permissible activities by board order (section 4(c)(8) of the bhc act

Permissible Activities by Board Order(Section 4(c)(8) of the BHC Act) Section 3600.0

As a general rule, a bank holding company mustprovide 60 days’ prior written notice to itsReserve Bank to engage in any nonbankingactivity, or to acquire or retain the shares of acompany engaged in an activity based on sec-tion 4(c)(8) or 4(a)(2). When a bank holdingcompany gives notice to a Reserve Bank forapproval to engage in, or retain or acquire sharesin a company engaged in, a nonbank activity,the BHC must be of the opinion that the activityis closely related to banking and, assuming thistest is met, that the activitiy is a proper incidentthereto. In addition, a BHC that also is an FHCmust provide 60 days’ prior written notice to itsReserve Bank to engage in an activity that iscomplementary to a financial activity under sec-tion 4(k)(1)(B). In considering such a notice, theBoard must determine whether performance ofthe activity can reasonably be expected to pro-duce benefits to the public, such as greater con-venience, increased competition, or gains in effi-ciency, that outweigh possible adverse effects,such as undue concentration of resources,decreased or unfair competition, conflicts ofinterest, or unsound banking practices.

As an exception to the general rule, no priornotice is required for a bank holding companythat is qualified under section 4(j)(4) of theBHC Act to engage de novo, directly or througha subsidiary, in an activity that the Board permit-ted under section 225.28 of Regulation Y beforeNovember12,1999.Afterpassageof theGramm-Leach-Bliley Act of 1999, this list of activitiescannot be expanded. For all bank holding com-panies that are not qualified under section 4(j)(4),for all other nonbanking activities based on sec-tion 4(c)(8) or section 4(a)(2), and for all activi-ties that are complementary to a financial activ-ity under section 4(k)(1)(B), the bank holding

company must provide the appropriate priorwritten notice of its proposal to its ReserveBank.1 The Board must review the notice with-out disapproving it each time the bank holdingcompany wishes to engage in a proposed activ-ity. The inspection objective and procedures setforth below can be implemented for each of theactivities summarized in subsequent sections.

3600.0.1 INSPECTION OBJECTIVE

1. To determine what financial effect nonbank-ing activities have on the parent and the banksubsidiaries, and if there is any degree ofexposure in the activities because of a lack ofappropriate audit systems and controls.

3600.0.2 INSPECTION PROCEDURES

1. Review the company’s financial statementsfor accuracy and determine if any factors ortrends could have an adverse impact on theparent holding company or the banksubsidiaries.

2. Review the adequacy of the company’s poli-cies, procedures, practices, internal controls,and audit coverage regarding nonbankingactivities, and whether they are adhered to.

1. A bank holding company that is qualified under section4(j)(4) of the BHC Act may provide 12 calendar days’ priorwritten notice before engaging by acquisition in an activitypermitted under section 225.28 or engaging in an activitybased on section 4(c)(8) and approved by the Board by order.

BHC Supervision Manual June 2000

Permissible Activities by Board Order(Operating a ‘‘Pool Reserve Plan’’) Section 3600.1

Two bank holding companies (Company A) and(Company B) had requested the Board to deter-mine whether their planned nonbank subsidiaryactivities were of the kind described in Section4(c)(8) of the BHC Act. The applications hadbeen filed prior to the passage of the BankHolding Company Act Amendments of 1970.The applicants proposed to expand their activi-ties under a ‘‘pool reserve plan’’ to includecorrespondent banks. Such activities were lim-ited to subsidiary banks.The ‘‘pool reserve plan’’ was described as a

method of pooling of loss reserves with respectto term loans to small businesses and the estab-lishment of uniform credit standards in thatregard. The ‘‘pool reserve plan’’ permitted banksto adopt a uniform and liberal credit policy inextending credit and the usual method ofexchanging participations between the banks.The General Counsel of the Board of Gover-

nors determined, on October 14, 1971, pursuantto delegated authority, that the proposed activi-

ties would be ‘‘so closely related to banking ormanaging or controlling banks as to be a properincident thereto’’ in accordance with Section4(c)(8) of the BHC Act, as amended by theBHC Act Amendments of 1970. The approval(1971 FRB 1037) included the following condi-tions that:1. The subsidiary was to amend its charter so

that the charter would authorize it to perform itsfunctions, and make its services available tobanks, but not to lenders other than banks, andto amend its proposed contracts with correspon-dent banks;2. Any correspondent banks could terminate

their contract with the subsidiary respectingfuture transactions upon 90-day prior writtennotice, and that;3. The subsidiary be subject to the same lim-

itations with the respect to the ownership of anycollateral acquired in the course of the conductof its proposed activities as were its parents,(Company A and Company B).

BHC Supervision Manual December 1992Page 1

Permissible Activities by Board Order (Engaging inBanking Activities via Foreign Branches) Section 3600.5

3600.5.1 NEW YORK INVESTMENTCOMPANY

On May 10, 1977, the Board approved an appli-cation of a foreign-owned domestic bank toform a holding company, and, at the same time,for that holding company to acquire substan-tially all of the voting shares of an investmentcompany organized and operating under articleXII of the New York State Banking Law (a NewYork investment company).

The investment company at that time wasengaged in providing lending and internationalbanking services, including letters of credit,acceptances, and other financing facilities inconnection with exports and imports, interna-tional transfers of funds, and foreign-exchangeservices; investmentsand foreign-exchange trans-actions for its own account; leasing improvedreal estate and data processing equipment; andmaintenance of credit balances incidental to orrelated to the foregoing activities. Although theholding company believed that certain of theactivities of the New York investment companyhad already been determined by the Board to bepermissible for bank holding companies, itrequested approval of its application on the basisthat all the activities that a New York invest-ment company is permitted to engage in underNew York law are closely related to banking. ANew York investment company had not previ-ously been determined by the Board to be anactivity permissible for bank holding companies.

The Board noted that the structural and com-petitive circumstances under which a New Yorkinvestment company operates are unique to NewYork and have served in the past as a means forforeign-bank entry into New York in cases whereentry through a direct branch or agency waseither unavailable or undesirable for the pur-poses sought. Most of the lending and bankingservices offered by these companies are alsooffered by commercial banks generally and, inthis connection, compete with foreign bankingorganizations and domestic commercial banksand their Edge corporation subsidiaries. How-ever, under article XII of the New York StateBanking Law, a New York investment companyis permitted to engage in various other activitieswhich the Board does not consider to be closelyrelated to banking.

Based on the foregoing, the Board’s approvalin this case was limited to and contingent uponthe New York investment company’s (1) con-tinuing to engage principally in transactionsinvolving international or foreign commerce,

and not accept demand deposits; (2) complyingwith all Board or legislatively imposed reserveand interest-rate requirements; (3) divesting ofoffices in another state within two years; (4) con-fining activities of its foreign branch to thosepermitted in the Board’s order; and (5) notengaging in the activities of underwriting, sell-ing, or distributing securities; buying or sellingcoin and bullion; or acting as a financial agentof the U.S. government or as a depositary ofpublic moneys of the United States, or in anynew activity which New York investment com-panies by subsequent enactment may be permit-ted to engage in, without the prior approval ofthe Board. (See 1977 FRB 595.)

3600.5.2 ENGAGING IN BANKINGACTIVITIES THROUGH FOREIGNBRANCHES OF A NONBANKCOMPANY

A bank holding company applied for the Board’sapproval to retain direct or indirect ownershipof a subsidiary, ‘‘CBC,’’ a Delaware-charteredcorporation, after it established branches inNassau and Luxembourg, to engage in certaincommercial banking activities. The activitiesincluded accepting funds in U.S. dollars or for-eign currency in wholesale money markets inamounts over $100,000, making commercialloans in amounts over $100,000, placing fundswith and making loans and advances to subsidi-ary and affiliated organizations, engaging inforeign-exchange transactions, and other activi-ties constituting commercial banking outside theUnited States. CBC held the shares of a numberof nonbanking subsidiaries of the BHC pursuantto section 4(c)(1)(C) of the BHC Act, whichpermits a subsidiary of a bank holding companyto perform services for its parent company.

The purpose of the proposal was to providethe BHC with increased flexibility in funding itsdomestic operations by allowing CBC to gainaccess to the offshore wholesale money market.The proposed foreign branches of CBC, byobtaining banking licenses, would give directaccess to Eurocurrency interbank markets, andthe activities of the proposed branches wereexpected to be viewed as an integral part of alarge U.S.–headquartered entity, making thebranches competitive in the offshore interbankmarkets.


The Board decided that the lending and bank-ing services that the proposed branches wouldofferweregenerallyofferedbycommercialbanks,and thus are permissible activities of foreignbranches of domestic banks and foreign subsidi-aries of bank holding companies. The proposedactivities of CBC’s branches were substantiallysimilar to activities that the Board had previ-ously approved under section 4(c)(8) of theBHC Act for the foreign branches of the NewYork investment company, incorporated underarticle XII of the New York Banking Law (see1977 FRB 595 and 1979 FRB 667). CBC didnot propose to engage in any activity that wouldnot be permitted for a separately incorporatedforeign subsidiary of a bank holding company.The Board, therefore, ruled that the proposedactivities of CBC were closely related to bank-ing (1982 FRB 251).

CBC proposed to engage in no bankingactivities in the United States, stating that itsonly U.S. activities would consist of its indirectnonbanking activities through subsidiaries. Thesubsidiaries would be funded through fundsraised by the proposed foreign branches. In this

connection, the BHC committed to accepting noplacement of or deposits from,1 or extending nocredit to (other than a subsidiary or affiliatedorganization) a United States resident.2 The BHCcommitted that the liabilities to CBC of anyperson, other than an affiliate, would not exceed10 percent of the capital and surplus of CBC.The Board felt that these prudential conditionswere adequate to meet any supervisory concernsto which the proposal might give rise and thusapproved the application, subject to the obtain-ing of the necessary licensing requirements ofthe countries involved.

1. A placement or deposit received from a foreign branch,office, subsidiary, affiliate, or other foreign establishment(‘‘foreign affiliate’’) controlled by one or more domestic cor-porations is not regarded as a placement or deposit receivedfrom a U.S. resident if such funds are used in its foreignbranches or that of other foreign affiliates of the controllingdomestic corporation(s).

2. Credit extended to a foreign affiliate, controlled by oneor more domestic corporations, is not regarded as creditextended to a U.S. resident if the proceeds will be used in itsforeign business or that of other foreign affiliates of thecontrolling domestic corporation(s).

Permissible Activities by Board Order (Engaging in Banking Activities via Foreign Branches) 3600.5


Permissible Activities by Board Order(Operating a Securities Exchange) Section 3600.6

A domestic bank holding company (the BHC)and a foreign banking organization (the FBO),subject to the BHC Act, applied for the Board’spermission to engage in operating a securitiesexchange under the authority of section 4(c)(8)of the BHC Act and section 225.24 of Regula-tion Y. The BHC proposed to control approxi-mately 17 percent of the voting shares of group(the group), and the FBO planned to controlapproximately another 11 percent of the votingshares of the group. The group owned about54.1 percent of a financial network subsidiary(FNS), which operated an electronic securitiesexchange (the exchange) for the secondary trad-ing of equity and equity-related securities listedon the London Stock Exchange (LSE). TheBHC and FBO indicated that the group plannedto establish an office in the United States. Inanticipation of the establishment of this office,theBHCandFBOrequested theBoard’sapprovalto acquire their interests in the group. A BHCmust obtain the Board’s approval if a foreigncompany held by the BHC seeks to engage inbusiness in the United States.

The exchange is a screen-based electronicmarket that provides securities trade matching,trade execution, and related services to U.S. andforeign market makers, broker-dealers, andinstitutional investors that become members ofthe exchange. Members may access the exchangeand enter bid and ask quotations using elec-tronic terminals that are linked to designatedfinancial networks (for example, a Bloombergterminal) or through a personal computer linkeddirectly to the exchange. The exchange can beaccessed from terminals located anywhere in theworld. Trading, however, may occur only dur-ing the operating hours of the LSE. Ordersentered in the exchange’s system appear onseparate electronic order books for each secu-rity, which display the best bid and ask quotesfor thesecurity indescendingorder.Theexchangeautomatically and continuously matches equalbid and ask offers for each listed security on afirst-come, first-served basis.

FNS does not take a principal position insecurities, clear or settle the securities transac-tions executed on the exchange, or assume anyprincipal risk for securities trades executed onthe exchange. FNS and its shareholders are notobligated to guarantee any member’s trades.Each member of the exchange must be a mem-ber of the London Clearing House, or mustappoint a member of the London Clearing Houseto clear the member’s trades on the exchange.Trades matched by the exchange are registered

at the end of each business day with the LondonClearing House in the name of the appropriateclearing member. London Clearing House thenbecomes the counterparty to each side of thetrade until the trade is settled. The trade issettled through a designated system operated bya corporation established by the Bank of Englandto settle uncertificated U.K. equities.

The exchange is a recognized investmentexchange under section 37(3) of the U.K. Finan-cial Services Act of 1986, and is regulated andsupervisedby theU.K.FinancialServicesAuthor-ity (FSA), under the securities laws of the UnitedKingdom. While FNS makes its services avail-able to customers in the United States, the SEChas granted it a limited volume exception fromthe registration requirements of the SecuritiesExchange Act of 1934. The SEC exemptiveorder permits FNS to operate in the UnitedStateswithout registeringasasecuritiesexchangeprovided (1) the exchange’s average daily vol-ume of trades involving U.S. members does notexceed $40 million, and (2) the exchange’sworldwide average daily volume does not exceed10 percent of the average daily trading volumeon the LSE. The SEC exemptive order requiresthe exchange to comply with other conditionsthat are designed to ensure orderly and fairmarkets and to protect U.S. investors.

The Board had not previously determined byregulation or order that the operation of a securi-ties exchange is closely related to banking withinthe meaning of section 4(c)(8) of the BHC Act.The principal function of a securities exchangeis to provide a centralized facility for the execu-tion, clearance, and settlement of securities trans-actions. The Board indicated in its order thatbanks and BHCs are authorized to provide secu-rities brokerage services to their customers and,as part of those services, to execute and clearsuch transactions on a securities exchange. TheBoard also noted that BHC subsidiaries autho-rized to act as dealers in securities (section 20subsidiaries) may provide securities execution,clearance, and settlement services in connectionwith their dealer operations. In addition, theBoard noted that broker or dealer subsidiaries ofbanks and BHCs often become members ofsecurities exchanges and thus acquire a smallownership (less than 5 percent) in a mutuallyowned exchange (for example, the New YorkStock Exchange). Through the development ofthese relationships, banks and BHCs have gained

BHC Supervision Manual June 2000Page 1

considerable experience with and knowledge ofthe rules and operations of securities exchanges.

Banks and BHCs also provide services thatare functionally and operationally similar tothose of the exchange. Banks and BHC subsidi-aries acting as securities brokers may executecross-trades for their customers and therebymatch equal bid and offer orders received fromthem. In addition, section 20 subsidiaries may, ifauthorized, act as a specialist or market makeron a securities exchange such as the NYSE orNASDAQ. A specialist generally maintains abook of current buy and sell orders received

from other brokers and matches equal bid andoffer quotes for execution. Market makers onNASDAQ also publish bid and ask prices atwhich they stand ready to execute transactionsin the relevant security.

For the above reasons, and based on all thefacts on record, the Board concluded that operat-ing a securities exchange is an activity that isclosely related to banking for the purposes ofsection 4(c)(8) of the BHC Act. The applicationwas approved on November 8, 1999. See 2000FRB 61 for the order and more specific informa-tion regarding the Board’s approval.

Operating a Securities Exchange 3600.6


Permissible Activities by Board Order (Acting as aCertification Authority for Digital Signatures) Section 3600.7

WHAT’S NEW IN THIS REVISEDSECTION

Effective January 2007, this section is amendedto include another Board order in which theBoard approved a notice for a foreign bank toact as a certification authority (CA) in connec-tion with financial and nonfinancial transac-tions and to engage in related data processingactivities. The bank planned to engage in theactivities by entering into an agreement with anewly organized, wholly owned indirect subsidi-ary of the bank. (See 2006 FRB C150.) Theproposed CA nonbanking activities are slightlydifferent, but are consistent with those CA non-banking activities that were previously approvedby the Board (discussed below).

3600.7.1 ACTING AS CERTIFICATIONAUTHORITY IN CONNECTION WITHFINANCIAL AND NONFINANCIALTRANSACTIONS

A foreign banking organization (FBO)1 subjectto the BHC Act and several bank holding com-panies (BHCs), deemed to be BHCs (all referredto as the notificants) within the meaning of theBHC Act, requested the Board’s approval undersection 4(c)(8) of the BHC Act and section225.24 of the Board’s Regulation Y (12 C.F.R.225.24) to retain 12.5 percent of the votinginterests in Indent Company (Indent), and toengage through Indent and other nonbank sub-sidiaries in acting as a CA in the United Statesin connection with financial and nonfinancialtransactions and other related activities. Indentrepresents a joint venture among the notificantsand other commercial banks and foreign bank-ing organizations. As proposed, Indent wouldact as the global rulemaking and coordinatingbody for a network of financial institutions thatwould act as CAs and thereby provide servicesdesigned to verify or authenticate the identity ofcustomers conducting financial and nonfinancialtransactions over the Internet and other ‘‘open’’electronic networks. To provide these services,Indent and its network of participating financialinstitutions (the identity system) would use digi-tal certificates and digital signatures created

through the use of public-key cryptography.In a CA system using public-key cryptogra-

phy, a company generates (or is assigned) apublic-key/private-key pair and registers with aCA as the unique ‘‘owner’’ of the key pair.2Private keys and public keys are a set of differ-ent but related mathematical functions that canbe used to encrypt and decrypt electronic com-munications. A message encrypted by a particu-lar private key can be decrypted only by itscorresponding public key. Although a privatekey and its corresponding public key are related,a private key cannot feasibly be derived from itscorresponding public key. Thus, while a privatekey must be kept confidential by the companythat is the registered owner of the key pair, thecompany’s public key can be made publiclyavailable without jeopardizing the confidential-ity of the company’s private key.

A company sending a business communica-tion (for example, a purchase order) to anotherentity over an open electronic network like theInternet uses its confidential private key to digi-tally sign the message being sent. A digitalsignature is a compressed and encrypted versionof the message to which it is attached. Theentity receiving the digitally signed messagethen uses the sender’s public key to decrypt thedigital signature.3 If the receiver successfullydecodes the signature with the sender’s publickey, the receiver can be assured that the mes-sage was created using the sender’s private key.4

To be assured that the message was actuallysent by the purported sender, however, the receivermust confirm that the private-key/public-keypair used to sign and decode the message isuniquely ‘‘owned’’ by the purported sender. ACA provides this assurance by issuing ‘‘digitalcertificates’’ certifying that the relevant private-key/public-key pair is uniquely associated withthe message sender and by verifying upon requestthe validity of such digital certificates.

1. Foreign banks may engage in permissible nonbankingactivities in the United States directly through a U.S. branchor agency. A foreign bank, however, must receive the Board’sapproval under section 4(c)(8) of the BHC Act to engage inthe United States in activities that are deemed to be closelyrelated to banking.

2. A number of nonbanking companies currently operateCA systems that rely on public-key cryptography to provideidentity-authentication services to senders and receivers ofelectronic communications.

3. The sender’s public key may be attached to the digitallysigned communication, or the receiver of the message mayobtain the sender’s public key from a publicly availabledatabase.

4. The receiver also can confirm that the message was notaltered after it was signed by comparing the message receivedwith the decrypted version of the message text embedded inthe digital signature.

BHC Supervision Manual January 2007Page 1

The notificants and other financial institutionsparticipating in the identity system (partici-pants)5 would create unique private-key/public-key pairs for, and issue digital certificates onbehalf of, eligible customers that contract withone of the participants to receive Indent identity-authentication services.6 Each participant wouldact as a repository for the digital certificates thatit has issued, that is, it would maintain a data-base containing information on the status of theoutstanding, expired, or revoked digital certifi-cates that it has issued to customers. The partici-pants also would verify for third parties thevalidity of digital certificates issued to theircustomers and, upon request of the third party,may provide an explicit warranty as to the valid-ity of the customers’ digital certificates.7 Theparticipants also may process and transmit veri-fication and warranty requests received fromcustomers concerning digital certificates issuedby other participants in the identity system. Inaddition, the participants may provide custom-ers with a limited range of software and hard-ware that is required for customers to use theidentity system.8

Indent would provide the infrastructure frame-work within which the participants would act as

CAs and provide related services. The primaryfunction of Indent would be to act as the ‘‘rootcertification authority’’ of the identity system,that is, issuing digital certificates to the partici-pants that establish their status as CAs in theidentity system and authenticating for customersof, and the other participants in, the identitysystem the identity of the participants.9 Indentalso would (1) establish and maintain the operat-ing rules governing the identity system, includ-ing the minimum technical requirements fordigital certificates and other components of thesystem; (2) monitor compliance by the partici-pants with the identity system’s operating rulesand technical standards; and (3) monitor collat-eral requirements and aggregate warranty expo-sure for the participants in the identity system.10

Section 4(c)(8) of the BHC Act provides thata bank holding company may, with the Board’sapproval, engage in any activity that the Boarddetermines to be closely related to banking. TheBoard previously has authorized BHCs undersection 4(c)(8) of the BHC Act to act as CAsand provide identity-authentication services inconnection with payment-related and other finan-cial transactions conducted over electronic net-works.11 The Board has not previously autho-rized BHCs under section 4(c)(8) to act as CAsor provide identity-authentication services inconnection with nonfinancial transactions.

Banks and BHCs have long provided identity-authentication services in connection with nonfi-nancial transactions conducted by third partiesand for their own traditional banking and lend-ing activities. For example, banks and BHCs areauthorized to provide notary services to custom-ers.12 The role of a notary is to authenticatesignatures on financial or nonfinancial docu-ments for the benefit of third parties.13 To verifya signature on a paper-based document, a notarymust verify the identity of the person signing

5. Participation in the identity system is available only toorganizations that are engaged primarily in the business ofproviding financial services; are subject to regulation andexamination by a government authority in their home country;and that meet certain eligibility criteria, such as minimumcapital requirements and debt-rating criteria. A participantalso must agree to be bound by the identity system operatingrules and to execute certain participation agreements. Finan-cial institutions would not be required to purchase an owner-ship interest in Indent to become a participant.

6. The participants may provide identity system–relatedservices only to customers that have agreed to be bound byapplicable provisions of Indent’s operating rules and havesigned the appropriate customer agreements. Indent’s operat-ing rules allow the participants to provide identity system–related services only to business entities, such as corporationsand governmental organizations, and not to natural persons.Indent’s operating rules and customer agreements would makeeach customer contractually responsible for ensuring that itsprivate key is kept confidential.

7. The operating rules of the identity system would providethat a company relying on a digital certificate issued by theparticipant would have recourse against the participant only ifthe company purchased an explicit warranty from the partici-pant, and then only up to the amount of the purchased war-ranty. The participant that issues a digital certificate couldrefuse to issue a warranty for a digital certificate for any bonafide reason. The identity system would limit the aggregateamount of warranties that the participant may have outstand-ing at any one time, and would require each participant to postcollateral with Indent to cover its warranty exposure.

8. For example, the participants may provide smart cardscontaining digital certificates and smart-card readers to theircustomers.

9. Digital certificates issued by the participant to a cus-tomer are digitally signed by the participant with its ownprivate key and are accompanied by a digital certificate issuedby Indent. The digital certificates Indent issues would certifythat the participant is an authorized participant in the identitysystem and that the private key the participant uses to digitallysign its certificates is uniquely associated with it, therebyauthenticating the identity of the participant.

10. The activities of the notificants and Indent would belimited to providing the identity-authentication and relatedservices described above. The notificants and Indent wouldnot provide a general encryption or electronic message ser-vice, or any warranty of the underlying financial or nonfinan-cial transactions between customers whose identities areauthenticated through the use of the identity system.

11. See Regulation Y, section 225.28(b)(14); 1997 FRB602, 606; and 1982 FRB 505, 510.

12. See 1998 FRB 481.13. 58 Am. Jur. 2d Notaries Public § 31 (2d ed. 1989).

Acting as a Certification Authority for Digital Signatures 3600.7


the document. The Board noted that the role aCA serves with respect to electronic documentsis functionally similar to the role a notary serveswith respect to paper-based documents.14

Banks have traditionally identified their cus-tomers to third parties through the issuance ofletters of introduction or letters of reference.15

In addition, banks and BHCs routinely authenti-cate the identity of customers and noncustomersin connection with their authorized check-cashing functions.16

Banks and BHCs also have long been autho-rized to issue signature guarantees to issuers ofsecurities and their transfer agents in connectionwith the transfer of securities.17 A bank issuinga signature guarantee warrants that the custom-er’s signature endorsing a certificated securityor authorizing the transfer of an uncertificatedsecurity is authentic. The issuing bank also war-rants that the signer was an appropriate personto endorse the security or authorization (or, ifthe signature is by an agent, that the agent hadactual authority to act on behalf of the appropri-ate person) and that the signer had legal capac-ity to sign. In light of these warranties, a bankproviding a signature guarantee must verify theidentity of the customer providing the endorse-ment or signing the instruction.18

Identity-authentication services are an inte-gral part of many traditional banking functions.Banks and BHCs have developed sophisticatedmethods for authenticating the identity of cus-tomers and noncustomers that transact businessor communicate with the bank or BHC throughelectronic means or otherwise. Many of theseactivities are operationally and functionally simi-lar to the proposed activities, and make banksand BHCs particularly well equipped to provide

the proposed services. For example, banks andBHCs maintain systems to electronicallyauthenticate the identity of persons engaged incredit and debit card, automated teller machine(ATM), home banking, and wire transfer trans-actions with the institution.19 Banks and BHCsalso electronically authenticate the identity ofpersons in connection with the check and creditcard verification services they are authorized toprovide to merchants and other businesses.20

The Board noted that state banks and nationalbanks have recently been authorized to act asCAs and to provide identity-authentication ser-vices in connection with financial and nonfinan-cial transactions conducted over electronic net-works. Based on the foregoing, the Boardconcludes that acting as a CA and, more gener-ally, authenticating the identity of customersconducting financial and nonfinancial transac-tions are activities that are closely related tobanking within the meaning of section 4(c)(8)of the BHC Act.

Indent and the notificants also propose toengage in a number of activities as part of and inconnection with their proposed CA activities.These activities include (1) processing, transmit-ting, and storing data necessary for the opera-tion of the identity system, such as digital cer-tificates, requests for verification of digitalcertificates, and warranty requests; (2) develop-ing and marketing software and hardware neces-sary for operating the identity system; and(3) complying with, monitoring, and enforcingthe collateral-posting requirements associatedwith identity warranties. In addition, Indentwould establish operating policies, procedures,and guidelines for the identity system.

The Board’s Regulation Y permits BHCs toprovide data processing and data transmissionservices and facilities (including software andhardware) for the processing and transmissionof financial, banking, or economic data, and toengage in activities related to making, acquir-ing, brokering, or servicing extensions of credit,such as posting collateral and monitoring collat-eral requirements.21 Regulation Y also permitsBHCs to engage in incidental activities that are

14. The American Bar Association, for example, has notedthat the issuance of digital certificates by CAs is ‘‘analogousto traditional certification processes undertaken by notarieswith respect to documents executed with pen and ink.’’ ‘‘Digi-tal Signature Guidelines,’’ published by the Information Secu-rity Committee of the Electronic Commerce and InformationTechnology Division, Section of Science and Technology,American Bar Association. (Aug. 1, 1996), p. 54.

15. Banks have drafted letters of introduction or letters ofreference on behalf of their customers for the purpose ofintroducing the customer to other banks or third parties withwhich the customer seeks to do business.

16. Under the Uniform Commercial Code (UCC), a bankthat accepts a check for deposit warrants to the drawee bankthat all endorsements on the check are genuine, and the bankis liable to the drawee bank for the amount of the check plusexpenses and lost interest if an endorsement on the check wasforged.

17. Broker-dealer subsidiaries of BHCs also have providedsignature guarantees.

18. A bank issuing a signature guarantee is liable to theissuer of the security or its transfer agent for any loss thatresults from a breach of any of these warranties by the bank.

19. Article 4A of the UCC encourages banks to developand maintain commercially reasonable security procedures,such as algorithms or other encryption devices, for authenti-cating the identity of customers that transmit wire transferinstructions to the bank.

20. See Regulation Y, section 225.28(b)(2)(iii) and 1985FRB 648.

21. See Regulation Y, section 225.28(b)(2) and (14). ABHC may develop and sell hardware and software that is



necessary to the conduct of an activity that isclosely related to banking. Indent and the notifi-cants have represented that they would engagein the additional activities only in connectionwith their CA activities and would not engage insuch activities separate or apart from their CAactivities. The notificants also have committedthat the data processing and data transmissionactivities of the notificants and Indent, includingany proposed development or sale of hardwareand software, will comply with the Board’sregulations and interpretations. In light of thenature of these additional activities and the factthat they would be conducted only in connec-tion with the CA activities of Indent and thenotificants, and all the other facts of record, theBoard concludes that these activities are encom-passed within the activities previously approvedby the Board by regulation or are incidental tothe permissible CA activities of Indent and thenotificants and, therefore, are permissible underRegulation Y.22

Based on the facts stated in the Board’s order,the Board determined that the certification author-ity and other activities discussed were closelyrelated to banking under section 4(c)(8) of theBHC Act. The Board issued its approval orderon November 10, 1999. (See 2000 FRB 56). Seethe Board’s order for more specific informationand for the more detailed information and refer-ences in the order’s footnotes.

The Board approved another notice for a for-eign bank, specifically a foreign banking organi-zation that is subject to the BHC Act.23 Theforeign bank had requested the Board’s approvalunder sections 4(c)(8) and 4(j) of the BHC Act24

and section 225.24 of the Board’s RegulationY25 to act as a CA in connection with financialand nonfinancial transactions and to engage in

related data processing activities. It was pro-posed that the agreement be assigned to a newlyorganized wholly owned indirect subsidiary ofthe bank, CLX.

The proposed activities would be undertakenwithin the Identity Trust System (ITS), whichwould serve as a central rulemaking and coordi-nating body for a global network of institutionsthat would act as digital CAs. The CAs wouldverify or authenticate the identity of customersconducting financial and nonfinancial transac-tions over the Internet and on other ‘‘open’’electronic networks. To provide these services,ITS and its network of participating financialinstitutions would use digital signatures createdwith encryption technology. These digital signa-tures would uniquely identify participants in theITS who send signed messages over electronicnetworks. The CAs would issue digital certifi-cates that certify that the digital signature isuniquely associated with a particular messagesender so that the message recipient can beassured of the identity of its trading partner.

As a certification authority, CLX would pro-vide the technical systems and support neces-sary for banks to verify and authenticate theidentity of customers conducting electronic trans-actions and to register digital certificates to cus-tomers. These services would be provided to theforeign banking organization as well as to otherbanks that enter into contracts with CLX.26 Theforeign bank, and any other banks to whichCLX may provide services, would be respon-sible for performing the due diligence on cus-tomers that request digital credentials, a rolereferred to as‘‘registration authority.’’ Bank andother registration authorities would register thedigital certificates issued to their customers, andCLX would maintain a database of all certifi-cates issued through its registration authorities.CLX would also provide registration authoritieswith the software and hardware required to usethe ITS.

In this order, the Board referenced its previ-ous approval (2000 FRB 56) in which it deter-mined that the CA activities conducted in con-nection with financial and nonfinancialtransactions and data processing were activitiesthat are closely related to banking for the pur-poses of section 4(c)(8) of the BHC Act. Alsofor this latter order, the Board found that theforeign bank’s proposed activities were consis-tent with those that it had previously approved.The foreign bank committed that it would con-duct its proposed nonbanking activities in accor-

designed and marketed for processing and transmitting finan-cial, banking, or economic data. It may also develop and sellgeneral purpose hardware so long as it does not constitutemore than 30 percent of the cost of any packaged offering.

22. The notificants may engage in data processing and datatransmission activities, including the development and sale ofhardware and software, pursuant to this order only to theextent such activities are necessary to permit the properoperation of the identity system. The notificants and Indentalso must conduct their data processing and data transmissionactivities subject to the software and hardware limitations inRegulation Y.

23. As a foreign bank operating an agency in the UnitedStates, the foreign bank is subject to the BHC Act by opera-tion of section 8(a) of the International Banking Act of 1978(12 U.S.C. 3106(a)).

24. 12 U.S.C. 1843(c)(8) and 1843(j).25. 12 C.F.R. 225.24.

26. These banks would also have to enter into agreementsto participate with ITS.



dance with the limitations set forth in Regula-tion Y and the Board’s above-mentioned previousorder governing these proposed activities. The

Board approved the notice on June 8, 2006(2006 FRB C149).

3600.7.2 LAWS, REGULATIONS, INTERPRETATIONS, AND ORDERS

Subject Laws 1 Regulations 2 Interpretations 3 Orders

Acting as a certification author-ity for financial and nonfinan-cial transactions and related dataprocessing activities.

12U.S.C.1843(c)(8)

225.28(b)(14) 2000 FRB 562006 FRB 149

1. 12 U.S.C., unless specifically stated otherwise.2. 12 C.F.R., unless specifically stated otherwise.

3. Federal Reserve Regulatory Service reference.



Permissible Activities by Board Order(Private Limited Investment Partnerships) Section 3600.8

A bank holding company (the applicant) appliedunder section 4(c)(8) of the Bank Holding Com-pany Act and the Board’s Regulation Y toengage de novo through a wholly owned subsid-iary (the company) in privately placing limitedpartnership interests in a group of partnershipshaving a limited number of investors. The com-pany was to serve as the investment adviser,administrator, and sole general partner of aseries of seven partnerships (the partnerships)that would be sold to a number of institutionalinvestors.Thecompanywouldmaintainanequityinterest of approximately 1.25 percent of thetotal capitalization in each partnership.

The partnerships were to be engaged solely ininvesting in limited amounts of debt and equitysecurities, including interests in real estate invest-ment equity trusts (REITs).1 The partnerships,together with the applicant and its other subsidi-aries, were not to hold more than 5 percent ofany class of voting securities of any issuer,and not more than 25 percent of the total equityof any issuer.2 The equity investments wereto be held in accordance with section 4(c)(6)of the BHC Act and section 225.22(d)(5) ofRegulation Y.

The company also proposed to privately placelimited partnership interests with new sophisti-cated institutional investors and possibly formsimilar additional partnerships in the future. Thecompany was not to privately place debt securi-ties issued by the partnerships without priorapproval from the Federal Reserve System. Theapplicant committed that the private placementof limited partnership interests would conformto the limitations and conditions for privateplacements in previous Board orders approvingprivate-placement activities (for example, 1990FRB 26 and 1989 FRB 829).3 Each investor wasrequired to have an initial minimum investmentof $100,000. Investors with $250,000 or moreunder management by the company, however,would be permitted to invest in any partnership

in any amount. The applicant would continuethe company’s practice of allowing existinginvestors in a partnership to add to their invest-ment in the partnership in any amount. Theapplication was approved on June 28, 1994(1994 FRB 736).

Subsequently, another bank holding company(the BHC applicant) applied for the Board’sapproval under section 4(c)(8) of the BHC Actand section 225.23 of Regulation Y to engagede novo, through a wholly owned asset-management subsidiary (AMS), in establishingand serving as the general partner of limitedpartnerships (the limited partnerships) that wouldinvest in a wide variety of commodities andexchange-traded and over-the-counter instru-ments including those specified in the Boardorder. AMS would be the general partner ofeach partnership and would hold a nominalequity interest in each one. In this case, AMSwould not provide investment advice directly tothe limited partnerships, but would employunaffiliated investment advisers to manage theinvestments of the limited partnerships, pursu-ant to parameters set by AMS. Interests in thelimited partnerships would be privately placedwith institutional customers by the BHC appli-cant’s subsidiary banks.

One or more of the limited partnerships couldinvest a substantial portion of their assets incommodity pools, which would require the appli-cant to register as a commodity pool operator(CPO). The interests purchased by the limitedpartnerships would consist of less than 5 percentof the outstanding voting securities of any com-modity pool and less than 10 percent of the totalequity of any commodity pool. The applicantproposed that the limited partnerships purchasesuch assets with debt. It further stated that itwould not permit any limited partnership thatinvested in distressed debt instruments to useborrowed funds to purchase or carry distresseddebt instruments or to use the distressed debtinstruments as collateral in acquiring other assets.The applicant also indicated that the leverageemployed by the limited partnerships wouldinclude margin credit from broker-dealers, re-verse repurchase agreements, and short sales.

The limited partnerships would invest in debtand equity instruments and distressed debtinstruments.4 The applicant stated that invest-

1. The partnerships were not to invest in futures contractsor options on futures contracts on any financial or nonfinan-cial commodity, or knowingly invest in debt that, upon acqui-sition, is in default without the prior approval of the FederalReserve System. The applicant further committed that itwould not use the investments of the partnerships to obtain orexercise control over any issuer of securities owned or held bythe partnerships. Also, no directors, officers, or employees ofthe applicant and its affiliates will serve as directors, officers,or employees of any issuer of which the applicant and itsaffiliates held more than 10 percent ownership of total equity.

2. The applicant committed that all subordinated debt of anissuer would be subject to this 25 percent limit.

3. See the current Regulation Y, section 225.28(b)(7)(iii),regarding private-placement services.

4. The Board had previously permitted bank holding com-


ments in debt and equity securities and dis-tressed debt would be made in accordance withthe BHC Act’s limitations and those of pre-vious Board decisions. (See 1995 FRB 1128 andsection 3104.0.)

The limited partnerships, together with theapplicant and its subsidiaries, would make invest-ments not greater than 5 percent of any class ofvoting securities of any issuer, and not greaterthan 25 percent of the total equity, including thesubordinated debt, of any issuer. No directors,officers, or employees of the applicant wouldserve as directors, officers, and employees ofany issuer of which the applicant and its subsid-iaries (that is, the limited partnerships) wouldhold more than 10 percent of the total equity.For this case, the Board required AMS to con-solidate the assets and liabilities of the limited

partnerships in the financial statements of AMSfor regulatory capital purposes. In addition, AMSwas required to establish an appropriate risk-management structure consisting of investmentand position limits for each investment adviserbefore engaging in the proposed activities. Com-pliance and trading limits would be monitoredby computerized systems to be established bythe applicant. The Board approved the notice onApril 24, 1996, subject to all the facts of recordand the commitments furnished. See 1996 FRB569. For more recent Board orders wherebybank holding companies propose to act as aCPO and to control a private limited partnershipthat invested solely in permissible investmentsfor a bank holding company, see 1999 FRB 209,1998 FRB 852, and 1998 FRB 361.

panies to sponsor, organize, and manage closed-end invest-ment companies and unregistered limited partnerships thatinvest in securities.

Private Limited Investment Partnerships 3600.8


Permissible Activities by Board Order(FCM Activities) Section 3600.13

3600.13.1 SERVING AS ANDCONTROLLING A PRIVATE LIMITEDPARTNERSHIP AS A COMMODITYPOOL OPERATOR

A bank holding company applied for the Board’sapproval under section 4(c)(8) of the Bank Hold-ing Company Act (BHC Act) and section 225.23of the Board’s Regulation Y (12 C.F.R. 225.23)to engage de novo through a wholly ownedasset-management subsidiary (ASM) that wouldbe established to serve as the general partner oflimited partnerships (the partnerships) that wouldinvest in a wide variety of commodities andexchange-traded and over-the-counter instru-ments, including interests in investment fundsthat invest in futures and options on futures onfinancial and nonfinancial commodities (com-modity pools). It was indicated that the partner-ships would not directly invest in futures oroptions on futures contracts for purposes otherthan hedging. The partnerships would purchaseand sell derivative contracts on precious metalsand financial commodities, instruments, andindices for hedging purposes. It was furtherstated that one of the limited partnerships mayinvest a substantial portion of its assets in com-modity pools, which would require the ASM(the general partner) to become a registered

commodity pool operator (CPO) with the Com-modity Futures Trading Commission (CFTC).As such, the ASM would register as a CPO withthe CFTC, and a portion of the general partner’sactivities would become subject to the record-keeping, reporting, fiduciary standards, and otherrequirements of the Commodity Exchange Act(7 U.S.C. 2 et seq.), CFTC, and National FuturesAssociation.

The Board previously has found that a subsid-iary of a state member bank may serve as theCPO of investment funds engaged in purchasingand selling futures and options on futures oncertain commodities.1 In addition, the Board haspermittedbankholdingcompanies to trade futuresand options on futures on financial and nonfi-nancial commodities.2 For these reasons, theBoard has concluded that serving as a CPO, andcontrolling as a CPO a private limited partner-ship that invests solely in investments that abank holding company is permitted to makedirectly, under the circumstances of this case(1996 FRB 569) are closely related to banking.See also 1998 FRB 1075, 1998 FRB 852–854,1998 FRB 361, and 1994 FRB 736.

1. See 1996 FRB 239.2. See 1995 FRB 185.


Permissible Activities by Board Order(Insurance Activities) Section 3600.17

3600.17.1 ENGAGING IN TITLEINSURANCE AGENCY ACTIVITIESPURSUANT TO REGULATION Y

A bank holding company applied under section4(c)(8) of the BHC Act and section 225.23(a) ofthe Board’s Regulation Y to acquire all theoutstanding shares of a title insurance agency.The title insurance agency is to conduct activi-ties pursuant to exemption G of the Garn–StGermain Depository Institutions Act of 1982(the act) and section 225.28(b)(11)(vii) of Regu-lation Y. Title VI of the act amended section4(c)(8) of the BHC Act to provide that insur-ance agency, brokerage, and underwriting activi-ties are not ‘‘closely related to banking’’ andthus are not permissible activities for bank hold-ing companies, unless the activities are includedwithin one of seven specific exemptions(A through G) in section 4(c)(8).

The applicant claimed that it was authorizedto operate a title insurance agency under exemp-tion G, which authorizes those bank holdingcompanies that engaged in insurance agencyactivities before 1971 to engage, or control acompany engaged in, insurance agency activi-ties. The company has been engaged in the saleof insurance related to extensions of credit by itssubsidiary banks since 1939.

The bank holding company applicant was oneof 16 active companies with grandfather rightsunder exemption G.1 Previously, the Board deter-mined (1985 FRB 171) that those companiesthat had received Board approval to engagein general insurance agency activities before1971 would be grandfathered under exemptionG with respect to the sale of any type of insur-ance that is within the scope of general insur-anceagencyactivities—evenan insuranceagencyactivity (such as title insurance) not actuallyoffered by the applicant bank holding companybefore 1971. The Board found that there is norequirement in the statute that a company quali-fying for exemption G engage only in thoseinsurance agency activities it conducted withBoard approval before 1971. Thus, although theBoard may not have specifically approved titleinsurance before 1971, provided the proposedactivity is encompassed within the authorizationof insurance agency activities, the activity fallswithin exemption G.

The Board determined selling title insurancethrough a title insurance agency to be permis-sible pursuant to exemption G and the Board’sregulations. The Board approved the applicationon November 17, 1988 (1989 FRB 31).

1. There are currently 12 companies remaining.


Permissible Activities by Board Order(Underwriting and Dealing) Section 3600.21


Effective July 2008, this section has been revised

to incorporate a name change to the Financial

Industry Regulatory Authority, or FINRA (for-

merly, the National Association of Securities

Dealers, or NASD).

3600.21.1 UNDERWRITING ANDDEALING IN COMMERCIAL PAPERTO A LIMITED EXTENT

A bank holding company applied for the Board’sapproval under section 4(c)(8) of the BHC Actand section 225.21(a) of the Board’s Regula-tion Y to underwrite and deal in third-partycommercial paper to a limited extent. As pro-posed, the activity will be conducted through acommercial finance subsidiary (the company).The company is to act for issuers as an under-writer of commercial paper, purchasing com-mercial paper for resale to institutional investorssuch as banks, insurance companies, mutualfunds, and nonfinancial businesses. In addition,the company may place commercial paper asagent for issuers and advise issuers on the ratesand maturities of proposed issues that are likelyto be accepted in the market—activities previ-ously approved by the Board (1987 FRB 138).The activities in this order (1987 FRB 367)differ from those previously authorized (1987FRB 138) in that the applicant will underwriteand deal in commercial paper as principal.

The Board may not approve a proposal of amember bank affiliate if upon consummation itwould be ‘‘engaged principally’’ in the flotation,underwriting, public sale, or distribution of com-mercial paper (hereafter referred to as ‘‘under-writing and dealing in’’) within the meaning ofthe former section 20 of the Glass-Steagall Act(12 U.S.C. 377). The Board concluded that evenif placement of commercial paper were deemedto constitute an activity, the commercial lendingsubsidiary would not be ‘‘engaged principally’’in underwriting and dealing in securities. Thesubsidiary’s activity was not substantial under aformer 5 percent limit on the subsidiary’s grossincome (increased to 25 percent, effective March6, 1997) from its commercial paper activitiesand a former 5 percent limit on its market share.The company is required to restrict its commer-cial paper activities so it does not exceed theselimits.

The Board concluded that underwriting and

dealing in commercial paper is closely related tobanking on the same basis as acting as place-ment agent and adviser to issuers in commercialpaper (1987 FRB 138). Banks provide servicesthat are operationally and functionally similarto the services of underwriting and dealing incommercial paper. Banking organizations areparticularly well equipped to provide such ser-vices. In the Board’s view, the underwriting anddealing activity represents a natural extension ofcommercial lending activities traditionally con-ducted by banks, involving little additional riskor new conflicts of interest, and potentiallyyielding significant public benefits in the formof increased competition and convenience.

The Board concluded that the applicant couldconduct the activities to the extent and in themanner described in the order, consistent withthe former section 20 of the Glass-Steagall Actand section 4(c)(8) of the BHC Act. The Board’sapproval extended only to commercial paperunderwriting, dealing, placement, and advisoryactivity conducted in accordance with the limi-tations stated in the order (1987 FRB 367).

3600.21.2 ENGAGE INUNDERWRITING AND DEALING, TOA LIMITED EXTENT, IN MUNICIPALREVENUE BONDS, MORTGAGE-RELATED SECURITIES, ANDCOMMERCIAL PAPER

On April 30, 1987, the Board approved by orderthe applications of three bank holding com-panies to engage through subsidiaries in under-writing and dealing in commercial paper, one-to four-family mortgage-backed securities, andmunicipal revenue bonds.1 (For a completedescription of the nonbanking activities autho-rized by the Board in this order, see 1987 FRB473.) The subsidiaries are to be involved inunderwriting and dealing in U.S. governmentsecurities as their major activity. Board approval

1. The applicants had previously received Board approvalunder section 4(c)(8) of the BHC Act for the subsidiariesmentioned in the order to engage in underwriting and dealingin U.S. government and agency and state municipal securitiesthat state member banks are authorized to underwrite and dealin under section 16 of the Glass-Steagall Act. The newlyproposed underwriting and dealing activities were approvedin addition to the previously approved activities.

BHC Supervision Manual July 2008Page 1

could only occur if the affiliates would not be‘‘principally engaged’’ in underwriting and deal-ing in ‘‘securities’’ under the provisions of theformer section 20 of the Glass-Steagall Act.

A hearing was held on February 3, 1987,because of the important legal and factual issuesinvolved. The Board reaffirmed its finding in itsprevious decisions (1987 FRB 138 and 367) thatthe applicants were not principally engaged inthe proposed securities activities if they limitedtheir underwriting and dealing income fromthese securities to 5 percent of the total grossincome of the affiliate, and if they limited theirmarket share in each of these securities to 5 per-cent of the total domestic market.2 The Boardestablished a number of conditions to ensurethat the underwriting activity would be consis-tent with safe and sound banking practices andwould avoid conflicts of interest, undue concen-tration of resources, and other adverse effects.

The Board determined, consistent with itsprevious underwriting and dealing decisions inadministering the Glass-Steagall Act, that arange of between 5 percent and 10 percent ofgross revenue and market share is the appropri-ate framework for determining whether an affili-ate is engaged principally in securities activities.The lower end of the range—5 percent—wasthe level applied at the time. The Board notedthat it would review this level within a yearon the basis of experience gained from opera-tions to determine whether a higher level wouldbe permissible. On September 21, 1989, theBoard modified section 20 orders to increasefrom 5 percent to 10 percent the revenue limiton the amount of total revenues a section 20subsidiary may derive from ineligible securitiesunderwriting and dealing activities (increased to25 percent, effective March 6, 1997) (1989 FRB751).3

The Board’s approval of the applicationsextends only to the activities conducted withinthe limitations of the order and is subject to thegross revenue limitation discussed above. Twoof the applicants also proposed to underwriteand deal in consumer-receivable-related securi-ties (CRRs). Although the companies noted cer-tain similarities between these securities andmortgage-related securities, the Board did notbelieve that the record before the Board pro-vided a sufficient basis for it to make a formalfinding (as required by the BHC Act) that under-writing and dealing in CRRs is closely related tobanking and a proper incident thereto. The Boardnoted that the market for CRRs was relativelynew and untested compared with the market forone- to four-family mortgage-related securitiesand municipal revenue bonds. The Board indi-cated that it would reconsider the matter within60 days on the basis of more complete informa-tion to be submitted by the applicants regardingthe types of assets that would be securitized, themanner in which this would be accomplished,and other matters bearing on risk.

In a subsequent order, six BHCs applied forand received the Board’s conditional approval(1987 FRB 731) for the activity, but the Boardstayed its order for the same period of timeapplicable to the stay issued by the SecondCircuit Court of Appeals (see footnote 2 andsection 3600.21.3). After approving the orderset out in 1987 FRB 731, the Board approvedseveral other orders that rely on this order andthe limitations imposed therein. (See the follow-ing Board orders: 1987 FRB 607, 616, 618, 620,622, 731, 738, 742, 928; 1988 FRB 133, 500,699, 700, 706, 819; 1989 FRB 33, 190, 396,398, 520, 645, 647; 1990 FRB 79, 158, 256,461, 554, 568, 573, 652, 682, 756; 1991 FRB954; 1992 FRB 338; 1993 FRB 141, 716; and1994 FRB 249, 346.)

The major difference between the threeapplications decided on April 30, 1987, andthe two applications previously approved bythe Board (1987 FRB 138 and 367) is that theunderwriting would take place in an affiliateengaged in underwriting and dealing in U.S.government securities. This arrangement raisedthe major legal question of whether these gov-ernment securities could serve as a basis formeasuring the principal activity of the affiliate.In its approval, the Board took into account thefact that the Glass-Steagall Act specifically

2. The U.S. Court of Appeals for the Second Circuit upheldthe Board’s determination that the underwriting subsidiarieswould not be engaged principally in ineligible securitiesunderwriting and dealing under the above revenue limitation;the U.S. Supreme Court declined to review that decision(Securities Industry Association v. Board of Governors of the

Federal Reserve System, 839 F.2d 47 (2d Cir. 1988), cert.

denied, 108 S.Ct. 697 (1988)). The Supreme Court also letstand the lower court’s determination that the 5 percent mar-ket share limitation was not adequately supported by the factsof record, thus sustaining elimination of the market share testthat had been invalidated by the U.S. Court of Appeals.Accordingly, the Board decided not to impose a market sharelimitation on orders approved on August 4 and 8, 1988.

3. The Board in this order also modified its section 20orders to permit underwriting and dealing in securities ofaffiliates if the securities are rated by a nonaffiliated, nation-

ally recognized rating organization or are issued or guaranteedby the Federal National Mortgage Association, the FederalHome Loan Mortgage Corporation, or the GovernmentNational Mortgage Corporation, or represent interests in suchobligations.

Permissible Activities by Board Order (Underwriting and Dealing) 3600.21


allows member banks to underwrite U.S. gov-ernment securities and that the act intends affili-ates to have a broader scope for underwritingthan member banks. On that basis, the Boardhad previously allowed affiliates of memberbanks to engage in underwriting of U.S. govern-ment securities.

3600.21.3 ENGAGE IN LIMITEDUNDERWRITING AND DEALING INCONSUMER-RECEIVABLE-RELATEDSECURITIES

Six bank holding companies applied for theBoard’s approval to engage in limited under-writing and dealing in consumer-receivable-related securities (CRRs). CRRs, which werefirst issued in 1985, consist of debt obligationsthat are secured by or represent an interest in adiversified pool of loans to or receivables fromconsumers, such as loans to individuals to financethe purchase of automobiles or personal creditcard accounts.

The Board concluded that underwriting anddealing in CRRs is an activity closely related tobanking on the basis that banks provide servicesthat are operationally and functionally so similarto the services proposed that banking organiza-tions are particularly well equipped to providethem. In accordance with section 16 of theGlass-Steagall Act, banks underwrite and dealin certain mortgage-related securities that areissued or guaranteed by the United States or byU.S. government agencies. Some of the securi-ties represent interests in pools of mortgageloans for residential housing purposes made bybanks and other financial institutions. Suchsecurities are very similar to CRRs.

Both CRRs and bank-eligible mortgage-related securities represent interests in pools ofloans made by financial institutions to individu-als to finance the purchase of housing or con-sumer goods and services.

The techniques involved in underwriting anddealing in bank-eligible mortgage-related secu-rities are also very similar to those that would beinvolved in conducting the approved activitywith respect to CRRs. In each case, the under-writer must perform substantially identical func-tions of evaluating prepayment risk, analyzingcredit and cash flow from a pool of numerousindividuals’ loans, negotiating or bidding, anddistributing and dealing.

In addition, banks now directly perform someof the functions involved in the approvedactivity. Banks select the consumer loans thatform the pool of interests that are then sold to

investors. Banks also advise issuers of CRRsand assist issuers in privately placing thesesecurities.

Because of the similarity between securitiesinvolved in CRRs and the previously approvedbank-ineligible one- to four-family mortgage-related securities nonbanking activities set forthin a previous order (1987 FRB 473), the Boardrequired that this activity be conducted in accor-dance with the same requirements established inthat order. This includes a requirement that thesecurities be rated for investment quality by anationally recognized agency.

The Board concluded, based on the reasonsset forth in its previous order (1987 FRB 473),that the approved activity would not result in aviolation of the former section 20 of the Glass-Steagall Act and is closely related and a properincident to banking. The Board’s approval ofthese applications is restricted to underwritingand dealing to a limited extent in securitiesrepresenting an interest in or backed by a diver-sified pool of loans to or receivables from indi-viduals for the purchase of consumer goods andservices, and the limitations of section225.25(b)(16) of Regulation Y (1987 FRB 731).

3600.21.4 LIMITED UNDERWRITINGAND DEALING IN DEBT ANDEQUITY SECURITIES

Five bank holding companies applied for theBoard’s approval under section 4(c)(8) of theBHC Act for their wholly owned subsidiaries tounderwrite and deal in, on a limited basis—

1. debt securities, including, without limitation,sovereign debt securities, corporate debt, debtsecurities convertible into equity securities,and securities issued by a trust or other vehi-cle secured by or representing interests indebt obligations; and

2. equity securities, including, without limita-tion, common stock, preferred stock, Ameri-can Depositary Receipts, and other direct andindirect equity ownership interests in corpo-rations and other entities.

Section 16 of the Banking Act of 1933(the Glass-Steagall Act) prohibits a memberbank from underwriting and dealing in thesesecurities (referred to hereafter as ‘‘bank-ineligible securities’’). However, as far as theGlass-Steagall Act is concerned, an affiliate of a



member bank may underwrite and deal inbank-ineligible securities so long as it is notengaged principally or substantially in thatactivity (12 U.S.C. 377).

The applicants had previously received Boardapproval to underwrite and deal in U.S. govern-ment and agency securities and state andmunicipal securities that state member banks arespecifically authorized to deal in under section16 of the Glass-Steagall Act (referred to hereaf-ter as ‘‘bank-eligible securities’’). The Boardhad also authorized the subsidiaries to under-write and deal in commercial paper, one- tofour-family mortgage-backed securities, munici-pal revenue bonds, and consumer-receivable-related securities—all securities that memberbanks may not underwrite or deal in under sec-tion 16 of the Glass-Steagall Act.4

To ensure that the subsidiaries would not beprincipally or substantially engaged in under-writing or dealing in the ineligible securities inviolation of the former section 20 of the Glass-Steagall Act, the Board’s approval was madesubject to the requirement that gross revenuesfrom those ineligible securities activities wouldnot exceed 5 percent of the subsidiary’s totalgross revenues on average (moving average)over any two-year period. (See 1989 FRB 192and 196–197.) The Board increased this level to10 percent on September 5, 1989.

The subsidiaries are also subject to a frame-work of structural and operating limitationsestablished to avoid the potential for conflicts ofinterest, unsound banking practices, unfair com-petition, loss of public confidence in affiliatebanks, and other adverse effects from the con-duct of the bank-ineligible securities underwrit-ing and dealing activity.

The Board recognized that underwriting anddealing in securities is a natural extension ofactivities currently conducted by banks, involv-ing manageable risks and potential conflicts ofinterest when conducted in an organizationalstructure that insulates these activities frombanking activities supported by the federal safetynet of deposit insurance and access to FederalReserve lending. The Board has acknowledgedthat certain bank holding companies have anexisting expertise in securities underwriting,dealing, brokerage, investment advisory activi-

ties, and broad financial skills that make themwell equipped to provide the new services.

The Board’s approval of each application issubject to the conditions stated in previousorders (see 1989 FRB 192; 1990 FRB 158, 455,573, 652, 683, 756; 1991 FRB 672; 1993 FRB133, 719; and 1994 FRB 249, 449). The condi-tions consist of structural and operating limita-tions designed to avoid conflicts of interest andpotential adverse effects, and other conditionsdesigned to ensure safe and sound operations.The conditions include requirements, limita-tions, and prohibitions with regard to—

1. capital adequacy;2. credit extensions to customers of the under-

writing subsidiary;3. maintaining the separateness of an under-

writing affiliate’s activity;4. disclosures by the underwriting subsidiary;5. marketing activities on behalf of an under-

writing subsidiary;6. investment advice by bank or thrift

affiliates;7. extensions of credit to the underwriting sub-

sidiary and to purchasers or issuers of ineli-gible securities (or to major users of projectsfunded by industrial revenue bonds);

8. transfers of information;9. reporting and recordkeeping requirements;

10. transfer of activities and formation of sub-sidiaries of an underwriting subsidiary toengage in underwriting and dealing; and

11. reciprocal arrangements and prohibitionsagainst discriminatory treatment regardingunaffiliated securities firms.

3600.21.5 ACTING AS ADEALER–MANAGER INCONNECTION WITH CASH-TENDERAND EXCHANGE-OFFERTRANSACTIONS

In connection with a bank holding companyapplication to underwrite and deal in, to a lim-ited extent, all types of equity securities throughits section 20 nonbanking subsidiary, an appli-cant also proposed to act as a dealer–manager inconnection with cash-tender and exchange-offertransactions. Dealer–managers generally act asagent for tender or exchange offerors in arrang-ing or facilitating mergers, acquisitions, andother corporate transactions. All-cash tenderoffers do not, of themselves, involve the issu-ance, public sale, or distribution of securities.The Board thus concluded that all revenues

4. See the following Board orders: 1987 FRB 473, 607,616, 618, 620, 622, 731, 738, 742, 928; 1988 FRB 133, 500,699, 706, 819; 1989 FRB 33, 190, 396, 398, 520, 645, 647;1990 FRB 79, 158, 256, 461, 554, 568, 573, 652, 682, 756;1991 FRB 672; 1993 FRB 133, 719; and 1994 FRB 249, 449.



derived from the section 20 company acting as adealer–manager in connection with such tenderoffers may be treated as bank-eligible revenuesfor purposes of determining compliance withthe Board’s 10 percent revenue limitation(changed to 25 percent, effective March 6, 1997)on bank-ineligible securities activities. The Boardapproved the application on November 24, 1993(see 1994 FRB 49, footnote 5).

3600.21.6 UNDERWRITING‘‘PRIVATE OWNERSHIP’’INDUSTRIAL DEVELOPMENTBONDS

A bank holding company (the notificant) pro-vided notice under section 4(c)(8) of the BankHolding Company Act (BHC Act) (12 U.S.C.1843(c)(8)) and section 225.23 of the Board’sRegulation Y (12 C.F.R. 225.23) of its proposalto engage de novo through its section 20 subsid-iary (the company) in underwriting, to a limitedextent, certain ‘‘private ownership’’ industrialdevelopment bonds. The bonds are issued forthe provision of the following governmentalservices: water facilities, sewer facilities, solidwaste disposal facilities, electric energy and gasfacilities, and local district heating or coolingfacilities (collectively, traditional governmentalservices). The notificant controls one banksubsidiary.

The company is currently engaged in limitedunderwriting and dealing in certain municipalrevenue bonds, activities permissible under sec-tion 20 of the Glass-Steagall Act (12 U.S.C.377).5 The company is a broker–dealer regis-tered with the Securities and Exchange Com-mission (SEC) under the Securities ExchangeAct of 1934 (15 U.S.C. 78a et seq.) and is amember of the Financial Industry RegulatoryAuthority (FINRA). Thus, the company is sub-ject to the recordkeeping and reporting obliga-tions, fiduciary standards, and other require-ments of the Securities Exchange Act of 1934,the SEC, and the FINRA. The notificant engagesdirectly and through subsidiaries in other per-missible nonbanking activities.

The Board previously determined that theactivities of underwriting and dealing in munici-pal revenue bonds, including industrial develop-ment bonds, are so closely related to banking asto be proper incidents thereto within the mean-ing of section 4(c)(8) of the BHC Act.6 Certain

bank holding companies previously requestedapproval to underwrite and deal in only munici-pal revenue bonds, as opposed to a full range ofdebt securities. Their requests were limited tounderwriting and dealing in industrial develop-ment bonds that are ‘‘public ownership’’ indus-trial development bonds. Public ownership indus-trial development bonds are those ‘‘tax-exemptbonds where the issuer, or the governmentalunit on behalf of which the bonds are issued, isthe sole owner for federal income tax purposesof the financed facility.’’7

The notificant plans to engage through thecompany in underwriting private ownershipindustrial development bonds issued solely forthe provision of traditional governmental ser-vices. It committed to conduct this activity sub-ject to the same limitations and other conditionsthat govern underwriting and dealing in publicownership industrial development bonds.8

The underwriting risk and the risk analysisrequired to underwrite private ownership indus-trial development bonds issued for traditionalgovernmental services is essentially the same asthe risk and analysis related to underwritingtraditional public ownership bonds. For each,the funds for the repayment of the bonds arederived from revenue generated by the financedfacility, including revenue resulting from a ser-vice contract between the owner/lessor of thefinanced facility and a state or local governmentor political subdivision, pursuant to which thestate or local government or political subdivi-sion agrees to purchase the output of the facil-ity.9 The notificant committed that all the pri-

5. See 1993 FRB 716.6. Citicorp, J.P. Morgan & Co. Incorporated, and Bankers

Trust New York Corporation, 1987 FRB 473, aff’d sub nom.

Securities Industry Ass’n v. Board of Governors of the Fed-

eral Reserve System, 839 F.2d 47 (2d Cir.), cert. denied, 486U.S. 1059 (1988), as modified by order approving modifica-tions to section 20 orders, 1989 FRB 751 (‘‘Citicorp/Morgan/

Bankers Trust’’). See also J.P. Morgan & Co. Incorporated, et

al., 1989 FRB 192, aff’d sub nom. Securities Industry Ass’n v.

Board of Governors of the Federal Reserve System, 900 F.2d360 (D.C. Cir. 1990).

7. See 1987 FRB 502. Examples of financed facilitiesinclude airports and mass-commuting facilities.

8. Citicorp/Morgan/Bankers Trust. All the bonds that thenotificant proposed that the company underwrite would qualifyas ‘‘exempt facility bonds’’ under the Internal Revenue Code(the code). See 26 U.S.C. 142. The types of exempt facilitybonds that the company would underwrite may, subject tocertain volume caps and other limitations, be tax-exemptunder the code even if the proceeds of the bonds are used tofinance facilities that are privately owned. See 26 U.S.C. 103,141, 142, 146, and 147.

9. Typically, in the case of public ownership bonds, thegovernmental unit that issues the bonds owns the financedfacility and repays the bonds from the revenue generated bythe facility and this service contract. The governmental unit



vate ownership bonds that the company wouldunderwrite would be rated ‘‘investment quality’’by a nationally recognized rating agency to thesame extent as are the municipal revenue bondsthat the company currently underwrites.

Considering these circumstances, the Boardconcluded that underwriting and dealing in pri-vate ownership bonds issued for the provisionof traditional governmental services is a permis-

sible activity if conducted subject to the condi-tions and prudential limitations set forth inCiticorp/Morgan/Bankers Trust (1987 FRB 473and 1989 FRB 751 (Modification Order)) andagreed to in 1993 FRB 716. The notificationwas approved on October 24, 1995 (see 1995FRB 1116).

may also enter into a contract with a third party to operate thefinanced facility. In the case of the private ownership bondsthat the notificant plans to underwrite, the governmental unitthat issues the bonds either uses the proceeds of the bonds toacquire or construct a facility, which the governmental unitthen leases to a third party, or lends the proceeds of the bondsto a third party to acquire or construct the facility. The thirdparty agrees to make lease payments or loan repayments tothe governmental unit that enable the governmental unit topay debt service on the bonds. As security for the lease orloan agreement, the third party assigns and pledges the rev-enues generated by the facility and a service contract with astate or local government or political subdivision.



Permissible Activities by Board Order (Issuance & Sale of Mortgage-Backed Securities Guaranteed by GNMA) Section 3600.23

A foreign bank subject to the Bank HoldingCompany Act applied for the Board’s approvalto engage in various nonbanking activities, onebeing to purchase mortgage loans and to issuesecurities for its own account, through a whollyowned subsidiary or third party servicers, and tosell securities guaranteed by the GovernmentNational Mortgage Association (GNMA).Because National Banks are specifically autho-rized under the Glass–Steagall Act (12 U.S.C.24) to issue and sell securities guaranteed byGNMA, as well as to underwrite and deal insuch securities, the Board concluded that theissuance and sale of GNMA securities is closely

related to banking (1988 FRB 573). In addition,the Board determined that the statutory exemp-tion reflects a Congressional determination thatGNMA securities are not the type of securitiesthat would lead to unsound speculation or thatthe public interest in the issuance and sale ofGNMA securities by banks outweighs anypotential harm resulting therefrom. Also, theBoard previously determined that underwritingand dealing in GNMA certificates is of suffi-ciently low risk to be generally permissibleactivities for bank holding companies (12 C.F.R.225.25(b)(16)).


Permissible Activities by Board Order (Sales Tax Refund Agentand Cashing U.S. Dollar Payroll Checks) Section 3600.24

A foreign bank, subject to Section 4 of the BHCAct,applied for theBoard’spermission toacquire,through its wholly owned subsidiary, all theshares of a company located in New York, NewYork. The acquired company would engage inseveral nonbanking activities. Two of the activi-ties, not previously approved by the Board forBHCs, consisted of acting as a sales tax refundagent for the State of Louisiana and CashingU.S. Dollar Payroll Checks Drawn on Unaffili-ated Banks. Both activities were found to beclosely related to banking subject to the factsand conditions found in the Board order andbriefly discussed below. The application wasapproved on August 15, 1990 (1990 FRB 860).

3600.24.1 ACTING AS A SALES TAXREFUND AGENT FOR THE STATE OFLOUISIANA

The company being acquired serves as theState’sexclusive sales tax refund agent for its tax-freeshopping program for foreign visitors. Undertheprogram, foreignvisitorspresentsales invoicesevidencing sales taxes paid in Louisiana to thecompany’s office in the state. It refunds the taxin U.S. dollars to the visitor, less a handling fee.A portion of the handling fee is then remitted to

the State and local tax authorities refund to thecompany the amount of tax refunds advanced.The Board found the activity to be closelyrelated to banking since banks: (1) routinelyforward to taxing authorities tax receipts deliv-ered to the bank on taxes due; (2) commonly actas fiscal agent for government authorities whichinvolves disbursing funds on behalf of state andlocal governments.

3600.24.2 CASHING U.S. DOLLARPAYROLL CHECKS DRAWN ONUNAFFILIATED BANKS

The company being acquired also cashes, andthe Applicant plans to continue cashing, U.S.dollar payroll checks on a limited basis, pri-marily to accommodate employees in airportfacilities that lack banking services, but wherethe company maintains offices. Since checkcashing is a fundamental banking activity per-formed routinely by banks, and the companybeing acquired proposed to cash only checksdrawn on unaffiliated banks, the Board foundthe activity to be closely related to banking. TheBoard stipulated, however, that the Applicantwas not to use the acquired company’s offices asbranches of the Applicant or any affiliated bank.


Permissible Activities by Board Order(Providing Government Services) Section 3600.25

A bank holding company (the notificant)requested the Board’s approval, under section4(c)(8) of the BHC Act and section 225.24(a) ofRegulation Y, to acquire through its whollyowned subsidiary a cash-express company, cer-tain assets of an exchange company, and anotherfirm to engage in various nonbanking activities.Many of the nonbanking activities had previ-ously been determined by the Board to be closelyrelated to banking in Regulation Y, by order, orby interpretation. In addition to those nonbank-ing activities already approved, the notificantrequested the Board’s approval to engage inproviding various governmental service activi-ties at the offices of the cash-express company:

1. postage stamps and postage-paid envelopes2. vehicle registration services, including the

sale, distribution, and renewal of licenseplates and license tags for motor vehicles

3. public-transportation tickets and tokens4. notary public services

The Board noted that banks are permitted toprovide customer access to the type of govern-ment services involved in the proposal, wherebythe banks may be acting in an agency capacityor accomplishing the distribution of some of theservices using automated teller machines(ATMs).1 The Board thus concluded that theproposed nonbank activities are closely relatedto banking. Based on all the facts and commit-ments provided by the notificant, and the repre-sentations and conditions relied upon in reach-ing a decision, the Board approved the proposalon April 2, 1998 (1998 FRB 481).

1. See 12 C.F.R. 7.1010 and OCC Interpretive Letter No.718 (March 14, 1996) (postage stamps, acting as an agent forthe state in selling and renewing license plates and licensetags, and public-transportation tickets from ATMs). See alsoOCC Conditional Approval Letter No. 267 (January 12,1988)(notary services).


Permissible Activities by Board Order (Real Estate SettlementThrough a Permissible Title Insurance Agency)Section 3600.26

A BHC Applicant requested the Board’s permis-sion under section 4(c)(8) of the BHC Act toacquire all the outstanding shares of a companyengaged in title insurance agency and real estatesettlement activities. The Board previouslydetermined that title insurance agency activitiesare permissible under section 4(c)(8)(G) ofthe BHC Act, for which the BHC Applicantqualifies.

The real estate settlement services consist of:(1) reviewing the status of the title in the titlecommitment, resolving any exceptions to thetitle, and reviewing the purchase agreement toidentify any requirement in it in order to ensurecompliance with them; (2) verifying payoffs onexisting loans secured by the real estate andverifying the amount of and then calculating thepro rating of special assessments and taxes onthe property; (3) obtaining an updated titleinsurance commitment to the date of closing,preparing the required checks, deeds, affidavits,and obtaining any authorization letters needed;(4) establishing a time and place for the closing,conducting the closing, and ensuring that allparties properly execute all appropriate docu-ments and meet all commitments; (5) collectingand disbursing funds for the parties, holdingfunds in escrow pending satisfaction of certaincommitments, preparing the HUD settlementstatement, the deed of trust, mortgage notes, theTruth-in-Lending statement, and purchaser’saffidavits; and (6) recording all of the docu-ments required under law.

In reviewing the proposed activity, the Boardnoted that real estate settlement services areprovided by the Applicant’s bank subsidiaries inconnection with their origination of mortgageloans, and banks within the Applicant’s state aregenerally permitted to conduct real estate settle-ment activities. It was further noted that banksroutinely prepare collateral security agreementsand other documentation required to close loansin accordance with federal and state lendingrequirements as part of the general lendingactivities authorized under the Board’s Regula-tion Y.

The Board concluded that aspects of the pro-posed real estate settlement activities are directlylinked to permissible title insurance agency ac-tivities by BHCs. These activities can directlyaffect the insured risks under a title insurancepolicy. Title insurance agents have special expe-rience in assessing potential title defects thatcan arise in real estate settlement. Title insur-ance agents thus have the expertise to generallyengage in real estate settlements.

For these reasons, the proposed real estatesettlement activities conducted through a per-missible title insurance agency, were deemed bythe Board to be closely related to banking forpurposes of section 4(c)(8) of the BHC Act. TheBoard approved the application by order onOctober 15, 1990 (1990 FRB 1058).


Providing Administrative and CertainOther Services to Mutual Funds Section 3600.27

A bank holding company (the applicant) appliedunder sections 3(a)(3) and 4(c)(8) of the BHCAct to acquire another company (the company),thereby indirectly acquiring its subsidiary (thesubcompany) as well as the subsidiary bank andnonbank companies of the company and thesubcompany. Upon consummation of the trans-action, the company and subcompany would besubject to the provisions of the BHC Act. Bothcompanies applied for permission under section3(a)(1) of the BHC Act to become a bank hold-ing company.

The applicant also applied for the Board’spermission to engage, through one subsidiary ofthe subcompany (the adviser), in providingadministrativeandcertainotherservices tomutualfunds, nonbanking activities that the Board hasnot previously considered under section 4(c)(8)of the BHC Act. The applicant also applied forthe Board’s permission to acquire certain othernonbanking subsidiaries of the company (aslisted in appendix B of the order) to engage inmaking or servicing loans, providing trust ser-vices, and providing investment advisory non-bankingservicespursuant tosection225.28(b)(1),(b)(5), and (b)(6) of Regulation Y.

In addition, the applicant provided notice ofits intent to indirectly acquire a foreign trustcompany, a trust administration company, andan advisory company. The companies engage inactivities that are permissible under section211.10 of Regulation K.

3600.27.1 GLASS-STEAGALL ACTISSUES IN PROVIDINGADMINISTRATIVE SERVICES

The administrative services the applicant pro-posed to provide through the adviser and itsaffiliates raised a number of issues under theGlass-Steagall Act. Under that act, a companythat owns a member bank may not control‘‘through stock ownership or in any other man-ner’’ a company that engages principally in dis-tributing, underwriting, or issuing securities.

Because mutual funds continuously issue andredeem securities, the Board in 1972 issued aninterpretation setting out its position on theGlass-Steagall Act as it governs the relationshipbetween mutual funds and companies that ownmember banks (12 C.F.R. 225.125). The Boardfound that the Glass-Steagall Act prohibitsaffiliates of banks from sponsoring, organizing,or controlling mutual funds or distributing theirshares.

The Board also found, however, that the Glass-Steagall Act does not prohibit all relationshipsbetween a bank holding company and a mutualfund and that it is permissible, under the BHCAct and the Glass-Steagall Act, for bank hold-ing companies to provide investment advice tomutual funds. Also, the Board found that theGlass-Steagall Act does not prohibit bank hold-ing companies from providing certain other ser-vices to mutual funds, such as acting as custo-dian, transfer agent, or registrar.1 Banks andaffiliates of banks may serve as investment ad-viser, transfer agent, custodian, and registrar.They may not act as distributor to the fund. Theapplication raised the question whether it wasconsistent with the Glass-Steagall Act for anaffiliate of a member bank to act as an adminis-trator to a mutual fund.

3600.27.2 PERMISSIBILITY OFPROPOSED ADMINISTRATIVE-SERVICES ACTIVITIES

The adviser furnishes a variety of services toopen-end investment companies (mutual funds)and closed-end investment companies in theUnited States. Because certain of the activitiesof the adviser and its affiliates are prohibited bythe Glass-Steagall Act, the applicant has takensteps and has committed to terminate the

1. The Board imposed a number of restrictions on therelationship between bank holding companies and mutualfunds to avoid conflicts of interest and to address potentialsafety-and-soundness concerns. The Board’s rule includesrestrictions preventing a bank holding company or any of itssubsidiaries from—

• acting as investment adviser to any investment companythat has a name similar to the holding company or any of itssubsidiary banks;

• purchasing for its own account shares of any investmentcompany for which the holding company serves as invest-ment adviser;

• purchasing in its sole discretion in a fiduciary capacityshares of an investment company advised by the holdingcompany; or

• extending credit to an investment company advised by theholding company as collateral for a loan used to purchaseshares of the investment company.

In addition, the rule requires that, in cases in which a cus-tomer purchases or sells securities of the fund through theholding company or is advised by the holding company topurchase shares of the fund, the customer be informed inwriting of the holding company’s involvement with the fund,and be informed that the shares of the fund are not federallyinsured and are not guaranteed by, or obligations of, a bank.


adviser’s role as a sponsor of new mutual funds.The applicant also committed that it would notacquire those of the adviser’s subsidiaries thatengaged in the distribution of mutual fundshares. The applicant further committed that itwould not be involved in the distribution of theshares of any mutual fund. The applicant repre-sented to the Board, that, after the acquisition ofthe company, neither the adviser nor any of itsaffiliates would be obligated by any agreementto engage in any sales activities in connectionwith any mutual fund’s shares and would notenter into any distribution agreement with anymutual fund, unless permitted to do so by achange in current law.

The adviser will not—

1. engage in the development of marketingplans except to give advice to the distributorregarding regulatory compliance;

2. engage in advertising activities with respectto the funds and will not be involved in thepreparation of a fund’s sales literature, exceptto review it for the sole purpose of ensuringcompliance with pertinent regulatoryrequirements; or

3. permit employees of the adviser to engagein sales activities at meetings or seminars(such activities would be conducted solelyby the fund’s distributor).

It was noted that the applicant did not proposeproviding administrative services to those mutualfunds that are marketed and sold primarily tocustomers of any of the applicant’s subsidiarybanks.

The Board believes that it is permissibleunder the Glass-Steagall Act for the applicant toprovide the following administrative services tomutual funds as proposed:

1. maintaining and preserving the records ofthe fund, including financial and corporaterecords

2. computing the fund’s net asset value, divi-dends, and performance data and financialinformation regarding the fund

3. furnishing statistical and research data4. preparing and filing with the Securities and

Exchange Commission (SEC) and statesecurities regulators registration statements,notices, reports, and other material requiredto be filed under applicable laws

5. preparing reports and other informationalmaterials regarding the fund, including prox-

ies and other shareholder communications,and reviewing prospectuses

6. providing legal and regulatory advice to thefund in connection with its other adminis-trative functions

7. providing office facilities and clerical sup-port for the fund

8. developing and implementing proceduresfor monitoring compliance with regulatoryrequirements and compliance with the fund’sinvestment objectives, policies, and restric-tions as established by the fund’s board

9. providing routine fund accounting servicesand liaison with outside auditors

10. preparing and filing tax returns11. reviewing and arranging for payment of

fund expenses12. providing communication and coordination

services with regard to the fund’s invest-ment adviser, transfer agent, custodian, dis-tributor, and other service organizations thatrender recordkeeping or shareholder com-munication services

13. reviewing and providing advice to the dis-tributor, fund, and investment adviserregarding sales literature and marketing plansto ensure regulatory compliance

14. providing the distributor’ s personnelwith information about fund performanceand administration

15. participating in seminars, meetings, and con-ferences designed to present information tobrokers and investment companies, but notin connection with the sale of shares of thefunds to the public, concerning the opera-tion of the funds, including administrativeservices provided by the bank holding com-pany to the funds

16. assisting existing funds in the developmentof additional portfolios

17. providing reports to the fund’s boardregarding fund activities

A mutual fund administrator provides ser-vices that are essentially ministerial or clerical.The administrator does not have policymakingauthority or control over the mutual fund. Thepolicymaking functions rest with the board ofdirectors of the mutual fund. The board of direc-tors is responsible for the selection and reviewof the major contractors to the fund, includingthe investment adviser and, in certain circum-stances, the administrator.

The Investment Company Act of 1940requires that at least 40 percent of the board ofdirectors of a mutual fund be disinterested per-sons who are not affiliated with the investmentadviser, with any person that the SEC has deter-

Providing Administrative and Certain Other Services to Mutual Funds 3600.27


mined to have a material business or profes-sional relationship with the fund, with anyemployee or officer of the fund, with any regis-tered broker or dealer, or with any other inter-ested or affiliated person. These unaffiliatedboard members must approve the fund’s con-tracts with its investment adviser, underwriter,and often its administrator. The applicant com-mitted that the adviser will provide administra-tive services only to mutual funds whose boardof directors consists of a majority of disinter-ested persons.

In situations in which the applicant’s subsidi-aries serve as administrator to the mutual fund,the Board permitted one representative of theadministrator to serve as a director of the fund.The applicant contended that such an interlock-ing director would facilitate the provision ofadministrative services by providing the fundwith a person knowledgeable in the operation ofthe fund who would be in a position to advisethe board of directors on administration.

The applicant proposed that a director inter-lock would be used only in situations in which acompany unaffiliated with it serves as the invest-ment adviser to the mutual fund. With regard tothe adviser’s serving as an administrator, thisinterlocking director would be deemed an inter-ested person and would be excluded from thoseactions that must be taken by disinterested boardmembers, such as the approval of an investmentadvisory contract or a contract for the adminis-trator. The applicant committed that the adviserwould serve as administrator only to mutualfunds for which a majority of the board ofdirectors are disinterested individuals. The Boardbelieved that, in this proposed arrangement, theapplicant would not control a mutual fund if oneemployee of the adviser or an affiliate2 wouldserve as a director of a mutual fund to which theadvisor provides administrative services.

The applicant plans, in a small number ofcases, to provide mutual funds with a combina-tion of administrative, investment advisory, andother services. The OCC has permitted nationalbanks that serve as investment adviser to mutualfunds also to provide some administrative ser-vices to those mutual funds. In addition, a num-ber of national banks have been providing theseand other services as ‘‘ subadministrator’’ tomutual funds that are advised by the bank or anaffiliate.

In the Board’s opinion, permitting a bankholdingcompany that servesas investmentadviser

to a mutual fund and also in essence providesministerial or supporting functions asadministrator to that fund would not signifi-cantly increase the bank holding company’sability to control the mutual fund. In otherwords, the adviser would not, by virtue ofbecoming an administrator to a fund that it or anaffiliate advises, become involved in policy-making functions of these funds to a greaterextent than when it provides solely investmentadvisory services. The Board believes that con-trol would continue to rest with the board ofdirectors of the mutual fund.

With regard to providing a combination ofadvisory and administrative services, the appli-cant further committed that it would not haveany director or officer interlocks with thesemutual funds. It would also not have any direc-tor or officer interlocks with mutual funds towhich it provides both advisory and administra-tive services.

In providing the combination of services, theapplicant would be subject to the Board’s inter-pretation on investment advisory activities(12 C.F.R. 225.125) and would therefore berequired to conform the adviser’s activities tothe interpretation within two years. On this con-dition, and subject to the commitments made bythe applicant, the Board concluded that the pro-posal was permissible under the Glass-SteagallAct.

3600.27.3 BOARD’S CONCLUSIONON PROVIDING ADMINISTRATIVESERVICES

The Board found the applicant’s proposedactivities to be closely related to banking because(1) it had previously determined by regulationthat a bank holding company could act as invest-ment adviser to a mutual fund; (2) nationalbanks, including national bank trust depart-ments, provide administrative services to mutualfunds; and (3) it had also permitted bank hold-ing companies to provide certain individualfinancial data processing services (calculation ofinvestment values and tax consulting) by amutual fund administrator. The Board thusapproved the application on April 21, 1993(1993 FRB 626), based on the facts of recordand all of the commitments and representationsmade by the applicant, and subject to the termsand conditions set forth in the order.

2. This director cannot serve as an officer, director, oremployee of the applicant, its bank, or any subsidiary bank orbank holding company of the applicant.

Providing Administrative and Certain Other Services to Mutual Funds 3600.27


Developing Broader Marketing Plans and Advertisingand Sales Literature for Mutual Funds Section 3600.28


Effective July 2008, this section has been revised

to incorporate a name change to the Financial

Industry Regulatory Authority, or FINRA (for-

merly, the National Association of Securities

Dealers, or NASD).

A foreign banking organization (FBO), subjectto the provisions of the Bank Holding CompanyAct, had requested the Board’s approval toacquire, through a wholly owned subsidiary (thecompany), substantially all the assets of anasset-management partnership (the partnership).The company would be an investment adviserregistered with the Securities and ExchangeCommission (SEC) under the Investment Com-pany Act of 1940. The company’s acquisition ofthe partnership would also include a member-ship interest in a services firm that would pro-vide transfer-agency services to mutual fundsadvised by the company (the funds).

The FBO, among other things, proposed toprovide marketing support to a mutual fund bydirectly contacting broker-dealers, 401(k) planproviders, financial planners, insurance compa-nies, and other financial intermediaries to rec-ommend the funds. It would be primarilyresponsible for the development of marketingplans and the preparation of advertising andsales literature materials for the funds. TheBoard had not previously considered whether abank holding company could provide promo-tional or marketing services to the extent thatwas proposed.

3600.28.1 CONTROLCONSIDERATIONS INVOLVINGPROMOTIONAL AND MARKETINGACTIVITIES

Under the Glass-Steagall Act, a company thatowns a member bank may not own or control‘‘through stock ownership or in any other man-ner’’ a company that engages principally in dis-tributing, underwriting, or issuing securities.1

The Board has found that this provision prohib-its affiliates of banks from sponsoring, organiz-ing, or controlling a mutual fund. The Boardpreviously has determined, however, that theGlass-Steagall Act does not prohibit a bank

holding company from providing advisory andadministrative services to a mutual fund.2

The proposed promotional and marketingactivities would not, it was believed, cause theFBO to control the funds or to be involved inthe underwriting and distribution of the funds’securities to the public. The proposed promo-tional activities involved contact only with finan-cial intermediaries. The activities are similar tothe activities previously approved by the Board.The Board had previously permitted bank hold-ing companies to present information about theoperations of the mutual funds advised andadministered by the bank holding company atmeetings or seminars for brokers of mutualfunds.3 In addition, the Office of the Comptrol-ler of the Currency (OCC) had also authorizedsubsidiaries of national banks to provide mar-keting and advertising support to mutual fundsin connection with their brokerage and advisoryservices.

As for the distribution and sales of the funds,it was proposed that an independent distributorbe given that responsibility.4 The independentdistributor would serve as the principal under-writer of the funds and would enter into salesagreements with financial intermediaries to sellshares of the funds on their behalf.5 Actual saleswould be conducted by the independent dis-tributor or by an independent broker–dealer forthe funds.

The FBO did not propose to solicit retailcustomers to purchase shares in particular funds,to accept orders for the purchase of shares, or toengage in any retail sales activities. Neither thecompany nor any of its employees would receivetransaction-based income or commissions inconnection with the company’s promotional ormarketing activities.

The company would have primary responsi-bility for preparing the advertising and market-ing materials. The independent distributor, how-ever, would be responsible for placing all

1. 12 U.S.C. 221a and 377.

2. See 12 C.F.R. 225.28(b)(6) and 12 C.F.R. 225.125.3. See 1993 FRB 626 (footnote 15).4. The FBO committed that none of its U.S. affiliates,

including the company, would be obligated by any agreementto engage in any sales activities with regard to shares of thefunds, nor would such affiliates enter into any distributionagreement with the funds without the prior approval of theBoard.

5. The funds could enter into distribution agreements withintermediaries, but in no event could the company enter intosuch agreements.


advertisements. The independent distributorwould also have legal responsibility, under therules of the Financial Industry Regulatory Author-ity (FINRA), for the form and use of all adver-tising and sales literature prepared by the com-pany, and would also be responsible for filingthese materials with the FINRA or SEC.

For the reasons cited, the Board believed thatthe promotional and marketing activities pro-posed by the FBO would not involve the com-pany in the underwriting or distribution of sharesof the funds for the purposes of the Glass-Steagall Act.

3600.28.2 MANAGEMENTINTERLOCK CONTROLCONSIDERATIONS

The FBO also proposed that the chief executiveofficer serve as the chairman of the four-memberboard of trustees of the funds and that no morethan three officers or employees of the companyserve as junior-level officers of the funds. Theemployees would serve as assistant secretary,assistant treasurer, or assistant vice president ofthe funds and would be supervised by the boardof trustees or senior-level officers. Theseemployees would have no policymaking author-

ity at the funds and would not be responsiblefor, or involved in, making recommendations onpolicy decisions. No employee or officer of thecompany would serve as a senior-level officerof the funds.

The Board had previously authorized a bankholding company to have director and officerinterlocks with mutual funds that the bank hold-ing company advises or administers.6 The Boardconcluded that the proposed interlocks betweenthe company and the funds, in this case, wouldnot compromise the independence of the boardsof trustees of the funds, compromise the inde-pendent distribution of the funds, or result incontrol of the funds by the FBO.

Based on the facts given, the Board con-cluded that the control of the funds would restwith the independent members of the boards oftrustees of the funds and that the proposed inter-locks between the company and the funds wouldnot compromise the independence of the boardsof the funds or permit the FBO to control thefunds. The Board concluded that the proposalwas consistent with the Glass-Steagall Act. Thenotice was approved on June 16, 1997. See1997 FRB 679, 1998 FRB 1075–77, 1998 FRB852–853, and 1998 FRB 680–82.

6. See 1996 FRB 1129.

Broader Marketing Plans and Advertising and Sales Literature for Mutual Funds 3600.28


Permissible Activities by Board Order (ProvidingEmployment Histories to Third Parties) Section 3600.29

A bank holding company gave notice undersection 4(c)(8) of the Bank Holding CompanyAct (BHC Act) (12 U.S.C. 1843(c)(8)) and sec-tion 225.23 of the Board’s Regulation Y(12 C.F.R. 225.23) of its intention to engagede novo through its mortgage subsidiary in pro-viding employment histories to third parties fora fee.

The employment histories to be provided bythe mortgage subsidiary would include the namesof past and current employers of an individualand the salary and length of employment foreach position, if the individual has consented tothe release of such information. The mortgagesubsidiary would compile an individual’semployment history from information availablefrom state departments of employment servicesandothersimilar sources.This informationwouldbe provided for a fee to any third-party creditgrantor for the purpose of assessing the credit-worthiness of a prospective borrower.1

3600.29.1 CREDIT-RELATEDEMPLOYMENT HISTORIES

The mortgage subsidiary will provide employ-ment histories to third-party credit grantors,including depository and nondepository grant-ors, for use in making decisions to extend creditonly with the express consent of the individualinvolved. The bank holding company commit-ted that the mortgage subsidiary will complywith the Fair Credit Reporting Act (15 U.S.C.1681 et seq.) (FCRA) and all applicable stateand federal laws and regulations.

In the normal course of their lending activi-ties, banks collect and analyze employment andsalary information, including names of past andcurrent employers and salary histories. The Boardpreviously determined that providing past creditinformation, which includes employment his-tory information, to a credit grantor who isconsidering a borrower’s application for creditis an activity that is closely related to bankingand permissible for bank holding companies.2

Accordingly, the Board concluded that provid-ing employment histories to third-party credit

grantors for use in making decisions to extendcredit is an activity that is closely related tobanking.

3600.29.2 NON-CREDIT-RELATEDEMPLOYMENT HISTORIES

The bank holding company also intends to pro-vide employment histories to third-party deposi-tory institutions and their affiliates, includingcredit unions and their affiliates, for use in theregular course of their business, including thehiring of employees. The mortgage subsidiarywould provide this information to such entitiesonly with the express consent of the individualinvolved. Regardless of whether the customer isa third-party depository institution or other creditgrantor, the activity would only involve provid-ing employment information. The bank holdingcompany does not plan to provide any addi-tional service, such as analyzing an individual’screditworthiness. The bank holding companycommitted that its mortgage subsidiary willcomply with the FCRA and all applicable stateand federal laws and regulations in performingthe proposed activity.

The Board had not previously determinedwhether providing such employment informa-tion to third parties for a fee is closely related tobanking under section 4 of the BHC Act and,therefore, permissible for bank holding compa-nies. The Board had previously permitted bankholding companies to provide employmentinformation, including employment histories, todepository institutions and their affiliates in con-nection with the provision of career counselingservices (see section 3600.15.1.1).3 To the extentthat these organizations use the information tobe provided by the mortgage subsidiary forother purposes, it will only be used in con-nection with the operation of their bankingbusiness.

The Board thus concluded that providingemployment histories for use by depositoryinstitutions and their affiliates in the regularcourse of their business is an activity that isclosely related to banking. For these reasons,the Board, on May 8, 1995, approved the bankholding company’s notice to provide suchemployment information (1995 FRB 732). The1. Credit grantors could include lessors if the leasing trans-

action was the functional equivalent of an extension of credit.2. See Regulation Y, section 225.25(b)(24) (12 C.F.R.

225.25(b)(24)). The bank holding company committed that itwould not promote its mortgage subsidiary as a provider ofemployment information to non–depository institutions forgeneral business purposes unrelated to credit decisions.

3. See 1994 FRB 51.


approval was specifically conditioned on com-pliance with the commitments made in connec-tion with the notice.

Permissible Activities by Board Order (Providing Employment Histories to Third Parties)3600.29


Permissible Activities by Board Order(Title Abstracting) Section 3600.30

3600.30.1 REAL ESTATE TITLEABSTRACTING ACTIVITIES

A bank holding company (the notificant) gavenotice under section 4(c)(8) of the Bank Hold-ing Company Act (the BHC Act) (12 U.S.C.1843(c)(8)) and section 225.23 of the Board’sRegulation Y (12 C.F.R. 225.23) of its intentionto acquire a title abstracting company (the com-pany) and thereby engage in real estate titleabstracting in the state of Iowa.1 Real estate titleabstracting, as proposed by the notificant, islimited to reporting factual information concern-ing the interests or ownership of selected realproperty. An abstracter obtains this informationby performing a title search of records main-tained at a local public records office to deter-mine the ownership history of the property,including any liens, encumbrances, mortgages,or future interests affecting it. The abstracterthen prepares a written report, also known as an‘‘abstract of title,’’ that recites the results of thetitle search. Because Iowa state law does notpermit the sale of title insurance, real estatelenders obtain the opinion of an attorney certify-ing that title to a particular parcel of real prop-erty is free of defects. The abstract of titleprovides the factual information necessary forthe attorney to determine whether a lender wouldhave an unencumbered security interest in theproperty to be mortgaged.

The notificant proposes to provide real estatetitle abstracting services to affiliated and unaf-filiated lenders in an Iowa county. The companywould perform the proposed activities in con-nection with real estate loans made by affiliatesor unaffiliated companies and, in certain cases,when no financing is provided, such as in con-nection with intrafamily transfers of real estateand property distributed as part of estate planning.

The notificant would not provide any insuranceagainst title defects, guarantee any title, or pro-vide any certification with respect to a title. Thenotificant would be liable for damages causedby negligence in performing a title search butwould not be responsible for any defects in thetitle.2 The equivalent of title insurance in Iowais provided by the attorney who certifies that thetitle is free from defects. The Board has notpreviously determined that providing real estatetitle abstracting is closely related to banking

under section 4(c)(8) of the BHC Act and, there-fore, permissible for bank holding companies.

The Board believes that the proposed realestate title abstracting activities are integrallyrelated to the provision of loans secured by realestate. A bank must be aware of any encum-brances on property that serves as collateral fora loan made by the bank. Banks in the statetypically rely on an attorney’s opinion, based oninformation in an abstract of title, to determinethat they have a secured position in real estateserving as collateral. The abstract of title pro-vides information necessary to determine theadequacy of the real estate collateral for the loanand is an integral part of secured real estatelending in Iowa. Thus, the bank has a particularneed for the information in the abstract of title.Accordingly, the Board believes that the pro-posed activities are integrally related to theprovision of secured real estate lending and,therefore, are closely related to banking.

The Office of the Comptroller of the Cur-rency (OCC) has authorized national banks toconduct this activity.3 The OCC has concludedthat the performance of a title search and thepreparation of an abstract of title are necessaryparts of the real estate lending process and thatit would be convenient and useful under theapplicable standards in the National Bank Actfor national banks to be able to perform thesetasks themselves.4

The proposed activities are not equivalent toproviding title insurance—an activity that is notgenerally permissible under section 4(c)(8) ofthe BHC Act.5 Title insurance generally includesprovidingan indemnificationagainst losses result-ing from a title defect discovered after the con-veyance of property. Title insurance typicallyprotects a purchaser or lender against claims notidentified by a title search or claims not specifi-cally exempted by the title insurance policy. Thenotificant does not propose to certify or guaran-tee title and would not be liable to the purchaseror the lender for any title defects.

1. The notificant would merge the company into its whollyowned leasing subsidiary.

2. Title abstracters may insure against liability for negli-gence by purchasing an errors and omissions policy.

3. OCC Interpretative Letter No. 450, September 22, 1988.4. National banks are not permitted to sell title insurance.5. Section 4(c)(8) provides that insurance agency, broker-

age, and underwriting activities are not ‘‘closely related tobanking’’ and, thus, are not permissible activities for bankholding companies, unless the activities are included withinone of seven specific exemptions (A through G) in sec-tion 4(c)(8) (12 U.S.C. 1843(c)(8)(A)–(G)).


The Board concluded, based on all the factsof record, that the proposed activities are closelyrelated to banking and approved the notice onJune 30, 1995. (See 1995 FRB 805.) Approvalof the proposal was specifically conditioned onthe notificant’s compliance with the commit-ments made in connection with the notice.

3600.30.2 AIRCRAFT TITLEABSTRACTING ACTIVITIES

An attorney representing a bank holding com-pany (BHC) requested an opinion as to whetherthe providing of title abstracts on U.S.-registeredaircraft would be a permissible activity for anew subsidiary of a BHC. The aircraft titleabstracting activities would be limited to report-ing factual information concerning the owner-ship history of the relevant aircraft and theexistence of liens or encumbrances affecting theaircraft. The information would be obtained byperforming a title search of records. The titlesearch would be documented in a written report,known as an ‘‘abstract of title,’’ describing thefactual information located by the title search

concerning the existing title owner of the air-craft, previous transfers of the aircraft’s title,and the existence of any liens or encumbrancesaffecting title to the aircraft.6 The subsidiarywould provide the information to affiliated andunaffiliated lenders and other parties in connec-tion with aircraft financing and sales transac-tions. The aircraft title abstracting activitieswould not include providing insurance againstdefects in the title of any aircraft, guarantee anyaircraft title, or provide any certification withrespect to an aircraft title. Based on facts andinformation provided and other facts, the LegalDivision staff issued an opinion on October 7,2002, that concluded that the proposed aircrafttitle abstracting to be conducted by the subsidi-ary would be within the scope of the titleabstracting activities previously authorized bythe Board on June 30, 1995. (See 1995 FRB805, 806.)

6. The attorney requesting the opinion reported that federallaw requires that all changes in title of, and liens and encum-brances affecting, U.S.-registered aircraft must be filed withthe Federal Aviation Administration.

Permissible Activities by Board Order (Title Abstracting) 3600.30


Section 4(c)(8) of the BHC Act (Board Staff Legal Interpretation—FinancingCustomers’ Commodity Purchase and Forward Sales) Section 3610.1

A bank holding company (BHC), that has electedto be a financial holding company within themeaning of the Bank Holding Company Act of1956 (12 U.S.C. 1841 et seq.) (the BHC Act)inquired if it would be permissible under theBHC Act and the Board’s Regulation Y (12C.F.R. 225) for the BHC to engage in ‘‘com-modity purchase and forward sale’’ (CPFS) trans-actions as a method of financing the commodityinventories of its customers.1

Two alternative structures were described forthe CPFS transactions. In the first structure, theBHC would purchase a commodity from itscustomer and simultaneously enter into a for-ward sale agreement under which the customerwould be obligated to repurchase the commod-ity from the BHC at a predetermined price on apredetermined future date. The second structureis similar to the first structure except that itwould involve a third party, either as the initialseller of the commodity to the BHC or as theultimate purchaser of the commodity from theBHC. During the term of a CPFS transaction,the BHC would hold title to the underlyingcommodity, would mark the commodity to mar-ket on a daily basis, and would call for addi-tional margin if the market value of the com-modity falls below a specific collateral threshold.

The BHC Act permits bank holding compa-nies to engage in any activity that the Board haddetermined by regulation or order as of Novem-ber 11, 1999, ‘‘to be so closely related to bank-ing as to be a proper incident thereto.’’2 TheBoard had determined by regulation issued priorto November 11, 1999, that ‘‘[m]aking, acquir-ing, brokering, or servicing loans or other exten-sions of credit (including factoring, issuing let-ters of credit and accepting drafts) for thecompany’s account or for the account of others’’is such an activity.3

Under the proposed CPFS transactions, theBHC would earn a fixed return on a CPFStransaction, just as it would on an ordinarysecured loan, and its risk exposure would effec-

tively be limited to counterparty credit risk. TheBHC would subject any prospective CPFS coun-terparty to the same credit-review process usedfor loan applicants, and the BHC’s internalcredit-review personnel would also review out-standing CPFS arrangements. As proposed, theBHC would never enter into an agreement topurchase a commodity unless it simultaneouslyenters into an agreement to sell the commodityto a creditworthy counterparty on a fixed futuredate at a fixed price. The BHC indicated that afixed future sale price would be equal to theinitial purchase price plus a fixed interest com-ponent (and thus would not vary based on move-ments in the price of the commodity). In otherwords, unless the ultimate purchaser defaults,the BHC would be repaid its principal plus afixed amount of interest at maturity of the trans-action. In addition, the BHC would not bear anycommodity price risk; the price it would receivefor the commodities on the maturity date of thetransaction would be fixed on the date it entersinto the transaction. If the ultimate purchaserdefaults on its obligation to purchase the under-lying commodity upon maturity, the BHC wouldhave a claim against this purchaser to recoverthe equivalent of principal and interest. TheBHC could then sell the commodity into themarket to mitigate credit losses in the samemanner as it would liquidate any collateral sup-porting a loan in default. Any commoditiesacquired by the BHC as a result of counterpartydefault would be held in accordance with thelimits applicable to assets acquired by a BHC inthe course of collecting a debt previouslycontracted.4

Moreover, the BHC represented that all non-price risks and costs of owning the commodityduring the term of the CPFS transaction, such asstorage risk and the cost of insurance, would beborne by the ultimate purchaser. In all cases,although the BHC would take title to the under-lying commodity at the inception of a CPFStransaction, it would take title in the form of awarehouse receipt only; that is, the commoditywould continue to be stored in a licensed ware-house owned and operated by an entity otherthan the BHC. The commodity would not bephysically moved as a result of the transaction.The BHC would acquire title to the underlyingcommodity in a CPFS transaction as an incident

1. The BHC indicated that the commodities involved inthese transactions would include agricultural commodities(such as corn, wheat, soybeans and other legumes, cotton,cocoa, coffee, sugar, various oilseeds and oils, and dairyproducts), live cattle, timber, and exchange-traded metals. TheBHC’s CPFS transactions would, in all cases, involve com-modities (1) for which contracts have been approved fortrading on a U.S. futures exchange by the Commodity FuturesTrading Commission or (2) which the BHC can show, toBoard staff’s satisfaction, have readily-available price quotesand are traded regularly in global commodity markets.

2. See 12 U.S.C. 1843(c)(8).3. See 12 C.F.R. 225.28(b)(1).

4. See 12 C.F.R. 225.22(d)(1).


to the financing it provides to its customers andnot for speculative purposes. The BHC repre-sented that the BHC does not and will not holditself out as making a market in the commodity.In addition, the BHC also represented that theBHC does not and will not (1) own, operate, orinvest in facilities for the extraction, transporta-tion, storage, or distribution of commodities or(2)process, refine,orotherwisealter commodities.

The BHC would account for the CPFS trans-action as an ‘‘ asset purchased under an agree-ment to resell’’ and would recognize profit andloss on the transaction on an accrual basis, in amanner similar to a traditional loan. During theterm of the transaction, the ultimate purchasercounterparty in a CPFS transaction would gen-erally record the underlying commodity as anasset on its balance sheet and would record itsobligation to purchase the commodity as a short-term debt liability.

The interpretation noted that the Board hadpreviously found a three-party commodityfinanc-ing arrangement similar to the BHC’s proposedthree-party CPFS transactions to be an exten-sion of credit permissible for BHCs under Regu-lation Y. In a 1973 order, the Board approved asa permissible lending activity for bank holdingcompanies an arrangement under which a BHCwould finance a utility’s coal purchases by pur-chasing from a third party, and taking title to, aquantity of coal on a monthly basis at the direc-tion of the utility customer. (See 1973 FRB698.) The BHC would store the coal on thepremises of the utility under a lease arrange-ment with the utility. The utility would use thecoal continuously throughout the followingmonthand would pay the BHC monthly for the amount

of coal used, at a price equal to the BHC’sacquisition cost for the coal plus a fixed amountof interest. The utility explicitly bore the risk ofloss or damage to the coal during storage. If theutility defaulted, the BHC had the right to sellthe coal to cover its losses and the right to suethe utility for any shortfall in the liquidationproceeds. As with the proposed CPFS transac-tions, the utility’s motive for the transaction wasto obtain financing for its commodities inventory.

Based on the information the BHC providedand the Board’s precedents, Board legal staffopined that the proposed CPFS transactions arewithin the scope of permissible lending activi-ties for BHCs under section 225.28(b)(1) ofRegulation Y. The BHC should have policiesand procedures to identify whether a CPFStransaction would create heightened legal orreputational risk to the BHC, and to manage anysuch risk. In particular, the BHC should havepolicies and procedures to identify whether aparticular CPFS transaction (1) lacks economicsubstance or business purpose; (2) may bedesigned by the counterparty for questionableaccounting, regulatory, or tax purposes; or (3) maybe accounted for or disclosed by the counter-party in a way that is misleading or inconsistentwith the substance of the transaction or applica-ble regulatory or accounting requirements.

The Board legal staff’s opinion is limitedsolely to the permissibility of the proposedCPFS activities described above under Regula-tion Y and does not address the permissibility ofany other activities or authorize the BHC toengage in any other activities in the UnitedStates. (See the Board’s staff legal interpretationdated May 15, 2006.)

Board Staff Legal Interpretation—Financing Customers’ Commodity Purchase and Forward Sales 3610.1


Section 4(c)(8) of the BHC Act (Board Staff Legal Interpretation—Certain Volumetric-Production-Payment Transactions Involving Physical Commodities) Section 3610.2

A foreign bank (that qualifies as a financialholding company under section 4(k) of the BHCAct and is treated as a bank holding company(BHC) under section 4(c)(9) of the BHC Actrequested a confirmation from the Board’s legalstaff on whether certain volumetric-production-payment (VPP) transactions involving physicalcommodities would be considered as extensionsof credit that are permissible for a BHC undersection 4(c)(8) of the BHC Act and section225.28(b)(1) of the Board’s Regulation Y.1

In 2004, the Board approved a proposal bythe BHC to engage in physical-commodity trad-ing as an activity that is complementary to theBHC’s commodity derivatives activities.2 Theorder limited the value of physical commoditiesthat the BHC may hold under this authority to5 percent of the BHC’s tier 1 capital. The BHCalso requested confirmation that VPP transac-tions and any physical commodities delivered tothe BHC under a VPP would not count againstthe 5 percent of tier 1 capital limit.

A VPP is a royalty interest, typically in ahydrocarbon (such as oil or natural gas) reservethat entitles the VPP holder, in exchange for anupfront payment, to receive specified quantitiesof hydrocarbons on a regular basis during thelife of the VPP transaction. A VPP is consideredto be a real property interest in most states.Relying on its physical-commodity tradingauthority, the BHC had already entered into twoVPP transactions in the United States. In each ofthese transactions, a wholly owned, consoli-dated, U.S. special-purpose-vehicle subsidiaryof the BHC (the SPV) had acquired a VPP froma hydrocarbon producer (the customer) inexchange for cash.3 The VPP transactions aredesigned to provide funding to the customers.The VPP does not give the BHC the right tocontrol production of the oil or gas, and theBHC is therefore dependent on the customermeeting its contractual obligation to produce theagreed-upon volume of oil or gas according tothe agreed-upon schedule.

Simultaneously with its purchase of the VPPinterest from the customer, the SPV and theBHC enter into an agreement under which theBHC makes an upfront payment to the SPV andthe SPV agrees to deliver to the BHC the vol-umes of oil or gas to be received by the SPVfrom the customer under the VPP. As the SPVdelivers the oil or gas to the BHC under this

agreement, the BHC arranges to sell it, eitherback to the customer or into the marketplace, atthe then-current market price for the commodity.

The BHC also may decide to temporarilyretain hydrocarbons it acquires pursuant to aVPP in order, for example, to take advantage ofan anticipated rise in price for the relevant com-modity. The BHC agreed that any hydrocarbonsacquired under a VPP will be counted againstthe BHC’s 5 percent of tier 1 capital limit underthe order if they are not immediately sold to athird party. The BHC represented that it hedgesits commodity-price risk from the VPP by enter-ing into a fixed-rate commodity swap with athird party (which may be the customer) thatconverts the BHC’s variable proceeds from theperiodic sale of the oil or gas into fixed-ratepayments. Accordingly, in the absence of coun-terparty defaults, by the end of the VPP term theBHC will have recouped the original amountadvanced to the customer plus a fixed return.

The BHC stated that the VPP transactionsgenerally are treated as loans for U.S. federalincome tax purposes. In addition, the BHC indi-cated that it will treat VPP transactions as loansfor accounting purposes. Board staff stated thatit expects (1) the BHC will follow generallyaccepted accounting principles in reporting anyVPP transactions and (2) all of the BHC’s VPPtransactions will be entered into for legitimatebusiness purposes.

The BHC argued that a VPP transaction isvery similar to a traditional lending arrangementbecause the discounted present value of thehydrocarbons to be delivered to the BHC overthe life of a VPP transaction is estimated toequal the purchase price paid by the BHC forthe VPP interest plus a margin meant to coverthe BHC’s cost of funds, risk associated withthe transaction, and a fixed profit. Importantly,the VPP does not give the BHC any variableupside potential if there is excess productionfrom the producer’s hydrocarbon reserve.4 More-over, the commodity-price swap hedges theBHC’s commodity-price risk associated withthe VPP, thus guaranteeing the BHC a return ofprincipal and a fixed amount of interest if nei-

1. 12 C.F.R. 225.28(b)(1).2. See 2004 FRB 215.3. [TEXT REDACTED]

4. If the reserve produces more hydrocarbons than aresubject to the VPP, the production is for the benefit of theproducer. If the reserve underproduces in a given periodduring the life of the VPP, the BHC would be entitled to anappropriate amount of overproduction in subsequent months(and extra reimbursement to reflect default interest).


ther the producer nor the swap counterpartydefaults. Accordingly, the VPP transactions arenot designed to serve as a vehicle for the BHCto take on commodity-price risk, own commodi-ties, or engage in commodity dealing.5

As described above, as part of a VPP transac-tion, the BHC will hold a royalty interest in ahydrocarbon reserve and will periodically taketitle, if only momentarily, to physical commodi-ties. The Board has previously concluded, how-ever, that ownership of commodities in connec-tion with a financing transaction does not preventthe transaction from being treated as a form ofcredit extension permissible for a BHC if theeconomics of the transaction are substantiallythe same as those of a loan.6

Based on the information provided by theBHC’s counsel, Board legal staff opined that theabove-described VPP transactions are a form ofpermissible lending activity for BHCs undersection 225.28(b)(1) of Regulation Y when

entered into for the purpose of providing financ-ing to a third-party customer. Any commoditiesthat the BHC receives pursuant to a VPP trans-action and that are not immediately sold to thirdparties would be subject to the 5 percent of tier1 capital limit on the value of commodities thatthe BHC may hold under its physical-commodity-trading authority.

The staff opinion informed the BHC that itshould have in place policies and procedures to(1) identify whether a VPP transaction wouldcreate heightened legal or reputational risk tothe BHC and (2) manage any such risk. Inparticular, the BHC should have policies andprocedures to identify whether a particular VPPtransaction (1) lacks economic substance orbusiness purpose; (2) may be designed by thecounterparty for questionable accounting, regu-latory, or tax purposes; or (3) may be accountedfor or disclosed by the counterparty in a waythat is misleading or inconsistent with the sub-stance of the transaction or applicable regula-tory or accounting requirements.

The staff opinion is limited solely to the per-missibility of the VPP transactions described inthe opinion under Regulation Y. The opiniondoes not address the permissibility of any otheractivities or authorize the BHC to engage in anyother activities in the United States. (See theBoard legal staff’s opinion dated May 15, 2006.)

5. As noted above, the BHC has the authority to engage inphysical-commodity trading, including making and takingdelivery of physical commodities, and may use this authorityto retain ownership of hydrocarbons delivered under a VPP inorder to benefit from anticipated changes in hydrocarbonprices.

6. See 1973 FRB 698.

Board Staff Legal Interpretation—Certain Volumetric-Production-Payment Transactions Involving Physical Commodities 3610.2


Impermissible ActivitiesSection 3700.0

The BHC Act states that a nonbank activity isimpermissible unless explicitly exempt from thegeneral prohibition of section 4. While thiscould cause an unlimited list of impermissibleactivities, the Board has compiled a list of activ-ities which have been specifically determined tobe impermissible (see Manual section 3000.0,Appendix 3).The inspection objective is to determine

whether a specific activity conducted by a bankholding company or its subsidiary is permissiblefor the bank holding company. The Board hasruled specific activities to be impermissiblealthough it has stated also that certain imper-missible activities may be engaged in underlimited special circumstances.In addition, a bank holding company may be

entitled to grandfather privileges which are con-sidered as either permanent (where there is nodeadline for termination of an activity) or tem-porary, in which case the activity must havebeen terminated prior to December 31, 1980. A

holding company may be granted an exemptionfrom section 4 of the Act (i.e., family, hardships,etc.) which allows it to engage in activities thatwould otherwise be impermissible. Because ofthe variety of factors which must be considered,the examiner should exercise care when deter-mining the permissibility of an activity for abank holding company.The subsections of this chapter present a

selected numberof those activities which havebeen determined to be impermissible for bankholding companies. While an activity is permis-sible only after it has been determined as suchby the Board, it must be remembered that indetermining permissibility, the Board has insome instances (i.e., data processing services,courier services, etc.) included restrictions whichwould limit the overall nature or performance ofthe activity. Therefore, even the permissibleactivitiesmaybecomeimpermissible if theactionsof the bank holding company are not in accor-dance with the stated restrictions.


Impermissible Activities(Land Investment and Development) Section 3700.1

The Board of Governors has ruled that landdevelopment1 is impermissible for bank holdingcompanies. However, for land acquired throughforeclosure, a limited amount of developmentmay be allowed in an effort to minimize thepotential loss on the project. Each case must beconsidered separately to determine if it warrantsadditional development.The basic determination of impermissibility

was established by the Board in denying a por-tion of the application by UB Financial Corp.,Phoenix, Arizona, to retain the H. S. PickrellCompany, Phoenix, Arizona (1972 FRB 429).The order stated in part, ‘‘The Board is of theopinion that the activities of purchasing andselling of land or participating as a joint ven-turer in real estate development are not so

closely related to banking as to be a properincident thereto, and that insofar as the applica-tion pertains to those activities, it should bedenied.’’The determination that limited development

for land acquired through foreclosure is permis-sible iscontained inaBoardorderdatedNovember1, 1973, in connection with an application byLiberty National Corporation, Oklahoma City,Oklahoma, to retain Liberty Mortgage Com-pany, Oklahoma City, Oklahoma (1973 FRB919), in which it is indicated that a limitedamount of real estate development might bepermissible if necessary to minimize losses onreal estate acquired in connection with debtspreviously contracted.

1. The Board, by specific order, has permitted a limitedincursion into this area as an accommodation to BHCs acquir-ing thrifts or to thrifts that qualify as ‘‘banks’’ and seek toform bank holding companies (1986 FRB 487, 731)


Impermissible Activities(Insurance Activities) Section 3700.2

3700.2.1 PREMIUM FUNDING

Insurance premium funding, sometimes knownas equity funding, is the financing of the sales ofmutual fund shares and life insurance policies asa package. It should not be confused with loansmade to an insured for the purpose of payingpremiums on hazard insurance (insurance pre-mium financing); in that case the lender may benamed loss payee or owner of the policy and thelender has the right to submit the policy forcancellation in order to collect the amount owed.Insurance premium financing is a permissibleactivity pursuant to Section 225.25(b)(1) ofRegulation Y (Refer to 1974 FRB 310).The Board has determined insurance pre-

mium funding to be impermissible for bankholding companies (12 C.F.R. 225.126). Thisdetermination is based on the policies containedin sections 20, 21, and 32 of the Banking Act of1933 (the Glass–Steagall Act Provisions) asdescribed in the opinion of the United StatesSupreme Court in Investment Company Insti-tute v. Camp, 401 U.S. 617 (1971).‘‘In the Board’s opinion, the Glass–Steagall

Actprovisions,as interpretedby theU.S.SupremeCourt, forbid a bank holding company to spon-sor, organize or control a mutual fund’’ (12C.F.R. 225.125). In enacting the Glass–SteagallAct, Congress indicated that affiliations of com-mercial banks and securities companies giverise to a potential conflict of interest and un-sound banking practices. Pursuant to section4(c)(8) of the Act, the Board is required toconsider whether the performance of a particu-lar nonbank activity by a holding company pro-duces benefits to the public that outweigh possi-ble adverse effects, such as potential conflict ofinterest and unsound banking practices. There-fore, the potential conflict of interest and un-sound banking practices arising in the affiliationof commercial banks and mutual funds pre-cludes the Board from approving insurance pre-mium funding as a permissible banking activity.

3700.2.2 LIFE INSURANCEUNDERWRITING

The life insurance discussed in this section isthat life insurance which is not sold in connec-tion with a credit transaction by a bank holdingcompany or its subsidiary. The Board has ruledthat this activity is impermissible for bank hold-ing companies (12 C.F.R. 225.126). The Boarddeveloped its position during consideration of

the application of First Oklahoma Bancorpora-tion, Inc., Oklahoma City, Oklahoma, for priorapproval pursuant to section 4(c)(8) of the Actto acquire sufficient additional shares of Under-writers Life InsuranceCompany,OklahomaCity,Oklahoma, so as to own at least 80 per cent ofthe outstanding shares and thereby to engage inthe activity of underwriting life insurance notsold in connection with a credit transaction by abank holding company or a subsidiary.In acting on the First Oklahoma application,

the Board relied on an earlier decision denyingan application by Transamerica Corporation,San Francisco, California, to retain its shares ofOccidental Life Insurance Company of Califor-nia (1957 FRB 1014). In the Transamerica case,a hearing examiner found that the life insuranceunderwriting activities of Occidental were notso closely related to banking to be a properincident to managing and controlling banks. Inthe First Oklahoma case, the application waspresented on the question of whether the activi-ties of Underwriters Life were so closely relatedto banking or managing or controlling banks asto be a proper incident thereto. The Board deter-mined in First Oklahoma, that there was noreasonable basis for the contention that the ac-tivities of Underwriters Life were permissible.The activity of acting as an underwriter (rein-

surer) for credit life and credit accident andhealth (disability) insurance is, however, consid-ered a permissible activity (12 C.F.R. 225.135).

3700.2.3 SALE OF LEVEL-TERM LIFEINSURANCE

The Board has stated that the sale of level-termlife insurance is not covered by section225.25(b)(8)(ii) of Regulation Y. This positionwas stated in its order approving the applicationby Fidelity Corporation of Pennsylvania, Rose-mount, Pennsylvania, to acquire Local FinanceCorporation, Providence, Rhode Island, except-ing those proposed activities of level-term lifeinsurance sales (1973 FRB 472). Insurance thatdoes not decline in coverage as the outstandingloan balance is reduced results in the insuredparty carrying more insurance than is necessaryto cover the outstanding loan balance. Becauseof this position, the Board would not allow thesale of this type of insurance by the applicantand its subsidiary.


3700.2.4 UNDERWRITING REALESTATE MORTGAGE GUARANTEEINSURANCE

Mortgage guaranty insurance is essentially alimited guarantee of a mortgage loan. Such in-surance typically covers the top 20 or 25 percentof a mortgage loan. In the event of default bythe borrower, the lender acquires title to theproperty and then submits a claim to the insurer.The insurer then has a choice of two options:(1) take title to the property and pay the lenderthe unpaid principal and interest; or (2) pay thelender the 20 or 25 percent insured portion ofthe loan, with the lender retaining title to theproperty.The Board has determined that ‘‘the under-

writing of mortgage guarantee insurance is prin-cipally a credit determination, similar to thosemadebybanks in their regularcourseofbusiness’’(1974 FRB 727). Therefore, this activity is con-sidered closely related to banking for purposesof permissibility under section 4(c)(8) of theAct. However, the Board noted that the privatemortgage insurance industrywas relativelyyoungand still developing with a limited, untested,operating history. In addition, the Board be-lieved that the times were such that it was‘‘desirable for bank holding companies gener-ally to slow their present rate of expansion anddirect their energies toward strong and efficientoperations within their existing activities, ratherthan toward expansion into new activities’’ (thego-slow policy), and, therefore, concluded thatit would not be appropriate to adopt the under-writing of mortgage guarantee insurance as per-missible for bank holding companies.

3700.2.5 UNDERWRITING PROPERTYAND CASUALTY INSURANCE

On May 12, 1978, the Board denied NCNBCorporation’s application to retain its indirectsubsidiaries, Superior Insurance Company and

Superior Claim Service, both of Florence, NorthCarolina. These companies engaged, respec-tively in the activities of underwriting propertyand casualty insurance related to extensions ofcredit by NCNB’s affiliates, in adjusting insur-ance claims and in appraising and valuing prop-erty in connection therewith. Neither of theseactivities had previously been determined by theBoard to be closely related to banking. TheBoard concluded that the circumstances pre-sented did not provide a reasonable basis forbelieving that the proposed activity was closelyrelated to banking or managing and controllingbanks (1978 FRB 506).

3700.2.6 TITLE INSURANCE

The Board issued a letter (See Board letter reIndependence Bancorp, Inc., dated 3/17/86) to abank holding company which filed an applica-tion with the Board to acquire ade novotitleabstract company which planned to engage in,among other things, the sale of title insurance.The sale of title insurance had not been previ-ously approved by the Board as a permissiblenonbanking activity. In responding to the appli-cation, the Board determined that the proposedtitle insurance activities were not closely relatedto banking.The Board’s discretion to decide what types

of insurance activities are closely related tobanking was removed by the Garn–St GermainDepository Institutions Act of 1982 (‘‘GarnAct’’), which amended section 4(c)(8) of theBHC Act. The Garn Act stated that ‘‘it is notclosely related to banking or managing or con-trolling banks for a bank holding company toprovide insurance as a principal, agent, orbroker. . . .’’ The Garn Act lists certain specificexceptions to this general prohibition, none ofwhich permits the sale of title insurance. TheBoard thus concluded that the Garn Act doesnot allow it the discretion to approve this type ofnonbanking activity.

Impermissible Activities (Insurance Activities) 3700.2


Impermissible Activities(Real Estate Brokerage and Syndication) Section 3700.3

3700.3.1 BROKERAGE

Real estate brokerage is the negotiating of a realestate contract between a buyer and seller forwhich the broker receives a fee or commissionand in which the broker takes no possessoryinterest in the subject matter of the contract. TheBoard has stated that this activity is consideredimpermissible for bank holding companies. TheBoard’s position was expressed in its orderapproving an application by Boatmen’s Banc-shares, Inc., St. Louis, Missouri, to acquireWilliams, Kurrus and Company, St. Louis, Mis-souri (1972 FRB 428). The Board stated that ithad determined that real estate brokerage activi-ties were not so closely related to banking ormanaging or controlling banks as to be a properincident thereto. Since Boatman’s had not dem-onstrated to the Board’s satisfaction that the realestate brokerage field activities are so closelyrelated to banking or managing or controllingbanks as to be a proper incident thereto, theBoard approved the Boatman’s application onthe condition that Boatman’s terminate its realestate brokerage activities.

3700.3.2 SYNDICATION

The Board ruled that this activity is not permis-sible for bank holding companies. The Board’sposition was developed during consideration of

the application of BankAmerica Corporation,San Francisco, California, for prior Board ap-proval to engagede novounder section 4(c)(8)of the Act in the activity of real estate syndica-tion through a subsidiary, BankAmerica RealtyServices, Inc., San Francisco, California. TheBoard concluded that the subsidiary’s proposedactivities of organizing, promoting, selling part-nership interests, and acting as the sole generalpartner of real estate syndicates went beyondthe functions performed by an advisory com-pany to a real estate investment trust permissi-ble under section 225.25(b)(4) of Regulation Y.The Board also stated that it felt that the

policies contained in sections 20 and 32 of theBanking Act of 1933 (the Glass–Steagall ActProvisions) must be considered in conjunctionwith section 4(c)(8) of the Act. These policies,described in the opinion of the United StatesSupreme Court in Investment Company Insti-tute v. Camp, 401 U.S. 617 (1971), forbid abank holding company to sponsor, organize orcontrol an open-ended investment company(mutual fund) or a closed-end investment com-pany primarily or frequently engaged in theissuance, sale and distribution of securities.Because the activities of real estate syndicationresemble the issuance, sale and distribution ofsecurities of a closed-end investment company,this activity is not permissible for a bank hold-ing company (12 C.F.R. 225.125).


Impermissible Activities(General Management Consulting) Section 3700.4

The Board has stated that general managementconsulting is not so closely related to banking ormanaging or controlling banks as to be a properincident thereto. This ruling is contained in theBoard’s order denying the application of FirstCommerce Corporation, New Orleans, Louisi-ana, to acquire W. R. Smolkin & Associates,Inc., New Orleans, Louisiana. In its order theBoard describes general management consultingas follows:‘‘. . . including, but not limited to, the provi-

sion of analysis or advice as to a firm’s(i) purchasing operations, such as inventory con-trol, sources of supply, and cost minimizationsubject to constraints; (ii) production opera-tions, such as quality control, work measure-ment, product methods, scheduling shifts, timeand motion studies, and safety standards;(iii) marketing operations, such as market test-ing, advertising programs, market development,packaging, and brand development; (iv) plan-ning operations, such as demand and costprojections, plant location, program planning,corporate acquisitions and mergers, and deter-mination of long-term and short-term goals;(v) personnel operations, such as recruitment,training, incentive programs, employee compen-sation, and management-personnel relations;(vi) internal operations, such as taxes, corporateorganization, budgeting systems, budget con-trol, data processing systems evaluation, andefficiency evaluation; or (vii) research opera-tions, such as product development, basicresearch, and product design and innovation.’’(1972 FRB 674) The Board denied the case anddetermined that the activity of providing generalmanagement consulting services could lead to

unwanted conflict of interest situations for BHCsthat advised clients that were also customers ofits own subsidiary banks. The Board also desiredto maintain a distinct separation between bank-ing and commerce.In its order denying the application of Marine

Midland Banks, Inc., Buffalo, New York, toacquire Carter H. Golembe Associates, Inc.,Washington, D.C., the Board further defines theconcept of management consulting by statingthat Golembe, ‘‘. . . provides consulting serviceson a confidential basis to banks, bank holdingcompanies and bankers’ associations. It makesbank feasibility studies and renders advice withrespect to geographic expansion, product exten-sion, mergers and acquisitions and applicationsto State and federal regulatory agencies. A por-tion ofGolembe’s consulting services also relatesto internal bank operations, such as marketing,trust and bank credit card operations and loan orinterest rate policies. Other studies and analysesare performed upon request of individual banks.Golembe also provides advice with respect tothe organization and operation of State Bankers’associations and serves as a consultant to vari-ous banking groups with respect to legislativeand regulatory matters affecting the bankingindustry. The foregoing consulting services fur-nished by Golembe are considered by the Boardto be but a specialized form of managementconsulting.’’ (1972 FRB 676)Management consulting to nonaffiliated com-

mercial banks and nonbank depository institu-tions has been determined by the Board to be apermissible activity for bank holding companiesunder section 4(c)(8) of the Act (Regulation Y,section 225.25(b)11, as amended).


Impermissible Activities(Property Management) Section 3700.5

The Board has ruled that this activity is imper-missible for bank holding companies. However,bank holding companies may conduct propertymanagement activities for three types of prop-erty as follows:1. Property held in a fiduciary capacity;2. Property owned by the holding company

or its subsidiary for its own bank and bank-related operations;3. Property acquired by the holding company

or its subsidiary as a result of a default on a debtpreviously contracted.The Board announced on June 30, 1972, that

it would not include this general activity on thelist of permissible activities. Because the Boarddid not intend to limit any authority given bystatute or regulation to a holding company or its

subsidiary concerning property management,the Board described in its order the three typesof property, as shown above, for which a hold-ing company or its subsidiary could engage inpropertymanagement activities (1972 FRB 652).In addition to the prohibition of property

management activities in general, the Board hasruled that the operation of a commercial parkinglot is impermissible. In its order approving theapplication by Multibank Financial Corpora-tion, Boston, Massachusetts, to acquire theB. M. C. Durfee Trust Company, Fall River,Massachusetts, a commercial bank, the Boardstated that operating a commercial parking lotwas not considered closely related to bankingand conditioned its approval on divestment ofthe parking lot operation (1973 FRB 679).


Impermissible Activities(Travel Agencies) Section 3700.6

The Board through its rulemaking authority didnot include operating a travel agency on the listof permissible activities for bank holding com-panies. This activity is considered not to beclosely related to banking or managing or con-trolling banks (1976 FRB 148). The Board refer-enced a decision of the United States Court ofAppeals for the District of Columbia, CourierAssociation vs. Board, 516 F. 2d 1229 (1975).The Board felt the only relevant criteria for

this activity was whether banks have generallyprovided the service. The Board noted that therewere few bank-affiliated travel agencies, mostof which had only been recently established.The Board concluded that operating a travelagency was not closely related to banking.On June 1, 1978, the Comptroller of the Cur-

rency issued Banking Circular No. 108, whichrequested all national banks then operating travelagencies, to divest themselves of those agencieswithin a reasonable period of time not to exceedthree years. The Comptroller’s office concludedthat the continued operation of a travel agencyby a national bank is inappropriate and mayexpose the bank to a substantial risk of loss bylitigation. This action by the Comptroller pre-cludes bank holding companies from relying onsection 4(c)(5) of the Act to conduct travelagencies. Thus, holding companies have no

authority to engage in travel agency activitiesunder the Act unless grandfathered.On April 2, 1979, the Board issued a letter, a

copy of which went directly to all bank holdingcompanies engaging in the activity of operatinga travel agency pursuant to section 4(c)(5) of theAct, indicating that no bank holding companiescould engage in the activity solely pursuant tosection 4(c)(5) and that those engaged in suchactivity had to terminate the activity by Decem-ber 31, 1980 (Z–8421 on office copy only).Subsequently, abankholdingcompanyapplied

to the Board to acquire a company (‘‘Company’’)that engages in a variety of data processing anddata transmission activities for customers. TheCompany’s data bases that are provided to cus-tomers included a program by which customerscould receive airline and hotel information andcould make airline and hotel reservations. TheBoard determined that the receipt of such infor-mation and the ability to make airline and hotelreservations was not closely related to banking.Accordingly, the Board required, as a conditionfor approval of the application, the bank holdingcompany to eliminate the travel reservation ser-vice from the roster of third party data baseprograms provided by Company (Refer to 1986FRB 497).


Impermissible Activities (Providing Credit Ratings on Bonds,Preferred Stock, and Commercial Paper) Section 3700.7

As part of the Security Pacific Corporation’s(bank holding company) application to acquireDuff & Phelps, Inc. (Company), which engagedin investment advisory, investment manage-ment, and financial advisory services, the Board,on December 11, 1984, denied the Applicant’srequest to engage in the activity of providingcredit ratings on bonds, preferred stock andcommercial paper. Private credit ratings wereincluded as part of the investment researchreports sold to institutional investors. The Com-pany also provided credit ratings on a fee basisfor companies that request public disclosure.As part of the public rating process, the ratedcompany is given the opportunity to make apresentation to the Company’s Credit RatingCommittee.In this situation, the Security Pacific Corpora-

tion had a vested interest in the ratings of thecorporations to which it lends in the ratings ofmunicipal bonds it underwrites, in the ratings ofthe commercial paper and municipal bonds forwhich it provides backup lines of credit, and inthe ratings of fixed-income securities which itholds for trades. Numerous potential conflictsexisted such as: possible inadvertent releases ofconfidential information obtained during thecredit rating process; the advance release to theApplicant of credit ratings for companies towhich the Applicant had very large loans out-standing; the potential for pressures by theAppli-cant on the Company to modify favorably thecredit rating of one of the Applicant’s majorcustomers; and the subtle pressure on the Com-pany’s staff resulting from ownership by Appli-cant about companies in which the Applicanthad a substantial interest. Similar conflicts couldhave also arisen between the Company’s creditrating function and the Applicant’s investmentof trust assets.The Applicant acknowledged the potential

conflicts but argued that various steps could betaken to ameliorate them and bring them withina manageable framework. The Applicant there-

fore proposed a number of techniques for isolat-ing the credit rating activities of the Companyfrom influence by the Applicant, including theestablishment of a separate corporation with anumber of independent directors, a prohibitionon contacts between the Applicant and the mem-bers of the Company’s Credit Rating Commit-tee, and also certain record keeping require-ments for that committee.The Board considered these positive sugges-

tions as well as others to assure full disclosureof the relationships between the Applicant andany of the companies that would be rated by theCompany as well as a prohibition on the Com-pany rating the Applicant’s securities, securitieswhich the Applicant has underwritten, or securi-ties for which the Applicant provided a guaran-tee or backup letter of credit. The Board, how-ever, believed that the conflicts in the relationshipbetween a major lender and a credit rating com-pany were so pervasive that they could not beovercome through adoption of an informationbarrier. The employees of the Company wouldinevitably be aware of interests of the Applicantin firms being rated by them and, it seemsreasonable to assume that this knowledge could,at times, influence their decisions.The Board’s concerns regarding conflicts of

interest with respect to the credit rating activitywere not based on any doubts regarding theintegrity of the parties to the application, butrather were based on the Board’s responsibilityto assess the possible adverse effects that mightbe associated with an affiliation between a bankholding company and a public credit ratingorganization. Thus the Board was acting in fur-therance of one of the general purposes of theBank Holding Company Act, ‘‘to prevent possi-ble future problems rather than to solve existingones.’’ The Board, in view of the pervasiveconflicts of interest between the Applicant’sexisting operations and the Company’s creditrating business, decided against approving theperformance of public credit ratings.


Impermissible Activities (Acting as a Specialist in Foreign-Currency Options on a Securities Exchange) Section 3700.8

Currency options are a new and innovativeaspect of foreign exchange. A currency optionrepresents the contractual right (but not the obli-gation) to purchase or sell a predeterminedamount of currency at a specific price at anytime before a specific date. Currency-optionsadvocates argue that currency options eliminatethe risk of a loss due to exchange movementsand give the holder a chance to profit if thecurrency fluctuation is favorable. They require apremium to be paid when the contract is enteredinto. The premiums can run from about 1.5 per-cent to 5 percent, depending on the expirationdate and the exercise price of the option.

Currency options are traded on two types ofmarkets: the over-the-counter, or interbankmarket, and on three regulated exchanges, theChicago Mercantile Exchange (CME), the Chi-cago Board Options Exchange (CBOE), and thePhiladelphia Exchange (PHLX). The CBOE, asecurities exchange, uses multiple ‘‘market mak-ers’’ instead of specialist positions; the CME, acommodities exchange, like other commoditiesexchanges, does not use specialist positions.

Most of the writing of currency options iscurrently done by banks which will customizethe option, with maturity dates and currencyvalues in excess of the standardized exchangecontracts. Banks developed the over-the-countermarket where they trade currency options amongthemselves, and banks are also the largest cus-tomers on the exchanges where they hedge therisks associated with their foreign-exchangepositions.

In general, the specialist system is unique tosecurities exchanges, and specialists exist forthe purpose of achieving certain market results.Commodity exchanges do not use the servicesof specialists. The rules of the Securities andExchange Commission permit the designationof specialists to ‘‘engage in a course of dealingsfor . . . their . . . own account to assist in themaintenance, so far as practicable, of a fair andorderly market . . .’’ provided that the securitiesexchanges adopt the following types of rulesgoverning specialists: minimum capital require-ments, rules to suspend or remove specialists ifthey fail to perform their designated marketfunctions, rules restricting dealing activities tothose reasonably necessary to permit the spe-cialist to maintain a fair and orderly market ornecessary to permit him or her to act as anodd-lot dealer, provisions governing his or herbrokerage activities in specialist securities, andprocedures to provide for the effective and sys-tematic surveillance of the activities of special-

ists (17 C.F.R. 240.11(b)(1)). In addition, theIRS formerly granted special tax treatment tospecialists transactions.

The rules of the PHLX require that odd-lotorders must be given to the specialist. The spe-cialist functions as a broker with respect tocertain transactions that cannot be executed byfloor traders immediately, for example, stop-lossorders and limit orders. All such orders aregiven to the specialist for execution and becomepart of his ‘‘book’’; PHLX rules address priorityof orders (customers’ orders receive priority)and conflicts of interest by governing special-ists’ trades and those of affiliated persons andfirms in ‘‘securities’’ in which the person isdesignated as specialist.

There is one specialist position for each cur-rency option traded on the PHLX, and the pri-mary function of a specialist is to act as marketmaker, as necessary, for its assigned currencyoption. The specialist thus undertakes all activ-ity, including dealing for its own account, to theextent necessary, as required to maintain a fairand orderly market in options on a particularcurrency. In essence, the specialist makes a con-tinuous two-sided market in the assigned cur-rency option when market forces do not.

Although currency options are functionallyequivalent to other instruments which banksregularly deal in for their own account, theapplicant’s proposed activities were not consid-ered as closely related to banking. The appli-cant’s analysis did not focus on the criticalcomponents of the proposed specialist activities,which are distinct from the foreign-exchangebrokerage and dealing activities generally con-ducted by banks. Because the proposed special-ist activities are to be carried out in the contextof market making on a regulated exchange, theywere significantly different from the foreign-exchangeactivitiescurrentlyconductedbybanks.When a bank engages in foreign-exchange trad-ing, it does so to service the needs of its custom-ers and to generate trading profits. However,unlike traditional foreign-exchange trading, bankcustomers are not serviced directly by a special-ist. Instead, the exchange benefits from thespecialist’s efforts if markets are perceivedto be deep and liquid. Depth and liquidity makethe contracts viable and the exchange profitable,and do not directly benefit the bank’s customers.

The applicant’s original proposal implicitlyacknowledged that banks have not traditionally


been involved with trading on stock exchanges,and thus have not generally possessed the expe-rience and expertise in trading, hedging, andmanaging aggregate exposure required for thesuccessful operation of a specialist position. Theapplicants originally proposed to engage in theactivities through a joint venture because theylacked the requisite trading expertise to profit-ably undertake the activity alone. In its discus-sion of the management of risk exposure of thespecialist, the applicants originally stated, ‘‘Thechoice of the appropriate hedge to start with andthe monitoring over the life of the option of thathedge are specialized and difficult tasks thatrequire expertise and experience.’’ Conductingexchange specialist activities requires the floor-trading experience and back-office capabilitiesof an experienced exchange member.

As of December 1984, only one commercialbank, Bank of America, acted as a specialist inexchange-traded currency options. In Janu-

ary 1984, the Office of the Comptrol-ler of the Currency granted permission for Bankof America to act as the specialist in PHLX-traded options on the Deutschemark through ajoint venture subsidiary with Tague SecuritiesCorporation. The Board, however, was not boundto a determination that specialist activities wereclosely related to banking simply because onebank engages in the activity. Bank of Americaapparently considered it necessary to conduct itsspecialist activity through a joint venture with asecurities firm, which reinforced the view thatthe activity requires experience and expertisenot generally possessed by banks.

Given the applicant’s acknowledgment of theimportance of floor-trading expertise and experi-ence to the specialist function, and the substan-tive absence of bank involvement in such anactivity, the Board concluded that the proposedactivities were not closely related to bankingand thus denied the applicant’s request.

Impermissible Activities (Specialist in Foreign-Currency Options on a Securities Exchange)3700.8


Impermissible Activities (Design and Assembly of Hardware for Processingor Transmission of Banking and Economic Data) Section 3700.9

A bank holding company applied to acquire allthe voting shares of a company (‘‘Company’’)that engages in a variety of data processing anddata transmission activities for customers suchas securities and commodities exchanges, bro-kerage firms, commercial banks, savings andloan associations, insurance companies, andinvestment managers. In addition to engaging inother nonbanking activities, the companydesignsand assembles the hardware that is used in con-nection with the services it provides. The Boardhad not previously considered whether the as-sembly of hardware designed for the processingand transmission of banking, financial and eco-nomic data is closely related to banking or per-missible as an incidental activity.The bank holding company stated that Com-

pany’s assembly of hardware was incidental toits provision of data processing services becausesuch assembly was necessary to assure the avail-ability, reliability, and quality of componentsused by Company, and that stock quotationfirms like Company could only assure suchproduct characteristics by the design and assem-

bly of the hardware that provides the quotationinformation. In support of the argument, thebank holding company asserted that competitorsof Company also design and assemble the hard-ware that provides the Company service.In view of the fact that finished hardware of

the type provided by Company is available, and,in fact, is marketed by companies providingservices similar to Company, the Board foundthat the continuation of Company’s design andassembly of hardware activities could not beconsidered ‘‘necessary’’ to the Company’s pro-vision of its permissible data processing ser-vices, and thus could not be considered inci-dental to Company’s provision of permissibleservices. As a condition for approval of the bankholding company’s application to acquire all ofthe voting shares ofCompany, theBoard requiredthe bank holding company to divest of Compa-ny’s hardware assembly activities within twoyears of the acquisition (Refer to 1986 FRB497).


Impermissible Activities(Armored Car Services) Section 3700.10

In 1971 and again in 1984, the Board issued forpublic comment proposals to expand the activi-ties permissible to bank holding companiesunder section 4(c)(8). Included in those propos-als was the provision of armored car services.The proposals would have authorized bank hold-ing companies to provide fully insured trans-portation of cash, securities, and valuables (pri-marily between commercial customers andfinancial institutions) and such ancillary ser-vices as coin wrapping, change delivery, maildelivery, payroll-check cashing, servicing ofautomatic teller machines, and leasing safes tocommercial customers.In response to both the 1971 and 1984 pro-

posals, the Board received various commentsagainst adding this activity to the Regulation Ylist of permissible nonbanking activities, prima-rily from armored car operators and their tradeassociations. The commenters maintained thatthe activity is not closely related to banking but,rather, is essentially a transportation activityrequiring no banking expertise.In view of the issues raised by the comments

on this activity and the minimal interest by bankholding companies, the Board decided not toadd the activity to the Regulation Y list ofpermissible activities. However, the Board statedit would consider individual applications forthis activity (1973 FRB 898); 51Federal Regis-ter 39,999 (1986). The Board expressed noopinion as to whether the activity would meettheNational Couriertest and would be a properincident to banking.In 1988, a bank holding company (the appli-

cant) filed an application to engage in armoredcar activities through a de novo nonbank subsid-iary. After notice of the application was pub-lished, the Board received comments opposingthe proposal and was requested to order a for-mal hearing. In response, the Board publishedan order requiring a formal public administra-tive hearing on the application. One issue, amongothers, that the Board directed to be consideredwas whether the proposed armored car serviceswere ‘‘so closely related to banking or manag-ing or controlling banks as to be a proper inci-dent thereto’’ under section 4(c)(8) of the BHCAct.An administrative hearing was held on

June 16 and July 11, 1989, before an administra-tive law judge (ALJ). The ALJ issued a recom-mended decision in which he concluded thatthe proposed armored car activities were not‘‘closely related to banking’’ and recommendedthat the Board deny the application. The ALJ

found that none of theNational Couriercriteriawere demonstrated by the record. The ALJ’sconclusion relied on certain operational distinc-tions between the proposed armored car servicesand the services banks traditionally performthemselves.Following receipt of exceptions to the recom-

mended decision, the Board reviewed the entirerecord of the proceedings and determined thatthe ALJ had erred in concluding that armoredcar services were not ‘‘closely related to bank-ing.’’ The Board concluded that, even acceptingthe factual findings, the slight operational dis-tinctions cited in the recommended decisionwere not significant. The Board found thatalthough theremay be some distinctions betweenbank-provided armored car services and the pro-posed full-service, for-hire armored car service,the nature of the customers served and the eco-nomic basis of the services provided do notfundamentally alter the nature of the services. Itwas therefore clear to the Board that the ser-vices then provided by the applicant as well asother banks and bank holding companies tothemselves and their customers are sufficiently‘‘operationally and functionally similar’’ to theproposed service as to equip banking organiza-tions particularly well to perform the proposedservice, and hence fulfill the secondNationalCourier test.The Board also noted that bank holding com-

panies are permitted to provide courier servicesforunaffiliatedpartiesundersection225.25(b)(10)of Regulation Y. The only essential differencebetween the two services relates to the intrinsicvalue of the materials transported. The Boardconcluded that the services themselves werecertainly functionally and operationally similar,thereby lending additional support to its favor-able finding under the secondNational Couriertest.The Board also found that the thirdNational

Courier test was met, that the applicant haddemonstrated ‘‘the dependence of banks on aspecialized form of the proposed services.’’ TheBoard found that the record amply demonstratedthat banks are highly dependent upon the spe-cialized transportation services provided byarmored cars, which transport cash and valu-ables with a high degree of security. The appli-cant was proposing to engage in just those spe-cialized services; it did not propose to start ageneral moving or trucking service. The record


therefore supported a determination that thethird National Courier test was also satisfied.Accordingly, the Board found, based on therecord before it, that providing for-hire armoredcar services to the general public was an activitythat is closely related to banking.This determination, however, is only one of

two steps needed for the Board to approve anonbank activity for a bank holding company.The Board must also find that the activity is a‘‘proper incident thereto.’’ On this issue, theALJ declined to make any factual or legal deter-minations concerning the proper-incident test orstatebranching laws.However, under theBoard’srules (12 C.F.R. 262.4 (1990)), the ALJ wasrequired to provide a recommended decisionwith regard toall unresolved issues prior to afinal Board determination (12 C.F.R. 263.11). Afinal disposition on the application thereforewas not possible at that juncture, and the Boardremanded the case to the ALJ for a recom-mended decision on the proper-incident stan-dard and other unresolved issues (see 1990 FRB676).In accordance with the Board’s remand order,

a second formal hearing was held before theALJ. Additional evidenceandpost-hearing briefsweresubmitted, includingevidenceon theproper-incident test, in support of this and other unre-solved issues. The ALJ then issued his supple-mental decision, which again recommendeddenial of the application. The ALJ found that, inthis case, the applicant’s record failed to providea definitive proposal on which the Board couldmake a determination under the proper-incidenttest. The ALJ found that the applicant hadoffered only a skeletal structure and operationplan that was fleshed out only to a limited extentat the hearings. In addition, the ALJ found theapplication and other facts of record to be defi-cient with regard to possible public benefits andadverse effects. The ALJ further determined thatthe record had not shown that the proposedactivity, as structured, would be lawful underthe branch-banking laws of the states in whichthe applicant proposed to operate.Based on its review of the ALJ’s supplemen-

tal decision and the remainder of the record, theBoard determined that the record failed to sup-port a finding that the proposed armored caractivities, in this particular instance, would be a‘‘proper incident’’ to banking. The Board there-fore adopted the ALJ’s recommendation to denythe application, but only on the narrow groundsof inconsistency of the proposal, as then struc-

tured, with section 23B of the Federal ReserveAct.In its order, the Board stressed that the burden

of proof is upon an applicant to establish thatthe nonbanking activity it proposes to conduct—in this case the provision of armored carservices—isnot onlyclosely related to banking,but alsoa ‘‘proper incident thereto.’’ The Board’sreview of the entire proceeding disclosed certainaspects of the application that appeared on itsface to violate the arm’s-length transactionrequirement of section FRA 23B. In the Board’sview, a proposal to engage in nonbanking activ-ities pursuant to section 4(c)(8) will not producenet benefits to the public, as required under thepublic-benefit test, if it violates the kind ofstatutory requirement, such as section 23B, thatwas specifically intended to prevent unsafe orunsound banking practices when a bank affiliateengages in nonbanking activities.The first potential violation would arise from

the fact that the proposed service by the bankholding company’s nonbank subsidiary to itsbank affiliate would cost more than the bankwas paying for similar armored car servicesprovided by an unaffiliated provider. The Boardnoted that although there may be a justificationfor the higher pricing structure that would meetthe standards set forth in section 23B, no justifi-cation appeared in the record. The Board couldtherefore only conclude that the bank may notbe obtaining services from the nonbank provider‘‘on terms . . . atleast as favorable to such bank. . . asthose prevailing for comparable transac-tions with or involving other nonaffiliated com-panies,’’ as required by section 23B.The second potential violation of section 23B

arose from the absence of a ‘‘precise breakdownof the services the nonbank subsidiary will pur-chase from the bank holding company’s subsid-iary bank and the projected cost of those ser-vices,’’ as called for in the Board’s prior order inthis matter. The applicant provided no detailedcost figures for the wide variety of services theapplicant’s banking subsidiary was to provide tothe nonbank subsidiary. The bank holding com-pany proposed to charge the bank subsidiary an‘‘estimated’’ percentage (the fee was admittedto have had no ‘‘factual basis’’ reflected in therecord) of the nonbank subsidiary’s direct oper-ating expenses to cover all of the services pro-vided by the bank holding company’s bankingsubsidiary to its nonbanking subsidiary. Undersection 23B, the provision of services by a bankto an affiliate must be paid for on an arm’s-length basis. This requires, where there are nocomparable transactions between a bank and anonaffiliate, that the bank’s provision of ser-

Impermissible Activities (Armored Car Services) 3700.10


vices to its affiliate be on terms that in goodfaith would be offered to, or would apply to,nonaffiliated companies. The Board found thatthe banking subsidiary would not in good faithhave provided back-office services to an unaffil-iated armored car company by charging a flatfee that had no factual basis and without deter-mining the relationship of the fee to the actualcosts of providing the services. Therefore, the

potential violations of section 23B, on theirface, constrained the Board to deny the applica-tion as it was structured (see 1993 FRB 352).The Board noted its denial did not affect the

Board’s prior ruling in the case that armored carservices are closely related to banking, and waswithout prejudice to the filing of a new proposalfrom which a favorable proper-incident findingcould be made.

Impermissible Activities (Armored Car Services) 3700.10


Impermissible Activities(Computer Output Microfilm Service) Section 3700.11

The authority of bank holding companies undersection 225.25(b) of the Board’s Regulation Yto engage in data processing activities is intendedto limit those activities to providing facilitiesthat perform banking functions, such as checkcollection, or other similar functions for custom-ers that are depository or other similar insti-

tutions,suchasmortgagecompanies.With respectto this activity, the Board issued an interpreta-tion that authorizes bank holding companies toprovide the formatting for computer outputmicrofilm only as an output option for dataotherwise permissibly processed by the holdingcompany system (1982 FRB 552).


Impermissible Activities (Clearing Securities Options and Other FinancialInstruments for the Accounts of Professional Floor Traders)Section 3700.12

A foreign banking organization subject to theBHC Act applied for the Board’s approval undersection 4(c)(8) to engagede novothrough itssubsidiary (Company), in theexchangeandclear-ance of: (1) exchange traded securities optionsand other securities and (2) futures and optionson futures that relate to financial instruments.The proposed customer base was comprised pri-marily of market makers and other professionalfloor traders dealing for their own accounts.Most of the professional traders were expectedto be market makers and specialists, includingindividuals, small partnerships, or small corpo-rations, that were to trade primarily on the Chi-cago Board of Options Exchange (CBOE).1

Previously, the Board approved the executionand clearance of financial instruments as apermissible nonbanking activity.2 Under Boardprecedent, the nonbanking subsidiary engagedin such services has generally serviced a broadrange of retail and/or institutional customers.Under this proposal, Company was to cleartrades for a specialized customer base com-prised primarily of professional floor tradersthat executed trades for their own accounts.Nonbanking subsidiaries of BHCs, operating

in accordance with prior Board approvals, havegenerally performed both execution and clear-ance services. By performing both services, thenonbank subsidiary is able to control riskbecause it executes the majority of the trans-actions that it clears. The nonbank subsidiarycan refuse to execute an order that it deemsinappropriate or it can require additional fundsor collateral from the customerin advance ofand as a condition to executing the transaction.Unlike prior Board cases, Company plans to

provide primarily clearing services. As a clear-ing agent, it would guarantee the financial per-

formance of its customers to the clearing organi-zation of the exchanges on which it operates.3

After the start of trading on any day, Com-pany would be obligated to settle each tradeentered into by its customers even when thecustomer may not have the financial resourcesto honor its obligation. Since the trades havealready been executed by the time that theywould be presented to Company by these pro-fessional floor traders, Company would be un-able to decline transactions that posed unaccept-able risk. On an intraday basis, professionaltraders, who are not employees of Company andwho trade in relatively volatile instruments,could expose Company to financial risks be-yond the trader’s capacity to repay and beyondCompany’s own resources.The applicants proposed to limit the risk ex-

posure created by Company’s activities throughthe establishment of risk guidelines and proce-dures that were intended to monitor the intradaytrading activities of its floor traders. No suchsystem had been developed for the industry formonitoring the intraday activities of floor trad-ers on a real-time basis. Most of Company’straders would primarily operate on exchangesthat used an open outcry system rather than anelectronic trading system. As a result, Companymay not know its real-time committed positionsuntil the end of the trading day and therefore thepossibility existed that a floor trader could ex-ceed Company’s risk limits and incur substan-tial losses before Company could act to mitigateits credit risk exposure. Professional floor trad-ers generally operate with much higher levels ofleverage than the average brokerage customer ofa securities firm. Since most of Company’s cus-tomers were to be market makers, such traderscould at times take positions contrary to themarket.

1. Market makers on the CBOE are floor traders thatperform a dealer function by trading for their own accounts, attheir own risk, and for their own profit. Market makerscompete with other market makers assigned to the same classof options. In contrast, floor brokers on the CBOE generallyact only as an agent, executing customer and firm proprietaryorders.2. Refer to sections 225.25(b)(3) (trust companies engag-

ing in agency activities related to the clearing of securities);225.25(b)(15) (securities brokerage activities); 225.25(b)(18)(execution and clearance of futures and options on futures) ofthe Board’s Regulation Y.

3. With this arrangement clearing firms may also be liablefor the obligations of other members of the exchange. Gener-ally, losses of a failed member firm are covered in the follow-ing order:

1. by the assets of the failed firm;2. by the excess capital of the clearing organization;3. by the guarantee fund of the clearing organization;

and4. by direct assessments made on surviving member

firms.

Since member clearing firms are the ultimate source of capitalfor both the clearing association and the guarantee fund, thesurviving firms will bear the ultimate burden of any loss.


Such circumstances potentially expose theclearing firms to substantial losses. If the clear-ing firm exhausts all or most of its capital infunding the obligations of floor traders that havelost substantial amounts of money in trading,parent companies of the clearing firm may haveto cover the firm’s remaining contingent liabili-ties. Such risks may be acceptable for somenonbanking institutions currently providing theseservices, but they may be inappropriate for U.S.domiciled banking organizations.The Board carefully considered the benefits

of the proposal, including the Applicants entryinto a concentrated market, its experience with

similar activities on foreign exchanges, andCompany’s proposed risk management systems.The Board concluded that the proposal, as it wascurrently structured (including the absence of aneffective means to monitor and limit the poten-tial credit risk exposure to the parent bank hold-ing company) involved potential adverse effectsthat outweighed the potential public benefits.The Board thus determined that the balance ofpublic interest factors that it is required to con-sider under section 4(c)(8) of the BHC Act werenot favorable. The application was denied bythe Board on January 9, 1991 (1991 FRB 189).

Impermissible Activities (Clearing Securities Options and Other Financial Instruments for theAccounts of Professional Floor Traders) 3700.12


permissible activities by board order (section 4(c)(8) of the bhc act

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