|
[Main Tabs]
[Table of Contents - 4000]
[Index]
[Previous Page]
[Next Page]
[Search]
4000 - Advisory Opinions
Obligations Under the "Interagency Policy Statement on Retail
Sales of Nondeposit Products" and the FDIC's Recordkeeping and
Disclosure Requirements
FDIC--99--6
August 18, 1999
Michael B. Phillips, Counsel
This letter responds to the issues presented in your letter of
January 6, 1999, to Russell Marshall and William Tullis of the Atlanta
Regional Office of the Federal Deposit Insurance Corporation (the
"FDIC") regarding certain securities activities of your client,
(the "Bank"). Your letter responded to a letter dated
August 25, 1998, from the Federal Deposit Insurance Corporation (the
"FDIC") with respect to the Bank's obligations under (i) the
Interagency Policy Statement
on Retail Sales of Nondeposit Products ("Interagency
Statement"), and (ii) the FDIC's recordkeeping and disclosure
requirements in 12 C.F.R. Part
344. In particular, your letter requested that the FDIC
consider certain interpretative guidance by the Office of the
Comptroller of the Currency (the "OCC") and other federal
regulators regarding compensation disclosure obligations arising from
riskless principal transactions that involve debt securities. Your
letter was forwarded to the FDIC's Legal Division in Washington, D.C.
for response. We apologize for the delay in responding to your letter.
In your letter, you cited the Bank's internal procedures that
conform with the Interagency Statement and provided information
supporting your position that because the majority of the Bank's
securities transactions constitute "riskless principal"
transactions involving primarily debt securities, the compensation
disclosure requirements of Part 344 should not be applied to the
Bank's securities transactions. In addition, you provided data with
respect to the Bank's qualification for an exemption under
12 C.F.R. § 344.2(a)(1)
(i.e., that the Bank conducted an average of less than 200
securities transactions over a three-year period) for the period of
1995--97 and thereby qualified for an exemption from the recordkeeping
and other requirements in 12 C.F.R.
§§ 344.4(a)(2) through (4) and 344.8(a)(1) through (3). This
letter addresses the aforementioned matters and provides guidance
concerning further information that we need from the Bank for purposes
of reviewing compliance with the Interagency Statement and the
applicability of the exemption in 12 C.F.R. § 344.2(a)(1).
I. Interagency Policy Statement on Retail Sales of
Nondeposit Products
In your letter, you stated that the Bank acknowledges that it is
subject to the Interagency Statement for purposes of its securities
transactions. In this regard, you asserted that the Bank is
implementing the various requirements in the Interagency Statement and
is adopting "more formalized procedures with respect to its
nondeposit activities to strengthen its compliance with the Interagency
Statement." We are interested in whether the Bank has completed
implementation of those procedures. If so, we request you transmit to
the FDIC (to the attention of Counsel Michael B. Phillips at the above
address) a copy of those procedures so that we can confirm whether the
procedures comply with the Interagency Statement's requirements.
II. Applicability of Part 344
We agree with the statement in your letter that the Bank's
transactions involving certificates of deposit ("CDs") with
maturities of less than 9 months are not subject to Part 344. Such
transactions are exempted from Part 344 because such short-term CDs do
not constitute "securities" under the definition in 12 C.F.R.
§ 344.3(m)(5). However, we have determined that the operative period
for purposes of the exemption category in 12 C.F.R. § 344.2(a)(1) is
1996--98, not the period 1995--97, which was discussed in your letter.
We recognize that the earlier period was the focus of the FDIC
examination of the Bank to which your letter of April 7, 1998
responded.
In response to the FDIC's letter of August 25, 1998, you provided
statistics with respect to the Bank's securities transactions during
the period 1995--97. In your letter, you stated that this information
supports the Bank's exemption from the FDIC's record
keeping
{{2-29-00 p.4984.41}}requirements in 12 C.F.R.
§ 344.3(a)(2) through (4) and the securities trading procedures in
§ 344.8(a)(1) through
(3). The relevant calculations for purposes of the exemption in
§ 344.2(a)(1) involve
several provisions of Part 344:
• Section 344.2(a)(2), which states that the record
keeping requirements of Section 344.4 do not apply to banks effecting
less than 500 government securities transactions per year;
• Section 344.3(m), which excludes from the definition of
the term "security" deposit accounts (§ 344.3(m)(1)) and
certificates of deposit that qualify as "any note, draft, bill of
exchange, or bankers acceptance which has a maturity at the time of
issuance of not exceeding nine months, exclusive of days of grace or
any renewal thereof" (§ 344.3(m)(5)); and
• Section 344.2(a)(1), which states that the requirements
of §§ 344.4(a)(2) through (4) and 344.8(a)(1) through (3) do not
apply to a bank effecting an average of fewer than 200 securities
transactions per year for customers over the prior three calendar
years.
For purposes of your response to the FDIC examination of the Bank
in 1998, we concur with your determination that the Bank has satisfied
exemption category § 344.2(a)(1) for the period
1995--97--i.e., the Bank has engaged in an average of fewer
than 200 securities transactions per year. However, we have determined
that the period 1996--98 is the relevant period for purposes of the
FDIC's current review of whether the Bank meets that exemption
category. Note that § 344.2(a)(1) requires data "over the prior
three calendar year period." Regarding the Bank's request, that
period currently would be 1996--98, not 1995--97.
According to your letter, in 1997, the amount of nonexempted
securities transactions significantly increased from the two prior
years. In 1997, the Bank engaged in 424 nonexempt securities
transactions. However, in 1995 and 1996, nonexempt securities
transactions totaled 77 and 58, respectively. Given this trend, it is
anticipated that the three-year average for the period 1996--98 likely
exceeded the average for the period of 1995--97 (i.e., 184.6
transactions per year).
Note that even if the results for the period of 1996--98 establish
that the 200 transaction threshold for the exemption category in
§ 344.2(a)(1) is met, only the recordkeeping and securities trading
policy requirements in Part 344 would be exempted. The
notification/reporting requirements
(§§ 344.5 and 344.6),
the settlement requirements (§ 344.7), and the insider trading policy
requirements (§ 344.9)
still would apply to the Bank's securities transactions.
III. Disclosure of Bank Compensation on Riskless
Principal Transactions Effected on Behalf of the Bank's Customers
According to your letter, the Bank's "riskless principal"
transactions involving debt securities should not be subject to Part
344's disclosure requirements regarding markups or markdowns. Your
rationale is based on the treatment by the U.S. Securities and Exchange
Commission (the "SEC") of such transactions in its Rule
10b--10, 1
in addition to Interpretive Letter No. 626 issued by the OCC. That
Letter concerns an OCC regulation that is substantially similar to the
FDIC's Part 344 and is patterned after the SEC's Rule
10b--10. 2
In addition, you informed us that the Bank has redesigned its
confirmations to customers to (i) disclose that the customer's
securities transactions is being conducted on a "riskless
principal" basis, (ii) explain what constitutes a "riskless
principal" transaction, (iii) describe the markup or markdown
involved in the transaction and (if applicable) other
{{2-29-00 p.4984.42}}fees imposed by the Bank, and (iv)
indicate that if specific inquiry is directed by the customer, more
detailed disclosure concerning the markup will be provided.
With respect to the SEC's Rule 10b--10, you noted that for riskless
principal transactions, the SEC requires that a broker-dealer disclose
to the customer the amount of the markup, markdown or other
compensation charged by the broker-dealer only if the
securities traded are equity securities, not "debt
securities." 3
You also note that OCC Interpretive Letter No. 626 indicates that
compensation need not be disclosed in the case of riskless principal
transactions involving debt securities provided that certain conditions
are met. 4
In evaluating your request, we are using the term "riskless
principal" securities transactions to refer to those securities
transactions in which a broker-dealer, after receiving an order to buy
(or sell) a security from a customer, purchases (or sells) the security
for its own account to offset a contemporaneous sale to (or purchase
from) the customer. In 1989, the Board of Governors of the Federal
Reserve System (the "FRB") determined that riskless principal
transactions by bank holding companies and their bank subsidiaries do
not violate the Glass-Steagall
Act. 5
In that 1989 order, the FRB described such transactions as follows:
If the firm elects to act as a riskless principal in
executing the transaction, it will purchase the securities from a third
party dealer at that dealer's "inside" price and then, acting as
a principal, resell them to the customer, adding a mark up over its
cost. However, the broker-dealer does not confirm the transaction with
its customer until the securities have been purchased from the third
party dealer. 6
For purposes of the FRB's determination that riskless principal
transactions subject to certain
restrictions 7
are closely related to banking for purposes of Section 4(c)(8) of the
Bank Holding Company Act, the FRB has commented:
In acting as a riskless principal . . . Company would not
obligated to its customer to buy or sell securities until after an
offsetting purchase or sell securities until after an offsetting
purchase or sale of the securities has already been executed. If the
market price of the securities ordered by the customer suddenly were to
change significantly, before Company is able to arrange an offsetting
open market transaction on terms that would protect it from loss,
Company can decline to execute the
order. 8
We concur that the compensation disclosure requirements of Part 344
as applied to riskless principal transactions involving debt securities
should be construed in a manner that is consistent with the SEC's Rule
10b--10. Part 344 was revised, in part, to better conform with the
SEC's regulations governing broker-dealer confirmations, and thereby
provide better regulatory parity between (1) banks and bank customers,
and (2) broker-dealers and their customers. Thus, the FDIC will not
require disclosure of the compensation at issue, as the SEC does not
require such disclosure.
However, consistent with OCC Interpretive Letter No. 626, we will
require that two categories of conditions must be met by the Bank in
order that the compensation disclosure requirements in Part 344 will be
found not to apply to such transactions. Under its Interpretive Letter,
the OCC has imposed certain conditions to ensure compliance with the
Glass-Steagall Act. In addition, the OCC has required certain
conditions with respect to disclosures to customers.
{{8-31-00 p.4984.43}}
With respect to compliance with the Glass-Steagall Act, for purposes
of the Bank's riskless principal transactions involving debt
securities, the FDIC will require the Bank's compliance with the
following conditions:
• The Bank will limit its riskless principal
activities to securities transactions with institutional customers
concerning investment grade, debt securities.
• The Bank will not execute riskless principal transactions
on behalf of any of its foreign subsidiaries or its affiliates.
• The Bank will not represent itself as a market maker or
dealer for the debt securities.
• The Bank will not enter quotes for specific securities in
the National Association of Securities Dealers automated quotation
system ("NASDAQ") or any other dealer quotation system in
connection with riskless principal transactions.
• The Bank will not make any general solicitation or
advertisement for any security being bought or sold.
With respect to disclosure requirements and related confirmation
and recordkeeping requirements, for purposes of the Bank's riskless
principal transactions involving debt securities, the FDIC will require
the Bank's compliance with the following conditions:
• Confirmations will (i) refer to the transactions
as "riskless principal" transactions; (ii) explain what
constitutes a "riskless principal" transaction; (iii) describe
the markup or markdown involved in such transactions and (if
applicable) other fees imposed by the Bank; and (iv) indicate that if
specific inquiry is directed by the customer, more detailed disclosure
concerning the markups will be provided.
• The Bank will disclose its capacity in each customer
trade to be that of a "riskless principal."
• Except for the compensation reporting requirements in
Part 344 (12 C.F.R. § 344.5(b)(5) and (6)), the other reporting
requirements in 12 C.F.R.
§ 344.5 will continue to apply.
• The Bank will adopt procedures that fully conform with
Part 344 to code and identify all riskless principal transactions and
maintain appropriate records, including original order tickets with
time sampling of both receipt and execution of orders.
• The Bank will disclose whether it is being compensated by
means of a spread, and the Bank will adhere to internal policy under
which spreads will approximate a typical commission and will be within
the limits required under the Federal securities laws.
The conditions set forth in OCC Interpretive Letter No. 626 with
respect to compliance with the Glass-Steagall Act are similar to
commitments obtained by the FRB in connection with its orders approving
certain riskless principal transactions by subsidiaries of bank holding
companies. 9
The FDIC agrees with the FRB's view in those orders that certain
conditions are necessary for riskless principal securities transactions
to ensure that those transactions will not constitute securities
underwriting or brokerage activities in violation of the Glass-Steagall
Act. 10
To date, the FRB has not issued interpretive guidance with respect to
the compensation disclosure issues that are presented in your
letter. 11
{{8-31-00 p.4984.44}}
Note that this interpretation of Part 344 specifically involves the
compensation disclosure requirements in
12 C.F.R. § 344.5(b)(5)
and (6). The other disclosure requirements in Part 344 would apply to
all transactions involving a "security" as defined in
12 C.F.R. § 344.3(m),
including riskless principal transactions involving debt securities.
Disclosure requirements specific to debt securities are set forth in 12
C.F.R. § 344.5(b)(8) through (12).
If you have any questions regarding this letter, please contact me
at (202) 898--3581.
1 17 C.F.R. § 240.10b--10. The rationale for the SEC's
treatment of riskless principal transactions involving debt securities
is stated in the preamble to its 1994 revision of Rule 10b--10.
See 59 Fed. Reg. 59612, 59615--616 (1995). According to the
preamble, the SEC will defer mandating markup disclosure for riskless
principal transactions involving debt securities until it determines
whether there is sufficient "transparency" in the debt securities
markets. Go Back to Text
2 See 12 C.F.R. Part 12 (OCC). The FRB also has
promulgated regulations substantially similar to the FDIC's Part 344.
See 12 C.F.R. § 208.34. Go Back to Text
3 The definition of "debt securities" in § 344.3(h) of
the FDIC's regulations is substantially identical to the SEC's
definition of that term in Rule 10b--10(d)(4). See 17 C.F.R.
§ 240.10b--10(d)(4). Go Back to Text
4 OCC Interpretive Letter No. 626 (July 7, 1993). Go Back to Text
5 75 Fed. Res. Bull. 829 (1989). Go Back to Text
6 Id. at 831. Go Back to Text
7 For a listing of conditions required by the FRB in its
latest order involving riskless principal activities, see 82
Fed. Res. Bull. 748 (1996). Go Back to Text
8 75 Fed. Res. Bull. 829, 832 (1989). Go Back to Text
9 See the FRB's Order Revising the Limitations
Applicable to Riskless Principal Activities, 82 Fed. Res. Bull. 759,
760--61 (1996). The FRB also has issued orders regarding riskless
principal transactions by specific bank holding companies.
See 82 Fed. Res. Bull. 748 (1996) (The Bank of New York); 75
Fed. Res. Bull. 829 (1989) (Bankers Trust). Go Back to Text
10 In 1997, the FRB revised its regulations governing bank
holding companies at 12 C.F.R. Part 225 (Part Y) with respect to
riskless principal transactions as permissible activities for purposes
of Section 4(c)(8) of the Bank Holding Company Act. See
12 C.F.R.
§ 225.28(b)(7)(ii). Go Back to Text
11 The FRB's securities transaction confirmation regulations
for state-member banks, which are substantially equivalent to the
FDIC's Part 344, are set forth in 12 C.F.R. § 208.34. The FRB's
compensation disclosure requirements are provided in
§ 208.34(d)(2)(v) and (vi). Go Back to Text
[Main Tabs]
[Table of Contents - 4000]
[Index]
[Previous Page]
[Next Page]
[Search]
|
