Activities of Insured State Banks and Insured Savings Associations

SUMMARY: The FDIC is seeking public comment on its proposal to amend

its rules and regulations governing activities and investments of

insured state banks. The FDIC proposes to add safety and soundness

standards to govern insured state nonmember banks that engage in the

public sale, distribution or underwriting of stocks, bonds, debentures,

notes or other securities through a subsidiary if those activities are

permissible for a national bank subsidiary but are not permissible for

the national bank itself. In addition, the FDIC proposes to require

that insured state nonmember banks file a notice before commencing any

activities permissible for subsidiaries of a national bank that are not

permissible for the parent national bank itself. The FDIC also proposes

to remove and reserve the provisions addressing, ``Securities

Activities of Subsidiaries of Insured State Banks: Bank Transactions

with Affiliated Securities Companies.'' The proposed effect of these

amendments will be to require banks to notify the FDIC prior to

conducting securities or other activities through subsidiaries that are

not permissible for the bank itself. These amendments also will

consolidate all securities activities regulation.

DATES: Comments must be received by February 1, 1999.

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), 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

Recently, the FDIC reassessed part 362 of its rules, ``Activities

and Investments of Insured State Banks'' (12 CFR part 362) and

Sec. 337.4 of its rules, ``Securities Activities of Subsidiaries of

Insured State Banks: Bank Transactions with Affiliated Securities

Companies'' (12 CFR 337.4). That reassessment resulted in an amended

part 362 that is published as a final rule elsewhere in this issue of

the Federal Register. Although, in connection with that reassessment,

FDIC proposed removing Sec. 337.4, the FDIC decided to leave that rule

in place to retain the safety and soundness standards governing

securities activities that are not subject to section 24 of the Federal

Deposit Insurance Act (FDI Act) (12 U.S.C. 1831a) (discussed below)

during a further comment period on rules that would govern those

activities.

In this proposal, the FDIC seeks comment on proposed safety and

soundness standards governing an insured state nonmember bank

subsidiary engaging in the public sale, distribution or underwriting of

stocks, bonds, debentures, notes or other securities permissible for a

subsidiary of a national bank that are not permissible for the parent

national bank directly. The proposal also requests comment on a

proposed requirement that a notice be filed before an insured state

nonmember bank subsidiary engages in any other activity permissible for

a subsidiary of a national bank that is not permissible for the parent

national bank directly. Under the proposal, the FDIC would remove and

reserve Sec. 337.4. The proposal is described in more detail below.

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

section 24 of the FDI Act. Section 24 was added to the FDI Act by the

Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)

(Pub. L. 102-242). 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, with

certain exceptions, section 24 prohibits an insured state bank from

engaging as principal in any type of activity that is not permissible

for a national bank unless the bank meets applicable capital

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

significant risk to the appropriate deposit insurance fund. Section 24

also prohibits an insured state bank subsidiary from engaging as

principal in any activity or making any equity investment of a type

that is not permissible for a national bank subsidiary unless the bank

meets applicable capital requirements and the FDIC determines that the

activity will not pose a significant risk to the appropriate deposit

insurance fund.

Since section 24 was enacted, the Office of the Comptroller of the

Currency (OCC) has confirmed--through its rule governing operating

subsidiaries--that there may be activities that are not permissible for

a national bank itself, but that are permissible for national bank

subsidiaries. Effective December 31, 1996, the OCC amended its

regulations governing the acquisition and establishment of operating

subsidiaries by national banks. 12 CFR part 5. These regulations

establish a process through which a national bank may seek approval to

conduct activities in an operating subsidiary that are part of or

incidental to the business of banking as determined by the OCC pursuant

to 12 U.S.C. 24 (Seventh) or other statutory authority but that differ

from the activities that are permissible for the national bank itself.

The OCC always requires an application from a bank seeking to conduct a

bank-impermissible activity in an operating subsidiary. If the activity

proposed for the operating subsidiary has not been approved previously

by the OCC, the OCC will publish a notice of the application in the

Federal Register and solicit comment. The OCC may also follow this

notice and comment procedure if the activity is one that the OCC has

previously approved. 12 CFR 5.34(f).

The framework in the regulation sets up a review process that has

two, equally important components. First, the OCC reviews operating

subsidiary applications to determine whether the proposed activities

are legally permissible for an operating subsidiary. Second, the OCC

evaluates the proposal to determine whether it is consistent with safe

and sound banking practices and OCC policy and does not endanger the

safety or soundness of the particular parent national bank.

The operating subsidiary rule sets out a number of conditions, or

firewalls, that the OCC will impose each time it approves the conduct

of an activity in an operating subsidiary that the parent

[[Page 66340]]

bank could not do directly.1 In addition, the rule

contemplates the imposition of other bank-specific conditions tailored

to the facts and circumstances presented by the individual application.

To date, the OCC has received and published notice of three

applications to conduct activities, through an operating subsidiary,

which would not be permissible for a national bank. Two applications

were filed by NationsBank, National Association, (Charlotte, North

Carolina) to engage in limited real estate development activities in

connection with bank premises and to provide real estate lease

financing through operating subsidiaries of the bank. The FDIC, in its

final rule published elsewhere in today's Federal Register, dealt with

state nonmember banks which seek to engage in real estate activities

permissible for a national bank only through a subsidiary (subpart B of

the amended part 362).

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\1\ Under these conditions, the Sec. 5.34(f) operating

subsidiary generally must: be physically separate from the parent;

hold itself out as a separate and distinct entity; use a different

name; have adequate capital; maintain separate accounting and

corporate records; have independent policies and procedures designed

to inform customers of the independence of the subsidiary; negotiate

contracts with the parent at arm's length; hold separate board

meetings; have at least one-third of the members of the board who

are not directors of the bank who have relevant expertise; and have

internal controls to manage financial and operational risks.

Moreover, if the operating subsidiary will be conducting activities

as principal, additional safety and soundness conditions are

imposed, including that the bank's equity investment in the

subsidiary must be deducted from the bank's capital and assets, and

the assets and liabilities of the subsidiary may not be consolidated

with those of the bank. In addition, the OCC will apply sections 23A

and 23B of the Federal Reserve Act (12 U.S.C. 371c and 371c-1) to

transactions between the parent bank and its operating subsidiary.

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Another application was filed by Zions First National Bank, (Salt

Lake City, Utah) (Zions) to conduct municipal revenue bond underwriting

activities on April 8, 1997. The OCC published notice and requested

comment in the Federal Register on April 18, 1997. 62 FR 19171. On

December 11, 1997, the OCC announced its approval of the Zions'

application allowing an operating subsidiary of a national bank to

engage in the activities of underwriting, dealing in, and investing in

state and municipal revenue bonds, subject to certain safety and

soundness requirements.2

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\2\ Zions applied to the OCC pursuant to 12 CFR 5.34(f) to

commence a new activity in an existing operating subsidiary. The

subsidiary would underwrite, deal in, and invest in securities of

states and their political subdivisions. These securities include

the following: (1) Obligations presently defined by the OCC as

general obligations of states and political subdivisions (General

Obligation Securities); and (2) other obligations of states and

their political subdivisions that do not qualify under the OCC's

current definitions as general obligations (Revenue Bonds). The OCC

determined that the activity was permissible for an operating

subsidiary under the authority of 12 U.S.C. 24 (Seventh) that allows

a national bank to own operating subsidiaries that conduct

activities that are incidental to the business of banking. In this

case, the OCC determined that the activity of underwriting revenue

bonds is incidental to banking by finding that underwriting revenue

bonds is the functional equivalent or a logical outgrowth of

activities that are currently conducted by national banks. However,

the OCC reiterated that section 20 of the Glass-Steagall Act

prohibits the affiliation of member banks with firms that

principally engage in underwriting bank-ineligible securities. As a

result, the OCC imposed a 25 percent revenue limitation on the

Zions' subsidiary to conform to the limitation for section 20

subsidiaries set by Board of Governors of the Federal Reserve

System. The OCC imposed the conditions set forth in Sec. 5.34(f),

including corporate separateness requirements and the applications

of sections 23A and 23B of the Federal Reserve Act to transactions

between the bank and its subsidiary. In addition, the OCC imposed

other conditions tailored to the Zions' application. For example, it

required disclosures to customers, including use of the Interagency

Statement on Retail Sales of Nondeposit Investment Products

(Interagency Statement), and limited opinions on the bonds by bank

directors, officers and employees.

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This OCC approval means that the requirement under section 24 and

subpart A of part 362, that an insured state nonmember bank apply to

the FDIC for consent to engage in this activity through a subsidiary,

no longer applies. However, the FDIC did not remove Sec. 337.4 as

proposed, but instead left Sec. 337.4 in place to require that an

insured state nonmember bank file a notice and comply with the FDIC's

safety and soundness requirements to engage in the distribution or

underwriting of stocks, bonds, debentures, notes or other securities

through a subsidiary.3

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\3\ Section 362.4 of the final regulation establishes rules by

which subsidiaries of insured state banks may conduct certain

securities activities which are not permissible for a national bank

subsidiary. Section 362.8(b) established similar rules for

securities affiliates of insured state nonmember bank subsidiaries

of so-called ``nonbank bank holding companies.'' As is specified in

Sec. 337.4(i), the activities of such subsidiaries and affiliates

are controlled by part 362, not Sec. 337.4.

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Section 337.4 of the FDIC's regulations 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 banks directly, under section 16

of the Banking Act of 1933 (12 U.S.C. 24 (Seventh)), commonly known as

the Glass-Steagall Act. Section 337.4 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 banks under section 16;

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 bank under section 16 be deducted from the bank's capital.

Under the current version of Sec. 337.4, a subsidiary of a state

nonmember bank that wanted to underwrite, deal in, and invest in

municipal revenue bonds (securities of states and their political

subdivisions that do not qualify under the OCC's current definition of

general obligation bonds) would have to file a notice under Sec. 337.4

and meet its requirements. To underwrite, deal in, or invest in

municipal revenue bonds, the bank and its subsidiary would be required

to:

1. File a notice at least 60 days prior to the consummation of the

operation of the subsidiary;

2. Meet the ``bona fide subsidiary'' requirements as set forth in

definition in Sec. 337.4;

3. Deduct the capital invested in subsidiary from bank's total

capital;

4. Underwrite only debt securities of investment grade, unless the

subsidiary has been in continuous operation for the five year period

preceding the notice.4

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\4\ According to the information provided in the application,

the Zions' subsidiary appears to meet the 5-year operation test that

Sec. 337.4 would apply to a state nonmember bank subsidiary. Section

337.4 has no procedure for a bank to file an application to be

relieved of the five year operation requirement; however, there is a

waiver application procedure in Sec. 337.10. Any such application

would be granted at the discretion of the FDIC's Board of Directors.

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The applicability of Sec. 337.4 is not impacted by the OCC's

approval of the Zions application. The application of Sec. 337.4 is

independent of and was adopted prior to section 24 of the FDI Act and

part 362. Section 337.4 is invoked based on the securities activities

of the bank subsidiary and was adopted pursuant to an analysis of the

Glass-Steagall Act undertaken in the early 1980s. 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. Now, in this rulemaking proceeding, the FDIC proposes to

remove and reserve Sec. 337.4 and address

[[Page 66341]]

the FDIC's standards governing bank subsidiary activities through part

362.

II. Description of the Proposal

In this proposal, the FDIC imposes safety and soundness constraints

on insured state nonmember bank subsidiaries that engage in the public

sale, distribution or underwriting of stocks, bonds, debentures, notes

or other securities that may be permissible for a national bank

subsidiary but are not permissible for a national bank directly. In

this proposal, the FDIC also requires that an insured state nonmember

bank file a 30-day advance notice before the bank's subsidiary may

engage in other activities not permissible for a national bank directly

that may be permissible for a national bank subsidiary. This 30-day

advance notice is designed to allow the FDIC to review any such

activity and consider whether safety and soundness considerations make

it prudent that conditions be placed on FDIC's consent to allow such

activities. The FDIC believes it gave sufficient notice in its August

26, 1997, proposal to amend part 362 that the FDIC could adopt a final

rule governing the insured state nonmember bank subsidiaries that

engage in the public sale, distribution or underwriting of stocks,

bonds, debentures, notes or other securities that are not permissible

for a national bank that are permissible for national bank

subsidiaries. However because regulatory text was not provided in its

earlier proposal, the FDIC believes that it is appropriate to provide

an additional opportunity for public comment before approving a final

rule to govern insured state nonmember bank subsidiaries that engage in

the public sale, distribution or underwriting of stocks, bonds,

debentures, notes or other securities that may be permissible for a

national bank subsidiary but are not permissible for a national bank.

A. Requirements for Securities Activities

There are three general reasons the FDIC proposes the imposition of

certain standards upon a state nonmember bank seeking to engage in the

sale, distribution or underwriting of stocks, bonds, debentures, notes

or other securities that may be permissible for a national bank

subsidiary but are not permissible for a national bank itself: to

ensure the bank is independent and operated in a manner consistent with

safe and sound banking practices; to protect the insurance fund (the

FDIC wants to avoid claims against the bank arising out of the public's

misperception as to with whom it is dealing and in what capacity); and

to comply with section 21 of the Glass-Steagall Act (12 U.S.C. 378),

which prohibits securities companies from taking deposits and banks

from engaging in certain securities activities. The FDIC has attempted

to meet these goals in a manner that minimizes the burden to insured

state nonmember banks without jeopardizing the FDIC's goals.

Thus, the FDIC proposal contains more flexible physical separation

standards than exist in the current version of Sec. 337.4. The FDIC

views these proposed physical separation standards, coupled with the

comprehensive requirements that include affirmative disclosures,

investment limits, transaction requirements and capital standards, as

adequate to protect bank safety and soundness, maintain the legal

separation between the bank and its subsidiary and avoid customer

confusion.

The FDIC also proposes to eliminate the different treatment of

state nonmember bank subsidiaries depending upon the type of securities

underwritten by the subsidiary. Instead, the FDIC is focusing on

prudent management policies and practices, and the sufficiency of the

subsidiary's capitalization. Additionally, the FDIC proposes to

eliminate the tiered approach to the securities activities of the

subsidiary, which limited for five years the underwriting by a new

subsidiary to investment quality debt securities, investment quality

equity securities, mutual funds that invest exclusively in investment

quality equity securities and/or investment quality debt securities.

Section 337.4 currently does not permit a subsidiary to engage in the

public sale, distribution or underwriting of stocks, bonds, debentures,

notes or other securities that are not permissible for a bank under

section 16 of the Glass-Steagall Act, unless the subsidiary meets the

bona fide definition and the activities are limited to underwriting of

investment quality securities. Later, a subsidiary can engage in

additional underwriting if it meets the definition of a bona fide

subsidiary 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.

Current Sec. 337.4 requires a bona fide subsidiary 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 section 16 are

not counted toward the bank's capital; that is, the investment in the

subsidiary is deducted before compliance with capital requirements is

measured.

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 cannot be conducted by the bank itself is very small.

These subsidiaries engage in the underwriting of debt and equity

securities and distribution and management of mutual funds.

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

[[Page 66342]]

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.

B. Notice Requirement for Other Activities Generally

Under a safety and soundness standard, subpart B of the revised

part 362 requires insured state nonmember bank subsidiaries engaging in

certain enumerated activities to meet certain standards established by

the FDIC, even if the OCC has determined that the activity in question

is permissible for a subsidiary of a particular national bank. Under

the modifications contained in this proposal, the FDIC would obtain the

opportunity to review situations in which a state nonmember bank

subsidiary seeks to engage in any activity determined by the OCC to be

permissible for a national bank through its subsidiary, rather than

through the national bank itself. This review would be analogous to the

safety and soundness evaluation undertaken by the OCC with respect to

operating subsidiary applications filed under Sec. 5.34(f) of its rules

(12 CFR 5.34(f)). It also would provide the FDIC with an opportunity to

impose appropriate conditions on the operations of the subsidiary. The

FDIC's Board of Directors wants to ensure that the FDIC can make a

determination if there are adverse effects on the safety and soundness

of the insured state nonmember bank and reserve authority to impose

appropriate conditions.

C. Authority

The FDIC's action in proposing this regulation is fully within the

agency's authority and is consistent with its stated goal of

safeguarding the safety and soundness of insured state nonmember banks.

The courts have recognized that defining what constitutes an unsafe or

unsound banking practice in a particular fact situation is within the

domain of the banking agencies. The United States Court of Appeals for

the Fifth Circuit, on two occasions, stated that ``[o]ne of the

purposes of the banking acts is clearly to commit the progressive

definition and eradication of such practices to the expertise of the

appropriate regulatory agencies.'' Groos National Bank v. Comptroller

of the Currency, 573 F.2d 880, 897 (5th Cir. 1978); First National Bank

of LaMargue v. Smith, 610 F.2d 1258, 1265 (5th Cir. 1980). The United

States Court of Appeals for the D.C. Circuit has stated with regard to

the OCC's authority under section 8 of the Federal Deposit Insurance

Act (12 U.S.C. 1818)--one of the statutory provisions from which the

FDIC derives authority for this rulemaking--that ``the Comptroller is

entitled to accomplish his regulatory responsibilities over ``unsafe

and unsound'' practices both by cease and desist proceedings and by

rules defining and explicating the practices which in his discretion he

finds threatening to a stable and effective national banking system.''

Independent Bankers Association of America v. Heimann, 613 F.2d 1164,

1169 (D.C. Cir. 1979). In his testimony on financial modernization, the

FDIC's Chairman recently confirmed the view that barriers between

banking and commerce should be lowered cautiously and incrementally

with safeguards to protect the insured bank.5

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\5\ See ``Testimony on Financial Modernization'' of Andrew C.

Hove, Jr., Chairman, Federal Deposit Insurance Corporation, Before

the Subcommittee on Finance and Hazardous Materials, Committee on

Commerce, United States House of Representatives, July 17, 1997.

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Under the proposed regulation, the FDIC is not waiving its right to

address on a case-by-case basis practices, conduct, or acts that are

not specifically addressed by this regulation which it finds constitute

unsafe and unsound practices. The FDIC will continue to monitor bank

direct and indirect involvement in securities activities and will take

whatever future action is appropriate.

The FDIC requests comments about all aspects of this 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. Majority-owned Subsidiaries Engaging in the Public Sale,

Distribution or Underwriting of Stocks, Bonds, Debentures, Notes or

Other Securities That Are Not Permissible for a National Bank Under

Section 16 of the Banking Act of 1933

1. Description of the Rule

In connection with its recent adoption of restrictions, under

subpart A of part 362, for insured state bank subsidiaries seeking to

engage in the sale, distribution or underwriting of stocks, bonds,

debentures, notes or other securities that are not permissible for a

national bank and its subsidiary, the FDIC has determined that such

activities may involve risk. The FDIC consequently requires insured

state banks to file a notice to conduct this activity through a

majority-owned subsidiary. As long as the FDIC does not object to the

notice, the bank may conduct the activity in compliance with the

requirements set out in the rule. The fact that prior consent is not

required by subpart A does not preclude the FDIC from taking any

appropriate action with respect to the activities if the facts and

circumstances warrant such action.

In developing the proposed amendments under consideration here, the

FDIC did not see a need for differing treatment based on whether the

insured state nonmember bank subsidiaries that engage in the public

sale, distribution or underwriting of stocks, bonds, debentures, notes

or other securities that are not permissible for a national bank are

engaging in a similar activity that is permissible for a national bank

subsidiary. In either instance, the proposal would provide the same

comprehensive structure for insured state nonmember bank subsidiaries

that engage in the public sale, distribution or underwriting of stocks,

bonds, debentures, notes or other securities that are not permissible

for a national bank.

Thus, the standards being proposed as amendments to subpart B

addressing safety and soundness concerns are the same as those that

were adopted in subpart A in the final rule. The difference is that the

activities addressed in subpart A are not permissible for a national

bank subsidiary while the activities addressed in subpart B are those

that are permissible for a national bank subsidiary. Thus, the

activities addressed in subpart A are addressed primarily under the

authority found in section 24 of the FDI Act whereas the activities

addressed in subpart B are addressed under the authority found in

section 8 of the FDI Act.

The revised language would be located in subpart B of part 362 and

would become part of proposed Sec. 362.8(a).

Subpart A of part 362 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. In subpart A, the FDIC

grouped the exception for insured state bank subsidiaries that engage

in the public sale, distribution or underwriting of stocks, bonds,

debentures, notes or other securities that are not permissible for a

national bank together with the real estate exception in the structure

of the regulation to promote uniform standards across activities. In a

parallel fashion in subpart B, the FDIC proposes to group the exception

for insured state nonmember banks that acquire or establish

subsidiaries that engage in the public sale, distribution or

underwriting of stocks, bonds, debentures, notes or other securities

that are permissible for

[[Page 66343]]

a national bank only through a subsidiary together with the real estate

exception in the structure of the regulation, to promote uniform

standards across activities.

Similarly, the authority, constraints and notice process refers

back to subpart A and incorporates the same requirements and

limitations as govern securities underwriting activities thereunder. In

both instances the proposal would require the insured state nonmember

bank and its subsidiary to meet and continue to meet the following

standards to engage in the activity after notice to the FDIC, rather

than making a full application:

1. The bank must meet the requirements for an ``eligible depository

institution;'' 6

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\6\ An ``eligible depository institution'' is a depository

institution that: (1) Has been chartered and operating for at least

three years or is in an acceptable holding company structure; (2)

received an FDIC-assigned composite UFIRS rating of 1 or 2 at its

most recent examination; (3) received a rating of 1 or 2 under the

``management'' component of the UFIRS at its most recent

examination; (4) received at least a satisfactory CRA rating from

its primary federal regulator at its last examination; (5) received

a compliance rating of 1 or 2 from its primary federal regulator at

its last examination; and (6) is not subject to any corrective or

supervisory order or agreement.

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2. The bank must be well capitalized after deducting its investment

in the subsidiary;

3. The subsidiary must be an ``eligible subsidiary;'' 7

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\7\ An entity is an ``eligible subsidiary'' if it: (1) Meets the

capital requirements; (2) is physically separate and distinct in its

operations; (3) maintains separate accounting and other records; (4)

observes separate business formalities; (5) has a chief executive

officer who is not an employee of the bank; (6) has a majority of

its board of directors who are neither directors nor officers of the

state-chartered depository institution; (7) conducts business

pursuant to independent policies and procedures; (8) has only one

business purpose; (9) has a current written business plan that is

appropriate to the type and scope of business conducted by the

subsidiary; (10) has adequate management; and (11) establishes

policies and procedures to ensure adequate computer, audit and

accounting systems, internal risk management controls, and has the

necessary operational and managerial infrastructure to implement the

business plan.

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4. The bank and the subsidiary must comply with the investment

limits, transaction requirements and collateralization requirements in

dealing with each other;

5. The bank must adopt policies and procedures to govern its

participation in financing transactions arranged by the subsidiary;

6. The bank may not express an opinion of value or advisability of

securities underwritten by the subsidiary unless the customer is

notified of the bank's relationship with the subsidiary;

7. The subsidiary must be registered with SEC and agree to notify

the regional office of any material actions against the subsidiary by

any state authorities or the SEC; and

8. The bank may not buy securities underwritten by the subsidiary

as principal or fiduciary unless the bank's board of directors

approves.

The proposed requirements are uniform with other part 362 notice

procedures for insured state bank subsidiaries to engage in activities

not permissible for national banks or their subsidiaries, and would

recognize the level of risk present in subsidiaries that engage in the

public sale, distribution or underwriting of stocks, bonds, debentures,

notes or other securities that are not permissible for a national bank

itself. These requirements are not all presently found in Sec. 337.4

but the FDIC believes that only banks that are well-run and well-

managed should be given the opportunity to engage in securities

activities that are not permissible for a national bank under the

streamlined notice procedures. These criteria are imposed as expedited

processing criteria rather than substantive criteria. Banks not meeting

these criteria that want to engage in these activities should be

subject to the scrutiny of the application process. Although operations

not permissible for a national bank are conducted and managed by a

separate majority-owned subsidiary, such activities are part of the

analysis of the consolidated financial institution. The condition of

the institution and the ability of its management are an important

component in determining if the risks of the securities activities will

have a negative impact on the insured institution.

When the FDIC initially implemented Sec. 337.4 on securities

activities of subsidiaries of insured state nonmember banks, the FDIC

determined that some risk may be associated with those activities. The

FDIC continues to see a need to address that risk. The FDIC requests

comment on the application of these safeguards to these activities,

including 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, Public Law 104-

67; and the efficacy of more limited restrictions on officer and

director interlocks to prevent both liability and information sharing

and any related issues.8

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\8\ 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. 77o and section

20 of the Securities and Exchange Act of 1934, 15 U.S.C. 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

section 15 or section 20. 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 faith and

nonparticipation. See First Interstate Bank of Denver, N.A. v.

Pring, 969 F.2d 891 (10th Cir. 1992), rev'd on other grounds, 511

U.S. 164 (1994); Arena Land & Inv. Co. Inc. v. Petty, 906 F. Supp.

1470 (D. Utah 1994); San Francisco-Oklahoma Petroleum Exploration

Corp. v. Carstan Oil Co., Inc., 765 F.2d 962 (10th Cir. 1985);

Seattle-First National Bank v. Carlstedt, 978 F. Supp. 1543 (W.D.

Okla. 1987). However, to the extent that any securities underwriting

liability may have been reduced due to the enactment of The Private

Securities Litigation Reform Act of 1995, Pub .L. 104-67, then the

FDIC's concerns regarding controlling person liability may be

reduced. It is likely that the FDIC will want to await the

development of the standards under this new law before taking

actions that could risk liability on a parent bank that has a

subsidiary that engages in the public sale, distribution or

underwriting of stocks, bonds, debentures, notes or other securities

that are not permissible for a national bank.

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2. Substantive Changes to the Subsidiary Underwriting Activities

Generally, these proposed amendments to subpart B, as compared to

the current provisions of Sec. 337.4 governing the state nonmember bank

subsidiaries that engage in the public sale, distribution or

underwriting of stocks, bonds, debentures, notes or other securities

that are not permissible for a bank under section 16 of Glass-Steagall,

have been streamlined to make compliance easier. In addition, state

nonmember banks that deem any particular constraint to be burdensome

may file an application with the FDIC to have the constraint removed

for that bank and its majority-owned subsidiary.

The FDIC has proposed to eliminate those constraints that were

deemed to overlap with other requirements or that could be eliminated

and still maintain safety and soundness. The FDIC has determined that

it can adequately monitor other securities activities through its

regular reporting and examination processes. We invite comment on

whether the elimination of the other notices now found in Sec. 337.4,

such as the notice requirement for any

[[Page 66344]]

securities activity in Sec. 337.4(d), is appropriate.

The FDIC proposes the removal of the customer disclosures currently

contained in Sec. 337.4. Instead, the FDIC will be relying on the

Interagency Statement on the Retail Sale of Nondeposit Investment

Products (FIL-9-94,9 February 17, 1994) (or any successor

requirement) as applicable guidance to ensure that appropriate

disclosures are made when the subsidiary's products are sold on bank

premises, are sold by bank employees or are sold when the bank receives

a referral fee. While the current regulation requires disclosures,

those disclosures are similar but not identical to the disclosures

required by the Interagency Statement. This change makes compliance

easier. Comments submitted to the FDIC in connection with its recent

revisions to subpart A of part 362 support this change and recognize

that any retail sale of nondeposit investment products to bank

customers under such circumstances are subject to the Interagency

Statement. The FDIC requests comment on whether the Interagency

Statement provides adequate disclosures for retail sales in a

securities subsidiary and whether required compliance with that policy

statement needs to be specifically mentioned in the regulatory text.

Comment is invited on whether any other disclosures currently in

Sec. 337.4 should be retained or if any additional disclosures would be

appropriate.

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\9 \ Financial institution letters (FILs) are available in the

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

Washington, D.C. 20429.

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The FDIC proposes to continue to impose many of the safeguards

found in section 23A of the Federal Reserve Act (12 U.S.C. 371c) and to

impose the safeguards similar to section 23B of the Federal Reserve Act

(12 U.S.C. 371c-1). The FDIC requests comment on the restrictions that

have been removed, including whether any of these restrictions should

be reimposed for securities activities. The FDIC also invites

suggestions for further improvements.

The FDIC proposes that the notice period be shortened from the

existing 60 days to 30 days and that the required notice and

application procedures be located in subpart G of part 303. Previously,

specific instructions and guidelines on the form and content of any

applications or notices required under Sec. 337.4 were found within

that section.

With regard to any insured state nonmember banks that have been

engaging in these activities under a notice filed and in compliance

with Sec. 337.4, the proposed regulation would allow those activities

to continue under the terms of that approval. This result differs from

the approach set out in Sec. 362.5(b) (applicable to state banks

engaging in securities activities impermissible for a national bank and

its subsidiary), which requires that the bank and its majority-owned

subsidiaries meet the core eligibility requirements, the investment and

transaction limitations, and capital requirements contained in

Sec. 362.4(c), (d), and (e). The FDIC did not consider the additional

requirements to be necessary in subpart B, because we are not aware of

any insured state nonmember banks having subsidiaries that are

underwriting only securities that would fall under subpart B. We

believe that any subsidiaries that are underwriting the types of

securities regulated under subpart B already are required to follow the

continuation requirements found in subpart A.

3. Notice for Change in Circumstances

The final rule in subpart A applicable to state banks engaging in

securities activities impermissible for a national bank and its

subsidiary (Sec. 362.4(b)(5)) requires the bank to provide written

notice to the appropriate Regional Office of the FDIC within 10

business days of a change in circumstances. A change in circumstances

is described as a material change in a subsidiary's business plan or

management. Under the proposal, subpart B incorporates this requirement

by reference. The FDIC believes that it can address a bank's falling

out of compliance with any of the other requirements of the regulation

through the normal supervision and examination process.

B. Other Activities Permissible for Subsidiaries of a National Bank

That Are Not Permissible for a National Bank

In this proposal, the FDIC requires that an insured state nonmember

bank file a 30-day advance notice before the bank's subsidiary may

engage in other activities not permissible for a national bank that may

be permissible for a national bank subsidiary. This 30-day advance

notice is designed to allow FDIC to review any such activity and

consider whether safety and soundness considerations make it prudent

that conditions be placed on FDIC's consent to allow such activities.

Since section 24 was enacted, the OCC has confirmed through its

rule governing operating subsidiaries that there may be activities that

are permissible for national bank subsidiaries even though the parent

national bank may not conduct them directly. The FDIC needs to review

the activities and assess their safety and soundness in determining

whether the activity is appropriate for an insured state nonmember

bank's subsidiary. The FDIC also needs to determine whether any

conditions should be placed on the conduct of that activity. The FDIC

cannot assess the activities that may be approved in the future and

adopt specific standards to govern those activities. This safety and

soundness review and, if appropriate, the imposition of conditions

should be done on a case-by-case basis. The FDIC has elected to limit

its review to a 30-day period to limit the burden from this

requirement.

IV. Additional Requests for Comments

The FDIC is specifically requesting comments that address the

following:

(1) What criteria should the FDIC use to decide whether an activity

that is permissible for a national bank subsidiary but not permissible

for the national bank may be conducted in a safe and sound fashion by a

subsidiary of an insured state nonmember bank?

(2) Should activities that are permissible for a national bank

subsidiary but are not permissible for the national bank be limited to

subsidiaries of insured state nonmember banks of a certain asset size,

with a certain composite rating, etc.?

(3) What are the likely competitive effects of authorizing insured

state nonmember banks to engage (through subsidiaries) in activities

that are permissible for a national bank subsidiary but are not

permissible for the national bank?

(4) Alternately, are there other approaches or methods which would

facilitate access without compromising traditional safety and soundness

concerns?

Comments addressing these issues and any other aspects of the

general subject of permitting subsidiaries of insured state nonmember

banks to engage in activities that are permissible for a national bank

subsidiary but are not permissible for the national bank will be

welcomed.

V. Paperwork Reduction Act

In accordance with the Paperwork Reduction Act of 1980 (44 U.S.C.

3501 et seq.) the FDIC may not conduct or sponsor, and a person is not

required to respond to, a collection of information unless it displays

a currently valid Office of Management and Budget (OMB) control number.

The collection of information contained in this proposed rule has been

submitted to

[[Page 66345]]

OMB for review. Comments on the collection of information should be

sent to the desk officer for the agencies: Alexander T. Hunt, Office of

Information and Regulatory Affairs, Office of Management and Budget,

New Executive Office Building, Room 3208, Washington, DC 20503. Copies

of comments should also be sent to: Steven F. Hanft, FDIC Clearance

Officer, Office of the Executive Secretary, Federal Deposit Insurance

Corporation, 550 17th Street, NW, Washington, DC 20429, (202) 898-3907.

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]]. For further information on the Paperwork Reduction

Act aspect of this rule, contact Steven F. Hanft at the above address.

Comment is solicited on:

(i) Whether the proposed collection of information is necessary for

the proper performance of the functions of the agency, including

whether the information will have practical utility;

(ii) The accuracy of the agency's estimate of the burden of the

proposed collection of information, including the validity of the

methodology and assumptions used;

(iii) The quality, utility, and clarity of the information to be

collected; and

(iv) Ways to minimize the burden of the collection of information

on those who are to respond, including through the use of appropriate

automated, electronic, mechanical, or other technological collection

techniques or other forms of information technology, e.g., permitting

electronic submission of responses.

Title of the collection: The proposed rule will modify an

information collection previously approved by OMB titled ``Activities

and Investments of Insured State Banks'' under control number 3064-

0111.

Summary of the collection: Generally, the collection includes the

description of the activity in which an insured state bank or its

subsidiary proposes to engage that would be impermissible absent the

FDIC's consent or nonobjection, and information about the relationship

of the proposed activity to the bank's and /or subsidiary's operation

and compliance with applicable laws and regulations.

Need and Use of the information: The FDIC uses the information to

determine whether to grant consent or provide a nonobjection for the

insured state bank or its subsidiary to engage in the proposed activity

that otherwise would be impermissible pursuant to section 8 of the FDI

Act and 12 CFR part 362.

Proposed changes to the collection: The proposed rule will modify

the collection in two ways. First, by adding, at Sec. 362.8(a)(2), the

requirement of a notice to the FDIC before the state nonmember bank

through a subsidiary engages in either the public sale, distribution or

underwriting of stocks, bonds, debenture, notes or other securities if

those activities are permissible for a national bank subsidiary but are

not permissible for the national bank itself. Second, by adding, at

Sec. 362.8(b), the requirement of a notice to the FDIC before the state

nonmember bank through a subsidiary engages in activities that are

permissible for a national bank subsidiary but are not permissible for

the national bank itself. The contents of both notices are described at

Sec. 303.121(b) of the final part 362 rule also published in today's

Federal Register.

Respondents: Banks or their subsidiaries desiring to engage in

activities that would be impermissible absent the FDIC's consent or

nonobjection.

Estimated annual burden resulting from this proposed rulemaking:

Frequency of response: Occasional

Number of responses: 1

Average number of hours to prepare a response: 8 hours

Total annual burden: 8 hours

VI. Regulatory Flexibility Act Analysis

Pursuant to section 605(b) of the Regulatory Flexibility Act, the

FDIC certifies that this proposed rule will not have a significant

economic impact on a substantial number of small entities. As noted

above in connection with the Paperwork Reduction Act, the FDIC

estimates that the incidences in which insured state nonmember banks

will be required to file a notice under the rule will be infrequent,

and will not require significant time to complete. Furthermore, the

proposed rule streamlines requirements for insured state nonmember

banks. It simplifies the requirements that apply when insured state

nonmember banks conduct certain securities activities through majority-

owned corporate subsidiaries. Whenever possible, the rule clarifies the

expectations of the FDIC when it requires notices or applications to

consent to activities by insured state banks. The proposed rule will

make it easier for small insured state banks to locate the rules that

apply to their investments.

List of Subjects

12 CFR Part 303

Administrative practice and procedure, Authority delegations

(Government agencies), Bank deposit insurance, Banks, banking, Bank

merger, Branching, Foreign branches, Golden parachute payments, Insured

branches, Interstate branching, Reporting and recordkeeping

requirements, Savings associations.

12 CFR Part 337

Banks, banking, Reporting and recordkeeping requirements, Savings

associations, Securities.

12 CFR Part 362

Administrative practice and procedure, Authority delegations

(Government agencies), Bank deposit insurance, Banks, banking, Insured

depository institutions, Investments, Reporting and recordkeeping

requirements.

For the reasons set forth above and under the authority of 12

U.S.C. 1819(a) (Tenth), the FDIC Board of Directors hereby proposes to

amend 12 CFR chapter III as follows:

PART 303--FILING PROCEDURES AND DELEGATIONS OF AUTHORITY

1. The authority citation for part 303 continues to read as

follows:

Authority: 12 U.S.C. 378, 1813, 1815, 1816, 1817, 1818, 1819

(Seventh and Tenth), 1820, 1823, 1828, 1831a, 1831e, 1831o, 1831p-1,

1835a, 3104, 3105, 3108, 3207; 15 U.S.C. 1601-1607.

2. In Sec. 303.122, the first sentence of paragraph (a) and the

first sentence of paragraph (b) are revised to read as follows:

Sec. 303.122 Processing.

(a) Expedited processing. A notice filed by an insured state bank

seeking to commence or continue an activity under Sec. 362.4(b)(3)(i),

Sec. 362.4(b)(5), Sec. 362.8(a)(2), or Sec. 362.8(b) of this chapter

will be acknowledged in writing by the FDIC and will receive expedited

processing, unless the applicant is notified in writing to the contrary

and provided a basis for that decision. * * *

(b) Standard processing for applications and notices that have been

removed from expedited processing. For an application filed by an

insured state bank seeking to commence or continue an activity under

Sec. 362.3(a)(iii)(A), Sec. 362.3(b)(2)(i), Sec. 362.3(b)(2)(ii)(C),

Sec. 362.4(b)(1), Sec. 362.4(b)(2), Sec. 362.4(b)(4), Sec. 362.5(b)(2),

Sec. 362.8(a)(2), or Sec. 362.8(c) of this chapter or for notices which

are not processed pursuant to the expedited

[[Page 66346]]

processing procedures, the FDIC will provide the insured state bank

with written notification of the final action as soon as the decision

is rendered. * * *

PART 337--UNSAFE AND UNSOUND BANKING PRACTICES

4. The authority citation for part 337 continues to read as

follows:

Authority: 12 U.S.C. 375a(4), 375b, 1816, 1818(a), 1818(b),

1819, 1820(d)(10), 1821(f), 1828(j)(2), 1831f, 1831f-1.

Sec. 337.4 [Removed and Reserved]

5. Sec. 337.4 is removed and reserved.

PART 362--ACTIVITIES OF INSURED STATE BANKS AND INSURED SAVINGS

ASSOCIATIONS

6. The authority citation for part 362 continues to read as

follows:

Authority: 12 U.S.C. 1816, 1818, 1819(a) (Tenth), 1828(m),

1831a, 1831e.

Subpart B--Safety and Soundness Rules Governing Insured State

Nonmember Banks

7. In Sec. 362.6, remove the third sentence and add two sentences

in its place to read as follows:

Sec. 362.6 Purpose and scope.

* * * The following standards shall apply for insured state

nonmember banks to conduct either real estate investment or to engage

in the public sale, distribution or underwriting of stocks, bonds,

debentures, notes or other securities through a subsidiary if those

activities are permissible for a national bank subsidiary but are not

permissible for the national bank itself. The FDIC also requires that

notices be filed before insured state nonmember banks conduct any other

activities through a subsidiary if those activities are permissible for

a national bank subsidiary but are not permissible for a national bank.

* * *

8. In Sec. 362.8, revise paragraph (a), redesignate paragraph (b)

as paragraph (c) and add new paragraph (b) to read as follows:

Sec. 362.8 Restrictions on activities of insured state nonmember

banks.

(a) Real estate investment or engaging in the public sale,

distribution or underwriting of stocks, bonds, debentures, notes or

other securities through a subsidiary if those activities are

permissible for a national bank subsidiary but are not permissible for

the national bank itself. The FDIC Board of Directors has found that,

depending on the facts and circumstances presented by a particular

case, real estate investment or engaging in the public sale,

distribution or underwriting of stocks, bonds, debentures, notes or

other securities activities may have adverse effects on the safety and

soundness of an insured state nonmember bank. Therefore, an insured

state nonmember bank may not establish or acquire a subsidiary that

engages in such real estate investment or in the public sale,

distribution or underwriting of stocks, bonds, debentures, notes or

other securities activities unless the insured state nonmember bank:

(1) Has an approval previously granted by the FDIC and continues to

meet the conditions and restrictions of the approval; or

(2) Meets the requirements for engaging in real estate investment

or securities underwriting activities (as relevant) as set forth in

Sec. 362.4(b)(5), and submits a corresponding notice under Sec. 303.121

and Sec. 303.122(a) of this chapter to which no objection is taken by

FDIC, or applies for and obtains the FDIC's consent in accordance with

the procedures of Sec. 303.121 and Sec. 303.122(b) of this chapter.

(b) Other activities permissible for subsidiaries of a national

bank that are not permissible for a national bank. The FDIC Board of

Directors has found that depending on the facts and circumstances of a

particular case, the conduct of an activity in a subsidiary of an

insured state nonmember bank that is not permissible for a national

bank may have adverse effects on the safety and soundness of the

insured state nonmember bank. The FDIC Board of Directors has found

that the FDIC cannot make a determination whether there are adverse

effects on the safety and soundness of an insured state nonmember bank

engaging through a subsidiary in an activity not permissible for a

national bank but permissible for a subsidiary of a national bank,

unless the FDIC has had an opportunity for prior review of the

activities. Therefore, an insured state nonmember bank may not

establish or acquire a subsidiary that engages in such an activity

unless the insured state nonmember bank obtains the FDIC's consent.

Consent will be given only if the FDIC determines the activity poses no

adverse effects on the safety and soundness of the insured state

nonmember bank. Notices should be filed in compliance with

Secs. 303.121 and 303.122(a) of this chapter. Approvals granted under

Sec. 303.122(a) of this chapter may be made subject to any conditions

or restrictions found by the FDIC to be necessary to protect the

deposit insurance funds from risk, prevent unsafe or unsound banking

practices, and/or ensure that the activity is consistent with the

purposes of federal deposit insurance and other applicable law. If the

FDIC previously granted an approval to the insured state nonmember bank

to engage in the activity, the bank need not file another notice under

this section.

* * * * *

By order of the Board of Directors.

Dated at Washington, DC, this 5th day of November 1998.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.

[FR Doc. 98-31151 Filed 11-30-98; 8:45 am]

BILLING CODE 6714-01-P