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Board Interpretations of Regulation H

3-410

ADVERTISING—Using Names of Honorary Directors and Advisory Board Members

It has been brought to the attention of the Board of Governors that some banks having an advisory board of honorary directors make a practice of listing the names of such honorary directors or members of advisory boards with the names of duly elected directors in advertising material under a single caption such as “Directors and Members of Advisory Board” without distinguishing between members of the respective bodies.
It is understood that honorary directors and members of advisory boards have no managerial powers, do not vote at directors’ meetings and have no function other than to offer their advice to the officers of the bank and the board of directors.
Because of the difference in their functions and their status the Board of Governors feels that the names of the members of advisory boards or honorary directors should not be listed under a single inclusive caption in advertising material with names of duly elected directors without clearly indicating the exact status of each person listed. It is felt that the public should be able readily to ascertain the individuals duly elected by the shareholders as directors and charged with responsibility as such. To indicate that the status of such directors is the same as that of members of advisory boards or persons serving in an honorary capacity would appear to misrepresent the facts.
It is realized that advisory boards usually serve in relation to designated branches and that publication of combined lists as referred to herein is relatively unusual. If such lists are published by state member banks, however, it is suggested that the position of the Board be brought to the attention of the publishing bank and that it be requested to clearly identify elected directors if publication of combined lists is considered desirable. S-1561; April 7, 1955.
3-411

ADVERTISING—False or Misleading

From time to time the Board of Governors receives inquiries and complaints regarding advertising by member banks.
Quite apart from any question of unfair trade practices, the Board feels that false or misleading advertising by member banks of the Federal Reserve System constitutes an unsafe and unsound banking practice that is a proper subject of concern to the Board and the Federal Reserve Banks from a bank supervisory standpoint. S-1970; Oct. 13, 1965.
3-414.9

BANKING PRACTICES—Trust Company Affiliate Issuing Mortgage Bonds

A trust company, which is an affiliate of a member bank, makes loans secured by real estate mortgages and the obligations secured by such mortgages are assigned to corporate trustees in order to secure the payment of bonds of the trust company which are issued and sold to the public. While the company receives deposits to some extent and does a considerable amount of trust business, it appears that its principal business is the making of mortgage loans and the issuance and sale of its mortgage bonds. In view of the nature of such bonds and the manner of their issue, such trust company is engaged principally in the issue and sale of securities within the meaning of section 20 of the Banking Act of 1933, and, therefore, appropriate action should be taken to comply with the requirements of that section with respect to the divorcement of member banks from companies engaged principally in the issue and sale of securities. Digest of 1934 Fed. Res. Bull. 485.
3-415

BANKING PRACTICES—Acting as Medium or Agent in Security Loans

This refers to Mr.
’s letters of 
regarding the seventh paragraph of section 19 of the Federal Reserve Act, which forbids a member bank to “act as the medium or agent of any nonbanking corporation . . . in making loans on the security of stocks, bonds, and other investment securities to brokers or dealers in stocks, bonds, and other investment securities.”
In his letter of
 , Mr.
 referred to the possible application of this statutory provision to a situation where a member bank informs the treasurer of a corporation with excess short-term balances that a particular government securities dealer or dealers may wish to borrow short-term funds. The bank would not participate in the ensuing negotiations between the corporation and the dealer.
The Board’s views were requested with respect to (1) whether a bank engaged in such practices should be held to be acting as the “medium or agent” of the corporation involved and (2) whether such loans come within the purview of the seventh paragraph of section 19.
The legislative history of the Banking Act of 1933 (of which said paragraph is a part) does not reveal the purpose of Congress in using the phrase “medium or agent” therein. Accordingly, it must be interpreted in the light of the ordinary meaning and legal interpretation of the words themselves.
The general meaning of the words “medium” and “agent,” as well as their legal definitions, leads the Board to conclude that their use in the statute was intended to preclude member banks from actively participating in bringing nonbanking interests and dealers together for the purpose of making loans on securities, or arranging such loans, and to prohibit them from serving in a representative capacity in such loan transactions. A member bank which simply gives information concerning the possible placement of excess funds to a corporate customer requesting such information would not be participating in bringing the parties together, arranging a loan, or representing the parties, and, consequently should not be considered a medium or agent in the transaction.
This interpretation of the statutory provision is applicable only to the factual situation described. That is to say, so long as the member bank confines itself strictly to providing information requested of it concerning the identity of possible borrowers of excess funds, the bank would not be acting as a medium or agent of the lending corporation. If, however, the bank were to contact either party or attempt to bring them together, or participate in the negotiation of the loan, it might be acting as a medium or agent in violation of section 19.
It is the Board’s view that the loans of the types which were described in Mr.
’s letters come within the purview of the statutory provision. The Senate Banking Committee of the 73rd Congress stated, in its Report No. 77, that its proposal was intended to prevent “speculative market loans,” and the Senate Committee of the 72nd Congress made an identical statement in its Report on S. 4412 (S. Rep. No. 584, 9).
However, these statements were made, according to the committee itself, to outline “in general broad terms the main objects . . . , although without endeavoring to do more than suggest the major features”. In each case the statement was followed by a review of the actual provisions of the bill “in order to indicate the precise content of the various sections”. The committee there pointed out that the relevant section would apply to secured loans to dealers in “stocks, bonds, and other investment securities” (S. Rep. No. 584, 13-14; S. Rep. Nos. 77, 13, 15). As will be noted, in this description of the precise content of the provision, the entire field of “investment securities” was referred to, and the scope of the provision was not described as confined to speculative market loans.
In any event, although the comments of a Committee of the Senate are entitled to some weight, the terms of the statutory provision enacted by Congress are of principal significance. The seventh paragraph of section 19, quoted above, refers to “loans” without limitation; it is not, in terms, confined to speculative loans. It also seems significant that the statute explicitly refers to loans to dealers in bonds and other investment securities as well as to dealers in stocks.
In addition to the legal difficulty in interpreting the words of the seventh paragraph as confined to speculative loans, it might be extremely difficult, in practice, to determine whether particular loans were “speculative.” Since dealers in obligations of the United States government often deal in other securities as well, it might be uncertain whether the purpose of the loan was or was not speculative.
It would seem that this could hardly be determined by the nature of the collateral; since Congress referred to “loans on the security of . . . investment securities” generally, it seems clear that loans subject to the paragraph (including speculative loans) could be secured by United States government obligations as well as other securities. This difficulty of distinguishing speculative from nonspeculative loans may have been one reason for Congress’s decision to cover loans to brokers and dealers generally, even though the principal purpose of the legislation was to prevent speculative loans.
It is also to be noted that Congress, in enacting the Banking Act of 1933, included special provisions relating to obligations of the United States in situations where this was considered appropriate. Among these were the amendments to the eighth paragraph of section 13 of the Federal Reserve Act, the second paragraph of section 23A of that act, and paragraph Seventh of section 5136 of the Revised Statutes. In view of this legislative advertence to the special status of government securities transactions in other sections of the 1933 act, it would be more difficult to infer that a similar intent existed with respect to the seventh paragraph of section 19 and that Congress inadvertently failed to express that intent. S-1984; Feb. 10, 1966.
3-415.2

BANKING PRACTICES—Limitation on Securities Investments; Meaning of “Obligor or Maker”

From time to time the New York State Dormitory Authority offers issues of bonds with respect to each of which a different educational institution enters into an agreement to make “rental” payments to the authority sufficient to cover interest and principal thereon when due. The Board of Governors of the Federal Reserve System has been asked whether a member state bank may invest up to 10 percent of its capital and surplus in each such issue.
Paragraph Seventh of section 5136 of the U.S. Revised Statutes (12 USC 24) provides that “In no event shall the total amount of the investment securities of any one obligor or maker, held by [a national bank] for its own account, exceed at any time 10 per centum of its capital stock . . . and surplus fund.” That limitation is made applicable to member state banks by the twentieth paragraph of section 9 of the Federal Reserve Act (12 USC 335).
The Board considers that, within the meaning of these provisions of law, “obligor” does not include any person that acts solely as a conduit for transmission of funds received from another source, irrespective of a promise by such person to pay principal or interest on the obligation. While an obligor does not cease to be such merely because a third person has agreed to pay the obligor amounts sufficient to cover principal and interest on the obligations when due, a person that promises to pay an obligation, but as a practical matter has no resources with which to assume payment of the obligation except the amounts received from such third person, is not an “obligor” within the meaning of section 5136.
Review of the New York Dormitory Authority Act (N.Y. Public Authorities Law §§ 1675-1690), the authority’s interpretation thereof, and materials with respect to the authority’s “Revenue Bonds, Mills College of Education Issue, Series A” indicates that the authority is not an “obligor” on those and similar bonds. Although the authority promises to make all payments of principal and interest, a bank that invests in such bonds cannot be reasonably considered as doing so in reliance on the promise and responsibility of the authority. Despite the authority’s obligation to make payments on the bonds, if the particular college fails to perform its agreement to make rental payments to the authority sufficient to cover all payments of bond principal and interest when due, as a practical matter the sole source of funds for payments to the bondholder is the particular college. The authority has general borrowing power but no resources from which to assure repayment of any borrowing except from the particular colleges, and rentals received from one college may not be used to service bonds issued for another.
Accordingly, the Board has concluded that each college for which the authority issues obligations is the sole “obligor” thereon. A member state bank may therefore invest an amount up to 10 percent of its capital and surplus in the bonds of a particular college that are eligible investments under the Investment Securities Regulation of the Comptroller of the Currency (12 CFR part 1), whether issued directly or indirectly through the dormitory authority. 1966 Fed. Res. Bull. 1618; 12 CFR 250.142.
3-415.3

BANKING PRACTICES—Acquisition of Majority of Shares of Mutual Fund

The Board recently considered whether section 20 of the Banking Act of 1933 (12 USC 377) would prohibit a member bank, while acting as trustee of a tax-exempt employee benefit trust or trusts, from, under the following circumstances, acquiring a majority of the shares of an open-end investment company (“fund”) registered under the Investment Company Act of 1940, or more than 50 percent of the number of fund’s shares voted at the preceding election of directors of the fund.
The bank has acted as trustee, since December 1963, pursuant to a trust agreement with a county medical society to administer its group retirement program, under which individual members of the society could participate in accordance with the provisions of the Self-Employed Individuals Tax Retirement Act of 1962 (commonly referred to as “H.R. 10”).
Under the trust agreement as presently constituted, each employee who is a participating member of the medical society directs the bank to invest his contributions to the retirement plan in such proportions as he may elect in insurance or annuity contracts or in a diversified portfolio of securities and other property. The diversified portfolio held by the bank is invested and administered by the bank solely at the direction of a committee of the medical society.
It has now been proposed that the trust agreement be amended to provide that all investments constituting the trust fund, apart from insurance and annuity contracts, will be made exclusively in shares of a single open-end investment company to be named in the trust agreement and that the assets constituting the diversified portfolio now held by the bank, as trustee, will be exchanged for the fund’s shares. The bank will, in addition to holding the shares of the Fund, allocate income and dividends to the accounts of the various participants in the retirement program, invest and reinvest income and dividends, and perform other ministerial functions.
In addition, it is proposed to amend the trust agreement so that voting of the shares held by the bank as trustee will be controlled exclusively by the participants. Under the proposed amendment, the bank will sign all proxies prior to mailing them to the participants, “it being intended that the Participant(s) shall vote the proxies notwithstanding the fact that the Trustee is the owner of the shares. . . .”
The bank believes that amendments are now under consideration that will also require investment of the assets of these plans exclusively in the fund’s shares. Accordingly, the bank may eventually own the fund’s shares in several separate trust accounts and in an aggregate amount equal to a majority of the fund’s shares.
Section 20 of the Banking Act of 1933 provides in relevant part that “no member bank shall be affiliated in any manner described in section 2(b) hereof with any corporation . . . engaged principally in the issue, flotation, underwriting, public sale, or distribution at wholesale or retail or through syndicate participation of stocks . . . or other securities. . . .”
Section 2(b) defines the term “affiliate” to include “any corporation, business trust, association or other similar organization (1) of which a member bank, directly or indirectly, owns or controls either a majority of the voting shares or more than 50 per centum of the number of shares voted for the election of its directors, trustees, or other persons exercising similar functions at the preceding election, or controls in any manner the election of a majority of its directors, trustees, or other persons exercising similar functions. . . .”
The Board has previously taken the position, in an interpretation involving the term “affiliate” under the Banking Act of 1933, that it would not require a member bank to obtain and publish a report of a corporation the majority of the stock of which is held by the member bank as executor or trustee, provided that the member bank holds such stock subject to control by a court or by a beneficiary or other principal and that the member bank may not lawfully exercise control of such stock independently of any order or direction of a court, beneficiary or other principal. 1933 Fed. Res. Bull. 651. The rationale of that interpretation—which was reaffirmed by the Board in 1957—would appear to be equally applicable to the facts in the present case. In the circumstances, and on the basis of the Board’s understanding that the bank will not vote any of fund’s shares or control in any manner the election of any of its directors, trustees, or other persons exercising similar functions, the Board has concluded that the situation in question would not fall within the purpose or coverage of section 20 of the Banking Act of 1933 and, therefore, would not involve a violation of the statute. 1968 Fed. Res. Bull. 508; 12 CFR 250.220.
3-415.4

BANKING PRACTICES—Purchase of Stock of Operations Subsidiary

The Board of Governors has reexamined its position that the so-called “stock-purchase prohibition” of section 5136 of the Revised Statutes (12 USC 24), which is made applicable to member state banks by the 20th paragraph of section 9 of the Federal Reserve Act (12 USC 335), forbids the purchase by a member bank “for its own account of any shares of stock of any corporation” (the statutory language), except as specifically permitted by provisions of Federal law or as comprised within the concept of “such incidental powers as shall be necessary to carry on the business of banking”, referred to in the first sentence of paragraph “Seventh” of RS 5136.
In 1966 the Board expressed the view that said incidental powers do not permit member banks to purchase stock of “operations subsidiaries”—that is, organizations designed to serve, in effect, as separately incorporated departments of the bank, performing, at locations at which the bank is authorized to engage in business, functions that the bank is empowered to perform directly (see 1966 Fed. Res. Bull. 1151).
The Board now considers that the incidental powers clause permits a bank to organize its operations in the manner that it believes best facilitates the performance thereof. One method of organization is through departments; another is through separate incorporation of particular operations. In other words, a wholly owned subsidiary corporation engaged in activities that the bank itself may perform is simply a convenient alternative organizational arrangement.
Reexamination of the apparent purposes and legislative history of the stock-purchase prohibition referred to above has led the Board to conclude that such prohibition should not be interpreted to preclude a member bank from adopting such an organizational arrangement unless its use would be inconsistent with other federal law, either statutory or judicial.
In view of the relationship between the operation of certain subsidiaries and the branch banking laws, the Board has also reexamined its rulings on what constitutes “money lent” for the purposes of section 5155 of the Revised Statutes (12 USC 36), which provides that “The term ‘branch’ . . . shall be held to include any branch bank, branch office, branch agency, additional office, or any branch place of business . . . at which deposits are received, or checks paid, or money lent.”1
The Board noted in its 1967 interpretation that offices that are open to the public and staffed by employees of the bank who regularly engage in soliciting borrowers, negotiating terms, and processing applications for loans (so-called loan production offices) constitute branches (1967 Fed. Res. Bull. 1334). The Board also noted that later in that year it considered the question whether a bank holding company may acquire the stock of a so-called “mortgage company” on the basis that the company would be engaged in “furnishing services to or performing services for such bank holding company or its banking subsidiaries” (the so-called servicing exemption of section 4(c)(1)(C) of the Bank Holding Company Act, 12 USC 1843). In concluding affirmatively, the Board stated that “the appropriate test for determining whether the company may be considered as within the servicing exemption is whether the company will perform as principal any banking activities—such as receiving deposits, paying checks, extending credit, conducting a trust department, and the like. In other words, if the mortgage company is to act merely as an adjunct to a bank for the purpose of facilitating the bank’s operations, the company may appropriately be considered as within the scope of the servicing exemption.” (1967 Fed. Res. Bull. 1911; 12 CFR 225.122).
The Board believes that the purposes of the branch banking laws and the servicing exemption are related. Generally, what constitutes a branch does not constitute a servicing organization and, vice versa, an office that only performs servicing functions should not be considered a branch (see 1958 Fed. Res. Bull. 431, last paragraph; 12 CFR 225.104(e)). When viewed together, the above-cited interpretations on loan production offices and mortgage companies represent a departure from this principle. In reconsidering the laws involved, the Board has concluded that a test similar to that adopted with respect to the servicing exemption under the Bank Holding Company Act is appropriate for use in determining whether or not what constitutes “money [is] lent” at a particular office, for the purpose of the federal branch banking laws.
Accordingly, the Board considers that the following activities, individually or collectively, do not constitute the lending of money within the meaning of section 5155 of the revised statutes: Soliciting loans on behalf of a bank (or a branch thereof), assembling credit information, making property inspections and appraisals, securing title information, preparing applications for loans (including making recommendations with respect to action thereon), soliciting investors to purchase loans from the bank, seeking to have such investors contract with the bank for the servicing of such loans, and other similar agent-type activities. When loans are approved and funds disbursed solely at the main office or a branch of the bank, an office at which only preliminary and servicing steps are taken is not a place where “money [is] lent”. Because preliminary and servicing steps of the kinds described do not constitute the performance of significant banking functions of the type that Congress contemplated should be performed only at governmentally approved offices, such office is accordingly not a branch.
To summarize the foregoing, the Board has concluded that, insofar as federal law is concerned, a member bank may purchase for its own account shares of a corporation to perform, at locations at which the bank is authorized to engage in business, functions that the bank is empowered to perform directly. Also, a member bank may establish and operate, at any location in the United States, a “loan production office” of the type described herein. Such offices may be established and operated by the bank either directly, or indirectly through a wholly owned subsidiary corporation.
This interpretation supersedes both the Board’s 1966 ruling on “operations subsidiaries” and its 1967 ruling on “loan production offices,” referred to above. 1968 Fed. Res. Bull. 681; 12 CFR 250.141.
1
In the Board’s judgment, the statutory enumeration of three specific functions that establish branch status is not meant to be exclusive but to ensure that offices at which any of these functions is performed are regarded as branches by the bank regulatory authorities. In applying the statute the emphasis should be to ensure that significant banking functions are made available to the public only at governmentally authorized offices.
3-416.11

BANKING PRACTICES—Ineligible Acceptances; Amount Limitations

Since 1923, the Board has been of the view that “the acceptance power of state member banks is not necessarily confined to the provisions of section 13 (of the Federal Reserve Act), inasmuch as the laws of many states confer broader acceptance powers upon their state banks, and certain state member banks may, therefore, legally make acceptances of kinds which are not eligible for rediscount, but which may be eligible for purchase by Federal Reserve Banks under section 14.” 1923 Fed. Res. Bull. 316, 317.
In 1963, the Comptroller of the Currency ruled that “[n] ational banks are not limited in the character of acceptances which they may make in financing credit transactions, and bankers’ acceptances may be used for such purpose, since the making of acceptances is an essential part of banking authorized by 12 USC 24.” Comptroller’s Manual 7.7420. Therefore, national banks are authorized by the Comptroller to make acceptances under 12 USC 24, although the acceptances are not the type described in section 13 of the Federal Reserve Act.
A review of the legislative history surrounding the enactment of the acceptance provisions of section 13 reveals that Congress believed in 1913 that it was granting to national banks a power which they would not otherwise possess and had not previously possessed. See remarks of Congressmen Phelan, Helvering, Saunders, and Glass, 51 Cong. Rec. 4676, 4798, 4885, and 5064 (September 10, 12, 13, and 17 of 1913). Nevertheless, the courts have long recognized the evolutionary nature of banking and of the scope of the “incidental powers” clause of 12 USC 24. See Merchants Bank v. State Bank, 77 U.S. 604 (1870) (upholding the power of a national bank to certify a check under the “incidental powers” clause of 12 USC 24).
It now appears that, based on the Board’s 1923 ruling, and the Comptroller’s 1963 ruling, both state member banks and national banks may make acceptances which are not of the type described in section 13 of the Federal Reserve Act. Yet, this appears to be a development that Congress did not contemplate when it drafted the acceptance provisions of section 13.
The question is presented whether the amount limitations of section 13 should apply to acceptances made by a member bank that are not of the type described in section 13. (The amount limitations are of two kinds: (1) A limitation on the amount that may be accepted for any one customer, and (2) a limitation on the aggregate amount of acceptances that a member bank may make.) In interpreting any federal statutory provision, the primary guide is the intent of Congress, yet, as noted earlier, Congress did not contemplate in 1913, the development of so-called “ineligible acceptances.” (Although there is some indication that Congress did contemplate state member banks’ making acceptances of a type not described in section 13 [remarks of Congressman Glass, 51 Cong. Rec. 5064], the primary focus of congressional attention was on the acceptance powers of national banks.) In the absence of an indication of congressional intent, we are left to reach an interpretation that is in harmony with the language of the statutory provisions and with the purposes of the Federal Reserve Act.
Section 13 authorizes acceptances of two types. The seventh paragraph of section 13 (12 USC 372) authorizes certain acceptances that arise out of specific transactions in goods. (These acceptances are sometimes referred to as “commercial acceptances.”) The twelfth paragraph of section 13 authorizes member banks to make acceptances “for the purpose of furnishing dollar exchange as required by the usages of trade” in foreign transactions. (Such acceptances are referred to as “dollar exchange acceptances.”) In the twelfth paragraph, there is a 10 percent limit on the amount of dollar exchange acceptances that may be accepted for any one customer (unless adequately secured) and a limitation on the aggregate amount of dollar exchange acceptances that a member bank may make. (The twelfth paragraph, in imposing these limitations, refers to the acceptance of “such drafts or bills of exchange referred to (in) this paragraph.”) Similarly, the seventh paragraph imposes on commercial acceptances a parallel 10 percent per-customer limitation, and limitations on the aggregate amount of commercial acceptances. (In the case of the aggregate limitations, the seventh paragraph states that “no bank shall accept such bills to an amount” in excess of the aggregate limit; the reference to “such bills” makes clear that the limitation is only in respect of drafts or bills of exchange of the specific type described in the seventh paragraph.)
Based on the language and parallel structure of the seventh and twelfth paragraphs of section 13, and in the absence of a statement of congressional intent in the legislative history, the Board concludes that the per-customer and aggregate limitations of the twelfth paragraph apply only to acceptances of the type described in that paragraph (dollar exchange acceptances), and the per-customer and aggregate limitations of the seventh paragraph (12 USC 372) apply only to acceptances of the type described in that paragraph. 1973 Fed. Res. Bull. 450; 12 CFR 250.163.
3-416.12

BANKING PRACTICES—Banker’s Acceptances Under Bank Export Services Act

Section 207 of the Bank Export Services Act (title II of Pub. L. 97-290) (BESA) raised the limits on the aggregate amount of eligible banker’s acceptances (BAs) that may be created by an individual member bank from 50 percent (or 100 percent with the permission of the Board) of its paid-up and unimpaired capital stock and surplus (capital) to 150 percent (or 200 percent with the permission of the Board) of its capital. Section 207 also prohibits a member bank from creating eligible BAs for any one person in the aggregate in excess of 10 percent of the institution’s capital. This section of the BESA applies the same limits applicable to member banks to U.S. branches and agencies of foreign banks that are subject to reserve requirements under section 7 of the International Banking Act of 1978 (12 USC 3105). The Board is clarifying the proper meaning of the seventh paragraph of section 13 of the Federal Reserve Act, as amended by the BESA.
This section of the BESA provides that any portion of an eligible BA created by an institution subject to the BA limitations contained therein (covered bank) that is conveyed through a participation to another covered bank shall not be included in the calculation of the creating bank’s BA limits. The amount of the participation is to be applied to the calculation of the BA limits applicable to the covered bank receiving the participation. Although a covered bank that has reached its 150 or 200 percent limit can continue to create eligible acceptances by conveying participations to other covered banks, Congress has in effect imposed an aggregate limit on the eligible acceptances that may be created by all covered banks equal to the sum of 150 or 200 percent of the capital of all covered banks.
The Board has clarified that under the statute an eligible BA created by a covered bank that is conveyed through a participation to an institution that is not subject to the limitations of this section of the BESA continues to be included in the calculation of the limits applicable to the creating covered bank. This will ensure that the total amount of eligible BAs that may be created by covered banks does not exceed the limitations established by Congress. In addition, this ensures that participations in acceptances are not used as a device for the avoidance of reserve requirements. Finally, this promotes the congressional intent, with respect to covered banks, that foreign and domestic banks be on an equal footing and under the same legal requirements.
In addition, the amount of a participation received by a covered bank from an institution not covered by the limitations of the act is to be included in the calculation of the limits applicable to the covered bank receiving the participation. This result is based upon the language of the statute which includes within a covered bank’s limits on eligible BAs outstanding the amount of participations received by the covered bank. This provision reflects congressional intent that a covered bank not be obligated on eligible banker’s acceptances, and participations therein, for an amount in excess of 150 or 200 percent of the institution’s capital.
The statute also provides that eligible acceptances growing out of domestic transactions are not to exceed 50 percent of the aggregate of all eligible acceptances authorized for covered banks. The Board has clarified that this 50 percent limitation is applicable to the maximum permissible amount of eligible BAs (150 or 200 percent of capital), regardless of the bank’s amount of eligible acceptances outstanding. The statutory language prior to the BESA amendment made clear that covered banks could issue eligible acceptances growing out of domestic transactions up to 50 percent of the amount of the total permissible eligible acceptances the bank could issue. The legislative history of the BESA indicates no intent to change this domestic-acceptance limitation.
The statute also provides that for the purpose of the limitations applicable to U.S. branches and agencies of foreign banks, a branch’s or agency’s capital is to be calculated as the dollar equivalent of the capital stock and surplus of the parent foreign bank as determined by the Board. The Board has clarified that for purposes of calculating the BA limits applicable to U.S. branches and agencies of foreign banks, the identity of the parent foreign bank is generally the same as for reserve requirement purposes; that is, the bank entity that owns the branch or agency most directly. The Board has also clarified that the procedures currently used for purposes of reporting to the Board on the Annual Report of Foreign Banking Organizations, Form FR Y-7, are also to be used in the calculation of the acceptance limits applicable to U.S. branches and agencies of foreign banks. (The FR Y-7 generally requires financial statements prepared in accordance with local accounting practices and an explanation of the accounting terminology and the major features of the accounting standards used in the preparation of the financial statements.) Conversions to the dollar equivalent of the worldwide capital of the foreign bank should be made periodically, but in no event less frequently than quarterly. In this regard, the Board recognizes the need to be flexible in dealing with the effect of foreign exchange rate fluctuations on the calculation of the worldwide capital of the parent foreign bank. Each foreign bank is to be responsible for coordinating the BA activity of its U.S. branches and agencies (including the aggregation of such activity) and establishing procedures that ensure that examiners will be able readily to determine compliance with the BESA limits. 1983 Fed. Res. Bull. 540; 12 CFR 250.164.
3-416.13

BANKING PRACTICES—Banker’s Acceptances; Definition of Participations

Section 207 of the Bank Export Services Act (title II of Pub. L. 97-290) (BESA) raised the limits on the aggregate amount of eligible banker’s acceptances (BAs) that may be created by a member bank from 50 percent (or 100 percent with the permission of the Board) of its paid-up and unimpaired capital stock and surplus (capital) to 150 percent (or 200 percent with the permission of the Board) of its capital. Section 207 also prohibits a member bank from creating eligible BAs for any one person in the aggregate in excess of 10 percent of the institution’s capital. Eligible BAs growing out of domestic transactions are not to exceed 50 percent of the aggregate of all eligible acceptances authorized for a member bank. This section of the BESA applies the same limits applicable to member banks to U.S. branches and agencies of foreign banks that are subject to reserve requirements under section 7 of the International Banking Act of 1978 (12 USC 3105).1
This section of the BESA also provides that any portion of an eligible BA created by a covered bank (senior bank) that is conveyed through a “participation agreement” to another covered bank (junior bank) shall not be included in the calculation of the senior bank’s banker’s-acceptance limits established by section 207 of BESA.2 However, the amount of the participation is to be included in the BA limits applicable to the junior bank. The language of the statute does not define what constitutes a participation agreement for purposes of the applicability of the BESA limitations. However, the statute does authorize the Board to further define any of the terms used in section 207 of the BESA (12 USC 372(g)). The Board is clarifying the term “participation” for purposes of the BA limitations of the BESA.
The legislative history of section 207 of the BESA indicates that Congress intended that the junior bank be obligated to the senior bank in the event that the account party defaults on its obligation to pay, but that the junior bank need not also be obligated to pay the holder of the acceptance at the time the BA is presented for payment. H. Rep. No. 97-629, 97th Cong., 2nd Sess. 15 (1982); 128 Cong. Rec. H 4647 (daily ed. July 27, 1982) (remarks by Rep. Barnard); and 128 Cong. Rec. H 8462 (daily ed. October 1, 1982) (remarks by Rep. Barnard). The legislative history also indicates that Congress intended that eligible BAs in which participations had been conveyed not be required to indicate the name(s) (or interest(s)) of the junior bank(s) on the acceptance in order for the BA to be excluded from the BESA limitations applicable to the senior bank. 128 Cong. Rec. S 12237 (daily ed. Sept. 24, 1982) (remarks of Senators Heinz and Garn); and 128 Cong. Rec. H 4647 (daily ed. July 27, 1982) (remarks of Rep. Barnard).
In view of congressional intent with regard to what constitutes a participation in an eligible BA, the Board has determined that, for purposes of the BESA limits, a participation must satisfy the following two minimum requirements:
  • 1.
    a written agreement entered into between the junior and senior bank under which the junior bank acquires the senior bank’s claim against the account party to the extent of the amount of the participation that is enforceable in the event that the account party fails to perform in accordance with the terms of the acceptance and
  • 2.
    the agreement between the junior and senior bank provides that the senior bank obtains a claim against the junior bank to the extent of the amount of the participation that is enforceable in the event the account party fails to perform in accordance with the terms of the acceptance
Consistent with congressional intent, the minimum requirements do not require the junior bank to be obligated to pay the holder of the acceptance at the time the BA is presented for payment. Similarly, the minimum requirements do not require the name(s) or interest(s) of the junior bank(s) to appear on the face of the acceptance.
An eligible BA that is conveyed through a participation that does not satisfy these minimum requirements would continue to be included in the BA limits applicable to the senior bank. Further, an eligible BA conveyed to a covered bank through a participation that provided for additional rights and obligations among the parties would be excluded from the BESA limitations of the senior bank provided the minimum requirements were satisfied.
A participation structured pursuant to these minimum requirements would be as follows: Upon the conveyance of the participation, the senior bank retains its entire obligation to pay the holder of the BA at maturity. The senior bank has a claim against the junior bank to the extent of the amount of the participation that is enforceable in the event the account party fails to perform in accordance with the terms of the acceptance. Similarly, the junior bank has a corresponding claim against the account party to the extent of the amount of the participation that is enforceable in the event the account party fails to perform in accordance with the terms of the acceptance.
The Board is not requiring the senior bank and the account party specifically to agree that the senior bank’s rights are assignable because the Board believes such rights to be assignable even in the absence of an explicit agreement.
The junior and senior banks may contract among themselves as to which party(ies) have the responsibility for administering the arrangement, enforcing claims, or exercising remedies.
The Board recognizes that both the junior bank’s claim on the account party and the senior bank’s claim on the junior bank involve risk. Therefore, it is essential that these risks be assessed by the banks involved in accordance with prudent and sound banking practices. The examiners will in the normal course of the examination process review the risk assessment procedures instituted by the banks. The junior bank should review the creditworthiness of each account party when the junior bank acquires a participation, and the senior bank should review on an ongoing basis the creditworthiness of the junior bank. Junior bank agreement to rely exclusively upon the credit judgment of the senior bank and purchase on an ongoing basis from the senior bank all participations in BAs regardless of the identity of the account party is not appropriate in view of the risks involved. However, in those cases involving a participation between a parent bank and its Edge affiliate where the credit review for both entities is performed by the parent bank, the Edge corporation should maintain documentation indicating that it concurs with the parent bank’s analysis and that the acceptance participation is appropriate for inclusion in the Edge corporation’s portfolio.
Similarly, the Board has determined that it is appropriate to include the risks incurred by the senior bank in assessing the senior bank’s capital and the risks incurred by the junior bank in assessing the junior bank’s capital.
In view of this clarification of the issues relating to participations in BAs, the Board encourages the private sector to develop standardized forms for BAs and participations therein that clearly delineate the rights and responsibilities of the relevant parties. 12 CFR 250.165.
1
The institutions subject to the BA limitations of BESA will hereinafter be referred to as “covered banks.”
2
The use of the terms “senior bank” and “junior bank” has no implications regarding priority of claims. These terms merely represent a shorthand method of identifying the depository institution that has created the acceptance and conveyed the participation (senior bank) and the depository institution that has received the participation (junior bank).
3-416.14

BANKING PRACTICES—Purchase of Equity Securities to Hedge Bank-Permissible Equity Derivative Transactions

The Board has considered the issue of whether a state member bank may acquire equity securities in order to hedge the bank’s exposure arising from one or more equity derivative transactions lawfully entered into by the bank with a third party. An equity derivative transaction is a contract that provides for the bank to pay or receive an amount that is based, at least in part, on the price or total return of an individual equity security, a group of equity securities, or an index of equity securities. Examples of an equity derivative transaction include equity swaps, equity index swaps, equity index deposits, and equity-linked loans.
Section 9 of the Federal Reserve Act (12 U.S.C. 335) provides that state member banks are subject to the same limitations and conditions on the purchase, sale, underwriting, and holding of investment securities and stock that apply to national banks under 12 U.S.C. 24 (seventh).
The Office of the Comptroller of the Currency (OCC) has reaffirmed that section 24 (seventh) generally prohibits national banks from acquiring equity securities (see OCC Interpretive Ltr. No. 892 (Sept. 13, 2000)). The OCC also has determined that a national bank, subject to certain conditions and OCC review and approval, may acquire equity securities solely for the purpose of hedging the bank’s exposure arising from customer-driven equity derivative transactions lawfully entered into by the bank (Id.). The General Accounting Office has reviewed and concurred with this decision (see “Equity Hedging: OCC Needs to Establish Policy on Publishing Interpretive Decisions,” GAO-01-945 (Aug. 2001)).
In light of these decisions and other relevant facts, the Board will not apply section 9 of the Federal Reserve Act so as to prohibit a state member bank from purchasing equity securities to hedge the risks arising from equity derivative transactions entered into by the bank with an unaffiliated third party, provided such purchases are made in accordance with the same conditions and restrictions applicable to national banks and the state member bank receives the Board’s prior approval as described below.
These conditions and restrictions provide that, among other things, a state member bank may acquire an equity security solely for purposes of hedging the bank’s exposure arising from one or more equity derivative transactions entered into by the bank with, and at the request of, an unaffiliated third party. A state member bank may not acquire equity securities for speculative or investment purposes.
A state member bank also may not acquire through its equity hedging activities more than 5 percent of the stock of any issuer. Federal law also prohibits a state member bank from underwriting or dealing in any equity security (see 12 U.S.C. 24 (seventh), 335). Accordingly, a state member bank may not hold itself out to the public as willing to purchase or sell any equity security or act as a market maker in any security by continuously quoting bid and ask prices for the security.
A state member bank also must receive the approval of the director of Board’s Division of Banking Supervision and Regulation prior to acquiring any equity security for hedging purposes. A request for approval should fully describe the proposed scope of the bank’s equity hedging and related equity derivative activities. In addition, any request should describe the policies, procedures, internal controls, and limits that the bank will use to monitor and control the risks associated with the bank’s equity derivative and equity hedging activities and to ensure compliance with the limitations applicable to the bank’s equity hedging activities.
A state member bank also must have the authority under applicable state law to enter into equity derivative transactions and to purchase equity securities in order to hedge the risks arising from such transactions. In addition, a state member bank must comply with any applicable state notice or approval requirements to engage in equity hedging activities.
The Board expects to monitor a state member bank that receives approval to engage in equity hedging activities to ensure that the bank acquires equity securities only for purposes of hedging the risks arising from the bank’s equity derivative transactions and does not violate the prohibition contained in section 24 (seventh) on a member bank acquiring stock for speculative or investment purposes. In addition, the Board will monitor the equity hedging activities of state member banks to ensure that they are conducted in a safe and sound manner. BOARD STATEMENT of Feb. 21, 2002.
Authority: FRA § 9, 12 U.S.C. 335.
3-416.15

BANKING PRACTICES—Policy Statement on Section 9(13) of the Federal Reserve Act

(a) Under section 9(13) of the Federal Reserve Act (12 U.S.C. 330), a state member bank may “exercise all corporate powers granted it by the State in which it was created . . . except that the [Board] may limit the activities of State member banks and subsidiaries of State member banks in a manner consistent with section 24 of the Federal Deposit Insurance Act.” The Board interprets this provision as vesting the Board with the authority to prohibit or otherwise restrict state member banks and their subsidiaries from engaging as principal in any activity (including acquiring or retaining any investment) that is not permissible for a national bank, unless the activity is permissible for state banks by federal statute or under part 362 of the Federal Deposit Insurance Corporation’s (FDIC) regulations, 12 CFR part 362. The Board reminds state member banks of the fundamental canon of federal banking law that activities are permissible for a national bank only if authority is provided under federal law, including the National Bank Act.
(b) The Board generally believes that the same bank activity, presenting the same risks, should be subject to the same regulatory framework, regardless of which agency supervises the bank. This principle of equal treatment helps to level the competitive playing field among banks with different charters and different federal supervisors and to mitigate the risks of regulatory arbitrage.
(c) In alignment with this principle, the Board generally presumes that it will exercise its discretion under section 9(13) of the Federal Reserve Act (12 U.S.C. 330) to limit state member banks and their subsidiaries to engaging as principal in only those activities that are permissible for national banks—in each case, subject to the terms, conditions, and limitations placed on national banks with respect to the activity—unless those activities are permissible for state banks by federal statute or under 12 CFR part 362. For example, if the OCC conditions permissibility on a national bank demonstrating, to the satisfaction of its supervisory office, that the bank has controls in place to conduct the activity in a safe and sound manner, and receiving a written nonobjection from OCC supervisory staff before engaging in a particular activity, then the activity would not be permissible for a state member bank unless the bank makes the same demonstration and receives a written nonobjection from Federal Reserve supervisory staff before commencing such activity.
(d) If a state member bank or its subsidiary proposes to engage in an activity as principal that is not permissible for a national bank or for an insured state member bank under federal statute or part 362 of this title, the state member bank or subsidiary may not engage in the activity unless the bank has received the prior permission of the Board under section 208.3(d)(2). Under that provision, a state member bank may not, without the permission of the Board, change the general character of its business or the scope of the corporate powers it exercises at the time of its admission. In determining whether to grant permission to engage in an activity under section 208.3(d)(2), the Board will rebuttably presume that a state member bank and its subsidiaries are prohibited from engaging as principal in any activity that is impermissible for national banks, unless the activity is permissible for state banks under federal statute or part 362 of this title. This presumption may be rebutted if there is a clear and compelling rationale for the Board to allow the proposed deviation in regulatory treatment among federally supervised banks, and the state member bank has robust plans for managing the risks of the proposed activity in accordance with principles of safe and sound banking. Depending on the applicant and the activity, an application to the FDIC may also be required under section 24 of the Federal Deposit Insurance Act (12 U.S.C. 1831a).
(e) This statement does not impact the legal obligation of insured state member banks to seek approval from the FDIC when required under section 24 of the Federal Deposit Insurance Act and part 362 of this title. As established under those provisions, insured state banks may not engage as principal in any type of activity that is not permissible for a national bank unless—(1) the FDIC has determined that the activity would pose no significant risk to the Deposit Insurance Fund; and (2) the state bank is, and continues to be, in compliance with applicable capital standards.
(f) The Board also reiterates to state member banks that legal permissibility is a necessary, but not sufficient, condition to establish that a state member bank may engage in a particular activity. Under section 208.3(d)(1), a state member bank must at all times conduct its business and exercise its powers with due regard to safety and soundness. Under appendix D-1 of this part, at a minimum, a state member bank should have in place and implement internal controls and information systems that are appropriate for the nature, scope, and risks of its activities. Further, under section 208.3(d)(3), a state member bank must comply at all times with this part and conditions of membership prescribed by the Board; in addition, a state member bank must comply with other applicable laws and regulations, including those related to consumer compliance and anti-money laundering. With respect to any novel and unprecedented activities, appropriate systems to monitor and control risks, including liquidity, credit, market, operational, and compliance risks, are particularly important; Federal Reserve supervisors will expect banks to be able to explain and demonstrate an effective control environment related to such activities. 12 CFR 208.112.
Authority: FRA § 9(13), 12 U.S.C. 330.
3-418

BRANCHES—Teller’s Window on Adjoining Land

It is the Board’s view that where a teller’s window is to be located on premises contiguous to those of the bank building, it is not an “additional office, or . . . place of business” and is not to be considered a new branch, the establishment of which would require the Board’s approval. S-1510; Sept. 1, 1953.
3-421

BRANCHES—Building to House Computer Service

The Board was requested to determine whether a service building to be located several blocks from the bank’s nearest office housing, among other things, the bank’s electronic computer and related equipment would constitute a branch for which the Board’s approval would be required by section 9, paragraph 3 of the Federal Reserve Act. On the equipment in the service building, the bank intends to perform deposit account processing, including the processing of customers’ “bank-by-mail” deposits, for its own banking offices and, apparently, for some of its correspondent banks. The bank stated that no banking business with the public would be transacted at the service building.
The Board has concluded that, on the basis of its understanding of the functions proposed to be performed at the service building, such building would not constitute a branch requiring the approval of the Board. The Board’s conclusion, of course, is based only on the specific matters covered in the correspondence that has been received at the Board concerning this matter, and should be regarded as applicable only with respect to state member banks, and any correspondent state member bank being served by the service building.
In reaching its conclusion, the Board took particular cognizance of the assurance of the bank that no banking business with the public would be transacted over the counter at the service building. The Board also deemed it appropriate to read the provisions of the law relating to the establishment of branches by state member banks in the light of the Bank Service Corporation Act of 1962 (12 USC 1861 et seq.), which clearly contemplates the performance of important services for banks at locations other than their banking offices. S-1893; Oct. 2, 1963.
3-422

BRANCHES—Television Facility

The Board’s opinion has been requested as to whether the operation by state member banks of nearby facilities, unoccupied by bank personnel and not connected to bank property except by closed-circuit TV and pneumatic tube, requires Board approval for the establishment of branches. In one case, a branch was located in a large shopping center and the bank wished to open a TV facility about 200 feet from the existing branch on the parking area. In another case, the bank wished to open a TV facility approximately 150 feet from the bank building on a parking lot diagonally across from the bank at a street intersection. In neither case was competition with other banks a matter of importance.
Federal statutes define a branch to include any “place of business . . . at which deposits are received or checks paid, or money lent.” The answer, therefore, depends upon whether such a TV facility is a place of business at which deposits are received or checks are paid.
A typical unit consists of a two-way screen and sound system. The customer presses a button to signal the teller, who then appears on the TV screen. The customer’s image also appears on a screen in the teller’s booth. The door of the cash tray is opened by the teller through remote control and the customer places his deposit or withdrawal slip therein. A pneumatic tube system sends the carrier to the teller’s station inside the bank. The teller’s actions may be watched by the customer. The teller places the passbook, receipt, or cash in the carrier and sends it back to the customer. There are no mechanical controls by the customer, the entire operation being performed by the teller inside the bank. However, the customer and the teller see each other during the entire transaction and may converse freely at all times.
The Board has consistently taken the position that any facility at which a teller is stationed and which is separated from the bank’s building by property not owned or controlled by the bank is a “branch,” unless the facility is connected to the bank building by a bank-controlled passage through which people may pass. Thus, in several cases where the facilities were located only across a street or alley and there was no connecting passage (bridge or tunnel) over which the bank had exclusive control, Board permissions were given for the establishment of branches.
However, in the facilities under consideration, the funds would pass immediately through a tube to or from an employee in the bank building and the facilities would not be occupied by an employee of the bank who even temporarily held funds in his custody. This fact differentiates such facilities from those considered in the past at which a teller is stationed.
Accordingly, the Board has concluded that the operation of the TV facilities described above would not constitute the establishment of branches. In cases arising in the future under similar conditions, the Board’s permission to establish a branch would not be necessary. If the conditions are substantially dissimilar, the matter should be submitted to the Board for its consideration. S-1982; Feb. 1, 1966.
3-423

BRANCHES—Sale of Bank’s Money Orders Off Premises as Establishment of Branch Office

The Board of Governors has been asked to consider whether the appointment by a member bank of an agent to sell the bank’s money orders, at a location other than the premises of the bank, constitutes the establishment of a branch office.
Section 5155 of the Revised Statutes (12 USC 36), which is also applicable to member banks, defines the term branch as including “any branch bank, branch office, branch agency, additional office, or any branch place of business . . . at which deposits are received, or checks paid, or money lent.” The basic question is whether the sale of a bank’s money orders by an agent amounts to the receipt of deposits at a branch place of business within the meaning of this statute.
Money orders are classified as deposits for certain purposes. However, they bear a strong resemblance to traveler’s checks that are issued by banks and sold off premises. In both cases, the purchaser does not intend to establish a deposit account in the bank, although a liability on the bank’s part is created. Even though they result in a deposit liability, the Board is of the opinion that the issuance of a bank’s money orders by an authorized agent does not involve the receipt of deposits at a “branch place of business” and accordingly does not require the Board’s permission to establish a branch. 12 CFR 208.110; 1997 Fed. Res. Bull. 787.

BRANCHES—Closing Notices and Policies; Joint Policy Statement

See 3-1503.5.
3-423.9

CAPITAL

See this heading under “Guidance, beginning at 3-1504.5.
3-425

CONDITIONS OF MEMBERSHIP—Engaging in Trust Business

The opening of a trust department by a state member bank which has previously exercised only the general powers of commercial banking constitutes a material broadening in the functions of the bank within the meaning of the Board’s general condition of membership. Accordingly, a state bank admitted to membership subject to this general condition, must obtain the Board’s permission before opening a trust department or engaging de novo in trust business. Digest of 1924 Fed. Res. Bull. 865.
3-428

CONDITIONS OF MEMBERSHIP—Changes Not Involving Undue Risk; Agency and Fiduciary Functions

Quoted below is the text of a letter to the president of a Federal Reserve Bank:
“Vice President
 raised questions regarding the policy of the Board in granting permission to member state banks to act in various agency capacities and requested clarification of existing policy in that connection. The Board has reviewed these policy questions and, effective immediately, has adopted the procedure set out below, to be followed in cases in which a state member bank submits a request under Standard Condition of Membership Number 1.
“In all cases that require Board permission to make a change in the general character of the state member bank’s business or in the scope of the corporate powers exercised by it at the time of admission to membership, and which clearly involve neither undue risk nor unusual circumstances or the exercise of unusual powers, the Reserve Bank shall make a factual determination to that effect and advise the state member bank that the application has been approved on behalf of the Board of Governors.
“It is believed that this procedure will permit more expeditious handling of requests without conflicting with the Board’s responsibilities in these matters. Under this procedure, a state member bank request under Condition of Membership Number 1 for permission to make a change in the general character of its business or in the scope of the corporate powers exercised by it will be reviewed and analyzed by the Reserve Bank as at present. If the Reserve Bank is satisfied that a factual determination as described above is warranted, it will advise the state member bank that the application has been approved on behalf of the Board (without referring to the factual determination) and will forward to the Board a copy of the letter to the bank, as well as a memorandum setting forth the analysis and basis for the determination. If the Reserve Bank is inclined to believe that the application should be denied or that the application involves any doubts that might prevent such a clear factual determination, it will submit the application together with its recommendation and memorandum to the Board. Cases will thus be submitted to the Board in all instances where the state member bank would be exposed to more than normal risk or where there are unusual circumstances or powers.
“With more specific reference to the questions raised in Mr.
’s letter, the Board has taken this occasion to review its policy with respect to applications for permission to act in various agency capacities. The acceptance of certain types of agency accounts, requiring management responsibilities, would clearly represent a change in the geneneral character of a bank’s business or in the scope of its corporate powers that would require express Federal Reserve permission. However, other types of agency functions may be so limited in duties and responsibilities, or so nearly like or a part of commercial banking operations, that their exercise should not be considered as requiring express permission. This would appear particularly true when a bank acts largely in a nondiscretionary capacity, such as paying agent on a bond issue, as depository, as escrow agent with no management responsibility, or as safekeeping agent.
“The Board believes that the undertaking of fiduciary duties does require express permission. Authority of a state member bank to act in a nondiscretionary agency capacity might be included in a state statute setting forth fiduciary functions, but this would not require Federal Reserve permission unless the bank exercises such authority as part of a larger operation of a fiduciary nature. For example, permission would appear necessary for a state member bank to act as ‘trustee and paying agent’ for a bond issue, but not merely as ‘paying agent’. It is hoped that this expression of the Board’s views will be helpful in deciding whether certain agency functions require express permission under the condition of membership.” S-1872; May 29, 1963.
3-429

CONDITIONS OF MEMBERSHIP—Exercise of Fiduciary Powers

This letter supplements the Board’s letter S-1872, dated May 29, 1963, with respect to applications by state member banks for permission, under applicable provisions of Standard Condition of Membership Number 1, to exercise statutory fiduciary powers.
In appropriate cases, in the discretion of the Reserve Bank, such applications should be the subject of a field investigation, including an interview with the bank’s directors and executive officers at which the responsibilities and potential liabilities inherent in fiduciary activities are fully explored, together with the requirements for sound and creditable administration of fiduciary appointments.
With respect to each such application (whether the Reserve Bank is to advise of approval on behalf of the Board or whether the application is to be forwarded to the Board for action—see S-1872 [at 3-428]) the Reserve Bank will prepare a memorandum supporting its conclusion relative to the appropriateness of the exercise of the powers for which permission has been requested. Such memorandum shall reflect the results of the field investigation, if any, and shall include a recitation and analysis of all factors of importance bearing on whether the requested permission should be granted, i.e., the condition of the member bank and the adequacy of its capital structure; the general character and ability of the management of the bank; local conditions, including the competitive situation, affecting the need for the corporate fiduciary services desired to be furnished; qualifications of those directors, officers, and employees who would be responsible for supervision and administration of fiduciary activities; and the availability of legal counsel to advise and pass upon fiduciary matters.
A form of letter-advice is enclosed which should be used in each case where a Reserve Bank, under authority contained in S-1872 [at 3-428], acts on behalf of the Board in granting permission to a state member bank to exercise statutory fiduciary powers. As in the case of Board-approved applications, a copy of the letter of authority may be furnished interested state banking authorities.
Suggested Letter of Advice to State Member Bank Authorizing, on Behalf of the Board of Governors, the Exercise of Fiduciary Powers
  • Board of Directors
  • [Name of Bank]
  • [City], [State]
Gentlemen:
Consideration has been given to your request for permission, under applicable provisions of your condition of membership numbered 1, to exercise fiduciary powers. [For cases involving exercise of full statutory powers]
On behalf of the Board of Governors of the Federal Reserve System, permission is hereby granted to
to exercise any and all fiduciary powers now or hereafter conferred upon such bank by or pursuant to the laws of the State of 
[For cases involving limited exercise of statutory powers ]
On behalf of the Board of Governors of the Federal Reserve System, permission is hereby granted to
to act as
, with the understanding that (fiduciary appointments of other kinds) (any other fiduciary appointments) will not be accepted without first obtaining the permission of the Board.
Very truly yours,
(To be signed by president or first vice
president)
S-1879; July 22, 1963.
3-432

CONDITIONS OF MEMBERSHIP—Acceptance of Individual Retirement Account Trusts

The Board has considered the question whether to permit state member banks that do not have trust powers or are not exercising them to accept individual retirement account trusts and self-employed retirement trusts established under the Employee Retirement Income Security Act of 1974 without first obtaining the Board’s permission to act as a trustee which would normally be required as a condition for such activities. The Board has decided that state member banks that do not have the Board’s permission to exercise fiduciary powers and are not prevented by state law from exercising such powers may accept individual retirement account trusts and self-employed retirement trusts if, pursuant to the terms of the instruments establishing the accounts, they may be invested only in savings accounts or time deposits of the bank. However, collective investment funds for these accounts may not be established and operated by state member banks without the prior permission of the Board. S-2283; May 20, 1975.
3-434

ELIGIBILITY—Building and Loan Associations

Building and loan associations do not constitute banks within the meaning of the Federal Reserve Act and are ineligible for membership. Digest of 1915 Fed. Res. Bull. 212.
3-435

ELIGIBILITY—Private Bankers

A private banker is not permitted by the terms of the Federal Reserve Act to become a member institution. Digest of 1917 Fed. Res. Bull. 693.
3-436

ELIGIBILITY—Acceptance Corporations

Acceptance corporations are in the same relation to the Federal Reserve System as private bankers and are ineligible for membership in the System. Digest of 1918 Fed. Res. Bull. 634.
3-437

ELIGIBILITY—Trust Companies

A trust company is eligible for admission to the Federal Reserve System although it does substantially no commercial banking business. Digest of 1934 Fed. Res. Bull. 486.
3-440

SECURITIES-RELATED ACTIVITIES—Obligations Concerning Institutional Customers

As a result of broadened authority provided by the Government Securities Act Amendments of 1993 (15 USC 78o-3 and 78o-5)), the Board is adopting sales-practice rules for the government securities market, a market with a particularly broad institutional component. Accordingly, the Board believes it is appropriate to provide further guidance to banks on their suitability obligations when making recommendations to institutional customers.
The Board’s suitability rule, section 208.25(d), is fundamental to fair dealing and is intended to promote ethical sales practices and high standards of professional conduct. Banks’ responsibilities include having a reasonable basis for recommending a particular security or strategy, as well as having reasonable grounds for believing the recommendation is suitable for the customer to whom it is made. Banks are expected to meet the same high standards of competence, professionalism, and good faith regardless of the financial circumstances of the customer.
In recommending to a customer the purchase, sale, or exchange of any government security, the bank shall have reasonable grounds for believing that the recommendation is suitable for the customer upon the basis of the facts, if any, disclosed by the customer as to the customer’s other security holdings and financial situation and needs.
The interpretation in this section concerns only the manner in which a bank determines that a recommendation is suitable for a particular institutional customer. The manner in which a bank fulfills this suitability obligation will vary, depending on the nature of the customer and the specific transaction. Accordingly, the interpretation in this section deals only with guidance regarding how a bank may fulfill customer-specific suitability obligations under section 208.37(d).1
While it is difficult to define in advance the scope of a bank’s suitability obligation with respect to a specific institutional-customer transaction recommended by a bank, the Board has identified certain factors that may be relevant when considering compliance with section 208.25(d). These factors are not intended to be requirements or the only factors to be considered but are offered merely as guidance in determining the scope of a bank’s suitability obligations.
The two most important considerations in determining the scope of a bank’s suitability obligations in making recommendations to an institutional customer are the customer’s capability to evaluate investment risk independently and the extent to which the customer is exercising independent judgment in evaluating a bank’s recommendation. A bank must determine, based on the information available to it, the customer’s capability to evaluate investment risk. In some cases, the bank may conclude that the customer is not capable of making independent investment decisions in general. In other cases, the institutional customer may have general capability but may not be able to understand a particular type of instrument or its risk. This is more likely to arise with relatively new types of instruments, or those with significantly different risk or volatility characteristics than other investments generally made by the institution. If a customer is either generally not capable of evaluating investment risk or lacks sufficient capability to evaluate the particular product, the scope of a bank’s customer-specific obligations under section 208.25(d) would not be diminished by the fact that the bank was dealing with an institutional customer. On the other hand, the fact that a customer initially needed help understanding a potential investment need not necessarily imply that the customer did not ultimately develop an understanding and make an independent investment decision.
A bank may conclude that a customer is exercising independent judgment if the customer’s investment decision will be based on its own independent assessment of the opportunities and risks presented by a potential investment, market factors, and other investment considerations. Where the bank has reasonable grounds for concluding that the institutional customer is making independent investment decisions and is capable of independently evaluating investment risk, then a bank’s obligations under section 208.25(d) for a particular customer are fulfilled.2 Where a customer has delegated decision-making authority to an agent, such as an investment advisor or a bank trust department, the interpretation in this section shall be applied to the agent.
A determination of capability to evaluate investment risk independently will depend on an examination of the customer’s capability to make its own investment decisions, including the resources available to the customer to make informed decisions. Relevant considerations could include—
  • 1.
    the use of one or more consultants, investment advisors, or bank trust departments;
  • 2.
    the general level of experience of the institutional customer in financial markets and specific experience with the type of instruments under consideration;
  • 3.
    the customer’s ability to understand the economic features of the security involved;
  • 4.
    the customer’s ability to independently evaluate how market developments would affect the security; and
  • 5.
    the complexity of the security or securities involved.
A determination that a customer is making independent investment decisions will depend on the nature of the relationship that exists between the bank and the customer. Relevant considerations could include—
  • 1.
    any written or oral understanding that exists between the bank and the customer regarding the nature of the relationship between the bank and the customer and the services to be rendered by the bank;
  • 2.
    the presence or absence of a pattern of acceptance of the bank’s recommendations;
  • 3.
    the use by the customer of ideas, suggestions, market views and information obtained from other government securities brokers or dealers or market professionals, particularly those relating to the same type of securities; and
  • 4.
    the extent to which the bank has received from the customer current comprehensive portfolio information in connection with discussing recommended transactions or has not been provided important information regarding its portfolio or investment objectives.
Banks are reminded that these factors are merely guidelines that will be utilized to determine whether a bank has fulfilled its suitability obligation with respect to a specific institutional customer transaction and that the inclusion or absence of any of these factors is not dispositive of the determination of suitability. Such a determination can only be made on a case-by-case basis taking into consideration all the facts and circumstances of a particular bank/customer relationship, assessed in the context of a particular transaction.
For purposes of the interpretation in this section, an institutional customer shall be any entity other than a natural person. In determining the applicability of the interpretation in this section to an institutional customer, the Board will consider the dollar value of the securities that the institutional customer has in its portfolio and/or under management. While the interpretation in this section is potentially applicable to any institutional customer, the guidance contained in this section is more appropriately applied to an institutional customer with at least $10 million invested in securities in the aggregate in its portfolio and/or under management. 12 CFR 208.111; 1997 Fed. Res. Bull. 404; 1997 Fed. Res. Bull. 787.
1
The interpretation in this section does not address the obligation related to suitability that requires that a bank have “a ‘reasonable basis’ to believe that the recommendation could be suitable for at least some customers.” In the Matter of the Application of F.J. Kaufman and Company of Virginia and Frederick J. Kaufman, Jr., 50 SEC 164 (1989).
2
See footnote 1 of this interpretation.
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