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FDIC Federal Register Citations

[Federal Register: March 19, 1997 (Volume 62, Number 53)]
[Rules and Regulations]               
[Page 13275-13288]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr19mr97-11]
[[Page 13275]]
_______________________________________________________________________
Part VI
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Part 13
Federal Reserve System
12 CFR Part 208 and 211
Federal Deposit Insurance Corporation
12 CFR Part 368
_______________________________________________________________________

Government Securities Sales Practices; Final Rule
[[Page 13276]]

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 13
[Docket No. 97-05]
RIN 1557-AB52
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 211
[Regulations H and K, Docket No. R-0921]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 368
RIN 3064-AB66
 
Government Securities Sales Practices
AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of 
Governors of the Federal Reserve System; Federal Deposit Insurance 
Corporation.
ACTION: Joint final rule.
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SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of 
Governors of the Federal Reserve System (Board), and Federal Deposit 
Insurance Corporation (FDIC) (collectively, the agencies) are issuing 
rules regarding sales practices concerning government securities by 
depository institutions within their respective jurisdictions. The 
agencies are adopting the final rules in light of recent statutory 
changes authorizing the agencies to adopt rules governing transactions 
in government securities in order to provide consistent treatment for 
government securities customers. The final rules minimize regulatory 
burdens to the extent feasible, consistent with the goal of providing 
purchasers of government securities with consistent treatment 
regardless of whether they engage in transactions in government 
securities with banks or nonbank government securities brokers and 
dealers.
EFFECTIVE DATE: This joint rule is effective July 1, 1997.
FOR FURTHER INFORMATION, CONTACT: OCC: Ellen Broadman, Director, or 
Elizabeth Malone, Senior Attorney, Securities & Corporate Practices 
Division (202/874-5210); Joseph W. Malott, National Bank Examiner, 
Capital Markets (202/874-5070); or Mark J. Tenhundfeld, Assistant 
Director, Legislative and Regulatory Activities (202/874-5090), 250 E 
Street, SW, Washington, DC 20219.
    Board: Oliver Ireland, Associate General Counsel (202/452-3625), or 
Lawranne Stewart, Senior Attorney (202/452-3513), Legal Division, Board 
of Governors of the Federal Reserve System, 20th and C Streets, NW, 
Washington, DC 20551. For the hearing impaired only, Telecommunication 
Device for Deaf (TDD), Ernestine Hill or Dorothea Thompson (202/452-
3544).
    FDIC: William A. Stark, Assistant Director (202/898-6972), Keith 
Ligon, Chief (202/898-3618), Kenton Fox, Senior Capital Markets 
Specialist (202/898-7119), Division of Supervision; or Karen L. Main, 
Senior Attorney (202/898-8838), Legal Division, Federal Deposit 
Insurance Corporation, 550 17th Street, NW, Washington, DC 20429.
SUPPLEMENTARY INFORMATION:
The Government Securities Act Amendments of 1993
    The Government Securities Act Amendments of 1993 (Amendments) 
(Pub.L. 103-202), codified at section 15C(b)(3) of the Securities 
Exchange Act of 1934 (Exchange Act) (15 U.S.C. 78o-5(b)(3)), authorize 
the agencies to adopt rules and regulations governing transactions in 
government securities as may be necessary to prevent fraudulent and 
manipulative acts and practices and to promote just and equitable 
principles of trade. Id. section 15C(b)(3)(A). Rules adopted pursuant 
to the Amendments apply to transactions in government securities by 
banks that have filed, or are required to file, notice as government 
securities brokers or dealers.
    The Amendments require the banking agencies to consider the 
sufficiency and appropriateness of existing laws and rules applicable 
to government securities brokers or dealers and associated persons 
before promulgating rules governing transactions in government 
securities. Id. section 15C(b)(3)(C). In determining whether existing 
laws are sufficient, the agencies may consider rules that expressly 
apply to government securities activities of financial institutions and 
other sales practice rules that do not expressly apply to these 
activities but that are used by examiners and bankers as guidance for 
transactions in government securities. S. Rep. No. 109, 103d Cong., 1st 
Sess. at 14. The agencies also may consider the extent to which 
additional rules are necessary to establish consistent treatment for 
bank customers engaged in transactions involving government securities.
    The Amendments also eliminated the statutory limitations on the 
National Association of Securities Dealers (NASD) authority to apply 
sales practice rules to transactions in government securities by 
government securities broker-dealers that are members of the NASD. See 
section 106 of the Amendments (15 U.S.C. 78o-3). To implement this 
expanded sales practice authority, the NASD proposed, and the SEC 
approved August 20, 1996 (see SEC Release No. 34-37588), the 
application of the NASD Conduct Rules (formerly, the Rules of Fair 
Practice) to transactions in government securities. The NASD Conduct 
Rules include a Business Conduct Rule and a Suitability Rule, as well 
as a Suitability Interpretation. The rules and the interpretation that 
the agencies promulgated in both the proposed and final rules (see text 
that follows) are substantially identical to the NASD Business Conduct 
and Suitability Rules and the NASD Suitability Interpretation.
The Proposal
    On April 25, 1996 (61 FR 18470), the agencies requested comment on 
whether they should require a bank that is a government securities 
broker or dealer to comply with rules that are substantively identical 
to the NASD Business Conduct and Suitability Rules and the NASD 
Suitability Interpretation. The proposal defined ``bank that is a 
government securities broker or dealer'' as a bank that has filed 
notice, or is required to file notice, as a government securities 
broker or dealer under the provisions of the Government Securities Act 
(15 U.S.C. 78o-5(a)) and applicable Treasury rules (17 CFR 400.1(d) and 
401).
    The proposal required a bank that is a government securities broker 
or dealer and its associated persons: (a) To observe high standards of 
commercial honor and just and equitable principles of trade in the 
conduct of its business as a government securities broker or dealer; 
and (b) to have reasonable grounds for believing that recommendations 
are suitable for a customer based on the facts, if any, disclosed by a 
customer regarding his, her, or its other securities holdings and 
financial situation and needs. The proposal provided that, if a bank is 
doing business with a non-institutional customer, the bank must make 
reasonable efforts to obtain information concerning the customer's 
financial situation and tax status and investment objectives before 
executing a transaction it recommended to the customer. The suitability 
rule contained in the proposal, like the Suitability Rule of the NASD, 
applies only in situations where a bank makes a ``recommendation'' to 
its customer.
[[Page 13277]]
    The proposal also set out a suitability interpretation that 
identifies factors that may be relevant when evaluating a bank's 
compliance with the suitability rule when dealing with an institutional 
customer other than a natural person. The interpretation identified: 
(a) the customer's capability to evaluate investment risk 
independently; and (b) the extent to which the customer is exercising 
independent judgement in evaluating a bank's recommendation as the two 
most important considerations in determining the scope of the bank's 
responsibilities to an institutional customer. The suitability 
interpretation provided that a bank will have met the requirements of 
the suitability rule with respect to a particular institutional 
customer where the bank has reasonable grounds to determine that the 
institutional customer is capable of independently evaluating 
investment risk and is exercising independent judgement in evaluating a 
recommendation.
    The proposed suitability interpretation set forth certain factors 
for banks to apply in evaluating an institutional customer's capability 
to evaluate investment risk independently. These factors include: The 
customer's use of consultants, advisors, or bank trust departments; the 
experience of the customer generally and with respect to the specific 
instrument; the customer's ability to understand the investment and to 
evaluate independently the effect of market developments on the 
investment; and the complexity of the security involved. The 
interpretation stressed that an institutional customer's ability to 
evaluate investment risk independently may vary depending on the 
particular type of instrument or its risk. Moreover, the interpretation 
noted that an institutional customer with general ability to evaluate 
investment risk may be less able to do so when dealing with new types 
of instruments or instruments with which the customer has little or no 
experience.
    The proposed suitability interpretation further provided that a 
determination that an institutional customer is making an independent 
investment decision depends on factors such as the understanding 
between the bank and its customer as to the nature of their 
relationship, the presence or absence of a pattern of acceptance of the 
bank's recommendations, the customer's use of ideas, suggestions, and 
information obtained from other market professionals, and the extent to 
which the customer has provided the bank with information concerning 
the customer's portfolio or investment objectives.
    While the proposed suitability interpretation stated that these 
factors would be considered relevant in evaluating whether a bank that 
is a government securities broker or dealer has fulfilled the 
requirements of the suitability rule with respect to any institutional 
customer that is not a natural person, it further stated that the 
factors cited would be considered most relevant for an institutional 
customer with at least $10 million invested in securities in the 
aggregate in its portfolio or under management.
Final Rules and Comments Received
    The final rules adopt the business conduct and suitability rules 
and the suitability interpretation as proposed, excepting only the 
addition of a definition of ``government security'' in the final rules 
and minor modifications of the suitability interpretation to conform 
that interpretation to the NASD's Suitability Interpretation. As 
discussed in greater detail below, the agencies continue to believe 
that banks and their customers will benefit significantly from a 
consistent set of rules applied to banks engaged in transactions in 
government securities.
    The agencies received a total of 18 comments. Of these, eight were 
from trade organizations representing interests ranging from the banks 
and the securities companies to state governments and retired persons. 
Seven other comments were from insured depository institutions or their 
affiliates, two were from State governments, and the remaining comment 
was from a securities dealer. The comments were fairly evenly split, 
with banks and securities companies and their respective trade 
organizations generally opposing the proposal and the rest of the 
commenters favoring it.
    Commenters typically responded to some or all of the specific 
questions set out in the proposal. Below is a summary of the comments, 
along with the agencies' responses, that follows the order of questions 
presented for comment in the proposal.
Issue 1. Adoption of rules substantially similar to the NASD Business 
Conduct and Suitability Rules
    Eight commenters opposed adoption of these rules for banks while 
seven favored adoption of the rules.
    (a) Comments supporting adoption of the proposed rules. Commenters 
representing purchasers of government securities stated that certain 
government securities, such as collateralized mortgage obligations, 
carry considerable risk and are unsuitable for certain investors. The 
purchasers' representatives stated further that customers need to be 
protected from potential misconduct in the sale of government 
securities. They believe that banks should be held to the same 
standards as apply to other entities that engage in government 
securities transactions and that the existence of customer protections 
should not depend on the type of entity selling the security. Several 
of the commenters also stated their support for the suitability 
interpretation, with one commenter stating that a suitability 
determination must be made on a case-by-case basis and another stating 
that banks should be required to ask for specific information about an 
investor before making a recommendation.
    (b) Comments opposing adoption of the proposed rules. Those 
opposing the application of these rules to banks advanced several 
arguments to support their conclusion that the rule is unnecessary. 
Their arguments fall into the following eight broad categories.
    (i) There have been no significant sales practice abuses.
    (ii) The Amendments and the legislative history indicate that the 
banking agencies are not required to adopt sales practice rules.
    (iii) There are sufficient market incentives to ensure that the 
good relations that exist between banks and their customers would 
likely discourage banks from making unsuitable recommendations of 
government securities.
    (iv) A suitability obligation is particularly inappropriate in the 
case of institutional investors, because institutional investors need 
less protection than do retail customers and because a bank will lack 
adequate information needed to detect anomalies between an 
institutional customer's investment objectives and the type of trade.
    (v) The rules will impose significant additional burdens on banks, 
in part because the rules are too ambiguous.
    (vi) The rules could have unintended adverse consequences by 
discouraging investors from performing their own research in order to 
shift responsibility (and, therefore, liability) for making appropriate 
investments to the bank that makes a recommendation.
    (vii) Case law and other issuances, such as the Interagency 
Statement on Retail Sales of Nondeposit Investment Products (the 
Interagency Statement), OCC Banking Circular 277--Risk Management of 
Financial Derivatives, the Board's Trading Activities Manual (March 
1994) and SR 93-69 (FIS) (Dec. 20, 1993), and the Rules of the 
Municipal Securities Rulemaking Board
[[Page 13278]]
(MSRB), provide sufficient guidance to banks and bank examiners on 
appropriate sales practices.
    (viii) The agencies should consider alternatives to adopting the 
rules as proposed, such as adopting guidelines or amending the proposal 
to include a statement that compliance with certain requirements 
creates a safe harbor.
    (c) Analysis of Issue 1. After carefully considering all the 
arguments advanced by the commenters, the agencies continue to believe 
that the benefits of the rules in question significantly outweigh the 
burdens and, therefore, are adopting the rules substantially as 
proposed. The agencies believe that adoption of final rules 
substantially in the form proposed is appropriate to provide consistent 
treatment for government securities customers. Although bank and 
nonbank government securities dealers will continue to be subject to 
different regulatory structures, adoption of business conduct and 
suitability rules that are consistent with the NASD rules will ensure 
that customers of both bank and nonbank government securities broker-
dealers receive consistent treatment in their government securities 
transactions. The agencies agree with those who stated that certain 
government securities can carry considerable risk and that the rules 
appropriately focus the banking industry's attention on the issue of 
suitability in recommending these securities. An analysis of the 
comments opposing adoption of the rules follows.
    (i) Lack of evidence of abuses. Opponents of the rules are correct 
that sales practice abuses have not been found to be a significant 
problem in financial institutions engaged in government securities 
transactions. However, losses stemming from unsuitable transactions in 
government securities can create reputational risk for banks. The 
agencies believe that banking practices that comport with the final 
rules will help minimize this risk to banks due to losses incurred by 
their customers.
    (ii) Rules not required by statute. Opponents of the rules also 
correctly noted that the Amendments and the legislative history do not 
require the bank regulatory agencies to adopt sales practice rules. 
However, the Amendments authorize the agencies to adopt rules as may be 
necessary to promote, among other things, just and equitable principles 
of trade. The final rules accomplish this by providing guidance to 
banks about the extent of their obligations when recommending a 
government security to a customer. They also enable a customer to 
receive consistent treatment, regardless of whether the customer 
conducts business with a bank or nonbank government securities broker-
dealer.
    (iii) Sufficient market alternatives. The agencies intend for the 
rules to facilitate the good relations noted by many commenters that 
exist between banks and their customers. In addition to codifying the 
business conduct and suitability rules, the final rules provide banks 
with guidance concerning those factors that a bank may find relevant 
when determining its suitability obligations to an institutional 
customer. This guidance is provided to assist banks in identifying when 
an institutional customer is capable of evaluating investment risk 
independently and is exercising independent judgement in evaluating the 
bank's recommendation.
    (iv) Suitability obligation inappropriate for institutional 
customers. The agencies agree with the commenters who stated that any 
suitability rule should reflect the differences between institutional 
and non-institutional customers. Banks frequently will have knowledge 
about an investment and its risks that are not possessed or easily 
obtained by the non-institutional customer. A more sophisticated 
institutional customer, on the other hand, may have both the 
understanding of how a particular securities issue could perform and a 
desire to make investment decisions without relying on a bank's 
recommendation.
    The final rules recognize the wide variety of customer profiles, 
even among institutional customers, and provides guidance intended to 
assist a bank in determining the nature of its suitability obligations 
to a customer. Under the final rules, the nature of a suitability 
determination changes, depending on the type of customer. For a 
comparatively unsophisticated customer, the determination will need to 
focus more on whether a particular investment is appropriate for that 
customer after a review of the customer's financial condition and 
objectives. For a more sophisticated customer, the focus of the 
suitability determination shifts initially to the question of whether 
the customer is capable of evaluating risk and the bank's 
recommendation. The suitability interpretation provides illustrative 
factors that are intended to help a bank determine how to fulfill its 
suitability obligation for a given institutional customer. As noted in 
the interpretation, these factors are not intended to be requirements 
or the only factors to be considered but are offered merely as guidance 
in determining the scope of a bank's suitability obligations.
    (v) Increased burden. The agencies believe that the sales practice 
rules will not subject banks to a material increase in regulatory 
burden. Almost all banks that are government securities broker-dealers 
also are municipal securities broker-dealers or sell other securities 
for which they are required to comply with business conduct and 
suitability rules. As a consequence, banks frequently will have 
obtained the information needed to comply with the business conduct and 
suitability rules from customers in the course of other securities 
transactions, and will have implemented policies and procedures that 
can be applied to transactions involving government securities.
    (vi) Unintended adverse consequences. The agencies disagree with 
the commenters who suggested that the rules will discourage customers 
from consulting with their own internal or external advisors before 
making an investment. These commenters are concerned that the rules 
will shift liability to banks by creating disincentives for a customer 
to undertake research that is independent of that conducted by a bank. 
As noted in the proposal, the suitability and business conduct rules 
and suitability interpretation do not provide a basis for a private 
right of action against a bank by a customer based on a violation of 
these rules or interpretation. Thus, a customer will have every 
incentive after the rules are adopted that it had before adoption to 
undertake whatever due diligence it thinks is appropriate in evaluating 
an investment recommendation.
    (vii) Existing guidance adequate. While those opposed to the rules 
are correct that there are banking agency issuances that address sales 
practices in other areas of securities sales, these issuances do not 
provide customers who engage in government securities transactions with 
banks with treatment that is consistent with that provided under the 
NASD Business Conduct or Suitability Rules or the NASD Suitability 
Interpretation. Moreover, existing guidance does not address government 
securities sales practices for all types of customers. The final rules 
will provide a framework that will be consistent throughout the banking 
industry for analyzing the obligations of a bank engaged in government 
securities transactions.
    (viii) Suggested alternatives. One bank commenter recommended that 
the agencies adopt guidelines instead of the proposed sales practice 
rules. Another suggested that the agencies adopt an
[[Page 13279]]
``appropriateness'' standard pursuant to which a bank would focus on 
the customer's ability to understand the nature of, and risks inherent 
in, a given transaction. Two commenters suggested that the final rules 
contain an assurance that compliance with the interpretive guidance 
will create, at a minimum, a rebuttable presumption that a bank's 
suitability obligations with respect to institutional customers have 
been satisfied. Finally, another commenter suggested that banks be 
insulated from liability if an institutional customer has retained a 
third party professional investment advisor or if the bank executes a 
transaction that is consistent with an institutional account's 
specifically enumerated authorized investment guidelines.
    The agencies have concluded, however, that adopting the rules in 
the form of a regulation will provide consistent treatment of 
customers, regardless of whether they conduct business with a bank or a 
nonbank government securities broker-dealer. The agencies also have 
decided not to create any safe harbors whereby a bank would be presumed 
to have fulfilled its suitability obligation. The creation of such a 
presumption would be acceptable only if a definable class of 
institutional customers could be identified that would not benefit from 
the suitability rule under any conceivable circumstance. 
``Institutional customers'' include, among others, colleges, churches, 
charities, and governments. Given the wide diversity of characteristics 
that such entities present, the agencies have concluded that it is more 
appropriate for a bank to determine suitability on a case-by-case 
basis. Furthermore, nonbank broker-dealers do not have safe harbors 
whereby compliance with the suitability obligation is presumed. To 
create a safe harbor for banks would reduce the benefits of consistent 
treatment of customers.
Issue 2. Benefits of Consistency Among Government Securities Brokers 
and Dealers
    Of the seven commenters responding to this issue, five stated that 
there are benefits of consistent treatment by government securities 
broker-dealers while two stated that consistency would not provide 
significant benefits.
    (a) Comments favoring consistency. Several commenters stated that 
customers are more likely to receive equal treatment if the agencies 
impose rules similar to those imposed by the NASD. One commenter noted 
that the substance of the rules applied by the banking agencies should 
be as uniform as possible with those applied by the NASD to minimize 
the extent to which there are gaps in the existing regulatory 
framework. Another commenter stated that a customer should not have to 
bear the burden of determining which set of rules apply to different 
dealers who are performing exactly the same functions concerning 
exactly the same types of investments. In this commenter's view, the 
agencies'' role in maintaining the safety and soundness of banks 
includes protecting customers. A third commenter observed that 
fragmentation of the market is likely if different rules apply.
    (b) Comments opposing consistency. A trade association representing 
both bank and nonbank interests stated that a majority of its members 
believes that adopting the final rules is not justified because the 
level playing field already exists in the form of remedial and 
enforcement authority that the agencies may exercise. Another commenter 
noted that there are significant differences between bank and nonbank 
government securities broker-dealers, and concluded that these 
differences justify using different standards. This commenter believes 
that the different standards continue to result in the same level of 
customer protection, thus obviating the need to adopt the rules set out 
in the proposal.
    (c) Analysis of Issue 2. The agencies believe that the final rules 
will provide consistent treatment to customers engaging in government 
securities transactions, regardless of whether the customer receives a 
recommendation from a bank or nonbank government securities broker-
dealer. The existing regulatory and common law does not provide this 
consistent treatment. The final rules avoid requiring customers to 
ascertain which rules apply to which institution. Moreover, the 
agencies expect that the final rules, by focusing banks' attentions on 
suitability concerns, will minimize the disputes between banks and 
their customers concerning the suitability of a given recommendation.
Issue 3. Sufficiency of the Standard Provided in the Business Conduct 
Rule
    Five commenters responded to this issue. Four commenters believe 
that the business conduct rule is sufficiently clear, while one 
commenter believes that additional interpretation is necessary.
    (a) Comments finding business conduct rule clear. One commenter 
stated that the business conduct rule, taken together with the 
suitability rule, is sufficiently clear. In this commenter's opinion, a 
rule of this nature should provide a general code of conduct that 
protects the integrity of the profession by setting a baseline of good 
conduct. Another commenter suggested that more specific guidelines may 
be too restrictive and not benefit the customer or bank. A third 
commenter restated its request for changes in the examination 
procedures to ensure compliance with the final rule but suggested that 
banks should have less latitude in the types of information requested 
from a customer. The fourth commenter stated its general agreement that 
the business conduct rule is clear.
    (b) Comments finding the business conduct rule unclear. The one 
comment finding the business conduct rule unclear stated that the rule 
does not delineate proper conduct for sales practices. This commenter 
stated that it views the NASD guidance related to the business conduct 
rule as providing appropriate additional clarification.
    (c) Analysis of Issue 3. The agencies believe that the business 
conduct rule set out in the proposal is sufficiently clear. As noted by 
one commenter, the rule establishes a baseline of appropriate behavior 
in the industry. A bank then has the flexibility to comply with this 
standard in ways that it finds appropriate and effective. Attempts at 
additional clarification in this area are likely to provide little 
additional meaningful guidance without becoming so detailed as to be 
overly burdensome and restrictive. The agencies also are concerned that 
additional clarification in the business conduct rule would detract 
from the objective of ensuring consistent treatment for customers of 
bank and nonbank government securities broker-dealers. The agencies 
note that the NASD is continuing to consider issues concerning the 
application of certain interpretations of their Business Conduct Rule 
to the government securities markets.
Issue 4. Definition of ``Recommendation''
    The issue of whether to define ``recommendation'' or provide 
guidance as to what is and is not a recommendation generated responses 
from seven commenters, four of whom requested additional guidance or a 
definition and three of whom stated that no additional guidance or 
definition is needed.
    (a) Comments favoring defining ``recommendation.'' A point 
consistently made by those requesting additional guidance is that the 
rules should clarify that a recommendation does not include providing 
routine market information, such as market observations, forecasts 
about the general
[[Page 13280]]
direction of interest rates, and price quotations. One commenter also 
stated that the rules should not treat subjective analyses of market 
information as a recommendation, because to do so would discourage 
banks from providing this information. This commenter suggested that 
the rules exclude from the definition of ``recommendation'' the 
providing of several investment alternatives for an investor's 
consideration. Two commenters proposed definitions that would include, 
generally speaking, an unconditional affirmative statement by one party 
urging another to enter into a particular transaction, an explicit 
identification of the statement as a recommendation, and/or a 
requirement that information be given to the bank expressly for the 
purpose of enabling the bank to make a recommendation. One of these 
commenters stated that reliance should not be considered reasonable 
unless an institutional customer has provided information regarding its 
portfolio, its liabilities, and the range of investment opportunities 
available to the customer. Another commenter concluded that the 
definition is so vague that the commenter will have to assume, despite 
the fact that it makes no recommendations, that all current sales 
activities constitute making a recommendation and then build systems 
and increase staff to evaluate and document the suitability of each 
customer purchase. Another commenter suggested that a definition should 
not include trade or hedging ideas unless there is a written agreement 
between the parties or unless applicable law expressly imposes 
affirmative obligations to the contrary. This commenter noted that this 
approach would be consistent with the ``impersonal advisory services'' 
rule proposed by the SEC in 1994.
    (b) Comments opposing defining ``recommendation.'' Commenters 
opposing defining ``recommendation'' expressed concern that a 
definition would create a safe harbor protecting banks against 
liability and stated that individual facts and circumstances must be 
reviewed to determine whether a recommendation has been made. One 
commenter stated further that the line of when a bank is recommending a 
product is clear, namely, when the bank provides information to explain 
why a customer should purchase a particular product. This commenter 
suggested that once a customer expresses an interest in a particular 
product, the suitability obligation should be triggered even if no 
explicit recommendation is made.
    (c) Analysis of Issue 4. The agencies have decided not to define 
``recommendation,'' for several reasons. First, a determination of 
whether a recommendation has been made necessarily depends on the facts 
of a given situation. The agencies believe that a definition would not 
change the need to review the entire circumstances of a transaction, 
and, therefore, do not believe that a definition would provide a 
significant benefit. Second, the agencies are concerned that a 
definition might be misinterpreted as a safe harbor whereby a 
government securities broker-dealer effectively recommends an 
investment but argues that it had no suitability obligation because the 
advice technically was not a recommendation according to the literal 
terms of a definition. Third, the agencies believe that there is no 
need to define the term, because bankers and examiners already are 
accustomed to the use of the term in the municipal securities area 
where similar rules currently exist. Finally, for the reasons 
previously stated, the agencies believe that government securities 
customers will benefit from rules that are consistent for both bank and 
nonbank government securities broker-dealers. Given that the NASD and 
SEC recently decided not to define ``recommendation,'' a decision to do 
so in the banking agencies'' rule could result in a material difference 
that could undermine the benefits of consistency and could lead to 
confusion concerning what effect the definition would have on the other 
rules.
    While the agencies do not believe it is appropriate to define the 
term ``recommendation,'' they note that they would not view the 
provision of general market information, including market observations, 
forecasts about interest rates, and price quotations, as making a 
recommendation under the rule, absent other conduct.
Issue 5. Adoption of Additional Rules
    Of the four commenters addressing the need to adopt rules similar 
to other sections of the Rules of Fair Practice or interpretations 
similar to other NASD interpretations, all four supported adopting 
additional rules and interpretations.
    (a) Comments supporting additional rules. One commenter suggested 
that the agencies adopt those parts of the NASD Rules of Fair Practice 
that require the establishment of a system to supervise personnel 
involved in government securities transactions. Another commenter 
stated that the rules should be extended to those practices that 
adversely affect transactions, such as markups, churning, and 
frontrunning. A third commenter suggested that the agencies adopt rules 
concerning the supervision of employees, the establishment of written 
procedures, and the requirement of internal inspections. This commenter 
noted that the banking industry and its customers would benefit from 
additional uniformity with nonbank government securities dealers. The 
final commenter suggested that the agencies adopt additional rules 
similar to those applicable to bank municipal securities dealers.
    (b) Comments opposing additional rules. While no commenter 
specifically opposed adopting additional rules, several noted their 
general opposition to the agencies adopting any rules in this area. The 
arguments advanced by these commenters are summarized in the discussion 
of the first issue.
    (c) Analysis of Issue 5. The agencies have decided not to adopt 
rules other than the Suitability and Business Conduct Rules and 
Suitability Interpretation at this time. In some cases, the NASD Rules 
overlap with safety and soundness standards that already apply to banks 
(see, e.g., Rule 3010 of the NASD's Conduct Rules, which requires each 
member to establish and maintain a system of supervision that is 
reasonably designed to achieve compliance with applicable securities 
laws and regulations). Other NASD Rules appear to codify existing 
duties and principles to which bank employees acting in a fiduciary 
capacity must adhere (see, e.g., Rule 2330 of the NASD's Conduct Rules, 
which prohibits members and associated persons from making improper use 
of a customer's securities or funds). While the agencies believe that 
the business conduct rule is sufficiently broad to address much of the 
conduct proscribed by other NASD Rules, the agencies will consider 
whether there is a need to adopt additional rules as the agencies 
examine banks for compliance with the rules and interpretation adopted 
herein. Banks should determine the adequacy and appropriateness of 
their policies, procedures, and internal controls with respect to the 
final rules.
Issue 6. Ability to contract out of the rules
    Four of the six commenters addressing this issue favor allowing a 
bank and its customers to establish standards by contract that would 
govern that relationship, while two opposed this option.
    (a) Comments favoring allowing parties to contract out of the 
rules. One commenter suggested that the agencies look to the Principles 
and Practices for
[[Page 13281]]
Wholesale Financial Market Transactions, prepared in 1995 under the 
coordination of the Federal Reserve Bank of New York, for guidance on 
the appropriate set of governing assumptions regarding institutional 
relationships. This commenter noted that the Amendments contain no 
limitation on the agencies'' ability to permit this flexibility. While 
this commenter opposed adoption of the rules in general, the commenter 
stated that, if the agencies adopt the rules, they should clarify that 
a bank would be insulated from liability to the extent that the bank 
and customer contractually limit liability. Another commenter opined 
that a written contract should control on the question of suitability 
and that the agencies should provide guidance on when an oral agreement 
will suffice (such as, for instance, allowing oral agreements to 
control if they are entered into on a recorded line). A third commenter 
stated that banks should be encouraged to clarify the nature of the 
relationship with their customers, including providing disclaimers 
about the nature of the information given if appropriate. The fourth 
commenter expressed its support for allowing parties to contract out of 
the rules but then suggested that the presence or absence of a contract 
should be one of the factors considered if a bank's compliance with its 
suitability obligation is in dispute.
    (b) Comments opposing allowing parties to contract out of the 
rules. Those commenters who opposed allowing banks to contract out of 
the rules expressed concern that an agreement should not be used to 
protect banks that make unsuitable recommendations. One commenter noted 
that a contract should be only one factor to consider when determining 
whether a suitability obligation has been satisfied. The other 
commenter opposed to contractually limiting liability stated that, if 
parties are allowed to do so, the final rules should require periodic 
review of the contract. According to this commenter, the changing 
nature of financial markets may render a contract inappropriate over 
time.
    (c) Analysis of Issue 6. The agencies believe that a contract 
establishing the nature of the relationship can be helpful in 
determining the relationship between the bank and its customer, but 
that such a contract will not be determinative of whether the bank has 
fulfilled its obligation under the rules. The agencies also believe 
that the benefits to be gained by both the banking industry and its 
customers from having uniform suitability rules and interpretations 
would be significantly undermined if banks were permitted to establish 
by contract a safe harbor from their obligations under the rules. 
Accordingly, the final rules do not go beyond the proposed 
interpretation, which provides that written and oral agreements will be 
considered as one of several factors that may be relevant in 
determining whether the bank has fulfilled its obligations under the 
suitability rule. Additionally, the agencies note that because the 
rules do not create a private right of action, there is no need to 
provide a mechanism in the rule for a bank to insulate itself from 
liability to customers arising from a violation of the rules.
Issue 7. Definition of ``Institutional Customer''
    Eight commenters addressed the issue of how to define an 
``institutional customer.'' Of these, four opposed using $50 million in 
total assets as the measure by which institutional customers are judged 
while one favored using this cutoff. Five commenters expressed support 
for a test based on assets under management as the appropriate measure, 
and one opposed any test based on asset size, portfolio size, or 
revenue.
    (a) Comment favoring use of $50 million in total assets. The one 
commenter favoring the use of $50 million in assets as the threshold 
for determining who is an institutional customer stated that the level 
of assets usually is a good determinant of whether the customer is 
sophisticated. This commenter also noted that customers above that size 
can afford to hire a professional manager, and suggested that there is 
no reason to shift to the dealer the responsibility for ensuring that 
investments are suitable. The commenter suggested further that an 
appropriate benchmark for governmental entities is whether a 
government's budget is at least $50 million. Finally, this commenter 
opined that a customer should be considered ``institutional'' if it is 
registered as an investment adviser under either U.S. or foreign law 
and that the definition should clarify that a bank, savings 
association, or insurance company may be domestic or foreign.
    (b) Comments opposing use of $50 million in total assets. All of 
the commenters opposed to defining ``institutional customer'' by using 
total assets stated that asset size is not a good proxy for 
sophistication. One commenter maintained that a rule that does not 
apply to all registered investment companies will result in banks being 
less willing to make recommendations to small investment companies 
because the suitability obligations to the small companies will be more 
onerous. Another commenter stated that this test will only place more 
burdens and risks on banks. The commenter opposed to any test based on 
asset size, portfolio size, or revenue stated that the tests are 
inaccurate and arbitrary. Concerning an asset size test, this commenter 
noted that all but the smallest local governments have assets of at 
least $50 million, although most of these assets are in the form of 
buildings, land, sewage facilities, and so on. This commenter opposed a 
revenue test because the cyclical nature of tax receipts will 
temporarily swell the amounts available for investment by a government, 
thereby resulting in many small governments being deemed 
``institutional customers'' even though they need the protections 
afforded by the suitability rule. Finally, this commenter believes that 
portfolio size is problematic because it is unclear which governmental 
entity's portfolio should be considered. To illustrate this problem, 
this commenter asked whether investments of a state government and 
local governments within that state should be considered as held in one 
portfolio and whether pension funds invested by a city are part of the 
city's portfolio. Two other commenters stated their general opposition 
to an asset size test set at $50 million.
    (c) Comments favoring portfolio size as the appropriate test. Of 
the four commenters favoring a test based on portfolio size, one agreed 
that $10 million was the appropriate cutoff. Two others stated that, 
while portfolio size is a better measure of sophistication than is 
asset size, $10 million is too high a threshold. Finally, one commenter 
stated that portfolio size should be considered, but that it should be 
only one of several factors looked at.
    (d) Analysis of Issue 7. The agencies have decided to adopt a 
definition of ``institutional customer'' that is consistent with the 
NASD's definition. As a result, all customers will receive consistent 
treatment under the suitability rule. Moreover, transactions with all 
customers other than natural persons will be covered by the suitability 
interpretation, although the factors identified in the interpretation 
will be most appropriate for a customer with at least $10 million 
invested in securities in the aggregate in its portfolio and/or under 
management. If an entity has less than $50 million in total assets, a 
bank making a recommendation to that entity must make a reasonable 
effort to obtain information about the customer's financial and tax 
status, investment
[[Page 13282]]
objectives, and other information used or considered reasonable by the 
bank in making a recommendation.
    The agencies believe that if a different measure were used, the 
inconsistencies between their rule and the NASD's Suitability Rule 
would make the agencies' rule more difficult to apply. Also, examiners, 
auditors, and compliance officers likely would encounter difficulties 
determining compliance with suitability requirements if the measure for 
an institutional customer varies, as some commenters suggested, 
depending on the type of entity and security involved.
    The agencies believe that some commenters may have misinterpreted 
the significance of the tests for determining when an investor is an 
``institutional customer.'' All customers, whether institutional or 
not, are covered by the suitability rule. In all cases, a bank must 
have reasonable grounds for believing that a recommendation is suitable 
based on the facts, if any, disclosed by a customer concerning the 
customer's other security holdings and financial situation and needs. 
Moreover, in all cases, a bank must make a determination based on the 
facts of a particular situation whether it has fulfilled its 
suitability obligation. The thresholds identified in the regulation and 
interpretation are provided solely for the purpose of assisting a bank 
in identifying the type of information that may be relevant in deciding 
if the suitability obligation is met in a given case. For all entities 
other than natural persons (but particularly for entities with at least 
$10 million invested in securities in the aggregate in its portfolio 
and/or under management), a bank should consider the factors identified 
in the suitability interpretation in deciding whether a customer is 
capable of evaluating investment risk independently and whether the 
customer is exercising independent judgement in evaluating a bank's 
recommendation. For entities (including natural persons) with less than 
$50 million in total assets, a bank is required to make reasonable 
efforts to obtain the additional information listed in the section 
captioned ``Customer information'' (12 CFR 13.5, 208.25(e), and 368.5, 
respectively). This information will be in addition to whatever other 
information the bank obtains in its effort to determine whether it has 
met its suitability obligation.
Issue 8: Other Suggestions
    One commenter stated that the factors listed in the suitability 
interpretation concerning a customer's ability to evaluate risk are 
reasonable but do not require banks to provide information the customer 
needs in order to make an informed investment decision. This commenter 
suggested that the interpretation should require banks to provide 
certain types of transaction-specific information, such as valuation 
information, an instrument's behavior under a stress test, and the 
types of risks incurred.
    The agencies agree that this information may be useful to a 
customer in many cases. However, a comparatively unsophisticated 
customer likely will rely on the bank to evaluate this information 
before making a recommendation, while a more sophisticated customer 
will, in many cases, request this information from the bank or obtain 
this information on its own. Accordingly, the agencies have decided not 
to require the information suggested by the commenter.
    This commenter also identified what it believes are shortcomings in 
each of the considerations listed in the suitability interpretation. 
Many of the shortcomings cited focus on the inapplicability or 
inappropriateness of a certain factor in a given set of circumstances. 
The agencies acknowledge that not all of the factors identified will be 
helpful in every case. However, the interpretation is not presented as 
a checklist of required information. The factors listed neither create 
nor reduce a bank's suitability obligation. Their relevance will vary, 
depending on the circumstances of a given situation. The agencies 
believe that the factors will be helpful in assisting a bank's 
determination of whether it has met its suitability obligation. 
Therefore, the agencies are adopting the suitability interpretation as 
proposed, making only the modifications to the proposed interpretation 
that are necessary to conform the agencies' suitability interpretation 
to that of the NASD.
    Two commenters requested that the agencies clarify that the final 
rules do not apply to institutions that are subject to NASD 
jurisdiction. The agencies recognize that many banks conduct a 
significant portion of their securities activities through subsidiaries 
or affiliates that are registered broker-dealers. The agencies confirm 
that securities activities conducted in registered broker-dealers that 
are NASD members are subject to the NASD rules and will not be subject 
to the agencies' final rules.
    Another commenter requested that the agencies add a cross-reference 
in the final rules to the definition of ``government securities'' used 
in the Securities Exchange Act (15 U.S.C. 78c(a)(42)) in order to 
assist bankers working with the rules. The agencies agree that a 
reference to this definition would be helpful, and have amended the 
final rules accordingly.
    Finally, one commenter asserted that the Regulatory Flexibility Act 
certification contained in the proposal is flawed because it fails to 
focus on the 300 domestic banks that are covered by the proposal.1 
The agencies note that they did focus on these banks in determining the 
impact that the rules would have on small entities. See 61 FR 18472 
(``As an initial matter, the proposed rule would apply only to those 
banks that have given notice or are required to give notice that they 
are government securities brokers or dealers under section 15C of the 
Securities Exchange Act of 1934 (15 U.S.C. 78o-5) and applicable 
Treasury rules under section 15C (17 CFR 400.1(d) and 401), including 
approximately 300 domestic banks and branches of foreign banks.''). The 
Regulatory Flexibility Act certification in these final rules also 
focuses on these banks as the appropriate pool to consider when 
evaluating the rules' impact on small entities. See discussion of the 
Regulatory Flexibility Act that follows.
---------------------------------------------------------------------------
    \1\ Data obtained since the proposal was published show that 
this figure is approximately 160 banks covered by the rule. See 
discussion of the Regulatory Flexibility Act for additional analysis 
of the number of institutions covered.
---------------------------------------------------------------------------
Regulatory Flexibility Act
    Under section 605(b) of the Regulatory Flexibility Act (RFA) (5 
U.S.C. 605(b)), the regulatory flexibility analysis otherwise required 
under section 604 of the RFA (5 U.S.C. 604) is not required if the head 
of the agency certifies that the rule will not have a significant 
economic impact on a substantial number of small entities and the 
agency publishes such certification and a statement providing the 
factual basis for such certification in the Federal Register along with 
the final rule.
    Pursuant to section 605(b) of the RFA, the OCC, Board, and the FDIC 
each individually certifies that these final rules will not have a 
significant economic impact on a substantial number of small entities. 
As noted in the proposal and in the preamble to the final rules, the 
rules will apply only to those banks that have given notice or are 
required to give notice that they are government securities brokers or 
dealers under section 15C of the Securities Exchange Act of 1934 (15 
U.S.C. 78o-5) and applicable Treasury rules under section 15C (17 CFR 
400.1(d) and 401).
[[Page 13283]]
Most small banking institutions are not required to give notice under 
section 15C, as Treasury rules provide exemptions for financial 
institutions that engage in fewer than 500 government securities 
brokerage transactions per year and for financial institutions with 
government securities dealing activities limited to sales and purchases 
in a fiduciary capacity. See 17 CFR 401.3 and 401.4. Other exemptions 
from the notice requirements also are available. See 17 CFR Part 401. 
Additionally, the agencies note that many banks conduct a significant 
portion of their securities activities through subsidiaries or 
affiliates that are registered broker-dealers. Securities activities 
conducted in registered broker-dealers that are NASD members are 
subject to the NASD Rules and would not be subject to the agencies' 
final rules. As a consequence, currently there are only approximately 
160 banks that are registered as a government securities broker-dealer. 
Of these, only 7 are ``small entities'' for purposes of the Regulatory 
Flexibility Act. See 13 C.F.R. 121.601.
Paperwork Reduction Act
    In accordance with section 3506 of the Paperwork Reduction Act of 
1995 (44 U.S.C. 3506; see also 5 CFR 1320 Appendix a.1), the agencies 
have reviewed the final rules and have determined that no collections 
of information pursuant to the Paperwork Reduction Act are contained in 
the rules.
OCC Executive Order 12866 Statement
    The Office of Management and Budget has concurred with the OCC's 
determination that these final rules are not a significant regulatory 
action under Executive Order 12866.
OCC Unfunded Mandates Act of 1995 Statement
    Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law 
104-4 (Unfunded Mandates Act), requires that the agency prepare a 
budgetary impact statement before promulgating a rule that includes a 
Federal mandate that may result in the expenditure by State, local, and 
tribal governments, in the aggregate, or by the private sector, of $100 
million or more in any one year. If a budgetary impact statement is 
required, section 205 of the Unfunded Mandates Act also requires the 
agency to identify and consider a reasonable number of regulatory 
alternatives before promulgating a rule. As discussed in the preamble, 
the final rules set forth sales practice responsibilities of banks that 
are government securities brokers or dealers. The OCC has determined 
that the final rules will not result in expenditures by State, local, 
or tribal governments or by the private sector of more than $100 
million. Accordingly, the OCC has not prepared a budgetary impact 
statement or addressed specifically the regulatory alternatives 
considered.
Small Business Regulatory Enforcement Fairness Act
    The Small Business Regulatory Enforcement Fairness Act of 1996 
(Pub. L. 104-121, 104th Cong., 2d Sess. (1996)) provides generally for 
agencies to report rules to Congress and for Congress to review the 
rules. The reporting requirement is triggered in instances where the 
agency in question issues a final rule as defined by the Administrative 
Procedure Act at 5 U.S.C. 551. The agencies will file the appropriate 
reports pursuant to the statute concerning their final rules.
    The Office of Management and Budget has determined that these final 
rules do not constitute ``major'' rules as defined by the statute.
List of Subjects
12 CFR Part 13
    Banks, banking, Government securities, National banks, Securities
12 CFR Part 208
    Accounting, Agriculture, Banks, banking, Confidential business 
information, Crime, Currency, Federal Reserve System, Flood insurance, 
Mortgages, Reporting and recordkeeping requirements, Securities.
12 CFR Part 211
    Exports, Federal Reserve System, Foreign banking, Holding 
companies, Investments, Reporting and recordkeeping requirements.
12 CFR Part 368
    Banks, banking, Securities.
Office of the Comptroller of the Currency
12 CFR CHAPTER I
Authority and Issuance
    For the reasons set out in the preamble, a new part 13 is added to 
chapter I of title 12 of the Code of Federal Regulations to read as 
follows:
PART 13--GOVERNMENT SECURITIES SALES PRACTICES
Sec.
13.1  Scope.
13.2  Definitions.
13.3  Business conduct.
13.4  Recommendations to customers.
13.5  Customer information.
Interpretations
13.100  Obligations concerning institutional customers.
    Authority: 12 U.S.C. 1 et seq., and 93a; 15 U.S.C. 78o-5.
Sec. 13.1  Scope.
    This part applies to national banks that have filed notice as, or 
are required to file notice as, government securities brokers or 
dealers pursuant to section 15C of the Securities Exchange Act (15 
U.S.C. 78o-5) and Department of the Treasury rules under section 15C 
(17 CFR 400.1(d) and part 401).
Sec. 13.2  Definitions.
    (a) Bank that is a government securities broker or dealer means a 
national bank that has filed notice, or is required to file notice, as 
a government securities broker or dealer pursuant to section 15C of the 
Securities Exchange Act (15 U.S.C. 78o-5) and Department of the 
Treasury rules under section 15C (17 CFR 400.1(d) and part 401).
    (b) Customer does not include a broker or dealer or a government 
securities broker or dealer.
    (c) Government security has the same meaning as this term has in 
section 3(a)(42) of the Securities Exchange Act of 1934 (15 U.S.C. 
78c(a)(42)).
    (d) Non-institutional customer means any customer other than:
    (1) A bank, savings association, insurance company, or registered 
investment company;
    (2) An investment adviser registered under section 203 of the 
Investment Advisers Act of 1940 (15 U.S.C. 80b-3); or
    (3) Any entity (whether a natural person, corporation, partnership, 
trust, or otherwise) with total assets of at least $50 million.
Sec. 13.3  Business conduct.
    A bank that is a government securities broker or dealer shall 
observe high standards of commercial honor and just and equitable 
principles of trade in the conduct of its business as a government 
securities broker or dealer.
Sec. 13.4  Recommendations to customers.
    In recommending to a customer the purchase, sale or exchange of a 
government security, a bank that is a government securities broker or 
dealer shall have reasonable grounds for believing that the 
recommendation is suitable for the customer upon the basis of the 
facts, if any, disclosed by the customer as to the customer's other 
security holdings and as to the
[[Page 13284]]
customer's financial situation and needs.
Sec. 13.5  Customer information.
    Prior to the execution of a transaction recommended to a non-
institutional customer, a bank that is a government securities broker 
or dealer shall make reasonable efforts to obtain information 
concerning:
    (a) The customer's financial status;
    (b) The customer's tax status;
    (c) The customer's investment objectives; and
    (d) Such other information used or considered to be reasonable by 
the bank in making recommendations to the customer.
Interpretations
Sec. 13.100  Obligations concerning institutional customers.
    (a) As a result of broadened authority provided by the Government 
Securities Act Amendments of 1993 (15 U.S.C. 78o-3 and 78o-5), the OCC 
is adopting sales practice rules for the government securities market, 
a market with a particularly broad institutional component. 
Accordingly, the OCC believes it is appropriate to provide further 
guidance to banks on their suitability obligations when making 
recommendations to institutional customers.
    (b) The OCC's suitability rule (Sec. 13.4) is fundamental to fair 
dealing and is intended to promote ethical sales practices and high 
standards of professional conduct. Banks' responsibilities include 
having a reasonable basis for recommending a particular security or 
strategy, as well as having reasonable grounds for believing the 
recommendation is suitable for the customer to whom it is made. Banks 
are expected to meet the same high standards of competence, 
professionalism, and good faith regardless of the financial 
circumstances of the customer.
    (c) In recommending to a customer the purchase, sale, or exchange 
of any government security, the bank shall have reasonable grounds for 
believing that the recommendation is suitable for the customer upon the 
basis of the facts, if any, disclosed by the customer as to the 
customer's other security holdings and financial situation and needs.
    (d) The interpretation in this section concerns only the manner in 
which a bank determines that a recommendation is suitable for a 
particular institutional customer. The manner in which a bank fulfills 
this suitability obligation will vary, depending on the nature of the 
customer and the specific transaction. Accordingly, the interpretation 
in this section deals only with guidance regarding how a bank may 
fulfill customer-specific suitability obligations under 
Sec. 13.4.1
---------------------------------------------------------------------------
    \1\ The interpretation in this section does not address the 
obligation related to suitability that requires that a bank have ``* 
* * a `reasonable basis' to believe that the recommendation could be 
suitable for at least some customers.'' In the Matter of the 
Application of F.J. Kaufman and Company of Virginia and Frederick J. 
Kaufman, Jr., 50 SEC 164 (1989).
---------------------------------------------------------------------------
    (e) While it is difficult to define in advance the scope of a 
bank's suitability obligation with respect to a specific institutional 
customer transaction recommended by a bank, the OCC has identified 
certain factors that may be relevant when considering compliance with 
Sec. 13.4. These factors are not intended to be requirements or the 
only factors to be considered but are offered merely as guidance in 
determining the scope of a bank's suitability obligations.
    (f) The two most important considerations in determining the scope 
of a bank's suitability obligations in making recommendations to an 
institutional customer are the customer's capability to evaluate 
investment risk independently and the extent to which the customer is 
exercising independent judgement in evaluating a bank's recommendation. 
A bank must determine, based on the information available to it, the 
customer's capability to evaluate investment risk. In some cases, the 
bank may conclude that the customer is not capable of making 
independent investment decisions in general. In other cases, the 
institutional customer may have general capability, but may not be able 
to understand a particular type of instrument or its risk. This is more 
likely to arise with relatively new types of instruments, or those with 
significantly different risk or volatility characteristics than other 
investments generally made by the institution. If a customer is either 
generally not capable of evaluating investment risk or lacks sufficient 
capability to evaluate the particular product, the scope of a bank's 
customer-specific obligations under Sec. 13.4 would not be diminished 
by the fact that the bank was dealing with an institutional customer. 
On the other hand, the fact that a customer initially needed help 
understanding a potential investment need not necessarily imply that 
the customer did not ultimately develop an understanding and make an 
independent investment decision.
    (g) A bank may conclude that a customer is exercising independent 
judgement if the customer's investment decision will be based on its 
own independent assessment of the opportunities and risks presented by 
a potential investment, market factors and other investment 
considerations. Where the bank has reasonable grounds for concluding 
that the institutional customer is making independent investment 
decisions and is capable of independently evaluating investment risk, 
then a bank's obligations under Sec. 13.4 for a particular customer are 
fulfilled.2 Where a customer has delegated decision-making 
authority to an agent, such as an investment advisor or a bank trust 
department, the interpretation in this section shall be applied to the 
agent.
---------------------------------------------------------------------------
    \2\ See footnote 1 in paragraph (d) of this section.
---------------------------------------------------------------------------
    (h) A determination of capability to evaluate investment risk 
independently will depend on an examination of the customer's 
capability to make its own investment decisions, including the 
resources available to the customer to make informed decisions. 
Relevant considerations could include:
    (1) The use of one or more consultants, investment advisers, or 
bank trust departments;
    (2) The general level of experience of the institutional customer 
in financial markets and specific experience with the type of 
instruments under consideration;
    (3) The customer's ability to understand the economic features of 
the security involved;
    (4) The customer's ability to independently evaluate how market 
developments would affect the security; and
    (5) The complexity of the security or securities involved.
    (i) A determination that a customer is making independent 
investment decisions will depend on the nature of the relationship that 
exists between the bank and the customer.
    Relevant considerations could include:
    (1) Any written or oral understanding that exists between the bank 
and the customer regarding the nature of the relationship between the 
bank and the customer and the services to be rendered by the bank;
    (2) The presence or absence of a pattern of acceptance of the 
bank's recommendations;
    (3) The use by the customer of ideas, suggestions, market views and 
information obtained from other government securities brokers or 
dealers or market professionals, particularly those relating to the 
same type of securities; and
    (4) The extent to which the bank has received from the customer 
current comprehensive portfolio information in
[[Page 13285]]
connection with discussing recommended transactions or has not been 
provided important information regarding its portfolio or investment 
objectives.
    (j) Banks are reminded that these factors are merely guidelines 
that will be utilized to determine whether a bank has fulfilled its 
suitability obligation with respect to a specific institutional 
customer transaction and that the inclusion or absence of any of these 
factors is not dispositive of the determination of suitability. Such a 
determination can only be made on a case-by-case basis taking into 
consideration all the facts and circumstances of a particular bank/
customer relationship, assessed in the context of a particular 
transaction.
    (k) For purposes of the interpretation in this section, an 
institutional customer shall be any entity other than a natural person. 
In determining the applicability of the interpretation in this section 
to an institutional customer, the OCC will consider the dollar value of 
the securities that the institutional customer has in its portfolio 
and/or under management. While the interpretation in this section is 
potentially applicable to any institutional customer, the guidance 
contained in this section is more appropriately applied to an 
institutional customer with at least $10 million invested in securities 
in the aggregate in its portfolio and/or under management.
    Dated: February 18, 1997.
Eugene A. Ludwig,
Comptroller of the Currency.
Federal Reserve System
12 CFR CHAPTER II
Authority and Issuance
    For the reasons set forth in the joint preamble, parts 208 and 211 
of chapter II of title 12 of the Code of Federal Regulations are 
amended as follows:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL 
RESERVE SYSTEM (REGULATION H)
    1. The authority citation for Part 208 is revised to read as 
follows:
    Authority: 12 U.S.C. 36, 248(a), 248(c), 321-338a, 371d, 461, 
481-486, 601, 611, 1814, 1823(j), 1828(o), 1831o, 1831p-1, 3105, 
3310, 3331-3351 and 3906-3909; 15 U.S.C. 78b, 781(b), 781(g), 
781(i), 78o-4(c)(5), 78o-5, 78q, 78q-1, and 78w: 31 U.S.C. 5318; 42 
U.S.C. 4012a, 4104a, 4104b, 4106, and 4128.
    2. A new Sec. 208.25 is added to subpart A to read as follows:
Sec. 208.25  Government securities sales practices.
    (a) Scope. This subpart is applicable to state member banks that 
have filed notice as, or are required to file notice as, government 
securities brokers or dealers pursuant to section 15C of the Securities 
Exchange Act (15 U.S.C. 78o-5) and Department of the Treasury rules 
under section 15C (17 CFR 400.1(d) and part 401).
    (b) Definitions--(1) Bank that is a government securities broker or 
dealer means a state member bank that has filed notice, or is required 
to file notice, as a government securities broker or dealer pursuant to 
section 15C of the Securities Exchange Act (15 U.S.C. 78o-5) and 
Department of the Treasury rules under section 15C (17 CFR 400.1(d) and 
part 401).
    (2) Customer does not include a broker or dealer or a government 
securities broker or dealer.
    (3) Government security has the same meaning as this term has in 
section 3(a)(42) of the Securities Exchange Act of 1934 (15 U.S.C. 
78c(a)(42)).
    (4) Non-institutional customer means any customer other than:
    (i) A bank, savings association, insurance company, or registered 
investment company;
    (ii) An investment adviser registered under section 203 of the 
Investment Advisers Act of 1940 (15 U.S.C. 80b-3); or
    (iii) Any entity (whether a natural person, corporation, 
partnership, trust, or otherwise) with total assets of at least $50 
million.
    (c) Business conduct. A bank that is a government securities broker 
or dealer shall observe high standards of commercial honor and just and 
equitable principles of trade in the conduct of its business as a 
government securities broker or dealer.
    (d) Recommendations to customers. In recommending to a customer the 
purchase, sale or exchange of a government security, a bank that is a 
government securities broker or dealer shall have reasonable grounds 
for believing that the recommendation is suitable for the customer upon 
the basis of the facts, if any, disclosed by the customer as to the 
customer's other security holdings and as to the customer's financial 
situation and needs.
    (e) Customer information. Prior to the execution of a transaction 
recommended to a non-institutional customer, a bank that is a 
government securities broker or dealer shall make reasonable efforts to 
obtain information concerning:
    (1) The customer's financial status;
    (2) The customer's tax status;
    (3) The customer's investment objectives; and
    (4) Such other information used or considered to be reasonable by 
the bank in making recommendations to the customer.
    3. A new Sec. 208.129 is added to subpart B to read as follows:
Sec. 208.129  Obligations concerning institutional customers.
    (a) As a result of broadened authority provided by the Government 
Securities Act Amendments of 1993 (15 U.S.C. 78o-3 and 78o-5), the 
Board is adopting sales practice rules for the government securities 
market, a market with a particularly broad institutional component. 
Accordingly, the Board believes it is appropriate to provide further 
guidance to banks on their suitability obligations when making 
recommendations to institutional customers.
    (b) The Board's Suitability Rule, Sec. 208.25(b), is fundamental to 
fair dealing and is intended to promote ethical sales practices and 
high standards of professional conduct. Banks'' responsibilities 
include having a reasonable basis for recommending a particular 
security or strategy, as well as having reasonable grounds for 
believing the recommendation is suitable for the customer to whom it is 
made. Banks are expected to meet the same high standards of competence, 
professionalism, and good faith regardless of the financial 
circumstances of the customer.
    (c) In recommending to a customer the purchase, sale, or exchange 
of any government security, the bank shall have reasonable grounds for 
believing that the recommendation is suitable for the customer upon the 
basis of the facts, if any, disclosed by the customer as to the 
customer's other security holdings and financial situation and needs.
    (d) The interpretation in this section concerns only the manner in 
which a bank determines that a recommendation is suitable for a 
particular institutional customer. The manner in which a bank fulfills 
this suitability obligation will vary, depending on the nature of the 
customer and the specific transaction. Accordingly, the interpretation 
in this section deals only with guidance regarding how a bank may 
fulfill customer-specific suitability obligations under 
Sec. 208.25(d).1
---------------------------------------------------------------------------
    \1\ The interpretation in this section does not address the 
obligation related to suitability that requires that a bank have ``* 
* * a `reasonable basis' to believe that the recommendation could be 
suitable for at least some customers.'' In the Matter of the 
Application of F.J. Kaufman and Company of Virginia and Frederick J. 
Kaufman, Jr., 50 SEC 164 (1989).
---------------------------------------------------------------------------
[[Page 13286]]
    (e) While it is difficult to define in advance the scope of a 
bank's suitability obligation with respect to a specific institutional 
customer transaction recommended by a bank, the Board has identified 
certain factors that may be relevant when considering compliance with 
Sec. 208.25(d). These factors are not intended to be requirements or 
the only factors to be considered but are offered merely as guidance in 
determining the scope of a bank's suitability obligations.
    (f) The two most important considerations in determining the scope 
of a bank's suitability obligations in making recommendations to an 
institutional customer are the customer's capability to evaluate 
investment risk independently and the extent to which the customer is 
exercising independent judgement in evaluating a bank's recommendation. 
A bank must determine, based on the information available to it, the 
customer's capability to evaluate investment risk. In some cases, the 
bank may conclude that the customer is not capable of making 
independent investment decisions in general. In other cases, the 
institutional customer may have general capability, but may not be able 
to understand a particular type of instrument or its risk. This is more 
likely to arise with relatively new types of instruments, or those with 
significantly different risk or volatility characteristics than other 
investments generally made by the institution. If a customer is either 
generally not capable of evaluating investment risk or lacks sufficient 
capability to evaluate the particular product, the scope of a bank's 
customer-specific obligations under Sec. 208.25(d) would not be 
diminished by the fact that the bank was dealing with an institutional 
customer. On the other hand, the fact that a customer initially needed 
help understanding a potential investment need not necessarily imply 
that the customer did not ultimately develop an understanding and make 
an independent investment decision.
    (g) A bank may conclude that a customer is exercising independent 
judgement if the customer's investment decision will be based on its 
own independent assessment of the opportunities and risks presented by 
a potential investment, market factors and other investment 
considerations. Where the bank has reasonable grounds for concluding 
that the institutional customer is making independent investment 
decisions and is capable of independently evaluating investment risk, 
then a bank's obligations under Sec. 208.25(d) for a particular 
customer are fulfilled.2 Where a customer has delegated decision-
making authority to an agent, such as an investment advisor or a bank 
trust department, the interpretation in this section shall be applied 
to the agent.
---------------------------------------------------------------------------
    \2\ See footnote 1 in paragraph (d) of this section.
---------------------------------------------------------------------------
    (h) A determination of capability to evaluate investment risk 
independently will depend on an examination of the customer's 
capability to make its own investment decisions, including the 
resources available to the customer to make informed decisions. 
Relevant considerations could include:
    (1) The use of one or more consultants, investment advisers, or 
bank trust departments;
    (2) The general level of experience of the institutional customer 
in financial markets and specific experience with the type of 
instruments under consideration;
    (3) The customer's ability to understand the economic features of 
the security involved;
    (4) The customer's ability to independently evaluate how market 
developments would affect the security; and
    (5) The complexity of the security or securities involved.
    (i) A determination that a customer is making independent 
investment decisions will depend on the nature of the relationship that 
exists between the bank and the customer. Relevant considerations could 
include:
    (1) Any written or oral understanding that exists between the bank 
and the customer regarding the nature of the relationship between the 
bank and the customer and the services to be rendered by the bank;
    (2) The presence or absence of a pattern of acceptance of the 
bank's recommendations;
    (3) The use by the customer of ideas, suggestions, market views and 
information obtained from other government securities brokers or 
dealers or market professionals, particularly those relating to the 
same type of securities; and
    (4) The extent to which the bank has received from the customer 
current comprehensive portfolio information in connection with 
discussing recommended transactions or has not been provided important 
information regarding its portfolio or investment objectives.
    (j) Banks are reminded that these factors are merely guidelines 
that will be utilized to determine whether a bank has fulfilled its 
suitability obligation with respect to a specific institutional 
customer transaction and that the inclusion or absence of any of these 
factors is not dispositive of the determination of suitability. Such a 
determination can only be made on a case-by-case basis taking into 
consideration all the facts and circumstances of a particular bank/
customer relationship, assessed in the context of a particular 
transaction.
    (k) For purposes of the interpretation in this section, an 
institutional customer shall be any entity other than a natural person. 
In determining the applicability of the interpretation in this section 
to an institutional customer, the Board will consider the dollar value 
of the securities that the institutional customer has in its portfolio 
and/or under management. While the interpretation in this section is 
potentially applicable to any institutional customer, the guidance 
contained in this section is more appropriately applied to an 
institutional customer with at least $10 million invested in securities 
in the aggregate in its portfolio and/or under management.
PART 211--INTERNATIONAL BANKING OPERATIONS (REGULATION K)
    1. The authority citation for Part 211 is revised to read as 
follows:
    Authority: 12 U.S.C. 221 et seq., 1818, 1841 et seq., 3101 et 
seq., 3109 et seq.; 15 U.S.C. 78o-5.
    2. Section 211.24 is amended by revising the section heading and 
adding a new paragraph (h) to read as follows:
Sec. 211.24  Approval of offices of foreign banks; procedures for 
applications; standards for approval; representative-office activities 
and standards for approval; preservation of existing authority; reports 
of crimes and suspected crimes; government securities sales practices.
* * * * *
    (h) Government securities sales practices. An uninsured state-
licensed branch or agency of a foreign bank that is required to give 
notice to the Board under section 15C of the Securities Exchange Act of 
1934 (15 U.S.C. 78o-5) and the Department of the Treasury rules under 
section 15C (17 CFR 400.1(d) and part 401) shall be subject to the 
provisions of 12 CFR 208.25 to the same extent as a state member bank 
that is required to give such notice.
[[Page 13287]]
    By order of the Board of Governors of the Federal Reserve Board, 
March 11, 1997.
Jennifer J. Johnson,
Deputy Secretary of the Board.
Federal Deposit Insurance Corporation
12 CFR CHAPTER III
Authority and Issuance
    For the reasons set out in the preamble, a new part 368 is added to 
chapter III of title 12 of the Code of Federal Regulations to read as 
follows:
PART 368--GOVERNMENT SECURITIES SALES PRACTICES
Sec.
368.1  Scope.
368.2  Definitions.
368.3  Business conduct.
368.4  Recommendations to customers.
368.5  Customer information.
368.100  Obligations concerning institutional customers.
    Authority: 15 U.S.C. 78o-5.
Sec. 368.1  Scope.
    This part is applicable to state nonmember banks and insured state 
branches of foreign banks that have filed notice as, or are required to 
file notice as, government securities brokers or dealers pursuant to 
section 15C of the Securities Exchange Act (15 U.S.C. 78o-5) and 
Department of the Treasury rules under section 15C (17 CFR 400.1(d) and 
part 401).
Sec. 368.2  Definitions.
    (a) Bank that is a government securities broker or dealer means a 
state nonmember bank or an insured state branch of a foreign bank that 
has filed notice, or is required to file notice, as a government 
securities broker or dealer pursuant to section 15C of the Securities 
Exchange Act (15 U.S.C. 78o-5) and Department of the Treasury rules 
under section 15C (17 CFR 400.1(d) and part 401).
    (b) Customer does not include a broker or dealer or a government 
securities broker or dealer.
    (c) Government security has the same meaning as this term has in 
section 3(a)(42) of the Securities Exchange Act of 1934 (15 U.S.C. 
78c(a)(42)).
    (d) Non-institutional customer means any customer other than:
    (1) A bank, savings association, insurance company, or registered 
investment company;
    (2) An investment adviser registered under section 203 of the 
Investment Advisers Act of 1940 (15 U.S.C. 80b-3); or
    (3) Any entity (whether a natural person, corporation, partnership, 
trust, or otherwise) with total assets of at least $50 million.
Sec. 368.3  Business conduct.
    A bank that is a government securities broker or dealer shall 
observe high standards of commercial honor and just and equitable 
principles of trade in the conduct of its business as a government 
securities broker or dealer.
Sec. 368.4  Recommendations to customers.
    In recommending to a customer the purchase, sale or exchange of a 
government security, a bank that is a government securities broker or 
dealer shall have reasonable grounds for believing that the 
recommendation is suitable for the customer upon the basis of the 
facts, if any, disclosed by the customer as to the customer's other 
security holdings and as to the customer's financial situation and 
needs.
Sec. 368.5  Customer information.
    Prior to the execution of a transaction recommended to a non-
institutional customer, a bank that is a government securities broker 
or dealer shall make reasonable efforts to obtain information 
concerning:
    (a) The customer's financial status;
    (b) The customer's tax status;
    (c) The customer's investment objectives; and
    (d) Such other information used or considered to be reasonable by 
such bank in making recommendations to the customer.
Sec. 368.100  Obligations concerning institutional customers.
    (a) As a result of broadened authority provided by the Government 
Securities Act Amendments of 1993 (15 U.S.C. 78o-3 and 78o-5), the FDIC 
is adopting sales practice rules for the government securities market, 
a market with a particularly broad institutional component. 
Accordingly, the FDIC believes it is appropriate to provide further 
guidance to banks on their suitability obligations when making 
recommendations to institutional customers.
    (b) The FDIC's suitability rule (Sec. 368.4) is fundamental to fair 
dealing and is intended to promote ethical sales practices and high 
standards of professional conduct. Banks' responsibilities include 
having a reasonable basis for recommending a particular security or 
strategy, as well as having reasonable grounds for believing the 
recommendation is suitable for the customer to whom it is made. Banks 
are expected to meet the same high standards of competence, 
professionalism, and good faith regardless of the financial 
circumstances of the customer.
    (c) In recommending to a customer the purchase, sale, or exchange 
of any government security, the bank shall have reasonable grounds for 
believing that the recommendation is suitable for the customer upon the 
basis of the facts, if any, disclosed by the customer as to the 
customer's other security holdings and financial situation and needs.
    (d) The interpretation in this section concerns only the manner in 
which a bank determines that a recommendation is suitable for a 
particular institutional customer. The manner in which a bank fulfills 
this suitability obligation will vary, depending on the nature of the 
customer and the specific transaction. Accordingly, the interpretation 
in this section deals only with guidance regarding how a bank may 
fulfill customer-specific suitability obligations under Sec. 368.4. 
1
---------------------------------------------------------------------------
     1  The interpretation in this section does not address the 
obligation related to suitability that requires that a bank have `` 
* * * a `reasonable basis' to believe that the recommendation could 
be suitable for at least some customers.'' In the Matter of the 
Application of F.J. Kaufman and Company of Virginia and Frederick J. 
Kaufman, Jr., 50 SEC 164 (1989).
---------------------------------------------------------------------------
    (e) While it is difficult to define in advance the scope of a 
bank's suitability obligation with respect to a specific institutional 
customer transaction recommended by a bank, the FDIC has identified 
certain factors that may be relevant when considering compliance with 
Sec. 368.4. These factors are not intended to be requirements or the 
only factors to be considered but are offered merely as guidance in 
determining the scope of a bank's suitability obligations.
    (f) The two most important considerations in determining the scope 
of a bank's suitability obligations in making recommendations to an 
institutional customer are the customer's capability to evaluate 
investment risk independently and the extent to which the customer is 
exercising independent judgement in evaluating a bank's recommendation. 
A bank must determine, based on the information available to it, the 
customer's capability to evaluate investment risk. In some cases, the 
bank may conclude that the customer is not capable of making 
independent investment decisions in general. In other cases, the 
institutional customer may have general capability, but may not be able 
to understand a particular type of instrument or its risk. This is more 
likely to arise with relatively new types of instruments, or those with 
significantly different risk or volatility characteristics than other 
investments generally made by the institution. If a customer is either 
generally not capable
[[Page 13288]]
of evaluating investment risk or lacks sufficient capability to 
evaluate the particular product, the scope of a bank's customer-
specific obligations under Sec. 368.4 would not be diminished by the 
fact that the bank was dealing with an institutional customer. On the 
other hand, the fact that a customer initially needed help 
understanding a potential investment need not necessarily imply that 
the customer did not ultimately develop an understanding and make an 
independent investment decision.
    (g) A bank may conclude that a customer is exercising independent 
judgement if the customer's investment decision will be based on its 
own independent assessment of the opportunities and risks presented by 
a potential investment, market factors and other investment 
considerations. Where the bank has reasonable grounds for concluding 
that the institutional customer is making independent investment 
decisions and is capable of independently evaluating investment risk, 
then a bank's obligations under Sec. 368.4 for a particular customer 
are fulfilled. 2 Where a customer has delegated decision-making 
authority to an agent, such as an investment advisor or a bank trust 
department, the interpretation in this section shall be applied to the 
agent.
---------------------------------------------------------------------------
     2  See footnote 1 in paragraph (d) of this section.
---------------------------------------------------------------------------
    (h) A determination of capability to evaluate investment risk 
independently will depend on an examination of the customer's 
capability to make its own investment decisions, including the 
resources available to the customer to make informed decisions. 
Relevant considerations could include:
    (1) The use of one or more consultants, investment advisers, or 
bank trust departments;
    (2) The general level of experience of the institutional customer 
in financial markets and specific experience with the type of 
instruments under consideration;
    (3) The customer's ability to understand the economic features of 
the security involved;
    (4) The customer's ability to independently evaluate how market 
developments would affect the security; and
    (5) The complexity of the security or securities involved.
    (i) A determination that a customer is making independent 
investment decisions will depend on the nature of the relationship that 
exists between the bank and the customer. Relevant considerations could 
include:
    (1) Any written or oral understanding that exists between the bank 
and the customer regarding the nature of the relationship between the 
bank and the customer and the services to be rendered by the bank;
    (2) The presence or absence of a pattern of acceptance of the 
bank's recommendations;
    (3) The use by the customer of ideas, suggestions, market views and 
information obtained from other government securities brokers or 
dealers or market professionals, particularly those relating to the 
same type of securities; and
    (4) The extent to which the bank has received from the customer 
current comprehensive portfolio information in connection with 
discussing recommended transactions or has not been provided important 
information regarding its portfolio or investment objectives.
    (j) Banks are reminded that these factors are merely guidelines 
that will be utilized to determine whether a bank has fulfilled its 
suitability obligation with respect to a specific institutional 
customer transaction and that the inclusion or absence of any of these 
factors is not dispositive of the determination of suitability. Such a 
determination can only be made on a case-by-case basis taking into 
consideration all the facts and circumstances of a particular bank/
customer relationship, assessed in the context of a particular 
transaction.
    (k) For purposes of the interpretation in this section, an 
institutional customer shall be any entity other than a natural person. 
In determining the applicability of the interpretation in this section 
to an institutional customer, the FDIC will consider the dollar value 
of the securities that the institutional customer has in its portfolio 
and/or under management. While the interpretation in this section is 
potentially applicable to any institutional customer, the guidance 
contained in this section is more appropriately applied to an 
institutional customer with at least $10 million invested in securities 
in the aggregate in its portfolio and/or under management.
    By order of the Board of Directors, dated at Washington, D.C., 
this 11th day of March, 1997.
Federal Deposit Insurance Corporation
Robert E. Feldman,
Deputy Executive Secretary.
[FR Doc. 97-6803 Filed 3-18-97; 8:45 am]
BILLING CODES: 4810-33-P, 6210-01-P, 6714-01-P

Last Updated 03/19/1997 regs@fdic.gov