includable as permanent capital.
    Given these competing and dual characteristics that certain types 
of preferred stock may possess, we have endeavored to carefully craft 
regulations that appropriately balance mission and policy issues 
relating to these instruments in addition to addressing safety and 
soundness concerns.

C. Authority

    Congress broadly authorized each FCS bank and association to adopt 
bylaws providing for the classes and terms of stock issued by the 
institution.\3\ Congress specifically included preferred stock within 
the meaning of ``stock.'' \4\ Congress did not define ``preferred 
stock'' in the Farm Credit Act of 1971, as amended (Act). Congress 
defined ``permanent capital'' in the Act to mean:
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    \3\ See 12 U.S.C. 2013(9), 2073(16), 2093(8), 2122(9), and 
2154a(b).
    \4\ See 12 U.S.C. 2154a(a)(2).
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    (A) Current year retained earnings;
    (B) Allocated and unallocated earnings (which, in the case of 
earnings allocated in any form by a System bank to any association or 
other recipient and retained by the bank, shall be considered, in whole 
or in part, permanent capital of the bank or of any such association or 
other recipient as provided under an agreement between the bank and 
each such association or other recipient);
    (C) All surplus (less allowances for losses);
    (D) Stock issued by a System institution, except:
    (i) Stock that may be retired by the holder of the stock on 
repayment of the holder's loan, or otherwise at the option or request 
of the holder; and
    (ii) Stock that is protected under section 4.9A of the Act or is 
otherwise not at risk; and
    (E) Any other debt or equity instruments or other accounts that the 
FCA determines appropriate to be considered permanent capital.
    When first implementing the new capitalization statutes added by 
the 1987 amendments to the Act, FCA stated: ``No stock may be issued by 
Farm Credit institutions after October 5, 1988, that is not both at 
risk and retireable at the discretion of the board of directors 
provided minimum capital adequacy standards are met. These are the

[[Page 31543]]

essential characteristics of permanent capital.'' \5\ Therefore, FCA 
may authorize System institutions to issue preferred stock so long as 
the stock is at risk and the institution's board retains discretion 
over stock retirements.
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    \5\ 53 FR 40033 (October 13, 1988).
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    Section 4.3 of the Act \6\ requires FCA to ensure that System 
institutions ``achieve and maintain adequate capital.'' Title V of the 
Act \7\ authorizes FCA to adopt regulations to implement the Act and to 
take enforcement action in response to, or to prevent, an unsafe or 
unsound practice. Congress specifically provided that capitalization of 
System institutions, including the manner in which stock is issued, 
held, transferred, and retired, is subject to FCA regulation.\8\
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    \6\ 12 U.S.C. 2154.
    \7\ 12 U.S.C. 2241 et seq.
    \8\ See 12 U.S.C. 2014, 2074(a), 2094, 2146.
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III. Section-by-Section Discussion of Proposed Changes

A. Standards of Conduct--Sec.  612.2165

    There is the potential that an insider with access to material 
confidential information may be able to use that information to make 
advantageous purchases of preferred stock or request retirement before 
negative information becomes publicly available. In particular, 
directors, who are insiders, as well as borrowers and investors, will 
inevitably possess earlier and more detailed knowledge about the 
affairs of the institution than other investors. Insiders will know in 
advance whether a floating or administered dividend rate on preferred 
stock will change and, if so, by how much and when. They will also know 
whether the association will have to stop paying dividends due to 
capital or earnings problems. For these reasons, we believe strong 
regulatory controls are appropriate.
    Currently, System institution (defined to include banks, 
associations, and service organizations) directors are prohibited by 
Sec.  612.2140 from making use of non-public information or using their 
position or inside information to obtain a personal benefit. Section 
612.2165 requires the board of directors establish requirements and 
procedures ``to promote public confidence in the institution and the 
System * * * and prevent the improper use of official * * * 
information.'' Employees are prohibited by Sec.  612.2150(b) and (e) 
from divulging or making use of ``any fact, information, or document 
not generally available to the public that is acquired by virtue of 
employment with a System institution'' and from using such information 
to obtain any personal benefit.
    In addition, Sec.  612.2160 requires each institution to ensure 
that its directors and employees comply with the Standards of Conduct 
regulations and to ``act promptly to preserve the integrity of and 
public confidence in the institution in any matter involving a conflict 
of interest;'' to ``[t]ake appropriate measures to ensure that all 
directors and employees are informed of the requirements of this 
regulation'' and the institution's related policies and procedures; and 
to ``[a]dopt and implement policies and procedures that will preserve 
the integrity of and public confidence in the institution and the 
System * * * .'' Under Sec.  612.2170, the institution must designate a 
Standards of Conduct Official to advise directors, director candidates, 
and employees on standards of conduct regulations and policies. The 
Standards of Conduct Official must also report to the board and the FCA 
any violation that ``may have an adverse impact on continued public 
confidence in the System or any of its institutions.''
    Although the current standards of conduct regulations discussed 
above are comprehensive, we believe that enhancements to these 
regulations would strengthen our requirements, reduce the potential for 
conflicts of interest, and heighten the awareness of this important 
issue. Thus, we are proposing to add two new provisions. The purposes 
of these provisions are to help ensure fair and equitable treatment of 
all stockholders and to address the potential issue that employees and 
directors could use information regarding changes in dividend rates, 
regulatory capital ratios, the financial condition of the institution, 
or other material information that is not available to all investors to 
their advantage.
    Specifically, proposed Sec.  612.2165(b)(14) requires FCS 
institutions to establish policies and procedures that prohibit 
directors and employees from purchasing or retiring any stock in 
advance of the release of material non-public information concerning 
the institution to other stockholders. Proposed Sec.  612.2165(b)(15) 
requires FCS institutions to establish policies and procedures 
specifying when directors and employees may purchase and retire 
preferred stock in the institution.
    We are also proposing other corresponding controls relating to 
insider transactions and retirement of equities that are discussed 
later in this preamble.

B. Lending Limits--Sec.  614.4351

    The agency has routinely required FCS institutions that issue 
preferred stock that does not qualify as total surplus \9\ (such as 
preferred stock with a planned continual redemption feature) to exclude 
it from their lending limit base calculation (the maximum amount an 
institution can extend to an individual borrower). This control has 
been instituted to limit significant fluctuations in an institution's 
lending base that may occur due to stock purchases and redemptions and 
to limit the ability of an institution to appreciably increase its 
lending base with volatile securities. This condition has also been 
imposed to reduce the possibility that an FCS institution would be in 
noncompliance with FCA regulations due to routine preferred stock 
redemptions that caused the institution's capital levels to decline to 
a level where large loans would exceed the institution's legal lending 
limit. Lastly, this condition is also an effective safety and soundness 
control to limit the level of credit risk to a single counterparty or 
obligor.
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    \9\ See 12 CFR 615.5301(i).
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    For these same reasons, we are now proposing to institute a similar 
requirement in our regulations by adding a new paragraph (a)(3) to 
Sec.  614.4351 to the computation of the lending and leasing limit 
base. This provision will require FCS institutions to deduct from their 
lending limit base any amounts of preferred stock not eligible to be 
included in total surplus as defined in Sec.  615.5301(i).

C. Investments in FCS Institution Preferred Stock--Sec.  615.5175

    We believe there is a need to increase our oversight of the flow of 
capital between FCS institutions through investments in preferred 
stock. Proposed Sec.  615.5175 provides that FCS banks, associations, 
and service corporations may purchase preferred stock issued by another 
FCS institution, including Farmer Mac, only with the written prior 
approval of the FCA, except pursuant to Sec.  615.5171 (which relates 
to transfer of capital from banks to associations).\10\ The proposal 
also requires that an institution's request to purchase preferred stock 
in another FCS institution, including Farmer Mac, explain the terms and 
risk characteristics of the investment and the purpose and objectives 
for making the investment.
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    \10\ The FCA is concurrently considering amendments that will 
address investments by Farmer Mac in other FCS institutions.

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[[Page 31544]]

    As the safety and soundness regulator, we believe that it is 
important for FCS institutions to build their capital primarily through 
earnings. Diversified capital sources, however, can be a valuable 
source of additional financial strength. For example, preferred stock 
issuances can be a useful method for FCS institutions to build capital 
to fulfill their ongoing mission to serve agriculture and rural areas. 
However, for the reasons explained below, we believe that investment by 
one FCS institution in another FCS institution needs to be closely 
monitored.
    FCS banks and associations have statutory authority to purchase 
nonvoting equities in other FCS institutions.\11\ Historically, 
investments in preferred stock of other FCS institutions have been made 
to provide financial assistance. For instance, in the 1980s, several 
FCS banks purchased preferred stock issued by financially troubled 
associations. Today, there are a number of FCS institutions that are 
issuing preferred stock for a variety of other reasons, including 
meeting long-term capital objectives and supporting growth.
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    \11\ See 12 U.S.C. 2013(11), (16), 2073(7),( 8).
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    There have not been any recent investments by FCS banks, 
associations, or service corporations in the preferred stock of other 
FCS institutions, including Farmer Mac. Nevertheless, certain preferred 
stock investments of this nature could potentially reduce the perceived 
quality of FCS and Farmer Mac capital. These investments could be used 
to improve the regulatory capital ratios of individual FCS institutions 
without providing additional risk-bearing resources to the System as a 
whole. For example, if two FCS associations invested in each other's 
preferred stock, FCA regulations would require each FCS institution to 
deduct from its assets and total capital an amount equal to the 
reciprocal investment before computing its regulatory capital.\12\ 
However, if the investment came from a third FCS institution and there 
were no reciprocal investments, the regulatory capital of the issuing 
institutions could also increase. Furthermore, an FCS institution's 
ability to invest unlimited amounts in preferred stock issued by other 
FCS institutions creates concentration and systemic risks.
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    \12\ See 12 CFR 615.5210(e)(1).
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D. Capital Adequacy--Definitions--Sec.  615.5201

    We are proposing to modify our definitions in subpart H that apply 
to our capital adequacy regulations by defining preferred stock by 
class and maturity. Current Sec.  615.5201 does not specifically define 
preferred stock, but includes preferred stock within the definition of 
permanent capital. We are proposing changes to better define and 
capture the various classes of preferred stock currently offered in the 
marketplace. We are proposing to use these new definitions to 
differentiate how each class is treated for permanent capital ratio 
computation purposes, which we discuss later in this preamble. Also, to 
the extent appropriate to the activities of the FCS institutions, we 
are proposing definitions similar to those used by other financial 
regulatory agencies.\13\
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    \13\ We refer collectively to the Office of the Comptroller of 
the Currency, the Board of Governors of the Federal Reserve System, 
the Federal Deposit Insurance Corporation, and the Office of Thrift 
Supervision as the ``other financial regulatory agencies.''
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    Under the proposal, the reference to term preferred stock is 
removed from the definition of permanent capital in Sec.  
615.5201(1)(5). Instead, preferred stock is more broadly defined under 
proposed Sec.  615.5201(m) as stock that is ``permanent capital and has 
dividend and/or liquidation preference over common stock.'' The 
definition of preferred stock is further described as including, but 
not limited to, the following instruments:
    (1) Convertible preferred stock, which means preferred stock that 
is mandatorily convertible into any other class of equities.
    (2) Intermediate-term preferred stock, which means term preferred 
stock with an original maturity of at least 5 years but less than 20 
years.
    (3) Limited life preferred stock, which means preferred stock that 
has an original maturity of less than 5 years or preferred stock that 
has an effective maturity of less than 5 years and no stated maturity 
date.
    (4) Long-term preferred stock, which means term preferred stock 
with an original maturity of 20 years or more.
    (5) Perpetual preferred stock, which means preferred stock that 
does not have a maturity date and has no other provisions that will 
require future retirement of the issue.
    For consistency with the other financial regulatory agencies and to 
provide for future use, we reference convertible preferred stock in the 
proposed rule even though we do not refer to such stock anywhere else 
in our regulations and no System institution has issued such stock.

E. Treatment of Preferred Stock for Permanent Capital Computations--
Sec.  615.5203

    We are proposing to add new Sec.  615.5203 to address the treatment 
of preferred stock for permanent capital computational purposes. This 
provision is similar to current Sec.  615.5201(l)(5), which phases out 
the amount of term preferred stock that is eligible to be counted as 
permanent capital as it matures. Also, similar to the rules established 
by the other financial regulatory agencies, this proposal gives 
institutions less credit for preferred stock that lacks permanence and 
other positive characteristics of equity for meeting regulatory capital 
standards.
    We believe revisions to our current regulations are needed to more 
accurately address the relative levels of ``permanency'' of all classes 
of preferred stock. FCS institutions can issue classes of preferred 
stock that possess notably different terms/characteristics and have 
varying levels of ``permanency.'' As previously discussed, some FCS 
institutions have offered preferred stock that they intend to redeem at 
any time with the approval of the institution's board, as long as the 
institution meets its regulatory capital requirements (e.g., 
continually redeemed preferred stock). Such stock often lacks 
characteristics of stable equity because its effective maturity can be 
very short. Yet, under our current permanent capital regulations, this 
stock is treated the same as perpetual preferred stock that is not 
routinely retired, allowing an FCS institution to count the full amount 
outstanding as permanent capital.
    Term preferred stock, however, is treated less favorably during the 
last 5 years of its term under our current regulations for permanent 
capital computational purposes. At the beginning of each of the last 5 
years of the term of the stock, the amount that is eligible to be 
counted as permanent capital is reduced by 20 percent of the original 
amount of the stock (net of redemptions). Thus, stock that has a 
remaining maturity of less than 1 year is no longer eligible to be 
counted as permanent capital. As a result, certain equity instruments 
that are outstanding for only a short time period may be counted 100 
percent in permanent capital, whereas other equity instruments with an 
original maturity of more than 5 years, but a similar short remaining 
maturity, are given less equity credit.
    Therefore, we are proposing changes to better align our capital 
requirements with the true characteristics of an equity instrument and 
remove inconsistencies.

[[Page 31545]]

These changes also reduce safety and soundness concerns that may result 
from overreliance on equity that lacks stability and is not expected to 
remain as a permanent feature of the institution's capital base. 
Additionally, these amendments would help reduce the volatility in an 
institution's permanent capital ratio that may result from ongoing 
purchases and redemptions of the institution's preferred stock.
    We believe it is essential that an instrument be available to 
participate in losses while the institution is operating as a going 
concern. As an instrument approaches maturity, it begins to take on 
characteristics of a short-term obligation. For this reason, we are 
proposing to reduce, or discount, the outstanding amount of preferred 
stock that is eligible for inclusion in the permanent capital ratio as 
the instrument nears maturity. More specifically, for the purposes of 
computing the minimum permanent capital ratio, proposed Sec.  615.5203 
would permit a System institution to include preferred stock that it 
issues based on its ``effective maturity'' as follows:

------------------------------------------------------------------------
                                                              Amount
                                                           includable in
                   Effective maturity                      the permanent
                                                           capital ratio
                                                           (in percent)
------------------------------------------------------------------------
5 years or more.........................................             100
4 years or more and less than 5 years...................              80
3 years or more and less than 4 years...................              60
2 years or more and less than 3 years...................              40
1 year or more and less than 2 years....................              20
Less than 1 year........................................               0
------------------------------------------------------------------------

    For the purpose of this section ``effective maturity'' is the 
earlier of:
    (1) The remaining term to the stated maturity date; or
    (2) Either the remaining term to the earliest possible date on 
which an FCS institution may grant a stockholder's request for stock 
redemption, or the estimated duration of the weighted average term to 
maturity of the instrument's expected cash flows as determined under 
Sec.  615.5202(c) as described below.
    To use the estimated duration method, a System institution must 
adequately document and support its methodology and assumptions using 
historical redemption rates, appropriate discount rates, and, if 
applicable, timing of call or other features (e.g., interest rate step-
ups or caps). The information must be sufficient for FCA or an 
independent third party to validate the data and analysis to determine 
its appropriateness. Additionally, at least quarterly, the System 
institution must validate and adjust, as needed, its duration 
estimation and conduct appropriate interest rate stress testing on its 
estimation. However, in calculating effective maturity, a System 
institution is not required to include isolated retirements made in 
unusual or extraordinary circumstances (such as the death of a holder 
or a merger).
    We recognize that at the time a class of stock is first issued, an 
FCS institution may not have sufficient information regarding potential 
redemption rates to estimate the duration of the instrument. Therefore, 
FCS institutions may use data gathered on the duration of preferred 
stock with similar characteristics issued by other financial 
institutions (including other FCS institutions) or previously issued by 
the institution to support their estimation.
    The regulation also makes explicit that FCA reserves the right to 
make the final determination of the appropriate capital treatment for 
any instrument. The FCA will continue to evaluate the terms and 
characteristics of each issuance of preferred stock as well as the 
institution's policy and practice of retirement in making its 
determination.
    We are also proposing to limit the total amount of preferred stock 
with an effective maturity of less than 5 years that an FCS bank, 
association, or service corporation may include as permanent capital 
for computation of the permanent capital ratio. Specifically, proposed 
Sec.  615.5203(e) limits such stock to 25 percent of the institution's 
permanent capital (after deductions required in the permanent capital 
ratio computation). This provision is similar to our regulatory limit 
on the amount of term preferred stock that may be included as total 
surplus.\14\ We are proposing this limit because we believe it is 
appropriate and necessary to ensure that each FCS institution's 
permanent capital continues to be primarily composed of equities that 
are likely to be a long-term feature of the FCS institution's capital 
base. Further, it is essential for each FCS institution to maintain a 
stable capital base to meet the future needs of the institution.
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    \14\ See 12 CFR 615.5301(1)(4).
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F. Implementation of Cooperative Principles--Sec.  615.5230

    We propose to make a one-word addition to Sec.  615.5230(b)(1) to 
read: ``each issuance of preferred stock * * * shall be approved by a 
majority of the shares of each class of equities adversely affected by 
the preference * * *'' (Added word emphasized). This change clarifies 
our intent. We do not consider this to be a substantive change since 
the revised language conforms to our current interpretation of this 
rule.

G. Permanent Capital Requirements--Sec.  615.5240

    We have not made any substantive changes to this section. Current 
Sec.  615.5240(b) separately enumerates different, yet overlapping, 
permanent capital requirements for: (1) Common stock and participation 
certificates; (2) perpetual preferred stock; and (3) term preferred 
stock. We have made paragraph (b) easier to read and apply by 
consolidating it into one list for all equities. Additionally, we moved 
the content of existing paragraph (c), covering retirement of borrower 
stock, to Sec.  615.5270, Retirement of Other Equities.

H. Limitations on FCS Association Preferred Stock--Sec.  615.5245

    The proposal would limit the amount of preferred stock that a 
single investor may hold in any one FCS association offering. This 
limitation is intended to reduce the potential that any one holder of 
association preferred stock could have undue influence on any one class 
of stock. Thus, a single investor would be less likely to affect 
dividend rates or redemptions, or influence a decision

[[Page 31546]]

that could affect the institution. Additionally, this is another 
condition that we have imposed on FCS associations that have issued 
preferred stock. Specifically, proposed Sec.  615.5245(a) requires an 
association board of directors to adopt a policy to ensure that no 
holder at the date of purchase or transfer acquires more than the 
greater of $2 million or 5 percent of any class of outstanding 
preferred stock in the association.
    Additionally, Sec.  615.5245(b) requires boards of directors of FCS 
associations offering preferred stock to borrowers to adopt a policy 
that prohibits the association from extending credit to borrowers to 
purchase preferred stock in the association. The possibility exists 
that an FCS association's short-term administered loan rate could be 
less than the dividend rate on the association's preferred stock, 
providing an arbitrage opportunity. Generally, we would consider this 
type of lending a practice that is inconsistent with the mission 
objectives of the System.

I. Disclosure and Review Requirements for FCS Equities--Sec. Sec.  
615.5250 to 615.5255

    Under current rules, FCA has two affirmative responsibilities when 
an institution seeks to sell preferred stock: (1) We review the 
proposed disclosure statement for adequacy of disclosure; and (2) we 
determine whether the stock qualifies as permanent capital. In 
connection with new stock issuances we also routinely:
     Determine whether the stock issuance qualifies as total 
surplus or core surplus; and,
     Assess whether the stock issuance may present any legal, 
policy, operational, or safety and soundness issues.
    The proposed rule retains the same basic regulatory framework, 
requiring banks, associations, and service corporations to submit a 
proposed disclosure statement to FCA before any sale may take place, 
but clarifies and streamlines the current review and clearance process. 
We have also created separate regulatory sections for borrower stock 
and nonborrower equities. The disclosure requirements in proposed Sec.  
615.5250 for borrower stock remain fundamentally the same. We have, 
however, made some organizational and plain language changes. The 
changes we are proposing to our clearance and review process for 
equities not purchased as a condition of obtaining a loan are contained 
in proposed Sec.  615.5255.
    We anticipate that the new provisions will expedite processing of 
offerings that do not present significant supervisory or compliance 
concerns or raise significant legal or policy issues. For issuances 
where each purchaser and subsequent transferee must acquire at least 
$250,000 of the stock and meets the Securities and Exchange Commission 
definition of ``accredited investor'' or ``qualified institutional 
buyer,'' a disclosure statement is deemed reviewed and cleared by FCA 
unless FCA notifies the institution to the contrary within 30 days of 
receipt of a complete disclosure statement submission (which consists 
of the proposed disclosure statement and any additional materials 
requested by FCA).\15\
---------------------------------------------------------------------------

    \15\ Current rules allow FCA waiver of disclosure requirements 
for minimum purchases of $100,000 by sophisticated investors. We 
have updated this threshold to $250,000 (the $100,000 limit has 
remained the same for more than 15 years) to better reflect the 
activities of market participants.
---------------------------------------------------------------------------

    Under this process, an institution may also conclude that FCA will 
consider the stock permanent capital unless FCA notifies the 
institution to the contrary within 30 days. Upon request, FCA will 
provide written confirmation of its determination on how it will treat 
the proposed issuance for all other regulatory capital measures. We 
believe the shorter time period is appropriate for market-driven 
issuances purchased by sophisticated investors that do not raise novel 
or safety and soundness issues.
    In contrast, FCA has heightened interest about smaller, nonstandard 
issuances offered to unsophisticated borrowers and other investors who 
may be unaware of the risks involved with the purchase. Therefore, we 
are proposing to apply a 60-day time period for these issuances. For 
issuances offered to unsophisticated borrowers and investors, a 
disclosure statement is deemed reviewed and cleared and an institution 
may conclude that FCA will consider the stock permanent capital unless 
FCA notifies the institution to the contrary within 60 days of receipt 
of a complete disclosure statement submission.
    We believe these proposed changes will clarify our process and 
expedite FCS institutions' ability to issue preferred stock that does 
not have unique features or raise significant supervisory, legal, or 
policy issues. These amendments will also help address the concern that 
the current process could impede an FCS institution's ability to issue 
stock to sophisticated investors within a specific time period.
    Under our current regulations, a FCS institution must disclose to 
investors purchasing non-borrower equities: (1) All of the information 
required by part 620 in the annual report to shareholders as of a date 
within 135 days of the proposed sale; (2) the institution's 
capitalization bylaws; and, (3) a written description of the terms and 
conditions under which the equity is issued. In addition to specific 
terms and conditions, the description must disclose:
     The equity is an at-risk investment and not a compensating 
balance and the equity is retirable only at the discretion of the board 
of directors and only if minimum permanent capital standards 
established under subpart H of this part are met;
     Whether the institution presently meets its minimum 
permanent capital standards;
     Whether the institution knows of any reason the 
institution may not meet its permanent capital standard on the next 
earnings distribution date; and,
     The rights, if any, to share in patronage distributions.
    In addition to the above disclosures, we are proposing to add a new 
requirement that FCS institutions establish a method to disclose and 
make information on insider preferred stock purchases and retirements 
readily available to the public. Under proposed Sec.  615.5255(h), at a 
minimum, each FCS institution offering preferred stock must make this 
information available upon request. A FCS institution can also use 
other means, such as their Web sites, to make information on insider 
preferred stock transactions available to the public or provide this 
information along with the other required disclosures at purchase. We 
believe making this information available will help increase 
transparency of insider transactions, reduce the potential for insider 
abuses, and may provide eligible purchasers useful information 
regarding their decision on preferred stock purchases and retirements.
    At this time, we are not proposing any additional changes to our 
list of required disclosures. However, we invite comments from the 
public on whether any additional disclosures would be beneficial for 
investors to receive regarding the sale of non-borrower FCS equities.
    Current Sec.  615.5250(c)(4) provides that ``no officer, director, 
employee, or agent'' shall make any disclosure in connection with the 
sale of equities, through the disclosure statement or otherwise, that 
is inaccurate or misleading, or omit to make any statement needed to 
prevent other disclosures from being misleading. We are proposing to 
change this provision

[[Page 31547]]

in proposed Sec.  615.5255(g) by applying the rule to each 
``institution'' in addition to specific individuals. Since this section 
applies to equities offered by institutions, this amendment places 
responsibility for accurate and truthful disclosures on the institution 
itself in addition to individual officers, directors, employees, and 
agents. We also note that FCA considers this provision applicable to 
all forms of communication regarding a proposed offering--including 
marketing materials and Web page advertisements--and not just to the 
formal disclosure statement submitted to FCA.
    We are also proposing to add Sec.  615.5255(j), which provides that 
in addition to FCA requirements, each institution is responsible for 
ensuring its compliance with all applicable Federal and State 
securities laws. This provision reiterates that FCA review and 
clearance of a disclosure statement does not excuse or replace 
compliance with any other applicable law and does not replace or 
supersede oversight by any other governmental entity with authority 
over a securities issuance.

J. Retirement of Other Equities--Sec.  615.5270

    We are proposing amendments that would restrict the ability of an 
FCS institution board to retire and delegate to management the 
retirement of preferred stock under certain conditions. Additionally, 
these new provisions would increase FCS institution board involvement 
in the retirement of equities that are at risk. We are proposing these 
new provisions to address the safety and soundness, mission, and policy 
concerns discussed earlier in this preamble. These new controls will 
help ensure that FCS equities are fundamentally composed of equities 
that are likely to remain a long-term feature of the institution's 
capital and are available to absorb losses of the institution. 
Additionally, we believe these measures will help ensure the 
appropriateness of FCS activities within the context of its Government-
sponsored enterprise mission.
    We are proposing several new restrictions relating to the 
retirement of preferred stock in Sec.  615.5270. First, an FCS bank, 
association, or service corporation would not be able to retire limited 
life preferred stock, except pursuant to Sec. Sec.  615.5280 and 
615.5290 (which relates to retirement in the event of default or 
restructuring) and except for stock at the end of its stated maturity, 
unless the institution's permanent capital ratio would be in excess of 
8 percent after any retirements. Second, an FCS bank, association, or 
service corporation would be prohibited from retiring any preferred 
stock prior to 12 months after the date of issuance, except pursuant to 
Sec. Sec.  615.5280 and 615.5290. These provisions are intended to 
promote the stability (``permanence'') of capital while restricting the 
issuance of equities that could function like demand deposits or money 
market instruments.
    The FCA is also considering other regulatory measures to ensure 
that equities issued by FCS institutions are a stable and permanent 
feature of an institution's capital base. Specifically, we invite 
comments on whether FCA should institute a longer prohibition on 
retirement of preferred stock, such as 5 years (rather than 1 year as 
currently proposed). We also invite specific comment on whether FCA 
should only allow FCS institutions to retire preferred stock on a pro 
rata basis by class and not on an individual basis (except in the case 
of hardship or death). These provisions are two of many possible 
measures that could help address both the policy and safety and 
soundness concerns with stock that is continually redeemable. Thus, we 
are interested in gathering a broad range of perspectives on this 
subject.
    We are also proposing to move the provisions relating to the 
delegation of retirement of at-risk borrower stock in Sec.  615.5240(c) 
to Sec.  615.5270(e) and apply those same revisions to all at-risk 
stock issued by FCS institutions. Thus, an institution's board of 
directors would only be able to delegate authority to retire at-risk 
stock to institution management if:
    (1) The board has determined that the institution's capital 
position is adequate;
    (2) All retirements are in accordance with the institution's 
capital adequacy plan or capital restoration plan;
    (3) The institution's permanent capital ratio will be in excess of 
9 percent after any retirements;
    (4) The institution satisfies all applicable minimum surplus and 
collateral standards after any retirements; and
    (5) Management reports the aggregate amount and net effect of stock 
purchases and retirements to the board of directors each quarter.
    We are further proposing to require FCS institutions to adopt a 
written policy covering the retirement of preferred stock. 
Specifically, proposed Sec.  615.5270(f) would require each board of 
directors of a bank, association, or service corporation that issues 
preferred stock to adopt a written policy covering retirement of 
preferred stock. The policy must, at a minimum:
    (1) Establish any delegations of authority to retire preferred 
stock and the conditions of delegation (which must meet all the 
proposed requirements discussed above).
    (2) Contain specific limitations on the amount of stock that may be 
retired during a single quarter (or shorter) time period;
    (3) Ensure that all stockholder requests for retirement are treated 
fairly and equitably;
    (4) Prohibit any insider, including institution officers, 
directors, employees, or agents, from retiring any preferred stock in 
advance of the release of material non-public information concerning 
the institution to other stockholders; and
    (5) Establish when insiders may retire their preferred stock.
    The proposal would also require the institution's board to review 
its policy at least annually to ensure that it continues to be 
appropriate for the institution's current financial condition and 
consistent with its long-term goals established in its capital adequacy 
plan.
    The FCA expects FCS institution boards to fully consider the effect 
preferred stock retirements have on the institution's capital adequacy, 
current year earnings, patronage to other shareholders, and future 
capital needs.
    We believe these new regulations are necessary to ensure that FCS 
institutions fulfill their mission objectives in an appropriate and 
safe and sound manner, as intended under the Act. We also believe that 
these provisions will reduce the potential for insider abuse and the 
potential or appearance of unfair treatment or dealings relating to the 
retirement of preferred stock.

K. Payment of Dividends--Sec.  615.5295

    This proposal adds a new section to address the payment of 
dividends. These changes further address our mission and policy 
concerns relating to the issuance of preferred stock that can be 
continually redeemed.
    Under proposed Sec.  615.5295(a), an FCS institution's board of 
directors would be required to declare a dividend on a class of stock 
before any dividends may be paid to stockholders. We are adding this 
provision to emphasize the distinction between debt and equity 
securities. We are concerned that payment of accrued dividends before 
an institution's board has declared them makes the dividend payments 
perform too much like interest payments on debt instruments.
    Proposed Sec.  615.5295(b) prohibits an FCS institution from 
declaring or paying any dividend unless after declaration or payment of 
the dividend the institution

[[Page 31548]]

would continue to meet its regulatory capital standards under this 
part. This provision implements section 4.3A(d) of the Act,\16\ which 
prohibits payments of dividends if such action would cause the 
institution to fail to meet its permanent capital requirements and 
extends this safety and soundness measure to include all regulatory 
capital requirements.
---------------------------------------------------------------------------

    \16\ 12 U.S.C. 2154a(d).
---------------------------------------------------------------------------

    Lastly, proposed Sec.  615.5295(c) would require an FCS institution 
to exclude any accrued but unpaid dividends from regulatory capital 
computations. We are proposing this amendment to remove any potential 
that capital could be inflated through temporary accounts as an 
additional safety and soundness measure.

L. Disclosure of Insider Preferred Stock Transactions

    We are proposing to amend Sec.  620.5(j)(2) relating to the 
required disclosures of transactions with senior officers and directors 
in FCS institution annual reports to shareholders. We are proposing to 
add a new requirement that FCS institutions disclose insider preferred 
stock transactions and make other organizational changes to this 
section. We are proposing this new disclosure requirement along with 
other disclosure amendments previously discussed in an effort to 
increase the transparency of insider preferred stock transactions.
    Specifically, Sec.  620.5(j)(2)(a) would require FCS institutions 
to state the name of each senior officer or director that held 
preferred stock issued by the institution during the reporting period, 
the current amount of preferred stock held by the senior officer or 
director, the average dividend rate on the preferred stock currently 
held, and the amount of purchases and retirements by the individual 
during the reporting period. A FCS institution may disclose this 
information in tabular form as follows:

----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
Name of senior officer or        Amount of           Average dividend    Purchases..........  Retirements
 director.                        preferred stock     rate.
                                  held.
----------------------------------------------------------------------------------------------------------------

M. Conforming Changes

    We propose to make a conforming change to Sec.  611.1135 to update 
a cross-reference that would be changed by this proposed rule.

IV. Regulatory Flexibility Act

    Pursuant to section 605(b) of the Regulatory Flexibility Act (5 
U.S.C. 601 et seq.), the FCA hereby certifies that the proposed rule 
will not have a significant impact on a substantial number of small 
entities. Each of the banks in the System, considered together with its 
affiliated associations and service corporations, has assets and annual 
income in excess of the amounts that would qualify them as small 
entities. Therefore, System institutions are not ``small entities'' as 
defined in the RegulatoryFlexibility Act.

List of Subjects

12 CFR Part 611

    Agriculture, Banks, Banking, Rural areas.

12 CFR Part 612

    Agriculture, Banks, Banking, Conflicts of interest, Rural areas.

12 CFR Part 614

    Agriculture, Banks, Banking, Flood insurance, Foreign trade, 
Reporting and recordkeeping requirements, Rural areas.

12 CFR Part 615

    Accounting, Agriculture, Banks, Banking, Government securities, 
Investments, Rural areas.

12 CFR Part 620

    Accounting, Agriculture, Banks, Banking, Reporting and 
recordkeeping requirements, Rural areas.

    For the reasons stated in the preamble, we propose to amend parts 
611, 612, 614, 615, and 620 of chapter VI, title 12 of the Code of 
Federal Regulations as follows:

PART 611--ORGANIZATION

    1. The authority citation for part 611 continues to read as 
follows:

    Authority: Secs. 1.3, 1.13, 2.0, 2.10, 3.0, 3.21, 4.12, 4.15, 
4.20, 4.21, 5.9, 5.10, 5.17, 6.9, 6.26, 7.0-7.13, 8.5(e) of the Farm 
Credit Act (12 U.S.C. 2011, 2021, 2071, 2091, 2121, 2142, 2183, 
2203, 2208, 2209, 2243, 2244, 2252, 2278a-9, 2278b-6, 2279a-2279f-1, 
2279aa-5(e)); secs. 411 and 412 of Pub. L. 100-233, 101 Stat. 1568, 
1638; secs. 409 and 414 of Pub. L. 100-399, 102 Stat. 989, 1003, and 
1004.

Subpart I--Service Organizations

    2. Amend Sec.  611.1135 by revising paragraph (f) to read as 
follows:


Sec.  611.1135  Incorporation of service corporations.

* * * * *
    (f) When your service corporation issues equities, what are the 
disclosure requirements? Your service corporation must provide the 
disclosures described in Sec.  615.5255 of this chapter.

PART 612--STANDARDS OF CONDUCT AND REFERRAL OF KNOWN OR SUSPECTED 
CRIMINAL VIOLATIONS

    3. The authority citation for part 612 continues to read as 
follows:

    Authority: Secs. 5.9, 5.17, 5.19 of the Farm Credit Act (12 
U.S.C. 2243, 2252, 2254).

Subpart A--Standards of Conduct

    4. Amend Sec.  612.2165 by revising paragraphs (b)(12) and (b)(13) 
and adding new paragraphs (b)(14) and (b)(15) to read as follows:


Sec.  612.2165  Policies and procedures.

* * * * *
    (b) * * *
    (12) Establish reporting requirements, consistent with this part, 
to enable the institution to comply with Sec.  620.5 of this chapter, 
monitor conflicts of interest, and monitor recusal compliance;
    (13) Establish appeal procedures available to any employee to whom 
any required approval has been denied;
    (14) Prohibit directors and employees from purchasing or retiring 
any stock in advance of the release of material non-public information 
concerning the institution to other stockholders; and
    (15) Establish when directors and employees may purchase and retire 
their preferred stock in the institution.

PART 614--LOAN POLICIES AND OPERATIONS

    5. The authority citation for part 614 continues to read as 
follows:

    Authority: 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128; secs. 
1.3, 1.5, 1.6, 1.7, 1.9, 1.10, 1.11, 2.0, 2.2, 2.3, 2.4, 2.10, 2.12, 
2.13, 2.15, 3.0, 3.1, 3.3, 3.7, 3.8, 3.10, 3.20, 3.28, 4.12, 4.12A, 
4.13B, 4.14, 4.14A, 4.14C, 4.14D, 4.14E, 4.18, 4.18A, 4.19, 4.25, 
4.26, 4.27, 4.28, 4.36, 4.37, 5.9, 5.10, 5.17, 7.0, 7.2, 7.6, 7.8, 
7.12, 7.13, 8.0, 8.5, of the Farm Credit Act (12 U.S.C. 2011, 2013, 
2014, 2015, 2017, 2018, 2019, 2071, 2073, 2074, 2075, 2091, 2093, 
2094, 2097, 2121, 2122, 2124, 2128, 2129, 2131, 2141, 2149, 2183, 
2184, 2201, 2202, 2202a, 2202c, 2202d, 2202e, 2206, 2206a, 2207, 
2211, 2212, 2213, 2214, 2219a, 2219b, 2243, 2244, 2252, 2279a, 
2279a-2,

[[Page 31549]]

2279b, 2279c-1, 2279f, 2279f-1, 2279aa, 2279aa-5); sec. 413 of Pub. 
L. 100-233, 101 Stat. 1568, 1639.

Subpart J--Lending and Leasing Limits

    6. Amend Sec.  614.4351 by adding a new paragraph (a)(3) to read as 
follows:


Sec.  614.4351  Computation of lending and leasing limit base.

    (a) * * *
    (3) Any amounts of preferred stock not eligible to be included in 
total surplus as defined in Sec.  615.5301(i) of this chapter must be 
deducted from the lending limit base.
* * * * *

PART 615--FUNDING AND FISCAL AFFAIRS, LOAN POLICIES AND OPERATIONS, 
AND FUNDING OPERATIONS

    7. The authority citation for part 615 continues to read as 
follows:

    Authority: Secs. 1.5, 1.7, 1.10, 1.11, 1.12, 2.2, 2.3, 2.4, 2.5, 
2.12, 3.1, 3.7, 3.11, 3.25, 4.3, 4.3A, 4.9, 4.14B, 4.25, 5.9, 5.17, 
6.20, 6.26, 8.0, 8.3, 8.4, 8.6, 8.7, 8.8, 8.10, 8.12 of the Farm 
Credit Act (12 U.S.C. 2013, 2015, 2018, 2019, 2020, 2073, 2074, 
2075, 2076, 2093, 2122, 2128, 2132, 2146, 2154, 2154a, 2160, 2202b, 
2211, 2243, 2252, 2278b, 2278b-6, 2279aa, 2279aa-3, 2279aa-4, 
2279aa-6, 2279aa-7, 2279aa-8, 2279aa-10, 2279aa-12); sec. 301(a) of 
Pub. L. 100-233, 101 Stat. 1568, 1608.

Subpart F--Property, Transfers of Capital, and Other Investments

    8. Add new Sec.  615.5175 to read as follows:


Sec.  615.5175  Investments in Farm Credit System institution preferred 
stock.

    Except as provided for in Sec.  615.5171, Farm Credit banks, 
associations and service corporations may only purchase preferred stock 
issued by another Farm Credit System institution, including the Federal 
Agricultural Mortgage Corporation, with the written prior approval of 
the Farm Credit Administration. The request for approval should explain 
the terms and risk characteristics of the investment and the purpose 
and objectives for making the investment.

Subpart H--Capital Adequacy

    9. Amend Sec.  615.5201 by:
    a. Removing paragraph (l)(5) and redesignating existing paragraphs 
(l)(6), (1)(7), and (1)(8) as (l)(5), (1)(6), and (1)(7), respectively.
    b. Redesignating existing paragraphs (m), (n), (o), (p), and (q) as 
paragraphs (n), (o), (p), (q) and (r), respectively and adding a new 
paragraph (m) to read as follows:


Sec.  615.5201  Definitions.

* * * * *
    (m) Preferred stock means stock that is permanent capital and has 
dividend and/or liquidation preference over common stock. Preferred 
stock includes, but is not limited to, the following instruments:
    (1) Convertible preferred stock, which means preferred stock that 
is mandatorily convertible into any other class of equities.
    (2) Intermediate-term preferred stock, which means term preferred 
stock with an original maturity of at least 5 years but less than 20 
years;
    (3) Limited life preferred stock, which means preferred stock that 
has an original maturity of less than 5 years or preferred stock that 
has an effective maturity of less than 5 years and no stated maturity 
date.
    (4) Long-term preferred stock, which means term preferred stock 
with an original maturity of 20 years or more; and,
    (5) Perpetual preferred stock, which means preferred stock that 
does not have a maturity date and has no other provisions that will 
require future retirement of the issue.
* * * * *
    10. Add new Sec.  615.5203 to read as follows:


Sec.  615.5203  Treatment of preferred stock in the permanent capital 
ratio.

    (a) For the purposes of computing the minimum permanent capital 
ratio, a Farm Credit bank, association, or service corporation may 
include its preferred stock as permanent capital based on its effective 
maturity as follows:

------------------------------------------------------------------------
                                                              Amount
                                                           includable in
                   Effective maturity                      the permanent
                                                           capital ratio
                                                           (in percent)
------------------------------------------------------------------------
5 years or more.........................................             100
4 years or more and less than 5 years...................              80
3 years or more and less than 4 years...................              60
2 years or more and less than 3 years...................              40
1 year or more and less than 2 years....................              20
Less than 1 year........................................               0
------------------------------------------------------------------------

    (b) For the purpose of this section effective maturity is the 
earlier of:
    (1) The remaining term to the stated maturity date; or
    (2) Either the remaining term to the earliest possible date on 
which an institution may grant a stockholder's request for stock 
redemption, or the estimated duration of the weighted average term to 
maturity of the instrument's expected cash flows as determined under 
paragraph (c) of this section.
    (c) To use the estimated duration method, an institution must 
adequately document and support its methodology and assumptions using 
historical redemption rates, appropriate discount rates, and, if 
applicable, timing of call or other features (e.g., interest rate step-
ups or caps). Additionally, at least quarterly, the institution must 
validate and adjust, as needed, its duration estimation and conduct 
appropriate interest rate stress testing on its estimation.
    (d) In calculating effective maturity, an institution is not 
required to include isolated retirements made in unusual or 
extraordinary circumstances (such as the death of a holder or merger).
    (e) The total amount of preferred stock with an effective maturity 
of less than 5 years that an institution may include as permanent 
capital for computation of the permanent capital ratio is limited to 25 
percent of the institution's permanent capital (after deductions 
required in the permanent capital ratio computation).
    (f) The Farm Credit Administration reserves the right to make the 
final determination of the appropriate capital treatment for any 
instrument.

[[Page 31550]]

Subpart I--Issuance of Equities

    11. Revise Sec.  615.5230(b)(1) to read as follows:


Sec.  615.5230  Implementation of cooperative principles.

    (b) * * *
    (1) Each issuance of preferred stock (other than preferred stock 
outstanding on October 5, 1988, and stock into which such outstanding 
stock is converted that has substantially similar preferences) shall be 
approved by a majority of the shares of each class of equities 
adversely affected by the preference, voting as a class, whether or not 
such classes are otherwise authorized to vote;
* * * * *
    12. Revise Sec.  615.5240 to read as follows:


Sec.  615.5240  Permanent capital requirements.

    (a) The capitalization bylaws shall enable the institution to meet 
the capital adequacy standards established under subparts H and K of 
this part and the total capital requirements established by the board 
of directors of the institution.
    (b) In order to qualify as permanent capital, equities issued under 
the bylaws must meet the following requirements:
    (1) Retirement must be solely at the discretion of the board of 
directors and not upon a date certain (other than the original maturity 
date of preferred stock) or upon the happening of any event, such as 
repayment of the loan, and not pursuant to any automatic retirement or 
revolvement plan;
    (2) Retirement must be at not more than book value;
    (3) The institution must have made the disclosures required by this 
subpart;
    (4) For common stock and participation certificate dividends, 
dividends must be noncumulative and payable only at the discretion of 
the board; and
    (5) For cumulative preferred stock, the board of directors must 
have discretion to defer payment of dividends.
    13. Add a new Sec.  615.5245 to read as follows:


Sec.  615.5245  Limitations on FCS association preferred stock.

    The board of directors of each association offering preferred stock 
to eligible borrowers must adopt a policy that:
    (a) Includes measures to ensure that no holder acquires more than 
the greater of $2 million or 5 percent of any class of outstanding 
preferred stock in the association at the date of purchase or transfer.
    (b) Prohibits the association from extending credit for preferred 
stock purchases in the association.
    14. Revise Sec.  615.5250 to read as follows:


Sec.  615.5250  Disclosure requirements for borrower stock.

    (a) For sales of borrower stock, which for this subpart means 
equities purchased as a condition for obtaining a loan, an institution 
must provide a prospective borrower with the following documents prior 
to loan closing:
    (1) The institution's most recent annual report filed under part 
620 of this chapter;
    (2) The institution's most recent quarterly report filed under part 
620 of this chapter, if more recent than the annual report;
    (3) A copy of the institution's capitalization bylaws; and
    (4) A written description of the terms and conditions under which 
the equity is issued. In addition to specific terms and conditions, the 
description must disclose:
    (i) That the equity is an at-risk investment and not a compensating 
balance;
    (ii) That the equity is retirable only at the discretion of the 
board of directors and only if minimum permanent capital standards 
established under subpart H of this part are met;
    (iii) Whether the institution presently meets its minimum permanent 
capital standards;
    (iv) Whether the institution knows of any reason the institution 
may not meet its permanent capital standard on the next earnings 
distribution date; and
    (v) The rights, if any, to share in patronage distributions.
    (b) Notwithstanding the provisions of paragraph (a) of this 
section, no materials previously provided to a purchaser (except the 
disclosures required by paragraph (a)(4) of this section) need be 
provided again unless the purchaser requests such materials.
    15. Add new Sec.  615.5255 to read as follows:


Sec.  615.5255  Disclosure and review requirements for other equities.

    (a) A bank, association, or service corporation must submit a 
proposed disclosure statement to the Farm Credit Administration (FCA) 
for review and clearance prior to the proposed sale of any other 
equities, which for this subpart means equities not purchased as a 
condition for obtaining a loan.
    (b) An institution may not offer to sell other equities until a 
disclosure statement is reviewed and cleared by FCA.
    (c) A disclosure statement must include:
    (1) All of the information required by part 620 of this chapter in 
the annual report to shareholders as of a date within 135 days of the 
proposed sale. An institution may incorporate by reference its most 
recent annual report to shareholders and the most recent quarterly 
report filed with the FCA in satisfaction of this requirement;
    (2) The information required by Sec.  615.5250(a)(3) and (a)(4); 
and
    (3) A discussion of the intended use of the sale proceeds.
    (4) An institution is not required to provide the materials 
identified in paragraphs (c)(1) and (c)(2) of this section to a 
purchaser who previously received them unless the purchaser requests 
it.
    (d) For any class of stock where each purchaser and all subsequent 
transferees acquire at least $250,000 of the stock and meets the 
definition of ``accredited investor'' or ``qualified institutional 
buyer'' contained in 17 CFR 230.501 and 230.144A, a disclosure 
statement submitted pursuant to this section is deemed reviewed and 
cleared by FCA and an institution may treat stock that meets all 
requirements of part 615 as permanent capital for the purpose of 
meeting the minimum permanent capital standards established under 
subpart H unless FCA notifies the institution to the contrary within 30 
days of receipt of a complete disclosure statement submission. A 
complete disclosure statement submission includes the proposed 
disclosure statement plus any additional materials requested by FCA.
    (e) For all other issuances, a disclosure statement submitted 
pursuant to this section is deemed reviewed and cleared by FCA, and an 
institution may treat stock that meets all requirements of part 615 as 
permanent capital for the purpose of meeting the minimum permanent 
capital standards established under subpart H unless FCA notifies the 
institution to the contrary within 60 days of receipt of a complete 
disclosure statement submission. A complete disclosure statement 
submission includes the proposed disclosure statement plus any 
additional materials requested by FCA.
    (f) Upon request, FCA will inform the institution how it will treat 
the proposed issuance for other regulatory capital ratios or 
computations.
    (g) No institution, officer, director, employee, or agent shall 
make any disclosure, through a disclosure statement or otherwise, in 
connection with the sale of equities that is inaccurate or misleading, 
or omit to

[[Page 31551]]

make any statement needed to prevent other disclosures from being 
misleading.
    (h) Each bank and association must establish a method to disclose 
and make information on insider preferred stock purchases and 
retirements readily available to the public. At a minimum, each 
institution offering preferred stock must make this information 
available upon request.
    (i) The requirements of this section do not apply to the sale of 
Farm Credit System institution equities to:
    (1) Other Farm Credit System institutions,
    (2) Other financing institutions in connection with a lending or 
discount relationship, or
    (3) Non-Farm Credit System lenders that purchase equities in 
connection with a loan participation transaction.
    (j) In addition to the requirements of this section, each 
institution is responsible for ensuring its compliance with all 
applicable Federal and state securities laws.

Subpart J--Retirement of Equities and Payment of Dividends

    16. Amend subpart J of part 615 by revising the heading to read as 
stated above.
    17. Amend Sec.  615.5270 by adding new paragraphs (c), (d), (e), 
and (f) to read as follows:


Sec.  615.5270  Retirement of other equities.

* * * * *
    (c) A bank, association, or service corporation may not retire 
limited life preferred stock at any time, except pursuant to Sec. Sec.  
615.5280 and 615.5290 and except for stock at the end of its stated 
maturity, unless the institution's permanent capital ratio will be in 
excess of 8 percent after any retirements.
    (d) No preferred stock may be retired prior to 12 months after the 
date of issuance, except pursuant to Sec. Sec.  615.5280 and 615.5290.
    (e) A bank, association, or service corporation board of directors 
may delegate authority to retire at-risk stock to institution 
management if:
    (1) The board has determined that the institution's capital 
position is adequate;
    (2) All retirements are in accordance with the institution's 
capital adequacy plan or capital restoration plan;
    (3) The institution's permanent capital ratio will be in excess of 
9 percent after any retirements;
    (4) The institution will continue to satisfy all applicable minimum 
surplus and collateral standards after any retirements; and
    (5) Management reports the aggregate amount and net effect of stock 
purchases and retirements to the board of directors each quarter.
    (f) Each board of directors of a bank, association, or service 
corporation that issues preferred stock must adopt a written policy 
covering the retirement of preferred stock. The policy must, at a 
minimum:
    (1) Establish any delegations of authority to retire preferred 
stock and the conditions of delegation, which must meet the 
requirements of paragraph (d) of this section.
    (2) Contain specific limitations on the amount of stock that may be 
retired during a single quarter (or shorter) time period;
    (3) Ensure that all stockholder requests for retirement are treated 
fairly and equitably;
    (4) Prohibit any insider, including institution officers, 
directors, employees, or agents, from retiring any preferred stock in 
advance of the release of material non-public information concerning 
the institution to other stockholders; and
    (5) Establish when insiders may retire their preferred stock. The 
institution's board must review its policy at least annually to ensure 
that it continues to be appropriate for the institution's current 
financial condition and consistent with its long-term goals established 
in its capital adequacy plan.
    18. Add new Sec.  615.5295 to read as follows:


Sec.  615.5295  Payment of dividends.

    (a) The board of directors of a bank, association, or service 
corporation must declare a dividend on a class of stock before any 
dividends may be paid to stockholders.
    (b) No bank, association, or service corporation may declare or pay 
any dividend unless after declaration or payment of the dividend the 
institution would continue to meet its regulatory capital standards 
under this part.
    (c) Each bank, association, and service corporation must exclude 
any accrued but unpaid dividends from regulatory capital computations 
under this part.

PART 620--DISCLOSURE TO SHAREHOLDERS

    20. The authority citation for part 620 continues to read as 
follows:

    Authority: Secs. 5.17, 5.19, 8.11 of the Farm Credit Act (12 
U.S.C. 2252, 2254, 2279aa-11); sec. 424 of Pub. L. 100-233, 101 
Stat. 1568, 1656.

Subpart B--Annual Report to Shareholders

    21. Revise Sec.  620.5(j)(2) to read as follows:


Sec.  620.5  Contents of the annual report to shareholders.

* * * * *
    (j) * * *
    (2) Transactions other than loans. For each person who served as a 
senior officer or director on January 1 of the year following the 
fiscal year of which the report is filed, or at any time during the 
fiscal year just ended, describe briefly any transaction or series of 
transactions other than loans that occurred at any time since the last 
annual meeting between the institution and such person, any member of 
the immediate family of such person, or any organization with which 
such person is affiliated.
    (i) For transactions relating to the purchase or retirement of 
preferred stock issued by the institution, state the name of each 
senior officer or director that held preferred stock issued by the 
institution during the reporting period, the current amount of 
preferred stock held by the senior officer or director, the average 
dividend rate on the preferred stock currently held, and the amount of 
purchases and retirements by the individual during the reporting 
period.
    (ii) For all other transactions, state the name of the senior 
officer or director who entered into the transaction or whose immediate 
family member or affiliated organization entered into the transaction, 
the nature of the person's interest in the transaction, and the terms 
of the transaction. No information need be given where the purchase 
price, fees, or charges involved were determined by competitive bidding 
or where the amount involved in the transaction (including the total of 
all periodic payments) does not exceed $5,000, or the interest of the 
person arises solely as a result of his or her status as a stockholder 
of the institution and the benefit received is not a special or extra 
benefit not available to all stockholders.
* * * * *

    Dated: May 27, 2004.
Jeanette C. Brinkley,
Secretary, Farm Credit Administration Board.
[FR Doc. 04-12514 Filed 6-3-04; 8:45 am]
BILLING CODE 6705-01-P