FOOTNOTES

^* Valentine V. Craig is a Chartered Financial Analyst in the FDIC's Division of Research and Statistics. The author gratefully acknowledges the comments of the FDIC's Legal Division in preparing this article.

¹ Much of the history of merchant banking is derived from Banks (1999).

² The "prudent man rule" refers to the fiduciary responsibility of investment managers. In the earlier interpretation, each investment in a portfolio was expected to meet safety standards in and of itself. Under the revised interpretation, the Department of Labor accepted the concept of portfolio diversification of risk, thereby permitting portfolio managers to invest a small portion of the portfolio in riskier investments as long as the portfolio in the aggregate met fiduciary standards of risk.

³ Fenn, Liang, and Prowse (2000).

⁴ Ibid.

⁵ A leveraged buyout is the purchase of a company's stock or assets by a very leveraged acquirer, one whose debt financing is based solely on the value of the acquired firm. The LBO began as a means for the owners of small, privately held companies to cash out and shift ownership to family or management when these buyers did not have much equity capital (the major LBO transactions of the 1970s). Today's LBOs more typically involve bringing large public companies private, with a small group of investors acquiring most of a firm's common stock and issuing a combination of private equity and a large amount of debt, much of it junk bonds.

⁶ What's Really Driving Banks' Profits (2000).

⁷ Unrealized gains generally occur after a company has an initial public offering (IPO) but the stock has not been sold because of its lock-up period. A bank would typically apply a discount, or "haircut," to the value of the unsold IPO shares to account for volatility, with the gain being the difference between this discounted value and the investment's cost.

⁸ The FRB does not identify the institutions or their individual financial information.

⁹ The New York Times (1999).

¹⁰ What's Really Driving (2000).

¹¹ Ibid.

¹² Ibid.

¹³ For more information on this issue, see Blair (1994).

¹⁴ Sections 16, 20, 21, and 32 of the Banking Act of 1933 are commonly referred to as the Glass-Steagall Act.

¹⁵ Ferguson (2000).

¹⁶ These capital charges apply to some investments held by state banks under Section 24 of the Federal Deposit Insurance Act. Section 24(d) allows a state bank to hold, through subsidiaries, equity investments that are not permissible for a national bank if the investment poses no harm to the deposit fund and the bank is and continues to be in compliance with applicable capital standards. Under the proposed rule, the FDIC may permit a lower capital deduction for such investments under Section 24 in certain instances. The FDIC and the other banking agencies also reserve the authority to impose higher capital charges where appropriate.

¹⁷ Also exempt are investments held under Section 24(f) of the Federal Deposit Insurance Act. Section 24(f) permits state banks to retain and acquire stock that does not exceed 100 percent of the bank's capital if the bank is located in a state that permitted, as of September 30, 1991, investment in publicly traded companies and registered investment companies, and the bank made or maintained an investment in such securities during the period beginning September 30, 1990, and ending November 26, 1991.