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FDIC Federal Register Citations

[Federal Register: March 19, 1997 (Volume 62, Number 53)]

[Rules and Regulations]

[Page 13275-13288]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr19mr97-11]

[[Page 13275]]

_______________________________________________________________________

Part VI

Department of the Treasury

Office of the Comptroller of the Currency

12 CFR Part 13

Federal Reserve System

12 CFR Part 208 and 211

Federal Deposit Insurance Corporation

12 CFR Part 368

_______________________________________________________________________

Government Securities Sales Practices; Final Rule

[[Page 13276]]

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 13

[Docket No. 97-05]

RIN 1557-AB52

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 211

[Regulations H and K, Docket No. R-0921]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 368

RIN 3064-AB66

Government Securities Sales Practices

AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of

Governors of the Federal Reserve System; Federal Deposit Insurance

Corporation.

ACTION: Joint final rule.

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SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of

Governors of the Federal Reserve System (Board), and Federal Deposit

Insurance Corporation (FDIC) (collectively, the agencies) are issuing

rules regarding sales practices concerning government securities by

depository institutions within their respective jurisdictions. The

agencies are adopting the final rules in light of recent statutory

changes authorizing the agencies to adopt rules governing transactions

in government securities in order to provide consistent treatment for

government securities customers. The final rules minimize regulatory

burdens to the extent feasible, consistent with the goal of providing

purchasers of government securities with consistent treatment

regardless of whether they engage in transactions in government

securities with banks or nonbank government securities brokers and

dealers.

EFFECTIVE DATE: This joint rule is effective July 1, 1997.

FOR FURTHER INFORMATION, CONTACT: OCC: Ellen Broadman, Director, or

Elizabeth Malone, Senior Attorney, Securities & Corporate Practices

Division (202/874-5210); Joseph W. Malott, National Bank Examiner,

Capital Markets (202/874-5070); or Mark J. Tenhundfeld, Assistant

Director, Legislative and Regulatory Activities (202/874-5090), 250 E

Street, SW, Washington, DC 20219.

Board: Oliver Ireland, Associate General Counsel (202/452-3625), or

Lawranne Stewart, Senior Attorney (202/452-3513), Legal Division, Board

of Governors of the Federal Reserve System, 20th and C Streets, NW,

Washington, DC 20551. For the hearing impaired only, Telecommunication

Device for Deaf (TDD), Ernestine Hill or Dorothea Thompson (202/452-

3544).

FDIC: William A. Stark, Assistant Director (202/898-6972), Keith

Ligon, Chief (202/898-3618), Kenton Fox, Senior Capital Markets

Specialist (202/898-7119), Division of Supervision; or Karen L. Main,

Senior Attorney (202/898-8838), Legal Division, Federal Deposit

Insurance Corporation, 550 17th Street, NW, Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

The Government Securities Act Amendments of 1993

The Government Securities Act Amendments of 1993 (Amendments)

(Pub.L. 103-202), codified at section 15C(b)(3) of the Securities

Exchange Act of 1934 (Exchange Act) (15 U.S.C. 78o-5(b)(3)), authorize

the agencies to adopt rules and regulations governing transactions in

government securities as may be necessary to prevent fraudulent and

manipulative acts and practices and to promote just and equitable

principles of trade. Id. section 15C(b)(3)(A). Rules adopted pursuant

to the Amendments apply to transactions in government securities by

banks that have filed, or are required to file, notice as government

securities brokers or dealers.

The Amendments require the banking agencies to consider the

sufficiency and appropriateness of existing laws and rules applicable

to government securities brokers or dealers and associated persons

before promulgating rules governing transactions in government

securities. Id. section 15C(b)(3)(C). In determining whether existing

laws are sufficient, the agencies may consider rules that expressly

apply to government securities activities of financial institutions and

other sales practice rules that do not expressly apply to these

activities but that are used by examiners and bankers as guidance for

transactions in government securities. S. Rep. No. 109, 103d Cong., 1st

Sess. at 14. The agencies also may consider the extent to which

additional rules are necessary to establish consistent treatment for

bank customers engaged in transactions involving government securities.

The Amendments also eliminated the statutory limitations on the

National Association of Securities Dealers (NASD) authority to apply

sales practice rules to transactions in government securities by

government securities broker-dealers that are members of the NASD. See

section 106 of the Amendments (15 U.S.C. 78o-3). To implement this

expanded sales practice authority, the NASD proposed, and the SEC

approved August 20, 1996 (see SEC Release No. 34-37588), the

application of the NASD Conduct Rules (formerly, the Rules of Fair

Practice) to transactions in government securities. The NASD Conduct

Rules include a Business Conduct Rule and a Suitability Rule, as well

as a Suitability Interpretation. The rules and the interpretation that

the agencies promulgated in both the proposed and final rules (see text

that follows) are substantially identical to the NASD Business Conduct

and Suitability Rules and the NASD Suitability Interpretation.

The Proposal

On April 25, 1996 (61 FR 18470), the agencies requested comment on

whether they should require a bank that is a government securities

broker or dealer to comply with rules that are substantively identical

to the NASD Business Conduct and Suitability Rules and the NASD

Suitability Interpretation. The proposal defined ``bank that is a

government securities broker or dealer'' as a bank that has filed

notice, or is required to file notice, as a government securities

broker or dealer under the provisions of the Government Securities Act

(15 U.S.C. 78o-5(a)) and applicable Treasury rules (17 CFR 400.1(d) and

401).

The proposal required a bank that is a government securities broker

or dealer and its associated persons: (a) To observe high standards of

commercial honor and just and equitable principles of trade in the

conduct of its business as a government securities broker or dealer;

and (b) to have reasonable grounds for believing that recommendations

are suitable for a customer based on the facts, if any, disclosed by a

customer regarding his, her, or its other securities holdings and

financial situation and needs. The proposal provided that, if a bank is

doing business with a non-institutional customer, the bank must make

reasonable efforts to obtain information concerning the customer's

financial situation and tax status and investment objectives before

executing a transaction it recommended to the customer. The suitability

rule contained in the proposal, like the Suitability Rule of the NASD,

applies only in situations where a bank makes a ``recommendation'' to

its customer.

[[Page 13277]]

The proposal also set out a suitability interpretation that

identifies factors that may be relevant when evaluating a bank's

compliance with the suitability rule when dealing with an institutional

customer other than a natural person. The interpretation identified:

(a) the customer's capability to evaluate investment risk

independently; and (b) the extent to which the customer is exercising

independent judgement in evaluating a bank's recommendation as the two

most important considerations in determining the scope of the bank's

responsibilities to an institutional customer. The suitability

interpretation provided that a bank will have met the requirements of

the suitability rule with respect to a particular institutional

customer where the bank has reasonable grounds to determine that the

institutional customer is capable of independently evaluating

investment risk and is exercising independent judgement in evaluating a

recommendation.

The proposed suitability interpretation set forth certain factors

for banks to apply in evaluating an institutional customer's capability

to evaluate investment risk independently. These factors include: The

customer's use of consultants, advisors, or bank trust departments; the

experience of the customer generally and with respect to the specific

instrument; the customer's ability to understand the investment and to

evaluate independently the effect of market developments on the

investment; and the complexity of the security involved. The

interpretation stressed that an institutional customer's ability to

evaluate investment risk independently may vary depending on the

particular type of instrument or its risk. Moreover, the interpretation

noted that an institutional customer with general ability to evaluate

investment risk may be less able to do so when dealing with new types

of instruments or instruments with which the customer has little or no

experience.

The proposed suitability interpretation further provided that a

determination that an institutional customer is making an independent

investment decision depends on factors such as the understanding

between the bank and its customer as to the nature of their

relationship, the presence or absence of a pattern of acceptance of the

bank's recommendations, the customer's use of ideas, suggestions, and

information obtained from other market professionals, and the extent to

which the customer has provided the bank with information concerning

the customer's portfolio or investment objectives.

While the proposed suitability interpretation stated that these

factors would be considered relevant in evaluating whether a bank that

is a government securities broker or dealer has fulfilled the

requirements of the suitability rule with respect to any institutional

customer that is not a natural person, it further stated that the

factors cited would be considered most relevant for an institutional

customer with at least $10 million invested in securities in the

aggregate in its portfolio or under management.

Final Rules and Comments Received

The final rules adopt the business conduct and suitability rules

and the suitability interpretation as proposed, excepting only the

addition of a definition of ``government security'' in the final rules

and minor modifications of the suitability interpretation to conform

that interpretation to the NASD's Suitability Interpretation. As

discussed in greater detail below, the agencies continue to believe

that banks and their customers will benefit significantly from a

consistent set of rules applied to banks engaged in transactions in

government securities.

The agencies received a total of 18 comments. Of these, eight were

from trade organizations representing interests ranging from the banks

and the securities companies to state governments and retired persons.

Seven other comments were from insured depository institutions or their

affiliates, two were from State governments, and the remaining comment

was from a securities dealer. The comments were fairly evenly split,

with banks and securities companies and their respective trade

organizations generally opposing the proposal and the rest of the

commenters favoring it.

Commenters typically responded to some or all of the specific

questions set out in the proposal. Below is a summary of the comments,

along with the agencies' responses, that follows the order of questions

presented for comment in the proposal.

Issue 1. Adoption of rules substantially similar to the NASD Business

Conduct and Suitability Rules

Eight commenters opposed adoption of these rules for banks while

seven favored adoption of the rules.

(a) Comments supporting adoption of the proposed rules. Commenters

representing purchasers of government securities stated that certain

government securities, such as collateralized mortgage obligations,

carry considerable risk and are unsuitable for certain investors. The

purchasers' representatives stated further that customers need to be

protected from potential misconduct in the sale of government

securities. They believe that banks should be held to the same

standards as apply to other entities that engage in government

securities transactions and that the existence of customer protections

should not depend on the type of entity selling the security. Several

of the commenters also stated their support for the suitability

interpretation, with one commenter stating that a suitability

determination must be made on a case-by-case basis and another stating

that banks should be required to ask for specific information about an

investor before making a recommendation.

(b) Comments opposing adoption of the proposed rules. Those

opposing the application of these rules to banks advanced several

arguments to support their conclusion that the rule is unnecessary.

Their arguments fall into the following eight broad categories.

(i) There have been no significant sales practice abuses.

(ii) The Amendments and the legislative history indicate that the

banking agencies are not required to adopt sales practice rules.

(iii) There are sufficient market incentives to ensure that the

good relations that exist between banks and their customers would

likely discourage banks from making unsuitable recommendations of

government securities.

(iv) A suitability obligation is particularly inappropriate in the

case of institutional investors, because institutional investors need

less protection than do retail customers and because a bank will lack

adequate information needed to detect anomalies between an

institutional customer's investment objectives and the type of trade.

(v) The rules will impose significant additional burdens on banks,

in part because the rules are too ambiguous.

(vi) The rules could have unintended adverse consequences by

discouraging investors from performing their own research in order to

shift responsibility (and, therefore, liability) for making appropriate

investments to the bank that makes a recommendation.

(vii) Case law and other issuances, such as the Interagency

Statement on Retail Sales of Nondeposit Investment Products (the

Interagency Statement), OCC Banking Circular 277--Risk Management of

Financial Derivatives, the Board's Trading Activities Manual (March

1994) and SR 93-69 (FIS) (Dec. 20, 1993), and the Rules of the

Municipal Securities Rulemaking Board

[[Page 13278]]

(MSRB), provide sufficient guidance to banks and bank examiners on

appropriate sales practices.

(viii) The agencies should consider alternatives to adopting the

rules as proposed, such as adopting guidelines or amending the proposal

to include a statement that compliance with certain requirements

creates a safe harbor.

arguments advanced by the commenters, the agencies continue to believe

that the benefits of the rules in question significantly outweigh the

burdens and, therefore, are adopting the rules substantially as

proposed. The agencies believe that adoption of final rules

substantially in the form proposed is appropriate to provide consistent

treatment for government securities customers. Although bank and

nonbank government securities dealers will continue to be subject to

different regulatory structures, adoption of business conduct and

suitability rules that are consistent with the NASD rules will ensure

that customers of both bank and nonbank government securities broker-

dealers receive consistent treatment in their government securities

transactions. The agencies agree with those who stated that certain

government securities can carry considerable risk and that the rules

appropriately focus the banking industry's attention on the issue of

suitability in recommending these securities. An analysis of the

comments opposing adoption of the rules follows.

(i) Lack of evidence of abuses. Opponents of the rules are correct

that sales practice abuses have not been found to be a significant

problem in financial institutions engaged in government securities

transactions. However, losses stemming from unsuitable transactions in

government securities can create reputational risk for banks. The

agencies believe that banking practices that comport with the final

rules will help minimize this risk to banks due to losses incurred by

their customers.

(ii) Rules not required by statute. Opponents of the rules also

correctly noted that the Amendments and the legislative history do not

require the bank regulatory agencies to adopt sales practice rules.

However, the Amendments authorize the agencies to adopt rules as may be

necessary to promote, among other things, just and equitable principles

of trade. The final rules accomplish this by providing guidance to

banks about the extent of their obligations when recommending a

government security to a customer. They also enable a customer to

receive consistent treatment, regardless of whether the customer

conducts business with a bank or nonbank government securities broker-

dealer.

(iii) Sufficient market alternatives. The agencies intend for the

rules to facilitate the good relations noted by many commenters that

exist between banks and their customers. In addition to codifying the

business conduct and suitability rules, the final rules provide banks

with guidance concerning those factors that a bank may find relevant

when determining its suitability obligations to an institutional

customer. This guidance is provided to assist banks in identifying when

an institutional customer is capable of evaluating investment risk

independently and is exercising independent judgement in evaluating the

bank's recommendation.

(iv) Suitability obligation inappropriate for institutional

customers. The agencies agree with the commenters who stated that any

suitability rule should reflect the differences between institutional

and non-institutional customers. Banks frequently will have knowledge

about an investment and its risks that are not possessed or easily

obtained by the non-institutional customer. A more sophisticated

institutional customer, on the other hand, may have both the

understanding of how a particular securities issue could perform and a

desire to make investment decisions without relying on a bank's

recommendation.

The final rules recognize the wide variety of customer profiles,

even among institutional customers, and provides guidance intended to

assist a bank in determining the nature of its suitability obligations

to a customer. Under the final rules, the nature of a suitability

determination changes, depending on the type of customer. For a

comparatively unsophisticated customer, the determination will need to

focus more on whether a particular investment is appropriate for that

customer after a review of the customer's financial condition and

objectives. For a more sophisticated customer, the focus of the

suitability determination shifts initially to the question of whether

the customer is capable of evaluating risk and the bank's

recommendation. The suitability interpretation provides illustrative

factors that are intended to help a bank determine how to fulfill its

suitability obligation for a given institutional customer. As noted in

the interpretation, these factors are not intended to be requirements

or the only factors to be considered but are offered merely as guidance

in determining the scope of a bank's suitability obligations.

(v) Increased burden. The agencies believe that the sales practice

rules will not subject banks to a material increase in regulatory

burden. Almost all banks that are government securities broker-dealers

also are municipal securities broker-dealers or sell other securities

for which they are required to comply with business conduct and

suitability rules. As a consequence, banks frequently will have

obtained the information needed to comply with the business conduct and

suitability rules from customers in the course of other securities

transactions, and will have implemented policies and procedures that

can be applied to transactions involving government securities.

(vi) Unintended adverse consequences. The agencies disagree with

the commenters who suggested that the rules will discourage customers

from consulting with their own internal or external advisors before

making an investment. These commenters are concerned that the rules

will shift liability to banks by creating disincentives for a customer

to undertake research that is independent of that conducted by a bank.

As noted in the proposal, the suitability and business conduct rules

and suitability interpretation do not provide a basis for a private

right of action against a bank by a customer based on a violation of

these rules or interpretation. Thus, a customer will have every

incentive after the rules are adopted that it had before adoption to

undertake whatever due diligence it thinks is appropriate in evaluating

an investment recommendation.

(vii) Existing guidance adequate. While those opposed to the rules

are correct that there are banking agency issuances that address sales

practices in other areas of securities sales, these issuances do not

provide customers who engage in government securities transactions with

banks with treatment that is consistent with that provided under the

NASD Business Conduct or Suitability Rules or the NASD Suitability

Interpretation. Moreover, existing guidance does not address government

securities sales practices for all types of customers. The final rules

will provide a framework that will be consistent throughout the banking

industry for analyzing the obligations of a bank engaged in government

securities transactions.

(viii) Suggested alternatives. One bank commenter recommended that

the agencies adopt guidelines instead of the proposed sales practice

rules. Another suggested that the agencies adopt an

[[Page 13279]]

``appropriateness'' standard pursuant to which a bank would focus on

the customer's ability to understand the nature of, and risks inherent

in, a given transaction. Two commenters suggested that the final rules

contain an assurance that compliance with the interpretive guidance

will create, at a minimum, a rebuttable presumption that a bank's

suitability obligations with respect to institutional customers have

been satisfied. Finally, another commenter suggested that banks be

insulated from liability if an institutional customer has retained a

third party professional investment advisor or if the bank executes a

transaction that is consistent with an institutional account's

specifically enumerated authorized investment guidelines.

The agencies have concluded, however, that adopting the rules in

the form of a regulation will provide consistent treatment of

customers, regardless of whether they conduct business with a bank or a

nonbank government securities broker-dealer. The agencies also have

decided not to create any safe harbors whereby a bank would be presumed

to have fulfilled its suitability obligation. The creation of such a

presumption would be acceptable only if a definable class of

institutional customers could be identified that would not benefit from

the suitability rule under any conceivable circumstance.

``Institutional customers'' include, among others, colleges, churches,

charities, and governments. Given the wide diversity of characteristics

that such entities present, the agencies have concluded that it is more

appropriate for a bank to determine suitability on a case-by-case

basis. Furthermore, nonbank broker-dealers do not have safe harbors

whereby compliance with the suitability obligation is presumed. To

create a safe harbor for banks would reduce the benefits of consistent

treatment of customers.

Issue 2. Benefits of Consistency Among Government Securities Brokers

and Dealers

Of the seven commenters responding to this issue, five stated that

there are benefits of consistent treatment by government securities

broker-dealers while two stated that consistency would not provide

significant benefits.

(a) Comments favoring consistency. Several commenters stated that

customers are more likely to receive equal treatment if the agencies

impose rules similar to those imposed by the NASD. One commenter noted

that the substance of the rules applied by the banking agencies should

be as uniform as possible with those applied by the NASD to minimize

the extent to which there are gaps in the existing regulatory

framework. Another commenter stated that a customer should not have to

bear the burden of determining which set of rules apply to different

dealers who are performing exactly the same functions concerning

exactly the same types of investments. In this commenter's view, the

agencies'' role in maintaining the safety and soundness of banks

includes protecting customers. A third commenter observed that

fragmentation of the market is likely if different rules apply.

(b) Comments opposing consistency. A trade association representing

both bank and nonbank interests stated that a majority of its members

believes that adopting the final rules is not justified because the

level playing field already exists in the form of remedial and

enforcement authority that the agencies may exercise. Another commenter

noted that there are significant differences between bank and nonbank

government securities broker-dealers, and concluded that these

differences justify using different standards. This commenter believes

that the different standards continue to result in the same level of

customer protection, thus obviating the need to adopt the rules set out

in the proposal.

will provide consistent treatment to customers engaging in government

securities transactions, regardless of whether the customer receives a

recommendation from a bank or nonbank government securities broker-

dealer. The existing regulatory and common law does not provide this

consistent treatment. The final rules avoid requiring customers to

ascertain which rules apply to which institution. Moreover, the

agencies expect that the final rules, by focusing banks' attentions on

suitability concerns, will minimize the disputes between banks and

their customers concerning the suitability of a given recommendation.

Issue 3. Sufficiency of the Standard Provided in the Business Conduct

Rule

Five commenters responded to this issue. Four commenters believe

that the business conduct rule is sufficiently clear, while one

commenter believes that additional interpretation is necessary.

(a) Comments finding business conduct rule clear. One commenter

stated that the business conduct rule, taken together with the

suitability rule, is sufficiently clear. In this commenter's opinion, a

rule of this nature should provide a general code of conduct that

protects the integrity of the profession by setting a baseline of good

conduct. Another commenter suggested that more specific guidelines may

be too restrictive and not benefit the customer or bank. A third

commenter restated its request for changes in the examination

procedures to ensure compliance with the final rule but suggested that

banks should have less latitude in the types of information requested

from a customer. The fourth commenter stated its general agreement that

the business conduct rule is clear.

(b) Comments finding the business conduct rule unclear. The one

comment finding the business conduct rule unclear stated that the rule

does not delineate proper conduct for sales practices. This commenter

stated that it views the NASD guidance related to the business conduct

rule as providing appropriate additional clarification.

conduct rule set out in the proposal is sufficiently clear. As noted by

one commenter, the rule establishes a baseline of appropriate behavior

in the industry. A bank then has the flexibility to comply with this

standard in ways that it finds appropriate and effective. Attempts at

additional clarification in this area are likely to provide little

additional meaningful guidance without becoming so detailed as to be

overly burdensome and restrictive. The agencies also are concerned that

additional clarification in the business conduct rule would detract

from the objective of ensuring consistent treatment for customers of

bank and nonbank government securities broker-dealers. The agencies

note that the NASD is continuing to consider issues concerning the

application of certain interpretations of their Business Conduct Rule

to the government securities markets.

Issue 4. Definition of ``Recommendation''

The issue of whether to define ``recommendation'' or provide

guidance as to what is and is not a recommendation generated responses

from seven commenters, four of whom requested additional guidance or a

definition and three of whom stated that no additional guidance or

definition is needed.

(a) Comments favoring defining ``recommendation.'' A point

consistently made by those requesting additional guidance is that the

rules should clarify that a recommendation does not include providing

routine market information, such as market observations, forecasts

about the general

[[Page 13280]]

direction of interest rates, and price quotations. One commenter also

stated that the rules should not treat subjective analyses of market

information as a recommendation, because to do so would discourage

banks from providing this information. This commenter suggested that

the rules exclude from the definition of ``recommendation'' the

providing of several investment alternatives for an investor's

consideration. Two commenters proposed definitions that would include,

generally speaking, an unconditional affirmative statement by one party

urging another to enter into a particular transaction, an explicit

identification of the statement as a recommendation, and/or a

requirement that information be given to the bank expressly for the

purpose of enabling the bank to make a recommendation. One of these

commenters stated that reliance should not be considered reasonable

unless an institutional customer has provided information regarding its

portfolio, its liabilities, and the range of investment opportunities

available to the customer. Another commenter concluded that the

definition is so vague that the commenter will have to assume, despite

the fact that it makes no recommendations, that all current sales

activities constitute making a recommendation and then build systems

and increase staff to evaluate and document the suitability of each

customer purchase. Another commenter suggested that a definition should

not include trade or hedging ideas unless there is a written agreement

between the parties or unless applicable law expressly imposes

affirmative obligations to the contrary. This commenter noted that this

approach would be consistent with the ``impersonal advisory services''

rule proposed by the SEC in 1994.

(b) Comments opposing defining ``recommendation.'' Commenters

opposing defining ``recommendation'' expressed concern that a

definition would create a safe harbor protecting banks against

liability and stated that individual facts and circumstances must be

reviewed to determine whether a recommendation has been made. One

commenter stated further that the line of when a bank is recommending a

product is clear, namely, when the bank provides information to explain

why a customer should purchase a particular product. This commenter

suggested that once a customer expresses an interest in a particular

product, the suitability obligation should be triggered even if no

explicit recommendation is made.

``recommendation,'' for several reasons. First, a determination of

whether a recommendation has been made necessarily depends on the facts

of a given situation. The agencies believe that a definition would not

change the need to review the entire circumstances of a transaction,

and, therefore, do not believe that a definition would provide a

significant benefit. Second, the agencies are concerned that a

definition might be misinterpreted as a safe harbor whereby a

government securities broker-dealer effectively recommends an

investment but argues that it had no suitability obligation because the

advice technically was not a recommendation according to the literal

terms of a definition. Third, the agencies believe that there is no

need to define the term, because bankers and examiners already are

accustomed to the use of the term in the municipal securities area

where similar rules currently exist. Finally, for the reasons

previously stated, the agencies believe that government securities

customers will benefit from rules that are consistent for both bank and

nonbank government securities broker-dealers. Given that the NASD and

SEC recently decided not to define ``recommendation,'' a decision to do

so in the banking agencies'' rule could result in a material difference

that could undermine the benefits of consistency and could lead to

confusion concerning what effect the definition would have on the other

rules.

While the agencies do not believe it is appropriate to define the

term ``recommendation,'' they note that they would not view the

provision of general market information, including market observations,

forecasts about interest rates, and price quotations, as making a

recommendation under the rule, absent other conduct.

Issue 5. Adoption of Additional Rules

Of the four commenters addressing the need to adopt rules similar

to other sections of the Rules of Fair Practice or interpretations

similar to other NASD interpretations, all four supported adopting

additional rules and interpretations.

(a) Comments supporting additional rules. One commenter suggested

that the agencies adopt those parts of the NASD Rules of Fair Practice

that require the establishment of a system to supervise personnel

involved in government securities transactions. Another commenter

stated that the rules should be extended to those practices that

adversely affect transactions, such as markups, churning, and

frontrunning. A third commenter suggested that the agencies adopt rules

concerning the supervision of employees, the establishment of written

procedures, and the requirement of internal inspections. This commenter

noted that the banking industry and its customers would benefit from

additional uniformity with nonbank government securities dealers. The

final commenter suggested that the agencies adopt additional rules

similar to those applicable to bank municipal securities dealers.

(b) Comments opposing additional rules. While no commenter

specifically opposed adopting additional rules, several noted their

general opposition to the agencies adopting any rules in this area. The

arguments advanced by these commenters are summarized in the discussion

of the first issue.

rules other than the Suitability and Business Conduct Rules and

Suitability Interpretation at this time. In some cases, the NASD Rules

overlap with safety and soundness standards that already apply to banks

(see, e.g., Rule 3010 of the NASD's Conduct Rules, which requires each

member to establish and maintain a system of supervision that is

reasonably designed to achieve compliance with applicable securities

laws and regulations). Other NASD Rules appear to codify existing

duties and principles to which bank employees acting in a fiduciary

capacity must adhere (see, e.g., Rule 2330 of the NASD's Conduct Rules,

which prohibits members and associated persons from making improper use

of a customer's securities or funds). While the agencies believe that

the business conduct rule is sufficiently broad to address much of the

conduct proscribed by other NASD Rules, the agencies will consider

whether there is a need to adopt additional rules as the agencies

examine banks for compliance with the rules and interpretation adopted

herein. Banks should determine the adequacy and appropriateness of

their policies, procedures, and internal controls with respect to the

final rules.

Issue 6. Ability to contract out of the rules

Four of the six commenters addressing this issue favor allowing a

bank and its customers to establish standards by contract that would

govern that relationship, while two opposed this option.

(a) Comments favoring allowing parties to contract out of the

rules. One commenter suggested that the agencies look to the Principles

and Practices for

[[Page 13281]]

Wholesale Financial Market Transactions, prepared in 1995 under the

coordination of the Federal Reserve Bank of New York, for guidance on

the appropriate set of governing assumptions regarding institutional

relationships. This commenter noted that the Amendments contain no

limitation on the agencies'' ability to permit this flexibility. While

this commenter opposed adoption of the rules in general, the commenter

stated that, if the agencies adopt the rules, they should clarify that

a bank would be insulated from liability to the extent that the bank

and customer contractually limit liability. Another commenter opined

that a written contract should control on the question of suitability

and that the agencies should provide guidance on when an oral agreement

will suffice (such as, for instance, allowing oral agreements to

control if they are entered into on a recorded line). A third commenter

stated that banks should be encouraged to clarify the nature of the

relationship with their customers, including providing disclaimers

about the nature of the information given if appropriate. The fourth

commenter expressed its support for allowing parties to contract out of

the rules but then suggested that the presence or absence of a contract

should be one of the factors considered if a bank's compliance with its

suitability obligation is in dispute.

(b) Comments opposing allowing parties to contract out of the

rules. Those commenters who opposed allowing banks to contract out of

the rules expressed concern that an agreement should not be used to

protect banks that make unsuitable recommendations. One commenter noted

that a contract should be only one factor to consider when determining

whether a suitability obligation has been satisfied. The other

commenter opposed to contractually limiting liability stated that, if

parties are allowed to do so, the final rules should require periodic

review of the contract. According to this commenter, the changing

nature of financial markets may render a contract inappropriate over

time.

establishing the nature of the relationship can be helpful in

determining the relationship between the bank and its customer, but

that such a contract will not be determinative of whether the bank has

fulfilled its obligation under the rules. The agencies also believe

that the benefits to be gained by both the banking industry and its

customers from having uniform suitability rules and interpretations

would be significantly undermined if banks were permitted to establish

by contract a safe harbor from their obligations under the rules.

Accordingly, the final rules do not go beyond the proposed

interpretation, which provides that written and oral agreements will be

considered as one of several factors that may be relevant in

determining whether the bank has fulfilled its obligations under the

suitability rule. Additionally, the agencies note that because the

rules do not create a private right of action, there is no need to

provide a mechanism in the rule for a bank to insulate itself from

liability to customers arising from a violation of the rules.

Issue 7. Definition of ``Institutional Customer''

Eight commenters addressed the issue of how to define an

``institutional customer.'' Of these, four opposed using $50 million in

total assets as the measure by which institutional customers are judged

while one favored using this cutoff. Five commenters expressed support

for a test based on assets under management as the appropriate measure,

and one opposed any test based on asset size, portfolio size, or

revenue.

(a) Comment favoring use of $50 million in total assets. The one

commenter favoring the use of $50 million in assets as the threshold

for determining who is an institutional customer stated that the level

of assets usually is a good determinant of whether the customer is

sophisticated. This commenter also noted that customers above that size

can afford to hire a professional manager, and suggested that there is

no reason to shift to the dealer the responsibility for ensuring that

investments are suitable. The commenter suggested further that an

appropriate benchmark for governmental entities is whether a

government's budget is at least $50 million. Finally, this commenter

opined that a customer should be considered ``institutional'' if it is

registered as an investment adviser under either U.S. or foreign law

and that the definition should clarify that a bank, savings

association, or insurance company may be domestic or foreign.

(b) Comments opposing use of $50 million in total assets. All of

the commenters opposed to defining ``institutional customer'' by using

total assets stated that asset size is not a good proxy for

sophistication. One commenter maintained that a rule that does not

apply to all registered investment companies will result in banks being

less willing to make recommendations to small investment companies

because the suitability obligations to the small companies will be more

onerous. Another commenter stated that this test will only place more

burdens and risks on banks. The commenter opposed to any test based on

asset size, portfolio size, or revenue stated that the tests are

inaccurate and arbitrary. Concerning an asset size test, this commenter

noted that all but the smallest local governments have assets of at

least $50 million, although most of these assets are in the form of

buildings, land, sewage facilities, and so on. This commenter opposed a

revenue test because the cyclical nature of tax receipts will

temporarily swell the amounts available for investment by a government,

thereby resulting in many small governments being deemed

``institutional customers'' even though they need the protections

afforded by the suitability rule. Finally, this commenter believes that

portfolio size is problematic because it is unclear which governmental

entity's portfolio should be considered. To illustrate this problem,

this commenter asked whether investments of a state government and

local governments within that state should be considered as held in one

portfolio and whether pension funds invested by a city are part of the

city's portfolio. Two other commenters stated their general opposition

to an asset size test set at $50 million.

the four commenters favoring a test based on portfolio size, one agreed

that $10 million was the appropriate cutoff. Two others stated that,

while portfolio size is a better measure of sophistication than is

asset size, $10 million is too high a threshold. Finally, one commenter

stated that portfolio size should be considered, but that it should be

only one of several factors looked at.

(d) Analysis of Issue 7. The agencies have decided to adopt a

definition of ``institutional customer'' that is consistent with the

NASD's definition. As a result, all customers will receive consistent

treatment under the suitability rule. Moreover, transactions with all

customers other than natural persons will be covered by the suitability

interpretation, although the factors identified in the interpretation

will be most appropriate for a customer with at least $10 million

invested in securities in the aggregate in its portfolio and/or under

management. If an entity has less than $50 million in total assets, a

bank making a recommendation to that entity must make a reasonable

effort to obtain information about the customer's financial and tax

status, investment

[[Page 13282]]

objectives, and other information used or considered reasonable by the

bank in making a recommendation.

The agencies believe that if a different measure were used, the

inconsistencies between their rule and the NASD's Suitability Rule

would make the agencies' rule more difficult to apply. Also, examiners,

auditors, and compliance officers likely would encounter difficulties

determining compliance with suitability requirements if the measure for

an institutional customer varies, as some commenters suggested,

depending on the type of entity and security involved.

The agencies believe that some commenters may have misinterpreted

the significance of the tests for determining when an investor is an

``institutional customer.'' All customers, whether institutional or

not, are covered by the suitability rule. In all cases, a bank must

have reasonable grounds for believing that a recommendation is suitable

based on the facts, if any, disclosed by a customer concerning the

customer's other security holdings and financial situation and needs.

Moreover, in all cases, a bank must make a determination based on the

facts of a particular situation whether it has fulfilled its

suitability obligation. The thresholds identified in the regulation and

interpretation are provided solely for the purpose of assisting a bank

in identifying the type of information that may be relevant in deciding

if the suitability obligation is met in a given case. For all entities

other than natural persons (but particularly for entities with at least

$10 million invested in securities in the aggregate in its portfolio

and/or under management), a bank should consider the factors identified

in the suitability interpretation in deciding whether a customer is

capable of evaluating investment risk independently and whether the

customer is exercising independent judgement in evaluating a bank's

recommendation. For entities (including natural persons) with less than

$50 million in total assets, a bank is required to make reasonable

efforts to obtain the additional information listed in the section

captioned ``Customer information'' (12 CFR 13.5, 208.25(e), and 368.5,

respectively). This information will be in addition to whatever other

information the bank obtains in its effort to determine whether it has

met its suitability obligation.

Issue 8: Other Suggestions

One commenter stated that the factors listed in the suitability

interpretation concerning a customer's ability to evaluate risk are

reasonable but do not require banks to provide information the customer

needs in order to make an informed investment decision. This commenter

suggested that the interpretation should require banks to provide

certain types of transaction-specific information, such as valuation

information, an instrument's behavior under a stress test, and the

types of risks incurred.

The agencies agree that this information may be useful to a

customer in many cases. However, a comparatively unsophisticated

customer likely will rely on the bank to evaluate this information

before making a recommendation, while a more sophisticated customer

will, in many cases, request this information from the bank or obtain

this information on its own. Accordingly, the agencies have decided not

to require the information suggested by the commenter.

This commenter also identified what it believes are shortcomings in

each of the considerations listed in the suitability interpretation.

Many of the shortcomings cited focus on the inapplicability or

inappropriateness of a certain factor in a given set of circumstances.

The agencies acknowledge that not all of the factors identified will be

helpful in every case. However, the interpretation is not presented as

a checklist of required information. The factors listed neither create

nor reduce a bank's suitability obligation. Their relevance will vary,

depending on the circumstances of a given situation. The agencies

believe that the factors will be helpful in assisting a bank's

determination of whether it has met its suitability obligation.

Therefore, the agencies are adopting the suitability interpretation as

proposed, making only the modifications to the proposed interpretation

that are necessary to conform the agencies' suitability interpretation

to that of the NASD.

Two commenters requested that the agencies clarify that the final

rules do not apply to institutions that are subject to NASD

jurisdiction. The agencies recognize that many banks conduct a

significant portion of their securities activities through subsidiaries

or affiliates that are registered broker-dealers. The agencies confirm

that securities activities conducted in registered broker-dealers that

are NASD members are subject to the NASD rules and will not be subject

to the agencies' final rules.

Another commenter requested that the agencies add a cross-reference

in the final rules to the definition of ``government securities'' used

in the Securities Exchange Act (15 U.S.C. 78c(a)(42)) in order to

assist bankers working with the rules. The agencies agree that a

reference to this definition would be helpful, and have amended the

final rules accordingly.

Finally, one commenter asserted that the Regulatory Flexibility Act

certification contained in the proposal is flawed because it fails to

focus on the 300 domestic banks that are covered by the proposal.¹

The agencies note that they did focus on these banks in determining the

impact that the rules would have on small entities. See 61 FR 18472

(``As an initial matter, the proposed rule would apply only to those

banks that have given notice or are required to give notice that they

are government securities brokers or dealers under section 15C of the

Securities Exchange Act of 1934 (15 U.S.C. 78o-5) and applicable

Treasury rules under section 15C (17 CFR 400.1(d) and 401), including

approximately 300 domestic banks and branches of foreign banks.''). The

Regulatory Flexibility Act certification in these final rules also

focuses on these banks as the appropriate pool to consider when

evaluating the rules' impact on small entities. See discussion of the

Regulatory Flexibility Act that follows.

---------------------------------------------------------------------------

\1\ Data obtained since the proposal was published show that

this figure is approximately 160 banks covered by the rule. See

discussion of the Regulatory Flexibility Act for additional analysis

of the number of institutions covered.

---------------------------------------------------------------------------

Regulatory Flexibility Act

Under section 605(b) of the Regulatory Flexibility Act (RFA) (5

U.S.C. 605(b)), the regulatory flexibility analysis otherwise required

under section 604 of the RFA (5 U.S.C. 604) is not required if the head

of the agency certifies that the rule will not have a significant

economic impact on a substantial number of small entities and the

agency publishes such certification and a statement providing the

factual basis for such certification in the Federal Register along with

the final rule.

Pursuant to section 605(b) of the RFA, the OCC, Board, and the FDIC

each individually certifies that these final rules will not have a

significant economic impact on a substantial number of small entities.

As noted in the proposal and in the preamble to the final rules, the

rules will apply only to those banks that have given notice or are

required to give notice that they are government securities brokers or

dealers under section 15C of the Securities Exchange Act of 1934 (15

U.S.C. 78o-5) and applicable Treasury rules under section 15C (17 CFR

400.1(d) and 401).

[[Page 13283]]

Most small banking institutions are not required to give notice under

section 15C, as Treasury rules provide exemptions for financial

institutions that engage in fewer than 500 government securities

brokerage transactions per year and for financial institutions with

government securities dealing activities limited to sales and purchases

in a fiduciary capacity. See 17 CFR 401.3 and 401.4. Other exemptions

from the notice requirements also are available. See 17 CFR Part 401.

Additionally, the agencies note that many banks conduct a significant

portion of their securities activities through subsidiaries or

affiliates that are registered broker-dealers. Securities activities

conducted in registered broker-dealers that are NASD members are

subject to the NASD Rules and would not be subject to the agencies'

final rules. As a consequence, currently there are only approximately

160 banks that are registered as a government securities broker-dealer.

Of these, only 7 are ``small entities'' for purposes of the Regulatory

Flexibility Act. See 13 C.F.R. 121.601.

Paperwork Reduction Act

In accordance with section 3506 of the Paperwork Reduction Act of

1995 (44 U.S.C. 3506; see also 5 CFR 1320 Appendix a.1), the agencies

have reviewed the final rules and have determined that no collections

of information pursuant to the Paperwork Reduction Act are contained in

the rules.

OCC Executive Order 12866 Statement

The Office of Management and Budget has concurred with the OCC's

determination that these final rules are not a significant regulatory

action under Executive Order 12866.

OCC Unfunded Mandates Act of 1995 Statement

Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law

104-4 (Unfunded Mandates Act), requires that the agency prepare a

budgetary impact statement before promulgating a rule that includes a

Federal mandate that may result in the expenditure by State, local, and

tribal governments, in the aggregate, or by the private sector, of $100

million or more in any one year. If a budgetary impact statement is

required, section 205 of the Unfunded Mandates Act also requires the

agency to identify and consider a reasonable number of regulatory

alternatives before promulgating a rule. As discussed in the preamble,

the final rules set forth sales practice responsibilities of banks that

are government securities brokers or dealers. The OCC has determined

that the final rules will not result in expenditures by State, local,

or tribal governments or by the private sector of more than $100

million. Accordingly, the OCC has not prepared a budgetary impact

statement or addressed specifically the regulatory alternatives

considered.

Small Business Regulatory Enforcement Fairness Act

The Small Business Regulatory Enforcement Fairness Act of 1996

(Pub. L. 104-121, 104th Cong., 2d Sess. (1996)) provides generally for

agencies to report rules to Congress and for Congress to review the

rules. The reporting requirement is triggered in instances where the

agency in question issues a final rule as defined by the Administrative

Procedure Act at 5 U.S.C. 551. The agencies will file the appropriate

reports pursuant to the statute concerning their final rules.

The Office of Management and Budget has determined that these final

rules do not constitute ``major'' rules as defined by the statute.

List of Subjects

12 CFR Part 13

Banks, banking, Government securities, National banks, Securities

12 CFR Part 208

Accounting, Agriculture, Banks, banking, Confidential business

information, Crime, Currency, Federal Reserve System, Flood insurance,

Mortgages, Reporting and recordkeeping requirements, Securities.

12 CFR Part 211

Exports, Federal Reserve System, Foreign banking, Holding

companies, Investments, Reporting and recordkeeping requirements.

12 CFR Part 368

Banks, banking, Securities.

Office of the Comptroller of the Currency

12 CFR CHAPTER I

Authority and Issuance

For the reasons set out in the preamble, a new part 13 is added to

chapter I of title 12 of the Code of Federal Regulations to read as

follows:

PART 13--GOVERNMENT SECURITIES SALES PRACTICES

Sec.

13.1 Scope.

13.2 Definitions.

13.3 Business conduct.

13.4 Recommendations to customers.

13.5 Customer information.

Interpretations

13.100 Obligations concerning institutional customers.

Authority: 12 U.S.C. 1 et seq., and 93a; 15 U.S.C. 78o-5.

Sec. 13.1 Scope.

This part applies to national banks that have filed notice as, or

are required to file notice as, government securities brokers or

dealers pursuant to section 15C of the Securities Exchange Act (15

U.S.C. 78o-5) and Department of the Treasury rules under section 15C

(17 CFR 400.1(d) and part 401).

Sec. 13.2 Definitions.

(a) Bank that is a government securities broker or dealer means a

national bank that has filed notice, or is required to file notice, as

a government securities broker or dealer pursuant to section 15C of the

Securities Exchange Act (15 U.S.C. 78o-5) and Department of the

Treasury rules under section 15C (17 CFR 400.1(d) and part 401).

(b) Customer does not include a broker or dealer or a government

securities broker or dealer.

section 3(a)(42) of the Securities Exchange Act of 1934 (15 U.S.C.

78c(a)(42)).

(d) Non-institutional customer means any customer other than:

(1) A bank, savings association, insurance company, or registered

investment company;

(2) An investment adviser registered under section 203 of the

Investment Advisers Act of 1940 (15 U.S.C. 80b-3); or

(3) Any entity (whether a natural person, corporation, partnership,

trust, or otherwise) with total assets of at least $50 million.

Sec. 13.3 Business conduct.

A bank that is a government securities broker or dealer shall

observe high standards of commercial honor and just and equitable

principles of trade in the conduct of its business as a government

securities broker or dealer.

Sec. 13.4 Recommendations to customers.

In recommending to a customer the purchase, sale or exchange of a

government security, a bank that is a government securities broker or

dealer shall have reasonable grounds for believing that the

recommendation is suitable for the customer upon the basis of the

facts, if any, disclosed by the customer as to the customer's other

security holdings and as to the

[[Page 13284]]

customer's financial situation and needs.

Sec. 13.5 Customer information.

Prior to the execution of a transaction recommended to a non-

institutional customer, a bank that is a government securities broker

or dealer shall make reasonable efforts to obtain information

concerning:

(a) The customer's financial status;

(b) The customer's tax status;

(d) Such other information used or considered to be reasonable by

the bank in making recommendations to the customer.

Interpretations

Sec. 13.100 Obligations concerning institutional customers.

(a) As a result of broadened authority provided by the Government

Securities Act Amendments of 1993 (15 U.S.C. 78o-3 and 78o-5), the OCC

is adopting sales practice rules for the government securities market,

a market with a particularly broad institutional component.

Accordingly, the OCC believes it is appropriate to provide further

guidance to banks on their suitability obligations when making

recommendations to institutional customers.

(b) The OCC's suitability rule (Sec. 13.4) is fundamental to fair

dealing and is intended to promote ethical sales practices and high

standards of professional conduct. Banks' responsibilities include

having a reasonable basis for recommending a particular security or

strategy, as well as having reasonable grounds for believing the

recommendation is suitable for the customer to whom it is made. Banks

are expected to meet the same high standards of competence,

professionalism, and good faith regardless of the financial

circumstances of the customer.

of any government security, the bank shall have reasonable grounds for

believing that the recommendation is suitable for the customer upon the

basis of the facts, if any, disclosed by the customer as to the

customer's other security holdings and financial situation and needs.

(d) The interpretation in this section concerns only the manner in

which a bank determines that a recommendation is suitable for a

particular institutional customer. The manner in which a bank fulfills

this suitability obligation will vary, depending on the nature of the

customer and the specific transaction. Accordingly, the interpretation

in this section deals only with guidance regarding how a bank may

fulfill customer-specific suitability obligations under

Sec. 13.4.¹

---------------------------------------------------------------------------

\1\ The interpretation in this section does not address the

obligation related to suitability that requires that a bank have ``*

* * a `reasonable basis' to believe that the recommendation could be

suitable for at least some customers.'' In the Matter of the

Application of F.J. Kaufman and Company of Virginia and Frederick J.

Kaufman, Jr., 50 SEC 164 (1989).

---------------------------------------------------------------------------

(e) While it is difficult to define in advance the scope of a

bank's suitability obligation with respect to a specific institutional

customer transaction recommended by a bank, the OCC has identified

certain factors that may be relevant when considering compliance with

Sec. 13.4. These factors are not intended to be requirements or the

only factors to be considered but are offered merely as guidance in

determining the scope of a bank's suitability obligations.

(f) The two most important considerations in determining the scope

of a bank's suitability obligations in making recommendations to an

institutional customer are the customer's capability to evaluate

investment risk independently and the extent to which the customer is

exercising independent judgement in evaluating a bank's recommendation.

A bank must determine, based on the information available to it, the

customer's capability to evaluate investment risk. In some cases, the

bank may conclude that the customer is not capable of making

independent investment decisions in general. In other cases, the

institutional customer may have general capability, but may not be able

to understand a particular type of instrument or its risk. This is more

likely to arise with relatively new types of instruments, or those with

significantly different risk or volatility characteristics than other

investments generally made by the institution. If a customer is either

generally not capable of evaluating investment risk or lacks sufficient

capability to evaluate the particular product, the scope of a bank's

customer-specific obligations under Sec. 13.4 would not be diminished

by the fact that the bank was dealing with an institutional customer.

On the other hand, the fact that a customer initially needed help

understanding a potential investment need not necessarily imply that

the customer did not ultimately develop an understanding and make an

independent investment decision.

(g) A bank may conclude that a customer is exercising independent

judgement if the customer's investment decision will be based on its

own independent assessment of the opportunities and risks presented by

a potential investment, market factors and other investment

considerations. Where the bank has reasonable grounds for concluding

that the institutional customer is making independent investment

decisions and is capable of independently evaluating investment risk,

then a bank's obligations under Sec. 13.4 for a particular customer are

fulfilled.^{2 Where a customer has delegated decision-making}

authority to an agent, such as an investment advisor or a bank trust

department, the interpretation in this section shall be applied to the

agent.

---------------------------------------------------------------------------

\2\ See footnote 1 in paragraph (d) of this section.

---------------------------------------------------------------------------

(h) A determination of capability to evaluate investment risk

independently will depend on an examination of the customer's

capability to make its own investment decisions, including the

resources available to the customer to make informed decisions.

Relevant considerations could include:

(1) The use of one or more consultants, investment advisers, or

bank trust departments;

(2) The general level of experience of the institutional customer

in financial markets and specific experience with the type of

instruments under consideration;

(3) The customer's ability to understand the economic features of

the security involved;

(4) The customer's ability to independently evaluate how market

developments would affect the security; and

(5) The complexity of the security or securities involved.

(i) A determination that a customer is making independent

investment decisions will depend on the nature of the relationship that

exists between the bank and the customer.

Relevant considerations could include:

(1) Any written or oral understanding that exists between the bank

and the customer regarding the nature of the relationship between the

bank and the customer and the services to be rendered by the bank;

(2) The presence or absence of a pattern of acceptance of the

bank's recommendations;

(3) The use by the customer of ideas, suggestions, market views and

information obtained from other government securities brokers or

dealers or market professionals, particularly those relating to the

same type of securities; and

(4) The extent to which the bank has received from the customer

current comprehensive portfolio information in

[[Page 13285]]

connection with discussing recommended transactions or has not been

provided important information regarding its portfolio or investment

objectives.

(j) Banks are reminded that these factors are merely guidelines

that will be utilized to determine whether a bank has fulfilled its

suitability obligation with respect to a specific institutional

customer transaction and that the inclusion or absence of any of these

factors is not dispositive of the determination of suitability. Such a

determination can only be made on a case-by-case basis taking into

consideration all the facts and circumstances of a particular bank/

customer relationship, assessed in the context of a particular

transaction.

(k) For purposes of the interpretation in this section, an

institutional customer shall be any entity other than a natural person.

In determining the applicability of the interpretation in this section

to an institutional customer, the OCC will consider the dollar value of

the securities that the institutional customer has in its portfolio

and/or under management. While the interpretation in this section is

potentially applicable to any institutional customer, the guidance

contained in this section is more appropriately applied to an

institutional customer with at least $10 million invested in securities

in the aggregate in its portfolio and/or under management.

Dated: February 18, 1997.

Eugene A. Ludwig,

Comptroller of the Currency.

Federal Reserve System

12 CFR CHAPTER II

Authority and Issuance

For the reasons set forth in the joint preamble, parts 208 and 211

of chapter II of title 12 of the Code of Federal Regulations are

amended as follows:

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL

RESERVE SYSTEM (REGULATION H)

1. The authority citation for Part 208 is revised to read as

follows:

Authority: 12 U.S.C. 36, 248(a), 248(c), 321-338a, 371d, 461,

481-486, 601, 611, 1814, 1823(j), 1828(o), 1831o, 1831p-1, 3105,

3310, 3331-3351 and 3906-3909; 15 U.S.C. 78b, 781(b), 781(g),

781(i), 78o-4(c)(5), 78o-5, 78q, 78q-1, and 78w: 31 U.S.C. 5318; 42

U.S.C. 4012a, 4104a, 4104b, 4106, and 4128.

2. A new Sec. 208.25 is added to subpart A to read as follows:

Sec. 208.25 Government securities sales practices.

(a) Scope. This subpart is applicable to state member banks that

have filed notice as, or are required to file notice as, government

securities brokers or dealers pursuant to section 15C of the Securities

Exchange Act (15 U.S.C. 78o-5) and Department of the Treasury rules

under section 15C (17 CFR 400.1(d) and part 401).

(b) Definitions--(1) Bank that is a government securities broker or

dealer means a state member bank that has filed notice, or is required

to file notice, as a government securities broker or dealer pursuant to

section 15C of the Securities Exchange Act (15 U.S.C. 78o-5) and

Department of the Treasury rules under section 15C (17 CFR 400.1(d) and

part 401).

(2) Customer does not include a broker or dealer or a government

securities broker or dealer.

(3) Government security has the same meaning as this term has in

section 3(a)(42) of the Securities Exchange Act of 1934 (15 U.S.C.

78c(a)(42)).

(4) Non-institutional customer means any customer other than:

(i) A bank, savings association, insurance company, or registered

investment company;

(ii) An investment adviser registered under section 203 of the

Investment Advisers Act of 1940 (15 U.S.C. 80b-3); or

(iii) Any entity (whether a natural person, corporation,

partnership, trust, or otherwise) with total assets of at least $50

million.

or dealer shall observe high standards of commercial honor and just and

equitable principles of trade in the conduct of its business as a

government securities broker or dealer.

(d) Recommendations to customers. In recommending to a customer the

purchase, sale or exchange of a government security, a bank that is a

government securities broker or dealer shall have reasonable grounds

for believing that the recommendation is suitable for the customer upon

the basis of the facts, if any, disclosed by the customer as to the

customer's other security holdings and as to the customer's financial

situation and needs.

(e) Customer information. Prior to the execution of a transaction

recommended to a non-institutional customer, a bank that is a

government securities broker or dealer shall make reasonable efforts to

obtain information concerning:

(1) The customer's financial status;

(2) The customer's tax status;

(3) The customer's investment objectives; and

(4) Such other information used or considered to be reasonable by

the bank in making recommendations to the customer.

3. A new Sec. 208.129 is added to subpart B to read as follows:

Sec. 208.129 Obligations concerning institutional customers.

(a) As a result of broadened authority provided by the Government

Securities Act Amendments of 1993 (15 U.S.C. 78o-3 and 78o-5), the

Board is adopting sales practice rules for the government securities

market, a market with a particularly broad institutional component.

Accordingly, the Board believes it is appropriate to provide further

guidance to banks on their suitability obligations when making

recommendations to institutional customers.

(b) The Board's Suitability Rule, Sec. 208.25(b), is fundamental to

fair dealing and is intended to promote ethical sales practices and

high standards of professional conduct. Banks'' responsibilities

include having a reasonable basis for recommending a particular

security or strategy, as well as having reasonable grounds for

believing the recommendation is suitable for the customer to whom it is

made. Banks are expected to meet the same high standards of competence,