Appendix — Securities Industry Ass'n v. Board of Governors of the Federal Reserve System
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SUPREME COURT, U.S.
VASHINGTON, D.C,
MAR 12 1966
Nig | concn
IN THE
Supreme Court of the United States
OCTOBER TERM, 1987
>
SECURITIES INDUSTRY ASSOCIATION,
—_—V—
Petitioner,
BOARD OF GOVERNORS OF THE —_
FEDERAL RESERVE SYSTEM, ef al.,
Respondents.
APPENDIX TO PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
Of Counsel:
William J. Fitzpatrick
Securities Industry Association
120 Broadway
New York, New York 10271
(212) 608-1500
Donald J. Crawford
Securities Industry Association
1850 M Street, N.W.
Washington, D.C. 20036
(202) 296-9410
James B. Weidner
(Counsel of Record)
David A. Schulz
Mark Holland
ROGERS & WELLS
206 Park Avenue
New York, New York 10166
(212) 878-8000
Attorneys for Petitioner
Securities Industry
Association
APPENDIX A
APPENDIX B
APPENDIX C
APPENDIX D
TABLE OF CONTENTS
Opinion of the United States Court of
Appeals for the Second Circuit in Secu-
rities Industry Association v. Board of
Governors, No. 87-4041 and consoli-
dated cases (2d Cir. Feb. 8, 1988) ....
Order of the Board of Governors of the
Federal Reserve System Approving Ap-
plications of Citicorp, J.P. Morgan &
Co. Incorporated and Bankers Trust
New York Corporation to Engage in
Limited Underwriting and Dealing in
Certain Securities, Citicorp, 73 Fed.
Se eS,
Order of the Board of Governors of the
Federal Reserve System Conditionally
Approving Application of The Chase
Manhattan Corporation to Underwrite
and Deal in Certain Securities to a Lim-
ited Extent, The Chase Manhattan Cor-
poration, 73 Fed. Res. Bull. 607 (1987)
Order of the Board of Governors of the
Federal Reserve System Conditionally
Approving Applications of Chemical
New York Corporation to Underwrite
and Deal in Certain Securities to a Lim-
ited Extent and to Place Commercial
Paper, Chemical New York Corpora-
tion, 73 Fed. Res. Bull. 616 (1987)....
PAGE
la
53a
146a
1Sla
APPENDIX E
APPENDIX F
APPENDIX G
APPENDIX H
Order of the Board of Governors of the
Federal Reserve System Approving Ap-
plication of Citicorp to Underwrite and
Deal in Commercial Paper to a Limited
Extent, Citicorp, 73 Fed. Res. Bull. 618
Order of the Board of Governors of the
Federal Reserve System Conditionally
Approving Application of Manufactur-
ers Hanover Corporation to Under-
write and Deal in Certain Securities to a
Limited Extent and to Place Commer-
cial Paper, Manufacturers Hanover
Corporation, 73 Fed. Res. Bull. 620
Order of the Board of Governors of the
Federal Reserve System Conditionally
Approving Application of Security Pa-
cific Corporation to Underwrite and
Deal in Certain Securities to a Limited
Extent, Security Pacific Corporation,
73 Fed. Res. Bull. 622 (1987) ........
Selected Provisions of the Banking Act
of 1933 (Glass-Steagall Act), Pub. L.
No. 73-66, 48 Stat. 162 (12 U.S.C.
§§ 24 (Seventh), 78, 377, 378)........
PAGE
156a
160a
166a
APPENDIX A
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
i
Nos. 1488, 1489, 1490, 1491, 1492,
1493, 1494—August Term 1986
(Argued June 23, 1987 Decided February 8, 1988)
Docket Nos. 87-4041, 87-4055, 87-4057, 87-4059,
87-4061, 87-4063, 87-4067, 87-4069, 87-4071, 87-4073,
87-4075, 87-4077, 87-4079, 87-4085
+
SECURITIES INDUSTRY ASSOCIATION,
Petitioner-Cross-Respondent,
—_—V.—
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYS-
TEM, PAUL A. VOLCKER, as Chairman of the Board
of Governors of the Federal Reserve System, MAN-
UEL H. JOHNSON, WAYNE D. ANGELL, ROBERT H.
HELLER, and MARTHA R. SEGER, as members of the
Board of Governors of the Federal Reserve System,
Respondents,
BANKERS TRUST NEW YORK CORPORATION, J.P. MOR-
GAN & CO. INCORPORATED, and CITICCRP and THE
CHASE MANHATTAN CORPORATION, MANUFACTUR-
ERS HANOVER CORPORATION, and CHEMICAL NEW
YORK CORP, SECURITY PACIFIC CORPORATION,
Intervenors-Respondents Cross-Petitioners.
+
2a
Before:
CARDAMONE, PIERCE and WINTER,
Circuit Judges.
a
The Securities Industry Association petitions for review
of six orders of the Board of Governors of the Federal
Reserve System. The Board found that bank holding
company subsidiaries already engaged entirely in under-
writing and dealing in federal, state, and local govern-
ment securities could underwrite and deal in, to a limited
extent, municipal revenue bonds, mortgage related securi-
ties, and commercial paper without contravening § 20 of
the Glass-Steagall Act. Bankers Trust New York Corp.,
J.P. Morgan & Co., Inc., Citicorp, The Chase Manhattan
Corp., Manufacturers Hanover Corp., Chemical New
York Corp. and Security Pacific Corp. cross-petition for
review of the Board’s limitations on the securities activi-
ties of their subsidiaries.
Petitions for review denied.
Cross-petition for review denied in part and granted in
part.
ae
JAMES B. WEIDNER, New York, New York
(David A. Schulz, Mark Holland, Peter
Kimm, Jr., Roger & Wells, New York,
New York; William J. Fitzpatrick, New
York, New York; Donald J. Crawford,
Washington, D.C., of counsel), for
Petitioner-Cross-Respondent Securities
Industry Association.
AOR OO A ee -
DL Tween 5 ta hmm = Sh ee
‘iment iene iain iat
3a
MICHAEL S. HELFER, Washington, D.C.
(Christopher Lipsett, Thomas P. Olson,
Wilmer, Cutler & Pickering, Washington,
D.C., of counsel), Pro Hac Vice for
Intervenor-Respondent Cross-Petitioner
Citibank.
LEWIS B. KADEN, New York, New York
(Lowell Gordon Harriss, D. Scott Wise,
Davis Polk & Wardwell, New York, New
York, of counsel), for JIntervenor-
Respondent Cross-Petitioner J.P Morgan
& Co. Incorporated.
RICHARD M. ASHTON, Washington, D.C.,
(Richard K. Willard, Assistant Attorney
General, U.S. Department of Justice, Mi-
chael Bradfield, General Counsel, Kay E.
Bondehagen, Douglas B. Jordan, Wash-
ington, D.C.; Robert M. Kimmitt, De-
partment of the Treasury; Richard V.
Fitzgerald, Office of the Comptroller
of the Currency, Washington, D.C.,
of counsel), for Respondents Board of
Governors of the Federal Reserve Sys-
tem, et al.
DAVIS POLK & WARDWELL, New York, New
York, attorneys for J.P. Morgan & Co.,
Incorporated; White & Case, New York,
New York, attorneys for Bankers Trust
New York Corporation; Shearman &
Sterling, New York, New York and
Wilmer, Cutler & Pickering, Washington,
D.C., attorneys for Citicorp; Cravath,
Swaine & Moore, New York, New York,
4a :
attorneys for Chemical New York Cor- )
poration; Milbank, Tweed, Hadley &
McCloy, New York, New York, attorneys
for The Chase’ Manhattan Corpora- |
tion; Simpson Thacher & Bartlett, New .
York, New York, attorneys for Manufac-
turers Hanover Corporation; O’Melveny |
& Myers, New York, New York, attor-
neys for Security Pacific Corporation;
all of counsel), filed a brief on be-
half of Intervenors-Respondents Cross-
Petitioners.
MARTIN GLENN, O’Melveny & Myers, New
York, New York (Russell A. Freeman,
Dan C. Aardal, Security Pacific Corpo-
ration, Los Angeles, California; Edward
J. McAniff, Michael J. Fairclough,
O’Melveny & Myers, Los Angeles, Cali- !
fornia; William T. Coleman, Jr., John H. |
Beisner, Jacob M. Lewis, James P. Nehf,
O’Melveny & Myers, Washington, D.C.,
of counsel), filed a brief on behalf of
Intervenor-Respondent, Cross-Petitioner
Security Pacific Corporation.
DAVID M. MILES, Washington, D.C. (Harvey
L. Pitt, Henry A. Hubschman, Fried,
Frank, Harris, Shriver & Jacobson,
Washington, D.C.; Matthew P. Fink,
Senior Vice President and General Coun-
sel, Sarah O’Neil, Associate General
Counsel, Investment Company Institute,
Washington, D.C., of counsel), filed a
se
Sa
brief on behalf of Investment Company
Institute as Amicus Curiae.
HOGAN & HARTSON, Washington, D.C.
(Neal L. Petersen, Keith R. Fisher, James
G. Christiansen, Washington, D.C., of
counsel), filed a brief on behalf of Bank
Capital Markets Association as Amicus
Curiae.
JOHN J. GILL, General Counsel, Washington,
D.C. (Michael F. Crotty, Associate Gen-
eral Counsel-Litigation, American Bank-
ers Association, Washington, D.C., of
counsel), filed a brief on behalf of the
American Bankers Association as Amicus
Curiae.
7
CARDAMONE, Circuit Judge:
We review on this appeal those provisions of the Bank-
ing Act of 1933 that separated the commercial and invest-
ment banking industries and are known as the
Glass-Steagall Act. See Pub. L. No. 73-66, §§ 16, 20, 21,
& 32, 48 Stat. 162 (1933). Demand for divorcing banking
and securities activities followed in the wake of the stock
market crash of 1929, which occurred, it was said, be-
cause a mountain of credit rested on only a molehill of
cash. The actions of the Federal Reserve Board that we
review today allow commercial and investment banking
to compete in a narrow market, and to that extent
dismantle the wall of separation installed between them
by the Glass-Steagall Act. Whether Santayana’s notion
6a
that those who will not learn from the past are con-
demned to repeat it fairly characterizes the consequences
of the Board’s action is not for us to say. Our task is to
review the Glass-Steagall Act, the legislative history that
surrounded its enactment, and its prior judicial construc-
tion to determine whether the Board reasonably inter-
preted the Act’s often ambiguous terms.
The Securities Industry Association (SIA) and seven
bank holding companies petition for review of six related
orders of the Board of Governors of the Federal Reserve
System (Board). The orders approved the bank holding
companies’ applications to utilize subsidiaries as the vehi-
cle by which they can underwrite and deal in certain
securities. The Board determined that the approved ac-
tivities would not run afoul of § 20 of the Glass-Steagall
Act, which proscribes affiliations of banks—here, the
holding companies’ member bank subsidiaries—with en-
tities that are “engaged principally” in underwriting and
dealing in securities. At the same time, the Board limited
the scope of the approved activities. The decisions allow-
ing bank subsidiaries to engage in securities transactions
and the limitations that were imposed are the focus of the
petitions seeking review. For the reasons set forth below,
we deny the petitions for review save for the bank holding
companies’ cross-petition for review that seeks to elimi-
nate the market share limitation.
BACKGROUND
I The Board’s Orders
On April 30, 1987 the Board approved the applications
of Citicorp, J.P. Morgan & Co., Inc., and Bankers Trust
New York Corp. to engage in limited securities activities
through wholly-owned subsidiaries. 73 Fed. Reserve Bull.
7a
473 (1987). At the time of the applications, the subsidi-
aries were engaged entirely in underwriting and dealing in
U.S. government and agency securities and those of state
and municipal governments. The holding companies
sought to extend their subsidiaries’ activities to underwrit-
ing and dealing in municipal revenue bonds, mortgage
related securities, consumer receivables related securities,
and commercial paper.' With the exception of the con-
sumer receivables, on which decision was deferred be-
cause of an insufficient record, the Board approved the
applications by a vote of three to two. Limitations on the
scope of the activities more restrictive than those initially
proposed by the holding companies—to be discussed
more fully below—were imposed.
On May 18, 1987 the Board approved the applications
of four other bank holding companies, Chase Manhattan
Corp., Chemical New York Corp., Manufacturers Hano-
ver Corp., and Security Pacific Corp., to underwrite and
deal in the same activities to the same extent approved in
its April 30th order. 73 Fed. Reserve Bull. 607 (1987); id.
at 616; id. at 620; id. at 622. With the exception of Chase
Manhattan, each holding company then had an existing
subsidiary currently engaged in underwriting and dealing
in federal, state, and local government securities. Chase
Manhattan’s application included a request for its subsid-
iary to engage in government securities activities, which
the Board approved. The Board also approved Citicorp’s
supplemental application to deal in commercial paper. /d.
at 618.
l J.P. Morgan & Co. did not apply to underwrite or deal in consumer
receivables related securities and Citicorp did not propose to engage in
activities relating to commercial paper.
8a
SIA, a trade association representing securities brokers,
dealers, and underwriters, petitioned for review of the
April 30th and May 18th orders, arguing that the ap-
proved activities would violate § 20 of the Glass-Steagall
Act. The holding companies cross-petitioned challenging
the Board imposed limitations. We granted a stay of the
orders on May 19, 1987 pending this expedited appeal.
Il The Board’s Analysis
The bank holding companies’ applications were made
pursuant to § 4(c)(8) of the Bank Holding Company Act
of 1956, which allows a bank holding company to acquire
the “shares of any company the activities of which the
Board . . . has determined . . . to be so closely related
to banking . . . as to be a proper incident thereto.” 12
U.S.C. § 1843(c)(8) (1982). The determination that the
approved securities activities are closely related to bank-
ing is not contested on this appeal. Rather, since the
Board’s discretion under § 4(c)(8) is limited by the Glass-
Steagall Act, cf. Board of Governors of Fed. Reserve Sys.
v. Investment Co. Inst., 450 U.S. 46, 76-77 (1981) UCN,
the principal issue before the Board was whether the
approval of the activities would contravene that Act.
Section 20 of the Glass-Steagall Act forbids a member
bank of the Federal Reserve System from affiliating with
an organization “engaged principally” in, inter alia,
underwriting or dealing in securities. 12 U.S.C. § 377
(1982). Bank holding companies have been allowed since
1978—without a court challenge by SIA—to acquire or
form subsidiaries that underwrite and deal in securities
representing obligations of the United States and of states
and their political subdivisions. See, e.g., United Ban-
corp, 64 Fed. Reserve Bull. 222 (1978); see also 12 C.F.R.
i ene Nos Tal ow
CRON SiS REN tt pati
9a
§ 225.25(b)(16) (1987) (regulation permitting such activ-
ity). Section 16 of the Glass-Steagall Act expressly per-
mits banks themselves to underwrite and deal in these
governmental securities, known as “bank-eligible securi-
ties.” 12 U.S.C. § 24 (Seventh) (1982 & Supp. IV 1986).
Given the authorization in § 16 for banks to engage in
bank-eligible securities activities, the Board concluded
that Congress did not aim in § 20 to proscribe bank
affiliates from engaging in the same activities. 73 Fed.
Reserve Bull. at 478-81. It reasoned that it would be
anomalous not to permit the bank’s subsidiary to engage
in the activities lawfully permitted the bank. That illogical
result necessarily follows if bank-eligible securities are
defined as “securities” under § 20 because that section
prohibits a member bank from being affiliated with an
organization “engaged principally” in securities dealing.
Hence, according to the Board, “securities” cannot logi-
cally mean bank-eligible securities. “Securities” in § 20
must therefore only refer to those types of securities that
under § 16 banks cannot themselves deal in or under-
write, known as “bank-ineligible securities.” The activi-
ties approved in the orders at issue on _ this
appeal—underwriting and dealing in municipal revenue
bonds, mortgage related securities, and commercial
paper—cannot be conducted by a member bank and are
therefore bank-ineligible securities activities.
Establishing as a predicate that the proscription in § 20
extends only to bank-ineligible securities, the Board
turned to the question of when an affiliate is “engaged
principally” in such activity. Relying on its order in
Bankers Trust New York Corp., 73 Fed. Reserve Bull. 138
10a
(1987),’ the Board held that the term “engaged princi-
pally” means any substantial activity. 73 Fed. Reserve
Bull. at 482. It then concluded that subsidiaries would not
be engaged substantially in bank-ineligible activities if no
more than five to ten percent of their total gross revenues
was derived from such activities over a two-year period,
and if the activities in connection with each type of bank-
ineligible security did not constitute more than five to ten
percent of the market for that particular security. Jd. at
485-86. The Board then proceeded to approve gross
revenue and market share levels at five percent—the low
end of the acceptable range—but stated that it would
review the five percent limitations within a year after the
implementation of its orders. The applicants wanted, of
course, to engage in higher levels of activity.
On review, SIA argues that the Board erroneously
construed the Glass-Steagall Act by construing the word
“securities” in § 20 not to include bank-eligible securities.
In other words, SIA contends that § 20 limits both bank-
eligible and bank-ineligible security activities by a mem-
ber bank affiliate. SIA also objects to the Board’s
construction of “engaged principally.” The bank holding
companies urge us to adopt the Board’s construction of
§ 20 with regard to “securities”, but argue, at the same
time, that the Glass-Steagall Act mandates that the Board
allow a higher level of bank-ineligible activity than that
approved.
2 Petitions for review of this order are pending in the United States
Court of Appeals for the District of Columbia Circuit.
lla
THRESHOLD MATTERS
I The Moratorium
Subsequent to the stay granted in this case, Congress
enacted and the President signed into law on August 10,
1987 the Competitive Equality Banking Act of 1987, Pub.
L. No. 100-86, 101 Stat. 552 (CEBA),’ the provisions of
which impose a moratorium period, effective retroac-
tively, prohibiting the Board from approving affiliate
involvement in certain securities transactions. Section
201(b) provides that between March 6, 1987 and March 1,
1988,
(2) A Federal banking agency may not authorize or
allow by action, inaction, or otherwise any bank
holding company or subsidiary or affiliate thereof
. . to engage in the United States to any extent
whatever—
(A) in the flotation, underwriting, public sale,
dealing in, or distribution of securities if that ap-
proval would require the agency to determine that
the entity which would conduct such activities would
not be engaged principally in such activities... .
CEBA, § 201(b), 101 Stat. at 582 (to be codified at 12
U.S.C. § 1841 note).
Under § 202 the Board may issue an order during the
moratorium period pursuant to its authority in existence
before CEBA “if the effective date of such . . . order is
delayed until the expiration of such moratorium.” 101
3 In September the panel wrote to counsel requesting them to advise
whether in light of CEBA this appeal remains viable. All counsel
promptly responded by early October, 1987 that in their view the
appeal was not mooted by the moratorium legislation.
12a
Stat. at 584 (to be codified at 12 U.S.C. § 1841 note).
According to the Joint Explanatory Statement of the
Conference Committee to fall within this exception an
order “must contain or otherwise be subject to” a specifi-
cation “that the powers in question may not be exercised
before the moratorium has expired.” H.R. Conf. Rep.
No. 261, 100th Cong., Ist Sess. 149 (1987), reprinted in
1987 U.S. Code Cong. & Admin. News 588, 618.
Each order subject to our review was issued during the
moratorium period and each approved of activities cov-
ered by § 201. Nevertheless, the Board noted in its April
30th order that it was aware that Congress might impose
the moratorium and that there might be an exception for
orders that delay the effective date. 73 Fed. Reserve Bull.
at 502. The Board then called to the applicants’ attention
that subsequent legislation might require them to cease
the approved activities in the event of a moratorium and
also retained jurisdiction “to act to carry out the require-
ments of any legislation adopted by Congress” that af-
fected the activities approved under the order. /d.
Identical explanations and caveats appear in the other
orders relevant to this appeal. Thus, their effective date
effectively was delayed in the event of a moratorium, as
mandated by § 202. CEBA therefore in no way precludes
our review of the substantive issues presented in these
petitions. Before considering them, we discuss briefly the
applicable standard of review.
II Standard of Review
The starting point for reviewing an agency’s construc-
tion of a statute is the language of the statute. See, e.g.,
Federal Deposit Ins. Corp. v. Philadelphia Gear Corp.,
106 S. Ct. 1931, 1934 (1986); Board of Governors of the
13a
Fed. Reserve Sys. v. Dimension Fin. Corp., 474 U.S. 361,
368 (1986); Chevron U.S.A. Inc. v. Natural Resources
Defense Council, Inc., 467 U.S. 837, 842-43 (1984). An
agency’s construction of unambiguous statutory language
is never an issue because the clear language of the statute
must be given effect by the agency and the courts. See
Chevron, 467 U.S. at 842-43 (“If the intent of Congress is
clear, that is the end of the matter; for the court, as well
as the agency, must give effect to the unambiguously
expressed intent of Congress.”). Only when the statutory
language is ambiguous must a court inquire whether the
agency’s construction is permissible. Jd. at 843. If the
Board’s interpretation of the Glass-Steagall Act is reason-
able its decision must be upheld. See Securities Indus.
Ass’n v. Board of Governors of the Fed. Reserve Sys.,
716 F.2d 92, 95 (2d Cir. 1983) (“Because the Board has
both primary responsibility for implementing the Glass-
Steagall Act and expert knowledge of commercial bank-
ing, we must uphold its interpretation of the Act if it is
reasonable.”), aff’d, 468 U.S. 207 (1984). Thus, the first
question is whether § 20 is ambiguous.
The Board readily concedes that the term “securities”
in § 20 could be read to include not only those securities
that banks are expressly permitted to underwrite or deal
in, that is, bank-eligible securities, but also those that
banks are not entitled to underwrite or deal in, that is,
bank-ineligible securities. Unlike § 16—which expressly
distinguishes bank-eligible from bank-ineligible securi-
ties—§ 20 does not distinguish the terms. Hence, at least
on the surface § 20 would appear to refer to both kinds of
securities.
But a closer examination of Glass-Steagall leads us to
reject this conclusion. In the first place, the Act makes
l4a
three different references to the term “securities.” Section
16 distinguishes bank-eligible from bank-ineligible securi-
ties. 12 U.S.C. § 24 (Seventh) (1982 & Supp. IV 1986).
Repealed § 19(e), discussed infra note 4, referred to
“securities of any sort.” 48 Stat. at 188 (emphasis added).
And §§ 20 and 32 refer simply to “securities.” 12 U.S.C.
§ 377 (1982) (§ 20); 48 Stat. at 194 (codified as amended
at 12 U.S.C. § 78 (1982)) (§ 32). That Congress chose
three distinctively different ways to describe securities
raises a red flag that cautions against declaring that the
meaning of that term in § 20 is clear.
Further support for the proposition that § 20 is uncer-
tain is provided by the subsequent amendment to § 21 of
Glass-Steagall. Section 21 originally did not expressly
exempt bank-eligible securities as did § 16. A 1935
amendment made it plain that § 21 did not prevent that
which § 16 permitted. See Banking Act of 1935, Pub. L.
No. 74-305, § 303, 49 Stat. 684, 707. The significance of
this to the issue of § 20’s ambiguity is that the amend-
ment was only intended to clarify existing law, see, e.g.,
H.R. Rep. No. 742, 74th Cong., Ist Sess. 16 (1935); S.
Rep. No. 1260, 73d Cong., 2d Sess. 2 (1934); Securities
Indus. Ass’n v. Board of Governors of the Fed. Reserve
Sys., 807 F.2d 1052, 1057-58 (D.C. Cir. 1986) (Bankers
Trust Il), cert. denied, 107 S. Ct. 3228 (1987), and did not
purport to effect any substantive change. But, if the 1935
amendment was not intended to alter the substance of
§ 21, it follows that the Congress that enacted Glass-
Steagall did not invariably make an explicit distinction
between bank-eligible and bank-ineligible securities, even
when it aimed to distinguish them from one another.
Based on this, we can conclude with some confidence that
Congress’ reference in § 20 to “securities” is ambiguous,
lSa
and undertake to decide whether the Board’s interpreta-
tion of securities in § 20 is reasonable and therefore
entitled to deference.
Of course, “deference is not to be a device that emascu-
lates the significance of judicial review.” Securities Indus.
Ass’n v. Board of Governors of the Fed. Reserve Sys.,
468 U.S. 137, 142-43 (1984) (Bankers Trust I). One factor
militating against deference to the Board’s definition of
securities is its failure to address an apparent contradic-
tion, discussed below, between its interpretation of § 20
and its prior view of § 32. This failure implicates two
factors that courts take into consideration in deciding
whether to accord deference to an administrative agency
charged with implementing a statute: first, “the thor-
oughness, validity, and consistency of an agency’s reason-
ing,” Federal Election Comm’n v. Democratic Senatorial
Campaign Comm., 454 U.S. 27, 37 (1981), and, second,
the consistency of the agency’s present interpretation with
its earlier pronouncements, Morton v. Ruiz, 415 U.S.
199, 237 (1974); Skidmore v. Swift & Co., 323 U.S. 134,
140 (1944).
The Board should have examined § 32 in its analysis of
§ 20 because—as the Supreme Court has indicated—
“§§ 32 and 20 contain identical language, were enacted
for similar purposes, and are part of the same statute.”
Securities Indus. Ass’n v. Board of Governors of the Fed.
Reserve Sys., 468 U.S. 207, 219 (1984) (Schwab). Thus,
an established interpretation of the language of one
section is important in interpreting the language of the
other. See id. In that respect, the Board’s 120-page opin-
ion is deficient.
The Board’s earlier view of § 32 suggests that bank-
eligible securities were included within the term “securi-
16a
ties” in § 32. In 1936 the Board exempted from § 32
individuals dealing in or underwriting “bonds, notes,
certificates of indebtedness, and Treasury bills of the
United States.” 22 Fed. Reserve Bull. 51, 52 (1936). As
SIA argues, this suggests that the Board understood that
bank-eligible securities were covered by § 32, because
there was otherwise no need to exempt from § 32 individ-
uals involved in those securities activities. At oral argu-
ment the Board’s response to SIA’s contention was that it
had merely failed to explain its reasoning for the exemp-
tion, and that granting the exemption from the prohibi-
tions of § 32 was done only for purposes of clarity.
This could be a plausible explanation, but in this
instance we think it is not. Although in its current form
Regulation R does exempt from § 32 individuals engaged
in any securities activity permitted to banks under § 16,
see 12 C.F.R. § 218.2 (1987), the exemption, as originally
enacted, did not exempt a// forms of bank-eligible securi-
ties, but only the obligations of the United States. Omit-
ted from exemption were the general obligations of the
States or their political subdivisions. See 22 Fed. Reserve
Bull. at 52. From this it is obvious that the Board did not
read § 32 as excluding ab initio all bank-eligible securi-
ties, but rather that it exercised the authority granted it by
Congress under § 32—authority not granted in § 20—to
create a narrow exemption for individuals dealing in
United States government obligations. In addition, in a
footnote to the 1936 regulation, the Board enumerated
instances in which the terms of § 32 did not apply. See 22
Fed. Reserve Bull, at 51 n.1. Plainly, the Board knew how
to say when § 32 did not apply to a certain activity, and
how to state that a certain activity was subject to § 32,
17a
but was nevertheless exempted pursuant by the Board
under its statutory authority.
The Board’s orders on appeal here are not instances
where the Board failed to adopt an expressly articulated
position on the meaning of § 20. Cf. Investment Co. Inst.
v. Camp, 401 U.S. 617, 627-28 (1971) (Camp). Nonethe-
less, its failure to address—in what is an otherwise com-
prehensive and reasoned decision—the significance of its
prior interpretation of § 32 counsels against granting it
full deference. Our own review of the history of the
Glass-Steagall Act leads us nonetheless to conclude that
construing § 20 as not encompassing activities by bank
affiliates in bank-eligible securities is essential if Con-
gress’ purpose in enacting § 20 is to be effectuated.
DISCUSSION
The two principal issues presented to this court are the
Board’s constructions of the terms “securities” and “en-
gaged principally” under § 20 of the Glass-Steagall Act.
The proper interpretation of § 20 is an issue of first
impression and necessitates a comprehensive examination
of both the relevant legislation and the events surround-
ing its enactment.
I Glass-Steagall: A Statutory Overview
The whole of the Banking Act of 1933, ch. 89, Pub. L.
No. 73-66, 48 Stat. 162 (1933) (codified as amended in
scattered sections of 12 U.S.C.), is sometimes referred to
as the Glass-Steagall Act. See ICI, 450 U.S. at 53. It is
perhaps more accurate to consider §§ 16, 20, 21, and 32
of the Banking Act of 1933 in particular as the Glass-
Steagall Act. See Schwab, 468 U.S. at 216 & n.15. These
sections, the “ ‘Maginot Line’ of the financial world,” see
18a
Macey, Special Interest Groups Legislation and the Judi-
cial Function: The Dilemma of Glass-Steagall, 33 Emory
L.J. 1, 5 (1984) [hereinafter Glass-Steagall Dilemma}
(quoting Bevis Longstreth, “Current Issues Facing the
Securities Industry and the SEC,” May 4, 1982 speech to
the SIA), were meant to separate commercial and invest-
ment banking.*
4 The Glass-Steagall Act originally contained a fifth section—
§ 1%e)—which also was designed to effect a separation between
commercial and investment banking. It read in pertinent part:
(e) Every such holding company affiliate shall, in its application
for such voting permit, (1) show that it does not own, control, or
have any interest in, and is not participating in the management or
direction of, any corporation, business trust, association, or other
similar organization formed for the purpose of, or engaged princi-
pally in, the issue, flotation, underwriting, public sale, or distribu-
tion, at wholesale or retail or through syndicate participation, of
stocks, bonds, debentures, notes, or other securities of any sort
(hereinafter referred to as ‘securities company’); . . .
Pub. L. No. 73-66, ch. 89, § 19(e), 48 Stat. 162, 188 (1933), repealed,
Pub. L. No. 89-485, § 13(c), 80 Stat. 236, 242 (1966).
Thus, § 19%e) was the Glass-Steagall Act provision that originally
dealt with bank holding companies. Section 19%e) operated indirectly;
bank holding companies were required to apply to the Reserve Board
for a permit entitling them to exercise the voting rights of the shares of
stock which they held in member banks. See 48 Stat. at 186. In order
to ob.ain a voting permit, a bank holding company had to divest itself
of ownership or control of its securities affiliate(s). The reason for this
indirect method was Congress’ hesitancy to legislate in regard to state-
chartered institutions. See S. Rep. No. 77, 73d Cong., Ist Sess. 10
(1933); 75 Cong. Rec. 9905 (1932) (remarks of Sen. Walcott). Yet,
§ 1%e) was largely ineffectual because bank holding companies simply
elected not to vote the shares of their securities affiliates. See JC/, 450
U.S. at 69-70. In addition, after the enactment of the Bank Holding
Company Act of 1956, which broadened the Banking Act’s definition
of “affiliate,” it became doubtful whether § 1%e) was “sufficiently
useful to justify [its] retention.” S. Rep. No. 1179, 89th Cong., 2d
Sess. 12 (1966). The “loophole” therefore was closed by a 1966
amendment. See 80 Stat. at 242.
19a
Section 16 of the Glass-Steagall Act applies to federally
chartered banks and restricts their powers. In pertinent
part, the statute as amended provides:
The business of dealing in securities and stock by the
[member bank] shall be limited to purchasing and
selling such securities and stock without recourse,
solely upon the order, and for the account of, cus-
tomers, and in no case for its own account, and the
{member bank] shall not underwrite any issue of
securities or stock . . . . The limitations and restric-
tions herein contained as to dealing in, underwriting
and purchasing for its own account, investment secu-
rities shall not apply to obligations of the United
States, or general obligations of any State or of any
political subdivision thereof... .
12 U.S.C. § 24 (Seventh) (1982 & Supp. IV 1986).
As can be readily seen, § 16 forbids national banks
from underwriting “any issue of securities or stock”* and
also limits their ability to deal in securities. As noted, it
expressly excepts from its coverage underwriting and
dealing in the obligations of the United States or general
obligations of states or their political subdivisions, which
we have termed “bank-eligible securities.”
Section 21 seeks to draw the same line as § 16 does for
commercial banks, but from the perspective of invest-
ment banks. See Bankers Trust I, 468 U.S. at 148. Section
21 as amended reads in pertinent part:
5 As it was originally written, § 16 only prohibited underwriting
“securities.” See 48 Stat. at 185 (1933). One of the so-called “techni-
cal” provisions of the Banking Act of 1935 amended § 16 by adding
“and stock” after the references to “securities.” Banking Act of 1935,
Pub. L. No. 74-305, ch. 614, tit. III, § 308(a), 49 Stat. 684, 709 (1935).
20a
(a) After the expiration of one year after June 16,
1933, it shall be unlawful—
(1) For any person, firm, corporation, associa-
tion, business trust, or other similar organization,
engaged in the business of issuing, underwriting,
selling, or distributing, at wholesale or retail, or
through syndicate participation, stocks, bonds, de-
bentures, notes, or other securities, to engage at the
same time to any extent whatever in the business of
receiving deposits subject to check or to repayment
upon presentation of a passbook, certificate of de-
posit, or other evidence of debt, or upon request of
the depositor: Provided, That the provisions of
this paragraph shall not prohibit national banks or
State banks or trust companies (whether or not
members of the Federal Reserve System) or other
financial institutions or private bankers from dealing
in, underwriting, purchasing, and selling investment
securities, or issuing securities, to the extent permit-
ted to national banking associations by the provi-
sions of sectiou 24 of this title... .
12 U.S.C. § 378(a)(1) (1982). Section 21 prohibits firms
“engaged” in certain investment banking activities from
undertaking commercial banking activities. See Bankers
Trust I, 468 U.S. at 148; JCI, 450 U.S. at 62-63. As
originally drafted and enacted it did not contain the § 16
proviso that allowed banks to underwrite and deal in
bank-eligible securities. See Banking Act of 1933, § 21, 48
Stat. at 189. A 1935 amendment to § 21 made explicit
that § 21 did not prohibit those activities permitted mem-
ber banks under § 16. See Banking Act of 1935, Pub. L.
No. 74-305, ch. 614, tit. II], § 303(a), 49 Stat. 684, 707
(1935).
2la
Sections 32 and 20 are the Glass-Steagall Act’s “re-
maining ramparts” in the line between commercial and
investment banking. Glass-Steagall Dilemma, supra, at 6.
Section 32 as amended reads in its entirety:
No officer, director, or employee of any corpora-
tion or unincorporated association, no partner or
employee of any partnership, and no individual,
primarily engaged in the issue, flotation, underwrit-
ing, public sale, or distribution, at wholesale or
retail, or through syndicate participation, of stocks,
bonds, or other similar securities, shall serve the
same time as an officer, director, or employee of any
member bank except in limited classes of cases in
which the Board of Governors of the Federal Reserve
System may allow such service by general regulations
when in the judgment of the said Board it would not
unduly influence the investment policies of such
member bank or the advice it gives its customers
regarding investments.
12 U.S.C. § 78 (1982) (emphasis added). Section 32 pro-
hibits personnel “interlocks” between member banks and
firms that are “primarily engaged” in the business of
underwriting or dealing in securities. In its original form,
the section authorized the Board to permit an individual
exemption from the prohibitions of § 32. See Banking
Act of 1933, § 32, 48 Stat. at 194. In 1935 Congress
amended § 32 to allow the Board to promulgate a general
regulation to exempt “classes of cases” from the reach of
§ 32. See Banking Act of 1935, § 307, 49 Stat. at 709. In
1936 the Board promulgated Regulation R, which ex-
empted from § 32 individuals dealing in “bonds, notes,
certificates of indebtedness, and Treasury bills of the
United States.” See 22 Fed. Reserve Bull. 51, 52 (1936).
22a
The current version of Regulation R is found at 12 C.F.R.
§ 218.2 (1987).
Finally, § 20—the proper interpretation of which is the
principal question presented on this appeal—provides in
pertinent part:
After one year from June 16, 1933, no member
bank shall be affiliated in any manner described in
subsection (b) of section 22la of this title with any
corporation, association, business trust, or other
similar organization engaged principally in the issue,
flotation, underwriting, public sale, or distribution at
wholesale or retail or through syndicate participation
of stocks, bonds, debentures, notes, or other securi-
ee
12 U.S.C. § 377 (1982) (emphasis added). As discussed
above, the Board concluded that § 20 only proscribes
member bank affiliation with firms “engaged principally
in the issue, flotation, underwriting, public sale, or distri-
bution” of bank-ineligible securities, those which banks
are prevented under § 16 from dealing in themselves.
Throughout this opinion we have adopted, for clarity’s
sake, the term “underwriting and dealing in” to refer to
“the issue, flotation. . .” language in § 20.
II The Meaning of “Securities” in § 20
When called upon to interpret the Glass-Steagall Act,
judges “face a virtually insurmountable burden due to the
vast dichotomy between the ostensible legislative intent
and the actual motivations of Congress.” Glass-Steagall
Dilemma, supra, at 1-2. Divining the aim of Congress in
enacting § 20 is particularly formidable because the issue
of the proper relationship between commercial banks and
ee
23a
their affiliates caused considerable disagreement among
legislators and experts who participated in the develop-
ment of what became the Banking Act of 1933. See
generally Perkins, The Divorce of Commercial and In-
vestment Banking: A History, 88 Banking L.J. 483, 505-
12 (1971) [hereinafter Banking Divorce]. Consequently,
we approach the subject first by examining the legislative
history of § 20, analyzing the Congressional compromise
that resulted in the enactment of § 20, and then by
looking at prior judicial construction of the Act.
A. Legislative History
1. Envisioning § 20—Congress’ Purpose
The Act’s legislative history reflects the notion that the
underlying cause of the stock market crash in 1929 and
subsequent bank insolvencies came about from the exces-
sive use of bank credit to speculate in the stock market.
See S. Rep. No. 77, 73d Cong., Ist Sess. 3-9 (1933)
[hereinafter 1933 Senate Report]; see also 75 Cong. Rec.
9883-84 (1932) (remarks of Sen. Glass) (criticizing trans-
formation of the Federal Reserve System from a commer-
cial banking system into one used for “stock-market
speculative operations”). Bank affiliates were identified
as a major factor in the overextension of credit for
security loans. See 1933 Senate Report, supra, at 9-10.
Congress’ concern was not limited solely to how securi-
ties affiliates contributed to the excesses in bank credit; its
apprehension was far more fundamental and structural.
Senator Bulkley, for example, repeatedly stressed that the
debate over affiliates should not obscure “[t]he important
and underlying question [of] whether banking institutions
receiving commercial and savings deposits ought to be
permitted at all to engage in the investment-security
24a
business.” 75 Cong. Rec. 9910 (1932). He argued that
“It]he existence of security affiliates is a mere incident to
this question,” id., and reiterated that “the real question
is not whether . . . banks shall be permitted to have
investment-security affiliates but rather whether they
should be permitted to engage in the investment-security
business in any manner at all, through affiliates or other-
wise,” id. at 9911.
Two large problems attendant upon the involvement of
a commercial bank in investment banking—either on its
own or through use of an affiliate—were identified by
Congress. The first was “the danger of banks using bank
assets in imprudent securities investments.” JCI, 450 U.S.
at 66; see also Camp, 401 U.S. at 630. The second
“focused on the more subtle hazards that arise when a
commercial bank goes beyond the business of acting as
fiduciary Or managing agent and enters the investment
banking business either directly or by establishing an
affiliate to hold and sell particular investments.” Camp,
401 U.S. at 630.
In Camp the Supreme Court described these subtle
hazards: loss of public confidence in a bank if its affiliate
lost money; the temptation for a bank to shore up an
affiliate through unsound loans; imprudent lending to
companies in which the security affiliate has invested or
become interested; possible loss of a bank’s goodwill
should its depositors suffer losses on investments that
they purchased in reliance on the relationship between the
bank and its affiliate; bank loans used for purposes of
buying securities; commercial bank involvement in invest-
ment banking which might facilitate the loss of disinter-
ested investment advice and encourage violations of
fiduciary obligations. Camp, 401 U.S. at 631-33; see
ee
25a
Operation of the National and Federal Reserve Banking
Systems, Hearings on S. 71 Before a Subcomm. of the
Senate Comm. on Banking and Currency, 7\st Cong., 3d
Sess. 1063-64 (1931) [hereinafter 1/93] Hearings]; 75
Cong. Rec. 9911-12 (1932) (remarks of Sen. Bulkley).
Sections 16 and 21 effectively barred commercial banks
from direct engagement in investment banking, with the
notable exception of government securities. Yet even
before the 1929 crash, direct involvement by a bank had
been considered “improper,” see Camp, 401 U.S. at 629,
but bank affiliates had developed as the medium for
commercial banks’ indirect entry into investment bank-
ing, see id. Even though the stock market debacle laid
bare the dangers arising from the activities of securities
affiliates, opinion was divided on how best to mitigate
those dangers.
No one argued that the affiliate system had not been
abused in the past, see, e.g., 193] Hearings, supra, at
298-99 (remarks of Charles E. Mitchell, Chairman, Na-
tional City Bank of New York). Experts believed that an
adequate check on such abuse was to establish rigorous
examination requirements for affiliates, which had re-
mained largely unregulated before 1929. See, e.g., id. at
117 (testimony of J.H. Case, Chairman, Board of Direc-
tors of the Federal Reserve Bank of New York); id. at 192
(testimony of A.H. Wiggin, Chairman of the Governing
Board, Chase National Bank); id. at 364 (testimony of
O.D. Young, Chairman of the Board, General Electric
Co.); id. at 405 (testimony of M.W. Traylor, Chairman of
the Board, First National Bank of Chicago). Others
thought that if the slate were wiped clean, affiliates
should not be legal, but that in 1933 a complete divorce
between commercial and investment banking was not
26a
feasible given the established role of affiliates in the
banking system. See, e.g., id. at 22 (testimony of J. Pole,
Comptroller of the Currency); id. at 38-39 (testimony of
G.L. Harrison, Governor, Federal Reserve Bank of New
York); id. at 148 (testimony of A.C. Miller, Member,
Federal Reserve Board).
Some advocated complete separation of the commercial
and investment banking industries. See, e.g., id. at 231
(testimony of B.W. Trafford, Vice Chairman, First Na-
tional Bank of Boston). Senator Glass—an adherent of
this view—was of the opinion that a “complete separa-
tion” was both warranted and capable of being accom-
plished. E.g., Operation of the National and Federal
Reserve Banking Systems, Hearings on §.4115 Before the
Senate Comm. on Banking and Currency, 72d Cong., Ist
Sess. 42, 267 (1932) (remarks of Sen. Glass) [hereinafter
1932 Hearings]. Senator Glass’ views are significant, of
course, because of his role in drafting and shaping the
Banking Act of 1933, a portion of which bears his name.
Cf. North Haven Bd. of Educ. v. Bell, 456 U.S. 512, 526-
27 (1982) (remarks of sponsor of language ultimately
enacted “are an authoritative guide to the statute’s con-
struction”). Yet, despite the Senator’s goal of complete
separation, the Senate took a less drastic step. Acknowl-
edging that “[i]t has been suggested. . . that the affiliate
system be simply ‘abolished,’ ” the Senate rejected this as
impossible and stated that its goals toward regulating
affiliates were to (1) separate “as far as possible” member
banks from affiliates of all kinds; (2) limit advances or
loans from parent to affiliate; and (3) install satisfactory
examination requirements for affiliates. 1933 Senate Re-
port, supra, at 10 (emphasis added).
27a
2. Construing § 20—Congress’ Compromise
Section 20 was Congress’ solution to the problem of
affiliates and establishes the boundary separating banks
from their security affiliates. While § 21 prohibits firms
“engaged” in investment banking activities from accept-
ing deposits, § 20 prohibits commercial bank affiliation
with firms “engaged principally” in underwriting and
dealing in securities. The inference following from this
different terminology is obvious: § 20 applies a “less
stringent standard” than the absolute bar between com-
mercial and investment banking laid down by §§ 16 and
21. JCI, 450 U.S. at 60 n.26. Nor can the difference in
terminology be attributed to oversight. Section 21 origi-
nally contained the term “engaged principally.” In offer-
ing the amendment that deleted “principally,” Senator
Bulkley argued that “[i]t has become apparent that at
least some of the great investment houses are engaged in
so many forms of business that there is some doubt as to
whether the investment business is the principal one.” 77
Cong. Rec. 4180 (1933). Given that one of the leading
advocates of Glass-Steagall recognized that “engaged”
connoted a stricter standard than “engaged principally,” it
is inconceivable that the latter term could remain in § 20
by sheer happenstance. Thus, while the original impetus
behind the Glass-Steagall bill on the floor of Congress
may have been to sever completely the commercial and
investment banking industries, it fell short of that goal—a
victim of legislative compromise.
Legislative history also supports the view that § 20’s
use of the word “securities” did not imply a complete
separation between commercial and investment banking.
A colloquy between Senators Glass and Long is illuminat-
ing:
28a
MR. LONG. I have been told that the Senator has
said that he did not think this bill would prohibit the
handling of Government and State bonds by the
Federal reserve banks, that the Senator’s provision
against affiliates handling bonds was not intended to
affect the handling of Government and State bonds.
MR. GLASS. They are expressly excluded from
the terms of the bill.
MR. LONG. As to both affiliates and the banks?
MR. GLASS. As to affiliates? We are trying to
abolish the affiliates in a period of years.
MR. LONG. The Senator has no objection, has
he, to an affiliate handling them if they handle
nothing but the Government and State Bonds under
supervision, the same supervision the banks are
given?
MR. GLASS. I am objecting to affiliates alto-
gether. I am objecting to a national banking institu-
tion setting up a back-door arrangement by which it
may engage in a business which the national bank act
denies it the privilege of doing. If investment bank-
ing is a profitable business, who does not know that
such business will be set up as a separate institution,
not using the money and prestige and facilities of a
national bank and its deposits to engage in invest-
ment activities? I want to make it impossible hereaf-
ter to have the portfolios of commercial banks filled
with useless speculative securities, so that when strin-
gency comes upon the country these banks may not
respond to the requirements of commerce. That is
what is the matter with the country to-day, and it is
because this bill would avert a repetition of that
29a
disaster that intense and bitter opposition has been
organized against it.
76 Cong. Rec. 2000 (1933). Senator Glass’ aspiration to
divorce completely commercial banks from their security
affiliates was never attained: § 20 only prohibits affilia-
tion with firms that are “engaged principally” in forbid-
den investment activity. SIA urges from the above
colloquy that Senator Glass objected to affiliates’ han-
dling even securities that banks themselves could under-
write under the proposed legislation and that the
Senator’s view carried the day in § 20 as enacted. On the
contrary, we believe Senator Glass’ response to Senator
Long indicates that he was primarily concerned with
“back-door” arrangements between banks and their secu-
rity affiliates that permitted affiliates to engage in the
securities business denied by law to the bank itself.
Senator Glass’ reservation did not encompass affiliate
activity in a business that § 16 grants to a bank “the
privilege of doing.”
Further, Senator Long’s initial query indicates that the
issue Of whether affiliates ought to be able to engage in
bank-eligible activities to the same extent as banks them-
selves was not dormant during the debates. Thus, Senator
Long commented that those who had opposed some
provisions in the bill “have seen some virtue in it. I
particularly refer to the divorcing of the affiliates, except
in so far as they handle municipal and Government bonds
and securities.” 76 Cong. Rec. 2274 (1933). To make
certain affiliates had the same right to deal in government
obligations, Senator Long had printed and circulated an
amendment to the Glass-Steagall bill to that effect. Pro-
posed Amend. to S. 4412, 72d Cong., 2d Sess. (Jan. 10,
1933). Despite Senator Long’s repeated insistence that
30a
§ 20 would not preclude bank-eligible activities by an
affiliate, this amendment was never formally raised in
debate. The Banking Act of 1933 became law five months
later, on June 16, 1933, and it can be plausibly urged that
the bill finally agreed upon and enacted into law made his
amendment unnecessary. Recognizing the power of Sena-
tor Long’s position, SIA argues that statements and
actions taken during debate are not entitled to much
weight. See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S.
185, 203 n.24 (1976). A look at subsequent events in this
case illustrates the soundness of that rule. In 1935, just
two years after his strong rhetoric in the Banking Act
debate, Senator Glass himself supporied a proposed
amendment to that law granting to commercial banks the
right to underwrite securities. 79 Cong. Rec. 11,827
(1935). So much for not having “the portfolios of com-
mercial banks filled with useless securities.”
Thus, it seems eminently reasonable to conclude from
Senator Glass’ response to Senator Long, as well as other
evidence in the legislative history, that Congress’ concern
was primarily with bank affiliate activities in bank-
ineligible securities. Bank affiliates often “devote[d]
themselves ... to perilous underwriting operations,
stock speculation, and maintaining a market for the
banks’ own stock often largely with the resources of the
parent bank.” 1933 Senate Report, supra, at 10. Accord-
ing to Senator Glass, “[w]hat the committee had foremost
in its thought was to exclude from commercial banking all
investment securities except those of an undoubted char-
acter that would be surely liquidated; and for that reason
we made an exception [in § 16] of United States securities
and of the general liabilities of States and subdivisions of
States.” 76 Cong. Rec. 2092 (1933). Given that Glass-
3la
Steagall was a means to sever commercial banking only
from more speculative, “perilous” investment activities,
in which bank-eligible activities were not included, an
interpretation of “securities” in § 20 that excludes bank-
eligible securities from its reach is entirely consistent with
Congress’ aim.
The history of security affiliates in the United States
also supports this view. Many banks formed security
affiliates in order to handle the sale of government bonds
used to finance World War I. B. Klebaner, Commercial
Banking in the United States: A History 109-10 (1974);
Banking Divorce, supra, at 490-91; see also 1932 Hear-
ings, supra, at 29 (testimony of A.M. Pope, President,
Investment Bankers’ Ass’n of Am.). Banks were “ex-
pected” to aid the government in distributing war loans
and were “encouraged” to aid potential investors by
lending them the purchase price of government bonds.
Banking Divorce, supra, at 491. It was not until the
1920’s that affiliates began to expand into private debt
and equity securities activities in response to the demands
of the public and business. See id. at 493-96; see also 77
Cong. Rec. 3835 (1933) (remarks of Rep. Steagall) (“Our
great banking system was diverted from its original pur-
poses into investment activities, and its service devoted to
speculation and international high finance.”); 75 Cong.
Rec. 9904-05 (1932) (remarks of Sen. Walcott) (businesses
began to finance their requirements by sale of securities
rather than by borrowing; growth of affiliates was “the
outgrowth of the willingness of public to buy readily and
without very much inquiry”). It was not the affiliate
system as a concept that worried Congress, but the
affiliate system as it had developed. The evil that Con-
gress intended to attack was bank involvement in specula-
32a
tive securities, that is, bank-ineligible securities. We
cannot attribute to Congress a purpose to limit a// securi-
ties activities when it consistently made clear that it was
only concerned with one type.
An elucidation of SIA’s suggested interpretation of § 20
shows the anomalies that an over-literal interpretation of
the term “securities” in that section might bring. If bank-
eligible securities are included in the prohibitions of § 20,
an affiliate could “engage” (but not principally) in bank-
ineligible securities activities. Alternatively, the same affil-
iate could engage to the identical extent in bank-eligible
securities activities. SIA’s construction would permit ei-
ther, or both, types of activity—up to a certain point.
Two banks could each have an affiliate, one engaged in
underwriting and dealing in high-risk securities prohibited
to banks, and the other engaged in the government
obligations that Congress felt to be of such negligible risk
that it allowed, and encouraged, banks themselves to deal
in them. It is paradoxical to presume that it was Con-
gress’ purpose to place both affiliates on the same foot-
ing.
A subsequent amendment to the Glass-Steagall Act also
argues against too strict a construction of § 20. As men-
tioned earlier, Congress amended § 21 in 1935 to “make it
clear that [§ 21] does not prohibit any financial institu-
tion or private banker from engaging in the securities
business” to the extent permitted in § 16. H.R. Rep. No.
742, 74th Cong., Ist Sess. 16 (1935); see also S. Rep. No.
1007, 74th Cong., Ist Sess. 15 (1935); S. Rep. No. 1260,
73d Cong., 2d Sess. 2 (1934). SIA claims that because
§ 20 was also amended at the same time, see H.R. Rep.
No. 742, 74th Cong., Ist Sess. 16 (1935) (amendment to
§ 20 regarding formalities of affiliate liquidation), the
33a
failure to add to § 20 a similar proviso indicates a
deliberate legislative determination that § 16 activities are
within the scope of § 20. We cannot agree.
First, this argument belies the clarifying nature of the
amendment to § 21. See Bankers Trust II, 807 F.2d at
1057-58. Second, we decline to hold that in failing to
amend § 20 in the same manner Congress planned to
clarify the meaning of the term “securities” by its silence.
There is evidence that the Banking Act of 1933 itself was
not the driving force that caused banks to divest them-
selves of their affiliates. Instead, economic conditions
and Congress’ investigation into stock market practices
were instrumental in bringing banks to divorce themselves
voluntarily from their affiliates. See B. Klebaner, supra,
at 140; Banking Divorce, supra, at 522-24. Given this
voluntary divestiture, § 20 became much less of a contro-
versy in practice than it had been in legislative debate.
Viewed in that perspective, it is not so unusual that
Congress failed to amend § 20 in order to “clarify” the
intent of that section as it had with § 21.
Finally, amicus Investment Company Institute (ICI)
argues that repealed § 19%e)’s definition of securities—
“securities of any sort”—confirms that “securities” in
§ 20 must mean both bank-eligible and bank-ineligible
securities. To the contrary, “securities of any sort” is just
as ambiguous as the word “securities” standing alone,
and the phrase is vulnerable to the same construction as
that advanced for § 20.
Thus, the legislative history strongly supports the view
that “securities” in § 20 only refers to bank-ineligible
securities.
34a
B. Prior Judicial Construction
The compromise aspect of § 20 exposes the difficulties
of fitting this case comfortably within the traditional
“subtle hazards” analysis developed in Camp and used by
the Supreme Court in subsequent Glass-Steagall Act
cases. Under this analysis, the Court noted the hazards
that Congress sought to prevent when the Act was passed
and then examined whether a particular activity would
implicate them. See Schwab, 468 U.S. at 220-21; Bankers
Trust I, 468 U.S. at 154-60; JCI, 450 U.S. at 66-68;
Camp, 401 U.S. at 630-34. By using in § 20 the language
“engaged principally” rather than a more restrictive term,
Congress expressed a legislative choice to tolerate at least
some of those hazards. This situation is not entirely
inconsistent with subtle hazards analysis—which never
controlled the result in a Glass-Steagall case but only
reinforced a conclusion already reached as a matter of
statutory interpretation. See Bankers Trust II, 807 F.2d at
1069. Nor, for that matter, has the existence of one hazard
required reversal of the Board: a hazard need not “be
‘totally obliterated’ to permit a banking practice—
avoidance of the hazard ‘to a large extent’ suffices.” Jd.
(quoting JC/, 450 U.S. at 67 n.39).
Accordingly, in reviewing the Board’s determination
that § 20 does not encompass bank-eligible securities, we
give due regard not only to the hazards inherent in
affiliation, but also to the manner in which Congress
ultimately addressed those hazards through § 20. See
Commissioner v. Engle, 464 U.S. 206, 217 (1984); South-
eastern Community College v. Davis, 442 U.S. 397, 411
(1979). As the Supreme Court stated in Board of Gover-
nors of the Federal Reserve System v. Dimension Finan-
cial Corp., 474 U.S. 361 (1986):
_———
35a
Application of “broad purposes” of legislation at the
expense of specific provisions ignores the complexity
of the problems Congress is called upon to address
and the dynamics of legislative action. Congress may
be unanimous in its intent to stamp out some vague
social or economic evil; however, because its Mem-
bers may differ sharply on the means for effectuating
that intent, the final language of the legislation may
reflect hard-fought compromises. Invocation of the
“plain purpose” of legislation at the expense of the
terms of the statute itself takes no account of the
processes of compromise and, in the end, prevents
the effectuation of congressional intent.
474 U.S. at 373-74.
In light of these principles, the Court’s subtle hazards
analysis does not preclude the Board’s construction of
§ 20. As noted, Congress was not concerned with affilia-
tion per se, but rather with the dangers attendant upon
the entry of commercial banks into the investment bank-
ing field either directly or indirectly. Yet even after ac-
knowledging these perils, Congress allowed banks to
underwrite and deal in bank-eligible securities under § 16,
making it plain therefore that it believed the risks were
not so great when banks dealt in these securities. As
Senator Bulkley stressed, whether or not a bank chooses
to engage in these activities itself or through an affiliate is
relatively unimportant compared to the question of
whether a bank should engage in them at all. Since banks
are allowed under § 16 to underwrite and deal in govern-
ment obligations without limitation, it would be incon-
gruous for § 20 to prohibit banks from affiliating with
entities that are merely “engaged principally” in those
Same activities.
36a
Further, the Supreme Court observed that “[i]n both
the Glass-Steagall Act itself and in the Bank Holding
Company Act, Congress indicated that a bank affiliate
may engage in activities that would be impermissible for
the bank itself.” JC7, 450 U.S. at 64. Similarly, in Schwab
the Court commented that “the fact that § 16 of the
Glass-Steagall Act allows banks to engage directly in [a
service] suggests that the activity was not the sort that
concerned Congress in its effort to secure the Nation’s
banks from the risks of the securities market.” 468 U.S.
at 221. The same principle necessarily applies here. As we
recently stated, “the latitude the Act grants bank holding
companies partially to engage in activities such as under-
writing, which implicate the Act’s policies whether con-
ducted by banks or by bank holding companies, suggests
that bank holding companies can, under the Act, be
allowed principally to engage in activities which pose the
dangers the Act addressed only when conducted by
banks.” Securities Indus. Ass’n v. Board of Governors of
the Fed. Reserve Sys., 716 F.2d 92, 100 (2d Cir. 1983),
aff'd, Schwab, 468 U.S. 207 (1984). Because underwrit-
ing and dealing in government securities pose no hazards
to banks themselves, a fortiori bank affiliates should be
able principally to engage in the same activity.
In sum, the Board’s construction of Glass-Steagall is
not only reasonable, but dictated by a thorough examina-
tion of the legislative history of Glass-Steagall and of the
hazards that Congress sought to prevent when enacting
§ 20. We hold that it was not Congress’ purpose in § 20 to
preclude a bank affiliate from engaging in the same
activities to the same extent as a member bank and we
uphold the Board’s determination that the reference in
—
37a
§ 20 to “securities” does not encompass those securities
which § 16 allows banks themselves to underwrite.
Ill “Engaged Principally”
We now turn to the Board’s determination of when a
security affiliate is “engaged principally” in activities
covered by § 20. In their applications the bank holding
companies sought to comply with the “engaged princi- _
pally” standard of § 20 by proposing limitations on their
underwriting and dealing in bank-ineligible securities. J.P.
Morgan & Co., for example, proposed that its bank-
ineligible securities activities would not exceed during any
rolling two-year period 15 percent of its total business.
J.P. Morgan & Co. Proposal, 50 Fed. Reg. 41,025 (1985).
It proposed a combination of accounting tests to measure
its compliance with the 15 percent limitation.®° The other
companies proposed total volume limits of ten to 15
percent of their total business.
The Board rejected these proposals. Following the
analysis set forth in its Bankers Trust order, 73 Fed.
6 The limitation would be met if two of the following three tests were
satisfied:
(1) The dollar volume of underwriting commitments [or underwrit-
ing sales if larger] and dealer sales attributable to ineligible securi-
ties activities with the total dollar volume of all of JPMS’s
activities;
(2) The average assets acquired in connection with ineligible securi-
ties activities with the average assets acquired in connection with all
of JPMS’s activities; and
(3) The gross income [i.e., income before expenses and taxes] from
ineligible securities activities with the gross income from all of
JPMS'’s activities.
50 Fed. Reg. 41,025 (1985). “JPMS” is a wholly-owned subsidiary of
J.P. Morgan Securities Holdings Inc., which is itself wholly-owned by
J.P. Morgan & Co. Inc.
38a
Reserve Bull. 138 (1987), the Board concluded that “en-
gaged principally” in § 20 denotes any “substantial”
bank-ineligible activity. See 73 Fed. Reserve Bull. at 482.
Measured quantitatively, the Board stated that an affiliate
would not be principally or substantially engaged in
bank-ineligible activities if: (1) the gross revenue from
§ 20 activities did not exceed five to ten percent of the
affiliate’s total gross revenues (gross revenue limitation or
gross revenue test); and (2) the affiliate’s activities in
connection with each particular type of ineligible security
did not account for more than five to ten percent of the
total amount of that type of security underwritten domes-
tically by all firms (or, with commercial paper, the average
amount of dealer-placed commercial paper outstanding)
during the previous calendar year (market share limita-
tion or market share test).’ Applying this measure to the
applications before it, the Board selected the lower five
percent figure for both gross revenue and market share
limitations. It recognized that this was a “conservative
approach,” but stated that it would review the limitations
within one year of the implementation of its orders. 73
Fed. Reserve Bull. at 485.
The bank holding companies petition for review of this
interpretation of “engaged principally.” First, they argue
that the Board’s view contravenes Supreme Court prece-
dent. Second, they contend that the limitation is inconsis-
tent with the language, structure, and legislative intent of
_—
The Board was unpersuaded, as we are, that § 20 permits two or
more affiliates to combine their total gross incomes for purposes of
determining whether or not the affiliates are “engaged principally” in
ineligible activity. 73 Fed. Reserve Bull. at 486 n.45. The reason is
plain. The provisions of § 20 apply to each individual company
affiliated with a member bank.
39a
the Glass-Steagall Act. Finally, cross-petitioner Security
Pacific Corporation argues that the Board erred in adopt-
ing an inflexible percentage test instead of approaching
each affiliate’s application on a case-by-case basis.
The term “engaged principally” is intrinsically ambigu-
ous. As discussed above, we must uphold the Board’s
interpretation if it is reasonable. Unlike the facts pre-
sented on the issue of the scope of § 20, the Board’s
position here does not contradict its prior interpretations.
Accordingly, we defer to the Board’s construction of
§ 20.
A. Agnew
The Board found that “principally” in § 20 means
“substantially.” The banks urge that in Board of Gover-
nors Of the Fed. Reserve Sys. v. Agnew, 329 U.S. 441
(1947), the Supreme Court decided that “principally”
means something more than substantially, and therefore
that the Board’s decision conflicts with Agnew.
In Agnew the Board issued an order that required the
removal of directors of a national bank because of their
affiliation with a company which, in the Board’s view,
was “primarily engaged” in_underwriting securities as
prohibited by § 32 of the Act. The United States Court of
Appeals for the District of Columbia reversed the Board
and held that a company is not “primarily engaged” in
underwriting unless the activity is its chief or principal
activity—one exceeding 50 percent of the company’s
business. See Agnew, 153 F.2d 785, 790-91 (D.C. Cir.
1946). The Court of Appeals rejected the Board’s argu-
ment that “primarily” in § 32 could mean “substantially”
or “importantly.”
40a
The Supreme Court reversed, holding that “primarily”
in § 32 meant “substantially.” 329 U.S. at 446. In support
of that conclusion, the Court noted that Congress used
three different terms in the Glass-Steagall Act to describe
underwriting firms: (1) those merely “engaged” in under-
writing (§ 21); (2) those “primarily engaged” in under-
writing (§ 32); and (3) those “engaged principally” in
underwriting (§ 20). 329 U.S. at 448. It then concluded
that “[t]he inference seems reasonable to us that Congress
by the words it chose marked a distinction which we
should not obliterate by reading ‘primarily’ to mean
‘principally’.” Jd. Because the Board has found that a
gross income level of ten percent of covered activities will
trigger § 32, see Staff Opinion 3-939, 1 Fed. Reserve Reg.
Serv. 389 (Dec. 14, 1981), the holding companies argue
that “principally” under § 20 mandates approval of a
higher level of activity, and that their proposed ten to 15
percent limitations were well within that level.
The statements in Agnew regarding the meaning of
“principally” are not dispositive in the instant case. For
one thing the meaning of § 20 was not before the Su-
preme Court in that case. See Cohens v. Virginia, 19 U.S.
(6 Wheat.) 264, 398 (1821). Further, the statements con-
cerning § 20 are not essential to its holding that “primar-
ily” means “substantially.” See Kastigar v. United States,
406 U.S. 441, 454-55 (1972). The main focus of the
Court’s analysis is on definitions of “primary,” see 329
U.S. at 446, and on the perils Congress sought to check
by enacting § 32, id. at 447. In fact, the brief discussion
of § 20 is used to demonstrate that “[t]here is other
intrinsic evidence in the Banking Act of 1933 to support
our conclusion [on the meaning of “primary”].” /d.
ss ee ae
t
SE
= 4ia
Hence, we read Agnew as holding only that “primarily
engaged” in § 32 means any “substantial activity.”
B. “Substantially”
The Board’s construction of “engaged principally” as
denoting any substantial activity is reasonable. We do not
conclude that because “engaged principally” in § 20 and
“primarily engaged” in § 32 both denote “substantial
activity” that the two terms are therefore synonymous.
Substantiality is an amorphous qualitative concept that
has many quantitative definitionat manifestations, see
The Shorter Oxford English Dictionary 2172 (3d ed.
1973), which vary with the context in which the term is
used. Hence, the Agnew dicta that “engaged principally”
and “primarily engaged” do not necessarily mean the
same thing, see 329 U.S. at 448-49, is not entirely circum-
scribed by the Board’s interpretation. In fact, the same
considerations that compelled the Court in Agnew to
conclude that “primarily” in § 32 means “substantially”
apply equally—if not more forcefully—here.
The Supreme Court in Agnew rejected a reading that
“primarily” meant “chief” or “leading” because the con-
cerns that Congress addressed in enacting § 32 do not
vanish if the firm’s underwriting activities are 49 percent
rather than 51 percent. See 329 U.S. at 447. In both
Situations, “a bank director interested in the underwriting
business may use his influence in the bank to involve it or
its customers in securities which his underwriting house
has in its portfolio or has committed itself to take.” Jd.
The banks’ argument essentially adopts the Court of
Appeals holding in Agnew, that is, “principally” means
“chief” or “first.” But the same reasoning that guided the
Supreme Court guides us. The worries envisioned by
- 42a
bank affiliation with securities firms do not disappear
simply because the activity is less than 50 percent of a
firm’s business.
An example illuminates how equating “principally” in
§ 20 with “chief” or “first” begets the dangers foreseen
by Congress. Such an interpretation would allow a mem-
ber bank to become affiliated with any large integrated
securities firm. One commentator has pointed out that
reading “principally” as “chief” would allow a bank to be
affiliated with Merrill Lynch & Co., Inc., one of the
nation’s largest investment bankers. See Plotkin, What
Meaning Does Glass-Steagall Have for Today’s Financial
World?, 95 Banking L.J. 404, 414-16 (1977). It cannot be
supposed that the Congress that enacted Glass-Steagall
would have intended that § 20 not prohibit such affilia-
tions. This is not to say that “principally” cannot in some
contexts mean “chief” or “first,” but rather that in § 20
the term must be given a definition that is both sensible
and in harmony with legislative purpose.
Moreover, the logic of the holding companies’ position
is that “principally” in § 20 is a directly quantitative, not
a qualitative, term. “Substantially,” on the other hand,
reflects the qualitative aspects of “principally.” When
Congress wanted to use a quantitative test in the Banking
Act of 1933, it knew how to do it. See § 2(b), (c), 48 Stat.
at 162-63 (definition of affiliate); § 13, 48 Stat. at 183
(collateral requirements for ioans to affiliates); § 16 (Sev-
enth), 48 Stat. at 185 (limitations on banks’ purchase of
securities for own account), § 19(b), 48 Stat. at 187 (level
of assets for holding company affiliates to be maintained
free of any liens); § 19(c), 48 Stat. at 187 (shareholders’
liability determination). Because in § 20 Congress de-
parted from a quantitative approach, the argument that a
43a
qualitative test should be controlling is all the more
compelling.
SIA and ICI advance several arguments against the
Board’s interpretation of “principally.” They assert that
“engaged principally” in § 20 at least covers any firm
“formed for the purpose of” underwriting securities,
relying on the Supreme Court’s statement in /C/ regard-
ing repealed § 19(e) that “[a]ll companies formed for the
purpose of issuing or underwriting securities would surely
meet the ‘engaged principally’ test.” 450 U.S. at 70 n.43.
Concededly, the subsidiaries here were formed for the
purpose of engaging in securities activities.
Yet, this argument is unpersuasive too. The Court’s
statement in JCI is dicta and seems to indicate nothing
more remarkable than that a company formed for the
purpose of underwriting securities most likely would be
expected to be engaged principally in that activity. Fur-
ther, since § 20 does not restrict bank-eligible securities
activities, SIA and ICI arguably miss the point. Compa-
nies formed for the purpose of dealing in bank-eligible
securities would not fall within the prohibitions of § 20.°
8 SIA and ICI point to testimony that at least one affiliate was formed
for the purpose of dealing in bank-ineligible securities. The President
of J.P. Morgan & Co. said during the Board hearing that the holding
company established its bank-eligible securities subsidiary because it
thought that there might be changes in the law allowing dealing in a
wider range of securities and that they wanted to have a subsidiary in
place when those changes came about. Because we hold that § 20
allows affiliates to engage to a greater extent in securities than the
banks themselves, any formation of an affiliate would likely have in
part a purpose to engage in those activities prohibited to banks. SIA’s
argument therefore is also a back-door attempt to have us broaden the
scope of § 20 to include bank-ineligible securities, an argument we
have rejected.
44a
To support their argument, SIA and ICI also rely on
former § 19(e) of the Glass-Steagall Act. Section 19(e)—
repealed in 1966— indirectly limited bank holding compa-
nies’ acquisition of subsidiaries “formed for the purpose
of, or engaged principally in” prohibited securities activi-
ties. 48 Stat. at 188; see also supra note 4. Because § 20
and § 19(e) were intended to accomplish the same result,
SIA and ICI argue that we should read the two sections as
being coextensive.
Even assuming that SIA and ICI are correct, § 19(e)
would not have prohibited the activities here approved. It
originally was intended to apply to “any affiliate formed
for the purpose of, or engaged in” securities activities.
See 1932 Hearings, supra, at 13 (text of proposed § 20(e))
(emphasis added). As originally conceived, any securities
activity was prohibited under § 19(e). Thus, there are
only two situations when the term “formed for the
purpose of” had any meaning independent from “en-
gaged in”: when a company had been formed for the
purpose of engaging in unpermitted activities, but had (1)
not yet commenced activities, or (2) ceased the activities,
but might possibly resume them. Plainly, the evil that the
“formed for the purpose of” standard was designed to
avoid was the formation of subsidiaries ready to
“engage”—but not yet engaged—in unauthorized securi-
ties activities.
Congress eventually added the term “principally” to
“engaged” in § 19(e), presumably to have § 19(e) corres-
pond with the standard laid down in § 20. We think that
the original meaning of the “formed for the purpose of”
language in § 19(e) was retained after this amendment to
qualify the new and less restrictive standard of “engaged
principally.” Thus, § 19(e) prevented subsidiaries from
45a
either engaging principally in banned activities—which we
have held above to be only bank-ineligible activities—or
being formed for the purpose of engaging principally in
such activities. Even if the proscriptions of § 20 are
coextensive with those of former § 19(e), none of the
subsidiaries here has been formed for the purpose of
engaging principally in bank-ineligible activities. Section
19(e) therefore would not apply.
Alternatively, SIA claims that Congress intended that
§ 20 bar underwriting or dealing activities that constitute
a “regular” or “integral” part of the affiliate’s business,
as opposed to “incidental” or “occasional” activities. The
activities that concerned Congress did not necessarily
arise only with the frequency of their repetition. In any
event, the Board’s interpretation of “principally” as any
“substantial” activity adequately addresses any apprehen-
sion arising from the frequency or integral nature of an
activity.
The final argument raised by SIA is that because the
Board’s interpretation of “engaged principally” necessi-
tates regulation, it a@ fortiori contravenes the Glass-
Steagall Act. It is true that “Congress rejected a
regulatory approach when it drafted the statute.” Bankers
Trust I, 468 U.S. at 153. The Board’s interpretation is one
that attempts to walk the line that Cong’-ss laid down.
The mere necessity of “regulation” in carrying out Glass-
Steagall’s “prohibitions” is insufficient te justify rejec-
tion of an otherwise reasonable interpretation of the Act.
Cf. Bankers Trust II, 807 F.2d at 1067 (“The Glass-
Steagall Act does impose a system of flat ‘prohibitions’
and ‘prophylactic’ measures, but this cannot obviate the
need to examine particular factual situations to determine
on which side of the prohibitory line they fall.”).
46a
Consequently, the-Board’s view of “engaged princi-
pally” as meaning any substantial activity is reasonable
and consistent with Congressional purpose.
C. Gross Revenue Limitation
The Board determined that substantial activity, mea-
sured quantitatively, constituted five to ten percent of an
affiliate’s gross revenues over a two-year period. 73 Fed.
Reserve Bull. at 485. It set the approved level of activity
at the five percent end of this range, but stated its intent
to review this level within a year after the order’s effective
date. /d.
One troublesome facet of the Board’s ruling is that
“engaged principally” in § 20 is equally restrictive as—if
not more restrictive than—“primarily engaged” in § 32.
The Board has stated that if a firm’s prohibited activities
constitute less than ten percent of its gross business, see
Staff Opinion 3-939, 1 Fed. Reserve Reg. Serv. 389 (Dec.
14, 1981), or amount to less than ten million dollars
regardless of the percentage figure, see Board Letter 3-
896, 1 Fed. Reserve Reg. Serv. 367 (May 22, 1959), the
firm is not “primarily engaged” in such activities under
§ 32. By placing the permissible level of § 20 activity
currently at only five percent of gross revenues—and
never more than ten percent—the Board is employing, at
least for the present, a more restrictive gross revenue test
for § 20 than for § 32.
This initially seems to contradict the Supreme Court’s
indication that §§ 32 and 20 should be interpreted consist-
ently. See Schwab, 468 U.S. at 219 (the term “public sale”
should be interpreted consistently because “§§ 32 and 20
contain identical language, were enacted for similar pur-
poses, and are part of the same statute.”). But with
a
47a
regard to “engaged principally” versus “primarily en-
gaged,” §§ 20 and 32 differ; accordingly, there is justifica-
tion for interpreting them slightly differently.
The legislative history also supports the conclusion that
the Board’s stringent quantitative interpretation of § 20 is
reasonable. What became § 20 was proposed by Eugene
Meyer, a governor of the Federal Reserve Board, as a
substitute for the section which eventually became § 32,
see 1932 Hearings, supra, at 387-88, because he believed
that the language in the predecessor to § 32—in relevant
respects identical to § 32—was overbroad and that it
would therefore be ineffectual. See id. at 387. Meyer
commented on the “difficulties in the way of accomplish-
ing a complete divorce of member banks from their
affiliates arising from the fact that a law intended for that
purpose is likely to be susceptible of evasion or else to
apply to many cases to which it is not intended to apply,”
id. at 388, and tentatively suggested substituting what is
now § 20 for what is now § 32. It defies logic that § 20
should be interpreted /ess restrictively than § 32, based on
Meyer’s comments that § 20 was intended to be more
restrictive than § 32.
Further support for a stricter interpretation of § 20
than of § 32 is derived from the fact that the dangers
resulting from affiliation are arguably greater than those
resulting only from personnel interlocks. The public asso-
ciates a member bank and its affiliate because of their
common ownership and often similar names. The poten-
tial for the public to associate the misfortunes of the
affiliate with the bank is far greater than the association
of firms with personnel interlocks, which are generally
unknown to the public.
48a
Given these considerations, we defer to the Board’s
determination that § 20 aliows an affiliate to engage in
bank-ineligible securities activities so long as those activi-
ties do not exceed five to ten percent of the affiliate’s
gross revenue. This range is both reasonable and consist-
ent with the statute. Because of the Board’s expertise we
also defer to its decision to set the gross revenue limita-
tion at five percent.
D. Market Share Limitation
The Board’s second limitation on the subsidiaries’
bank-ineligible securities activities provides that the sub-
sidiaries’ involvement in each activity may not exceed a
five percent share of the total market for that activity. It
reasoned that it has employed a market share limitation in
determining whether a firm is “primarily engaged” in
securities activities within the meaning of § 32. 73 Fed.
Reserve Bull. at 484. The Board stated that “the fact that
an affiliate would be a major force in a particular
securities market would be an evidentiary factor suggest-
ing that the affiliate is ‘engaged principally’ in underwrit-
ing securities.” Jd. It also concluded that a sales volume
test—currently employed under its interpretation of
§ 32—would be subject to manipulation and that a mar-
ket share test “would provide a useful and objective
proxy for sales volume.” Jd. It was concerned that sales
volume could be easily inflated by use of repurchase
and reverse repurchase agreements for government
securities—a common practice among government securi-
ties dealers—or by “churning.” Jd.
The bank holding companies argue that neither § 20
nor the legislative history of the Glass-Steagall Act pro-
vides a basis for the Board’s market share test. They
49a
assert that § 20 mandates an inquiry only into activities
within a subsidiary rather than one into the size of the
subsidiary’s activity in relation to the market as a whole.
A market share test, they claim, is intended sub silentio to
promote competition rather than to protect against the
hazards of affiliation envisioned by Congress.
The Board’s justifications for imposing a market share
limitation are not persuasive. It cites only two instances in
which it has relied on market share data under § 32. One
citation is to a 1947 internal letter from the Board to the
Federal Reserve Bank of New York. The second citation
is to a 1948 letter now included in a compilation of Board
interpretations of Regulation R. See Fed. Reserve Reg.
Serv. 4 3-895 (1948). The 1948 interpretative letter appar-
ently was intended as a guide for future decisions.
It is true that § 32 implicitly delegates to the Board the
power to determine when a firm is “primarily engaged”
in securities activities, in the same way that § 20 implicitly
delegates the power to determine when a firm is “engaged
principally” in securities activities. Yet Congress chose to
grant the Board power to exempt individuals from § 32,
but did not grant it similar power in § 20. Since Congress
expressly granted the Board different regulatory power in
§ 32 than in § 20, it does not at all follow that the Board’s
power to define the meaning of § 20 is coextensive with
its power under § 32. Thus, the Board’s reliance on § 32
is not dispositive.
We discern no support in § 20 for the Board’s market
share limitation. In the legislative history there is evidence
that before the enactment of Glass-Steagall, banks and
bank affiliates had acquired an increasingly large share of
securities activity in relation to investment banks. See W.
Peach, The Security Affiliates of National Banks 108-10
50a
(1941). For example, between 1927 and 1930 the percent-
age share of commercial banks in origination of bond
issues more than doubled. /d. at 109. This increasing
market share of commercial banks in traditional invest-
ment banking activities was not unknown to Congress.
See 1931 Hearings, supra, at 299 (testimony of C.E.
Mitchell, Chairman, National City Bank of New York)
(presenting data). But, the fact that this was brought to
Congress’s attention and that Congress did not directly
address it is, if anything, a strong indication that Con-
gress was not concerned about market share. Rather, by
using the term “engaged principally,” Congress indicated
that its principal anxiety was over the perceived risk to
bank solvency resulting from their over-involvement in
securities activity. A market share limitation simply does
not further reduce this congressional worry.
In addition, the Board has not proven on the record
before us that a market share limitation is an objective
proxy for a sales volume test. The Board makes no claim
that the Act empowers it to limit the power of bank
affiliates to compete in the securities markets open to
them. Consequently, the banks’ cross-petition to elimi-
nate the market share limitation is granted.
E. Security Pacific’s Claims
Security Pacific proposed in its application that its
subsidiary engage in bank-ineligible securities activities
constituting up to 15 percent of the subsidiary’s gross
revenues. The Board approved a lower level of up to five
percent of gross revenues, consistent with its orders ap-
proving the other subsidiaries’ activities. Security Pacific
argues that the Board abused its discretion in setting the
lower limitation and by failing to adopt a case-by-case
ae ee
Sla
approach to determining appropriate levels of § 20 activ-
ity.
The gravamen of Security Pacific’s argument is that its
subsidiary should not be equated with the other bank
holding company subsidiaries, all of which are based in
New York. Security Pacific is located in California. The
New York subsidiaries, Security Pacific argues, will be
able to engage in a higher level of bank-eligible activities
and, consequently, a higher level of bank-ineligible activi-
ties, since bank-ineligible activity levels correspond di-
rectly with the total securities activity of the subsidiary.
Security Pacific claims that this mandates allowing a
higher level of activity for its subsidiary.
We disagree. Section 20 must be read to set down at
some point a hard and fast limit on the amount of bank-
ineligible securities activity, and we have determined that
the Board’s limit of five to ten percent of the gross
revenue is reasonable. Beyond this limit, there is no room
for adjustment in order to ameliorate competitive in-
equality.
Within the range set by the Board there is, of course,
leeway for adjustments that reflect the competitive posi-
tions of certain subsidiaries. Security Pacific declined to
submit evidence of special circumstances that might dis-
tinguish it from the other affiliates involved and warrant
approval of a level of bank-ineligible activity greater than
five percent. Given this failure, the Board’s approval of a
five percent level for Security Pacific was not an abuse of
its discretion.
Security Pacific also argues that the Board’s limitations
are inconsistent with Board precedent holding that quan-
titative measures should be determined on a case-by-case
52a
basis. As noted above, § 20 sets down a line that cannot
be crossed no matter how exceptional the circumstances,
and it cannot be drawn differently in each case.
CONCLUSION
In sum § 20 of the Glass-Steagall Act forbids member
bank affiliation with firms that are “engaged principally”
in underwriting or dealing in “securities.” It was not
Congress’ plan to forbid affiliates from those activities
that banks themselves could engage in without limitation.
The Board’s interpretation of § 20 under which govern-
ment securities—those that banks may without limitation
underwrite and deal in—are excluded from the prohibi-
tion contained in § 20 is therefore consistent with the
Congressional scheme. The Board’s qualitative and quan-
titative constructions of the term “engaged principally”
are reasonable, with the exception of the market share
limitation. Accordingly, we deny the petitions and cross-
petitions for review except with respect to the market
share limitation.
Petitions and cross-petitions for review are denied save
for the cross-petition for review that seeks to eliminate
the market share limitation, which cross-petition is
granted.
hen koe eee a
Senedd
APPENDIX B
Citicorp
New York, New York
J.P. Morgan & Co. Incorporated
New York, New York
Bankers Trust New York Corporation
New York, New York
Order Approving Applications to Engage in Limited
Underwriting and Dealing in Certain Securities
Citicorp, J.P. Morgan & Co. Incorporated, and Bankers
Trust New York Corporation, New York, New York (collec-
tively ‘‘Applicants’’), bank holding companies within the
meaning of the Bank Holding Company Act (‘‘BHC Act’’),
have each applied for the Board’s approval under section
4(c)(8) of the BHC Act and section 225.21(a) of the Board’s
Regulation Y, 12 C.F.R. § 225.21(a), to engage through wholly
owned subsidiaries, Citicorp Securities, Inc. (‘‘CSI’’), J.P.
Morgan Securities Inc. (‘‘JPMS’’), J.P. Morgan Municipal
Finance Inc. (‘‘JPMMF’’), and BT Securities Corporation
(‘‘BTSC’’), respectively, in underwriting and dealing in, on a
limited basis, certain securities that member banks may not un-
derwrite and deal in, specifically:
(1) municipal revenue bonds, including so-called ‘‘pub-
lic ownership”’ industrial development bonds;'
l The industrial development bonds covered by the applications are
only those tax exempt bonds in which the governmental issuer, or the
governmental unit on behalf of which the bonds are issued, is the
owner for federal income tax purposes of the financed facility (such as
airports, mass commuting facilities and water pollution control facili-
ties).
S4a
(2) mortgage-related securities (obligations secured by
or representing an interest in residential real estate);
(3) consumer-receivable-related securities (‘‘CRRs’’)
(obligations secured by or representing an interest in loans
or receivables of a type generally made to or due from con-
sumers); and
(4) commercial paper.”
These securities (hereinafter ‘‘ineligible securities’’) may be
held by member banks for investment purposes under section
16 of the Banking Act of 1933 (the ‘‘Glass-Steagall Act’’) (12
U.S.C. § 24, Seventh), but may not under that section be
underwritten or dealt in by member banks.
Applicants have previously received Board approval under
section 4(c)(8) of the BHC Act for the above-mentioned subsid-
iaries (collectively the ‘‘underwriting subsidiaries’’) to under-
write and deal in U.S. government and agency and state and
municipal securities that state member banks are authorized to
underwrite and deal in under section 16 of the Glass-Steagall
Act (hereinafter ‘‘eligible securities’’).? These eligible securities
include certain municipal revenue bonds (issued for certain
housing, university or dormitory purposes) as well as mortgage-
related securities issued or sold by certain agencies of the fed-
eral government. The proposed new underwriting and dealing
activities would be provided in addition to the previously ap-
proved activities, with the subsidiaries serving customers
2 J.P. Morgan has not proposed td underwrite and deal in CRRs. Citi-
corp’s present application does not cover commercial paper, although
it has filed a separate application with the Board to underwrite com-
mercial paper.
3_—‘These activities are authorized for bank holding companies under
section 225.25(b)(16) of Regulation Y. 12 C.F.R. § 225.25(b)(16). In
general, member banks may underwrite and deal in obligations of the
United States, general obligations of states and political subdivisions,
and certain securities issued or guaranteed by government agencies. 12
U.S.C. §§ 24 Seventh, and 335.
55a
through offices in New York and, in the case of Citicorp, in sev-
eral other cities in the United States.*
Citicorp, with total consolidated assets of $196 billion, is the
largest banking organization in the nation.*® It operates eight
banking subsidiaries and engages directly and through subsidi-
aries in a broad range of permissible nonbanking activities. J.P.
Morgan & Co. Incorporated, with total consolidated assets of
$76 billion, is the fourth largest banking organization in the na-
tion. It operates two subsidiary banks and engages directly and
through subsidiaries in a variety of permissible nonbanking ac-
tivities. Bankers Trust New York Corporation, with total con-
solidated assets of $56.4 billion, is the eighth largest banking
Organization in the nation. It also operates two subsidiary
banks and engages directly and through subsidiaries in a variety
of nonbanking activities.
Notice of the applications, affording interested persons an
opportunity to submit comments on the proposals, has been
published (50 Federal Register 20,847 and 41,025 (1985) and 51
Federal Register 16,590 (1986)). In addition, on December 31,
1986, the Board announced that it would hold a public hearing
on February 3, 1987, on the applications, and requested specific
comment on certain major issues, including a framework of
prudential limitations to address the potential for conflicts of
interest, unsound banking practices and other adverse effects
raised by the proposals.
Four commenters, including the Securities Industry Associa-
tion (‘‘SIA’’), a trade association of the investment banking in-
dustry, and the Investment Company Institute (‘‘ICI’’), a trade
association of the mutual fund industry, opposed one or more
of the proposals (collectively the ‘‘protestants’’). The majority
of the written comments were from banking organizations and
trade associations representing segments of the banking indus-
try and were in favor of the proposals. The Antitrust Division
4 _ For purposes of the Order, in accordance with common industry us-
age, the term dealing refers to the business activity of holding oneself
out to the public as being willing to buy and sell securities as principal
in the secondary market.
5 All asset data are as of December 31, 1986.
56a
of the U.S. Department of Justice and the U.S. Treasury De-
partment also supported approval of the proposals.
Because each of the underwriting subsidiaries that propose to
underwrite and deal in the ineligible securities would be affili-
ated through common ownership with a member bank, the
Board must determine whether, upon consummation, the sub-
sidiaries would be ‘‘engaged principally’’ in underwriting or the
public sale of securities within the meaning of section 20 of the
Glass-Steagall Act.° If so, the Board may not approve the appli-
cations.’ In addition, the Board must determine whether the
proposed activities are so closely related to banking as to be a
proper incident thereto within the meaning of section 4(c)(8) of
the BHC Act (12 U.S.C. § 1843(c)(8)) and are, on this basis, ac-
tivities in which bank holding companies may engage.
In two previous decisions, the Board considered some of the
issues that are raised in the applications now before the Board.
On December 24, 1986, the Board approved the application of
6 Section 20 of the Glass-Steagall Act (12 U.S.C. § 377) provides that:
‘*. . , no member bank shall be affiliated . . . with any corpora-
tion. . . engaged principally in the issue, flotation, underwriting,
public sale, or distribution at wholesale or retail or through syndi-
cate participation of stocks, bonds, debentures, notes, or other se-
ee.) 57
Because Applicants propose that certain of their officers and directors
will also be officers and directors of the underwriting subsidiaries, the
proposal raises an issue under section 32 of the Glass-Steagall Act (12
U.S.C. § (78) which provides that:
No officer, director, or employee of any corporation. . . primarily
engaged in the issue, flotation, underwriting, public sale, or distri-
bution, at wholesale or retail, or through syndicate participation, of
stocks, bonds, or other similar securities shall serve [at] the same
time as an officer, director, or employee of any member bank ex-
cept in limited classes of cases in which the Board of Governors of
the Federal Reserve System may allow such service by general regu-
lations when in the judgment of the said Board it would not unduly
influence the investment policies of such member bank or the advice
it gives its customers regarding investments.
7 See Securities Industry Association v. Board of Governors of the
Federal Reserve System, 468 U.S. 207, 216 (1984) (hereinafter
**Schwab’’).
ree een
57a
Bankers Trust New York Corporation (‘‘Bankers Trust’’) to en-
gage in the placement of commercial paper issued by third par-
ties as one activity of a commercial lending affiliate.* In that
decision, the Board concluded that the placement activity in-
volved did not constitute underwriting, distributing, or the pub-
lic sale of securities for purposes of section 20. The Board
further concluded that, even assuming this activity is covered by
section 20, the term ‘‘engaged principally’’ in section 20 of the
Glass-Steagall Act would allow the activity in an affiliate of a
member bank if it is relatively insubstantial in terms of the total
activity of the affiliate and the size of the market. Specifically,
the Board cited the fact that since the gross revenues generated
by the commercial paper activities of the affiliate would be no
more than 5 percent of the affiliate’s total gross revenues and
that the affiliate’s share of the total market for dealer placed
commercial paper would not exceed 5 percent, the proposal
would not violate section 20. In addition, the Board established
a number of conditions to assure that the conduct of the activity
was consistent with safe and sound banking practices and
avoided conflicts of interest, concentration of resources, and
other adverse effects. The Board applied this same framework
of analysis in approving, on March 18, 1987, an application by
The Chase Manhattan Corporation (‘‘Chase’’) to engage in un-
derwriting and dealing in commercial paper in a commercial fi-
nance subsidiary of the parent bank holding company.’ The
Board has been guided by these two decisions in deciding the
applications now before the Board.
An index to this decision is contained in Appendix A to this
Order.
Part I. Introduction & Summary of Findings
These applications raise fundamental questions concerning
the scope of the Glass-Steagall Act’s restrictions on the securi-
ties activities of member bank affiliates. Their resolution re-
8 73 FEDERAL RESERVE BULLETIN 138 (1987).
9 The Chase Manhattan Corporation, 73 Federal Reserve Bulletin 367
(Order dated March 18, 1987).
58a
quires application of a statute adopted over 50 years ago in very
different circumstances to a financial services marketplace that
technology and other competitive forces have altered in a man-
ner and to an extent never envisioned by the enacting Congress.
Applicants’ member bank affiliates seek to activate until now
dormant provisions in section 20 of the Glass-Steagall Act to
participate in underwriting and dealing in certain securities, so
long as they are not engaged principally in this activity.
In its evaluation of the issues raised by the applications, the
Board has been guided, as it must, by the terms of the statute
and the underlying Congressional intent and purposes of the
Act as evident in its structure and legislative history. Thus, the
Board fully recognizes that Congress, through the Glass-
Steagall Act, intended to separate commercial banks from gen-
eral securities underwriting firms. Both the Board and the
federal courts have often articulated the potential dangers to
commercial banks from general underwriting activities that mo-
tivated the Congress in enacting the Glass-Steagall Act. The
Board remains fully sensitive to these concerns.
Nevertheless, despite these dangers, the Congress drew a
clear distinction between member banks and their affiliates in
the Glass-Steagall Act. Except for certain specifically enumer-
ated securities, including government securities, member banks
were prohibited under the Glass-Steagall Act from engaging in
any underwriting whatsoever. Member bank affiliates, on the
other hand, were given a different statutory treatment under
section 20 of the Act.
Member bank affiliates are permitted to participate in other-
wise impermissible securities underwriting so long as they are
not ‘‘engaged principally”’’ in this activity. While prior to this
time, there apparently has been no incentive to test the meaning
of this authorization, the Board is now asked to apply it to spe-
cific proposals to engage in certain underwriting activities.
Thus, the Board’s task is to apply this explicit Congressional
authorization to the proposed activities, but in a manner that
gives effect to the Congressional intent in adopting the Glass-
Steagall Act. Because of the precedent-setting nature of these
applications, the Board has given them careful attention, ex-
59a
tending over a period in excess of a year, during which time the
statutory language, the legislative history, and the implications
of these proposals for banking organizations and the financial
markets generally have been carefully analyzed by the Board on
a number of occasions. In addition, the Board conducted a
hearing before the Board members on these important issues.
For the reasons set out in its decisions in the Bankers Trust
and Chase cases, the Board believes it is bound by the statutory
language of section 20 to conclude that a member bank affiliate
may underwrite and deal in the ineligible securities proposed in
the applications, provided that this line of business does not
constitute a principal or substantial activity for the affiliate.
The Board reaffirms its conclusion in those cases that Congress
intended that the ‘‘engaged principally’ standard permit a level
of otherwise impermissible underwriting activity in an affiliate
that would not be quantitatively so substantial as to present a
danger to affiliated banks. The Board believes that it is only on
this basis—that the activity would be insubstantial—that Con-
gress concluded that, despite the hazards from underwriting
that caused it to ban banks from engaging in underwriting, this
activity would be permissible for the affiliates of member
banks.
The Board devoted a considerable effort to evaluation of the
factors that should be used to determine the level of ineligible
underwriting and dealing activity that would not exceed the
substantiality threshold. Taking into account its precedent in
the administration of the Glass-Steagall Act and the comments
at the hearing on this issue, the Board again concluded that the
principal factors that should be included in this judgment are
gross revenue and market share. As explained in detail below,
the Board believes that these factors are not susceptible to ma-
nipulation to increase artificially levels of activity and fairly re-
flect the amount of involvement of a bank affiliate in securities
underwriting.
With respect to the appropriate quantitative level of ineligible
activity permitted under section 20, the Board concludes that a
member bank affiliate would not be substantially engaged in
underwriting or dealing in ineligible securities if its gross reve-
60a
nue from that activity does not exceed a range of between five
to ten percent of its total gross revenues. The Board also be-
lieves that a similar range should apply to the market share test
it believes is appropriate under section 20. This range was estab-
lished by reference to the Board’s interpretations of the “‘pri-
marily engaged’’ standard in section 32 of the Glass-Steagall
Act. As discussed below, under these interpretations, a com-
pany would not generally be considered engaged substantially
in ineligible securities activity if its gross revenues from that ac-
tivity did not exceed 5 percent of its total gross revenues. Where
underwriting volume was not large in absolute terms, however,
somewhat higher levels of revenue were permitted, but gener-
ally not greater than 10 percent of total gross revenues.
Applying this framework to the current applications, the
Board came to the conclusion that, in view of the fact that the
volume of ineligible securities activity projected by Applicants
would be very large in absolute terms, the lower end of the per-
missible range, 5 percent, should determine whether Appli-
cants’ gross income or market share from ineligible activity
would be substantial. The Board recognizes that this 5 percent
threshold for measuring the concept of ‘engaged principally”’
is a conservative interpretation of the level of activity permitted
by section 20. The Board believes that a conservative, step by
step approach is merited in applying the provision of a statute
that was intended to deal with a crisis in our banking system
and that has not been extensively interpreted by the courts as
applied to the applications now before the Board. In the light of
experience, the Board will consider, not later than one year
from the date of this Order, whether, under the framework es-
tablished by the Board in this Order, somewhat higher levels of
activity would be consistent with the Board’s finding that un-
derwriting and dealing in ineligible securities in an affiliate of a
member bank is permissible so long as the level of this activity
measured by gross revenue and market share is not substantial.
In addition, the three applications now before the Board raise
an important issue that was not present in the Bankers Trust
and Chase applications. In those two cases, the applicants pro-
posed to place or underwrite commercial paper in a subsidiary
6la
that was not engaged in securities underwriting activities at all.
Here, the three Applicants propose to underwrite and deal in se-
curities in a subsidiary that is otherwise engaged in underwriting
and dealing in government securities and other securities that
banks may underwrite and deal in pursuant to section 16 of the
Glass-Steagall Act.
Thus, in the three pending applications the Board must con-
sider whether underwriting U.S. government securities and
other securities that a bank may underwrite pursuant to section
16 of the Glass-Steagall Act should be considered a permissible
activity for the purposes of applying section 20 of the Glass-
Steagall Act to the proposed underwriting subsidiaries. If un-
derwriting these securities, and particularly U.S. government
securities, is considered permissible under section 20, as it is un-
der section 16, an affiliate engaged principally in these activities
could be then less than principally engaged in underwriting the
otherwise impermissible securities proposed in the applications,
including commercial paper, mortgage-backed securities and
municipal revenue bonds. The answer to this question has vital
significance for bank holding companies seeking to underwrite
and deal in ineligible securities. Because of the operation of the
net capital rules established by the Securities and Exchange
Commission for broker-dealers, as a practical matter it is not
feasible for bank affiliates to underwrite and deal in ineligible
securities, other than commercial paper, within the confines of
section 20 unless the subsidiary in which this activity takes place
is engaged principally in underwriting and dealing in eligible
securities—essentially U.S. government securities.
The question as to whether underwriting and dealing in gov-
ernment securities is included within the prohibition of section
20 of the Glass-Steagall Act depends upon an analysis of the
language of the statute, the intention of Congfess and the
Board’s own practice in administering the Act. The Board de-
cided, in December 1986, not to resolve this question until after
a hearing had given the parties an opportunity to develop fur-
ther the record on this matter.
62a
In the light of these considerations, the Board has concluded
that U.S. government and other securities specifically made eli-
gible for underwriting and dealing by member banks in section
16 should not be viewed as the kind of activity proscribed by
section 20. The Board took into account, first, the fact that the
Board has previously decided that a member bank affiliate is
not engaged principally in impermissible activities if its sole
business is underwriting and dealing in U.S. government and
other eligible securities. Second, the Board considered that
Congress did not intend to apply a more restrictive underwrit-
ing standard to member bank affiliates than it legislated for
member banks themselves.
The~ Board’s conclusion with respect to the content and
meaning of the authorization of section 20 to member bank af-
filiates to be less than engaged principally in otherwise imper-
missible underwriting activities is all the more compelling
because the Buard has reached the conclusion that the activities
proposed in these applications can be conducted by bank affili-
ates on a safe and sound basis and without undue risk to affili-
ated banks. On the contrary, the evidence seems to indicate that
without this authority banking organizations will be at a disad-
vantage in the competition to supply the credit necds v* he
most creditworthy borrowers with access to the less costly com-
mercial paper market, with a consequent continuing decline in
the overall quality of bank loan portfolios.
The Board has also evaluated whether the activities proposed
in the applications are closely related to banking and a proper
incident thereto under section 4(c)(8) of the BHC Act. 12
U.S.C. § 1843(c)(8). As stated in detail below, the Board has
concluded that, because of the considerable experience of banks
in underwriting and dealing in eligible securities, which are
closely analogous to the proposed ineligible securities activities,
and because the proposed commercial paper activities are func-
tionally equivalent to traditional commercial banking func-
tions, banking organizations are fully familiar with the
proposed activities and have the expertise and capability to
10 See 12 C.F.R. § 225.25(b\(16).
63a
carry out the proposed functions. The Board also concluded
that the proposed de novo participation in this activity would
have the beneficial effect of substantially increasing competi-
tion, particularly in the highly concentrated commercial paper
market, with the substantial expected public benefits of lower-
ing financing costs as well as providing greater convenience to
customers and increased efficiency in the proposed services.
As noted above, Congress recognized that a member bank af-
filiate that is not engaged principally in underwriting activities
covered by section 20 could engage in otherwise impermissible
securities underwriting even though it was aware that this activ-
ity could give rise to subtle hazards that could impair public
confidence in depository institutions. The Board believes Con-
gress was prepared to accept these risks because they could be
contained within fully acceptable limits through maintaining
the corporate separateness of the underwriting firm and the af-
filiated bank and through limitations on the relative size of the
otherwise impermissible activities to assure their insubstantial-
ity. These prudential limits have been fully implemented in the
Board’s interpretation of the Glass-Steagall Act.
In addition, other safeguards, both as a practical matter and
under other statutory authorities, will be in place. As a practical
matter, the securities which the Applicants propose to under-
write and the Board is prepared to authorize are securities that
member banks are eligible to purchase for their own account,
are of high quality and involve minimum risk. In terms of the
statutory framework, the Board notes that bank holding com-
pany affiliates that engage in securities underwriting would be
subject to SEC jurisdiction under the securities laws. Moreover,
although not required by the Glass-Steagall Act, the Board be-
lieves it is appropriate to require that member bank affiliates
underwriting otherwise impermissible securities observe a num-
ber of prudential considerations to assure capital adequacy and
to limit both transactions and the flow of information between
an underwriting subsidiary and other affiliates of the parent
banking organization. These prudential considerations are ex-
plained in Part III below.
64a
Accordingly, the Board has concluded that, subject to the
limitations established in this Order, approval of each of the
three applications would not result in a violation of the Glass-
Steagall Act and would be consistent with the closely related
and proper incident to banking standards of section 4(c)(8) of
the Bank Holding Company Act.
Part II. Glass-Steagall Act
A. Applicants’ Contentions
The Applicants contend that the underwriting subsidiaries
would not be ‘‘engaged principally’’ in underwriting securities
within the meaning of section 20 of the Glass-Steagall Act be-
cause the subsidiaries will limit the volume of their ineligible ac-
tivity to a small percentage of their total business and so that
the subsidiaries would not have a significant share of the mar-
ket for any of the ineligible securities underwritten or dealt in."
11 Citicorp proposes (in the third year and thereafter) to limit the total
sales volume of underwriting by CSI in ineligible municipal revenue
bonds, mortgage-related securities and CRRs to no more than 10 per-
cent of all securities (both eligible and ineligible) underwritten by the
affiliate during the previous year. Citicorp would similarly limit the af-
filiate’s dealing in ineligible securities to 10 percent of its total securi-
ties dealing activity. Citicorp would also restrict the affiliate’s
underwriting of each type of security to no more than 3 percent of the
total amount of each type of ineligible security underwritten domesti-
cally during the previous calendar year by all firms (mortgage-related
securities and CRRs constitute a single category for this purpose). It
would also limit the amount of each type of securities it may hold for
dealing so as not to exceed this market cap.
Morgan proposes to limit ineligible underwriting and dealing activity
by its affiliates (JPMS and JPMMEF) in municipal revenue bonds,
mortgage-related securities and commercial paper so that the activity
will not, over any two-year period, account for more than 15 percent
of the total consolidated eligible and ineligible securities activity of the
affiliates as measured by two of the following three criteria: gross in-
come, sales volume and average assets acquired in connection with the
activity. Morgan would adopt the same market limitations as Citicorp,
except that it proposes a 10 percent market share limitation for com-
RR ee ee ee ee
et wel
65a
The Applicants contend that the term ‘‘engaged principally”’
in section 20 means the chief or single largest activity, and that,
therefore, their underwriting subsidiaries may underwrite and
deal in ineligible securities so long as this ineligible activity does
not constitute more than 50 percent of the subsidiaries’ total
business activity or represent its single largest business activ-
ity.'* On this basis and subject to the proposed limitations on
each subsidiary’s ineligible securities underwriting and dealing
activity, Applicants contend their underwriting subsidiaries
would be ‘‘engaged principally’’ in underwriting and dealing in
eligible securities, which is permissible under section 20, and,
therefore, the subsidiaries could not by definition be engaged
principally in underwriting ineligible securities in violation of
section 20 of the Glass-Steagall Act. Applicants further claim
that, even under the broadest reading of ‘‘principally’’ as de-
noting any substantial activity, their subsidiaries would not be
engaged principally in ineligible securities activity under the
limitations proposed in their applications.
Applicants also argue that the proposed dealing activities are
not covered by section 20 of the Glass-Steagall Act, which they
claim is limited to activities involving the initial distribution of
securities. They base this claim on the fact that section 20 does
not refer to ‘‘dealing’’ per se, but to the functions of issuance,
flotation, underwriting, public sale, or distribution of securi-
ties.
mercial paper based upon the average amount of dealer-placed com-
mercial paper outstanding during the previous four calendar quarters.
Bankers Trust proposes to conduct, through its affiliate BTSC, ineli-
gible underwriting and dealing activity involving municipal revenue
bonds, commercial paper, and mortgage- and-consumer-receivable-
related securities under the same tests as proposed by Morgan.
12. The Applicants rely on a dictionary definition of the term ‘‘princi-
pally’’ to mean the single largest activity and statements in the U.S. Su-
preme Court decision in Board of Governors of the Federal Reserve
System v. Agnew, 329 U.S. 441, 446, 448 (1947), concerning section 32
of the Glass-Steagall Act, which they argue indicate that ‘‘principally’’
as used in section 20 means more than 50 percent of the company’s
business.
66a
B. Protestants’ Comments
The protestants claim that Applicants’ view of the term
principally’? would vitiate the central purpose of the Glass-
Steagall Act by allowing member banks to reestablish ‘‘security
affiliates’ that could rival the largest investment banking firms.
For this reason, the protestants contend that the term ‘‘princi-
pally’’ must be interpreted consistent with Congressional intent
to denote any substantial, significant, regular or non-incidental
activity, whether or not it is the largest activity of the affiliate.
ICI further contends that the ‘‘engaged principally’’ standard
of section 20 also would cover any company ‘‘formed for the
purpose of’’ underwriting securities of any sort, the description
of a securities company that was contained in the now repealed
section 19(e) of the Glass-Steagall Act.’? ICI contends that each
of the underwriting subsidiaries was formed for the purpose of
underwriting securities and thus, in its view, would be ‘‘engaged
principally’’ in underwriting securities under section 20.
The protestants also contend that the terms ‘‘stocks, bonds
debentures, notes, or other securities’’ in section 20 include all
securities, both eligible and ineligible. Thus, they argue that,
even under Applicants’ interpretation of ‘‘engaged princi-
pally,’’ the proposals to conduct ineligible securities activity in
a government securities underwriting subsidiary would violate
section 20 because the subsidiary’s largest activity would be
underwriting and dealing in ‘‘securities,’’ albeit the preponder-
ance of these securities would be bank-eligible U.S. govern-
ment, state, and municipal securities.
“é
13 Banking Act of 1933, Pub. L. No. 66, § 19%e), 48 Stat. 162, 188
(codified at 12 U.S.C. § 61(e) (1964)), repealed by Act to Amend the
Bank Holding Company Act of 1956, Pub. L. No. 89-485, § 13(c), 80
Stat. 236 (1966).
Section 19(e) prohibited a holding company affiliate, which was de-
fined to include a bank holding company, from voting the shares of its
subsidiary member bank if the holding company affiliate controlled, or
participated in the management or direction of, any business organiza-
tion ‘‘formed for the purpose of, or engaged principally in, the issue,
flotation, underwriting, public sale, or distribution . . . of stocks,
bonds, debentures, notes, or other securities of any sort.’’
67a
Applicants counter that the term ‘‘securities’’ in section 20
does not include government securities and other securities
member banks are authorized to underwrite and deal in under
section 16, on the theory that a member bank affiliate may en-
gage in any activity authorized for the member bank under the
Glass-Steagall Act.
C. Analysis of Glass-Steagall Act Issues
1. Securities that a Member Bank May Underwrite are
not Covered by the Prohibition of Section 20.
Protestants contend that the term securities in section 20 en-
compasses all securities—both incligible as well as bank eligible
securities—and that, therefore, the proposed subsidiaries would
be ‘‘engaged principally’ in underwriting securities for pur-
poses of section 20 even under Applicants’ view of the term
**principally.”’
The Board notes that, on its face, section 20 draws no distinc-
tion between eligible and ineligible securities, as is the case un-
der other sections of the Glass-Steagall Act. The section simply
contains a prohibition on a member bank’s affiliation with any
corporation engaged principally in underwriting ‘‘stocks,
bonds, debentures, notes, or other securities.’’
Looking at the statute as a whole, however, the Board be-
lieves that Congress did not intend to include the eligible securi-
ties activity authorized for member banks under section 16 of
the Glass-Steagall Act within the scope of section 20’s prohibi-
tion against an affiliate’s being engaged principally in the un-
derwriting or public sale of ‘‘stocks, bonds, debentures, notes,
or other securities.’’ In the Board’s view, the structure and
Congressional intent of the Glass-Steagall Act make clear that
in light of the express authorization in section 16 for member
banks to underwrite eligible securities, the limitation of section
20 against a member bank affiliate being engaged principally in
underwriting securities does not encompass bank eligible securi-
ties. In this regard, the Supreme Court has stated that the struc-
ture of the Glass-Steagall Act reveals a Congressional intent to
impose a ‘“‘less stringent standard’’ on member bank affiliates
68a
under section 20 than is applied to the direct activities of mem-
ber banks under section 16 of the Act'* and that under the
Glass-Steagall Act ‘‘a bank affiliate may engage in activities
that would be impermissible for the bank itself.’’’’
As section 16 expressly provides, and as was clear prior to its
enactment, banks have the power to underwrite and deal in gov-
ernment obligations.'® Given that section 20 establishes a less
rigorous standard for member bank affiliates than is applicable
to a member bank, it follows, a fortiori, that such bank eligible
underwriting and dealing activity is permitted for a meinber
bank affiliate. In reaching this conclusion, the Board has ap-
plied a fundamental principle of statutory construction that the
various provisions of a statute should be construed as a whole
and that a particular section of a statute may not be interpreted
in isolation without regard to other sections of the statute of
which it is a part."’
In accordance with this interpretation, the Board has for
some time authorized bank holding companies, including those
that controlled member banks, to establish subsidiaries to un-
derwrite and deal in securities that are expressly authorized for
member banks to underwrite and deal in under section 16,'® and
in 1984 authorized such activity for bank holding companies
14. Board of Governors of the Federal Reserve System v. Investment
Company Institute, 450 U.S. 46, 61 n.26 (‘‘JC/ IP’).
1S ICT IH, 450 U.S. at 63-64.
16 2 FF. Redlich, The Molding of American Banking: Men and Ideas
389 (1951); W. Peach, The Security Affiliates of National Banks 43-44
(1941).
17 See United States v. Morton, 467 U.S. 822, 828, rehearing denied,
468 U.S. 1226 (1984); Philbrook v. Giodgett, 421 U.S. 707, 713 (1975);
United Mine Workers of America v. Andrews, 581 F.2d 888, 892
(D.C. Cir.), cert. denied, 439 U.S. 928 (1978). 2A Sutherland Statutory
Construction § 46.05 (4th ed. 1984).
18 United Bancorp, 64 FEDERAL RESERVE BULLETIN 222 (1978); Stepp,
Inc., 64 FEDERAL RESERVE BULLETIN 223 (1978); United Oklahoma
Bankshares, Inc., 65 FEDERAL RESERVE BULLETIN 363 (1979); Citi-
corp, 68 FEDERAL RESERVE BULLETIN 249 (1982).
69a
generally by regulation.'? The Board’s decision in these cases
was premised upon its view that the conduct of such bank eligi-
ble securities activities by member bank affiliates is not the type
of activity prohibited by section 20 or 32 of the Glass-Steagall
Act.
The interpretation of section 20 urged by protestants that a
member bank affiliate may not underwrite securities that are
expressly authorized for a member bank itself not only runs
counter to the Supreme Court’s statements regarding the scope
of section 20, but is also inconsistent with the fundamental pur-
pose of the Glass-Steagall Act. The Glass-Steagall Act was en-
acted with one central purpose in mind, to protect bank
depositors from the hazards that Congress viewed as attribut-
able to the combination of commercial and investment bank-
ing. However, Congress did not view the _ traditional
underwriting activities of banks in government securities as giv-
ing rise to these dangers to the bank and its depositors and on
this basis permitted the continuation of that activity within the
bank itself.”°
Section 20 was designed to limit the scope of activities of
member bank affiliates as a complement to the restrictions on
banks’ direct underwriting and dealing activities,”’ and as a
means of enforcing the separation of commercial from invest-
ment banking.” Clearly, therefore, section 20 was not designed
to prohibit affiliates from engaging in activity a bank could
19 12 C.F.R. § 225.25(b)(16). The Board notes that protestants did not
challenge the Board’s rule authorizing this activity for bank holding
companies or any of its approvals for bank holding companies to en-
gage in this activity.
20 = See ICI IT, 450 U.S. at 61-62.
21 The Senate Report on the bill that subsequently became the Glass-
Steagall Act indicates that Congress was concerned with the fact that
banks had formed affiliates to conduct activity ‘‘never contemplated
by the National Banking Act.’’ S. Rep. No. 77, 73d Cong., Ist Sess. 10
(1933). Accord: 75 Cong. Rec. 9887 (1932) (remarks of Sen. Glass) and
75 Cong. Rec. 9911 (1932) (remarks of Sen. Bulkley). See also Invest-
ment Company Institute v. Camp, 401 U.S. 617, 629 (1971) (“JCI TP’).
22. = See ICI IT, 450 U.S. at 61-62.
70a
lawfully conduct.” Moreover, there is some evidence in the leg-
islative history of the Glass-Steagall Act that section 20 was not
meant to prohibit the underwriting of government securities. 76
Cong. Rec. 2000, 2274 (1933) (remarks of Sen. Long); 76 Cong.
Rec. 1941 (1933) (remarks of Sen. Glass).
To read the statute otherwise would mean that Congress in-
tended to impose a substantially stricter standard on an affiliate
than on the member bank itself, an interpretation that would be
out of harmony with the central purpose of the Act to protect
the bank and its depositors. Moreover, with respect to the anal-
ogous question raised in JCI IJ, as to whether an activity could
be prohibited under section 21 that was authorized under sec-
tion 16, the Supreme Court stated that section 21 ‘‘surely was
not intended to require banks to abandon an accepted banking
practice that was subjected to regulation under section 16.’’ 450
U.S. at 63. In affirming the Board’s decision authorizing bank
holding companies to act as discount brokers, the Court also
noted that the fact that section 16 authorizes the activity for
member banks suggested that it was not the type of activity at
which the Glass-Steagall Act was aimed.”
Similarly, the United States Court of Appeals for the D.C.
Circuit has recently stated that ‘‘those activities of commercial
banks that section 16 places on the acceptable commercial
banking side of the line [between commercial and investment
banking] cannot be placed by section 21 on the impermissible
investment banking side of the line.’’** Accordingly, the court
concluded that section 21 of the Glass-Steagall Act would not
prohibit a bank from selling securities to the extent authorized
for member banks under section 16, even before the amend-
ment to section 21 in 1935 excepting from section 21’s prohibi-
tion activities authorized for member banks under section 16.
a).
24 Schwab, 468 U.S. at 221.
25 = Securities Industry Association v. Board of Governors of the Federal
Reserve System, 807 F.2d 1052, 1058 (D.C. Cir. 1987), petition for
cert. pending No. 86-1429 (‘‘Bankers Trust IT’).
T7la
The court reached this conclusion on two separate and inde-
pendent grounds, both of which, in the Board’s view, support
the conclusion that section 20 does not cover activity authorized
under section 16. First, the court noted, as Applicants point
out, that the 1935 Amendment to section 21 was termed a clari-
fying amendment ‘‘to make it clear that [section 21] does not
prohibit any financial institution or private banker from engag-
ing in the securities business to the limited extent permitted to
national banks under [section 16].’’”° This the court felt neces-
sarily implied that the authorization under section 16 also ap-
plied to the prohibition of section 21 against selling and
underwriting securities generally, even before the 1935 amend-
ment. Second, the court noted that, unless the authorization of
section 16 was read as an exception to section 21, a member
bank would be prohibited by section 21 from conducting activi-
ties the bank was expressly authorized to conduct under section
16, a result the court termed absurd. /d. at 1058.
The Board believes this reasoning is directly applicable to sec-
tion 20, which by its terms covers the same types of securities
and the same underwriting and selling activities described in
section 21. Thus, in order to avoid the illogic of barring a mem-
ber bank affiliate from activity expressly authorized for the
member bank, the Board believes that section 20 must necessar-
ily not cover securities activity authorized for member banks
under section 16.7’ Moreover, given the fact that Congress has
26
27
H. Rep. No. 742, 74th Cong., Ist Sess. 16 (1935). Relying on the leg-
islative history, the court in Bankers Trust II said the 1935 amendment
to section 21 was ‘‘simply to leave no doubt of the need to read the two
sections [16 and 21] harmoniously. . . .’’ 807 F.2d at 1058.
The SIA claims that an interpretation of section 20 that prohibits a
bank affiliate from underwriting and dealing in even eligible securities
is not unreasonable because Congress may have intended the under-
writing of government securities to be conducted directly by the
bank—a federally regulated entity. Such an explanation is implausible,
in the Board’s view, because when Congress undertook to regulate
broker-dealers generally shortly after passage of the Glass-Steagall
Act, companies dealing only in government securities were expressly
exempted from federal regulation. Thus, any company that under-
wrote only government securities would not have been subject to fed-
eral regulation.
72a
legislated a less stringent standard for member bank affiliates
than for banks and that Congress, as the court concludes, did
not intend section 21 even before its amendment to bar member
banks from activity authorized under section 16, it follows that
Congress must necessarily have intended not to bar their affili-
ates from such activity.”
Finally, the Board notes that the limited expansion of the ac-
tivities of Applicants’ government securities subsidiaries, as
proposed in the applications and limited by this Order, would
not transform these subsidiaries, which would derive substan-
tially all of their income from permissible eligible underwriting
activities and would not engage in a full investment banking
business, into the type of general securities underwriting affili-
ates Congress intended to divorce from member banks in 1933.
Since eligible securities cannot reasonably be viewed as secu-
rities for purposes of section 20, member bank affiliates that
conduct such eligible securities underwriting activity cannot be
viewed as engaged in the securities underwriting business pro-
scribed by section 20 and thus may—as may any other member
28 Protestants contend that the failure of Congress to amend section 20
in 1935 to permit member bank affiliates to underwrite securities au-
thorized under section 16 demonstrates member bank affiliates were
not intended to be permitted to conduct such activity. The Board,
however, believes that the better view is that articulated in Bankers
Trust IT that the 1935 amendment merely clarified the preexisting state
of affairs and that, just as banks were not prohibited by section 21
from engaging in activity permitted under section 16 even before the
amendment, member bank affiliates must necessarily not have been
prohibited from engaging in such activity under section 20. Thus, Con-
gress’ failure to amend section 20 in 1935 does not mean that Congress
intended to bar member bank affiliates from activity permitted for
member banks. Moreover, it was necessary to clarify section 21 be-
cause it is a criminal statute and the Attorney General had expressed
the view with respect to certain aspects of section 21 that clarification
would be desirable. Banking Act of 1935: Hearings on S. 1715 and
H.R. 7617 Before a Subcomm. of the Senate Comm. on Banking and
Currency, 74th Cong., Ist Sess. 139-140 (1935) (Testimony of J.F.T.
O’Connor). Section 20, however, is not a criminal statute and in light
of the Board’s ability to issue interpretations of that statute, there was
no pressing need for clarification, as was the case with section 21.
he oh eee ee
73a
bank affiliate—engage in ineligible underwriting and dealing
activity where such activity is not a principal line of business for
the affiliate. In the Board’s view, there is no basis in the terms
or legislative intent of section 20 to prohibit an eligible securi-
ties underwriting subsidiary from underwriting and dealing in
any ineligible securities activity while allowing a subsidiary en-
gaged in commercial finance, mortgage banking, securities bro-
kerage or other nonbanking activity permissible for bank
holding companies to engage to some extent in ineligible securi-
ties activities.
In this regard, the Board has considered the proposed limited
expansion of Applicants’ government securities subsidiaries’
activities in light of the hazards to the bank and its customers
that the Glass-Steagall Act is intended to prevent. As noted,
Congress clearly did not view the underwriting of bank-eligible
securities as harmful to the bank or its depositors and Congress
plainly permitted ineligible underwriting activity so long as it
did not amount to a principal activity. Moreover, as noted, the
Board’s order in this case goes further than Congress under the
Glass-Steagall Act and establishes limitations on the conduct of
the activity under the Bank Holding Company Act to assure
that the activity will not produce significant conflicts of inter-
est, unsound banking practices, unfair or decreased competi-
tion, undue concentration of resources or other adverse
effects.”
29 _siIn its evaluation of this case, the Board has carefully considered the
fact that Applicants’ underwriting subsidiaries were formed in major
part through the transfer to the subsidiaries of government securities
activities previously conducted as departments or divisions of the Ap-
plicants’ member bank subsidiaries. As indicated, the Board has previ-
ously approved the transfer of such activities to the holding
companies’ underwriting subsidiaries as a permissible nonbanking ac-
tivity under the BHC Act. Accordingly, the Applicants are engaged in
this activity pursuant to law and regulatory authorization. While the
transfer of these functions could result in the deliberate creation of a
large base of eligible activity, the size of the ineligible activity that may
be conducted by these affiliates is sharply limited by the ‘‘engaged
principally’’ provisions of the Glass-Steagall Act as interpreted by the
74a
For the above reasons, the Board believes that the term ‘‘se-
curities’’ in section 20 must be read as not including those secu-
rities that member banks are expressly authorized to underwrite
and deal in under section 16.
2. Dealing Constitutes the Underwriting or Public Sale of
Securities Under Section 20.
Applicants maintain that ‘‘dealing’’ is not an activity covered
by the terms ‘“‘issue, flotation, underwriting, public sale, or dis-
tribution”’ in section 20, particularly if dealing is limited only to
secondary market sales and does not involve an initial distribu-
tion of securities. For the reasons set out below and more fully
in the attached Appendix B, the Board concludes that the secu-
rities activity covered by section 20 is not limited to the initial
distribution of securities, but also includes the activity of hold-
ing oneself out to the public as being willing to buy and sell se-
curities as a principal in the secondary market, or ‘‘dealing’’ as
that term is used by the Applicants. This conclusion is consis-
tent with the literal meaning of the term ‘‘public sale’’ in section
20, the legislative history of the section, judicial interpretation,
the purposes of the Act, and the Board’s longstanding practice.
Literally, the term ‘‘public sale’’ in section 20 is broad
enough to encompass dealing in securities. A dealer commonly
refers to a person who holds himself out to the public as being
willing to buy and sell securities for its own account. 2 L. Loss,
Securities Regulation 1215, 1297 (2d ed. 1961). Moreover, the
legislative history of the Glass-Steagall Act indicates that Con-
gress intended to cover not only underwriting activity but also
stock speculation, market making and participation in trading
Board. As discussed below, these provisions involve the concept of a
quantitative limitation on underwriting activity which is embodied in
the income and market share criteria for establishing ‘‘substantiality’’
contained in this Order. The Board wishes to stress that the latter crite-
rion, in particular, creates a limitation on underwriting activity which
is independent of the size of the affiliate that might be established by
purposeful transfer of activities from the bank to the underwriting
affiliate.
75a
pools—activities attributable to dealing and not generally asso-
ciated with initial distribution activities.”
On this basis, the Board for many years has consistently ruled
that dealing is covered by section 32 of the Act, which, as
noted, is identical to section 20 in terms of its coverage of issu-
ance, flotation, underwriting, public sale, or distribution activi-
ties.
The conclusion that dealing constitutes the ‘‘public sale’’ of
securities under section 20 is also supported by the Supreme
Court’s observation in Schwab, 468 U.S. at 217-18, that the ac-
tivities described in section 20 refer, at a minimum, to opera-
tions in which the affiliate acts as a principal.
3. The Term ‘‘Engaged Principally’’ in Section 20
Denotes any Substantial Activity.
In its Bankers Trust decision, the Board concluded that, even
if the placement as agent of commercial paper were deemed to
constitute an activity covered by section 20 of the Glass-Steagall
Act, Bankers Trust’s commercial lending affiliate would not be
‘*engaged principally’’ in underwriting or dealing in securities
within the meaning of section 20 under the 5 percent income
and market share limits at issue in that case. The Board held
that the term ‘‘engaged principally’’ in section 20 denotes any
activity of the underwriting affiliate that is substantial, even if
30 «See S. Rep. No. 77, 73d Cong., Ist Sess. 10 (1933). See also Opera-
tion of the National and Federal Reserve Banking Systems, 1931:
Hearings on S. Res. 71 Before a Subcomm. of the Senate Comm. on
Banking and Currency, 7\st Cong., 3d Sess. 198-199, 306-309, 1063-
1064. The conclusion that section 20 covers dealing is also more con-
sistent with the purposes of the Glass-Steagall Act to address the
Congress’ concern over the ‘‘subtle hazards’’ of a bank having a pecu-
niary interest in the purchase and sale of particular securities. /C/ /,
401 U.S. at 629-34; Securities Industry Association v. Board of Gover-
nors of the Federal Reserve System, 468 U.S. 137, 145 (1984) (‘‘Bank-
ers Trust I"); Schwab, 468 U.S. at 220.
31 20 FEDERAL RESERVE BULLETIN 393 (1934); 20 FEDERAL RESERVE
BULLETIN 750 (1934); 51 FEDERAL RESERVE BULLETIN 810 (1965); 12
C.F.R. § 218.110(d).
76a
the activity does not represent more than 50 percent of the affil-
iate’s total business activity or its single largest or most impor-
tant activity. A similar decision was made in the Chase case.
After considering the submissions by the parties and other in-
terested persons at the hearing and in post-hearing materials,
the Board continues to be of the view, for the reasons expressed
in full in Bankers Trust, that the term ‘‘engaged principally”’ in
section 20 denotes any substantial activity of the affiliate.
In this regard, the Board has considered the argument by ICI
regarding the now repealed section 19(e) of the Glass-Steagall
Act. While section 19(e) and section 20 were designed to accom-
plish the same general objective and overlap to some extent in
the case of a securities company affiliated with a member bank
within a bank holding company system, section 20 does not
contain the ‘‘formed for the purpose of”’’ language found in sec-
tion 19(e).
Moreover, nothing in the legislative history of the Glass-
Steagall Act or the 1966 legislation which repealed section 19(e)
indicates that the ‘‘engaged principally’’ standard of section 20
incorporated the ‘‘formed for the purpose of’’ standard. Sec-
tion 19(e) was repealed, at the recommendation of the Board,
because it was ‘‘doubtful’’ whether section 19(e) was ‘‘suffi-
ciently useful’’ to justify its retention in light of the enactment
of the Bank Holding Company Act.”
The Board has also considered the Supreme Court’s discus-
sion of section 19(e) in JC/ JT, 450 U.S. at 70 n.43. In the
Board’s view, the Court’s statements merely reflect the view
that if a company is formed in order to underwrite securities,
one would expect the company to be ‘‘engaged principally’’ in
that activity. The Court was not presented with a situation,
such as that presented here, in which the company’s largest ac-
tivity is permissible government securities underwriting activi-
ties and its ineligible activities are insubstantial. In this regard,
the Board is unaware of any instance of a member bank affili-
32 ~—s SS. Rep. No. 1179, 89th Cong., 2d Sess. 12 (1966); Bank Holding
Company Act, Report of the Board of Governors of the Federal Re-
serve System to the Comm. on Banking and Currency, U.S. Senate,
85th Cong., 2d Sess. 26 (Comm. Print 1958).
77a
ated in a bank holding company system with a securities com-
pany that was covered by the ‘‘formed for the purpose of”’
language of section 19(e), but not by ‘‘engaged principally’’
language.
Finally, the Board notes that the ‘‘formed for the purpose
of’’ language—like the ‘‘engaged principally’’ terminology in
section 20—is susceptible to different meanings. For example,
the ‘‘formed for the purpose of’’ language could be construed
to refer to the situation where the company was specifically
formed to underwrite ineligible securities and would not cover
the situation where the company was formed for the purpose of
commercial finance (as in the Bankers Trust and Chase cases
previously approved by the Board) or to underwrite bank-
eligible securities as in these cases.
Nevertheless, while the Board does not believe the ‘‘formed
for the purpose of’’ standard has been incorporated in the ‘‘en-
gaged principally’ standard of section 20, the Board does note
that section 19(e), because of its overlap with and close relation-
ship to section 20, does tend to confirm the Board’s conclusion
that the ‘‘engaged principally’’ standard of section 20 must be
read to cover any substantial ineligible activity of the affiliate in
order to carry out Congressional intent to separate member
banks from securities affiliates.
The Board has also considered Applicants’ contention, reiter-
ated at the hearing and in post-hearing materials, that the
Board is required by the Supreme Court’s Agnew decision to
determine that the ‘‘engaged principally’’ standard of section
20 denotes only that activity of the affiliate that constitutes
more than 50 percent of its total business activity or its single
largest activity. The Board has carefully considered Applicants’
position, but remains of the view that the Supreme Court in the
Agnew case does not determine dispositively the meaning of
‘engaged principally’ in section 20. As the Board noted in its
Bankers Trust Order, section 20 was not at issue in Agnew be-
cause of the absence of a stockholder affiliation between the
member bank and the securities company involved. 73 FED-
ERAL RESERVE BULLETIN 143, 144 (1987). Nor was any such
determination necessary to the Court’s decision regarding the
78a
term ‘‘primarily engaged”’ in section 32, since even if the Court
determined that the two standards were identical, it would not
have been precluded from reaching the same conclusion—that
‘*primarily’’ meant any substantial activity, given that ‘‘princi-
pally’’ can also mean any substantial activity. As was explained
in the Bankers Trust Order, at the time the Glass-Steagall Act
was passed, an accepted dictionary definition of principally in-
cluded ‘‘important’’ and ‘‘primarily.”’
As noted in Bankers Trust, the Board believes its conclusion
regarding the meaning of section 20 is particularly appropriate
in light of the fact that to hold otherwise would mean that sec-
tion 20 would apply to no one, since investment banking firms
typically engage in numerous other activities in addition to se-
curities underwriting and dealing. This rationale led the Court
in Agnew to affirm the Board’s interpretation that section 32
denoted any substantial activity. Indeed, such a view would per-
mit member banks to establish the very affiliations with the na-
tion’s largest investment banking businesses that section 20 was
precisely designed to prohibit.*°
At the hearing, Applicants also disputed the Board’s conclu-
sion that common sense would suggest that Congress could not
have intended to apply a less stringent standard where a mem-
ber bank and an underwriter were affiliated thrcugh common
stock ownership than was applied where a member bank and an
33 In order to support its strict interpretation of section 32, the Agnew
Court observed that the Act distinguished between firms primarily en-
gaged and engaged principally in underwriting. 329 U.S. at 448. In the
Board’s view, the Agnew Court reached its decision on the meaning of
‘*primarily engaged’’ on the basis of the terms and legislative intent of
the statute. 329 U.S. at 447. Its subsequent references in the opinion to
‘*principally’’ in section 20 were clearly meant to bolster its decision
made on the basis of the terms and legislative intent of the statute.
While the Court’s observation is a part of the Court’s reasoning, it is
not a legally binding ruling on the scope of section 20. In addition, in
the Board’s view, the Court’s supplemental argumentation should not
be accorded controlling weight here, given that the Court in Agnew
had no occasion to consider the fact that viewing ‘‘principally’’ to
mean the chief or single largest activity would produce results that are
inconsistent with what the Court understood to be the basic purpose of
the legislation.
79a
unaffiliated underwriter merely shared a common director. In
Bankers Trust, the Board pointed out that Applicants’ view of
principally would mean that a member bank could be affiliated
through common stock ownership with a securities company
substantially but not predominantly engaged in underwriting,
but could not establish a single management interlock with the
company, a seemingly anomalous result in light of the greater
potential in common ownership situations for adverse effects of
the type that led Congress to enact the Glass-Steagall Act.** Ap-
plicants contend that Congress in fact intended to apply a more
lenient standard in common ownership situations because the
securities affiliate of a member bank would be subject to exami-
nation and rules limiting transactions between the member
bank and its affiliates.
At the outset, the Board notes that there is nothing in the leg-
islative history to support Applicants’ view. Moreover, the Su-
preme Court has stated that Congress in 1933 rejected the view
that examination and regulation of bank securities affiliates
would address the concerns Congress perceived when commer-
cial and investment banking functions are combined. Bankers
Trust I, 468 U.S. at 147. Rather, Congress felt that most com-
mercial and investment banking functions were ‘‘fundamen-
tally incompatible.’’ Jd. The Board also notes that the
examination authority and affiliate transaction restrictions con-
tained in the Glass-Steagall Act were not comprehensive and
did not foreclose the possibility of the type of adverse effects
that concerned Congress and resulted in enactment of the
Glass-Steagall Act. For example, section 23A of the Federal Re-
serve Act,” to which Applicants point, did not apply to pur-
chases of assets by a member bank from an affiliate until 1982,
thus allowing dumping of securities in a member bank or the
purchase by a member bank of low quality assets from a securi-
34 73 FEDERAL RESERVE BULLETIN at 143, 144.
35 Banking Act of 1933, Pub. L. No. 66, § 13, 48 Stat. 162, 183 (codi-
fied at 12 U.S.C. 371c (1976), amended by Garn-St. Germain Deposi-
tory Institutions Act of 1982, Pub. L. No. 97-320, § 410, 96 Stat. 1469,
1515.
‘
80a
ties affiliate, a hazard Congress was specifically concerned with
in 1933.
APPROPRIATE MEASURES OF ‘‘ENGAGED PRINCI-
PALLY”’
Having determined that the ‘‘engaged principally’’ standard
of section 20 denotes any substantial activity, the Board must
determine whether, under the limitations proposed by the Ap-
plicants, their subsidiaries’ ineligible underwriting and dealing
activity would be substantial. In making this determination, the
Board has been guided by the Congressional intent underlying
section 20 of the Glass-Steagall Act to insulate member banks
from the dangers Congress associated with the combination of
commercia! and investment banking by allowing member bank
affiliates to underwrite and deal in ineligible securities only at a
level that would not be substantial. Taking these factors into ac-
count in the Bankers Trust and Chase cases, the Board deter-
mined that where ineligible activity would not exceed 5 percent
of the affiliate’s gross revenues or 5 percent of the market for
the type of security being placed or underwritten, the activity
would not be substantial.
Applicants have suggested a number of differing methods for
determining when an affiliate is ‘‘engaged principally’’ in un-
derwriting activity, including limitations based on sales volume
alone or on sales volume, assets devoted to the activity or in-
come on a two out of three basis. The Board, however, con-
tinues to believe that the most appropriate measure of
‘*engaged principally’’ is the gross revenue the affiliate derives
from the ineligible underwriting and dealing activity relative to
the revenue derived from its total business activities. This is
consistent with the Board’s practice under the ‘‘primarily en-
gaged’”’ standard of section 32 of the Glass-Steagall Act, which
gives substantial weight to the size of the company’s revenue
from underwriting activity relative to its total revenue.” In ad-
dition, the Board believes it appropriate to consider the signifi-
36 ~—Letter from the Board to the Federal Reserve Banks (August 11,
1958), reprinted in Federal Reserve Regulatory Service (‘‘F.R.R.S.’’),
q 3-895.
8la
cance of the organization’s presence in the market for the
particular activity, also a factor considered by the Board in
prior rulings under the Glass-Steagall Act.°”
As noted in the Bankers Trust Order, the Board believes that
gross revenue is the appropriate test to determine whether a
subsidiary is ‘‘engaged principally’’ because it is an objective
and meaningful measure of the importance of the activity to the
subsidiary as a whole and also reflects the level of risk involved
in the activity, a major consideration behind enactment of the
Glass-Steagall Act. In addition, a gross revenue test goes some
way toward avoiding the potential for manipulation present in a
test based solely on sales volume. Although gross revenues may
be influenced to enlarge ineligible operations, the sales volume
of a government securities subsidiary could be easily inflated by
daily ‘‘matched book’’ operations or be increased through
churning of the affiliate’s dealing activity in permissible securi-
ties in order to create a larger base against which ineligible ac-
tivity would not appear to be substantial. The Board also notes
that the average assets test suggested would not take into ac-
count ineligible underwriting activities which do not entail sub-
stantial or lengthy investment of the underwriting subsidiary’s
own funds.”
The Board has considered Applicants’ comments at the hear-
ing regarding the desirability of their proposed tests, including
their view that the volume tests would not be subject to artificial
increases because of increased costs and legal constraints. The
37_—s I.
38 Matched book activities would consist of repurchase and reverse re-
purchase agreements for government securities, used by dealers and
their financial institutions customers for short term funding, hedging
and arbitrage. As government securities dealers, Applicants’ subsidi-
aries would have a high volume of such activity.
39 Bankers Trust’s and Morgan’s reliance on tests based on assets de-
voted to the activity, income and sales volume, on a ‘‘two out of
three’’ basis, are similarly flawed because an affiliate could derive a
substantial amount of its income from ineligible activity even though
the ineligible activity met the asset and sales volume test, both of
which, in the Board’s judgment, would be open to increasing the base
of eligible activity to support ineligible activity.
82a
Board, however, continues to be of the view that a revenue test
is the best overall measure under section 20, posing the fewest
opera
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