Skip to main content
  1. Home
  2. Banks and Banking
  3. Regulation H
  4. Board Rulings and Staff Opinions Interpreting Regulation H

Board Rulings and Staff Opinions Interpreting Regulation H

3-447.01

BANKING PRACTICES—Recordkeeping and Confirmation Rules; Affiliated Banks

The question was raised whether an affiliated bank would be a “customer” if securities transactions were effected by another bank at the direction of and for the account of the affiliated bank. An affiliate bank is a “customer” as defined in section 208.8(k) of Regulation H. However, because the bank is not exercising investment discretion, the affiliate bank may, pursuant to section 208.8(k)(4)(i), waive rights to the otherwise required notifications entirely by written agreement with the bank, waive the right to notification except upon request, or require a form of notification less extensive than that otherwise required by the regulation. Any such agreement, however, must make clear the affiliated bank’s right to receive the notification within the time period prescribed by the regulation at no additional cost. STAFF OP. of January 14, 1980.
Authority: 12 CFR 208.8(k) (revised 1998; now 12 CFR 208.34(b)(5)).
3-447.02

BANKING PRACTICES—Recordkeeping and Confirmation Rules; Commercial Paper and Money Market Mutual Fund Shares

The question was raised whether commercial paper and shares of money market mutual funds constitute securities subject to the confirmation requirements of Regulation H. Staff agreed that commercial paper, which by common usage is understood to mean corporate indebtedness exempt from registration under section 3(a)(3) of the Securities Act of 1933, as amended, comes within the exclusionary language of section 208.8(k)(1)(v)(E) of Regulation H, which states that the term “security” does not include any “note, draft, bill of exchange, or banker’s acceptance which has a maturity at the time of issuance not exceeding nine months.”
Shares of money market mutual funds, on the other hand, do come within the definition of “security.” It should be noted, however, that staff believes transactions in money market fund shares derive primarily from accounts over which the banks exercise investment discretion and therefore, pursuant to the regulation, are not required to be confirmed on an individual basis except upon customer request. STAFF OP. of April 24, 1980.
Authority: 12 CFR 208.8(k) (revised 1998; now 12 CFR 208.34(b)(11)).
3-447.1

BANKING PRACTICES—Campaign Contributions

The question has arisen whether member banks or bank holding companies may make campaign contributions to candidates for state or federal political office. Section 441b of the Federal Election Campaign Act prohibits national banks from making contributions in connection with either state or federal elections. The act allows corporations to establish “separate segregated funds” and to solicit contributions to such funds, which may be used for certain political purposes. The act does not prohibit state member banks and bank holding companies from making political contributions and expenditures consistent with local law.
In January of 1978, the Board issued a policy statement reflecting the Board’s expectation that all banks and bank holding companies subject to the Board’s authority will obey applicable law and will refrain from making payments that may constitute unsafe or unsound banking practices.* The Board’s statement does not prohibit all political expenditures by bank holding companies or their subsidiaries, but the Board is concerned that in certain cases such expenditures may constitute unsafe or unsound banking practices calling for remedial Board action. STAFF OP. of June 19, 1981.
Authority: 2 USC 441b.
*
In 1996, this statement was determined to be self-evident and unnecessary and was therefore rescinded.
3-447.11

BANKING PRACTICES—Trust Departments’ Use of Discount Brokerage Services of Affiliate

The question was raised whether a state member bank could use the discount brokerage services of an affiliate bank for transactions of its trust customer accounts. The inquiry was prompted by the Board’s “BankAmerica-Schwab” order dated January 7, 1983, which indicated Board approval of trust departments’ use of discount brokerage affiliates. Staff has also received other inquiries on the use of discount brokerage affiliates by bank trust departments, or arrangements with unaffiliated discount brokers in which the bank would directly share in commissions generated by its trust department accounts. In the following discussion, the term “affiliate” refers to either a subsidiary of the bank or a subsidiary of a bank holding company of which the bank is a member.
The inquiries arise because of the application of common law fiduciary standards that are directed to preventing conflicts of interest. Under the common law, it is generally accepted that a fiduciary cannot profit from a transaction entered into for a trust account, apart from the fees that it receives for discharging its fiduciary responsibilities. Accordingly, the receipt of commission income for securities brokerage transactions entered into on behalf of a trust account, in addition to the fee received for account administration, raises conflict of interest considerations to which traditional prohibitions of fiduciary law are directed.
The BankAmerica-Schwab order only suggested that there is no indication that banks would in fact use an affiliate discount brokerage service in violation of any fiduciary duty. It did not attempt to delineate under what circumstances such use would or would not result in violations of fiduciary duty.
The general rule, often considered inflexible, is that trustees shall not place themselves in a position where their own interests are or may be in conflict with their fiduciary duty (see, e.g., Albright v. Jefferson County National Bank, 293 N.Y. 31, 53 NE 2d. 753 (1944)). As a corollary, it is widely recognized that trustees may not receive any personal benefit, advantage, gain, or profit from their administration of trusts, apart from their regular administration fees (76 Am. Jur. 2d. § 318; Scott on Trusts 3d Ed. § 170.22). A conflict, of course, arises from the trust institution’s exercising any “discretion” to direct fee-producing securities transactions to an affiliate. In this context, such discretion could involve either investment discretion (deciding what investments to buy or sell) or simply the discretionary power to choose among securities brokers. Because of the obvious commonality of interest, when a discount broker affiliate is used, the trust institution (i.e., bank or trust company) may be considered to share indirectly in the commission income of the affiliate even if there is no direct remittance of fee to the bank. Therefore, except when specifically authorized1 by the trust instrument, account settlor, the beneficiaries, or a court, as appropriate under the circumstances, the receipt of extra fees for discount brokerage services is believed to constitute improper self-dealing. In the absence of state law to the contrary, any such fees should be reimbursed to the trust or trusts for which the securities transactions were executed.
Staff believes that the following more specific standards provide additional guidance in determining whether and in what circumstances use of affiliate brokerage services may be permissible:
  • A trust institution or affiliate may receive additional fee income from securities transactions executed on behalf of accounts if specific written consent or authorization is obtained after disclosure of the fee arrangement. Such specific, written authorization is usually obtainable in connection with most agencies, as well as those directed trusts and revocable trusts in which an outside authorizing party has full power either to direct or to approve the arrangements in question.
  • Specific consent or authorization from all interested parties is generally not obtainable for most personal trusts and estates, other than the above-mentioned accounts, because of the difficulty of ascertaining all beneficial interests or inability to obtain legally binding consents from minor beneficiaries. Additional fee income for securities transactions for such accounts would therefore be improper, unless such an arrangement is determined to be specifically authorized under state law. Furthermore, any such transactions resulting in extra fees involving court-supervised accounts, such as executorships and administratorships, would need court approval.
  • As to most employee benefit accounts, the Employee Retirement Income Security Act of 1974 (ERISA), has superseded state law. The U.S. Department of Labor (DOL) has jurisdiction to interpret what transactions, including payment of additional fees to plan fiduciaries for brokerage services, may result in “prohibited transactions” pursuant to that statute. Several provisions of ERISA appear to provide potential exemptions for “reasonable” fees in connection with securities transactions. To date, however, related DOL rulings do not appear to offer any but very narrowly circumscribed conditions under which trust institutions or their affiliates could receive additional fees for security transactions (if applicable, required conditions would include a requirement of review and specific approvals by an independent fiduciary (see 29 CFR 2550.408 b-2, and Prohibited Transaction Class Exemption 79-1)). Therefore, the trust institution should obtain a reasoned opinion of counsel or a DOL ruling on this matter before proceeding with such a fee program involving employee benefit accounts.
Even when adequate specific authorizations have been obtained for participating accounts, trust institutions charging separate fees for securities transactions must, of course, still provide such service and exercise any remaining fiduciary discretion, in the best interest of the accounts in question. Examiners expect to see appropriate written policies and committee approvals regarding the adoption of any such program. In particular, the trust institution should establish safeguards including appropriate monitoring procedures to ensure that abuses such as “churning” do not occur. Periodic pricing adjustments and redisclosures would also be expected as necessary to ensure that security transaction fees remain reasonable and competitive, and disclosures accurate. STAFF OP. of Sept. 19, 1983.
1
Any such consent or authorization must, however, be clearly expressed, or it may not be recognized by the courts (see, e.g., Bogert and Bogert, Trusts and Trustees, 2d. Ed., § 543(U); 76 Am. Jur. 2d. § 336 et seq.).2d. § 336 et seq.).
3-447.12

BANKING PRACTICES—Leasing Office Space to Broker

The Board rescinded its ruling, previously at this locator number, regarding the leasing of office space to a securities broker. State member banks that wish to enter into arrangements with registered broker-dealers to provide uninsured investment products to bank customers on bank premises should refer to the interagency policy statement at 3-1579.51. STAFF OP. of July 12, 1994.
3-447.13

BANKING PRACTICES—Permissible Investments

State banks that are members of the Federal Reserve System may purchase and hold for their own account common stock in the Federal Agricultural Mortgage Corporation (Farmer Mac) incidental to their participation in the secondary market for agricultural real estate. Farmer Mac was created as a government-sponsored private corporation under title VII of the Agricultural Credit Act of 1987 (Pub. L. 100-233, 12 USC 2279aa). The primary purpose of this portion of the act is to establish a secondary market for agricultural real estate mortgages in order to increase the availability of long-term credit and to improve liquidity and lending capacity in agricultural markets. Farmer Mac would be capitalized by issuing voting and nonvoting common stock and preferred stock (12 USC 2279aa-4). Voting common stock may be sold only to “banks, other financial entities, insurance companies, and [Farm Credit] System institutions” (12 USC 2279aa-2(a)(9)(B) and 2279aa-4(a)(2)). Further, institutions that wish to participate in the secondary market, including loan originators, may be required to make capital contributions to Farmer Mac in exchange for common stock (12 USC 2279aa-4). The act contemplates that the originators of loans will include banks as well as other financial institutions (12 USC 2279aa(7)). The act also provides for banks and other financial institutions to be represented on the board of directors (12 USC 2279aa-2(b)(2)(A)).
In general, banks are prohibited from owning corporate stock. Paragraph seventh of section 5136 of the Revised Statutes (12 USC 24, seventh) provides, in part, that “[e]xcept as hereinafter provided or otherwise permitted by law, nothing herein contained shall authorize the purchase by [a national bank] for its own account of shares of stock of any corporation.” The limitations and conditions placed on securities transactions by that paragraph are extended to state member banks under paragraph 20 of section 9 of the Federal Reserve Act (12 USC 335).
Although banks are generally prohibited from owning stock, the Board has in the past found that section 5136 would not prohibit banks from holding stock where Congress has evidenced a clear intention that banks be allowed to hold such stock in order to achieve a legislative purpose. For example, the Board concluded that section 5136 did not prohibit banks from owning common stock in the Student Loan Marketing Association (Sallie Mae), noting that the statute creating Sallie Mae allowed the stock to be sold only to certain qualified insured lenders, including banks, and provided for representation of banks and other financial institutions on Sallie Mae’s board of directors. The legislative history of the statute also clearly indicates that Congress intended that banks would become purchasers of Sallie Mae stock.
The provisions of the statute creating Farmer Mac strongly parallel those of the Sallie Mae statute. The legislative histories of both Sallie Mae and Farmer Mac indicate that Congress envisioned the development of secondary markets through the creation of private entities owned entirely by institutions involved in lending in the particular market under consideration. As with Sallie Mae, it is clear from the explicit provisions of the enabling statute as well as from the legislative history that Congress contemplated that banks, including state member banks, would purchase and hold stock in Farmer Mac.
Paragraph seventh of section 5136 of the Revised Statutes, as made applicable to state member banks by paragraph 20 of section 9 of the Federal Reserve Act, does not prohibit the acquisition of shares in Farmer Mac. State member banks are therefore not prohibited from purchasing such shares in nominal amounts consistent with safe and sound banking practices and state law. STAFF OP. of July 26, 1988.
Authority: RS 5136, 7, 12 USC 24, 7; FRA § 9, 12 USC 335; 12 CFR 208.8.
3-447.14

BANKING PRACTICES—Permissible Investments

Board staff found the following proposed investments permissible for state member banks:
  • an investment in a limited partnership formed by a group of credit card issuers and credit card merchant-service providers to develop marketing materials for inclusion in credit card statements (An operating subsidiary of each participating institution was a limited partner in the partnership, and each participating institution had one share in a corporation that acted as a general partner in the limited partnership.)
  • a minority investment by an operating subsidiary of the state member bank in a general partnership formed by the operating subsidiary and a nonfinancial entity for the purpose of engaging in the origination of residential mortgages
  • a majority interest by an operating subsidiary of a state member bank in a limited liability company (LLC) formed by the operating subsidiary and a nonfinancial entity for the purpose of engaging in the origination of residential mortgages
  • a minority interest by an operating subsidiary of a state member bank in an LLC formed by the operating subsidiary and a nonbank credit card service provider for the purpose of providing credit card payment services to merchants
  • a minority interest in an LLC formed by a group of financial institutions to act as a title insurance agent
Each investment must meet the following criteria:
  • The activities of the enterprise would be limited to activities that are permissible for the investing state member bank.
  • The bank, through its subsidiary, would have the ability either to prevent changes in the activities of the enterprise or to withdraw if it engaged in impermissible activities.
  • The structure of the proposed investment would limit the bank’s potential exposure to liability as a result of the activities of the LLC or its co-venturer. The proposed activities would not expose the investing bank to open-ended liability for the obligations of an enterprise over which the bank would not have control. In each case, the exposure of the state member bank to such losses would be limited, both as a legal and accounting matter.
  • The proposed investment would be related to the state member bank’s banking business and was not merely a passive investment. Each proposed minority investment would enhance or extend existing lines of business or would permit the institution to provide services to customers that otherwise would not have been economical for the institution to offer.
A state member bank may participate in a limited partnership either as a limited or general partner as long as the investment is made principally to permit the formation and management of the limited partnership. Section 16 prohibits the purchase of stock, it does not bar an investment in a partnership. Though limited liability partnerships have attributes in common with corporations, as long as the partnership engages only in activities permissible for a state member bank, the activities are not barred by section 16 of the Glass-Steagall Act. STAFF OPs. of June 13, 1995, and July 11, 1996.
Authority: 12 USC 335.
3-447.3

BRANCHES—Industrial Loan Company Restrictions

Certain states have proposed or enacted legislation that prohibits out-of-state industrial loan companies and industrial banks (collectively, ILCs), but not other types of banks, from establishing a de novo branch in their states. The question has been raised whether these state ILC restrictions, if enacted, would affect the ability of other out-of-state banks to establish de novo branches in those states.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Riegle-Neal Act) permits the appropriate federal banking agency for a state bank or national bank to approve an application to establish and operate a de novo branch in a state (other than the bank’s home state) in which the bank does not maintain a branch only if certain conditions are met (see 12 USC 36(g), 321, and 1828(d)(4)). These conditions require, among other things, that the host state have a law in effect that “(I) applies equally to all banks, and (II) expressly permits all out-of-state banks to establish de novo branches in such state.” If a host state’s law fails either of these requirements, the appropriate federal banking agency would not be able to approve the establishment of a de novo branch in the host state by any out-of-state bank.
If a state enacts legislation that prohibits an out-of-state ILC, but not other types of banks, from establishing a de novo branch in the state, the state’s de novo branching laws would not meet the requirements of the Riegle-Neal Act and the appropriate federal banking agency would not be permitted to approve the establishment of de novo branches in that state by any out of-state bank. This is because the state’s de novo branching law would not apply equally to all banks and would not expressly permit all out of-state banks to establish de novo branches in that state.
Another type of state law permits all out-of-state banks to establish de novo branches in the host state but prohibits an out-of-state ILC, but not other types of banks, from establishing a branch on the premises of a commercial affiliate of the ILC. This type of state law does not apply equally to all banks and does not meet the requirements of the Riegle-Neal Act. If, however, the state law expressly permits all out-of-state banks to establish de novo branches in the state, but also provides that banks chartered in the state and out-of-state banks may not establish or maintain a branch in the state on the premises of a commercial affiliate, the state law would apply equally to all banks and appears to comply with the requirements of the Riegle-Neal Act. STAFF OP. of July 28, 2006.
Authority: 12 USC 36(g), 321, and 1828(d)(4).
3-447.6

CONDITIONS OF MEMBERSHIP—Acquisition of Insurance Subsidiary

A question regarding notification and approval was raised in connection with a state member bank’s acquisition of a subsidiary engaged in insurance underwriting. There is no specific rule requiring a state member bank to give the Board prior notice of, or acquire the Board’s approval for, the acquisition of an operations subsidiary to engage in activities that the bank itself may lawfully perform. However, section 208.7(a)(1) of Regulation H prohibits a state member bank from causing or permitting a change in the general character of its business or the scope of its corporate powers approved at the time of admission to membership, except with the permission of the Board. Further, when a state member bank’s acquisition of the assets of another institution may result in a change in the general character of its business or in the scope of its corporate powers, section 208.7(b) requires that a detailed report, setting forth all the facts in connection with the transaction, be made to the Federal Reserve Bank of the District in which the bank is located. Although the latter procedure is not generally used to cover the acquisition of an operations subsidiary, the procedures outlined above may be followed when a state member bank is contemplating the formation of a subsidiary to engage in insurance underwriting. STAFF OP. of April 2, 1981.
Authority: 12 CFR 208.7(a)(1) and (b) (revised 1998; now 12 CFR 208.3(d)).
See also 3-447.61.
3-447.61

CONDITIONS OF MEMBERSHIP—Acquisition of Insurance Underwriting Activities

The Board’s staff was asked if Regulation H makes a distinction between a state-chartered bank that is authorized by state law to act as an underwriter of credit life and credit health and accident insurance and a state-chartered bank that is authorized to engage in such activity through a wholly owned subsidiary. Federal law forbids a member bank to purchase for its own account any shares of stock of any corporation except as specifically permitted under federal law or as included within the incidental powers necessary to carry on the business of banking. Federal law permits a member bank to purchase the shares of a wholly owned subsidiary engaged in activities the bank could engage in directly. Thus, such activity must be permissible for a state-chartered bank under state law. Where state law permits a state member bank to engage in an activity only through a subsidiary and not directly, such an investment would be permissible under federal law if it was determined that the activities of the subsidiary are encompassed within the incidental powers of the bank within the meaning of 12 USC 24.
Regulation H requires that a state member bank’s ownership or operation of a subsidiary be consistent with certain requirements. Also, state member banks must receive the prior permission of the Board if the proposed activity, conducted either directly or indirectly, would cause a change in the business or powers of a member bank. Finally, Regulation Y permits a state bank that is a subsidiary of a bank holding company to engage in activity through a wholly owned subsidiary that the bank could engage in directly. STAFF OP. of Aug. 6, 1981.
Authority: RS § 5136, 12 USC 24 FRA § 9 § 20, 12 USC 335; BHCA § 4(c)(5), 12 USC 1843(c)(5); 12 CFR 208, 225.4(e), and 250.141.
3-448

ELIGIBILITY—Insuring Corporation

A state insuring corporation that exists primarily to service its members and offers no banking services itself would not be eligible for membership in the Federal Reserve System. The stated purposes of the corporation appear to contravene the original intent of the discount and advance provisions of the Federal Reserve Act, which allow credit to be extended to member banks for short-term or seasonal purposes rather than for long-term liquidity needs. STAFF OP. of Oct. 4, 1974.
Authority: 12 CFR 201.0 and 201.6; FRA § 13, 12 USC 343 and 347c.
3-450

RESERVE BANK AUTHORITY—Applications to Exercise Fiduciary Powers

The Reserve Banks, acting on the Board’s behalf, may approve applications for permission to exercise fiduciary powers. In acting on these applications, the Reserve Banks should take into account the fiduciary expertise of the individuals involved and should consider the relative size of the trust department in making this assessment. Greater emphasis should be placed on the bank’s condition, the adequacy of its capital, and the competency of the bank’s management. Additionally, the proposed trust officer, proposed supervision of fiduciary business, proposed legal counsel, and local conditions should be evaluated. BD. ORDER of June 22, 1967.
Authority: 12 CFR 208 and 265.
3-451

SECURITY PROCEDURES—Edge and Agreement Corporations

The Bank Protection Act applies to Edge Act and agreement corporations to the extent that they have dealings with the public involving exposure of money and/or securities to possible criminal acts. This applicability extends to regulatory reporting requirements. STAFF OP. of Aug. 8, 1977.
Authority: Bank Protection Act § 3(b), 12 USC 1883; 12 CFR 208.60(a) and 208.61.
3-452

SECURITY PROCEDURES—Substitutes for Removing Excess Currency to Protected Place

Locked teller reserve drawers with keys in possession of the teller are not a permissible substitute for removing excess money to a “locked safe, vault or other protected place” unless time locks at all times prevent tellers from leaving the drawers open. STAFF OP. of Aug. 27, 1969.
Authority: Bank Protection Act § 3(a), 12 USC 1883; 12 CFR 208.61.
3-453

SECURITY PROCEDURES—Standby Power Equivalency Alternatives for Alarm Systems

Equivalency alternatives to the standby powerduration requirements for protection equipment include accessibility of battery replacement or other source substitution at all times, an indicator alerting police when standby power is being used, and a service arrangement for power source replacement with a notice, explaining how and when to contact the service organization situated adjacent to the device. STAFF OP. of Dec. 16, 1970.
Authority: Bank Protection Act of 1968 § 3(a), 12 USC 1883; 12 CFR 208.61(c)(2).
3-454

SECURITY PROCEDURES—Safe Deposit Boxes and Safes

Safe deposit boxes must be kept in a vault or safe during nonbusiness hours. A safe with steel walls 1½ inch thick and a steel door at least 1 inches thick is acceptable for safe deposit boxes, provided the additional standards for safes are met. STAFF OP. of Nov. 9, 1972.
Authority: Bank Protection Act § 3(a), 12 USC 1883; 12 CFR 208.61(c)(2).
3-455

SECURITY PROCEDURES—“Vault”

A vault is a container large enough to walk around in. STAFF OP. of Nov. 9, 1972.
Authority: Bank Protection Act § 3(a), 12 USC 1883; 12 CFR 208.61(c)(2).
3-456

SECURITY PROCEDURES—Designation of Security Officer

A bank’s security officer must be an officer or other employee of the bank and may not be a private security agency. STAFF OP. of March 28, 1969.
Authority: Bank Protection Act § 3(a), 12 USC 1883; 12 CFR 208.61(b).
Back to top