Activities of Insured State Banks and Insured Savings Associations

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Parts 303, 337 and 362

RIN 3064-AC12

Activities of Insured State Banks and Insured Savings

Associations

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Notice of proposed rulemaking.

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SUMMARY: As part of the FDIC's systematic review of its regulations and

written policies under section 303(a) of the Riegle Community

Development and Regulatory Improvement Act of 1994 (CDRI), the FDIC is

seeking public comment on its proposal to revise and consolidate its

rules and regulations governing activities and investments of insured

state banks and insured savings associations. The FDIC proposes to

combine its regulations governing the activities and investments of

insured state banks with those governing insured savings associations.

In addition, the proposal updates the FDIC's regulations governing the

safety and soundness of securities activities of subsidiaries and

affiliates of insured state nonmember banks. The FDIC's proposal

modernizes this group of regulations and harmonizes the provisions

governing activities that are not permissible for national banks with

those governing the securities activities of state nonmember banks. The

proposed regulation will make a number of substantive changes and will

revise the regulations by deleting obsolete provisions, rewriting the

regulatory text to make it more readable, conforming the treatment of

state banks and savings associations to the extent possible given the

underlying statutory and regulatory scheme governing the different

charters. The proposal establishes a number of new exceptions and will

allow institutions to conduct certain activities after providing the

FDIC with notice rather than filing an application. The proposal also

will revise these regulations by deleting obsolete provisions,

rewriting the regulatory text to make it more readable, removing a

number of the current restrictions on those activities and conforming

the disclosures required under the current regulation to an existing

interagency statement concerning the retail sales of nondeposit

investment products.

DATES: Comments must be received by December 11, 1997.

ADDRESSES: Send written comments to Robert E. Feldman, Executive

Secretary, Attention: Comments/OES, Federal Deposit Insurance

Corporation, 550 17th Street, N.W., Washington, D.C. 20429. Comments

may be hand delivered to the guard station at the rear of the 17th

Street Building (located on F Street), on business days between 7:00

a.m. and 5:00 p.m. (Fax number (202) 898-3838; Internet Address:

[email protected]). Comments may be inspected and photocopied in the

FDIC Public Information Center, Room 100, 801 17th Street, N.W.

Washington, D.C. 20429, between 9:00 a.m. and 4:30 p.m. on business

days.

FOR FURTHER INFORMATION CONTACT: Curtis Vaughn, Examination Specialist,

(202/898-6759) or John Jilovec, Examination Specialist, (202/898-8958)

Division of Supervision; Linda L. Stamp, Counsel, (202/ 898-7310) or

Jamey Basham, Counsel, (202/ 898-7265), Legal Division, FDIC, 550 17th

Street, N.W., Washington, D.C. 20429.

SUPPLEMENTARY INFORMATION:

I. Background

Section 303 of the Riegle Community Development and Regulatory

Improvement Act of 1994 (RCDRIA) requires that the FDIC review its

regulations for the purpose of streamlining those regulations, reducing

any unnecessary costs and eliminating unwarranted constraints on credit

availability while faithfully implementing statutory requirements.

Pursuant to that statutory direction the FDIC has reviewed part 362

``Activities and Investments of Insured State Banks,'' Sec. 303.13

``Applications and Notices by Savings Associations,'' and Sec. 337.4

``Securities Activities of Subsidiaries of Insured State Banks: Bank

Transactions with Affiliated Securities Companies' and proposes to make

a number of changes to those regulations. The proposal is described in

more detail below. In brief, however, the proposal would restructure

existing part 362, placing the substance of the text of the current

regulation into new subpart A. Subpart A would address the Activities

of Insured State Banks which implements section 24 of the Federal

Deposit Insurance Act (FDI Act). 12 U.S.C. 1831a. Section 24 restricts

and prohibits insured state banks and their subsidiaries from engaging

in activities and investments of a type that are not permissible for

national banks and their subsidiaries. In addition, the proposal would

move the FDIC's regulations governing the securities activities of

subsidiaries of insured state nonmember banks (currently at 12 CFR

337.4) into subpart A of part 362 and revise those regulations by

deleting obsolete provisions, rewriting the regulatory text to make it

more readable, removing a number of the obsolete current restrictions

on those activities, and removing the disclosures required under the

current regulation to conform the required disclosures to the

Interagency Statement on the Retail Sale of Nondeposit Investment

Products (Interagency Statement).

Safety and Soundness Rules Governing Insured State Nonmember Banks

would be set out in new subpart B. Subpart B would establish modern

standards for insured state nonmember banks to conduct real estate

investment activities through a subsidiary and for those insured state

nonmember banks that are not affiliated with a bank holding company

(nonbank banks) to conduct securities activities in an affiliated

organization. The existing restrictions on these securities activities

are found in Sec. 337.4 of this chapter.

Existing Sec. 303.13 of this chapter which relates to activities of

state savings associations and filings by all savings associations

would be revised in a number of ways and primarily placed in new

subpart C of part 362. Procedures to be used by all savings

associations when Acquiring, Establishing, or Conducting New Activities

through a Subsidiary would be placed in new subpart D. Subpart E would

contain the revised provisions concerning application and notice

procedures as well as delegations for insured state banks. Subpart F

would contain the revised provisions concerning application and notice

procedures as well as delegations for insured savings associations.

[[Page 47970]]

In addition, the FDIC is processing a complete revision of part 303

of the FDIC's rules and regulations. Part 303 contains the FDIC's

applications procedures and delegations of authority. As a part of that

process and for ease of reference, the FDIC is proposing to remove the

applications procedures relating to activities and investments of

insured state banks from part 362 and place them in subpart G of part

303. The procedures applicable to insured savings associations will be

consolidated in subpart H of part 303. We anticipate that the proposed

changes to part 303 will be published for comment within 90 days of

today's publication. At that time, subparts G and H of part 303 will be

designated as the place where the text of subparts E and F of this

proposed rule eventually will be located.

Part 362 of the FDIC's regulations implements the provisions of

section 24 of the FDI Act (12 U.S.C. 1831a). Section 24 was added to

the FDI Act by the Federal Deposit Insurance Corporation Improvement

Act of 1991 (FDICIA). With certain exceptions, section 24 limits the

direct equity investments of state chartered insured banks to equity

investments of a type permissible for national banks. In addition,

section 24 prohibits an insured state bank from directly, or indirectly

through a subsidiary, engaging as principal in any activity that is not

permissible for a national bank unless the bank meets its capital

requirements and the FDIC determines that the activity will not pose a

significant risk to the appropriate deposit insurance fund. The FDIC

may make such determinations by regulation or order. The statute

requires institutions that held equity investments not conforming to

the new requirements to divest no later than December 19, 1996. The

statute also requires that banks file certain notices with the FDIC

concerning grandfathered investments.

Part 362 was adopted in two stages. The provisions of the current

regulation concerning equity investments appeared in the Federal

Register on November 9, 1992, at 57 FR 53234. The provisions of the

current regulation concerning activities of insured state banks and

their majority-owned subsidiaries appeared in the Federal Register on

December 8, 1993, at 58 FR 64455.

Section 303.13 of the FDIC's regulations (12 CFR 303.13) implements

sections 28 and 18(m) of the FDI Act. Both sections were added to the

FDI Act by the Financial Institutions Reform, Recovery, and Enforcement

Act of 1989 (FIRREA). While section 28 of the FDI Act and section 24 of

the FDI Act are similar, there are a number of fundamental differences

in the two provisions which caused the implementing regulations to

differ in some respects.

Section 18(m) of the FDI Act (12 U.S.C. 1828(m)) requires state and

federal savings associations to provide the FDIC with notice 30 days

before establishing or acquiring a subsidiary or engaging in any new

activity through a subsidiary. Section 28 (12 U.S.C. 1831e) governs the

activities and equity investments of state savings associations and

provides that no state savings association may engage as principal in

any activity of a type or in an amount that is impermissible for a

federal savings association unless the FDIC determines that the

activity will not pose a significant risk to the affected deposit

insurance fund and the savings association is in compliance with the

fully phased-in capital requirements prescribed under section 5(t) of

the Home Owners' Loan Act (HOLA, 12 U.S.C. 1464(t)). Except for its

investment in service corporations, a state savings association is

prohibited from acquiring or retaining any equity investment that is

not permissible for a federal savings association. A state savings

association may acquire or retain an investment in a service

corporation of a type or in an amount not permissible for a federal

savings association if the FDIC determines that neither the amount

invested in the service corporation nor the activities of the service

corporation pose a significant risk to the affected deposit insurance

fund and the savings association continues to meet the fully phased-in

capital requirements. A savings association was required to divest

itself of prohibited equity investments no later than July 1, 1994.

Section 28 also prohibits state and federal savings associations from

acquiring any corporate debt security that is not of investment grade

(commonly known as ``junk bonds'').

Section 303.13 of the FDIC's regulations was adopted as an interim

final rule on December 29, 1989 (54 FR 53548). The FDIC revised the

rule after reviewing the comments and the regulation as adopted

appeared in the Federal Register on September 17, 1990 (55 FR 38042).

The regulation establishes application and notice procedures governing

requests by a state savings association to directly, or through a

service corporation, engage in activities that are not permissible for

a federal savings association; the intent of a state savings

association to engage in permissible activities in an amount exceeding

that permissible for a federal savings association; or the intent of a

state savings association to divest corporate debt securities not of

investment grade. The regulation also establishes procedures to give

prior notice for the establishment or acquisition of a subsidiary or

the conduct of new activities through a subsidiary.

Section 337.4 of the FDIC's regulations (12 CFR 337.4) governs

securities activities of subsidiaries of insured state nonmember banks

as well as transactions between insured state nonmember banks and their

securities subsidiaries and affiliates. The regulation was adopted in

1984 (49 FR 46723) and is designed to promote the safety and soundness

of insured state nonmember banks that have subsidiaries which engage in

securities activities that are impermissible for national banks under

section 16 of the Banking Act of 1933 (12 U.S.C. section 24 seventh),

commonly known as the Glass-Steagall Act. It requires that these

subsidiaries qualify as bona fide subsidiaries, establishes transaction

restrictions between a bank and its subsidiaries or other affiliates

that engage in securities activities that are prohibited for national

banks, requires that an insured state nonmember bank give prior notice

to the FDIC before establishing or acquiring any securities subsidiary,

requires that disclosures be provided to securities customers in

certain instances, and requires that a bank's investment in a

securities subsidiary engaging in activities that are impermissible for

a national bank be deducted from the bank's capital.

On August 23, 1996, the FDIC published a notice of proposed

rulemaking (61 FR 43486, August 23, 1996) (August proposed rule) to

amend part 362. Under the proposed rule a notice procedure would have

replaced the application currently required in the case of real estate

investment, life insurance and annuity investment activities provided

certain conditions and restrictions were met. The proposed rule set

forth notice processing procedures for real estate, life insurance

policies and annuity contract investments for well-capitalized, well-

managed insured state banks. Under the proposal, all real estate

activities would be required to be conducted in a majority-owned

subsidiary, while life insurance policies and annuity contracts could

be held directly or through a majority-owned subsidiary. Notices would

have been filed with the appropriate FDIC regional office. The FDIC

regional office would have had 60 days to process a notice under the

proposal, with a possible extension of 30 days. If the FDIC did not

object to the

[[Page 47971]]

notice prior to the expiration of the notice period (or any extension),

the bank could have proceeded with the investment activity. In the

event a bank fell out of compliance with any of the eligibility

conditions after starting the activity, it would have been required to

report the noncompliance to the appropriate FDIC regional office within

10 business days of the occurrence.

With respect to investments in real estate activities, the August

proposed rule set forth 9 conditions which banks would have had to meet

to be ``eligible'' for the notice procedure. These 9 conditions

addressed the bank's capital levels and financial condition (must be

well-capitalized after deducting investment in real estate and must

have a Uniform Financial Institutions Rating System (UFIRS) rating of 1

or 2), how the real estate activity would be conducted (a ``bona fide''

subsidiary which only engages in real estate activities), management

experience and independence of the real estate subsidiary (subsidiary

must have management with real estate experience, a written business

plan, and at least one director with real estate experience who is not

an employee, officer or director of the bank), and placed limits on

bank transactions with the subsidiary and customers (sections 23A and

23B of the Federal Reserve Act applied to transactions between the bank

and its subsidiary and tying and insider transactions were prohibited).

The August proposed rule also set forth the contents of the notice that

was to be sent to the FDIC regional office. The required information

included 7 items; information regarding the proposed activity (general

description of proposed real estate activity, a copy of the written

business plan, and a description of the subsidiary's operations

including management's expertise), the amount of investment and impact

on bank capital (aggregate amount of investment in activity and pro

forma effect of deducting such investments on the bank's capital

levels) and the bank's authority to engage in such activity (copy of

the board of directors' resolution authorizing activity and

identification of state law permitting the activity). Under the August

proposal, the regional office could have requested additional

information.

After considering the comments to the August proposed rule and

reconsidering the issues underlying the current regulation, we have

restructured the approach we are taking under part 362. As a result,

the FDIC withdrew the August proposed rule, which is published

elsewhere in today's Federal Register in favor of the more

comprehensive approach presently proposed.

While the August proposed rule amended existing part 362, the

current proposal would replace existing part 362. Unlike the rule

proposed in August, the current proposal is not limited to considering

the notice procedure used under part 362. In drafting the current

proposal, we have deleted items that are either duplicative,

unnecessary due to the passage of time, or have proven unwarranted

given our experience in implementing section 24 over the last five

years. In addition, we have refined the notice procedure that was

proposed in August. We are no longer recommending a life insurance

policy and annuity contract investment notice due to recent guidance

provided by the Office of the Comptroller of the Currency (OCC). The

OCC's guidance appears to eliminate the necessity for an application

with respect to virtually all of the life insurance and annuity

investments received by the FDIC in the past. While Section 24 and the

part 362 application process would continue to apply to those life

insurance and annuity investments which are impermissible for national

banks, the FDIC has decided that there is no need to adopt a notice

process that specifically addresses what we expect to be an extremely

small number of situations. We invite comment on whether we are correct

in concluding that there is no longer a need for a notice process for

life insurance and annuity investments which are impermissible for

national banks.

II. Description of Proposal

The FDIC proposes to divide part 362 into six subparts. Before

describing the reorganization of part 362, we would like to make a few

general comments concerning the proposal. First, we moved substantive

aspects of the regulation that were formerly found in the definitions

of terms like ``bona fide subsidiary'' to the applicable regulation

text. This reorganization should assist the reader in understanding and

applying the regulation. Second, current part 362 contains a number of

provisions relating to divesture. We have deleted any divestiture

provisions in the current proposal that we found to be unnecessary due

to the passage of time. Third, we are proposing to combine the rules

covering the equity investments of banks and savings associations into

part 362 and to regulate these investments as consistently as possible

given the limitations imposed by statute. Fourth, unlike the

regulations promulgated by the Office of Thrift Supervision we do not

distinguish between activities carried out by a first tier subsidiary

of a savings association versus a lower-tier subsidiary. Finally,

although the FDIC agrees with the principles applicable to transactions

between insured depository institutions and its affiliates contained in

sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c and

371c-1), our experience over the last five years in applying section 24

has led us to conclude that extending 23A and 23B by reference to bank

subsidiaries is inadvisable. For that reason, the proposed regulation

does not incorporate sections 23A and 23B of the Federal Reserve Act by

cross-reference; rather, the proposal adapts the principles set forth

in sections 23A and 23B to the bank/subsidiary relationship as

appropriate. In drafting the proposed revision to part 362, we have

considered each of the requirements contained in sections 23A and 23B

in the context of transactions between an insured institution and its

subsidiary and refined the restrictions appropriately. The FDIC

requests comment on whether these proposals assist in the application

of the principles of 23A and 23B to the subsidiaries of insured

depository institutions. We also request comment on all aspects of

these restrictions including whether this approach strikes a better

balance between caution and commercial reality by harmonizing the

capital deductions and the principles of 23A and 23B.

Subpart A of the proposed regulation would deal with the activities

and investments of insured state banks. Except for those sections

pertaining to the applications, notices and related delegations of

authority (procedural provisions), existing part 362 would essentially

become subpart A under the current proposal. The procedural provisions

of existing part 362 have been transferred to subpart E. As proposed,

subpart A addresses the activities of the insured state bank in

Sec. 362.3. The activities carried on in a subsidiary of the insured

state bank are addressed in a separate section (see Sec. 362.4 in the

proposed regulation). We are soliciting comment on whether this

reorganization of part 362 is helpful.

The ability of insured state banks to engage in activities as

principal is directly linked to the ability of a national bank to

engage in the same type of activity. National banks have a limited

ability to hold equity investments in real estate. Even so, if a

particular real estate investment has been determined to be permissible

for a national bank, an insured state bank only needs to document that

determination to undertake the

[[Page 47972]]

investment. Insured state banks that want to undertake a real estate

investment which is impermissible for a national bank (or continue to

hold the real estate investment in the case of investments acquired

before enactment of section 24 of the FDI Act), must file an

application with the FDIC for consent. The FDIC may approve such

applications if the investment is made through a majority-owned

subsidiary, the institution meets the applicable capital standards set

by the appropriate Federal banking agency and the FDIC determines that

the activity does not pose a significant risk to the appropriate

deposit insurance fund.

The FDIC has determined that real estate investment activities may

pose significant risks to the deposit insurance funds. For that reason,

the FDIC is proposing to establish standards that an insured state

nonmember bank must meet before engaging in real estate investment

activities that are not permissible for a national bank. Under a safety

and soundness standard, subpart B of the proposed regulation requires

insured state nonmember banks to meet the standards established by the

FDIC, even if the Comptroller of the Currency determines that those

activities are permissible for a national bank subsidiary. Subpart B

also would establish modern standards for insured state nonmember banks

to govern transactions between those insured state nonmember banks that

are not affiliated with a bank holding company (nonbank banks) and

affiliated organizations conducting securities activities. The existing

restrictions on these securities activities are found in Sec. 337.4 of

this chapter. The new rule will only cover those entities not covered

by orders issued by the Board of Governors of the Federal Reserve

System (FRB) governing the securities activities of those banks that

are affiliated with a bank holding company or a member bank.

Subpart B prohibits an insured state nonmember bank not affiliated

with a company that is treated as a bank holding company (see section

4(f) of the Bank Holding Company Act, 12 U.S.C. 1843(f)), from becoming

affiliated with a company that directly engages in the underwriting of

securities not permissible for a national bank unless the standards

established under the proposed regulation are met.

Subpart C of the proposed regulation concerns the activities and

investments of insured state savings associations. The provisions

applicable to activities of savings associations currently appearing in

Sec. 303.13 would be revised in a number of ways and placed in new

subpart C. To the extent possible, activities and investments of

insured state savings associations would be treated consistently with

the treatment provided insured state banks. Thus, we revised a number

of definitions currently contained in Sec. 303.13 to track the

definitions used in subpart A. We request comment on whether the

revisions made in subpart C contribute to the efficient operation of

savings associations and their service corporations while continuing to

implement the statutory requirements.

Subpart D of the proposal requires that an insured savings

association provide a 30 day notice to the FDIC whenever the

institution establishes or acquires a subsidiary or conducts a new

activity through a subsidiary. This provision does not alter the notice

required by statute. We moved this requirement to a new subpart to

accommodate Federally chartered savings associations by limiting the

amount of regulation text they would have to read to comply with this

statutory notice. Comment is invited on whether this separation avoids

confusion, enhances readability and simplifies compliance.

Subparts E and F of the proposal each contain the notice and

application requirements and the delegations of authority for the

substantive matters covered by the proposal for insured state banks and

state savings associations, respectively.

The FDIC requests comments about all aspects of the proposed

revision to part 362. In addition, the FDIC is raising specific

questions for public comment as set out in connection with the analysis

of the proposal below.

III. Section by Section Analysis

A. Subpart A--Activities of Insured State Banks

Section 362.1 Purpose and Scope

The purpose and scope of subpart A is to ensure that the activities

and investments undertaken by insured state banks and their

subsidiaries do not present a significant risk to the deposit insurance

funds, are not unsafe and are not unsound, are consistent with the

purposes of federal deposit insurance and are otherwise consistent with

law. This subpart implements the provisions of section 24 of the FDI

Act that restrict and prohibit insured state banks and their

subsidiaries from engaging in activities and investments of a type that

are not permissible for national banks and their subsidiaries. The

phrase ``activity permissible for a national bank'' means any activity

authorized for national banks under any statute including the National

Bank Act (12 U.S.C. 21 et seq.), as well as activities recognized as

permissible for a national bank in regulations, official circulars,

bulletins, orders or written interpretations issued by the OCC. This

subpart governs activities conducted ``as principal'' and therefore

does not govern activities conducted as agent for a customer, conducted

in a brokerage, custodial, advisory, or administrative capacity, or

conducted as trustee. We moved this language from Sec. 362.2(c) of the

current version of part 362 where the term ``as principal'' is defined

to mean acting other than as agent for a customer, acting as trustee,

or conducting an activity in a brokerage, custodial or advisory

capacity. The FDIC previously described this definition as not

covering, for example, acting as agent for the sale of insurance,

acting as agent for the sale of securities, acting as agent for the

sale of real estate, or acting as agent in arranging for travel

services. Likewise, providing safekeeping services, providing personal

financial planning services, and acting as trustee were described as

not being ``as principal'' activities within the meaning of this

definition. In contrast, real estate development, insurance

underwriting, issuing annuities, and securities underwriting would

constitute ``as principal'' activities. Further, for example, travel

agency activities have not been brought within the scope of part 362

and would not require prior consent from the FDIC even though a

national bank is not permitted to act as travel agent. This result

obtains from the fact that the state bank would not be acting ``as

principal'' in providing those services. Thus, the fact that a national

bank may not engage in travel agency activities would be of no

consequence. Of course, state banks would have to be authorized to

engage in travel agency activities under state law. We intend to

continue to interpret section 24 and part 362 as excluding any coverage

of activities being conducted as agent. To highlight this issue,

provide clarity and alert the reader of this rule that activities being

conducted as agent are not within the scope of section 24 and part 362,

we have moved this language to the purpose and scope paragraph. We

[[Page 47973]]

request comment on whether moving this language to the purpose and

scope paragraph assists users of this rule in interpreting its

parameters. We also invite comment on whether the ``as principal''

definition still would be necessary.

Equity investments acquired in connection with debts previously

contracted (DPC) that are held within the shorter of the time limits

prescribed by state or federal law are not subject to the limitations

of this subpart. The exclusion of equity investments acquired in

connection with DPC has been moved from the definition of ``Equity

investment'' to the purpose and scope paragraph to highlight this

issue, provide clarity and alert the reader of this rule that these

investments are not within the scope of section 24 and part 362.

However, the intent of the insured state bank in holding equity

investments acquired in connection with DPC continues to be relevant to

the analysis of whether the equity investment is permitted. Interests

taken as DPC are excluded from the scope of this regulation provided

that the interests are not held for investment purposes and are not

held longer than the shorter of any time limit on holding such

interests (1) set by applicable state law or regulation or (2) the

maximum time limit on holding such interests set by applicable statute

for a national bank. The result of the modification would be to make it

clear, for example, that real estate taken DPC may not be held for

longer than 10 years (see 12 U.S.C. 29) or any shorter period of time

set by the state. In the case of equity securities taken DPC, the bank

must divest the equity securities ``within a reasonable time'' (i.e, as

soon as possible consistent with obtaining a reasonable return) (see

OCC Interpretive Letter No. 395, August 24, 1987, (1988-89 Transfer

Binder) Fed Banking L. Rep. (CCH) p. 85,619, which interprets and

applies the National Bank Act) or no later than the time permitted

under state law if that time period is shorter.

In addition, any interest taken DPC may not be held for investment

purposes. For example, while a bank may be able to expend monies in

connection with DPC property and/or take other actions with regard to

that property, if those expenditures and actions are speculative in

nature or go beyond what is necessary and prudent in order for the bank

to recover on the loan, the property will not fall within the DPC

exclusion. The FDIC expects that bank management will document that DPC

property is being actively marketed and current appraisals or other

means of establishing fair market value may be used to support

management's decision not to dispose of property if offers to purchase

the property have been received and rejected by management.

Similarly to highlight this issue, provide clarity and alert the

reader of this rule, we have moved to the purpose and scope paragraph

the language governing any interest in real estate in which the real

property is (a) used or intended in good faith to be used within a

reasonable time by an insured state bank or its subsidiaries as offices

or related facilities for the conduct of its business or future

expansion of its business or (b) used as public welfare investments of

a type permissible for national banks. In the case of real property

held for use at some time in the future as premises, the holding of the

property must reflect a bona fide intent on the part of the bank to use

the property in the future as premises. We are not aware of any

statutory time frame that applies in the case of a national bank which

limits the holding of such property to a specific time period.

Therefore, the issue of the precise time frame under which future

premises may be held without implicating part 362 must be decided on a

case-by-case basis. If the holding period allowed for under state law

is longer than what the FDIC determines to be reasonable and consistent

with a bona fide intent to use the property for future premises, the

bank will be so informed and will be required to convert the property

to use, divest the property, or apply for consent to hold the property

through a majority-owned subsidiary of the bank. We note that the OCC's

regulations indicate that real property held for future premises should

``normally'' be converted to use within five years after which time it

will be considered other real estate owned and must be actively

marketed and divested in no later than ten years. (12 CFR 34). We

understand that the time periods set forth in the OCC's regulation

reflect safety and soundness determinations by that agency. As such,

and in keeping with what has been to date the FDIC's posture with

regard to safety and soundness determinations of the OCC, the FDIC will

substitute its own judgment to determine when a reasonable time has

elapsed for holding the property.

A subsidiary of an insured state bank may not engage in real estate

investment activities not permissible for a subsidiary of a national

bank unless the bank is in compliance with applicable capital standards

and the FDIC has determined that the activity poses no significant risk

to the deposit insurance fund. Subpart A provides standards for real

estate investment activities that are not permissible for a subsidiary

of a national bank. Because of safety and soundness concerns relating

to real estate investment activities, subpart B reflects special rules

for subsidiaries of insured state nonmember banks that engage in real

estate investment activities of a type that are not permissible for a

national bank but may be otherwise permissible for a subsidiary of a

national bank.

The FDIC intends to allow insured state banks and their

subsidiaries to undertake safe and sound activities and investments

that do not present a significant risk to the deposit insurance funds

and that are consistent with the purposes of federal deposit insurance

and other applicable law. This subpart does not authorize any insured

state bank to make investments or to conduct activities that are not

authorized or that are prohibited by either state or federal law.

Section 362.2 Definitions

Revised subpart A Sec. 362.2 contains--definitions. We have left

most of the definitions unchanged or edited them to enhance clarity or

readability without changing the meaning.

To standardize as many definitions as possible, we have

incorporated several definitions from section 3 of the FDI Act (12 U.S.

C. 1813). These definitions are ``Bank,'' ``State bank,'' ``Savings

association,'' ``State savings association,'' ``Depository

institution,'' ``Insured depository institution,'' ``Insured state

bank,'' ``Federal savings association,'' and ``Insured state nonmember

bank.'' This standardization required that we delete the definitions of

``depository institution'' and ``insured state bank''currently found in

part 362. No substantive change was intended by this change. The

definitions that were added by this change are ``Bank,'' ``State

bank,'' ``Savings association,'' ``State savings association,''

``Insured depository institution,'' ``Federal savings association,''

and ``Insured state nonmember bank.'' These definitions were added to

provide clarity throughout the proposed part 362 because we are

incorporating so many definitions from subpart A into subpart B

governing safety and soundness concerns of insured state nonmember

banks, subpart C governing the activities of state savings

associations, and subpart D governing subsidiaries of all savings

associations. We invite comment on whether readers view these

definitions as needing further changes to enhance clarity and

readability. We also invite comment on whether any of

[[Page 47974]]

the changes we have made may have changed the substance of the

regulation in ways that we may not have intended.

The definitions that have been left unchanged or edited to enhance

clarity or readability without changing the meaning are the following:

``Control,'' ``Extension of credit,'' ``Executive officer,''

``Director,'' ``Principal shareholder,'' ``Related interest,''

``National Securities exchange,'' ``Residents of state,''

``Subsidiary,'' and ``Tier one capital.'' We invite comment on whether

readers view these definitions as needing further changes to enhance

clarity and readability. We also invite comment on whether any of the

changes we have made may have changed the substance of the regulation

in ways that we may not have intended.

The name of one definition has been simplified without

substantively changing the meaning of the definition. That definition

is currently found in Sec. 362.2(g) and is described as follows ``An

insured state bank will be considered to convert its charter.'' We

moved this definition to Sec. 362.2(e) and call this definition,

``Convert its charter.'' The substance of the definition is intended to

remain unchanged by this revised language. We invite comment on whether

readers view the change in this definition as needing any further

changes to enhance clarity and readability. We also invite comment on

whether any of the changes we have made to this definition may have

changed the substance of the regulation in ways that we may not have

intended.

Although most of the definitions as set out in the proposal are the

same or virtually unchanged, a few of the definitions in the proposal

have been substantively revised. The proposed changes to these

definitions are discussed below.

We deleted the definitions of ``Activity permissible for a national

bank,'' ``An activity is considered to be conducted as principal,'' and

``Equity investment permissible for a national bank.'' We moved the

substance of the information that was contained in these definitions

into the scope paragraph in Sec. 362.1. We thought that including the

information that was in these definitions in the scope paragraph made

the coverage of the rule clearer to the reader and was consistent with

the purpose of the scope paragraph. We expect that some readers may

save time by realizing sooner that the regulation may be inapplicable

to conduct contemplated by a particular bank. We also thought that the

reader might be more likely to consider the scope paragraph than to

consider the definition section when reading the rule to determine its

applicability. We concluded that it would be unnecessary to duplicate

this same information in the definition section. We invite comment on

whether readers prefer to see these concepts in the scope paragraph and

whether readers also would prefer to see these concepts defined.

We deleted the definition of ``Equity interest in real estate'' and

moved the recitation of the permissibility of owning real estate for

bank premises and future premises, owning real estate for public

welfare investments and owning real estate from DPC to the scope

paragraph for the reasons stated in the preceding paragraph. These

activities are permissible for national banks and we thought that it

was unnecessary to continue to restate this information in the

definition section of the regulation. No substantive change is intended

by this simplification of the language. In addition, we determined that

the remainder of the definition of ``Equity interest in real estate''

did little to enhance clarity or understanding; therefore, we are

relying on the language defining ``Equity investment'' to cover real

estate investments. We conformed the definition of ``Equity

investment'' by deleting the reference to the deleted definition of

``Equity interest in real estate.'' No substantive change is intended

by shortening this language. We invite comment on whether the readers

view the definition of ``Equity interest in real estate'' as necessary

to enhance clarity and readability on these issues as well as whether

readers prefer seeing these concepts in the scope paragraph.

The remainder of the definition of ``Equity investment'' has been

shortened and edited to enhance readability. We intend no substantive

change by shortening this language. This concept is intended to

encompass an investment in an equity security or real estate as it does

in the current definition. We invite comment on the changes to this

definition and whether any further changes are needed.

With regard to the definition of ``Equity security,'' we modified

this definition by deleting the references to permissible national bank

holdings such as equity securities being held as a result of a

foreclosure or other arrangements concerning debt previously

contracted. Language discussing the exclusion of DPC and other

investments that are permissible for national banks has been relocated

to the scope paragraph for the reasons stated above. Thus, the equity

investment definitions no longer include these references. We intend no

substantive change through the deletion of this redundant language. We

invite comment on whether any ambiguity or unintended change in the

meaning may be created by removing this language from the definition.

We added a shorter definition of ``Real estate investment

activity'' meaning any interest in real estate held directly or

indirectly that is not permissible for a national bank. This term is

used in Sec. 362.4(b)(5) of subpart A and in Sec. 362.7 of subpart B

which contains safety and soundness restrictions on real estate

activities of subsidiaries of insured state nonmember banks that may be

deemed to be permissible for operating subsidiaries of national banks

that would not be permissible for a national bank, itself. We invite

comment on this definition, including its meaning and clarity as well

as the underlying safety and soundness proposal in subpart B. We

specifically invite comment on the exclusion of real estate leasing

from the definition of real estate investment activity. The proposal

has eliminated real estate leasing from the definition of real estate

investment activity in order to assure that banks using the notice

procedure are not getting involved in a commercial business. The notice

procedures are designed for institutions that wish to hold parcels of

real estate for ultimate sale. If an institution wishes to hold the

property to lease it for ongoing business purposes, we believe the

proposal should be considered under the application process.

We deleted the definitions of ``Investment in department'' and

``Department'' because we thought they were no longer needed in the

revised regulation text. The core standards applicable to a department

of a bank are set out in detail in Sec. 362.3(c) and defining the term

``Department'' no longer seems to be necessary. Regarding the

definition of ``Investment in department,'' we also considered this

definition unnecessary. We believe that if a calculation of

``Investment in department'' needs to be made, we will defer to state

law on this issue. We invite comment on whether the readers view these

definitions as necessary to enhance clarity and readability on these

issues. We also request comment on whether deference to state law on

this investment issue would cause any unintended consequences that we

have not foreseen.

Similarly, we deleted the definition of ``Investment in

subsidiary'' because the definition is no longer needed in the revised

regulation text. The core standards applicable to an insured state bank

and its subsidiary make a

[[Page 47975]]

definition of ``Investment in subsidiary'' superfluous. The core

standards contained in Sec. 362.4(c) set out the requirements in

detail. Therefore, defining the term ``Investment in subsidiary'' no

longer seems to be necessary. We invite comment on whether the readers

view this definition or a similar definition as necessary to enhance

clarity and readability on these issues.

We deleted the definition of ``bona fide subsidiary'' and chose to

make similar characteristics part of the eligible subsidiary criteria

in Sec. 362.4(c)(2). We thought that including these criteria as a part

of the substantive regulation text in that subsection, rather than as a

definition, makes reading the rule easier and the meaning clearer. We

invite comment on whether readers prefer to see this concept set forth

in the substantive section of the rule or the definition section and

whether readers believe any additional definition is necessary to

enhance clarity and readability.

The proposal substitutes the current definition of ``Lower income''

with a cross reference in Sec. 362.3(a)(2)(ii) to the definition of

``low income'' and ``moderate income'' as used for purposes of part 345

of the FDIC's regulations (12 CFR 345) which implements the Community

Reinvestment Act (CRA). 12 U.S.C. 2901, et seq. Under part 345, ``low

income'' means an individual income that is less than 50 percent of the

area median income or a median family income that is less than 50

percent in the case of a census tract or a block numbering area

delineated by the United States Census in the most recent decennial

census. ``Moderate income'' means an individual income that is at least

50 percent but less than 80 percent of the area median or a median

family income that is at least 50 but less than 80 percent in the case

of a census tract or block numbering area.

The definition ``Lower income'' is relevant for purposes of

applying the exception in the regulation which allows an insured state

bank to be a partner in a limited partnership whose sole purpose is

direct or indirect investment in the acquisition, rehabilitation, or

new construction of qualified housing projects (housing for lower

income persons). As we anticipate that insured state banks would seek

to use such investments in meeting their community reinvestment

obligations, the FDIC is of the opinion that conforming the definition

of lower income to that used for CRA purposes will benefit banks. We

note that the change will have the effect of expanding the housing

projects that qualify for the exception. We invite comment on this

change.

We have simplified the definition of the term ``Activity.'' As

modified the definition includes all investments. Where equity

investments are intended to be excluded, we expressly exclude those

investments in the regulation text. We invite comment on whether the

modification to the definition enhances clarity or whether the longer

definition found in the current regulation should be reinstated. In

particular, we invite comment on whether the definition should be

modified to take into account in some fashion a recent interpretation

by the agency under which it was determined that the act of making a

political campaign contribution does not constitute an ``activity'' for

purposes of part 362. The interpretation uses a three prong test to

help determine whether particular conduct should be considered an

activity and therefore subject to review under part 362 if the conduct

is not permissible for a national bank. If at least two of the tests

yield a conclusion that the conduct is part of the authorized conduct

of business by the bank, the better conclusion is that the conduct is

an activity. First, any conduct that is an integral part of the

business of banking as well as any conduct which is closely related or

incidental to banking should be considered an activity . In applying

this test it is important to focus on what banks do that makes them

different from other types of businesses. For example, lending money is

clearly an ``activity'' for purposes of part 362. The second test asks

whether the conduct is merely a corporate function as opposed to a

banking function. For example, paying dividends to shareholders is

primarily a general corporate function and not one associated with

banking because of some unique characteristic of banking as a business.

Generally, activities that are not general corporate functions will

involve interaction between the bank and its customers rather than its

employees or shareholders. The third test asks whether the conduct

involves an attempt by the bank to generate a profit. For example,

banks make loans and accept deposits in an effort to make money.

However, contracting with another company to generate monthly customer

statements should not be considered to be an activity unto itself as it

simply is entered into in support of the ``activity'' of taking

deposits. We also invite any other comments that would make this

definition easier to understand and apply.

The proposal modifies the definition of ``Company'' to add limited

liability companies to the list of entities that will be considered a

company. This change in the definition is being proposed in recognition

of the creation of limited liability companies and their growing

prevalence in the market place. We invite comment on whether this

addition to the list of forms of business enterprise is appropriate and

whether we should add any more forms of business enterprise.

The FDIC has changed the definition of ``Significant risk to the

fund'' by adding the second sentence that clarifies that this

definition includes the risk that may be present either when an

activity or an equity investment contributes or may contribute to the

decline in condition of a particular state-chartered depository

institution or when a type of activity or equity investment is found by

the FDIC to contribute or potentially contribute to the deterioration

of the overall condition of the banking system. We invite comment on

whether the definition should be modified in some other manner and if

so how. Our interpretation of the definition remains unchanged.

Significant risk to the deposit insurance fund shall be understood to

be present whenever there is a high probability that any insurance fund

administered by the FDIC may suffer a loss. The preamble accompanying

the adoption of this definition in final indicated that the FDIC

recognized that no investment or activity may be said to be without

risk under all circumstances and that such fact alone will not cause

the agency to determine that a particular activity or investment poses

a significant risk of loss to the fund. The emphasis rather is on

whether there is a high degree of likelihood under all of the

circumstances that an investment or activity by a particular bank, or

by banks in general or in a given market or region, may ultimately

produce a loss to either of the funds. The relative or absolute size of

the loss that is projected in comparison to the fund will not be

determinative of the issue. The preamble indicated that the definition

is consistent with and derived from the legislative history of section

24 of the FDI Act. Previously, the FDIC rejected the suggestion that

risk to the fund only be found if a particular activity or investment

is expected to result in the imminent failure of a bank. The suggestion

was rejected as the FDIC determined at that time that it was

appropriate to approach the issue conservatively. We think that this

conservatism is more clearly articulated in this modification to the

definition. We invite comments on whether this

[[Page 47976]]

additional language is necessary and whether any other language should

be added.

We re-defined the term ``Well-capitalized'' to incorporate the same

meaning set forth in part 325 of this chapter for an insured state

nonmember bank. For other state-chartered depository institutions, the

term ``well-capitalized'' has the same meaning as set forth in the

capital regulations adopted by the appropriate Federal banking agency.

We decided that it would simplify the calculations for the various

state-chartered depository institutions if the capital definition

imported the definitions used by those institutions when they deal with

their appropriate Federal banking agency. We deleted the other terms

defined under Sec. 362.2(x) as unnecessary due to the changes in the

regulation text. We invite comment on whether we have missed an item

that still needs to be included in this definition.

We added definitions of the following terms: ``Change in control,''

``Institution,'' ``Majority-owned subsidiary,'' ``Security'' and

``State-chartered depository institution.''

Under section 24 of the FDI Act, the grandfather with respect to

common or preferred stock listed on a national securities exchange and

shares of registered investment companies ceases to apply if the bank

undergoes a change in control. The phrase ``Change in control'' is

defined for the purposes of part 362 in what is currently

Sec. 362.3(b)(4)(ii) of the regulation. Under the proposal, the

definition is relocated into the definitions section and modified.

Under the current regulation a ``Change in control'' that will

result in the loss of the grandfather is defined to mean a transaction

in which the bank converts its charter, undergoes a transaction which

requires a notice to be filed under section 7(j) of the FDI Act (12

U.S.C. 1817(j)) except a transaction which is presumed to be a change

in control for the purposes of that section under FDIC's regulations

implementing section 7(j), any transaction subject to section 3 of the

Bank Holding Company Act ( 12 U.S.C. 1842) other than a one bank

holding company formation, a transaction in which the bank is acquired

by or merged into a bank that is not eligible for the grandfather, or a

transaction in which control of the bank's parent company changes. The

proposal would narrow the definition of ``Change in control'' by

defining the phrase to only encompass transactions subject to section

7(j) of the FDI Act (except for transactions which trigger the

presumptions under FDIC's regulations implementing section 7(j) or the

FRB's regulations implementing section 7(j)) and transactions in which

the bank is acquired by or merged into a bank that is not eligible for

the grandfather. This definition change will narrow the instances in

which a bank may lose its grandfathered ability to invest in common or

preferred stock listed on a national securities exchange and shares of

registered investment companies. It is our belief that the revised

definition, if adopted, will more closely approximate when a true

change in control has occurred.

We added a definition of ``Institution'' and defined it to mean the

same as a ``state-chartered depository institution'' to shorten the

drafting of the rule, particularly for those items that are applicable

to both insured state banks and insured state savings associations.

This definition is intended to enhance readability. We invite comment

on whether this definition creates any confusion or ambiguity.

We added a definition of ``Majority-owned subsidiary'' and defined

it to mean any corporation in which the parent insured state bank owns

a majority of the outstanding voting stock. We added this definition to

clarify our intention that the expedited notice procedures only be

available when an insured state bank interposes an entity that gives

limited liability to the parent institution. We interpret Congress's

intention in imposing the majority-owned subsidiary requirement in

section 24 of the FDI Act to generally require that such a subsidiary

provide limited liability to the insured state bank. Thus, except in

unusual circumstances, we have and will require majority-owned

subsidiaries to adopt a form of business that provides limited

liability to the parent bank. In assessing our experience with

applications, we have determined that the notice procedure will be

available only to banks that engage in activities through a majority-

owned subsidiary that takes the corporate form of business. We welcome

applications that may take a different form of business such as a

limited partnership or limited liability company, but would like to

develop more experience with appropriate separations to protect the

bank from liability under these other forms of business enterprise

through the application process before including these entities in a

notice procedure. We have decided that there may have been an ambiguity

in the notice provisions we proposed for comment and published August

23, 1996, in the Federal Register at 61 FR 43486. We intended that an

entity eligible for the notice procedure be in corporate form and

implied that requirement by incorporating the bona fide subsidiary

requirements that included references to a board of directors. The

addition of this definition should make our intention clear that the

notice procedure requires a majority-owned subsidiary to take the

corporate form. We invite comment on this definition, our substantive

decision to require the corporate form for a majority-owned subsidiary

of an insured state bank using the notice procedures, and our decision

to exclude other limited liability business forms from the notice

procedure. We also invite comment on any ambiguities or questions that

this definition may create.

We adopted the definition of ``Security'' from part 344 of this

chapter to eliminate any ambiguity over the coverage of this rule when

securities activities and investments are contemplated. We invite

comment on any ambiguities or questions that this definition may

create.

We defined ``State-chartered depository institution'' to mean any

state bank or state savings association insured by the FDIC to

eliminate confusion and ambiguity. We invite comment on any ambiguities

or questions that this definition may create.

We invite any general comment on the proposed definitions and

invite any suggestions for additional definitions that would be helpful

to the reader of the regulatory text.

Section 362.3 Activities of Insured State Banks

Equity Investment Prohibition

Section 362.3(a) of the proposal restates the statutory prohibition

on insured state banks making or retaining any equity investment of a

type that is not permissible for a national bank. The prohibition does

not apply if one of the statutory exceptions contained in section 24 of

the FDI Act (restated in the current regulation and carried forward in

the proposal) applies. The provision is being retained. The proposal

eliminates the reference to amount that is contained in the current

version of Sec. 362.3(a). We have reconsidered our interpretation of

the language of section 24 where paragraph (c) prohibits an insured

state bank from acquiring or retaining any equity investment of a type

that is impermissible for a national bank and paragraph (f) prohibits

an insured state bank from acquiring or retaining any equity investment

of a type or in an amount that is impermissible for a national bank. We

[[Page 47977]]

previously interpreted the language of paragraph (f) as controlling and

read that language into the entire statute. We reconsidered this

approach, decided that it was not the most reasonable construction of

this statute and determined that the language of paragraph (c) is

controlling. Thus, the language of paragraph (c) controls when any

other equity investment is being considered. Therefore, we deleted the

amount language from prohibition in the regulation. We request comment

on this change.

Exception for Majority-Owned Subsidiary

The FDIC proposes to retain the exception which allows investment

in majority-owned subsidiaries as currently in effect without any

substantive change. However, the FDIC has modified the language of this

section to remove negative inferences and make the text clearer. Rather

than stating that the bank may do what is not prohibited, the FDIC is

affirmatively stating that an insured state chartered bank may acquire

or retain investments through a majority-owned subsidiary. If an

insured state bank holds less than a majority interest in the

subsidiary, and that equity investment is of a type that would be

prohibited to a national bank, the exception does not apply and the

investment is subject to divestiture.

Majority ownership for the exception is understood to mean

ownership of greater than 50 percent of the outstanding voting stock of

the subsidiary. It is our understanding that national banks may own a

minority interest in certain types of subsidiaries. (See 12 CFR

5.34(1997)). Therefore, an insured state bank may hold a minority

interest in a subsidiary if a national bank could do so. Thus, the

statute does not necessarily require a state bank to hold at least a

majority of the stock of a company in order for the equity investment

in the company to be permissible under the regulation. Only investments

that would not be permissible for a national bank must be held through

a majority-owned subsidiary.

The regulation defines the business form of a majority-owned

subsidiary to be a corporation. There may be other forms of business

organization that are suitable for the purposes of this exception such

as partnerships or limited liability companies. The FDIC does not wish

to give blanket authorization to a non-corporate form of organization

since these forms may not provide for the same separations the FDIC

believes to be necessary to protect the insured bank from assuming the

liabilities of its subsidiary. The proposal anticipates that the Board

will review alternate forms of organization to assure that appropriate

separation between the insured depository institution and the

subsidiary is in place. We are soliciting comment on other forms of

business organization which the FDIC may allow. Please provide a

discussion of the separations inherent in alternate forms of business

organization.

To qualify for this exception, the majority-owned subsidiary must

engage in activities that are described in Sec. 362.4(b). The allowable

activities include both statutory and regulatory exceptions to the

general prohibitions of the regulation.

Investments in Qualified Housing Projects

The FDIC proposes to combine the language found in two paragraphs

of the current regulation. The FDIC proposes to retain the combined

paragraphs of the regulation with substantially the same language as

currently in effect. The changes that have been made reflect practical

clarifications resulting from the implications of the technical way the

qualified housing rules work and are not intended to be substantive. In

addition, the FDIC has modified the language of the text to remove

negative inferences and make the text clearer. Section 362.3(a)(2)(ii)

of the proposal provides an exception for qualified housing projects.

Under the exception, an insured state bank is not prohibited from

investing as a limited partner in a partnership, the sole purpose of

which is direct or indirect investment in the acquisition,

rehabilitation, or new construction of a residential housing project

intended to primarily benefit lower income persons throughout the

period of the bank's investment. The bank's investments, when

aggregated with any existing investment in such a partnership or

partnerships, may not exceed 2 percent of the bank's total assets. The

FDIC expects that banks use the figure reported on the bank's most

recent consolidated report of condition prior to making the investment

as the measure of their total assets. If an investment in a qualified

housing project does not exceed the limit at the time the investment

was made, the investment shall be considered to be a legal investment

even if the bank's total assets subsequently decline.

The current exception is limited to instances in which the bank

invests as a limited partner in a partnership. Comment is invited on

(1) whether the FDIC should expand the exception to include limited

liability companies and (2) whether doing so is permissible under the

statute. (Section 24(c)(3) of the FDI Act provides that a state bank

may invest ``as a limited partner in a partnership.'')

Grandfathered Investments in Listed Common or Preferred Stock and

Shares of Registered Investment Companies

The current regulation restates the statutory exception for

investments in common or preferred stock listed on a national

securities exchange and for shares of investment companies registered

under the Investment Company Act of 1940 that is available to certain

state banks if they meet the requirements to be eligible for the

grandfather. The statute requires, among other things, that a state

bank file a notice with the FDIC before relying on the exception and

that the FDIC approve the notice. The notice requirement, content of

notice, presumptions with respect to the notice, and the maximum

permissible investment under the grandfather also are set out in the

current regulation. The FDIC proposes to retain the regulatory language

as currently in effect without any substantive change. The exception is

found in Sec. 362.3(a)(2)(iii) of the proposal. Although there would be

no substantive change, the FDIC has modified the language of this

section to remove negative inferences and make the text clearer.

We deleted the reference in the current regulation describing the

notice content and procedure because we believe that most, if not all,

of the banks eligible for the grandfather already have filed notices

with the FDIC. Thus, we shortened the regulation by eliminating

language governing the specific content and processing of the notices.

Investment in common or preferred stock listed on a national securities

exchange or shares of an investment company is governed by the language

of the statute. Notices must conform to the statutory requirements

whether filed previously or filed in the future. Any bank that has

filed a notice need not file again. Comment is invited on whether the

regulatory filing requirements should be retained and eventually moved

into part 303 of this chapter.

Section 362.3(a)(2)(iii)(A) of the proposal implements the

grandfathered listed stock and registered shares provision found in

section 24(f)(2) of the FDI Act. Paragraph (B) of this section of the

proposal provides that the exception for listed stock and registered

shares ceases to apply in the event that the bank converts its charter

or the bank or its parent holding company undergoes a change in

control. This language restates the statutory language governing when

[[Page 47978]]

grandfather rights terminate. State banks should continue to be aware

that, depending upon the circumstances, the exception may be considered

lost after a merger transaction in which an eligible bank is the

survivor. For example, if a state bank that is not eligible for the

exception is merged into a much smaller state bank that is eligible for

the exception, the FDIC may determine that in substance the eligible

bank has been acquired by a bank that is not eligible for the

exception.

The regulation continues to provide that in the event an eligible

bank undergoes any transaction that results in the loss of the

exception, the bank is not prohibited from retaining its existing

investments unless the FDIC determines that retaining the investments

will adversely affect the bank and the FDIC orders the bank to divest

the stock and/or shares. This provision has been retained in the

regulation without any change except for the deletion of the citation

to specific authorities the FDIC may rely on to order divestiture.

Rather than containing specific citations, the proposal merely

references FDIC's ability to order divestiture under any applicable

authority. State banks should continue to be aware that any inaction by

the FDIC would not preclude a bank's appropriate banking agency (when

that agency is an agency other than the FDIC) from taking steps to

require divestiture of the stock and/or shares if in that agency's

judgment divestiture is warranted.

Finally, the FDIC has moved, simplified and shortened the limit on

the maximum permissible investment in listed stock and registered

shares. The proposal limits the investment in grandfathered listed

stock and registered shares to a maximum of one hundred percent (100

percent) of tier one capital as measured on the bank's most recent

consolidated report of condition. The FDIC continues to use book value

as the measure of compliance with this limitation. Language indicating

that investments by well-capitalized banks in amounts up to 100 percent

of tier one capital will be presumed not to present a significant risk

to the fund is being deleted as is language indicating that it will be

presumed to present a significant risk to the fund for an

undercapitalized bank to invest in amounts that high. In addition, we

deleted the language stating the presumption that, absent some

mitigating factor, it will not be presumed to present a significant

risk for an adequately capitalized bank to invest up to 100 percent of

tier one capital. At this time we believe that it is not necessary to

expressly state these presumptions in the regulation.

Language in the current regulation concerning the divestiture of

stock and/or shares in excess of that permitted by the FDIC (as well as

such investments in excess of 100 percent of the bank's tier one

capital) is deleted under the proposal as no longer necessary due to

the passage of time. In both instances the time allowed for such

divestiture has passed.

Comment is invited on whether this grandfather exception for

investment in listed stock and registered shares should be applied by

the FDIC as an exception that is separate and distinct from any other

exception under the regulation that would allow a subsidiary of an

insured state bank to hold equity securities. In short, should we allow

this exception in addition to the exception for stock discussed below

or should the FDIC consider any listed stock held by a subsidiary of

the bank pursuant to an exception in the regulation toward the 100

percent of tier one capital limit under this exception? We note that

the statute does not itself impose any conditions or restrictions on a

bank that enjoys the grandfather in terms of per issuer limits. Comment

is sought on whether it is appropriate to impose restrictions under the

regulation that would, for example, limit a bank to investing in less

than a controlling interest in any given issuer. Is there some other

limit or restriction the FDIC should consider imposing by regulation

that is important to ensuring that the grandfathered investments do not

pose a risk? Should this be done, if at all, solely through the notice

and approval process?

Stock Investment in Insured Depository Institutions Owned Exclusively

by Other Banks and Savings Associations

The content of the proposed regulation reflects the statutory

exception that an insured state bank is not prohibited from acquiring

or retaining the shares of depository institutions that engage only in

activities permissible for national banks, are subject to examination

and are regulated by a state bank supervisor, and are owned by 20 or

more depository institutions not one of which owns more than 15 percent

of the voting shares. In addition, the voting shares must be held only

by depository institutions (other than directors' qualifying shares or

shares held under or acquired through a plan established for the

benefit of the officers and employees). Section 24(f)(3)(B) of the FDI

Act does not limit the exception to voting stock. We are not proposing

to eliminate the reference to ``voting'' in the current regulation when

referencing control of the insured depository institution. Any other

reference to voting stock has been eliminated in the exception to allow

holding of non-voting stock. The FDIC seeks comment concerning

retaining the reference to ``voting'' stock when calculating the 15

percent ownership limitation contained in the statute.

Stock Investments in Insurance Companies

Section 362.3(b)(2)(v) of the proposal contains exceptions that

permit state banks to hold equity investments in insurance companies.

The exceptions are provided by statute and implemented in the current

version of part 362. For the most part, we brought the exceptions

forward into this proposal with no substantive editing. The exceptions

are discussed separately below.

Directors and Officers Liability Insurance Corporations

The first statutory exception permits insured state banks to own

stock in corporations that solely underwrite or reinsure financial

institution directors' and officers' liability insurance or blanket

bond group insurance. A bank's investment in any one corporation is

limited to 10 percent of the outstanding stock. We eliminated the

present limitation of 10 percent of the ``voting'' stock and changed

the present reference from ``company'' to ``corporation,'' conforming

the language to the statutory exception.

While the statute and regulation provide a limit on a bank's

investment in the stock of any one insurance company, there is no

statutory or regulatory ``aggregate'' investment limit in all insurance

companies nor does the statute combine this equity investment with any

other exception under which a state bank may invest in equity

securities. In the past, the FDIC has addressed investment

concentration and diversification issues on a case-by-case basis. The

FDIC is not at this time proposing to impose aggregate investment

limits on equity investments which have specific statutory carve outs

nor are we proposing to combine those investments with other equity

investments made under the exceptions to the regulation for which

aggregate investments are being proposed. The FDIC would like to

receive comment, however, on whether there should be an ``aggregate''

investment limit for equity investments in insurance companies.

[[Page 47979]]

Stock of Savings Bank Life Insurance Company

The second statutory exception for equity investments in insurance

companies permits any insured state bank located in the states of New

York, Massachusetts and Connecticut to own stock in savings bank life

insurance companies provided that consumer disclosures are made. Again,

this regulatory provision mirrors the specific statutory carve out

found in Section 24 and is contained in the present regulation. We have

carried this provision forward into the proposal with some changes.

The savings bank life insurance investment exception is broader

than the director and officer liability insurance company exception

discussed above. There are no individual or aggregate investment

limitations for investments in savings bank life insurance companies.

The proposed language is shorter than the existing regulation and makes

a substantive change by clarifying what the required disclosures are

for insured banks selling these products. As was indicated above,

insured banks located in New York, Massachusetts and Connecticut are

permitted to invest in the stock of a savings bank life insurance

company as long as certain disclosure requirements are met. The FDIC

proposes to amend the regulatory language to specifically require

compliance with the Interagency Statement in lieu of the disclosures

presently set out in the regulation. Insured banks selling savings bank

life insurance policies, other insurance products and annuities will be

required to provide customers with written disclosures that are

consistent with the Interagency Statement which include a statement

that the products are not insured by the FDIC, are not guaranteed by

the bank, and may involve risk of loss. The last disclosure--that such

products may involve risk of loss--is not currently required under the

regulation.

The FDIC would like to request comment regarding the disclosure

obligations of insured banks. It is the FDIC's view that savings bank

life insurance, other insurance products and annuities are ``nondeposit

investment products'' as that term is used in the Interagency

Statement. The FDIC is aware that insurance companies typically offer

annuity products and that many states regulate annuities through their

insurance departments. However, the FDIC agrees with the Comptroller of

the Currency that annuities are financial products and not insurance.

Nevertheless, annuities are nondeposit investment products and are

therefore subject to the requirements found in the Interagency

Statement when sold to retail customers on bank premises as well as in

other instances. On this basis, all the requirements in the Interagency

Statement should apply to the marketing and sale of annuities by a

financial institution.

While the existing regulatory language is similar to the

Interagency Statement in what it requires to be disclosed, it is not

identical. The FDIC believes the proposed changes will clarify the

standards which are to be followed by insured state banks.

It could be argued that the regulatory language in this part

repeats existing guidance and is unnecessary. We note, however, that

the statute requires that disclosures be made in order for the

exception to be available. While the Interagency Statement is

enforceable in the sense that noncompliance may constitute an unsafe or

unsound banking practice that may give rise to a cease and desist

action, the Interagency Statement is not itself a regulation with the

force and effect of law.

We seek comments on whether it would be preferable for the

regulation to fully set out the disclosure requirements rather than

cross referencing the Interagency Statement. Commenters should address

these points, as well as discuss the differences between enforcing

specific regulatory language versus enforcing a policy statement. We

invite comments on the applicability of the Interagency Statement in

the absence of the language referencing it in this regulation. We

invite comment on whether using the Interagency Statement makes

compliance easier for banks as it provides uniform standards applicable

to multiple products. We also invite comment on any other issues that

are of concern to the industry or the public in using these particular

disclosures when selling insurance and annuity products.

Other Activities Prohibition

Section 362.3(b) of the proposal restates the statutory prohibition

on insured state banks directly or indirectly engaging as principal in

any activity that is not permissible for a national bank. Activity is

defined in this proposal as the conduct of business by a state-

chartered depository institution, including acquiring or retaining any

investment. Because acquiring or retaining an investment is an activity

by definition, language has been added to make clear that this

prohibition does not supersede the equity investment exception of

Sec. 362.3(b). The prohibition does not apply if one of the statutory

exceptions contained in section 24 of the FDI Act (restated in the

current regulation and carried forward in the proposal) applies. The

FDIC has provided two regulatory exceptions to the prohibition on other

activities.

Consent Through Application

The limitation on activities contained in the statute states that

an insured state bank may not engage as principal in any type of

activity that is not permissible for a national bank unless the FDIC

has determined that the activity would pose no significant risk to the

appropriate deposit insurance fund, and the bank is and continues to be

in compliance with applicable capital standards prescribed by the

appropriate federal banking agency. Section 362.3(b)(2)(i) establishes

an application process for the FDIC to make the determination

concerning risk to the funds. The substance of this process is

unchanged from the current regulation.

Insurance Underwriting

This exception tracks the statutory exception in section 24 of the

FDI Act which grandfathers (1) an insured state bank engaged in the

underwriting of savings bank life insurance through a department of the

bank; (2) any insured state bank that engaged in underwriting of

insurance on or before September 30, 1991, which was reinsured in whole

or in part by the Federal Crop Insurance Corporation; and (3) well-

capitalized banks engaged in insurance underwriting through a

department of a bank. The exception is carried over from the current

regulation with a number of proposed modifications.

To use the savings bank life insurance exception, an insured state

bank located in Massachusetts, New York or Connecticut must engage in

the activity through a department of the bank that meets core standards

discussed below. The standards for conducting this activity are taken

from the current regulation with the exception of disclosure standards

which are discussed below. We have moved the requirements for a

department from the definitions to the substantive portion of the

regulation text.

The exception for underwriting federal crop insurance reflects the

statutory exception. This exception is unchanged from the current

regulation, and there are no regulatory limitations on the conduct of

the activity.

An insured state bank that wishes to use the grandfathered

insurance underwriting exception may do so only if the insured state

bank was lawfully providing insurance, as principal, as of November 21,

1991. Further, an insured

[[Page 47980]]

state bank must be well-capitalized if it is to engage in insurance

underwriting, and the bank must conduct the insurance underwriting in a

department that meets the core standards described below.

Banks taking advantage of this grandfather provision only may

underwrite the same type of insurance that was underwritten as of

November 21, 1991 and only may operate and have customers in the same

states in which it was underwriting policies on November 21, 1991. The

grandfather authority for this activity does not terminate upon a

change in control of the bank or its parent holding company.

Both savings bank life insurance activities and grandfathered

insurance underwriting must take place in a department of the bank

which meets certain core standards. The core operating standards for

the department require the department to provide customers with written

disclosures that are consistent with those in the Interagency

Statement. Consistent with the disclosure requirements of the current

regulation, the proposed rule requires the department to inform its

customers that only the assets of the department may be used to satisfy

the obligations of the department. Note that this language does not

require the bank to say that the bank is not obligated for the

obligations of the department. The bank and the department constitute

one corporate entity. In the event of insolvency, the insurance

underwriting department's assets and liabilities would be segregated

from the bank's assets and liabilities due to the requirements of state

law.

The FDIC views any financial product that is not a deposit and

entails some investment component to be a ``nondeposit investment

product'' subject to the Interagency Statement. Part 362 was

promulgated in 1992 before the Interagency Statement was issued in

February of 1994. While the disclosures currently required by part 362

are similar to the disclosures set out in the Interagency Statement,

they are not identical. Banks that engage in insurance underwriting are

thus covered by the Interagency Statement and part 362 and must comply

with similar but somewhat different requirements. We are proposing to

cross reference the Interagency Statement in part 362 to make

compliance clearer. We believe that using the uniform standards set

forth in the Interagency Statement will make compliance easier.

In the case of insurance underwriting activities conducted by a

department of the bank, the disclosure required by the Interagency

Statement that the product is not an obligation of the bank is not

correct as noted above, and the suggested language in the regulation

does not require this disclosure. This clarification is consistent with

other interpretations of the Interagency Statement which stated that

disclosures should be consistent with the types of products offered.

The FDIC would like to receive comment on whether such clarification is

necessary or whether the regulation language is seen as duplicating

other guidance.

The FDIC notes that the consumer disclosures are statutorily

required for savings bank life insurance. The Interagency Statement is

joint supervisory guidance issued by the Federal Banking Agencies, not

a regulation. The FDIC requests comment regarding the enforceability of

the Interagency Statement versus a regulation promulgated under the

rulemaking requirements of the Administrative Procedures Act.

The core separation standards restate the requirements currently

found in the definition of department. These standards require that the

department (1) be physically distinct from the remainder of the bank,

(2) maintain separate accounting and other records, (3) have assets,

liabilities, obligations and expenses that are separate and distinct

from those of the remainder of the bank; and (4) be subject to state

statutes that require the obligations, liabilities and expenses be

satisfied only with the assets of the department. The standards in the

proposed regulation are not changed from the current regulation, but

have been moved from the definitions section of the regulation to

ensure that requirements of the rule are shown in connection with the

appropriate regulatory exception.

Acquiring and Retaining Adjustable Rate and Money Market Preferred

Stock by the Bank

The proposal provides an exception that allows a state bank to

invest in up to 15 percent of the bank's tier one capital in adjustable

rate preferred stock and money market (auction rate) preferred stock

without filing an application with the FDIC. The exception was adopted

when the 1992 version of the regulation was adopted in final form. At

that time after reviewing comments, the FDIC found that adjustable rate

preferred stock and money market (auction rate) preferred stock were

essentially substitutes for money market investments such as commercial

paper and that their characteristics are closer to debt than to equity

securities. Therefore, money market preferred stock and adjustable rate

preferred stock were excluded from the definition of equity security.

As a result, these investments are not subject to the equity investment

prohibitions of the statute and of the regulation and are considered to

be an ``other activity'' for the purposes of this regulation.

This exception focuses on two categories of preferred stock. This

first category, adjustable rate preferred stock refers to shares where

dividends are established by contract through the use of a formula

based on Treasury rates or some other readily available interest rate

levels. Money market preferred stock refers to those issues where

dividends are established through a periodic auction process that

establishes yields in relation to short term rates paid on commercial

paper issued by the same or a similar company. The credit quality of

the issuer determines the value of the security, and money market

preferred shares are sold at auction.

We have modified the exception under the proposal by limiting the

15 percent measurement to tier one capital, rather than total capital.

Throughout the current proposal, we have measured capital-based

limitations against tier one capital. We changed the base in this

provision to increase uniformity within the regulation. We recognize

that this change may lower the permitted amount of these investments

held by institutions already engaged in the activity. An insured state

bank that has investments exceeding the proposed limit, but within the

total capital limit, may continue holding those investments until they

are redeemed or repurchased by the issuer. The 15 percent of tier one

capital limitation should be used in determining the allowable amount

of new purchases of money market preferred and adjustable rate

preferred stock. Of course, any institution that wants to increase its

holding of these securities may submit an application to the FDIC.

The FDIC seeks comment on whether this treatment of money market

preferred stock and adjustable rate preferred stock is still

appropriate. Comment is requested concerning whether other similar

types of investments should be given similar treatment. Comments also

are requested on whether the reduced capital base affects any

institution currently holding these investments or is likely to affect

the investment plans of any institution.

Activities That Are Closely Related to Banking Conducted by Bank or Its

Subsidiary

The proposed regulation continues the language found in the current

regulation titled, ``Activities that are

[[Page 47981]]

closely related to banking.'' This section permits an insured state

bank to engage as principal in any activity that is not permissible for

a national bank provided that the FRB by regulation or order has found

the activity to be closely related to banking for the purposes of

section 4(c)(8) of the Bank Holding Company Act (12 U.S.C. 1843(c)(8)).

This exception is subject to the statutory prohibition that does not

allow the FDIC to permit the bank to directly hold equity securities

that a national bank may not hold and which are not otherwise

permissible investments for insured state banks pursuant to

Sec. 362.3(b).

Additional language has been added to clarify that this subsection

does not authorize an insured state bank engaged in real estate leasing

to hold the leased property for more than two years at the end of the

lease unless the property is re-leased. This language is added to

ensure that this provision does not allow an insured state bank to hold

an equity interest in real estate after the end of the lease period.

The FDIC has decided to provide a two-year period for the bank to

divest the property if the bank cannot lease the property again.

Comment is invited on the reasonableness of this approach. Should the

FDIC consider an alternative approach that a bank may not enter a non-

operating lease unless title reverts to the lessee at the end of the

lease period? Are there other standards that the FDIC should consider

in this matter?

As does the current regulation, these provisions allow a state bank

to directly engage in any ``as principal'' activity included on the

FRB's list of activities that are closely related to banking (found at

12 CFR 225.28) and ``as principal'' in any activity with respect to

which the FRB has issued an order finding that the activity is closely

related to banking.

However, the consent to engage in real estate leasing directly by

an insured state bank has been modified. Comment is requested on

whether there are any additional activities permitted under the

proposed language that should be modified. Comment is requested on the

effect of the proposed treatment of real estate leasing activities on

banks that may want to engage in this activity in the future. Comment

also is requested on the perceived risks of leasing activities and

whether we should impose standards to address those risks. Comment is

requested on whether we should consider any other approach, including

returning to the language in the current regulation or deleting the

references to the Bank Holding Company Act (12 U.S.C. 1843(c)(8) and

the activities that the FRB by regulation or order has found to be

closely related to banking for the purposes of section 4(c)(8).

Guarantee Activities by Banks

The current regulation contains a provision that permits a state

bank with a foreign branch to directly guarantee the obligations of its

customers as set out in Sec. 347.3(c)(1) of the FDIC's regulations

without filing any application under part 362. It also permits a state

bank to offer customer-sponsored credit card programs in which the bank

guarantees the obligations of its retail banking deposit customers.

This provision has been deleted as unnecessary since we understand that

these activities are permissible for a national bank. In its current

rule, the FDIC added this provision to clarify that part 362 does not

prohibit these activities; however to shorten the regulation, such

clarifying language has been deleted since the activity is permissible

for a national bank. The FDIC seeks comment as to whether the deletion

of this language has an adverse impact on insured state depository

institutions and if there are specific activities that this provision

allowed that are not permissible for a national bank.

In the FDIC's proposal regarding the consolidation and

simplification of its international banking regulations found in the

Federal Register on July 15, 1997, at 62 FR 37748, a technical

amendment to the current version of part 362 is found. This amendment

updates the reference to Sec. 347.103(a)(1) of this chapter in

Sec. 362.4(c)(3)(I)(A). This amendment may become final as a part of

the consolidation and simplification of the FDIC's international

banking regulations to reflect the correct citation in the current

version of part 362. Nevertheless, we propose to eliminate the

references to guarantee activities in this proposal because we consider

them unnecessary as they duplicate powers granted to national banks. As

previously stated, we invite comment on the necessity of including

specific language dealing with the power to guarantee customer

obligations in the regulatory text of part 362.

Section 362.4 Subsidiaries of Insured State Banks

General Prohibition

The regulatory language implementing the statutory prohibition on

``as principal'' activities that are not permissible for a subsidiary

of a national bank has been separated from the prohibition on

activities which are not permissible for a national bank conducted in

the bank. By separating bank and subsidiary activities, Sec. 362.4 now

deals exclusively with activities that may be conducted in a subsidiary

of an insured state bank. We believe that separating the activities

that may be conducted at the bank level from the activities that must

be conducted by a subsidiary makes it easier for the reader to

understand the intent of the regulation. We invite comment on whether

this structure is more useful to the reader. We also invite comment on

whether any additional changes would make it easier for the reader to

interpret the regulation text.

Exceptions

Prohibited activities may not be conducted unless one of the

exceptions in the regulation applies. This language is similar to the

current part 362 and results in no substantive change to the

prohibition.

Consent Obtained Through Application

The proposal continues to allow approval by individual application

provided that the insured state bank meets and continues to meet the

applicable capital standards and the FDIC finds there is no significant

risk to the fund. The proposal would delete the language expressly

providing that approval is necessary for each subsidiary even if the

bank received approval to engage in the same activity through another

subsidiary. Deleting this language will not automatically permit a

state bank to establish a second subsidiary to conduct the same

activity that was approved for another subsidiary of the same bank.

Deleting the language leaves the issue to be handled on a case-by-case

basis by the FDIC pursuant to order. For example, if the FDIC approves

an application by a state bank to establish a majority-owned subsidiary

to engage in real estate investment activities, the order may (in the

FDIC's discretion) be written to allow additional such subsidiaries or

to require that any additional real estate subsidiaries must be

individually approved.

The notice procedures described herein requires that the subsidiary

must take the corporate organizational form. Insured state banks that

organize subsidiaries in a form other than a corporation may make

application under this section. Any bank that does not meet the notice

criteria or that desires relief from a limit or restriction included in

the notice criteria may also file an application under this section and

are encouraged to do so.

[[Page 47982]]

Application instructions have been moved to subpart E.

Language has been eliminated that prohibited an insured state bank

from engaging in insurance underwriting through a subsidiary except to

the extent that such activities are permissible for a national bank.

Eliminating this language does not result in any substantive change as

section 24 of the FDI Act clearly provides that the FDIC may not

approve an application for a state bank to directly or indirectly

conduct insurance underwriting activities that are not permissible for

a national bank. We invite comment on whether the language should be

retained in the regulation to make it clear to state banks that

applications to conduct such activities will not be approved.

The current part 362 allows state banks that do not meet their

minimum capital requirements to gradually phase out otherwise

impermissible activities that were being conducted as of December 19,

1992. These provisions are eliminated under the proposal due to the

passage of time. The relevant outside dates to complete the phase out

of those activities have passed (December 19, 1996, for real estate

activities and December 8, 1994, for all other activities).

Grandfathered Insurance Underwriting

The proposed regulation provides for three statutory exceptions

that allow subsidiaries to engage in insurance underwriting.

Subsidiaries may engage in the same grandfathered insurance

underwriting as the bank if the bank or subsidiary was lawfully

providing insurance as principal on November 21, 1991.

The limitations under which this subsidiary may operate have been

changed. Under the current regulation, the bank must be well-

capitalized. Under the proposal, the bank must be well-capitalized

after deducting its investment in the insurance subsidiary. The FDIC

believes that the capital deduction is an important element in

separating the operations of the bank and the subsidiary. This

deduction clearly delineates the capital that is available to support

the bank and the capital that is available to support the subsidiary.

Capital standards for insurance companies are based on different

criteria from bank capital requirements. Most states have minimum

capital requirements for insurance companies. The FDIC believes that a

bank's investment in an insurance underwriting subsidiary is not

actually ``available'' to the bank in the event the bank experiences

losses and needs a cash infusion. As a result, the bank's investment in

the insurance subsidiary should not be considered when determining

whether the bank has sufficient capital to meet its needs. Comment is

invited on whether the capital deduction is appropriate or necessary.

If the FDIC requires a capital deduction, should it be required in the

case of any insurance underwriting subsidiary that is given a statutory

grandfather, e.g., should title insurance subsidiaries also be subject

to the capital deduction? Should the capital deduction treatment depend

upon what type of insurance is underwritten (if there is a greater risk

associated with the insurance, should the capital deduction be

required)? Is the phase-in period appropriate and clearly written?

The proposed regulation requires a subsidiary engaging in

grandfathered insurance underwriting to meet the standards for an

``eligible subsidiary'' discussed below. This standard replaces the

``bona fide'' subsidiary standard in the current regulation. The

``eligible subsidiary'' standard generally contains the same

requirements for corporate separateness as the ``bona fide'' subsidiary

definition but adds the following provisions: (1) the subsidiary has

only one business purpose; (2) the subsidiary has a current written

business plan that is appropriate to its type and scope of business;

(3) the subsidiary has adequate management for the type of activity

contemplated, including appropriate licenses and memberships, and

complies with industry standards; and (4) the subsidiary establishes

policies and procedures to ensure adequate computer, audit and

accounting systems, internal risk management controls, and the

subsidiary has the necessary operational and managerial infrastructure

to implement the business plan. The FDIC requests comment on the effect

of these additional requirements on banks engaged in insurance

underwriting. We invite comment on whether these requirements

appropriately separate the subsidiary from the bank. We request comment

on whether the restrictions are appropriate to the identified risks

being undertaken by these banks.

In lieu of the prescribed disclosures contained in the current

regulation, the proposal prescribes that disclosures consistent with

the Interagency Statement be made. The proposal also eliminates the

acceptance of disclosures that are required by state law. While the

current regulation requires disclosures, those disclosures are similar

but not identical to the disclosures required by the Interagency

Statement. Again, this proposed change is intended to make compliance

with the Interagency Statement and the regulation easier. Comment is

sought on whether the disclosure requirements in the regulation are

necessary now that the Interagency Statement has been adopted. Any

retail sale of nondeposit investment products to bank customers is

subject to the Interagency Statement. The FDIC recognizes that some

grandfathered insurance underwriting subsidiaries may have a line of

business and customer base which is completely separate from the bank's

operations. The Interagency Statement would not normally apply as the

Statement does not technically apply unless there is a ``retail sale''

to a ``bank customer.'' If the FDIC were to rely wholly upon the

Interagency Statement there would be a gap from the current coverage of

the disclosure requirements. Should that be of concern to the FDIC?

Banks with subsidiaries engaged in grandfathered insurance

underwriting activities are expected to meet the new requirements of

this proposal. Banks which are not in compliance with the requirements

should provide a notice to the FDIC pursuant to Sec. 362.5(b). The FDIC

will consider the notices on a case-by-case basis.

The regulation provides that a subsidiary may continue to

underwrite title insurance based on the specific statutory authority

from section 24. This provision is currently in part 362 and is carried

forward into the proposal with no substantive change. The insured state

bank is only permitted to retain the investment if the insured state

bank was required, before June 1, 1991, to provide title insurance as a

condition of the bank's initial chartering under state law. The

authority to retain the investment terminates if a change in control of

the grandfathered bank or its holding company occurs after June 1,

1991. There are no statutory or regulatory investment limits on banks

holding these types of grandfathered investments.

The exception for subsidiaries engaged in underwriting crop

insurance is continued. Under section 24, insured state banks and their

subsidiaries are permitted to continue underwriting crop insurance

under two conditions: (1) they were engaged in the business on or

before September 30, 1991, and (2) the crop insurance was reinsured in

whole or in part by the Federal Crop Insurance Corporation. While this

grandfathered insurance underwriting authority requires that the bank

or its subsidiary had to be engaged in the activity as of a certain

date, the authority does not

[[Page 47983]]

terminate upon a change in control of the bank or its parent holding

company.

Majority-owned Subsidiaries Which Own a Control Interest in Companies

Engaged in Permissible Activities

The FDIC has found that it is not a significant risk to the deposit

insurance funds if a majority-owned subsidiary holds stock of a company

that engages in (1) any activity permissible for a national bank; (2)

any activity permissible for the bank itself (except engaging in

insurance underwriting and holding grandfathered equity investments);

(3) activities that are not conducted ``as principal;'' or (4) activity

that is not permissible for a national bank provided the Federal

Reserve Board by regulation or order has found the activity to be

closely related to banking, if the majority-owned subsidiary exercises

control over the issuer of the stock purchased by the subsidiary. These

exceptions are found in the current regulation but do not contain the

provision that the majority-owned subsidiary must exercise

control.1 This change clarifies that this exception is

intended only for subsidiaries that are operating a business that is

either permissible for the bank itself or is considered to be operated

other than ``as principal.'' As rewritten, the proposal differentiates

between the types of stock held by a majority-owned subsidiary--having

a controlling interest and simply investing in the shares of a company.

The FDIC intends that this provision cover lower level subsidiaries

that are engaged in activities that the FDIC has found present no

significant risk to the fund. The FDIC expects lower level subsidiaries

that engage in other activities to conform to the application or notice

procedures of this regulation. The FDIC recognizes that changing the

level of ownership permissible for these activities may adversely

affect some insured state bank. We invite comment on the effect of this

change. The FDIC invites comment on whether this language change was

necessary, whether it should be concerned about lower level

subsidiaries, whether this approach is appropriate to the risks

inherent in the activities and whether any other approach, including

returning to the language in the current regulation should be

considered.

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\1\ The current regulatory exception for activities conducted

not as principal provides for a test of 50% or less of the stock of

a corporation which engages solely in activities which are not

considered to be as principal. The term ``corporation'' is being

changed to ``company'' to accommodate the other forms of business

enterprise listed in the definition. The reference to 50% or less is

being deleted in order to avoid the confusion generated by that

limitation.

---------------------------------------------------------------------------

We deleted one other form of stock ownership at the majority

subsidiary level from the current regulation by deleting the language

now found in Sec. 362.4(c)(3)(iv)(C) of the current regulation titled,

``Stock of a corporation that engages in activities permissible for a

bank service corporation.'' Through a majority-owned subsidiary, this

section of the current regulation allows an insured state bank to

invest in 50% or less of the stock of a corporation which engages

solely in any activity that is permissible for a bank service

corporation. Since bank service corporations may engage in any activity

that is closely related to banking, this exception also allowed

majority-owned subsidiaries to own stock in those entities that solely

engaged in activities that were closely related to banking. This

exception has been deleted in this proposal because the coverage of the

proposed exceptions in Sec. 362.4(b)(3) would duplicate the coverage of

the existing exception.

Comment is requested on whether the proposed language clearly sets

forth the coverage of these exceptions. Comment is requested on whether

the proposed language clearly allows the same activities that the

current exception allows by permitting majority-owned subsidiaries to

hold stock of a company engaged in activities permissible for a bank

service corporation. The FDIC seeks comment on whether any inadvertent

substantive change has been made by eliminating the specific references

permitting the ownership of bank service company stock. We seek comment

on the use of the control test for defining activities for lower level

subsidiaries. We invite comment on whether any other approach,

including returning to the language in the current regulation should be

reconsidered. Should the FDIC use a majority-owned test for defining

when a lower level subsidiary exists?

We added clarifying language to the exception governing activities

closely related to banking. The first exception states that this

section does not authorize a subsidiary engaged in real estate leasing

to hold the leased property for more than two years at the end of the

lease unless the property is re-leased. This provision is the same at

the bank level. The second provision is that this section does not

authorize a subsidiary to acquire or hold the stock of a savings

association other than as allowed in Sec. 362.4(b)(4). As is discussed

below, this subsection does not allow a majority-owned subsidiary to

have a control interest in a savings association. Comment is requested

concerning the effect of this change.

Majority-Owned Subsidiaries Ownership of Equity Securities That Do Not

Represent a Control Interest

The proposed regulation significantly changes the exception in the

current regulation involving the holding of equity securities that do

not represent a control interest. The FDIC has determined that the

activity of holding the equity securities at the majority-owned

subsidiary level, subject to certain limitations, does not present a

significant risk to the deposit insurance funds.

This provision replaces two exceptions contained in the current

regulation: (1) grandfathered investments in common or preferred stock

and shares of investment companies, and (2) stock of insured depository

institutions. The proposed regulation adds an expanded exception

allowing the holding of other corporate stock.

The current regulation provides that an insured state bank that has

obtained approval to hold listed common or preferred stock and/or

shares of registered investment companies under the statutory

grandfather (discussed above) may hold the stock and/or shares through

a majority-owned subsidiary provided that any conditions imposed in

connection with the approval are met. The FDIC previously determined

that a majority-owned subsidiary could be accorded the same treatment

under the grandfather provided for by section 24(f) of the FDI Act

without risk to the fund. Thus, the bank should be permitted to invest

in those securities and investment company shares through a majority-

owned subsidiary.

The current regulation requires that each bank file a notice with

the FDIC of the bank's intent to make such investments and that the

FDIC determine that such investments will not pose a significant risk

to the deposit insurance fund before any insured state bank may take

advantage of the ``grandfather'' allowing investments in common or

preferred stock listed on a national securities exchange and shares of

an investment company registered under the Investment Company Act of

1940 (15 U.S.C. 80a-1, et seq.). In no event may the bank's investments

in such securities and/or investment company shares, plus those of the

subsidiary, exceed one hundred percent of the bank's tier one capital.

The FDIC may condition its finding of no risk upon whatever conditions

or restrictions it finds appropriate. The

[[Page 47984]]

``grandfather'' will be lost if the events occur that are discussed

above.

The proposed regulation eliminates the notice for these activities

and the specific reference to grandfathered activity and allows similar

activity for all insured state banks provided that the bank's

investment in the majority-owned subsidiary is deducted from capital

and the activity is subject to the eligibility requirements and

transaction limitations discussed below. Comment is invited on whether

this exception is more appropriately applied by the FDIC as an

exception that is separate and distinct from any other exception under

the regulation that would allow a subsidiary of an insured state bank

to hold equity securities. In short, should this exception be in

addition to any other exception for holding stock?

The FDIC proposes to expand the current regulatory exception from

the acquisition of stock in another insured bank through a majority-

owned subsidiary to an exception for the acquisition of stock of

insured banks, insured savings associations, bank holding companies,

and savings and loan holding companies. The exception would continue to

be limited to the acquisition of no more than 10 percent of the

outstanding voting stock of any one issuer. The acquisition would be

through a majority-owned subsidiary which was organized for the purpose

of holding such stock.

This exception is being expanded to cover savings association

stock, bank holding company stock and savings and loan holding company

stock in response to the FDIC's experience with applications that have

been presented to the FDIC in which insured state banks have sought

approval for these kinds of investments. In acting upon those

applications it has been the opinion of the FDIC to date that

investments in bank holding company stock should not present a risk to

the fund given the fact that bank holding companies are subject to a

very strong regulatory and supervisory scheme and are limited, for the

most part, to engaging in activities that are closely related to

banking. The FDIC proposes to allow investment in savings association

stock for similar reasons. Comment is invited on whether the exception

should allow investments in savings and loan holding company stock in

view of the broad range of activities in which savings and loan holding

companies may engage.

The FDIC has become aware that some insured state banks own a

sufficient interest in the stock of other insured state banks to cause

the bank which is so owned to be considered a majority-owned subsidiary

under part 362. It is the FDIC's position that such an owner bank does

not need to file a request under part 362 seeking approval for its

majority-owned subsidiary that is an insured state bank to conduct as

principal activities that are not permissible for a national bank. As

the majority-owned subsidiary is itself an insured state bank, that

bank is required under part 362 and section 24 of the FDI Act to

request consent on its own behalf for permission to engage in any as

principal activity that is not permissible for a national bank.

The proposal encompasses the exceptions contained in the previous

regulation and expands the exception to a majority-owned subsidiary of

other insured state bank to acquire corporate stock. In order for an

insured state bank to use the exception, the bank must be well-

capitalized exclusive of the bank's investment in the subsidiary and

must make the capital deduction for purposes of reporting capital on

the bank's Call Report. For insured state banks that are using the

current exception for grandfathered equities and holding bank stock,

the capital deduction requirement is new. This requirement is similar

to that found in the proposed notice procedures for state nonmember

banks to engage in activities not permissible for national banks and

recognizes the level of risk present in securities investment

activities. Insured state banks that are currently engaging in these

activities but are not in compliance with the requirements contained in

the proposal should provide notice under Sec. 362.5(b).

The subsidiary may only invest in corporate equity securities if

the bank and subsidiary meet the eligibility requirements. Those

requirements are: (1) the state-chartered depository institution may

have only one majority-owned subsidiary engaging in this activity; (2)

the majority-owned subsidiary's investment in equity securities (except

stock of an insured depository institution, a bank holding company or a

savings and loan holding company) must be limited to equity securities

listed on a national securities exchange; (3) the state-chartered

depository institution and majority-owned subsidiary may not have

control over any issuer of stock purchased; and (4) the majority-owned

subsidiary's equity investments (except stock of an insured depository

institution, a bank holding company or a savings and loan holding

company) must be limited to equity securities listed on a national

securities exchange.

The requirement that the subsidiary's investment be limited to 10

percent of the outstanding voting stock of any company. This limitation

reflects the FDIC's intent that this exception be used only as a

vehicle for investment in equity securities. The 10 percent limitation

was chosen because it reflects a level of investment that is generally

recognized as not involving control of the business. This requirement

is to be read together with the eligibility requirement that the

depository institution may not exercise control over any issuer of

stock purchased by the subsidiary. These requirements reflect the

FDIC's intent that the depository institution is not operating a

business through investments in equity securities. Comment is requested

as to the appropriateness of the 10 percent limitation.

The FDIC believes that only listed securities should be allowed

under this exception. Listed securities are more liquid than nonlisted

securities and companies whose stock is listed must meet capital and

other requirements of the exchange. These requirements provide some

assurances as to the quality of the investment. The requirement that

securities be listed is not extended to bank and savings association

stock, bank holding company stock, or stock of a savings association

holding company. These companies are part of a highly regulated

industry which provides some investment quality assurance. Banks that

may want to invest in unlisted securities in other industries should be

subject to the scrutiny of the application process.

To qualify for this exception, the state-chartered depository

institution may not extend credit to the majority-owned subsidiary,

purchase any debt instruments from the majority-owned subsidiary, or

originate any other transaction that is used to benefit the majority-

owned subsidiary which invests in stock under this subpart. As noted

above, the depository institution may have only one subsidiary engaged

in this activity. These requirements reflect the FDIC's desire that the

scope of the exception be limited. Institutions that wish to have

multiple subsidiaries engaged in holding equity securities and wish to

extend credit to finance these transactions should use the applications

procedures to request consent.

We added a provision relating to portfolio management. The FDIC is

concerned that a majority-owned subsidiary not engage in activities

which the FDIC has identified as speculative. Therefore for the

purposes of this subsection, investment in the equity securities of any

company does not include pursuing short-term trading activities. The

exception has been

[[Page 47985]]

created to facilitate holding of corporate equity securities that are

within the overall investment strategies of the state-chartered

depository institution and its subsidiaries. It is expected that these

investment strategies take account of such factors as quality,

diversification and marketability as well as income. Short term trading

that emphasizes income over other investment factors is speculative and

may not be pursued through this exception.

In addition to requesting comment on the particular exception as

proposed, the FDIC requests comment on whether it is appropriate for

the regulation to contain any exception that would allow an insured

state bank to hold equity securities at the subsidiary level. The FDIC

also requests comment on the adequacy of the restrictions and

constraints that it has proposed for the banks and subsidiaries that

would hold these investments. What additional constraints, if any,

should we consider adding for the banks and subsidiaries that would

hold these investments? We note that the statute does not itself impose

any conditions or restrictions on a bank that enjoys the grandfather

for investment in equity securities in terms of per issuer limits.

Comment is sought on whether it is appropriate to impose the

restriction that limits a bank and its subsidiary to investing in less

than a controlling interest in any given issuer. Is there some other

limit or restriction the FDIC should consider imposing by regulation

that is important to ensuring that the grandfathered investments do not

pose a risk?

Majority-owned Subsidiaries Conducting Real Estate Investment

Activities and Securities Underwriting

The FDIC has determined that real estate investment and securities

underwriting activities do not represent a significant risk to the

deposit insurance funds, provided that the activities are conducted by

a majority-owned subsidiary in compliance with the requirements set

forth. These activities require the insured state banks to file a

notice. Then, as long as the FDIC does not object to the notice, the

bank may conduct the activity in compliance with the requirement. The

fact that prior consent is not required by this subpart does not

preclude the FDIC from taking any appropriate action with respect to

the activities if the facts and circumstances warrant such action.

Engage in Real Estate Investment Activities

Under section 24 of the FDI Act and the current version of part

362, an insured state bank may not directly or indirectly engage in

real estate investment activities not permissible for a national bank.

Section 24 does not grant FDIC authority to permit an insured state

bank to directly engage in real estate investment activities not

permissible for a national bank. The circumstances under which national

banks may hold equity investments in real estate are limited. If a

particular real estate investment is permissible for a national bank,

an insured state bank only needs to document that determination. If a

particular real estate investment is not permissible for a national

bank and an insured state bank wants to engage in real estate

investment activities (or continue to hold the real estate investment

in the case of investments acquired before enactment of section 24 of

the FDI Act), the insured state bank must file an application with FDIC

for consent. The FDIC may approve such applications if the investment

is made through a majority-owned subsidiary, the institution is well

capitalized and the FDIC determines that the activity does not pose a

significant risk to the deposit insurance fund.

The FDIC approved 92 of 95 applications from December 1992 through

June 30, 1997, involving real estate investment activities. The FDIC

denied one application, approved one in part, and one bank withdrew its

application. The real estate investment applications generally have

fallen into three categories: (1) requests for consent to hold real

estate at the subsidiary level while liquidating the property where the

bank expects that liquidation will be completed later than December 19,

1996; (2) requests for consent to continue to engage in real estate

investment activity in a subsidiary, where such activities were

initiated prior to enactment of section 24 of the FDI Act; and (3)

requests for consent to initiate for the first time real estate

investment activities through a majority-owned subsidiary.

The approved applications have involved investments which have

ranged from less than 1 percent to over 70 percent of the bank's tier

one capital. The majority of the investments, however, involved

investments of less than 10 percent of tier one capital with only seven

applications involving investments exceeding 25 percent of tier one

capital. The applications filed with the FDIC have involved a range of

real estate investments including holding residential properties,

commercial properties, raw land, the development of both residential

and commercial properties, and leasing of previously improved property.

The applications approved by the FDIC include 33 residential

properties, 39 commercial properties and 20 applications covering a mix

of commercial and residential properties. The assets of the

institutions that submitted approved applications ranged from $1

million to $6.7 billion. The institutions which have been approved to

continue or commence new real estate investment activity primarily have

had composite ratings of 1 or 2 ratings under the UFIRS. However, 6

institutions were rated 3, and 3 institutions were rated 4. The 4-rated

institutions submitted applications to continue an orderly divestiture

of real estate investments after December 19, 1996. Of the approved

applications, 9 were to conduct new real estate investment activities,

while 80 were submitted to continue holding existing real estate or to

hold existing real estate after December 19, 1996, to pursue an orderly

liquidation. The remaining 3 approved applications asked for consent to

continue existing holdings and conduct new real estate activities. One

application was partially approved and partially denied. This

application involved a bank that applied for consent to continue direct

real estate activities and consent to continue indirect real estate

investment activities through a subsidiary. The FDIC approved the

application to continue the real estate investment activity through the

subsidiary and denied the application for the bank to engage directly

in real estate investment activities.

To date, the FDIC has evaluated a number of factors when acting on

applications for consent to engage in real estate investment

activities. Where appropriate, the FDIC has fashioned conditions

designed to address potential risks that have been identified in the

context of a given application. In evaluating an application to conduct

equity real estate investment activity, the FDIC considers the type of

proposed real estate investment activity to determine if the activity

is unsuitable for an insured depository institution. The FDIC also

reviews the proposed subsidiary structure and its management policies

and practices to determine if the insured state bank is adequately

protected and analyzes capital adequacy to ensure that the insured

institution has sufficient capital to support its more traditional

banking activities.

In every instance in which the FDIC has approved an application to

conduct a real estate investment activity, we have determined that it

was necessary to impose a number of conditions in granting the

approval. In short, the FDIC has determined on a case-by-case basis

that the conduct of certain real estate

[[Page 47986]]

investment activities by a majority-owned corporate subsidiary of an

insured state bank will not present a significant risk to the deposit

insurance fund provided certain conditions are observed. In drafting

this proposed regulation, we have evaluated the conditions usually

imposed when granting such approval to insured state banks and

incorporated these conditions within the proposal where appropriate.

The FDIC requests general comment on whether the conditions imposed

under the proposed regulation are appropriate. Comments are invited on

each condition, especially on the requirements that the subsidiary have

an independent chief executive officer and that a majority of its board

be composed of individuals who are not directors, officers, or

employees of the insured institution.

The proposed rule would allow majority-owned subsidiaries to invest

in and/or retain equity interests in real estate not permissible for a

national bank provided that the insured state bank qualifies as an

``eligible depository institution,'' as that term is defined within the

proposed regulation, and the majority-owned subsidiary qualifies as an

``eligible subsidiary,'' which is also defined within the proposed

rule. The insured state bank must also abide by the investment and

transaction limitations set forth in the proposed regulation. Under the

proposed regulation, the insured state bank may not invest more than 10

percent of the bank's tier one capital in any one majority-owned real

estate subsidiary. In addition, the total of the insured state bank's

investment in all of its majority-owned subsidiaries which are

conducting real estate activities may not exceed 20 percent of its tier

one capital under the proposed regulation. Under the proposed rule, the

20 percent aggregate investment limit applies to subsidiaries engaged

in the same activity.

For the purpose of calculating the dollar amount of the investment

limitations, the bank would calculate 10 percent and 20 percent of its

tier one capital after deducting all amounts required by the proposed

regulation or any FDIC order. We request comment on all aspects and any

implications of this proposal.

Under the proposed regulation, the insured state bank must file a

notice with the FDIC providing a description of the proposed activity

and the manner in which it will be conducted. A description of the

other items required to be contained in the notice under this proposal

are contained in subpart E of the proposed regulation.

The FDIC recognizes that some real estate investments or activities

are more time, management and capital intensive than others. Our

experience in reviewing the applications filed under section 24 has led

us to conclude that extremely small equity investments in real estate--

held under certain conditions--do not pose a significant risk to the

deposit insurance fund. As a result, the proposed regulation provides

relief to insured state banks having such small investments in a

majority-owned subsidiary engaging in real estate investment

activities. The FDIC is attempting to strike a reasonable balance

between prudential safeguards and regulatory burden in its proposed

regulation. As a result, the proposed regulation establishes certain

exceptions from the requirements necessary to establish an eligible

subsidiary whenever the insured state bank's investment is of a de

minimis nature and meets certain other criteria. Under the proposal,

whenever the bank's investment in its majority-owned subsidiary

conducting real estate activities does not exceed 2 percent of the

bank's tier one capital and the bank's investment in the subsidiary

does not include extensions of credit from the bank to the subsidiary,

a debt instrument purchased from the subsidiary or any other

transaction originated from the bank to the benefit of the subsidiary,

the subsidiary is relieved of certain of the requirements that must be

met to establish an eligible subsidiary under the regulation. Under the

proposed regulation, an insured state bank with a limited investment in

a majority-owned subsidiary need not adhere to the requirements that

the subsidiary be physically separate from the insured state bank; the

chief executive officer of the subsidiary is not required to be an

employee separate from the bank; a majority of the board of directors

of the subsidiary need not be separate from the directors or officers

of the bank; and the subsidiary need not establish separate policies

and procedures as described in the proposed regulation in

Sec. 362.4(c)(2)(xi). The FDIC requests comment on the exceptions being

proposed for establishing an eligible subsidiary whenever the bank's

investment is of such a limited nature. Are there any of the other

requirements necessary to establish an ``eligible subsidiary'' that

should be excepted for banks with such limited investments? Commenters

should keep in mind that the FDIC's goal is to reduce regulatory burden

while maintaining adequate protection of the deposit insurance funds.

Comment is requested on all aspects of this real estate investment

activity authority.

Under current law, an insured state bank must apply to the FDIC

prior to engaging in real estate investment activities that are

impermissible for a national bank. The proposed regulation contains a

procedure under which certain insured state banks may participate in

real estate investment activity under specific circumstances by filing

a notice with the FDIC. To qualify for the notice procedure proposed

under Sec. 362.4(b)(5), the real estate investment activities must be

conducted by a majority-owned subsidiary that further qualifies as an

``eligible subsidiary'' under the proposal. The characteristics of an

eligible subsidiary are set forth in Sec. 362.4(c)(2) of the regulation

and further described below. If the institution or its investment does

not meet the criteria established under the proposed regulation for

using the notice procedure, an application may be filed with the FDIC

under Sec. 362.4(b)(1). The FDIC encourages institutions to file an

application if the institution wishes to request relief from any of the

requirements necessary to be considered an eligible depository

institution or an eligible subsidiary. The FDIC recognizes that not all

real estate investment requires a subsidiary to be established exactly

as outlined under the eligible subsidiary definition.

Section 362.4(b)(5) of the proposal permits certain highly rated

banks (defined in Sec. 362.4(c)(1) of the proposal as eligible

depository institutions) to engage, through a majority-owned

subsidiary, in real estate investment activities not otherwise

permissible for a national bank by filing a notice according to the

procedures set forth in subpart E of the proposed regulation.

Comment is requested on all aspects of this proposal to allow real

estate activities through a notice procedure.

Engage in the Public Sale, Distribution or Underwriting of Securities

That Are Not Permissible for a National Bank Under Section 16 of the

Banking Act of 1933

The current regulation provides that an insured state nonmember

bank may establish a majority-owned subsidiary that engages in the

underwriting and distribution of securities without filing an

application with the FDIC if the requirements and restrictions of

Sec. 337.4 of the FDIC's regulations are met. Section 337.4 governs the

manner in which subsidiaries of insured state nonmember banks must

operate if the subsidiaries engage in securities activities that would

not be permissible for the bank itself under section 16 of

[[Page 47987]]

the Banking Act of 1933, commonly known as the Glass-Steagall Act. In

short, the regulation lists securities underwriting and distribution as

an activity that will not pose a significant risk to the fund if

conducted through a majority-owned subsidiary that operates in

accordance with Sec. 337.4. The proposed regulation makes significant

changes to that exception.

Due to the existing cross reference to Sec. 337.4, FDIC reviewed

Sec. 337.4 as a part of its review of part 362 for CDRI. The purpose of

the review was to streamline and clarify the regulation, update the

regulation as necessary given any changes in the law, regulatory

practice, and the marketplace since its adoption, and remove any

redundant or unnecessary provisions. As a result of that review, the

FDIC proposes making a number of substantive changes to the rules which

govern securities sales, distribution, or underwriting by subsidiaries

of insured state nonmember banks and eliminating Sec. 337.4 as a

separate regulation. The revised language would be relocated to part

362 and would become what is proposed Sec. 362.4(b)(5)(ii). Although

the FDIC has chosen to place the exception in the part of the

regulation governing activities by insured state banks, by law, only

subsidiaries of state nonmember banks may engage in securities

underwriting activities that are not permissible for national banks. As

we have previously stated, subpart A of this regulation does not grant

authority to conduct activities or make investments, subpart A only

gives relief from the prohibitions of section 24 of the FDI Act. We

placed the exception for securities underwriting with the real estate

exception in the structure of the regulation to promote uniform

standards across activities, even though it is possible that a state

member bank could qualify for the real estate exception and not the

securities exception. We request comment on whether this placement

causes any confusion. Of course, as the appropriate Federal banking

agency for state member banks, the FRB may impose more stringent

restrictions on any activity conducted by a state member bank.

The following discussion describes the purpose and background of

Sec. 337.4, the conditions and restrictions imposed by that rule on

securities activities, the language of the exception in proposed part

362 and the proposed revisions to the conditions and restrictions

governing this activity.

History of Section 337.4

On August 23, 1982, the FDIC adopted a policy statement on the

applicability of the Glass-Steagall Act to securities activities of

insured state nonmember banks (47 FR 38984). That policy statement

expressed the opinion of the FDIC that under the Glass-Steagall Act:

(1) Insured state nonmember banks may be affiliated with companies that

engage in securities activities, and (2) securities activities of bona

fide subsidiaries of insured state nonmember banks are not prohibited

by section 21 of the Glass-Steagall Act (12 U.S.C. 378) which prohibits

deposit taking institutions from engaging in the business of issuing,

underwriting, selling, or distributing stocks, bonds, debentures,

notes, or other securities.

The policy statement applies solely to insured state nonmember

banks. As noted in the policy statement, the Bank Holding Company Act

of 1956 (12 U.S.C. 1841 et. seq.) places certain restrictions on non-

banking activities. Insured state nonmember banks that are members of a

bank holding company system need to take into consideration sections

4(a) and 4(c)(8) of the Bank Holding Company Act of 1956 (12 U.S.C.

1843 (a) and (c)) and applicable Federal Reserve Board regulations

before entering into securities activities through subsidiaries.

The policy statement also expressed the opinion of the Board of

Directors of the FDIC that there may be a need to restrict or prohibit

certain securities activities of subsidiaries of state nonmember banks.

As the policy statement noted, ``the FDIC * * * recognizes its ongoing

responsibility to ensure the safe and sound operation of insured state

nonmember banks, and depending upon the facts, the potential risks

inherent in a bank subsidiary's involvement in certain securities

activities.''2

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\2\ Representatives of mutual fund companies and investment

bankers brought action challenging the Federal Deposit Insurance

Corporation Policy Statement. Their suit was dismissed without

prejudice, pending the outcome of FDIC's rulemaking process.

Investment Company Institute v. United States, D.D.C. Civil Action

No. 82-2532, filed September 8, 1982.

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In November 1984, after notice and comment proceedings, the FDIC

adopted a final rule regulating the securities activities of affiliates

and subsidiaries of insured state nonmember banks under the FDI Act. 49

FR 46709 (Nov. 28, 1984), regulations codified at 12 CFR 337.4

(1986).3 Although the rule does not prohibit such securities

activities outright, it does restrict that activity in a number of ways

and only permits the activities if authorized under state law. Banks

only could maintain ``bona fide'' subsidiaries that engaged in

securities work. The rule defined ``bona fide subsidiary'' so as to

limit the extent to which banks and their securities affiliates and

subsidiaries could share company names or logos, as well as places of

business. 12 CFR 337.4(a)(2)(ii), (iii); 49 FR 46710. The definition

required banks and subsidiaries to maintain separate accounting records

and to observe separate corporate formalities. 12 CFR 337.4(a)(2)(iv),

(v). The two entities were required not to share officers and to

conduct business pursuant to independent policies and procedures,

including the maintenance of separate employees and payrolls. Id.

Sec. 337.4(a)(2)(vi), (vii), (viii); 49 FR 46711-12. Finally, and

perhaps most importantly, the rule required a subsidiary to be

``adequately capitalized.'' 12 CFR 337.4(a)(2)(i).

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\3\ After the regulations were adopted, the representatives of

mutual fund companies and investment bankers brought another action

challenging the regulations allowing insured banks, which are not

members of the Federal Reserve System, to have subsidiary or

affiliate relationships with firms engaged in securities work. The

United States District Court for the District of Columbia, Gerhard

A. Gesell, J., 606 F.Supp. 683, upheld the regulations, and

representatives appealed and also petitioned for review. The Court

of Appeals held that: (1) representatives had standing to challenge

regulations under both the Glass-Steagall Act and the FDI Act, but

(2) regulations did not violate either Act. Investment Company

Institute, v. Federal Deposit Insurance Corporation, 815 F.2d 1540

(U.S.C.A. D.C.1987).

A trade association representing Federal Deposit Insurance

Corporation-insured savings banks also brought suit challenging FDIC

regulations respecting proper relationship between FDIC-insured

banks and their securities-dealing ``subsidiaries'' or

``affiliates.'' On cross motions for summary judgment, the District

Court, Jackson, J., held that: (1) trade association had standing,

and (2) regulations were within authority of FDIC. National Council

of Savings Institutions v. Federal Deposit Insurance Corporation,

664 F.Supp. 572 ( D.C. 1987).

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The rule has been amended several times since its

adoption.4 The last amendment to this rule was in 1988. When

the FDIC initially implemented

[[Page 47988]]

its regulation on securities activities of subsidiaries of insured

state nonmember banks and bank transactions with affiliated securities

companies, the FDIC determined that some risk may be associated with

those activities. To address that risk, the FDIC regulation: (1)

Defined bona fide subsidiary, (2) required notice of intent to acquire

or establish a securities subsidiary, (3) limited the permissible

securities activities of insured state nonmember bank subsidiaries, and

(4) placed certain other restrictions on loans, extensions of credit,

and other transactions between insured state nonmember banks and their

subsidiaries or affiliates that engage in securities activities.

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\4\ 50 FR 2274, Jan. 16, 1985; 51 FR 880, Jan. 9, 1986; 51 FR

23406, June 27, 1986; 51 FR 45756, Dec. 22, 1986; 52 FR 23544, June

23, 1987; 52 FR 39216, Oct. 21, 1987; 52 FR 47386, Dec. 14, 1987; 53

FR 597, Jan. 8, 1988; 53 FR 2223, Jan. 27, 1988. The FDIC amended

the regulations governing the securities activities of certain

subsidiaries of insured state nonmember banks and the affiliate

relationships of insured state nonmember banks with certain

securities companies to make technical corrections, delete the

requirement that the offices of securities subsidiaries and

affiliates must be accessed through a separate entrance from that

used by the bank (the existing requirement for physically separate

offices was retained), delete the prohibition against securities

subsidiaries and affiliates sharing a common name or logo with the

bank, and to establish a number of affirmative disclosure

requirements regarding securities recommended, offered, or sold by

or through a securities subsidiary or affiliate are not FDIC insured

deposits unless otherwise indicated and that such securities are not

obligations of, nor are guaranteed by the bank.

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As defined in Sec. 337.4, the term ``bona fide'' subsidiary means a

subsidiary of an insured state nonmember bank that at a minimum: (1) Is

adequately capitalized, (2) is physically separate and distinct in its

operations from the operations of the bank, (3) maintains separate

accounting and other corporate records, (4) observes separate corporate

formalities such as separate board of directors' meetings, (5)

maintains separate employees who are compensated by the subsidiary, (6)

shares no common officers with the bank, (7) a majority of the board of

directors is composed of persons who are neither directors nor officers

of the bank, and (8) conducts business pursuant to independent policies

and procedures designed to inform customers and prospective customers

of the subsidiary that the subsidiary is a separate organization from

the bank and that investments recommended, offered or sold by the

subsidiary are not bank deposits, are not insured by the FDIC, and are

not guaranteed by the bank nor are otherwise obligations of the bank.

This definition was imposed to ensure the separateness of the

subsidiary and the bank. This separation is necessary as the bank would

be prohibited by the Glass-Steagall Act from engaging in many

activities the subsidiary might undertake and the separation safeguards

the soundness of the parent bank.

The regulation provides that the insured state nonmember bank must

give the FDIC written notice of intent to establish or acquire a

subsidiary that engages in any securities activity at least 60 days

prior to consummating the acquisition or commencement of the operation

of the subsidiary. These notices serve as a supervisory mechanism to

apprise the FDIC that insured state nonmember banks are conducting

securities activities through their subsidiaries that may expose the

banks to potential risks.

The regulation adopted a tiered approach to the activities of the

subsidiary and limited the underwriting of securities that would

otherwise be prohibited to the bank itself under the Glass-Steagall Act

unless the subsidiary met the bona fide definition and the activities

were limited to underwriting of investment quality securities. A

subsidiary may engage in additional underwriting if it meets the

definition of bona fide and the following additional conditions are

met:

(a) The subsidiary is a member in good standing of the National

Association of Securities Dealers (NASD);

(b) The subsidiary has been in continuous operation for a five-year

period preceding the notice to the FDIC;

(c) No director, officer, general partner, employee or 10 percent

shareholder has been convicted within five years of any felony or

misdemeanor in connection with the purchase or sale of any security;

(d) Neither the subsidiary nor any of its directors, officers,

general partners, employees, or 10 percent shareholders is subject to

any state or federal administrative order or court order, judgment or

decree arising out of the conduct of the securities business;

(e) None of the subsidiary's directors, officers, general partners,

employees or 10 percent shareholders are subject to an order entered

within five years issued by the Securities and Exchange Commission

(SEC) pursuant to certain provisions of the Securities Exchange Act of

1934 or the Investment Advisors Act of 1940; and

(f) All officers of the subsidiary who have supervisory

responsibility for underwriting activities have at least five years

experience in similar activities at NASD member securities firms.

A bona fide subsidiary is required to be adequately capitalized,

and therefore, these subsidiaries are required to meet the capital

standards of the NASD and SEC. As a protection to the insurance fund, a

bank's investment in these subsidiaries engaged in securities

activities that would be prohibited to the bank under the Glass-

Steagall Act is not counted toward the bank's capital, that is, the

investment in the subsidiary is deducted before compliance with capital

requirements is measured.

An insured state nonmember bank that has a subsidiary or affiliate

engaging in the sale, distribution, or underwriting of stocks, bonds,

debentures or notes, or other securities, or acting as an investment

advisor to any investment company is prohibited under Sec. 337.4 from

engaging in any of the following transactions:

(1) Purchasing in its discretion as fiduciary any security

currently distributed, underwritten or issued by the subsidiary unless

the purchase is authorized by a trust instrument or is permissible

under applicable law;

(2) Transacting business through the trust department with the

securities firm unless the transactions are at least comparable to

transactions with an unaffiliated company;

(3) Extending credit or making any loan directly or indirectly to

any company whose obligations are underwritten or distributed by the

securities firm unless the securities are of investment quality;

(4) Extending credit or making any loan directly or indirectly to

any investment company whose shares are underwritten or distributed by

the securities company;

(5) Extending credit or making any loan where the purpose of the

loan is to acquire securities underwritten or distributed by the

securities company;

(6) Making any loans or extensions of credit to a subsidiary or

affiliate of the bank that distributes or underwrites securities or

advises an investment company in excess of the limits and restrictions

set by section 23A of the Federal Reserve Act;

(7) Making any loan or extension of credit to any investment

company for which the securities company acts as an investment advisor

in excess of the limits and restrictions set by section 23A of the

Federal Reserve Act; and

(8) Directly or indirectly conditioning any loan or extension of

credit to any company on the requirement that the company contract with

the bank's securities company to underwrite or distribute the company's

securities or condition a loan to a person on the requirement that the

person purchase any security underwritten or distributed by the bank's

securities company.

An insured state nonmember bank is prohibited under Sec. 337.4 from

becoming affiliated with any company that directly engages in the sale,

distribution, or underwriting of stocks, bonds, debentures, notes, or

other securities unless: (1) The securities business of the affiliate

is physically separate and distinct from the operation of the bank; (2)

the bank and the affiliate share no common officers; (3) a majority of

the board of directors of the bank is composed of persons who are

neither directors nor officers of the affiliate; (4) any employee of

the affiliate who is also an employee of the bank does not conduct any

securities activities of the affiliate on the premises of the bank that

involve customer contact; and (5) the affiliate conducts business

pursuant to

[[Page 47989]]

independent policies and procedures designed to inform customers and

prospective customers of the affiliate that the affiliate is a separate

organization from the bank and that investments recommended, offered or

sold by the affiliate are not bank deposits, are not insured by the

FDIC, and are not guaranteed by the bank nor are otherwise obligations

of the bank. The FDIC chose not to require notices relative to

affiliates because it would normally find out about the affiliation in

a deposit insurance application or a change of bank control notice.

The FDIC created an atmosphere where bank affiliation with entities

engaged in securities activities is very controlled. The FDIC has

examination authority over bank subsidiaries. Under section 10(b) of

the FDI Act, the FDIC has the authority to examine affiliates to

determine the effect of that relationship on the insured institution.

Nevertheless, the FDIC generally has allowed these entities to be

functionally regulated, that is FDIC usually examines the insured state

nonmember bank and primarily relies on SEC and NASD oversight of the

securities subsidiary or affiliate.

The FDIC views its established separations for banks and securities

firms as creating an environment in which the FDIC's responsibility to

protect the insurance fund has been met without creating too much

overlapping regulation for the securities firms. The FDIC maintains an

open dialogue with the NASD and the SEC concerning matters of mutual

interest. To that end, the FDIC entered into an agreement in principle

with the NASD concerning examination of securities companies affiliated

with insured institutions and has begun a dialogue with the SEC

concerning the exchange of information which may be pertinent to the

mission of the FDIC.

The number of banks which have subsidiaries engaging in securities

activities that can not be conducted in the bank itself is very small.

These subsidiaries engage in the underwriting of debt and equity

securities and distribution and management of mutual funds. The FDIC

has received notices from 444 banks that have subsidiaries that engage

in activities that do not require the subsidiary to meet the definition

of bona fide such as investment advisory activities, sale of

securities, and management of the bank's securities portfolio.

Since implementation of the FDIC's Sec. 337.4 regulation, the

relationships between banks and securities firms have not been a matter

of supervisory concern due to the protections FDIC has in place.

However, the FDIC realizes that in a time of financial turmoil these

protections may not be adequate and a program of direct examination

could be necessary to protect the insurance fund. Thus, the

continuation of the FDIC's examination authority in that area is

important.

The FRB permits a nonbank subsidiary of a bank holding company to

underwrite and deal in securities through its orders under the Bank

Holding Company Act and section 20 of the Glass-Steagall Act. The FDIC

has reviewed its securities underwriting activity regulations in light

of the FRB recently adopted operating standards that modify the FRB's

section 20 orders.5 The FDIC also reviewed the comments

received by the FRB. The FRB conducted a comprehensive review of the

prudential limitations established in its decisions. The FRB sought

comment on modifying these limitations to allow section 20 subsidiaries

to operate more efficiently and serve their customers more

effectively.6 The FDIC found the analysis of the FRB

instructive and has determined that its regulation already incorporates

many of the same modifications that the FRB has made. The FDIC is

proposing other changes consistent with the FRB approach and will

endeavor to explain the differences in the approach taken by the FDIC.

Consistent with the approach adopted by the FRB, the FDIC proposes to

have the securities underwriting subsidiaries and the insured state

nonmember banks use the disclosures adopted in the Interagency

Statement where applicable. Thus, the Interagency Statement will be

applicable when sales of these products occur on bank premises. The

FDIC agrees with the FRB that using these interagency disclosure

standards promotes uniformity, makes it easier for banks to train their

employees, and enhances compliance.

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\5\ August 21, 1997.

\6\ 61 FR 57679, November 7, 1996, and 62 FR 2622, January 17,

1997.

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In contrast, FDIC will be taking a different approach on some of

these safeguards because it is not proposing a separate statement of

operating standards. Thus, the FDIC will retain safeguards in its rule

that FRB is shifting to or handling in a different way through the

FRB's still to be released statement of operating standards. With

respect to other safeguards that the FDIC is proposing to continue to

apply to the securities underwriting activities conducted by insured

state nonmember banks through their ``eligible subsidiaries,'' FDIC has

determined that each of these safeguards provides appropriate

protections for bank subsidiaries engaged in underwriting activities.

For these purposes, the FDIC has modified the safeguard requiring

that banks and their securities underwriting subsidiaries maintain

separate officers and employees. As discussed below, that modification

would be consistent with the Interagency Statement. However, the chief

executive officer of the subsidiary may not be an employee of the bank

and a majority of its board of directors must not be directors or

officers of the bank. This standard is the same as the operating

standard on interlocks adopted by the FRB to govern its section 20

orders.

One of the reasons for these safeguards involves the FDIC's

continuing concerns that the bank should be protected from liability

for the securities underwriting activities of the subsidiary. Under the

securities laws, a parent company may have liability as a ``controlling

person.'' 7 The FDIC views management and board of director

separation as enhanced protection from controlling person liability as

well as protection from disclosures of material nonpublic information.

Protection from disclosures of material nonpublic information also may

be enhanced by the use of appropriate policies and

procedures.8

[[Page 47990]]

The FDIC requests comment on the retention of these safeguards, the

utility of management and board separations to limit controlling person

liability and the inappropriate disclosure of material nonpublic

information, the extent that any securities underwriting liability may

have been reduced due to the enactment of The Private Securities

Litigation Reform Act of 1995, P.L. 104-67, the efficacy of more

limited restrictions on officer and director interlocks to prevent both

liability and information sharing and any related issues.

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\7\ Liability of ``controlling persons'' for securities law

violations by the persons or entities they ``control'' is found in

section 15 of the Securities Act of 1933, 15 U.S.C. Sec. 77o and

section 20 of the Securities and Exchange Act of 1934, 15 U.S.C.

Sec. 78t(a). Although the tests of liability under these statutes

vary slightly, the FDIC is concerned that liability may be imposed

on a parent entity that is a bank under the most stringent of these

authorities in the securities underwriting setting. Under the Tenth

Circuit's permissive test for controlling person liability, any

appearance of an ability to exercise influence, whether directly or

indirectly, and even if such influence cannot amount to control, is

sufficient to cause a person to be a controlling person within the

meaning of Sec. 77o or Sec. 78t(a). Although liability may be

avoided by proving no knowledge or good faith, proving no knowledge

requires no knowledge of the general operations or actions of the

primary violator and good faith requires both good fait

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