banks and savings
associations into part 362 to regulate these investments as
consistently as possible given the limitations imposed by the different
statutes that govern each kind of insured institution. Finally,
although the FDIC agrees with the principles applicable to transactions
between insured depository institutions and its affiliates contained in
section 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c and
371c--1), our experience over the last five years in applying section
24 has led us to conclude that extending 23A and 23B by reference to
bank subsidiaries is inadvisable. For that reason, the final regulation
does not incorporate sections 23A and 23B of the Federal Reserve Act by
cross-reference; rather, the regulation adapts similar principles to
those set forth in sections 23A and 23B to the bank/subsidiary
relationship as appropriate. In drafting the final rule, we have
considered each of the requirements contained in sections 23A and 23B
in the context of transactions between an insured institution and its
subsidiary and refined the restrictions appropriately. We are
comfortable that this approach strikes a better balance between caution
and commercial reality by harmonizing the capital deductions and the
principles of 23A and 23B.
Subpart A of the final rule deals with the activities and investments
of insured state banks. Except for those sections pertaining to the
applications, notices and related delegations of authority (procedural
provisions), existing part 362 essentially becomes subpart A under the
current proposal. The procedural provisions of existing part 362 have
been transferred to subpart G of part 303. Subpart A addresses the
activities of insured state banks in § 362.3. The activities carried
on in subsidiaries of insured state banks are addressed separately in
§ 362.4.
Under a safety and soundness standard, subpart B of the final
regulation requires subsidiaries of insured state nonmember
banks engaged in certain activities to meet the standards established
by the FDIC, even if the OCC determines that those activities are
permissible for a national bank subsidiary. The FDIC has determined
that real estate investment activities may pose significant risks to
the deposit insurance funds. For that reason, the FDIC established
standards that an insured state nonmember bank must meet before
engaging in real estate investment activities that are not permissible
for a national bank, even if they are permissible for the subsidiary of
a national bank.
Subpart B also establishes modern standards for insured state
nonmember banks to govern transactions between those insured state
nonmember banks that are not affiliated with a bank holding company
(nonbank banks) and affiliated organizations conducting securities
activities. The existing restrictions on these securities activities
are found in § 337.4 of this chapter. The new rule only covers those
entities not covered by orders issued by the Board of Governors of the
Federal Reserve System (FRB) governing the securities activities of
those banks that are affiliated with a bank holding company or a member
bank.
In addition, subpart B prohibits an insured state nonmember bank not
affiliated with a company that is treated as a bank holding company
(see section 4(f) of the Bank Holding Company Act, 12 U.S.C. 1843(f)),
from becoming affiliated with a company that directly engages in the
underwriting of securities not permissible for a bank itself unless the
standards established under the proposed regulation are met.
Subpart C of the final rule concerns the activities and investments
of insured state savings associations. The substantive provisions
applicable to activities of savings associations currently appearing in
subpart G of part 303, effective October 1, 1998, (formerly § 303.13)
would be revised in a number of ways and placed in new subpart C. To
the extent possible, activities and investments of insured state
savings associations are treated consistently with the treatment
accorded insured state banks. Thus, we revised a number of definitions
currently contained in subpart G of part 303 to track the definitions
used in subpart A or part 362.
Subpart D of the final rule requires that an insured savings
association provide a 30-day notice to the FDIC whenever the
institution establishes or acquires a subsidiary or conducts a new
activity through a subsidiary. This provision does not alter the notice
required by a statute and current subpart G of part 303. We moved this
requirement to a new subpart to accommodate Federally chartered
savings associations
{{2-26-99 p.3124.14-E}}by limiting the amount
of regulation text they would have to read to learn how to comply with
this statutory notice.
III. Comment Summary
The FDIC received 129 comments in response to the proposed
regulation. The overall comments generally favored the FDIC's approach
to streamlining the consent process for banks and savings associations
to engage in activities using standardized criteria with seven comments
specifically supporting the FDIC's efforts to streamline these rules.
Comments were received from 102 financial institutions, 2 one bank
holding companies, 3 state banking departments, 14 trade associations,
2 investment companies, 4 Congressmen, 1 federal banking regulator and
1 individual.
The overwhelming majority of the comments (107), primarily from
Massachusetts, were focused on concerns over proposed changes to the
standards governing holding equity securities in subsidiaries by banks
having grandfathered authority to hold the securities at the bank
level. We have responded to these comments by reinstating the exception
for a grandfathered bank to hold equity securities in a subsidiary. A
complete discussion of this issue is found in the section by section
analysis.
With regard to the structure of the rule and the consolidation of
the banking and savings activities into a single rule, five comments
expressly supported the FDIC's efforts to accomplish these goals.
However, one comment suggested using a table like the Office of Thrift
Supervision (OTS) has used to aid understanding this complex and
difficult regulation. Three comments support cross-referencing the
Interagency Statement rather than restating disclosure requirements. A
readability analysis was submitted by one individual and, based upon
the results, the individual questioned whether the FDIC was successful
in achieving the state objective of using plain English. This
individual offered his services to the FDIC as a writing consultant.
Other general comments observed that diversifying into new activities
increases safety and soundness and were pleased that the FDIC supports
state institutions' exercising of new powers. Two comments indicated
that in the preamble, the FDIC had overstated the authority of the FRB
to impose more stringent standards on any activity conducted by a state
member bank. This statement is derived from section 24(i); however, we
intended to refer to those activities not permissible for national
banks. At least one bank and the state banking departments
advocate further streamlining of the regulations to make it easier for
banks to use their capital through subsidiaries. The bank suggested
that banks must have more flexibility to keep their capital in the
banking system, rather than paying out more dividends to shareholders.
Although we favor diversifying the banks' income stream and making
bankers' compliance burden as light as possible, we also are charged
with maintaining safety and soundness and meeting the requirements of
section 24 of the FDI Act. Thus, we strive to balance these interests
in crafting more flexible regulations.
Most of the remaining comments addressed the substance of the
regulation and provided constructive feedback on the regulation text.
Two comments focusing on the Purpose and Scope Section suggested a
definition of what is meant by "acting as principal," although we
already had a definition of "as principal." Two comments objected
to the FDIC accepting the time period imposed by the National Bank Act
on real estate that is acquired for debts previously contracted as a
limitation that carries over to state banks. We believe that the
authority of a national bank to own real estate is governed by the
statute and that this limitation is inherent in that authority. Thus,
we believe that a state bank is constrained by this same limitation
unless relief can be granted by the FDIC. Relief may be granted by the
FDIC only if the state bank transfers the property to a majority-owned
subsidiary with appropriate capital and complies with whatever other
constraints the FDIC deems adequate to protect the deposit insurance
fund from significant risk.
In the definitions section, eight comments requested that we expand
the definition of majority-owned subsidiary to include limited
liability companies and limited partnership interests. One comment
suggested that the qualified housing exception also include limited
liability companies. Four comments expressed concern over the change to
the definition of "change of control." Four
{{2-26-99 p.3124.14-F}}comments expressed
concern about the change to the definition of "significant risk to
the deposit insurance fund." One comment suggested a definition of
"investment in subsidiary" and further clarification of the items
to be included in debt and equity.
With regard to the activities of insured state banks, two comments
supported the FDIC's new interpretation of when the "in an
amount" limitation is applicable. Six comments addressed insurance
activities, including three addressing the appropriate disclosures.
Five comments addressed the change in the measurement of the applicable
capital limit for adjustable rate and money market preferred stock. Six
comments addressed the 4(c)(8) list (closely related to banking)
activities, including specific alternatives on real estate leasing. One
comment supported the change in the qualified housing projects
exception to conform the meaning of lower income to that used in the
community reinvestment regulations in defining low and moderate income.
With regard to the activities of subsidiaries of insured state
banks, one comment thought the control concept was unnecessary for
lower tier subsidiaries. Over one hundred ten comment letters addressed
the various issues involving the holding of equity securities through a
majority-owned subsidiary, with the overwhelming majority of the
comments coming from Massachusetts banking interests to advocate not
changing the constraints governing banks in that state owning
grandfathered equity securities in a subsidiary. Several of these
comment letters identified more than one issue. Twenty comments
addressed the issues involved with engaging in real estate investment
activity through a majority-owned subsidiary. Nine comments addressed
the issues identified in securities underwriting activity through a
majority-owned subsidiary. Eleven comments addressed the eligible
depository institution criteria. Twelve comments addressed the eligible
subsidiary criteria and generally expressed the view that the eligible
subsidiary was an improvement over the bona fide subsidiary concept
found in the old rule. Seventeen comments addressed the investment and
transaction limits criteria. Eight comments were directed to the way
the capital requirements operate. One comment said that banks should
have the option of complying with original conditions or the new rule.
With regard to the real estate activities covered by subpart B, five
comments addressed this issue and generally thought that the FDIC
should not impose additional regulations on state nonmember banks.
With regard to subpart C governing savings associations, one comment
expressed the view that thrifts do not know what is permissible for
national banks and needed greater specificity in the regulation. There
were no comments on subpart D; however, no substantive change was made
to this statutory filing requirement.
With regard to subparts E and F governing the notice and application
processing and content, two comments were received in favor of firmer
processing deadlines.
IV. Section by Section Analysis
A. Subpart A—Activities of Insured State Banks
Section 362.1 Purpose and Scope
As described in the preamble accompanying the proposal, included
within the proposed changes to the regulation was the inclusion of a
purpose and scope paragraph describing the statutory background,
intent, and nature of items covered by this subpart. Several commenters
acknowledged the FDIC's efforts to restructure the regulation and
agreed that the proposed reorganization simplifies what continues to be
complex material. These commenters stated that the use of purpose and
scope paragraphs helps clarify the coverage of each subpart.
The intent of § 362.1 is to clarify that the purpose and scope of
subpart A is to ensure that activities and investments undertaken by
insured state banks and their subsidiaries do not present a significant
risk to the deposit insurance funds, are not unsafe and are not
unsound, are consistent with the purposes of federal deposit insurance,
and are otherwise consistent with law. Subpart A implements the
provisions of section 24 of the FDI Act that restrict and prohibit
insured state banks and their subsidiaries from engaging in activities
and investments of a type that are not permissible for national banks
and their subsidiaries. The phrase "activity permissible for a
national bank"
{{2-26-99 p.3124.14-G}}means any activity
authorized for national banks under any statute including the National
Bank Act (12 U.S.C. 21 et seq.), as well as activities
recognized as permissible for a national bank in regulations, official
circulars, bulletins, orders or written interpretations issued by the
OCC.
This subpart governs activities conducted "as principal" and
therefore does not govern activities conducted as agent for a customer,
conducted in a brokerage, custodial, advisory, or administrative
capacity, conducted as trustee, or conducted in any substantially
similar capacity. As explained in the preamble accompanying the
proposal, we moved this language from § 362.2(c) of the former
version of part 362 where the term "as principal" was defined to
mean acting other than as agent for a customer, acting as trustee, or
conducting an activity in a brokerage, custodial or advisory capacity.
The FDIC previously described this definition as not covering, for
example, acting as agent for the sale of insurance, acting as agent for
the sale of securities, acting as agent for the sale of real estate, or
acting as agent in arranging for travel services. Likewise, providing
safekeeping services, providing personal financial planning services,
and acting as trustee were described as not being "as principal"
activities within the meaning of this definition. In contrast, real
estate development, insurance underwriting, issuing annuities, and
securities underwriting would constitute "as principal"
activities.
Further, for example, travel agency activities have not been brought
within the scope of part 362 and would not require prior consent from
the FDIC even though a national bank is not permitted to act as travel
agent. Agency activities are not covered by the regulations because the
state bank would not be acting "as principal" in providing those
services. Thus, the fact that a national bank may not engage in travel
agency activities is of no consequence. Of course, state banks would
have to be authorized to engage in travel agency activities under state
law. We intend to continue to interpret section 24 and part 362 as
excluding any coverage of activities being conducted as agent. To
highlight this issue, provide clarity, and alert the reader of this
rule that activities being conducted as agent are not within the scope
of section 24 and part 362, this language was moved to the purpose and
scope paragraph in the proposal.
Comments addressing the proposed treatment of "as principal"
were submitted by two industry trade groups. One group agreed that
moving the applicable language to the purpose and scope paragraph helps
clarify that section 24 does not apply to activities conducted in an
agency or similar capacity. However, both commenters recommended that
the FDIC define "as principal" by specifying what is meant by
acting as principal rather than providing a list of capacities exempt
from that definition. In other words, the commenters desired a
definition consisting of an inclusive list rather than a list of
exemptions. Additionally, one commenter expressed concern that the
current list of exempt capacities may omit certain agency-like roles.
As such, the commenter recommended that the FDIC include
"substantially similar capacities" in the list of capacities that
are not considered to be conducted "as principal."
The FDIC continues to believe that including the "as
principal" language in the purpose and scope paragraph provides
clarity regarding activities coming within the scope of section 24. As
such, the FDIC elects not to separately define "as principal",
and has deleted as redundant an overlapping definition of "as
principal" contained in § 362.2(c) of the proposal. Additionally,
the FDIC cannot reasonably list all capacities that will be considered
to be "as principal". Therefore, the FDIC is not persuaded that
changing the nature of the definition to an inclusive list of
capacities that are considered "as principal" would alleviate
confusion. Instead, "as principal" activities will continue to be
described as being all capacities other than the listed exceptions. The
FDIC nonetheless agrees that the current list may exclude certain
agency-like roles and is therefore adding the phrase "or in any
substantially similar capacity" to the regulatory language of
§ 362.1(b)(1). Also, the FDIC has added a list of examples of
activities that are not "as principal" to provide the public with
additional guidance.
The preamble of the proposal also explains that equity investments
acquired in connection with debts previously contracted
{{2-26-99 p.3124.14-H}}(DPC) are
not within the scope of this subpart when held within the shorter of
the time limits prescribed by state or federal law. The exclusion of
equity investments acquired in connection with DPC was moved from the
definition of "equity investment" in the former regulation to the
purpose and scope paragraph to highlight this issue, provide clarity,
and alert the reader of this rule that these investments are not within
the scope of section 24 and part 362. Interests taken as DPC are
excluded from the scope of this regulation provided that the interests
are not held for investment purposes and are not longer than the
shorter of any time limit on holding such interest (1) set by
applicable state law or regulation or (2) the maximum time limit on
holding such interests set by applicable statute for a national bank.
The result of the modification would be to make it clear, for example,
that real estate taken DPC may not be held for longer than 10 years
(see 12 U.S.C. 29) or any shorter period of time set by the state. In
the case of equity securities taken DPC, the bank must divest the
equity securities "within a reasonable time" (i.e., as soon as
possible consistent with obtaining a reasonable return) (see OCC
Interpretive Letter No. 395, August 24, 1987, (1988--89 Transfer
Binder) Fed Banking L. Rep. (CCH) p. 85619, which interprets and
applies the National Bank Act) or no later than the time permitted
under state law if that time period is shorter. Of course, a state bank
permitted to hold such interests under state law may apply to the FDIC
for consent to continue to hold the real property through a
majority-owned subsidiary. In the final rule, the FDIC has added some
general information about the manner in which a national bank may hold
DPC.
Two commenters objected to the FDIC imposing the national bank
holding period limits on insured state banks if those limits are
shorter than otherwise permitted under state law. One commenter
suggested applying a "reasonable time period" divestiture
standard similar to that concerning equity securities acquired DPC. The
holding periods governing a national bank's ability to own real estate
acquired DPC are contained within section 29 of the National Bank Act
(12. U.S.C. 29). Because a national bank can hold real estate acquired
DPC in limited circumstances, section 24 only allows a state bank to
hold such interests under the same constraints, i.e., for a
maximum of 10 years. Conversely, section 29 does not contain
divestiture periods for equity securities acquired DPC and the FDIC has
therefore elected to defer to a "reasonable time" standard.
However, due to the statutory limitation in section 29, no changes are
made to the exception for real estate acquired DPC and the regulation
will continue to apply the holding periods in the manner proposed.
As discussed in the proposal's preamble, the intent of the insured
state bank in holding equity investments acquired in connection with
DPC is also relevant to the analysis of whether the equity investment
is permitted. Any interest taken DPC may not be held for investment
purposes. For example, a bank may be able to expend monies in
connection with DPC property and/or take other actions with regard to
that property. However, if those expenditures and actions are not
permissible for a national bank, the property will not fall within the
DPC exception. For an additional example, if the bank's actions are
speculative in nature or go beyond what is necessary and prudent in
order for the bank to recover on the loan, a national bank would not be
permitted to take these actions. The FDIC expects bank management to
document that DPC property is being actively marketed; current
appraisals or other means of establishing fair market value may be used
to support management's decision not to dispose of property if offers
to purchase the property have been received and rejected by management.
Similarly, the proposal also moved to the purpose and scope
paragraph language governing any interest in real estate in which the
real property is (1) used or intended in good faith to be used within a
reasonable time by an insured state bank or its subsidiaries as offices
or related facilities for the conduct of its business or future
expansion of its business or (2) used as public welfare investments of
a type permissible for national banks. Again, this language was moved
from the definition of "equity investment" in the former
regulation to highlight this issue, provide clarity, and alert the
reader of this rule that such investments are not within the scope of
this subpart. In the
{{2-26-99 p.3124.14-I}}case of real
property held for use at some time in the future as premises, the
holding of the property must reflect a bona fide intent on the part of
the bank to use the property in the future as premises. We are not
aware of any statutory time frame that applies in the case of a
national bank which limits the holding of such property to specific
time period. Therefore, the issue of the precise time frame under which
future premises may be held without implicating part 362 must be
decided on a case-by-case basis. If the holding period allowed under
state law is longer than what the FDIC determines to be reasonable and
consistent with a bona fide intent to use the property for future
premises, the bank will be so informed and will be required to convert
the property to use, divest the property, or apply for consent to hold
the property through a majority-owned subsidiary of the bank. We note
that the OCC's regulations indicate that real property held for future
premises should normally be converted to use within five years after
which time it will be considered other real estate owned and must be
actively marketed and divested within no more than ten years (12 CFR
part 34). We understand that the time periods set forth in the OCC's
regulations reflect safety and soundness determinations by that agency.
As such, and in keeping with what has been to date the FDIC's posture
with regard to safety and soundness determinations of the OCC, the FDIC
will make its own judgment to determine when a reasonable time has
elapsed for holding property for future premises.
The purpose and scope paragraph also explains that a subsidiary of
an insured state bank may not engage in activities that are not
permissible for a subsidiary of a national bank unless the bank is in
compliance with applicable capital standards and the FDIC has
determined that the activity poses no significant risk to the deposit
insurance fund. Subpart A provides standards for certain activities
that are not permissible for a subsidiary of a national bank.
Additionally, because of safety and soundness concerns relating to real
estate investment activities, subpart B reflects special rules for
subsidiaries of insured state nonmember banks that engage in real
estate investment activities of a type that are not permissible for a
national bank, but that may be otherwise permissible for a subsidiary
of a national bank.
The FDIC intends to allow insured state banks and their subsidiaries
to undertake safe and sound activities and investments that do not
present a significant risk to the deposit insurance funds and that are
consistent with the purposes of federal deposit insurance and other
applicable law. This subpart does not authorize any insured state bank
to make investments or to conduct activities that are not authorized or
that are prohibited by either state or federal law.
Section 362.2 Definitions
Revised subpart A § 362.2 contains the definitions
applicable to this subpart. Most definitions are unchanged from those
used in the current regulation. Nonetheless, the proposal contains
edits to enhance clarity and readability, define additional terms, and
delete certain definitions as unnecessary.
To standardize as many definitions as possible, we incorporated the
following definitions from section 3 of the FDI Act (12 U.S.C. 1813):
"depository institution", "insured state bank",
"bank", "state bank", "savings association",
"state savings association", "insured depository
institution", "federal savings association", and "insured
state nonmember bank". This standardization required that we delete
the definitions of the first two terms, "depository institution"
and "insured state bank", currently found in part 362. No
substantive change was intended by this modification. The remaining
terms were added by reference to provide clarity throughout the
proposed part 362 because we incorporate many of the definitions from
subpart A into the other part 362 subparts. The FDIC received no
comments concerning these changes and is therefore adopting the
referenced definitions as proposed.
Several definitions were carried forward in the proposal from the
current regulation either unchanged or containing only minor edits to
enhance clarity or readability without changing the meaning. The
following definitions were carried forward without any substantive
meaning changes: "control", "extension of credit",
"executive officer", "director", "principal
shareholder", "related interest", "national securities
exchange", "residents of state",
"subsidiary",
{{2-26-99 p.3124.14-J}}and "tier one
capital". Again, the FDIC received no comments on the referenced
definitions which are adopted as proposed.
The name of one definition was simplified without substantively
changing its meaning. The subject definition was formerly found in
§ 362.2(g) and was described as follows "an insured state bank
will be considered to convert its charter". This definition is now
provided by § 362.2(f) and is named "convert its charter". No
commenters addressed this simplified title which is adopted as
proposed.
The definitions of "activity permissible for a national bank",
"an activity is considered to be conducted as principal", and
"equity investment permissible for a national bank" were deleted
in the proposed and final rule because the substance of the information
contained in those definitions was incorporated into the scope
paragraph in § 362.1. When developing the proposal, the FDIC
concluded that moving the information contained in these definitions to
the scope paragraph made the coverage of the rule clearer.
Additionally, placing this information at the beginning of the subpart
is consistent with the purpose of a scope paragraph. Some readers may
save time by realizing sooner that the regulation may be inapplicable
to conduct contemplated by a particular bank. It also may be more
logical for the reader to consider the scope paragraph to determine the
rule's applicability, rather than having to rely on the definition
section. Moreover, we concluded that it would be unnecessary to
duplicate this same information in the definition section. The FDIC
received no specific comments on the proposed treatment, but
respondents commenting on the overall structure of the proposal
generally favored the use of the purpose and scope paragraphs. The
final regulation incorporates the changes as proposed. The proposed
definition of "as principal" at § 362.2(c) duplicates material
set out in the scope section at § 362.1(b)(1), and has therefore been
eliminated in the final rule. Appropriate definitional language has
been added to § 362.1(b)(1).
The proposal also deleted the definition of "equity interest in
real estate" and moved the recitation of the permissibility of
owning real estate for bank premises and future premises, owning real
estate for public welfare investments, and owning real estate from DPC
to the scope paragraph for the reasons stated in the preceding
paragraph. These activities are permissible for national banks and we
concluded that it was unnecessary to continue to restate this
information in the definition section of the regulation. No substantive
change is intended by the simplification of this language. Further, we
determined that the remainder of the definition of "equity interest
in real estate" did little to enhance clarity or understanding,
therefore, we are relying on the language defining "equity
investment" to cover real estate investments.
Conforming changes were made to the definition of "equity
investment" by removing the reference to the deleted definition of
"equity interest in real estate". Additionally, the remaining
part of the "equity investment" definition was shortened and
edited to enhance readability. This definition is intended to encompass
an investment in an equity security, partnership interest, or real
estate as it did in the former regulation. No substantive changes were
intended by the changes described in this or the preceding paragraph.
The FDIC received no comments on these changes which are adopted as
proposed.
With regard to the definition of "equity security", we
modified the definition by deleting references to circumstances where
holding equity securities is permissible for national banks, such as
when equity securities are held as a result of a foreclosure or other
arrangements concerning debts previously contracted. Language
discussing the exclusion of DPC and other investments that are
permissible for national banks was relocated to the scope paragraph for
the reasons previously stated. Like the exceptions concerning equity
investments in real estate, no substantive change is intended by the
relocation of the subject exceptions to the purpose and scope
paragraph. No comments were received on this proposed treatment which
is adopted as proposed.
The definitions of "investment in a department" and
"department" were deleted because they are no longer needed in
the revised regulation text. The core standards applicable to a
department of a bank are detailed in § 362.3(c) and defining the term
"department" is therefore unnecessary. If a
{{2-26-99 p.3124.14-K}}calculation of an
"investment in a department" needs to be made, the FDIC intends
to defer to governing state law. As a result, a definition of
"investment in a department" is unnecessary and was deleted.
There were no comments addressing the removal of these definitions.
Similarly, we deleted the definition of "investment in a
subsidiary" because the definition is no longer needed in the
revised regulation text. Amount subject to the investment limits of
§ 362.4(d) are listed clearly in that subsection. The FDIC opted to
list amounts subject to investment limits in § 362.4(d) to separate
those debt-type investments from the equity-type investments subject to
the capital treatment of § 362.4(e). The regulation also contains
other investment limits applicable to both debt and equity investments.
Because of these different types of investment limits, the FDIC did not
find a single "investment in a subsidiary" definition helpful.
Therefore, the FDIC has elected not to incorporate such a definition
despite a request by one commenter. However, as the same commenter
suggested, the FDIC has attempted to clearly delineate amounts subject
to the various investment limits, transaction restrictions, and capital
requirements when applicable through both the regulation text and the
corresponding preamble language.
We deleted the definition of "bona fide subsidiary" and chose
to make similar characteristics part of the "eligible subsidiary"
criteria in § 362.4(c)(2). Including these criteria as a part of the
substantive regulation text in the referenced subsection, rather than
as a definition, makes reading the rule easier and the meaning clearer.
No commenters addressed this treatment. Comments concerning the various
elements of the eligible subsidiary criteria are discussed elsewhere in
this preamble under the appropriate section.
The regulation substitutes the current definition of "lower
income" with a cross reference in § 362.3(a)(2)(ii) to the
definition of "low income" and "moderate income" used for
purposes of part 345 of the FDIC's regulations (12 CFR 345) which
implements the Community Reinvestment Act (CRA). 12 U.S.C. 2901, et.
seq. Under part 345, "low income" means an individual income that
is less than 50 percent of the area median income or a median family
income that is less than 50 percent in the case of a census tract or a
block numbering area delineated by the United States Census in the most
recent decennial census. "Moderate income" means an individual
income that is at least 50 percent but less than 80 percent of the area
median or a median family income that is at least 50 but less than 80
percent in the case of a census tract or block numbering area.
The "lower income" definition is relevant for purposes of
applying the exception in the regulation which allows an insured state
bank to be a partner in a limited partnership whose sole purpose is
direct or indirect investment in the acquisition, rehabilitation, or
new construction of qualified housing projects (housing for lower
income persons). As we anticipate that insured state banks will seek to
use such investments in meeting their community reinvestment
obligations, the FDIC is of the opinion that conforming the definition
of lower income to that used for CRA purposes will benefit banks. This
change has the effect of expanding the housing project that qualify for
the exception. The FDIC received one comment addressing the altered
definition with the respondent favorably noting and supporting the
resultant effect. The final regulation adopts this change as proposed.
The regulation includes an altered definition of the term
"activity". As modified, the definition includes both activities
and investments. Where equity investments are intended to be excluded
from a particular section of the regulation, we expressly exclude those
investments in the regulatory text. Previously, the term
"activity" was defined differently depending upon whether it was
used in connections with the direct conduct of business by an insured
state bank or in connection with the conduct of business by a
subsidiary of the bank. This change was made both to simplify the
regulation and to reflect the section 24 definition of
"activity". No comments were received on this proposed change.
It is noted that no comments were received regarding the proposed
suggestion also to modify the "activity" definition to
incorporate a recent interpretation by the agency that determined that
the act of making a political campaign contribution does
{{2-26-99 p.3124.14-L}}not constitute an
"activity" for purposes of part 362. The referenced
interpretation uses a three prong analysis to help determine whether
particular conduct should be considered an activity and therefore
subject to review under part 362 if the conduct is not permissible for
a national bank.
First, any conduct that is an integral part of the business of
banking as well as any conduct which is closely related or incidental
to banking should be considered an activity. In applying this factor,
it is important to focus on what banks do that makes them different
from other types of businesses. For example, lending money is clearly
an "activity" for purposes of part 362. The second factor asks
whether the conduct is merely a corporate function as opposed to a
banking function. For example, paying dividends to shareholders is
primarily a general corporate function and not one associated with
banking because of some unique characteristics of banking as a
business. Generally, activities that are not general corporate
functions will involve interaction between the bank and its customers
rather than its employees or shareholders. The third factor asks
whether the conduct involves an attempt by the bank to generate a
profit. For example, banks make loans and accept deposits in an effort
to make money. However, contracting with another company to generate
monthly customer statements should not be considered to be an activity
in and of itself as it simply is entered into in support of the
"activity" of taking deposits. If at least two of the factors
yield a conclusion that the conduct is part of the authorized conduct
of business by the bank, the better conclusion is that the conduct is
an activity. Because of the lack of interest received on expanding the
definition to reflect this interpretation, no change is made to the
definition proposed. The FDIC intends to continue to apply the above
analysis when determining whether particular conduct should be
considered an activity.
The definition of "real estate investment activity" was
shortened to mean any interest in real estate held directly or
indirectly that is not permissible for a national bank. This term is
used in § 362.4(b)(5) of subpart A. Additionally, it is used in
§ 362.8 of subpart B which contains safety and soundness restrictions
on real estate activities of subsidiaries of insured state nonmember
banks that may be deemed to be permissible for operating subsidiaries
of national banks but that would not be permissible for a national bank
itself. The proposed definition contained a parenthetical excluding
real estate leasing from the definition of real estate investment
activities. By excluding leasing from the proposed "real estate
investment activity" definition, the FDIC was attempting to clearly
separate leasing activity from other real estate investment activities.
Under the current regulation, banks and their majority-owned
subsidiaries are allowed to engage in real estate leasing under the
regulatory exceptions enabling them to engage in activities closely
related to banking. 1
These regulatory exceptions were carried forward in the proposal.
However, the FDIC is concerned about certain activities encompassed
within this section. For example, the 4(c)(8) list includes real estate
leasing. When an individual or entity engages in leasing activity as
the lessor of a particular parcel, the landlord has an ownership
interest in the underlying real estate. Under section 24 of the FDI
Act, insured state banks are limited in their ability to own real
estate. We are concerned that an insured state bank could consider this
regulation and its certain conditions as the FDIC having permitted the
bank or its majority-owned subsidiaries to own real estate interests
that would not be permissible for a national bank or a subsidiary of a
national bank. To prevent insured state banks from attempting to use
this consent to leasing activity as a way to avoid the corporate
separations, transaction limitations and restrictions, and capital
treatment applicable to other real estate investment activities, the
proposed definition expressly excluded leasing. Additionally, the FDIC
was attempting to ensure that banks using the notice
proce-
{{2-26-99 p.3124.14-M}}dure to engage in real
estate investment activities were not, in effect, operating a
commercial business by virtue of the terms of the leasing activity.
The FDIC recognizes, however, that the proposed definition would
have effectively prevented an insured state bank's majority-owned
subsidiary that was proceeding under the notice procedure from leasing
property that it is otherwise permitted to own or
develop. 2
As a result, the insured state bank would have been required to submit
an application to seek further consent from the FDIC to lease real
property it was allowed to own. To correct this anomaly, the FDIC has
deleted the parenthetical from the definition and deals with the
activities of real estate leasing and other real estate investment
activities separately as discussed elsewhere in this preamble. The
subject definition is otherwise unchanged from the proposal.
The final rule includes a modified definition of "company" to
which we added limited liability companies to the list of entities
considered to be a company. This change was made to recognize the
creation of limited liability companies and their growing prevalence in
the market place. Four commenters suggested explicitly adding limited
liability partnerships to the list of business structures included in
the "company" definition. The FDIC believes the suggested change
is unnecessary because limited liability partnerships are already
included in the definition through the term "partnership".
As proposed, the FDIC adopted the modified definition of
"significant risk to the fund" with the second sentence that
clarifies that this definition includes the risk that may be present
either when an activity or an equity investment contributes or may
contribute to the decline in condition of a particular state-chartered
depository institution or when a type of activity or equity investment
is found by the FDIC to contribute or potentially contribute to the
deterioration of the overall condition of the banking system. Our
interpretation of the definition remains unchanged. Significant risk to
the deposit insurance fund is understood to be present whenever there
is a high probability that any insurance fund administered by the FDIC
may suffer a loss. The preamble accompanying the adoption of this
definition in 1992 (57 FR 53220, November 9, 1992) indicated that the
FDIC recognizes that no investment or activity may be said to be
without risk under all circumstances and that such a fact alone will
not cause the agency to determine that a particular activity or
investment poses a significant risk of loss to the fund. The definition
emphasizes that there is a high degree of likelihood under all of the
relevant circumstances that an investment or activity by a particular
bank, or by banks in general or in a given market or region, may
ultimately produce a loss to either of the funds. The relative or
absolute size of the loss that is projected in comparison to the fund
is not determinative of the issue. The preamble indicated that the
definition is consistent with and derived from the legislative history
of section 24 of the FDI Act. Previously, the FDIC rejected the
suggestion that a risk to the fund be found only if a particular
activity or investment is expected to result in the imminent failure of
a bank. The suggestion was rejected in 1992 as the FDIC determined that
it was inappropriate to approach the issue this narrowly in light of
the legislative intent.
Four commenters addressed the proposed change to the wording of this
definition. One industry trade association complimented the change.
However, two other groups expressed concern that the added sentence
results in a definition that is overly broad, and a state bank stated
that the change makes the definition incoherent. The latter three
commenters expressed concern that the added sentence contains no
qualifications or limitations. These commenters state that numerous
activities may negatively impact the condition of an institution or may
contribute to deterioration in the overall banking system without
causing loss to the insurance fund. The commenters suggest that section
24 requires the FDIC to consider the extent of the impact before
determining that an activity presents a significant risk to the fund.
The FDIC agrees with the commenters that consideration must be given to
the extent that a negative event may harm an
{{2-26-99 p.3124.14-N}}institution or the
overall banking industry. However, the FDIC believes that both
sentences contained in the definition must be read together. The second
sentence clarifies that significant risk is present whenever there is a
high probability that an activity or an equity investment will or could
result in a loss to an insurance fund administered by the FDIC,
regardless of whether the loss results from one or multiple
institutions. After consideration of the comments and the wording, the
FDIC adopts the expanded definition as proposed.
The proposal re-defined the term "well-capitalized" to
incorporate the same meaning set forth in part 325 of this chapter for
an insured state nonmember bank. For other state-chartered depository
institutions, the term "well-capitalized" has the same meaning as
set forth in the capital regulations adopted by the state. Importing
the capital definitions used by the various state-chartered depository
institutions should simplify the calculations when they deal with their
appropriate federal banking agency. The other terms defined under
§ 362.2(x) of the current regulation were deleted as unnecessary due
to the other changes in the regulation text.
The proposal added definitions of the following terms: "change in
control", "institution", "majority-owned subsidiary",
"security" and "state-chartered depository institution."
After reconsideration of the proposed definition of "change in
control", the FDIC decided to adopt certain changes to bring the
definition back into substantive consistency with the broader reach of
the term as is provided by the current regulation. The change in
control definition comes into play primarily in connection with section
24's grandfather with respect to common or preferred stock listed on a
national securities exchange and shares of registered investment
companies. Section 24 states that the grandfather ceases to apply if
the bank converts its charter or undergoes a change in control.
The definition proposed at § 362.2(c) covered any instance in
which the bank undergoes a transaction which requires a notice to be
filed under section 7(j) of the FDI Act (12 U.S.C. 1817(j)) except a
transaction which is presumed to be a change in control for the
purposes of that section under FDIC's or FRB's regulations
implementing section 7(j), or in which the bank is acquired by or
merged into a bank that is not eligible for the grandfather. This
proposed definition eliminated two other instances which the current
regulation, at § 362.3(b) (4)(ii), treats as a change in control:
any transaction subject to section 3 of the Bank Holding Company Act
(12 U.S.C. 1842) other than a one bank holding company formation
(section 3 transactions), and a transaction in which control of the
bank's parent company changes (parent control changes).
In the preamble to the proposal, the FDIC indicated that elimination
of the section 3 transactions and the parent control changes would
bring the definition more in line with what constituted a true change
in control. For example, the section 3 transaction language in the
current rule would encompass all mergers between the holding company of
a grandfathered bank and another bank holding company, regardless of
which holding company was the survivor. However, upon further
reflection, the FDIC has decided that total elimination of the section
3 transactions would create anomalous results. If a controlling
interest in a grandfathered bank was acquired by an unrelated holding
company (which requires approval under section 3), it is difficult to
argue how this is materially less of a change in control than if
control of the bank was acquired by an individual in a section 7(j)
transaction. Still, there are cases in which a rigid application of the
section 3 transactions would reach too far. In contrast to the example
in which a bank holding company acquires control of a grandfathered
bank, the FRB's approval under section 3 is required if a bank holding
company acquires anything more than five percent of any outstanding
class of a bank's voting shares. The revised definition at
§ 362.2(c) contained in the final rule therefore includes
transactions subject to section 3 approval only when a bank holding
company acquires control of a grandfathered bank through the section 3
transaction. The current exclusion for one bank holding company
formations also is maintained in the final rule.
Also, the elimination of the parent control changes in the proposed
rule created poten-
{{2-26-99 p.3124.14-O}}tially confusing
ambiguities, particularly when coupled with the elimination of the
section 3 transactions. For example, if the holding company of a bank
eligible for the grandfather is acquired and merged into an unrelated
bank holding company (again, which requires approval under section 3),
it is difficult to argue how this is materially less of a change in
control than if the bank itself was merged with an unrelated bank. But
the merger and acquisition language in the proposed definition referred
only to the bank itself. The final rule expands the merger language to
holding companies, accordingly. As another example, it is difficult to
argue that a transaction requiring the holding company of a
grandfathered bank to submit a change in control notice under section
7(j) is materially less of a change in control than a transaction
requiring the grandfathered bank itself to file such a notice, and the
7(j) language in the proposed rule did not expressly refer to holding
company transactions. In the final rule, the FDIC has therefore revised
the 7(j) language to clarify its applicability to both scenarios.
The FDIC received three similar comments expressing concern about
the proposed changes to the "change in control" definition. The
commenters acknowledge that deleting certain instances from the current
definition reduces the instances in which a bank would lose its
grandfathered rights. Nonetheless, the commenters feel that it is
unclear whether the proposed changes may have also inadvertently
broadened the reach of the remaining transactions causing the
grandfathered right to be terminated. This ambiguity appears to result
from an incomplete understanding of whether the definition continues to
exclude transactions presumed to be a change in control under the
FDIC's and FRB's regulations implementing section 7(j) of the FDI
Act. The FDIC wants to assure commenters that the regulatory language
of the final definition, like that of the proposal, continues to
exclude such presumed changes in control from the events that result in
a loss of the subject grandfathered rights.
One additional commenter took exception to the FDIC's position
concerning the ability to look to the substance of a transaction in
determining whether grandfather rights terminate. The commenter
objected to the FDIC's statement in the preamble to the proposed rule
that state banks should be aware that, depending upon the
circumstances, the grandfather could be considered terminated after a
merger transaction in which an eligible bank is the survivor. For
example, if a state bank that is not eligible for the grandfather is
merged into a much smaller state bank that is eligible for the
grandfather, the FDIC may determine that in substance the eligible bank
has been acquired by a bank that is not eligible for the grandfather.
The commenter argues that the FDIC's interpretation is inconsistent
with the FDIC's current regulations, and claims that if the FDIC
subjects such transactions to subjective criteria such as relative
asset size, institutions considering mergers or acquisitions will be
disadvantaged because of the uncertainty regarding the potential loss
of grandfathered status. The commenter also asserts that the FDIC's
interpretation is inconsistent with congressional intent because
section 24 did not define change in control; Congress clearly intended
the use of "change in control" language in section 24(f)(5) to
reference the meaning of the phrase "change in control"
established by the Change in Bank Control Act (CBCA) (12 U.S.C.
1817(j)). In the commenter's view, since the CBCA predates section 24
by nine years, Congress intended to use "change in control" as a
term of art.
The interpretation set out in the preamble to the proposal is
consistent with the FDIC's current regulation and is in fact set out
in the preamble accompanying the FDIC's original adoption of the
change in control provisions under part 362 in 1992. 57 FR 53227 (Nov.
9, 1992). The commenter's argument takes too narrow a view of section
24(f)(5), as the FDIC pointed out in proposing the change of control
provisions of current part 362. In light of the broader congressional
action under section 24 to generally prohibit equity investments by
state banks which are not permissible for a national bank, and the
limited nature of the grandfather exception, it is appropriate to
define the universe of events constituting a change in control so as to
encompass transactions constituting a true acquisition. 57 FR 30444
(July 9, 1992). In modifying the change in control provisions of part
362,
{{2-26-99 p.3124.14-P}}the FDIC
has narrowed the definition somewhat, as discussed above, to
approximate more closely when a true change in control of the bank has
taken place. If, as the commenter argues, change in control only
includes transactions subject to the CBCA, the exclusion under the CBCA
for all transactions reviewable under the Bank Merger Act (12 U.S.C.
1828(c)) or the Bank Holding Company Act would be brought to bear.
Therefore, the FDIC rejects the arguments provided by the commenter as
being an overly narrow interpretation of the statute.
We defined "state chartered depository institution" and
"institution" to mean any state bank or state savings association
insured by the FDIC. These definitions should enhance readability and
eliminate ambiguity concerning the subject terms. Defining
"institution" enables us to shorten the drafting of the rule. No
comments were received regarding these definitions which are adopted as
proposed.
Additionally, the proposal added a definition of "majority-owned
subsidiary" which was defined to mean any corporation in which the
parent insured state bank owns a majority of the outstanding voting
stock. This definition was added to clarify our intention that
expedited notice procedures only be available when an insured state
bank interposes an entity providing limited liability to the parent
institution. We interpret Congress's intention in imposing the
majority-owned subsidiary requirement in section 24 of the FDI Act to
generally require that such a subsidiary provide limited liability to
the insured state bank. Thus, except in unusual circumstances, we have
and will require majority-owned subsidiaries to adopt a form of
business that provides limited liability to the parent bank. In
assessing our experience with applications, we have determined that the
notice procedure will be available only to banks that engage in
activities through a majority-owned subsidiary that takes the corporate
form of business. We welcome applications that may take a different
form of business such as a limited partnership or limited liability
company, but would like to develop more experience with appropriate
separations to protect the bank from liability under these other forms
of business enterprise throughthe application process
before including such entities in a notice procedure.
Eight commenters objected to the FDIC's decision to construct the
definition around the corporate form of business. The commenters were
unanimous in suggesting that the FDIC expand the definition to include
limited liability companies (LLCs), limited liability partnerships
(LLPs), and limited partnerships. Several of the commenters note that
these forms of business have been in existence in many states for a
number of years, and they project that the presence of such structures
will continue to increase given the tax benefits, limited liability,
and flexible structure provided by these business forms. The
respondents contend that these business forms sufficiently insulate the
members and partners from liability. One commenter noted that they are
aware of no significant judicial challenge to the liability insulation
provided by these business forms. As such, the commenter asserts that
the proposed definition contravenes congressional intent because it
does not recognize a business form that would provide limited liability
to the insured state bank. Finally, the commenters note that both the
FRB and the OCC have recently permitted the limited liability
organizational form for operating subsidiaries.
Limited liability partnerships and companies are both relatively new
business forms. There is little definitive legal guidance concerning
the liability protection offered by these organizational structures.
Among the unresolved issues is the question of how to structure the
management of LLCs and LPs to afford the same level of separateness
provided by the corporate form under the eligible subsidiary criteria.
Because of the limited existing case law regarding piercing the veil of
LLCs and LLPs, the FDIC is unable to determine the appropriate
objective separation criteria that will provide the parent bank with
substantially the same liability protection offered by an independent
corporate structure. Thus, we have not expanded the definition to
include LLCs and LLPs at this time. The FDIC views this decision to
preclude LLCs and LLPs as consistent with the agency's interpretation
of the congressional intent to limiting liability for subsidiaries'
activities from accruing to the insured state bank.
{{2-26-99 p.3124.14-Q}}
The effect of the FDIC's decision is that the notice process is
limited to banks with subsidiaries organized using the corporate form.
We encourage banks to submit applications when they want to use an
alternative business form. Then, the banks can propose appropriate
objective separations that fit the particular activity and the FDIC can
evaluate these separations on a case-by-case basis. At some future
date, more standardized criteria may emerge. Then, the FDIC may
consider re-visiting this issue. The FDIC does not intend any exclusion
of these forms by omitting them from the notice processing criteria.
They simply do not allow for the more limited review involved in an
expedited notice processing system.
Although the FDIC requires the first level majority-owned subsidiary
to be a corporation, it is noted that the final regulation contains a
provision, at § 362.4(b)(3), allowing lower level subsidiaries to
assume other business forms including LLCs and LLPs. Please refer to
the applicable discussion of this section elsewhere in this preamble.
The final rule also incorporates the definition of "security"
from part 344 of this chapter to eliminate any ambiguity over the
coverage of this rule when securities activities and investments are
contemplated.
Section 362.3 Activities in Insured State Banks
Equity Investment Prohibition. Section 362.3(a) restates
the statutory prohibition on insured state banks making or retaining
any equity investment of a type that is not permissible for a national
bank. The prohibition does not apply if one of the statutory exceptions
contained in section 24 of the FDI Act (as restated in the current
regulation and carried forward in the final regulation) applies. As
discussed in the preamble accompanying the proposal, the final
regulation eliminates the reference to "amount" that is contained
in the current version of § 362.3(a). The FDIC reconsidered our
interpretation of the language of section 24 in which paragraph (c)
prohibits an insured state bank from acquiring or retaining any equity
investment of a type that is impermissible for a national bank and
paragraph (f) prohibits an insured state bank from acquiring or
retaining any equity investment of a type or in an amount that is
impermissible for a national bank. We previously interpreted the
language of paragraph (f) as controlling and read that language into
the entire statute. We reconsidered this approach and decided that it
was not the most reasonable construction of this statute and determined
that the language of the earlier paragraph (c) is controlling without
the necessity to import the language of (f). We believe that the second
mention as contained in paragraph (f) should be limited to those items
discussed under paragraph (f). Thus, the language of paragraph (c)
controls when any other equity investment is being considered.
Therefore, we deleted the amount language from the prohibition stated
in the regulation. The FDIC received comments from two parties
expressly approving this revised interpretation.
Exception for subsidiaries of which the bank is
majority owner. The final regulation retains the exception
allowing investments in subsidiaries of which the bank is majority
owner as currently in effect without any substantive change. However,
the FDIC has modified the language of this section to remove negative
inferences and make the text clearer. Rather than stating that the bank
may do what is not prohibited, the FDIC affirmatively states that an
insured state chartered bank may acquire or retain investments in these
subsidiaries. If an insured state bank holds less than a majority
interest in the subsidiary, and that equity investment is of a type
that would be prohibited to a national bank, the exception does not
apply and the investment is subject to divestiture.
Majority ownership for the exception is understood to mean
ownership of greater than 50 percent of the outstanding voting stock of
the subsidiary. National banks may own a minority interest in certain
types of subsidiaries. (See 12 CFR 5.34 (1998)). Therefore,
an insured state bank may hold a minority interest in subsidiary if a
national bank could do so. Thus, section 24 does not necessarily
require a state bank to hold at least a majority of the stock of a
company in order for the equity investment in the company to be
permissible.
For purposes of the notice procedure, the regulation defines the
business form of a majority-owned subsidiary to be a corporation. As is
discussed above in connection
{{2-26-99 p.3124.14-R}}with the definition of
a "Majority-owned subsidiary", there may be other forms of
business organization that are suitable for the purposes of this
exception such as partnerships or limited liability companies, but the
FDIC prefers to review such alternate forms of organization on a
case-by-case basis through the application process to assure that
appropriate separation between the insured depository institution and
the subsidiary is in place.
To qualify for the exception, the majority-owned subsidiary may
engage only in the activities described in § 362.4(b). The allowable
activities include exceptions to the general statutory prohibition,
some of which have a statutory basis and others of which are derived
through the FDIC's power to create regulatory exceptions.
Investments in qualified housing projects. Section
362.3(a)(2)(ii) of the final regulation provides an exception for
qualified housing projects. The final regulation combines the language
found in two paragraphs of the current regulation with the resulting
paragraph retaining substantially the same language. Changes were made
to clarify some technical aspects of the manner in which the qualified
housing rules work and are not intended to be substantive. In addition,
the FDIC modified the language of the text to remove negative
inferences and make the text clearer.
Under this exception, an insured state bank is allowed to invest as
a limited partner in a partnership, the sole purpose of which is direct
or indirect investment in the acquisition, rehabilitation, or new
construction of a residential housing project intended to primarily
benefit lower income persons throughout the period of the bank's
investment. The bank's investments, when aggregated with any existing
investment in such a partnership or partnerships, may not exceed 2
percent of the bank's total assets. The FDIC expects a bank to use the
figure reported on the bank's most recent consolidated report of
condition (Call Report) prior to making the investment as the measure
of its total assets. If an investment in a qualified housing project
does not exceed the limit at the time the investment is made, the
investment shall be considered to be a legal investment even if the
bank's total assets subsequently decline.
The current exception is limited to instances in which the bank
invests as a limited partner in a partnership. In the proposal, comment
was invited on (1) whether the FDIC should expand the exception to
include limited liability companies and (2) whether doing so is
permissible under the statute. (Section 24(c)(3) of the FDI Act
provides that a state bank may invest "as a limited partner in a
partnership".) No comments were received on the legal issue. One
comment applauded our suggestion to expand this statutory exception by
regulation. In the final rule, we have expanded § 362.3(a)(2)(ii) to
permit insured state banks to invest in qualified housing projects as a
limited partner or through a limited liability company.
Although the statutory language in the paragraph allowing an
investment in qualified housing projects explicitly allows only a
limited partnership investment, it does not prohibit other forms of
ownership. For the purpose of this investment and consistent with the
underlying public policy purposes of this statute, we consider limited
liability companies to be substantially equivalent to limited
partnership interests. It is consistent with the FDIC's authority
under the statute to extend the qualified housing projects exception by
regulation to cover the limited liability company form of business
enterprise in this circumstance. Limited partnership interests and
limited liability companies provide similar forms of business
enterprise. Although we have been unwilling to expand the regulatory
exceptions to allow limited liability companies to substitute for
corporate forms of business enterprise where uniform separation
standards were required to protect the bank from the liability of its
subsidiaries that conduct activities not permissible for national bank
subsidiaries, we believe that no similar impediments exist here. We
also acknowledge that we have been reluctant to extend this exception
to limited liability companies in the past when informal
interpretations were requested. 3
However, we believe, and no commenter raised a contrary argument, that
it is appropriate to extend the statutory exception to
{{2-26-99 p.3124.14-S}}cover these
substantially similar organizational structures through this
regulation. Thus, subject to the other limitations in the rule, we are
allowing by regulation insured state banks to invest in limited
liability companies that invest in the acquisition, rehabilitation or
construction of a qualified housing project.
Grandfathered investments in listed common or preferred stock
and shares of registered investment companies. Available only to
certain grandfathered state banks, § 326.3 (a)(2)(iii) of the
final regulation carries forward the statutory exception for
investments in common or preferred stock listed on a national
securities exchange and for shares of investment companies registered
under the Investment Company Act of 1940. Although there is no
substantive change, the FDIC has modified the language of this section
to remove negative inferences and make the text clearer.
To use the grandfathered authority, section 24 requires, among other
things, that a state bank file a notice with the FDIC before relying on
the exception and that the FDIC approve the notice. The notice
requirement, content of notice, presumptions with respect to the
notice, and the maximum permissible investment under the grandfather
also are set out in the current regulation. The references contained in
the current regulation describing the notice content and procedures
were deleted because we believe that most, if not all, of banks
eligible for the grandfather already have filed notices with the FDIC.
Thus, we eliminated language governing the specific content and
processing of notices and cross-referencing the notice procedures under
subpart G of part 303. Any bank that has filed a notice need not file
again.
Paragraph (B) of this section of the final regulation provides that
the exception for listed stock and registered shares ceases to apply in
the event that the bank converts its charter or the bank or its parent
holding company undergoes a change in control. This language restates
the statutory language governing when grandfather rights terminate. As
is discussed in the preamble above in connection with the definition of
"change in control", the FDIC has revised both the current and
proposed scope of transactions encompassed in the notion of a change in
control.
The regulation continues to provide that in the event an eligible
bank undergoes any transaction that results in the loss of the
exception, the bank is not prohibited from retaining its existing
investments unless the FDIC determines that retaining the investments
will adversely affect the bank and the FDIC orders the bank to divest
the stock and/or shares. This provision has been retained in the final
rule without any change except for the deletion of the citation to
specific authorities the FDIC may rely on concerning divestiture.
Rather than containing specific citations, the final regulation merely
references the FDIC's ability to order divestiture under any
applicable authority. State banks should continue to be aware that any
inaction by the FDIC would not preclude a bank's appropriate banking
agency (when that agency is an agency other than the FDIC) from taking
steps to require divestiture of the stock and/or shares if, in that
agency's judgment, divestiture is warranted.
The FDIC has moved, simplified, and shortened the limit on the
maximum permissible investment in listed stock and registered shares.
The final regulation limits the bank's investment in grandfathered
listed stock and registered shares, when made, to a maximum of 100
percent of tier one capital as measured on the bank's most recent Call
Report prior to the investment. The final rule modifies the proposed
regulatory language somewhat, to clarify how the maximum investment
limit is to be determined. The final rule uses the lower of the bank's
cost or the market value of the stock and shares as the measure of
compliance with this limit. The proposal referred to book value. At the
time the FDIC adopted the current version of the rule, call report
instructions and generally accepted accounting principles (GAAP)
provided that equity securities were generally to be carried at the
lower of cost or market value. The FDIC adopted the book value approach
at that time, in response to industry comments that a market value
approach would exhaust a bank's grandfather authority as the value of
its stock and shares appreciated. Now that call report instructions and
GAAP require
{{2-26-99 p.3124.14-T}}stock and shares
covered by the rule to be reported at market value in many cases, the
book value approach no longer serves the desired purpose. The FDIC is
expressly referring to the lower of cost or market approach in the
final rule, in order to maintain consistency with the current rule. The
lower of cost or market approach is also consistent with the federal
banking agencies' rules for determining tier one capital, which
require exclusion of net unrealized holding losses on
available-for-sale equity securities with readily determinable fair
values.
Language indicating that investments by well-capitalized banks in
amounts up to 100 percent of tier one capital will be presumed not to
present a significant risk to the fund was deleted, as was language
indicating that it will be presumed to present a significant risk to
the fund for an undercapitalized bank to invest in amounts that high.
In addition, the proposed rule deleted the language stating the
presumption that, absent some mitigating factor, it will not be
presumed to present a significant risk for an adequately capitalized
bank to invest up to 100 percent of tier one capital. The FDIC received
one comment asking that we retain regulatory language describing these
presumptions for well- and adequately-capitalized banks. The commenter
believes that removal of the presumptions will create uncertainty and
may cause banks to hesitate to take full advantage of these investment
opportunities. The FDIC nonetheless believes at this time that it is
not necessary to expressly state these presumptions in the regulation.
However, this action does not alter the FDIC's position regarding the
presumptions.
Language in the current regulation concerning the divestiture of
stock and/or shares in excess of that permitted by the FDIC (as well as
such investments in excess of 100 percent of the bank's tier one
capital) has been deleted under the proposal as no longer necessary due
to the passage of time. In both instances, the time allowed for such
divestiture has passed.
We note that the statute does not impose any conditions or
restrictions on a bank that enjoys the grandfather in terms of per
issuer limits. The proposal invited comment on whether the FDIC should
impose restrictions under the regulation that would, for example, limit
a bank to investing in less than a controlling interest in any given
issuer. Additionally, we asked whether the regulation should
incorporate other limits or restrictions to ensure the grandfathered
investments do not pose a risk. Although no comments specifically
addressed these questions, several commenters referred to the fact that
most institutions to which the grandfather is applicable have already
filed notices with the FDIC regarding those investments. These
institutions have since complied with any imposed conditions, or
subsequently applied to have the conditions altered or removed. The
commenters do not feel that banks should now be subject to requirements
the FDIC did not originally impose. Moreover, the commenters point out
that the FDIC and state banking authorities routinely review investment
portfolios as part of the supervisory process and can address any
deficiencies on a case-by-case basis. Upon further reflection, the FDIC
is persuaded not to impose any new regulatory requirements on these
grandfathered institutions for directly held investments. However, the
FDIC wants to emphasize that it expects banks using this grandfathered
investment authority to establish prudent limits and controls governing
these investments. Equity securities and registered shares that are
held by the bank must be consistent with the institution's overall
investment goals and will be reviewed by examiners in that context. The
FDIC will not take exception to listed stock and registered shares that
are well regarded by knowledgeable investors, marketable, held in
moderate proportions, and meet the institution's overall investment
goals.
Stock investment in insured depository institutions owned
exclusively by other banks and savings associations (banker's banks).
Section 362.3(b)(2)(iv) of the final regulation continues to
reflect the statutory exception that an insured state bank is not
prohibited from acquiring or retaining the shares of depository
institutions that engage only in activities permissible for national
banks, are subject to examination and are regulated by a state bank
supervisor, and are owned by 20 or more depository institutions not one
of which owns more than 15 percent of the voting shares. In addition,
the
{{2-26-99 p.3124.14-U}}voting shares must be
held only by depository institutions (other than directors' qualifying
shares or shares held under or acquired through a plan established for
the benefit of the officers and employees). Note that the proposal
modified this exception to no longer limit the bank's investment in
such depository institutions to "voting" stock. This change was
made to allow banks to hold non-voting interests in these entities
because section 24(f)(3)(B) of the FDIC Act does not limit the
exception to voting stock. However, the final regulation retains the
reference to "voting" stock in determining the various ownership
and control thresholds. The FDIC received no comments on this provision
which is adopted as proposed.
Stock investments in insurance companies. Section
362.3(a)(2)(v) of the final regulation incorporates statutory
exceptions permitting state banks to hold equity investments in
insurance companies. The exceptions are provided by statute and are
implemented in the current version of part 362. For the most part, the
exceptions are carried forward into the final regulation with no
substantive editing. The exceptions are discussed separately below.
Directors and officers liability insurance corporations.
The first exception permits insured state banks to own stock in
corporations that solely underwrite or reinsure financial institution
directors' and officers' liability insurance or blanket bond group
insurance. A bank's investment in any one corporation is limited to 10
percent of the outstanding stock. Consistent with the proposal, we
eliminated the present limitation of 10 percent of the "voting"
stock and changed the present reference from "company" to
"corporation" conforming the language to the statutory exception.
While the statute and regulation provide a limit on a bank's
investment in the stock of any one insurance company under this
provision, there is no statutory or regulatory "aggregate"
investment limit in all insurance companies, nor does the statute
combine these investments with any other exception under which a state
bank may invest in equity securities. In the past, the FDIC has
addressed investment concentration and diversification issues on a
case-by-case basis. Nonetheless, the FDIC invited comment on whether it
should incorporate aggregate limits on grandfathered bank investments
in insurance companies. Responses addressing this issue were submitted
by two trade associations and one bank consortium. While one trade
association suggested that it would be prudent for the FDIC to
incorporate some form of investment limit, the other two parties
strongly opposed the imposition of any regulatory limit on what are
statutory exceptions. The FDIC has elected not to impose aggregate
investment limits on equity investments specifically permitted by
statute, nor will it combine the bank's investments in insurance
companies with other equity investments made pursuant to any regulatory
exception. Instead, the FDIC will continue to address investment
concentration and diversification issues on a case-by-case basis.
Stock of savings bank life insurance company. The second
exception for equity investments in insurance companies permits any
insured state bank located in New York, Massachusetts, or Connecticut
to own stock in savings bank life insurance companies provided that
certain consumer disclosures are made. Again, this regulatory provision
mirrors the specific statutory exception found in section 24. The
savings bank life insurance investment exception is broader than the
director and officer liability insurance company exception discussed
above. There are no individual or aggregate investment limitations for
investments in savings bank life insurance companies.
Consistent with the proposal, the provision implementing this
exception in the current regulation was carried forward into the final
regulation with some modifications. The language describing this
exception was revised to affirmatively permit banks located in New
York, Massachusetts, or Connecticut to own stock in a savings bank life
insurance company provided the company provides the required
disclosures. Additionally, the final regulation alters the required
disclosure from that provided by the current regulation. Rather than
continue the disclosure language currently contained in
§ 362.3(b)(3), the FDIC has decided to require disclosures of the
type provided for in the Interagency Statement. As a result, these
companies are required to provide their retail customers with written
and oral disclo-
{{2-26-99 p.3124.14-V}}sures consistent with
the Interagency Statement when selling savings bank life insurance
policies, other insurance products, and annuities. The required
disclosures in the Interagency Statement include a statement that the
products are not insured by the FDIC, are not a deposit or other
obligation of, or guaranteed by, the bank, and are subject to
investment risks, including the possible loss of the principal amount
invested. While the existing regulatory language is similar to the
Interagency Statement in what it requires to be disclosed, it is not
identical. The last disclosure--that such products may involve risk of
loss--is not required under the current regulation.
Although commenters generally supported referencing the Interagency
Statement rather than incorporating a different disclosure standard, a
savings bank life insurance company and a United States Congressman
objected to the "risk of loss" disclosure. The savings bank life
insurance company claims that a disclosure of that nature is a
falsehood unsupported by factual data. Both commenters are concerned
that the "risk of loss" disclosure places savings bank life
insurance companies at a competitive disadvantage relative to other
entities selling life insurance products. The Congressman suggested
replacing the required disclosure concerning "may involve risk of
loss" with "may involve market risk, if applicable".
It is the FDIC's view that FDIC-insured deposits differ from
savings bank life insurance products and annuities because investors in
such products are exposed to a possible loss of the principal amount
invested. The Interagency Statement does not distinguish between the
relative loss exposure presented by various nondeposit investment
products. The distinction is simply between insured deposits and other
investment products. Savings bank life insurance, other insurance
products, and annuities contain an investment risk component exposing
the investor to a loss of principal despite the assertion offered by
one commenter. Further, investors in nondeposit products are exposed to
more than market risks. The FDIC is therefore unwilling to change the
nature of the required disclosure.
Nevertheless, the FDIC recognizes that the language proposed in
§ 362.3(a)(2)(v)(B) may be interpreted to mean the
subject disclosure must contain the phrase "may involve
risk of loss". The FDIC intends for the disclosures to be consistent
with the Interagency Statement and was simply paraphrasing the
respective disclosure content in the event the Interagency Statement is
succeeded by another statement or regulation. Included in the required
disclosures is a statement specifying that the nondeposit product is
"subject to investment risks, including possible loss of the
principal amount invested". The actual Interagency Statement
language may convey a less threatening tone concerning the possibility
of loss. To avoid confusion and reflect the FDIC's actual intent, the
phrase "may involve risk of loss" was replaced with "are
subject to investment risks, including possible loss of the principal
amount invested" in the final rule.
The FDIC is aware that insurance companies, including savings bank
life insurance companies, typically offer annuity products and that
many state regulate annuities through their insurance departments. The
FDIC agrees with the OCC that annuities are investment products that
are subject to the requirements found in the Interagency Statement
when sold to retail customers on bank premises as well as in other
instances specified in the Interagency Statement.
Other activities prohibition. Section 362.3(b) of the
final regulation restates the statutory limit prohibiting insured state
banks from directly or indirectly engaging as principal in any activity
that is not permissible for a national bank. Activity is defined in the
rule as the conduct of business by a state-chartered depository
institution and includes acquiring or retaining any investment. Because
acquiring or retaining an investment is an activity by definition, the
proposal added language to make clear that this prohibition does not
supersede the equity investment exceptions of § 362.3 (a)(2). The
prohibition does not apply if one of the statutory exceptions contained
in section 24 of the FDI Act (restated in the current regulation and
carried forward in the final regulation) applies. The FDIC has also
provided a regulatory exception to the prohibition on other activities
concerning the acquisition of certain debt-like instruments. Insured
state banks desiring to engage in
{{2-26-99 p.3124.14-W}}other activities must
submit an application to the FDIC pursuant to
§ 362.3 (b)(2)(i).
Consent through Application. The limit on activities
contained in section 24 states that an insured state bank may not
engage as principal in any type of activity that is not permissible for
a national bank unless the FDIC has determined that the activity would
pose no significant risk to the appropriate deposit insurance fund, and
the bank is and continues to be in compliance with applicable capital
standards prescribed by the appropriate federal banking agency. Section
362.3(b)(2)(i) establishes an application process for the FDIC to make
the determination concerning risk to the funds. The substance of this
process is unchanged from the current regulation.
Insurance underwriting. This exception tracks the
statutory exception in section 24 which grandfathers: (1) Certain
insured state banks engaged in the underwriting of savings bank life
insurance through a department of the bank; (2) any insured state bank
that engaged in underwriting of insurance on or before September 30,
1991, which was reinsured in whole or in part by the Federal Crop
Insurance Corporation; and (3) certain well-capitalized banks engaged
in insurance underwriting through a department of a bank. The exception
is carried forward from the current regulation with a number of
modifications.
The savings bank life insurance exception applies to insured state
banks located in Massachusetts, New York, or Connecticut. To use this
exception, banks must engage in the activity through a department of
the bank meeting the core standards discussed below. The standards for
conducting this activity are taken from the current regulation with the
exception of the disclosure standards which are discussed below. We
moved the requirements for a department from the definitions section to
the substantive portion of the regulation text.
The exception for underwriting federal crop insurance is unchanged
from the current regulation, and there are no regulatory limitations on
the conduct of the activity.
An insured state bank that wishes to use the remaining grandfathered
insurance underwriting exception may do so only if the insured state
bank was lawfully providing insurance, as principal, as of November 21,
1991. Further, the insured state bank must be well-capitalized if it is
to engage in insurance underwriting and the bank must conduct the
insurance underwriting in a department that meets the core standards
described below. Banks taking advantage of this grandfather provision
may underwrite only the same type of insurance that was underwritten as
of November 21, 1991, and may operate and have customers only in the
same states in which it was underwriting policies on November 21, 1991.
The grandfather authority for this activity does not terminate upon a
change in control of the bank or its parent holding company.
Both savings bank life insurance activities and grandfathered
insurance underwriting must take place in a department of the bank
which meets certain core operating and separation standards. Consistent
with the disclosure requirements of the current regulation, the core
operating standards require the department to inform its customers that
only the assets of the department may be used to satisfy the
obligations of the department. Note that this language does not require
the bank to say that the bank is not responsible for the obligations of
the department. The bank and the department constitute one corporate
entity. In the event of insolvency, the insurance underwriting
department's assets and liabilities would be segregated from the
bank's assets and liabilities due to the requirements of state law.
The regulatory language of the final rule has been changed to clarify
that a bank seeking to operate its department under separation
standards different than the core standards in the rule may submit an
application to the FDIC.
The final regulation eliminates the proposed operating standard
requirement that the department provide customers with written
disclosures consistent with those in the Interagency Statement. The
FDIC proposed replacing the disclosure statement currently imposed by
§ 362.4(g)(1)(iii) with that required in the Interagency Statement to
increase consistency and reduce the regulatory burden of differing
requirements. Upon further reflection, the FDIC has decided that while
it is prudent to eliminate the disclosure currently required by part
362, the proposal to impose the Interagency State-
{{2-26-99 p.3124.14-X}}ment in connection
with this activity in this regulation is unnecessary. Unlike the
statutory exception permitting banks to engage in savings bank life
insurance activities, the authorizing statute does not require a
customer disclosure as a condition of engaging in other grandfathered
insurance activities. Nevertheless, banks engaged in grandfathered
insurance underwriting continue to be subject to the Interagency
Statement in connection with sales to bank customers, including the
disclosure provisions of that statement. Comments support this change
and recognize that any retail sale of nondeposit investment products to
bank customers is subject to the Interagency Statement if made on bank
premises, by a bank employee, or pursuant to a compensated referral.
The FDIC cannot, however, eliminate the regulatory requirement that
insured state banks engaged in savings bank life insurance activities
make disclosures to all consumers. Section 24(e) of the FDI Act
authorizes this activity only if the bank meets the consumer disclosure
requirements. Thus, under the statute, the FDIC must promulgate
consumer disclosures for savings bank life insurance. Section
362.4(c)(1) of the current regulation addresses banks engaging in
savings bank life insurance underwriting activities. The referenced
section requires the bank to make certain disclosures to purchasers of
life insurance policies, other insurance products, and annuities. As
discussed previously in this preamble, these disclosures are similar to
those set out in the Interagency Statement but they are not identical.
Currently, banks engaging in savings bank life insurance underwriting
are covered by the Interagency Statement and part 362. As a result,
banks have been required to comply with both of these similar but
somewhat different requirements. The final regulation replaces the
current disclosure requirement with a cross reference to the
Interagency Statement to make compliance easier. Banks engaging in
savings bank life insurance activities should note, however, that
consistent with the proposal and the current regulation, the final rule
carries forward the requirement that the department also inform
purchasers that only the assets of the insurance department may be used
to satisfy the obligations of the department. Comments and the FDIC's
response are described elsewhere in this preamble.
The core separation standards in the final rule restate the
requirements currently found in the definition of department. These
standards require the department to: (1) Be physically distinct from
the remainder of the bank; (2) maintain separate accounting and other
records; (3) have assets, liabilities, obligations, and expenses that
are separate and distinct from those of the remainder of the bank; and
(4) be subject to state statutes that permitting the obligations,
liabilities, and expenses to be satisfied only with the assets of the
department. The standards are unchanged from those in the current
regulation, but they have been moved from the definitions section to
ensure that the requirements are shown in connection with the
appropriate regulatory exception.
Acquiring and retaining adjustable rate and money market
preferred stock. The proposal provides an exception that allows a
state bank to invest in up to 15 percent of the bank's tier one
capital in adjustable rate preferred stock and money market (auction
rate) preferred stock without filing an application with the FDIC. The
exception was adopted when the 1992 version of the regulation was
adopted in final form. After reviewing comments at that time, the FDIC
found that adjustable rate preferred stock and money market (auction
rate) preferred stock were essentially substitutes for money market
investments such as commercial paper and that these investments possess
characteristics closer to debt than to equity securities. Therefore,
money market preferred stock and adjustable rate preferred stock were
excluded from the definition of equity security. As a result, these
investments are not subject to the equity investment prohibitions of
the statute or the regulation and they are considered to be an
"other activity" for the purposes of this regulation.
This exception focuses on two categories of preferred stock. This
first category, adjustable rate preferred stock, refers to shares where
dividends are established by contract through the use of a formula
based on Treasury rates or some other readily available interest rate
levels. Money market preferred stock refers to those issues where
dividends are established through a periodic
{{2-26-99 p.3124.14-Y}}auction process that
establishes yields in relation to short-term rates paid on commercial
paper issued by the same or a similar company. The credit quality of
the issuer determines the value of the security. Money market preferred
shares are sold at auction.
Consistent with other parts of the proposal, the FDIC has modified
the exception by limiting the 15 percent measurement to tier one
capital, rather than total capital. Throughout the final regulation,
all capital-based limitations are measured against tier one capital to
increase uniformity within the regulation. The FDIC recognizes that
this change may lower the permitted amount of these investments held by
institutions already engaged in the activity. An insured state bank
that has investments exceeding the proposed limit, but within the total
capital limit, may continue holding those investments until they are
redeemed or repurchased by the issuer. The 15 percent of tier one
capital limitation should be used in determining the allowable amount
of new purchases of money market preferred and adjustable rate
preferred stock. Of course, institutions wanting to increase their
holdings of these securities may submit an application to the FDIC.
The FDIC receiv
