Section 4(c)(8) of the BHC Act (EDP Servicing Company ... · PDF fileSection 4(c)(8) of the BHC Act ... missibility of bank holding company data pro- ... application memo for the history

Section 4(c)(8) of the BHC Act(EDP Servicing Company) Section 3160.0

3160.0.1 PROVISION OF DATAPROCESSING AND TRANSMISSIONSERVICES

Under section 4(c)(8) of the BHC Act, the per-missibility of bank holding company data pro-cessing activities is generally predicated uponthe type of data processed or transmitted. Sub-sidiaries formed under this section may engagein business directly with outside customers,unlike section 4(c)(1) subsidiaries, which canact only as servicers for affiliates1 and cannotdeal directly with outside customers.

The intent of section 4(c)(8) is to permit bankholding companies and their nonbank subsidi-aries to directly provide to customers financiallyor economically oriented services (or servicesthat are similar to these services) that bankshave traditionally used in their own internaloperations and provided to their customers. Suchservices (with prior approval) are unrestricted asto location and may be provided from out-of-state locations.

3160.0.2 INCIDENTAL ACTIVITIES

The Board regards the following as incidentalactivities necessary to carrying on permissibledata processing activities:

1. Making excess computer time available toanyone as long as the only involvement bythe bank holding company system is furnish-ing the facility and the necessary operatingpersonnel. This stipulation applies when—a. the equipment is not purchased solely for

the purpose of creating excess capacity tosell;

b. hardware is not offered in conjunctionwith excess capacity; and

c. the facilities for the use of the excesscapacity do not include providing anysoftware other than systems software(including language), network communi-cations support, and the operating person-nel and documentation necessary for main-taining and using these facilities.

2. Selling byproducts of permissible data pro-cessing and data transmission activities whentheyarenotdesigned,orappreciablyenhanced,for the purpose of marketability.

3. Furnishing any data processing service upon

request of a customer if the service is nototherwise reasonably available in the rel-evant market area.

3160.0.3 SECTION 4(c)(8) vs.SECTION 4(c)(1)

Section 4(c)(1) data processing subsidiaries,which do not require prior approval, are limitedas follows:

1. They can furnish computer services only forthe internal operations of the bank holdingcompany and its bank affiliates. 1

2. Direct computer services to nonaffiliated cus-tomers are not permitted. Any contract tofurnish services to nonaffiliated customersmust be between the affiliate bank and itscustomer, with the data processing subsidiaryacting as a servicer for its affiliate bank. Inaddition, the kinds of services furnished arelimited to those that a bank can normallyprovide.

Section 4(c)(8) data processing subsidiariesmay deal directly with the customer. In accor-dance with section 4(c)(8) of the BHC Act andsection 225.28(b)(14) of Regulation Y, the kindsof services nonbank subsidiaries of bank hold-ing companies may provide to others are—

1. data processing and transmission services,facilities (including hardware, software, docu-mentation, or operating personnel), data-bases, advice, and access to such services,facilities, or databases by any technologicalmeans, if—a. the data to be processed or furnished are

financial, banking, or economic data andb. the hardware provided in connection with

the data processing and transmission ser-vices is offered only in conjunction withsoftware designed and marketed for theprocessing and transmission of financial,banking, or economic data, and the general-purpose hardware does not constitute morethan 30 percent of the cost of any pack-aged offering.

2. data processing, data storage, and data trans-mission services for a third party that are notfinancial, banking, or economic related if thesubsidiary’s total annual revenue derived from

1. In this context, ‘‘affiliates’’ is limited to other organiza-tions that have subsidiaries of the same parent bank holdingcompany as the servicer.

BHC Supervision Manual June 2004Page 1

those activities does not exceed 30 percent ofits total annual revenues derived from dataprocessing, data storage, and data transmis-sion activities. On November 26, 2003, theBoard approved an increase of this limit to49 percent, effective January 8, 2004. See1993 FRB 1158, 2004 FRB 55, and section3160.2. The Board currently recognizes that,in certain situations, a bank holding com-pany may have bona fide operational reasonsfor conducting its financial and related nonfi-nancial data processing activities throughseparately incorporated subsidiaries. In thesecases, bank holding companies may requestpermission to administer the 49 percent rev-enue test on a business-line or multiple-entity basis. See section 225.28(b)(14) ofRegulation Y (12 C.F.R. 225.28(b)(14)).

3160.0.4 MINICOMPUTERACTIVITIES

Some data processing subsidiaries are activelyengaged in placing minicomputers with some oftheir customers. However, if the subsidiary actsas sales agent for the manufacturer and receivesa commission, it is in violation of section225.28(b)(14) of Regulation Y and should beadvised to cease the practice.

3160.0.5 HARDWARE ANDSOFTWARE AS AN INTEGRATEDPACKAGE

Customers of data processing services requirethat suppliers provide them with hardware andsoftware as an integrated package. Providinggeneral-purpose hardware is permissible only ifthe cost of the hardware does not exceed 30 per-cent of the cost of the packaged offering, andonly in conjuction with permissible software.When hardware is provided in a specializedform (such as ATMs), its provision meets theNational Courier test and is closely related tobanking and therefore not subject to the 30 per-cent limitation.

3160.0.6 PACKAGED FINANCIALSYSTEMS

The Board found that providing packaged finan-cial systems, including data processing hard-ware and software, to be installed on the prem-

ises of the customer is closely related to bankingif conducted within the limits of Regulation Y.

3160.0.7 EXCESS CAPACITY

The sale of excess computer time is currentlytreated in a Board interpretation as a permissibleincidental activity. The interpretation (12 C.F.R.225.123(e)(1)) currently permits a bank holdingcompany to make excess computer time avail-able to anyone so long as the only involvementof the holding company is furnishing the facilityand the necessary operating personnel. Dataprocessors that process time-sensitive data mustmaintain sufficient capacity to meet peakdemand and provide backup in case of equip-ment failure. Excess capacity necessarily resultsfrom such needs; thus the sale of excess capac-ity is necessary to reduce costs and to remaincompetitive. Bank holding companies are lim-ited in the sale of excess capacity as follows:

1. A bank holding company may not purchasedata processing equipment solely for the pur-pose of creating excess capacity.

2. A bank holding company may not sell hard-ware in conjunction with excess capacity.

3. A bank holding company may provide onlylimited types of software in connection withits sale of excess capacity. This includes sys-tems software (that is, software designedonly to control and operate the hardware andnot to perform substantive operations), net-work communications support, and the oper-ating personnel and documentation neces-sary for maintaining and using these facilities.

3160.0.8 BYPRODUCTS

The sale of byproducts for the development of aprogram for a permissible data processing activ-ity is treated in a Board interpretation (12 C.F.R.225.123(e)) as a permissible incidental activity.Byproducts may be data, software, or data pro-cessing techniques or information developed bythe bank holding company. Byproducts may notbe designed or appreciably enhanced for thepurpose of marketability.

3160.0.9 REQUIREMENT OFSEPARATE RECORDKEEPING

The Board’s data processing interpretation isdesigned to minimize any possibility of unfair

Section 4(c)(8) of the BHC Act (EDP Servicing Company) 3160.0


competition. A bank holding company subsidi-ary or related entity that provides permissibledata processing and data transmission activities(services, facilities, byproducts, or excesscapacity) must keep separate books and recordsand provide the documents to any new or renewalcustomer upon request.

3160.0.10 SUMMARY

Holding company EDP proposals are evaluatedfrom the standpoint of whether the proposeddata processing activities involve banking, finan-cial, or related economic data within the mean-ing of the Board’s Regulation Y. Processing,storing, and transmitting data for third parties,when the data are not financial, banking, oreconomic, is permissible if the revenues derivedfrom those activities do not exceed 49 percentof the subsidiary’s total annual revenues derivedfrom data processing, data storage, and datatransmission activities. For examples of previ-ous Board authorizations for data processingand transmission services in accordance withRegulation Y, see sections 3160.1 through 3160.5.

The data processing that is permissible underRegulation Y encompasses various data pro-cessing services, including sales analysis, inven-tory analysis, freight payment, municipal taxbilling, credit union accounting, and savingsand mortgage company bookkeeping and pay-roll processing.

3160.0.11 INSPECTION OBJECTIVES

1. To determine that the full range of EDPservices performed are permissible finan-cially oriented activities in compliance withapplicable laws and regulations.

2. To review the relationship between the dataprocessing subsidiary and its affiliates andthe effect of those relationships on the affairsand soundness of the bank affiliate.

3. To determine if operating policies are adequateand if management is operating in conform-ance with the established policies.

4. To initiate corrective action when policies,practices, procedures, or internal controls aredeficient or when violations of law or regula-tion have been noted.NOTE: All bank-related EDP servicers receive

EDP examinations conducted by the primarybank regulator; these examinations cover detailedoperations, audit, proper backup, and overallcomputeroperations.Thebankholdingcompany–related inspection should focus on the types and

permissibility of services performed, the rev-enue limitations of section 225.28(b)(14) ofRegulation Y, the types of customers serviced,and transactions between affiliates. The inspec-tion should also provide an overall financialevaluation.

3160.0.12 INSPECTION PROCEDURES

3160.0.12.1 Pre-Inspection

1. Where available, review the EDP examina-tion report in conjunction with the lead bankexamination for details of the subsidiary’soperations and management.

2. Review correspondence files and theapplication memo for the history of thesubsidiary.

3160.0.12.2 On-Site

3. Have a brief meeting with the chief execu-tive officer of the subsidiary to establishcontact and present a brief indication of thescope of the inspection.

4. Ask the controller of the company for theschedules and other information requestedin the entry letter.

5. Request the following information and sched-ules in addition to what was requested inthe entry letter:a. complete list of the computer applica-

tions the subsidiary performsb. list of customersc. policy and procedures manual, if anyd. copy of the latest internal and external

financial and operational audits andinternal control reviews

e. copy of the types of managementreports the subsidiary submits to the par-ent company and directors

f. internal management organization chartg. copy of the agreement executed with the

affiliates concerning the services pro-vided and the fees collected

6. Review minutes of meetings of the board ofdirectors and of the executive committee todetermine the broad types of the company’soperations.

7. Determine the scope of the inspection, basedon evaluations of—a. corporate minutes,b. schedules,



c. accounting records,d. internal controls, ande. the scope of the work performed by the

internal auditor.8. Review the trial balances and compare them

with the respective general ledger controlaccounts.

9. Where necessary, interview pertinent divi-sion heads.

10. Determine if management information sys-tems are adequate and if regular periodicreports are made available. Determine if thereports provide sufficient segregated detailson the annual revenues earned from (1) finan-cial-, banking-, or economic-related dataprocessing and data transmission servicesand (2) third-party nonfinancial data pro-cessing and data transmission services.Ascertain whether the information will allowverification of compliance with the revenuelimitations found in section 225.28(b)(14)of the Board’s Regulation Y.

11. Verify that the subsidiary of the bank hold-ing company is complying with the revenuelimitations found in section 225.28(b)(14)of Regulation Y.

12. Review the data processing, data storage,and data transmission services provided tocustomers for violations of the Board’s regu-lations and interpretations. Obtain sufficientdocumentation for the workpapers.

13. Prepare a statement of condition with aminimum two-year comparison. More than

two years may be prepared if the informa-tion is available and meaningful.

14. Prepare a statement of income using thesame procedures outlined above.

15. Reviewall significant internalpolicies.Deter-mine if the policies were developed inter-nally or by the parent company.

16. Review the subsidiary’s management reportsto the parent company. Is the reporting com-plete and frequent (at least quarterly)? Is theparent company fully aware of the subsid-iary’s operations or problems?

17. Review the adequacy of internal and exter-nal financial and operational audits andinternal control reviews. Interview the EDPauditor and review the audit reports andCPA management letters (for the period ofthe inspection). Also conduct interviewswith the auditors, including the EDP audi-tor (if one was engaged).

18. Review the condition of the company’srecords, that is, their availability, complete-ness, and accuracy. Deficiencies should bediscussed in detail with recommendationsfor improvement.

19. Review all intercompany transactions. Beconsistently alert for any transactions withaffiliate bank(s) that would be a violation ofFederal Reserve Act sections 23A and 23Band Regulation W.

20. Review significant litigation and other con-tingent liabilities.

3160.0.13 LAWS, REGULATIONS, INTERPRETATIONS, AND ORDERS

Subject Laws 1 Regulations 2 Interpretations 3 Orders

EDP auditing 225.28(b)(14)

Types of activities—incidentalactivities

225.123 and225.123(a)

4–176 1975 FRB 215

Data processing as an activityclosely related to banking

225.123(e) 1974 FRB 58

Section 4(c)(1) type of EDP services 225.118 4–195

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

3. Federal Reserve Regulatory Service reference.




Retention of data subsidiary 1972 FRB 318

Order authorizing a bank holdingcompany to engage in expandeddata processing and data transmis-sion activities

1982 FRB 505

Amendment of Regulation Y forexpanded activities

225.28(b)(14) 1982 FRB 5521997 FRB 275

Order authorizing a BHC to offerfinancial-office service and the ser-vice of designing and assemblingdata processing hardware. Receiptof hotel information and the abilityto make airline and hotel reserva-tions is not related to the provisionof banking, financial, and eco-nomic data.

225.28(b)(14) 1986 FRB 497

Order authorizing engaging in elec-tronic benefit services, stored-value-card services, and electronicdata interchange services

1993 FRB 1158

Order authorizing the provision ofa network for the processing andtransmission of medical paymentdata

1994 FRB 139

Order authorizing the provision oftraveler’s checks and postagestamps via an ATM card andterminal

1994 FRB 1107

Order allowing a BHC to processcertain nonfinancial data—personnel information for financialinstitutions for use in their internaloperations

1995 FRB 295

Order authorizing optical scanningand database preparation

1995 FRB 1049

Order authorizing engaging in thedevelopment, production, and pro-vision of customer home banking—personal financial managementusing personal computers

1996 FRB 363






Order allowing aBHC to engage in—

(1) providing data processing anddata transmission services to non-affiliatedfinancial institutionsand

1996 FRB 674

(2) assisting the institutions inoffering their customers bankingand financial services over theInternet

1996 FRB 680

Order approving limited nonfinan-cial data processing and transmis-sion services, including customeridentification, account, and infor-mation or verification files fordetecting fraudulent use.

1996 FRB 348

Order approving the developmentand provision of a data processingand data transmission system(‘‘gateway’’) to depository institu-tions and their affiliates. The sys-tem would make home bankingand other financial services avail-able to the institutions’ and affili-ates’ customers. The gateway wouldprovide customers with an elec-tronic link to an Internet provider.

1997 FRB 135

Order approving the developmentand sale of computer software tobroker-dealers and financial insti-tutions that would allow customersto purchase and sell securities overthe Internet using personalcomputers.

1997 FRB 335

Amendment of Regulation Y toexpand the ability of BHCs, includ-ing FHCs, to process, store, andtransmit nonfinancial data in con-nection with data processing, stor-age, and transmission activities.

2004 FRB 55





Section 4(c)(8) of the BHC Act (EDP Servicing—Network for theProcessing and Transmission of Medical Payment Data) Section 3160.1

A bank holding company applied for the Board’sapproval to acquire all the shares of a nonbankdata processing company to engage in the pro-cessing and transmission of certain medical-payment data. The nonbank subsidiary plans toengage in activities that specialize in a range ofmedical-payment electronic funds transfer ser-vices, including the development of softwareproducts related to the processing of medical-claims payments.

Basic network services.The Board deter-mined by order that a nonbank subsidiary of abank holding company may provide a networkfor the processing and transmission of medical-payment data between health-care providers(such as physicians, hospitals, and pharmacies)and entities responsible for paying medicalbenefits (such as health insurers, health main-tenance organizations, and preferred providerorganizations). These nonbanking activities arepermissible under the Bank Holding CompanyAct and the Board’s Regulation Y (12 C.F.R.225.28(b)(14)). The information on the patient’smedical-benefits card (made available by payingorganizations) would be used to access the sys-tem (similar to a debit or credit card). In gen-eral, health-care providers would enter claimsinformation into the network with a request forpayment, and the payers would authorize elec-tronic fund transfers for full or partial paymentof the claims.

The bank holding company’s nonbank sub-sidiary would also process and transmit medical-treatment data necessary for the processing ofclaims, and would furnish providers with accessto a coverage-information database. The data-base would transmit information about the termsof a particular payer’s medical coverage con-tract, such as the extent to which specific medi-cal treatments are covered by the patient’s insur-ance policy. While such medical and coveragedata are not financial data, the processing andtransmission of these data are essential to thetransmission and processing of the medical pay-ments and financial information in the network.Also, these data processing services allow theelectronic transfer of funds. The Board foundthat the processing and transmission of themedical and coverage data, in connection withthe nonbank subsidiary’s operation of a pay-ments network, are permissible as incidentalactivities. The Board further determined that thenonbank subsidiary’s operation of a medical-payments network would constitute permissibledata processing and data transmission activitiesunder the BHC Act.

Adjudication software.The Board also autho-rized the bank holding company’s nonbank sub-sidiary to furnish claims-adjudication softwareto payers. The software is designed for the pro-cessing of routine claims and would includethe basic rules of a payer’s coverage contract.Claims-adjudication processing would involvethe interaction of financial and banking data andmedical and coverage data as a necessary pre-lude to electronic funds transfer. The Boardfound that the processing of medical and cover-age data involved in claims adjudication is anintegral and necessary part of the processing ofrelated financial and banking information, andthe nonbank subsidiary’s processing of under-lying payment transactions. The Board con-cluded that the nonbank subsidiary’s provisionof claims-adjudication software is permissibleas an activity incidental to its provision of soft-ware for the processing of banking and financialdata and to its operation of a medical-paymentsnetwork.

Electronic data interchange.The bank hold-ing company’s nonbank subsidiary also plans toprovide medical–payments system participantswith statistical and other data derived from theinformation in its database. Each participantwould have on-line access to all of the data itplaces into the system, and third parties desig-nated by a payer or provider could also receiveaccess to the data owned by that customer. TheBoard has previously stated that bank holdingcompanies may provide byproducts of permis-sible data processing and data transmissionactivities as long as the byproducts are notdesigned, or appreciably enhanced, for the pur-pose of marketability (12 C.F.R. 225.123(e)(2)).The Board has also indicated that byproductsinclude data, software, or data processing tech-niques that may be applicable to the data pro-cessing requirements of other industries.

The nonbank subsidiary may perform limitedselection, combination, and similar functions onraw data so that the data can be transmitted tothe customer in a reorganized and more usableform. It may also design software that wouldenable customers to perform similar reorganiza-tion functions on raw data. The Board con-cluded that the proposed electronic datainterchange services would constitute permis-sible byproducts of the nonbank subsidiary’sprimary data processing activities, and are there-fore permissible as an incidental activity.

BHC Supervision Manual December 1997Page 1

The Board’s approval of the application onDecember 22, 1993, is based on the facts ofrecord and is subject to the commitments and

representations that were made by the applicantand the conditions referred to in the order. (See1994 FRB 139.)

4(c)(8) (EDP Servicing—Network for the Processing and Transmission of Medical Payment Data)3160.1


Electronic Benefit Transfer, Stored-Value-Card,and Electronic Data Interchange Services Section 3160.2

Four bank holding companies (the applicants)applied for the Board’s approval under section4(c)(8) of the Bank Holding Company Act toengage de novo, through their joint venture cor-poration (the company), in nonbanking activi-ties consisting of engaging in electronic benefittransfer services, stored-value-card services, andelectronic data interchange services. The appli-cants proposed to engage in the activities through-out the United States. The applicants providedata processing and transmission services throughthe company to retail merchants using point-of-sale (POS) terminals and to banks who aremembers of the company’s automated tellermachine (ATM) network.

3160.2.1 ELECTRONIC BENEFITTRANSFER SERVICES

The electronic benefit transfer services wouldinvolve data processing and transmission ser-vices required to permit the delivery of govern-mental program benefits (such as welfare pay-ments and food stamps) through the ATM andPOS terminals of participating merchants andbanks. Under a benefits-services system, a bene-fit recipient would be issued a magneticallyencoded card similar to an ATM card, whichcould be used to obtain access to a governmentbenefit account maintained on behalf of therecipient. The Board concluded that such activi-ties are financial activities that are operationallyand functionally similar to the electronic pay-ment and data processing services provided bybanks and bank holding companies in the opera-tion of ATM and POS networks. In particular,the proposed benefit services involve the pro-cessing of access and authorization requestssubmitted to, and the processing of electronicpayments originating from, financial accountson the same basis as transactions initiated withtraditional credit and debit cards. The Boardthus concluded that such electronic benefit trans-fer activities are closely related to banking andpermissible for bank holding companies underthe BHC Act.

3160.2.2 STORED-VALUE-CARDSERVICES

Stored-value-card services would involve dataprocessing and transmission services and elec-tronic payment services related to stored-valuecards. These cards are similar to credit or debit

cards in which authorized funds can be trans-ferred and credited using magnetic stripe orcomputer chip technology. The services wouldbe provided in connection with both ‘‘closed’’and ‘‘open’’ stored-value-card systems. Closedsystems include both single-vendor stored-value-card systems and systems designed for single-use sites. An open system, by contrast, refers tomultiple-vendor, multiple-site stored-value-cardsystems.

3160.2.2.1 Stored-Value-Card ClosedSystems

In most current closed systems, cash mustbe deposited in a particular vendor’s card-dispensing terminal, and the card received fromthe terminal may be used only for purchasesfrom that specific vendor. The card itself isdisposable, and the only account reconciliationthat may be required would involve the ven-dor’s own cash receipts, the amount of fundsdebited from the cards at turnstiles or otherpoints of sale, and the amount of the vendor’sliabilities stored on outstanding cards. The com-pany intended to play a role in the operation ofthis basic type of closed system, as well as tohelp develop and operate more complex closedsystems. These systems would use a plastic cardcontaining electronic technology, such as a com-puter chip or magnetic stripe, to which fundscould be credited and from which funds couldbe debited, for an indefinite period of time. Thecompany proposed performing accounting func-tions in customer accounts and accounting forthe level of the vendor’s stored liabilities. Insuch a capacity, the company would be respon-sible for the settlement and reconciliation ofthese customer and vendor accounts. The com-pany would also perform other functions, suchas embossing and issuing cards and arrangingfor funds collection.

3160.2.2.2 Stored-Value-Card OpenSystems

The applicants anticipate that stored-value cardseventually will operate in an open system simi-lar to a POS network, which allows value storedon a card to be used with a wide range ofparticipating vendors. The applicants expect that


the company’s principal stored-value-cardactivities would involve the development andoperation of such open systems.

In an open system, customers’ debit cardswould hold an integrated computer chip or sometype of comparable technology capable of stor-ing value for use in stored-value-card transac-tions. Value could be placed on the card at anATM adapted to read and place value on thechip, at a limited-purpose ATM-type machinewhose only functions would be to add value tothe chip and to transfer stored value back to thecustomer’s account, or at a cash-to-card machineor other value-transfer device (collectively, valueterminals). These value terminals would beoperated, in at least some cases, by the com-pany. Once value is placed on a card, equivalentfunds could be transferred to the company,which would hold the funds for payment ofstored-value-card transactions. Stored valuewould leave the chip when the customer pur-chases goods or services either at a POS termi-nal (which may be operated by the company) orat a vending machine, telephone booth, masstransit turnstile, or other unmanned deliverylocation (collectively, reader terminals), or whenthe customer transfers funds back to an accountat a value terminal. Reader terminals generallywould be offline devices not connected to thecompany’s ATM or POS networks. Instead of adirect electronic connection, a reader terminalwould retain, for a period of time, value repre-senting the amount of customer purchases at theterminal. Then, at the vendor’s convenience, thecompany, the vendor, or a third party wouldcollect value from the reader terminals usingspecially designed collection cards issued by thecompany. The collection cards would then besubmitted to the company so that funds can beproperly credited. Once these transactions occur,the company would be responsible for makingsettlement by transferring funds to the accountsof participating merchants and other appropriateparties.

The Board concluded that the company’sactivities in providing stored-value-card ser-vices, in both closed and open systems, areclosely related to banking. The activities involveprocessing debits and credits to the stored-valuecards and performing related accounting andsettlement functions, and are thus a data pro-cessing activity. Financial balances are main-tained and adjusted at POS and other terminalsas the customer purchases various items or addsvalue to the card, and the activity constitutes the

processing of banking, financial, or economicdata within the meaning of Regulation Y. Inaddition, aspects of the company’s stored-value-card services are functionally similar to the issu-ance and sale of consumer payment instrumentssuch as traveler’s checks, which are activitiesthat banks conduct and that the Board has previ-ously determined to be closely related to bank-ing within the meaning of the BHC Act. TheBoard concluded that the company’s proposedservices in connection with stored-value cards,in either an open system or a closed system, areclosely related to banking.

3160.2.3 ELECTRONIC DATAINTERCHANGE SERVICES

The company also proposes to furnish retailmerchants with data collected from sales trans-actions consummated at the merchant’s place ofbusiness (data services). The data collected andfurnished would relate to specific items andquantities of products purchased by the cus-tomer, as well as to customer-purchasing pat-terns over a period of time. The data would beformatted so that it could be used by the mer-chant for inventory control, targeted marketing,and other purposes. The company’s data ser-vices generally would be furnished to merchantsas an adjunct to its POS-transaction-processingservices and would be rendered through a retailmerchant’s POS terminals. The company doesnot intend to offer data services independently.In addition, the data that are collected by thecompany would be furnished only to the mer-chant that is a party to the underlying salestransaction; that is, the company does not intendto provide such information to third parties.

The company’s data services would be lim-ited to capturing, formatting, and furnishing datacollected from sales transactions consummatedat a particular merchant’s place of business. Inaddition, the data collected would be furnishedonly to that merchant and only in accordancewith the merchant’s specific instructions. Thecompany does not intend to provide software,render advice, or provide other services associ-ated with the marketing or other uses of thedata. The applicants do anticipate, however, thatthe company could provide additional relatedfunctions, such as issuing store coupons or cred-its related to a merchant’s marketing programsat POS terminals. Based on the facts presented,the Board determined that the sales data thatwould be processed under the proposed dataservices are financial and economic data withinthe meaning of Regulation Y.

Electronic Benefit Transfer, Stored-Value-Card, and Electronic Data Interchange Services Section 3160.2


3160.2.4 BOARD APPROVAL

Based on all the facts of record, the Boardapproved the applications. The Board’s approvalis specifically conditioned on compliance withthe commitments made in connection with theapplications and with the conditions referred toin the order. (See 1993 FRB 1158.)

Regulation Y provides that a bank holdingcompany may render advice to anyone on pro-cessing and transmitting banking, financial, andeconomic data. On November 26, 2003, theBoard approved an amendment to section225.28(b)(14) of Regulation Y to expand theability of all bank holding companies, includingfinancial holding companies, to process, store,and transmit nonfinancial data in connection

with their financial data processing, storage, andtransmission activities. The Board raised thetotal annual revenue limit from 30 percent to the49 percent limit that applies to nonfinancial dataprocessing activities. Specifically, a company (anonbank subsidiary of a bank holding company)conducting data processing, data storage, anddata transmission activities may conduct nonfi-nancial data processing, data storage, and datatransmission activities (those that are not finan-cial, banking, or economic in nature) if the totalannual revenue derived from those activitiesdoes not exceed 49 percent of the company’stotal annual revenues derived from data process-ing, data storage, and data transmission activi-ties. (See 12 C.F.R. 225.28(b)(14).)

Electronic Benefit Transfer, Stored-Value-Card, and Electronic Data Interchange Services Section 3160.2


Data Processing Activities: Obtaining Travelers’ Checks and PostageStamps Using an ATM Card and ATM Terminal Section 3160.3

Eleven bank holding companies (the applicants)applied for the Board’s approval to engagethrough a joint venture corporation (the com-pany) in certain nonbanking activities related tothe operation of a retail electronic funds transfernetwork, including data processing and datatransmission activities related to automated tellermachine (ATM) and point-of-sale (POS) trans-actions, as well as electronic benefit transfer,stored-value card, and electronic data captureand interchange services. (A complete list of theproposed activities is found at 1994 FRB 1110–1111.)

The applicants also proposed to offer throughthe company certain data processing and datatransmission services not previously consideredby the Board. Those services consisted of allow-ing customers to use their ATM cards at anATM terminal to withdraw funds from a bankaccount in the form of travelers’ checks or post-age stamps. Payment for the transactions wouldbe accomplished by a debit to a cardholder’sdeposit account.

The transactions would occur at terminalsthat would not be owned and operated by thecompany. Cardholders buying postage stampsor travelers’ checks at an ATM terminal would

purchase those products from the bank owningthe ATM. The decision on which travelers’checks to issue would remain with the bank thatowns the ATM terminal, and the company wouldnot be the issuer of the travelers’ checks.

The company’s primary activities would beprocessing and transmitting access requests andpayment authorizations. The company wouldalso provide terminal-driving services, load ATMterminals with postage stamps and travelers’checks, and market the products through thenetwork.

The Board determined that the proposedactivities involved the processing of access andauthorization requests submitted to depositaccounts on the same basis as other transactionsinitiated with a traditional debit card. The activ-ity is operationally and functionally similar tothe data processing services provided by banksand bank holding companies in their operationof ATM and POS networks. Traditionally, bankshave been permissibly engaged in the sale oftravelers’ checks and postage stamps. The Boardthus found the company’s proposed data pro-cessing and transmission activities, with respectto these transactions, to be closely related tobanking. (See 1994 FRB 1107.)


Providing Data Processing for ATM Distribution of Tickets, Gift Certificates,Telephone Cards, and Other Documents Section 3160.4

Five bank holding companies (the applicants)applied for the Board’s approval to engage,through a joint venture subsidiary (the com-pany), in certain data processing activities pur-suant to Regulation Y. The applicants, throughthe company, would provide data processingand related services to banks and other auto-mated teller machine (ATM) owners in connec-tion with the distribution through ATMs of tick-ets, gift certificates, prepaid telephone cards,and other documents evidencing a prepaymentfor goods or services.1

The company would provide the software andtelecommunications channels necessary to trans-mit cardholder requests, card-issuer authoriza-tions, and related switching and account recon-ciliation services. Specifically, the companywould provide terminal driving services thatinclude—

• establishing and maintaining an electroniclink between an ATM and a telecommunica-tions switch to transmit cardholder requestsand card-issuer authorizations; and

• operating the feature and functions displayson an ATM screen using computer software topermit an ATM to dispense various productsin addition to currency.

The company would also provide switching ser-vices and transaction processing to transmitaccount debiting, transaction authorization, andsettlement data between the ATM owner, or itsbank, and the cardholder’s bank.

A typical transaction would consist of anATM cardholder selecting a particular product,such as a concert ticket, from a menu displayedon the ATM screen. The electronic commands

transmitted by the company would verify thatthe deposit account or line of credit designatedby the cardholder had sufficient funds to effectthe purchase. Following authorization, the ATMwould dispense the product and issue a receipt.Thecard-issuingbankwould thendebitanamountequal to the cost of the purchase from the card-holder’s designated account and transfer thefunds to the account of the merchant or ATMowner, using settlement procedures establishedby the company’s ATM network.

The Board previously determined that a bankholding company could provide data processingand related services necessary to permit custom-ers to use an ATM card to debit a depositaccount or line of credit at an ATM terminal forcash and credit transactions, and for the pur-chase of travelers’ checks, money orders, andpostage stamps. The Board has further deter-mined that a bank holding company may pro-vide data processing services that support theuse of credit cards by consumers in the directpurchase of goods and services from a mer-chant. (See 1995 FRB 492, 1990 FRB 549, and1985 FRB 113.)

The data processing proposed in this caseinvolves the same type of data processing sup-port as the Board has previously approved forcredit card transactions and other more tradi-tional types of ATM transactions. The Boardthus concluded that the activities proposed bythe applicants are permissible, consisting of dataprocessing and transmission services encom-passed within the Board’s Regulation Y, and arethus closely related to banking within the mean-ing of section 4(c)(8) of the Bank Holding Com-pany Act. (See 1996 FRB 848.)

1. The tickets would include public transportation ticketsand tickets to entertainment events. Gift certificates and pre-paid telephone cards would be issued in fixed denominationsfor a specific merchant or group of merchants, and they wouldevidence prepayment of the purchase price of merchandise orservices to be selected by the bearer at some time in thefuture. The ATM owners would also sell products that couldbe offered for sale directly by a financial institution, such asmutual fund shares or insurance policies, where permitted byapplicable law.


Section 4(c)(8) of the BHC Act(Engage in Transmitting Money) Section 3160.5

3160.5.1 ENGAGE IN TRANSMITTINGMONEY IN THE UNITED STATES

A bank holding company gave notice undersection 4(c)(8) of the Bank Holding CompanyAct (BHC Act) (12 U.S.C. 1843(c)(8)) and sec-tion 225.23 of the Board’s Regulation Y (12C.F.R. 225.23) to engage de novo through twocompanies (the companies) in the activity oftransmitting money for customers within theUnitedStatesand its territories (‘‘domesticmoneytransmission services’’) to third parties locatedin foreign countries.1 The activity was to beconducted at first through a network of approxi-mately 1,200 ‘‘outside representative offices’’located in California, Florida, Illinois, and Texasthat are under contract with the companies toprovide money transmission services.2 The bankholding company proposes to engage in theplanned activity nationwide. The companies arecorporations that currently engage in the busi-ness of money transmission to Mexico throughrepresentatives in California, Florida, Illinois,and Texas.

Domestic money transmission services wouldbe provided in the following manner: A cus-tomer would contact the companies directly bymeans of a dedicated telephone located in theoutside representative office to request that thecompanies transmit funds to a third party for afee. The outside representative would collectcash and a fee from the customer, issue a receipt,and deposit funds in an account maintained bythe outside representative solely for the purposeof receiving funds in trust to be transmitted to athird party. The outside representative may main-tain this account at any bank, including a subsid-iary bank, but would have no agreement withany bank to accept deposits on its behalf. Nei-ther the outside representatives nor the compa-nies would be FDIC-insured institutions.

The companies would collect funds depositedin an outside representative’s account dailythrough an automated clearinghouse (ACH) orsimilar transaction and deposit an amount equalto the amount to be transmitted into an accountthey maintain at a bank, which may include one

of its subsidiary banks, located near the thirdparty receiving the funds. The third party wouldbe notified that money is available at a localdisbursement site, which could include a banksubsidiary of the bank holding company or con-sumer finance office or an unaffiliated check-cashing, finance, or other type of office. Fundswould be made available to the third party by acheck drawn on the companies’ account almostimmediately after the transmission order is placedby the customer.3

A customer would not transmit funds to anybank account maintained by the customer or anythird party. Thus, the bank holding companywould not use this service to collect deposits forcustomers of its subsidiary banks or any otherbank.

There was no agreement between a customerand a bank to accept money in an account foruse by the bank in connection with the proposeddomestic money transmission services. The com-panies and their outside representative wouldaccept money from a customer for the solepurpose of transmitting funds to a third party. Acustomer would not give funds to the companieswith the expectation that the companies wouldpermit the customer to reclaim the funds ondemand or after a period of time. Moreover, thecompanies would not maintain balances or payinterest on the money they receive, and theywould only hold funds long enough to transmitthem to the designated third party.4

The Board previously determined that moneytransmission abroad is closely related to bank-ing.5 The Office of the Comptroller of the Cur-rency (OCC) also has concluded that it is per-missible for a national bank to accept moneyfrom nonbank affiliates for the purpose of trans-mitting the funds to a foreign country and that a

1. The Board previously approved the bank holding com-pany’s acquisition of a company to engage in the activity oftransmitting funds to third parties in Mexico by using anunaffiliated foreign bank to make the cash payments. See1995 FRB 974.

2. Outside representative offices would be expanded toinclude consumer finance offices in addition to existinggrocery stores, travel agencies, pharmacies, and insuranceagencies.

3. The domestic money transmission services do not involvelending money because only funds provided by the customerwould be transmitted to a third party. The plan does notinvolve the paying of checks. Although the third party re-ceives money by means of a check drawn on an accountmaintained by the companies, the receipt of funds in checkform is not the payment of a check (seeIndependent BankersAss’n of America v. Smith, 534 F.2d 921, 943–45 (D.C. Cir.1976)).

4. Many states permit companies that are not chartered asbanks to transmit money without deeming this activity toinvolve the taking of deposits. The bank holding company isrequired to conduct the proposed activities in compliance withlicensing and other requirements of relevant state law.

5. See 1990 FRB 270.


nonbankaffiliate thatparticipateswith thenationalbank in transmitting money abroad would notbecome a branch of the bank.6 Based on all thefacts of record and for the reasons discussed inthis and the Board’s previous orders, the Boardconcludes that domestic money transmissionservices are closely related to banking. TheBoard has relied on the fact that the companiesare subject to licensing and examination by stateauthorities.7 The companies have committed tocomply with all applicable reporting require-ments, including reporting all transactions over$10,000 to the Internal Revenue Service. Thebank holding company committed to apply theinternal controls currently in place at the finan-

cial services company to ensure compliancewith the Bank Secrecy Act.8

Based on the foregoing and all the facts ofrecord, the Board approved the notice on Octo-ber 17, 1995 (see 1995 FRB 1130). The Board’sdecision was specifically conditioned on thebank holding company’s complying with all thecommitments made in connection with the noticeand obtaining all necessary approvals from stateregulators.

6. The OCC has reasoned that nonbank offices that trans-mit funds through a national bank to a third party do notconstitute ‘‘branches’’ under federal law.

7. This order was specifically conditioned on requiring thebank holding company to obtain all necessary state licenses.

8. These procedures include a weekly review of all transac-tions over $10,000. In addition, the companies will requirecustomer identification, including thecustomer’scurrentaddressand occupation, for all transmissions above $3,000. The com-panies also will run a computer match of all remitters andrecipients by name and Social Security number so that report-ing requirements cannot be evaded by means of a series oftransactions.

Section 4(c)(8) of the BHC Act (Engage in Transmitting Money) 3160.5


Support Services—Printing and SellingMICR-encoded items Section 3165.1

The Board has included within Regulation Y(section 225.28(b)(10)(ii)(B)) the authority forbank holding companies to engage in the print-ing and selling of magnetic ink character recog-nition (MICR)-encoded items as part of supportservices. This activity includes this primaryactivity and also the printing and selling ofcorporate image checks, cash tickets, voucherchecks, deposit slips, savings withdrawal pack-ages, and other forms that require MICR encod-ing. The activity was initially authorized as apermissible activity by Board order, wherebysuch documents were to be printed for and soldexclusively to depository institutions. The appli-cant associated with that Board order proposed

to acquire a controlling interest in a printingcompany that prints and sells checks and relateddocuments. It planned to engage in a joint ven-ture with another company that engages in checkprinting and other printing activities. The Boardconcluded for that application that checks andother MICR-encoded documents used in thepayments process are provided in specializedform and that they are an integral part of afundamental banking service, and thus the activ-ity is deemed closely related to banking. See1986 FRB 794. The Board included the non-banking activity in the Regulation Y ‘‘laundrylist,’’ effective April 1997.


Section 4(c)(8) of the BHC Act (Insurance Agency Activities ofBank Holding Companies) Section 3170.0

3170.0.1 INSURANCE ACTIVITIESPERMISSIBLE FOR BANK HOLDINGCOMPANIES

Before the enactment of the 1970 amendmentsto the Bank Holding Company Act, the Boardby order authorized certain bank holding com-panies to engage in insurance activities. Thespecific type of permissible insurance activityfor each bank holding company was describedin its Board order. These few bank holding-companies that commenced insurance agencyactivities before January 1, 1971, have grand-father rights under the current statutes and regu-lations (section 4(c)(8)), exemption G and 12(CFR 225.28(b)(11)(vii)). These bank holdingcompanies may, with the prior approval of theBoard, engage in general insurance agencyactivities without restriction as to location or totype of insurance sold. (See section 3170.0.3.7)

The 1970 amendments to the Bank HoldingCompany Act authorized the Board to deter-mine permissible nonbanking activities undersection 4(c)(8). Subsequently, on September 1,1971, the Board amended Regulation Y to per-mit bank holding companies to engage in cer-tain insurance agency activities.

The Board further amended the section ofRegulation Y concerning permissible insuranceagency activities on September 1, 1981. The1981 amendments limited permissible insuranceactivities previously authorized by RegulationY. The first amendment deleted from the Board’sregulations the authority for bank holding com-panies to act under section 4(c)(8) of the BankHolding Company as agent for the sale of insur-ance for themselves and their subsidiaries. Thisamendment reflected a court decision of theUnited States Court of Appeals for the FifthCircuit that acting as agent for the sale of insur-ance for the bank holding company and itsnonbanking subsidiaries was impermissible (per-missible for banks, however). Such insurance ispermissible, however, if conducted pursuant tosection 4(c)(1)(C) of the BHC Act.1 The second1981 amendment deleted from the Board’s regu-lations the authority to act as agent for insurance

sold as a matter of convenience to the public.The opinion also found that the part of theBoard’s regulation relating to the sale of ‘‘con-venience insurance’’2 exceeded the scope of theprovisions of section 4(c)(8) of the Bank Hold-ing Company Act. The sale of this other insur-ance was considered impermissible.

On October 15, 1982, Congress enacted theGarn–St Germain Depository Institutions Act(Public Law 97-320). Title VI of that act amendedsection 4(c)(8) of the Bank Holding CompanyAct.Thisamendmentstated that insuranceagency,brokerage, and underwriting activities arenot‘‘closely related’’ to banking within the mean-ing of section 4(c)(8) of the Bank Holding Com-pany Act. However, the amendment providedfor seven exceptions to the general prohibitionof bank holding companies engaging in insur-ance activities. One of the seven exceptionscontains grandfather exemptions for insuranceagency activities conducted on May 1, 1982, orfor those insurance activities approved by theBoard on or before May 1, 1982. As a result,bankholdingcompaniesreceivingBoardapprovalon or before May 1, 1982, may continue toengage in their insurance agency activities. (Seesection 3170.0.3.4)

The seven types of insurance activitiesallowed as permissible for bank holding compa-nies are as follows:1. Acting as agent, broker, or principal (i.e.,

underwriter) for credit-related life, accidentand health, or unemployment insurance.

2. For bank holding company finance subsidi-aries, acting as agent or broker for credit-related property insurance in connection withloans not exceeding $10,000 ($25,000 in thecase of a mobile home loan) made by financecompany subsidiaries of bank holding com-panies. (The Board interpreted this provisionas permitting only the sale of insurance thatdoes not exceed the outstanding balance ofthe loan—vendor’s single interest insurancerather than general property insurance thatcovers the borrower’s equity interest.)

1. The Board’s Regulation Y was amended as of Decem-ber 1983 to include the sale of insurance for a holdingcompany based on the services provision of section 4(c)(1)(C)of the BHC Act, which did not require any prior Boardapproval. Included in the regulation were the services ofselling, purchasing, or underwriting such insurance as blanketbond insurance, group insurance for employees, and propertyand casualty insurance for the bank holding company or itssubsidiaries.

2. ‘‘Convenience insurance’’ consisted of insurance thatwas sold as a matter of convenience to the purchaser. Thepremium income from the sale of this insurance was expectedto constitute less than 5 percent of the aggregate insurancepremium income of the holding company. The sale of thisinsurance was not designed to permit entry into the generalinsurance-agency business.


3. Acting as agent for the sale of any type ofinsurance in a place with a population notexceeding 5,000, or with insurance agencyfacilities that the bank holding company dem-onstrates to be inadequate.

4. Any insurance agency activity engaged in bya bank holding company or its subsidiarieson May 1, 1982 (or approved as of May 1,1982), including (i) insurance sales at newlocations of the same bank holding companyor subsidiaries in the state of the bank hold-ing company’s principal place of business oradjacent states or any state or states in whichinsurance activities were conducted by thebank holding company or any of its subsidi-aries on May 1, 1982, or, (ii) insurance cov-erage functionally equivalent to those engagedin or approved by the Board as of May 1,1982.

5. Acting, on behalf of insurance underwriters,as supervisor of retail agents who sell fidelityinsurance and property and casualty insur-ance on holding company assets or groupinsurance for the employees of a bank hold-ing company or its subsidiaries.

6. Any insurance agency activities engaged inby a bank holding company having totalconsolidated assets of $50,000,000 or less.Life insurance and annuities sold under thisprovision, however, must be authorized by(1), (2), or (3) above.

7. Any insurance agency activity that is per-formed by a registered bank holding com-pany, which was engaged in some insuranceactivity before January 1, 1971, pursuant tothe approval of the Board.These seven types of insurance allowed by

the amendment to section 4(c)(8) of the Garn–St Germain Act are generally consistent withthe types of insurance activities previously autho-rized by the Board. The one general exceptionrelated to the prohibition of the sale of propertyand casualty insurance.

3170.0.2 INSURANCE AGENCYACTIVITIES

Insurance agency activities are among the mostwidely practiced nonbank activities engaged inby bank holding companies. Many bank holdingcompanies are involved in the sale of insuranceat some level in the organization; however, theinspection focuses on these activities only whenperformed by the parent company or by a non-

bank subsidiary (excluding bank-owned subsid-iaries). Many of the smaller bank holding com-panies engage directly in these activities ratherthan through insurance agency subsidiaries. Ineither arrangement, however, sales are usuallyconducted on the premises of the subsidiarybank by personnel who most often serve asofficers or employees of the bank or parentcompany.

Performance of insurance agency activitieshas been profitable for most bank holding com-panies with many of the smaller companies rely-ing heavily on the commissions generated toservice acquisition or other related indebted-ness. In most cases, little or no expenditures forfixed assets are required since the premises ofthe subsidiary banks or parent company areutilized. Likewise, little or no liabilities areincurred since there are minimal assets to befinanced.

3170.0.3 PERMISSIBLE TYPES OFCOVERAGE INCLUDINGGRANDFATHER PRIVILEGES

As noted above, the Board, effective November7, 1986, approved a revision of specific insur-ance agency and underwriting activities permis-sible for bank holding companies under section4(c)(8) of the BHC Act (section 225.28(b)(11)of Regulation Y). In clarifying the scope ofinsurance activities that are closely related tobanking and permissible for bank holding com-panies under the Garn–St Germain Act, theBoard included in its revised Regulation Y theseven specific exemptions contained in thatstatute.

3170.0.3.1 Insurance ActivitiesPermissible for Bank Holding Companiesper Section 225.28(b)(11)(i) of theBoard’s Regulation Y

Permissible insurance agency activities includethe sale of life, accident and health, and involun-tary unemployment insurance that is directlyrelated to an extension of credit by a bankholding company with respect to its own exten-sions of credit and those of its subsidiaries. Forthe purpose of determining what activities arepermissible, the Board interpreted the term‘‘extension of credit’’ to include direct loans toborrowers, loans purchased from other lenders,and leases of real or personal property so longas the leases meet all the criteria contained insection 225.28(b)(3) of Regulation Y, which

Section 4(c)(8) of the BHC Act (Insurance Agency Activities of BHCs) 3170.0


defines leases as the functional equivalent of anextension of credit. (See the discussion of leas-ing in section 3140.0.)

The regulation requires that insurance cover-age be limited to the ‘‘outstanding balance due’’on an extension of credit. The ‘‘outstandingbalance due’’ is calculated as follows:1. Include:

a. principal and interestb. reasonable administrative fees outstand-

ing on the loanc. the balance of payments due in a lease

transaction2. Exclude:

a. the residual value of the leased item (sincethe lessor owns the leased item and thelessee is not obligated to purchase theitem by paying the residual value)

The insurance may provide for total repay-ment of the extension of credit in the event ofthe death of the borrower or for periodic pay-ments on the extension of credit when the bor-rower is temporarily disabled or unemployed.Such single or periodic payments may not exceedthe balance on the loan and thus provide foradditional general life or accident coverage.

While ordinarily such credit-related insurancecoverage would be declining term as paymentsreduce the balance due on an extension of credit(loans in connection with first mortgages), abank holding company may write or sell a levelterm policy on nonamortizing loans. Policieswritten or sold pursuant to this paragraph, more-over, may be individual rather than group poli-cies, and the premiums on such policies may beage-related. The Board continues to require thatinsurance policies sold or written to cover the‘‘outstanding balance due’’ insure only namedborrowers or lessees of a particular bank hold-ing company. Accordingly, such policies couldcover both spouses jointly only if both spouseswere actual borrowers or lessees under theterms of the agreement with the bank holdingcompany.

The Board permits, with regard to an exten-sion of credit, the sale and underwriting ofcredit-related life, accident and health, andinvoluntary unemployment insurance (1) withrespect to lease transactions, as previously dis-cussed, when such lease transactions are theequivalent of loans; (2) in connection with loanssecured by residential first mortgages; and (3) inconnection with the servicing of loans origi-nated or purchased by the applicant bank hold-ing company and subsequently sold.

The regulation explicitly permits the sale oflife, disability, and involuntary unemployment

insurance with respect to a lease transaction,provided the lease is the type of nonoperating,full payout lease described as permissible forbank holding companies in section 225.28(b)(3)of Regulation Y. The Board has determined thatsuch leases are the ‘‘functional equivalent of anextension of credit.’’ It believes that this type oflease is encompassed in the term ‘‘extension ofcredit’’ as it is used in exemption A of theGarn–St Germain Act.

As discussed previously, the first exemptionof the Garn–St Germain Act permits the saleof any type of life, disability, and involuntaryunemployment insurance relating to an exten-sion of credit, including home mortgage redemp-tion insurance. Home mortgage insuranceinsures the repayment of the unpaid balance of aresidential first mortgage loan in the event of thedeath or disability of the mortgagor. The Boardhas determined that home mortgage redemptioninsurance is closely related to banking becauseit supports the lending function (1986 FRB 339and 671) by providing for repayment of residen-tial mortgage loans at a time when the death ordisability of the borrower may delay or disruptthe scheduled repayment of such loans. Homemortgage redemption insurance in connectionwith residential mortgage loans is considered asfulfilling the same function as credit life andcredit accident and health insurance with respectto other types of loans. The Board recognizedthat such insurance functions as credit insurancein supporting a bank’s lending function (seethe Board’s approval for thesaleof such insur-ance by bank holding companies within 1975FRB 45).

In approving the activity of home mortgageredemption insurance by order, the Board previ-ously relied on commitments by applicants toinform, in writing, borrowers who are prospec-tive purchasers of such insurance that homemortgage redemption insurance is not requiredand that, if desired, it may be purchased fromother sources. The Board has also relied on acommitment for written notice to borrowers thatthe insurance contract may be rescinded at anytime after the loan commitment is made andbefore closing. The Board continues to requirethat such notices be provided to borrowers. Inaddition, the Board continues to rely on the factthat premiums for such insurance are payableperiodically during the term of the extension ofcredit, so as to increase the borrowers’ ability torescind the insurance and to limit premiumfinancing as an incentive to sell such insurance.



The Board considers an ‘‘extension of credit’’as covering loans that are made or purchased bythe bank holding company or its subsidiaries.Credit-related insurance may be continued onthe loans that were sold, and are now only beingserviced, provided that they were made or pur-chased by the bank holding company or itssubsidiaries. The Board permits bank holdingcompanies to sell credit-related life, accidentand health, and involuntary unemploymentinsurance where the bank holding company pre-viously placed funds at risk. In this situation, thebank holding company must continue to limit itsinsurance coverage to the outstanding balancedue on the extension of credit by the borrower.

A bank holding company may not sell orunderwrite insurance when merely servicing aloan andit has never placed its funds at riskeither by originating or purchasing the loan; thebank holding company is permitted to collectand transmit insurance premiums, act as inter-mediary in renewing existing policies or adjust-ing coverages, and engage in other activitieswhich are incidental to the servicing of loans.The bank holding company may collect a fee forsuch services, providing that the fee is based onthe provision of the service and is not a pre-mium for insurance sold. In that case, the bankholding company would be engaging in loanservicing rather than insurance activities.

3170.0.3.2 Section 225.28(b)(11)(ii) ofRegulation Y—Sale of Credit-RelatedProperty Insurance by Finance CompanySubsidiaries of a BHC

The Garn–St Germain Act restricts the authorityof bank holding companies to engage in prop-erty and casualty insurance activities. Before1982, the Board approved the sale of propertyand casualty insurance that was directly relatedto an extension of credit by a bank or bank-related firm in the bank holding company sys-tem. The sale of property insurance is nowlimited to an extension of credit made by afinance company that is a subsidiary of a bankholding company, acting as agent or broker. Afinance company subsidiary may only engage inthe sale of such property insurance if—1. the insurance is limited to assuring repay-

ment of the outstanding balance on suchextension of credit in the event of loss ordamage to any property used as collateral forthe extension of credit;

2. the extension of credit is not more than$10,000, or $25,000 if it is to finance thepurchase of a residential manufactured home3

and the credit is secured by the home; and3. the applicant commits to notify borrowers in

writing that—a. they are not required to purchase such

insurance from the applicant;b. such insurance does not insure any interest

of the borrower in the collateral; andc. the applicant will accept more comprehen-

sive property insurance in place of suchsingle interest insurance.

3170.0.3.2.1 Definition of a FinanceCompany

A ‘‘finance company’’ for purposes of the saleof property insurance includes all non-deposit-taking financial institutions that engage in asignificant degree of consumer lending (exclud-ing lending secured by first mortgages) and allfinancial institutions specifically defined by indi-vidual states as finance companies that engagein a significant degree of consumer lending.Finance companies, under this provision, includethose entities that may be authorized to acceptlimited types of time or savings deposits understate law but which a state has defined to be afinance company. Since exemption B of theGarn–St Germain Act is directed to consumerloans, the regulation requires that a qualifyingcompany be engaged in that type of lending to asignificant degree as measured by either numberof loans, percentage of loans, percentage of loanamounts outstanding, or some similar measure.The Board will evaluate the amount of the con-sumer lending on a case-by-case basis.

3170.0.3.2.2 Property Insurance aFinance Company May Sell

Section 225.28(b)(11)(ii) of Regulation Y per-mits finance company subsidiaries of bank hold-ing companies to engage in the sale of single-interest property insurance that insures againstdamage or loss only to the extent of the lender’sinterest in the property that serves as collateral-for a loan. The Garn–St Germain Act limits thepermissible insurance coverage to ‘‘the out-

3. These limitations increase at the end of each year, begin-ning with 1982, by the percentage increase in the ConsumerPrice Index for Urban Wage Earners and Clerical Workerspublished by the Bureau of Labor Statistics.



standing balance due on an extension of credit.’’It does not contemplate general property insur-ance that covers the entire value of the property,including the balance due the lender and theequity interest of the borrower/owner. Generallysuch insurance is declining balance and the onlyinterest in the collateral property that may beinsured is that of the lender.

The sale of single-interest insurance is per-mitted provided that the BHC finance companysubsidiary does not require such insurance ofborrowers who have adequate property insur-ance on the loan collateral. In addition, thefinance company subsidiary is required to dis-close in writing that such insurance, if required,need not be purchased from the lender and thatsuch insurance does not cover the borrower’sinterest in the property. The requirement is alsoimposed by the Board’s Regulation Z, section226.4(d)(2), if the premium is excluded fromthe finance charge.

3170.0.3.3 Section 225.28(b)(11)(iii) ofRegulation Y—Insurance in Small Towns

Engaging in any insurance activity is permittedin a place where the bank holding company or asubsidiary of the bank holding company has alending office in a community that—1. has a population not exceeding 5,000 (as

shown by the last preceding decennial cen-sus) or

2. has inadequate insurance-agency facilities,as determined by the Board, after notice andopportunity for hearing.In order to provide insurance agency activi-

ties in a town with a population not exceeding5,000, or in a community that has inadequateinsurance agency facilities, the bank holdingcompany must have a lending office that servesthe public in the small town. The regulationspecifically requires that the office be a lendingoffice in order to provide the bank holding com-pany with a link to the town, to avoid remoteoperation from a central location of a networkof small-town insurance agencies, and generallyto maintain insurance as a fee-generating activ-ity to help sustain a small-town lending office asan independent, viable profit center.

The current requirement does not limit thesale of insurance to a ‘‘principal place of bank-ing business’’ located in a community notexceeding a population of 5,000. Also, a bankholding company insurance agency is not pre-cluded from selling insurance to those residingoutside the community who initiate the transac-

tion at the agency’s place of business in thetown of less than 5,000. Advertising in thecommunity newspaper or a telephone book thatmay serve an area larger than the community of5,000 is also not prohibited. The current regula-tion requires that the bank holding company or asubsidiary thereof establish or have a lendingoffice in the community that has a populationnot exceeding 5,000.

3170.0.3.4 Section 225.28(b)(11)(iv) ofRegulation Y—Insurance AgencyActivities Conducted on May 1, 1982

This provision of the regulation includes engag-ing in any specific insurance agency activity4 ifthe bank holding company, or subsidiary con-ducting the specific insurance agency activity,conducted the insurance agency activity onMay 1, 1982, or received Board approval toconduct the insurance agency activity on orbefore May 1, 1982. Activities engaged in onMay 1, 1982, include activities carried on subse-quently as the result of an application to engagein such activities pending before the Board onMay 1, 1982, and approved subsequently by theBoard or as the result of an acquisition by suchcompany pursuant to a binding written contractentered into on or before May 1, 1982, ofanother company engaged in such activities atthe time of the acquisition.

A bank holding company or subsidiaryengaging in a specific insurance-agency activityunder section 225.28(b)(11)(iv) of Regulation Ymay—1. engage in such specific insurance-agency

activity only at locations—a. in the state in which the bank holding

company has its principal place of busi-ness (as defined in 12 U.S.C. 1842(d));

b. in any state or states immediately adjacentto such state; and

c. in any state in which the specific insurance-agency activity was conducted (or was

4. Nothing in paragraph (iv) precludes a BHC subsidiarythat is authorized to engage in a specific insurance-agencyactivity under this clause from continuing to engage in theparticular activity after merger with an affiliate, if the mergerwas for legitimate business purposes and prior notice has beenprovided to the Board.



approved to be conducted) by such bankholding company or subsidiary thereof orby any other subsidiary of such bank hold-ing company on May 1, 1982; and

2. provide other insurance coverages that maybecome available after May 1, 1982, so longas those coverages insure against the types ofrisks as (or are otherwise functionally equiva-lent to) coverages sold or approved to be soldon May 1, 1982, by such bank holding com-pany or subsidiary.This provision of the regulation parallels

exemption D of the Garn–St Germain Act andgrandfathers those insurance agency activities inwhich individual bank holding companies wereengaged on May 1, 1982. Under this provision,a bank holding company or subsidiary thereofmay continue to engage in particular types ofinsurance agency activities that were permis-sible before the passage of the Garn–St GermainAct but which are now prohibited by that act. Aqualifying bank holding company may engage,for example, in the sale of property and casualtyinsurance on property serving as collateral forloans made by a lending subsidiary of the hold-ing company.

A qualifying bank holding company mayalso engage in grandfathered insurance relatedto the provision of ‘‘other financial services’’previously authorized under section225.28(b)(11)(i)(B) of Regulation Y. This typeof insurance is not considered to be related to anextension of credit under the Garn–St GermainAct. As a result, the Boardno longer permitsthesale of insurance related to the provision of thegeneral financial services offered by a bank orbank-related firm. Such insurance included, forexample, insurance on the contents of safe depositboxes, or savings completion insurance on cer-tificates of deposit, Christmas club accounts,individual retirement accounts, tuition comple-tion plans, or credit-related insurance for ser-viced loans. Prior to the Garn–St Germain Act,insurance related to the provision of generalfinancial services was permitted to be sold toborrowers whose loans were neither purchasednor originated, but may have been serviced bythebankholdingcompany. Insurancewith respectto loan servicing was the primary type of insur-ance previously permitted by the Board as relatedto such financial services. Now, the Garn–StGermain Act limits the sale of insurance bybank holding companies in general to insurancerelated to an extension of credit.

3170.0.3.4.1 Limitations on Expansion ofGrandfather Rights

Exemption D provides for limited expansion ofgrandfathered insuranceagencyactivities inorderto permit qualifying bank holding companies toremain effective insurance agent competitors.The exemption presented three issues that theBoard resolved in paragraph (iv) of the regula-tion: (1) defining which subsidiaries of a bankholding company may engage in otherwiseimpermissible insurance agency activities underexemption D; (2) the scope of permissible geo-graphic expansion; and (3) the scope of product-line expansion.

Specific Subsidiaries That May Engage inGrandfathered Activities

Grandfather rights do not inure to the benefit ofthe entire holding company system by virtue ofthe fact that a particular subsidiary was engagedin insurance agency activities before May 1,1982. Only the subsidiary of the bank holdingcompany that was engaged in insurance activi-ties on May 1, 1982, or received Board approvalto engage in insurance activities before May 1,1982, has grandfather status.

The Board believes that the emphasis in thelegislative history on the transfer of grandfatherrights shows the intent of Congress to prohibitnot only the transfer of such rights from ‘‘grand-fathered’’ subsidiaries to those affiliates whollywithout grandfather rights, but also to prohibitthe transfer of grandfather rights with respect toparticular kinds of insurance from one ‘‘grand-fathered’’ subsidiary to another. Thus, a subsidi-ary that sold only credit life insurance before thegrandfather date should not acquire grandfatherrights to sell property and casualty insurancesolely because an affiliate sold property andcasualty insurance before the grandfather date.The grandfather rights of a particular subsidiaryare limited to the precise activities (or theirfunctional equivalent) engaged in before May 1,1982. This requirement does not preclude thetransfer of grandfather rights in the case of abona fide merger (1983 FRB 554, 555).

Section 225.28(b)(11) of the Board’s Regula-tion Y is only intended to clarify the exemptionsin title VI of the Garn–St Germain Act. It doesnot authorize any bank holding company tocommence any insurance activity, or to acquirea company with insurance activities, withoutcompliance with the notice and applicationrequirements of section 4(c)(8) of the BHC Act.



Geographic Expansion by a GrandfatheredSubsidiary of a Bank Holding Company.

The language of exemption D of the Garn–St Germain Act, while limiting the grand-fathered activities to those agency activi-ties conducted by the specific grandfatheredsubsidiary, does allow expansion into stateswhere such specific types of agency activities‘‘were conducted by the bank holding companyor any of its subsidiaries on May 1, 1982 . . .’’ Ifa bank holding company subsidiary is sellinga particular type of insurance in a givenstate, the Board does not believe there isany regulatory or business purpose served byrestricting another grandfathered subsidiaryfrom engaging in the same activity in the samelocation.

Product-Line Expansion

The Board’s regulation provides for product-line expansion. A grandfathered subsidiary ofa bank holding company may seek approvalfrom the Board to engage in the sale ofnew types of insurance that protect against thesame types of risks as, or are otherwise function-ally equivalent to, insurance sold on the grand-father date.

3170.0.3.4.2 Transfer of GrandfatherRights among Subsidiaries

A grandfathered subsidiary of a bank holdingcompany (or its successor) may retain itsgrandfather rights after merger with an affiliate,if such merger is based on legitimate businessconcerns, for example, centralized managementor increased efficiency, rather than as a means ofextending insurance powers. The regulation fur-ther provides that bank holding companies mustadvise the Board before any such merger forlegitimate business purposes in order to confirmthe transfer of grandfather rights.

3170.0.3.5 Section 225.28(b)(11)(v) ofRegulation Y—Bank Holding Company’sInsurance Coverage for InternalOperations

The Garn–St Germain Act approved, and therevised Regulation Y included, insurance agencyactivities where the activities are solely limitedto supervising on behalf of insurance underwrit-

ers the activities of retail insurance agents whosell—1. fidelity insurance and property and casualty

insurance on the real and personal propertyused in the operations of the bank holdingcompany or its subsidiaries and

2. group insurance that protects the employeesof the bank holding company or any of itssubsidiaries.This provision of Regulation Y is reflective

of an intent on the part of Congress to avoidpreempting certain practices permissible underTexas law. This insurance relates to a particularsituation that may have little applicabilityelsewhere.

3170.0.3.6 Section 225.28(b)(11)(vi) ofRegulation Y—Small Bank HoldingCompanies

The Board has determined in section225.28(b)(11)(vi) of its Regulation Y thatengaging in any insurance agency activity ispermissible if the bank holding company hastotal consolidated assets of $50 million or less.A bank holding company performing insuranceagency activities under this paragraphmay notengage in the sale of life insurance or annuitiesexcept as provided in section 225.28(b)(11)(i)and (iii) of Regulation Y, and it may not con-tinue to engage in insurance agency activitiespursuant to that provision more than 90 daysafter the end of the quarterly reporting period inwhich total assets of the holding company andits subsidiaries exceed $50 million.

A bank holding company is required to ceasegeneral insurance-agency activities pursuant tothis provision within 90 days after the end of thequarterly reporting period in which the bankholding company’s total assets exceed $50 mil-lion. Thereafter, the bank holding company maycontinue to engage in the sale of insurancepursuant to other exemptions.

3170.0.3.7 Section 225.28(b)(11)(vii) ofRegulation Y—Insurance AgencyActivities Conducted before 1971

The Board has determined in section225.28(b)(11)(vii) of its Regulation Y that anyinsurance agency activity performed at any loca-



tion in the United States directly or indirectly bya bank holding company that was engaged ininsurance agency activities before January 1,1971, as a consequence of approval by theBoard before January 1, 1971, is permissible.

3170.0.3.7.1 Agency Activities

The Board adopted a position in section225.28(b)(11)(vii)permittinganyqualifyingbankholding company to engage in general insurance-agency activities without restriction as to loca-tion or to type of insurance sold (1985 FRB 171and 1984 FRB 235, 470). A company qualifiesunder this provision if it was engaged in insur-ance agency activities as a consequence of Boardapproval before January 1, 1971. A very limitednumber of active bank holding companiesreceived such Board approval in the period frompassage of the BHC Act in 1956 until January 1,1971.

The regulation does not limit the insuranceagency activities of a qualifying company byrequiring that the company engage only in thesale of such types of insurance as it sold before1971 from such locations as it conducted insur-ance agency activities before 1971. The Board’sregulation permits the limited number of quali-fying companies to engage in general insurance-agency activities pursuant to exemption Gregardless of their precise insurance agencyactivities before 1971 (1985 FRB 171 and 1984FRB 470).

3170.0.4 INCOME FROM THE SALEOF CREDIT LIFE INSURANCE

3170.0.4.1 Policy Statement on Incomefrom Sale of Credit Life Insurance

Effective May 1, 1981, the Board adopted apolicy statement (1981 FRB 431) generally pro-hibiting employees, officers, directors, or othersassociated with a state member bank from prof-iting personally from the sale of life insurancein connection with loans made by the bank.The bank may, however, allow their employ-ees and officers to participate in the incomeunder a bonus or incentive plan not to exceed5 percent of the recipient’s annual salary.Income from the sale of credit-related lifeinsurance should most appropriately becredited to the bank, or alternately to a bank

holding company or other affiliate of the bankso long as the bank receives reasonable compen-sation for its role in selling the insurance. As ageneral rule, ‘‘reasonable compensation’’ meansan amount equivalent to at least 20 percent ofthe affiliate’s net income attributable to thebank’s credit life insurance sales. (Insuranceagency activities engaged in directly by abank subsidiary are regulated by the charteringauthority. However, intercompany transactionsshould be reviewed by BHC inspectionpersonnel.)

3170.0.4.2 Disposition of Credit LifeInsurance Income

The Comptroller of the Currency has issued aregulation dealing with sales of credit life, health,and accident insurance by national banks whichprohibits transfer of insurance commissions toan affiliate of the bank unless commission incomein proportion to the shares held by the bank’sminority shareholders is placed in trust and paidto them periodically. Where the subsidiary bankis wholly owned by a bank holding company,however, the regulation allows the commissionsto be credited to the holding company or to itswholly owned subsidiaries (12 C.F.R. 2).


1. To determine the extent of insurance opera-tions and the overall condition of subsidi-aries engaged in insurance agency and under-writing activities.

2. To determine whether the types of insurancesold are in accordance with the provisions ofsection 225.28(b)(11) of Regulation Y.

3. To determine the impact of the performanceof the activities on the parent bank holdingcompany and its subsidiaries.

4. To suggest corrective action when necessaryin the areas of policies, procedures, or lawsand regulations.


Where the insurance activities are performedthrough an insurance agency or underwritingsubsidiary, perform the following activities:1. Compare the company’s general ledgers with

statements prepared for the latest FR Y-6 andthe annual report to the state insurancedepartment.



2. Review minutes of the board of directorsmeetings.

3. Review the activity’s compliance with theBoard’s policy statement on income from thesale of credit life insurance (See section3170.0.4.1) and the Comptroller of the Cur-rency’s regulation dealing with the sales ofcredit life, health, and accident insurance bynational banks (12 C.F.R. 2).

4. Review any agreements, guarantees, orpledges between the subsidiary and its parentholding company or affiliates.

Where the insurance activities are performedthrough an insurance agency or underwritingsubsidiary or directly by the parent company,perform the following procedures:1. Obtain copies of insurance policies issued to

determine that the types and terms of insur-ance coverage sold are within the scope ofthose permitted by the Board under section225.28(b)(11) of Regulation Y.

2. Check for compliance with section 106(b) ofthe 1970 Amendments to the BHC Act (pro-hibition against tie-in arrangements).


Subject Laws1 Regulations2 Interpretations3 Orders

General description of permissibleinsurance agency and underwritingactivities

225.28(b)(11) 4–050.1 1986 FRB 829

Garn–St Germain DepositoryInstitutions Act, title VI amendingsection 4(c)(8) of the BHC Act

1843(c)(8)

Insurance agency activitiespermitted for national banks

Section 13,paragraph 11of the FederalReserve Act

Permissibility of some types ofmortgage insurance

40 FederalRegister276640 FederalRegister130421975 FRB 451975 FRB 678

Impermissibility of mortgageguarantee insurance

40 FederalRegister44624

Court review of activity 533 F. 2d 224(5th Circuit, 1976)558 F. 2d 729(5th Circuit, 1977)






Level term credit life insurance 39FederalRegister2631839 FederalRegister3279640 FederalRegister11647

Permissible insurance coveragelimited to actual debtors


Sale of home mortgage redemptioninsurance

1986 FRB 339,6711975 FRB 45

Joint credit life insurance 39FederalRegister389421974 FRB 138

Tie-in arrangements Section 106(b)of the BankHoldingCompany ActAmendmentsof 1970

225.7 38FederalRegister64411975 FRB 693,678, 686

Permissibility of selling insurancein small communities


Policy statement on income fromsale of credit life insurance

3–1556 1981 FRB 431

Transfer of insurance agencygrandfather rights in the case of abona fide merger

1983 FRB 554,555

Permissibility of credit-related propertyand casualty insurance activities

1984 FRB 452

Insurance agency activities conductedbefore 1971—BHCs permitted toengage in insurance agency activitieswithout restriction as to location or totype of insurance sold

1985 FRB 1711984 FRB 235,470

General insurance-agency subsidiaryqualifies for grandfather privilegesunder exemption D of the Garn–StGermain Act; grandfather privilegesdo not terminate upon its acquisitionby a nongrandfathered BHC

1987 FRB 276,672





Section 4(c)(8) of the BHC Act(Insurance Underwriters) Section 3180.0

3180.0.1 INSURANCEUNDERWRITING ACTIVITIES

On December 11, 1972, after consideration ofa public hearing held on March 24, 1972, theBoard amended Regulation Y to add the activityof underwriting credit life insurance and creditaccident and health insurance to the list ofactivities in which a bank holding company mayengage, provided that such insurance is directlyrelated to an extension of credit by the holdingcompany system. Such insurance ensures a bankor bank-related firm of repayment of a creditextension in the event of death or disabilitywhile at the same time providing the borrowerwith financial security in either event. In approv-ing this activity, the Board set forth, in a foot-note to Regulation Y, requirements to ensurethat performance of the activity would result indemonstrable benefits to the public. The Boardstated that applications to engage in underwrit-ing activities would be approved only in casesin which the applicant demonstrates that suchapproval would benefit the consumer or result inother public benefits and that normally such ashowing would be made by a projected reduc-tion in rates charged the public for the insuranceor an increase in other public benefits resultingfrom bank holding company performance of thisservice.

On October 3, 1986, the Board adopted arevision of the provisions of Regulation Y thatdeals with permissible insurance agency andunderwriting activities for bank holding compa-nies. The general revision of the insurance pro-visions of Regulation Y combined both theinsurance agency and insurance underwritingactivities reflects amendments to the Bank Hold-ing Company Act by the Garn–St GermainDepository Institutions Act of 1982. The revi-sion of the provisions relating to insuranceunderwriting eliminated the rate-reductionrequirement that previously applied to thosecompanies engaged in the underwriting of creditlife, credit accident and health, and involuntaryunemployment insurance. Accordingly, bankholding companies engaging in this activity maycharge premiums as permitted by the states.

In order for insurance underwriting (includ-ing home mortgage redemption insurance) to bepermissible in accordance with section225.28(b)(11) of the Board’s revised RegulationY, the insurance must—

1. be directly related to an extension of credit1

by the bank holding company or any of itssubsidiaries and

2. be limited to ensuring the repayment of theoutstanding principal balance due on theextension of credit in the event of the death,disability, or involuntary unemployment ofthe debtor.

3180.0.1.1 Insurance UnderwritingActivities Permissible for Bank HoldingCompanies per Section 225.28(b)(11)(i)of the Board’s Regulation Y—CreditInsurance

The Board permits the insurance underwritingactivities described above as well as the insur-anceagencyactivitiesdescribed insection3170.0.

In section 225.28(b)(11)(i) of Regulation Y,the Board issued three significant interpretationsof the term ‘‘extension of credit’’ as containedin the Garn–St Germain Act. It permits theunderwriting of credit-related life, accident andhealth, and involuntary unemployment insur-ance (1) with respect to lease transactions wheresuch lease transactions are the equivalent ofloans (leasing is addressed in section 3140.0),(2) in connection with loans secured by residen-tial first mortgages, and (3) in connection withthe servicing of loans originated or purchasedby the applicant bank holding company andsubsequently sold.

Permissible insurance underwriting requiresthat the credit insurance must be directly relatedto an extension of credit by the bank holdingcompany or any of its subsidiaries. An ‘‘exten-sion of credit’’ includes direct loans to borrow-ers, and the lease of real or personal property,and loans purchased from other lenders. Thefirstsignificant interpretation,notedabove,allowsthe inclusion of leasing personal or real prop-erty, provided the lease is a nonoperating andfull-payout lease, the insurance ensuring thepayment of the remaining lease payments thatare due in the event of the death, disability, orinvoluntary unemployment of the lessee.

1. ‘‘Extension of credit’’ includes direct loans to borrow-ers, loans purchased from other lenders, and leases of real orpersonal property so long as the leases are nonoperating andfull-payout leases.


The interpretation thus defines leases as thefunctional equivalent of an extension of credit.

The second interpretation in paragraph (i)of the regulation involving the definition of‘‘extension of credit’’ is the permissibility ofunderwriting home mortgage insurance, whichensures the repayment of the unpaid balance ofa residential first mortgage loan in the event ofthe death or disability of the mortgagor. Exemp-tion A of the Garn–St Germain Act permits theunderwriting of any type of life, disability, andinvoluntary unemployment insurance related toan extension of credit by a bank holding com-pany as long as the face value of the insurancepolicy does not exceed the ‘‘outstanding balancedue’’ on the extension of credit. The Boardcontinues to require that insurance policies writ-ten insure only named borrowers or lessees of aparticular bank holding company. Such policiescould cover both spouses jointly, but only ifboth spouses were actual borrowers or lesseesunder the terms of the agreement with the bankholding company (see 1974 FRB 138).

The Board had previously held that the under-writing of home mortgage insurance is not closelyrelated to banking in part because it is more likegeneral life insurance than credit life insuranceand in part because banks have not generallyunderwritten such insurance (see 1980 FRB 660and 1982 FRB 318). Recently, however, theBoard permitted bank holding companies tounderwrite such insurance (see 1986 FRB 339and 1986 FRB 671). In permitting this activityby order, the Board provided detailed findingsthat the underwriting of home mortgageredemption insurance is permitted by exemptionA of the Garn–St Germain Act, is closely relatedto banking, and does not present the possibilityof such significant adverse effects that it shouldnot be added to the list of activities permissiblefor bank holding companies. The Board alsofound that home mortgage insurance supportsthe lending function. The Board thus believes,for the reasons cited in the above-cited orders,that the underwriting of home mortgageredemption insurance is permissible for bankholding companies.

In approving the underwriting of home mort-gage insurance by order, the Board relied oncommitments by applicants to inform, in writ-ing, borrowers who are prospective purchasersof such insurance that home mortgage redemp-tion insurance is not required and that, if desired,it may be purchased from other sources. TheBoard has also relied on a commitment for

written notice to borrowers that the insurancecontract may be rescinded at any time after theloan commitment is made and before closing. Inprocessing applications to engage in the under-writing of home mortgage redemption insurancepursuant to the current regulation, the Board,and the Reserve Banks acting pursuant to del-egated authority, will continue to require thatsuch notices be provided to borrowers. In addi-tion, the Board will continue to rely on the factthat premiums for such insurance are payableperiodically during the term of the extension ofcredit, so as to increase the borrower’s ability torescind the insurance and to limit premiumfinancing as an incentive to sell and underwritesuch insurance.

A third significant interpretation of the term‘‘extension of credit’’ found in exemption A ofthe Garn–St Germain Act involves the under-writing of insurance in connection with the ser-viced loans (see section 3170.0.3.1) The Garn–St Germain Act limits bank holding companiesin general to insurance related to an extension ofcredit. The term ‘‘extension of credit’’ is used inexemption A to describe transactions in whichthe funds of the bank holding company or itssubsidiaries have been placed at risk, includingdirect loans or leases or loans that have beenpurchased. Loans that are merely being servicedby the bank holding company generally wouldnot be covered by this definition.

The underwriting of insurance on loans beingserviced is necessary only when the term of theinsurance was originally shorter than that of theloan. The bank holding company that is sellingand underwriting insurance on the loan that itoriginated and is servicing is, in effect, onlyextending the term of its original insurance pol-icy to be coterminous with the duration of theloan. It is providing insurance that it could haveprovided previously. A bank holding companymay not underwrite insurance in the case whereit is merely servicing a loan and it has neverplaced its funds at risk either by originating orpurchasing the loan.

3180.0.2 LIMITED PROPERTYINSURANCE RELATED TO ANEXTENSION OF CREDIT (FINANCECOMPANY SUBSIDIARY OF A BANKHOLDING COMPANY)

The Board’s revised regulation does not permitthe underwriting of this type of insurance. Seesection 225.28(b)(11)(ii) of Regulation Y andsection 3170.0.3.1 for information on autho-rized insurance agency activities.

Section 4(c)(8) of the BHC Act (Insurance Underwriters) 3180.0


3180.0.3 INSURANCE ACTIVITIESBEFORE 1971

TheBoard’s revised regulation (section225.28(b)(11)(vii)), as it relates to exemption G of theGarn–St Germain Act, does not authorize under-writing activities for bank holding companies.See section 3170.0.3.7 for information on therespective authorized insurance-agency activi-ties under exemption G.

3180.0.4 UNDERWRITING ASREINSURER

The majority of bank holding company subsidi-aries engaged in insurance underwriting arereinsurers rather than direct underwriters. Asreinsurer, these companies engage a direct insurerto issue the policies, collect the premiums, payclaims, maintain accounting books and records,prepare federal and state tax returns, and per-form other services necessary to conduct theinsurance activities. Usually, such reinsurancecompanies will have executed a reinsuranceagreement and a service agreement with thedirect underwriter which spell out all services tobe performed and set the fees to be paid for suchservices. The above arrangement involves aminimum of activity by the reinsurer and isprobably most often chosen by bank holdingcompanies since it does not place additionalburdens on management and precludes hiringactuaries and other professional personnel tomanage the insurance company.

There are many ratios or measures used toevaluate the condition of insurance underwrit-ers. The National Association of Insurance Com-missioners has developed a system consisting ofnine ratios that measure various aspects of lifeand health insurance companies’ financial con-dition and stability(The Early Warning Systemfor Life and Health Insurance Companies). Thesetests establish benchmarks which are likely todistinguish between troubled and sound compa-nies. The examiner may wish to compare thesubject company’s ratios to these benchmarks.When making comparisons, however, the exam-inershould recognize thatone insurermay requirea somewhat better ratio than another due togreaterunderwritingand investment risks.Smallercompanies will generally maintain a proportion-ately larger surplus account since loss experi-ence on a small volume of business tends tofluctuate more widely.

Another possible source of information avail-able to help determine a company’s condition isBest’s Insurance Reports. The report is pub-

lished annually and provides pertinent financialand historical data for legal reserve life insur-ance companies operating in the United Statesand Canada. It assigns a rating for each com-pany in the report. Information presented in thereport is taken from annual statements filed withthe state insurance departments. It should benoted that reports filed with the insurancedepartments are prepared using the statutorymethod of financial accounting and presentationrather than generally accepted accounting prin-ciples. Beginning in 1973, insurance companieswere required to adhere to generally acceptedaccounting principles for certification of finan-cial statements (seeAudits of Stock Life Insur-ance Companies, American Institute of Certi-fied Public Accountants), however, they continueto report under the statutory method to the stateinsurance departments. The statutory method isbasically a cash-basis accounting presentationwhich generally depicts a more conservativeposition. Certain assets are ‘‘not admitted’’ byregulatory authorities in the financial presenta-tion because they are not readily convertibleinto cash for the payment of claims and expenses.

Policy reserves represent the primary liabilityportion of underwriters’ balance sheets. Thereare several acceptable methods permitted bystate authorities for calculating these reserves.Most of these methods are rather complicatedand a description of their calculation is beyondthe scope of this manual. However, insurancecompanies are generally closely regulated bystate authorities, which place primary impor-tance on determining the adequacy of the policyreserves. A review of the latest available insur-ance examination report should give an evalua-tion of the adequacy of the reserves.

Reinsurance arrangements may distribute theinsurance and losses in many different waysbetween the direct insurer and the reinsurer. Anunderstanding of such arrangements is essentialin determining the extent of risk incurred by thecompany being inspected.


1. To determine the extent of underwritingactivities and the overall condition of subsid-iaries engaged in underwriting.

2. To determine whether the activities per-formed are within the scope of those permit-ted under section 225.28(b)(11) of Regula-tion Y.



3. To determine the impact of the underwritingoperations on the parent bank holding com-pany and its subsidiaries.

4. To suggest corrective action where necessaryin the areas of policies, procedures, or lawsand regulations.


Where the insurance underwriting activities areperformed through an underwriting subsidiary,perform the following procedures:1. Compare the company’s general ledgers with

statements prepared for the latest FR Y-6.(Generally, records are maintained on thestatutory accounting basis and are more eas-ily tied to the financial statements in theannual report to the state insurancedepartment).

2. Review minutes of the board of directorsmeetings.

3. Review the quality and liquidity of the sub-sidiarycompany’s investments inCDs,stocks,bonds, or other marketable securities.

4. Review intercompany transactions, includingbalances maintained with or assets purchasedfrom affiliated banks.

5. Reviewanyagreements,guarantees,orpledgesbetween the company and its parent holdingcompany or affiliates.Where the insurance activities are performed

either directly or through an underwriting sub-sidiary, perform the following procedures:1. Review copies of any reinsurance and/or ser-

viceagreementsexecutedwithother insurancecompanies.

2. Review the latest annual report submitted tothe state insurance department.

3. Review the latest report of examination pre-pared by the state insurance department.

4. Check calculation of premium charges by arandom sample of policies for adherence tothe state rate structure.

5. Obtain copies of insurance policies issued tocustomers to determine that the types ofinsurance coverage and terms offered arewithin the scope of those permitted undersection 225.28(b)(11) of Regulation Y.



Permissible underwritingactivities

12 U.S.C.1843(c)(A)–(G)

225.28(b)(11) 4–050.1

Underwriting of permissiblecredit-related homemortgage insurance

1986 FRB 671,339

Nonpermissibility ofmortgage guaranteeinsurance

1974 FRB 727

Underwriting of joint creditlife insurance

4–337 39 FederalRegister 74931974 FRB 138





Section 4(c)(8) of the BHC Act(Courier Services) Section 3190.0

Courier activities are permissible for bank hold-ing companies if the items being transported bythe courier are themselves related to bank opera-tions. Examples of such items are drafts, moneyorders, travelers’ checks, commercial papers,written instruments, and data processing mate-rial. Currency and bearer-type negotiable instru-ments which require more than normal securitymeasures may not be transported by the company.

If the courier company operates under theexemptive provision of section 4(c)(8) of theBank Holding Company Act, the followingrestrictions are placed on its operations to ensurecompetition:1. The company must be a separate, indepen-

dent corporate entity.2. The company must be profit-oriented and not

subsidized by the holding company system.3. Services of the company must be performed

on a specific-fee basis with direct paymentfrom the customer. Payment may not bemade indirectly such as through maintenanceby the customer of deposit balances at anaffiliated bank.

4. Upon request, the company must furnishcomparable services at comparable rates tofirms which compete with banking or dataprocessing subsidiaries of its parent com-pany, unless compliance with the requestwould be beyond the practical capacity of thecompany.The last restriction was intended to prevent

use of bank-affiliated courier services for thepurpose of gaining an advantage over competi-tors to whom courier services were not other-wise available.


1. To determine if the company is operating incompliance with applicable laws and regula-tions, and ensure that corrective action willbe taken, if appropriate.

2. To determine if courier services are providedto competing institutions upon theirrequest if courier services are not otherwiseavailable.


1. Determinewhether thecompanymakesknownto its customers its minimum rate schedulefor services and its general pricing policies.

2. Determine whether the company maintainsfor a period of two years or more the recordsof each request for service which it hasdenied to firms competing with the bankingand data processing subsidiaries of its parentcompany. The reasons for the denial mustalso be recorded and maintained for a likeperiod.

3. Review income statements of the companyto ascertain whether the company is operat-ing profitably, without a subsidy in any man-ner from any entity within the holding com-pany system. Any operating losses sustainedover an extended period of time are inconsis-tent with continued authority to engage incourier services.

4. Determine whether the materials transportedby the company are restricted to those whichwould normally be exchanged among banksand banking institutions, including audit andaccounting media of a banking or financialnature, and other business records or docu-ments used in processing such media.




Courier activities of bankholding companies

225.28(b)(10) 1973Fed.Reg.321361975Fed.Reg.36309

Conditions of entry intocourier activities

225.129 4–180



Section 4(c)(8) of the BHC Act (Courier Services) 3190.0


Section 4(c)(8) of the BHC Act(Management Consulting and Counseling) Section 3200.0

On February 26, 1974, the Board amendedRegulation Y to permit bank holding companiesto engage in the activity of providing bankmanagement consulting services to nonaffiliatedcommercial banks. The advisee institution mustbe a ‘‘bank’’ as that term is defined by section2(c) of the BHC Act or an operations subsidiaryof such an institution. (See 12 C.F.R. 250.141.)Effective April 20, 1982, the Board expandedthis activity by permitting holding companies toprovide management consulting advice to non-bank depository institutions. When expandingthe activity to include management consultingadvice to nonbank depository institutions, theBoard indicated that the advisory services pro-vided to nonbank institutions should generallybe the services that were then being provided tobanks.

Effective April 21, 1997, management con-sulting was expanded in Regulation Y (section225.28(b)(9)) to allow bank holding companiesto provide management consulting services toany customer on any matter so long as the totalannual revenue derived from third-party man-agement consulting services by a nonbank sub-sidiary of the bank holding company is less than30 percent of the subsidiary’s total annual rev-enues derived from all management consultingactivities. The Board continues to view ‘‘man-agement consulting’’ as including, but not lim-ited to, providing analysis or advice as to afirm’s—

1. purchasing operations, such as inventory con-trol, sources of supply, and cost minimiza-tion subject to constraints;

2. production operations, such as quality con-trol, work measurement, product methods,scheduling shifts, time and motion studies,and safety standards;

3. market operations, such as market testing,advertising programs, market development,packaging, and brand development;

4. planning operations, such as demand andcost projections, plant location, program plan-ning, corporate acquisitions and mergers, anddetermination of long-term and short-termgoals;

5. personnel operations, such as recruitment,training, incentive programs, employee com-pensation, and management-personnel rela-tions;

6. internal operations, such as taxes, corporateorganization, budgeting systems, budgetingcontrol, evaluation of data processing sys-tems, and efficiency evaluations; and

7. research operations, such as product develop-ment, basic research, and product design andinnovation.

By interpretation, the Board previously deter-mined that it considers bank management con-sulting advice to include, but not be limited to,advice concerning (1) bank operations, systems,and procedures; (2) computer operations andmechanization; (3) implementation of electronicfunds transfer systems; (4) site planning andevaluation; (5) bank mergers and the establish-ment of new branches; (6) operation and man-agement of a trust department; (7) internationalbanking and foreign-exchange transactions;(8) purchasing policies and practices; (9) costanalysis, capital adequacy, and planning;(10)auditing; (11)accountingprocedures; (12) taxplanning; (13) investment advice as authorizedin section 225.28(b)(6) of Regulation Y;(14) credit policies and administration, includ-ing credit documentation, evaluation, and debtcollection; (15) product development, includingspecialized lending provisions; (16) marketingoperations, including research, market develop-ment, and advertising programs; (17) personneloperations including recruiting, training, evalua-tion, and compensation; and (18) security mea-sures and procedures. Providing managementconsulting advice on compliance with laws andregulations may be accomplished only whenthese activities are incidental to a primary con-sulting activity and when such advice would notconstitute the rendering of legal advice.

In general, those consulting services that cor-respondent banks traditionally have provided totheir respondents (both bank and nonbank deposi-tory institutions) are considered to be includedwithin the scope of Regulation Y as permissibleservices to be provided by nonbank holdingcompany subsidiaries to nonaffiliated bank andnonbank depository institutions.

3200.0.1 MANAGEMENTCONSULTING LIMITATIONS

Recognizing the potential for conflict-of-interestsituations, such as the possibility for anticom-petitive cooperative arrangements, improper useof confidential information, and similar abusesthat this activity could entail, the Board incorpo-rated in Regulation Y a few restrictions on a


bank holding company. With regard to affilia-tion status, neither the bank holding companynor any of its subsidiaries may own or controldirectly or indirectly more than 5 percent of thevoting securities of the client institution. Theprohibition would not apply when the shareswere acquired in satisfaction of a debt previ-ously contracted or to shares acquired in a fidu-ciary capacity without sole discretionary votingauthority. A bank holding company may offerconsulting advice to a client institution whoseshares it holds in a fiduciary capacity with solediscretionary voting rights if said holding com-pany does not hold more than 5 percent of thevoting shares of that institution. Bank holdingcompanies are permitted to have common man-agement officials with the client institution towhich they provide management consulting ser-vices if such interlocks would be permissibleunder exceptions found in the Board’s Regula-tion L (Management Official Interlocks) thatapply to such institutions in need of manage-ment or operating expertise (12 C.F.R. 212.4(b)).

Management consulting services may not beprovided to a client on a daily or continuingbasis except where necessary to instruct theclient on how to perform the services for itself.The Board has informed bank holding compa-nies that their management consulting subsidi-aries should refrain from entering relationshipson a daily or continuing basis even when theclient institution may be experiencing financialor managerial difficulties. Particular cautionshould be exercised when a bank holding com-pany contemplates the subsequent acquisition ofthe client institution. However, when a bankholding company is attempting to acquire atroubled depository institution, limited manage-ment consulting services may be offered via anon-premises bank holding company employee.Nevertheless, the representative should not havethe authority to lend or make personnel deci-sions. Failure to heed these guidelines not onlywould cause the bank holding company to exceedthe permissible bounds of the activity, but alsocould cause the BHC to acquire control of theclient institution that might constitute an acqui-sition of a subsidiary within the meaning ofsection 3(a) of the BHC Act. Section225.31(d)(2)(i) of Regulation Y indicates that arebuttable presumption of control shall existwhen a company enters into an agreement, suchas a management contract, with a bank or othercompany pursuant to which the first company orany of its subsidiaries exercises significant influ-

ence over the general management or overalloperations of the bank or other companies.Reserve Bank personnel are encouraged to con-tact the Board’s applications section to discussthe restrictions on this activity whenever a BHCproposes to have its personnel assist a troubledor problem institution.

WhenevaluatingaBHC’sapplication toengagein management consulting, it is important tonote whether the applicant bank holding com-pany has exhibited the necessary expertise inoperating its own subsidiaries—and whether thisexpertise qualifies it to offer advice to others.


1. To verify that the bank holding company isperforming only those types of managementconsulting services at the locations for whichit received prior regulatory approval.

2. To verify that the advice being provided iswithin the scope of the approval and consis-tent with the activities of the interpretation(12 C.F.R. 225.131) and section 225.28(b)(9)of Regulation Y.

3. To determine that the bank holding companydoes not own or control, directly or indi-rectly, securities of its client depository insti-tutions except for shares acquired as theresult of a default on a debt previously con-tracted or shares held in a fiduciary capacity(within certain limits), provided the holdingcompany does not have sole discretionaryauthority to vote more than 5 percent of theclient’s shares. (See 12 C.F.R. 225.131.)

4. To determine that the bank holding companydoes not control the activities of a clientinstitution by virtue of nonexempt interlock-ing directors.

5. To determine that services rendered to theclient institutions are not being provided on adaily or continuing basis.

6. To determine that disclosure is made to eachclient of (1) the names of all depositoryinstitutions that are affiliates of the consult-ing company and (2) the names of all exist-ing client institutions located in the samecounty (or counties) or standard metropolitanstatistical area (or areas) (SMSA) as the cli-ent institution.


A thorough review of pertinent records, con-tracts, lists of clients, and documentation of the

Section 4(c)(8) of the BHC Act (Management Consulting and Counseling) 3200.0


services being provided to clients should beundertaken to determine that adequate manage-ment information systems and detailed revenueand other reports are available to verify theBHC’s compliance with the Board’s rule on therevenue limitations in section 225.28(b)(9) ofRegulation Y. Determine that services are beingprovided to the appropriate customer base andwithin the scope of the Board’s approval. Fur-ther, the examiner should ascertain the existenceof procedures to inform each potential client ofthe names of all depository and client institu-tions that are affiliates of the consulting com-pany and of the names of all existing clientslocated in the same market area as the prospec-tive client.

For management consulting services that donot involve any financial, economic, account-ing, and auditing matters, verify that the rev-enues earned are within the limits permitted bythe Board’s regulations and interpretations. Thebasis for any fee structure should be determinedto ascertain that the advice is being rendered onan explicit-fee basis, such as an hourly or daily

rate. Such fees should not be affected by factorsnot directly related to the service, such as bal-ances maintained by the client at any subsidiarydepository institution of the bank holding com-pany. The extent of the consultant company’sinvolvement in the day-to-day affairs and opera-tion of the client should also be reviewed.

The absence of parent company control, director indirect, over the clients of the managementconsulting subsidiary should be established. Theexaminer should compare listings of directorsand principal officers of the bank holding com-pany, its various affiliates, and the clients withdue regard to exempt interlocks. The examinershould determine the extent of ownership orcontrol by the bank holding company and itsaffiliates of any equity securities in its clients byrequesting a listing of all shares owned in out-side organizations. Overall conclusions, includ-ing recommendations concerning the operation,apparent violations, and any possible control ofclient institutions and conflicts of interest, shouldbe discussed with parent company managementand detailed in the inspection report.



Orders, interpretation precedingpermissibility of bank manage-ment consulting

225.131225.113

4–194 1972 FRB 6761972 FRB 674

Bank management consultingauthorized as permissible nonbankactivity

225.28(b)(9) 4–181 1974 FRB 2261974 FRB 675

Presumption of control 225.31(d)

Exemption from section 8 of Clay-ton Act for banks in low-incomeareas

3–830

Bank management consulting aspossible rendering of legal advice

39 Fed. Reg.41586

Other approvals 39 Fed. Reg.3910639 Fed. Reg.365081976 FRB 725






Justice Department concern overpossible conflicts of interest

1977 FRB 950

Limitations on activity whenacquisition of bank is involved

1976 FRB 6991977 FRB 1088

Permissible interlocking directors 212.4(a)(1) 1979 FRB 654

Deferral of decision to consideroffering of management consultingadvice to unaffiliated savings banksas a permissible activity

42 Fed. Reg.22560

Expanding activity to include non-bank depository institutions

1982 FRB 237and 238

Management consulting to failedsavings associations

1988 FRB 771

Expansion of the activity toinclude—1. services regarding financial, eco-

nomic, accounting, or audit mat-ters to any company;

2. the ability of the BHC’s non-bank subsidiary to provide lim-ited management consulting ser-vices to any third-party customeron any matter.

225.28(b)(9)(i) 1997 FRB 275





Section 4(c)(8) of the BHC Act(Employee Benefits Consulting Services) Section 3202.0

Within Regulation Y (section 225.28(b)(9)(ii)),management consulting and counseling activi-ties include employee benefits consulting ser-vices. These employee benefits consulting ser-vices include providing consulting services toemployee benefit, compensation, and insuranceplans, including designing plans, assisting in theimplementation of plans, providing administra-tive services to plans, and developing employeecommunication programs for plans.

The initial Board orders that were issued topermit employee benefit consulting services aresummarized here as historical examples of thenonbanking activity. Commitments made in thoseBoard orders should not be relied upon. Referonly to the provisions within the current Regula-tion Y, as cited above.

3202.0.1 BOARD ORDERSINVOLVING EMPLOYEE BENEFITSCONSULTING

A bank holding company (the applicant) appliedfor the Board’s approval under section 4(c)(8)of the BHC Act and Regulation Y to acquire100 percent of the voting shares of a companythat provides a full range of services involvingemployee benefits plans. The services are dividedinto four basic types of activities:

1. Plan design. Designing employee benefitplans, including determining actuarial fund-ing levels and cost estimates.

2. Plan implementation. Providing assistance inimplementing plans, including assistance inthe preparation of plan documents and in theimplementation of employee benefitadministration systems.

3. Administrative services. Providing adminis-trative services with respect to plans, includ-ing recordkeeping services, calculating andcertifying employment reports and govern-ment filings pursuant to ERISA, and provid-ing information to a client’s legal counsel inlabor relations and negotiations.

4. Employee communications. Developingemployee communication programs withrespect to plans for the benefit of the client.

The applicant represented that all of the pro-posed activities were included in trust com-pany or financial or investment advisory serviceactivities permissible under Regulation Y.Although certain employee benefits consult-

ing activities (as conducted by the companybeing acquired, particularly activities involvingplan administration) are conducted by trustcompanies or trust departments of banks in theircapacities as trustees or custodians of employeebenefit plans and investment managers of planassets, it was not apparent that the completerange of employee benefits consulting ser-vices were generally conducted by trust compa-nies or authorized by the Board as permis-sible trust company activities under RegulationY.

The Board believed that employee benefitsconsulting was essentially a financial planningactivity involving preparing and conveying finan-cial data to a client, which it had previouslydetermined to be closely related to banking andpermissible under Regulation Y in the areas ofinvestment advisory services, data processingservices, and courier services. The record didnot indicate, however, that employee benefitsconsulting is wholly encompassed within any orall of those activities. The Board, therefore, didnot agree with the applicant that all of theproposed activities were currently authorizedfor bank holding companies under existing pro-visions of Regulation Y.

A review of the four basic types of activitiesrevealed that many of the proposed employeebenefits consulting activities either were alreadyspecifically engaged in by banks and trust com-panies, or were functionally related to activitiesin which banks and trust companies were regu-larly engaged. The Board recognized, however,that the actuarial aspect of the employee bene-fits consulting activities is not generally includedin trust company or bank activities. Such activi-ties are limited in scope and purpose in that theyare conducted primarily as a means to ensureadequate funding of defined benefits plans. Inthis case, they were performed solely as a meansfor the applicant to provide a full range ofbenefits-planning activities for its clients. Theacquired company’s actuarial services would notbe conducted as an independent activity, butonly as a necessary and integrally related com-ponent of employee benefits consulting.1

1. As part of its acquisition, the bank holding companyproposed to assist firms in IRS audits of plans; inform clientsof developments in employee benefit programs through news-letters and other correspondence and through participation inseminars, public programs, and other forums; and engage inprofessional actuarial activities and other activities incidental


In Association of Data Processing Organiza-tions, Inc. v. Board of Governors, 745 F.2d 277(D.C. Cir. 1984), the court of appeals held thatthe Board may permit those activities that are ‘‘apart of’’ the overall permissible activity where,as here, ‘‘in both market contemplation andtechnological reality, the service is a unitaryone.’’ Based on this ruling, the Board concluded

that the applicant’s proposed activities are per-missible as closely related to banking, and wereapproved on June 19, 1985 (1985 FRB 656).

Another Board order permitting the provisionof employee benefits consulting services, whichis slightly different from the order cited above,is found in 1986 FRB 337. See also 1986 FRB729 and 1987 FRB 158, 681.

to the actuarial profession. The activities are generally relatedto the type of actuarial activities performed for purposes ofengaging in employee benefits consulting and that would notgenerate any significant income. Such activities were, there-fore, permissible as incidental to the bank holding company’sapproved activities. The applicant also proposed to provideexpert actuarial opinions of a general nature for purposes suchas divorce actions and personal injury litigation. The Boardbelieved that such activities were beyond the scope of inciden-tal activities and were not permissible.

Section 4(c)(8) of the BHC Act (Employee Benefits Consulting Services) 3202.0


Section 4(c)(8) of the BHC Act(Career Counseling) Section 3204.0

Career counseling services may be providedto—

1. a financial organization1 and individuals cur-rently employed by, or recently displacedfrom, a financial organization;

2. individuals who are seeking employment at afinancial organization; and

3. individuals who are currently employed in orwho seek positions in the finance, account-ing, and audit departments of any company.

The initial Board order that was issued to permitthe provision of career counseling services issummarized below as a historical example onthe origination of this nonbanking activity. Com-mitments made in the Board order should not berelied upon. See the current provisions of Regu-lation Y (section 225.28(b)(9)(iii)) for that pur-pose.

3204.0.1 CAREER COUNSELING—INITIAL BOARD ORDER

A bank holding company (the applicant) appliedfor the Board’s approval under section 4(c)(8)of the BHC Act and the Board’s Regulation Yto provide career counseling services to unaffili-ated parties through its wholly owned nonbanksubsidiary. The applicant proposed to expand itsemployee benefits consulting services to includecareer counseling activities. The nonbank sub-sidiary currently provides these services to theapplicantand itsaffiliatesundersection4(c)(1)(C)of the BHC Act. It plans to expand the provisionof these services nationwide to unaffiliated com-panies and individuals in a wide array of indus-tries. The services would provide assistance toindividuals who are employed and seekingadvancement in their careers and to unemployedindividuals who are seeking new employment.The nonbank subsidiary plans to provide theseservices directly to companies and advise thesecompanies on effective methods of providingcareer counseling services to their employees.

The nonbank subsidiary will advise unaffili-ated organizations on the advantages of includ-ing career counseling services as part of a com-prehensive employee benefits plan. It will assist

these organizations in establishing their ownfacilities to implement career counseling ser-vices for their current or former employees. Ifthe organization does not want to operate itsown counseling facility, the nonbank subsidiarywill provide the services directly to the organi-zation’s current or former employees at the non-bank subsidiary’s career assistance center.

The proposed career counseling servicesinclude (1) assessing an individual’s education,prior business experience, salary history, inter-ests, and skills to aid in finding employment orevaluating opportunities for career development;(2) assisting in the preparation of re´sumes andcover letters; (3) contacting employers regard-ing employment opportunities and making thisinformation available to clients; (4) conductinggeneral workshops on the financial aspects ofunemployment, current economic trends, theprocess of finding a job, and alternative careeroptions; and (5) providing individual counselingon setting and obtaining employment goals.

The issue presented to the Board was whetherthe proposed activities are closely related tobanking. The Board had not previously deter-mined whether providing career counselingservices to unaffiliated parties is closely relatedto banking under section 4 of the BHC Actand permissible for bank holding companies.The Board viewed the applicant’s proposalin four parts: (1) career counseling services forfinancial organizations (that is, banks, bank hold-ing companies and their subsidiaries, thriftinstitutions, and thrift holding companies andtheir subsidiaries) and employees of financialorganizations; (2) career counseling services forindividuals who are unemployed or employedoutside the banking industry and who seekemployment at banks and other financial institu-tions; (3) career counseling for individuals seek-ing financial positions (such as chief financialofficer, cash management positions, and account-ing and auditing personnel); and (4) career coun-seling services generally for any individualseeking any type of employment at any type ofcompany.

The Board determined that career counselingservices are closely related to banking whenthey are provided for (1) financial organiza-tions and individuals currently employed at, orrecently displaced from, a financial organiza-tion; (2) individuals who seek employment at afinancial organization; and (3) individuals who1. Financial organization means insured depository institu-

tion holding companies and their subsidiaries, other thannonbanking affiliates of diversified savings and loan holdingcompanies that engage in activities not permissible undersection 4 (c)(8) of the BHC Act.


are currently employed in, or who seek, finan-cially related positions at any company. TheBoard concluded that the record does not pres-ently support a finding that general career coun-seling services are otherwise closely related tobanking.2

The applicant will provide career counselingservices on a fee basis with no guarantee of

employment. The Board approved the order onNovember 8, 1993. As a condition to itsapproval, the applicant must comply with allcommitments made in connection with the appli-cation, as well as with other conditions statedwithin Regulation Y and the Board’s order.(1994 FRB 51)

2. When providing career counseling for an individualwithin one of the three proposed categories, the applicantwas permitted to provide limited career counseling servicesregarding positions outside of these categories as ‘‘incidental’’to the proposed career counseling services. However, theapplicant is not permitted to hold itself out as a provider ofgeneral career counseling services for individuals seekingcareer opportunities outside the banking or financial indus-tries. Regulation Y and judicial decisions construe ‘‘incidentalactivities’’ as activities that must be necessary to the provisionof a closely related activity in order to be considered inciden-tal. (See 12 C.F.R. 225.21(a)(2) andNational Courier Asso-ciation v. Board of Governors,516 F.2d 1229, 1240–41 (D.C.Cir. 1975).)

Section 4(c)(8) of the BHC Act (Career Counseling) 3204.0


Section 4(c)(8) of the BHC Act (Money Orders, Savings Bonds,and Travelers’ Checks) Section 3210.0

The Board has included in Regulation Y (seesection 225.28(b)(13)) the authority to issue andsell at retail money orders and similar consumer-type payment instruments; the sale of U.S. sav-ings bonds; and the issuance and sale of travel-ers’ checks. Previously, the Board, throughvarious orders, had authorized over time variousnonbanking activities in this regard. Initially, itpermitted by order and then the Board hadincluded in the list of permissible activities thesale and issuance at retail of money orders hav-ing a face value of not more than $1,000, thesale of U.S. savings bonds, and the issuance andsale of travelers’ checks. In its original order,effective February 26, 1979, the Board did notinclude the issuance of travelers’ checks. How-ever, after overwhelmingly favorable responsesto its proposal to include the issuance of travel-ers’ checks to the list of permissible activities,the Board included this activity effective Decem-ber 21, 1981. As part of the Board’s regulatoryreview of Regulation Y, and its subsequent over-haul, which was finalized and made effectiveFebruary 4, 1984, theissuanceof money orderswas listed as a permissible activity. On March16, 1984, the Board, by order, increased the facevalue of the payment instruments that the bankholding company could issue to $10,000, if thebank holding company agreed to meet certainweekly reporting requirements (1984 FRB 364).Also, by order dated December 16, 1985, theBoard allowed the sale of official checks withno maximum limitation as long as the proceedsof checks in excess of $10,000 were depositedin a demand account and the bank holding com-pany made weekly reports of these checks aswell as money orders that had a face value of upto $10,000 (1986 FRB 148). The Board laterauthorized the issuance and selling of variablydenominated payment instruments without limi-tation as to face value. (See 1993 FRB 42.) Aspart of the comprehensive revision of Regula-tion Y, effective April 21, 1997, the Boardremoved the limitation of the face amount ofpayment instruments. (See section 225.28(b)(13)of Regulation Y.)


1. To determine that the scope of the activityis within the parameters established by theBoard.

2. To determine if there is any loss exposuredue to the lack of systems and controls.


In determining whether a significant degree ofrisk exposure to the BHC exists, the examinershould address the following questions to man-agement, when considered appropriate:

1. Are there written agreements between thebank and its parent concerning the obliga-tions of each for the sale of money ordersand U.S. savings bonds and for the issuanceand sale of travelers’ checks? Do the agree-ments provide information on the fees,reimburseable expenses, sharing of over-head expenses, and taxes?

2. Who prints the travelers’ checks and moneyorders?

3. Is theprinterbondedorcoveredby insurance?4. Is the newly printed inventory of travelers’

checks and money orders received in dualcustody?

5. If check inventory sent to outlets is on aconsignment basis, does the consigneeacknowledge receipt on a ‘‘trust receipt’’?

6. Does the consignment ‘‘inventory invoice’’describe, in complete detail, the number ofchecks, serial numbers, and denominations?

7. How are inventories and sales monitored atthe outlet level?

8. What are the maximum dollar shipmentsfor the day, per outlet and per package?

9. Does the subsidiary bank maintain the settle-ment account?

10. What procedures are in effect to establishthe checks that have been sold?

11. What are the remittance requirements forthe agents for checks sold?

12. If losses and redemptions exceed proceedsfrom sales, who makes up the deficiency?

13. Does the parent invest the settlementaccount’s float, generated by the excess ofproceeds received over checks redeemed, inlong-term investments?

14. If a nonbank subsidiary acts as agent onbehalf of its parent, what fee is paid by theparent other than commissions on the saleof checks?

15. Is the subsidiary reimbursed for its expenses?16. What has been the history of losses?17. How long are losses carried in suspense

accounts before being charged off?18. Does the subsidiary bank maintain compen-

sating balances in financial institutions as


an inducement for the financial institutionsto carry the holding company’s travelers’checks? If so, does the parent compensate

the bank for lost income?19. What internal audit procedures are in place?

Discuss frequency, scope, and follow-up.

Section 4(c)(8) (Money Orders, Savings Bonds, and Travelers’ Checks) 3210.0




Adding activity topermissible list (excludingissuance of travelers’checks)

225.28(b)(13) 1979 FRB 265

Adding the issuance oftravelers’ checks topermissible list

225.28(b)(13) 1981 FRB 912

Increased face value orpayment instruments to$10,000, if weekly reportsprovided

1984 FRB 364

Sale of official checks withno maximum amount, ifchecks in excess of$10,000 deposited indemand deposit account, ifweekly reports of checksmade as well as moneyorders with face valueup to $10,000

1984 FRB 148

Sale of official checks withno maximum limitationprovided the proceeds ofchecks in excess of$10,000 were deposited ina demand account and thatweekly reports of the officialchecks were made as wellas the total value of officialchecks with face valuesexceeding $10,000

1986 FRB 148

Issuing and selling draftsand wire transfersin foreign currencies

1988 FRB 252

Issuing and selling variablydenominated paymentinstruments without limitationas to face value

1993 FRB 42

Removal of the limitationon the face amount ofpayment instruments

225.28(b)(13) 1997 FRB 275



Section 4(c)(8) (Money Orders, Savings Bonds, and Travelers’ Checks) 3210.0


Section 4(c)(8) of the BHC Act(Payment Instruments) Section 3210.1

As noted in section 3210.0, the Board has autho-rized the issuance and sale of various paymentinstruments. This section provides brief histori-cal summaries of the initial Board orders thatled to the incorporation of the activity into theRegulation Y ‘‘laundry list.’’ Provisions withinthe Board orders, including commitments andany regulatory references, should not be reliedupon as provisions that are currently authorized.For the current regulatory authorization, see sec-tion 225.28(b)(13) of Regulation Y, effectiveApril 1997.

3210.1.1 ISSUING CONSUMER-TYPEPAYMENT INSTRUMENTS HAVINGA FACE VALUE OF NOT MORETHAN $10,000

A bank holding company applied for the Board’sapproval under section 4(c)(8) of the BHC Actand section 225.23 of the Board’s Regulation Yto engage de novo in the issuance and sale ofvariably denominated payment instruments witha maximum face value of $10,000. The instru-ments would be sold in U.S. dollars and foreigncurrency by the holding company’s subsidiariesand unaffiliated financial institutions and wouldconsist of domestic and international moneyorders and official checks. They would also beused for certain internal transactions, such aspayroll. The Board had recently amended Regu-lation Y to include on the list of permissiblenonbanking activities the issuance or sale ofmoney orders and other similar consumer-typeinstruments with a face value not exceeding$1,000. The Board concluded that an increase inthe denomination of such instruments would notaffect their fundamental nature.

As a condition to its approval, the Boardrequired the bank holding company to file withthe Board weekly reports of daily data on theactivity. The issuance of such instruments with aface value of more than $1,000 could have anadverse effect on the bank holding company’sreserve base. Because reserve requirements serveas an essential monetary policy tool, the Boardwas concerned that the proposal might result inadverse effects resulting from an erosion ofreservable deposits within the banking system(1984 FRB 364).

3210.1.2 ISSUING AND SELLINGOFFICIAL CHECKS WITH NOMAXIMUM FACE VALUE

Effective December 16, 1985, the Board ap-proved by order a bank holding company’sapplication to sell official checks with no maxi-mum limitation on the face value, so long as theproceeds of checks in excess of $10,000 weredeposited in a demand account at its subsidiaryuntil the respective payment instrument waspaid. To address the Board’s monetary policyconcerns about the activity potentially causing asignificant reduction in the reserve base orresulting in other adverse effects on the conductof monetary policy, the bank holding companyagreed to make weekly reports of all outstand-ing instruments (including money orders andofficial checks) with face values of up to $10,000,and also the aggregate value of all official checkswith face values exceeding $10,000 (1986 FRB148).

3210.1.3 ISSUING AND SELLINGDRAFTS AND WIRE TRANSFERSPAYABLE IN FOREIGN CURRENCIES

A foreign bank subject to the BHC Act appliedfor the Board’s approval under section 4(c)(8)of the act and section 225.23(a)(3) of Regula-tion Y to engage de novo through a whollyowned subsidiary in the issuance and sale offoreign drafts and wire transfers with unlimitedface amounts that are payable in foreign cur-rencies. The applicant proposed to conductthese activities through the subsidiary as well asthrough a nationwide network of unaffiliatedselling agents, including commercial banks, thriftinstitutions, and others.

The Board previously determined that theissuance and sale of money orders and similarpayment instruments with a maximum face valueof $1,000 is closely related to banking. (Seeformer section 12 C.F.R. 225.25(b)(12).)1 TheBoard also approved by order a limited numberof applications to engage in the issuance andsale of (1) payment instruments with a $10,000maximum face amount (see 1987 FRB 727) and

1. Effective April 21, 1997, the $1,000 limit was elimi-nated. The revised Regulation Y (see section 225.28(b)(13))authorizes the issuance of payment instruments of any amount.


(2) payment instruments with unlimited faceamounts, subject to certain operational andreporting requirements (see 1986 FRB 148).

In considering the previous applications, theBoard expressed concern that the issuance ofpayment instruments in denominations largerthan $1,0002 would have an adverse effect onthe reserve base because such instruments arenot subject to the transaction reserve accountrequirements of the Board’s Regulation D. TheBoard noted that because reserve requirementsserve as an essential monetary policy tool, theconduct of monetary policy could be adverselyaffected by the erosion of reservable deposits inthe banking system.

To address the concerns expressed in previ-ous Board orders, the applicant committed thatthe proceeds of all sales of foreign-currency-denominated instruments will be held in demanddeposit accounts at U.S. commercial banks.Deposits stemming from the sale of instrumentswith denominations of $10,000 or less are to beswept daily into nonreservable instruments. Thetotal proceeds of the sale of any payment instru-ments with denominations greater than $10,000will be deposited in a demand deposit account ata U.S. depository institution, to be used to pur-chase foreign currency for each particular pay-ment instrument at the time of the transaction.The Board determined that these commitmentsand other procedures outlined in the orderadequately addressed its concerns about thepotential adverse effects on the reserve base.The Board approved the application on Febru-ary 3, 1988, subject to the continued evaluationof its potential for adverse effects on the con-duct of monetary policy (1988 FRB 252).

3210.1.4 ISSUING AND SELLINGVARIABLY DENOMINATEDPAYMENT INSTRUMENTS WITHOUTLIMITATION AS TO FACE VALUE

A bank holding company applied for the Board’sapproval under section 4(c)(8) of the BHC Act

to engage both directly and indirectly through abank holding company nonbank subsidiary inthe issuance and sale of variably denominatedpayment instruments without limitation as toface value and without the reporting and reserv-able deposit requirement previously imposed bythe Board on issuers of such instruments.

The Board previously determined by regula-tion that the issuance and sale of money ordersand other similar consumer-type payment instru-ments with a face value not exceeding $1,0003

is an activity that is closely related to bankingand is therefore permissible for bank holdingcompanies (see former section 225.25(b)(12) ofRegulation Y (12 C.F.R. 225.25(b)(12))).

Effective December 22, 1992, the Boardamended Regulation D to impose reserverequirements on teller’s checks. The Board’snotice amending Regulation D stated that bankholding companies that had received priorapproval under section 4(c)(8) of the BHC Actto issue and sell variably denominated paymentinstruments—subject to the demand depositrequirement, reporting requirement, or limits onthe denomination of payment instruments—could request relief by letter from those condi-tions. The Board believes that the adverse effectof erosion of the reserve base is addressed in theRegulation D revisions, and special reportingand demand deposit requirements previouslyimposed by the Board in connection withapprovals to engage in the issuance and sale ofvariably denominated payment instruments inamounts over $10,000 are no longer needed. Asa result, the Board determined not to imposethose requirements on the applicant and to grantthe applicant’s request for relief from the report-ing requirement to which it was subject. TheBoard approved the application on Novem-ber 12, 1992, subject to the Regulation D effec-tive date of December 22, 1992, and the con-ditions and commitments stated in the order(1993 FRB 42).

2. See footnote 1. 3. See footnote 1.

Section 4(c)(8) of the BHC Act (Payment Instruments) 3210.1


Section 4(c)(8) of the BHC Act (Arranging CommercialReal Estate Equity Financing) Section 3220.0

Effective September 1, 1982, the Board approvedan application of a bank holding company toengage in, through a nonbank subsidiary, theactivity of arranging equity financing for certaintypes of income-producing properties (1982 FRB647). The Board limited the activity by requir-ing that the holding company act only as anintermediary between developers and investorsto arrange financing, and imposed certain otherconditions to prevent the holding company fromengaging in real estate development or syndica-tion. At that time, however, the Board did notexpand the Regulation Y list of permissibleactivities for bank holding companies to includethis activity.

In February 1984, the Board added thearranging of commercial real estate equity financ-ing to the list of permissible nonbanking activi-ties in Regulation Y (section 225.28(b)(2)(ii)).Regulation Y incorporated the limitations placedon the activity by the Board’s 1982 order, whichis discussed below.

Equity financing involves arranging for thefinancing of commercial or industrial income-producing real estate through the transfer of thetitle, control, and risk of the project from theowner or developer to one or more investors. Inperforming the equity-financing activity for com-mercial or industrial income-producing realestate, consultations should be made with theowner or developer to determine the nature,objectives, and financing arrangements for theproperty or project. The project’s concept, archi-tectural design, building layout, suitability forits purpose and prospects, traffic flow, as well ascompetingprojects,source(s)ofcustomers,natureof the market, projected rentals and incomeflows, timetables for completion, and the avail-

ability of construction and long-term financingfor the property, have to be carefully reviewed.Financing alternatives, including equity financ-ing, should be predetermined.

The Board has found that the particular exper-tise and analysis required to provide equityfinancing for large commercial or industrialincome-producing properties is functionally andoperationally similar to the analysis and exper-tise that is required when a bank provides tradi-tional mortgage financing services for such prop-erties. This finding is supported by the fact thatequity financing can be viewed as an economicsubstitute for long-term mortgage financing. TheBoard’s view is that equity financing, subject tothe limitations described below, bears a func-tional relationship to investment advisory ser-vices that are traditionally and lawfully per-formed by commercial banks with respect tocommercial and industrial real estate.

The Board therefore, in 1984, approved add-ing the arranging of commercial real estateequity financing to the list of permissible non-banking activities in Regulation Y. On April 21,1997, the comprehensive revision of RegulationY removed certain restrictions from this non-banking activity. The activity currently consistsof acting as an intermediary for the financing ofcommercial or industrial income-producing realestate by arranging for the transfer of title, con-trol, and risk of such a real estate project to oneor more investors, if the bank holding companyand its affiliates do not have an interest in, orparticipate in, managing or developing a realestate project for which it arranges equityfinancing, and do not promote or sponsor thedevelopment of the property.




Application to engagein equity-financingactivities

1982 FRB 6471983 FRB 8171984 FRB 50

Adding activity topermissible list

225.28(b)(2)(ii) 1997 FRB 275



Section 4(c)(8) (Arranging Commercial Real Estate Equity Financing) 3220.0


4(c)(8)—Agency Transaction Services for CustomerInvestments (Securities Brokerage) Section 3230.0

WHAT’S NEW IN THIS REVISEDSECTION

Effective July 2008, this section has been revised

to incorporate a name change to the Financial

Industry Regulatory Authority, or FINRA (for-

merly, the National Association of Securities

Dealers, or NASD).

3230.0.1 OVERVIEW OF SECURITIESBROKERAGE AS A NONBANKINGACTIVITY

In addition to providing a full panoply of finan-cial services to their customers, banks and bankholding companies seek ‘‘off-balance-sheet’’ ornon-asset-building sources of revenue. Securi-ties brokerage is one type of endeavor perceivedto have growth and profit potential. The mainreasons for this are easy market entry, lowstart-up costs, and maximum use of a branchsystem and customer base.

After the deregulation of brokerage commis-sions in 1975, certain brokers began to competefor securities business by drastically reducingtheir commissions. In order to reduce operatingexpenses, yet still remain profitable at reducedcommission rates, these firms ceased investmentresearch and offered their customers a reducedlevel of service by ‘‘unbundling’’ brokerage ser-vices and offering only the execution of securi-ties transactions. Brokers who offer this reducedlevel of service have come to be known as‘‘discount brokers.’’

The Board, in 1983, added ‘‘securities broker-age’’ to the list of permissible activities for bankholding companies shortly after it approved theapplication of BankAmerica Corporation toacquire Charles Schwab & Co., as discussedbelow. In 1984, the U.S. Supreme Court sus-tained the Board’s approval order and ruled thatit is not a violation of the Glass-Steagall Act forbanks and bank-affiliated brokers to buy and sellsecurities as agent for customers (SIA v. Boardof Governors, 104 S. Ct. 3003). For additionalhistorical information regarding the expansionof securities brokerage nonbank activities byBoard order or by incorporation into RegulationY, see sections 3230.1 through 3230.3.

Before April 21, 1997, Regulation Y differen-tiated between securities brokerage services pro-vided alone (that is, discount brokerage ser-vices) and securities brokerage services providedin combination with investment advisory ser-vices (that is, full-service brokerage activities).

Regulation Y no longer distinguishes betweendiscount and full-service brokerage activities.

Regulation Y currently authorizes securitiesbrokerage services (including securities clearingand/or securities execution services on anexchange), whether alone or in combinationwith investment advisory services and inciden-tal activities (including such related activities assecurities credit, custodial services, individualretirement accounts, and cash-management ser-vices), if the services are restricted to buyingand selling securities solely as agent for theaccount of customers and do not include securi-ties underwriting or dealing. In addition to theinformation and examiner guidance provided inthis section, see the American Institute of Certi-fied Public Accountants’ Audit and Accounting

Guide—Brokers and Dealers in Securities.1 Theguide includes detailed information about thesecurities industry, broker-dealer functions,activities and operations, books and records,accounting and auditing standards and consider-ations, and other topics such as internal controlsand regulatory considerations.

3230.0.2 INITIAL BOARD ORDERAPPROVAL FOR SECURITIESBROKERAGE

On January 7, 1983, the Board approved theapplication of BankAmerica Corporation toacquire Charles Schwab & Co., which engagedin retail discount securities brokerage, securitiescredit lending, and certain incidental activities(1983 FRB 105). None of the proposed activi-ties was among those the Board had previouslydesignated in Regulation Y as being closelyrelated to banking.

In its order approving the application, theBoard found that the brokerage and securitiescredit activities were closely related to bankingfor purposes of section 4(c)(8) of the BankHolding Company Act (‘‘BHC Act’’). That deci-sion was based on the fact that many banksprovide various types of securities brokerageservices as an accommodation to customers andas an agent for trusts and other accounts man-aged by banks.

Banks also administer employee stock pur-chases, dividend reinvestment, and automatic

1. Issued as of May 1, 2007.

BHC Supervision Manual July 2008Page 1

investment service plans, which involve theperiodic purchase of a particular security orsecurities from a fixed list of securities, onbehalf of the customer. Banks often executeorders involving securities not listed on anexchange by dealing directly with dealers mak-ing a market in a particular security or withother third parties. In performing these services,banks exercise the same type of discretion andjudgment with respect to the best method ofexecution as brokers do with respect to similartypes of orders. Further, national banks areexpressly authorized by statute to purchase andsell securities without recourse, solely upon theorder, and for the account of, customers (12U.S.C. 24 (Seventh)).

The Board, in summary, noted that banks infact had generally provided securities brokerageto some extent. The company that was acquired,pursuant to the January 1983 order, providedseveral other services incidental to its discountbrokerage activities.

3230.0.2.1 Margin Lending

Historically, banks have had a significant amountoutstanding in loans to borrowers for the pur-pose of purchasing or carrying securities. Theextension of such credit secured by stock andother collateral, or margin lending, has longbeen an important bank activity. The Board,therefore, ruled that this activity was closelyrelated to banking and incidental to the securi-ties brokerage activities of the company beingacquired.

3230.0.2.2 Maintenance of CustomerSecurities Accounts

Charles Schwab & Co. offered various servicesto its brokerage customers. These servicesincluded individual retirement accounts for whichan unaffiliated savings and loan association servedas a trustee; a ‘‘sweep’’ arrangement, pursuantto which idle customer balances exceeding acertain minimum were automatically invested inan unaffiliated money market mutual fund; thepayment of interest on net free balances await-ing investment; and a specially named accountthat combined the payment of interest on freecredit balances with customer access to suchbalances through a debit card and checkingaccount offered under an arrangement with an

unaffiliated commercial bank. Increasingly, thesetypes of services were being offered by otherbrokerage firms. The Board found that each ofthese services was identical, or functionally andoperationally equivalent to, services generallyoffered by banks to customers directly or throughbank trust departments. Based on that finding,the Board found that the provision of thoseaccounts was closely related to banking as wellas an incidental activity in connection with secu-rities brokerage and margin lending activities.

3230.0.2.3 Custodial Services

The brokerage firm also provided various typesof securities custodial services involving thesafekeeping of customers’ securities, account-ing for dividends or interest received on suchsecurities, and other ancillary services. Banksgenerally offer securities custodial services inconnection with their trust departments and othersecurities transaction services. Furthermore, inextending margin credit, a lender is required tomaintain custody of the securities pledged to thelender as collateral to secure the loan. Accord-ingly, the Board found that the provision ofsecurities custodial services was closely relatedto banking and that it was a necessary incidentto permissible margin lending activities.

3230.0.3 MARGIN CREDITACTIVITIES AND SECURITIESBROKERAGE

When securities brokerage was added to thepermissible activities within Regulation Y, itwas contemplated that a bank holding company,or its nonbank subsidiary performing the permit-ted securities brokerage activities, would berequired to register as a broker–dealer with theSecurities and Exchange Commission and thatits margin credit activities would therefore besubject to the Board’s Regulation T. RegulationT governs securities credit by broker–dealers(12 C.F.R. 220).

3230.0.4 ACTIVITY ADDED TOREGULATION Y

On August 10, 1983, the Board adopted a finalrule deeming securities brokerage and marginlending ‘‘closely related’’ to banking, consistentwith the Glass-Steagall Act, and are, therefore,generally permissible for bank holding compa-nies. To clarify that services incidental to bro-

4(c)(8)—Agency Transaction Services for Customer Investments (Securities Brokerage) 3230.0


kerage services are permissible, the Board didinclude a list of permissible incidental services.The list included services such as offering custo-dial services, furnishing individual retirementaccounts, and cash-management services, pro-vided that the securities brokerage services arerestricted to buying and selling securities solelyas agent for the account of customers and do notinclude securities underwriting.

As for cash-management services, such ser-vices are intended to include customer-account-related functions, such as paying interest on netfree balances awaiting investment, providingarrangements under which free credit balancesare automatically invested in money marketmutual funds, and establishing arrangementsunder which access to such balances is providedby debit card or checking accounts.

The list of incidental activities in the regula-tion is not intended to be exhaustive. The Boardbelieves that to compete effectively with otherbrokers, bank holding companies should havethe flexibility to provide a full range of customer-account and custodial services, provided suchservices meet the test for permissible incidentalactivities under section 4(c)(8) of the BHC Actand are consistent with the Glass-Steagall Act.

As previously noted, Regulation Y, effectiveApril 21, 1997, permits securities brokeragewithout distinguishing between discount andfull-service brokerage activities. The previousregulatory requirement for certain disclosureshas been eliminated. Those disclosure require-ments are in an interagency policy statementthat governs the sale of securities and othernondeposit investment products on bank prem-ises (see sections 2010.6.1.3.1 and 2010.6.2.9),as well as in SEC rules. Similar disclosurerequirements are required by the Board’s policystatement that governs a bank holding compa-ny’s sale of shares of mutual funds and otherinvestment companies that it advises (see sec-tion 225.125 of Regulation Y).

3230.0.5 MARKET ENTRY INTOSECURITIES BROKERAGE

There are three general methods of market entryavailable to bank holding companies or non-bank subsidiaries of bank holding companieswishing to offer securities brokerage services:(1) become associated with a brokerage firm,(2) purchase an existing firm, or (3) establishtheir own brokerage operations. The most com-mon mode is broker association, which is lesscostly and the most rapid form of entry. The

following broker relationships are presentlyestablished:

1. Introducing broker. The first level of involve-ment occurs when a BHC or a nonbank sub-sidiary of a BHC serves as an ‘‘introducingbroker’’ in effecting securities transactionsby accepting the customers’ orders and trans-mitting the orders to the executing broker.2

Order tickets and records of original entryare prepared by the BHC or nonbank subsid-iary. In this situation, the executing brokergenerally produces customer confirmationsand account statements. These documentsoften prominently display the BHC or thebank holding company’s nonbank subsid-iary’s name and logo. The executing broker,the bank holding company, and/or its non-bank subsidiaries may offer safekeeping ser-vices and margin credit.

2. Omnibus account. A higher level of bankholding company nonbank subsidiary involve-ment occurs when the broker ‘‘carries’’ cus-tomer accounts by accepting and transmit-ting orders for execution, producing thecustomer confirmation, and maintaining allcustomer records. When carrying customers’accounts, the bank holding company’s non-bank subsidiary may maintain a single cus-tomer account, called an omnibus account,with the executing broker. Safekeeping andmargin credit services may be offered.

3. Separately incorporated broker–dealer sub-

sidiary affiliate. The highest level of involve-ment occurs when a bank holding companyorganizes or acquires a separately incorpo-rated broker–dealer subsidiary or affiliate,which transacts business like any other broker–dealer. This would include its own customerlists, both retail and wholesale; possibleexchange membership; and executing andclearing its own transaction.

3230.0.6 PURPOSE OF INSPECTIONOF SECURITIES BROKERAGEACTIVITIES

The purpose of the inspection is to evaluate

2. There is a lower level of involvement wherein the BHCor nonbank subsidiary is responsible for making the brokerageservices available to customers by advertising the distributingcustomer account applications. Account acceptances are gen-erally made by the unaffiliated broker who will receive ordersdirectly from customers.



any potential liability due to wrongful or negli-gent performance of responsibilities, to assessthe level of management expertise, and to deter-mine the degree of compliance with legal andpolicy parameters necessary to protect investors.


1. To determine the scope and nature of ser-vices provided.

2. To evaluate operations, audits, and controls.3. To review the sufficiency of administrative

policies and procedures.4. To determine the level of responsibility.5. To appraise the quality of management and

staff.6. To ascertain earnings, volume of business,

and prospects.7. To review compliance with applicable laws,

regulations, and policies.

3230.0.8 SCOPE OF INSPECTION

The scope of inspection will vary depending onthe nature of the brokerage operation. In defin-ing the scope of inspection, it is first necessaryto determine the extent of activities performedand the corporate structure. Any bank holdingcompany subsidiary (that is not a bank), whichfunctions as a securities broker, is required toregister as a broker–dealer with the Securitiesand Exchange Commission (SEC).3

In developing the scope of inspection, it is

emphasized that Reserve Bank examiners can

rely on the applicable self-regulatory organiza-

tion’s examination with respect to investor pro-

tection, compliance with SEC and SRO rules,

and Regulation T. The self-regulatory organiza-tions do not furnish an examination report, butinstead furnish a registered broker–dealer with aletter pertaining to examination findings. Hence,the scope of inspection for a registered broker–

dealer will commence with a review of a self-regulatory organization’s most recent letter deal-ing with its examination of brokerage activities.A broker–dealer belonging to more than oneself-regulatory organization will be examinedonly once in each examination cycle. Seriousviolations that could endanger a banking organi-zation (for example, fraudulent activities thatcould subject the organization to losses or law-suits) or significant violations that have not yetbeen corrected, should be noted in the bankholding company inspection report. Reserve Bankstaff are responsible for evaluating all otheraspects of securities brokerage activities.

The actual scope of this portion of the inspec-tion will range from a brief visit for a lim-ited service ‘‘arranger’’ relationship to extensivereview for an omnibus relationship or registeredbroker–dealer.

3230.0.9 MATERIALS REQUIRED FORINSPECTION

When commencing the securities brokerage por-tion of a bank holding company or its nonbanksubsidiary inspection, the following materialshould be obtained:

1. contractual agreement with the executingand/or clearing broker

2. recent activity report (for at least six months)3. income and expense reports4. written policies and procedures regarding—

a. order processing,b. settlements,c. account reconciliations,d. audit coverage, ande. trust department relationship

5. account application forms6. customer disclosure documents7. organization chart8. fee schedule9. internal and external audit reports

10. a copy of the contingency plan for continu-ance in emergencies

11. the most recent SRO letter pertaining to thelast brokerage examination


If applicable, the following areas should be cov-ered during the inspection.

3. A broker–dealer registered with the SEC (registeredbroker–dealer) is subject to SEC recordkeeping and confirma-tion rules, fair practice rules, professional qualification rulesfor individuals associated with securities firms, and theuniform net capital rule. Registered broker–dealers are alsorequired to pay for insurance coverage on customers’ assetsby the Securities Investor Protection Corporation (SIPC) andare required to be members and subject to the rules of theFinancial Industry Regulatory Authority (FINRA), or otherself-regulatory organizations, such as the New York StockExchange. These self-regulatory organizations (SROs) alsotest for broker compliance with Regulation T (12 C.F.R. 220).



3230.0.10.1 Organization andManagement

Review carefully the contractual agreement withthe executing and/or clearing broker and list allduties and obligations of the respective parties.Determine that the agreement contains anindemnification clause insulating against brokererror. Once the review is completed, the exam-iner can identify the type of relationship andplan the scope of the inspection.

Review the organization chart and matchresponsibilities and operational functions to theappropriate section. Evaluate management andstaff based upon their education, experience,performance, and the profitability and efficiencyof operations and any other relevant factors.

3230.0.10.2 Operations

A securities brokerage operation is organizedalong functional lines including—

1. execution,2. settlement,3. delivery,4. custody,5. recordkeeping, and6. audits and controls.

Before review, prepare a flow chart of the opera-tion to quickly overview the operational areasand to locate control points and identify poten-tial weaknesses.

3230.0.10.2.1 Execution

This area processes client orders. The ordersmay be received by telephone at the nonbanksubsidiary or directly by the executing broker.When the nonbank subsidiary accepts customerorders, they can be transmitted by direct wire tothe executing broker. Completed transactionsinitiated by the nonbank subsidiary are con-firmed back to the nonbank subsidiary, which inturn sends a confirmation to the client. Examin-ers should determine that proper safeguards arein place to ensure valid orders are received,pending orders are controlled, and completedorders are reported for customer notification andrecord update. The examiner should also deter-mine that the following are in place:

1. use of code numbers, names, or other verifi-cation devices when accepting orders

2. maintenance and reconcilement of a trade

log (orders received) and execution report(orders completed)

3. taping of telephone orders4. confirmation of completed orders are con-

firmed to clients in a timely fashion5. preparation and transmittal of input media

for record update

3230.0.10.2.2 Settlement

This area receives payments and proceeds, col-lects dividends and interest, and, in someinstances, effects margin calls on broker instruc-tion. Settlements are effected in two stages:

1. Broker vs. customer. Before settlement date,the customer must send cash or securities tothe broker as requested in the broker’s cus-tomer confirmation. Cash or securities arerequired to effect payment against deliveryor delivery against payment in accordancewith industry securities settlement procedures.

2. Broker vs. broker. When physical delivery ofsecurities is required, it is generally done ona firm-to-firm basis or to a firm’s safekeepingagent. Major equity securities, and an ever-increasing number of debt securities, are eli-gible for net settlement and securities immo-bilization with depositories. Usually, a netsettlement account is used for cash and secu-rities transactions; these accounts should bereconcileddaily.Thesettlementprocess shouldinclude a procedure that verifies executionprice and fees.

3230.0.10.2.3 Delivery

Securities are delivered to the executing brokerand purchased securities to clients. The exam-iner should determine that safeguards provideadequate control over certificates in process.Proper fail-to-deliver/receive and completedtransaction records should be maintained.

The securities broker that accepts customerorders generally is exposed to delivery risk bycustomers. Basically, customers can take advan-tage of the broker by placing an order to buysecurities when the customer has no funds avail-able to purchase securities or by placing anorder to sell securities that are not owned by thecustomer. Either type of transaction is permis-sible in a margin account, provided that thecustomer has the resources available to properly



margin the transaction. If the customer does nothave a margin account, the broker should notpurchase a security for the customer unless(1) there are sufficient funds in the customer’saccount or (2) the customer represents and thebroker ascertains that the customer will promptlymake full cash payment for the security beforeselling it and that the customer does not contem-plate selling it before making payment.Alternatively, the broker should not sell a secu-rity for a customer unless (1) the security is heldin the customer’s account, or (2) the brokeraccepts in good faith the customer’s statementthat the security is owned by the customer andthat it will be promptly deposited into the account.

By not executing a purchase or sale until thecustomer has deposited cash or securities,customer-default risks can be avoided on cashtransactions. However, for competitive reasons,many brokers would not wish to place suchstringent restrictions upon their customers—especially with respect to the purchase of securi-ties. Lack of proper account supervision canlead to the fraudulent customer practice of ‘‘freeriding,’’ wherein the customer will buy securi-ties in anticipation of a price rise. Before settle-ment date, the customer will sell the securitiesto take the profits. If the market price of thesecurities declines, the customer will dishonorthe trade, and thus attempt to leave the brokerholding the depreciated securities. Securitiesbrokerage procedures should be designed tolook for generally abusive practices bycustomers.

3230.0.10.2.4 Recordkeeping

Any records that must be prepared by the brokerunder inspection are subject to the Securitiesand Exchange Commission’s recordkeeping andconfirmation rules 17a-3 and 17a-4. Compliancewith those recordkeeping rules will be verifiedby stock exchange or FINRA examiners duringtheir routine compliance inspections.

3230.0.10.2.5 Audits and Controls

Complete the ‘‘Securities Brokerage/InternalControls Checklist’’ to determine whetheroperationsare satisfactorilycontrolledandauditedby the bank holding company’s or nonbanksubsidiary’s audit staff. All significant adminis-trative and operational aspects should be cov-

ered. Management should receive reports ofaudit findings and respond in writing as toactions taken.

3230.0.10.3 Conflicts of Interest

Determine that policies have been effectivelyimplemented covering relationships with affili-ated trust departments, self-dealing, fee-splittingor rebate arrangements, and officer/employeetransactions.

3230.0.10.3.1 Relationship with AffiliatedTrust Departments

Questions may arise concerning the permissibil-ity of a securities broker’s executing securitiestransactions for an affiliated trust department. Ingeneral, the receipt of commission income forsecurities brokerage transactions entered into onbehalf of a trust account (in addition to the feereceived for account administration) raisesconflict-of-interest considerations to which tra-ditional prohibitions of fiduciary law are directed.When a securities broker affiliate is used, thetrust institution may be considered to share indi-rectly in the commission income of the affiliateeven when there is no direct remittance of thefee to the bank. The staff letter at 3–447.11 ofthe Federal Reserve Regulatory Service pro-vides guidance in determining whether and inwhat circumstances use of affiliated discountbrokerage services may or may not be permis-sible. If questionable trust department use ofaffiliated broker services is disclosed, appropri-ate trust examiner(s) should be notified.

3230.0.10.4 Earnings, Volume Trends,and Prospects

Determine the present and future impact that thesecurities brokerage activities may have on thebank holding company and its subsidiaries. Ifpossible, a separate profit center should beestablished, thus providing a useful manage-ment tool that facilitates analysis of currentprofitability, business volume, fixed and vari-able costs, and degree of goal actualization.Periodic review of these factors will enablemanagement to direct available resources, aid inthe budget process, and provide a basis forbusiness planning. Prospects for profitable growthshould be assessed by noting changes in aggre-gate account levels and trade activity. The localcompetitive environment should be gauged and



market-share information noted. In consideringthese factors, the examiner should attempt todetermine what level of activity must be main-tained or attained in order for the securitiesbrokerage function to break even. Present asummary statement expressing an overall viewon the current state and future viability of theoperation.

3230.0.10.5 Compliance

The examiner should determine whether anyadditional state regulations must be compliedwith. Also determine that staff is aware of andcomplying with applicable regulations andlaws, which may be outside the scope of anexamination conducted by a self-regulatoryorganization.

3230.0.10.6 Presentation of Findings

The scope of inspection within the report shouldnote that securities brokerage activities werereviewed. It should be noted that in order toavoid duplication of examination procedures,the inspection did not focus upon securities lawscompliance (as verified by FINRA, or stock-exchange examiners), but instead focused uponfinancial and safety-and-soundness consider-ations. Appropriate nonbank subsidiary pagesshould be completed. Present a summary com-

ment in the confidential section reflecting anoverall appraisal of the operation. The self-regulatory organization responsible for examin-ing the securities brokerage operation should beidentified. Identify also the associated broker, ifany, with whom the organization conducts busi-ness. Any material exceptions should be notedwith management’s responses under an appro-priate caption within the open section. Mattersof importance should be brought forward to theExaminer’s Comments and Matters RequiringSpecial Board Attention page. In addition, anyother significant problems, detrimental prac-tices, or potential liabilities that could have anegative impact on the organization should becommented upon.

3230.0.11 EXAMINATIONCHECKLISTS

Two checklists are provided for use by theexaminer to aid in evaluating securities broker-age activities:

1. Securities Brokerage Inspections2. Securities Brokerage/Internal Controls

Allquestionsarenot applicable foreachbrokeragesubsidiary. The nature and scope of brokerageactivities determine the applicability of specificquestions. The term ‘‘banking organization’’ re-fers to a bank holding company and any of itsnonbank subsidiaries.

3230.0.11.1 Securities Brokerage Inspection Checklist

Yes No

1. Is a contractual agreement between the banking organization and theexecuting and/or clearing broker on file? *

2. Does the agreement indemnify the banking organization against brokererror? *

3. Does the agreement clearly define respective responsibilities of thebanking organization and broker? *

4. Was the agreement reviewed by the banking organization’s counsel? *

5. Was the agreement approved by the board of directors?If not, by whom?

*

6. Are written procedures covering brokerage activities in effect? *

7. Have job descriptions been prepared? *

8. Have specific policies been developed regarding—

*Response may require report comment.



Yes No

• relationships with affiliated bank trust depts? *

• conflicts of interest? *

• investment advice? *

9. Are investment advice or research services being offered? *

10. Are income and expense records separately maintained? *

11. Are brokerage activities included in the audit program? *

12. Are customer orders placed with banking organization personnel? *

If so, is customer authorization on file? *

Are telephone conversations tape recorded? *

Are transaction records maintained by traders? *

13. How are payments effected? (check one)

direct charge to customer account

payment through the mail

other

14. What is the timeframe of payment?prior to execution

upon verbal notification of execution

upon customer’s receipt of confirmation

after settlement date *

15. What is the frequency of settlement-account reconcilements?

daily

biweekly

weekly *

other

16. Does an affiliated trust department use the discount brokerage service? *

If yes, what type account?

discretionary trust **

discretionary agency **

custody

employee benefit **

17. Is sufficient insurance coverage in effect? *

Describe types and limits.

18. Does a review of records confirm that the broker functions solelyas an agent, i.e., does not engage in underwriting or takingpositions for its own account? *

19. Do monitoring and internal reporting procedures adequately trackprofitability and operating impact for management consideration? *


**If available documentation reveals that affiliated trust depart-ments use brokerage services to execute transactions for thistype of account, the appropriate federal regulator of trust activi-ties should be notified.



3230.0.11.2 Securities Brokerage/Internal Control Checklist

The following questions should be answered, to the extent applicable, in reviewing a securitiesbrokerage operation. Few brokers will perform all of the activities discussed below.

Yes No

1. Do internal audit procedures include the securities brokerage function? *

2. Has the banking organization adopted procedures for the periodicreview of insurance coverage relating to securities brokerage activities(e.g., errors and omissions, fidelity bonding, and securities in transit)? *

3. Has the banking organization adopted procedures with respect to theaccounts of directors, officers, or employees or their immediate fami-lies? *

4. Are procedures in place to prevent internally generated credits to thesecurities brokerage customers’ accounts from being automaticallyrecorded as collected funds? *

5. Are procedures in place to ensure that acceptance of a relatively largeorder will not be effected unless the order taker verifies that the cus-tomer placing the order has internal authorization to engage in largetrades? *

6. Has the banking organization adopted written procedures prohibitingemployees from furnishing investment advice? *

7. Are customer telephone orders tape recorded? *

8. Are tape recordings of telephone orders reviewed periodically toverify that employees have not made securities recommendations orfurnished investment advice? *

9. Are persons responsible for taking and transmitting orders precludedfrom preparing accounting entries? *

10. Is there adequate separation of duties between persons responsible formaking initial accounting entries and those responsible for makingsubsequent adjusting entries to prevent a concealment of theft orfraud? *

11. Does the securities brokerage function monitor and reconcile safe-keeping, clearing, payment, and income expense accounts on a regu-lar basis? *

12. Has management developed a contingency plan to ensure continuedbrokerage operations of the securities brokerage operation in theevent of fire, flood, power failure, or some other unforeseen event? *

13. With respect to termination of brokerage accounts, does the securitiesbrokerage operation have procedures in place to prevent an accountfrom being closed while an open securities order is outstanding? *

14. Does the credit-approval process require a credit decision to be madeby someone who routinely makes credit decisions—as opposed to amanager of a securities brokerage operation? *

15. If securities received from customers are registered in the name of athird party, are procedures in place to ensure that such securities areaccepted only upon satisfactory proof of ownership? *




Yes No

16. Are procedures in place to ensure that customers delivering securitiesregistered in a ‘‘street name’’ have title to such securities (i.e., they arenot lost or stolen securities)? *

17. Is only a limited number of responsible employees authorized toexecute or guarantee security assignments? *

18. Is the use of facsimile signature devices adequately controlled? *

19. Are procedures in place to control cash, securities, and documents per-taining to securities shipped for ‘‘delivery against payment’’? *

20. Are adequate physical controls maintained over securities on hand(e.g., restricted access to the ‘‘cage area’’)? *

21. Are detail records pertaining to securities in transfer and those pledgedas collateral to borrowings agreed periodically (at least quarterly) withthe securities record? *

22. Are security positions (and related general-ledger amounts) in suspenseaccounts investigated and resolved on a timely basis? *

23. Are fails to receive and fails to deliver periodically reviewed andreconciled? *




Board’s authority for rulemakingand jurisdiction over BHCs

1843(c)(8),1844(b)

Order approving the application ofa BHC to acquire a retail discountsecurities broker

1983 FRB 105

Order approving acquisition of retaildiscount broker by a BHC

1983 FRB 565

Securities brokerage as a permis-sible activity

225.28(b)(7)(i)

Credit by brokers and dealers—Regulation T

220

Order approving the provision ofcombined securities brokerage,investment advisory, and researchservices

1986 FRB 584

Securities brokerage subsidiary canexchange customer lists with affili-ates and confidential customerinformation (with customerapproval)

1988 FRB 571




Securities brokerage with discre-tionary investment managment andinvestment advisory services

1988 FRB 7001987 FRB 9301987 FRB 810

Full-service brokerage for institu-tional and retail customers—bank-ineligible securities

1989 FRB 3961997 FRB 275





4(c)(8)—Securities Brokerage (Board Decisions)Section 3230.05

This section serves as a prelude to the securitiesbrokerage sections that follow. Sections 3230.1through 3230.3 provide brief historical summa-ries of Board decisions on securities brokerage;these authorizations are now incorporated intoRegulation Y for this activity. The summariesprovide the reader with some historical perspec-tive as to how and why the current provisions ofRegulation Y evolved. The conditions and com-mitments within these orders may no longerapply to the current provisions of Regulation Y.Therefore, reference must be made to Regula-tion Y, section 225.28(b)(7)(i).

Before the 1997 revisions of the Board’sRegulation Y (12 C.F.R. 225), the Board’s rulesdifferentiated between securities brokerage ser-vices provided alone (that is, discount brokerageservices) and securities brokerage services pro-vided in combination with investment advisoryservices (that is, full-service brokerage activi-ties). The revisions to Regulation Y that becameeffective in April 1997 permit securities broker-age without distinguishing between discount andfull-service brokerage activities.

Another major change for securities broker-age activities concerns the types of disclosuresrequired of bank holding companies. Before the1997 revisions, bank holding companies provid-ing full-service brokerage services were requiredto make certain disclosures to customers regard-ing the uninsured nature of securities and werenot permitted to disclose confidential custo-

mer information without the customer’s con-sent. Effective in April 1997, these disclosurerequirements were eliminated. The disclosurerequirements—along with a number of otherrequirements that specifically address the poten-tial for customer confusion, training require-ments, suitability requirements, and othermatters—are already contained in an inter-agency policy statement that governs the sale ofsecurities and other nondeposit investment prod-ucts on bank premises, as well as in rulesadopted by the SEC. In addition, similar disclo-sure requirements are required by the Board’spolicy statement governing the sale by bankholding companies of shares of mutual fundsand other investment companies that the bankholding company advises.

Banking organizations and their affiliates, ingeneral, are becoming more effective in imple-menting the regulatory disclosure requirements.Customers are also becoming increasingly awarethat such investment products purchased at bank-ing organizations and their affiliates are not fed-erally insured. Moreover, the Board and theSEC have adequate supervisory authority toensure that bank holding companies complywith the applicable regulatory disclosurerequirements. To the extent that disclosures tocustomers are appropriate in areas not coveredby the regulatory policy statements or SECregulations, the Board will consider whether todevelop supervisory guidance.


4(c)(8) of the BHC Act—Securities Brokerage in Combinationwith Investment Advisory Services Section 3230.1

Two bank holding companies jointly applied forthe Board’s approval under section 4(c)(8) ofthe BHC Act and section 225.23(a)(3) of Regu-lation Y to form a de novo subsidiary that wouldengage in the following nonbanking activities:

1. providing portfolio investment advice to‘‘institutional customers’’

2. providingsecuritiesexecution(brokerage)ser-vices, related securities credit activities pur-suant to the Board’s Regulation T, and inci-dental activities

3. furnishing general economic information andadvice, general economical statistical fore-casting services, and industry studies to insti-tutional customers

4. serving as an investment adviser (as definedin section 2(a)(20) of the Investment Com-pany Act of 1940) to investment companiesregistered under that act

Separate fees are to be charged for the advi-sory services and the securities brokerage ser-vices. The company would also provide inciden-tal services such as custodial and cash-management services and acting as a registeredinvestment adviser. The services are to be pro-vided throughout the United States. The provid-ing of advisory services to retail clients was notauthorized by the Board. The applicant commit-ted to create a ‘‘Chinese Wall’’ between theaffiliated bank and the securities affiliate.

The Board determined that the activities wouldnotviolateGlass-SteagallActprohibitions.Boardapproval was conditioned with the requirementthat the standards of care and conduct applica-

ble to fiduciaries would be observed. The appli-cant would not allow the exchange of confiden-tial information between the de novo subsidiaryand its affiliates. The applicant further commit-ted that employees of the de novo subsidiarywould not be given customer lists and otherconfidential information obtained by its affili-ates in connection with commercial bankingoperations. Transmission of advisory researchand recommendations to the commercial lend-ing department of any of the bank holding com-pany’s affiliates was not permitted.

The proposal represented the combination ofactivities, previously determined to be closelyrelated to banking, in such a way that the func-tional nature and scope of the combined activi-ties conducted would not be altered. By Boardorder, the applicants’ application was approvedon June 13, 1986 (see 1986 FRB 584), subjectto the conditions stated therein. Other orderswere approved by the Board on August 5, 1987(1987 FRB 810), and October 1, 1987 (1987FRB 930), which also authorized a bank holdingcompany to engage in combined investmentadvisory and securities brokerage activities. Inthis order, the Board lowered the threshold fordefining an ‘‘institutional investor’’ from $5 mil-lion to $1 million.

The Board, effective September 10, 1992,added this nonbanking activity to those activi-ties that are permissible by regulation, currentlyfound in section 225.28(b)(7)(i) of Regula-tion Y, subject to the disclosure requirements,restrictions on exchanging confidential customerinformation, and other limitations stated therein.


4(c)(8)—Securities Brokerage with Discretionary InvestmentManagement and Investment Advisory Services Section 3230.2

A bank holding company applied to the Boardto expand the authority of its subsidiary toengage in offering investment advisory servicesfor ‘‘institutional customers’’ and its affiliates1

in conjunction with its previously approvedbrokerage services. The Board previouslyapproved by order (1986 FRB 584) an applica-tion for a different bank holding company tooffer the combination of investment advice andsecurities execution services for institutionalcustomers.

The proposed activities in this order (1987FRB 810) are similar except that the subsidiarywould additionally exercise limited investmentdiscretion at a customer’s specific request. Underthis plan, the subsidiary would offer as a ser-vice, within defined parameters established bythe client, discretion in buying and selling secu-rities on behalf of the client.

Such investment discretion would be exer-cised only at the request of a client; the subsidi-ary does not plan to market or solicit managedaccounts. Each client will receive confirmationof each transaction, as well as monthly state-ments which would indicate in detail the termsof each transaction executed on its behalf. Eachclient would always be aware of the scope of thesubsidiary’s activity for its account. The subsid-iary would receive a single fee for the combinedactivities of providing investment advice andexercising limited investment discretion.

The application was approved on August 5,1987, subject to the commitments made by theapplicant and the conditions (whether explic-

itly stated or incorporated by reference) in theorder.

The Board approved another order on Octo-ber 1, 1987 (1987 FRB 930), similar to theAugust 5, 1987, order, except that (1) the appli-cant proposed to lower the test for institutionalcustomers from the $5 million threshold to$1 million; (2) the applicant’s wholly ownedbrokerage subsidiary would share customer listswith its affiliates, but not confidential informa-tion obtained from the customer; and (3) thebrokerage subsidiary would have officer anddirector interlocks with the parent bank holdingcompany, but not with its bank affiliates. In theBoard’s view, these modifications did not alterthe underlying rationale of its earlier decision.

The Board approved another order on August10, 1988 (1988 FRB 700). The principal differ-ence between the August 5, 1987, order and thisproposal was the provision of such combinedservices toretail as well asinstitutionalcustom-ers. The provision of services to retail customersdoes not include discretionary investment man-agement. To further ensure the separation of theBHC and its bank affiliates and to avoid poten-tial conflicts of interests, the applicant madeseveral commitments, as detailed within theorder.

The Board, effective September 10, 1992,added the providing of discretionary investmentmanagement to the nonbanking activities thatare permitted by regulation, currently found insection 225.28(b)(7)(i) of Regulation Y.

1. The provision of such services by the subsidiary to otheraffiliates is a permissible servicing activity under section225.22(a) of Regulation Y.


4(c)(8) of the BHC Act—Offering Full Securities BrokerageServices for Bank-Ineligible Securities Section 3230.3

A bank holding company (applicant) applied forthe Board’s permission for its subsidiary to pro-vide investment advisory and brokerage serviceson a combined basis (‘‘full-service brokerage’’)to institutionaland retail customersand toengage,to a limited extent, in underwriting and dealingin one- to four-family mortgage-related securi-ties and consumer receivable–related securities(herein referred to as ‘‘ineligible securities’’).The applicant committed to conduct its ineli-gible securities underwriting and dealing activi-ties subject to the revenue test and the pruden-tial limitations established by the Board in 1987FRB 473, except for a market-share limitationwhich the Board decided not to require for thisBHC.

The Board determined previously that full-service brokerage for both institutional and retailcustomers is closely related and a proper inci-dent to banking under section 4(c)(8) of theBHC Act and does not violate the Glass-SteagallAct (1988 FRB 700 and 1986 FRB 584). ThisBHC’s proposal differs from prior cases in thatthe subsidiary will provide full-service broker-age to retail customers for ineligible securitiesthat it may hold as principal. The BHC hascommitted that the subsidiary will provide fulland appropriate disclosure of its interest in thetransaction as required by the securities laws,the National Association of Securities Dealers,and fiduciary principles.

The Board had previously authorized an under-writing subsidiary to provide full-servicebrokerage with respect to ineligible securitiesthat it holds as principal,but only to institutionalcustomers(1988 FRB 695). Applicant made the

samecommitments regardingdisclosuresas foundin 1988 FRB 695. The BHC committed furtherthat its subsidiary would prominently disclosein writing to each customer, at the commence-ment of the relationship, that it is not a bank;that it is separate from any affiliated bank; andthat the securities sold, offered, or recommendedby the subsidiary are not deposits, are not insuredby the FDIC, are not guaranteed by an affiliatedbank, and are not otherwise an obligation of anaffiliated bank, unless such is in fact the case.The Board emphasized that confirmations sentto customers will state whether the subsidiary isacting as agent or principal with respect to asecurity. The Board concluded that such disclo-sure commitments would be adequate. It recog-nized that in performing the full-service broker-age activity, the underwriting subsidiary wouldbe operating under a more extensive frameworkof prudential limitations than would be the caseif the full-service brokerage activity were con-ducted by a bank, a subsidiary of a bank, or byanother holding company subsidiary. Based onthe commitments made, the Board decided onMarch 14, 1989, to approve the proposed activi-ties (see 1989 FRB 396) subject to all the termsand conditions found in 1987 FRB 473, exceptfor the market-share limitation.

Effective September 10, 1992, the Board addedthis nonbanking activity to the activities permit-ted by regulation, currently found in section225.28(b)(7)(i) of Regulation Y and subject tothe Board’s disclosure and other requirementsand the limitations on exchanging confidentialinformation, as stated therein.


Section 4(c)(8)—(Private-Placementand Riskless-Principal Activities) Section 3230.4

This section discusses and provides a historicalreference of previous Board orders that initiallyauthorized, by order, a bank holding company’sacting as agent in the private placement of secu-rities and engaging in riskless-principal non-banking activities.With the Board’s incorpora-tion of private-placement and riskless-principalactivities into its adoption of changes to Regula-tion Y, effective April 21, 1997, the majority ofthe previous private-placement and riskless-principal commitments are not effective. Onlythose current requirements listed for private-placement and riskless-principal activities insection 225.28(b)(7) of Regulation Y (the laun-dry list of permissible nonbanking activities)should be used by the examiner in conductingthe supervision and inspection of bank holdingcompanies and their subsidiaries.

3230.4.1 ENGAGING INCOMMERCIAL-PAPER PLACEMENTACTIVITIES TO A LIMITED EXTENT

A bank holding company (the applicant) appliedpursuant to section 4(c)(8) of the Bank HoldingCompanyActandsection225.23(a)of theBoard’sRegulation Y to act as an agent and adviser toissuers of commercial paper in connection withthe placement of commercial paper with institu-tional purchasers. The commercial-paper-placement activity, as proposed, is to be con-ducted from a wholly owned commercial financesubsidiary (the company) of the applicant’s directsubsidiary.

The Board concluded that the proposedcommercial-paper-placement activity was sofunctionally and operationally similar to the roleof a bank that arranges a loan participationor syndication as to be a proper incident theretoand that banking organizations are particularlywell suited to perform the commercial-paper-placement function. The Board found that theproposal, as limited by the applicant, was con-sistent with section 20 of the Glass-Steagall Act,and could reasonably be expected to result inpublic benefits that would outweigh possibleadverse effects. The Board found, further, thatthe applicant could conduct the proposed activi-ties to the extent and in the manner described inthe order. The Board’s approval (1987 FRB138) extended only to the activities conductedwithin the limitations proposed by the applicantfor company and the BHC’s subsidiary banksand other subsidiaries. The placement of com-mercial paper in any manner other than as

described within the limitations and conditionsof the order would not be within the scope of theBoard’s approval. The Board also required thatno lending affiliate of the company would dis-close to the company any nonpublic customerinformation concerning an evaluation of thefinancial condition of an issuer whose paper isplaced by the company or of any other customerof the company, except as expressly required bysecurities law or regulation.

On May 25, 1988, the Board approved anorder (1988 FRB 500) for a bank holding com-pany to engage de novo, through a subsidiary, inacting as an agent and adviser to issuers ofcommercial paper in connection with the place-ment of commercial paper with institutional cus-tomers, as well as to engage in certain othersecurities and financial advisory activities. Theapplicant proposed to place commercial paper inaccordance with all the terms and conditions ofthe above order (1987 FRB 138), except one.The applicant did not propose any quantitativelimitations on its placement activity. The Boardconcluded that the proposed commercial-paperplacement did not constitute underwriting ordistributing under the Glass-Steagall Act andthat the quantitative limitations on the activitywere not necessary to ensure compliance withthat act. (See section 3230.4.2, in which a sub-sidiaryofabankholdingcompanywasauthorizedto privately place all types of debt and equitysecurities.)

3230.4.2 ACTING AS AGENT IN THEPRIVATE PLACEMENT OF ALLTYPES OF SECURITIES AND ACTINGAS RISKLESS PRINCIPAL

A bank holding company (the applicant) appliedfor the Board’s approval to transfer the private-placement business of its commercial bank sub-sidiary to its designated nonbanking subsidiaryfor securities underwriting and dealing. The sub-sidiary would act as agent in the private place-ment of all types of securities, including theproviding of related advisory services, and buyand sell all types of securities on the order ofinvestors as a riskless principal.

Because the section 20 subsidiary would beaffiliated through common ownership with amember bank, it may not be ‘‘principally


engaged’’ in the ‘‘ issue, flotation, underwriting,public sale, or distribution’’ of securities withinthe meaning of the former section 20 of theGlass-Steagall Act. In an earlier decision (1989FRB 751), the Board determined that a subsidi-ary is not engaged principally in section 20activities if revenues from underwriting anddealing in securities that banks are not autho-rized to underwrite and deal in directly (bank-ineligible securities) do not exceed 10 percentof the subsidiary’s gross revenues (25 percent,effective March 6, 1997). The applicant con-tended that the proposed private-placement andriskless-principal activities are not the kind ofsecurities activities described in section 20 and,thus, should not be subject to the revenue limiton bank-ineligible securities activities.

The private-placement market involves theplacement of new issues of securities with alimited number of sophisticated purchasers in anonpublic offering. In private-placement trans-actions, a financial intermediary acts solely asagent of the issuer in finding purchasers. Theintermediary does not purchase the securitiesand then try to resell them.

Privately placed securities are not subjectto the registration requirements of the SecuritiesAct of 1933. Such securities are only offered tofinancially sophisticated institutions and indi-viduals,1 not to the public. The applicant statedthat all of the individuals with whom the securi-ties would be placed will qualify as ‘‘ accreditedinvestors’’ under SEC rules. The Board con-cluded that the subsidiary’s private placementof debt and equity securities within the limitsproposed did not involve the underwriting orpublic sale of securities and that the revenuesfrom the proposed activities should not be sub-ject to the 10 percent revenue limitation (25percent, effective March 6, 1997) on bank-ineligible securities activities.

The Board noted that other limitations on theactivity should ensure that securities would notbe offered to the public. First, the applicantagreed that the subsidiary would not make anygeneral solicitation or advertisement to the pub-lic regarding the placement of particular securi-ties. Second, the minimum denomination of

securities to be placed would be $100,000. Third,the applicant agreed that the subsidiary wouldnot privately place securities that are registeredunder the Securities Act of 1933 and that thesubsidiary would be compelled to honor all pro-visions of that act, particularly those that limitthe scope of private placements to nonpublictransactions. Fourth, the subsidiary agreed notto privately place as agent the securities ofinvestment companies which are sponsored oradvised by the applicant or its subsidiaries.Fifth, the subsidiary will not purchase or repur-chase for its own account the securities beingplaced or will not inventory unsold portions ofsuch securities. Sixth, the applicant further agreedto consult with its Federal Reserve Bank staffbefore transferring its private-placement activi-ties from the subsidiary to any other nonbanksubsidiary of the applicant to ensure that thetransfer did not evade any of the firewall provi-sions committed to.

3230.4.3 INCORPORATION OFPRIVATE-PLACEMENTNONBANKING ACTIVITIES INTOREGULATION Y

The Board has added the activity of acting asagent in the private placement of securities tothe laundry list of nonbanking activities (see12 C.F.R. 225.28(b)(7)(ii)). Regulation Y adoptsthe definition of private-placement activitiesthat is used by the SEC and the federal securi-ties laws. In taking this action, the Board removedall but one restriction on private placement. Theremaining restriction prohibits a bank holdingcompany from purchasing for its own accountthe securities being placed or holding ininventory unsold portions of issues of thesesecurities. This restriction prevents a bankholding company from classifying its securi-ties underwriting activities as private-placementactivities.

3230.4.4 RISKLESS PRINCIPAL

‘‘ Riskless principal’’ is a broker-dealer that,after receiving an order to buy (or sell) a secu-rity from a customer, purchases (or sells) thesecurity for its own account to offset a simulta-neous sale to (or purchase from) the customer.

1. The subsidiary would not only place securities withinstitutional customers but with individuals whose net worth(or joint net worth with a spouse) exceeds $1 million. Suchplacement activities with individuals would not, in the Board’sopinion, result in a public offering.

Section 4(c)(8)—(Private-Placement and Riskless-Principal Activities) 3230.4


3230.4.4.1 Description ofRiskless-Principal Transactions

When acting as a dealer, the securities firmmaintains an inventory of securities for its ownaccount and buys and sells securities as princi-pal. Riskless-principal transactions are usuallyundertaken as an alternative method of execut-ing orders by customers to buy or sell securitieson an agency basis. In this situation, when acustomer places an order to purchase securitiesthat the broker-dealer does not maintain in itsinventory, the firm must purchase the securitiesfrom a third party. At this point, the broker-dealer has the option of acting either as theagent for the customer or a riskless principal inmaking the purchase. If the decision is made toact as a riskless principal, the broker-dealer willpurchase the securities from a third-party dealerat the dealer’s ‘‘inside price’’ (confirming thetransaction for its customer) and then, acting asprincipal, resell them to the customer, adding amarkup over cost. If the broker-dealer does notcomplete the purchase of the securities orderedby the customer, it is not obligated to providethe securities.

3230.4.4.2 Underwriting and RisklessPrincipal

In riskless-principal transactions, the subsidiarywould execute orders by an investor and wouldnot act on behalf of an issuer of new securities.The subsidiary would not be involved in makingany public offering of securities as agent for theissuer. Thus, these activities would not consti-tute underwriting for Glass-Steagall purposes.

3230.4.4.3 Summary of Board Action onActing as Agent in Private Placement andas Riskless Principal in Buying andSelling Securities

The Board concluded that the securities under-writing and dealing of the subsidiary’s riskless-principal activity did not constitute an under-writing of securities. The riskless-principalactivity would not be a public sale or underwrit-ing of securities and would not be viewed as abank-ineligible securities activity for purposesof the current 25 percent revenue test. As acondition for the approval of the riskless-principal activity, the Board required the subsid-iary to maintain specific records that wouldclearly identify such transactions so that exam-iners will be able to trace the resulting revenue.

The riskless-principal activity was found to beclosely related to banking. The Board furtherconcluded that the placement activity differedonly slightly in scope from those approved pre-viouslyand that theoperational limitationsagreedto by the applicant would ensure that the subsid-iary would not become involved in the publicoffering of any securities. The Board approvedthe application on October 30, 1989 (1989 FRB829). (See also 1997 FRB 146; 1996 FRB 350,748; 1995 FRB 49, 880, 1133; 1994 FRB 554,1014; 1993 FRB 1166; 1992 FRB 294, 335,552, 868; 1991 FRB 61; and 1990 FRB 26, 79,545, 567, 568 (footnote 7), 653, 659, 663, 667,672, 674, 766, 857, 864.)

3230.4.4.4 1996 Changes to theUnderwriting Conditions forRiskless-Principal Activities

In connection with a bank holding companyproposal considered by the Board on June 10,1996, the Board reviewed the continued appro-priateness of applying the underwriting con-ditions to the conduct of riskless-principalactivities. In that case, the Board determined,based on its experience in monitoring and exam-ining the conduct of riskless-principal activitiesby bank holding companies, that the underwrit-ing conditions were not necessary to addressidentifiable adverse effects. Accordingly, theBoard permitted the bank holding company toengage in riskless-principal transactions througha nonbank subsidiary without conducting thisactivity in accordance with the underwritingconditions (See 1996 FRB 748). The Boardnoted that riskless-principal transactions areessentially equivalent to securities brokeragetransactions and, therefore, must be conductedin compliance with federal securities laws. TheBoard concluded that the definitional limitations(see section 225.28(b)(7)(ii) of Regulation Y)would be all that is needed to purchase (or sell)securities as a riskless principal. The conditionsare designed to ensure that bank holding com-panies do not avoid the Glass-Steagall Act byclassifying underwriting and dealing activitiesas riskless-principal activities. In the June 10order, the bank holding company agreed that,if riskless-principal services were provided incombination with its advisory services, it wouldprovide its customers with the disclosures estab-lished by the Board for full-service brokerageactivitiesofbankholdingcompanies.With respect



to its decision, the Board decided to grant iden-tical relief to other bank holding companiesthat had been previously approved to conductriskless-principal nonbanking activities.

3230.4.4.5 Incorporation ofRiskless-Principal Transactions intoRegulation Y

As part of the Board’s February 19, 1997, adop-tion of the final amendments to Regulation Y, itretained the requirement that riskless-principaltransactions be conducted in the secondary mar-ket. It further determined to eliminate all buttwo restrictions with respect to riskless-principaltransactions. A bank holding company may thusbuy and sell in the secondary market all types ofsecurities on the order of customers as a risklessprincipal, to the extent of engaging in a trans-action in which the company, after receiving anorder to buy (or sell) a security from a customer,purchases (or sells) the security for its ownaccount to offset a contemporaneous sale to (or

purchase from) the customer. This does notinclude—

1. sellingbank-ineligiblesecuritiesat theorderof a customer that is the issuer of the securities,or selling in any transaction in which the bankholding company has a contractual agreement toplace the securities as agent of the issuer; or

2. acting as riskless principal in any trans-action involving a bank-ineligible security forwhich the bank holding company or any of itsaffiliates acts as an underwriter (during theperiod of the underwriting or for 30 days there-after) or dealer. A bank holding company or itsaffiliates may not enter quotes for specific bank-ineligiblesecurities inanydealerquotationsystemin connection with the bank holding company’sriskless-principal transactions, except that thecompany or its affiliate may enter bid or askquotations, or publish ‘‘offering wanted’’ or‘‘bid wanted’’ notices on trading systems otherthan NASDAQ or an exchange, if the companyor its affiliate does not enter price quotations ondifferent sides of the market for a particularsecurity for any two-day period. (See 12 C.F.R.225.28(b)(7)(ii).)



Section 4 (c)(8)—Acting as a Municipal SecuritiesBrokers’ Broker Section 3230.5

A BHC applied for the Board’s approval, pursu-ant to section 4(c)(8) and 225.23(a) of the Board’sRegulation Y, to acquire, through a securitiesbrokerage subsidiary, a 49 percent interest in ajoint venture partnership. The applicant was aone-bank holding company formed over a bank-ers’ bank. The shareholders comprised severalhundred banks. The joint venture partnership(the company) proposed to engage in the activ-ity of acting as a municipal securities brokers’broker.1 This consisted of providing municipalsecurities brokerage services to other registeredsecurities brokers and dealers, including dealerbanks. The company would act as an undis-

closed agent in the purchase and sale of munici-pal securities, including revenue bonds, for theaccount of its customers.

The applicant’s proposal involved the pur-chase and sale of municipal securities as agentonly and did not include dealing or otherwisetaking a position in such securities. The activityfell within the third-party securities activitiespermitted for member banks under section 16 ofthe Glass-Steagall Act (12 U.S.C. 24), whichallows banks to purchase and sell securities‘‘without recourse, solely upon the order, andfor the account of, customers.’’ National bankshad been permitted to engage in the activity ofacting as municipal securities brokers’ brokers.

The Board found the activity to be function-ally similar to the retail securities brokerageactivities performed by banks for their custom-ers as permitted under section 16 of the Glass-Steagall Act. The Board thus concluded that theactivity was closely related to banking. TheBoard’s approval of the order was based onseveral commitments made by the applicant andthe other joint venturer. The Board approved theapplication by order on June 26, 1985 (1985FRB 651).

1. Rule 15c3-1(a)(8)(ii) implementing section 15(c)(3) ofthe Securities and Exchange Act of 1934 defines a municipalsecurities brokers’ broker as a ‘‘municipal securities broker ordealer who acts exclusively as an undisclosed agent in thepurchase or sale of municipal securities for a registered brokerdealer or registered municipal securities dealer’’ who has ‘‘noretail customers’’ and ‘‘maintains no municipal securities inits proprietary or other accounts.’’ Municipal securities bro-kers’ brokers are subject to the federal securities laws applica-ble to securities brokers and are governed by the rules of theMunicipal Securities Rulemaking Board.


Section 4(c)(8) of the BHC Act (Acting as a Conduitin Securities Borrowing and Lending) Section 3230.6

A foreign bank holding company (the appli-cant), and its wholly owned subsidiary (the com-pany),acommercialbankingorganization locatedin New York state, applied pursuant to section4(c)(8) of the BHC Act and section 225.23(a) ofthe Board’s Regulation Y for prior approval toengage de novo on a domestic and internationalbasis, through the company, in the followingactivities:

1. providing investment advisory services andfinancial advisory services, including adviceregarding mergers, acquisitions, and capital-raising proposals by institutional customers,pursuant to section 225.28(b) of Regu-lation Y

2. providing securities brokerage services on anindividual basis as well as in combinationwith investment advisory services (‘‘full-servicebrokerage’’), includingexercising lim-ited investment discretion on behalf of insti-tutional customers

3. purchasing and selling all types of securitieson the order of institutional and retail cus-tomers as a ‘‘riskless principal’’

4. engaging in securities credit activities undersection 225.28(b)(6) of Regulation Y, includ-ing acting as a ‘‘conduit’’ or ‘‘intermediary’’in securities borrowing and lending

The Board previously determined by regula-tion that engaging in the above-listed nonbank-ing activities (1) and (2) is closely related tobanking under section 4(c)(8) of the BHC Act(see section 225.28(b)(6) and (7) of the Board’sRegulation Y). The Board previously deter-mined by order that, subject to certain prudentiallimitations, the proposed riskless-principalactivities (item 3) are so closely related to bank-ing as to be a proper incident thereto within themeaning of section 4(c)(8) of the BHC Act. Theapplicant has committed that the company willconduct its riskless-principal activities using thesame methods and procedures and subject to thesame prudential limitations established by theBoard in its orders that are found at 1989 FRB829 and 1990 FRB 26.

Banks and BHCs are permitted to borrow andlend securities held in their own portfolios (seethe FFIEC’s 1985 Supervisory Policy Statementon Securities Lending,Federal Reserve Regula-tory Service3–1579.5). In this case, the appli-cant proposed that the company borrow andlend the securities of noncustomer third parties.The company would seek out counterparties tosecurities borrowing and lending transactions

and would assume much the same risk in thesetransactions as if it was borrowing or lending itsown securities or its customers’ securities. Inthis capacity, it would act as a ‘‘conduit’’ or‘‘intermediary’’ in securities borrowing and lend-ing. The company would supply—upon therequest of another broker-dealer who is unableto obtain securities needed to satisfy customeror investment or operational needs—securitiesnot available in the company’s accounts or cus-tomer accounts by seeking out third-party non-customer lenders. In addition to locating thesecurities, the company proposes to coordinate,onbehalfof theborrowerand lender, theexchangeof securities and collateral that is necessary tothe transaction.1

The Board, in its review of this application,believed that banks generally perform servicesthat are operationally or functionally similar tothe proposed conduit services. The proposedconduit activity was believed to be similar to thesecurities borrowing and lending activities thatbanks conduct. National and state banks arepermitted to lend securities from their own port-folio, and with the customer’s consent, from theaccounts of customers, and banks regularly bor-row securities to meet their needs and the needsof customers. The fact that a third party issubstituted in place of a trust or other customerof a bank would not change significantly theway in which the securities lending activitywould be conducted. The same steps and proce-dures that would be necessary to effectuate theloan of a customer’s securities would be fol-lowed in loaning the securities of a noncustomerthird party.

The risk associated with the proposed activityis the same risk that a bank would incur inmanaging the lending of securities from its ownportfolio or the portfolio of a customer. The riskto the company, in acting as a conduit, is limitedto ensuring that the collateral posted by the

1. The company agreed to coordinate this exchange throughaccounts established at a specifically named, privately heldnational clearinghouse for the settlement of transactions incorporate and municipal securities. Once the company hadlocated the desired securities, the securities would be trans-ferred to an account maintained by it at the clearinghouse andsimultaneously delivered to an account of the borrower, alsoat that clearinghouse. At the same time, the borrower wouldbe required to post collateral, which the company wouldreceive into its clearinghouse account and simultaneouslydeliver to an account maintained by the lender at the clearing-house.


borrower continuously reflects the market valueof the securities loaned. The company commit-ted to mark this collateral to market on a dailybasis and to make calls for supplemental collat-eral where necessary.2 The company also repre-sented that it would not provide any indemnifi-cation to noncustomer third-party lenders ofsecurities.

The Board determined, for the above reasons,that the proposed conduit activity is closelyrelated to banking for the purposes of section4(c)(8) of the BHC Act and approved the orderon October 9, 1992 (1992 FRB 955).

The Board’s approval was subject to the fol-lowing specified conditions:

1. To minimize risk, the company is to actas a conduit only when the potential bor-rower and lender are matched before thetransaction. In addition, it will take variousmeasures to minimize operational risks,

including conducting its conduit activities inaccordance with the collateral requirementsimposed on the borrowers by the Board’sRegulation T.3 A conduit transaction willcommence only when a broker-dealerapproaches the company and needs to bor-row securities. Securities will not be bor-rowed in anticipation of a transaction.

2. At the end of each day, the company willmark to market the collateral posted by theborrower in all transactions in which it loanedsecurities or acted as an intermediary for alender. As proposed, the company wouldestablish credit lines for potential borrowersand lenders.4

3. The applicant committed that the companywill conduct its conduit activities in compli-ance with the FFIEC Supervisory PolicyStatement on Securities Lending (FederalReserve Regulatory Service3–1579.5).

2. If the price of the borrowed securities increases, theborrower is required under the Board’s Regulation T to pro-vide additional collateral to the company. The company, inturn, through transactions at the clearinghouse, will pass thecollateral to the initial lender of the securities. If the borroweris unable to satisfy this requirement, the company is to havethe contractual right to terminate the borrowing transaction bypurchasing the securities in the open market and deliveringthem to the lender, who will then be obligated to return theborrower’s collateral to the company. Because the borrowedsecurities will be marked to market daily by the company, themaximum exposure to the company in directly or indirectlyborrowing or lending securities is one day’s change in theprice of the borrowed securities.

3. The applicant committed that the Board’s RegulationT—which requires that all securities borrowing and lendingtransactions be collateralized by at least 100 percent of thevalue of the securities as computed on a daily basis—shall bethe company’s minimum guideline for posting collateral, andthat the company will require many transactions to be collat-eralized in excess of 100 percent of the value of securitiesmarked to market.

4. These credit policies are to include a review of alllenders and borrowers and the establishment of a credit com-mittee that will determine limits on the credit exposure of anysingle borrower. The applicant proposed that the companywould transact its business only with a select group of well-capitalized broker-dealers that will not be brokerage custom-ers of the company.

Section 4(c)(8) of the BHC Act (Acting as a Conduit in Securities Borrowing and Lending)3230.6


4(c)(8)—Underwriting and Dealing in U.S. Obligations, MunicipalSecurities, and Money Market Instruments Section 3240.0

The Board has authorized bank holding com-pany subsidiaries to engage in investment ortrading transactions as principal to underwriteand deal in certain securities and money marketinstruments that are eligible for bank underwrit-ing and dealing by state member banks. Basi-cally, the Board has subjected dealer subsidi-aries to the same restrictions that governunderwriting and dealing by state member bankspursuant to 12 U.S.C. 24 and 335. Permissibleactivities include underwriting and dealing intype I securities as defined in 12 C.F.R. 1,including obligations of the United States, gen-eral obligations of states and their political sub-divisions,1 and type I municipal bonds; type IIsecurities as defined in 12 C.F.R. 1, including, inpart, municipal revenue obligations for housing,university, or dormitory purposes that do notqualify as type I securities; and banker’s accep-tances and certificates of deposit. In addition,such dealer subsidiaries are subject to the appli-cable capital restrictions (10 percent of the leadbank’s capital and surplus) on dealing in type IIsecurities in 12 C.F.R. 1.7. These underwritingand dealing activities were added to the permis-sible activities section of Regulation Y, effectiveFebruary 6, 1984. Furthermore, dealer subsidi-aries are permitted to furnish investment advicewith respect to these bank-eligible securities.

The Board has authorized bank-affiliatedsecurities dealers to underwrite, deal in, or pri-vately place type III securities in separatelycapitalized nonbank subsidiaries subject toprudential limitations and restrictions to pre-clude such subsidiaries from being principallyengaged in the underwriting and distribution ofsecurities. In addition, the Board has authorizedbroker-dealer subsidiaries and brokerage subsid-iaries to privately place any type of debt orequity security.

3240.0.1 HISTORY OF BOARDAPPROVALS OF UNDERWRITINGAND DEALING IN GOVERNMENTOBLIGATIONS AND MONEYMARKET INSTRUMENTS

On February 27, 1978, the Board approved anapplication to engage de novo in underwriting

and dealing activities then being conducted bythe bank holding company’s only subsidiarybank. Thus, the formation of the subsidiarytransferred these operations from the bank to thenonbank subsidiary. The activity included theunderwriting and dealing in obligations of theUnited States and general obligations of variousstates and of political subdivisions. The Boarddetermined that this activity is closely related tobanking. The Board also approved, on February27, 1978, another application of a bank holdingcompany that would permit it to retain shares ina firm engaged in U.S. government securitiesunderwriting activities.

On March 20, 1979, the Board approved anapplication of a bank holding company to acquirea company that would engage de novo in theactivities of underwriting and dealing in certaingovernment and municipal securities and in pro-viding portfolio investment advice to individu-als, associations, corporations, state and localgovernments, and financial institutions (‘‘non-bank entities’’) and to unaffiliated commercialbanks. The Board determined that the proposedactivities were closely related to banking.

On March 2, 1982, the Board approved anapplication of a bank holding company to forman incorporated securities company subsidiarythat would engage de novo in the activities ofsoliciting, underwriting, dealing in, purchasing,and selling obligations of the United States,general obligations of various states, and moneymarket instruments such as banker’s accept-ances and certificates of deposit. The Boardregarded the government securities activitiesthat the bank holding company proposed toengage in as substantially the same as the activi-ties that the Board had approved in previousorders. Insofar as its proposal to deal in banker’sacceptances, certificates of deposit, and othermoney market instruments that state memberbanks may from time to time be authorized tounderwrite and deal in (such instruments are notregarded as ‘‘securities’’ subject to the prohibi-tions in sections 16 and 21 of the Glass-SteagallAct), the Board regarded such activities as closelyrelated to banking because banks engage in suchfunctions. The Board’s approval of the bankholding company’s application was subjected tothe same restrictions and prudent limitations asif the activity were conducted in the affiliate’slead bank. For example, the nonbank subsidiarycould not underwrite, deal in, or hold type II

1. The Gramm-Leach-Bliley Act authorized well-capitalized state member banks to deal in, underwrite, pur-chase, and sell all type I municipal securities and revenuebonds without any limitations relative to the bank’s capital.See section 2020.1 of theCommercial Bank ExaminationManual and SR-01-13.


securities of any issuer in amounts that wouldnot be permitted if such activities were con-ducted by the subsidiary national bank, norwould it be permitted to sell securities to trustaccounts of affiliated banks, except as permittedby regulations of the Comptroller of the Cur-rency. Type II securities can consist of certaintypes of public housing and dormitory bonds ofstates and municipalities. The amount of suchsecurities, of a single issue held by the bank,may not exceed 10 percent of the bank’s capitaland surplus (12 U.S.C 24 (seventh) and (12C.F.R. 1.3(d)). The Board further ruled that anypurchase of securities from the bank holdingcompany’s nonbank subsidiary by any of thebank holding company’s subsidiary banks atother than current market values would consti-tute an unsafe or unsound practice.

3240.0.2 ADDING THE ACTIVITYTO REGULATION Y

Effective February 6, 1984, underwriting anddealing in U.S. government obligations and cer-tain money market instruments was added to thelist of permissible activities of Regulation Y.The regulation, which was amended in 1997,continues to place the same limitations as wouldbe applicable if the activity were performed bythe bank holding company’s subsidiary memberbanks or its subsidiary nonmember banks as ifthey were member banks. (See Section225.28(b)(8)(i) of Regulation Y.)

3240.0.3 REGULATION OF DEALERACTIVITIES

While municipal securities dealers and dealersin government/agency securities are requiredto register as broker-dealers pursuant to theSecurities Exchange Act of 1934, there are atpresent no registration requirements for firmsthat deal only in money market instruments.Regardless of whether a bank holding companysubsidiary is registered as a broker-dealer withthe Securities and Exchange Commission (SEC),Federal Reserve System examiners will conductinspections to determine whether the subsidiaryis in compliance with the provisions of Regu-lation Y or any specific conditions in a bankholding company order pertaining to the organi-zation under inspection. In addition, examinerswill need to focus on financial, managerial, and

safety-and-soundness considerations in any bankholding company dealer subsidiary. In the eventa firm is a registered broker-dealer subjectto examination by the National Association ofSecurities Dealers (NASD), the inspection shouldbe designed to prevent duplication of effort,relying on work performed by NASD examinersto the greatest extent possible, yet still evaluatethe factors discussed above that are relevant foreither registered or unregistered dealers.

Effective May 20, 1985, the Federal ReserveBank of New York adopted a Capital AdequacyGuideline for U.S. Government Securities Deal-ers. The Federal Reserve Bank of New Yorkrecommends that U.S. government securitiesdealers that are not subject to federal oversightagree to comply voluntarily with the capitaladequacy guideline. Hence, it is expected thatany government securities dealer subject to Sys-tem inspection will comply with the SEC’s Uni-form Net Capital Rule (17 C.F.R. 240.15c3-1).

3240.0.4 DEALER ACTIVITIES

A firm operates as a dealer when it underwritesor deals in securities or money market instru-ments. Those activities are usually distinguishedas separate activities from normal investmentactivities. If the firm holds itself out to otherdealers or investors as a dealer or engages ina repetitive pattern of short-term purchasesand sales, the firm may be engaged in dealeractivities, regardless of its stated investmentactivities.

As noted previously, when the Board addedto the Regulation Y list of permissible activitiesthe activities of underwriting and dealing in U.S.government securities, certain money marketinstruments, and municipal securities, the Boardadded a restriction that such nonbank activitiesbe subject to the same restrictions as securitiesand money market instrument activities of mem-ber banks. Accordingly, the following discus-sion focuses upon permissible securities activi-ties of all member banks.

3240.0.5 GOVERNMENT ANDMUNICIPAL SECURITIES

The authority under which a bank may engagein securities trading and underwriting is foundin section 5136 of the Revised Statutes (12U.S.C. 24). That authority is restricted by limi-tations on percentage holding of classes ofsecurities as found in 12 C.F.R. 1.3. That regu-lation allows banks to deal in, underwrite,purchase, and sell type I securities without

4(c)(8)—Underwriting & Dealing in U.S. Obligations, Municipal Securities, & Money Market Instruments 3240.0


limit and type II securities limited to 10 per-cent of its capital and unimpaired surplus. Banksare prohibited from underwriting or dealingin type III securities for their own accounts.(See section 2020.1 of the Commercial Bank

4(c)(8)—Underwriting & Dealing in U.S. Obligations, Municipal Securities, & Money Market Instruments 3240.0

BHC Supervision Manual June 2003Page 2.1

Examination Manualfor further information ontype I, II, and III securities.)

There are three major types of securitiestransactions in which banks are involved. First,the bank may buy and sell securities on behalfof a customer. Those are agency transactions inwhich the agent (bank) assumes no substantialrisk and is compensated by a prearranged com-mission or fee. Second, as a dealer, the bankbuys and sells securities for its own account.That is termed a principal transaction becausethe bank is acting as a principal, buying orselling qualified securities through its own inven-tory and absorbing whatever market gain or lossis made on the transaction. The third type ofsecurities transaction frequently executed bybanks is a contemporaneous ‘‘riskless-principaltrade.’’ The dealer buys and sells qualified secu-rities as a principal, with the purchase and saleoriginating almost simultaneously. Exposure tomarket risks is limited by the brief period ofactual ownership, and profits result from dealer-initiated markup, the difference between the pur-chase and sale prices.

Dealers’ securities transactions involve cus-tomers and other securities dealers. The word‘‘customer,’’ as used in this section, means aninvestor. Transactions with other dealers are notconsideredcustomer transactionsunless thedealeris buying or selling for investment purposes.The following subsections include generaldescriptions of significant areas of permissibletrading and underwriting activities.

3240.0.6 U.S. GOVERNMENTSECURITIES TRADING

U.S. government security trading inventories aregenerally held with the objective of makingshort-term gains through market appreciationand dealer-initiated markups. The size of atransaction, the dealer efforts extended, and thenature of the security are common factors thataffect the markup differential. Markups on gov-ernment securities generally range between oneand four thirty-seconds of a point. Long matu-rity issues may have higher markups.

The market risk inherent in U.S. governmenttrading portfolios should be controlled by pol-icy. Standards should be established to limit thetotal securities inventory and the amount ofsecurities with similar yield or maturity char-acteristics. Limits imposed by policy shouldinclude commitments to purchase new govern-ments on a when-issued basis.

Payments for and deliveries of U.S. govern-ment and most agency securities are settled on

the business day following the trade. Govern-ment dealers and customers can negotiate same-day or delayed settlement for special situations,but the industry recognizes standard settlementas occurring on the trade date plus one businessday.

3240.0.6.1 ‘‘When-Issued’’ Trading

A significant source of risk to dealers involves‘‘when-issued’’ (WI) trading in governmentsecurities. WI trading is the buying and sellingof securities in the one- to two-week interimbetween the announcement of an offering andthe security issuance and payment date. TheDealer Surveillance Staff at the Federal ReserveBank of New York began to require WI positionreports from primary government securities deal-ers and request voluntary WI reports from cer-tain other government securities dealers in 1984.At the time the reporting requirements wereadopted, a senior official stated, ‘‘The opportu-nity to trade with several dealers simultaneouslywithout making payment could result in tradinglosses which exceed a participant’s ability tosettle.’’ In essence, the fact that settlement datecan extend to almost two weeks—as opposed tothe ordinary next-day settlement—presents anopportunity for firms to engage in a large vol-ume of trading without drawing on the firm’sability to purchase securities or effect deliveryagainst short positions. Hence, there is increasedcredit risk in such transactions. Consequently,the dealer’s trading position limits should includeWI limits to protect against the increased creditrisk associated with WI trading.

3240.0.6.2 Due Bills

A ‘‘due bill’’ is an obligation that results when afirm sells a security or money market instrumentand receives payment, but does not deliver theitem sold. Due bills issued should be consideredas borrowings by the issuing firm, and, alterna-tively, due bills received should be consideredas lending transactions.

Registered broker-dealers are subject to theSEC’s rule 15c3-3 (17 C.F.R. 240.15c3-3), ‘‘Cus-tomer Protection—Reserves and Custody ofSecurities.’’ Basically, this rule states the prin-ciple that a broker-dealer needs to safeguardcustomer assets and cannot use such assets to

4(c)(8)—Underwriting & Dealing in U.S. Obligations, Municipal Securities, & Money Market Instruments3240.0


fund its own business activities. While this ruleis not directly applicable to unregistered U.S.government securities or money market instru-ment dealers, the principle is transferable. Deal-ers should not issue due bills as a means ofobtaining operating funds or where the under-lying security can be delivered at settlement.Customers of the dealer enter transactions withan implicit understanding that securities transac-tions will be promptly executed and settledunless there is a clear understanding to the con-trary. Consequently, dealers should promptlydisclose the issuance of a due bill to a customerwhen funds are taken but securities or moneymarket instruments are not delivered to the cus-tomer. Such disclosure should reference theapplicable transaction; state the reason for thecreation of a due bill; describe the collateral, ifany, securing the due bill; and indicate that tothe extent the market value of the collateral isinsufficient, the customer may be an unsecuredcreditor of the dealer.

3240.0.6.3 Clearance

Securities clearance services for the bulk of U.S.government and federal-agency security transac-tions are provided by the Federal Reserve aspart of its telegraphic securities transfer system.The various Federal Reserve Banks will wiretransfer most government securities between thebook-entry safekeeping accounts of the sellerand buyer. The Federal Reserve’s systems alsoare used to facilitate security borrowings, loans,and pledges. Hence, the securities firm will needto use the services of a clearing bank.

3240.0.6.4 Short Sales

Another area of U.S. government security activ-ity involves short-sale transactions. A short saleis the sale and delivery of a security that theseller does not own. It is accomplished by bor-rowing the security for delivery. The borrowedsecurity iscollateralizedbyanappropriateamountof a similar security. Short sales are conductedto accommodate customer orders, to obtain fundsby leveraging existing assets, to hedge the mar-ket risk of other assets, or with the expectationthat the market price of the sold security willdecline sufficiently to allow the bank to com-plete the transaction by purchasing an equiva-lent security at a later date and a lower price.

3240.0.6.5 Arbitrage

Arbitrage is the coordinated purchase and saleof two securities or of a security and a futures oroptions contract in which there is a relativemarket imbalance. The objective of such activ-ity is to obtain earnings by taking advantage ofchanging yield spreads. Arbitrage opportunitiestake many forms and can exist whenever seg-ments of the securities markets are subject to ayield variance.

Exposure on arbitrage and/or short sales shouldbe closely monitored for compliance with prede-termined objectives. Risk should be controlledby point-spread limits coordinated with stop-loss buy provisions or sell provisions and byguidelines on the length of time a short positioncan remain uncovered.

3240.0.7 MONEY MARKET TRADING

Aside from short-term securities, banks custom-arily trade a substantial volume of other moneymarket instruments such as banker’s accep-tances. It should be noted that the SupremeCourt has opined that commercial paper is aGlass-Steagall security.

3240.0.7.1 Banker’s Acceptances

Banker’s acceptances are an obligation of theacceptor bank and an indirect obligation of thedrawer. They are normally secured by rights tothe goods being financed and are available in awide variety of principal amounts. Maturitiesare generally less than nine months. Accep-tances are priced like Treasury bills, with adiscount figured for the actual number of daysto maturity based on a 360-day year.

3240.0.7.2 Certificates of Deposit

Negotiable certificates of deposit (CDs) issuedby money-center banks are actively traded indenominations of $100,000 to $1 million. Inter-est generally is calculated on a 360-day year andpaid at maturity. Secondary market prices arecomputed based on current yield, net of accruedinterest due the seller. Eurodollar CDs trade likedomestic CDs except their yields are usuallyhigher and their maturities often longer.

Money market instruments trade with thesame-day or one-day settlement. Publicly quotedyields or dollar prices are usually based onround lot trades of $1 million, except for com-



mercial paper, which trades in round lots of$250,000. Odd-lot prices may vary, but becauseof the large dollar volume of most trades, thepercentage spread between the acquisition costand sale price is characteristically modest.

Management should attempt to minimize mar-ket risk by establishing a maximum holdinglimit for each class of money market instrument.Policy guidelines also should establish concen-tration limits for money market instrumentsissued by a single obligor. Such limits shouldinclude commitments.

A sound money market trading policy recog-nizes the need for a qualitative analysis of theissuers of instruments. Credit approvals shouldbe obtained before trading in CDs and accep-tances, and reviews should be conducted on aregular schedule.

Banks dealing in money market instrumentsare subject to a number of legal restrictions. Thesale of federal funds by a member bank to abank affiliate is limited under section 23A (12U.S.C. 371(c)) and subject to the restrictions ofsection 23B of the Federal Reserve Act (12U.S.C. 371(c-1)). The acquisition, as principal,of a certificate of deposit issued by an affiliatebank also is subject to section 23A limitationsand section 23B restrictions. These restrictionsdo not apply to transactions between bank sub-sidiaries that are 80 percent or more commonlyowned by a bank holding company. These trans-actions must be conducted on terms that areconsistent with safe and sound banking practices.

3240.0.8 REPURCHASEAGREEMENTS AND SECURITIESLENDING

The overwhelming majority of a governmentsecurity dealer’s inventory is financed by repur-chase agreements. In addition, many dealersoperate a ‘‘matched book’’ repo operationwhereby they finance the acquisition or carryingof securities by customers through reverserepurchase agreements and contemporaneouslyobtain funding for such transactions through thesale of the same or similar securities under arepurchase agreement. In addition, securitiesdealers often lend or borrow specific issues toeffect delivery against short positions or becauseof failure to receive securities required to bedelivered. For prudential guidelines that havebeen issued to financial institutions in connec-tion with repurchase agreements and securitieslending, see the FFIEC supervisory policystatements at sections 2140.0 and 2150.0,

which have been adopted by the Federal ReserveBoard.

Firms enter into ‘‘reverse repos’’ to financethe U.S. government securities inventory ofother dealers or mortgage bankers who haveoriginated pools of mortgages to back federalhousing agency securities. Repos are sold tocustomers in lieu of certificates of deposit. Cus-tomers find them attractive because interest canbe paid on repos having maturities of less thanseven days and because customer funds are col-lateralized by the security underlying the repur-chase transaction.

The rate of interest received and paid is gen-erally dictated by prevailing market rates. Prof-its are based on a modest positive spread betweeninterest earned and interest paid. A dealer mayattempt to improve that modest profit byincreasing the volume of such transactions, usingthe proceeds to finance or pyramid the acquisi-tion of reverse repos or securities to be used inadditional repo arrangements.

A common dealer strategy is to vary resaleand repurchase maturities in anticipation ofinterest-rate movements. If an upward rate trendis expected, the dealer will attempt to lock in acheaper source of funds at the current low rateby negotiating longer maturities for repos andshorter maturities for reverse repos. Conversely,if interest rates are expected to decline, thedealer attempts to negotiate longer-maturityreverse repos to ensure continuing higher earn-ings, while negotiating shorter-maturity repos totake advantage of cheaper future sources offunds. Care should be taken to limit exposure byinstituting policy guidelines that—

1. limit the aggregate amounts of reverse repoand repo positions,

2. specify acceptable amounts of funds forunmatched or extended maturity transactions,

3. determine maximum time gaps for unmatchedmaturity transactions and minimally accept-able interest-rate spreads for various matu-rity agreements, and

4. followtheprudentialguidelines in theFFIEC’spolicy statement on repurchase agreementsand securities lending. (See sections 2140.0and 2150.0.)

3240.0.9 POLICY SUMMARY

The legal responsibilities of directors requirethat they ensure that dealer activities are con-ducted on a sound and legal basis that can only



be accomplished if the directors endorse a writ-ten trading policy that addresses each area ofmarket and legal risk. Written policy guidelinesshould be distributed to each individual engagedin trading activities.

3240.0.10 SCOPE OF THEINSPECTION

The scope of inspection will vary depending onthe types of securities or money market instru-ment underwriting, dealing, and brokerageactivities conducted by the subsidiary. Examin-ers may encounter situations in which a securi-ties subsidiary is an SEC-registered broker-dealer because the subsidiary also executestransactions in municipal securities.

Registered broker-dealers are required tobecome members of the NASD or some other‘‘self-regulatory organization.’’ To avoid unnec-essary regulatory overlap, examiners can rely ontheNASD’scomplianceexaminationwith respectto investor protection, including compliance withrules of the SEC, NASD, and Municipal Securi-ties Rulemaking Board (MSRB), and the Board’sRegulation T governing securities credit (if appli-cable). Consequently, in commencing such aninspection, examiners should begin by request-ing and reviewing the NASD’s most recentexamination letter to the broker-dealer and seri-ous violations that could endanger the bankingorganization (for example, fraudulent activitiesthat could subject the organization to losses orlawsuits). Significant violations that have notyet been corrected should be noted in the bankholding company report.

Federal Reserve examiners retain responsibil-ity for inspecting certain areas of registeredbroker-dealer operations regardless of whetherthe NASD reviews them. Specifically, Systemexaminers should still evaluate management,financial results, and safety-and-soundness con-siderations, including internal controls. In addi-tion, examiners still need to verify that regis-tered broker-dealer subsidiaries comply withthe provisions of Regulation Y, sec-tion 225.28(b)(8)(i), or specific Board orderspertaining to the firm under inspection. Finally,the examiner should be prepared to reviewin-depth any activities or money market instru-ments that are not securities that might not havebeen reviewed by the NASD because the activi-ties are outside their scope of examination.


1. To determine if the policies, practices, proce-dures, and internal controls regarding dealeractivities are adequate.

2. To determine if officers are operating in con-formance with the established guidelines.

3. To evaluate the trading portfolio for creditquality and marketability.

4. To determine the scope and adequacy of theaudit-compliance functions.

5. To determine compliance with applicablelaws and regulations, including 12 C.F.R.225.28(b)(8)(i).

6. To ensure investor protection.7. To initiate corrective action when policies,

practices, procedures, or internal controls aredeficient or when violations of law or regula-tion have been noted.


1. Review the adequacy of the dealer’s inter-nal controls. (See section 3240.0.13.)

2. Based on the evaluation of internal controlsand the work performed by internal/external auditors, determine the scope ofthe inspection.

3. Test for compliance with policies, practices,procedures, and internal controls in con-junction with performing the remaining pro-cedures. Also, obtain a listing of any defi-ciencies noted in the latest review done byinternal/external auditors from the exam-inerassigned ‘‘InternalandExternalAudits,’’and determine if corrections have beenaccomplished.

4. Obtain a copy of the latest letter receivedfrom the self-regulatory organizationresponsible (if applicable) for examiningbroker-dealer activities of this subsidiary.

5. Request that the firm provide the followingschedules:a. aged schedule of securities that have

been acquired as a result of underwritingactivities

b. aged schedule of trading-account securi-ties and money market instruments heldfor trading or arbitrage purposes, whichshould reflect commitments to purchaseand sell securities and all joint-accountinterests

c. schedule of short-sale transactionsd. aged schedule of due billse. list of bonds borrowedf. aged schedule of ‘‘fails’’ to receive or

deliver securities on unsettled contracts



g. schedule of approved securities borrow-ers and approved limits

h. schedule of loaned securitiesi. schedule detailing account names

and/or account numbers of the—• affiliated banks’ permanent portfolio

accounts;• personal accounts maintained at the

firm by its employees;• accounts of brokers or other dealers;

and• personalaccountsofemployeesofother

brokers, dealers, or municipal securi-ties dealers

j. list of all joint accounts entered intosince the last examination

k. list of underwriting since the last exami-nation and whether such securities wereacquired by negotiation or competitivebid

l. list of all financial advisory relationships6. Compare balances of appropriate schedules

to the general ledger and review reconcilingitems for reasonableness.

7. Determine the extent and effectiveness oftrading-policy supervision by—a. reviewing the abstracted minutes of meet-

ings of the board of directors and/or ofany appropriate committee,

b. determining that proper authorization forthe trading officer or committee has beenmade,

c. ascertaining the limitations or restric-tions on delegated authorities,

d. evaluating the sufficiency of analyticaldata used in the most recent board orcommittee trading-department review,

e. reviewing the methods of reporting bydepartment supervisors and internalauditors to ensure compliance withestablished policy and law, and

f. reaching a conclusion about the effec-tiveness of director supervision of thetrading policy. Prepare a memo for theexaminer assigned ‘‘Duties and Respon-sibilities of Directors’’ stating your con-clusions. All conclusions should be sup-ported by factual documentation.

(Before continuing, refer to steps 14 and 15.They should be performed in conjunction withthe remaining examination steps.)8. Ascertain the general character of under-

writing and direct-placement activities andascertain the effectiveness of departmentmanagement by reviewing underwriter filesand ledgers, committee reports, and offer-ing statements to determine—a. the significance of underwriting activi-

ties and direct placements of securitiesas reflected by the volume of sales andprofit or loss on operations (comparecurrent data to comparable prior periods);

b. whether there is a recognizable patternin—• the extent of analysis of material infor-

mation relating to the ability of theissuer to service the obligation,

• rated quality of offerings,• point spread of profit margin for

unrated issues,• geographic distribution of issuers, and• syndicate participants, and

c. the volume of outstanding bids. Com-pare current data to comparable priorperiods.

9. Determine the general character of trading-account activities and whether the activitiesare in conformance with stated policy byreviewing departmental reports, budgets,and position records for various categoriesof trading activity and determining—a. the significance of present sales volume

compared to comparable prior periodsand departmental budgets;

b. whether the firm’s objectives are com-patiblewith thevolumeof tradingactivity;

c. significant inventory positions taken sincethe prior examination and determiningif—• the quality and maturity of the inven-

tory position was compatible with pru-dent practices, and

• the size of the position was withinprescribed limits and compatible witha sound trading strategy

d. the exposure on offsetting repurchasetransactions by—• reviewing the maturities of offsetting

‘‘repo’’ and ‘‘reverse repo’’ agree-ments to ascertain the existence, dura-tion, amounts, and strategy used tomanage unmatched maturity ‘‘gaps’’and extended (over 30 days) maturities;

• reviewing records since the lastinspection to determine the aggregateamounts of—— matchedrepurchasetransactionsand— ‘‘reverse repo’’ financing extended

to one or related firms(s); and• performing credit analyses of signifi-

cant concentrations with any single orrelated entities.



10. Determine the extent of risk inherent intrading-account securities which have beenin inventory in excess of 30 days.a. Determine the dollar volume in extended

holdings.b. Determine the amounts of identifiable

positions with regard to issue, issuer,yield, credit rating, and maturity.

c. Determine the current market value forindividual issues which show an internalvaluation markdown of 10 percent ormore.

d. Perform credit analyses on the issuers ofnonrated holdings identified as signifi-cant positions.

e. Perform credit analyses on those issueswith valuation writedowns consideredsignificant relative to the scope of trad-ing operations.

f. Discuss plans for disposal of slow-moving inventories with management anddetermine the reasonableness of thoseplans in light of current and projectedmarket trends.

11. Using an appropriate technique, select issuesfrom the schedule of trading-accountinventory. Test valuation procedures by—a. reviewing operating procedures and sup-

porting workpapers and determining ifprescribed valuation procedures are beingfollowed;

b. comparing dealer-prepared market prices,as of the most recent valuation date, toan independent pricing source (use tradedate ‘‘bid’’ prices); and

c. investigating any price differences noted.12. Using an appropriate technique, select trans-

actions from the schedule of short sales anddetermine—a. the degree of speculation reflected by

basis-point spreads,b. present exposure shown by computing

the cost to cover short sales, andc. if transactions are reversed in a reason-

able period of time.13. Analyze the effectiveness of operational

controls by reviewing recent cancellationsand fail items (fail to receive securities andfail to deliver securities) that are a week ormore beyond settlement date anddetermine—a. the amount of extended fails,b. the planned disposition of extended fails,c. if the control system allows a timely,

productive follow-up on unresolved fails,

d. the reasons for cancellations, ande. the planned disposition of securities that

have been inventoried before the recog-nition of a fail or a cancellation.

14. Determine compliance with applicable laws,rulings, and regulations by performing thefollowing:a. 12 C.F.R. 1.3—eligible securities.

• Review inventory schedules of under-writing and trading accounts and deter-mine if issues whose par value is inexcess of 10 percent of the affiliatedlead bank’s capital and unimpairedsurplus are type I securities.

• Determine that the total par value oftype II investments does not exceed10 percent of the affiliated lead bank’scapital and unimpaired surplus, basedon the combination of holdings andpermanent portfolio positions in thesame securities.

• Elicit management’s comments andreview underwriting records on directplacement of type II securities anddetermine if the broker-dealer is deal-ing or engaging in impermissible directplacement of type III securities.

b. Sections 23A and 23B of the FederalReserve Act (12 U.S.C. 371(c) and 375)—preferential treatment.Obtain a list ofdomestic affiliate relationships and a listof directors and principal officers andtheir business interests from appropriateexaminers and determine whethertransactions, including securities-clearance services, involving affiliates,insiders, or their interests are on termsless favorable to the bank than thosetransactions involving unrelated parties.

15. Test for unsafe and unsound practices andpossibleviolationsof theSecuritiesExchangeAct of 1934 by—a. reviewing transactions, including U.S.

government tender-offer subscriptionfiles, involving employees and directorsof dealer or other banks, and determin-ing if the funds used in the transactionswere misused bank funds or the proceedsof reciprocal or preferential loans,

b. reviewing sales to affiliated companiesto determine that the sold securities werenot subsequently repurchased at an addi-tional markup and that gains were notrecognized a second time,

c. reviewing securities position records andcustomer ledgers with respect to large-volume repetitive purchase and salestransactions and—



• independently testing market prices ofsignificant transactions which involvethe purchase and resale of the samesecurity to the same or related parties,and

• investigating the purchase of largeblocks of securities from dealer firmsjust prior to month-end and their sub-sequent resale to the same firm justafter the beginning of the next month

d. reviewing customer-complaint files anddetermining the reasons for suchcomplaints.

16. Discuss with an appropriate officer and pre-pare report comments concerning—a. the soundness of trading objectives, poli-

cies, and practices;b. the degree of legal and market risk

assumed by trading operations;c. the effectiveness of analytical, reporting,

and control systems;d. violations of law;e. internal control deficiencies;f. apparent or potential conflicts of interest;

andg. other matters of significance.

17. Reach a conclusion regarding the quality ofdepartment management and state your con-clusions on the appropriate inspection reportpages.

18. Update workpapers with any informationthat will facilitate future inspections.

3240.0.13 REVIEW OF INTERNALCONTROLS

As a part of carrying out the inspection proce-dures for this activity, the examiner is expectedto review the dealer’s system of internal con-trols. The examiner should concentrate the inter-nal controls review on the policies, practices,and procedures of the firm.

The system should be documented in a com-plete, concise manner and should include, whereappropriate, narrative descriptions, flow charts,copies of forms used, and other pertinent infor-mation.Items marked with asterisks require sub-stantiation by observation or testing.

3240.0.13.1 Securities UnderwritingTrading Policies

1. Has the board of directors, consistent with itsduties and responsibilities, adopted writtensecurities underwriting/trading policies that—a. outline objectives?b. establish limits and/or guidelines for the

following:

• price markups?• quality of issues?• maturity of issues?• inventory positions (including when-

issued (WI) positions)?• amounts of unrealized loss on inventory

positions?• length of time an issue will be carried in

inventory?• amounts of individual trades or under-

writer interests?• acceptability of brokers and syndicate

partners?c. recognize possible conflicts of interest and

establish appropriate proceduresregarding—• deposit and service relationships with

municipalities whose issues have under-writing links to the trading department?

• deposit relationshipswithsecurities firmshandling significant volumes of agencytransactions or syndicate participations?

• transfers made between trading-accountinventory and affiliated investmentportfolio(s)?

• the affiliated bank’s trust departmentacting as trustee, paying agent, and trans-fer agent for issues which have an under-writing relationship with the tradingdepartment?

d. state procedures for periodic, monthly orquarterly, valuation of trading inventoriesto market value?

e. state procedures for periodic independentverification of valuations of the tradinginventories?

f. outline methods of internal review andreporting by department supervisors andinternal auditors to ensure compliance withestablished policy?

g. identify permissible types of securities?2. Are theunderwriting/tradingpolicies reviewed

at least quarterly by the board of directors todetermine their adequacy in light of chang-ing conditions?

3. Is there a periodic review by the board toensure that the underwriting/trading depart-ment is in compliance with its policies?

3240.0.13.2 Offsetting Resale andRepurchase Transactions

1. Has the board of directors, consistent with itsduties and responsibilities, adopted written



offsetting repurchase transaction policiesthat—a. limit the aggregate amount of offsetting

repurchase transactions?b. limit theamounts inunmatchedorextended

(over 30 days) maturity transactions?c. determine maximum time gaps for

unmatched maturity transactions?d. determine minimally acceptable interest-

rate spreads for various maturitytransactions?

e. determine the maximum amount of fundsto be extended to any single or relatedfirms through ‘‘reverse repo’’ transactionsinvolving unsold (through forward sales)securities?

f. require firms involved in reverse repotransactions to submit corporate resolu-tions stating the names and limits of indi-viduals who are authorized to commit thefirm?

g. require submission of current financialinformation by firms involved in reverserepo transactions?

h. provide for periodic credit reviews andapprovals for firms involved in reverserepo transactions?

i. specify typesofacceptableoffsetting repur-chase transaction collateral?

j. require receipt of assurance letters thatunregulated securities dealers comply withthe Federal Reserve Bank of New York’s‘‘Capital Adequacy Guideline for U.S.Government Securities Dealers?’’

2. Are written collateral-control proceduresdesigned so that—a. collateral assignment forms are used?b. collateral assignments of registered

securities are accompanied by powers ofattorney signed by the registered owner,and are registered securities registered inthe dealer or dealer’s nominee name whenthey are assigned as collateral for extendedmaturity (over 30 days) reverse repotransactions?

c. funds are not disbursed until reverse repocollateral is delivered into the physicalcustody of the dealer or an independentsafekeeping agent?

d. funds are only advanced against pre-determinedcollateralmarginsordiscounts?

e. collateral margins or discounts are predi-cated upon the following:• the type of security pledged as

collateral?

• maturity of collateral?• historic and anticipated price volatility

of the collateral?• creditworthiness of the counterparty?• maturity of the reverse repo

agreements?• accrued interest?

f. maintenance agreements are required tosupport predetermined collateral marginor discount by daily mark to market ofrepurchase agreement securities?

g. maintenance agreements are structured toallow for obtaining additional securitiesor cash calls in the event of collateralprice declines?

h. collateral market value is frequentlychecked to determine compliance withmargin and maintenance requirements?

3240.0.13.3 Custody and Movement ofSecurities

*1. Are the dealer’s procedures such that per-sons do not have sole custody of securitiesin that—a. they do not have sole physical access to

securities?b. they do not prepare disposal docu-

ments that are not also approved byauthorized persons?

c. for the security custodian, supportingdisposal documents are examined oradequately tested by a second custodian?

d. no person authorizes more than one ofthe following transactions: execution oftrades, receipt and delivery of securi-ties, and collection or disbursement ofpayment?

2. Are securities physically safeguarded toprevent loss, unauthorized disposal, or use?a. Are negotiable securities kept under

dual control?b. Are securities counted frequently on a

surprise basis and reconciled to thesecurities record? Are the results ofsuch counts reported to management?

c. Does the dealer periodically test forcompliance with provisions of its insur-ance policies regarding custody ofsecurities?

d. For securities in the custody of others—• are custody statements agreed peri-

odically to position ledgers, and anydifferences followed up to aconclusion?



• are statements received from brokersand other dealers reconciled promptly,and any differences followed up to aconclusion?

• are positions for which no statementsare received confirmed periodically,and stale items followed up to aconclusion?

3. Are trading-account securities segregatedfrom other dealer-owned securities orsecuritiesheld insafekeeping forcustomers?

*4. Is access to the trading-securities vaultrestricted to authorized employees?

5. Do withdrawal authorizations requirecountersignature to indicate security countverifications?

6. Is registered mail used for mailing securi-ties, and are adequate receipt files main-tained for such mailings (if registered mailis used for some but not all mailings,indicate criteria and reasons)?

7. Are prenumbered forms used to controlsecurities trades, movements, andpayments?

8. If so, is numerical control of prenumberedforms accounted for periodically by per-sons independent of those activities?

9. Do alterations to forms governing the trade,movement, and payment of securitiesrequire—*a. signature of the authorizing party?b. use of a change-of-instruction form?

10. With respect to negotiability of registeredsecurities—a. are securities kept in non-negotiable

form whenever possible?b. are all securities received and not

immediately delivered transferred tothe name of the dealer or its nomineeand kept in non-negotiable form when-ever possible?

c. are securities received checked fornegotiability (endorsements, signa-ture, guarantee, legal opinion, etc.)and for completeness (coupons, war-rants, etc.) before they are placed inthe vault?

3240.0.13.4 Purchase and SalesTransactions

1. Are all transactions promptly confirmed inwriting to the actual customers or dealers?

2. Are confirmations compared or adequatelytested to purchase and sales memoranda andreports of execution of orders, and any differ-ences investigated and corrected (including

approval by a designated responsibleemployee)? Are confirmations and purchaseand sale memoranda checked or adequatelytested for computation and terms by a secondindividual?

3. Are comparisons received from other dealersor brokers compared with confirmations, andany differences promptly investigated? Arecomparisons approved by a designatedindividual?

3240.0.13.5 Customer and DealerAccounts

1. Do account bookkeepers periodically trans-fer to different account sections or otherwiserotate posting assignments?

2. Are letters mailed to customers requestingconfirmation of changes of address?

3. Are separate customer-account ledgers main-tained for—a. employees?b. affiliates?c. affiliated bank’s trust accounts?

4. Arecustomer inquiriesandcomplaintshandledexclusively by designated individuals whohave no incompatible duties?

3240.0.13.6 Other

1. Are the preparation, additions, and posting ofsubsidiary records performed and/oradequately reviewed by persons who do notalso have sole custody of securities?

2. Are subsidiary records reconciled, at leastmonthly, to the appropriate general-ledgeraccounts,andare reconciling itemsadequatelyinvestigated by persons who do not also havesole custody of securities?

3. Are fails to receive and deliver under a sepa-rate general-ledger control?a. Are fail accounts periodically reconciled

to the general ledger, and any differencesfollowed up to a conclusion?

b. Are periodic aging schedules prepared?c. Are stale fail items confirmed and fol-

lowed up to a conclusion?d. Are stale items valued periodically, and, if

any potential loss is indicated, is a particu-lar effort made to clear such items or toprotect the bank from loss by other means?

4. With respect to securities loaned and bor-rowed positions—



a. are details periodically reconciled to thegeneral ledger, and any differences fol-lowed up to a conclusion?

b. are positions confirmed periodically?

c. are all policies and procedures in con-formance with the FFIEC policy on secu-rities lending contained section 2140.0?



Authorization for statemember banks of the FederalReserve System to underwriteand deal in obligations of theUnited States, various states,and political subdivisions andother authorized obligationsfor state member banks

24 (7),335

250.120250.121250.122250.123250.142

3–414.943–414.953–414.963–414.973–415.22–425.11

Initial October 19, 1976, orderstating that the activity ofunderwriting and dealing incertain government andmunicipal securities wasclosely related to banking

41 FederalRegister47083 (1976)

Order approving application toengage de novo inunderwriting and dealing inmunicipal securities

1978 FRB 222

Order approving application ofa BHC that would permit it toretain shares in a governmentand municipal securitiesdealer to engage inunderwriting governmentsecurities

1978 FRB 2221978 FRB 223

Order approving application ofa BHC to acquire a companythat would engage de novo inunderwriting and dealing ingovernment and municipalsecurities and providinginvestment portfolio advice toassociations, state and localgovernments, and financialinstitutions (‘‘nonbankentities’’), and tounaffiliated banks

1979 FRB 363




Order approving anapplication of a BHC to forman incorporated securitiescompany that would engagede novo in the activities ofunderwriting and dealing in,purchasing, and selling U.S.government and municipalobligations, and money marketinstruments such as banker’sacceptances and certificatesof deposit. Securitiescompany limited topermissible BHC activities.

1982 FRB 249

Adding of the activity to thelist of permissible activities perRegulation Y

225.28(b)(8)(i) 1984 FRB 1211997 FRB 275



