Activities of Insured State Banks and Insured Savings Associations

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 has

revised and consolidated its rules and regulations governing activities

and investments of insured state banks and insured savings

associations. The rule implements sections 24, 28, and 18(m) of the

Federal Deposit Insurance Act, and also establishes certain safety and

soundness standards pursuant to the FDIC's authority under section 8.

The FDIC's final rule establishes a number of new exceptions and allows

institutions to conduct certain activities after providing the FDIC

with notice rather than filing an application. Subject to appropriate

separations and limitations, the activities that may be conducted

through a majority-owned subsidiary under these expedited notice

processing criteria are real estate investment and securities

underwriting. The FDIC combined its regulations governing the

activities and investments of insured state banks with those governing

insured savings associations. In addition, the FDIC's final rule

updates its regulations governing the safety and soundness of

securities activities of subsidiaries and affiliates of insured state

nonmember banks. The FDIC's final rule modernizes this group of

regulations and harmonizes the provisions governing activities that are

not permissible for national banks with those governing the securities

underwriting and distribution activities of subsidiaries of state

nonmember banks. The FDIC's final rule makes a number of substantive

changes and amends 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 FDIC's final rule also conforms most of the

disclosures required under the current regulation to the Interagency

Statement on the Retail Sale of Nondeposit Investment Products.

EFFECTIVE DATE: January 1, 1999.

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

Section 303 of the Riegle Community Development and Regulatory

Improvement Act of 1994 (RCDRIA) required 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 reviewed part 362

``Activities and Investments of Insured State Banks,'' subpart G of

Part 303, effective October 1, 1998, (formerly Sec. 303.13) ``Filings

by Savings Associations'', and Sec. 337.4 ``Securities Activities of

Subsidiaries of Insured State Banks: Bank Transactions with Affiliated

Securities Companies'', and proposed making a number of changes to

those regulations. That proposal is found in the September 12, 1997,

issue of the Federal Register at 62 FR 47969.

The FDIC's final rule restructures existing part 362, placing the

substance of the text of the current regulation into new subpart A.

Subpart A addresses the Activities of Insured State Banks implementing

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. Through

this new final rule, the FDIC introduces a new streamlined notice

processing concept for insured state nonmember banks that want to

engage in certain activities that are impermissible for national banks

and their subsidiaries.

Due to the experience that the FDIC has gained in reviewing

applications from insured state nonmember banks since the enactment of

section 24, the FDIC has standardized the eligibility criteria and

conditions for two activities. This mechanism gives insured state

nonmember banks a level of certainty that has been lacking for banks

that want to diversify their earnings and maintain their

competitiveness by investing in subsidiaries that engage in activities

not permissible for national banks. This framework sets forth the

eligibility criteria and conditions for majority-owned subsidiaries of

insured state nonmember banks to engage in real estate investment and

securities underwriting. This framework allows insured state nonmember

banks to proceed with their business plans in these areas with relative

certainty that the FDIC will consent to the execution of their plans

and with assurance that consent will be forthcoming on a predictable

schedule. This framework allows the insured state nonmember banks to be

creative and innovative in their business plan within the structure

appropriate to the activities being undertaken. The FDIC hopes that

this rule will assist the insured state nonmember banks as they

progress into the competitive financial environment of the 21st century

in which they operate their business.

The FDIC's final rule moves the part of the FDIC's regulations

governing securities underwriting not permissible for national banks

(currently at 12 CFR 337.4) into subpart A of part 362. Although the

proposal contemplated that the entire regulation, Securities Activities

of Insured State Nonmember Banks, found in Sec. 337.4 of this chapter

would be removed and reserved, we have postponed that action while

redeveloping some of the safety and soundness criteria that govern

insured state bank subsidiaries that engage in the public sale,

distribution or underwriting of securities and other activities that

are not permissible for a national bank but that are permissible for

national bank subsidiaries. The redeveloped regulatory language that

will amend subpart B of this regulation is published as a proposed rule

elsewhere in this issue of the Federal Register for further public

comment. During the period that Sec. 337.4 still exists, where

activities are covered by both Sec. 337.4 and this final rule, we have

provided relief from the requirements of Sec. 337.4 in this rulemaking.

For those activities that were covered under Sec. 337.4 and are now

covered under this part 362, we have attempted to modernize the

regulations governing those activities by updating the requirements,

revising the 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.

[[Page 66277]]

Safety and Soundness Rules Governing Insured State Nonmember Banks

is found in the new subpart B. Subpart B establishes 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.

Subpart G of part 303, effective October 1, 1998, (formerly

Sec. 303.13) of this chapter which relates to activities and filings by

savings associations is revised in a number of ways. First, the

substantive portions applicable to state savings associations of

subpart G are placed in new subpart C of part 362. The substantive

requirements applicable to all savings associations when Acquiring,

Establishing, or Conducting New Activities through a Subsidiary are

moved to new subpart D.

In the proposal, subpart E contained the revised application and

notice procedures as well as delegations of authority for insured state

banks, and subpart F contained the revised application and notice

procedures as well as delegations of authority for insured savings

associations. On a parallel track, the FDIC has completed its revision

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

substantially all of the FDIC's applications procedures and delegations

of authority. Subparts G and H of part 303 were designated as the place

where the text of subparts E and F of our proposed rule would be

located. As a part of the part 303 review process and for ease of

reference, the FDIC is removing the applications procedures relating to

activities and investments of insured state banks from part 362 and

placing them in subpart G of part 303. The procedures applicable to

insured savings associations are consolidated in subpart H of part 303.

These subparts are published as an amendment to part 303 as a part of

this final regulation.

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).

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. 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. In addition, section 24 prohibits

the subsidiary of an insured state bank from directly or indirectly

engaging as principal in any activity that is not permissible for a

national bank subsidiary 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.

Subpart G of Part 303, effective October 1, 1998, (formerly

Sec. 303.13) of the FDIC's regulations (12 CFR 303.140) implements FDI

Act sections 28 (12 U.S.C. 1831e) and 18(m) (12 U.S.C. 1828(m)). 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 between the two provisions which

caused the implementing regulations to differ in some respects.

Section 18(m) of the FDI Act 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 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

(12 U.S.C. 1464(t)) (HOLA). 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 established 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 established procedures to give

prior notice for the establishment or acquisition of a subsidiary or

the conduct of new activities through a subsidiary. Section 303.13 was

recently moved with stylistic, but not substantive changes, to subpart

G of part 303, effective October 1, 1998 of the FDIC's regulations.

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, including activities that are impermissible for

banks directly under section 16 of the Banking Act of 1933

[[Page 66278]]

(12 U.S.C. section 24 (seventh)), commonly known as the Glass-Steagall

Act. For those subsidiaries that engage in underwriting activities that

are prohibited for a bank, the regulation requires that these

subsidiaries qualify as bona fide subsidiaries, establishes transaction

restrictions between a bank and its subsidiaries or other affiliates

that engage in such securities activities, 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 such a securities subsidiary 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 1996 proposed rule)

to amend part 362. Under that proposed rule, a notice procedure would

have replaced the application currently required in the case of real

estate, 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. While the August 1996 proposed rule would

have amended existing part 362, this new final rule replaces existing

part 362.

After considering the comments to the August 1996 proposed rule and

reconsidering the issues underlying the current regulation, the FDIC

withdrew that proposed rule in favor of the more comprehensive approach

presently adopted. One major change was the elimination of a life

insurance policy and annuity contract investment notice due to

intervening guidance provided by the Office of the Comptroller of the

Currency (OCC) that 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.

II. Description of the Final Rule

The FDIC divided part 362 into four subparts and changed some of

the structure of the rule. Generally, 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. Next we deleted most of the provisions relating to

divesture because we found them to be unnecessary due to the passage of

time. Third, we combined the rules covering the equity investments of

banks and savings associations into part 362 to regulate these

investments as consistently as possible given the limitations imposed

by the different statutes that govern each kind of insured institution.

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

final regulation does not incorporate sections 23A and 23B of the

Federal Reserve Act by cross-reference; rather, the regulation adapts

similar principles to those set forth in sections 23A and 23B to the

bank/subsidiary relationship as appropriate. In drafting the final

rule, 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. We are comfortable that 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 final rule deals 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 essentially

becomes subpart A under the current proposal. The procedural provisions

of existing part 362 have been transferred to subpart G of part 303.

Subpart A addresses the activities of insured state banks in

Sec. 362.3. The activities carried on in subsidiaries of insured state

banks are addressed separately in Sec. 362.4.

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

regulation requires subsidiaries of insured state nonmember banks

engaged in certain activities to meet the standards established by the

FDIC, even if the OCC determines that those activities are permissible

for a national bank subsidiary. The FDIC has determined that real

estate investment activities may pose significant risks to the deposit

insurance funds. For that reason, the FDIC established standards that

an insured state nonmember bank must meet before engaging in real

estate investment activities that are not permissible for a national

bank, even if they are permissible for the subsidiary of a national

bank.

Subpart B also establishes 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 only covers 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.

In addition, 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 bank itself unless the

standards established under the proposed regulation are met.

Subpart C of the final rule concerns the activities and investments

of insured state savings associations. The substantive provisions

applicable to activities of savings associations currently appearing in

subpart G of part 303, effective October 1, 1998, (formerly

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 are treated consistently with the

treatment accorded insured state banks. Thus, we revised a number of

definitions currently contained in subpart G of part 303 to track the

definitions used in subpart A of part 362.

Subpart D of the final rule 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 and current subpart G of part 303. We moved this

requirement to a new subpart to accommodate Federally chartered savings

associations by limiting the

[[Page 66279]]

amount of regulation text they would have to read to learn how to

comply with this statutory notice.

III. Comment Summary

The FDIC received 129 comments in response to the proposed

regulation. The overall comments generally favored the FDIC's approach

to streamlining the consent process for banks and savings associations

to engage in activities using standardized criteria with seven comments

specifically supporting the FDIC's efforts to streamline these rules.

Comments were received from 102 financial institutions, 2 one bank

holding companies, 3 state banking departments, 14 trade associations,

2 investment companies, 4 Congressmen, 1 federal banking regulator and

1 individual.

The overwhelming majority of the comments (107), primarily from

Massachusetts, were focused on concerns over proposed changes to the

standards governing holding equity securities in subsidiaries by banks

having grandfathered authority to hold the securities at the bank

level. We have responded to these comments by reinstating the exception

for a grandfathered bank to hold equity securities in a subsidiary. A

complete discussion of this issue is found in the section by section

analysis.

With regard to the structure of the rule and the consolidation of

the banking and savings activities into a single rule, five comments

expressly supported the FDIC's efforts to accomplish these goals.

However, one comment suggested using a table like the Office of Thrift

Supervision (OTS) has used to aid understanding this complex and

difficult regulation. Three comments support cross-referencing the

Interagency Statement rather than restating disclosure requirements. A

readability analysis was submitted by one individual and, based upon

the results, the individual questioned whether the FDIC was successful

in achieving the stated objective of using plain English. This

individual offered his services to the FDIC as a writing consultant.

Other general comments observed that diversifying into new activities

increases safety and soundness and were pleased that the FDIC supports

state institutions' exercising of new powers. Two comments indicated

that in the preamble, the FDIC had overstated the authority of the FRB

to impose more stringent standards on any activity conducted by a state

member bank. This statement is derived from section 24(i); however, we

intended to refer to those activities not permissible for national

banks. At least one bank and the state banking departments advocate

further streamlining of the regulations to make it easier for banks to

use their capital through subsidiaries. The bank suggested that banks

must have more flexibility to keep their capital in the banking system,

rather than paying out more dividends to shareholders. Although we

favor diversifying the banks' income stream and making bankers'

compliance burden as light as possible, we also are charged with

maintaining safety and soundness and meeting the requirements of

section 24 of the FDI Act. Thus, we strive to balance these interests

in crafting more flexible regulations.

Most of the remaining comments addressed the substance of the

regulation and provided constructive feedback on the regulation text.

Two comments focusing on the Purpose and Scope Section suggested a

definition of what is meant by ``acting as principal,'' although we

already had a definition of ``as principal.'' Two comments objected to

the FDIC accepting the time period imposed by the National Bank Act on

real estate that is acquired for debts previously contracted as a

limitation that carries over to state banks. We believe that the

authority of a national bank to own real estate is governed by the

statute and that this limitation is inherent in that authority. Thus,

we believe that a state bank is constrained by this same limitation

unless relief can be granted by the FDIC. Relief may be granted by the

FDIC only if the state bank transfers the property to a majority-owned

subsidiary with appropriate capital and complies with whatever other

constraints the FDIC deems adequate to protect the deposit insurance

fund from significant risk.

In the definitions section, eight comments requested that we expand

the definition of majority-owned subsidiary to include limited

liability companies and limited partnership interests. One comment

suggested that the qualified housing exception also include limited

liability companies. Four comments expressed concern over the change to

the definition of ``change of control.'' Four comments expressed

concern about the change to the definition of ``significant risk to the

deposit insurance fund.'' One comment suggested a definition of

``investment in subsidiary'' and further clarification of the items to

be included in debt and equity.

With regard to the activities of insured state banks, two comments

supported the FDIC's new interpretation of when the ``in an amount''

limitation is applicable. Six comments addressed insurance activities,

including three addressing the appropriate disclosures. Five comments

addressed the change in the measurement of the applicable capital limit

for adjustable rate and money market preferred stock. Six comments

addressed the 4(c)(8) list (closely related to banking) activities,

including specific alternatives on real estate leasing. One comment

supported the change in the qualified housing projects exception to

conform the meaning of lower income to that used in the community

reinvestment regulations in defining low and moderate income.

With regard to the activities of subsidiaries of insured state

banks, one comment thought the control concept was unnecessary for

lower tier subsidiaries. Over one hundred ten comment letters addressed

the various issues involving the holding of equity securities through a

majority-owned subsidiary, with the overwhelming majority of the

comments coming from Massachusetts banking interests to advocate not

changing the constraints governing banks in that state owning

grandfathered equity securities in a subsidiary. Several of these

comment letters identified more than one issue. Twenty comments

addressed the issues involved with engaging in real estate investment

activity through a majority-owned subsidiary. Nine comments addressed

the issues identified in securities underwriting activity through a

majority-owned subsidiary. Eleven comments addressed the eligible

depository institution criteria. Twelve comments addressed the eligible

subsidiary criteria and generally expressed the view that the eligible

subsidiary was an improvement over the bona fide subsidiary concept

found in the old rule. Seventeen comments addressed the investment and

transaction limits criteria. Eight comments were directed to the way

the capital requirements operate. One comment said that banks should

have the option of complying with original conditions or the new rule.

With regard to the real estate activities covered by subpart B,

five comments addressed this issue and generally thought that the FDIC

should not impose additional regulations on state nonmember banks.

With regard to subpart C governing savings associations, one

comment expressed the view that thrifts do not know what is permissible

for national banks and needed greater specificity in the regulation.

There were no comments on subpart D; however, no substantive change was

made to this statutory filing requirement.

[[Page 66280]]

With regard to subparts E and F governing the notice and

application processing and content, two comments were received in favor

of firmer processing deadlines.

IV. Section by Section Analysis

A. Subpart A--Activities of Insured State Banks

Section 362.1 Purpose and Scope

As described in the preamble accompanying the proposal, included

within the proposed changes to the regulation was the inclusion of a

purpose and scope paragraph describing the statutory background,

intent, and nature of items covered by this subpart. Several commenters

acknowledged the FDIC's efforts to restructure the regulation and

agreed that the proposed reorganization simplifies what continues to be

complex material. These commenters stated that the use of purpose and

scope paragraphs helps clarify the coverage of each subpart.

The intent of Sec. 362.1 is to clarify that the purpose and scope

of subpart A is to ensure that 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. Subpart A 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, conducted as trustee, or conducted in any substantially

similar capacity. As explained in the preamble accompanying the

proposal, we moved this language from Sec. 362.2(c) of the former

version of part 362 where the term ``as principal'' was 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. Agency activities are not covered by the

regulations because 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 is 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, this language was moved to

the purpose and scope paragraph in the proposal.

Comments addressing the proposed treatment of ``as principal'' were

submitted by two industry trade groups. One group agreed that moving

the applicable language to the purpose and scope paragraph helps

clarify that section 24 does not apply to activities conducted in an

agency or similar capacity. However, both commenters recommended that

the FDIC define ``as principal'' by specifying what is meant by acting

as principal rather than providing a list of capacities exempt from

that definition. In other words, the commenters desired a definition

consisting of an inclusive list rather than a list of exemptions.

Additionally, one commenter expressed concern that the current list of

exempt capacities may omit certain agency-like roles. As such, the

commenter recommended that the FDIC include ``substantially similar

capacities'' in the list of capacities that are not considered to be

conducted ``as principal''.

The FDIC continues to believe that including the ``as principal''

language in the purpose and scope paragraph provides clarity regarding

activities coming within the scope of section 24. As such, the FDIC

elects not to separately define ``as principal'', and has deleted as

redundant an overlapping definition of ``as principal'' contained in

Sec. 362.2(c) of the proposal. Additionally, the FDIC cannot reasonably

list all capacities that will be considered to be ``as principal''.

Therefore, the FDIC is not persuaded that changing the nature of the

definition to an inclusive list of capacities that are considered ``as

principal'' would alleviate confusion. Instead, ``as principal''

activities will continue to be described as being all capacities other

than the listed exceptions. The FDIC nonetheless agrees that the

current list may exclude certain agency-like roles and is therefore

adding the phrase ``or in any substantially similar capacity'' to the

regulatory language of Sec. 362.1(b)(1). Also, the FDIC has added a

list of examples of activities that are not ``as principal'' to provide

the public with additional guidance.

The preamble of the proposal also explains that equity investments

acquired in connection with debts previously contracted (DPC) are not

within the scope of this subpart when held within the shorter of the

time limits prescribed by state or federal law. The exclusion of equity

investments acquired in connection with DPC was moved from the

definition of ``equity investment'' in the former regulation 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. 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. 85619, which interprets and applies the

National Bank Act) or no later than the time permitted under state law

if that time period is

[[Page 66281]]

shorter. Of course, a state bank permitted to hold such interests under

state law may apply to the FDIC for consent to continue to hold the

real property through a majority-owned subsidiary. In the final rule,

the FDIC has added some general information about the manner in which a

national bank may hold DPC.

Two commenters objected to the FDIC imposing the national bank

holding period limits on insured state banks if those limits are

shorter than otherwise permitted under state law. One commenter

suggested applying a ``reasonable time period'' divestiture standard

similar to that concerning equity securities acquired DPC. The holding

periods governing a national bank's ability to own real estate acquired

DPC are contained within section 29 of the National Bank Act (12.

U.S.C. 29). Because a national bank can hold real estate acquired DPC

in limited circumstances, section 24 only allows a state bank to hold

such interests under the same constraints, i.e., for a maximum of 10

years. Conversely, section 29 does not contain divestiture periods for

equity securities acquired DPC and the FDIC has therefore elected to

defer to a ``reasonable time'' standard. However, due to the statutory

limitation in section 29, no changes are made to the exception for real

estate acquired DPC and the regulation will continue to apply the

holding periods in the manner proposed.

As discussed in the proposal's preamble, the intent of the insured

state bank in holding equity investments acquired in connection with

DPC is also relevant to the analysis of whether the equity investment

is permitted. Any interest taken DPC may not be held for investment

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

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

that property. However, if those expenditures and actions are not

permissible for a national bank, the property will not fall within the

DPC exception. For an additional example, if the bank's actions are

speculative in nature or go beyond what is necessary and prudent in

order for the bank to recover on the loan, a national bank would not be

permitted to take these actions. The FDIC expects bank management to

document that DPC property is being actively marketed; 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, the proposal also moved to the purpose and scope

paragraph language governing any interest in real estate in which the

real property is (1) 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 (2) used as public welfare investments of

a type permissible for national banks. Again, this language was moved

from the definition of ``equity investment'' in the former regulation

to highlight this issue, provide clarity, and alert the reader of this

rule that such investments are not within the scope of this subpart. 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

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 within no more than

ten years (12 CFR part 34). We understand that the time periods set

forth in the OCC's regulations 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 make its own judgment to

determine when a reasonable time has elapsed for holding property for

future premises.

The purpose and scope paragraph also explains that a subsidiary of

an insured state bank may not engage in activities that are 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 certain activities

that are not permissible for a subsidiary of a national bank.

Additionally, 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 that 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 the definitions applicable to

this subpart. Most definitions are unchanged from those used in the

current regulation. Nonetheless, the proposal contains edits to enhance

clarity and readability, define additional terms, and delete certain

definitions as unnecessary.

To standardize as many definitions as possible, we incorporated the

following definitions from section 3 of the FDI Act (12 U.S.C. 1813):

``depository institution'', ``insured state bank'', ``bank'', ``state

bank'', ``savings association'', ``state savings association'',

``insured depository institution'', ``federal savings association'',

and ``insured state nonmember bank''. This standardization required

that we delete the definitions of the first two terms, ``depository

institution'' and ``insured state bank'', currently found in part 362.

No substantive change was intended by this modification. The remaining

terms were added by reference to provide clarity throughout the

proposed part 362 because we incorporate many of the definitions from

subpart A into the other part 362 subparts. The FDIC received no

comments concerning these changes and is therefore adopting the

referenced definitions as proposed.

Several definitions were carried forward in the proposal from the

current regulation either unchanged or containing only minor edits to

enhance clarity or readability without changing the meaning. The

following definitions

[[Page 66282]]

were carried forward without any substantive meaning changes:

``control'', ``extension of credit'', ``executive officer'',

``director'', ``principal shareholder'', ``related interest'',

``national securities exchange'', ``residents of state'',

``subsidiary'', and ``tier one capital''. Again, the FDIC received no

comments on the referenced definitions which are adopted as proposed.

The name of one definition was simplified without substantively

changing its meaning. The subject definition was formerly found in

Sec. 362.2(g) and was described as follows ``an insured state bank will

be considered to convert its charter''. This definition is now provided

by Sec. 362.2(f) and is named ``convert its charter''. No commenters

addressed this simplified title which is adopted as proposed.

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'' were deleted in

the proposed and final rule because the substance of the information

contained in those definitions was incorporated into the scope

paragraph in Sec. 362.1. When developing the proposal, the FDIC

concluded that moving the information contained in these definitions to

the scope paragraph made the coverage of the rule clearer.

Additionally, placing this information at the beginning of the subpart

is consistent with the purpose of a scope paragraph. Some readers may

save time by realizing sooner that the regulation may be inapplicable

to conduct contemplated by a particular bank. It also may be more

logical for the reader to consider the scope paragraph to determine the

rule's applicability, rather than having to rely on the definition

section. Moreover, we concluded that it would be unnecessary to

duplicate this same information in the definition section. The FDIC

received no specific comments on the proposed treatment, but

respondents commenting on the overall structure of the proposal

generally favored the use of the purpose and scope paragraphs. The

final regulation incorporates the changes as proposed. The proposed

definition of ``as principal'' at Sec. 362.2(c) duplicates material set

out in the scope section at Sec. 362.1(b)(1), and has therefore been

eliminated in the final rule. Appropriate definitional language has

been added to Sec. 362.1(b)(1).

The proposal also 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 concluded

that it was unnecessary to continue to restate this information in the

definition section of the regulation. No substantive change is intended

by the simplification of this language. Further, 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.

Conforming changes were made to the definition of ``equity

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

``equity interest in real estate''. Additionally, the remaining part of

the ``equity investment'' definition was shortened and edited to

enhance readability. This definition is intended to encompass an

investment in an equity security, partnership interest, or real estate

as it did in the former regulation. No substantive changes were

intended by the changes described in this or the preceding paragraph.

The FDIC received no comments on these changes which are adopted as

proposed.

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

the definition by deleting references to circumstances where holding

equity securities is permissible for national banks, such as when

equity securities are held as a result of a foreclosure or other

arrangements concerning debts previously contracted. Language

discussing the exclusion of DPC and other investments that are

permissible for national banks was relocated to the scope paragraph for

the reasons previously stated. Like the exceptions concerning equity

investments in real estate, no substantive change is intended by the

relocation of the subject exceptions to the purpose and scope

paragraph. No comments were received on this proposed treatment which

is adopted as proposed.

The definitions of ``investment in a department'' and

``department'' were deleted because they are no longer needed in the

revised regulation text. The core standards applicable to a department

of a bank are detailed in Sec. 362.3(c) and defining the term

``department'' is therefore unnecessary. If a calculation of an

``investment in a department'' needs to be made, the FDIC intends to

defer to governing state law. As a result, a definition of ``investment

in a department'' is unnecessary and was deleted. There were no

comments addressing the removal of these definitions.

Similarly, we deleted the definition of ``investment in a

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

regulation text. Amounts subject to the investment limits of

Sec. 362.4(d) are listed clearly in that subsection. The FDIC opted to

list amounts subject to investment limits in Sec. 362.4(d) to separate

those debt-type investments from the equity-type investments subject to

the capital treatment of Sec. 362.4(e). The regulation also contains

other investment limits applicable to both debt and equity investments.

Because of these different types of investment limits, the FDIC did not

find a single ``investment in a subsidiary'' definition helpful.

Therefore, the FDIC has elected not to incorporate such a definition

despite a request by one commenter. However, as the same commenter

suggested, the FDIC has attempted to clearly delineate amounts subject

to the various investment limits, transaction restrictions, and capital

requirements when applicable through both the regulation text and the

corresponding preamble language.

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). Including these criteria as a part of the

substantive regulation text in the referenced subsection, rather than

as a definition, makes reading the rule easier and the meaning clearer.

No commenters addressed this treatment. Comments concerning the various

elements of the eligible subsidiary criteria are discussed elsewhere in

this preamble under the appropriate section.

The regulation 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'' 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 ``lower income'' definition is relevant for purposes of

applying the

[[Page 66283]]

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 will 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. This change

has the effect of expanding the housing projects that qualify for the

exception. The FDIC received one comment addressing the altered

definition with the respondent favorably noting and supporting the

resultant effect. The final regulation adopts this change as proposed.

The regulation includes an altered definition of the term

``activity''. As modified, the definition includes both activities and

investments. Where equity investments are intended to be excluded from

a particular section of the regulation, we expressly exclude those

investments in the regulatory text. Previously, the term ``activity''

was defined differently depending upon whether it was used in

connection with the direct conduct of business by an insured state bank

or in connection with the conduct of business by a subsidiary of the

bank. This change was made both to simplify the regulation and to

reflect the section 24 definition of ``activity''. No comments were

received on this proposed change.

It is noted that no comments were received regarding the proposed

suggestion also to modify the ``activity'' definition to incorporate a

recent interpretation by the agency that determined that the act of

making a political campaign contribution does not constitute an

``activity'' for purposes of part 362. The referenced interpretation

uses a three prong analysis 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.

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 factor,

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 factor 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 factor 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 in and of itself

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

deposits. If at least two of the factors 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. Because of the

lack of interest received on expanding the definition to reflect this

interpretation, no change is made to the definition proposed. The FDIC

intends to continue to apply the above analysis when determining

whether particular conduct should be considered an activity.

The definition of ``real estate investment activity'' was shortened

to mean 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. Additionally, it is used in Sec. 362.8

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 but that would not be permissible for a national bank itself. The

proposed definition contained a parenthetical excluding real estate

leasing from the definition of real estate investment activities. By

excluding leasing from the proposed ``real estate investment activity''

definition, the FDIC was attempting to clearly separate leasing

activity from other real estate investment activities.

Under the current regulation, banks and their majority-owned

subsidiaries are allowed to engage in real estate leasing under the

regulatory exceptions enabling them to engage in activities closely

related to banking.1 These regulatory exceptions were

carried forward in the proposal. However, the FDIC is concerned about

certain activities encompassed within this section. For example, the

4(c)(8) list includes real estate leasing. When an individual or entity

engages in leasing activity as the lessor of a particular parcel, the

landlord has an ownership interest in the underlying real estate. Under

section 24 of the FDI Act, insured state banks are limited in their

ability to own real estate. We are concerned that an insured state bank

could consider this regulation and its certain conditions as the FDIC

having permitted the bank or its majority-owned subsidiaries to own

real estate interests that would not be permissible for a national bank

or a subsidiary of a national bank. To prevent insured state banks from

attempting to use this consent to leasing activity as a way to avoid

the corporate separations, transaction limitations and restrictions,

and capital treatment applicable to other real estate investment

activities, the proposed definition expressly excluded leasing.

Additionally, the FDIC was attempting to ensure that banks using the

notice procedure to engage in real estate investment activities were

not, in effect, operating a commercial business by virtue of the terms

of the leasing activity.

---------------------------------------------------------------------------

\1\ These regulatory exceptions were provided by

Sec. 362.4(c)(3)(ii)(A) and (B) depending upon whether conducted by

the bank or through a majority-owned subsidiary, respectively. The

exceptions provided that insured state banks or their majority-owned

subsidiaries could engage in principal in activities that the FRB by

regulation or order has found 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)).

---------------------------------------------------------------------------

The FDIC recognizes, however, that the proposed definition would

have effectively prevented an insured state bank's majority-owned

subsidiary that was proceeding under the notice procedure from leasing

property that it is otherwise permitted to own or develop.2

As a result, the insured state bank would have been required to submit

an application to seek further consent from the FDIC to lease real

property it was allowed to own. To correct this anomaly, the FDIC has

deleted the parenthetical from the definition and deals with the

activities of real estate leasing and other real estate investment

activities separately as discussed elsewhere in this preamble. The

subject definition is otherwise unchanged from the proposal.

---------------------------------------------------------------------------

\2\ Provided it meets the conditions imposed by

Sec. 362.4(b)(5).

---------------------------------------------------------------------------

The final rule includes a modified definition of ``company'' to

which we added limited liability companies to the list of entities

considered to be a company. This change was made to recognize the

creation of limited liability companies and their growing prevalence in

the market place. Four

[[Page 66284]]

commenters suggested explicitly adding limited liability partnerships

to the list of business structures included in the ``company''

definition. The FDIC believes the suggested change is unnecessary

because limited liability partnerships are already included in the

definition through the term ``partnership''.

As proposed, the FDIC adopted the modified definition of

``significant risk to the fund'' with 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. Our

interpretation of the definition remains unchanged. Significant risk to

the deposit insurance fund is 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 1992 (57 FR 53220, November 9, 1992) indicated that the

FDIC recognizes that no investment or activity may be said to be

without risk under all circumstances and that such a 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 definition

emphasizes that there is a high degree of likelihood under all of the

relevant 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

is not 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 a risk to the fund be found only if a particular

activity or investment is expected to result in the imminent failure of

a bank. The suggestion was rejected in 1992 as the FDIC determined that

it was inappropriate to approach the issue this narrowly in light of

the legislative intent.

Four commenters addressed the proposed change to the wording of

this definition. One industry trade association complimented the

change. However, two other groups expressed concern that the added

sentence results in a definition that is overly broad, and a state bank

stated that the change makes the definition incoherent. The latter

three commenters expressed concern that the added sentence contains no

qualifications or limitations. These commenters state that numerous

activities may negatively impact the condition of an institution or may

contribute to deterioration in the overall banking system without

causing loss to the insurance fund. The commenters suggest that section

24 requires the FDIC to consider the extent of the impact before

determining that an activity presents a significant risk to the fund.

The FDIC agrees with the commenters that consideration must be given to

the extent that a negative event may harm an institution or the overall

banking industry. However, the FDIC believes that both sentences

contained in the definition must be read together. The second sentence

clarifies that significant risk is present whenever there is a high

probability that an activity or an equity investment will or could

result in a loss to an insurance fund administered by the FDIC,

regardless of whether the loss results from one or multiple

institutions. After consideration of the comments and the wording, the

FDIC adopts the expanded definition as proposed.

The proposal 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 state. Importing the

capital definitions used by the various state-chartered depository

institutions should simplify the calculations when they deal with their

appropriate federal banking agency. The other terms defined under

Sec. 362.2(x) of the current regulation were deleted as unnecessary due

to the other changes in the regulation text.

The proposal added definitions of the following terms: ``change in

control'', ``institution'', ``majority-owned subsidiary'', ``security''

and ``state-chartered depository institution.''

After reconsideration of the proposed definition of ``change in

control'', the FDIC decided to adopt certain changes to bring the

definition back into substantive consistency with the broader reach of

the term as is provided by the current regulation. The change in

control definition comes into play primarily in connection with section

24's grandfather with respect to common or preferred stock listed on a

national securities exchange and shares of registered investment

companies. Section 24 states that the grandfather ceases to apply if

the bank converts its charter or undergoes a change in control.

The definition proposed at Sec. 362.2(c) covered any instance in

which the bank 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 or FRB's regulations implementing

section 7(j), or in which the bank is acquired by or merged into a bank

that is not eligible for the grandfather. This proposed definition

eliminated two other instances which the current regulation, at

Sec. 362.3(b)(4)(ii), treats as a change in control: 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 (section 3

transactions), and a transaction in which control of the bank's parent

company changes (parent control changes).

In the preamble to the proposal, the FDIC indicated that

elimination of the section 3 transactions and the parent control

changes would bring the definition more in line with what constituted a

true change in control. For example, the section 3 transaction language

in the current rule would encompass all mergers between the holding

company of a grandfathered bank and another bank holding company,

regardless of which holding company was the survivor. However, upon

further reflection, the FDIC has decided that total elimination of the

section 3 transactions would create anomalous results. If a controlling

interest in a grandfathered bank was acquired by an unrelated holding

company (which requires approval under section 3), it is difficult to

argue how this is materially less of a change in control than if

control of the bank was acquired by an individual in a section 7(j)

transaction. Still, there are cases in which a rigid application of the

section 3 transactions would reach too far. In contrast to the example

in which a bank holding company acquires control of a grandfathered

bank, the FRB's approval under section 3 is required if a bank holding

company acquires anything more than five percent of any outstanding

class of a bank's voting shares. The revised definition at

Sec. 362.2(c) contained in the final rule therefore includes

transactions subject to section 3 approval only when a bank holding

company acquires control of a grandfathered bank through the section 3

transaction. The current exclusion for one bank holding

[[Page 66285]]

company formations also is maintained in the final rule.

Also, the elimination of the parent control changes in the proposed

rule created potentially confusing ambiguities, particularly when

coupled with the elimination of the section 3 transactions. For

example, if the holding company of a bank eligible for the grandfather

is acquired and merged into an unrelated bank holding company (again,

which requires approval under section 3), it is difficult to argue how

this is materially less of a change in control than if the bank itself

was merged with an unrelated bank. But the merger and acquisition

language in the proposed definition referred only to the bank itself.

The final rule expands the merger language to holding companies,

accordingly. As another example, it is difficult to argue that a

transaction requiring the holding company of a grandfathered bank to

submit a change in control notice under section 7(j) is materially less

of a change in control than a transaction requiring the grandfathered

bank itself to file such a notice, and the 7(j) language in the

proposed rule did not expressly refer to holding company transactions.

In the final rule, the FDIC has therefore revised the 7(j) language to

clarify its applicability to both scenarios.

The FDIC received three similar comments expressing concern about

the proposed changes to the ``change in control'' definition. The

commenters acknowledge that deleting certain instances from the current

definition reduces the instances in which a bank would lose its

grandfathered rights. Nonetheless, the commenters feel that it is

unclear whether the proposed changes may have also inadvertently

broadened the reach of the remaining transactions causing the

grandfathered right to be terminated. This ambiguity appears to result

from an incomplete understanding of whether the definition continues to

exclude transactions presumed to be a change in control under the

FDIC's and FRB's regulations implementing section 7(j) of the FDI Act.

The FDIC wants to assure commenters that the regulatory language of the

final definition, like that of the proposal, continues to exclude such

presumed changes in control from the events that result in a loss of

the subject grandfathered rights.

One additional commenter took exception to the FDIC's position

concerning the ability to look to the substance of a transaction in

determining whether grandfather rights terminate. The commenter

objected to the FDIC's statement in the preamble to the proposed rule

that state banks should be aware that, depending upon the

circumstances, the grandfather could be considered terminated after a

merger transaction in which an eligible bank is the survivor. For

example, if a state bank that is not eligible for the grandfather is

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

grandfather, the FDIC may determine that in substance the eligible bank

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

The commenter argues that the FDIC's interpretation is inconsistent

with the FDIC's current regulations, and claims that if the FDIC

subjects such transactions to subjective criteria such as relative

asset size, institutions considering mergers or acquisitions will be

disadvantaged because of the uncertainty regarding the potential loss

of grandfathered status. The commenter also asserts that the FDIC's

interpretation is inconsistent with congressional intent because

section 24 did not define change in control; Congress clearly intended

the use of ``change in control'' language in section 24(f)(5) to

reference the meaning of the phrase ``change in control'' established

by the Change in Bank Control Act (CBCA) (12 U.S.C. 1817(j)). In the

commenter's view, since the CBCA predates section 24 by nine years,

Congress intended to use ``change in control'' as a term of art.

The interpretation set out in the preamble to the proposal is

consistent with the FDIC's current regulation and is in fact set out in

the preamble accompanying the FDIC's original adoption of the change in

control provisions under part 362 in 1992. 57 FR 53227 (Nov. 9, 1992).

The commenter's argument takes too narrow a view of section 24(f)(5),

as the FDIC pointed out in proposing the change of control provisions

of current part 362. In light of the broader congressional action under

section 24 to generally prohibit equity investments by state banks

which are not permissible for a national bank, and the limited nature

of the grandfather exception, it is appropriate to define the universe

of events constituting a change in control so as to encompass

transactions constituting a true acquisition. 57 FR 30444 (July 9,

1992). In modifying the change in control provisions of part 362, the

FDIC has narrowed the definition somewhat, as discussed above, to

approximate more closely when a true change in control of the bank has

taken place. If, as the commenter argues, change in control only

includes transactions subject to the CBCA, the exclusion under the CBCA

for all transactions reviewable under the Bank Merger Act (12 U.S.C.

1828(c)) or the Bank Holding Company Act would be brought to bear.

Therefore, the FDIC rejects the arguments provided by the commenter as

being an overly narrow interpretation of the statute.

We defined ``state-chartered depository institution'' and

``institution'' to mean any state bank or state savings association

insured by the FDIC. These definitions should enhance readability and

eliminate ambiguity concerning the subject terms. Defining

``institution'' enables us to shorten the drafting of the rule. No

comments were received regarding these definitions which are adopted as

proposed.

Additionally, the proposal added a definition of ``majority-owned

subsidiary'' which was defined to mean any corporation in which the

parent insured state bank owns a majority of the outstanding voting

stock. This definition was added to clarify our intention that

expedited notice procedures only be available when an insured state

bank interposes an entity providing 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

such entities in a notice procedure.

Eight commenters objected to the FDIC's decision to construct the

definition around the corporate form of business. The commenters were

unanimous in suggesting that the FDIC expand the definition to include

limited liability companies (LLCs), limited liability partnerships

(LLPs), and limited partnerships. Several of the commenters note that

these forms of business have been in existence in many states for a

number of years, and they project that the presence of such

[[Page 66286]]

structures will continue to increase given the tax benefits, limited

liability, and flexible structure provided by these business forms. The

respondents contend that these business forms sufficiently insulate the

members and partners from liability. One commenter noted that they are

aware of no significant judicial challenge to the liability insulation

provided by these business forms. As such, the commenter asserts that

the proposed definition contravenes congressional intent because it

does not recognize a business form that would provide limited liability

to the insured state bank. Finally, the commenters note that both the

FRB and the OCC have recently permitted the limited liability

organizational form for operating subsidiaries.

Limited liability partnerships and companies are both relatively

new business forms. There is little definitive legal guidance

concerning the liability protection offered by these organizational

structures. Among the unresolved issues is the question of how to

structure the management of LLCs and LPs to afford the same level of

separateness provided by the corporate form under the eligible

subsidiary criteria. Because of the limited existing case law regarding

piercing the veil of LLCs and LLPs, the FDIC is unable to determine the

appropriate objective separation criteria that will provide the parent

bank with substantially the same liability protection offered by an

independent corporate structure. Thus, we have not expanded the

definition to include LLCs and LLPs at this time. The FDIC views this

decision to preclude LLCs and LLPs as consistent with the agency's

interpretation of the congressional intent to limiting liability for

subsidiaries' activities from accruing to the insured state bank.

The effect of the FDIC's decision is that the notice process is

limited to banks with subsidiaries organized using the corporate form.

We encourage banks to submit applications when they want to use an

alternative business form. Then, the banks can propose appropriate

objective separations that fit the particular activity and the FDIC can

evaluate these separations on a case-by-case basis. At some future

date, more standardized criteria may emerge. Then, the FDIC may

consider re-visiting this issue. The FDIC does not intend any exclusion

of these forms by omitting them from the notice processing criteria.

They simply do not allow for the more limited review involved in an

expedited notice processing system.

Although the FDIC requires the first level majority-owned

subsidiary to be a corporation, it is noted that the final regulation

contains a provision, at Sec. 362.4(b)(3), allowing lower level

subsidiaries to assume other business forms including LLCs and LLPs.

Please refer to the applicable discussion of this section elsewhere in

this preamble.

The final rule also incorporates 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.

Section 362.3 Activities of Insured State Banks

Equity Investment Prohibition. Section 362.3(a) 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 (as restated in the current

regulation and carried forward in the final regulation) applies. As

discussed in the preamble accompanying the proposal, the final

regulation eliminates the reference to ``amount'' that is contained in

the current version of Sec. 362.3(a). The FDIC reconsidered our

interpretation of the language of section 24 in which 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 previously interpreted the

language of paragraph (f) as controlling and read that language into

the entire statute. We reconsidered this approach and decided that it

was not the most reasonable construction of this statute and determined

that the language of the earlier paragraph (c) is controlling without

the necessity to import the language of (f). We believe that the second

mention as contained in paragraph (f) should be limited to those items

discussed under paragraph (f). Thus, the language of paragraph (c)

controls when any other equity investment is being considered.

Therefore, we deleted the amount language from the prohibition stated

in the regulation. The FDIC received comments from two parties

expressly approving this revised interpretation.

Exception for subsidiaries of which the bank is majority owner. The

final regulation retains the exception allowing investments in

subsidiaries of which the bank is majority owner 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 affirmatively states that an insured state

chartered bank may acquire or retain investments in these subsidiaries.

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. National banks may own a minority interest in certain

types of subsidiaries. (See 12 CFR 5.34 (1998)). Therefore, an insured

state bank may hold a minority interest in a subsidiary if a national

bank could do so. Thus, section 24 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.

For purposes of the notice procedure, the regulation defines the

business form of a majority-owned subsidiary to be a corporation. As is

discussed above in connection with the definition of a ``Majority-owned

subsidiary'', there may be other forms of business organization that

are suitable for the purposes of this exception such as partnerships or

limited liability companies, but the FDIC prefers to review such

alternate forms of organization on a case-by-case basis through the

application process to assure that appropriate separation between the

insured depository institution and the subsidiary is in place.

To qualify for the exception, the majority-owned subsidiary may

engage only in the activities described in Sec. 362.4(b). The allowable

activities include exceptions to the general statutory prohibition,

some of which have a statutory basis and others of which are derived

through the FDIC's power to create regulatory exceptions.

Investments in qualified housing projects. Section 362.3(a)(2)(ii)

of the final regulation provides an exception for qualified housing

projects. The final regulation combines the language found in two

paragraphs of the current regulation with the resulting paragraph

retaining substantially the same language. Changes were made to clarify

some technical aspects of the manner in which the qualified housing

rules work and are not intended to be substantive. In addition, the

FDIC modified the

[[Page 66287]]

language of the text to remove negative inferences and make the text

clearer.

Under this exception, an insured state bank is allowed to invest 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 a bank to use the

figure reported on the bank's most recent consolidated report of

condition (Call Report) prior to making the investment as the measure

of its total assets. If an investment in a qualified housing project

does not exceed the limit at the time the investment is 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. In the proposal, comment

was 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''.). No comments were received on the legal issue. One

comment applauded our suggestion to expand this statutory exception by

regulation. In the final rule, we have expanded Sec. 362.3(a)(2)(ii) to

permit insured state banks to invest in qualified housing projects as a

limited partner or through a limited liability company.

Although the statutory language in the paragraph allowing an

investment in qualified housing projects explicitly allows only a

limited partnership investment, it does not prohibit other forms of

ownership. For the purpose of this investment and consistent with the

underlying public policy purposes of this statute, we consider limited

liability companies to be substantially equivalent to limited

partnership interests. It is consistent with the FDIC's authority under

the statute to extend the qualified housing projects exception by

regulation to cover the limited liability company form of business

enterprise in this circumstance. Limited partnership interests and

limited liability companies provide similar forms of business

enterprise. Although we have been unwilling to expand the regulatory

exceptions to allow limited liability companies to substitute for

corporate forms of business enterprise where uniform separation

standards were required to protect the bank from the liability of its

subsidiaries that conduct activities not permissible for national bank

subsidiaries, we believe that no similar impediments exist here. We

also acknowledge that we have been reluctant to extend this exception

to limited liability companies in the past when informal

interpretations were requested.3 However, we believe, and no

commenter raised any contrary argument, that it is appropriate to

extend the statutory exception to cover these substantially similar

organizational structures through this regulation. Thus, subject to the

other limitations in the rule, we are allowing by regulation insured

state banks to invest in limited liability companies that invest in the

acquisition, rehabilitation or construction of a qualified housing

project.

---------------------------------------------------------------------------

\3\ See 2 FDIC Law, Regulations, Related Acts (FDIC) 4903; 1994

WL 763183 (F.D.I.C.) and FDIC 94-50, 1994 FDIC Interp. Ltr. LEXIS

89, October 12, 1994.

---------------------------------------------------------------------------

Grandfathered investments in listed common or preferred stock and

shares of registered investment companies. Available only to certain

grandfathered state banks, Sec. 326.3(a)(2)(iii) of the final

regulation carries forward 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. Although there is no substantive change, the FDIC

has modified the language of this section to remove negative inferences

and make the text clearer.

To use the grandfathered authority, section 24 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 references contained in

the current regulation describing the notice content and procedures

were deleted because we believe that most, if not all, of banks

eligible for the grandfather already have filed notices with the FDIC.

Thus, we eliminated language governing the specific content and

processing of notices and cross-referencing the notice procedures under

subpart G of part 303. Any bank that has filed a notice need not file

again.

Paragraph (B) of this section of the final regulation 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 grandfather rights terminate. As

is discussed in the preamble above in connection with the definition of

``change in control'', the FDIC has revised both the current and

proposed scope of transactions encompassed in the notion of a change in

control.

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 final

rule without any change except for the deletion of the citation to

specific authorities the FDIC may rely on concerning divestiture.

Rather than containing specific citations, the final regulation merely

references the 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.

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

maximum permissible investment in listed stock and registered shares.

The final regulation limits the bank's investment in grandfathered

listed stock and registered shares, when made, to a maximum of 100

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

Report prior to the investment. The final rule modifies the proposed

regulatory language somewhat, to clarify how the maximum investment

limit is to be determined. The final rule uses the lower of the bank's

cost or the market value of the stock and shares as the measure of

compliance with this limit. The proposal referred to book value. At the

time the FDIC adopted the current version of the rule, call report

instructions and generally accepted accounting principles (GAAP)

provided that equity securities were generally to be carried at the

lower of cost or market value. The FDIC adopted the book value

[[Page 66288]]

approach at that time, in response to industry comments that a market

value approach would exhaust a bank's grandfather authority as the

value of its stock and shares appreciated. Now that call report

instructions and GAAP require stock and shares covered by the rule to

be reported at market value in many cases, the book value approach no

longer serves the desired purpose. The FDIC is expressly referring to

the lower of cost or market approach in the final rule, in order to

maintain consistency with the current rule. The lower of cost or market

approach is also consistent with the federal banking agencies' rules

for determining tier one capital, which require exclusion of net

unrealized holding losses on available-for-sale equity securities with

readily determinable fair values.

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 was deleted, as was 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, the proposed rule 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. The FDIC received

one comment asking that we retain regulatory language describing these

presumptions for well- and adequately-capitalized banks. The commenter

believes that removal of the presumptions will create uncertainty and

may cause banks to hesitate to take full advantage of these investment

opportunities. The FDIC nonetheless believes at this time that it is

not necessary to expressly state these presumptions in the regulation.

However, this action does not alter the FDIC's position regarding the

presumptions.

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) has been 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.

We note that the statute does not impose any conditions or

restrictions on a bank that enjoys the grandfather in terms of per

issuer limits. The proposal invited comment on whether the FDIC should

impose restrictions under the regulation that would, for example, limit

a bank to investing in less than a controlling interest in any given

issuer. Additionally, we asked whether the regulation should

incorporate other limits or restrictions to ensure the grandfathered

investments do not pose a risk. Although no comments specifically

addressed these questions, several commenters referred to the fact that

most institutions to which the grandfather is applicable have already

filed notices with the FDIC regarding those investments. These

institutions have since complied with any imposed conditions, or

subsequently applied to have the conditions altered or removed. The

commenters do not feel that banks should now be subject to requirements

the FDIC did not originally impose. Moreover, the commenters point out

that the FDIC and state banking authorities routinely review investment

portfolios as part of the supervisory process and can address any

deficiencies on a case-by-case basis. Upon further reflection, the FDIC

is persuaded not to impose any new regulatory requirements on these

grandfathered institutions for directly held investments. However, the

FDIC wants to emphasize that it expects banks using this grandfathered

investment authority to establish prudent limits and controls governing

these investments. Equity securities and registered shares that are

held by the bank must be consistent with the institution's overall

investment goals and will be reviewed by examiners in that context. The

FDIC will not take exception to listed stock and registered shares that

are well regarded by knowledgeable investors, marketable, held in

moderate proportions, and meet the institution's overall investment

goals.

Stock investment in insured depository institutions owned

exclusively by other banks and savings associations (banker's banks).

Section 362.3(b)(2)(iv) of the final regulation continues to reflect

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). Note that

the proposal modified this exception to no longer limit the bank's

investment in such depository institutions to ``voting'' stock. This

change was made to allow banks to hold non-voting interests in these

entities because section 24(f)(3)(B) of the FDIC Act does not limit the

exception to voting stock. However, the final regulation retains the

reference to ``voting'' stock in determining the various ownership and

control thresholds. The FDIC received no comments on this provision

which is adopted as proposed.

Stock investments in insurance companies. Section 362.3(a)(2)(v) of

the final regulation incorporates statutory exceptions permitting state

banks to hold equity investments in insurance companies. The exceptions

are provided by statute and are implemented in the current version of

part 362. For the most part, the exceptions are carried forward into

the final regulation with no substantive editing. The exceptions are

discussed separately below.

Directors and officers liability insurance corporations. The first

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. Consistent with the proposal, 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 under this

provision, there is no statutory or regulatory ``aggregate'' investment

limit in all insurance companies, nor does the statute combine these

investments 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. Nonetheless, the FDIC invited comment on whether it should

incorporate aggregate limits on grandfathered bank investments in

insurance companies. Responses addressing this issue were submitted by

two trade associations and one bank consortium. While one trade

association suggested that it would be prudent for the FDIC to

incorporate some form of investment limit, the other two parties

strongly opposed the imposition of any regulatory limit on what are

statutory

[[Page 66289]]

exceptions. The FDIC has elected not to impose aggregate investment

limits on equity investments specifically permitted by statute, nor

will it combine the bank's investments in insurance companies with

other equity investments made pursuant to any regulatory exception.

Instead, the FDIC will continue to address investment concentration and

diversification issues on a case-by-case basis.

Stock of savings bank life insurance company. The second exception

for equity investments in insurance companies permits any insured state

bank located in New York, Massachusetts, or Connecticut to own stock in

savings bank life insurance companies provided that certain consumer

disclosures are made. Again, this regulatory provision mirrors the

specific statutory exception found in section 24. 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.

Consistent with the proposal, the provision implementing this

exception in the current regulation was carried forward into the final

regulation with some modifications. The language describing this

exception was revised to affirmatively permit banks located in New

York, Massachusetts, or Connecticut to own stock in a savings bank life

insurance company provided the company provides the required

disclosures. Additionally, the final regulation alters the required

disclosure from that provided by the current regulation. Rather than

continue the disclosure language currently contained in

Sec. 362.3(b)(3), the FDIC has decided to require disclosures of the

type provided for in the Interagency Statement. As a result, these

companies are required to provide their retail customers with written

and oral disclosures consistent with the Interagency Statement when

selling savings bank life insurance policies, other insurance products,

and annuities. The required disclosures in the Interagency Statement

include a statement that the products are not insured by the FDIC, are

not a deposit or other obligation of, or guaranteed by, the bank, and

are subject to investment risks, including the possible loss of the

principal amount invested. While the existing regulatory language is

similar to the Interagency Statement in what it requires to be

disclosed, it is not identical. The last disclosure--that such products

may involve risk of loss--is not required under the current regulation.

Although commenters generally supported referencing the Interagency

Statement rather than incorporating a different disclosure standard, a

savings bank life insurance company and a United States Congressman

objected to the ``risk of loss'' disclosure. The savings bank life

insurance company claims that a disclosure of that nature is a

falsehood unsupported by factual data. Both commenters are concerned

that the ``risk of loss'' disclosure places savings bank life insurance

companies at a competitive disadvantage relative to other entities

selling life insurance products. The Congressman suggested replacing

the required disclosure concerning ``may involve risk of loss'' with

``may involve market risk, if applicable''.

It is the FDIC's view that FDIC-insured deposits differ from

savings bank life insurance products and annuities because investors in

such products are exposed to a possible loss of the principal amount

invested. The Interagency Statement does not distinguish between the

relative loss exposure presented by various nondeposit investment

products. The distinction is simply between insured deposits and other

investment products. Savings bank life insurance, other insurance

products, and annuities contain an investment risk component exposing

the investor to a loss of principal despite the assertion offered by

one commenter. Further, investors in nondeposit products are exposed to

more than market risks. The FDIC is therefore unwilling to change the

nature of the required disclosure.

Nevertheless, the FDIC recognizes that the language proposed in

Sec. 362.3(a)(2)(v)(B) may be interpreted to mean the subject

disclosure must contain the phrase ``may involve risk of loss''. The

FDIC intends for the disclosures to be consistent with the Interagency

Statement and was simply paraphrasing the respective disclosure content

in the event the Interagency Statement is succeeded by another

statement or regulation. Included in the required disclosures is a

statement specifying that the nondeposit product is ``subject to

investment risks, including possible loss of the principal amount

invested''. The actual Interagency Statement language may convey a less

threatening tone concerning the possibility of loss. To avoid confusion

and reflect the FDIC's actual intent, the phrase ``may involve risk of

loss'' was replaced with ``are subject to investment risks, including

possible loss of the principal amount invested'' in the final rule.

The FDIC is aware that insurance companies, including savings bank

life insurance companies, typically offer annuity products and that

many states regulate annuities through their insurance departments. The

FDIC agrees with the OCC that annuities are investment products that

are subject to the requirements found in the Interagency Statement when

sold to retail customers on bank premises as well as in other instances

specified in the Interagency Statement.

Other activities prohibition. Section 362.3(b) of the final

regulation restates the statutory limit prohibiting insured state banks

from directly or indirectly engaging as principal in any activity that

is not permissible for a national bank. Activity is defined in the rule

as the conduct of business by a state-chartered depository institution

and includes acquiring or retaining any investment. Because acquiring

or retaining an investment is an activity by definition, the proposal

added language to make clear that this prohibition does not supersede

the equity investment exceptions of Sec. 362.3(a)(2). 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 final regulation) applies. The FDIC has also provided a

regulatory exception to the prohibition on other activities concerning

the acquisition of certain debt-like instruments. Insured state banks

desiring to engage in other activities must submit an application to

the FDIC pursuant to Sec. 362.3(b)(2)(i).

Consent through Application. The limit on activities contained in

section 24 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 which grandfathers: (1) Certain insured state

banks 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

[[Page 66290]]

or before September 30, 1991, which was reinsured in whole or in part

by the Federal Crop Insurance Corporation; and (3) certain well-

capitalized banks engaged in insurance underwriting through a

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

regulation with a number of modifications.

The savings bank life insurance exception applies to insured state

banks located in Massachusetts, New York, or Connecticut. To use this

exception, banks must engage in the activity through a department of

the bank meeting the core standards discussed below. The standards for

conducting this activity are taken from the current regulation with the

exception of the disclosure standards which are discussed below. We

moved the requirements for a department from the definitions section to

the substantive portion of the regulation text.

The exception for underwriting federal crop insurance 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 remaining

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, the insured 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 may underwrite only the same type of insurance

that was underwritten as of November 21, 1991, and may operate and have

customers only 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 operating and separation standards. Consistent

with the disclosure requirements of the current regulation, the core

operating standards require 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 responsible 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

regulatory language of the final rule has been changed to clarify that

a bank seeking to operate its department under separation standards

different than the core standards in the rule may submit an application

to the FDIC.

The final regulation eliminates the proposed operating standard

requirement that the department provide customers with written

disclosures consistent with those in the Interagency Statement. The

FDIC proposed replacing the disclosure statement currently imposed by

Sec. 362.4(g)(1)(iii) with that required in the Interagency Statement

to increase consistency and reduce the regulatory burden of differing

requirements. Upon further reflection, the FDIC has decided that while

it is prudent to eliminate the disclosure currently required by part

362, the proposal to impose the Interagency Statement in connection

with this activity in this regulation is unnecessary. Unlike the

statutory exception permitting banks to engage in savings bank life

insurance activities, the authorizing statute does not require a

customer disclosure as a condition of engaging in other grandfathered

insurance activities. Nevertheless, banks engaged in grandfathered

insurance underwriting continue to be subject to the Interagency

Statement in connection with sales to bank customers, including the

disclosure provisions of that statement. Comments support this change

and recognize that any retail sale of nondeposit investment products to

bank customers is subject to the Interagency Statement if made on bank

premises, by a bank employee, or pursuant to a compensated referral.

The FDIC cannot, however, eliminate the regulatory requirement that

insured state banks engaged in savings bank life insurance activities

make disclosures to all consumers. Section 24(e) of the FDI Act

authorizes this activity only if the bank meets the consumer disclosure

requirements. Thus, under the statute, the FDIC must promulgate

consumer disclosures for savings bank life insurance. Section

362.4(c)(1) of the current regulation addresses banks engaging in

savings bank life insurance underwriting activities. The referenced

section requires the bank to make certain disclosures to purchasers of

life insurance policies, other insurance products, and annuities. As

discussed previously in this preamble, these disclosures are similar to

those set out in the Interagency Statement but they are not identical.

Currently, banks engaging in savings bank life insurance underwriting

are covered by the Interagency Statement and part 362. As a result,

banks have been required to comply with both of these similar but

somewhat different requirements. The final regulation replaces the

current disclosure requirement with a cross reference to the

Interagency Statement to make compliance easier. Banks engaging in

savings bank life insurance activities should note, however, that

consistent with the proposal and the current regulation, the final rule

carries forward the requirement that the department also inform

purchasers that only the assets of the insurance department may be used

to satisfy the obligations of the department. Comments and the FDIC's

response are described elsewhere in this preamble.

The core separation standards in the final rule restate the

requirements currently found in the definition of department. These

standards require the department to: (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 permitting the obligations,

liabilities, and expenses to be satisfied only with the assets of the

department. The standards are unchanged from those in the current

regulation, but they have been moved from the definitions section to

ensure that the requirements are shown in connection with the

appropriate regulatory exception.

Acquiring and retaining adjustable rate and money market preferred

stock. 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.

After reviewing comments at that time, 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 these investments possess characteristics

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 or the

regulation and they are

[[Page 66291]]

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. Money market preferred

shares are sold at auction.

Consistent with other parts of the proposal, the FDIC has modified

the exception by limiting the 15 percent measurement to tier one

capital, rather than total capital. Throughout the final regulation,

all capital-based limitations are measured against tier one capital to

increase uniformity within the regulation. The FDIC recognizes 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, institutions wanting to increase their

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

The FDIC received five comments regarding this proposed change.

Although the commenters applaud the desire for consistency, they

contend that the results of such a change are unjustified when done

principally for the sake of uniformity. Thus, the commenters suggest

that the FDIC either leave the measurement base unchanged or increase

the limit to offset the impact of the change. While the FDIC

acknowledges the concerns expressed by commenters, it is not persuaded

that changing the capital base from total to tier one capital creates a

significant hardship. Therefore, the final regulation uses the tier one

capital base to measure the applicable limit. The FDIC will handle

applications to exceed the governing threshold in an expeditious manner

according to procedures detailed in subpart G of part 303.

The final regulation incorporates a provision allowing insured

state banks to acquire and retain other instruments of a type

determined by the FDIC to have the character of debt securities

provided the instruments do not represent a significant risk to the

deposit insurance funds. In response to investor and client needs, the

financial markets continually develop new financial products. A recent

example of such an instrument is trust preferred stock. Trust preferred

stock is a hybrid instrument possessing characteristics typically

associated with debt obligations. Trust preferred securities are issued

by an issuer trust that uses the proceeds to purchase subordinated

deferrable interest debentures in a corporation. The corporation

guarantees the obligations of the issuer trust and agrees to indemnify

third parties for other expenses and liabilities incurred by the issuer

trust. Taken together, the debentures, guarantee, and expense indemnity

agreement constitute a full, irrevocable, and unconditional guarantee

of the obligations of the issuer trust by the issuer corporation. With

the exception of credit risk, investors in trust preferred stock are

protected from changes in the value of the instruments. Like investors

in debt securities, trust preferred stock investors do not share any

appreciation in the value of the issuer trust and have no voting rights

in the management or ordinary course of business of the issuer trust.

Additionally, trust preferred stock is not perpetual and distributions

on the stock resemble the periodic interest payments on debt. In

essence, such investments are functionally equivalent to investments in

the underlying debentures. In the future, as such new instruments come

to the FDIC's attention, the FDIC will provide public notice of its

determinations under the rule by issuing Financial Institution Letters

describing its decisions. Any investments in such instruments would be

aggregated with investments in adjustable rate and money market

preferred stock for purposes of applying the 15 percent of tier one

capital limit.

Activities that are closely related to banking. The language in the

proposal providing a regulatory exception allowing insured state banks

to engage in activities closely related to banking has been eliminated.

The proposed regulation continued language found in the current

regulation entitled ``Activities that are closely related to banking''.

Section 362.3(b)(2)(iv) of the proposal permitted 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)).

However, the proposed exception was subject to the statutory

restrictions prohibiting the bank from directly holding equity

investments that a national bank may not hold or which are not

otherwise permissible investments for insured state banks pursuant to

Sec. 362.3(b). Additionally, the proposal imposed limits on certain of

the activities authorized by the 4(c)(8) reference. Included in the

limits was a provision requiring the bank, when acting as a real

property lessor, to either re-lease the real estate or dispose of the

same within two years after the lease expires.

The FDIC received six comments on this provision, four of them

objecting to the two-year disposition period at the conclusion of a

real estate lease. Another opined that the bank's survival depends on

its ability to diversify by engaging in real estate leasing through a

subsidiary. An industry trade association supports continued reliance

on activities authorized by the FRB pursuant to 4(c)(8) of the Bank

Holding Company Act.

Upon further analysis, the FDIC has deleted the reference to the

4(c)(8) list because the activities included on that list generally are

of a type permissible for national banks. The one exception that

clearly is not generally permissible for a national bank involves real

estate leasing. It is noted that national banks are permitted to engage

in certain real estate leasing activities. As with other activities

permissible for national banks, insured state banks can engage in the

same real estate leasing activities subject to any limitations imposed

by the applicable state law. However, since section 24 of the FDI Act

does not permit the FDIC to allow insured state banks, at the bank

level, to hold equity investments that are not permissible for national

banks, any FDIC authorization for real estate leasing raises a question

whether, under a particular leasing arrangement, the bank as lessor

holds an interest in real estate tantamount to an equity investment.

Given the variety of potential lease structures, it is not practicable

for the FDIC to deal with this issue categorically, under a regulatory

exception, at this time. If authorized under state law, state banks are

permitted to engage in leasing activities through majority-owned

subsidiaries. This exception is discussed in the description of

Sec. 362.4(b) in this preamble.

Guarantee activities. The current regulation contains a provision

that

[[Page 66292]]

permits a state bank with a foreign branch to directly guarantee the

obligations of its customers as set out in what was formerly

Sec. 347.3(c)(1) of the FDIC's regulations without filing any

application under part 362. A technical amendment to part 362 was

recently made to update this reference to Sec. 347.103(a)(1) as

published in the Federal Register on April 8, 1998 (63 FR 17090). The

current regulation 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 these activities are permissible for

a national bank. In its current rule, the FDIC used this provision to

clarify that part 362 does not prohibit these activities. To shorten

the regulation, such clarifying language has been deleted since the

activity is permissible for a national bank. The FDIC received no

comments addressing this provision and it is dropped as proposed.

Section 362.4 Subsidiaries of Insured State Banks

General prohibition. The regulatory language implementing the

statutory prohibition on an insured state bank engaging in ``as

principal'' activities that are not permissible for a national bank is

separated from the prohibition on an insured state bank subsidiary

engaging in activities which are not permissible for a subsidiary of a

national bank. For ease of reference we separated bank and subsidiary

activities. Section 362.4 deals exclusively with activities that may be

conducted in a subsidiary of an insured state bank. Five commenters

supported this restructuring of the regulation. The FDIC believes that

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

the activities that must be or may be conducted by a subsidiary makes

it easier for the reader to focus on the analysis of the regulation.

Therefore, the general prohibition in the final regulation is adopted

as proposed.

Exceptions. First, the regulation provides that activities not

permissible for a national bank subsidiary may not be conducted by the

subsidiary of an insured state bank unless one of the exceptions in the

regulation applies. This language is similar to the current part 362

and we received no comments on the provision. The final regulation

contains no changes to the proposed language.

Consent obtained through application. The revised regulation allows

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. Language from the

current regulation is deleted that expressly provides 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 does 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; however, the issue will 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 more than one subsidiary to conduct the activity or to require

that any additional real estate subsidiaries must be individually

approved.

Application procedures may be used by a bank to request the FDIC's

consent to engage in an activity that is limited but not specifically

prohibited by this part. For instance, the notice procedures require

that the subsidiary take the corporate organizational form. Several

comments expressed concern about the restriction on the form of

business enterprise. Any subsidiary that is organized as a limited

liability company would be required to use the application procedures.

The FDIC does not intend to prohibit insured state banks from

organizing subsidiaries in a form other than a corporation, or to make

it more difficult to establish these other forms of business

enterprise. However, the FDIC would like to review other forms of

organizations, on a case-by-case basis, to satisfy itself that adequate

separations are placed between the bank and its subsidiary. At this

time, we have not found a way to craft standardized separation criteria

for these other forms of business enterprise. No commenters suggested

any criteria. Other requests that do not meet the notice criteria or

that desire relief from a limit or restriction included in the notice

criteria also are encouraged. Application instructions have been moved

to subpart G of part 303.

Consistent with the proposal, the final rule eliminates language

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.

The FDIC received no comment on this change. Therefore, the language is

unnecessary and has been eliminated as proposed.

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 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 regulation provides for

three statutory exceptions that allow subsidiaries to engage in

insurance underwriting, covering ``grandfathered'' insurance

activities, title insurance, and crop insurance.

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.

The current standard that the bank must be well-capitalized has

been changed. Consistent with the proposal, the final rule requires the

bank to be well-capitalized after deducting its investment in the

insurance subsidiary. One comment on this change argues that the risk

involved in insurance underwriting depends upon the type of insurance

and that not all insurance underwriting is inherently risky enough to

justify an automatic capital deduction. The FDIC believes that this

capital treatment is an important element to separate the operations of

the bank and the subsidiary. This treatment clearly delineates and

identifies 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 additional

capital. As a result, the bank's investment in the insurance subsidiary

should not be considered when determining whether the bank has

sufficient capital.

[[Page 66293]]

Another commenter objects to the introduction of the ``capital

deduction'' arguing that providing insurance as principal under the

``grandfather'' provision is not an activity for which a state bank

must obtain a risk to the fund determination. The comment asserts that

the provision is self-operative in the absence of any determination or

regulations of the FDIC, since Congress evaluated the risk to the

insurance funds created by the activity and found that risk to be

acceptable. The FDIC agrees that, other than the requirement that the

bank must be well-capitalized, section 24 itself imposes no additional

conditions or restrictions on the activity. Nevertheless, ever since

the FDIC originally promulgated its part 362 rules regarding the

conduct of this activity, the FDIC has noted that the activity can

involve material risks, and it is therefore prudent to separate those

risks from the insured state bank. See 58 FR 64482 (Dec. 8, 1993). The

FDIC has always imposed conditions on this activity, over and above

those addressed in section 24 itself, to protect bank safety and

soundness and protect the deposit insurance funds. See 58 FR 6465

(January 29, 1993). As noted at the time, the FDIC is not precluded

from imposing such restrictions, as section 24(i) itself clearly

indicates.

Commenters disagreed on the need for an aggregate investment limit

for equity investments in grandfathered insurance activities. One

comment argues that it is important to limit the maximum exposure to

the depository institution. Another comment states that such a limit is

not suggested by the statute, and the FDIC should retain the

flexibility to act on a case-by-case basis. After further consideration

of this issue, the FDIC is not convinced that the risks from the

different types of insurance subject to grandfather provisions are

similar. Therefore, an aggregate limit would not necessarily enhance

the safety and soundness of the banks involved in this activity. After

considering the comments received and for the reasons stated above, the

language in the final regulation is unchanged from the proposal.

The revisions to the regulation require 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. No comment was received relating to the

effect of these additional requirements on banks engaged in insurance

underwriting. We believe that the standards for adequate separation

between an insured state bank and any subsidiary engaged in insurance

underwriting should be similar to those that separate other

subsidiaries that engage in activities not permitted to the bank.

Therefore, no changes have been made to the proposed separation

standards.

In lieu of the prescribed disclosures contained in the current

regulation and in a departure from the proposal, the revision does not

prescribe disclosures. Instead, the FDIC is relying on the terms of the

Interagency Statement as applicable guidance when the subsidiary's

products are sold on bank premises, are sold by bank employees, or are

sold when the bank receives remuneration for a referral. The FDIC has

made the change primarily because it recognizes that there is a reduced

likelihood of customer confusion when sales of insurance products by a

subsidiary of an insured state bank are not made on bank premises, are

not made by bank employees, and are not a result of a referral from the

bank.

However, there is an increased risk of customer confusion where the

insured state bank and the subsidiary selling the product have similar

names. Those cases are addressed in part by a separation standard which

is discussed below. The separation standard requires that the

subsidiary conduct its 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

state-chartered depository institution and that the state-chartered

depository institution is not responsible for and does not guarantee

the obligations of the subsidiary. The institution and its subsidiary

should take any steps necessary to avoid customer confusion on behalf

of non-bank customers, or bank customers in transactions not covered by

the Interagency Statement.

Under Sec. 362.5(b)(2), banks with subsidiaries engaged in

grandfathered insurance underwriting activities are expected to meet

the new requirements, and have 90 days from the effective date to

achieve compliance or apply to the FDIC for approval to operate

otherwise. The FDIC will consider any such applications 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 with no substantive change. The insured state bank is permitted

only 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 terminate upon a change in control of the

bank or its parent holding company.

Majority-owned subsidiaries ownership of equity investments that

represent a control interest in a company. In proposed

Sec. 362.4(b)(3), the FDIC would have allowed majority-owned

subsidiaries of insured state banks to hold controlling interests in

lower-level subsidiaries engaged in certain activities which the FDIC

authorized to be conducted at the bank level in proposed

Sec. 362.3(b)(2). These activities were holding adjustable rate and

money market preferred stock; and engaging in activities found by the

FRB to be closely related to the business of banking under section

4(c)(8) of the Bank Holding Company Act (subject to certain

restrictions). Proposed Sec. 362.4(b)(3) differed from current

Sec. 362.4(c)(3)(iv)(C), which effectively

[[Page 66294]]

authorizes the majority-owned subsidiary to own stock of a corporation

engaged in 4(c)(8) activities by authorizing the ownership of stock of

a corporation that engages in activities permissible for a bank service

corporation but imposes no control requirement. Proposed

Sec. 362.4(b)(3) also contained no counterpart to current

Sec. 362.4(c)(3)(iv)(D), authorizing a majority-owned subsidiary to

invest in 50 percent or less of the stock of a corporation engaging

solely in activities which are not ``as principal'.

In the final version, at Sec. 362.4(b)(3), the FDIC has broadened

the proposed language, so that the overall effect of the section is to

authorize insured state banks to have lower-level subsidiaries engaged

in many of the same types of activities which the FDIC previously found

do not pose a significant risk when conducted at the bank level or

through a majority-owned subsidiary. The FDIC has received questions

concerning the types of activities and the restrictions on these

activities if conducted by lower-level subsidiaries. This addition to

the final regulation is intended to clarify that generally, the same

limitations are imposed on the lower-level subsidiary as are imposed on

the majority-owned subsidiary conducting the same type of activity. As

discussed below, the FDIC has retained the control requirement (subject

to one modification), because the overall design of the section is to

authorize lower-level subsidiaries to engage in approved activities. Of

course, banks also may apply to the FDIC for permission to make

additional investments in excess of or which differ from those where

general consent is granted under the rule.

As is also discussed below, the activities covered by the final

version of Sec. 362.4(b)(3) still differs from current

Sec. 362.4(c)(3)(iv)(C) and current Sec. 362.4(c)(3)(iv)(D), but

changes made from the proposed language narrow the gap.

First, the FDIC has found that it is not a significant risk to the

deposit insurance funds if a majority-owned subsidiary holds a

controlling interest in a company engaged in real estate or securities

activities authorized under the real estate investment activities and

securities activities sections of this regulation at Sec. 362.4(b)(5),

discussed below. The bank must file notice with the FDIC, and may

proceed if the FDIC does not object. The bank must meet the same core

eligibility criteria in Sec. 362.4(c)(1) that would apply if the bank

were conducting the activity directly through a majority-owned

subsidiary. The bank's investments in and transactions with the lower

tier company are subject to the same limits under Sec. 362.4(d) as

would apply if the bank were conducting the activity directly through a

majority-owned subsidiary. The majority-owned subsidiary must also

comply with the investment and transaction limits, to ensure that the

majority-owned subsidiary is not used as a conduit to the lower tier

company in derogation of the Sec. 362.4(d) limits on the lower tier

company. The bank must also deduct its equity investment in the

majority-owned subsidiary and the lower tier company from its capital

in accordance with Sec. 362.4(e), as would be the case if the bank were

conducting the activity directly through a majority-owned subsidiary.

If the lower tier company is engaged in securities activities of the

type contemplated by Sec. 362.4(b)(5)(ii), the bank and the lower tier

company must observe the additional requirements set out in that

section. Finally, either the majority-owned subsidiary must observe the

core eligibility criteria in Sec. 362.4(c)(2), or the lower tier

company must observe them. However, absent an application to the FDIC,

the latter option is available only if the lower tier company takes

corporate form. The FDIC's rationale for each of these limits on the

activities authorized by Sec. 362.4(b)(5) is discussed in detail below.

Second, the FDIC also has found that it is not a significant risk

to the deposit insurance funds if a majority-owned subsidiary holds a

controlling interest in a company which engages in: (1) Any activity

permissible for a national bank including such permissible activities

that may require the company to register as a securities broker; (2)

acting as an insurance agency; (3) acquiring or retaining adjustable

rate and money market preferred stock or other instruments of a similar

character to the same extent allowed for the bank itself under

Sec. 362.3(b)(2)(iii) and combined with the 15 percent limit therein;

or (4) engaging in real estate leasing activities to the same extent

permissible for the majority-owned subsidiary under Sec. 362.4(b)(6),

discussed below.

One comment, on the use of the control test for defining activities

for lower level subsidiaries, indicated concern over the change from

the current regulation. Specifically, concern was expressed relating to

a group of insured depository institutions that collectively own

through majority-owned subsidiaries a company engaged in securities

brokerage and insurance underwriting. None of the banks involved own a

control interest. The structure of the ownership was set up in reliance

upon the exception in current Sec. 362.4(c)(3)(iv)(D). The FDIC

recognizes that many community banks rely on formation of a consortium

of banks to provide permissible financial services for its customers

that one bank could not efficiently provide. We believe it would be

imprudent to penalize institutions that have invested in these

activities through a majority-owned subsidiary. Therefore, the proposed

regulatory language has been changed, creating an exception to the

control requirement where the company in question is controlled by

insured depository institutions.

The scope of the activities authorized under final Sec. 362.4(b)(3)

differ from current Sec. 362.4(c)(3)(iv)(C) and current

Sec. 362.4(c)(3)(iv)(D). The FDIC eliminated proposed

Sec. 362.3(b)(2)(iv), which would have authorized 4(c)(8) activities at

the bank level. In a parallel fashion, we eliminated current

Sec. 362.4(c)(3)(iv)(C), which effectively authorizes the majority-

owned subsidiary to own stock of a corporation engaged in 4(c)(8)

activities. As is discussed above in connection with that change, the

activities included on the 4(c)(8) list are generally of a type

permissible for national banks, and the authorization in

Sec. 362.4(b)(3)(ii)(A) of the final rule authorizes the lower-level

subsidiary to engage in activities permissible for national banks. As

is also discussed above, the 4(c)(8) list's inclusion of real estate

leasing is the one significant exception that was not otherwise dealt

with in this regulation. To address the elimination of real estate

leasing under the 4(c)(8) list, the FDIC has created Sec. 362.4(b)(6)

to govern real estate leasing by a majority-owned subsidiary. Such

activity also is authorized for a lower-level subsidiary under

Sec. 362.4(b)(3)(ii)(D) of the final rule.

With regard to current Sec. 362.4(c)(3)(iv)(D), authorizing a

majority-owned subsidiary to invest in 50 percent or less of the stock

of a corporation engaging solely in activities which are not ``as

principal'', the final version of Sec. 362.4(b)(3) has the effect of

authorizing non-principal activities which are financially-related.

Section 362.4(b)(3)(ii)(B) of the final rule authorizes insurance

agency activities by the lower-level subsidiary; and

362.4(b)(3)(ii)(A), authorizing the lower-level subsidiary to engage in

activities permissible for national banks, encompasses certain non-

principal activities, such as securities brokerage and investment

advisory services.

We have previously required applications to hold savings

association stock, although a savings association

[[Page 66295]]

could be owned, controlled or operated if the savings association

engages only in deposit-taking and other activities that are

permissible for a bank holding company.4

---------------------------------------------------------------------------

\4\ 12 U.S.C. 1843(c) and 12 CFR 225.28(b)(4)(ii).

---------------------------------------------------------------------------

If a bank was relying on a previous regulatory exception that has

now been eliminated, Sec. 362.5(b)(3) of the final rule provides the

activity may continue as previously conducted for 90 days after the

effective date of this regulation. If the activity of the lower-level

subsidiary is not authorized by the new rule, or the control standard

is not met in that time frame, the insured state bank must apply to the

FDIC for permission to continue the activity.

Equity securities held by a majority-owned subsidiary. The FDIC

sought comment on whether the final regulation should contain an

exception that would allow an insured state bank to hold equity

securities at the subsidiary level. In light of comments received on

this issue, Staff is further analyzing the proposal. Thus, the final

rule does not contain the provision that would have permitted a

majority-owned subsidiary of a state bank and savings association to

engage in equity securities investment activities. At this time, we are

proceeding with the remainder of the final regulation so as to avoid

further delay in the streamlining benefits that state banks and savings

associations will enjoy from the revisions. As a part of this

regulation, we are inserting provisions from the current regulation

that allow: (1) An insured state bank through a majority-owned

subsidiary to invest in up to ten percent of the stock of another

insured bank; and (2) an insured state bank that has received approval

to invest in equity securities pursuant to the statutory grandfather to

conduct these activities through a majority-owned subsidiary without

any additional approval from the FDIC. The provisions have been

continued to allow previously approved activities to continue while

staff is analyzing equity securities investment activities further.

The FDIC proposed to eliminate the notice for these activities, the

specific reference to grandfathered activity, and to allow similar

activity for all insured state banks. However, the exception provided

that the bank's investment in the majority-owned subsidiary be deducted

from capital and that the activity be subject to certain eligibility

requirements and transaction limitations. Comment was frequent and

strong that this proposal was unacceptable to the banks that held

stocks under the current regulation.

Numerous commenters argued that the statutory grandfather for banks

holding common and preferred stock investments and registered shares

extends to the bank and its subsidiaries. Section 24(f) is the

governing statute in this matter. The exception contained in this

provision extends only to the insured state bank. The statute makes no

mention of the bank's subsidiary. Section 24(c) of the FDI Act does

allow the bank to hold common or preferred stock or shares of

registered investment companies through a majority-owned subsidiary.

Activities conducted in a majority-owned subsidiary are subject to the

bank's compliance with applicable capital standards and the FDIC's

finding under section 24(d) that the activity poses no significant risk

to the funds.

Most of the comments received came from interested parties in the

Commonwealth of Massachusetts and referred to a type of subsidiary

authorized in Massachusetts to hold all types of securities, whether

permissible or impermissible for a national bank. These subsidiaries

were established to take advantage of specialized tax treatment under

Massachusetts law. The FDIC understands the tax-favored treatment of

these subsidiaries; however, that tax treatment is a matter of state

tax law and is not a factor in the FDIC's risk to the fund

determination under this statute. However, the FDIC is not

unsympathetic to the plight of insured state banks that have acted

lawfully in structuring their business to achieve tax-favored

treatment. The FDIC is unwilling to upset such good faith arrangements

without considering other alternatives.

Reflecting a sentiment that is contained in many comment letters,

one commenter stated, ``as a practical matter, we are unaware of any

circumstance where banks have been harmed by conducting these

activities through a subsidiary, and thus we believe that conducting

the grandfathered activities in that manner poses no risk to the

deposit insurance funds''. The FDIC recognizes that for the past 15

years there has been an unprecedented rise in the value of common and

preferred stock and registered shares, and these markets have

experienced no sustained, appreciable downturn in value in over 10

years. The FDIC does not base its risk to the fund determination on the

recent history of markets for listed common and preferred stock and

registered shares. The FDIC's policy regarding holding individual

stocks is to not take exception to holding corporate equities which are

well regarded by knowledgeable investors, marketable and held in

moderate proportions. In reviewing equities held on an aggregate basis,

the bank's portfolio of common and preferred stock and registered

shares is reviewed in context of its overall investment portfolio. The

holding of common and preferred stock and registered shares must be in

the context of the bank's overall goals of investment quality, maturity

pattern, diversification of risks, marketability of the portfolio, and

income production. The bank's overall investment strategies are then

judged in relationship to the: (1) General character of the

institution's business; (2) analysis of funding sources; (3) available

capital funds; and (4) economic and monetary factors.

The FDIC proposed that the bank's investment in a subsidiary

investing in equity securities be deducted from the bank's capital

before determining the adequacy of the bank's capital. This treatment

would separate the capital that is available to support the bank from

the capital that is available to support the activities of the

subsidiary. In that scenario, because the risks of holding equity

securities is borne by the capital of the subsidiary, the portfolio of

equity securities and registered shares does not have to be analyzed in

context of the bank's overall investment strategies. If the capital

separations are not present, then the risks of holding equity

securities through a fully consolidated subsidiary must be considered

in context of the bank's overall investment strategies. In addition, if

a bank chooses to hold investments that are permissible for a national

bank in a subsidiary that also may hold investments that are not

permissible for a national bank, the FDIC will treat the entire

subsidiary as engaged in an activity that is not permissible for a

national bank.

Many comments say that the FDIC's proposal for deducting a bank's

investment in its securities subsidiary from the bank's capital before

determining capital adequacy is inconsistent with the capital treatment

for recognition of 45% of net unrealized gains in the equities

portfolio under the FDIC's capital regulations (12 CFR part

325).5 The argument that has been made by these comments is

persuasive to the FDIC. The two approaches to treatment of gains on

securities do seem inconsistent, and the capital regulation is

consistent with the other federal financial institution regulators'

approach to capital treatment of common and preferred stock and shares

of registered investment companies.

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\5\ 63 FR 46518 (Sept. 1, 1998).

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[[Page 66296]]

State law in Massachusetts permits a state bank to establish a

subsidiary to hold the equity security and investment company share of

investments that the bank is permitted to make under state law. Those

investments if made directly by the bank are eligible for the

``grandfather'' provided for by section 24(f) of the FDI Act and

Sec. 362.3(a)(2)(iii). According to the comments, such subsidiaries

should be given the same treatment accorded to the bank, i.e., if the

bank is permitted by the FDIC to exercise its direct investment

authority, the bank should be permitted to invest in those securities

and investment company shares through a subsidiary under the same terms

as exist under the current rule without a capital deduction.

After considering the comments, the FDIC has decided to retain the

current provision allowing grandfathered banks to hold their

investments in common or preferred stock and shares of investment

companies through a majority-owned subsidiary until the staff analysis

of equity securities investments is completed. Section 362.4(b)(4)(i)

of the final regulation provides that any insured state bank that has

received approval to invest in common or preferred stock or shares of

an investment company pursuant to Sec. 362.3(a)(2)(iii) may conduct the

approved investment activities through a majority-owned subsidiary

provided that any conditions or restrictions imposed with regard to the

approval granted under Sec. 362.3(a)(2)(iii) are met. Section

362.3(a)(2)(iii) provides that no insured state bank may take advantage

of the ``grandfather'' provided for 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.) unless the bank files a notice with the FDIC

of the bank's intent to make such investments and the FDIC determines

that such investments will not pose a significant risk to the deposit

insurance funds. In no event may the bank's investments in such

securities and/or investment company shares exceed 100% 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

``grandfather'' will be lost if certain events occur (see

Sec. 362.3(a)(2)(iii)).

The maximum permissible investment by the consolidated bank and

majority-owned subsidiary engaged in this activity is 100 percent of

the bank's consolidated tier one capital. If the bank also holds listed

common or preferred stock or shares of registered investment companies

at the bank level pursuant to the grandfather, such securities will

count toward the limit. For a particular bank, the FDIC may impose a

limit on a case-by-case basis at its discretion of less than the

maximum permissible investment of 100 percent of tier 1 capital. The

FDIC may require divestiture of some or all of the investments if it is

determined that retention of the investments will have an adverse

effect on the safety and soundness of the consolidated bank. The

limitation of up to 100 percent of tier one capital, the requirement

for bank policies, and the reservation of the authority to require

divestiture are taken directly from the current regulation of these

activities when conducted at the bank level.

Bank stock. Section Sec. 362.4(b)(4)(ii) of the final regulation

restores the exception which allows an insured state bank to invest in

up to ten percent of the outstanding stock of another insured bank

without the FDIC's prior consent provided that the investment is made

through a majority-owned subsidiary which was organized for the purpose

of holding such shares. This exception is restored to the regulation to

provide relief for those state banks which are permitted under state

law to invest in the stock of other banks and have done so in reliance

on the current regulation. Insured state banks should note, however,

that the holding of such shares must of course be permissible under

other relevant state and federal law.

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 posture 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.

Again, we are reinstating the provision in the current rule that

permits a majority-owned subsidiary of a state bank to invest in up to

ten percent of the outstanding stock of another insured bank. No other

restrictions on this investment are imposed until the staff analysis of

equity securities investment activities is complete.

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 bank 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 requirements. The FDIC is not precluded from taking

any appropriate action or imposing additional requirements with respect

to the activities when the facts and circumstances warrant such action.

Engage in real estate investment activities. Section 24 of the FDI

Act and the current version of part 362 generally prohibit an insured

state bank from engaging in real estate investment activities not

permissible for a national bank, absent FDIC approval. 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 cas

This text is long and has been trimmed here. Open the source document for the complete record.