Skip to main content
  1. Home
  2. Holding and Nonbank Financial Companies
  3. Board Interpretations of Regulation Y

Board Interpretations of Regulation Y

4-171

ACQUISITION OF BANK INTERESTS—Dividends, Stock Splits, and Exercise of Subscription Rights

The Board of Governors has been asked whether a bank holding company may receive bank stock dividends or participate in bank stock splits without the Board’s prior approval, and whether such a company may exercise, without the Board’s prior approval, rights to subscribe to new stock issued by banks in which the holding company already owns stock.
Neither a stock dividend nor a stock split results in any change in a stockholder’s proportional interest in the issuing company or any increase in the assets of that company. Such a transaction would have no effect upon the extent of a holding company’s control of the bank involved; and none of the five factors required by the Bank Holding Company Act to be considered by the Board in approving a stock acquisition would seem to have any application. In view of the objectives and purposes of the act, the word “acquire” would not seem reasonably to include transactions of this kind.
On the other hand, the exercise by a bank holding company of the right to subscribe to an issue of additional stock of a bank could result in an increase in the holding company’s proportional interest in the bank. The holding company would voluntarily pay additional funds for the extra shares and would “acquire” the additional stock even under a narrow meaning of that term. Moreover, the exercise of such rights would cause the assets of the issuing company to be increased and in a sense, therefore, the “size or extent” of the bank holding company system would be expanded.
In the circumstances, it is the Board’s opinion that receipt of bank stock by means of a stock dividend or stock split, assuming no change in the class of stock, does not require the Board’s prior approval under the act, but that purchase of bank stock by a bank holding company through the exercise of rights does require the Board’s prior approval, unless one of the exceptions set forth in section 3(a) is applicable. 1957 Fed. Res. Bull. 1131; 12 CFR 225.103.
4-172

ACQUISITION OF BANK INTERESTS—Escrow Arrangements

In connection with a recent application to be come a bank holding company, the Board considered a situation in which shares of a bank were acquired and then placed in escrow by the applicant prior to the Board’s approval of the application. The facts indicated that the applicant company had incurred debt for the purpose of acquiring bank shares and immediately after the purchase the shares were transferred to an unaffiliated escrow agent with instructions to retain possession of the shares pending Board action on the company’s application to become a bank holding company. The escrow agreement provided that, if the application were approved by the Board, the escrow agent was to return the shares to the applicant company; and, if the application were denied, the escrow agent was to deliver the shares to the applicant company’s shareholders upon their assumption of debt originally incurred by the applicant in the acquisition of the bank shares. In addition, the escrow agreement provided that, while the shares were held in escrow, the applicant could not exercise voting or any other ownership rights with respect to those shares.
On the basis of the above facts, the Board concluded that the company had violated the prior approval provisions of section 3 of the Bank Holding Company Act (“act”) at the time that it made the initial acquisition of bank shares and that, for purposes of the act, the company continued to control those shares in violation of the act. In view of these findings, individuals and bank holding companies should not enter into escrow arrangements of the type described herein, or any similar arrangement, without securing the prior approval of the Board, since such action could constitute a violation of the act.
While the above represents the Board’s conclusion with respect to the particular escrow arrangement involved in the proposal presented, the Board does not believe that the use of an escrow arrangement would always result in a violation of the act. For example, it appears that a transaction whereby bank shares are placed in escrow pending Board action on an application would not involve a violation of the act so long as title to such shares remains with the seller during the pendency of the application; there are no other indicia that the applicant controls the shares held in escrow; and, in the event of a Board denial of the application, the escrow agreement provides that the shares would be returned to the seller. 1976 Fed. Res. Bull. 251; 12 CFR 225.134.
4-172.1

ACQUISITION OF BANK INTERESTS—Policy Statement on Nonvoting Equity Investments

I. Introduction
In recent months, a number of bank holding companies have made substantial equity investments in a bank or bank holding company (the “acquiree”) located in states other than the home state of the investing company through acquisition of preferred stock or nonvoting common shares of the acquiree. Because of the evident interest in these types of investments and because they raise substantial questions under the Bank Holding Company Act (the act), the Board believes it is appropriate to provide guidance regarding the consistency of such arrangements with the act.
This statement sets out the Board’s concerns with these investments, the considerations the Board will take into account in determining whether the investments are consistent with the act, and the general scope of arrangements to be avoided by bank holding companies. The Board recognizes that the complexity of legitimate business arrangements precludes rigid rules designed to cover all situations and that decisions regarding the existence or absence of control in any particular case must take into account the effect of the combination of provisions and covenants in the agreement as a whole and the particular facts and circumstances of each case. Nevertheless, the Board believes that the factors outlined in this statement provide a framework for guiding bank holding companies in complying with the requirements of the act.
II. Statutory and Regulatory Provisions
Under section 3(a) of the act, a bank holding company may not acquire direct or indirect ownership or control of more than 5 percent of the voting shares of a bank without the Board’s prior approval (12 USC 1842(a)(3)). In addition, this section of the act provides that a bank holding company may not, without the Board’s prior approval, acquire control of a bank; that is, it is unlawful, in the words of the statute, “for any action to be taken that causes a bank to become a subsidiary of a bank holding company” (12 USC 1842(a)(2)). Under the act, a bank is a subsidiary of a bank holding company if—
  • the company directly or indirectly owns, controls, or holds with power to vote 25 percent or more of the voting shares of the bank;
  • the company controls in any manner the election of a majority of the board of directors of the bank; or
  • the Board determines, after notice and opportunity for hearing, that the company has the power, directly or indirectly, to exercise a controlling influence over the management or policies of the bank (12 USC 1841(d)).
 In intrastate situations, the Board may approve bank holding company acquisitions of additional banking subsidiaries. However, when the acquiree is located outside the home state of the investing bank holding company, section 3(d) of the act prevents the Board from approving any application that will permit a bank holding company to “acquire, directly or indirectly, any voting shares of, interest in, or all or substantially all of the assets of any additional bank” (12 USC 1842 (d)(1)).
III. Review of Agreements
In apparent expectation of statutory changes that might make interstate banking permissible, bank holding companies have sought to make substantial equity investments in other bank holding companies across state lines, but without obtaining more than 5 percent of the voting shares or control of the acquiree. These investments involve a combination of the following arrangements:
  • options on, warrants for, or rights to convert nonvoting shares into substantial blocks of voting securities of the acquiree bank holding company or its subsidiary bank(s)
  • merger or asset acquisition agreements with the out-of-state bank or bank holding company that are to be consummated in the event interstate banking is permitted
  • provisions that limit or restrict major policies, operations, or decisions of the acquiree
  • provisions that make acquisition of the acquiree or its subsidiary bank(s) by a third party either impossible or economically impracticable
The various warrants, options, and rights are not exercisable by the investing bank holding company unless interstate banking is permitted, but may be transferred by the investor either immediately or after the passage of a period of time or upon the occurrence of certain events.
After a careful review of a number of these agreements, the Board believes that investments in nonvoting stock, absent other arrangements, can be consistent with the act. Some of the agreements reviewed appear consistent with the act since they are limited to investments of relatively moderate size in nonvoting equity that may become voting equity only if interstate banking is authorized.
However, other agreements reviewed by the Board raise substantial problems of consistency with the control provisions of the act because the investors, uncertain whether or when interstate banking may be authorized, have evidently sought to ensure the soundness of their investments, prevent takeovers by others, and allow for sale of their options, warrants, or rights to a person of the investor’s choice in the event a third party obtains control of the acquiree or the investor otherwise becomes dissatisfied with its investment. Since the act precludes the investors from protecting their investments through ownership or use of voting shares or other exercise of control, the investors have substituted contractual agreements for rights normally achieved through voting shares.
For example, various covenants in certain of the agreements seek to ensure the continuing soundness of the investment by substantially limiting the discretion of the acquiree’s management over major policies and decisions, including restrictions on entering into new banking activities without the investor’s approval and requirements for extensive consultations with the investor on financial matters. By their terms, these covenants suggest control by the investing company over the management and policies of the acquiree.
Similarly, certain of the agreements deprive the acquiree bank holding company, by covenant or because of an option, of the right to sell, transfer, or encumber a majority or all of the voting shares of its subsidiary bank(s) with the aim of maintaining the integrity of the investment and preventing takeovers by others. These long-term restrictions on voting shares fall within the presumption in the Board’s Regulation Y that attributes control of shares to any company that enters into any agreement placing long-term restrictions on the rights of a holder of voting securities (12 CFR 225.2(b)(4)).
Finally, investors wish to reserve the right to sell their options, warrants, or rights to a person of their choice to prevent being locked into what may become an unwanted investment. The Board has taken the position that the ability to control the ultimate disposition of voting shares to a person of the investor’s choice and to secure the economic benefits therefrom indicates control of the shares under the act.1 Moreover, the ability to transfer rights to large blocks of voting shares, even if nonvoting in the hands of the investing company, may result in such a substantial position of leverage over the management of the acquiree as to involve a structure that inevitably results in control prohibited by the act.
IV. Provisions That Avoid Control
In the context of any particular agreement, provisions of the type described above may be acceptable if combined with other provisions that serve to preclude control. The Board believes that such agreements will not be consistent with the act unless provisions are included that will preserve management’s discretion over the policies and decisions of the acquiree and avoid control of voting shares.
As a first step towards avoiding control, covenants in any agreement should leave management free to conduct banking and permissible nonbanking activities. Another step to avoid control is the right of the acquiree to “call” the equity investment and options or warrants to ensure that covenants that may become inhibiting can be avoided by the acquiree. This right makes such investments or agreements more like a loan in which the borrower has a right to escape covenants and avoid the lender’s influence by prepaying the loan.
A measure to avoid problems of control arising through the investor’s control over the ultimate disposition of rights to substantial amounts of voting shares of the acquiree would be a provision granting the acquiree a right of first refusal before warrants, options, or other rights may be sold and requiring a public and dispersed distribution of these rights if the right of first refusal is not exercised.
In this connection, the Board believes that agreements that involve rights to less than 25 percent of the voting shares, with a requirement for a dispersed public distribution in the event of sale, have a much greater prospect of achieving consistency with the act than agreements involving a greater percentage. This guideline is drawn by analogy from the provision in the act that ownership of 25 percent or more of the voting securities of a bank constitutes control of the bank.
The Board expects that one effect of this guideline would be to hold down the size of the nonvoting equity investment by the investing company relative to the acquiree’s total equity, thus avoiding the potential for control because the investor holds a very large proportion of the acquiree’s total equity. Observance of the 25 percent guideline will also make provisions in agreements providing for a right of first refusal or a public and widely dispersed offering of rights to the acquiree’s shares more practical and realistic.
Finally, certain arrangements should clearly be avoided regardless of other provisions in the agreement that are designed to avoid control. These are—
  • agreements that enable the investing bank holding company (or its designee) to direct in any manner the voting of more than 5 percent of the voting shares of the acquiree;
  • agreements whereby the investing company has the right to direct the acquiree’s use of the proceeds of an equity investment by the investing company to effect certain actions, such as the purchase and redemption of the acquiree’s voting shares; and
  • acquisition of more than 5 percent of the voting shares of the acquiree that “simultaneously” with their acquisition by the investing company become nonvoting shares, remain nonvoting shares while held by the investor, and revert to voting shares when transferred to a third party.
V. Review by the Board
This statement does not constitute the exclusive scope of the Board’s concerns, nor are the considerations with respect to control outlined in this statement an exhaustive catalog of permissible or impermissible arrangements. The Board has instructed its staff to review agreements of the kind discussed in this statement and to bring to the Board’s attention those that raise problems of consistency with the act. In this regard, companies are requested to notify the Board of the terms of such proposed merger or asset acquisition agreements or nonvoting equity investments prior to their execution or consummation. 1982 Fed. Res. Bull. 413; 12 CFR 225.143.
See also 4-271.2.
1
See Board letter dated March 18, 1982 to C.A. Cavendes, Sociedad Financiera.
4-173

ACQUISITION OF NONBANK INTERESTS—SBIC*

A registered bank holding company requested an opinion by the Board of Governors with respect to whether that company and its banking subsidiaries may acquire stock in a small-business investment company organized pursuant to the Small Business Investment Act of 1958.
It is understood that the bank holding company and its subsidiary banks propose to organize and subscribe for stock in a small-business investment company which would be chartered pursuant to the Small Business Investment Act of 1958, which provides for long-term credit and equity financing for small-business concerns.
Section 302(b) of the Small Business Investment Act authorizes national banks, as well as other member banks and nonmember insured banks to the extent permitted by applicable state law, to invest capital in small-business investment companies not exceeding 1 percent of the capital and surplus of such banks. Section 4(c)(4) of the Bank Holding Company Act exempts from the prohibitions of section 4 of the act “shares which are of the kinds and amounts eligible for investment by national banking associations under the provisions of section 5136 of the Revised Statutes.” Section 5136 of the Revised Statutes (paragraph “seventh”) in turn provides, in part, as follows:
Except as hereinafter provided or otherwise permitted by law, nothing herein contained shall authorize the purchase by the association for its own account of any shares of stock of any corporation. (Italics supplied.)
Since the shares of a small-business investment company are of a kind and amount expressly made eligible for investment by a national bank under the Small Business Investment Act of 1958, it follows, therefore, that the ownership or control of such shares by a bank holding company would be exempt from the prohibitions of section 4 of the Bank Holding Company Act by virtue of the provisions of section 4(c)(4) of that Act. * * * 1958 Fed. Res. Bull. 1161; 12 CFR 225.107.
*
Small-business investment company.
4-174

ACQUISITION OF NONBANK INTERESTS—SBIC

A question has been raised concerning the applicability of provisions of the Bank Holding Company Act of 1956 to the acquisition by a bank holding company of stock of a small business investment company (“SBIC”) organized pursuant to the Small Business Investment Act of 1958 (“SBI Act”).
As indicated in the interpretation of the Board published at page 1161 of the October 1958 issue of the Federal Reserve Bulletin (at 4-173), it is the Board’s opinion that, since stock of an SBIC is eligible for purchase by national banks and since section 4(c)(4) of the Holding Company Act exempts stock eligible for investment by national banks from the prohibitions of section 4 of that act, a bank holding company may lawfully acquire stock in such an SBIC.
However, section 304 of the SBI Act provides that debentures of a small business concern purchased by a small business investment company may be converted at the option of such company into stock of the small business concern. The question therefore arises as to whether, in the event of such conversion, the parent bank holding company would be regarded as having acquired “direct or indirect ownership or control” of stock of the small business concern in violation of section 4(a) of the Holding Company Act.
The Small Business Investment Act clearly contemplates that one of the primary purposes of that act was to enable SBICs to provide needed equity capital to small business concerns through the purchase of debentures convertible into stock. Thus, to the extent that a stockholder in an SBIC might acquire indirect control of stock of a small business concern, such control appears to be a natural and contemplated incident of ownership of stock of the SBIC. The Office of the Comptroller of the Currency has informally indicated concurrence with this interpretation insofar as it affects investments by national banks in stock of an SBIC.
Since the exception as to stock eligible for investment by national banks contained in section 4(c)(4) of the Holding Company Act was apparently intended to permit a bank holding company to acquire any stock that would be eligible for purchase by a national bank, it is the Board’s view that section 4(a)(1) of the act does not prohibit a bank holding company from acquiring stock of an SBIC, even though ownership of such stock may result in the acquisition of indirect ownership or control of stock of a small business concern which would not itself be eligible for purchase directly by a national bank or a bank holding company. 1959 Fed. Res. Bull. 258; 12 CFR 225.112.
4-174.1

ACQUISITION OF NONBANK INTERESTS—Applicability of Bank Service Corporation Act

Questions have been presented to the Board of Governors regarding the applicability of the recently enacted Bank Service Corporation Act (Public Law 87-856, approved October 23, 1962) in cases involving service corporations that are subsidiaries of bank holding companies under the Bank Holding Company Act of 1956. In addition to being charged with the administration of the latter act, the Board is named in the Bank Service Corporation Act as the federal supervisory agency with respect to the performance of bank services for state member banks.
(1) Holding-company-owned corporation serving only subsidiary banks. One question is whether the Bank Service Corporation Act is applicable in the case of a corporation, wholly owned by a bank holding company, which is engaged in performing “bank services,” as defined in section 1(b) of the act, exclusively for subsidiary banks of the holding company.
Except as noted below with respect to section 5 thereof, the Bank Service Corporation Act is not applicable in this case. This is true because none of the stock of the corporation performing the services is owned by any bank and the corporation, therefore, is not a “bank service corporation” as defined in section 1(c) of the act. A corporation cannot meet that definition unless part of its stock is owned by two or more banks. The situation clearly is unaffected by section 2(b) of the act, which permits a corporation that fell within the definition initially to continue to function as a bank service corporation although subsequently only one of the banks remains as a stockholder in the corporation.
However, although it is not a bank service corporation, the corporation in question and each of the banks for which it performs bank services are subject to section 5 of the Bank Service Corporation Act. That section, which requires the furnishing of certain assurances to the appropriate federal supervisory agency in connection with the performance of bank services for a bank, is applicable whether such services are performed by a bank service corporation or by others.
Section 4(a)(1) of the Bank Holding Company Act prohibits the acquisition by a bank holding company of “direct or indirect ownership or control” of shares of a nonbanking company, subject to certain exceptions. Section 4(c)(1) of the act exempts from section 4(a)(1) shares of a company engaged “solely in the business of furnishing services to or performing services for” its bank holding company or subsidiary banks thereof. Assuming that the bank services performed by the corporation in question are “services” of the kinds contemplated by section 4(c)(1) of the Bank Holding Company Act (as would be true, for example, of the electronic data processing of deposit accounts), the holding company’s ownership of the corporation’s shares in the situation described above clearly is permissible under that section of the act.
(2) Bank service corporation owned by holding company subsidiaries and serving also other banks. The other question concerns the applicability of the Bank Service Corporation Act and the Bank Holding Company Act in the case of a corporation, all the stock of which is owned either by a bank holding company and its subsidiary banks together or by the subsidiary banks alone, which is engaged in performing “bank services,” as defined in section 1(b) of the Bank Service Corporation Act, for the subsidiary banks and for other banks, as well.
In contrast to the situation under question (1), the corporation in this case is a “bank service corporation” within the meaning of section 1(c) of the Bank Service Corporation Act because of the ownership by each of the subsidiary banks of a part of the corporation’s stock. This stock ownership is one of the important facts differentiating this case from the first one. Being a bank service corporation, the corporation in question is subject to section 3 of the act concerning applications to bank service corporations by competitive banks for bank services, and to section 4 forbidding a bank service corporation from engaging in any activity other than the performance of bank services for banks. Section 5, mentioned previously and relating to “assurances,” also is applicable in this case.
The other important difference between this case and the situation in question (1) is that here the bank service corporation performs services for nonsubsidiary banks, as well as for subsidiary banks. This is permissible because section 2(a) of the Bank Service Corporation Act, which authorizes any two or more banks to invest limited amounts in a bank service corporation, removes all limitations and prohibitions of federal law exclusively relating to banks that otherwise would prevent any such investment. From the legislative history of section 2(a), it is clear that section 6 of the Bank Holding Company Act is among the limitations and prohibitions so removed. But for such removal, section 6(a)(1) of that act would make it unlawful for any of the subsidiary banks of the bank holding company in question to own stock in the bank service corporation subsidiary of the holding company, as the exemption in section 6(b)(1) would not apply because of the servicing by the bank service corporation of nonsubsidiary banks.
Because the bank service corporation referred to in the question is serving banks other than the subsidiary banks, the bank holding company is not exempt under section 4(c)(1) of the Bank Holding Company Act from the prohibition of acquisition of nonbanking interests in section 4(a)(1) of that act. The bank holding company, however, is entitled to the benefit of the exemption in section 4(c)(4) of the act. That section exempts from section 4(a) “shares which are of the kinds and amounts eligible for investment by national banking associations under the provisions of section 5136 of the Revised Statutes.” Section 5136 provides, in part, that: “Except as hereinafter provided or otherwise permitted by law, nothing herein contained shall authorize the purchase by the association for its own account of any shares of stock of any corporation.” As the provisions of section 2(a) of the Bank Service Corporation Act and its legislative history make it clear that shares of a bank service corporation are of a kind eligible for investment by national banks under section 5136, it follows that the direct or indirect ownership or control of such shares by a bank holding company is permissible within the amount limitation discussed below.
(3) Limit on investment by bank holding company system in stock of bank service corporation. In the situation presented by question (2), the bank holding company clearly owns or controls, directly or indirectly, all of the stock of the bank service corporation. The remaining question, therefore, is whether the total direct and indirect investment of the bank holding company in the bank service corporation exceeds the amount permissible under the Bank Holding Company Act.
The effect of sections 4(a)(1) and 4(c)(4) of the Bank Holding Company Act is to limit the amount of shares of a bank service corporation that a bank holding company may own or control, directly or indirectly, to the amount eligible for investment by a national bank, as previously indicated. Under section 2(a) of the Bank Service Corporation Act, the amount of shares of a bank service corporation eligible for investment by a national bank may not exceed “10 per centum [of the bank’s] . . . paid-in and unimpaired capital and unimpaired surplus.”
The Board’s view is that this aspect of the matter should be determined in accordance with the principles set forth in the January 1963 Federal Reserve Bulletin, at page 9, involving the application of sections 4(a)(1) and 4(c)(4) of the Bank Holding Company Act in the light of section 302(b) of the Small Business Investment Act limiting the amount eligible for investment by a national bank in the shares of a small business investment company to 2 percent of the bank’s “capital and surplus.”
Except for the differences in the percentage figures, the investment limitation in section 302(b) of the Small Business Investment Act is essentially the same as the investment limitation in section 2(a) of the Bank Service Corporation Act since, as an accounting matter and for the purposes under consideration, “capital and surplus” may be regarded as equivalent in meaning to “paid-in and unimpaired capital and unimpaired surplus.” Accordingly, the maximum permissible investment by a bank holding company system in the stock of a bank service corporation should be determined in accordance with the formula prescribed in 1963 Federal Reserve Bulletin, p. 9, referred to above. 1963 Fed. Res. Bull. 163; 12 CFR 225.115.
4-175

ACQUISITION OF NONBANK INTERESTS—SBIC

Under the provisions of section 4(c)(5) of the Bank Holding Company Act, as amended (12 USC 1843), a bank holding company may acquire shares of nonbank companies “which are of the kinds and amounts eligible for investment” by national banks. Pursuant to section 302(b) of the Small Business Investment Act of 1958 (15 USC 682(b)), as amended by title II of the Small Business Act Amendments of 1967 (Pub. L. 90-104, 81 Stat. 268, 270), a national bank may invest in stock of small business investment companies (SBICs) subject to certain restrictions.
On the basis of the foregoing statutory provisions, it is the position of the Board that a bank holding company may acquire direct or indirect ownership or control of stock of an SBIC subject to the following limits:
(1) The total direct and indirect investments of a bank holding company in stock of SBICs may not exceed—
(i) with respect to all stock of SBICs owned or controlled directly or indirectly by a subsidiary bank, 5 percent of that bank’s capital and surplus;
(ii) with respect to all stock of SBICs owned directly by a bank holding company that is a bank, 5 percent of that bank’s capital and surplus; and
(iii) with respect to all stock of SBICs otherwise owned or controlled directly or indirectly by a bank holding company, 5 percent of its proportionate interest in the capital and surplus of each subsidiary bank (that is, the holding company’s percentage of that bank’s stock times that bank’s capital and surplus) less that bank’s investment in stock of SBICs; and
(2) A bank holding company may not acquire direct or indirect ownership or control of 50 percent or more of the shares of any class of equity securities of an SBIC that have actual or potential voting rights.
 A bank holding company or a bank subsidiary that acquired direct or indirect ownership or control of 50 percent or more of any such class of equity securities prior to January 9, 1968 is not required to divest to a level below 50 percent. A bank that acquired 50 percent or more prior to January 9, 1968 may become a subsidiary in a holding company system without any necessity for divesting to a level below 50 percent, provided that such action does not result in the bank holding company acquiring control of a percentage greater than that controlled by such bank. 1968 Fed. Res. Bull. 440; 12 CFR 225.111.
A 1976 amendment to the Small Business Investment Act permits national banks to own 100 percent of the voting stock of an SBIC, rather than the less than 50 percent allowed at the time of this interpretation (see 4-295).
4-175.1

ACQUISITION OF NONBANK INTERESTS—Acquisition of Assets

From time to time questions have arisen as to whether and under what circumstances a bank holding company engaged in nonbank activities, directly or indirectly through a subsidiary, pursuant to section 4(c)(8) of the Bank Holding Company Act of 1956, as amended (12 USC 1843(c)(8)), may acquire the assets and hire employees of another company, without first obtaining Board approval pursuant to section 4(c)(8) and the Board’s Regulation Y (12 CFR 225.4(b)).
In determining whether Board approval is required in connection with the acquisition of assets, it is necessary to determine (a) whether the acquisition is made in the ordinary course of business1 or (b) whether it constitutes the acquisition, in whole or in part, of a going concern.2
The following examples illustrate transactions where prior Board approval will generally be required:
1. The transaction involves the acquisition of all or substantially all of the assets of a company, or a subsidiary, division, department or office thereof.
2. The transaction involves the acquisition of less than “substantially all” of the assets of a company, or a subsidiary, division, department or office thereof, the operations of which are being terminated or substantially discontinued by the seller, but such asset acquisition is significant in relation to the size of the same line of nonbank activity of the holding company (e.g., consumer finance, mortgage banking, data processing). For purposes of this interpretation, an acquisition would generally be presumed to be significant if the book value of the nonbank assets being acquired exceeds 50 percent of the book value of the nonbank assets of the holding company or nonbank subsidiary comprising the same line of activity.
3. The transaction involves the acquisition of assets for resale and the sale of such assets is not a normal business activity of the acquiring holding company.
4. The transaction involves the acquisition of the assets of a company, or a subsidiary, division, department or office thereof, and a major purpose of the transaction is to hire some of the seller’s principal employees who are expert, skilled and experienced in the business of the company being acquired.
In some cases it may be difficult, due to the wide variety of circumstances involving possible acquisition of assets, to determine whether such acquisitions require prior Board approval. Bank holding companies are encouraged to contact their local Reserve Bank for guidance where doubt exists as to whether such an acquisition is in the ordinary course of business or an acquisition, in whole or in part, of a going concern. 1974 Fed. Res. Bull. 725; revised, 1992 Fed. Res. Bull. 618; 12 CFR 225.132.
1
Section 225.4(c)(3) of the Board’s Regulation Y (12 CFR 225.4(c)(3)) generally prohibits a bank holding company or its subsidiary engaged in activities pursuant to authority of section 4(c)(8) of the act from being a party to any merger “or acquisition of assets other than in the ordinary course of business” without prior Board approval.
2
In accordance with the provisions of section 4(c)(8) of the act and section 225.4(b) of Regulation Y, the acquisition of a going concern requires prior Board approval.
4-176

ACTIVITIES CLOSELY RELATED TO BANKING

Effective June 15, 1971, the Board of Governors has amended section 225.4(a) of Regulation Y to implement its regulatory authority under section 4(c)(8) of the Bank Holding Company Act. In some respects activities determined by the Board to be closely related to banking are described in general terms that will require interpretation from time to time. The Board’s views on some questions that have arisen are set forth below.
Subsidiary engaging in activities on basis of more than one exemption. Section 225.4(a) states that a company whose ownership by a bank holding company is authorized on the basis of that section may engage solely in specified activities. That limitation refers only to activities the authority for which depends on section 4(c)(8) of the act. It does not prevent a holding company from establishing one subsidiary to engage, for example, in activities specified in section 225.4(a) and also in activities that fall within the scope of section 4(c)(1)(C) of the act—the “servicing” exemption.
Activities approved prior to 1970 amendments. The amendments to section 225.4(a) do not apply to restrict the activities of a company previously approved by the Board on the basis of section 4(c)(8) of the act. Activities of a company authorized on the basis of section 4(c)(8) either before the 1970 amendments or pursuant to the amended section 225.4(a) may be shifted in a corporate reorganization to another company within the holding company system without complying with the procedures of section 225.4(b), as long as all the activities of such company are permissible under one of the exemptions in section 4 of the act.
Relocation of activities. Under the procedures in section 225.4(c), a holding company that wishes to change the location at which it engages in activities authorized pursuant to section 225.4(a) must publish notice in a newspaper of general circulation in the community to be served. The Board does not regard minor changes in location as within the coverage of that requirement. A move from one site to another within a one mile radius would constitute such a minor change if the new site is in the same state.
Data Processing: In providing packaged data processing and transmission services for banking, financial, and economic data for installation on the premises of the customer, as authorized by section 225.4(a)(8)(ii), a bank holding company should limit its activities to providing facilities that perform banking functions, such as check collection, or other similar functions for customers that are depository or other similar institutions, such as mortgage companies.
In addition, the Board regards the following as incidental activities necessary to carry on the permissible activities in this area:
1. providing excess capacity, not limited to the processing or transmission of banking, financial, or economic data on data processing or transmission equipment or facilities used in connection with permissible data processing and data transmission activities, where—
  • equipment is not purchased solely for the purpose of creating excess capacity;
  • hardware is not offered in connection therewith; and
  • facilities for the use of the excess capacity do not include the provision of any software other than systems software (including language), network communications support, and the operating personnel and documentation necessary for the maintenance and use of these facilities;
2. providing by-products of permissible data processing and data transmission activities, where not designed, or appreciably enhanced, for the purpose of marketability;
3. furnishing any data processing service upon request of a customer if such data processing service is not otherwise reasonably available in the relevant market area; and
4. supplying formatting for computer output microfilm and supplying computer output microfilm only as an output option for data otherwise being permissibly processed by the holding company system.
In order to eliminate or reduce to an insignificant degree any possibility of unfair competition where services, facilities, by-products or excess capacity are provided by a bank holding company’s nonbank subsidiary or related entity, the entity providing the services, facilities, by-products and/or excess capacity should have separate books and financial statements and should provide these books and statements to any new or renewal customer requesting financial data. Consolidated or other financial statements of the bank holding company should not be provided unless specifically requested by the customer. 1971 Fed. Res. Bull. 514 and 1975 Fed. Res. Bull. 245; 12 CFR 225.123.
4-177

ACTIVITIES CLOSELY RELATED TO BANKING—Investment Adviser Activities

Effective February 1, 1972, the Board of Governors amended section 225.4(a) of Regulation Y to add “serving as investment adviser, as defined in section 2(a)(20) of the Investment Company Act of 1940, to an investment company registered under that act” to the list of activities it has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. During the course of the Board’s consideration of this amendment several questions arose as to the scope of such activity, particularly in view of certain restrictions imposed by sections 16, 20, 21 and 32 of the Banking Act of 1933 (12 USC 24, 377, 378, 78) (sometimes referred to hereinafter as the “Glass-Steagall Act provisions”) and the United States Supreme Court’s decision in Investment Company Institute v. Camp, 401 U.S. 617 (1971). The Board’s views with respect to some of these questions are set forth below.
It is clear from the legislative history of the Bank Holding Company Act Amendments of 1970 (84 Stat. 1760) that the Glass-Steagall Act provisions were not intended to be affected thereby. Accordingly, the Board regards the Glass-Steagall Act provisions and the Board’s prior interpretations thereof as applicable to a holding company’s activities as an investment adviser. Consistently with the spirit and purpose of the Glass-Steagall Act, this interpretation applies to all bank holding companies registered under the Bank Holding Company Act irrespective of whether they have subsidiaries that are member banks.
Under section 225.4(a)(5), as amended, bank holding companies (which term, as used herein, includes both their bank and nonbank subsidiaries) may, in accordance with the provisions of section 225.4(b), act as investment advisers to various types of investment companies, such as “open-end” investment companies (commonly referred to as “mutual funds”) and “closed-end” investment companies. Briefly, a mutual fund is an investment company which, typically, is continuously engaged in the issuance of it shares and stands ready at any time to redeem the securities as to which it is the issuer; a closed-end investment company typically does not issue shares after its initial organization except at infrequent intervals and does not stand ready to redeem its shares.
The Board intends that a bank holding company may exercise all functions that are permitted to be exercised by an “investment adviser” under the Investment Company Act of 1940, except to the extent limited by the Glass-Steagall Act provisions, as described, in part, hereinafter.
The Board recognizes that presently most mutual funds are organized, sponsored and managed by investment advisers with which they are affiliated and that their securities are distributed to the public by such affiliated investment advisers, or subsidiaries or affiliates thereof. However, the Board believes that (i) the Glass-Steagall Act provisions do not permit a bank holding company to perform all such functions, and (ii) it is not necessary for a bank holding company to perform all such functions in order to engage effectively in the described activity.
In the Board’s opinion, the Glass-Steagall Act provisions, as interpreted by the U.S. Supreme Court, forbid a bank holding company to sponsor, organize, or control a mutual fund. However, the Board does not believe that such restrictions apply to closed-end investment companies as long as such companies are not primarily or frequently engaged in the issuance, sale and distribution of securities. A bank holding company should not act as investment adviser to an investment company that has a name similar to the name of the holding company or any of its subsidiary banks, unless the prospectus of the investment company contains the disclosures required in paragraph (h) of this section. In no case should a bank holding company act as investment adviser to an investment company that has either the same name as the name of the holding company or any of its subsidiary banks, or a name that contains the word “bank.”
In view of the potential conflicts of interests that may exist, a bank holding company and its bank and nonbank subsidiaries should not purchase in their sole discretion, in a fiduciary capacity (including as managing agent), securities of any investment company for which the bank holding company acts as investment adviser unless, the purchase is specifically authorized by the terms of the instrument creating the fiduciary relationship, by court order, or by the law of the jurisdiction under which the trust is administered.
Under section 20 of the Glass-Steagall Act, a member bank is prohibited from being affiliated with a company that directly, or through a subsidiary, engages principally in the issue, flotation, underwriting, public sale, or distribution of securities. A bank holding company or its nonbank subsidiary may not engage, directly or indirectly, in the underwriting, public sale or distribution of securities of any investment company for which the holding company or any nonbank subsidiary provides investment advice except in compliance with the terms of section 20, and only after obtaining the Board’s approval under section 4 of the Bank Holding Company Act and subject to the limitations and disclosures required by the Board in those cases. The Board has determined, however, that the conduct of securities brokerage activities by a bank holding company or its nonbank subsidiaries, when conducted individually or in combination with investment advisory activities, is not deemed to be the underwriting, public sale, or distribution of securities prohibited by the Glass-Steagall Act, and the U.S. Supreme Court has upheld that determination. See Securities Industry Ass’n v. Board of Governors, 468 U.S. 207 (1984): see also Securities Industry Ass’n v. Board of Governors, 821 F.2d 810 (D.C. Cir. 1987), cert. denied, 484 U.S. 1005 (1988). Accordingly, the Board believes that a bank holding company or any of its nonbank subsidiaries that has been authorized by the Board under the Bank Holding Company Act to conduct securities brokerage activities (either separately or in combination with investment advisory activities) may act as agent, upon the order and for the account of customers of the holding company or its nonbank subsidiary, to purchase or sell shares of an investment company for which the bank holding company or any of its subsidiaries acts as an investment adviser. In addition, a bank holding company or any of its nonbank subsidiaries that has been authorized by the Board under the Bank Holding Company Act to provide investment advice to third parties generally (either separately or in combination with securities brokerage services) may provide investment advice to customers with respect to the purchase or sale of shares of an investment company for which the holding company or any of its subsidiaries acts as an investment adviser. In the event that a bank holding company or any of its nonbank subsidiaries provides brokerage or investment advisory services (either separately or in combination) to customers in the situations described above, at the time the service is provided the bank holding company should instruct its officers and employees to caution customers to read the prospectus of the investment company before investing and must advise customers in writing that the investment company’s shares are not insured by the Federal Deposit Insurance Corporation, and are not deposits, obligations of, or endorsed or guaranteed in any way by, any bank, unless that happens to be the case. The holding company or nonbank subsidiary must also disclose in writing to the customer the role of the company or affiliate as adviser to the investment company. These disclosures may be made orally so long as written disclosure is provided to the customer immediately thereafter. To the extent that a bank owned by a bank holding company engages in providing advisory or brokerage services to bank customers in connection with an investment company advised by the bank holding company or a nonbank affiliate, but is not required by the bank’s primary regulator to make disclosures comparable to the disclosures required to be made by bank holding companies providing such services, the bank holding company should require its subsidiary bank to make the disclosures required in this paragraph to be made by a bank holding company that provides such advisory or brokerage services.
Acting in such capacities as registrar, transfer agent, or custodian for an investment company is not a selling activity and is permitted under section 225.4(a)(4) of Regulation Y. However, in view of potential conflicts of interests, a bank holding company which acts both as custodian and investment adviser for an investment company should exercise care to maintain at a minimal level demand deposit accounts of the investment company which are placed with a bank affiliate and should not invest cash funds of the investment company in time deposit accounts (including certificates of deposit) of any bank affiliate. 1972 Fed. Res. Bull. 149; 1992 Fed. Res. Bull. 697; 1996 Fed. Res. Bull 942; 12 CFR 225.125.
4-178

ACTIVITIES CLOSELY RELATED TO BANKING—Community Welfare Projects

Under section 225.25(b)(6) of Regulation Y, a bank holding company may, in accordance with the provisions of section 225.23, engage in “making equity and debt investments in corporations or projects designed primarily to promote community welfare, such as the economic rehabilitation and development of low-income areas.” The Board included that activity among those the Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto, in order to permit bank holding companies to fulfill their civic responsibilities. As indicated hereinafter in this interpretation, the Board intends section 225.25(b)(6) to enable bank holding companies to take an active role in the quest for solutions to the nation’s social problems. Although the interpretation primarily focuses on low- and moderate-income housing, it is not intended to limit projects under section 225.25(b)(6) to that area. Other investments primarily designed to promote community welfare are considered permissible, but have not been defined on order to provide bank holding companies flexibility in approaching community problems. For example, bank holding companies may utilize this flexibility to provide new and creative approaches to the promotion of employment opportunities for low-income persons. Bank holding companies possess a unique combination of financial and managerial resources making them particularly suited for a meaningful and substantial role in remedying our social ills. Section 225.25(b)(6) is intended to provide an opportunity for them to assume such a role.
Under the authority of section 225.25(b)(6), a bank holding company may invest in community development corporations established pursuant to federal or state law. A bank holding company may also participate in other civic projects, such as a municipal parking facility sponsored by a local civic organization as a means to promote greater public use of the community’s facilities.
Within the category of permissible investments under section 225.25(b)(6) are investments in projects to construct or rehabilitate multifamily low- or moderate-income housing with respect to which a mortgage is insured under sections 221(d)(3), 221(d)(4), or 236 of the National Housing Act (12 USC 1701) and investments in projects to construct or rehabilitate low- or moderate-income housing which is financed or assisted by direct loan, tax abatement, or insurance under provisions of state or local law, similar to the aforementioned federal programs, provided that, with respect to all such projects the owner is, by statute, regulation, or regulatory authority, limited as to the rate of return on his investment in the project, as to rentals or occupancy charges for units in the project, and in such other respects as would be a “limited dividend corporation” (as defined by the secretary of Housing and Urban Development).
Investments in other projects that may be considered to be designed primarily to promote community welfare include but are not limited to (1) projects for the construction or rehabilitation of housing for the benefit of persons of low or moderate income, (2) projects for the construction or rehabilitation of ancillary local commercial facilities necessary to provide goods or services principally to persons residing in low- or moderate-income housing, and (3) projects designed explicitly to create improved job opportunities for low- or moderate-income groups (for example, minority equity investments, on a temporary basis, in small or medium-sized locally controlled businesses in low-income urban or other economically depressed areas). In the case of de novo projects, the copy of the notice with respect to such other projects which is to be furnished to Reserve Banks in accordance with the provisions of section 225.23 should be accompanied by a memorandum which demonstrates that such projects meet the objectives of section 225.25(b)(6).
Investments in corporations or projects organized to build or rehabilitate high-income housing, or commercial, office, or industrial facilities that are not designed explicitly to create improved job opportunities for low-income persons shall be presumed not to be designed primarily to promote community welfare, unless there is substantial evidence to the contrary, even though to some extent the investment may benefit the community.
Section 6 of the Depository Institutions Disaster Relief Act of 1992 permits state member banks (12 USC 338a) and national banks (12 USC 24 (Eleventh)) to invest in the stock of community development corporations that are designed primarily to promote the public welfare of low- and moderate-income communities and persons in the areas of housing, services, and employment. The Board and the Office of the Comptroller of the Currency have adopted rules that permit state member banks and national banks to make certain investments without prior approval. The Board believes that these rules are consistent with the Board’s interpretation of, and decisions regarding, the scope of community-welfare activities permissible for bank holding companies. Accordingly, approval received by a bank holding company to conduct activities designed to promote the community welfare under section 4(c)(8) of the Bank Holding Company Act (12 USC 1843(c)(8)) and section 225.25(b)(6) of the Board’s Regulation Y (12 CFR 225.25(b)(6)) includes approval to engage, either directly or through a subsidiary, in the following activities, up to 5 percent of the bank holding company’s total consolidated capital stock and surplus, without additional Board or Reserve Bank approval:
  • 1.
    invest in and provide financing to a corporation or project or class of corporations or projects that the Board previously has determined is a public-welfare project pursuant to paragraph 23 of section 9 of the Federal Reserve Act (12 USC 338a);
  • 2.
    invest in and provide financing to a corporation or project that the Office of the Comptroller of the Currency previously has determined, by order or regulation, is a public-welfare investment pursuant to section 5136 of the Revised Statutes (12 USC 24 (Eleventh));
  • 3.
    invest in and provide financing to a community development financial institution pursuant to section 103(5) of the Community Development Banking and Financial Institutions Act of 1994 (12 USC 4702(5));
  • 4.
    invest in, provide financing to, develop, rehabilitate, manage, sell, and rent residential property if a majority of the units will be occupied by low- and moderate-income persons or if the property is a “qualified low-income building” as defined in section 42(c)(2) of the Internal Revenue Code (26 USC 42(c)(2));
  • 5.
    invest in, provide financing to, develop, rehabilitate, manage, sell, and rent nonresidential real property or other assets located in a low- or moderate-income area provided the property is used primarily for low- and moderate-income persons;
  • 6.
    invest in and provide financing to one or more small businesses located in a low- or moderate-income area to stimulate economic development;
  • 7.
    invest in, provide financing to, develop, and otherwise assist job training or placement facilities or programs designed primarily for low- and moderate-income persons;
  • 8.
    invest in and provide financing to an entity located in a low- or moderate-income area if that entity creates long-term employment opportunities, a majority of which (based on full-time equivalent positions) will be held by low- and moderate-income persons; and
  • 9.
    provide technical assistance, credit counseling, research, and program-development assistance to low- and moderate-income persons,small businesses, or nonprofit corporations to help achieve community development.
For purposes of this interpretation, low- and moderate-income persons or areas means individuals and communities whose incomes do not exceed 80 percent of the median income of the area involved, as determined by the U.S. Department of Housing and Urban Development. Small businesses are businesses that are smaller than the maximum-size eligibility standards established by the Small Business Administration (SBA) for the Small Business Investment Company and Development Company Programs or the SBA section 7A loan program, and specifically include those businesses that are majority-owned by members of minority groups or by women.
For purposes of the sixth paragraph of this section, 5 percent of the total consolidated capital stock and surplus of a bank holding company includes its total investment in projects described in the sixth paragraph of this section, when aggregated with similar types of investments made by depository institutions controlled by the bank holding company. The term total consolidated capital stock and surplus of the bank holding company means total equity capital and the allowance for loan and lease losses. For bank holding companies that file the FR Y-9C (Consolidated Financial Statements for Bank Holding Companies), these items are readily ascertained from Schedule HC—Consolidated Balance Sheet (total equity capital (line 27h) and allowance for loan and lease losses (line 4b)). For bank holding companies filing the FR Y-SP (Parent Company Only Financial Statements for Small Bank Holding Companies), an approximation of these items is ascertained from the Balance Sheet (total equity capital (line 16e) and allowance for loan and lease losses (line 3b)) and from the Report of Condition for Insured Banks (Schedule RC—Balance Sheet (line 4b)). 1972 Fed. Res. Bull. 572, 12 CFR 225.127.
4-180

ACTIVITIES CLOSELY RELATED TO BANKING—Courier Activities

The Board’s amendment of section 225.4(a), which adds courier services to the list of closely related activities is intended to permit holding companies to transport time-critical materials of limited intrinsic value of the types utilized by banks and bank-related firms in performing their business activities. Such transportation activities are of particular importance in the check-clearing process of the banking system, but are also important to the performance of other activities, including the processing of financially related economic data. The authority is not intended to permit holding companies to engage generally in the provision of transportation services.
During the course of the Board’s proceedings pertaining to courier services, objections were made that courier activities were not a proper incident to banking because of the possibility that holding companies would or had engaged in unfair competitive practices. The Board believes that adherence to the following principles will eliminate or reduce to an insignificant degree any possibility of unfair competition:
  • a.
    A holding company courier subsidiary established under section 4(c)(8) should be a separate, independent corporate entity, not merely a servicing arm of a bank.
  • b.
    As such, the subsidiary should exist as a separate, profit-oriented operation and should not be subsidized by the holding company system.
  • c.
    Services performed should be explicitly priced, and shall not be paid for indirectly, for example, on the basis of deposits maintained at or loan arrangements with affiliated banks.
Accordingly, entry of holding companies into courier activities on the basis of section 4(c)(8) will be conditioned as follows:
1. The courier subsidiary shall perform services on an explicit fee basis and shall be structured as an individual profit center designed to be operated on a profitable basis. The Board may regard operating losses sustained over an extended period as being inconsistent with continued authority to engage in courier activities.
2. Courier services performed on behalf of an affiliate’s customer (such as the carriage of incoming cash letters) shall be paid for by the customer. Such payments shall not be made indirectly, for example, on the basis of imputed earnings on deposits maintained at or of loan arrangements with subsidiaries of the holding company.
Concern has also been expressed that bank-affiliated courier services will be utilized to gain a competitive advantage over firms competing with other holding company affiliates. To reduce the possibility that courier affiliates might be so employed, the Board will impose the following third condition:
3. The courier subsidiary shall, when requested by any bank or any data processing firm providing financially related data processing services which firm competes with a banking or data processing subsidiary of Applicant, furnish comparable service at comparable rates, unless compliance with such request would be beyond the courier subsidiary’s practical capacity. In this regard, the courier subsidiary should make known to the public its minimum rate schedule for services and its general pricing policies thereto. The courier subsidiary is also expected to maintain for a reasonable period of time (not less than two years) each request denied with the reasons for such denial.
1973 Fed. Res. Bull. 890; and 1975 Fed. Res. Bull. 588; 12 CFR 225.129.
4-181

ACTIVITIES CLOSELY RELATED TO BANKING—Bank Management Consulting Advice

The Board’s amendment of section 225.4(a), which adds bank management consulting advice to the list of closely related activities, describes in general terms the nature of such activity. This interpretation is intended to explain in greater detail certain of the terms in the amendment.
It is expected that bank management consulting advice would include, but not be limited to, advice concerning: bank operations, systems and procedures; computer operations and mechanization; implementation of electronic funds transfer systems; site planning and evaluation; bank mergers and the establishment of new branches; operation and management of a trust department; international banking; foreign exchange transactions; purchasing policies and practices; cost analysis, capital adequacy and planning; auditing; accounting procedures; tax planning; investment advice (as authorized in section 225.4(a) (5)); credit policies and administration, including credit documentation, evaluation, and debt collection; product development, including specialized lending provisions; marketing operations, including research, market development and advertising programs; personnel operations, including recruiting, training, evaluation and compensation; and security measures and procedures.
In permitting bank holding companies to provide management consulting advice to nonaffiliated “banks,” the Board intends such advice to be given only to an institution that both accepts deposits that the depositor has a legal right to withdraw on demand and engages in the business of making commercial loans. It is also intended that such management consulting advice may be provided to the “operations subsidiaries” of a bank, since such subsidiaries perform functions that a bank is empowered to perform directly at locations at which the bank is authorized to engage in business (12 CFR 250.141).
Although a bank holding company providing management consulting advice is prohibited by the regulation from owning or controlling, directly or indirectly, any equity securities in a client bank, this limitation does not apply to shares of a client bank acquired, directly or indirectly, as a result of a default on a debt previously contracted. This limitation is also inapplicable to shares of a client bank acquired by a bank holding company, directly or indirectly, in a fiduciary capacity, provided that the bank holding company or its subsidiary does not have sole discretionary authority to vote such shares or shares held with sole voting rights constitute not more than 5 percent of the outstanding voting shares of a client bank. 1974 Fed. Res. Bull. 223; 12 CFR 225.131.
4-184

ACTIVITIES NOT CLOSELY RELATED TO BANKING

Pursuant to section 4(c)(8) of the Bank Holding Company Act and section 225.4(a) of Regulation Y, the Board of Governors has determined that the following activities are not so closely related to banking or managing or controlling banks as to be a proper incident thereto:
  • insurance premium funding—that is, the combined sale of mutual funds and insurance
  • underwriting life insurance that is not sold in connection with a credit transaction by a bank holding company, or a subsidiary thereof
  • real estate brokerage (see 1972 Fed. Res. Bull. 428)
  • land development (see 1972 Fed. Res. Bull. 429)
  • real estate syndication
  • management consulting (see 1972 Fed. Res. Bull. 571)
  • property management (see 1972 Fed. Res. Bull. 652)
12 CFR 225.126.
4-185

BANK PREMISES COMPANIES—Shares Held by Bank Subsidiary

*     *     *     *     *
Finally, question is raised as to whether shares held by banking subsidiaries of the bank holding company in companies holding bank premises of such subsidiaries are exempted from the divestment requirements by section 4(c)(1) of the act. It is the Board’s view that section 4(c)(1), exempting shares owned or acquired by a bank holding company in any company engaged solely in holding or operating properties used wholly or substantially by any subsidiary bank, is to be read and interpreted, like section 4(c)(5), as applying to shares owned indirectly by a bank holding company through a banking subsidiary as well as to shares held directly by the bank holding company. A contrary interpretation would impair the right that member banks controlled by bank holding companies would otherwise have to invest, subject to the limitations of section 24A of the Federal Reserve Act, in stock of companies holding their bank premises; and such a result was not, in the Board’s opinion, intended by the Bank Holding Company Act. 1957 Fed. Res. Bull. 21; 12 CFR 225.101(g).
4-185.1

BANK PREMISES COMPANIES—Investment in Bank Premises by Holding Company Banks

The Board of Governors has been asked whether, in determining under section 24A of the Federal Reserve Act (12 USC 371d) how much may be invested in bank premises without prior Board approval, a state member bank, which is owned by a registered bank holding company, is required to include indebtedness of a corporation, wholly owned by the holding company, that is engaged in holding premises of banks in the holding company system.
Section 24A provides, in part, as follows:
 Hereafter . . . no State member bank, without the approval of the Board of Governors of the Federal Reserve System, shall (1) invest in bank premises, or in the stock, bonds, debentures, or other such obligations of any corporation holding the premises of such bank or (2) make loans to or upon the security of the stock of any such corporation, if the aggregate of all such investments and loans, together with the amount of any indebtedness incurred by any such corporation which is an affiliate of the bank, as defined in section 2 of the Banking Act of 1933, as amended [12 USC 221a], will exceed the amount of the capital stock of such banks.
A corporation that is owned by a holding company is an “affiliate of each of the holding company’s majority-owned banks as the term is defined in said section 2. Therefore, under the explicit provisions of section 24A, each state member bank, any part of whose premises is owned by such an affiliate, must include the affiliate’s total indebtedness in determining whether a proposed premises investment by the bank would cause the aggregate figure to exceed the amount of the bank’s capital stock, so that the Board’s prior approval would be required. Where the affiliate holds the premises of a number of the holding company’s banks, the amount of the affiliate’s indebtedness may be so large that Board approval is required for every proposed investment in bank premises by each majority-owned state member bank, to which the entire indebtedness of the affiliate is required to be attributed. The Board believes that, in these circumstances, individual approvals are not essential to effectuate the purpose of section 24A, which is to safeguard the soundness and liquidity of member banks, and that the protection sought by Congress can be achieved by a suitably circumscribed general approval.
Accordingly the Board herby grants general approval for any investment or loan (as described in section 24A) by any state member bank, the majority of the stock of which is owned by a registered bank holding company, if the proposed investment or loan will not cause either (1) all such investments and loans by the member bank (together with the indebtedness of any bank premises subsidiary thereof) to exceed 100 percent of the bank’s capital stock, or (2) the aggregate of such investments and loans by all of the holding company’s subsidiary banks (together with the indebtedness of any bank premises affiliates thereof) to exceed 100 percent of the aggregate capital stock of said banks. 1967 Fed. Res. Bull. 1334; 12 CFR 250.200.
4-185.4

CHANGE IN BANK CONTROL

See this heading beginning at 4-801.
4-185.5

“COMPANY”—Voting Trust and Buy-Sell Agreements

In response to a significant number of inquiries forwarded to the Board by staff of the Reserve Banks, the Board has considered the question of whether a voting trust or a buy-sell agreement relating to the voting shares of a bank constitutes a “company” as defined by section 2(b) of the Bank Holding Company Act. Section 2(b) defines a “company” as—
any corporation, partnership, business trust, association, or similar organization, or any other trust unless by its terms it must terminate within twenty-five years or not later than twenty-one years and ten months after the death of individuals living on the effective date of the trust. . . .
The Board has reviewed the essential elements of voting trust and buy-sell agreements in light of the underlying purposes of the Bank Holding Company Act and has recognized several conditions which appear common among these agreements and, when found to exist, can be useful in determining the applicability of the act to these agreements. Application of these conditions as guidelines for section 2(b) considerations should reduce the necessity for detailed ad hoc analysis of various agreements by providing a basis of uniform interpretation.
Therefore, the Board has determined that, under most circumstances, a voting trust agreement should not be considered a “company” as defined in section 2(b) of the act if it (1) relates only to the shares of a single bank, (2) terminates within 25 years, (3) engages in no other activity except to hold and vote the shares of a single bank, and (4) involves parties who are not participants in any similar voting trust or related agreement with respect to any other bank or nonbank business.
Further, a buy-sell agreement which satisfies conditions 1, 2, and 4 above with respect to voting trust agreements should not, under most circumstances, be considered a “company” under section 2(b) of the act.
It is the Board’s opinion that voting trusts and buy-sell agreements which satisfy all the conditions specified above, in most circumstances, do not present relationships at which the Bank Holding Company Act is aimed. Therefore, these “agreements” should not be required to register as bank holding companies under the act unless the Reserve Bank has knowledge of some other circumstances that would suggest an attempt to circumvent the purposes of the Bank Holding Company Act.
Voting trust and stock-purchase agreements which do not satisfy all of the above-specified conditions should not be automatically required to register but should continue to be reviewed in detail for elements of “company” status. S-2196; May 4, 1972.
4-186

DIVESTITURE—Policy Statement

From time to time the Board of Governors receives requests from companies subject to the Bank Holding Company Act, or other laws administered by the Board, to extend time periods specified either by statute or by Board order for the divestiture of assets held or activities engaged in by such companies. Such divestiture requirements may arise in a number of ways. For example, divestiture may be ordered by the Board in connection with an acquisition found to have been made in violation of law. In other cases the divestiture may be pursuant to a statutory requirement imposed at the time an amendment to the act was adopted, or it may be required as a result of a foreclosure upon collateral held by the company or a bank subsidiary in connection with a debt previously contracted in good faith. Certain divestiture periods may be extended in the discretion of the Board, but in other cases the Board may be without statutory authority, or may have only limited authority, to extend a specified divestiture period.
In the past, divestitures have taken many different forms, and the Board has followed a variety of procedures in enforcing divestiture requirements. Because divestitures may occur under widely disparate factual circumstances, and because such forced dispositions may have the potential for causing a serious adverse economic impact upon the divesting company, the Board believes it is important to maintain a large measure of flexibility in dealing with divestitures. For these reasons, there can be no fixed rule as to the type of divestiture that will be appropriate in all situations. For example, where divestiture has been ordered to terminate a control relationship created or maintained in violation of the act, it may be necessary to impose conditions that will assure that the unlawful relationship has been fully terminated and that it will not arise in the future. In other circumstances, however, less stringent conditions may be appropriate.
1. Avoidance of delays in divestitures. Where a specific time period has been fixed for accomplishing divestiture, the affected company should endeavor and should be encouraged to complete the divestiture as early as possible during the specific period. There will generally be substantial advantages to divesting companies in taking steps to plan for and accomplish divestitures well before the end of the divestiture period. For example, delays may impair the ability of the company to realize full value for the divested assets, for as the end of the divestiture period approaches the “forced sale” aspect of the divestiture may lead potential buyers to withhold firm offers and to bargain for lower prices. In addition, because some prospective purchasers may themselves require regulatory approval to acquire the divested property, delay by the divesting company may—by leaving insufficient time to obtain such approvals—have the effect of narrowing the range of prospective purchasers. Thus, delay in planning for divestiture may increase the likelihood that the company will seek an extension of the time for divestiture if difficulty is encountered in securing a purchaser, and in certain situations, of course, the Board may be without statutory authority to grant extensions.
2. Submission and approval of divestiture plans. When a divestiture requirement is imposed, the company affected should generally be asked to submit a divestiture plan promptly for review and approval by the Reserve Bank or the Board. Such a requirement may be imposed pursuant to the Board’s authority under section 5(b) of the Bank Holding Company Act to issue such orders as may be necessary to enable the Board to administer and carry out the purposes of the act and prevent evasions thereof. A divestiture plan should be as specific as possible, and should indicate the manner in which divestiture will be accomplished—for example, by a bulk sale of the assets to a third party, by “spinoff” or distribution of shares to the shareholders of the divesting company, or by termination of prohibited activities. In addition, the plan should specify the steps the company expects to take in effecting the divestiture and assuring its completeness, and should indicate the time schedule for taking such steps. In appropriate circumstances, the divestiture plan should make provision for assuring that “controlling influence” relationships, such as management or financial interlocks, will not continue to exist.
3. Periodic progress reports. A company subject to a divestiture requirement should generally be required to submit regular periodic reports detailing the steps it has taken to effect divestiture: Such a requirement may be imposed pursuant to the Board’s authority under section 5(b) of the Bank Holding Company Act, referred to above, as well as its authority under section 5(c) of the act to require reports for the purpose of keeping the Board informed as to whether the act and Board regulations and orders thereunder are being complied with. Reports should set forth in detail such matters as the identities of potential buyers who have been approached by the company, the dates of discussions with potential buyers and the identities of the individuals involved in such discussions, the terms of any offers received, and the reasons for rejecting any offers. In addition, the reports should indicate whether the company has employed brokers, investment bankers or others to assist in the divestiture, or its reasons for not doing so, and should describe other effort by the company to seek out possible purchasers. The purpose of requiring such reports is to insure that substantial and good faith efforts are being made by the company to satisfy its divestiture obligation. The frequency of such reports may vary depending upon the nature of the divestiture and the period specified for divestiture. However, such reports should generally not be required less frequently than every three months, and may in appropriate cases be required on a monthly or even more frequent basis. Progress reports as well as divestiture plans should be afforded confidential treatment.
4. Extensions of divestiture periods. Certain divestiture periods—such as the December 31, 1980 deadline for divestitures required by the 1970 amendments to the Bank Holding Company Act—are not extendable. In such cases it is imperative that divestiture be accomplished in a timely manner. In certain other cases, the Board may have discretion to extend a statutory prescribed divestiture period within specified limits. For example, under section 4(c)(2) of the act the Board may extend for three one-year periods the two-year period in which a bank subsidiary of a holding company is otherwise required to divest shares acquired in satisfaction of a debt previously contracted in good faith. In such case, however, when the permissible extensions expire the Board no longer has discretion to grant further extensions. In still other cases, where a divestiture period is prescribed by the Board, in the exercise of its regulatory judgment, the Board may have broader discretion to grant extensions.
Where extensions of specified divestiture periods are permitted by law, extensions should not be granted except under compelling circumstances. Neither unfavorable market conditions, nor the possibility that the company may incur some loss, should alone be viewed as constituting such circumstances—particularly if the company has failed to take earlier steps to accomplish a divestiture under more favorable circumstances. Normally, a request for an extension will not be considered unless the company has established that it has made substantial and continued good faith efforts to accomplish the divestiture within the prescribed period. Furthermore, requests for extensions of divestiture periods must be made sufficiently in advance of the expiration of the prescribed period both to enable the Board to consider the request in an orderly manner and to enable the company to effect a timely divestiture in the event the request for extension is denied. Companies subject to divestiture requirements should be aware that a failure to accomplish a divestiture within the prescribed period may in and of itself be viewed as a separate violation of the act.
5. Use of trustees. In appropriate cases a company subject to a divestiture requirement may be required to place the assets subject to divestiture with an independent trustee under instructions to accomplish a sale by a specified date, by public auction if necessary. Such a trustee may be given the responsibility for exercising the voting rights with respect to shares being divested. The use of such a trustee may be particularly appropriate where the divestiture is intended to terminate a control relationship established or maintained in violation of law, or where the divesting company has demonstrated an inability or unwillingness to take timely steps to effect a divestiture.
6. Presumptions of control. Bank holding companies contemplating a divestiture should be mindful of section 2(g)(3) of the Bank Holding Company Act, which creates a presumption of continued control over the transferred assets where the transferee is indebted to the transferor, or where certain interlocks exist, as well as section 225.2 of Regulation Y, which sets forth certain additional control presumptions. Where one of these presumptions has arisen with respect to divested assets, the divestiture will not be considered as complete until the presumption has been overcome. It should be understood that the inquiry into the termination of control relationships is not limited by the statutory and regulatory presumptions of control, and that the Board may conclude that a control relationship still exists even though the presumptions do not apply.
7. Role of the Reserve Banks. The Reserve Banks have a responsibility for supervising and enforcing divestitures. Specifically, in coordination with Board staff they should review divestiture plans to assure that proposed divestitures will result in the termination of control relationships and will not create unsafe or unsound conditions in any bank or bank holding company; they should monitor periodic progress reports to assure that timely steps are being taken to effect divestitures; and they should prompt companies to take such steps when it appears that progress is not being made. Where Reserve Banks have delegated authority to extend divestiture periods, that authority should be exercised consistently with this policy statement. S-2346; 1977 Fed. Res. Bull. 263; 12 CFR 225.138.
4-186.1

DIVESTITURE—Property Acquired in Satisfaction of Debts Previously Contracted

The Board recently considered the permissibility, under section 4 of the Bank Holding Company Act, of a subsidiary of a bank holding company acquiring and holding assets acquired in satisfaction of a debt previously contracted in good faith (a dpc acquisition). In the situation presented, a lending subsidiary of a bank holding company made a dpc acquisition of assets and transferred them to a wholly owned subsidiary of the bank holding company for the purpose of effecting an orderly divestiture. The question presented was whether such dpc assets could be held indefinitely by a bank holding company subsidiary as incidental to its permissible lending activity.
While the Board believes that dpc acquisitions may be regarded as normal, necessary and incidental to the business of lending, the Board does not believe that the holding of as sets acquired dpc without any time restrictions is appropriate from the standpoint of prudent banking and in light of the prohibitions in section 4 of the act against engaging in nonbank activities. If a nonbanking subsidiary of a bank holding company were permitted, either directly or through a subsidiary, to hold dpc assets of substantial amount over an extended period of time, the holding of such property could result in an unsafe or unsound banking practice or in the holding company engaging in an impermissible activity in connection with the assets, rather than liquidating them.
The Board notes that section 4(c)(2) of the Bank Holding Company Act provides an exemption from the prohibitions of section 4 of the act for bank holding company subsidiaries to acquire shares dpc. It also provides that such dpc shares may be held for a period of two years, subject to the Board’s authority to grant three one-year extensions up to a maximum of five years.1 Viewed in light of the congressional policy evidenced by section 4(c)(2), the Board believes that a lending subsidiary of a bank holding company or the holding company itself, should be permitted, as an incident to permissible lending activities, to make acquisitions of dpc assets. Consistent with the principles underlying the provisions of section 4(c)(2) of the act and as a matter of prudent banking practice, such assets may be held for no longer than five years from the date of acquisition. Within the divestiture period it is expected that the company will make good faith efforts to dispose of dpc shares or assets at the earliest practicable date. While no specific authorization is necessary to hold such assets for the five-year period, after two years from the date of acquisition of such assets, the holding company should report annually on its efforts to accomplish divestiture to its Reserve Bank. The Reserve Bank will monitor the efforts of the company to effect an orderly divestiture, and may order divestiture before the end of the five-year period if supervisory concerns warrant such action.
The Board recognizes that there are instances where a company may encounter particular difficulty in attempting to effect an orderly divestiture of dpc real estate holdings within the divestiture period, notwithstanding its persistent good faith efforts to dispose of such property. In the Depository Institutions Deregulation and Monetary Control Act of 1980 (Pub. L. 96-221), Congress, recognizing that real estate possesses unusual characteristics, amended the National Banking Act to permit national banks to hold real estate for five years and for an additional five-year period subject to certain conditions. Consistent with the policy underlying the recent congressional enactment, and as a matter of supervisory policy, a bank holding company may be permitted to hold real estate acquired dpc beyond the initial five-year period provided that the value of the real estate on the books of the company has been written down to fair market value, the carrying costs are not significant in relation to the overall financial position of the company, and the company has made good faith efforts to effect divestiture. Companies holding real estate for this extended period are expected to make active efforts to dispose of it and should keep the Reserve Bank advised on a regular basis concerning their ongoing efforts. Fair market value should be derived from appraisals, comparable sales, or some other reasonable method. In any case, dpc real estate would not be permitted to be held beyond 10 years from the date of its acquisition.
With respect to the transfer by a subsidiary of other dpc shares or assets to another company in the holding company system, including a section 4(c)(1)(D) liquidating subsidiary, or to the holding company itself, such transfers would not alter the original divestiture period applicable to such shares or assets at the time of their acquisition. Moreover, to ensure that assets are not carried at inflated values for extended periods of time, the Board expects, in the case of all such intracompany transfers, that the shares or assets will be transferred at a value no greater than the fair market value at the time of transfer and that the transfer will be made in a normal arm’s-length transaction.
With regard to dpc assets acquired by a banking subsidiary of a holding company, so long as the assets continue to be held by the bank itself, the Board will regard them as being solely within the regulatory authority of the primary supervisor of the bank. 1980 Fed. Res. Bull. 654; 12 CFR 225.140.
1
The Board notes that where the dpc shares or other similar interests represent less than 5 percent of the total of such interests outstanding, they may be retained on the basis of section 4(c)(6), even if originally acquired dpc.
4-187

5 PERCENT EXEMPTION—Shares Owned by Subsidiary Bank

The Board’s opinion has been requested on the following related matters under the Bank Holding Company Act of 1956.
The question is raised as to whether shares in a nonbanking company which were acquired by a banking subsidiary of the bank holding company many years ago when their acquisition was lawful and are now held as investments, and which do not include more than 5 percent of the outstanding voting securities of such nonbanking company and do not have a value greater than 5 percent of the value of the bank holding company’s total assets, are exempted from the divestment requirements of the act by the provisions of section 4(c)(5) of the act.
In the Board’s opinion, this exemption is as applicable to such shares when held by a banking subsidiary of a bank holding company as when held directly by the bank holding company itself. While the exemption specifically refers only to shares held or acquired by the bank holding company, the prohibition of the act against retention of nonbanking interests applies to indirect as well as direct ownership of shares of a nonbanking company, and, in the absence of a clear mandate to the contrary, any exception to this prohibition should be given equal breadth with the prohibition. Any other interpretation would lead to unwarranted results.
Although certain of the other exemptions in section 4(c) of the act specifically refer to shares held or acquired by banking subsidiaries, an analysis of those exemptions suggests that such specific reference to banking subsidiaries was for purpose of excluding nonbanking subsidiaries from such exemptions, rather than for the purpose of providing an inclusionary emphasis on banking subsidiaries.
It should be noted that the Board’s view as to this question should not be interpreted as meaning that each banking subsidiary could own up to 5 percent of the stock of the same nonbanking organization. In the Board’s opinion the limitations set forth in section 4(c)(5) apply to the aggregate amount of stock held in a particular organization by the bank holding company itself and by all of its subsidiaries.
Secondly, question is raised as to whether shares in a nonbanking company acquired in satisfaction of debts previously contracted (dpc) by a banking subsidiary of the bank holding company may be retained if such shares meet the conditions contained in section 4(c)(5) as to value and amount, notwithstanding the requirement of section 4(c)(2) that shares acquired dpc be disposed of within two years after the date of their acquisition or the date of the act, whichever is later. In the Board’s opinion, the 5 percent exemption provided by section 4(c)(5) covers any shares, including shares acquired dpc, that meet the conditions set forth in that exemption, and, consequently, dpc shares held by a banking subsidiary of a bank holding company which meet such conditions are not subject to the two-year disposition requirement prescribed by section 4(c)(2), although any such shares would, of course, continue to be subject to such requirement for disposition as may be prescribed by provisions of any applicable banking laws or by the appropriate bank supervisory authorities. * * * 1957 Fed. Res. Bull. 21; 12 CFR 225.101.
4-188

5 PERCENT EXEMPTION—Indirect Ownership of Investment Company Shares

The Board of Governors has been requested for an opinion regarding the exemptions contained in section 4(c)(5) of the Bank Holding Company Act of 1956. It is stated that Y Company is an investment company which is not a bank holding company and which is not engaged in any business other than investing in securities, which securities do not include more than 5 per centum of the outstanding voting securities of any company and do not include any asset having a value greater than 5 per centum of the value of the total assets of X Corporation, a bank holding company. It is stated that direct ownership by X Corporation of voting shares of Y Company would be exempt by reason of section 4(c)(5) from the prohibition of section 4 of the act against ownership by bank holding companies of nonbanking assets.
It was asked whether it makes any difference that the shares of Y Company are not owned directly by X Corporation but instead are owned through Subsidiaries A and B. X Corporation owns all the voting shares of Subsidiary A, which owns one-half of the voting shares of Subsidiary B. Subsidiaries A and B each own one-third of the voting shares of Y Company.
Section 4(c)(5) is divided into two parts. The first part exempts the ownership of securities of nonbanking companies when the securities do not include more than 5 percent of the voting securities of the nonbanking company and do not have a value greater than 5 percent of the value of the total assets of the bank holding company. The second part exempts the ownership of securities of an investment company which is not a bank holding company and is not engaged in any business other than investing in securities, provided the securities held by the investment company meet the 5 percent tests mentioned above.
In an interpretation published at page 21 of the January 1957 Federal Reserve Bulletin (at 4-187), the Board expressed the opinion that the first exemption in section 4(c)(5)—
is as applicable to such shares when held by a banking subsidiary of a bank holding company as when held directly by the bank holding company itself. While the exemption specifically refers only to shares held or acquired by the bank holding company, the prohibition of the act against retention of nonbanking interests applies to indirect as well as direct ownership of shares of a nonbanking company, and, in the absence of a clear mandate to the contrary, any exception to this prohibition should be given equal breadth with the prohibition. Any other interpretation would lead to unwarranted results.
The Board is of the view that the principles stated in that opinion are also applicable to the second exemption in section 4(c)(5), and that they apply whether or not the subsidiary owning the shares is a banking subsidiary. Accordingly, on the basis of the facts presented, the Board is of the opinion that the second exemption in section 4(c)(5) applies to the indirect ownership by X Corporation of shares of Y Company through Subsidiaries A and B. 1957 Fed. Res. Bull. 412; 12 CFR 225.102.
4-189

5 PERCENT EXEMPTION—Acquisition of Shares of Insurance Company

The Board has received a request for an interpretation of section 4(c)(6) of the Bank Holding Company Act (“act”)* in connection with a proposal under which a number of bank holding companies would purchase interests in an insurance company to be formed for the purpose of underwriting or reinsuring credit life and credit accident and health insurance sold in connection with extensions of credit by the stockholder bank holding companies and their affiliates.
Each participating holding company would own no more than 5 percent of the outstanding voting shares of the company. However, the investment of each holding company would be represented by a separate class of voting security, so that each stockholder would own 100 percent of its respective class. The participating companies would execute a formal “agreement among stockholders” under which each would agree to use its best efforts at all times to direct or recommend to customers and clients the placement of their life, accident and health insurance directly or indirectly with the company. Such credit-related insurance placed with the company would be identified in the records of the company as having been originated by the respective stockholder. A separate capital account would be maintained for each stockholder consisting of the original capital contribution increased or decreased from time to time by the net profit or loss resulting from the insurance business attributable to each stockholder. Thus, each stockholder would receive a return on its investment based upon the claims experience and profitability of the insurance business that it had itself generated. Dividends declared by the board of directors of the company would be payable to each stockholder only out of the earned surplus reflected in the respective stockholder’s capital account.
It has been requested that the Board issue an interpretation that section 4(c)(6) of the act provides an exemption under which participating bank holding companies may acquire such interests in the company without prior approval of the Board.
On the basis of a careful review of the documents submitted, in light of the purposes and provisions of the act, the Board has concluded that section 4(c)(6) of the act is inapplicable to this proposal and that a bank holding company must obtain the approval of the Board before participating in such a proposal in the manner described. The Board’s conclusion is based upon the following considerations:
(1) Section 2(a)(2)(A) of the act provides that a company is deemed to have control over a second company if it owns or controls “25 per centum or more of any class of voting securities” of the second company. In the case presented, the stock interest of each participant would be evidenced by a different class of stock and each would, accordingly, own 100 percent of a class of voting securities of the company. Thus, each of the stockholders would be deemed to “control” the company and prior Board approval would be required for each stockholder’s acquisition of stock in the company.
The Board believes that this application of section 2(a)(2)(A) of the act is particularly appropriate on the facts presented here. The company is, in practical effect, a conglomeration of separate business ventures each owned 100 percent by a stockholder the value of whose economic interest in the company is determined by reference to the profits and losses attributable to its respective class of stock. Furthermore, it is the Board’s opinion that this application of section 2(a)(2)(A) is not inconsistent with section 4(c)(6). Even assuming that section 4(c)(6) is intended to refer to all outstanding voting shares, and not merely the outstanding shares of a particular class of securities, section 4(c)(6) must be viewed as permitting ownership of 5 percent of a company’s voting stock only when that ownership does not constitute “control” as otherwise defined in the act. For example, it is entirely possible that a company could exercise a controlling influence over the management and policies of a second company, and thus “control” that company under the act’s definitions, even though it held less than 5 percent of the voting stock of the second company. To view section 4(c)(6) as an unqualified exemption for holdings of less than 5 percent would thus create a serious gap in the coverage of the act.
(2) The Board believes that section 4(c)(6) should properly be interpreted as creating an exemption from the general prohibitions in section 4 on ownership of stock in nonbank companies only for passive investments amounting to not more than 5 percent of a company’s outstanding stock, and that the exemption was not intended to allow a group of holding companies, through concerted action, to engage in an activity as entrepreneurs. Section 4 of the act, of course prohibits not only owning stock in nonbank companies, but engaging in activities other than banking or those activities permitted by the Board under section 4(c)(8) as being closely related to banking. Thus, if a holding company may be deemed to be engaging in an activity through the medium of a company in which it owns less than 5 percent of the voting stock it may nevertheless require Board approval, despite the section 4(c)(6) exemption.
To accept the argument that section 4(c)(6) is an unqualified grant of permission to a bank holding company to own 5 percent of the shares of any nonbanking company, irrespective of the nature or extent of the holding company’s participation in the affairs of the nonbanking company would, in the Board’s view, create the potential for serious and widespread evasion of the act’s controls over nonbanking activities. Such a construction would allow a group of 20 bank holding companies—or even a single bank holding company and one or more nonbank companies—to engage in entrepreneurial joint ventures in businesses prohibited to bank holding companies, a result the Board believes to be contrary to the intent of Congress.
In this proposal, each of the participating stockholders must be viewed as engaging in the business of insurance underwriting. Each stockholder would agree to channel to the company the insurance business it generates, and the value of the interest of each stockholder would be determined by reference to the profitability of the business generated by that stockholder itself. There is no sharing or pooling among stockholders of underwriting risks assumed by the company, and profit or loss from investments is allocated on the basis of each bank holding company’s allocable underwriting profit or loss. The interest of each stockholder is thus clearly that of an entrepreneur rather than that of an investor.
Accordingly, on the basis of the factual situation before the Board, and for the reasons summarized above, the Board has concluded that section 4(c)(6) of the act cannot be interpreted to exempt the ownership of 5 percent of the voting stock of a company under the circumstances described, and that a bank holding company wishing to become a stockholder in a company under this proposal would be required to obtain the Board’s approval to do so. 1977 Fed. Res. Bull. 60; 12 CFR 225.137.
*
Section 4(c)(6) of the act provides an exemption from the act’s prohibitions on ownership of shares in nonbanking companies for “shares of any company which do not include more than 5 per centum of the outstanding voting shares of such company.”
4-190

FOREIGN-BASED BANK HOLDING COMPANIES

Effective December 1, 1971 the Board of Governors has added a new section 225.4(g) to Regulation Y implementing its authority under section 4(c)(9) of the Bank Holding Company Act. The Board’s views on some questions that have arisen in connection with the meaning of terms used in section 225.4(g) are set forth below.
The term “activities” refers to nonbanking activities and does not include the banking activities that foreign banks conduct in the United States through branches or agencies licensed under the banking laws of any state of the United States or the District of Columbia.
A company (including a bank holding company) will not be deemed to be engaged in “activities” in the United States merely because it exports (or imports) products to (or from) the United States, or furnishes services or finances goods or services in the United States, from locations outside the United States. A company is engaged in “activities” in the United States if it owns, leases, maintains, operates, or controls any of the following types of facilities in the United States:
  • 1.
    a factory,
  • 2.
    a wholesale distributor or purchasing agency,
  • 3.
    a distribution center,
  • 4.
    a retail sales or service outlet,
  • 5.
    a network of franchised dealers,
  • 6.
    a financing agency, or
  • 7.
    similar facility for the manufacture, distribution, purchasing, furnishing, or financing of goods or services locally in the United States.
A company will not be considered to be engaged in “activities” in the United States if its products are sold to independent importers, or are distributed through independent warehouses, that are not controlled or franchised by it.
In the Board’s opinion, section 4(a)(1) of the Bank Holding Company Act applies to ownership or control of shares of stock as an investment and does not apply to ownership or control of shares of stock in the capacity of an underwriter or dealer in securities. Underwriting or dealing in shares of stock are nonbanking activities prohibited to bank holding companies by section 4(a)(2) of the act, unless otherwise exempted. Under section 225.4(g) of Regulation Y, foreign bank holding companies are exempt from the prohibitions of section 4 of the act with respect to their activities outside the United States; thus foreign bank holding companies may underwrite or deal in shares of stock (including shares of United States issuers) to be distributed outside the United States, provided that shares so acquired are disposed of within a reasonable time.
A foreign bank holding company does not “indirectly” own voting shares by reason of the ownership or control of such voting shares by any company in which it has a noncontrolling interest. A foreign bank holding company may, however, “indirectly” control such voting shares if its noncontrolling interest in such company is accompanied by other arrangements that, in the Board’s judgment, result in control of such shares by the bank holding company. The Board has made one exception to this general approach. A foreign bank holding company will be considered to indirectly own or control voting shares of a bank if that bank holding company acquires more than 5 percent of any class of voting shares of another bank holding company. A bank holding company may make such an acquisition only with prior approval of the Board.
A company is “indirectly” engaged in activities in the United States if any of its subsidiaries (whether or not incorporated under the laws of this country) are engaged in such activities. A company is not “indirectly” engaged in activities in the United States by reason of a noncontrolling interest in a company engaged in such activities.
Under the foregoing rules, a foreign bank holding company may have a noncontrolling interest in a foreign company that has a United States subsidiary (but is not engaged in the securities business in the United States) if more than half of the foreign company’s consolidated assets and revenues are located and derived outside the United States. For the purpose of such determination, the assets and revenues of the United States subsidiary would be counted among the consolidated assets and revenues of the foreign company to the extent required or permitted by generally accepted accounting principles in the United States. The foreign bank holding company would not, however, be permitted to “indirectly” control voting shares of the said United States subsidiary, as might be the case if there are other arrangements accompanying its noncontrolling interest in the foreign parent company that, in the Board’s judgment, result in control of such shares by the bank holding company. 1971 Fed. Res. Bull. 932; 12 CFR 225.124.
4-190.5

NONBANK BANKS—Limitations on Activities and Growth

Effective August 10, 1987, the Competitive Equality Banking Act of 1987 (CEBA) redefined the term “bank” in the Bank Holding Company Act (“BHC Act” or “act”) to include any bank the deposits of which are insured by the Federal Deposit Insurance Corporation as well as any other institution that accepts demand or checkable deposit accounts and is engaged in the business of making commercial loans (12 USC 1841(c)). CEBA also contained a grandfather provision for certain companies affected by this redefinition. CEBA amended section 4 of the BHC Act to permit a company that on March 5, 1987, controlled a nonbank bank (an institution that became a bank as a result of enactment of CEBA) and that was not a bank holding company on August 9, 1987, to retain its nonbank bank and not be treated as a bank holding company for purposes of the BHC Act if the company and its subsidiary nonbank bank observe certain limitations imposed by CEBA.1 Certain of these limitations are codified in section 4(f)(3) of the BHC Act and generally restrict nonbank banks from commencing new activities or certain cross-marketing activities with affiliates after March 5, 1987, increasing their assets at an annual rate exceeding 7 percent during any 12-month period after August 10, 1988, or permitting overdrafts for affiliates or incurring overdrafts on behalf of affiliates at a Federal Reserve Bank (12 USC 1843(f)(3)).2
The Board’s views regarding the meaning and scope of these limitations are set forth below and in provisions of the Board’s Regulation Y (12 CFR 225.51 and 52).
1
12 USC 1843(f). Such a company is treated as a bank holding company, however, for purposes of the anti-tying provisions in section 106 of the BHC Act Amendments of 1970 (12 USC 1971 et seq.) and the insider-lending limitations of section 22(h) of the Federal Reserve Act (12 USC 375b). The company is also subject to certain examination and enforcement provisions to ensure compliance with CEBA.
2
CEBA also prohibits, with certain limited exceptions, a company controlling a grandfathered nonbank bank from acquiring control of an additional bank or thrift institution or acquiring, directly or indirectly after March 5, 1987, more than 5 percent of the assets or shares of a bank or thrift institution (12 USC 1843(f)(2)).

Congressional Findings

At the outset, the Board notes that the scope and application of the act’s limitations on nonbank banks must be guided by the congressional findings set out in section 4(f)(3) of the BHC Act. Congress was aware that these nonbank banks had been acquired by companies that engage in a wide range of nonbanking activities, such as retailing and general securities activities that are forbidden to bank holding companies under section 4 of the BHC Act. In section 4(f)(3), Congress found that nonbank banks controlled by grandfathered nonbanking companies may, because of their relationships with affiliates, be involved in conflicts of interest, concentration of resources, or other effects adverse to bank safety and soundness. Congress also found that nonbank banks may be able to compete unfairly against banks controlled by bank holding companies by combining banking services with financial services not permissible for bank holding companies. Section 4(f)(3) states that the purpose of the nonbank-bank limitations is to minimize any such potential adverse effects or inequities by restricting the activities of nonbank banks until further congressional action in the area of bank powers could be undertaken. Similarly, the Senate report accompanying CEBA states that the restrictions CEBA places on nonbank banks “will help prevent existing nonbank banks from changing their basic character . . . while Congress considers proposals for comprehensive legislation; from drastically eroding the separation of banking and commerce; and from increasing the potential for unfair competition, conflicts of interest, undue concentration of resources, and other adverse effects.” (S. Rep. No. 100-19, 100th Cong., 1st Sess. 12 (1987). See also H. Rep. No. 100261, 100th Cong., 1st Sess. 124 (1987) (the “Conference Report”).)
Thus, Congress explicitly recognized in the statute itself that nonbanking companies controlling grandfathered nonbank banks, which include many of the nation’s largest commercial and financial organizations, were being accorded a significant competitive advantage that could not be matched by bank holding companies because of the general prohibition against nonbanking activities in section 4 of the BHC Act. Congress recognized that this inequality in regulatory approach could inflict serious competitive harm on regulated bank holding companies as the grandfathered entities sought to exploit potential synergies between banking and commercial products and services. (See Conference Report at 125-126.) The basic and stated purpose of the restrictions on grandfathered nonbank banks is to minimize these potential anticompetitive effects.
The Board believes that the specific CEBA limitations should be implemented in light of these congressional findings and the legislative intent reflected in the plain meaning of the terms used in the statute. In those instances when the language of the statute did not provide clear guidance, legislative materials and the congressional intent manifested in the overall statutory structure were considered. The Board also notes that prior precedent requires that grandfather exceptions in the BHC Act, such as the nonbank-bank limitations and particularly the exceptions thereto, are to be interpreted narrowly in order to ensure the proper implementation of congressional intent. 3
3
E.g., Maryland National Corporation, 73 Fed. Res. Bull. 310, 313-314 (1987). Cf., Spokane & Inland Empire Railroad Co. v. United States, 241 U.S. 344, 350 (1915).

Activity Limitation

Scope of “Activity”
The first limitation established under section 4(f)(3) provides that a nonbank bank shall not “engage in any activity in which such bank was not lawfully engaged as of March 5, 1987.”
The term “activity” as used in this provision of CEBA is not defined. The structure and placement of the CEBA activity restriction within section 4 of the BHC Act and its legislative history do, however, provide direction as to certain transactions that Congress intended to treat as separate activities, thereby providing guidance as to the meaning Congress intended to ascribe to the term generally. First, it is clear that the term “activity” was not meant to refer to banking as a single activity. To the contrary, the term must be viewed as distinguishing between deposit taking and lending activities and treating demand-deposit taking as a separate activity from general deposit taking and commercial lending as separate from the general lending category.
Under the activity limitation, a nonbank bank may engage only in activities in which it was “lawfully engaged” as of March 5, 1987. As of that date, a nonbank bank could not have been engaged in both demand-deposit taking and commercial-lending activity without placing it and its parent holding company in violation of the BHC Act. Thus, under the activity limitations, a nonbank bank could not after March 5, 1987, commence the demand-deposit taking or commercial-lending activity that it did not conduct as of March 5, 1987. The debates and Senate and conference reports on CEBA confirm that Congress intended the activity limitation to prevent a grandfathered nonbank bank from converting itself into a full-service bank by both offering demand deposits and engaging in the business of making commercial loans.4 Thus, these types of transactions provide a clear guide as to the type of banking transactions that would constitute activities under CEBA and the degree of specificity intended by Congress in interpreting that term.
It is also clear that the activity limitation was not intended simply to prevent a nonbank bank from both accepting demand deposits and making commercial loans; it has a broader scope and purpose. If Congress had meant the term to refer to just these two activities, it would have used the restriction it used in another section of CEBA dealing with nonbank banks owned by bank holding companies which has this result, i.e., the nonbank bank could not engage in any activity that would have caused it to become a bank under the prior bank definition in the act. (See 12 USC 1843(g)(1)(A).) Indeed, an earlier version of CEBA under consideration by the Senate Banking Committee contained such a provision for nonbank banks owned by commercial holding companies, which was deleted in favor of the broader activity limitation actually enacted. Committee Print No. 1, (Feb. 17, 1987). In this regard, both the Senate report and conference report refer to demand-deposit taking and commercial lending as examples of activities that could be affected by the activity limitation, not as the sole activities to be limited by the provision.5
Finally, additional guidance as to the meaning of the term “activity” is provided by the statutory context in which the term appears. The activity limitation is contained in section 4 of the BHC Act, which regulates the investments and activities of bank holding companies and their nonbank subsidiaries. The Board believes it reasonable to conclude that by placing the CEBA activity limitation in section 4 of the BHC Act, Congress meant that Board and judicial decisions regarding the meaning of the term “activity” in that section be looked to for guidance. This is particularly appropriate given the fact that grandfathered nonbank banks, whether owned by bank holding companies or unregulated holding companies, were treated as nonbank companies and not banks before enactment of CEBA.
This interpretation of the term “activity” draws support from comments by Senator Proxmire during the Senate’s consideration of the provision that the term was not intended to apply “on a product-by-product, customer-by-customer basis” (133 Cong. Rec. S4054-5 (daily ed. March 27, 1987)). This is the same manner in which the Board has interpreted the term “activity” in the nonbanking provision of section 4 as referring to generic categories of activities, not to discrete products and services.
Accordingly, consistent with the terms and purposes of the legislation and the congressional intent to minimize unfair competition and the other adverse effects set out in the CEBA findings, the Board concludes that the term “activity” as used in section 4(f)(3) means any line of banking or nonbanking business. This definition does not, however, envision a product-by-product approach to the activity limitation. The Board believes it would be helpful to describe the application of the activity limitation in the context of the following major categories of activities: deposit taking, lending, trust, and other activities engaged in by banks.
Deposit-Taking Activities
With respect to deposit taking, the Board believes that the activity limitation in section 4(f)(3) generally refers to three types of activity: demand-deposit taking; nondemand-deposit taking with a third-party-payment capability; and time- and savings-deposit taking without third-party-payment powers. As previously discussed, it is clear from the terms and intent of CEBA that the activity limitation would prevent, and was designed to prevent, nonbank banks that prior to the enactment of CEBA had refrained from accepting demand deposits in order to avoid coverage as a “bank” under the BHC Act, from starting to take these deposits after enactment of CEBA and thus becoming full-service banks. Accordingly, CEBA requires that the taking of demand deposits be treated as a separate activity.
The Board also considers nondemand deposits withdrawable by check or other similar means for payment to third parties or others to constitute a separate line of business for purposes of applying the activity limitation. In this regard, the Board has previously recognized that this line of business constitutes a permissible but separate activity under section 4 of the BHC Act. Furthermore, the offering of accounts with transaction capability requires different expertise and systems than nontransaction-deposit taking and represented a distinct new activity that traditionally separated banks from thrift and similar institutions.
Support for this view may also be found in the House Banking Committee report on proposed legislation prior to CEBA that contained a similar prohibition on new activities for nonbank banks. In discussing the activity limitation, the report recognized a distinction between demand deposits and accounts with transaction capability and those without transaction capability:
With respect to deposits, the Committee recognizes that it is legitimate for an institution currently involved in offering demand deposits or other third party transaction accounts to make use of new technologies that are in the process of replacing the existing check-based, paper payment system. Again, however, the Committee does not believe that technology should be used as a lever for an institution that was only inicidentally involved in the payment system to transform itself into a significant offeror of transaction account capability.6
Finally, this distinction between demand and nondemand checkable accounts and accounts not subject to withdrawal by check was specifically recognized by Congress in the redefinition of the term “bank” in CEBA to include an institution that takes demand deposits or “deposits that the depositor may withdraw by check or other means for payment to third parties or others” as well as in various exemptions from that definition for trust companies, credit card banks, and certain industrial banks.7
Thus, an institution that as of March 5, 1987, offered only time and savings accounts that were not withdrawable by check for payment to third parties could not thereafter begin offering accounts with transaction capability, for example, NOW accounts or other types of transaction accounts.
Lending
As noted, the CEBA activity limitation does not treat lending as a single activity; it clearly distinguishes between commercial and other types of lending. This distinction is also reflected in the definition of “bank” in the BHC Act in effect both prior to and after enactment of CEBA as well as in various of the exceptions from this definition. In addition, commercial lending is a specialized form of lending involving different techniques and analysis from other types of lending. Based upon these factors, the Board would view commercial lending as a separate and distinct activity for purposes of the activity limitation in section 4(f)(3). The Board’s decisions under section 4 of the BHC Act have not generally differentiated between types of commercial lending, and thus the Board would view commercial lending as a single activity for purposes of CEBA. Thus, a nonbank bank that made commercial loans as of March 5, 1987, could make any type of commercial loan thereafter.
Commercial lending. For purposes of the activity limitation, a commercial loan is defined in accordance with the Supreme Court’s decision in Board of Governors v. Dimension Financial Corporation, 474 U.S. 361 (1986), as a direct loan to a business customer for the purpose of providing funds for that customer’s business. In this regard, the Board notes that whether a particular transaction is a commercial loan must be determined not from the face of the instrument, but from the application of the definition of commercial loan in the Dimension decision to that transaction. Thus, certain transactions of the type mentioned in the Board’s ruling at issue in Dimension and in the Senate and conference reports in the CEBA legislation8 would be commercial loans if they meet the test for commercial loans established in Dimension. Under this test, a commercial loan would not include, for example, an open-market investment in a commercial entity that does not involve a borrower-lender relationship or negotiation of credit terms, such as a money-market transaction.
Other lending. Based upon the guidance in the act as to the degree of specificity required in applying the activity limitation with respect to lending, the Board believes that, in addition to commercial lending, there are three other types of lending activities: consumer mortgage lending, consumer credit card lending, and other consumer lending. Mortgage lending and credit card lending are recognized, discrete lines of banking and business activity, involving techniques and processes that are different from and more specialized than those required for general consumer lending. For example, these activities are, in many cases, conducted by specialized institutions, such as mortgage companies and credit card institutions, or through separate organizational structures within an institution, particularly in the case of mortgage lending. Additionally, the Board’s decisions under section 4 of the act have recognized mortgage banking and credit card lending as separate activities for bank holding companies. The Board’s Regulation Y reflects this specialization, noting as examples of permissible lending activity: consumer finance, credit card and mortgage lending (12 CFR 225.25(b)(1)). Finally, CEBA itself recognizes the specialized nature of credit card lending by exempting an institution specializing in that activity from the “bank” definition.
For purpose of the activity limitation, a consumer mortgage loan will mean any loan to an individual that is secured by real estate and that is not a commercial loan. A credit card loan would be any loan made to an individual by means of a credit card that is not a commercial loan.
Trust Activities
Under section 4 of the act, the Board has historically treated trust activities as a single activity and has not differentiated the function on the basis of whether the customer was an individual or a business (see 12 CFR 225.25 (b)(3)). Similarly, the trust company exemption from the “bank” definition in CEBA makes no distinction between various types of trust activities. Accordingly, the Board would view trust activities as a separate activity without additional differentiation for purposes of the activity limitation in section 4(f)(3).
Other Activities
With respect to activities other than the various traditional deposit-taking, lending, or trust activities, the Board believes it appropriate, for the reasons discussed above, to apply the activity limitation in section 4(f)(3) as the term “activity” generally applies in other provisions of section 4 of the BHC Act. Thus, a grandfathered nonbank bank could not, for example, commence after March 5, 1987, any of the following activities (unless it was engaged in such an activity as of that date): discount securities brokerage, full-service securities brokerage, investment advisory services, underwriting or dealing in government securities as permissible for member banks, foreign-exchange transaction services, real or personal property leasing, courier services, data processing for third parties, insurance-agency activities,9 real estate development, real estate brokerage, real estate syndication, insurance underwriting, management consulting, futures commission merchant, or activities of the general type listed in section 225.25(b) of Regulation Y.
Meaning of “Engaged in”
In order to be “engaged in” an activity, a nonbank bank must demonstrate that it had a program in place to provide a particular product or service included within the grandfathered activity to a customer and that it was in fact offering the product or service to customers as of March 5, 1987. Thus, a nonbank bank is not engaged in an activity as of March 5, 1987, if the product or service in question was in a planning state as of that date and had not been offered or delivered to a customer. Consistent with prior Board interpretations of the term “activity” in the grandfather provisions of section 4, the Board does not believe that a company may be engaged in an activity on the basis of a single isolated transaction that was not part of a program to offer the particular product or to conduct in the activity on an ongoing basis. For example, a nonbank bank that held an interest in a single real estate project would not thereby be engaged in real estate development for purposes of this provision, unless evidence was presented indicating the interest was held under a program to commence a real estate development business.
Meaning of “as of”
The Board believes that the grandfather date “as of March 5, 1987” as used throughout section 4(f)(3) should refer to activities engaged in on March 5, 1987, or a reasonably short period preceding this date not exceeding 13 months (133 Cong. Rec. S3957 (daily ed. March 26, 1987) (remarks of Senators Dodd and Proxmire)). Activities that the institution had terminated prior to March 5, 1988, however, would not be considered to have been conducted or engaged in “as of” March 5. For example, if within 13 months of March 5, 1987, the nonbank bank had terminated its commercial-lending activity in order to avoid the “bank” definition in the act, the nonbank bank could not recommence that activity after enactment of CEBA.
4
Conference Report at 124-125; S. Rep. No. 100-19 at 12, 32; H. Rep. No. 99-175, 99th Cong., 1st Sess. 3 (1985) (“the activities limitation is to prevent an institution engaged in a limited range of functions from expanding into new areas and becoming, in essence, a full-service bank”); 133 Cong. Rec. S4054 (daily ed. March 27, 1987); (comments of Senator Proxmire).
5
Conference Report at 124-125; S. Rep. No. 100-19 at 32.
6
H. Rep. No. 99-175, 99th Cong., 1st Sess. 13 (1985).
7
See 12 USC 1841(c)(2)(D), (F), (H), and (I).
8
S. Rep. No. 100-19 at 31; Conference Report at 123.
9
In this area, section 4 of the act does not treat all insurance-agency activities as a single activity. Thus, for example, the act treats the sale of credit-related life, accident, and health insurance as a separate activity from general insurance-agency activities. See 12 USC 1843(c)(8).

Cross-Marketing Limitation

Section 4(f)(3) also limits cross-marketing activities by nonbank banks and their affiliates. Under this provision, a nonbank bank may not offer or market a product or service of an affiliate unless the product or service may be offered by bank holding companies generally under section 4(c)(8) of the BHC Act. In addition, a nonbank bank may not permit any of its products or services to be offered or marketed by or through a nonbank affiliate unless the affiliate engages only in activities permissible for a bank holding company under section 4(c)(8). These limitations are subject to an exception for products or services that were being so offered or marketed as of March 5, 1987, but only in the same manner in which they were being offered or marketed as of that date.
Examples of Impermissible Cross-Marketing
The conference report illustrates the application of this limitation to the following two covered transactions: (i) products and services of an affiliate that bank holding companies may not offer under the BHC Act, and (ii) products and services of the nonbank bank. In the first case, the restrictions would prohibit, for example, a company from marketing life insurance or automotive supplies through its affiliate nonbank bank because these products are not generally permissible under the BHC Act (Conference Report at 126). In the second case, a nonbank bank may not permit its products or services to be offered or marketed through a life insurance affiliate or automobile-parts retailer because these affiliates engage in activities prohibited under the BHC Act (Id.).
Permissible Cross-Marketing
On the other hand, a nonbank bank could offer to its customers consumer loans from an affiliated mortgage banking or consumer finance company. These affiliates could likewise offer their customers the nonbank bank’s products or services provided the affiliates engaged only in activities permitted for bank holding companies under the closely-related-to-banking standard of section 4(c)(8) of the BHC Act. If the affiliate is engaged in both permissible and impermissible activities within the meaning of section 4(c)(8) of the BHC Act, however, the affiliate could not offer or market the nonbank bank’s products or services.
Product Approach to Cross-Marketing Restriction
Unlike the activity restrictions, the cross-marketing restrictions of CEBA apply by their terms to individual products and services. Thus, an affiliate of a nonbank bank that was engaged in activities that are not permissible for bank holding companies and that was marketing a particular product or service of a nonbank bank on the grandfather date could continue to market that product and, as discussed below, could change the terms and conditions of the loan. The nonbank affiliate could not, however, begin to offer or market another product or service of the nonbank bank.
The Board believes that the term “product or service” must be interpreted in light of its accepted ordinary commercial usage. In some instances, commercial usage has identified a group of products so closely related that they constitute a product line (e.g., certificates of deposit) and differences in versions of the product (e.g., a one-year certificate of deposit) simply represent a difference in the terms of the product.10 This approach is consistent with the treatment in CEBA’s legislative history of certificates of deposit as a product line rather than each particular type of CD as a separate product.11
In the area of consumer lending, the Board believes the following provide examples of different consumer loan products: mortgage loans to finance the purchase of the borrower’s residence, unsecured consumer loans, consumer installment loans secured by the personal property to be purchased (e.g., automobile, boat, or home-appliance loans), or second-mortgage loans.12 Under this interpretation, a nonbank bank that offered automobile loans through a nonbank affiliate on the grandfather date could market boat loans, appliance loans, or any type of secured consumer installment loan through that affiliate. It could not, however, market unsecured consumer loans, home mortgage loans, or other types of consumer loans.
In other areas, the Board believes that the determination as to what constitutes a product or service should be made on a case-by-case basis consistent with the principles that the terms “product or service” must be interpreted in accordance with their ordinary commercial usage and must be narrower in scope than the definition of “activity.” Essentially, the concept applied in this analysis is one of permitting the continuation of the specific product-marketing activity that was undertaken as of March 5, 1987. Thus, for example, while insurance underwriting may constitute a separate activity under CEBA, a nonbank bank could not market a life insurance policy issued by the affiliate if on the grandfather date it had only marketed homeowners’ policies issued by the affiliate.
Change in Terms and Conditions Permitted
The cross-marketing restrictions would not limit the ability of the institution to change the specific terms and conditions of a particular grandfathered product or service. The conference report indicates a legislative intent not to lock into place the specific terms or conditions of a grandfathered product or service (Conference Report at 126). For example, a nonbank bank marketing a three-year, $5,000 certificate of deposit through an affiliate under the exemption could offer a one-year $2,000 certificate of deposit with a different interest rate after the grandfather date (see footnote 11 above). Modifications that alter the type of product, however, are not permitted. Thus, a nonbank bank that marketed through affiliates on March 5, 1987, only certificates of deposit could not commence marketing MMDAs or NOW accounts after the grandfather date.
General changes in the character of the product or service as the result of market or technological innovation are similarly permitted to the extent that they do not transform a grandfathered product into a new product. Thus, an unsecured line of credit could not be modified to include a lien on the borrower’s residence without becoming a new product.
Meaning of “Offer or Market”
In the Board’s opinion, the terms “offer or market” in the cross-marketing restrictions refer to the presentation to a customer of an institution’s products or service through any type of program, including telemarketing, advertising brochures, direct mailing, personal solicitation, customer referrals, or joint-marketing agreements or presentations. An institution must have offered or actually marketed the product or service on March 5 or shortly before that date (as discussed above) to qualify for the grandfather privilege. Thus, if the cross-marketing program was in the planning stage on March 5, 1987, the program would not qualify for grandfather treatment under CEBA.
Limitations on Cross-Marketing to “In the Same Manner”
The cross-marketing restriction in section 4(f)(3) contains a grandfather provision that permits products or services that would otherwise be prohibited from being offered or marketed under the provision to continue to be offered or marketed by a particular entity if the products or services were being so offered or marketed as of March 5, 1987, but “only in the same manner in which they were being offered or marketed as of that date.” Thus, to qualify for the grandfather provision, the manner of offering or marketing the otherwise prohibited product or service must remain the same as on the grandfather date.
In interpreting this provision, the Board notes that Congress designed the joint-marketing restrictions to prevent the significant risk to the public posed by the conduct of such activities by insured banks affiliated with companies engaged in general commerce, to ensure objectivity in the credit-granting process and to “minimize the unfair competitive advantage that grandfathered commercial companies owning nonbank banks might otherwise engage over regulated bank holding companies and our competing commercial companies that have no subsidiary bank” (Conference Report at 125 -126). The Board believes that determinations regarding the manner of cross-marketing of a particular product or service may best be accomplished by applying the limitation to the particular facts in each case consistent with the stated purpose of this provision of CEBA and the general principle that grandfather restrictions and exceptions to general prohibitions must be narrowly construed in order to prevent the exception from nullifying the rule. Essentially, as in the scope of the terms “product or service,” the guiding principle of congressional intent with respect to this term is to permit only the continuation of the specific types of crossmarketing activity that were undertaken as of March 5, 1987.
Eligibility for Cross-Marketing Grandfather Exemption
The conference report also clarifies that entitlement to an exemption to continue to cross-market products and services otherwise prohibited by the statute applies only to the specific company that was engaged in the activity as of March 5, 1987 (Conference Report at 126). Thus, an affiliate that was not engaged in cross-marketing products or services as of the grandfather date may not commence these activities under the exemption even is such activities were being conducted by another affiliate (Id.; see also S. Rep. No. 100-19 at 33-34).
10
American Bankers Association, Banking Terminology (1981).
11
During the Senate debates on CEBA, Senator Proxmire in response to a statement from Senator Cranston that the joint-marketing restrictions do not lock into place the specific terms or conditions of the particular grandfathered product or service, stated—
That is correct. For example, if a nonbank bank was jointly marketing on March 5, 1987, a three-year, $5,000 certificate of deposit, this bill would not prohibit offering in the same manner a one-year, $2,000 certificate of deposit with a different interest rate (133 Cong. Rec. S3959 (daily ed. March 26, 1987)).
12
In this regard, the Supreme Court in United States v. Philadelphia National Bank, noted that “the principal banking products are of course various types of credit, for example: unsecured personal and business loans, mortgage loans, loans secured by securities or accounts receivable, automobile installment and consumer goods, installment loans, tuition financing, bank credit cards, revolving credit funds” (374 U.S. 321, 326 n.5 (1963)).

Eligibility for Grandfathered Nonbank-Bank Status

In reviewing the reports required by CEBA, the Board notes that a number of institutions that had not commenced business operations on August 10, 1987, the date of enactment of CEBA, claimed grandfather privileges under section 4(f)(3) of CEBA. To qualify for grandfather privileges under section 4(f)(3), the institution must have “bec[o]me a bank as a result of the enactment of [CEBA]” and must have been controlled by a nonbanking company on March 5, 1987 (12 USC 1843(f)(1)(A)). An institution that did not have FDIC insurance on August 10, 1987, and that did not accept demand deposits or transaction accounts or engage in the business of commercial lending on that date, would not have become a “bank” as a result of enactment of CEBA. Thus, institutions that had not commenced operations on August 10, 1987, could not qualify for grandfather privileges under section 4(f)(3) of CEBA. This view is supported by the activity limitations of section 4(f)(3), which, as noted, limit the activities of grandfathered nonbank banks to those in which they were lawfully engaged as of March 5, 1987. A nonbank bank that had not commenced conducting business activities on March 5, 1987, could not after enactment of CEBA engage in any activities under this provision. 1988 Fed. Res. Bull. 764; 12 CFR 225.145.
4-191

PRESUMPTION OF CONTROL—Under BHCA Section 2(g)(3)

Section 2(g)(3) of the Bank Holding Company Act (the “act”) establishes a statutory presumption that where certain specified relationships exist between a transferor and transferee of shares, the transferor (if it is a bank holding company, or a company that would be such but for the transfer) continues to own or control indirectly the transferred shares.1 This presumption arises by operation of law, as of the date of the transfer, without the need for any order or determination by the Board. Operation of the presumption may be terminated only by the issuance of a Board determination, after opportunity for hearing, “that the transferor is not in fact capable of controlling the transferee.”2
The purpose of section 2(g)(3) is to provide the Board an opportunity to assess the effectiveness of divestitures in certain situations in which there may be a risk that the divestiture will not result in the complete termination of a control relationship. By presuming control to continue as a matter of law, section 2(g)(3) operates to allow the effectiveness of the divestiture to be assessed before the divesting company is permitted to act on the assumption that the divestiture is complete. Thus, for example, if a holding company divests its banking interests under circumstances where the presumption of continued control arises, the divesting company must continue to consider itself bound by the act until an appropriate order is entered by the Board dispelling the presumption. Section 2(g)(3) does not establish a substantive rule that invalidates transfers to which it applies, and in a great many cases the Board has acted favorably on applications to have the presumption dispelled. It merely provides a procedural opportunity for Board consideration of the effect of such transfers in advance of their being deemed effective. Whether or not the statutory presumption arises, the substantive test for assessing the effectiveness of a divestiture is the same —that is, the Board must be assured that all control relationships between the transferor and the transferred property have been terminated and will not be reestablished.3
In the course of administering section 2(g)(3) the Board has had several occasions to consider the scope of that section. In addition, questions have been raised by and with the Board’s staff as to coverage of the section. Accordingly, the Board believes it would be useful to set forth the following interpretations of section 2(g)(3):
1. The terms “transferor” and “transferee,” as used in section 2(g)(3), include parents and subsidiaries of each. Thus, for example, where a transferee is indebted to a subsidiary of the transferor, or where a specified interlocking relationship exists between the transferor or transferee and a subsidiary of the other (or between subsidiaries of each), the presumption arises. Similarly, if a parent of the transferee is indebted to a parent of the transferor, the presumption arises. The presumption of continued control also arises where an interlock or debt relationship is retained between the divesting company and the company being divested, since the divested company will be or may be viewed as a “subsidiary” of the transferee or group of transferees.
2. The terms “officers,” “directors,” and “trustees,” as used in section 2(g)(3), include persons performing functions normally associated with such positions (including general partners in a partnership and limited partners having a right to participate in the management of the affairs of the partnership) as well as persons holding such positions in an advisory or honorary capacity. The presumption arises not only where the transferee or transferred company has an officer, director or trustee “in common with” the transferor, but where the transferee himself holds such a position with the transferor.4
It should be noted that where a transfer takes the form of a pro-rata distribution, or “spinoff,” of shares to a company’s shareholders, officers, and directors of the transferor company are likely to receive a portion of such shares. The presumption of continued control would, of course, attach to any shares transferred to officers and directors of the divesting company, whether by “spinoff” or outright sale. However, the presumption will be of legal significance—and will thus require an application under section 2(g)(3)—only where the total number of shares subject to the presumption exceeds one of the applicable thresholds in the act. For example, where officers and directors of a one-bank holding company receive in the aggregate 25 percent or more of the stock of a bank subsidiary being divested by the holding company, the holding company would be presumed to continue to control the “divested” bank. In such a case it would be necessary for the divesting company to demonstrate that it no longer controls either the divested bank or the officer/director transferees. However, if officers and directors were to receive in the aggregate less than 25 percent of the bank’s stock (and no other shares were subject to the presumption), section 2(g)(3) would not have the legal effect of presuming continued control of the bank.5 In the case of a divestiture of nonbank shares, an application under section 2(g)(3) would be required whenever officers and directors of the divesting company received in the aggregate more than 5 percent of the shares of the company being divested.
3. Although section 2(g)(3) refers to transfers of “shares,” it is not, in the Board’s view, limited to disposition of corporate stock. General or limited partnership interests, for example, are included within the term “shares.” Furthermore, the transfer of all or substantially all of the assets of a company, or the transfer of such a significant volume of assets that the transfer may in effect constitute the disposition of a separate activity of the company, is deeded by the Board to involve a transfer of “shares” of that company.
4. The term “indebtedness” giving rise to the presumption of continued control under section 2(g)(3) of the act is not limited to debt incurred in connection with the transfer; it includes any debt outstanding at the time of transfer from the transferee to the transferor or its subsidiaries. However, the Board believes that not every kind of indebtedness was within the contemplation of the Congress when section 2(g)(3) was adopted. Routine business credit of limited amounts and loans for personal or household purposes are generally not the kinds of indebtedness that, standing alone, support a presumption that the creditor is able to control the debtor. Accordingly, the Board does not regard the presumption of section 2(g)(3) as applicable to the following categories of credit, provided the extensions of credit are not secured by the transferred property and are made in the ordinary course of business of the transferor (or its subsidiary) that is regularly engaged in the business of extending credit; (i) consumer credit extended for personal or household use to an individual transferee; (ii) student loans made for the education of the individual transferee or a spouse or child of the transferee; (iii) a home mortgage loan made to an individual transferee for the purchase of a residence for the individual’s personal use and secured by the residence; and (iv) loans made to companies (as defined in section 2(b) of the act) in an aggregate amount not exceeding 10 percent of the total purchase price (or if not sold, the fair market value) of the transferred property. The amounts and terms of the preceding categories of credit should not differ substantially from similar credit extended in comparable circumstances to others who are not transferees. It should be understood that, while the statutory presumption in situations involving these categories of credit may not apply, the Board is not precluded in any case from examining the facts of a particular transfer and finding that the divestiture of control was ineffective based on the facts of record.
Section 2(g)(3) provides that a Board determination that a transferor is not in fact capable of controlling a transferee shall be made after opportunity for hearing. It has been the Board’s routine practice since 1966 to publish notice in the Federal Register of applications filed under section 2(g)(3) and to offer interested parties an opportunity for a hearing. Virtually without exception no comments have been submitted on such applications by parties other than the applicant and, with the exception of one case in which the request was later withdrawn, no hearings have been requested in such cases. Because the Board believes that the hearing provision in section 2(g)(3) was intended as a protection for applicants who are seeking to have the presumption overcome by a Board order, a hearing would not be of use where an application is to be granted. In light of the experience indicating that the publication of Federal Register notice of such applications has not served a useful purpose, the Board has decided to alter its procedures in such cases. In the future, Federal Register notice of section 2(g)(3) applications will be published only in cases in which the Board’s general counsel, acting under delegated authority, has determined not to grant such an application and has referred the matter to the Board for decision.6 1978 Fed. Res. Bull. 211, 237; 12 CFR 225.139.
1
The presumption arises where the transferee “is indebted to the transferor, or has one or more officers, directors, trustees, or beneficiaries in common with or subject to control by the transferor.”
2
The Board has delegated to its general counsel the authority to issue such determinations (12 CFR 265.2(b)(1)).
3
It should be noted, however, that the Board will require termination of any interlocking management relationships between the divesting company and the transferee or the divested company as a precondition of finding that a divestiture is complete. Similarly, the retention of an economic interest in the divested company that would create an incentive for the divesting company to attempt to influence the management of the divested company will preclude a finding that the divestiture is complete. (See the Board’s order in the matter of International Bank, 1977 Fed. Res. Bull. 1106, 1113.)
4
It has been suggested that the words “in common with” in section 2(g)(3) evidence an intent to make the presumption applicable only where the transferee is a company having an interlock with the transferor. Such an interpretation would, in the Board’s view, create an unwarranted gap in the coverage of section 2(g)(3). Furthermore, because the presumption clearly arises where the transferee is an individual who is indebted to the transferor such an interpretation would result in an illogical internal inconsistency in the statute.
5
Of course, the fact that section 2(g)(3) would not operate to presume continued control would not necessarily mean that control had in fact been terminated if control could be exercised through other means.
6
It should be noted that in the event a third party should take exception to a Board order under section 2(g)(3) finding that control has been terminated, any rights such party might have would not be prejudiced by the order. If such party brought facts to the Board’s attention indicating that control had not been terminated the Board would have ample authority to revoke its order and take necessary remedial action.
Orders issued under section 2(g)(3) are published in the Federal Reserve Bulletin.
4-191.1

PRESUMPTION OF CONTROL—Investigation of Circumstances That May Indicate Control

Effective September 21, 1971, the Board amended Regulation Y, establishing a series of presumptions to be used by the Board in making findings regarding control of a bank or other company for purposes of determining whether a company is a bank holding company within the meaning of section 2 of the Bank Holding Company Act and whether a bank holding company has nonbanking interests in violation of the general prohibition in section 4 of the act.
The Board regards the circumstances described in the rebuttable presumptions as constituting sufficient legal bases (unless evidence rebutting the presumptions is offered) upon which to make determinations of control and impose the sanctions of the act upon the companies involved. There are a number of other circumstances that, standing alone, might not support valid presumptions of control but nonetheless are indicia of control and may call for further investigation to uncover facts that may support a determination of control. Such circumstances include, but are not limited to, the following:
  • 1. A company owns at least 10 percent of each of two banks or at least 5 percent of each of three or more banks.
  • 2. A company owning 5 percent or more of a bank or bank holding company has been instrumental in: hiring or firing a person or persons; establishing policies or places for branches; establishing hours of business; deciding on rates, terms, or acceptance of loans or deposits; following uniform advertising practices or using a common telephone system; or in any other respects directing the activities of management or establishing the policies of the bank or company.
  • 3. A company lends to enable the borrower to acquire voting shares of a bank or other company on terms more favorable to the borrower than the bank usually requires for loans to persons with comparable credit standing.
  • 4. A partnership has significant interests in a bank or bank holding company.
 The Board expects that a Reserve Bank will search its records with respect to registered bank holding companies to determine whether any of the rebuttable presumptions or guidelines described above apply to relationships involving such companies. An investigation should also be initiated in connection with any holding company application received by a Reserve Bank. With respect to banks that are not now, or proposing to become, members of a holding company system, it is expected that the applicability of the presumptions or guidelines will be investigated in connection with regular bank examinations.
A major reason the Board amended section 225.2 of Regulation Y was to furnish guidance to the public so that benefits may result to the extent that companies will avoid entering into the kinds of relationships described or will comply with provisions of the act by applying to the Board for approval of the relationships involved. The foregoing guidelines for use by the Reserve Banks were included in the Federal Register document amending section 225.2 as a further effort along this line.
The Board anticipates that its action will minimize demands on its time, and the Reserve Banks should keep this objective in mind when recommending action on control situations. Upon discovery of a control situation, a Reserve Bank should make every effort to resolve the problem with the company without resorting to the procedures set out in section 225.2(c). Whenever possible and appropriate, informal discussions with the companies involved should be initiated to bring the problem to their attention and encourage them to terminate the control situation or comply with the applicable provisions of the act.
If a Reserve Bank believes that Board action with respect to a particular control situation is necessary, it should send all relevant evidence to the Board, together with an evaluation of the importance of the control situation, the likelihood of its existence in other cases, and a statement indicating the efforts between the Bank and the company to cure the problem. Additionally, the Reserve Banks are encouraged at any time to submit suggestions for additional presumptions or guidelines. * * * S-2173; Sept. 17, 1971.
4-192

SERVICING EXEMPTION—Purchase of Instalment Paper for Subsidiary Banks

Section 4(c)(1) of the Bank Holding Company Act, among other things, exempts from the nonbanking divestment requirements of section 4(a) of the act shares of a company engaged “solely in the business of furnishing services to or performing services for” its bank holding company or subsidiary banks thereof.
The Board of Governors has had occasion to express opinions as to whether this section of law applies to the following two sets of facts:
(1) In the first case, Corporation X, a nonbanking subsidiary of a bank holding company (Holding Company A), was engaged in the business of purchasing instalment paper suitable for investment by banking subsidiaries of Holding Company A. All instalment paper purchased by Corporation X was sold by it to a bank which is a subsidiary of Holding Company A, without recourse, at a price equal to the cost of the instalment paper to Corporation X, and with compensation to the latter based on the earnings from such paper remaining after certain reserves, expenses, and charges. The subsidiary bank sold participations in such instalment paper to the other affiliated banks of Holding Company A which desired to participate. Purchases by Corporation X consisted mainly of paper insured under title I of the National Housing Act and, in addition, Corporation X purchased time payment contracts covering sales of appliances by dealers under contractual arrangements with utilities, as well as paper covering home improvements which was not insured. Pursuant to certain service agreements, Corporation X made all collections, enforced guaranties, filed claims under title I insurance and performed other services for the affiliated banks. Also Corporation X rendered to banking subsidiaries of Holding Company A various accounting, statistical and advisory services such as payroll, life insurance and budget loan instalment accounting.
(2) In the second case, Corporation Y, a nonbanking subsidiary of a bank holding company (Holding Company B, which was also a bank), solicited business on behalf of Holding Company B from dealers, throughout several adjoining or contiguous states, who made time sales and desired to convert their time sales paper into cash; but Corporation Y made no loans or purchases of sales contracts and did not discount or advance money for time sales obligations. Corporation Y investigated credit standings of purchasers obligated on time sales contracts to be acquired by Holding Company B. Corporation Y received from dealers the papers offered by them and inspected such papers to see that they were in order, and transmitted to Holding Company B for its determination to purchase, including, in some cases, issuance of drafts in favor of dealers in order to facilitate their prompt receipt of payment for instalment paper purchased by Holding Company B. Corporation Y made collections of delinquent paper or delinquent instalments, which sometimes involved repossession and resale of the automobile or other property which secured the paper. Also, upon request of purchasers obligated on paper held by Holding Company B, Corporation Y transmitted instalment payments to Holding Company B. Holding Company B reimbursed Corporation Y for its actual costs and expenses in performing the services mentioned above, including the salaries and wages of all Corporation Y officers and employees.
While the term “services” is sometimes used in a broad and general sense, the legislative history of the Bank Holding Company Act indicates that in section 4(c)(1) the word was meant to be somewhat more limited in its application. An early version of the bill specifically exempted companies engaged in serving the bank holding company and its subsidiary banks in “auditing, appraising, investment counseling.” The statute as finally enacted does not expressly mention any specific type of servicing activity for exemption. In recommending the change, the Senate Banking and Currency Committee stated that the types of services contemplated are “in the fields of advertising, public relations, developing new business, organization, operations, preparing tax returns, personnel, and many others,” which indicates that latitude should be given to the range of activities contemplated by this section beyond those specifically set forth in the early draft of the bill. (84th Cong., 2d sess., Senate Report 1095, part 2, p. 3.) It nevertheless seems evident that Congress intended such services to be types of activities generally comparable to those mentioned above from the early bill (“auditing, appraising, investment counseling”) and in the excerpt from the committee report on the later bill (“advertising, public relations, developing new business, organization, operations, preparing tax returns, personnel, and many others”). This legislative history and the context in which the term “services” is used in section 4(c)(1) seem to suggest that the term was in general intended to refer to servicing operations which a bank could carry on itself, but which the bank or its holding company chooses to have done through another organization. Moreover, the report of the Senate Banking and Currency Committee indicated that the types of servicing permitted under section 4(c)(1) are to be distinguished from activities of a “financial, fiduciary, or insurance nature,” such as those which might be considered for possible exemption under section 4(c)(6)* of the act.
With respect to the first set of facts, the Board expressed the opinion that certain of the activities of Corporation X, such as the accounting, statistical and advisory services referred to above, may be within the range of servicing activities contemplated by section 4(c)(1), but that this would not appear to be the case with the main activity of Corporation X, which was the purchase of instalment paper and the resale of such paper at cost, without recourse, to banking subsidiaries of Holding Company A. This latter and basic activity of Corporation X appeared to involve essentially a financial relationship between it and the banking subsidiaries of Holding Company A and appeared beyond the category of servicing exemptions contemplated by section 4(c)(1) of the act. Accordingly, it was the Board’s view that Corporation X could not be regarded as qualifying under section 4(c)(1) as a company engaged “solely in the business of furnishing services to or performing services for” Holding Company A or subsidiary banks thereof.
With respect to the second set of facts, the Board expressed the opinion that some of the activities engaged in by Corporation Y were clearly within the range of servicing activities contemplated by section 4(c)(1). There was some question as to whether or not some of the other activities of Corporation Y mentioned above could meet the test, but on balance, it seemed that all such activities probably were activities in which Holding Company B, which as already indicated was a bank, could itself engage, at the present locations of Corporation Y, without being engaged in the operation of bank branches at those locations. In the circumstances, while the question was not free from doubt, the Board expressed the opinion that the activities of Corporation Y were those of a company engaged “solely in the business of furnishing services to or performing services for” Holding Company B within the meaning of section 4(c)(1) of the act, and that, accordingly, the control by Holding Company B of shares in Corporation Y was exempted under that section. 1958 Fed. Res. Bull. 431; 12 CFR 225.104.
*
Redesignated section 4(c)(8) in 1966.
4-192.5

SECURITIES ACTIVITIES

See this heading beginning at 4-867.
4-193

SERVICING EXEMPTION—Furnishing Insurance

The Board of Governors has been requested by a bank holding company for an interpretation under section 4(c)(1) of the Bank Holding Company Act which, among other things, exempts from the nonbanking divestment requirements of section 4(a) of the act, shares of a company engaged “solely in the business of furnishing services to or performing services for” its bank holding company or subsidiary banks thereof.
It is understood that a nonbanking subsidiary of the holding company engages in writing comprehensive automobile insurance (fire, theft, and collision) which is sold only to customers of a subsidiary bank of the holding company in connection with the bank’s retail instalment loans; that when payment is made on a loan secured by a lien on a motor vehicle, renewal policies are not issued by the insurance company; and that the insurance company receives the usual agency commissions on all comprehensive automobile insurance written for customers of the bank.
It is also understood that the insurance company writes credit life insurance for the benefit of the bank and its instalment-loan customers; that each insured debtor is covered for an amount equal to the unpaid balance of his note to the bank, not to exceed $5,000; that as the note is reduced by regular monthly payments, the amount of insurance is correspondingly reduced so that at all times the debtor is insured for the unpaid balance of his note; that each insurance contract provides for payment in full of the entire loan balance upon the death or permanent disability of the insured borrower; and that this credit life insurance is written only at the request of, and solely for, the bank’s borrowing customers. It is further understood that the insurance company engages in no other activity.
As indicated in the Board’s opinion published in the 1958 Federal Reserve Bulletin, page 431 (at 4-192), the term “services,” while sometimes used in a broad and general sense, appears to be somewhat more limited in its application in section 4(c)(1) of the Bank Holding Company Act. Unlike an early version of the Senate bill (S. 2577, before amendment), the act as finally enacted does not expressly mention any type of servicing activity for exemption. The legislative history of the act, however, as indicated in the relevant portion of the report of the Senate Banking and Currency Committee on amended S. 2577 (84th Cong., 2d sess., Senate Report 1095, part 2, p. 3) makes it evident that Congress had in mind the exemption of services comparable to the types of activities mentioned expressly in the early Senate bill (“auditing, appraising, investment counseling”) and in the committee report on the later bill (“advertising, public relations, developing new business, organization, operations, preparing tax returns, personnel, and many others”). Furthermore, this committee report expressly stated that the provision of section 4(c)(1) with respect to “furnishing services to or performing services for” was not intended to supplant any exemption contained under section 4(c)(6)* of the act.
The only activity of the insurance company (writing comprehensive automobile insurance and credit life insurance) appears to involve an insurance relationship between it and a banking subsidiary of the holding company which the legislative history clearly indicates does not come within the meaning of the phrase “furnishing services to or performing services for” a bank holding company or its banking subsidiaries.
Accordingly, it is the Board’s view that the insurance company could not be regarded as qualifying as a company engaged “solely in the business of furnishing services to or performing services for” the bank holding company or banks with respect to which the latter is a bank holding company. 1958 Fed. Res. Bull. 1280; 12 CFR 225.109.
*
Redesignated section 4(c)(8) in 1966.
4-194

SERVICING EXEMPTION—Furnishing Services to Nonsubsidiary Banks

The Board of Governors has been requested for an opinion as to whether the performance of certain functions by a bank holding company for four banks of which it owns less than 25 percent of the voting shares is in violation of section 4(a) of the Bank Holding Company Act.
It is claimed that the holding company is engaged in “managing” four nonsubsidiary banks, for which services it receives “management fees.” Specifically, the company engages in the following activities for the four nonsubsidiary banks: (1) establishment and supervision of loaning policies; (2) direction of the purchase and sale of investment securities; (3) selection and training of officer personnel; (4) establishment and enforcement of operating policies; and (5) general supervision over all policies and practices.
The question raised is whether these activities are prohibited by section 4(a)(2) of the Bank Holding Company Act, which permits a bank holding company to engage in only three categories of business; (1) banking; (2) managing or controlling banks; and (3) furnishing services to or performing services for any bank of which the holding company owns or controls 25 percent or more of the voting shares.
Clearly, the activities of the company with respect to the four nonsubsidiary banks do not constitute “banking.” With respect to the business of “managing or controlling” banks, it is the Board’s view that such business, within the purview of section 4(a)(2), is essentially the exercise of a broad governing influence of the sort usually exercised by bank stockholders, as distinguished from direct or active participation in the establishment or carrying out of particular policies or operations. The latter kinds of activities fall within the third category of businesses in which a bank holding company is permitted to engage. In the Board’s view, the activities enumerated above fall in substantial part within that third category.
Section 4(a)(2), like all other sections of the Holding Company Act, must be interpreted in the light of all of its provisions, as well as in the light of other sections of the act. The expression “managing . . . banks,” if it could be taken by itself, might appear to include activities of the sort enumerated. However, such an interpretation of those words would virtually nullify the last portion of section 4(a)(2), which permits a holding company to furnish services to or perform services for “any bank of which it owns or controls 25 per centum or more of the voting shares.”
Since Congress explicitly authorized the performance of services for banks that are at least 25 percent owned by a holding company, it obviously intended that the holding company should not perform services for banks in which it owns less than 25 percent of the voting shares. However, if the second category—“managing or controlling banks”— were interpreted to permit the holding company to perform services for any bank, including a bank in which it held less than 25 percent of the stock (or no stock whatsoever), the last clause of section 4(a)(2) would be meaningless.
It is principally for this reason—that is, to give effective meaning to the final clause of section 4(a)(2)—that the Board interprets “managing or controlling banks” in that provision as referring to the exercise of a stockholder’s management or control of banks, rather than direct and active participation in their operations. To repeat, such active participation in operations falls within the third category (“furnishing services to or performing services for any bank”) and consequently may be engaged in only with respect to banks in which the holding company “owns or controls 25 per centum or more of the voting shares.”
Accordingly, it is the Board’s conclusion that, in performing the services enumerated, the bank holding company is “furnishing services to or performing services for” the four banks referred to. Under the act such furnishing or performing of services is permissible only if the holding company owns or controls 25 percent of the voting shares of each bank receiving such services, and, since the company owns less than 25 percent of the voting shares of these banks, it follows that these activities are prohibited by section 4(a)(2).
While this conclusion is required, in the Board’s opinion, by the language of the statute, it may be noted further that any other conclusion would make it possible for a bank holding company or any other corporation, through arrangements for the “managing” of banks in the manner here involved, to acquire effective control of banks without acquiring bank stocks and thus to evade the underlying objectives of section 3 of the act. 1959 Fed. Res. Bull. 1475: 12 CFR 225.113.
4-195

SERVICING EXEMPTION—Data Processing Services for Customers of Subsidiary Banks

The question has been presented to the Board of Governors whether a wholly owned nonbanking subsidiary (“service company”) of a bank holding company, which is now exempt from the prohibitions of section 4 of the Bank Holding Company Act of 1956 (“the act”) because its sole business is the providing of services for the holding company and the latter’s subsidiary banks, would lose its exempt status if it should provide data processing services for customers of the subsidiary banks.
The Board understood from the facts presented that the service company owns a computer which it utilizes to furnish data processing services for the subsidiary banks of its parent holding company. Customers of these banks have requested that the banks provide for them computerized billing, accounting, and financial records maintenance services. The banks wish to utilize the computer services of the service company in providing these and other services of a similar nature. It is proposed that, in each instance where a subsidiary bank undertakes to provide such services, the bank will enter into a contract directly with the customer and then arrange to have the service company perform the services for it, the bank. In no case will the service company provide services for anyone other than its affiliated banks. Moreover, it will not hold itself out as, nor will its parent corporation or affiliated banks represent it to be, authorized or willing to provide services for others.
Section 4(c)(1) of the act permits a holding company to own shares in “any company engaged solely . . . in the business of furnishing services to or performing services for such holding company and banks with respect to which it is a bank holding company. . . .” The Board has ruled heretofore that the term “services” as used in section 4(c)(1) is to be read as relating to those services (excluding “closely related” activities of “a financial, fiduciary, or insurance nature” within the meaning of section 4(c)(6)) which a bank itself can provide for its customers (1958 Fed. Res. Bull. 431; 12 CFR 225.104 at 4-192). A determination as to whether a particular service may legitimately be rendered or performed by a bank for its customers must be made in the light of applicable federal or state statutory or regulatory provisions. In the case of a state-chartered bank, the laws of the state in which the bank operates, together with any interpretations thereunder rendered by appropriate bank authorities, would govern the right of the bank to provide a particular service. In the case of a national bank, a similar determination would require reference to provisions of federal law relating to the establishment and operation of national banks, as well as to pertinent rulings or interpretations promulgated thereunder.
Accordingly, on the assumption that all of the services to be performed are of the kinds that the holding company’s subsidiary banks may render for their customers under applicable federal or state law, the Board concluded that the rendition of such services by the service company for its affiliated banks would not adversely affect its exempt status under section 4(c)(1) of the act.
In arriving at the above conclusion, the Board emphasized that its views were premised explicitly upon the facts presented to it, and particularly its understanding that banks are permitted, under applicable federal or state law, to provide the proposed computer services. The Board emphasized also that in respect to the service company’s operations, there continues in effect the requirement under section 4(c)(1) that the service company engage solely in the business of furnishing services to or performing services for the bank holding company and its subsidiary banks. The Board added that any substantial change in the facts that had been presented might require reexamination of the service company’s status under section 4(c)(1). 1964 Fed. Res. Bull. 1137; 12 CFR 225.118.
4-196

SERVICING EXEMPTION—Mortgage Companies

The Board of Governors recently considered whether a bank holding company may acquire, either directly or through a subsidiary, the stock of a so-called “mortgage company” that would be operated on the following basis: The company would solicit mortgage loans on behalf of a bank in the holding company system, assemble credit information, make property inspections and appraisals and secure title information. The company would also participate in the preparation of applications for mortgage loans, which it would submit, together with recommendations with respect to action thereon, to the bank, which alone would decide whether to make any or all of the loans requested. The company would in addition solicit investors to purchase mortgage loans from the bank and would seek to have such investors contract with the bank for the servicing of such loans.
Under section 4 of the Bank Holding Company Act (12 USC 1843), a bank holding company is generally prohibited from acquiring “direct or indirect ownership” of stock of nonbanking corporations. The two exceptions principally involved in the question presented are with respect to (1) stock that is eligible for investment by a national bank (section 4(c)(5) of the act) and (2) shares of a company “furnishing services to or performing services for such bank holding company or its banking subsidiaries” (section 4(c)(1)(C) of the act).
The Board has previously indicated its view that a national bank is forbidden by the socalled “stock-purchase prohibition” of paragraph “seventh” of section 5136 of the Revised Statutes (12 USC 24) to purchase “for its own account . . . any shares of stock of any corporation” except (1) to the extent permitted by specific provisions of federal law or (2) 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 said paragraph “seventh”. There is no specific statutory provision authorizing a national bank to purchase stock in a mortgage company, and in the Board’s view such purchase may not properly be regarded as authorized under the “incidental powers” clause (see 1966 Fed. Res. Bull. 1151; 12 CFR 208.119). Accordingly, a bank holding company may not acquire stock in a mortgage company on the basis of the section 4(c)(5) exemption.
However, the Board does not believe that such conclusion prejudices consideration of the question whether such a company is within the section 4(c)(1)(C) “servicing” exemption. The basic purpose of section 4 of the act is to confine a bank holding company’s activities to the management and control of banks. In determining whether an activity in which a bank could itself engage is within the servicing exemption, the question is simply whether such activity may appropriately be considered as “furnishing services to or performing services for” a bank.
As indicated in the Board’s interpretation published in the 1958 Federal Reserve Bulletin at page 431 (12 CFR 225.104 at 4-192), the legislative history of the servicing exemption indicates that it includes the following activities: “auditing, appraising, investment counseling” and “advertising, public relations, developing new business, organization, operations, preparing tax returns, and personnel.” The legislative history further indicates that some other activities also are within the scope of the exemption. However, the types of servicing permitted under such exemption must be distinguished from activities of a “financial, fiduciary, or insurance nature,” such as those that might be considered for possible exemption under section 4(c)(8) of the act.
In considering the interrelation of these exemptions in the light of the purpose of the prohibition against bank holding company interests in nonbanking organizations, the Board has concluded that the appropriate test for determining whether a mortgage 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.1
On this basis, the Board concluded that, insofar as the Bank Holding Company Act is concerned, a bank holding company may acquire, either directly or through a subsidiary, the stock of a mortgage company whose functions are as described in the question presented. On the other hand, in the Board’s view, a bank holding company may not acquire, on the basis of the servicing exemption, a mortgage company whose functions include such activities as extending credit for its own account, arranging interim financing, entering into mortgage service contracts on a fee basis, or otherwise performing functions other than solely on behalf of a bank. 1967 Fed. Res. Bull. 1911; 12 CFR 225.122.
1
Insofar as the 1958 interpretation referred to above suggested that the branch banking laws are an appropriate general test for determining the scope of the servicing exemption, such interpretation is hereby modified. In view of the different purposes to be served by the branch banking laws and by section 4 of the Bank Holding Company Act, the Board has concluded that basing determinations under the latter solely on the basis of determinations under the former is inappropriate.
4-197

SERVICING EXEMPTION—Operations Subsidiaries

In orders approving the retention by a bank holding company of a 4(c)(8) subsidiary, the Board has stated that it would permit, without any specific regulatory approval, the formation of a wholly owned subsidiary of an approved 4(c)(8) company to engage in activities that such a company could itself engage in directly through a division or department (Northwestern Financial Corporation, 1979 Fed. Res. Bull. 566). Section 4(a)(2) of the act provides generally that a bank holding company may engage directly in the business of managing and controlling banks and permissible nonbank activities, and in furnishing services directly to its subsidiaries. Even though section 4 of the act generally prohibits the acquisition of shares of nonbanking organizations, the Board does not believe that such prohibition should apply to the formation by a holding company of a wholly owned subsidiary to engage in activities that it could engage in directly. Accordingly, as a general matter, the Board will permit without any regulatory approval a bank holding company to form a wholly owned subsidiary to perform servicing activities for subsidiaries that the holding company itself could perform directly or through a department or a division under section 4(a)(2) of the act. The Board believes that permitting this type of subsidiary is not inconsistent with the nonbanking prohibitions of section 4 of the act, and is consistent with the authority in section 4(c)(1)(C) of the act, which permits a bank holding company, without regulatory approval, to form a subsidiary to perform services for its banking subsidiaries. The Board notes, however, that a servicing subsidiary established by a bank holding company in reliance on this interpretation will be an affiliate of the subsidiary bank of the holding company for the purposes of the lending restrictions of section 23A of the Federal Reserve Act (12 USC 371c). 1980 Fed. Res. Bull. 774; 12 CFR 225.141.

SERVICING EXEMPTION—Applicability of Bank Service Corporation Act

See 4-174.1.
4-198

TRANSACTIONS BETWEEN BANK AND NONBANK SUBSIDIARIES—Edge Corporation

The Board has been asked whether it is permissible for the commercial banking affiliates of a bank holding company registered under the Bank Holding Company Act of 1956, as amended, to acquire and hold the shares of the holding company’s Edge corporation subsidiary organized under section 25(a) of the Federal Reserve Act.
Section 9 of the Bank Holding Company Act amendments of 1966 (Pub. L. 89-485, approved July 1, 1966) repealed section 6 of the Bank Holding Company Act of 1956. That rendered obsolete the Board’s interpretation of section 6 that was published in the March 1966 Federal Reserve Bulletin, page 339. Thus, so far as federal banking law applicable to state member banks is concerned, the answer to the foregoing question depends on the provisions of section 23A of the Federal Reserve Act, as amended by the 1966 amendments to the Bank Holding Company Act. By its specific terms, the provisions of section 23A do not apply to an affiliate organized under section 25(a) of the Federal Reserve Act.
Accordingly, the Board concludes that, except for such restrictions as may exist under applicable state law, it would be legally permissible by virtue of paragraph 20 of section 9 of the Federal Reserve Act for any or all of the state member banks that are affiliates of a registered bank holding company to acquire and hold shares of the Edge corporation subsidiary of the bank holding company within the amount limitation in the last sentence of paragraph 12 of section 25(a) of the Federal Reserve Act. 1966 Fed. Res. Bull. 1152; 12 CFR 225.121.
4-199

TRANSACTIONS BETWEEN BANK AND NONBANK SUBSIDIARIES—Adversely Affecting Bank Subsidiaries

The Board has become increasingly concerned about transactions between banking and nonbanking subsidiaries of the same bank holding company that may adversely affect the banking subsidiaries. In this regard, it has approved the sending of a letter to all bank holding companies emphasizing its concern about such transactions and noting the relevant provisions of law that may be involved.
We would appreciate your transmitting the enclosed letter and its attachment to all bank holding companies headquartered in your District. * * *
The purpose of this letter is to inform you of the Board’s concern with respect to situations in which a bank holding company’s banking subsidiary may have been exposed to adverse consequences because of transactions with the company’s nonbanking subsidiaries. Such a situation would be one in which a banking subsidiary of a bank holding company has purchased assets of poor quality from a mortgage banking or consumer finance subsidiary of the holding company at prices significantly higher than they would bring in an “arm’s-length” transaction, thus contributing to problems in the subsidiary bank. Such a transaction could be in violation of section 23A of the Federal Reserve Act. As you are aware, this section of the act regulates extensions of credit between a member bank and its affiliates, including holding company subsidiaries, for the purpose of preventing adverse impacts on a bank through less than arm’s-length dealings with its affiliates.
In 1974 the Board published an interpretation of section 23A reaffirming a 1958 interpretation, concluding that extensions of credit for purposes of section 23A include purchases of obligations from an affiliate whether or not such purchases are made at a discount from face value. Thus, such extensions of credit would have to meet the amount and security limitations and requirements of section 23A.
This interpretation is enclosed, and the Board wishes to emphasize that it continues to reflect the Board’s view as to the applicability of section 23A to this type of transaction. As the attached interpretation notes, however, the restrictions of section 23A do not apply in those instances in which the transaction between the subsidiary bank and its affiliate is structured in an arm’s-length manner. For example, when the commitment to purchase is made in advance of the extension of credit by the affiliate, and is based upon the bank’s independent evaluation of the creditworthiness of the borrower, section 23A would not be applicable, inasmuch as “the member bank would be taking advantage of an investment opportunity rather than being impelled by an improper incentive to alleviate working capital needs of the affiliate that are directly attributable to excessive outstanding commitments.” Furthermore, these restrictions do not in any way interfere with the strength that a holding company can provide to its affiliates through management expertise and capital injections rather than credit extensions.
Since the example described in the second paragraph involves a violation of federal law, the Board wishes to call the attention of each bank holding company to the provision in question as well as to make it clear that the Board might consider cease-and-desist proceedings under the Financial Institutions Supervisory Act of 1966 to be appropriate in such circumstances. Further, the Board wishes to note that under certain circumstances, such as where assets are purchased for significantly more than they would bring in an arm’s-length commercial transaction, the transactions could constitute a misapplication of bank funds and subject the officers and directors involved to possible criminal liability (18 USC 656).
Situations may arise where the transaction itself does not technically violate section 23A, for example, a transaction with a real estate investment trust that is advised by an affiliate of a member bank. However, if such a transaction were to involve the purchase of poor quality assets at significantly more than they would bring in an arm’s-length commercial transaction, it could constitute an unsafe and unsound practice and might subject the institution to cease-and-desist proceedings under the Financial Institutions Supervisory Act of 1966. Further, under certain circumstances such purchases could, as noted above, constitute a misuse of bank assets that would subject any officers or directors involved to possible criminal liability.
The Board expects that all bank holding companies and their subsidiary banks will adhere to both the letter and the spirit of section 23A. The staffs of the Reserve Banks remain available for consultation with respect to any proposed transaction about which you have questions. Further, the Board’s staff, as well as the Reserve Banks’ staffs, will be closely scrutinizing transactions between subsidiary banks, their affiliates, and other “related” institutions in accordance with the principles cited. S-2301; Dec. 5, 1975.
4-200

VIOLATIONS—Of Bank Holding Company Act

The Board presently has pending before it a number of bank holding company applications in which violations of the Bank Holding Company Act or Regulation Y are disclosed, or in the processing of which such violations have been uncovered. In addition, the Board is aware of additional instances in which Reserve Banks have instructed bank holding company applicants to defer filing of applications, or to effect divestiture of acquisitions made in violation of the act or Regulation Y, because of such violations.
The 1970 Amendments to the Bank Holding Company Act have now been in effect for almost five years, and the Board believes that there has been ample time for companies subject to the act to inform themselves of their responsibilities under the act and the Board’s regulations and interpretations. The Board is concerned that violations are continuing to occur, either because companies have failed to take steps to inform themselves of their legal obligations, or because they do not believe that the law will be enforced. The Board believes that each bank holding company in your Federal Reserve District should be notified that it will in the future be held strictly responsible for complying with both the procedural and substantive requirements of the act and Regulation Y.
The Board will continue to fulfill its responsibility to refer to the Department of Justice, for possible criminal prosecution, any apparently willful violation that comes to its attention. Further, in the future when it comes to the Board’s attention that an acquisition has been made, or activities commenced, without the requisite prior approval of the Board, whether or not such violation of the law appears to have been “willful,” such conduct will be considered to reflect adversely on the managerial factors in connection with an application for permission to retain the illegally acquired activity and may in and of itself constitute ground for denial of such an application. In appropriate cases the Board may also initiate cease-and-desist proceedings under the Financial Institutions Supervisory Act.
With respect to those past violations as to which it presently has knowledge, it is the Board’s intention to scrutinize the underlying facts carefully to determine whether willful violations have occurred. In appropriate cases the Board may require an applicant who seeks to retain an activity heretofore acquired or commenced in violation of the law to consent to the entry of a cease-and-desist order prohibiting future violations as a condition to the retention or continuation of that activity.
Reserve Banks should report violations of which they are now or hereafter become aware to the Board’s Legal Division. Bank holding companies in your District should also be reminded that your staff is available to consult with any company that has a question concerning its responsibilities under the act or Regulation Y. S-2295; Nov. 3, 1975.
Back to top