Letter confirms that it is legally permissible for a national bank to purchase and hold options on the shares of stock of a company when the bank has acquired shares in satisfaction of debt previously contracted (DPC). The bank would hold the options to hedge the market risk associated with changes in the value of the DPC shares.

O

Comptroller of the Currency

Administrator of National Banks

Washington, DC 20219

Interpretive Letter #961

April 2003

March 17, 2003 12 U.S.C. 24(7)

Subject: Hedging Risks of DPC Stock Holdings

Dear [ ]:

This is in response to your letter of March 5, 2002, requesting confirmation that

[ ] (the “Bank”) may buy and sell options on the shares of stock of a company

when the Bank has acquired shares of the company in satisfaction of debts previously contracted

(“DPC Shares”). The Bank would buy and sell the options to hedge the market risk associated

with changes in the value of DPC Shares. For the reasons discussed below and subject to the

limitations described herein, we believe that the proposed hedging activity is permissible for the

Bank.

Background

In carry out its lending activities, the Bank sometimes receives DPC Shares as part of contractual

workout arrangements. The terms of the workout arrangements sometimes restrict the ability of

the Bank to dispose of the DPC shares it receives.1 The Bank believes it would be prudent to

hedge the risks of holding DPC Shares against fluctuations in market value. The Bank proposes

to use a hedging strategy known as a “butterfly option.” Under this hedging strategy, at the time

the Bank receives DPC shares, the Bank will (1) buy a “put” option at a strike price lower than

the current market price of the DPC Shares and (2) sell a “call” option at a strike price higher

than the current market price of the DPC Shares. The Bank’s management believes this hedging

strategy will reduce market risk.2

1 The Bank sometimes also may acquire DPC shares that have limited marketability for other reasons. For example,

the shares may be thinly traded or their transfer may be restricted under the Federal securities laws

an the current market price of the DPC Shares. The Bank’s management believes this hedging

strategy will reduce market risk.2

1 The Bank sometimes also may acquire DPC shares that have limited marketability for other reasons. For example,

the shares may be thinly traded or their transfer may be restricted under the Federal securities laws.

2 The amount the Bank receives for selling the call offsets in part the amount the Bank pays for purchasing the put.

The butterfly thus allows the Bank to receive protection against market declines at a reduced cost.

The Bank commits that it will use the options solely to hedge risk of DPC Shares and will not

engage in speculation. The Bank plans to purchase the butterfly options at the time the Bank

acquires the DPC shares and anticipates holding the options without adjustment until it disposes

of the DPC shares.3 The Bank represents that it will not take anticipatory short positions or

maintain residual positions in the options that do not operate as a hedge of market exposure in

DPC Shares, except as necessary to the orderly taking or unwinding of a hedging position.

Discussion

National banks are authorized to lend under express authorities in the National Bank Act and as

part of the business of banking. They may acquire securities, including shares of stock, through

foreclosure or otherwise in the ordinary course of collecting a debt previously contracted (DPC).

Such securities may be held for up to five years unless the OCC extends the holding period for

up to another five years.4 Hedging risks arising from that permissible banking activity is an

essential and integral part of that banking activity. In our opinion, the Bank may buy and sell

options as a technique to hedge its market exposures from DPC Shares, provided that the Bank

establishes an appropriate risk measurement and management and compliance process to conduct

such hedging activities

another five years.4 Hedging risks arising from that permissible banking activity is an

essential and integral part of that banking activity. In our opinion, the Bank may buy and sell

options as a technique to hedge its market exposures from DPC Shares, provided that the Bank

establishes an appropriate risk measurement and management and compliance process to conduct

such hedging activities. This process is necessary for the Bank to achieve its risk management

objectives in a safe and sound manner and, thus, must be established before the OCC can

determine that the proposed activities are convenient and useful in conducting permissible

banking activities and thereby permissible as an activity incidental to the business of banking.

A. The National Bank Act (“Act”)

A national bank may engage in activities pursuant to 12 U.S.C. § 24(Seventh) if the activities are

part of, or incidental to, the business of banking. Section 24(Seventh) expressly provides that

national banks shall have the power:

To exercise . . . all such incidental powers as shall be necessary to carry on the business

of banking; by discounting and negotiating promissory notes, drafts, bills of exchange,

and other evidences of debt; by receiving deposits; by buying and selling exchange, coin,

and bullion; by loaning money on personal security; and by obtaining, issuing, and

circulating notes according to the provisions of title 62 of the Revised Statutes.5

The Supreme Court has held that this authority is a broad grant of power to engage in the

business of banking, including, but not limited to, the five enumerated powers and in the

3 Should the Bank wish to change its planned procedures for purchasing and holding the options, the Bank should

confer with its Examiner in Charge (“EIC”) prior to making such a change.

4 See OCC Interpretive Letter No. 643 (July 1, 1992), reprinted in [1991-1992 Transfer Binder] Fed. Banking L.

Rep

to, the five enumerated powers and in the

3 Should the Bank wish to change its planned procedures for purchasing and holding the options, the Bank should

confer with its Examiner in Charge (“EIC”) prior to making such a change.

4 See OCC Interpretive Letter No. 643 (July 1, 1992), reprinted in [1991-1992 Transfer Binder] Fed. Banking L.

Rep. (CCH) ¶ 83,551; OCC Interpretive Letter No. 511 (June 20, 1990), reprinted in [1990-1991 Transfer Binder]

Fed. Banking L. Rep. (CCH) ¶ 83,213.

5 12 U.S.C. § 24(Seventh).

2

business of banking as a whole. 6 National banks also are authorized to engage in an activity that

is incidental to the performance of the five enumerated powers or incidental to the performance

of an activity that is part of the business of banking.7 Incidental activities are activities that are

permissible for national banks, not because they are part of the powers expressly authorized for

banks or the “business of banking,” but rather because they are “convenient” or “useful” to those

activities.8

B.

Making Loans and Hedging the Associated Risks Are Part of the Business of

Banking

Making loans is an express power listed in the National Bank Act and is recognized as a core

part of the business of banking.9 Lending involves risks that banks must manage as part of the

business of banking. Banks hedge loans as a means of managing those risks.10 The OCC has

6 NationsBank of North Carolina v. Variable Annuity Life Insurance Co., 513 U.S. 251 (1995) (“VALIC”). Judicial

cases affirming OCC interpretations establish that an activity is within the scope of the “business of banking” if the

activity: [1] is functionally equivalent to or a logical outgrowth of a traditional banking activity; [2] would respond

to customer needs or otherwise benefit the bank or its customers; and [3] involves risks similar to those already

assumed by banks. See, e.g., Merchant Bank v

ses affirming OCC interpretations establish that an activity is within the scope of the “business of banking” if the

activity: [1] is functionally equivalent to or a logical outgrowth of a traditional banking activity; [2] would respond

to customer needs or otherwise benefit the bank or its customers; and [3] involves risks similar to those already

assumed by banks. See, e.g., Merchant Bank v. State Bank, 77 U.S. 604 (1871); M&M Leasing Corp. v. Seattle First

National Bank, 563 F.2d 1377, 1382 (9th Cir. 1977), cert. denied, 436 U.S. 956 (1978); American Insurance Assn. v.

Clarke, 865 F.2d 278, 282 (2d Cir. 1988). In IAA v. Hawke, 211 F.3d 638 (D.C. Cir. 2000), the court expressed the

position that the “logical outgrowth” rationale needed to be kept within bounds, but endorsed the “functional

equivalent” component of the test.

7 VALIC, supra, at 253.

8 The leading case defining when an activity is authorized as “incidental” under Section 24(Seventh) is Arnold

Tours, Inc. v. Camp, 472 F.2d 427, 431-32 (1st Cir. 1972). In that decision, the First Circuit held that the term

“necessary” in Section 24(Seventh) should be broadly construed to encompass “incidental” activities that are

“convenient or useful” to an expressly enumerated power. The Supreme Court later clarified in VALIC that these

incidental powers include activities that are convenient and useful to the business of banking as well as those that are

convenient and useful to the expressly enumerated powers under the National Bank Act. See VALIC, supra.

Recently, the Ninth Circuit confirmed that these incidental powers should be broadly construed, stating that “[t]he

incidental powers of national banks are thus not limited to activities deemed essential to the exercise of enumerated

powers but include activities closely related to banking and useful in carrying out the business of banking.” Bank of

America v. San Francisco, 309 F.3d 551, 562 (9th Cir. 2002)

9 12 U.S.C. § 24(Seventh)

se incidental powers should be broadly construed, stating that “[t]he

incidental powers of national banks are thus not limited to activities deemed essential to the exercise of enumerated

powers but include activities closely related to banking and useful in carrying out the business of banking.” Bank of

America v. San Francisco, 309 F.3d 551, 562 (9th Cir. 2002)

9 12 U.S.C. § 24(Seventh). The National Bank Act provides, in pertinent part, that national banks shall have the

power “[t]o exercise . . . all such incidental powers as shall be necessary to carry on the business of banking; by

discounting and negotiating promissory notes, drafts, bills of exchange, and other evidences of debt; . . . by loaning

money on personal security.” Id. This power is often referred to generally as a national bank’s lending authority.

10 OCC Interpretive Letter No. 896 (August 21, 2000), reprinted in [2000-2001 Transfer Binder] Fed. Banking L.

Rep. (CCH) ¶ 81-415 (“Agricultural Loan Hedge Letter”). Other banking activities also involve risks that banks

must manage as part of the business of banking. See, e.g. OCC Interpretive Letter No. 892 (September 13, 2000),

reprinted in [2000-2001 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 81-411 (“Equity Hedge Letter”) (national

bank may hedge risk of derivatives activities by purchasing equity securities); United States General Accounting

Office, Equity Hedging--Report to the Honorable James A. Leach, House of Representatives, GAO-01-945 (August

2001); Decision of the Office of the Comptroller of the Currency on the Request by Chase Manhattan Bank, N.A. to

Offer the Chase Market Index Investment Deposit Account (August 8, 1988) (“MII Deposit”) (national bank may

buy and sell futures on the S&P 500 Index to hedge deposits with interest rates tied to the S&P 500 Index).

3

ames A. Leach, House of Representatives, GAO-01-945 (August

2001); Decision of the Office of the Comptroller of the Currency on the Request by Chase Manhattan Bank, N.A. to

Offer the Chase Market Index Investment Deposit Account (August 8, 1988) (“MII Deposit”) (national bank may

buy and sell futures on the S&P 500 Index to hedge deposits with interest rates tied to the S&P 500 Index).

3

long recognized that hedging the risks associated with bank permissible lending activities is an

integral part of those permissible banking activities. National banks hedge against the risk of

loss due to the interest rate fluctuations inherent in their own loan operations.11 National banks

also hedge bank loans to minimize the credit risk in those transactions.12 As discussed below,

hedging these lending risks by buying and selling options on DPC Shares can be part of a bank’s

permissible lending activities.

C.

Buying and Selling Options to Hedge Market Risk on DPC Shares as an

Activity that is Incidental to the Business of Banking

Section 24(Seventh) authorizes national banks to engage in “all such incidental powers” as shall

be necessary to carry on the “business of banking.”13 An activity is incidental to the business of

banking if it is “convenient” or “useful” to an expressly enumerated power or to the business of

banking as a whole.14

1.

Hedging through options can be an effective hedging strategy.

The Bank has demonstrated that the proposed option hedging can be an effective hedging

strategy. For example, if the market price of DPC Shares falls, the Bank could exercise its put

option and receive cash equal to the strike price of DPC Shares

expressly enumerated power or to the business of

banking as a whole.14

1.

Hedging through options can be an effective hedging strategy.

The Bank has demonstrated that the proposed option hedging can be an effective hedging

strategy. For example, if the market price of DPC Shares falls, the Bank could exercise its put

option and receive cash equal to the strike price of DPC Shares. Thus, the proposed hedging can

facilitate and improve the Bank’s ability to reduce credit exposures to its borrowers by protecting

the value of DPC Shares it receives in a workout.15

11 Comptroller’s Handbook, “Mortgage Banking” (March 1996); OCC Letter to Gregory Crane (October 26, 1976);

OCC Letter to Alan E. Rothenberg, Vice President, Bank of America, from Robert Bloom, First Deputy Comptroller

(Policy) (October 11, 1976). Similarly, the Department of the Treasury recognizes that interest rate risk of fixed-

rate loans can be neutralized by hedging with appropriate interest rate swap, forward, futures, or option contracts.

Department of the Treasury, Banking Industry -- Trends and Current Issues: Report titled “Modernizing the

Financial System” (November 6, 1995).

12 OCC Banking Bulletin 96-43: Credit Derivatives, Guidelines for National Banks (August 12, 1996); OCC

Interpretive Letter No. 356 (January 7, 1986), reprinted in [1985-1987 Transfer Binder] Fed. Banking L. Rep.

(CCH) ¶ 85,526. In addition, national banks may assist customers in hedging their own loans against cash market

risks, by obtaining, or by assisting customers in obtaining, hedging instruments. OCC Letter to Jeffrey S. Lillien,

The First National Bank of Chicago (June 13, 1986); OCC Letter to Randall R. Kaplan, Caplin & Drysdale from

Judith A. Walter, Senior Deputy Comptroller (June 13, 1986); OCC Letter to Thomas N. Rose, Eldredge & Clark,

from Michael A. Mancusi, Senior Deputy Comptroller for National Bank Operations (November 5, 1985).

13 12 U.S.C. § 24(Seventh)

g instruments. OCC Letter to Jeffrey S. Lillien,

The First National Bank of Chicago (June 13, 1986); OCC Letter to Randall R. Kaplan, Caplin & Drysdale from

Judith A. Walter, Senior Deputy Comptroller (June 13, 1986); OCC Letter to Thomas N. Rose, Eldredge & Clark,

from Michael A. Mancusi, Senior Deputy Comptroller for National Bank Operations (November 5, 1985).

13 12 U.S.C. § 24(Seventh).

14 In considering whether an activity is “convenient” or “useful” and therefore “incidental” to the business of

banking, the OCC may consider whether the activity facilitates the operations of the bank as a banking enterprise,

enhances the efficiency or quality of the content or delivery of banking services of products, optimizes the use and

value of a bank’s facilities and competencies, or enables the bank to avoid economic waste in its banking franchise.

See OCC Interpretive Letter No. 845 (Oct. 20, 1998), reprinted in [1998-1999 Transfer Binder] Fed. Banking L.

Rep. (CCH) ¶ 81,300. See also 12 C.F.R. § 7.5001(d).

4

15 The OCC also permits national banks to engage in certain activities to preserve the value of their real estate DPC

property. For example, national banks can make necessary advances to run a business and thereby preserve its

going concern value when the business is acquired to secure or collect debt previously contracted. See 12 C.F.R.

2.

The proposed equity hedging is similar to activities the OCC has

previously approved as convenient and useful to bank permissible

activities.

The OCC also has long permitted national banks to use futures, options, and options on futures to

manage or “hedge” risks arising from permissible banking activities

acquired to secure or collect debt previously contracted. See 12 C.F.R.

2.

The proposed equity hedging is similar to activities the OCC has

previously approved as convenient and useful to bank permissible

activities.

The OCC also has long permitted national banks to use futures, options, and options on futures to

manage or “hedge” risks arising from permissible banking activities. The OCC has recognized

the permissibility of such activities both for the purpose of providing bank customers with the

ability to hedge their own risks and as a means for banks to hedge directly the risks that arise

from permissible banking activities.16 For example, in 2000, the OCC considered a proposal to

hedge the risk in a bank’s agricultural loans by purchasing cash-settled options on futures on

commodities that serve as the primary collateral for the loans. The OCC determined that using

options on futures contracts on agricultural commodities to hedge bank permissible lending

activities is permissible for national banks.17 However, the OCC would not permit the bank to

engage in the proposed activity until it had an appropriate risk management process in place.18

The proposed options hedges are similar to equity hedges the OCC has previously approved for

certain national banks as convenient and useful to bank permissible activities. The OCC has

determined that, subject to specified conditions and standards, the national banks could purchase

and hold equity securities to hedge risks arising from permissible equity derivative

transactions.19 The OCC concluded that the equity hedges provided the national banks in

§ 34.86; OCC Interpretive Letter No. 576 (March 27, 1992) reprinted in [1991-1992 Transfer Binder] Fed. Banking

L. Rep. (CCH) ¶ 83,346; OCC Interpretive Letter No. 12 (December 7, 1977) reprinted in [1978-1979 Transfer

Binder] Fed. Banking L. Rep. (CCH) ¶ 85,087.

16 See OCC Interpretive Letter No

equity hedges provided the national banks in

§ 34.86; OCC Interpretive Letter No. 576 (March 27, 1992) reprinted in [1991-1992 Transfer Binder] Fed. Banking

L. Rep. (CCH) ¶ 83,346; OCC Interpretive Letter No. 12 (December 7, 1977) reprinted in [1978-1979 Transfer

Binder] Fed. Banking L. Rep. (CCH) ¶ 85,087.

16 See OCC Interpretive Letter No. 356, supra (bank registered as a futures commission merchant could execute

customer orders for agricultural and metals futures in connection with its loans to the customers); MII Deposit,

supra, (bank could offer a deposit with a rate of return based in part on the return on a stock index and could hedge

the bank’s interest rate risk by purchasing futures on that stock index); OCC Interpretive Letter No. 937

(May 14, 2002) reprinted in [2001-2002 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 81,462 (bank could hedge

risks arising from intermediation transactions based on electricity prices); OCC No Objection Letter No. 87-5

(July 20, 1987), reprinted in [1988-1989 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 84,034 (bank could act as

principal in commodity price index swaps with its customers); OCC No Objection Letter 90-1 (February 16, 1990),

reprinted in [1989-1990 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 83,095 (bank could act as principal in

unmatched commodity price index swaps with its customers and hedge its price risk exposure using exchange-traded

commodity futures); OCC Letter from Horace G. Sneed, Senior Attorney, Legal Advisory Services Division

(March 2, 1992) (unpublished) (bank could manage its commodity index swaps on a portfolio basis and hedge the

swaps with swaps, exchange-traded futures or over-the-counter (OTC) options; OCC Interpretive Letter No. 652

(September 13, 1994), reprinted in [1994 Transfer Binder] Fed. Banking L. Rep

mmodity futures); OCC Letter from Horace G. Sneed, Senior Attorney, Legal Advisory Services Division

(March 2, 1992) (unpublished) (bank could manage its commodity index swaps on a portfolio basis and hedge the

swaps with swaps, exchange-traded futures or over-the-counter (OTC) options; OCC Interpretive Letter No. 652

(September 13, 1994), reprinted in [1994 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 83,600 (bank could

engage in equity and equity derivative swaps and hedge risk using futures contracts, options and similar OTC

instruments).

17 Agricultural Loan Hedge Letter, supra.

18 Id.

5

19 Similarly, the OCC has determined that national banks may take physical delivery of commodities to hedge bank

permissible commodity-linked derivative transactions as a convenient and useful means to manage the risks arising

from those permissible banking transactions. OCC Interpretive Letter Nos. 632 and 684, supra.

question with a cost-effective, means to hedge risks arising from customer-driven equity

derivative transactions and thus were a convenient and useful activity incidental to the business

of banking for those banks.20

The OCC also has permitted national banks to hedge obligations to make payments on bank

permissible employee compensation and benefit plans with incidental life insurance.21 The OCC

later concluded that it was convenient and useful for a national bank to hedge an employee

compensation program with bank impermissible insurance company products and investments

because the hedge virtually eliminated all the risk arising under the program to the bank.22

In each case cited above, the hedging instrument was viewed as an asset held incidental to a

permissible banking activity in order to hedge the bank’s risks or obligations, rather than as a

security held by the bank for investment. The transactions were used to manage risks arising

from otherwise bank permissible banking activities and not entered into for speculative purposes

the bank.22

In each case cited above, the hedging instrument was viewed as an asset held incidental to a

permissible banking activity in order to hedge the bank’s risks or obligations, rather than as a

security held by the bank for investment. The transactions were used to manage risks arising

from otherwise bank permissible banking activities and not entered into for speculative purposes.

In much the same manner, incidental to the express permissible banking activity of lending, the

Bank would buy and sell options on equity securities for the sole purpose of hedging its market

risk on DPC Shares. This conclusion is consistent with the foregoing OCC precedents

permitting bank-impermissible investments for hedging purposes to manage risks arising from

permissible banking activities.

3.

The hedging must be conducted in a safe and sound manner.

Buying and selling options for the stated purpose of hedging market exposures on DPC securities

does not automatically qualify that activity as an activity that is incidental to banking, however.

The nature of the hedging activity proposed requires specialized risk measurement and

management capacities on the part of a bank, and qualified personnel, in order for the activity to

be conducted so it will actually perform the function of hedging market risks. Thus, in order for

the proposed activity to be permissible for the Bank because it is “convenient” or “useful” to

conducting authorized banking activities, the Bank must establish an appropriate risk

measurement and management process for its DPC Share hedging activity in accordance with

applicable requirements contained in the OCC’s Derivatives Handbook23 and OCC Banking

20 See Equity Hedge Letter, supra. See also OCC Interpretive Letter No

useful” to

conducting authorized banking activities, the Bank must establish an appropriate risk

measurement and management process for its DPC Share hedging activity in accordance with

applicable requirements contained in the OCC’s Derivatives Handbook23 and OCC Banking

20 See Equity Hedge Letter, supra. See also OCC Interpretive Letter No. 684, supra (national banks may take

physical delivery of equities and commodities to hedge bank permissible derivative transactions as a convenient and

useful means to manage the risks arising from those permissible banking transactions). The General Accounting

Office has issued a report agreeing with the OCC’s conclusion. United States General Accounting Office, Equity

Hedging--Report to the Honorable James A. Leach, House of Representatives, GAO-01-945 (August 2001).

21 OCC Interpretive Letter No. 848 (November 23, 1998), reprinted in [1998-1999 Transfer Binder] Fed. Banking

L. Rep. (CCH) ¶ 81-202; OCC Bulletin 96-51 (September 20, 1996), reprinted in Fed. Banking L. Rep. (CCH) ¶ 35-

491.

22 OCC Interpretive Letter No. 878 (December 22, 1999), reprinted in [1998-1999 Transfer Binder] Fed. Banking

L. Rep. (CCH) ¶ 81-373.

6

23 Handbook for National Bank Examiners, Risk Management of Financial Derivatives (January 1997)(“Derivatives

Handbook”).

Circular No. 277.24 As part of the Bank’s risk management process, the Bank’s management

should:

•

•

•

document its decisions on hedging DPC Share market exposures;

develop a clear methodology for determining the amount of market risk from DPC

Shares that the Bank needs to hedge; and

establish objective criteria for the purchase and sale of options sufficient to demonstrate

that the options will be used solely to hedge against losses

•

•

•

document its decisions on hedging DPC Share market exposures;

develop a clear methodology for determining the amount of market risk from DPC

Shares that the Bank needs to hedge; and

establish objective criteria for the purchase and sale of options sufficient to demonstrate

that the options will be used solely to hedge against losses.

In addition, the Bank should develop and implement compliance policies and procedures to

ensure that any potential conflicts of interest are appropriately considered and that the hedges

will comply with applicable securities laws, including applicable insider trading standards.

Because buying and selling options in respect of DPC Shares may raise issues under the federal

securities laws, the Bank should consult with competent securities counsel to ensure its activities

comply with federal securities laws before entering into such transactions.

Finally, the Bank’s audit or another qualified independent control unit should conduct a review

to evaluate the adequacy and effectiveness of the Bank’s risk and compliance management

policies and procedures to ensure that the DPC Share hedging activity is conducted in

conformance with the applicable requirements of BC-277 and securities laws.

D. Use of Options to Hedge Banking Risk is not Prohibited Underwriting or

Dealing under Section 24(Seventh)

Section 24(Seventh) addresses the ability of a national bank to underwrite or deal in securities

ompliance management

policies and procedures to ensure that the DPC Share hedging activity is conducted in

conformance with the applicable requirements of BC-277 and securities laws.

D. Use of Options to Hedge Banking Risk is not Prohibited Underwriting or

Dealing under Section 24(Seventh)

Section 24(Seventh) addresses the ability of a national bank to underwrite or deal in securities.

Specifically, Section 24(Seventh) provides that:

[t]he business of dealing in securities and stock by the association shall be limited to

purchasing and selling such securities and stock without recourse, solely upon the order,

and for the account of, customers, and in no case for its own account, and the association

shall not underwrite any issue of securities or stock: Provided, That the association may

purchase for its own account investment securities under such limitations and restrictions

as the Comptroller of the Currency may by regulation prescribe.

Here, the Bank is not “dealing” in or “underwriting” securities as prohibited by Section

24(Seventh). Although “dealing” and “underwriting” are not defined in Section 24(Seventh),25

24 October 27, 1993, reprinted in [1993-1994 Transfer Binder] Fed. Banking Law. Rep. (CCH) ¶ 62-152, as

supplemented by Supplemental Guidance 1 to BC-277 (January 1997) (“BC-277”).

7

25 Although the securities laws definitions are not dispositive in determining whether a particular type of securities

activity is permitted for banks, these definitions provide a useful starting point for characterizing a bank’s securities

activities. Under section 3 of the Securities Exchange Act of 1934, a “dealer” is defined as “any person engaged in

the business of buying and selling securities for his own account, through a broker or otherwise, but does not include

any person insofar as he buys or sells securities for his own account, either individually or in some fiduciary

ing point for characterizing a bank’s securities

activities. Under section 3 of the Securities Exchange Act of 1934, a “dealer” is defined as “any person engaged in

the business of buying and selling securities for his own account, through a broker or otherwise, but does not include

any person insofar as he buys or sells securities for his own account, either individually or in some fiduciary

“underwriting” is generally understood as encompassing the purchase of securities from an issuer

for distribution and sale to investors.26 Case law confirms that one cannot be an underwriter in

the absence of a public offering.27

“Dealing” in securities is generally understood to encompass the purchase of securities as

principal for resale to others.28 Dealing is buying and selling as part of a regular business. A

dealer typically maintains an inventory of securities and holds itself out to the public as willing

to purchase and sell and continuously quote prices.29

Under the above definitions, the Bank’s use of options on equity securities for hedging exposures

resulting from DPC Shares is not “underwriting” or “dealing.” The Bank has committed to sell

and purchase debt securities solely for the purpose of hedging. The Bank will not purchase

securities from an issuer for sale to investors in connection with a public offering -- essential

elements of underwriting. Further, in conducting hedging activities, the Bank will not engage in

a regular business of buying and selling equity options in the secondary market, will not publicly

offer the equity options from hedging DPC Shares to investors and will not hold itself out as

available to buy and sell securities. 30

capacity, but not part of a regular business.” 15 U.S.C. § 78c(a)(5)

activities, the Bank will not engage in

a regular business of buying and selling equity options in the secondary market, will not publicly

offer the equity options from hedging DPC Shares to investors and will not hold itself out as

available to buy and sell securities. 30

capacity, but not part of a regular business.” 15 U.S.C. § 78c(a)(5). Under the Securities Act of 1933, an

“underwriter” includes “any person who has purchased from an issuer with a view to, or offers or sells for an issuer

in connection with, the distribution of any security.” 15 U.S.C. § 77(b)(a)(11).

26 OCC Interpretive Letter No. 388 (June 16, 1987), reprinted in [1988-1989 Transfer Binder] Fed. Banking L. Rep.

(CCH) ¶ 85,612; OCC Interpretive Letter No. 329 (March 4, 1985), reprinted in [1985-1987 Transfer Binder] Fed.

Banking L. Rep. (CCH) ¶ 85,499.

27 SIA v. Board of Governors, 807 F.2d 1052 (D.C. Cir. 1986), cert. denied, 483 U.S. 1005 (1987).

28 See Equity Hedge Letter, supra (banks’ purchase of equity securities for hedging customer-driven equity

derivative transactions is not “dealing” or “underwriting”). See also OCC Interpretive Letter No. 393 (July 5, 1987),

reprinted in [1988-1989 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 85,617 (national bank with limited market

presence not considered a dealer); Louis Loss, Securities Regulation 2983-84 (3d ed. 1990).

29 Citicorp, J.P. Morgan & Co. Inc., Bankers Trust New York Corporation, 73 Fed. Res. Bull. 473 n.4 (1987); OCC

Interpretive Letter No. 684, supra; Equity Hedging Letter, supra.

30 Although securities law is not determinative in interpreting banking law, we note that the Securities and

Exchange Commission (SEC) has recognized that entities that purchase and sell securities to hedge their own risks,

and that do not hold themselves out as available to buy and sell securities are not dealers under the GSA. See

Fireman’s Fund Mortgage Corp., 1987 SEC No-Act. LEXIS 2330 (July 20, 1987)

ecurities law is not determinative in interpreting banking law, we note that the Securities and

Exchange Commission (SEC) has recognized that entities that purchase and sell securities to hedge their own risks,

and that do not hold themselves out as available to buy and sell securities are not dealers under the GSA. See

Fireman’s Fund Mortgage Corp., 1987 SEC No-Act. LEXIS 2330 (July 20, 1987). See also Citicorp Homeowners,

Inc., 1987 SEC No-Act. LEXIS 2596 (Oct. 7, 1987) (involving mortgages and hedging with government securities);

Meridian Mortgage Corp., 1987 SEC No-Act. LEXIS 2020 (April 7, 1987) (involving mortgages and hedging with

government securities).

8

9

Conclusion

The Bank may purchase and sell options on DPC Shares to hedge the risk of holding those shares

against fluctuations in market value, provided the Bank has established effective risk

measurement and management processes as described in section C. 3., above, to conduct the

proposed hedging as described herein.

Sincerely,

/s/ Julie L. Williams

Julie L. Williams

First Senior Deputy Comptroller and Chief Counsel