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Inactive Financial Institution Letters 


[Federal Register: September 12, 1997 (Volume 62, Number 177)]
[Proposed Rules]
[Page 47969-48025]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12se97-16]

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Proposed Rules
                                                Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.

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[[Page 47969]]

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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Parts 303, 337 and 362

RIN 3064-AC12


Activities of Insured State Banks and Insured Savings
Associations

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Notice of proposed rulemaking.

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SUMMARY: As part of the FDIC's systematic review of its regulations and
written policies under section 303(a) of the Riegle Community
Development and Regulatory Improvement Act of 1994 (CDRI), the FDIC is
seeking public comment on its proposal to revise and consolidate its
rules and regulations governing activities and investments of insured
state banks and insured savings associations. The FDIC proposes to
combine its regulations governing the activities and investments of
insured state banks with those governing insured savings associations.
In addition, the proposal updates the FDIC's regulations governing the
safety and soundness of securities activities of subsidiaries and
affiliates of insured state nonmember banks. The FDIC's proposal
modernizes this group of regulations and harmonizes the provisions
governing activities that are not permissible for national banks with
those governing the securities activities of state nonmember banks. The
proposed regulation will make a number of substantive changes and will
revise the regulations by deleting obsolete provisions, rewriting the
regulatory text to make it more readable, conforming the treatment of
state banks and savings associations to the extent possible given the
underlying statutory and regulatory scheme governing the different
charters. The proposal establishes a number of new exceptions and will
allow institutions to conduct certain activities after providing the
FDIC with notice rather than filing an application. The proposal also
will revise these regulations by deleting obsolete provisions,
rewriting the regulatory text to make it more readable, removing a
number of the current restrictions on those activities and conforming
the disclosures required under the current regulation to an existing
interagency statement concerning the retail sales of nondeposit
investment products.

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

ADDRESSES: Send written comments to Robert E. Feldman, Executive
Secretary, Attention: Comments/OES, Federal Deposit Insurance
Corporation, 550 17th Street, N.W., Washington, D.C. 20429. Comments
may be hand delivered to the guard station at the rear of the 17th
Street Building (located on F Street), on business days between 7:00
a.m. and 5:00 p.m. (Fax number (202) 898-3838; Internet Address:
comments@fdic.gov). Comments may be inspected and photocopied in the
FDIC Public Information Center, Room 100, 801 17th Street, N.W.
Washington, D.C. 20429, between 9:00 a.m. and 4:30 p.m. on business
days.

FOR FURTHER INFORMATION CONTACT: Curtis Vaughn, Examination Specialist,
(202/898-6759) or John Jilovec, Examination Specialist, (202/898-8958)
Division of Supervision; Linda L. Stamp, Counsel, (202/ 898-7310) or
Jamey Basham, Counsel, (202/ 898-7265), Legal Division, FDIC, 550 17th
Street, N.W., Washington, D.C. 20429.

SUPPLEMENTARY INFORMATION:

I. Background

    Section 303 of the Riegle Community Development and Regulatory
Improvement Act of 1994 (RCDRIA) requires that the FDIC review its
regulations for the purpose of streamlining those regulations, reducing
any unnecessary costs and eliminating unwarranted constraints on credit
availability while faithfully implementing statutory requirements.
Pursuant to that statutory direction the FDIC has reviewed part 362
"Activities and Investments of Insured State Banks," Sec. 303.13
"Applications and Notices by Savings Associations," and Sec. 337.4
"Securities Activities of Subsidiaries of Insured State Banks: Bank
Transactions with Affiliated Securities Companies' and proposes to make
a number of changes to those regulations. The proposal is described in
more detail below. In brief, however, the proposal would restructure
existing part 362, placing the substance of the text of the current
regulation into new subpart A. Subpart A would address the Activities
of Insured State Banks which implements section 24 of the Federal
Deposit Insurance Act (FDI Act). 12 U.S.C. 1831a. Section 24 restricts
and prohibits insured state banks and their subsidiaries from engaging
in activities and investments of a type that are not permissible for
national banks and their subsidiaries. In addition, the proposal would
move the FDIC's regulations governing the securities activities of
subsidiaries of insured state nonmember banks (currently at 12 CFR
337.4) into subpart A of part 362 and revise those regulations by
deleting obsolete provisions, rewriting the regulatory text to make it
more readable, removing a number of the obsolete current restrictions
on those activities, and removing the disclosures required under the
current regulation to conform the required disclosures to the
Interagency Statement on the Retail Sale of Nondeposit Investment
Products (Interagency Statement).
    Safety and Soundness Rules Governing Insured State Nonmember Banks
would be set out in new subpart B. Subpart B would establish modern
standards for insured state nonmember banks to conduct real estate
investment activities through a subsidiary and for those insured state
nonmember banks that are not affiliated with a bank holding company
(nonbank banks) to conduct securities activities in an affiliated
organization. The existing restrictions on these securities activities
are found in Sec. 337.4 of this chapter.
    Existing Sec. 303.13 of this chapter which relates to activities of
state savings associations and filings by all savings associations
would be revised in a number of ways and primarily placed in new
subpart C of part 362. Procedures to be used by all savings
associations when Acquiring, Establishing, or Conducting New Activities
through a Subsidiary would be placed in new subpart D. Subpart E would
contain the revised provisions concerning application and notice
procedures as well as delegations for insured state banks. Subpart F
would contain the revised provisions concerning application and notice
procedures as well as delegations for insured savings associations.

[[Page 47970]]

    In addition, the FDIC is processing a complete revision of part 303
of the FDIC's rules and regulations. Part 303 contains the FDIC's
applications procedures and delegations of authority. As a part of that
process and for ease of reference, the FDIC is proposing to remove the
applications procedures relating to activities and investments of
insured state banks from part 362 and place them in subpart G of part
303. The procedures applicable to insured savings associations will be
consolidated in subpart H of part 303. We anticipate that the proposed
changes to part 303 will be published for comment within 90 days of
today's publication. At that time, subparts G and H of part 303 will be
designated as the place where the text of subparts E and F of this
proposed rule eventually will be located.
    Part 362 of the FDIC's regulations implements the provisions of
section 24 of the FDI Act (12 U.S.C. 1831a). Section 24 was added to
the FDI Act by the Federal Deposit Insurance Corporation Improvement
Act of 1991 (FDICIA). With certain exceptions, section 24 limits the
direct equity investments of state chartered insured banks to equity
investments of a type permissible for national banks. In addition,
section 24 prohibits an insured state bank from directly, or indirectly
through a subsidiary, engaging as principal in any activity that is not
permissible for a national bank unless the bank meets its capital
requirements and the FDIC determines that the activity will not pose a
significant risk to the appropriate deposit insurance fund. The FDIC
may make such determinations by regulation or order. The statute
requires institutions that held equity investments not conforming to
the new requirements to divest no later than December 19, 1996. The
statute also requires that banks file certain notices with the FDIC
concerning grandfathered investments.
    Part 362 was adopted in two stages. The provisions of the current
regulation concerning equity investments appeared in the Federal
Register on November 9, 1992, at 57 FR 53234. The provisions of the
current regulation concerning activities of insured state banks and
their majority-owned subsidiaries appeared in the Federal Register on
December 8, 1993, at 58 FR 64455.
    Section 303.13 of the FDIC's regulations (12 CFR 303.13) implements
sections 28 and 18(m) of the FDI Act. Both sections were added to the
FDI Act by the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 (FIRREA). While section 28 of the FDI Act and section 24 of
the FDI Act are similar, there are a number of fundamental differences
in the two provisions which caused the implementing regulations to
differ in some respects.
    Section 18(m) of the FDI Act (12 U.S.C. 1828(m)) requires state and
federal savings associations to provide the FDIC with notice 30 days
before establishing or acquiring a subsidiary or engaging in any new
activity through a subsidiary. Section 28 (12 U.S.C. 1831e) governs the
activities and equity investments of state savings associations and
provides that no state savings association may engage as principal in
any activity of a type or in an amount that is impermissible for a
federal savings association unless the FDIC determines that the
activity will not pose a significant risk to the affected deposit
insurance fund and the savings association is in compliance with the
fully phased-in capital requirements prescribed under section 5(t) of
the Home Owners' Loan Act (HOLA, 12 U.S.C. 1464(t)). Except for its
investment in service corporations, a state savings association is
prohibited from acquiring or retaining any equity investment that is
not permissible for a federal savings association. A state savings
association may acquire or retain an investment in a service
corporation of a type or in an amount not permissible for a federal
savings association if the FDIC determines that neither the amount
invested in the service corporation nor the activities of the service
corporation pose a significant risk to the affected deposit insurance
fund and the savings association continues to meet the fully phased-in
capital requirements. A savings association was required to divest
itself of prohibited equity investments no later than July 1, 1994.
Section 28 also prohibits state and federal savings associations from
acquiring any corporate debt security that is not of investment grade
(commonly known as "junk bonds").
    Section 303.13 of the FDIC's regulations was adopted as an interim
final rule on December 29, 1989 (54 FR 53548). The FDIC revised the
rule after reviewing the comments and the regulation as adopted
appeared in the Federal Register on September 17, 1990 (55 FR 38042).
The regulation establishes application and notice procedures governing
requests by a state savings association to directly, or through a
service corporation, engage in activities that are not permissible for
a federal savings association; the intent of a state savings
association to engage in permissible activities in an amount exceeding
that permissible for a federal savings association; or the intent of a
state savings association to divest corporate debt securities not of
investment grade. The regulation also establishes procedures to give
prior notice for the establishment or acquisition of a subsidiary or
the conduct of new activities through a subsidiary.
    Section 337.4 of the FDIC's regulations (12 CFR 337.4) governs
securities activities of subsidiaries of insured state nonmember banks
as well as transactions between insured state nonmember banks and their
securities subsidiaries and affiliates. The regulation was adopted in
1984 (49 FR 46723) and is designed to promote the safety and soundness
of insured state nonmember banks that have subsidiaries which engage in
securities activities that are impermissible for national banks under
section 16 of the Banking Act of 1933 (12 U.S.C. section 24 seventh),
commonly known as the Glass-Steagall Act. It requires that these
subsidiaries qualify as bona fide subsidiaries, establishes transaction
restrictions between a bank and its subsidiaries or other affiliates
that engage in securities activities that are prohibited for national
banks, requires that an insured state nonmember bank give prior notice
to the FDIC before establishing or acquiring any securities subsidiary,
requires that disclosures be provided to securities customers in
certain instances, and requires that a bank's investment in a
securities subsidiary engaging in activities that are impermissible for
a national bank be deducted from the bank's capital.
    On August 23, 1996, the FDIC published a notice of proposed
rulemaking (61 FR 43486, August 23, 1996) (August proposed rule) to
amend part 362. Under the proposed rule a notice procedure would have
replaced the application currently required in the case of real estate
investment, life insurance and annuity investment activities provided
certain conditions and restrictions were met. The proposed rule set
forth notice processing procedures for real estate, life insurance
policies and annuity contract investments for well-capitalized, well-
managed insured state banks. Under the proposal, all real estate
activities would be required to be conducted in a majority-owned
subsidiary, while life insurance policies and annuity contracts could
be held directly or through a majority-owned subsidiary. Notices would
have been filed with the appropriate FDIC regional office. The FDIC
regional office would have had 60 days to process a notice under the
proposal, with a possible extension of 30 days. If the FDIC did not
object to the

[[Page 47971]]

notice prior to the expiration of the notice period (or any extension),
the bank could have proceeded with the investment activity. In the
event a bank fell out of compliance with any of the eligibility
conditions after starting the activity, it would have been required to
report the noncompliance to the appropriate FDIC regional office within
10 business days of the occurrence.
    With respect to investments in real estate activities, the August
proposed rule set forth 9 conditions which banks would have had to meet
to be "eligible" for the notice procedure. These 9 conditions
addressed the bank's capital levels and financial condition (must be
well-capitalized after deducting investment in real estate and must
have a Uniform Financial Institutions Rating System (UFIRS) rating of 1
or 2), how the real estate activity would be conducted (a "bona fide"
subsidiary which only engages in real estate activities), management
experience and independence of the real estate subsidiary (subsidiary
must have management with real estate experience, a written business
plan, and at least one director with real estate experience who is not
an employee, officer or director of the bank), and placed limits on
bank transactions with the subsidiary and customers (sections 23A and
23B of the Federal Reserve Act applied to transactions between the bank
and its subsidiary and tying and insider transactions were prohibited).
The August proposed rule also set forth the contents of the notice that
was to be sent to the FDIC regional office. The required information
included 7 items; information regarding the proposed activity (general
description of proposed real estate activity, a copy of the written
business plan, and a description of the subsidiary's operations
including management's expertise), the amount of investment and impact
on bank capital (aggregate amount of investment in activity and pro
forma effect of deducting such investments on the bank's capital
levels) and the bank's authority to engage in such activity (copy of
the board of directors' resolution authorizing activity and
identification of state law permitting the activity). Under the August
proposal, the regional office could have requested additional
information.
    After considering the comments to the August proposed rule and
reconsidering the issues underlying the current regulation, we have
restructured the approach we are taking under part 362. As a result,
the FDIC withdrew the August proposed rule, which is published
elsewhere in today's Federal Register in favor of the more
comprehensive approach presently proposed.
    While the August proposed rule amended existing part 362, the
current proposal would replace existing part 362. Unlike the rule
proposed in August, the current proposal is not limited to considering
the notice procedure used under part 362. In drafting the current
proposal, we have deleted items that are either duplicative,
unnecessary due to the passage of time, or have proven unwarranted
given our experience in implementing section 24 over the last five
years. In addition, we have refined the notice procedure that was
proposed in August. We are no longer recommending a life insurance
policy and annuity contract investment notice due to recent guidance
provided by the Office of the Comptroller of the Currency (OCC). The
OCC's guidance appears to eliminate the necessity for an application
with respect to virtually all of the life insurance and annuity
investments received by the FDIC in the past. While Section 24 and the
part 362 application process would continue to apply to those life
insurance and annuity investments which are impermissible for national
banks, the FDIC has decided that there is no need to adopt a notice
process that specifically addresses what we expect to be an extremely
small number of situations. We invite comment on whether we are correct
in concluding that there is no longer a need for a notice process for
life insurance and annuity investments which are impermissible for
national banks.

II. Description of Proposal

    The FDIC proposes to divide part 362 into six subparts. Before
describing the reorganization of part 362, we would like to make a few
general comments concerning the proposal. First, we moved substantive
aspects of the regulation that were formerly found in the definitions
of terms like "bona fide subsidiary" to the applicable regulation
text. This reorganization should assist the reader in understanding and
applying the regulation. Second, current part 362 contains a number of
provisions relating to divesture. We have deleted any divestiture
provisions in the current proposal that we found to be unnecessary due
to the passage of time. Third, we are proposing to combine the rules
covering the equity investments of banks and savings associations into
part 362 and to regulate these investments as consistently as possible
given the limitations imposed by statute. Fourth, unlike the
regulations promulgated by the Office of Thrift Supervision we do not
distinguish between activities carried out by a first tier subsidiary
of a savings association versus a lower-tier subsidiary. Finally,
although the FDIC agrees with the principles applicable to transactions
between insured depository institutions and its affiliates contained in
sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c and
371c-1), our experience over the last five years in applying section 24
has led us to conclude that extending 23A and 23B by reference to bank
subsidiaries is inadvisable. For that reason, the proposed regulation
does not incorporate sections 23A and 23B of the Federal Reserve Act by
cross-reference; rather, the proposal adapts the principles set forth
in sections 23A and 23B to the bank/subsidiary relationship as
appropriate. In drafting the proposed revision to part 362, we have
considered each of the requirements contained in sections 23A and 23B
in the context of transactions between an insured institution and its
subsidiary and refined the restrictions appropriately. The FDIC
requests comment on whether these proposals assist in the application
of the principles of 23A and 23B to the subsidiaries of insured
depository institutions. We also request comment on all aspects of
these restrictions including whether this approach strikes a better
balance between caution and commercial reality by harmonizing the
capital deductions and the principles of 23A and 23B.
    Subpart A of the proposed regulation would deal with the activities
and investments of insured state banks. Except for those sections
pertaining to the applications, notices and related delegations of
authority (procedural provisions), existing part 362 would essentially
become subpart A under the current proposal. The procedural provisions
of existing part 362 have been transferred to subpart E. As proposed,
subpart A addresses the activities of the insured state bank in
Sec. 362.3. The activities carried on in a subsidiary of the insured
state bank are addressed in a separate section (see Sec. 362.4 in the
proposed regulation). We are soliciting comment on whether this
reorganization of part 362 is helpful.
    The ability of insured state banks to engage in activities as
principal is directly linked to the ability of a national bank to
engage in the same type of activity. National banks have a limited
ability to hold equity investments in real estate. Even so, if a
particular real estate investment has been determined to be permissible
for a national bank, an insured state bank only needs to document that
determination to undertake the

[[Page 47972]]

investment. Insured state banks that want to undertake a real estate
investment which is impermissible for a national bank (or continue to
hold the real estate investment in the case of investments acquired
before enactment of section 24 of the FDI Act), must file an
application with the FDIC for consent. The FDIC may approve such
applications if the investment is made through a majority-owned
subsidiary, the institution meets the applicable capital standards set
by the appropriate Federal banking agency and the FDIC determines that
the activity does not pose a significant risk to the appropriate
deposit insurance fund.
    The FDIC has determined that real estate investment activities may
pose significant risks to the deposit insurance funds. For that reason,
the FDIC is proposing to establish standards that an insured state
nonmember bank must meet before engaging in real estate investment
activities that are not permissible for a national bank. Under a safety
and soundness standard, subpart B of the proposed regulation requires
insured state nonmember banks to meet the standards established by the
FDIC, even if the Comptroller of the Currency determines that those
activities are permissible for a national bank subsidiary. Subpart B
also would establish modern standards for insured state nonmember banks
to govern transactions between those insured state nonmember banks that
are not affiliated with a bank holding company (nonbank banks) and
affiliated organizations conducting securities activities. The existing
restrictions on these securities activities are found in Sec. 337.4 of
this chapter. The new rule will only cover those entities not covered
by orders issued by the Board of Governors of the Federal Reserve
System (FRB) governing the securities activities of those banks that
are affiliated with a bank holding company or a member bank.
    Subpart B prohibits an insured state nonmember bank not affiliated
with a company that is treated as a bank holding company (see section
4(f) of the Bank Holding Company Act, 12 U.S.C. 1843(f)), from becoming
affiliated with a company that directly engages in the underwriting of
securities not permissible for a national bank unless the standards
established under the proposed regulation are met.
    Subpart C of the proposed regulation concerns the activities and
investments of insured state savings associations. The provisions
applicable to activities of savings associations currently appearing in
Sec. 303.13 would be revised in a number of ways and placed in new
subpart C. To the extent possible, activities and investments of
insured state savings associations would be treated consistently with
the treatment provided insured state banks. Thus, we revised a number
of definitions currently contained in Sec. 303.13 to track the
definitions used in subpart A. We request comment on whether the
revisions made in subpart C contribute to the efficient operation of
savings associations and their service corporations while continuing to
implement the statutory requirements.
    Subpart D of the proposal requires that an insured savings
association provide a 30 day notice to the FDIC whenever the
institution establishes or acquires a subsidiary or conducts a new
activity through a subsidiary. This provision does not alter the notice
required by statute. We moved this requirement to a new subpart to
accommodate Federally chartered savings associations by limiting the
amount of regulation text they would have to read to comply with this
statutory notice. Comment is invited on whether this separation avoids
confusion, enhances readability and simplifies compliance.
    Subparts E and F of the proposal each contain the notice and
application requirements and the delegations of authority for the
substantive matters covered by the proposal for insured state banks and
state savings associations, respectively.
    The FDIC requests comments about all aspects of the proposed
revision to part 362. In addition, the FDIC is raising specific
questions for public comment as set out in connection with the analysis
of the proposal below.

III. Section by Section Analysis

A. Subpart A--Activities of Insured State Banks

Section 362.1 Purpose and Scope
    The purpose and scope of subpart A is to ensure that the activities
and investments undertaken by insured state banks and their
subsidiaries do not present a significant risk to the deposit insurance
funds, are not unsafe and are not unsound, are consistent with the
purposes of federal deposit insurance and are otherwise consistent with
law. This subpart implements the provisions of section 24 of the FDI
Act that restrict and prohibit insured state banks and their
subsidiaries from engaging in activities and investments of a type that
are not permissible for national banks and their subsidiaries. The
phrase "activity permissible for a national bank" means any activity
authorized for national banks under any statute including the National
Bank Act (12 U.S.C. 21 et seq.), as well as activities recognized as
permissible for a national bank in regulations, official circulars,
bulletins, orders or written interpretations issued by the OCC. This
subpart governs activities conducted "as principal" and therefore
does not govern activities conducted as agent for a customer, conducted
in a brokerage, custodial, advisory, or administrative capacity, or
conducted as trustee. We moved this language from Sec. 362.2(c) of the
current version of part 362 where the term "as principal" is defined
to mean acting other than as agent for a customer, acting as trustee,
or conducting an activity in a brokerage, custodial or advisory
capacity. The FDIC previously described this definition as not
covering, for example, acting as agent for the sale of insurance,
acting as agent for the sale of securities, acting as agent for the
sale of real estate, or acting as agent in arranging for travel
services. Likewise, providing safekeeping services, providing personal
financial planning services, and acting as trustee were described as
not being "as principal" activities within the meaning of this
definition. In contrast, real estate development, insurance
underwriting, issuing annuities, and securities underwriting would
constitute "as principal" activities. Further, for example, travel
agency activities have not been brought within the scope of part 362
and would not require prior consent from the FDIC even though a
national bank is not permitted to act as travel agent. This result
obtains from the fact that the state bank would not be acting "as
principal" in providing those services. Thus, the fact that a national
bank may not engage in travel agency activities would be of no
consequence. Of course, state banks would have to be authorized to
engage in travel agency activities under state law. We intend to
continue to interpret section 24 and part 362 as excluding any coverage
of activities being conducted as agent. To highlight this issue,
provide clarity and alert the reader of this rule that activities being
conducted as agent are not within the scope of section 24 and part 362,
we have moved this language to the purpose and scope paragraph. We

[[Page 47973]]

request comment on whether moving this language to the purpose and
scope paragraph assists users of this rule in interpreting its
parameters. We also invite comment on whether the "as principal"
definition still would be necessary.
    Equity investments acquired in connection with debts previously
contracted (DPC) that are held within the shorter of the time limits
prescribed by state or federal law are not subject to the limitations
of this subpart. The exclusion of equity investments acquired in
connection with DPC has been moved from the definition of "Equity
investment" to the purpose and scope paragraph to highlight this
issue, provide clarity and alert the reader of this rule that these
investments are not within the scope of section 24 and part 362.
However, the intent of the insured state bank in holding equity
investments acquired in connection with DPC continues to be relevant to
the analysis of whether the equity investment is permitted. Interests
taken as DPC are excluded from the scope of this regulation provided
that the interests are not held for investment purposes and are not
held longer than the shorter of any time limit on holding such
interests (1) set by applicable state law or regulation or (2) the
maximum time limit on holding such interests set by applicable statute
for a national bank. The result of the modification would be to make it
clear, for example, that real estate taken DPC may not be held for
longer than 10 years (see 12 U.S.C. 29) or any shorter period of time
set by the state. In the case of equity securities taken DPC, the bank
must divest the equity securities "within a reasonable time" (i.e, as
soon as possible consistent with obtaining a reasonable return) (see
OCC Interpretive Letter No. 395, August 24, 1987, (1988-89 Transfer
Binder) Fed Banking L. Rep. (CCH) p. 85,619, which interprets and
applies the National Bank Act) or no later than the time permitted
under state law if that time period is shorter.
    In addition, any interest taken DPC may not be held for investment
purposes. For example, while a bank may be able to expend monies in
connection with DPC property and/or take other actions with regard to
that property, if those expenditures and actions are speculative in
nature or go beyond what is necessary and prudent in order for the bank
to recover on the loan, the property will not fall within the DPC
exclusion. The FDIC expects that bank management will document that DPC
property is being actively marketed and current appraisals or other
means of establishing fair market value may be used to support
management's decision not to dispose of property if offers to purchase
the property have been received and rejected by management.
    Similarly to highlight this issue, provide clarity and alert the
reader of this rule, we have moved to the purpose and scope paragraph
the language governing any interest in real estate in which the real
property is (a) used or intended in good faith to be used within a
reasonable time by an insured state bank or its subsidiaries as offices
or related facilities for the conduct of its business or future
expansion of its business or (b) used as public welfare investments of
a type permissible for national banks. In the case of real property
held for use at some time in the future as premises, the holding of the
property must reflect a bona fide intent on the part of the bank to use
the property in the future as premises. We are not aware of any
statutory time frame that applies in the case of a national bank which
limits the holding of such property to a specific time period.
Therefore, the issue of the precise time frame under which future
premises may be held without implicating part 362 must be decided on a
case-by-case basis. If the holding period allowed for under state law
is longer than what the FDIC determines to be reasonable and consistent
with a bona fide intent to use the property for future premises, the
bank will be so informed and will be required to convert the property
to use, divest the property, or apply for consent to hold the property
through a majority-owned subsidiary of the bank. We note that the OCC's
regulations indicate that real property held for future premises should
"normally" be converted to use within five years after which time it
will be considered other real estate owned and must be actively
marketed and divested in no later than ten years. (12 CFR 34). We
understand that the time periods set forth in the OCC's regulation
reflect safety and soundness determinations by that agency. As such,
and in keeping with what has been to date the FDIC's posture with
regard to safety and soundness determinations of the OCC, the FDIC will
substitute its own judgment to determine when a reasonable time has
elapsed for holding the property.
    A subsidiary of an insured state bank may not engage in real estate
investment activities not permissible for a subsidiary of a national
bank unless the bank is in compliance with applicable capital standards
and the FDIC has determined that the activity poses no significant risk
to the deposit insurance fund. Subpart A provides standards for real
estate investment activities that are not permissible for a subsidiary
of a national bank. Because of safety and soundness concerns relating
to real estate investment activities, subpart B reflects special rules
for subsidiaries of insured state nonmember banks that engage in real
estate investment activities of a type that are not permissible for a
national bank but may be otherwise permissible for a subsidiary of a
national bank.
    The FDIC intends to allow insured state banks and their
subsidiaries to undertake safe and sound activities and investments
that do not present a significant risk to the deposit insurance funds
and that are consistent with the purposes of federal deposit insurance
and other applicable law. This subpart does not authorize any insured
state bank to make investments or to conduct activities that are not
authorized or that are prohibited by either state or federal law.
Section 362.2  Definitions
    Revised subpart A Sec. 362.2 contains--definitions. We have left
most of the definitions unchanged or edited them to enhance clarity or
readability without changing the meaning.
    To standardize as many definitions as possible, we have
incorporated several definitions from section 3 of the FDI Act (12 U.S.
C. 1813). These definitions are "Bank," "State bank," "Savings
association," "State savings association," "Depository
institution," "Insured depository institution," "Insured state
bank," "Federal savings association," and "Insured state nonmember
bank." This standardization required that we delete the definitions of
"depository institution" and "insured state bank" currently found in
part 362. No substantive change was intended by this change. The
definitions that were added by this change are "Bank," "State
bank," "Savings association," "State savings association,"
"Insured depository institution," "Federal savings association,"
and "Insured state nonmember bank." These definitions were added to
provide clarity throughout the proposed part 362 because we are
incorporating so many definitions from subpart A into subpart B
governing safety and soundness concerns of insured state nonmember
banks, subpart C governing the activities of state savings
associations, and subpart D governing subsidiaries of all savings
associations. We invite comment on whether readers view these
definitions as needing further changes to enhance clarity and
readability. We also invite comment on whether any of

[[Page 47974]]

the changes we have made may have changed the substance of the
regulation in ways that we may not have intended.
    The definitions that have been left unchanged or edited to enhance
clarity or readability without changing the meaning are the following:
"Control," "Extension of credit," "Executive officer,"
"Director," "Principal shareholder," "Related interest,"
"National Securities exchange," "Residents of state,"
"Subsidiary," and "Tier one capital." We invite comment on whether
readers view these definitions as needing further changes to enhance
clarity and readability. We also invite comment on whether any of the
changes we have made may have changed the substance of the regulation
in ways that we may not have intended.
    The name of one definition has been simplified without
substantively changing the meaning of the definition. That definition
is currently found in Sec. 362.2(g) and is described as follows "An
insured state bank will be considered to convert its charter." We
moved this definition to Sec. 362.2(e) and call this definition,
"Convert its charter." The substance of the definition is intended to
remain unchanged by this revised language. We invite comment on whether
readers view the change in this definition as needing any further
changes to enhance clarity and readability. We also invite comment on
whether any of the changes we have made to this definition may have
changed the substance of the regulation in ways that we may not have
intended.
    Although most of the definitions as set out in the proposal are the
same or virtually unchanged, a few of the definitions in the proposal
have been substantively revised. The proposed changes to these
definitions are discussed below.
    We deleted the definitions of "Activity permissible for a national
bank," "An activity is considered to be conducted as principal," and
"Equity investment permissible for a national bank." We moved the
substance of the information that was contained in these definitions
into the scope paragraph in Sec. 362.1. We thought that including the
information that was in these definitions in the scope paragraph made
the coverage of the rule clearer to the reader and was consistent with
the purpose of the scope paragraph. We expect that some readers may
save time by realizing sooner that the regulation may be inapplicable
to conduct contemplated by a particular bank. We also thought that the
reader might be more likely to consider the scope paragraph than to
consider the definition section when reading the rule to determine its
applicability. We concluded that it would be unnecessary to duplicate
this same information in the definition section. We invite comment on
whether readers prefer to see these concepts in the scope paragraph and
whether readers also would prefer to see these concepts defined.
    We deleted the definition of "Equity interest in real estate" and
moved the recitation of the permissibility of owning real estate for
bank premises and future premises, owning real estate for public
welfare investments and owning real estate from DPC to the scope
paragraph for the reasons stated in the preceding paragraph. These
activities are permissible for national banks and we thought that it
was unnecessary to continue to restate this information in the
definition section of the regulation. No substantive change is intended
by this simplification of the language. In addition, we determined that
the remainder of the definition of "Equity interest in real estate"
did little to enhance clarity or understanding; therefore, we are
relying on the language defining "Equity investment" to cover real
estate investments. We conformed the definition of "Equity
investment" by deleting the reference to the deleted definition of
"Equity interest in real estate." No substantive change is intended
by shortening this language. We invite comment on whether the readers
view the definition of "Equity interest in real estate" as necessary
to enhance clarity and readability on these issues as well as whether
readers prefer seeing these concepts in the scope paragraph.
    The remainder of the definition of "Equity investment" has been
shortened and edited to enhance readability. We intend no substantive
change by shortening this language. This concept is intended to
encompass an investment in an equity security or real estate as it does
in the current definition. We invite comment on the changes to this
definition and whether any further changes are needed.
    With regard to the definition of "Equity security," we modified
this definition by deleting the references to permissible national bank
holdings such as equity securities being held as a result of a
foreclosure or other arrangements concerning debt previously
contracted. Language discussing the exclusion of DPC and other
investments that are permissible for national banks has been relocated
to the scope paragraph for the reasons stated above. Thus, the equity
investment definitions no longer include these references. We intend no
substantive change through the deletion of this redundant language. We
invite comment on whether any ambiguity or unintended change in the
meaning may be created by removing this language from the definition.
    We added a shorter definition of "Real estate investment
activity" meaning any interest in real estate held directly or
indirectly that is not permissible for a national bank. This term is
used in Sec. 362.4(b)(5) of subpart A and in Sec. 362.7 of subpart B
which contains safety and soundness restrictions on real estate
activities of subsidiaries of insured state nonmember banks that may be
deemed to be permissible for operating subsidiaries of national banks
that would not be permissible for a national bank, itself. We invite
comment on this definition, including its meaning and clarity as well
as the underlying safety and soundness proposal in subpart B. We
specifically invite comment on the exclusion of real estate leasing
from the definition of real estate investment activity. The proposal
has eliminated real estate leasing from the definition of real estate
investment activity in order to assure that banks using the notice
procedure are not getting involved in a commercial business. The notice
procedures are designed for institutions that wish to hold parcels of
real estate for ultimate sale. If an institution wishes to hold the
property to lease it for ongoing business purposes, we believe the
proposal should be considered under the application process.
    We deleted the definitions of "Investment in department" and
"Department" because we thought they were no longer needed in the
revised regulation text. The core standards applicable to a department
of a bank are set out in detail in Sec. 362.3(c) and defining the term
"Department" no longer seems to be necessary. Regarding the
definition of "Investment in department," we also considered this
definition unnecessary. We believe that if a calculation of
"Investment in department" needs to be made, we will defer to state
law on this issue. We invite comment on whether the readers view these
definitions as necessary to enhance clarity and readability on these
issues. We also request comment on whether deference to state law on
this investment issue would cause any unintended consequences that we
have not foreseen.
    Similarly, we deleted the definition of "Investment in
subsidiary" because the definition is no longer needed in the revised
regulation text. The core standards applicable to an insured state bank
and its subsidiary make a

[[Page 47975]]

definition of "Investment in subsidiary" superfluous. The core
standards contained in Sec. 362.4(c) set out the requirements in
detail. Therefore, defining the term "Investment in subsidiary" no
longer seems to be necessary. We invite comment on whether the readers
view this definition or a similar definition as necessary to enhance
clarity and readability on these issues.
    We deleted the definition of "bona fide subsidiary" and chose to
make similar characteristics part of the eligible subsidiary criteria
in Sec. 362.4(c)(2). We thought that including these criteria as a part
of the substantive regulation text in that subsection, rather than as a
definition, makes reading the rule easier and the meaning clearer. We
invite comment on whether readers prefer to see this concept set forth
in the substantive section of the rule or the definition section and
whether readers believe any additional definition is necessary to
enhance clarity and readability.
    The proposal substitutes the current definition of "Lower income"
with a cross reference in Sec. 362.3(a)(2)(ii) to the definition of
"low income" and "moderate income" as used for purposes of part 345
of the FDIC's regulations (12 CFR 345) which implements the Community
Reinvestment Act (CRA). 12 U.S.C. 2901, et seq. Under part 345, "low
income" means an individual income that is less than 50 percent of the
area median income or a median family income that is less than 50
percent in the case of a census tract or a block numbering area
delineated by the United States Census in the most recent decennial
census. "Moderate income" means an individual income that is at least
50 percent but less than 80 percent of the area median or a median
family income that is at least 50 but less than 80 percent in the case
of a census tract or block numbering area.
    The definition "Lower income" is relevant for purposes of
applying the exception in the regulation which allows an insured state
bank to be a partner in a limited partnership whose sole purpose is
direct or indirect investment in the acquisition, rehabilitation, or
new construction of qualified housing projects (housing for lower
income persons). As we anticipate that insured state banks would seek
to use such investments in meeting their community reinvestment
obligations, the FDIC is of the opinion that conforming the definition
of lower income to that used for CRA purposes will benefit banks. We
note that the change will have the effect of expanding the housing
projects that qualify for the exception. We invite comment on this
change.
    We have simplified the definition of the term "Activity." As
modified the definition includes all investments. Where equity
investments are intended to be excluded, we expressly exclude those
investments in the regulation text. We invite comment on whether the
modification to the definition enhances clarity or whether the longer
definition found in the current regulation should be reinstated. In
particular, we invite comment on whether the definition should be
modified to take into account in some fashion a recent interpretation
by the agency under which it was determined that the act of making a
political campaign contribution does not constitute an "activity" for
purposes of part 362. The interpretation uses a three prong test to
help determine whether particular conduct should be considered an
activity and therefore subject to review under part 362 if the conduct
is not permissible for a national bank. If at least two of the tests
yield a conclusion that the conduct is part of the authorized conduct
of business by the bank, the better conclusion is that the conduct is
an activity. First, any conduct that is an integral part of the
business of banking as well as any conduct which is closely related or
incidental to banking should be considered an activity . In applying
this test it is important to focus on what banks do that makes them
different from other types of businesses. For example, lending money is
clearly an "activity" for purposes of part 362. The second test asks
whether the conduct is merely a corporate function as opposed to a
banking function. For example, paying dividends to shareholders is
primarily a general corporate function and not one associated with
banking because of some unique characteristic of banking as a business.
Generally, activities that are not general corporate functions will
involve interaction between the bank and its customers rather than its
employees or shareholders. The third test asks whether the conduct
involves an attempt by the bank to generate a profit. For example,
banks make loans and accept deposits in an effort to make money.
However, contracting with another company to generate monthly customer
statements should not be considered to be an activity unto itself as it
simply is entered into in support of the "activity" of taking
deposits. We also invite any other comments that would make this
definition easier to understand and apply.
    The proposal modifies the definition of "Company" to add limited
liability companies to the list of entities that will be considered a
company. This change in the definition is being proposed in recognition
of the creation of limited liability companies and their growing
prevalence in the market place. We invite comment on whether this
addition to the list of forms of business enterprise is appropriate and
whether we should add any more forms of business enterprise.
    The FDIC has changed the definition of "Significant risk to the
fund" by adding the second sentence that clarifies that this
definition includes the risk that may be present either when an
activity or an equity investment contributes or may contribute to the
decline in condition of a particular state-chartered depository
institution or when a type of activity or equity investment is found by
the FDIC to contribute or potentially contribute to the deterioration
of the overall condition of the banking system. We invite comment on
whether the definition should be modified in some other manner and if
so how. Our interpretation of the definition remains unchanged.
Significant risk to the deposit insurance fund shall be understood to
be present whenever there is a high probability that any insurance fund
administered by the FDIC may suffer a loss. The preamble accompanying
the adoption of this definition in final indicated that the FDIC
recognized that no investment or activity may be said to be without
risk under all circumstances and that such fact alone will not cause
the agency to determine that a particular activity or investment poses
a significant risk of loss to the fund. The emphasis rather is on
whether there is a high degree of likelihood under all of the
circumstances that an investment or activity by a particular bank, or
by banks in general or in a given market or region, may ultimately
produce a loss to either of the funds. The relative or absolute size of
the loss that is projected in comparison to the fund will not be
determinative of the issue. The preamble indicated that the definition
is consistent with and derived from the legislative history of section
24 of the FDI Act. Previously, the FDIC rejected the suggestion that
risk to the fund only be found if a particular activity or investment
is expected to result in the imminent failure of a bank. The suggestion
was rejected as the FDIC determined at that time that it was
appropriate to approach the issue conservatively. We think that this
conservatism is more clearly articulated in this modification to the
definition. We invite comments on whether this

[[Page 47976]]

additional language is necessary and whether any other language should
be added.
    We re-defined the term "Well-capitalized" to incorporate the same
meaning set forth in part 325 of this chapter for an insured state
nonmember bank. For other state-chartered depository institutions, the
term "well-capitalized" has the same meaning as set forth in the
capital regulations adopted by the appropriate Federal banking agency.
We decided that it would simplify the calculations for the various
state-chartered depository institutions if the capital definition
imported the definitions used by those institutions when they deal with
their appropriate Federal banking agency. We deleted the other terms
defined under Sec. 362.2(x) as unnecessary due to the changes in the
regulation text. We invite comment on whether we have missed an item
that still needs to be included in this definition.
    We added definitions of the following terms: "Change in control,"
"Institution," "Majority-owned subsidiary," "Security" and
"State-chartered depository institution."
    Under section 24 of the FDI Act, the grandfather with respect to
common or preferred stock listed on a national securities exchange and
shares of registered investment companies ceases to apply if the bank
undergoes a change in control. The phrase "Change in control" is
defined for the purposes of part 362 in what is currently
Sec. 362.3(b)(4)(ii) of the regulation. Under the proposal, the
definition is relocated into the definitions section and modified.
    Under the current regulation a "Change in control" that will
result in the loss of the grandfather is defined to mean a transaction
in which the bank converts its charter, undergoes a transaction which
requires a notice to be filed under section 7(j) of the FDI Act (12
U.S.C. 1817(j)) except a transaction which is presumed to be a change
in control for the purposes of that section under FDIC's regulations
implementing section 7(j), any transaction subject to section 3 of the
Bank Holding Company Act ( 12 U.S.C. 1842) other than a one bank
holding company formation, a transaction in which the bank is acquired
by or merged into a bank that is not eligible for the grandfather, or a
transaction in which control of the bank's parent company changes. The
proposal would narrow the definition of "Change in control" by
defining the phrase to only encompass transactions subject to section
7(j) of the FDI Act (except for transactions which trigger the
presumptions under FDIC's regulations implementing section 7(j) or the
FRB's regulations implementing section 7(j)) and transactions in which
the bank is acquired by or merged into a bank that is not eligible for
the grandfather. This definition change will narrow the instances in
which a bank may lose its grandfathered ability to invest in common or
preferred stock listed on a national securities exchange and shares of
registered investment companies. It is our belief that the revised
definition, if adopted, will more closely approximate when a true
change in control has occurred.
    We added a definition of "Institution" and defined it to mean the
same as a "state-chartered depository institution" to shorten the
drafting of the rule, particularly for those items that are applicable
to both insured state banks and insured state savings associations.
This definition is intended to enhance readability. We invite comment
on whether this definition creates any confusion or ambiguity.
    We added a definition of "Majority-owned subsidiary" and defined
it to mean any corporation in which the parent insured state bank owns
a majority of the outstanding voting stock. We added this definition to
clarify our intention that the expedited notice procedures only be
available when an insured state bank interposes an entity that gives
limited liability to the parent institution. We interpret Congress's
intention in imposing the majority-owned subsidiary requirement in
section 24 of the FDI Act to generally require that such a subsidiary
provide limited liability to the insured state bank. Thus, except in
unusual circumstances, we have and will require majority-owned
subsidiaries to adopt a form of business that provides limited
liability to the parent bank. In assessing our experience with
applications, we have determined that the notice procedure will be
available only to banks that engage in activities through a majority-
owned subsidiary that takes the corporate form of business. We welcome
applications that may take a different form of business such as a
limited partnership or limited liability company, but would like to
develop more experience with appropriate separations to protect the
bank from liability under these other forms of business enterprise
through the application process before including these entities in a
notice procedure. We have decided that there may have been an ambiguity
in the notice provisions we proposed for comment and published August
23, 1996, in the Federal Register at 61 FR 43486. We intended that an
entity eligible for the notice procedure be in corporate form and
implied that requirement by incorporating the bona fide subsidiary
requirements that included references to a board of directors. The
addition of this definition should make our intention clear that the
notice procedure requires a majority-owned subsidiary to take the
corporate form. We invite comment on this definition, our substantive
decision to require the corporate form for a majority-owned subsidiary
of an insured state bank using the notice procedures, and our decision
to exclude other limited liability business forms from the notice
procedure. We also invite comment on any ambiguities or questions that
this definition may create.
    We adopted the definition of "Security" from part 344 of this
chapter to eliminate any ambiguity over the coverage of this rule when
securities activities and investments are contemplated. We invite
comment on any ambiguities or questions that this definition may
create.
    We defined "State-chartered depository institution" to mean any
state bank or state savings association insured by the FDIC to
eliminate confusion and ambiguity. We invite comment on any ambiguities
or questions that this definition may create.
    We invite any general comment on the proposed definitions and
invite any suggestions for additional definitions that would be helpful
to the reader of the regulatory text.
Section 362.3  Activities of Insured State Banks
Equity Investment Prohibition
    Section 362.3(a) of the proposal restates the statutory prohibition
on insured state banks making or retaining any equity investment of a
type that is not permissible for a national bank. The prohibition does
not apply if one of the statutory exceptions contained in section 24 of
the FDI Act (restated in the current regulation and carried forward in
the proposal) applies. The provision is being retained. The proposal
eliminates the reference to amount that is contained in the current
version of Sec. 362.3(a). We have reconsidered our interpretation of
the language of section 24 where paragraph (c) prohibits an insured
state bank from acquiring or retaining any equity investment of a type
that is impermissible for a national bank and paragraph (f) prohibits
an insured state bank from acquiring or retaining any equity investment
of a type or in an amount that is impermissible for a national bank. We

[[Page 47977]]

previously interpreted the language of paragraph (f) as controlling and
read that language into the entire statute. We reconsidered this
approach, decided that it was not the most reasonable construction of
this statute and determined that the language of paragraph (c) is
controlling. Thus, the language of paragraph (c) controls when any
other equity investment is being considered. Therefore, we deleted the
amount language from prohibition in the regulation. We request comment
on this change.
Exception for Majority-Owned Subsidiary
    The FDIC proposes to retain the exception which allows investment
in majority-owned subsidiaries as currently in effect without any
substantive change. However, the FDIC has modified the language of this
section to remove negative inferences and make the text clearer. Rather
than stating that the bank may do what is not prohibited, the FDIC is
affirmatively stating that an insured state chartered bank may acquire
or retain investments through a majority-owned subsidiary. If an
insured state bank holds less than a majority interest in the
subsidiary, and that equity investment is of a type that would be
prohibited to a national bank, the exception does not apply and the
investment is subject to divestiture.
    Majority ownership for the exception is understood to mean
ownership of greater than 50 percent of the outstanding voting stock of
the subsidiary. It is our understanding that national banks may own a
minority interest in certain types of subsidiaries. (See 12 CFR
5.34(1997)). Therefore, an insured state bank may hold a minority
interest in a subsidiary if a national bank could do so. Thus, the
statute does not necessarily require a state bank to hold at least a
majority of the stock of a company in order for the equity investment
in the company to be permissible under the regulation. Only investments
that would not be permissible for a national bank must be held through
a majority-owned subsidiary.
    The regulation defines the business form of a majority-owned
subsidiary to be a corporation. There may be other forms of business
organization that are suitable for the purposes of this exception such
as partnerships or limited liability companies. The FDIC does not wish
to give blanket authorization to a non-corporate form of organization
since these forms may not provide for the same separations the FDIC
believes to be necessary to protect the insured bank from assuming the
liabilities of its subsidiary. The proposal anticipates that the Board
will review alternate forms of organization to assure that appropriate
separation between the insured depository institution and the
subsidiary is in place. We are soliciting comment on other forms of
business organization which the FDIC may allow. Please provide a
discussion of the separations inherent in alternate forms of business
organization.
    To qualify for this exception, the majority-owned subsidiary must
engage in activities that are described in Sec. 362.4(b). The allowable
activities include both statutory and regulatory exceptions to the
general prohibitions of the regulation.
Investments in Qualified Housing Projects
    The FDIC proposes to combine the language found in two paragraphs
of the current regulation. The FDIC proposes to retain the combined
paragraphs of the regulation with substantially the same language as
currently in effect. The changes that have been made reflect practical
clarifications resulting from the implications of the technical way the
qualified housing rules work and are not intended to be substantive. In
addition, the FDIC has modified the language of the text to remove
negative inferences and make the text clearer. Section 362.3(a)(2)(ii)
of the proposal provides an exception for qualified housing projects.
Under the exception, an insured state bank is not prohibited from
investing as a limited partner in a partnership, the sole purpose of
which is direct or indirect investment in the acquisition,
rehabilitation, or new construction of a residential housing project
intended to primarily benefit lower income persons throughout the
period of the bank's investment. The bank's investments, when
aggregated with any existing investment in such a partnership or
partnerships, may not exceed 2 percent of the bank's total assets. The
FDIC expects that banks use the figure reported on the bank's most
recent consolidated report of condition prior to making the investment
as the measure of their total assets. If an investment in a qualified
housing project does not exceed the limit at the time the investment
was made, the investment shall be considered to be a legal investment
even if the bank's total assets subsequently decline.
    The current exception is limited to instances in which the bank
invests as a limited partner in a partnership. Comment is invited on
(1) whether the FDIC should expand the exception to include limited
liability companies and (2) whether doing so is permissible under the
statute. (Section 24(c)(3) of the FDI Act provides that a state bank
may invest "as a limited partner in a partnership.")
Grandfathered Investments in Listed Common or Preferred Stock and
Shares of Registered Investment Companies
    The current regulation restates the statutory exception for
investments in common or preferred stock listed on a national
securities exchange and for shares of investment companies registered
under the Investment Company Act of 1940 that is available to certain
state banks if they meet the requirements to be eligible for the
grandfather. The statute requires, among other things, that a state
bank file a notice with the FDIC before relying on the exception and
that the FDIC approve the notice. The notice requirement, content of
notice, presumptions with respect to the notice, and the maximum
permissible investment under the grandfather also are set out in the
current regulation. The FDIC proposes to retain the regulatory language
as currently in effect without any substantive change. The exception is
found in Sec. 362.3(a)(2)(iii) of the proposal. Although there would be
no substantive change, the FDIC has modified the language of this
section to remove negative inferences and make the text clearer.
    We deleted the reference in the current regulation describing the
notice content and procedure because we believe that most, if not all,
of the banks eligible for the grandfather already have filed notices
with the FDIC. Thus, we shortened the regulation by eliminating
language governing the specific content and processing of the notices.
Investment in common or preferred stock listed on a national securities
exchange or shares of an investment company is governed by the language
of the statute. Notices must conform to the statutory requirements
whether filed previously or filed in the future. Any bank that has
filed a notice need not file again. Comment is invited on whether the
regulatory filing requirements should be retained and eventually moved
into part 303 of this chapter.
    Section 362.3(a)(2)(iii)(A) of the proposal implements the
grandfathered listed stock and registered shares provision found in
section 24(f)(2) of the FDI Act. Paragraph (B) of this section of the
proposal provides that the exception for listed stock and registered
shares ceases to apply in the event that the bank converts its charter
or the bank or its parent holding company undergoes a change in
control. This language restates the statutory language governing when

[[Page 47978]]

grandfather rights terminate. State banks should continue to be aware
that, depending upon the circumstances, the exception may be considered
lost after a merger transaction in which an eligible bank is the
survivor. For example, if a state bank that is not eligible for the
exception is merged into a much smaller state bank that is eligible for
the exception, the FDIC may determine that in substance the eligible
bank has been acquired by a bank that is not eligible for the
exception.
    The regulation continues to provide that in the event an eligible
bank undergoes any transaction that results in the loss of the
exception, the bank is not prohibited from retaining its existing
investments unless the FDIC determines that retaining the investments
will adversely affect the bank and the FDIC orders the bank to divest
the stock and/or shares. This provision has been retained in the
regulation without any change except for the deletion of the citation
to specific authorities the FDIC may rely on to order divestiture.
Rather than containing specific citations, the proposal merely
references FDIC's ability to order divestiture under any applicable
authority. State banks should continue to be aware that any inaction by
the FDIC would not preclude a bank's appropriate banking agency (when
that agency is an agency other than the FDIC) from taking steps to
require divestiture of the stock and/or shares if in that agency's
judgment divestiture is warranted.
    Finally, the FDIC has moved, simplified and shortened the limit on
the maximum permissible investment in listed stock and registered
shares. The proposal limits the investment in grandfathered listed
stock and registered shares to a maximum of one hundred percent (100
percent) of tier one capital as measured on the bank's most recent
consolidated report of condition. The FDIC continues to use book value
as the measure of compliance with this limitation. Language indicating
that investments by well-capitalized banks in amounts up to 100 percent
of tier one capital will be presumed not to present a significant risk
to the fund is being deleted as is language indicating that it will be
presumed to present a significant risk to the fund for an
undercapitalized bank to invest in amounts that high. In addition, we
deleted the language stating the presumption that, absent some
mitigating factor, it will not be presumed to present a significant
risk for an adequately capitalized bank to invest up to 100 percent of
tier one capital. At this time we believe that it is not necessary to
expressly state these presumptions in the regulation.
    Language in the current regulation concerning the divestiture of
stock and/or shares in excess of that permitted by the FDIC (as well as
such investments in excess of 100 percent of the bank's tier one
capital) is deleted under the proposal as no longer necessary due to
the passage of time. In both instances the time allowed for such
divestiture has passed.
    Comment is invited on whether this grandfather exception for
investment in listed stock and registered shares should be applied by
the FDIC as an exception that is separate and distinct from any other
exception under the regulation that would allow a subsidiary of an
insured state bank to hold equity securities. In short, should we allow
this exception in addition to the exception for stock discussed below
or should the FDIC consider any listed stock held by a subsidiary of
the bank pursuant to an exception in the regulation toward the 100
percent of tier one capital limit under this exception? We note that
the statute does not itself impose any conditions or restrictions on a
bank that enjoys the grandfather in terms of per issuer limits. Comment
is sought on whether it is appropriate to impose restrictions under the
regulation that would, for example, limit a bank to investing in less
than a controlling interest in any given issuer. Is there some other
limit or restriction the FDIC should consider imposing by regulation
that is important to ensuring that the grandfathered investments do not
pose a risk? Should this be done, if at all, solely through the notice
and approval process?
Stock Investment in Insured Depository Institutions Owned Exclusively
by Other Banks and Savings Associations
    The content of the proposed regulation reflects the statutory
exception that an insured state bank is not prohibited from acquiring
or retaining the shares of depository institutions that engage only in
activities permissible for national banks, are subject to examination
and are regulated by a state bank supervisor, and are owned by 20 or
more depository institutions not one of which owns more than 15 percent
of the voting shares. In addition, the voting shares must be held only
by depository institutions (other than directors' qualifying shares or
shares held under or acquired through a plan established for the
benefit of the officers and employees). Section 24(f)(3)(B) of the FDI
Act does not limit the exception to voting stock. We are not proposing
to eliminate the reference to "voting" in the current regulation when
referencing control of the insured depository institution. Any other
reference to voting stock has been eliminated in the exception to allow
holding of non-voting stock. The FDIC seeks comment concerning
retaining the reference to "voting" stock when calculating the 15
percent ownership limitation contained in the statute.
Stock Investments in Insurance Companies
    Section 362.3(b)(2)(v) of the proposal contains exceptions that
permit state banks to hold equity investments in insurance companies.
The exceptions are provided by statute and implemented in the current
version of part 362. For the most part, we brought the exceptions
forward into this proposal with no substantive editing. The exceptions
are discussed separately below.
Directors and Officers Liability Insurance Corporations
    The first statutory exception permits insured state banks to own
stock in corporations that solely underwrite or reinsure financial
institution directors' and officers' liability insurance or blanket
bond group insurance. A bank's investment in any one corporation is
limited to 10 percent of the outstanding stock. We eliminated the
present limitation of 10 percent of the "voting" stock and changed
the present reference from "company" to "corporation," conforming
the language to the statutory exception.
    While the statute and regulation provide a limit on a bank's
investment in the stock of any one insurance company, there is no
statutory or regulatory "aggregate" investment limit in all insurance
companies nor does the statute combine this equity investment with any
other exception under which a state bank may invest in equity
securities. In the past, the FDIC has addressed investment
concentration and diversification issues on a case-by-case basis. The
FDIC is not at this time proposing to impose aggregate investment
limits on equity investments which have specific statutory carve outs
nor are we proposing to combine those investments with other equity
investments made under the exceptions to the regulation for which
aggregate investments are being proposed. The FDIC would like to
receive comment, however, on whether there should be an "aggregate"
investment limit for equity investments in insurance companies.

[[Page 47979]]

Stock of Savings Bank Life Insurance Company
    The second statutory exception for equity investments in insurance
companies permits any insured state bank located in the states of New
York, Massachusetts and Connecticut to own stock in savings bank life
insurance companies provided that consumer disclosures are made. Again,
this regulatory provision mirrors the specific statutory carve out
found in Section 24 and is contained in the present regulation. We have
carried this provision forward into the proposal with some changes.
    The savings bank life insurance investment exception is broader
than the director and officer liability insurance company exception
discussed above. There are no individual or aggregate investment
limitations for investments in savings bank life insurance companies.
The proposed language is shorter than the existing regulation and makes
a substantive change by clarifying what the required disclosures are
for insured banks selling these products. As was indicated above,
insured banks located in New York, Massachusetts and Connecticut are
permitted to invest in the stock of a savings bank life insurance
company as long as certain disclosure requirements are met. The FDIC
proposes to amend the regulatory language to specifically require
compliance with the Interagency Statement in lieu of the disclosures
presently set out in the regulation. Insured banks selling savings bank
life insurance policies, other insurance products and annuities will be
required to provide customers with written disclosures that are
consistent with the Interagency Statement which include a statement
that the products are not insured by the FDIC, are not guaranteed by
the bank, and may involve risk of loss. The last disclosure--that such
products may involve risk of loss--is not currently required under the
regulation.
    The FDIC would like to request comment regarding the disclosure
obligations of insured banks. It is the FDIC's view that savings bank
life insurance, other insurance products and annuities are "nondeposit
investment products" as that term is used in the Interagency
Statement. The FDIC is aware that insurance companies typically offer
annuity products and that many states regulate annuities through their
insurance departments. However, the FDIC agrees with the Comptroller of
the Currency that annuities are financial products and not insurance.
Nevertheless, annuities are nondeposit investment products and are
therefore subject to the requirements found in the Interagency
Statement when sold to retail customers on bank premises as well as in
other instances. On this basis, all the requirements in the Interagency
Statement should apply to the marketing and sale of annuities by a
financial institution.
    While the existing regulatory language is similar to the
Interagency Statement in what it requires to be disclosed, it is not
identical. The FDIC believes the proposed changes will clarify the
standards which are to be followed by insured state banks.
    It could be argued that the regulatory language in this part
repeats existing guidance and is unnecessary. We note, however, that
the statute requires that disclosures be made in order for the
exception to be available. While the Interagency Statement is
enforceable in the sense that noncompliance may constitute an unsafe or
unsound banking practice that may give rise to a cease and desist
action, the Interagency Statement is not itself a regulation with the
force and effect of law.
    We seek comments on whether it would be preferable for the
regulation to fully set out the disclosure requirements rather than
cross referencing the Interagency Statement. Commenters should address
these points, as well as discuss the differences between enforcing
specific regulatory language versus enforcing a policy statement. We
invite comments on the applicability of the Interagency Statement in
the absence of the language referencing it in this regulation. We
invite comment on whether using the Interagency Statement makes
compliance easier for banks as it provides uniform standards applicable
to multiple products. We also invite comment on any other issues that
are of concern to the industry or the public in using these particular
disclosures when selling insurance and annuity products.
Other Activities Prohibition
    Section 362.3(b) of the proposal restates the statutory prohibition
on insured state banks directly or indirectly engaging as principal in
any activity that is not permissible for a national bank. Activity is
defined in this proposal as the conduct of business by a state-
chartered depository institution, including acquiring or retaining any
investment. Because acquiring or retaining an investment is an activity
by definition, language has been added to make clear that this
prohibition does not supersede the equity investment exception of
Sec. 362.3(b). The prohibition does not apply if one of the statutory
exceptions contained in section 24 of the FDI Act (restated in the
current regulation and carried forward in the proposal) applies. The
FDIC has provided two regulatory exceptions to the prohibition on other
activities.
Consent Through Application
    The limitation on activities contained in the statute states that
an insured state bank may not engage as principal in any type of
activity that is not permissible for a national bank unless the FDIC
has determined that the activity would pose no significant risk to the
appropriate deposit insurance fund, and the bank is and continues to be
in compliance with applicable capital standards prescribed by the
appropriate federal banking agency. Section 362.3(b)(2)(i) establishes
an application process for the FDIC to make the determination
concerning risk to the funds. The substance of this process is
unchanged from the current regulation.
Insurance Underwriting
    This exception tracks the statutory exception in section 24 of the
FDI Act which grandfathers (1) an insured state bank engaged in the
underwriting of savings bank life insurance through a department of the
bank; (2) any insured state bank that engaged in underwriting of
insurance on or before September 30, 1991, which was reinsured in whole
or in part by the Federal Crop Insurance Corporation; and (3) well-
capitalized banks engaged in insurance underwriting through a
department of a bank. The exception is carried over from the current
regulation with a number of proposed modifications.
    To use the savings bank life insurance exception, an insured state
bank located in Massachusetts, New York or Connecticut must engage in
the activity through a department of the bank that meets core standards
discussed below. The standards for conducting this activity are taken
from the current regulation with the exception of disclosure standards
which are discussed below. We have moved the requirements for a
department from the definitions to the substantive portion of the
regulation text.
    The exception for underwriting federal crop insurance reflects the
statutory exception. This exception is unchanged from the current
regulation, and there are no regulatory limitations on the conduct of
the activity.
    An insured state bank that wishes to use the grandfathered
insurance underwriting exception may do so only if the insured state
bank was lawfully providing insurance, as principal, as of November 21,
1991. Further, an insured

[[Page 47980]]

state bank must be well-capitalized if it is to engage in insurance
underwriting, and the bank must conduct the insurance underwriting in a
department that meets the core standards described below.
    Banks taking advantage of this grandfather provision only may
underwrite the same type of insurance that was underwritten as of
November 21, 1991 and only may operate and have customers in the same
states in which it was underwriting policies on November 21, 1991. The
grandfather authority for this activity does not terminate upon a
change in control of the bank or its parent holding company.
    Both savings bank life insurance activities and grandfathered
insurance underwriting must take place in a department of the bank
which meets certain core standards. The core operating standards for
the department require the department to provide customers with written
disclosures that are consistent with those in the Interagency
Statement. Consistent with the disclosure requirements of the current
regulation, the proposed rule requires the department to inform its
customers that only the assets of the department may be used to satisfy
the obligations of the department. Note that this language does not
require the bank to say that the bank is not obligated for the
obligations of the department. The bank and the department constitute
one corporate entity. In the event of insolvency, the insurance
underwriting department's assets and liabilities would be segregated
from the bank's assets and liabilities due to the requirements of state
law.
    The FDIC views any financial product that is not a deposit and
entails some investment component to be a "nondeposit investment
product" subject to the Interagency Statement. Part 362 was
promulgated in 1992 before the Interagency Statement was issued in
February of 1994. While the disclosures currently required by part 362
are similar to the disclosures set out in the Interagency Statement,
they are not identical. Banks that engage in insurance underwriting are
thus covered by the Interagency Statement and part 362 and must comply
with similar but somewhat different requirements. We are proposing to
cross reference the Interagency Statement in part 362 to make
compliance clearer. We believe that using the uniform standards set
forth in the Interagency Statement will make compliance easier.
    In the case of insurance underwriting activities conducted by a
department of the bank, the disclosure required by the Interagency
Statement that the product is not an obligation of the bank is not
correct as noted above, and the suggested language in the regulation
does not require this disclosure. This clarification is consistent with
other interpretations of the Interagency Statement which stated that
disclosures should be consistent with the types of products offered.
The FDIC would like to receive comment on whether such clarification is
necessary or whether the regulation language is seen as duplicating
other guidance.
    The FDIC notes that the consumer disclosures are statutorily
required for savings bank life insurance. The Interagency Statement is
joint supervisory guidance issued by the Federal Banking Agencies, not
a regulation. The FDIC requests comment regarding the enforceability of
the Interagency Statement versus a regulation promulgated under the
rulemaking requirements of the Administrative Procedures Act.
    The core separation standards restate the requirements currently
found in the definition of department. These standards require that the
department (1) be physically distinct from the remainder of the bank,
(2) maintain separate accounting and other records, (3) have assets,
liabilities, obligations and expenses that are separate and distinct
from those of the remainder of the bank; and (4) be subject to state
statutes that require the obligations, liabilities and expenses be
satisfied only with the assets of the department. The standards in the
proposed regulation are not changed from the current regulation, but
have been moved from the definitions section of the regulation to
ensure that requirements of the rule are shown in connection with the
appropriate regulatory exception.
Acquiring and Retaining Adjustable Rate and Money Market Preferred
Stock by the Bank
    The proposal provides an exception that allows a state bank to
invest in up to 15 percent of the bank's tier one capital in adjustable
rate preferred stock and money market (auction rate) preferred stock
without filing an application with the FDIC. The exception was adopted
when the 1992 version of the regulation was adopted in final form. At
that time after reviewing comments, the FDIC found that adjustable rate
preferred stock and money market (auction rate) preferred stock were
essentially substitutes for money market investments such as commercial
paper and that their characteristics are closer to debt than to equity
securities. Therefore, money market preferred stock and adjustable rate
preferred stock were excluded from the definition of equity security.
As a result, these investments are not subject to the equity investment
prohibitions of the statute and of the regulation and are considered to
be an "other activity" for the purposes of this regulation.
    This exception focuses on two categories of preferred stock. This
first category, adjustable rate preferred stock refers to shares where
dividends are established by contract through the use of a formula
based on Treasury rates or some other readily available interest rate
levels. Money market preferred stock refers to those issues where
dividends are established through a periodic auction process that
establishes yields in relation to short term rates paid on commercial
paper issued by the same or a similar company. The credit quality of
the issuer determines the value of the security, and money market
preferred shares are sold at auction.
    We have modified the exception under the proposal by limiting the
15 percent measurement to tier one capital, rather than total capital.
Throughout the current proposal, we have measured capital-based
limitations against tier one capital. We changed the base in this
provision to increase uniformity within the regulation. We recognize
that this change may lower the permitted amount of these investments
held by institutions already engaged in the activity. An insured state
bank that has investments exceeding the proposed limit, but within the
total capital limit, may continue holding those investments until they
are redeemed or repurchased by the issuer. The 15 percent of tier one
capital limitation should be used in determining the allowable amount
of new purchases of money market preferred and adjustable rate
preferred stock. Of course, any institution that wants to increase its
holding of these securities may submit an application to the FDIC.
    The FDIC seeks comment on whether this treatment of money market
preferred stock and adjustable rate preferred stock is still
appropriate. Comment is requested concerning whether other similar
types of investments should be given similar treatment. Comments also
are requested on whether the reduced capital base affects any
institution currently holding these investments or is likely to affect
the investment plans of any institution.
Activities That Are Closely Related to Banking Conducted by Bank or Its
Subsidiary
    The proposed regulation continues the language found in the current
regulation titled, "Activities that are

[[Page 47981]]

closely related to banking." This section permits an insured state
bank to engage as principal in any activity that is not permissible for
a national bank provided that the FRB by regulation or order has found
the activity to be closely related to banking for the purposes of
section 4(c)(8) of the Bank Holding Company Act (12 U.S.C. 1843(c)(8)).
This exception is subject to the statutory prohibition that does not
allow the FDIC to permit the bank to directly hold equity securities
that a national bank may not hold and which are not otherwise
permissible investments for insured state banks pursuant to
Sec. 362.3(b).
    Additional language has been added to clarify that this subsection
does not authorize an insured state bank engaged in real estate leasing
to hold the leased property for more than two years at the end of the
lease unless the property is re-leased. This language is added to
ensure that this provision does not allow an insured state bank to hold
an equity interest in real estate after the end of the lease period.
The FDIC has decided to provide a two-year period for the bank to
divest the property if the bank cannot lease the property again.
Comment is invited on the reasonableness of this approach. Should the
FDIC consider an alternative approach that a bank may not enter a non-
operating lease unless title reverts to the lessee at the end of the
lease period? Are there other standards that the FDIC should consider
in this matter?
    As does the current regulation, these provisions allow a state bank
to directly engage in any "as principal" activity included on the
FRB's list of activities that are closely related to banking (found at
12 CFR 225.28) and "as principal" in any activity with respect to
which the FRB has issued an order finding that the activity is closely
related to banking.
    However, the consent to engage in real estate leasing directly by
an insured state bank has been modified. Comment is requested on
whether there are any additional activities permitted under the
proposed language that should be modified. Comment is requested on the
effect of the proposed treatment of real estate leasing activities on
banks that may want to engage in this activity in the future. Comment
also is requested on the perceived risks of leasing activities and
whether we should impose standards to address those risks. Comment is
requested on whether we should consider any other approach, including
returning to the language in the current regulation or deleting the
references to the Bank Holding Company Act (12 U.S.C. 1843(c)(8) and
the activities that the FRB by regulation or order has found to be
closely related to banking for the purposes of section 4(c)(8).
Guarantee Activities by Banks
    The current regulation contains a provision that permits a state
bank with a foreign branch to directly guarantee the obligations of its
customers as set out in Sec. 347.3(c)(1) of the FDIC's regulations
without filing any application under part 362. It also permits a state
bank to offer customer-sponsored credit card programs in which the bank
guarantees the obligations of its retail banking deposit customers.
This provision has been deleted as unnecessary since we understand that
these activities are permissible for a national bank. In its current
rule, the FDIC added this provision to clarify that part 362 does not
prohibit these activities; however to shorten the regulation, such
clarifying language has been deleted since the activity is permissible
for a national bank. The FDIC seeks comment as to whether the deletion
of this language has an adverse impact on insured state depository
institutions and if there are specific activities that this provision
allowed that are not permissible for a national bank.
    In the FDIC's proposal regarding the consolidation and
simplification of its international banking regulations found in the
Federal Register on July 15, 1997, at 62 FR 37748, a technical
amendment to the current version of part 362 is found. This amendment
updates the reference to Sec. 347.103(a)(1) of this chapter in
Sec. 362.4(c)(3)(I)(A). This amendment may become final as a part of
the consolidation and simplification of the FDIC's international
banking regulations to reflect the correct citation in the current
version of part 362. Nevertheless, we propose to eliminate the
references to guarantee activities in this proposal because we consider
them unnecessary as they duplicate powers granted to national banks. As
previously stated, we invite comment on the necessity of including
specific language dealing with the power to guarantee customer
obligations in the regulatory text of part 362.
Section 362.4  Subsidiaries of Insured State Banks
General Prohibition
    The regulatory language implementing the statutory prohibition on
"as principal" activities that are not permissible for a subsidiary
of a national bank has been separated from the prohibition on
activities which are not permissible for a national bank conducted in
the bank. By separating bank and subsidiary activities, Sec. 362.4 now
deals exclusively with activities that may be conducted in a subsidiary
of an insured state bank. We believe that separating the activities
that may be conducted at the bank level from the activities that must
be conducted by a subsidiary makes it easier for the reader to
understand the intent of the regulation. We invite comment on whether
this structure is more useful to the reader. We also invite comment on
whether any additional changes would make it easier for the reader to
interpret the regulation text.
Exceptions
    Prohibited activities may not be conducted unless one of the
exceptions in the regulation applies. This language is similar to the
current part 362 and results in no substantive change to the
prohibition.
Consent Obtained Through Application
    The proposal continues to allow approval by individual application
provided that the insured state bank meets and continues to meet the
applicable capital standards and the FDIC finds there is no significant
risk to the fund. The proposal would delete the language expressly
providing that approval is necessary for each subsidiary even if the
bank received approval to engage in the same activity through another
subsidiary. Deleting this language will not automatically permit a
state bank to establish a second subsidiary to conduct the same
activity that was approved for another subsidiary of the same bank.
Deleting the language leaves the issue to be handled on a case-by-case
basis by the FDIC pursuant to order. For example, if the FDIC approves
an application by a state bank to establish a majority-owned subsidiary
to engage in real estate investment activities, the order may (in the
FDIC's discretion) be written to allow additional such subsidiaries or
to require that any additional real estate subsidiaries must be
individually approved.
    The notice procedures described herein requires that the subsidiary
must take the corporate organizational form. Insured state banks that
organize subsidiaries in a form other than a corporation may make
application under this section. Any bank that does not meet the notice
criteria or that desires relief from a limit or restriction included in
the notice criteria may also file an application under this section and
are encouraged to do so.

[[Page 47982]]

Application instructions have been moved to subpart E.
    Language has been eliminated that prohibited an insured state bank
from engaging in insurance underwriting through a subsidiary except to
the extent that such activities are permissible for a national bank.
Eliminating this language does not result in any substantive change as
section 24 of the FDI Act clearly provides that the FDIC may not
approve an application for a state bank to directly or indirectly
conduct insurance underwriting activities that are not permissible for
a national bank. We invite comment on whether the language should be
retained in the regulation to make it clear to state banks that
applications to conduct such activities will not be approved.
    The current part 362 allows state banks that do not meet their
minimum capital requirements to gradually phase out otherwise
impermissible activities that were being conducted as of December 19,
1992. These provisions are eliminated under the proposal due to the
passage of time. The relevant outside dates to complete the phase out
of those activities have passed (December 19, 1996, for real estate
activities and December 8, 1994, for all other activities).
Grandfathered Insurance Underwriting
    The proposed regulation provides for three statutory exceptions
that allow subsidiaries to engage in insurance underwriting.
Subsidiaries may engage in the same grandfathered insurance
underwriting as the bank if the bank or subsidiary was lawfully
providing insurance as principal on November 21, 1991.
    The limitations under which this subsidiary may operate have been
changed. Under the current regulation, the bank must be well-
capitalized. Under the proposal, the bank must be well-capitalized
after deducting its investment in the insurance subsidiary. The FDIC
believes that the capital deduction is an important element in
separating the operations of the bank and the subsidiary. This
deduction clearly delineates the capital that is available to support
the bank and the capital that is available to support the subsidiary.
Capital standards for insurance companies are based on different
criteria from bank capital requirements. Most states have minimum
capital requirements for insurance companies. The FDIC believes that a
bank's investment in an insurance underwriting subsidiary is not
actually "available" to the bank in the event the bank experiences
losses and needs a cash infusion. As a result, the bank's investment in
the insurance subsidiary should not be considered when determining
whether the bank has sufficient capital to meet its needs. Comment is
invited on whether the capital deduction is appropriate or necessary.
If the FDIC requires a capital deduction, should it be required in the
case of any insurance underwriting subsidiary that is given a statutory
grandfather, e.g., should title insurance subsidiaries also be subject
to the capital deduction? Should the capital deduction treatment depend
upon what type of insurance is underwritten (if there is a greater risk
associated with the insurance, should the capital deduction be
required)? Is the phase-in period appropriate and clearly written?
    The proposed regulation requires a subsidiary engaging in
grandfathered insurance underwriting to meet the standards for an
"eligible subsidiary" discussed below. This standard replaces the
"bona fide" subsidiary standard in the current regulation. The
"eligible subsidiary" standard generally contains the same
requirements for corporate separateness as the "bona fide" subsidiary
definition but adds the following provisions: (1) the subsidiary has
only one business purpose; (2) the subsidiary has a current written
business plan that is appropriate to its type and scope of business;
(3) the subsidiary has adequate management for the type of activity
contemplated, including appropriate licenses and memberships, and
complies with industry standards; and (4) the subsidiary establishes
policies and procedures to ensure adequate computer, audit and
accounting systems, internal risk management controls, and the
subsidiary has the necessary operational and managerial infrastructure
to implement the business plan. The FDIC requests comment on the effect
of these additional requirements on banks engaged in insurance
underwriting. We invite comment on whether these requirements
appropriately separate the subsidiary from the bank. We request comment
on whether the restrictions are appropriate to the identified risks
being undertaken by these banks.
    In lieu of the prescribed disclosures contained in the current
regulation, the proposal prescribes that disclosures consistent with
the Interagency Statement be made. The proposal also eliminates the
acceptance of disclosures that are required by state law. While the
current regulation requires disclosures, those disclosures are similar
but not identical to the disclosures required by the Interagency
Statement. Again, this proposed change is intended to make compliance
with the Interagency Statement and the regulation easier. Comment is
sought on whether the disclosure requirements in the regulation are
necessary now that the Interagency Statement has been adopted. Any
retail sale of nondeposit investment products to bank customers is
subject to the Interagency Statement. The FDIC recognizes that some
grandfathered insurance underwriting subsidiaries may have a line of
business and customer base which is completely separate from the bank's
operations. The Interagency Statement would not normally apply as the
Statement does not technically apply unless there is a "retail sale"
to a "bank customer." If the FDIC were to rely wholly upon the
Interagency Statement there would be a gap from the current coverage of
the disclosure requirements. Should that be of concern to the FDIC?
    Banks with subsidiaries engaged in grandfathered insurance
underwriting activities are expected to meet the new requirements of
this proposal. Banks which are not in compliance with the requirements
should provide a notice to the FDIC pursuant to Sec. 362.5(b). The FDIC
will consider the notices on a case-by-case basis.
    The regulation provides that a subsidiary may continue to
underwrite title insurance based on the specific statutory authority
from section 24. This provision is currently in part 362 and is carried
forward into the proposal with no substantive change. The insured state
bank is only permitted to retain the investment if the insured state
bank was required, before June 1, 1991, to provide title insurance as a
condition of the bank's initial chartering under state law. The
authority to retain the investment terminates if a change in control of
the grandfathered bank or its holding company occurs after June 1,
1991. There are no statutory or regulatory investment limits on banks
holding these types of grandfathered investments.
    The exception for subsidiaries engaged in underwriting crop
insurance is continued. Under section 24, insured state banks and their
subsidiaries are permitted to continue underwriting crop insurance
under two conditions: (1) they were engaged in the business on or
before September 30, 1991, and (2) the crop insurance was reinsured in
whole or in part by the Federal Crop Insurance Corporation. While this
grandfathered insurance underwriting authority requires that the bank
or its subsidiary had to be engaged in the activity as of a certain
date, the authority does not

[[Page 47983]]

terminate upon a change in control of the bank or its parent holding
company.
Majority-owned Subsidiaries Which Own a Control Interest in Companies
Engaged in Permissible Activities
    The FDIC has found that it is not a significant risk to the deposit
insurance funds if a majority-owned subsidiary holds stock of a company
that engages in (1) any activity permissible for a national bank; (2)
any activity permissible for the bank itself (except engaging in
insurance underwriting and holding grandfathered equity investments);
(3) activities that are not conducted "as principal;" or (4) activity
that is not permissible for a national bank provided the Federal
Reserve Board by regulation or order has found the activity to be
closely related to banking, if the majority-owned subsidiary exercises
control over the issuer of the stock purchased by the subsidiary. These
exceptions are found in the current regulation but do not contain the
provision that the majority-owned subsidiary must exercise
control.1 This change clarifies that this exception is
intended only for subsidiaries that are operating a business that is
either permissible for the bank itself or is considered to be operated
other than "as principal." As rewritten, the proposal differentiates
between the types of stock held by a majority-owned subsidiary--having
a controlling interest and simply investing in the shares of a company.
The FDIC intends that this provision cover lower level subsidiaries
that are engaged in activities that the FDIC has found present no
significant risk to the fund. The FDIC expects lower level subsidiaries
that engage in other activities to conform to the application or notice
procedures of this regulation. The FDIC recognizes that changing the
level of ownership permissible for these activities may adversely
affect some insured state bank. We invite comment on the effect of this
change. The FDIC invites comment on whether this language change was
necessary, whether it should be concerned about lower level
subsidiaries, whether this approach is appropriate to the risks
inherent in the activities and whether any other approach, including
returning to the language in the current regulation should be
considered.
---------------------------------------------------------------------------

    \1\ The current regulatory exception for activities conducted
not as principal provides for a test of 50% or less of the stock of
a corporation which engages solely in activities which are not
considered to be as principal. The term "corporation" is being
changed to "company" to accommodate the other forms of business
enterprise listed in the definition. The reference to 50% or less is
being deleted in order to avoid the confusion generated by that
limitation.
---------------------------------------------------------------------------

    We deleted one other form of stock ownership at the majority
subsidiary level from the current regulation by deleting the language
now found in Sec. 362.4(c)(3)(iv)(C) of the current regulation titled,
"Stock of a corporation that engages in activities permissible for a
bank service corporation." Through a majority-owned subsidiary, this
section of the current regulation allows an insured state bank to
invest in 50% or less of the stock of a corporation which engages
solely in any activity that is permissible for a bank service
corporation. Since bank service corporations may engage in any activity
that is closely related to banking, this exception also allowed
majority-owned subsidiaries to own stock in those entities that solely
engaged in activities that were closely related to banking. This
exception has been deleted in this proposal because the coverage of the
proposed exceptions in Sec. 362.4(b)(3) would duplicate the coverage of
the existing exception.
    Comment is requested on whether the proposed language clearly sets
forth the coverage of these exceptions. Comment is requested on whether
the proposed language clearly allows the same activities that the
current exception allows by permitting majority-owned subsidiaries to
hold stock of a company engaged in activities permissible for a bank
service corporation. The FDIC seeks comment on whether any inadvertent
substantive change has been made by eliminating the specific references
permitting the ownership of bank service company stock. We seek comment
on the use of the control test for defining activities for lower level
subsidiaries. We invite comment on whether any other approach,
including returning to the language in the current regulation should be
reconsidered. Should the FDIC use a majority-owned test for defining
when a lower level subsidiary exists?
    We added clarifying language to the exception governing activities
closely related to banking. The first exception states that this
section does not authorize a subsidiary engaged in real estate leasing
to hold the leased property for more than two years at the end of the
lease unless the property is re-leased. This provision is the same at
the bank level. The second provision is that this section does not
authorize a subsidiary to acquire or hold the stock of a savings
association other than as allowed in Sec. 362.4(b)(4). As is discussed
below, this subsection does not allow a majority-owned subsidiary to
have a control interest in a savings association. Comment is requested
concerning the effect of this change.
Majority-Owned Subsidiaries Ownership of Equity Securities That Do Not
Represent a Control Interest
    The proposed regulation significantly changes the exception in the
current regulation involving the holding of equity securities that do
not represent a control interest. The FDIC has determined that the
activity of holding the equity securities at the majority-owned
subsidiary level, subject to certain limitations, does not present a
significant risk to the deposit insurance funds.
    This provision replaces two exceptions contained in the current
regulation: (1) grandfathered investments in common or preferred stock
and shares of investment companies, and (2) stock of insured depository
institutions. The proposed regulation adds an expanded exception
allowing the holding of other corporate stock.
    The current regulation provides that an insured state bank that has
obtained approval to hold listed common or preferred stock and/or
shares of registered investment companies under the statutory
grandfather (discussed above) may hold the stock and/or shares through
a majority-owned subsidiary provided that any conditions imposed in
connection with the approval are met. The FDIC previously determined
that a majority-owned subsidiary could be accorded the same treatment
under the grandfather provided for by section 24(f) of the FDI Act
without risk to the fund. Thus, the bank should be permitted to invest
in those securities and investment company shares through a majority-
owned subsidiary.
    The current regulation requires that each bank file a notice with
the FDIC of the bank's intent to make such investments and that the
FDIC determine that such investments will not pose a significant risk
to the deposit insurance fund before any insured state bank may take
advantage of the "grandfather" allowing investments in common or
preferred stock listed on a national securities exchange and shares of
an investment company registered under the Investment Company Act of
1940 (15 U.S.C. 80a-1, et seq.). In no event may the bank's investments
in such securities and/or investment company shares, plus those of the
subsidiary, exceed one hundred percent of the bank's tier one capital.
The FDIC may condition its finding of no risk upon whatever conditions
or restrictions it finds appropriate. The

[[Page 47984]]

"grandfather" will be lost if the events occur that are discussed
above.
    The proposed regulation eliminates the notice for these activities
and the specific reference to grandfathered activity and allows similar
activity for all insured state banks provided that the bank's
investment in the majority-owned subsidiary is deducted from capital
and the activity is subject to the eligibility requirements and
transaction limitations discussed below. Comment is invited on whether
this exception is more appropriately applied by the FDIC as an
exception that is separate and distinct from any other exception under
the regulation that would allow a subsidiary of an insured state bank
to hold equity securities. In short, should this exception be in
addition to any other exception for holding stock?
    The FDIC proposes to expand the current regulatory exception from
the acquisition of stock in another insured bank through a majority-
owned subsidiary to an exception for the acquisition of stock of
insured banks, insured savings associations, bank holding companies,
and savings and loan holding companies. The exception would continue to
be limited to the acquisition of no more than 10 percent of the
outstanding voting stock of any one issuer. The acquisition would be
through a majority-owned subsidiary which was organized for the purpose
of holding such stock.
    This exception is being expanded to cover savings association
stock, bank holding company stock and savings and loan holding company
stock in response to the FDIC's experience with applications that have
been presented to the FDIC in which insured state banks have sought
approval for these kinds of investments. In acting upon those
applications it has been the opinion of the FDIC to date that
investments in bank holding company stock should not present a risk to
the fund given the fact that bank holding companies are subject to a
very strong regulatory and supervisory scheme and are limited, for the
most part, to engaging in activities that are closely related to
banking. The FDIC proposes to allow investment in savings association
stock for similar reasons. Comment is invited on whether the exception
should allow investments in savings and loan holding company stock in
view of the broad range of activities in which savings and loan holding
companies may engage.
    The FDIC has become aware that some insured state banks own a
sufficient interest in the stock of other insured state banks to cause
the bank which is so owned to be considered a majority-owned subsidiary
under part 362. It is the FDIC's position that such an owner bank does
not need to file a request under part 362 seeking approval for its
majority-owned subsidiary that is an insured state bank to conduct as
principal activities that are not permissible for a national bank. As
the majority-owned subsidiary is itself an insured state bank, that
bank is required under part 362 and section 24 of the FDI Act to
request consent on its own behalf for permission to engage in any as
principal activity that is not permissible for a national bank.
    The proposal encompasses the exceptions contained in the previous
regulation and expands the exception to a majority-owned subsidiary of
other insured state bank to acquire corporate stock. In order for an
insured state bank to use the exception, the bank must be well-
capitalized exclusive of the bank's investment in the subsidiary and
must make the capital deduction for purposes of reporting capital on
the bank's Call Report. For insured state banks that are using the
current exception for grandfathered equities and holding bank stock,
the capital deduction requirement is new. This requirement is similar
to that found in the proposed notice procedures for state nonmember
banks to engage in activities not permissible for national banks and
recognizes the level of risk present in securities investment
activities. Insured state banks that are currently engaging in these
activities but are not in compliance with the requirements contained in
the proposal should provide notice under Sec. 362.5(b).
    The subsidiary may only invest in corporate equity securities if
the bank and subsidiary meet the eligibility requirements. Those
requirements are: (1) the state-chartered depository institution may
have only one majority-owned subsidiary engaging in this activity; (2)
the majority-owned subsidiary's investment in equity securities (except
stock of an insured depository institution, a bank holding company or a
savings and loan holding company) must be limited to equity securities
listed on a national securities exchange; (3) the state-chartered
depository institution and majority-owned subsidiary may not have
control over any issuer of stock purchased; and (4) the majority-owned
subsidiary's equity investments (except stock of an insured depository
institution, a bank holding company or a savings and loan holding
company) must be limited to equity securities listed on a national
securities exchange.
    The requirement that the subsidiary's investment be limited to 10
percent of the outstanding voting stock of any company. This limitation
reflects the FDIC's intent that this exception be used only as a
vehicle for investment in equity securities. The 10 percent limitation
was chosen because it reflects a level of investment that is generally
recognized as not involving control of the business. This requirement
is to be read together with the eligibility requirement that the
depository institution may not exercise control over any issuer of
stock purchased by the subsidiary. These requirements reflect the
FDIC's intent that the depository institution is not operating a
business through investments in equity securities. Comment is requested
as to the appropriateness of the 10 percent limitation.
    The FDIC believes that only listed securities should be allowed
under this exception. Listed securities are more liquid than nonlisted
securities and companies whose stock is listed must meet capital and
other requirements of the exchange. These requirements provide some
assurances as to the quality of the investment. The requirement that
securities be listed is not extended to bank and savings association
stock, bank holding company stock, or stock of a savings association
holding company. These companies are part of a highly regulated
industry which provides some investment quality assurance. Banks that
may want to invest in unlisted securities in other industries should be
subject to the scrutiny of the application process.
    To qualify for this exception, the state-chartered depository
institution may not extend credit to the majority-owned subsidiary,
purchase any debt instruments from the majority-owned subsidiary, or
originate any other transaction that is used to benefit the majority-
owned subsidiary which invests in stock under this subpart. As noted
above, the depository institution may have only one subsidiary engaged
in this activity. These requirements reflect the FDIC's desire that the
scope of the exception be limited. Institutions that wish to have
multiple subsidiaries engaged in holding equity securities and wish to
extend credit to finance these transactions should use the applications
procedures to request consent.
    We added a provision relating to portfolio management. The FDIC is
concerned that a majority-owned subsidiary not engage in activities
which the FDIC has identified as speculative. Therefore for the
purposes of this subsection, investment in the equity securities of any
company does not include pursuing short-term trading activities. The
exception has been

[[Page 47985]]

created to facilitate holding of corporate equity securities that are
within the overall investment strategies of the state-chartered
depository institution and its subsidiaries. It is expected that these
investment strategies take account of such factors as quality,
diversification and marketability as well as income. Short term trading
that emphasizes income over other investment factors is speculative and
may not be pursued through this exception.
    In addition to requesting comment on the particular exception as
proposed, the FDIC requests comment on whether it is appropriate for
the regulation to contain any exception that would allow an insured
state bank to hold equity securities at the subsidiary level. The FDIC
also requests comment on the adequacy of the restrictions and
constraints that it has proposed for the banks and subsidiaries that
would hold these investments. What additional constraints, if any,
should we consider adding for the banks and subsidiaries that would
hold these investments? We note that the statute does not itself impose
any conditions or restrictions on a bank that enjoys the grandfather
for investment in equity securities in terms of per issuer limits.
Comment is sought on whether it is appropriate to impose the
restriction that limits a bank and its subsidiary to investing in less
than a controlling interest in any given issuer. Is there some other
limit or restriction the FDIC should consider imposing by regulation
that is important to ensuring that the grandfathered investments do not
pose a risk?
Majority-owned Subsidiaries Conducting Real Estate Investment
Activities and Securities Underwriting
    The FDIC has determined that real estate investment and securities
underwriting activities do not represent a significant risk to the
deposit insurance funds, provided that the activities are conducted by
a majority-owned subsidiary in compliance with the requirements set
forth. These activities require the insured state banks to file a
notice. Then, as long as the FDIC does not object to the notice, the
bank may conduct the activity in compliance with the requirement. The
fact that prior consent is not required by this subpart does not
preclude the FDIC from taking any appropriate action with respect to
the activities if the facts and circumstances warrant such action.
Engage in Real Estate Investment Activities
    Under section 24 of the FDI Act and the current version of part
362, an insured state bank may not directly or indirectly engage in
real estate investment activities not permissible for a national bank.
Section 24 does not grant FDIC authority to permit an insured state
bank to directly engage in real estate investment activities not
permissible for a national bank. The circumstances under which national
banks may hold equity investments in real estate are limited. If a
particular real estate investment is permissible for a national bank,
an insured state bank only needs to document that determination. If a
particular real estate investment is not permissible for a national
bank and an insured state bank wants to engage in real estate
investment activities (or continue to hold the real estate investment
in the case of investments acquired before enactment of section 24 of
the FDI Act), the insured state bank must file an application with FDIC
for consent. The FDIC may approve such applications if the investment
is made through a majority-owned subsidiary, the institution is well
capitalized and the FDIC determines that the activity does not pose a
significant risk to the deposit insurance fund.
    The FDIC approved 92 of 95 applications from December 1992 through
June 30, 1997, involving real estate investment activities. The FDIC
denied one application, approved one in part, and one bank withdrew its
application. The real estate investment applications generally have
fallen into three categories: (1) requests for consent to hold real
estate at the subsidiary level while liquidating the property where the
bank expects that liquidation will be completed later than December 19,
1996; (2) requests for consent to continue to engage in real estate
investment activity in a subsidiary, where such activities were
initiated prior to enactment of section 24 of the FDI Act; and (3)
requests for consent to initiate for the first time real estate
investment activities through a majority-owned subsidiary.
    The approved applications have involved investments which have
ranged from less than 1 percent to over 70 percent of the bank's tier
one capital. The majority of the investments, however, involved
investments of less than 10 percent of tier one capital with only seven
applications involving investments exceeding 25 percent of tier one
capital. The applications filed with the FDIC have involved a range of
real estate investments including holding residential properties,
commercial properties, raw land, the development of both residential
and commercial properties, and leasing of previously improved property.
The applications approved by the FDIC include 33 residential
properties, 39 commercial properties and 20 applications covering a mix
of commercial and residential properties. The assets of the
institutions that submitted approved applications ranged from $1
million to $6.7 billion. The institutions which have been approved to
continue or commence new real estate investment activity primarily have
had composite ratings of 1 or 2 ratings under the UFIRS. However, 6
institutions were rated 3, and 3 institutions were rated 4. The 4-rated
institutions submitted applications to continue an orderly divestiture
of real estate investments after December 19, 1996. Of the approved
applications, 9 were to conduct new real estate investment activities,
while 80 were submitted to continue holding existing real estate or to
hold existing real estate after December 19, 1996, to pursue an orderly
liquidation. The remaining 3 approved applications asked for consent to
continue existing holdings and conduct new real estate activities. One
application was partially approved and partially denied. This
application involved a bank that applied for consent to continue direct
real estate activities and consent to continue indirect real estate
investment activities through a subsidiary. The FDIC approved the
application to continue the real estate investment activity through the
subsidiary and denied the application for the bank to engage directly
in real estate investment activities.
    To date, the FDIC has evaluated a number of factors when acting on
applications for consent to engage in real estate investment
activities. Where appropriate, the FDIC has fashioned conditions
designed to address potential risks that have been identified in the
context of a given application. In evaluating an application to conduct
equity real estate investment activity, the FDIC considers the type of
proposed real estate investment activity to determine if the activity
is unsuitable for an insured depository institution. The FDIC also
reviews the proposed subsidiary structure and its management policies
and practices to determine if the insured state bank is adequately
protected and analyzes capital adequacy to ensure that the insured
institution has sufficient capital to support its more traditional
banking activities.
    In every instance in which the FDIC has approved an application to
conduct a real estate investment activity, we have determined that it
was necessary to impose a number of conditions in granting the
approval. In short, the FDIC has determined on a case-by-case basis
that the conduct of certain real estate

[[Page 47986]]

investment activities by a majority-owned corporate subsidiary of an
insured state bank will not present a significant risk to the deposit
insurance fund provided certain conditions are observed. In drafting
this proposed regulation, we have evaluated the conditions usually
imposed when granting such approval to insured state banks and
incorporated these conditions within the proposal where appropriate.
The FDIC requests general comment on whether the conditions imposed
under the proposed regulation are appropriate. Comments are invited on
each condition, especially on the requirements that the subsidiary have
an independent chief executive officer and that a majority of its board
be composed of individuals who are not directors, officers, or
employees of the insured institution.
    The proposed rule would allow majority-owned subsidiaries to invest
in and/or retain equity interests in real estate not permissible for a
national bank provided that the insured state bank qualifies as an
"eligible depository institution," as that term is defined within the
proposed regulation, and the majority-owned subsidiary qualifies as an
"eligible subsidiary," which is also defined within the proposed
rule. The insured state bank must also abide by the investment and
transaction limitations set forth in the proposed regulation. Under the
proposed regulation, the insured state bank may not invest more than 10
percent of the bank's tier one capital in any one majority-owned real
estate subsidiary. In addition, the total of the insured state bank's
investment in all of its majority-owned subsidiaries which are
conducting real estate activities may not exceed 20 percent of its tier
one capital under the proposed regulation. Under the proposed rule, the
20 percent aggregate investment limit applies to subsidiaries engaged
in the same activity.
    For the purpose of calculating the dollar amount of the investment
limitations, the bank would calculate 10 percent and 20 percent of its
tier one capital after deducting all amounts required by the proposed
regulation or any FDIC order. We request comment on all aspects and any
implications of this proposal.
    Under the proposed regulation, the insured state bank must file a
notice with the FDIC providing a description of the proposed activity
and the manner in which it will be conducted. A description of the
other items required to be contained in the notice under this proposal
are contained in subpart E of the proposed regulation.
    The FDIC recognizes that some real estate investments or activities
are more time, management and capital intensive than others. Our
experience in reviewing the applications filed under section 24 has led
us to conclude that extremely small equity investments in real estate--
held under certain conditions--do not pose a significant risk to the
deposit insurance fund. As a result, the proposed regulation provides
relief to insured state banks having such small investments in a
majority-owned subsidiary engaging in real estate investment
activities. The FDIC is attempting to strike a reasonable balance
between prudential safeguards and regulatory burden in its proposed
regulation. As a result, the proposed regulation establishes certain
exceptions from the requirements necessary to establish an eligible
subsidiary whenever the insured state bank's investment is of a de
minimis nature and meets certain other criteria. Under the proposal,
whenever the bank's investment in its majority-owned subsidiary
conducting real estate activities does not exceed 2 percent of the
bank's tier one capital and the bank's investment in the subsidiary
does not include extensions of credit from the bank to the subsidiary,
a debt instrument purchased from the subsidiary or any other
transaction originated from the bank to the benefit of the subsidiary,
the subsidiary is relieved of certain of the requirements that must be
met to establish an eligible subsidiary under the regulation. Under the
proposed regulation, an insured state bank with a limited investment in
a majority-owned subsidiary need not adhere to the requirements that
the subsidiary be physically separate from the insured state bank; the
chief executive officer of the subsidiary is not required to be an
employee separate from the bank; a majority of the board of directors
of the subsidiary need not be separate from the directors or officers
of the bank; and the subsidiary need not establish separate policies
and procedures as described in the proposed regulation in
Sec. 362.4(c)(2)(xi). The FDIC requests comment on the exceptions being
proposed for establishing an eligible subsidiary whenever the bank's
investment is of such a limited nature. Are there any of the other
requirements necessary to establish an "eligible subsidiary" that
should be excepted for banks with such limited investments? Commenters
should keep in mind that the FDIC's goal is to reduce regulatory burden
while maintaining adequate protection of the deposit insurance funds.
Comment is requested on all aspects of this real estate investment
activity authority.
    Under current law, an insured state bank must apply to the FDIC
prior to engaging in real estate investment activities that are
impermissible for a national bank. The proposed regulation contains a
procedure under which certain insured state banks may participate in
real estate investment activity under specific circumstances by filing
a notice with the FDIC. To qualify for the notice procedure proposed
under Sec. 362.4(b)(5), the real estate investment activities must be
conducted by a majority-owned subsidiary that further qualifies as an
"eligible subsidiary" under the proposal. The characteristics of an
eligible subsidiary are set forth in Sec. 362.4(c)(2) of the regulation
and further described below. If the institution or its investment does
not meet the criteria established under the proposed regulation for
using the notice procedure, an application may be filed with the FDIC
under Sec. 362.4(b)(1). The FDIC encourages institutions to file an
application if the institution wishes to request relief from any of the
requirements necessary to be considered an eligible depository
institution or an eligible subsidiary. The FDIC recognizes that not all
real estate investment requires a subsidiary to be established exactly
as outlined under the eligible subsidiary definition.
    Section 362.4(b)(5) of the proposal permits certain highly rated
banks (defined in Sec. 362.4(c)(1) of the proposal as eligible
depository institutions) to engage, through a majority-owned
subsidiary, in real estate investment activities not otherwise
permissible for a national bank by filing a notice according to the
procedures set forth in subpart E of the proposed regulation.
    Comment is requested on all aspects of this proposal to allow real
estate activities through a notice procedure.
Engage in the Public Sale, Distribution or Underwriting of Securities
That Are Not Permissible for a National Bank Under Section 16 of the
Banking Act of 1933
    The current regulation provides that an insured state nonmember
bank may establish a majority-owned subsidiary that engages in the
underwriting and distribution of securities without filing an
application with the FDIC if the requirements and restrictions of
Sec. 337.4 of the FDIC's regulations are met. Section 337.4 governs the
manner in which subsidiaries of insured state nonmember banks must
operate if the subsidiaries engage in securities activities that would
not be permissible for the bank itself under section 16 of

[[Page 47987]]

the Banking Act of 1933, commonly known as the Glass-Steagall Act. In
short, the regulation lists securities underwriting and distribution as
an activity that will not pose a significant risk to the fund if
conducted through a majority-owned subsidiary that operates in
accordance with Sec. 337.4. The proposed regulation makes significant
changes to that exception.
    Due to the existing cross reference to Sec. 337.4, FDIC reviewed
Sec. 337.4 as a part of its review of part 362 for CDRI. The purpose of
the review was to streamline and clarify the regulation, update the
regulation as necessary given any changes in the law, regulatory
practice, and the marketplace since its adoption, and remove any
redundant or unnecessary provisions. As a result of that review, the
FDIC proposes making a number of substantive changes to the rules which
govern securities sales, distribution, or underwriting by subsidiaries
of insured state nonmember banks and eliminating Sec. 337.4 as a
separate regulation. The revised language would be relocated to part
362 and would become what is proposed Sec. 362.4(b)(5)(ii). Although
the FDIC has chosen to place the exception in the part of the
regulation governing activities by insured state banks, by law, only
subsidiaries of state nonmember banks may engage in securities
underwriting activities that are not permissible for national banks. As
we have previously stated, subpart A of this regulation does not grant
authority to conduct activities or make investments, subpart A only
gives relief from the prohibitions of section 24 of the FDI Act. We
placed the exception for securities underwriting with the real estate
exception in the structure of the regulation to promote uniform
standards across activities, even though it is possible that a state
member bank could qualify for the real estate exception and not the
securities exception. We request comment on whether this placement
causes any confusion. Of course, as the appropriate Federal banking
agency for state member banks, the FRB may impose more stringent
restrictions on any activity conducted by a state member bank.
    The following discussion describes the purpose and background of
Sec. 337.4, the conditions and restrictions imposed by that rule on
securities activities, the language of the exception in proposed part
362 and the proposed revisions to the conditions and restrictions
governing this activity.
History of Section 337.4
    On August 23, 1982, the FDIC adopted a policy statement on the
applicability of the Glass-Steagall Act to securities activities of
insured state nonmember banks (47 FR 38984). That policy statement
expressed the opinion of the FDIC that under the Glass-Steagall Act:
(1) Insured state nonmember banks may be affiliated with companies that
engage in securities activities, and (2) securities activities of bona
fide subsidiaries of insured state nonmember banks are not prohibited
by section 21 of the Glass-Steagall Act (12 U.S.C. 378) which prohibits
deposit taking institutions from engaging in the business of issuing,
underwriting, selling, or distributing stocks, bonds, debentures,
notes, or other securities.
    The policy statement applies solely to insured state nonmember
banks. As noted in the policy statement, the Bank Holding Company Act
of 1956 (12 U.S.C. 1841 et. seq.) places certain restrictions on non-
banking activities. Insured state nonmember banks that are members of a
bank holding company system need to take into consideration sections
4(a) and 4(c)(8) of the Bank Holding Company Act of 1956 (12 U.S.C.
1843 (a) and (c)) and applicable Federal Reserve Board regulations
before entering into securities activities through subsidiaries.
    The policy statement also expressed the opinion of the Board of
Directors of the FDIC that there may be a need to restrict or prohibit
certain securities activities of subsidiaries of state nonmember banks.
As the policy statement noted, "the FDIC * * * recognizes its ongoing
responsibility to ensure the safe and sound operation of insured state
nonmember banks, and depending upon the facts, the potential risks
inherent in a bank subsidiary's involvement in certain securities
activities."2
---------------------------------------------------------------------------

    \2\ Representatives of mutual fund companies and investment
bankers brought action challenging the Federal Deposit Insurance
Corporation Policy Statement. Their suit was dismissed without
prejudice, pending the outcome of FDIC's rulemaking process.
Investment Company Institute v. United States, D.D.C. Civil Action
No. 82-2532, filed September 8, 1982.
---------------------------------------------------------------------------

    In November 1984, after notice and comment proceedings, the FDIC
adopted a final rule regulating the securities activities of affiliates
and subsidiaries of insured state nonmember banks under the FDI Act. 49
FR 46709 (Nov. 28, 1984), regulations codified at 12 CFR 337.4
(1986).3 Although the rule does not prohibit such securities
activities outright, it does restrict that activity in a number of ways
and only permits the activities if authorized under state law. Banks
only could maintain "bona fide" subsidiaries that engaged in
securities work. The rule defined "bona fide subsidiary" so as to
limit the extent to which banks and their securities affiliates and
subsidiaries could share company names or logos, as well as places of
business. 12 CFR 337.4(a)(2)(ii), (iii); 49 FR 46710. The definition
required banks and subsidiaries to maintain separate accounting records
and to observe separate corporate formalities. 12 CFR 337.4(a)(2)(iv),
(v). The two entities were required not to share officers and to
conduct business pursuant to independent policies and procedures,
including the maintenance of separate employees and payrolls. Id.
Sec. 337.4(a)(2)(vi), (vii), (viii); 49 FR 46711-12. Finally, and
perhaps most importantly, the rule required a subsidiary to be
"adequately capitalized." 12 CFR 337.4(a)(2)(i).
---------------------------------------------------------------------------

    \3\ After the regulations were adopted, the representatives of
mutual fund companies and investment bankers brought another action
challenging the regulations allowing insured banks, which are not
members of the Federal Reserve System, to have subsidiary or
affiliate relationships with firms engaged in securities work. The
United States District Court for the District of Columbia, Gerhard
A. Gesell, J., 606 F.Supp. 683, upheld the regulations, and
representatives appealed and also petitioned for review. The Court
of Appeals held that: (1) representatives had standing to challenge
regulations under both the Glass-Steagall Act and the FDI Act, but
(2) regulations did not violate either Act. Investment Company
Institute, v. Federal Deposit Insurance Corporation, 815 F.2d 1540
(U.S.C.A. D.C.1987).
    A trade association representing Federal Deposit Insurance
Corporation-insured savings banks also brought suit challenging FDIC
regulations respecting proper relationship between FDIC-insured
banks and their securities-dealing "subsidiaries" or
"affiliates." On cross motions for summary judgment, the District
Court, Jackson, J., held that: (1) trade association had standing,
and (2) regulations were within authority of FDIC. National Council
of Savings Institutions v. Federal Deposit Insurance Corporation,
664 F.Supp. 572 ( D.C. 1987).
---------------------------------------------------------------------------

    The rule has been amended several times since its
adoption.4 The last amendment to this rule was in 1988. When
the FDIC initially implemented

[[Page 47988]]

its regulation on securities activities of subsidiaries of insured
state nonmember banks and bank transactions with affiliated securities
companies, the FDIC determined that some risk may be associated with
those activities. To address that risk, the FDIC regulation: (1)
Defined bona fide subsidiary, (2) required notice of intent to acquire
or establish a securities subsidiary, (3) limited the permissible
securities activities of insured state nonmember bank subsidiaries, and
(4) placed certain other restrictions on loans, extensions of credit,
and other transactions between insured state nonmember banks and their
subsidiaries or affiliates that engage in securities activities.
---------------------------------------------------------------------------

    \4\ 50 FR 2274, Jan. 16, 1985; 51 FR 880, Jan. 9, 1986; 51 FR
23406, June 27, 1986; 51 FR 45756, Dec. 22, 1986; 52 FR 23544, June
23, 1987; 52 FR 39216, Oct. 21, 1987; 52 FR 47386, Dec. 14, 1987; 53
FR 597, Jan. 8, 1988; 53 FR 2223, Jan. 27, 1988. The FDIC amended
the regulations governing the securities activities of certain
subsidiaries of insured state nonmember banks and the affiliate
relationships of insured state nonmember banks with certain
securities companies to make technical corrections, delete the
requirement that the offices of securities subsidiaries and
affiliates must be accessed through a separate entrance from that
used by the bank (the existing requirement for physically separate
offices was retained), delete the prohibition against securities
subsidiaries and affiliates sharing a common name or logo with the
bank, and to establish a number of affirmative disclosure
requirements regarding securities recommended, offered, or sold by
or through a securities subsidiary or affiliate are not FDIC insured
deposits unless otherwise indicated and that such securities are not
obligations of, nor are guaranteed by the bank.
---------------------------------------------------------------------------

    As defined in Sec. 337.4, the term "bona fide" subsidiary means a
subsidiary of an insured state nonmember bank that at a minimum: (1) Is
adequately capitalized, (2) is physically separate and distinct in its
operations from the operations of the bank, (3) maintains separate
accounting and other corporate records, (4) observes separate corporate
formalities such as separate board of directors' meetings, (5)
maintains separate employees who are compensated by the subsidiary, (6)
shares no common officers with the bank, (7) a majority of the board of
directors is composed of persons who are neither directors nor officers
of the bank, and (8) conducts business pursuant to independent policies
and procedures designed to inform customers and prospective customers
of the subsidiary that the subsidiary is a separate organization from
the bank and that investments recommended, offered or sold by the
subsidiary are not bank deposits, are not insured by the FDIC, and are
not guaranteed by the bank nor are otherwise obligations of the bank.
    This definition was imposed to ensure the separateness of the
subsidiary and the bank. This separation is necessary as the bank would
be prohibited by the Glass-Steagall Act from engaging in many
activities the subsidiary might undertake and the separation safeguards
the soundness of the parent bank.
    The regulation provides that the insured state nonmember bank must
give the FDIC written notice of intent to establish or acquire a
subsidiary that engages in any securities activity at least 60 days
prior to consummating the acquisition or commencement of the operation
of the subsidiary. These notices serve as a supervisory mechanism to
apprise the FDIC that insured state nonmember banks are conducting
securities activities through their subsidiaries that may expose the
banks to potential risks.
    The regulation adopted a tiered approach to the activities of the
subsidiary and limited the underwriting of securities that would
otherwise be prohibited to the bank itself under the Glass-Steagall Act
unless the subsidiary met the bona fide definition and the activities
were limited to underwriting of investment quality securities. A
subsidiary may engage in additional underwriting if it meets the
definition of bona fide and the following additional conditions are
met:
    (a) The subsidiary is a member in good standing of the National
Association of Securities Dealers (NASD);
    (b) The subsidiary has been in continuous operation for a five-year
period preceding the notice to the FDIC;
    (c) No director, officer, general partner, employee or 10 percent
shareholder has been convicted within five years of any felony or
misdemeanor in connection with the purchase or sale of any security;
    (d) Neither the subsidiary nor any of its directors, officers,
general partners, employees, or 10 percent shareholders is subject to
any state or federal administrative order or court order, judgment or
decree arising out of the conduct of the securities business;
    (e) None of the subsidiary's directors, officers, general partners,
employees or 10 percent shareholders are subject to an order entered
within five years issued by the Securities and Exchange Commission
(SEC) pursuant to certain provisions of the Securities Exchange Act of
1934 or the Investment Advisors Act of 1940; and
    (f) All officers of the subsidiary who have supervisory
responsibility for underwriting activities have at least five years
experience in similar activities at NASD member securities firms.
    A bona fide subsidiary is required to be adequately capitalized,
and therefore, these subsidiaries are required to meet the capital
standards of the NASD and SEC. As a protection to the insurance fund, a
bank's investment in these subsidiaries engaged in securities
activities that would be prohibited to the bank under the Glass-
Steagall Act is not counted toward the bank's capital, that is, the
investment in the subsidiary is deducted before compliance with capital
requirements is measured.
    An insured state nonmember bank that has a subsidiary or affiliate
engaging in the sale, distribution, or underwriting of stocks, bonds,
debentures or notes, or other securities, or acting as an investment
advisor to any investment company is prohibited under Sec. 337.4 from
engaging in any of the following transactions:
    (1) Purchasing in its discretion as fiduciary any security
currently distributed, underwritten or issued by the subsidiary unless
the purchase is authorized by a trust instrument or is permissible
under applicable law;
    (2) Transacting business through the trust department with the
securities firm unless the transactions are at least comparable to
transactions with an unaffiliated company;
    (3) Extending credit or making any loan directly or indirectly to
any company whose obligations are underwritten or distributed by the
securities firm unless the securities are of investment quality;
    (4) Extending credit or making any loan directly or indirectly to
any investment company whose shares are underwritten or distributed by
the securities company;
    (5) Extending credit or making any loan where the purpose of the
loan is to acquire securities underwritten or distributed by the
securities company;
    (6) Making any loans or extensions of credit to a subsidiary or
affiliate of the bank that distributes or underwrites securities or
advises an investment company in excess of the limits and restrictions
set by section 23A of the Federal Reserve Act;
    (7) Making any loan or extension of credit to any investment
company for which the securities company acts as an investment advisor
in excess of the limits and restrictions set by section 23A of the
Federal Reserve Act; and
    (8) Directly or indirectly conditioning any loan or extension of
credit to any company on the requirement that the company contract with
the bank's securities company to underwrite or distribute the company's
securities or condition a loan to a person on the requirement that the
person purchase any security underwritten or distributed by the bank's
securities company.
    An insured state nonmember bank is prohibited under Sec. 337.4 from
becoming affiliated with any company that directly engages in the sale,
distribution, or underwriting of stocks, bonds, debentures, notes, or
other securities unless: (1) The securities business of the affiliate
is physically separate and distinct from the operation of the bank; (2)
the bank and the affiliate share no common officers; (3) a majority of
the board of directors of the bank is composed of persons who are
neither directors nor officers of the affiliate; (4) any employee of
the affiliate who is also an employee of the bank does not conduct any
securities activities of the affiliate on the premises of the bank that
involve customer contact; and (5) the affiliate conducts business
pursuant to

[[Page 47989]]

independent policies and procedures designed to inform customers and
prospective customers of the affiliate that the affiliate is a separate
organization from the bank and that investments recommended, offered or
sold by the affiliate are not bank deposits, are not insured by the
FDIC, and are not guaranteed by the bank nor are otherwise obligations
of the bank. The FDIC chose not to require notices relative to
affiliates because it would normally find out about the affiliation in
a deposit insurance application or a change of bank control notice.
    The FDIC created an atmosphere where bank affiliation with entities
engaged in securities activities is very controlled. The FDIC has
examination authority over bank subsidiaries. Under section 10(b) of
the FDI Act, the FDIC has the authority to examine affiliates to
determine the effect of that relationship on the insured institution.
Nevertheless, the FDIC generally has allowed these entities to be
functionally regulated, that is FDIC usually examines the insured state
nonmember bank and primarily relies on SEC and NASD oversight of the
securities subsidiary or affiliate.
    The FDIC views its established separations for banks and securities
firms as creating an environment in which the FDIC's responsibility to
protect the insurance fund has been met without creating too much
overlapping regulation for the securities firms. The FDIC maintains an
open dialogue with the NASD and the SEC concerning matters of mutual
interest. To that end, the FDIC entered into an agreement in principle
with the NASD concerning examination of securities companies affiliated
with insured institutions and has begun a dialogue with the SEC
concerning the exchange of information which may be pertinent to the
mission of the FDIC.
    The number of banks which have subsidiaries engaging in securities
activities that can not be conducted in the bank itself is very small.
These subsidiaries engage in the underwriting of debt and equity
securities and distribution and management of mutual funds. The FDIC
has received notices from 444 banks that have subsidiaries that engage
in activities that do not require the subsidiary to meet the definition
of bona fide such as investment advisory activities, sale of
securities, and management of the bank's securities portfolio.
    Since implementation of the FDIC's Sec. 337.4 regulation, the
relationships between banks and securities firms have not been a matter
of supervisory concern due to the protections FDIC has in place.
However, the FDIC realizes that in a time of financial turmoil these
protections may not be adequate and a program of direct examination
could be necessary to protect the insurance fund. Thus, the
continuation of the FDIC's examination authority in that area is
important.
    The FRB permits a nonbank subsidiary of a bank holding company to
underwrite and deal in securities through its orders under the Bank
Holding Company Act and section 20 of the Glass-Steagall Act. The FDIC
has reviewed its securities underwriting activity regulations in light
of the FRB recently adopted operating standards that modify the FRB's
section 20 orders.5 The FDIC also reviewed the comments
received by the FRB. The FRB conducted a comprehensive review of the
prudential limitations established in its decisions. The FRB sought
comment on modifying these limitations to allow section 20 subsidiaries
to operate more efficiently and serve their customers more
effectively.6 The FDIC found the analysis of the FRB
instructive and has determined that its regulation already incorporates
many of the same modifications that the FRB has made. The FDIC is
proposing other changes consistent with the FRB approach and will
endeavor to explain the differences in the approach taken by the FDIC.
Consistent with the approach adopted by the FRB, the FDIC proposes to
have the securities underwriting subsidiaries and the insured state
nonmember banks use the disclosures adopted in the Interagency
Statement where applicable. Thus, the Interagency Statement will be
applicable when sales of these products occur on bank premises. The
FDIC agrees with the FRB that using these interagency disclosure
standards promotes uniformity, makes it easier for banks to train their
employees, and enhances compliance.
---------------------------------------------------------------------------

    \5\ August 21, 1997.
    \6\ 61 FR 57679, November 7, 1996, and 62 FR 2622, January 17,
1997.
---------------------------------------------------------------------------

    In contrast, FDIC will be taking a different approach on some of
these safeguards because it is not proposing a separate statement of
operating standards. Thus, the FDIC will retain safeguards in its rule
that FRB is shifting to or handling in a different way through the
FRB's still to be released statement of operating standards. With
respect to other safeguards that the FDIC is proposing to continue to
apply to the securities underwriting activities conducted by insured
state nonmember banks through their "eligible subsidiaries," FDIC has
determined that each of these safeguards provides appropriate
protections for bank subsidiaries engaged in underwriting activities.
    For these purposes, the FDIC has modified the safeguard requiring
that banks and their securities underwriting subsidiaries maintain
separate officers and employees. As discussed below, that modification
would be consistent with the Interagency Statement. However, the chief
executive officer of the subsidiary may not be an employee of the bank
and a majority of its board of directors must not be directors or
officers of the bank. This standard is the same as the operating
standard on interlocks adopted by the FRB to govern its section 20
orders.
    One of the reasons for these safeguards involves the FDIC's
continuing concerns that the bank should be protected from liability
for the securities underwriting activities of the subsidiary. Under the
securities laws, a parent company may have liability as a "controlling
person." 7 The FDIC views management and board of director
separation as enhanced protection from controlling person liability as
well as protection from disclosures of material nonpublic information.
Protection from disclosures of material nonpublic information also may
be enhanced by the use of appropriate policies and
procedures.8

[[Page 47990]]

The FDIC requests comment on the retention of these safeguards, the
utility of management and board separations to limit controlling person
liability and the inappropriate disclosure of material nonpublic
information, the extent that any securities underwriting liability may
have been reduced due to the enactment of The Private Securities
Litigation Reform Act of 1995, P.L. 104-67, the efficacy of more
limited restrictions on officer and director interlocks to prevent both
liability and information sharing and any related issues.
---------------------------------------------------------------------------

    \7\ Liability of "controlling persons" for securities law
violations by the persons or entities they "control" is found in
section 15 of the Securities Act of 1933, 15 U.S.C. Sec. 77o and
section 20 of the Securities and Exchange Act of 1934, 15 U.S.C.
Sec. 78t(a). Although the tests of liability under these statutes
vary slightly, the FDIC is concerned that liability may be imposed
on a parent entity that is a bank under the most stringent of these
authorities in the securities underwriting setting. Under the Tenth
Circuit's permissive test for controlling person liability, any
appearance of an ability to exercise influence, whether directly or
indirectly, and even if such influence cannot amount to control, is
sufficient to cause a person to be a controlling person within the
meaning of Sec. 77o or Sec. 78t(a). Although liability may be
avoided by proving no knowledge or good faith, proving no knowledge
requires no knowledge of the general operations or actions of the
primary violator and good faith requires both good faith and
nonparticipation. See First Interstate Bank of Denver, N.A. v.
Pring, 969 F.2d 891 (10th Cir. 1992), rev'd on other grounds, 511
U.S. 164 (1994); Arena Land & Inv. Co. Inc. v. Petty, 906 F.Supp.
1470 (D. Utah 1994); San Francisco-Oklahoma Petroleum Exploration
Corp. v. Carstan Oil Co., Inc. 765 F.2d 962 (10th Cir. 1985); and
Seattle-First National Bank v. Carlstedt, 978 F.Supp. 1543 (W.D.
Okla. 1987). However, to the extent that any securities underwriting
liability may have been reduced due to the enactment of The Private
Securities Litigation Reform Act of 1995, P.L. 104-67, then the
FDIC's concerns regarding controlling person liability may be
reduced. It is likely that the FDIC will want to await the
development of the standards under this new law before taking
actions that could risk liability on a parent bank that has an
underwriting subsidiary.
    \8\ See "Anti-manipulation Rules Concerning Securities
Offerings," Regulation M, 17 CFR 200 (1997) where the SEC grapples
with limiting trading advantages that might otherwise accrue to
affiliates by limiting trading in prohibited securities by
affiliates. The SEC is attempting to prevent trading on material
nonpublic information. To reduce the danger of such trading, the SEC
has a broad ban on affiliated purchasers. To narrow that exception
while continuing to limit access to the nonpublic information that
might otherwise occur, the SEC has limited access to material
nonpublic information through restraints on common officers.
Alternatively, the SEC could prohibit trading by affiliates that
shared any common officers or employees. In narrowing this exception
to "those officers or employees that direct, effect or recommend
transactions in securities," the SEC stated that it "believes that
this modification will resolve substantially commenters" concerns
that sharing one or more senior executives with a distribution
participant, issuer, or selling security holder would preclude an
affiliate from availing itself of the exclusion." 62 FR 520 at 523,
fn. 22 (January 3, 1997). As the SEC also stated, the requirement
would not preclude the affiliates from sharing common executives
charged with risk management, compliance or general oversight
responsibilities.
---------------------------------------------------------------------------

Substantive Changes to the Subsidiary Underwriting Activities
    Generally, the regulations governing the securities underwriting
activity of state nonmember banks have been streamlined to make
compliance easier. In addition, state nonmember banks that deem any
particular constraint to be burdensome may file an application with the
FDIC to have the constraint removed for that bank and its majority-
owned subsidiary. The FDIC has eliminated those constraints that were
deemed to overlap other requirements or that could be eliminated while
maintaining safety and soundness standards. For example, the FDIC
proposes to eliminate the notice requirement for all state nonmember
banks subsidiaries that engage in any securities activities that are
permissible for a national bank. Under the proposal, a notice would be
required only of state nonmember bank subsidiaries that engage in
securities activities that would be impermissible for a national bank.
The FDIC has determined that it can adequately monitor the other
securities activities through its regular reporting and examination
processes. We invite comment on whether the elimination of these
notices is appropriate.
    As indicated in the following discussion on core eligibility
requirements, the proposed regulation establishes new criteria which
must be met to qualify for the notice procedures to conduct, as
principal, activities through a subsidiary that are not permissible for
a national bank. The insured state bank must be an "eligible
depository institution" and the subsidiary must be an "eligible
subsidiary." The terms are defined below but to summarize briefly, an
"eligible depository institution" must be chartered and operating for
at least three years, have satisfactory composite and management
ratings under the Uniform Financial Institution Rating System (UFIRS)
as well as satisfactory compliance and CRA ratings, and not be subject
to any formal or informal corrective or supervisory order or agreement.
These requirements would be uniform with other part 362 notice
procedures for insured state banks to engage in activities not
permissible for national banks and recognize the level of risk present
in securities underwriting activities. These requirements are not
presently found in Sec. 337.4 but the FDIC believes that only banks
that are well-run and well-managed should be given the opportunity to
engage in securities activities that are not permissible for a national
bank under the streamlined notice procedures. Other banks that want to
enter these activities should be subject to the scrutiny of the
application process. Although management and operations not permissible
for a national bank are conducted by a separate majority-owned
subsidiary, such activities are part of the analysis of the
consolidated financial institution. The condition of the institution
and the ability of its management are an important component in
determining if the risks of the securities activities will have a
negative impact on the insured institution.
    One of the other notable differences in the proposed regulation is
the substitution of the "eligible subsidiary" criteria for that of
the "bona fide subsidiary" definition contained in Sec. 337.4(a)(2).
The definitions are similar, but changes have been made to the existing
capital and physical separation requirements. Also, new requirements
have been added to ensure that the subsidiary's business is conducted
according to independent policies and procedures. With regard to those
subsidiaries which engage in the public sale, distribution or
underwriting of securities that are not permissible for a national
bank, additional conditions must also be met. The conditions are that
(1) the state-chartered depository institution must adopt policies and
procedures, including appropriate limits on exposure, to govern the
institution's participation in financing transactions underwritten or
arranged by an underwriting majority-owned subsidiary; (2) the state-
chartered depository institution may not express an opinion on the
value or the advisability of the purchase or sale of securities
underwritten or dealt in by a majority-owned subsidiary unless the
state-chartered depository institution notifies the customer that the
majority-owned subsidiary is underwriting, making a market,
distributing or dealing in the security; (3) the majority-owned
corporate subsidiary is registered and is a member in good standing
with the appropriate SROs, and promptly informs the appropriate
regional director of the Division of Supervision (DOS) in writing of
any material actions taken against the majority-owned subsidiary or any
of its employees by the state, the appropriate SROs or the SEC; and (4)
the state-chartered depository institution does not knowingly purchase
as principal or fiduciary during the existence of any underwriting or
selling syndicate any securities underwritten by the majority-owned
subsidiary unless the purchase is approved by the state-chartered
depository institution's board of directors before the securities are
initially offered for sale to the public. These requirements are also
similar to but simplify the requirements currently contained in
Sec. 337.4.
    In addition, the FDIC proposes to eliminate the five-year period
limiting the securities activities of a state nonmember bank's
underwriting subsidiary's business operations. Rather, with notice and
compliance with the safeguards, a state nonmember bank's securities
subsidiary may conduct any securities business set forth in its
business plan after the notice period has expired without an objection
by the FDIC. The reasons the FDIC initially chose the more conservative
posture are rooted in the time they were adopted. When the FDIC
approved establishment of the initial underwriting subsidiaries, it had
no experience supervising investment banking operations in the United
States. Because affiliation between banks and securities underwriters
and dealers was long considered impractical or illegal, banks had not
operated such entities since enactment of the Glass-Steagall Act in

[[Page 47991]]

1933. Moreover, pre-Glass-Steagall affiliations were considered,
rightly or wrongly, to have caused losses to the banking industry and
investors, although some modern research questions this
view.9 Thus, the affiliation of banks and investment banks
presented unknown risks that were considered substantial in 1983. In
addition, although the FDIC recognized that supervision and regulation
of broker-dealers by the SEC provided significant protections, the FDIC
had little experience with how these protections operated. The FDIC has
now gained experience with supervising the securities activities of
banks and is better able to assess the appropriate safeguards to impose
on these operations to protect the bank and the deposit insurance
funds. For those reasons, the limitations and restrictions contained in
Sec. 337.4 on underwriting other than "investment quality debt
securities" or "investment quality equity securities" have been
eliminated from the proposed regulation. It should also be noted that
certain safeguards have been added to the system since Sec. 337.4 was
adopted. These safeguards include risk-based capital standards and the
Interagency Statement. The FDIC proposes the removal of the disclosures
currently contained in Sec. 337.4. Instead, the FDIC will be relying on
the Interagency Statement for the appropriate disclosures on bank
premises. The FDIC requests comment on whether the Interagency
Statement provides adequate disclosures for retail sales in a
securities subsidiary and whether required compliance with that policy
statement needs to be specifically mentioned in the regulatory text.
Comment is invited on whether any other disclosures currently in
Sec. 337.4 should be retained or if any additional disclosures would be
appropriate.
---------------------------------------------------------------------------

    \9\ See, e.g., George J. Benston, The Separation of Commercial
and Investment Banking: The Glass-Steagall Act Revisited and
Reconsidered 41 (1990).
---------------------------------------------------------------------------

    Finally, the FDIC proposes to continue to impose many of the
safeguards found in section 23A of the Federal Reserve Act (12 U.S.C.
371c) and to impose the safeguards of section 23B of the Federal
Reserve Act (12 U.S.C. 371c-1). Although section 23B did not exist
until 1987 10 and only covers transactions where banks and
their subsidiaries are on one side and other affiliates are on the
other side, the FDIC had included some similar constraints in the
original version of Sec. 337.4. Now, most of the transaction
restrictions imposed by section 23B are being added to promote
consistency with the restrictions imposed by other banking agencies on
similar activities. Briefly, section 23B requires inter-affiliate
transactions to be on arm's length terms, prohibits representing that a
bank is responsible for the affiliate's (in this case subsidiary's)
obligations, and prohibits a bank from purchasing certain products from
an affiliate. While imposing the 23B-like transaction restrictions, the
FDIC is eliminating any overlapping safeguards. The FDIC requests
comment on the restrictions that have been removed, including whether
any of these restrictions should be reimposed for securities
activities. The FDIC invites comment on the restrictions it has modeled
on 23A and 23B. Specifically, the FDIC would like to know if the
restrictions it has proposed address the identified risks without
overburdening the industry with duplicative or ambiguous requirements.
The FDIC invites suggestions for further improvements.
---------------------------------------------------------------------------

    \10\ Aug. 10, 1987, Pub. L. 100-86, Title I, s 102(a), 101 Stat.
564.
---------------------------------------------------------------------------

    In contrast to the section 23B transaction restrictions, section
23A did exist and was incorporated into Sec. 337.4 by reference. To
simplify compliance for transactions between state nonmember banks and
their own subsidiaries, the FDIC has restated the constraints of both
sections 23A and 23B in the regulatory text language and only included
the restrictions that are relevant to a particular activity. The FDIC
hopes that this restatement will clarify the standards being imposed on
state nonmember banks and their subsidiaries without requiring banks to
undertake extensive analysis of the provisions of sections 23A and 23B
that are inapplicable to the direct bank-subsidiary relationship or to
particular activities. In addition, the FDIC has sought to eliminate
transaction restrictions that would duplicate the restrictions on
information flow or transactions imposed by the SROs and/or by the
SEC.11 The FDIC does not seek to eliminate the obligation to
protect material nonpublic information nor does it seek to undercut or
minimize the importance of the restrictions imposed by the SROs and
SEC. Rather, the FDIC seeks to avoid imposing burdensome overlapping
restrictions merely because a securities underwriting entity is owned
by a bank. Further, the FDIC seeks to avoid restrictions where the risk
of loss or manipulation is small or the costs of compliance are
disproportionate to the purposes the restrictions serve. In addition,
the FDIC defers to the expertise of the SEC which has found that
greater flexibility for market activities during public offerings is
appropriate due to greater securities market transparency, the
surveillance capabilities of the SROs, and the continuing application
of the anti-fraud and anti-manipulation provisions of the federal
securities laws.12
---------------------------------------------------------------------------

    \11\ See "Anti-manipulation Rules Concerning Securities
Offerings," 62 FR 520 (January 3, 1997); 15 U.S.C. 78o(f),
requiring registered brokers or dealers to maintain and enforce
written policies and procedures reasonably designed to prevent the
misuse of material nonpublic information; and "Broker-Dealer
Policies and Procedures Designed to Segment the Flow and Prevent the
Misuse of Material Nonpublic Information," A Report by the Division
of Market Regulation, U.S. SEC, (March 1990).
    \12\ Id. at 520.
---------------------------------------------------------------------------

    The FDIC requests comment on whether the restrictions that the FDIC
has restated from sections 23A and 23B provide adequate restrictions
for a securities underwriting subsidiary of a bank, whether any other
restrictions currently in Sec. 337.4 should be retained, whether any
additional restrictions would be appropriate, and any other issues of
concern regarding the appropriate restrictions that should be
applicable to a bank's securities underwriting subsidiary. In addition,
the FDIC requests comment on the adequacy of the best practices
requirements that would be imposed by the SROs and, indirectly, by the
SEC on transactions and information flow. The FDIC also requests
comment on the adequacy of the ethical walls that would prevent the
flow of information from a securities underwriting subsidiary of a bank
to its parent, thus eliminating the necessity of additional transaction
restrictions. To the extent that these ethical walls may be
insufficient barriers to the flow of nonpublic information due to
management and/or employee interlocks or other issues that may not be
readily apparent, the FDIC requests comment on any weaknesses that
might be noted in the more limited transaction restrictions imposed
under this proposal.
    Consistent with the current notice procedure found in Sec. 337.4,
an insured state nonmember bank may indirectly through a majority-owned
subsidiary engage in the public sale, distribution or underwriting of
securities that would be impermissible for a national bank provided
that the bank files notice prior to initiating the activities, the FDIC
does not object prior to the expiration of the notice period and
certain conditions are, and continue to be, met. The FDIC proposes that
the notice period be shortened from the existing 60 days to 30 days and
that required filing procedures be contained in subpart E of part 362.
Previously, specific instructions and guidelines on the form

[[Page 47992]]

and content of any applications or notices required under Sec. 337.4
were found within that section. With regard to those insured state
nonmember banks that have been engaging in a securities activity under
a notice filed and in compliance with Sec. 337.4, Sec. 362.5(b) of the
proposed regulation would allow those activities to continue as long as
the bank and its majority-owned subsidiaries meet the core eligibility
requirements, the investment and transaction limitations, and capital
requirements contained in Sec. 362.4(c), (d), and (e). We will require
these securities subsidiaries to meet the additional conditions
specified in Sec. 362.4(b)(5)(ii) that require securities subsidiaries
to adopt appropriate policies and procedures, register with the SEC and
take steps to avoid conflicts of interest. We also require the state
nonmember bank to adopt policies concerning the financing of issues
underwritten or distributed by the subsidiary. The state nonmember bank
and its securities subsidiary would have one year from the effective
date of the regulation to meet these restrictions and would be expected
to be working toward full compliance over that time period. Failure to
meet the restrictions within a year after the adoption of a final rule
would necessitate an application for the FDIC's consent to continue
those activities to avoid supervisory concern.
    To qualify for the streamlined notice procedure, a bank must be
well-capitalized after deducting from its tier one capital the equity
investment in the subsidiary as well as the bank's pro rata share of
any retained earnings of the subsidiary. The deduction must be
reflected on the bank's consolidated report of income and condition and
the resulting capital will be used for assessment risk classification
purposes under part 327 and for prompt corrective action purposes under
part 325. However, the capital deduction will not be used to determine
whether the bank is "critically undercapitalized" under part 325.
Since the risk-based capital requirements had not been adopted when the
current version of Sec. 337.4 was adopted, no similar capital level was
required of banks to establish an underwriting subsidiary, although the
capital deduction has always been required. This requirement is uniform
with the requirements found in the other part 362 notice procedures for
insured state banks to engage in activities not permissible for
national banks. We believe the well-capitalized standard and the
capital deduction recognize the level of risk present in securities
underwriting activities by a subsidiary of a state nonmember bank. This
risk includes the potential that a bank could reallocate capital from
the insured depository institution to the underwriting subsidiary.
Thus, it is appropriate for the FDIC to retain the capital deduction
even though the FRB eliminated the requirement that a holding company
deduct its investment in a section 20 subsidiary on August 21, 1997.
Additional Requests for Comments
    With regard to securities activities, the FDIC is specifically
requesting comments that address the following:
    (1) Whether it is inherently unsafe or unsound for insured state
nonmember banks to establish or acquire subsidiaries that will engage
in securities activities or for insured state nonmember banks to be
affiliated with a business engaged in securities activities;
    (2) Whether certain securities activities when engaged in by
subsidiaries of insured state nonmember banks pose safety and soundness
problems whereas others do not;
    (3) Whether, and in what circumstances, securities activities of
insured state nonmember banks should be considered unsafe or unsound;
    (4) Whether securities activities of subsidiaries present conflicts
of interest that warrant restricting the manner in which the bank may
deal with its securities subsidiary (or its securities affiliate), or
the manner in which common officers or employees may function, etc.;
    (5) Should securities activities be limited to subsidiaries of
insured state banks of a certain asset size, with a certain composite
rating, etc.;
    (6) Should insured state nonmember banks obtain the FDIC's prior
approval before establishing or acquiring subsidiaries that will engage
in securities activities in all cases, in some cases, or not at all;
    (7) Should revenue limits similar to those that the FRB has
established for section 20 subsidiaries be imposed on securities
subsidiaries of insured state nonmember banks;
    (8) Do the potential benefits, if any that would be available to
insured state nonmember banks as a result of competing in the
securities area through subsidiaries offset potential disadvantages to
the institutions;
    (9) Why haven't more banks availed themselves of the powers
available under 337.4 and will the proposed regulation result in
increased activity in the securities area;
    (10) Alternately, are there other approaches or methods which would
facilitate access without compromising traditional safety and soundness
concerns;
    (11) Are there any perceived public harms in insured state
nonmember banks embarking on such activities; and
    (12) The FDIC is also requesting comment on how to determine if a
securities subsidiary is in fact a true subsidiary and not the alter
ego of the parent bank.
    Comments addressing these issues and any other aspects of the
general subject of permitting subsidiaries and affiliates of insured
state nonmember banks to engage in securities activities will be
welcomed.
Notice for Change in Circumstances
    The proposal requires the bank to provide written notice to the
appropriate Regional Office of the FDIC within 10 business days of a
change in circumstances. Under the proposal, a change in circumstances
is described as a material change in subsidiary's business plan or
management. The FDIC believes that it can address a bank's falling out
of compliance with any of the other conditions of approval through the
normal supervision and examination process. We request comment on
whether specific language should be included in the regulation text
that a bank must continue to meet all eligibility, capital, and
investment and transaction criteria.
    The FDIC is concerned about changes in circumstances which result
from changes in management or changes in a subsidiary's business plan.
If material changes to either condition occur, the rule requires the
institution to submit a notice of such changes to the appropriate FDIC
regional director (DOS) within 10 days of the material change. The
standard of material change would indicate such events as a change in
chief executive officer of the subsidiary or a change in investment
strategy or type of business or activity engaged in by the subsidiary.
The regional director also may address other changes that come to the
attention of the FDIC during the normal supervisory process.
    In the case of a state member bank, the FDIC will communicate our
concerns with the appropriate persons in the Federal Reserve System
regarding the continued conduct of an activity after a change in
circumstances. The FDIC will work with the identified persons within
the Federal Reserve System to develop the appropriate response to the
new circumstances.

[[Page 47993]]

    It is not the FDIC's intention to require any bank which falls out
of compliance with eligibility conditions to immediately cease any
activity in which the bank had been engaged subject to a notice to the
FDIC. The FDIC will deal with such eventuality rather on a case-by-case
basis through the supervision and examination process. In short, the
FDIC intends to utilize the supervisory and regulatory tools available
to it in dealing with the bank's failure to meet eligibility
requirements on a continuing basis. The issue of the bank's ongoing
activities will be dealt with in the context of that effort. The FDIC
is of the opinion that the case-by-case approach to whether a bank will
be permitted to continue an activity is preferable to forcing a bank
to, in all instances, immediately cease the activity in question. Such
an inflexible approach could exacerbate an already poor situation.
Core Eligibility Requirements
    The proposed regulation has been organized much differently from
the current regulation where separation standards between an insured
state bank and its subsidiary are contained in the regulation's
definition of "bona fide" subsidiary. The proposed regulation
introduces the concept of core eligibility requirements. These
requirements are used to determine those institutions that qualify to
use the notice processes introduced in this regulation and to establish
general criteria that the Board will be reviewing in considering
applications. These requirements are defined in two parts. The first
part defines the eligible depository institution criteria and the
second part defines the eligible subsidiary standards.
    An "eligible depository institution" is a depository institution
that has been chartered and operating for at least three years;
received an FDIC-assigned composite UFIRS rating of 1 or 2 at its most
recent examination; received a rating of 1 or 2 under the
"management" component of the UFIRS at its most recent examination;
received at least a satisfactory CRA rating from its primary federal
regulator at its last examination; received a compliance rating of 1 or
2 from its primary federal regulator at its last examination; and is
not subject to any corrective or supervisory order or agreement. The
FDIC believes that this criteria is appropriate to ensure that the
notice procedures are available only to well-managed institutions that
do not present any supervisory, compliance or CRA concerns.
    The standards for an "eligible depository institution" are being
standardized with similar requirements for other types of notices and
applications made to the FDIC. In developing the eligibility standards,
several items have been added that previously were not a stated
standard for banks wishing to engage in activities not permissible for
a national bank.
    The requirement that the institution has been chartered and
operated for three or more years reflects the experience of the FDIC
that newly formed depository institutions need closer scrutiny.
Therefore, a request by this type of institution to become involved in
activities not permissible for a national bank should receive
consideration under the application process rather than being eligible
for a notice process.
    The FDIC's existing standard is that only well-managed, well-
capitalized banks should be eligible for engaging in activities not
permissible for national banks through a notice procedure. Banks which
have composite ratings of 1 or 2 have shown that they have the
requisite financial and managerial resources to run a financial
institution without presenting a significant risk to the deposit
insurance fund. While lower-rated financial institutions may have the
requisite financial and managerial resources and skills to undertake
such activities, the FDIC believes that those institutions should be
subject to the formal part 362 application process as opposed to the
streamlined notice process described herein. Such institutions are not
on their face as sound on an overall basis as those rated 1 or 2. For
that reason, the FDIC feels that it is more prudent to require
institutions rated 3 or below to utilize the application process.
    In addition, the FDIC is adding to the proposed rule a requirement
that the management component of the bank's most recent rating be a 1
or 2 also. The FDIC believes that both capital and management are
extremely important to the safety and soundness of a financial
institution. As noted above, a bank with a composite rating of 1 or 2
has shown that it is strong when taking into account all components of
the uniform financial institutions rating system. While there are few
financial institutions with 1 or 2 composite ratings with weak
management, we believe that only those institutions that are well-
managed should be eligible for the notice processes.
    Banks which wish to become involved in activities not permissible
for a national bank through the notice process should be exemplary in
all areas of its operations. Therefore, the proposal requires that the
institution have a satisfactory or better CRA rating, a 1 or 2
compliance rating, and not be subject to any formal or informal
enforcement action.
    A filing may be removed from notice processing if: (1) A CRA
protest is received that warrants additional investigation or review,
or the appropriate regional director of the Division of Consumer
Affairs (DCA) determines that the filing presents a significant CRA or
compliance concern; (2) the appropriate regional director (DOS)
determines that the filing presents a significant supervisory concern,
or raises a significant legal or policy issue; or (3) the appropriate
regional director (DOS) determines that other good cause exists for
removal. If a filing is removed from notice processing procedures, the
applicant will be promptly informed in writing of the reason.
    The FDIC specifically requests comment on whether the standards for
eligibility are appropriate.
Eligible Subsidiary
    The FDIC's support of the concepts of expansion of bank powers is
based in part on establishing a corporate separateness between the
insured depository institution and the entity conducting activities
that are not permissible for the depository institution directly. The
proposal establishes these separations as well as standards for
operations through the concept of "eligible subsidiary." An entity is
an "eligible subsidiary" if it: (1) Meets applicable statutory or
regulatory capital requirements and has sufficient operating capital in
light of the normal obligations that are reasonably foreseeable for a
business of its size and character; (2) is physically separate and
distinct in its operations from the operations of the state-chartered
depository institution, provided that this requirement shall not be
construed to prohibit the state-chartered depository institution and
its subsidiary from sharing the same facility if the area where the
subsidiary conducts business with the public is clearly distinct from
the area where customers of the state-chartered depository institution
conduct business with the institution--the extent of the separation
will vary according to the type and frequency of customer contact; (3)
maintains separate accounting and other business records; (4) observes
separate business formalities such as separate board of directors'
meetings; (5) has a chief executive officer who is not an employee of
the bank; (6) has a majority of its board of directors who are neither
directors nor officers of the state-

[[Page 47994]]

 chartered depository institution; (7) conducts business pursuant to
independent policies and procedures designed to inform customers and
prospective customers of the subsidiary that the subsidiary is a
separate organization from the state-chartered depository institution
and that the state-chartered depository institution is not responsible
for and does not guarantee the obligations of the subsidiary; (8) has
only one business purpose; (9) has a current written business plan that
is appropriate to the type and scope of business conducted by the
subsidiary; (10) has adequate management for the type of activity
contemplated, including appropriate licenses and memberships, and
complies with industry standards; and (11) establishes policies and
procedures to ensure adequate computer, audit and accounting systems,
internal risk management controls, and has the necessary operational
and managerial infrastructure to implement the business plan.
    The separations are currently outlined in the definitions of "bona
fide" subsidiary contained in Sec. 337.4 and part 362. The broad
principles of separation upon which the "bona fide" subsidiary
definition and the "eligible subsidiary" definition are based
include: (1) Adequate capitalization of the subsidiary; (2) separate
corporate functions; (3) separation of facilities; (4) separation of
personnel; and (5) advertising the bank and the subsidiary as separate
entities.
    While the "bona fide" subsidiary definitions currently used are
substantially similar, there is one substantial difference. Each
regulation has a different approach to the issue of common officers
between the bank and the subsidiary. The language in the current part
362 allows the subsidiary and the parent bank to share officers so long
as a majority of the subsidiary's executive officers were neither
officers nor directors of the bank. Section 337.4 contains a
requirement that there be no shared officers. The "eligible
subsidiary" concept adopts a more limited standard. The eligible
subsidiary requirements loosen the separations among employees and
officers from those in place under the bona fide subsidiary definitions
in both Sec. 337.4 and part 362 and in Board orders authorizing most
real estate activities. The eligible subsidiary only requires that the
chief executive officer not be an employee of the institution. We
consider officers to be employees of the institution. This limitation
would allow the chief executive officer to be an employee of an
affiliated entity or be on the board of directors of the institution.
Are there other methods of achieving the concept of separation without
requiring different public contact employees and officers for the bank
and the subsidiary?
    In deciding the standards to become an "eligible subsidiary," the
FDIC not only has reconciled the differing standards on shared
officers, but also has modified some of the previous standards used in
the definition of "bona fide" subsidiary. The changes are found in
the capital requirement, the physical separation requirement, the
separate employee standard, and the requirement that the subsidiary's
business be conducted pursuant to independent policies and procedures.
    The requirement that the subsidiary be adequately capitalized was
revised to provide that the subsidiary must meet any applicable
statutory or regulatory capital requirements, that the subsidiary have
sufficient operating capital in light of the normal obligations that
are reasonably foreseeable for a business of its size and character,
and that the subsidiary's capital meet any commonly accepted industry
standard for a business of its size and character. This definition
clarifies that the FDIC expects the subsidiary to meet the capital
requirements of its primary regulator, particularly those subsidiaries
involved in securities and insurance.
    The physical separation requirement was clarified by the addition
of a sentence which indicates that the extent to which the bank and the
subsidiary must carry on operations in physically distinct areas will
vary according to the type and frequency of public contacts. It is not
the intent of the FDIC to require physical separation where such a
standard adds little value. For instance, a subsidiary engaged in
developing commercial real estate would not require the same physical
separation from the bank as a subsidiary engaged in retail securities
activities. The possibility of customer confusion should be the
determining factor in deciding the separation requirements for the
subsidiary.
    The proposal has eliminated the provision contained in the bona
fide subsidiary definition that required the bank and subsidiary to
have separately compensated employees who have contact with the public.
This provision was imposed to reduce confusion relating to whether
customers were dealing with the bank or the subsidiary. Since the
adoption of the bona fide subsidiary definition, the Interagency
Statement was issued. This interagency statement recognizes the concept
of employees who work both for a registered broker-dealer and the bank.
Because of the disclosures required in the Interagency Statement
informing the customer of the nature of the product being sold and the
physical separation requirements, the need for separate public contact
employees is diminished. Comment is requested concerning the need for
separate public contact employees. Specifically, is there a need for
separate employees when an insured depository institution sells a
financial instrument underwritten by a subsidiary or real estate
developed by a subsidiary? Are the disclosures concerning the
affiliation between the bank and the underwriter required by the
Interagency Statement sufficient to protect customers from confusion
about who is responsible for the product?
    Language was added that the subsidiary must conduct business so as
to inform customers that the bank is not responsible for and does not
guarantee the obligations of the subsidiary. This language is taken
from section 23B of the Federal Reserve Act which prohibits banks from
entering into any agreement to guarantee the obligations of their
affiliates and prohibits banks and well as their affiliates from
advertising that the bank is responsible for the obligations of its
affiliates. This type of disclosure is intended to reduce customer
confusion concerning who is responsible for the products purchased.
    After issuing its proposal last August, the FDIC received comment
concerning the requirement that a majority of the board of the
subsidiary be neither directors nor officers of the bank. The comment
questioned if this restriction extended to directors and officers of
the holding company. The FDIC is primarily concerned about risk to the
deposit insurance funds and is therefore looking to establish
separation between the insured bank and its subsidiary. The eligible
subsidiary requirement is designed to assure that the subsidiary is in
fact a separate and distinct entity from the bank. This requirement
should prevent "piercing of the corporate veil" and insulate the
bank, and the deposit insurance fund, from any liabilities of the
subsidiary.
    We recognize that a director or officer employed by the bank's
parent holding company or sister affiliate is not as "independent" as
a totally disinterested third party. The FDIC is, however, attempting
to strike a reasonable balance between prudential safeguards and
regulatory burden. The requirement that a majority of the board not be
directors or officers of the bank will provide certain benefits that
the FDIC thinks are very important in the context of subsidiary
operation. The FDIC expects

[[Page 47995]]

these persons to act as a safeguard against conflicts of interest and
be independent voices on the board of directors. While the presence of
"independent" directors may not, in and of itself, prevent piercing
of the corporate veil, it will add incremental protection and in some
circumstances may be key to preserving the separation of the bank and
its subsidiary in terms of liability. In view of the other standards of
separateness that have been established under the eligible subsidiary
standard as well as the imposition of investment and transaction
limits, we do not believe that a connection between the bank's parent
or affiliate will pose undue risk to the insured bank.
    The FDIC requests comment on the appropriateness of the proposed
separation standards. In particular, comment is requested concerning
the provision requiring that a majority of the board of the subsidiary
not be directors or officers of the state chartered depository
institution. What impact does this requirement have on finding
qualified directors? Should the standard be the same for different
types of activities?
    In addition to the separation standards, the "eligible
subsidiary" concept introduces operational standards that were not
part of the "bona fide" subsidiary definition. These standards
provide guidance concerning the organization of the subsidiary that the
FDIC believes are important to the independent operation of the
subsidiary.
    The proposed regulation requires that a subsidiary engaged in
insurance, real estate or securities have only one business purpose
among those categories. Because the FDIC is limiting a bank's
transactions with subsidiaries engaged in insurance, real estate, or
securities activities that are not permissible for a subsidiary of a
national bank, and the aggregate limitations only extend to
subsidiaries engaged in the same type of business, the FDIC is limiting
the scope of the subsidiary's activities. The FDIC is seeking comment
on the effect of limiting the subsidiary's activities to one business
purpose. Should the term "one business purpose" be defined more
broadly? For instance, should a subsidiary engaged in real estate
investment activities also be allowed to be engaged in real estate
brokerage in the same subsidiary?
    The proposal requires that the subsidiary have a current written
business plan that is appropriate to its type and scope of business.
The FDIC believes that an institution that is contemplating involvement
with activities that are not permissible for a national bank or a
subsidiary of a national bank should have a carefully conceived plan
for how it will operate the business. We recognize that certain
activities do not require elaborate business plans; however, every
activity should be given board consideration to determine the scope of
the activity allowed and how profitability is to be attained.
    The requirement for adequate management of the subsidiary
establishes the FDIC's desire that the insured depository institution
consider the importance of management in the success of an operation.
The requirement to obtain appropriate licenses and memberships and to
comply with industry standards indicates the FDIC's support of
securities and insurance industry standards in determining adequacy of
subsidiary management.
    An important factor in controlling the spread of liabilities from
the subsidiary to the insured depository institution is that the
subsidiary establishes necessary internal controls, accounting systems,
and audit standards. The FDIC does not expect to supplement this
requirement with specific guidance since the systems must be tailored
to specific activities, some of which are otherwise regulated.
    The FDIC seeks comments on the appropriateness of the restrictions
contained in the "eligible subsidiary" standard. Are there other
restrictions that should be considered? Are there standards that are
unnecessary to achieve separation between the insured depository
institution and the subsidiary?
Investment and Transaction Limits
    The proposal contains investment limits and other requirements that
apply to an insured state bank and its subsidiaries that engage as
principal in activities that are not permissible for a national bank if
the requirements are imposed by order or expressly imposed by
regulation. The provision is not contained in the current regulation;
however, Sec. 337.4 imposes by reference the limitations of section 23A
of the Federal Reserve Act (Sec. 337.4 was adopted prior to the
adoption of section 23B of the Federal Reserve Act), and both section
23A and section 23B restrictions have been imposed by the Board on
insured state banks seeking the FDIC's consent to engage in activities
not permissible for a national bank.
    On August 23, 1996, the FDIC issued a proposed revision to part
362. The proposed rule would have imposed sections 23A and 23B on bank
investments and transactions with subsidiaries that hold equity
investments in real estate not permissible for a national bank. The
FDIC received a significant number of negative comments regarding the
imposition of sections 23A and 23B on real estate subsidiaries. After a
thorough review, the FDIC has determined that several of the major
points in this area have merit. Some of the provisions of section 23A
and 23B are inapplicable while others duplicate existing legal
requirements. The FDIC believes that merely incorporating sections 23A
and 23B by reference raises significant interpretative issues, as
pointed out by the commenters, and only promotes confusion in an
already complex area.
    For these reasons, in this proposal the FDIC is proposing a
separate subsection which sets forth the specific investment limits and
arm's length transaction requirements which the FDIC believes are
necessary. In general, the provisions impose investment limits on any
one subsidiary and an aggregate investment on all subsidiaries that
engage in the same activity, requires that extensions of credit from a
bank to its subsidiaries be fully-collateralized when made, prohibits
the bank from taking a low quality asset as collateral on such loans,
and requires that transactions between the bank and its subsidiaries be
on an arm's length basis.
    The proposal expands the definition of bank for the purposes of the
investment and transaction limitations. A bank includes not only the
insured entity but also any subsidiary that is engaged in activities
that are not subject to these investment and transaction limits.
    Sections 23A and 23B of the Federal Reserve Act combine the bank
and all of its subsidiaries in imposing investment limitations on all
affiliates. The FDIC is using the same concept in separating
subsidiaries conducting activities that are subject to investment and
transaction limits from the bank and any other subsidiary that engages
in activities not subject to the investment and transaction limits.
    This rule will prohibit a bank from funding a subsidiary subject to
the investment and transaction limits through a subsidiary that is not
subject to the limits. The FDIC invites comment on the appropriateness
of this restriction on subsidiary to subsidiary transactions.
Investment Limit
    Under the proposal, a bank may be restricted in its investments in
certain of its subsidiaries. Those limits are basically the same as
would apply

[[Page 47996]]

between a bank and its affiliates under section 23A. As is the case
with covered transactions under section 23A, extensions of credit and
other transactions that benefit the bank's subsidiary would be
considered part of the bank's investment. The only exception would be
for arm's length extensions of credit made by the bank to finance sales
of assets by the subsidiary to third parties. These transactions would
not need to comply with the collateral requirements and investment
limitations of section 23A, provided that they met certain arm's length
standards. The imposition of section 23A-type restrictions is intended
to make sure that adequate safeguards are in place for the dealings
between the bank and its subsidiary.
    When the August proposal was published for comment, the FDIC
invited comment on whether all provisions of sections 23A should be
imposed or whether just certain restrictions are necessary. For
instance, should the regulation simply provide that the bank's
investment in the subsidiary is limited to 10 percent of capital and
that there is an aggregate investment limit of 20 percent for all
subsidiaries rather than, in effect, subjecting transactions between
the bank and its subsidiary to all of the restrictions of section 23A.
Eight of the seventeen commenters addressed this issue. Two commenters
supported the incorporation of all the limits and restrictions in
sections 23A stating that it encourages uniformity in approach for
structuring transactions between the bank and its subsidiary. The
remaining commenters generally considered the imposition of section 23A
requirements to be unduly restrictive. One comment challenged that the
wholesale incorporation of section 23A limitations is inappropriate
since Congress has already determined that transactions with
subsidiaries present little risk to banks. In fact, in the words of the
commenter, if the subsidiary is wholly-owned, the bank is really
dealing with itself.
    In contrast to the bank-affiliate relationship being governed by
the statutory limits of sections 23A and 23B, inherent in the idea of a
subsidiary is the subsidiary's value to the bank as an asset. That
value increases as the subsidiary earns profits and decreases as the
subsidiary loses money. The increases are reflected in the subsidiary's
retained earnings and the consolidated retained earnings of the bank as
a whole. The FDIC wants to dissociate the bank's equity investment in
the subsidiary from any lending to or covered transactions with the
subsidiary. Thus, the FDIC proposes to treat the bank's equity
investment as a deduction from capital, while treating any lending to
or covered transactions with the subsidiary as transactions subject to
10% and 20% limits that are similar to those that govern the bank-
affiliate relationship. Then, the question arises as to how to properly
treat retained earnings at the subsidiary level. If retained earnings
at the subsidiary level were treated as subject to the 10% and 20%
limits, the bank could be forced to take the retained earnings out of
the subsidiary to stay under the applicable limits. If retained
earnings are allowed to accumulate without limit, then the bank could
declare dividends to its shareholders based on the retained earnings at
the subsidiary. Later, in the event that the subsidiary incurred
losses, the bank's capital could become inadequate based on the
subsidiary's losses. Thus, the FDIC requires that retained earnings be
deducted from capital in the same way as the equity investment is
deducted.
    The definition of "investment" under this provision has four
components. The first component is any extension of credit by the bank
to the subsidiary. The term "extension of credit" is defined in part
362 to have the same meaning as that under section 22(h) of the Federal
Reserve Act and would therefore apply not only to loans but also to
commitments of credit. The second component is "any debt securities of
the subsidiary" held by the bank. This component recognizes that debt
securities are very similar to extensions of credit. The third
component is the acceptance of securities issued by the subsidiary as
collateral for extensions of credit to any person or company. The
fourth and final component addresses any extensions or commitments of
credit to a third party for investment in the subsidiary, investment in
a project in which the subsidiary has an interest, or extensions of
credit or commitments of credit which are used for the benefit of, or
transferred to, the subsidiary.
    Two of the components of the definition of "investment" are
borrowed from and consistent with sections 23A and 23B. It is the
FDIC's intent to include the types of investments or extensions of
credit which would normally be subject to the 23A and 23B investment
limits. We note in particular that the fourth component of the
definition of "investment" includes language similar to the
"attribution rule." Indirect investments and extensions of credit by
a bank to its subsidiaries will be included in the calculation of the
10%/20% investment limits.
    In addition to the differences in coverage created by the proposed
definition of investment versus the section 23A covered transactions,
the percentage restrictions are calculated differently from section
23A. The proposal calculates the 10%/20% limits based on tier one
capital while section 23A uses total capital. As was discussed earlier,
the FDIC is using tier one capital as its measure to create consistency
throughout the regulation.
    Also, the proposal limits the aggregate investment to all
subsidiaries conducting the same activity. There is not a "same
activity" standard in section 23A. The FDIC believes that the
aggregate limitations should reflect a restriction on concentrations in
a particular activity and not a general limitation on activities that
are not permissible for a national bank. For the purposes of this
paragraph, the FDIC intends to interpret the "same activity" standard
to mean broad categories of activities such as real estate investment
activities or securities underwriting. The FDIC specifically requests
comments on this provision of the proposal. The FDIC has consistently
maintained that it applies section 23A and 23B-like standards. It
believes that its proposal continues to do so, but would like comment
on the effect of the proposed change.
Arm's Length Transaction Requirement
    A major provision of 23B of the Federal Reserve Act is that any
transaction between a bank and its affiliates must be on terms and
conditions that are substantially the same as those prevailing at the
time for comparable transactions with unaffiliated parties. This type
of requirement, which is generally referred to as an "arm's length
transaction" requirement, is intended to make sure that an affiliate
does not take advantage of the bank. The proposal requires transactions
between the bank and its real estate subsidiaries to meet this
requirement. The arm's length transaction requirement found in the
proposal is modeled on the statutory provisions of section 23B. The
types of transactions covered by the requirement include: (1)
Investments in the subsidiary, (2) the purchase from or sale to the
subsidiary of any assets, including securities, (3) entering into any
contract, lease or other agreement with the subsidiary, and (4) paying
compensation to the subsidiary or any person who has an interest in the
subsidiary. The proposal indicates, however, that the restrictions do
not apply to an insured state bank giving immediate credit to a
subsidiary for

[[Page 47997]]

uncollected items received in the ordinary course of business.
    The arm's length transaction requirement is meant to protect the
bank from abusive practices. To the extent that the subsidiary offers
the parent bank a transaction which is at or better than market terms
and conditions, the bank may accept such transaction since the bank is
receiving a benefit, as opposed to being harmed. It may be the case,
however, that a bank will be unable to meet the regulatory standard
because there are no known comparable transactions between unaffiliated
parties. In these situations, the FDIC will review the transactions and
expect the bank to meet the "good faith" standard found in section
23B.
    When engaging in transactions with a subsidiary, banks and bank
counsel should be aware of the FDIC's separate corporate existence
concerns. Bank subsidiaries should be organized and operated as
separate corporate entities. Subsidiaries should be adequately
capitalized for the business they are engaged in and separate corporate
formalities should be observed. Frequent transactions between the bank
and its subsidiary which are not on an arm's length basis may lead to
questions as to whether the subsidiary is actually a separate corporate
entity or merely the alter ego of the bank. One of the primary reasons
for the FDIC requiring that certain activities be conducted through an
eligible subsidiary is to provide the bank, and the deposit insurance
funds, with liability protection. To the extent a bank ignores the
separate corporate existence of the subsidiary, this liability
protection is jeopardized.
Last Updated 11/9/2011 communications@fdic.gov