THE GRAMM-LEACH-BLILEY ACT P.L. 106-102 FINANCIAL … · FINANCIAL SERVICES MODERNIZATION Working Summary No. 4 ... The symbolism of enactment of major new financial services

THE GRAMM-LEACH-BLILEY ACT

P.L. 106-102

FINANCIAL SERVICES MODERNIZATION

Working Summary No. 4

_________________________________________________

WASHINGTON REPORT ON FINANCIAL INSTITUTIONS

Gibson, Dunn & Crutcher LLP Financial Institutions Group

Washington, D.C. www.gdclaw.com

December 16, 1999

Gibson, Dunn & Crutcher LLP i December 16, 1999 Financial Institutions Group Washington Report


Financial Services Modernization Working Summary No. 4

The symbolism of enactment of major new financial services legislation on the verge the year 2000 is compelling. A new law for a new century. After almost two decades of attempts, the antiquated and outmoded Glass-Steagall Act of 1933 has been substantially replaced, and the Bank Holding Company ("BHC") Act of 1956 has been modernized. The enactment of the Gramm-Leach-Bliley Act (the "Act") is a landmark achievement.

The memorandum that follows sets forth the changes made by this new Act, both in its own terms and in the context of prior law. It attempts to lay out all of the Act's provisions topically and thus help to make its opportunities and issues more accessible to both executives and lawyers.

The long process that produced the Act also helps us understand its scope, purpose, and effects. Over the last two decades, the case for modernization of Glass-Steagall and the BHC Act was often made: Technology and the ingenuity of business leaders and lawyers had substantially eroded legal barriers between "banking," "securities," and "insurance." Securities and insurance firms were offering banking or bank-substitute products and services, while commercial banking organizations increasingly penetrated the securities and insurance businesses. The existing legal framework was out-of-joint with marketplace reality. It distorted competition and caused inefficiencies.

Even a short list of major developments since the Reagan Administration proposed its modernization bill in 1983 indicates the breadth of change since that time:

• = securities, insurance, and retailing companies acquired "nonbank banks;"

• = South Dakota and Delaware banks were authorized to engage in insurance underwriting;

• = Section 20 affiliates of major banks engaged in investment banking;

• = national banks began selling insurance out of "town of 5000" offices;

• = Mellon Bank acquired the Dreyfus mutual fund complex;

• = the VALIC and Barnett Supreme Court decisions validating regulatory authorization of national bank insurance activities resulted in an end to the "fortress insurance" opposition to reform;

• = over 50 insurance and securities firms acquired thrifts and became "unitary" S&L holding companies; and

Gibson, Dunn & Crutcher LLP December 16, 1999 Financial Institutions Group Washington Report

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• = Citigroup was created by a combination of Travelers/Salomon Smith Barney and Citicorp.

The parallel legislative events are also telling. The 1983 Treasury Department proposal, which would have permitted a bank holding company to engage in full-service securities and insurance activities, was not seriously considered. Efforts focused instead on the possibility of a few new securities powers for banking organizations, and then stopping new "nonbank banks." The latter was achieved in 1987 legislation, even as bank expansion through regulatory action accelerated. The Bush Administration proposed a broad financial services restructuring bill in 1991. But in the aftermath of the S&L debacle and the wave of bank failures and in the face of deep industry divisions over expanded bank affiliations, this bill turned into the re-regulatory Federal Deposit Insurance Corporation Improvement Act.

The Act has direct lineage to the 1995 bill introduced by Chairman Jim Leach, which permitted banking, securities, insurance and other "financial" affiliations in a revised Bank Holding Company Act with the Federal Reserve as the preeminent "umbrella" regulator (and thus revived the 1983 Treasury bill concept, rather than the 1991 Bush model). Although many specific changes have been made, the Act retains this framework. (It is perhaps noteworthy that except for the specter of Microsoft and the privacy provisions, issues of electronic commerce are not significant elements of the Act.)

The stated goal was "financial services" modernization. Nevertheless, most participants in the legislative process viewed it from the perspective of their core industry -- banking, securities, or insurance. Two major industry compromises involved the drawing of regulatory lines between banking and securities and banking and insurance that have the effect of limiting direct bank expansion. Parallel "functional regulation" amendments address the jurisdiction and roles of the SEC, the federal banking agencies, and the state insurance commissioners. However, the Act does contain in Section 104 significant tools for the development of integrated financial services. Its federal preemption provisions contain broad language preempting any discriminatory or other state laws that may interfere with the operation of integrated banking and financial companies.

Another major inter-industry issue concerned the ability of nonfinancial firms to provide banking products through a thrift in a unitary savings and loan holding company ("Unitary") structure. This issue was given greater impetus by an application by Wal-Mart to acquire a thrift and by the fear that Microsoft or another major technology company might do so as well. While grandfathering existing Unitaries, the Act provides that no new Unitaries may be established – and thus reinforces the line drawn in the Act between financial and nonfinancial firms.


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The other major issues addressed by the Act fall into two categories. The first is consumer and "public" issues associated with the Community Reinvestment Act ("CRA"), consumer protection, and, most important, privacy. The Act reaffirms CRA but calls for significant new disclosures by community group beneficiaries of that law. It also establishes a significant, new framework for privacy disclosures and protections by a very broad range of "financial" companies. The second category includes proposals that had been pending for some time and found a vehicle in the Act, notably, Federal Home Loan Bank system reforms and the interstate licensing of insurance agents and brokers.

Throughout 1999, the financial modernization bills had unprecedented momentum, moving from introduction to Senate and House passage in a matter of months. The actual fate of the Bill hung in the balance until the very end of the process, when the bank subsidiary and CRA compromises removed the threat of a presidential veto. In the end, the Act rested on a broad consensus both in Washington and among industry groups.

Seventy-two days after the year 2000 begins, the centerpiece affiliations provisions of the Act take effect and new, wide-ranging financial companies will be legally permissible. How quickly, and how many companies will develop a "financial services" perspective remains to be seen. In the meantime, the immediate efforts will focus on the many implementing regulations to be adopted and the prospects for new combinations. A new page is being turned.

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Editor's Note:

This memorandum is organized topically, roughly following the order of the Act's major parts, but it does not follow the section-by-section order of the Act's text. As detailed in the table of contents, the order of major topics is as follows: the new financial holding company structure and activities, the supervision of financial holding companies by the Federal Reserve, the extent of preemption of state insurance and other law, the insurance and other financial activities of national banks and their operating subsidiaries, CEBA bank amendments, foreign bank provisions, consumer protection and privacy, federal securities law amendments, provisions concerning the Federal Home Loan Bank System, thrift provisions, insurer redomestication, the multi-state licensing of insurance agents, and various miscellaneous provisions.

This memorandum updates our prior reports: Working Summary No. 1 (December 30, 1998), covering the Financial Services Act of 1998, the Senate version of H.R. 10, and H.R. 4870; Working Summary No. 2 (April 28, 1999), discussing H.R. 10 as passed by the House Banking Committee on March 23, 1999, and Working Summary No. 3 (September 30, 1999) discussing H.R. 10 and S. 900 in Conference.

We continue to regard this memorandum as a work in progress. The length and complexity of the Act mean that there are probably issues that we have not discussed that should be included. Further, although we have worked hard to make this memorandum an accurate discussion of this legislation, we may not have succeeded in every instance. Implementing regulations that will be released in the coming months will also expand the discussion of these issues and raise new ones. ACCORDINGLY, WE WELCOME --INDEED INVITE --YOUR COMMENTS AND CRITICISMS. Our websites will allow you to access updated versions of this memorandum, and we encourage you to communicate your comments, corrections, and thoughts directly to us via e-mail at the addresses below. Or, of course, you may contact any of us the old-fashioned way: by telephone or by fax, at the numbers listed below. We look forward to hearing from you.

Our “Financial Modernization” site is accessible through the Gibson, Dunn & Crutcher LLP webpages --

• = WORKING SUMMARY Website--www.gibsondunninstitute.com; and

• = Gibson, Dunn & Crutcher LLP Webpage-- www.gdclaw.com (with link to WORKING SUMMARY).

Cantwell F. Muckenfuss, III (202) 955-8514

[email protected] Amy L. Goodman (202) 955-8653

[email protected] Robert C. Eager (202) 955-8544

[email protected] Christopher L. Bosland (202) 955-8220

[email protected] Christopher J. Bellini (202) 887-3693

[email protected] Donna Y. James (202) 887-3566

[email protected] Victoria P. Rostow (202) 955-8295 [email protected]

R. Dines Warren Jr. (202) 955-8511 [email protected] GDC LLP FAX (202) 467-0539

Gibson, Dunn & Crutcher LLP v December 16, 1999 Financial Institutions Group Washington Report

SHORT FORMS USED IN SUMMARY NO. 4

1940 Act ................................ Investment Company Act of 1940 Advisers Act.......................... Investment Advisers Act of 1940 AFBA .................................... appropriate federal banking agency BHC....................................... bank holding company BHC Act................................ Bank Holding Company Act of 1956 CEBA .................................... Competitive Equality Banking Act of 1987 CFI......................................... community financial institution CFTC..................................... Commodity Futures Trading Commission CRA....................................... Community Reinvestment Act of 1977 DI........................................... depository institution DIF......................................... Deposit Insurance Fund DOJ ....................................... Department of Justice EFTA..................................... Electronic Funds Transfer Act Exchange Act ........................ Securities Exchange Act of 1934 FDI Act.................................. Federal Deposit Insurance Act FDIC...................................... Federal Deposit Insurance Corporation Fed......................................... Board of Governors of the Federal Reserve System FHC ....................................... financial holding company FHFB..................................... Federal Housing Finance Board FHLBA.................................. Federal Home Loan Bank Act FHLBank ............................... Federal Home Loan Bank FHLB System ........................ Federal Home Loan Bank System FIPA ...................................... Financial Information Privacy Act of 1999 FR Act ................................... Federal Reserve Act FTC........................................ Federal Trade Commission GAO ...................................... General Accounting Office Glass-Steagall Act ................. Glass-Steagall Act of 1933 HOLA.................................... Home Owners’ Loan Act of 1933 House Banking Committee ... House Banking and Financial Services Committee H.R. 10 .................................. Financial Services Act of 1999, as reported by the House Banking

and Financial Services Committee (or the "Bill") HSR.........................................Hart-Scott-Rodino IB Act .................................... International Banking Act of 1978 IBHC ..................................... investment bank holding company NAIC ..................................... National Association of Insurance Commissioners NARAB................................. National Association of Registered Agents and Brokers NASD.................................... National Association of Securities Dealers NB Act................................... National Bank Act OCC....................................... Office of the Comptroller of the Currency OFHEO.................................. Office of Federal Housing Enterprise Oversight OTS ....................................... Office of Thrift Supervision PCA ....................................... prompt corrective action


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QTL ....................................... qualified thrift lending Revised Statutes .................... Revised Statutes of the United States RFC ....................................... Resolution Funding Corporation SAIF ...................................... Savings Association Insurance Fund Senate Banking Committee... Senate Banking, Housing and Urban Affairs S&LHC Act........................... Savings and Loan Holding Company Act SEC ....................................... Securities and Exchange Commission SS...........................................Staff Side by Side Comparison of S. 900 and H.R. 10 (9/1/99) Treasury................................. Department of the Treasury Unitary................................... unitary savings and loan holding company WFHC ................................... wholesale financial holding company WFI........................................ wholesale financial institution

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I.THE FUTURE IS HERE: EFFECTIVE DATES AND STUDIES .............................................. 1

A. Effective Dates........................................................................................................ 1 B. Studies and Reporting Dates ................................................................................... 2

II.INTRODUCTION....................................................................................................................... 3

A. Background: The Financial Modernization Bills in 1998 and 1999....................... 3 B. Overview of Financial Modernization Issues ......................................................... 4 C. Depository Holding Companies: Existing Legal Framework................................ 5

1. The Glass-Steagall Act................................................................................... 5 2. The BHC Act ................................................................................................. 6 3. Statutes Governing Activities of Banks ......................................................... 7 4. Savings and Loan Holding Company ............................................................ 7 5. International Banking Act of 1978................................................................. 7

III.FINANCIAL HOLDING COMPANIES ("FHCS") .................................................................. 8

A. Overview: Activities and Affiliations of a FHC .................................................... 8 B. Qualification to be a FHC ....................................................................................... 9

1. Self-Executing Declaration: "Well-Capitalized" and Well-Managed" ......... 9 2. CRA Requirement for Subsidiary DIs ........................................................... 9

C. FHC Activities ...................................................................................................... 10 1. Overview...................................................................................................... 10 2. Definition of "Financial Activities" ............................................................. 10 3. Passive Control of Companies Through Securities Underwriting,

Merchant Banking or Insurance Company Investments .............................. 11 4. Definition of "Insurance Company"............................................................. 14 5. Complementary Activities ........................................................................... 14 6. Additional Financial Activities .................................................................... 15 7. Fed Authority to Expand the List................................................................. 15 8. A Note on Nonfinancial Activities............................................................... 16 9. After-the-Fact Fed Notice for New Activities ............................................. 17 10. Divestiture Procedures ................................................................................. 18 11. Repeal of Savings Bank Provisions ............................................................. 18

D. Failure to Continue to Meet FHC Requirements .................................................. 18 E. Grandfathered Nonfinancial Activities ................................................................. 19

1. Grandfather for Nonfinancial Companies.................................................... 19 2. Grandfather for Commodity Activities ........................................................ 19

F. Report on New Financial Activities...................................................................... 20 G. Effective Date of FHC Provisions ........................................................................ 20

IV.ANTITRUST PROVISIONS................................................................................................... 20

A. Antitrust Review of Acquisitions and Mergers .................................................... 20 B. Hart-Scott-Rodino Provisions............................................................................... 21

1. HSR Size-Of-Person and Size-of-Transaction Thresholds .......................... 21 2. HSR Notification and Waiting Period Requirements .................................. 22


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3. HSR Exemptions.......................................................................................... 22

V.FEDERAL RESERVE REGULATION OF FINANCIAL HOLDING COMPANIES ........... 23

A. Overview............................................................................................................... 23 B. "Umbrella" Authority of the Fed .......................................................................... 24

1. Approval of Bank Acquisitions.................................................................... 24 2. Compliance with Threshold FHC Requirements ......................................... 24 3. FHC Capital Standards................................................................................. 25 4. Source of Strength Authority ....................................................................... 25 5. Reporting and Examination.......................................................................... 25 6. Prudential Safeguards................................................................................... 25 7. Role as Supervisor, as well as Enforcer ....................................................... 26 8. Informal Authority as "First Among Equals" Regulator.............................. 26

C. Audits of the Federal Reserve............................................................................... 26 D. GAO Conflicts of Interest Study........................................................................... 26

VI."FED LITE" REGULATION OF BHCS AND SUBSIDIARIES ........................................... 27

A. BHC Reports ......................................................................................................... 27 B. BHC Examinations ............................................................................................... 27 C. Prudential Safeguards for DIs ............................................................................... 28 D. Authorization to Release Reports ......................................................................... 28

VII.SUPERVISION OF NONBANK REGULATED ENTITIES................................................ 28

A. Definition of Functionally Regulated Subsidiary ................................................. 29 B. Restrictions on Reporting Requirements and Examinations................................. 30

1. Limits on Reports......................................................................................... 30 2. Limits on Examinations ............................................................................... 30 3. SEC Examination of Investment Companies............................................... 30

C. Federal and State Interagency Consultation and Information Sharing ................. 31 D. Capital ................................................................................................................... 31 E. Limits on Fed's Supervisory Authority ................................................................. 32

1. Material Risk Exception............................................................................... 32 2. Statutory Compliance Exception.................................................................. 33

F. BHC Act -- Source of Strength ............................................................................. 33 G. FDI Act -- Source of Strength............................................................................... 33 H. Use of Insurance Funds......................................................................................... 34 I. Application of Fed Prohibitions to AFBAs .......................................................... 34

VIII.SEC. 104: PREEMPTION OF STATE LAW...................................................................... 35

A. Overview Of Section 104...................................................................................... 35 1. Already Effective ......................................................................................... 35 2. Broad Preemption to Allow Affiliations with Depository Institutions ........ 35 3. Broad Definition of Depository Institution and Affiliated Persons ............. 36 4. Broad Definition of “Insurer” ...................................................................... 36


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5. Broad Nondiscrimination Tests Applicable to State Insurance Sales Laws ............................................................................................................. 36

6. Special Rule for Pre-9/3/98 State Sales Laws (“Old Law”) ........................ 36 7. Double-Edged “Safe Harbor” Tests ............................................................. 36 8. Barnett Preserved ......................................................................................... 37 9. Broad Nondiscrimination Tests Applicable to State Insurance

Nonsales Laws and Laws Affecting All Other Depository Affiliations ................................................................................................... 37

10. Expedited Dispute Resolution...................................................................... 37 B. McCarran-Ferguson Reaffirmed ........................................................................... 37 C. Preemption of Restrictions on Affiliations ........................................................... 38

1. Broad Preemption for Affiliations with Depository Institutions ................. 38 2. Exceptions for State Insurance Regulators .................................................. 38 3. Partial Preemption of State Laws Governing Affiliations and

Investments by Insurers under Section 306 ................................................. 40 4. Insurer Redomestication Preemption Under Title III................................... 40

D. Overview of Federal Preemption of State Law Concerning Insurance and Other Activities ..................................................................................................... 40

E. Insurance Sales...................................................................................................... 41 1. General rule.................................................................................................. 42 2. “Old Law” .................................................................................................... 42 3. Barnett preserved ......................................................................................... 43 4. “Safe Harbor”............................................................................................... 43 5. “No Inferences”............................................................................................ 46 6. Nondiscrimination........................................................................................ 46

F. State Law Governing Insurance Activities Other than Sales................................ 46 G. State Law Governing Activities Other Than Insurance ........................................ 47 H. Preservation of State Securities, Corporate Governance, and Antitrust

Laws ...................................................................................................................... 48 1. Jurisdiction of State Securities Regulators to Enforce State Antifraud

Laws ............................................................................................................. 49 2. Corporate Governance and Antitrust Laws.................................................. 49

I. Expedited Dispute Resolution............................................................................... 49

IX.BANK-INSURANCE ISSUES--BACKGROUND................................................................. 50

X.INSURANCE ACTIVITIES OF NATIONAL BANKS........................................................... 51

A. Overview............................................................................................................... 51 B. Functional Regulation of Insurance ...................................................................... 51 C. National Bank Insurance Activities ...................................................................... 51

1. Scope of Principal Activities........................................................................ 51 2. Definition of "Insurance" ............................................................................. 52 3. Bank Products Exception ............................................................................. 52 4. Offshore Insurance Activities Sec. 302(d) (p. 71) ............................................ 52 5. Title Insurance.............................................................................................. 53


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D. Disputes Over New Insurance Products................................................................ 53 1. Appellate Review......................................................................................... 54 2. Deference ..................................................................................................... 54 3. Statute of Limitations................................................................................... 54

XI.SUBSIDIARIES OF BANKS.................................................................................................. 55

A. Background ........................................................................................................... 55 1. The 1996 OCC Part 5 Rule .......................................................................... 55 2. Background Concerning Subsidiaries of State Banks.................................. 55 3. The Operating Subsidiary Controversy........................................................ 56 4. The Final House and Senate Bills ................................................................ 57

B. The Conference Compromise ............................................................................... 57 C. National Bank Financial Subsidiaries ................................................................... 58

1. Financial Activities, With Exceptions.......................................................... 58 2. Qualification Requirements ......................................................................... 59 3. Expansion Of Financial Activities By Rulemaking ..................................... 60 4. Factors To Be Considered............................................................................ 60 5. Additional Financial Activities .................................................................... 61 6. Risk Management And Corporate Separation.............................................. 61 7. Affiliate Transactions................................................................................... 61 8. Antitying ...................................................................................................... 61 9. Failure to Continue to Meet Qualifying Requirements................................ 62

D. Subsidiaries of State Banks................................................................................... 62

XII.NEW REVENUE BOND ACTIVITIES OF NATIONAL BANKS...................................... 63

XIII.CEBA BANKS...................................................................................................................... 63

A. Cross Marketing Restrictions................................................................................ 64 B. Activities ............................................................................................................... 64 C. Asset Acquisition .................................................................................................. 64 D. Daylight Overdrafts .............................................................................................. 65 E. Divestiture............................................................................................................. 65 F. Foreign Bank Subsidiaries of a Credit Card Bank................................................ 65

XIV.FOREIGN BANKS............................................................................................................... 65

A. Qualification to be a Financial Holding Company ............................................... 66 B. Venture Capital/Merchant Banking ...................................................................... 67

1. Passive Control of Companies Through Merchant Banking Investments .................................................................................................. 68

2. Nonqualifying Foreign Banks ...................................................................... 69 3. Noncompliant Foreign Bank FHCs.............................................................. 69

C. Expanded Fed "Prudential" Regulatory Authority Over Foreign Banks and Their U.S. Affiliates.............................................................................................. 69

D. IB Act Grandfather Rights .................................................................................... 70 E. Subsidiaries as Representative Offices ................................................................. 70 F. Examination of Nonbank Affiliates ...................................................................... 70


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G. Interstate Branches and Agencies of Foreign Banks ............................................ 70

XV.CONSUMER PROTECTION RULES FOR SALES OF INSURANCE PRODUCTS THROUGH BANKS...................................................................................................... 71

A. Federal Agency Rulemaking................................................................................. 71 1. Anti-coercion Rules ..................................................................................... 71 2. Consumer Protection Rulemaking ............................................................... 72 3. Disclosure and Advertising .......................................................................... 72 4. Adjustments ................................................................................................. 72 5. Consumer Acknowledgment........................................................................ 73 6. Prohibition on Misrepresentation................................................................. 73 7. Physical Segregation .................................................................................... 73

B. Domestic Violence Discrimination....................................................................... 74 C. AFBA Consumer Grievance Process.................................................................... 74 D. Effect on Other Federal and State Consumer Protection Rules ............................ 74

1. General Standard.......................................................................................... 74 2. Coordination with Insurance Law................................................................ 74 3. Preemption ................................................................................................... 75 4. Nondiscrimination Against Non-affiliated Agents ...................................... 75

XVI.PRIVACY PROVISIONS..................................................................................................... 75

A. Legislative Background ........................................................................................ 75 1. House Bill .................................................................................................... 75 2. Conference ................................................................................................... 76

B. Overview............................................................................................................... 77 C. Duty to Protect Consumer Information................................................................. 78 D. Opt-Out for Third-Party Sharing .......................................................................... 78

1. General Exception for Marketing and Servicing ......................................... 79 2. Specific Exceptions...................................................................................... 79 3. Limits on Reuse of Information ................................................................... 80 4. Prohibition on Sale of Account Information for Telemarketing.................. 80

E. Disclosure of Privacy Policy and Procedure......................................................... 80 F. Rulemakings to Develop Federal Privacy Standards............................................ 81 G. Enforcement .......................................................................................................... 81 H. Relation to State Privacy Laws ............................................................................. 82 I. Study of Information Sharing Among Financial Affiliates .................................. 82 J. Definitions............................................................................................................. 83

1. "Financial Institution" .................................................................................. 83 2. "Consumer" .................................................................................................. 83

K. Pretext Calling ...................................................................................................... 83 L. Effective Date ....................................................................................................... 84

XVII. COMMUNITY REINVESTMENT ACT...................................................................... 84

A. Overview............................................................................................................... 84 B. CRA Compliance as a Prerequisite for Financial Affiliations.............................. 85


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C. CRA Sunshine Requirements ............................................................................... 85 D. Small Bank CRA Examinations............................................................................ 86 E. Federal Reserve and Treasury Reports on CRA Lending..................................... 87

XVIII. ATM FEE REFORM ..................................................................................................... 87

XIX.OTHER CONSUMER PROVISIONS.................................................................................. 88

A. Study of the Effect of Financial Modernization Legislation on the Accessibility of Small Business and Farm Loans................................................. 88

B. Fair Treatment of Women by Financial Advisers................................................. 88 C. Provision of Technical Assistance to Microenterprises........................................ 88

XX.SECURITIES LAW AMENDMENTS .................................................................................. 88

A. Banks Acting as Brokers and Dealers................................................................... 89 1. Identified Bank Products.............................................................................. 89 2. Definition of "Broker".................................................................................. 90 3. Definition of "Dealer" .................................................................................. 90 4. "New Hybrid Products"................................................................................ 91

B. Investment Company Act and Advisers Act Amendments .................................. 91 1. Banks as Investment Advisers ..................................................................... 91 2. Investment Company Custodians................................................................. 92 3. Loans to Investment Companies .................................................................. 92 4. Independent Directors .................................................................................. 92 5. Interested Persons......................................................................................... 92 6. Bank Common Trust Funds ......................................................................... 92 7. Disclosure re Bank Mutual Funds................................................................ 93

C. SEC Supervision of Investment Banking Holding Companies ............................ 93 D. Reporting of Bank--Loan Loss Reserves .............................................................. 93

XXI.FEDERAL HOME LOAN BANK SYSTEM AMENDMENTS.......................................... 94

A. System Membership.............................................................................................. 94 1. Voluntary Savings Association Membership............................................... 94 2. Community Financial Institutions................................................................ 94

B. Advances to Member Borrowers .......................................................................... 95 C. Qualified Thrift Lender Provisions....................................................................... 95 D. REFCorp Bond Payments by FHLBanks ............................................................. 95 E. Management of the Banks .................................................................................... 95 F. Federal Housing Finance Board Enforcement Authority ..................................... 96 G. Capital Structure of Federal Home Loan Banks ................................................... 96

XXII. DEPOSIT INSURANCE FUNDS: ELIMINATION OF THE SAIF AND DIF RESERVES.................................................................................................................... 97

XXIII. UNITARY SAVINGS AND LOAN HOLDING COMPANIES .................................. 97

A. Background ........................................................................................................... 97 1. Bar to New Unitaries.................................................................................... 98


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2. Unitary Grandfather ..................................................................................... 98 3. Multiple S&LHCs ........................................................................................ 99 4. Corporate Reorganizations........................................................................... 99 5. OTS Authority to Issue Interpretations and Prevent Evasions..................... 99 6. Mutual Holding Companies ......................................................................... 99 7. Optional Conversion to Bank of Federal Savings Association.................... 99

XXIV. MUTUAL BANK HOLDING COMPANY ................................................................ 100

XXV. REDOMESTICATION OF MUTUAL INSURERS ................................................... 100

A. Redomestication.................................................................................................. 100 B. Preemption .......................................................................................................... 101

XXVI. UNIFORM MULTISTATE LICENSING OF STATE LICENSED INSURANCE AGENTS AND BROKERS................................................................. 102

A. Uniform Licensing Reforms ............................................................................... 102 B. Delayed Effective Date ....................................................................................... 102 C. Standards for State Compliance.......................................................................... 102 D. Association Operations ....................................................................................... 103

XXVII. MISCELLANEOUS .................................................................................................... 105

A. Repeal of Stock Loan Limit ................................................................................ 105 B. Report on Online Banking and Lending Requirements ...................................... 105 C. Expanded Small Bank Access to S Corporation Treatment ............................... 106 D. Plain Language Requirement .............................................................................. 106 E. Bank Officers and Directors as Officers and Directors of Public Utilities......... 106 F. Interstate Branches: Interest Rates and Other Charges...................................... 107 G. Control of Bankers' Banks .................................................................................. 107 H. Approval for Purchases of Securities.................................................................. 107 I. Membership of Loan Guarantee Boards ............................................................. 108 J. Grand Jury proceedings ...................................................................................... 108 K. Rental Car Agency Insurance Activities............................................................. 108

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I. THE FUTURE IS HERE: EFFECTIVE DATES AND STUDIES

A. Effective Dates

A number of the GLB Act's titles and sections specify when their provisions become effective. Any provision that does not have a specified effective date became effective upon enactment -- November 12, 1999, when the President signed the GLB Act into law. Following is a calendar of effective dates for various provisions is the Act.

• = Date of Enactment/ November 12, 1999:

--Bank-insurance affiliation, sales, cross-marketing rules (Section 104) --Insurance activities of national banks, expedited dispute resolution (Subtitle III. A) --Mutual insurance holding company redomestication (Subtitle III. B) --Savings and Loan Holding Companies (Title IV) [May 4, 1999, grandfather date] --Fraudulent Access to Financial Information (Subtitle V. B) --Elimination of SAIF and DIF special reserves (Section 736) --Securities and Exchange Commission ("SEC") authority to permit investment bank holding companies (Section 231)

• = January 1, 2000--Effective date for revised REFCorp funding obligation of the Federal Home Loan Banks (Section 607)

• = March 12, 2000--Effective date for Title I, regarding the establishment and regulation of financial holding companies (Section 161) (The Board of Governors of the Federal Reserve System ("Fed") and Department of the Treasury ("Treasury") are required to issue implementing rules; there is no prescribed deadline, but rules are expected by this date)

• = May 12, 2000:

--“Coordinated” final rules implementing privacy provisions by the various responsible agencies (Section 504)

--Effective date for voluntary membership in Federal Home Loan Banks by savings associations (Section 603)

• = August 12, 2000--Office of the Comptroller of the Currency ("OCC") regulations “prescribing procedures” that implement financial operating subsidiary provisions (Section 121)

• = November 12, 2000:

--Banking agency rules concerning insurance customer protections (Section 305) --Effective date for Title V Subtitle A privacy provisions (unless final rules specify

otherwise) (Section 510) --Final rules regarding Federal Home Loan Bank capital (Section 608)


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• = May 12, 2001:

--Effective date of federal securities laws amendments revising banks' broker-dealer and investment company exemptions (Subtitles II. A&B) (Sections 209 and 225)

--Final Federal Reserve rules regarding derivative transactions and intraday credit due; effective date to be specified by rule (Section 121(a)(3))

• = November 12, 2002--Effective date of National Association of Registered Agents and Brokers (unless obviated by actions by a majority of the states) (Subtitle III. C)

• = November 12, 2004--Joint Federal Reserve and Treasury rules concerning merchant banking activities by financial subsidiaries

B. Studies and Reporting Dates

• = March 15, 2000: --Federal Reserve Board study of the Community Reinvestment Act ("CRA") lending.

Report due on or before March 15, 2000. (Section 713) --Responsiveness to community needs for financial services. A "baseline" report is

due by March 15, 2000, with a final report to be submitted before the end of the 2-year period beginning on the date of enactment. (Section 715)

• = May 12, 2000: --Feasibility study of requiring notice of any fees imposed on a consumer in

connection with an electronic fund transfer initiated using an automated teller machine. Report due by the end of the 6-month period beginning on the date of enactment. (Section 704)

--Expanded small bank access to S Corporation treatment. Report due by the end of the 6-month period beginning on the date of enactment. (Section 721)

• = November 12, 2000 -- General Accounting Office study of conflicts of interest. Report due by the end of the 1-year period beginning on the date of enactment. (Section 728)

• = May 12, 2001 -- Use of subordinated debt to protect financial system and deposit funds from "too-big-to-fail" institutions. Report due by the end of the 18-month period beginning on the date of enactment. (Section 108)


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• = November 12, 2001 -- Study and report on adapting existing legislative requirements to on-line banking and lending. Report due by the end of the 2-year period beginning on the date of enactment. (Section 729)

• = January 1, 2002 -- Study of information sharing among financial affiliates. (Section 508)

• = November 12, 2004 -- Study of financial modernization’s effect on the accessibility of small business and farm loans. Report due by the end of the 5-year period beginning on the date of enactment. (Section 109)

II. INTRODUCTION

A. Background: The Financial Modernization Bills in 1998 and 1999

The process that has led to the enrollment of the GLB Act began in 1995 when James Leach became Chairman of the House Banking Committee. Although the Bill passed by that Committee in 1995 died in that Congress, a similar bill was again introduced by Leach in 1997. That bill, numbered H.R. 10, was reported by the House Banking Committee in 1997, and in modified form by the House Commerce Committee in 1998. After further significant modification by the Rules Committee, H.R. 10 was passed by the House by a single vote with the help of strenuous arm twisting by the House leadership in May 1998. It was then marked up by the Senate Banking, Housing and Urban Affairs Committee (herein the "Senate Banking Committee") in September 1998, but was not taken up by the Senate before the end of the Congress. That bill came closer to passage than any financial modernization bill to date and largely resolved bank-insurance, bank-securities and other issues that had long stood as obstacles to the progress of prior modernization bills. Yet in the end, the 1998 version of H.R. 10 joined the long list of earlier failed bills including, notably, the 1983 Reagan Treasury Department proposal, the 1984 and 1986 Garn bills, the 1987 D'Amato/Cranston proposal, the 1988 Proxmire Glass-Steagall Reform bill, and the 1991 Bush Treasury bill.

When the 106th Congress convened in 1999, both returning Chairman Leach of the House Banking and Financial Services Committee (herein the "House Banking Committee") and Chairman Gramm signaled their intention to give priority to financial modernization legislation. Leach reintroduced H.R. 10 substantially in the form passed by the Senate Banking Committee in September 1998, with a limited number of changes, some reflecting further agreements reached in preparation for Senate floor consideration of the 1998 H.R. 10 version (e.g., amendments to Section 104 concerning preemption of state insurance law).

Subsequently, using a somewhat modified text worked out in conjunction with Rep. John LaFalce (D-New York), the ranking Democrat on his Committee, Chairman Leach held a mark-up of H.R. 10 with the House Banking Committee in March. As amended, H.R. 10 was reported favorably on March 11, 1999 by a 51-8 vote.


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On a parallel track, new Senate Banking Committee Chairman Gramm also took up financial modernization in his Committee. The Senate Banking Committee held a mark-up of S. 900, Chairman Gramm’s bill, on April 4, 1999, and reported the bill on a partisan 11-9 vote. The Senate passed this bill on May 6, 1999, by a largely partisan vote of 54-44.

In the House, H.R. 10 was subsequently considered by the House Commerce Committee under sequential referral. That Committee adopted a modified version of H.R. 10 on a voice vote on June 10, 1999. The House Rules Committee then considered the Banking and Commerce versions of H.R. 10 and reported its version for floor consideration. On July 1, 1999, the House passed H.R. 10 by a 343-86 vote.

After an organizational meeting before the August recess, the joint House-Senate Conference held a series of meetings after September 23 before issuing a Statement of Managers (the "Conference Report") on the final bill on November 1. As discussed below, the Conference did not make significant changes in the structure of the bill. The Conferees were able to resolve all the outstanding issues and thus cleared the way for the bill's enactment. Compromises with the Administration were worked out that reaffirmed the importance of the Community Reinvestment Act ("CRA") and authorized financial subsidiaries of banks. The Conference largely held the line established pre-conference on the controversial issues of privacy and the transferability of a grandfathered unitary savings and loan holding company ("Unitary") to a nonfinancial company. It determined not to permit such Unitary transfers and rejected the effort to amend the privacy provisions to require a consumer opt-out for information sharing among affiliates. As reported by the Conference, the final bill then was passed by the Senate on a 90-8 vote and by the House of Representatives on a 362-57 vote. The President signed the Act into law on November 12, 1999.

B. Overview of Financial Modernization Issues

From the outset, "financial modernization" has been defined primarily in terms of expanding the permissible affiliations of commercial banks through revisions to the Glass-Steagall Act of 1933 and the Bank Holding Company Act. Within this framework, a number of difficult issues were raised--difficult for policy reasons or for their competitive implications for insurance companies, banks and securities firms and, correspondingly, for the regulatory jurisdiction and roles of the existing state and federal agencies responsible for each of these industry segments. These issues include:

• = What kinds of companies should be able to be affiliates of an insured bank? To what extent should financial holding companies ("FHCs") be able to have commercial affiliates or hold substantial interests short of full operational control in nonfinancial firms? (See Sections 101-103)

• = What activities should insured banks be able to conduct, either directly or through subsidiaries? Should subsidiaries of banks be able to engage in all types of "financial" activities? (See Sections 121-122)


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• = What powers and functions (if any) should an umbrella regulator of the ultimate parent company have? Should the Fed be the dominant regulator and, if so, through an expansion of its BHC Act authority? (See Sections 103, 111-116)

• = To what extent should state law be preempted with respect to the creation of bank-insurance or other financial affiliations and the sales, cross-marketing or other operations of affiliated financial companies? (See Section 104)

• = Should financial investment products offered by banks (other than deposits, loans or familiar trust products) be categorized as "securities" and thus be regulated under the federal securities laws? (See Title II)

• = How should "insurance" be defined for purposes of the National Bank Act (the "NB Act")? (See Section 302)

• = Should a nonfinancial company continue to be able to acquire an insured thrift and operate as a "unitary savings and loan holding company."? (See Title IV)

• = What changes should be made to the International Banking Act (the "IB Act") in financial modernization legislation? (See Sections 103, 141, 142, 732)

• = Should modernization legislation include fundamental reform of the Federal Home Loan Bank System ("FHLB System")? (See Title VI)

• = How should the Community Reinvestment Act of 1977 ("CRA") apply to a FHC, and do consumers need additional protections? (See Sections 305, 711-715)

C. Depository Holding Companies: Existing Legal Framework

The Act makes significant amendments to these existing statutes governing companies that control depository institutions ("DIs"): the Glass-Steagall Act, the BHC Act, the National Bank Act, the Savings and Loan Holding Company Act (the "S&LHC Act"). It also amends the Federal Deposit Insurance Act (the "FDI Act"), and the IB Act. As background for the discussion of the Act, following is a thumbnail summary of this existing framework.

1. The Glass-Steagall Act

The Glass-Steagall Act comprises four separate provisions of the extensive Banking Act of 1933. One purpose of the Glass-Steagall Act was to restrict, to differing degrees, the ability of banks and their affiliates to participate in the business of underwriting and dealing in certain securities. The Bills address the two Glass-Steagall Act provisions concerning affiliations: Section 20 (12 U.S.C. § 377) which prohibits a Fed member bank (and thus a national bank) from affiliating with a company "engaged principally" in underwriting, dealing, publicly selling or distributing securities; and Section 32 (12 U.S.C. § 78) which prohibits officer, director or employee interlocks between a Fed member bank and a company or person "primarily engaged" in the securities activities listed in Section 20.


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Beginning in the late 1980s, the Fed interpreted the "engaged principally" language in Section 20 of the Glass-Steagall Act to allow a bank holding company ("BHC") under the BHC Act to control a company that engages predominantly in bank-eligible securities activities and other permissible BHC Act activities also to derive a portion of its revenues from general securities ("bank-ineligible") underwriting and dealing. Since 1996, the Fed has adopted substantial revisions to its governing regulations to allow these so-called "Section 20 companies" to derive up to 25% of their revenues from bank-ineligible activities and to reduce substantially "firewall" and other operating requirements initially placed on Section 20 companies. These rulings mean that the existing Section 20 barriers between commercial and investment banking are largely irrelevant as a practical business matter. The Act repeals these provisions.

Two other Glass-Steagall Act provisions that are not at issue in the financial modernization debate restrict the combination of deposit-taking and investment banking in one entity. Section 16 (12 U.S.C. § 24 (Seventh)) restricts a national bank's and a Fed member bank's ability to underwrite and deal in securities and stocks (12 U.S.C. § 335)--other than "bank-eligible" governmental securities--and prohibits such banks from purchasing or selling securities except upon the order and for the account of customers. Section 21 (12 U.S.C. § 378), the obverse of Section 16, prohibits organizations that underwrite or deal in securities from accepting deposits--if an activity is permissible for a bank under Section 16, it is not prohibited by Section 21.

2. The BHC Act

Since 1956, the BHC Act has regulated the types of direct nonbanking affiliations permissible for BHCs that control banks. It defines a BHC as "any company which has control over any bank or over any company that is or becomes a [BHC]" pursuant to the BHC Act. 12 U.S.C. § 1841(a). The threshold definition of "bank" was amended in 1966, 1970 and 1987. It now is defined as any bank insured under the FDI Act or any institution that both takes transactional deposits and engages in the business of making commercial loans. 12 U.S.C. § 1841(c). The BHC Act excludes from this "bank" definition insured federal or state savings associations, as well as qualifying credit card banks, industrial loan companies and trust companies. The Act does not change the scope of the "bank" definition.

Subject to certain exceptions under Section 4 of the BHC Act, a BHC today may not control any company unless that company is a bank or directly engages in activities that are deemed by the Fed to be "so closely related to banking . . . as to be a proper incident thereto." 12 U.S.C. § 1843(c)(8). The Fed has interpreted this standard to prohibit or restrict affiliation with, inter alia, real estate brokerage or development companies and commercial or industrial companies. In 1982, Congress statutorily mandated that a BHC could not conduct general insurance underwriting or agency activities (subject to certain limited exceptions and grandfathers).

For almost twenty years, banking interests have pressed unsuccessfully for significant liberalization or repeal of the Glass-Steagall Act and the BHC Act. At the same time, the practical effect of both statutes has been significantly changed through regulatory


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interpretation and a large number of bank-nonbank combinations. The range and variety of such cross-industry relationships have provided a powerful impetus for change, as both banking and nonbanking companies have steadily pressed the limits of the Glass-Steagall Act/BHC Act framework at the bank regulatory agencies, in the courts, and in the marketplace. Revision of the BHC Act is the centerpiece of the Act.

3. Statutes Governing Activities of Banks

The activities of national banks are determined by the NB Act, and state bank activities are determined by reference to state law and the FDI Act, particularly section 24 of that statute (12 U.S.C. § 1831a). For BHC subsidiary banks, the nonbanking limitations of Section 4 of the BHC Act do not apply to the activities of the bank or its operating subsidiaries. Section 121(d) adds new FDI Act Section 46 addressing subsidiaries of state banks.

4. Savings and Loan Holding Company

As developed in the 1950s and 1960s, the S&LHC Act paralleled the BHC Act (as then in effect) by imposing holding company regulation on companies controlling more than one insured savings association ("multiple savings and loan holding companies"), which were limited to specified activities and to controlling thrifts in one state. A company that controlled a single insured savings association, a "Unitary", however, was not subject to any limit on its activities. Amended in the 1980s by the imposition of a "qualified thrift lender" ("QTL") requirement on Unitaries, this framework has stood as a foil to the BHC Act structure. An unsuccessful effort was made in the House in 1995 (and again in the 1997 House Banking Committee version of the Bills) to require all thrifts to convert into banks and their holding companies to become BHCs and thus to terminate the Unitary structure. The Act provides financial activities for S&LHCs, but terminates the opportunity to create new Unitaries.

5. International Banking Act of 1978 The IB Act established the first federal regulation of foreign banking

organizations operating in the United States. Consistent with the concept of "national treatment," it attempts to put foreign and U.S. banking organizations' domestic banks on approximately the same footing. Under the IB Act, a foreign bank with one or more U.S. branches, as well as a foreign bank that controls a U.S. bank, is regulated as a BHC. Various amendments are made concerning foreign banks, which are allowed to have financial affiliations like BHCs.


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III. FINANCIAL HOLDING COMPANIES ("FHCS")

A. Overview: Activities and Affiliations of a FHC Sec. 103 (pp. 5-14)

The centerpiece of the GLB Act is Title I, which revises and expands the existing Bank Holding Company Act of 1956 (the "BHC Act") framework by adding a new Section 4(k) to permit a holding company system to engage in a full range of financial activities. This term is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking for a holding company with a securities affiliate and additional activities that the Fed, in consultation with the Secretary of the Treasury, determines to be "financial in nature," "incidental to such financial activities," or "complementary to a financial activity" as long as such an activity does not "pose a substantial risk to the safety and soundness of depository institutions or the financial system generally."

The legislation provides that the expansion of the list of permissible financial activities should take into account (1) the purposes of the BHC Act and the GLB Act; (2) changes or reasonably expected changes in the financial services marketplace or in the technology for delivering financial services; and (3) whether such activity is "necessary and appropriate" for a FHC (i) to compete effectively with other companies to provide financial services, (ii) to efficiently deliver information or services that are financial in nature through the use of technological means, including any application necessary to protect the security of or efficacy of systems for the transmission of data or financial transactions, and (iii) to offer customers any available technological means for using financial services or for the document imaging of data. This should allow the Fed to designate activities as financial so that bank holding companies ("BHCs") may keep abreast of competition and technological change by taking into account developments in technology and competition.

The GLB Act thus provides dramatically expanded financial affiliation opportunities for existing BHCs and allows all financial companies to control a full-service insured bank. The GLB Act does not include any nonfinancial activities "basket" (except to the extent permitted through merchant banking and insurance company investments). It does allow a 10-year to 15-year grandfather for the nonfinancial activities of predominantly financial nonbanking companies that become FHCs.

In general the Conferees agreed to the Senate Bill's framework for FHCs, but adopted the FHC designation from the House bill. The FHC framework in the Act is set forth in Section 103, which adds new Subsections 4(k)-(l)-(m) of the BHC Act. A BHC becomes a "FHC" by filing a self-executing declaration with the Fed stating that its subsidiary banks meet a "well-capitalized" and "well-managed" standard--they also must have at least a "satisfactory" CRA rating. The Act requires an application to the Fed prior to any acquisition of a bank.

A FHC may make other acquisitions of "financial" companies or engage in financial activities encompassed on the lengthy list in the bill by filing an after-the-fact notice with the Fed. The prior approval of the Fed is not required with respect to the acquisition or establishment of nonbank companies engaged in other financial activities.


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A Note on Wholesale Banks: The original version of H.R. 10 and subsequent versions of the House bill provided for a new "wholesale financial holding company" ("WFHC") that controls an uninsured Wholesale Financial Institution ("WFI"), but no insured institution. In modified form, "wholesale bank" provisions were debated in Conference, but in the end were deleted from the final bill.

B. Qualification to be a FHC Sec. 103 (pp. 9-10)

1. Self-Executing Declaration: "Well-Capitalized" and Well-Managed"

The qualifications to engage in the Section 4(k) financial activities are set forth in new BHC Act Section 4(l). To engage in financial activities, a BHC must file a declaration with the Fed electing to engage in activities under new BHC Act Section 4(k) and certifying that it is eligible to do so because all of its insured DI subsidiaries are well-capitalized and well-managed. These terms are not specifically defined in the GLB Act because they are currently defined for BHC Act purposes. Under current BHC capital regulations, a bank is "well-capitalized" if it meets its primary regulator's definition for that status under the Federal Deposit Insurance Act ("FDI Act") for prompt corrective action purposes.

For example, under Regulation H, a state member bank must maintain leverage capital of at least 5%, Tier I risk-based capital of at least 6%, and total risk-based capital of at least 10%. The bank also must not be subject to any supervisory agreement or action related to capital adequacy. 12 C.F.R. § 208.43. A "well-managed" bank must have at least a composite rating of 1 or 2, with a rating for the management component of at least 2 on its most recent examination. 12 U.S.C. § 1841(o)(9).

The GLB Act retains the present requirement under section 3 of the BHC Act that the Fed must approve the acquisition of a "bank" by any BHC or other company. 12 U.S.C. § 1842. A company seeking to become a FHC by acquiring its first bank thus will also be subject to an application requirement and Fed process as is presently required.

2. CRA Requirement for Subsidiary DIs

The Fed must determine that each DI controlled by a FHC has a satisfactory or better rating under the CRA in order for a company to become a FHC or for a FHC to engage in new financial activities or acquire, directly or indirectly, a company engaged in any activity under subsection (k) or (n). Investments in companies under the Act's merchant banking or insurance company investment provisions (Section 4(k)(4)(H) or (I)) are not subject to this requirement.

The Act also amends Section 804 of the CRA to require rejection of a notice to become a FHC is any subsidiary DI of the company does not have at least a "satisfactory" CRA rating. This provision includes a limited exception for a company filing the FHC election notice that it had acquired during the previous 12 months a DI with an unsatisfactory CRA rating. In


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such a case, the election will not be rejected if the company had filed an "affirmative plan" to bring the institution to at least a satisfactory rating; and the institution's appropriate federal banking agency ("AFBA") had accepted that plan. Other CRA amendments are discussed below.

C. FHC Activities Sec. 103 (pp. 5-15)

1. Overview

The GLB Act provides a broad definition of "financial activities," including banking, insurance, investment banking and other securities activities, and permits the scope of "financial" and incidental activities to evolve with technology and competition. It also permits passive investments in any type of company through merchant banking and insurance company investments, subject to the requirements described below. This list of "financial activities" has remained largely unchanged since the 1997 House Banking Committee version of H.R. 10.

The Act also includes a new category--"complementary" activities--that on its face permits somewhat greater elasticity at the outer edges of permissible FHC activities. Since the Fed will ultimately determine the scope of such provisions, it remains to be seen how much practical effect it will have.

2. Definition of "Financial Activities"

The Act's list of "financial activities" includes:

• = Lending, trust and other banking activities--lending, exchanging, transferring, investing for others, or safeguarding money or securities.

• = Insurance activities--acting as principal, agent or broker for the purposes of insuring, guaranteeing or indemnifying against loss, harm, damage, illness, disability or death, or providing and issuing annuities.

• = Financial or economic advice or services--providing financial, investment or economic advisory services, including advising an investment company (as defined by Section 3 of the Investment Company Act of 1940 (the "1940 Act") (15 U.S.C. § 80a-3).

• = Pooled investments--issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly.

• = Securities underwriting and dealing--underwriting, dealing in or making a market in securities.

• = Existing BHC activities--engaging in any activity that the Fed has, by regulation or order, determined to be permissible for a BHC under Section 4(c)(8) of the


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BHC Act (12 U.S.C. § 1843(c)(8)) as in effect the day before enactment of the Act.

• = Regulation K activities--engaging in any activity in the United States that is permissible for a BHC to engage in outside the United States and, under Section 4(c)(13) of the BHC Act (12 U.S.C. § 1843(c)(13)), was determined to be usual in connection with the transaction of banking or other financial operations abroad, including, for example, management consulting and data processing services.

3. Passive Control of Companies Through Securities Underwriting, Merchant Banking or Insurance Company Investments Sec. 103 (pp. 7-9)

Currently, a BHC, may engage in U.S. merchant banking/venture capital activities in a highly restricted manner mostly through BHC Act Section 4(c)(6) or a Small Business Investment Company ("SBIC"). Section 4(c)(6) permits a BHC to make a "passive," investment of up to 4.9% of any class of voting securities of a U.S. investment company plus a nonvoting equity investment that when combined with the voting investment does not exceed 24.9% of the company's equity. Subject to certain requirements, a BHC owned SBIC may acquire up to 49.9% of the equity securities of a designated "small business," depending on the number of other shareholders in the company and the size of their holdings relative to that of the BHC.

In general, a FHC may have operational "control" only over entities that are engaged in activities that are financial in nature or incidental to financial activities. However, the GLB Act accommodates the needs of FHCs that control investment banks, merchant banks or insurance companies (including companies providing and issuing annuities) if they meet certain requirements. Detailed parallel provisions address stock ownership of companies by insurance or annuity companies or in connection with "bona fide" underwriting or merchant banking activities. The Act permits FHCs to hold controlling shares of a company as long as the investment is made in the ordinary course of business and the overall relationship is sufficiently passive to be properly regarded as an investment relationship, not the actual operation of another company.

a. Merchant Banking

To conduct merchant banking activities a FHC must have a "securities affiliate" or an affiliate of an insurance company that provides investment advice to an insurance company and is an investment adviser registered under the Investment Advisers Act of 1940 (the "Advisers Act"). It should be noted that the corresponding provision in the House bill required merchant banking activities through a broker-dealer engaged in securities underwriting and an affiliate of the broker-dealer.

The Act specifically permits such a securities or insurance (or any affiliate of the securities affiliate) to acquire or control, as principal or on behalf of one or more entities, shares, assets or interests in a company or other entity, whether or not constituting control, if:


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• = the shares, assets or ownership interests are not acquired or held by a DI or a subsidiary of a DI (other than a "financial subsidiary" of a bank, if such activities are authorized under Section 122 in 2004);

• = the shares, assets or ownership interests are held for a period of time that will permit their sale or disposition on a reasonable basis consistent with the financial viability of the activities; and

• = during the period the shares, assets or ownership interests are held, the BHC does not “routinely manage or operate” the company or entity except as necessary to achieve a reasonable return on the investment. A prior version had specified that the BHC must not "actively" manage the company except as "necessary to achieve the objective" for which it is held (e.g., to temporarily run a company having financial difficulties in order to preserve the investment).

The Fed and Treasury are specifically authorized to issue regulations governing merchant banking activities, including rules governing transactions with controlled companies, if they jointly deem such rules appropriate to implement the purpose of the GLB Act and prevent evasions. As passed by the House, H.R. 10 limited the ability of an insured DI affiliate to fund one of these companies or entities by prohibiting the DI from engaging in any covered transaction, as defined in Section 23A(b)(7) of the Federal Reserve Act (the "FR Act"), 12 U.S.C. § 371c(b)(7)--including, for example, a loan or asset purchase --with such a company or entity. The Senate passed bill contained no similar provision.

The Conference Report states that the merchant banking authorization "is designed to recognize the essential role that these activities play in modern finance." The 1999 House Banking Committee Report on H.R. 10 discussed the requirements placed on merchant banking and noted the tensions between policy and practicality. On the one hand, the H.R. 10 report states, the requirements are intended to ensure that "these investments do not result in breaching the barrier between banking and commerce." H.R. Rep. No. 106-74, pt. I, at 122 (1999) (herein "1999 House Banking Committee Report"). At the same time, it states that the requirements are not intended to put the merchant banking activities of FHCs at a competitive disadvantage. "The Committee recognizes that there may be special circumstances when active, day to day management or operation may be necessary to achieve the objectives of the investment." The committee intends to permit investment banking firms to continue to conduct their principal investing in substantially the same manner as at present. The Fed shall take into account that investment banking firms affiliated with depository institutions should be able to compete on an equal basis for principal investments with firms unaffiliated with any depository institutions so that the effectiveness of these organizations in their investment banking activities is not compromised." 1999 House Banking Committee Report at 123.


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b. Insurance Investments Sec. 103 (pp. 7-8)

Parallel to the merchant banking provisions, the Act permits insurance or annuity companies in a FHC to invest in or control a company, as permitted to insurance companies under state insurance law. Such investments must be made in the ordinary course of business of an insurance company, as determined by insurance regulators in the company's state of domicile, and the insurance company may not “routinely manage or operate” the company or entity except as necessary to achieve a reasonable return on the investment.

The Act specifically states that it is financial in nature to directly or indirectly acquire or control, whether as principal, or on behalf of one or more entities (including entities other than a DI or a subsidiary of a DI that the BHC controls) or otherwise, shares, assets or ownership interests (including debt or equity securities, partnership interests, trust certificates or other instruments representing ownership) of a company or other entity whether or not constituting control of the company or entity, engaged in any nonfinancial activity if:

• = the shares are not acquired or held by a DI or subsidiary of a DI;

• = the shares are held by an insurance company "predominantly engaged" in underwriting life, accident and health, or property and casualty insurance (other than credit related insurance) or providing and insuring annuities;

• = the shares represent investments made in the ordinary course of business of an insurance company, as determined by insurance regulators in the company's state of domicile; and

• = while such investments are held the BHC does not "routinely" manage or operate a company in which it invests except as necessary to obtain a "reasonable return on investment." New BHC Act Section 4(k)(4)(I).

The Conference Report states that to the extent that a FHC participates in the management or operation of a portfolio company, such participation would "ordinarily be for the purpose of safeguarding the investment in accordance with the applicable requirements of state insurance law. This is irrespective of any overlap between board members and officers of the FHC and the portfolio company." Conference Report at 3-4. A colloquy between Senator Bennett of Utah and Chairman Gramm made three points about this provision. First, in the same vein as the Conference Report, Bennett stated that the existence of overlapping directors or officers between an insurance company and a portfolio company was not intended to "result necessarily" in a determination that the holding company routinely managed or operated the portfolio company. Second, Bennett expressed the view that a holding company may routinely manage or operate a portfolio company that has been "generating a below-average rate of return on investment." Finally, he stated that the determination of whether an investment was made by an insurer in the ordinary course of business would be made by the insurance regulator in the


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state where the insurer is located. Gramm concurred with each of these three statements. 145 Cong. Rec. S13902 (daily ed. November 4, 1999).

c. CRA Ratings

The general bar against engaging in new financial activities or acquiring financial companies if a BHC's subsidiary DI has an unsatisfactory CRA rating does not apply to the acquisition of shares under the above merchant banking or insurance company investments sections of the GLB Act "by an affiliate already engaged in" such activities.

4. Definition of "Insurance Company"

For purposes of the BHC Act, an "insurance company" includes "any person engaged in the business of insurance to the extent of such activities."

5. Complementary Activities Sec. 103 (p. 5)

New Subsection 4(k)(1) also gives the Fed authority to allow a FHC to engage in any activity that is "complementary" to a financial activity and does not "pose a substantial risk to the safety and soundness of depository institutions or the financial system generally." Although this provision is now structured to include such complementary activities as part of the basic FHC activities language, it is not self-executing and must be specifically implemented by the Fed. The incorporation of this provision into the Act suggests an intention to encourage the Fed to consider favorably proposals for "complementary to financial" activities.

Although the prior House and Senate bills each included language regarding complementary activities, they were less integral to the FHC structure. The final language is closest to the Senate bill, which had provided for "additional activities" -- activities that the Fed may determine, by regulation or order, to be complementary to financial activities or "any other service" that does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

The House bill took a different approach. Subject to Fed prior approval, the bill permitted FHCs to engage in a "small" amount of activities that are "complementary" to financial activities. It did not define "complementary," and thus left it to the Fed. The original industry proponents of this language suggested that the production of materials on "financial" or related subjects by a publishing affiliate of a FHC might be deemed "complimentary." That provision had been included in the 1999 version of H.R. 10 as a compromise for companies that were seeking to restore a nonfinancial activities "basket" to the bill. The 1997 version of the legislation adopted by the House Banking Committee in effect had permitted 15% of a FHC's business to be nonfinancial. No significant effort was made in the 1999 mark-up to revive such a provision.


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6. Additional Financial Activities Sec. 103 (p. 8)

The GLB Act directs the Fed to define by regulation or order, "consistent with the purposes of this Act," the following activities as financial in nature and to determine the extent to which they are financial in nature or incidental to activities that are financial in nature:

• = Lending, trust and other banking activities--lending, exchanging, transferring, investing for others, or safeguarding financial assets other than money or securities;

• = Financial transfers--providing any device or other instrumentality for transferring money or other financial assets; and

• = Third-party financial transactions--arranging, effecting or facilitating financial transactions for the account of third parties.

These activities had been included on the 1997 House Banking Committee list of pre-approved "financial activities." While regarded as financial, these were separated and made subject to a specific Fed determination because of Fed concern regarding the potential scope of the relationships and activities that might be permitted if a blanket pre-approval was provided in the bill.

7. Fed Authority to Expand the List Sec. 103 (p.5-6)

The GLB Act gives the Fed authority, by regulation or order, to expand the list of "financial" or "incidental" activities, but requires consultation with the Treasury. It also includes a mirror-image provision that allows the Treasury, in consultation with the Fed, to determine the scope of "financial" activities for national bank operating subsidiaries. Despite specific language in the Conference Report encouraging interagency cooperation, inside-the-Beltway observers suggest that this structure may not produce collaboration on any significant matters between the two agencies.

The GLB Act requires the Fed to notify and consult with Treasury concerning any "request, proposal or application" under new BHC Act Section 4(k)(1) for a determination as to whether an activity is financial in nature or incidental to a financial activity. New BHC Act Section 4(k)(2). The Fed may not make such an affirmative determination if Treasury states in writing its belief to the contrary within 30 days (unless the Fed agrees to extend the time for Treasury's response). Conversely, the Treasury may recommend that the Fed find an activity to be financial in nature or incidental to a financial activity. Within 30 days of the recommendation or such longer time as the Fed and Treasury agree to, the Fed must notify the Treasury in writing whether it will initiate a public rulemaking to deem the activity to be financial or the reasons for not taking such action.


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In making such "financial" determinations, the Fed and Treasury are directed to "take into account" the following: (i) the purposes of the BHC Act and the GLB Act; (ii) changes, or reasonably expected changes, in the financial services marketplace, or in the technology for delivering financial services; and (iii) whether the activity is "necessary or appropriate" to allow BHCs and their affiliates (1) to compete effectively with other companies seeking to provide financial services in this country, (2) to efficiently deliver information and services that are financial in nature through the use of technological means, including any application necessary to protect the security of or efficacy of systems for the transmission of data or financial transactions, or (3) to offer to customers available or emerging technological means for using financial services. New BHC Act Section 4(k)(3).

Objections had been raised by the OCC and representatives of some bank interests that the Fed-Treasury sharing arrangement would give the Fed a disproportionately large role in determining which activities are permissible in a BHC. The OCC also objected that unless "interpretations" were added to the list of items subject to the joint determinative process, Fed interpretations of "financial in nature" activities might be regarded unilaterally and without the interagency consultations.

The Conference Report reference to establishment of a "consultative process" by the Fed and Treasury echoes a longer statement in the House Banking Committee's 1999 Report which stated:

One of the significant issues faced by the Committee in constructing a new framework for the financial system is the appropriate role of the Secretary of the Treasury. As the Cabinet Secretary who attends to the financial condition of the country, the Secretary of the Treasury clearly should play a role in the evolution of the financial system. In order to achieve the appropriate balance and to limit regulatory arbitrage that could occur as expanded affiliations are allowed to take place in either the holding company or in an operating subsidiary, Title I establishes a system of coordination between the Federal Reserve and the Secretary of the Treasury for the approval of new financial activities. Under this system, both the Federal Reserve and the Secretary of the Treasury may approve new financial activities for holding companies and national bank operating subsidiaries, respectively, after consultation with each other. Both agencies are given the right to propose to each other that an activity be deemed to be financial or to object to a determination that an activity is financial. Under this structure, an objection by one will have the effect of prohibiting the determination by the other. 1999 House Banking Committee Report at 98.

8. A Note on Nonfinancial Activities

The Act omits a provision from H.R. 10 allowing limited investments in "developing activities" that have not yet been found by the Fed to be financial in nature or incidental to financial activities. This H.R. 10 provision would have allowed a FHC to engage in the activity without prior Fed approval provided that the company "reasonably concludes" that


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the activity is financial in nature or incidental to a financial activity, if action size limitations were met and within ten days of commencing the activity (or consummating an acquisition of a company engaged in the activity), the Fed receives a written notice describing the activity. This provision left it unclear whether a FHC would be required to divest such a company or cease such an activity if the Fed subsequently determined that the activity was not financial in nature or incidental to a financial activity.

The question of whether to allow FHCs to engage to a limited extent in nonfinancial activities was contentious throughout much of the financial modernization debate, but it became clear early in 1999 that no nonfinancial "basket" would be included in this legislation. The 1997 House Banking Committee version of H.R. 10 broke new ground by permitting a FHC to derive up to 15% of its domestic revenues from domestic commercial affiliates, for example, through the ownership of commercial, retail, manufacturing or industrial enterprises, but could acquire an existing company only if the target had less than $750,000,000 in consolidated assets. This prohibition was designed to prevent a FHC from affiliating with any of the 1,000 largest U.S. commercial companies in consolidated assets.

This House Banking Committee commercial "basket" was reduced in the House Commerce Committee and then eliminated on the House floor in 1998, except for a 10- to 15- year grandfather provision for nonbanking companies that become FHCs (discussed below). The Senate Banking Committee mark-up in 1998 did not consider a nonfinancial basket amendment. In 1999, Chairman Gramm circulated a "discussion draft" containing a commercial basket and Rep. LaFalce also included a basket in his proposal, H.R. 665. However, at the time of both mark-ups, the basket proposals were dropped in favor of the addition of a "complementary" activities and "other services" category under the definition of financial in nature. See discussions in other relevant sections.

9. After-the-Fact Fed Notice for New Activities Sec. 103 (p. 8)

Within 30 days after commencing an activity, or completing an acquisition involving any activity permissible under new BHC Act Section 4(k), a BHC must provide written notice to the Fed describing the activity so conducted. This provision further states that a qualifying BHC or its nonbank subsidiary may engage without prior Fed approval in any nonbanking financial activities listed under new BHC Act Section 4(k)(5) or permitted by the Fed under Section 4(k)(6).

Accordingly, it appears that the prior approval of the Fed is required to engage in any other new financial activities on a FHC-by-FHC basis. Potentially, by regulation, the Fed could establish an expedited approval process for previously approved new financial activities subject to the terms or conditions of the original order or regulation.


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10. Divestiture Procedures Sec. 116(b) (p. 35)

The GLB Act would amend Section 5(e) of the BHC Act to allow a company to decide whether to remain a BHC or FHC in situations in which the Fed has reasonable cause to believe that a continued nonbanking activity, or ownership or control of nonbank subsidiaries (other than nonbank subsidiaries of a bank), constitutes a serious risk to the safety, soundness and stability of a BHC subsidiary bank. Under current law, the Fed is authorized to order the BHC to terminate such activities or to divest itself of any ownership or control of the nonbank subsidiary through a sale or distribution of shares to the shareholders of the BHC. 12 U.S.C. § 1844(e)(1). Under the GLB Act, the BHC would be allowed to elect whether to terminate the activity or the ownership or control of the nonbank subsidiary at issue, as under present law, or alternatively, ownership or control of the bank itself.

11. Repeal of Savings Bank Provisions Sec. 118 (p. 36)

Under Section 3(f) of the BHC Act as added in 1987, qualifying State-chartered savings banks in a BHC could retain certain insurance activities. This is a grandfather for savings banks located in New York, Massachusetts or Connecticut, engaged in selling or underwriting savings bank life insurance as of March 5, 1987. This provision is repealed.

D. Failure to Continue to Meet FHC Requirements Sec. 103 (p. 10)

A FHC that ceases to meet the capital or managerial qualifying requirements for FHC status will be so notified by the Fed. New BHC Act Section 4(m). The FHC, in turn, has 45 days (unless extended by the Fed) to execute a corrective agreement with the Fed. If the FHC requirements are not met within 180 days of receipt of the notice, the Fed may, at its discretion and subject to such terms and conditions as the Fed may impose and to such extension of time as the Fed may allow, require the company to divest control of its DIs. In lieu of divestiture of its DIs, a FHC may elect to cease activities conducted under the GLB Act that currently are not permissible under Section 4(c)(8) of the BHC Act.

Failure to maintain a satisfactory or better CRA rating is not a basis for the Fed to take action under this provision. A FHC with a subsidiary that does not maintain a satisfactory CRA rating, however, will not be permitted to expand into new financial activities as long as such noncompliance continues. Ironically, depending on the severity of action proposed by the Fed under these provisions, an unsatisfactory CRA rating for a DI may have a substantially greater negative affect on the FHC than the Fed remedial action if the DI is not well-capitalized or well-managed. This is so because the unsatisfactory CRA rating triggers an automatic statutory bar on new financial activities or investments for the FHC. In contrast, when a DI is not well-capitalized or well-managed, the Act provides an administrative process based upon the FHC's planned action to remedy the problem. This process will not inhibit the new financial activities or investments unless the Fed so requires.


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Overall, the effect of these noncompliance provisions create a significant need for consolidated monitoring of the status of DIs in a FHC system to ensure that pending proposals to engage in financial activities or to acquire financial companies are not disrupted by a DI receiving an unsatisfactory CRA rating or ceasing to be well-capitalized or well-managed.

E. Grandfathered Nonfinancial Activities

1. Grandfather for Nonfinancial Companies Sec. 103 (pp. 10-11)

When a company other than a BHC or a foreign bank becomes a FHC, it may continue to engage in any activity, including nonfinancial or commercial activities, until November 12, 2009, 10 years from the enactment of the GLB Act (five additional years are possible with Fed permission) provided that the company: (i) was lawfully engaged in the activity as of September 30, 1999; (ii) is predominantly engaged in financial activities; and (iii) continues to engage in only those activities conducted on September 30, 1997, as well as financial activities. A company is predominantly engaged in financial activities if 85% of its consolidated annual gross revenues (excluding revenues from DIs) are from--and remain from--financial activities or activities incidental thereto.

During this period, a grandfathered FHC may not acquire nonfinancial or commercial assets from other companies. Affiliated DIs and nonfinancial companies may not cross-market each other's products or services, nor may they engage in covered transactions under the Federal Reserve Act (the "FR Act") Section 23A(b)(7) (12 U.S.C. § 371c(b)(7)) -- that is, extensions of credit, loans, asset purchases, guarantees or letters of credit, affiliated securities purchases or acceptance of such securities as collateral for a loan.

A grandfathered activity may be extended after the 10-year sunset date by the Fed for up to 5 years if the extension "would not be detrimental to the public interest." In view of the asset acquisition and cross-marketing limitations, the practical utility of this grandfather may be limited.

2. Grandfather for Commodity Activities Sec. 103 (p. 11)

The GLB Act also permits a company that is not a BHC or a foreign bank and that becomes a FHC to continue to engage in, or to control shares of any company engaged in, the trading, sale, or investment in commodities and underlying physical properties, if the following conditions are met: (i) the holding company was lawfully engaged in the activity in the United States as of September 30, 1997; and (ii) the aggregate assets attributable to such grandfathered commodity activities equal no more than 5% of the FHC's total assets. New BHC Act Section 4(n). The Fed may allow increases in this amount if appropriate and consistent with the GLB Act's purposes. To retain this grandfather, the grandfathered commodity entity and its DI affiliates may not offer or market the products or services of the other.


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F. Report on New Financial Activities Sec. 103(d) (p. 14)

The Act retains a modified requirement for a joint report to be submitted by the Fed and Treasury four years from the date of enactment of the legislation. The report is to summarize the new activities, including both "financial in nature" activities and grandfathered commercial activities that an FHC may engage in pursuant to new BHC Act Sections 4(k)(1) or (n). The report shall also contain: (1) a review of any actions taken by the Fed or Treasury with regard to any activities deemed to be incidental or complementary to activities that are "financial in nature," including rates and guidelines they adopt and applications approved or disapproved; (2) the risks to the safety and soundness of affiliated DIs posed by commercial activities; and (3) the effects of mergers and acquisitions on market concentration in the financial services industry. The report is due on or before November 12, 2003.

G. Effective Date of FHC Provisions Sec. 161 (p. 47)

The GLB Act expressly provides that the provisions relating to FHCs (i.e., Title I) will become effective 120 days after its enactment, or March 12, 2000. This provision expressly excludes Section 104, which accordingly becomes effective on the enactment date. In a colloquy with Senator Dodd, Chairman Gramm stated on the Senate floor that the 120-day period was intended to allow the Fed and other agencies to adopt regulations and was not intended to prevent the establishment of financial affiliations on that date even if agency regulations have not been adopted in final form by that date. 145 Cong. Rec. S13901 (daily ed. November 4, 1999).

IV. ANTITRUST PROVISIONS

A. Antitrust Review of Acquisitions and Mergers Sec. 131-133 (p. 45-46)

For a number of years, antitrust experts have discussed streamlining the antitrust review of financial institutions mergers and acquisitions by eliminating or modifying the current law that requires the Fed to review proposed acquisitions on antitrust grounds. In 1998, provisions in a House Banking Committee bill eliminated the Fed’s authority to review bank acquisitions on antitrust grounds. This change left antitrust review in the hands of the DOJ for DI acquisitions, or the FTC for non-DI transactions. Subsequently, the Fed’s authority was restored on the floor of the House.

S. 900 contains no provision relating to this issue. H. R. 10 retains the current up to 30-day post-approval waiting period requirement for DOJ or FTC review, as well as the requirement that a court reviewing an acquisition conduct a de novo review applying the same standard that the Fed applies in its initial review. In addition, federal banking regulators are required to share with the U.S. Attorney General and the FTC any information that the antitrust agencies deem necessary for antitrust review of appropriate transactions.


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These provisions also clarify the jurisdiction of the FTC in mergers and acquisitions involving affiliates and subsidiaries by stating that no nondepository affiliate or subsidiary of a bank or savings association shall be deemed to be a bank or savings association for purposes of any law enforced by the FTC. The Act also amends the antitrust laws to make clear that banks and bank holding companies proposing to acquire a nonbank company engaged in financial activities must provide the appropriate antitrust agencies with prior notice of the transaction under the Hart-Scott-Rodino Act (15 U.S.C. § 18a).

Finally, these provisions require the General Accounting Office ("GAO") to report annually to Congress on market concentration in the financial services industry and its impact on consumers. The analysis is to focus on affiliations and acquisitions involving DIs, DI holding companies, securities firms and insurance companies. This subtitle will sunset on the end of the 5-year period beginning on the date of enactment of the Bill.

B. Hart-Scott-Rodino Provisions Sec. 133 (p. 46)

As noted above, under Section 103 of the Act a new BHC Act subsection 4(k) allows FHCs to acquire entities that are engaged in financial activities, without obtaining approval under the BHC Act. Section 133(c) of the Act amends two provisions of the Hart-Scott-Rodino Act (the "HSR Act"), 15 U.S.C. 18a(c)(7) and (c)(8), to withdraw the HSR exemption from transactions authorized by new subsection 4(k).

Thus, after the effective date of the Act, acquisitions by FHCs authorized by subsection 4(k) will require compliance with the notification and waiting period requirements of the HSR Act, provided the statutory size-of-person and size-of-transaction thresholds of the HSR Act are met and no other HSR exemptions apply. The Act leaves undisturbed the exemptions in subsection (c)(7) of the HSR Act for "transactions which require agency approval under section 18(c) of the Federal Deposit Insurance Act (12 U.S.C. 1828(c))", and in subsection (c)(8) of the HSR Act for "transactions which require agency approval under . . . sections 403 and 408(e) of the National Housing Act (12 U.S.C. 1726 and 1730(a)), or section 5 of the Home Owners' Loan Act of 1933, (12 U.S.C. 1464)."

1. HSR Size-Of-Person and Size-of-Transaction Thresholds

The HSR Act generally applies to transactions in which either the "acquiring person" or the "acquired person" has either annual net sales or total assets of $100 million or more, and the other has either annual net sales or total assets of $10 or more as a result of which the acquiring person would hold more than $15 million worth of the assets or voting securities of the acquired person. The HSR Act also applies to any acquisition of voting securities as a result of which the acquiring person would hold 50% or more of the issuer's voting securities, valued at $15 million or less, if either the issuer's annual net sales or its total assets exceed $25 million. Partnership and limited liability company interests are not "voting securities" for purposes of the HSR Act, although acquisitions of all of the interests in a partnership or LLC may be reportable.


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Put differently, (1) an asset acquisition valued at $15 million or less is generally exempt; (2) an acquisition resulting in the holding of less than 50% of the issuer's outstanding voting securities, valued at $15 million or less is exempt; and (3) an acquisition resulting in the holding of 50% or more of an issuer's voting securities is exempt if (a) the stock held is valued at $15 million or less and (b) the issuer's annual net sales and total assets are both less than $25 million.

2. HSR Notification and Waiting Period Requirements

If the HSR Act applies to a proposed acquisition, the acquiring and acquired persons must each file notification with both the Federal Trade Commission ("FTC") and the Antitrust Division of the U.S. Department of Justice ("DOJ"), and wait 30 days before closing the transaction. The acquiring person pays a filing fee of $45,000. This 30-day waiting period may be extended if either the FTC or DOJ decides to investigate the transaction and requests additional information from the parties.

In the event of a so-called "second request," the waiting period expires 20 days after both parties have substantially complied with the agency's request. Before expiration of the waiting period, the enforcement agencies may challenge the proposed transaction in federal court and seek an injunction to prevent its consummation. If during the 30-day waiting period both the FTC and DOJ decide not to investigate further, "early termination" of the waiting period may be granted. Special waiting period and second request rules apply to tender offers.

An HSR Act Notification and Report Form requires certain information about the filing person, a description of the transaction and copy of the letter of intent or definitive agreement; copies of recent SEC filings and financial statements; and information concerning the filing person's revenues (by Standard Industrial Classification or "SIC" codes); its subsidiaries, shareholders and shareholdings; any activities in SIC code categories that overlap with those of the other filing party; certain customer-supplier relationships between the filing parties; and certain prior acquisitions by the acquiring person. In addition, the filing party must supply copies of documents that analyze or evaluate the proposed transaction with respect to market- or competition-related factors.

3. HSR Exemptions

A variety of exemptions is available under the HSR Act and its implementing rules, including:

• Acquisitions of bonds, mortgages, deeds of trust and other non-voting securities;

• Acquisitions of voting securities by a person that already holds at least 50% of the issuer's voting securities;

• Acquisitions of up to 10% of an issuer's voting securities solely for the purpose of investment;

• Certain acquisitions requiring agency or regulatory approval;


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• Certain acquisitions of real property, or of the voting securities of entities that hold primarily real property;

• Certain acquisitions of voting securities by persons who have filed HSR Act notification for previous acquisitions of voting securities of the same issuer;

• Certain "intra-person" transactions between entities under common control;

• Acquisitions of convertible securities, options and warrants that do not presently vote for election of directors;

• Certain acquisitions by "institutional investors" solely for the purpose of investment;

• Certain acquisitions by "foreign persons" and certain acquisitions of the assets or voting securities of foreign persons;

• Certain acquisitions by creditors, or by insurers;

• Certain acquisitions of assets in the ordinary course of business;

• Acquisitions by securities underwriters in the ordinary course of business; and

• Certain acquisitions by qualified employee stock option plans.

Each of these exemptions, and a number of others, are subject to specific rules and informal interpretations that govern their availability.

V. FEDERAL RESERVE REGULATION OF FINANCIAL HOLDING COMPANIES

The GLB Act retains the Fed's jurisdiction over BHCs but modifies the BHC Act's supervisory framework concerning BHCs and their nonbank subsidiaries. Also, it will inevitably expand the Fed's ability to influence other financial sectors of the economy by expanding the BHC Act to permit BHCs to acquire other regulated and previously unregulated financial companies. Separately, as discussed in the next section below, to effectuate the concept of functional regulation, the GLB Act alters the direct supervisory role of the Fed and other AFBAs over "regulated" nonbank subsidiaries or affiliates of a FHC, a national or state bank, or a savings and loan holding company.

A. Overview

At present, BHCs and their nonbank subsidiaries are subject to thoroughgoing holding company regulation by the Fed. The Fed has also extended the requirements of the Basle Committee risk-based capital standards to BHCs, even though they were drafted for banks and are currently applied only to banks in most other countries. In contrast, companies that currently do not control a commercial bank but do control another regulated or unregulated financial company--such as an insurance underwriter, broker-dealer, bank that is not a BHC Act "bank" (e.g., credit card bank, industrial loan company or grandfathered CEBA bank) or an insured thrift--are not subject to significant regulation at the parent holding company level.


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The GLB Act selects the BHC Act as the base supervisory framework for a company that owns a commercial bank and engages in financial activities. The GLB Act clearly establishes the Fed as a powerful umbrella regulator, with more detailed express statutory authority over BHCs than it has today. However, in recognition of the less onerous holding company regulation that applies to financial companies that currently own financial institutions that may become BHCs and FHCs by acquiring a commercial bank, the GLB Act adopts a "Fed Lite" administrative approach that streamlines the Fed's supervisory authority in certain ways and defers to the actions and paperwork requirements of the "functional" regulators of insurers, broker-dealers, investment companies, and banks.

In this context, "functional regulation" means the general retention by the state and federal regulators of their present exclusive jurisdiction and authority over operating entities. The authority of state insurance regulators to approve or deny acquisitions of insurance companies is addressed separately in Section 104 of the GLB Act. As a consequence, the regulators of operating companies will largely continue in their roles as the front-line, day-to-day regulators of the entities under their jurisdiction.

Nevertheless, under the GLB Act, the Fed has the potential to affect the operations and activities of downstream companies through the formal and informal actions it can take. The GLB Act contains numerous trigger points related to legal noncompliance and other serious problems affecting bank affiliates that could lead to direct Fed involvement and to the possible exercise of remedial authority affecting both FHCs and their affiliated operating companies. In addition, the Fed will have an informal ability to affect downstream companies because of its power over the FHC parent and the tendency of other regulatory agencies to respect and accommodate Fed positions.

B. "Umbrella" Authority of the Fed

Briefly, the Fed's powers include the following.

1. Approval of Bank Acquisitions

The GLB Act retains the requirement that any company seeking to acquire a bank, including a nonbanking company seeking to become a FHC by acquiring its first bank, must file a detailed application with the Fed and receive Fed approval. Although the Fed decided in the 1997 revisions to Regulation Y voluntarily to limit the use of the applications process to address general supervisory matters through an application approval, the Fed retains this significant gatekeeper authority.

2. Compliance with Threshold FHC Requirements

The Fed has broad remedial authority over a FHC if one of its bank subsidiaries ceases to be "well-capitalized" or "well-managed." This well-capitalized/well-managed requirement is very demanding, and a look at the historical record of the last 20 years suggests that even generally strong and well-run banks have had episodes of difficulty. In view of this


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history, the GLB Act may well give the Fed the opportunity over time to address the activities and operations of many FHCs under this remedial authority.

3. FHC Capital Standards Sec. 112 (p. 31)

At present, the Fed has no express statutory authority to impose capital requirements on BHCs, but has adopted by regulation both leverage and risk-based capital requirements parallel to the Basle Committee standards for banks. Although an early House Banking Committee provision that would have granted the Fed express authority to set such capital requirements was subsequently dropped, the present GLB Act appears to assume the existence of this authority by stating that the Fed shall not impose capital requirements on regulated subsidiaries of FHCs. No such limit is placed on the Fed’s ability to adopt capital standards for either the FHC or for unregulated subsidiaries.

4. Source of Strength Authority Sec. 112 (pp. 29-30)

The Fed at present has asserted its authority through Regulation Y to require a parent BHC to be a source of financial strength for its bank subsidiaries (even though the one federal Court of Appeals to look at the issue found the Fed’s statutory authority lacking). Parallel to the capital provisions, the GLB Act limits the authority of the Fed and other banking agencies to order regulated insurance or securities affiliates of a FHC, or subsidiaries of a DI owned by a FHC, to serve as a source of strength. This language again provides an implied basis for Fed or other agency source of strength authority by appearing to assume its existence while expressly limiting it in specified contexts.

5. Reporting and Examination Sec. 111 (pp. 25-27)

The GLB Act gives the Fed the power to require reports by FHCs and their subsidiaries and to examine FHCs and their subsidiaries, subject to the "Fed Lite" requirements that the Fed take full advantage of reports and examinations generated by other regulators and subject to certain exceptions for regulated subsidiaries.

6. Prudential Safeguards Sec. 114 (pp. 32-34)

The GLB Act, in addition, grants the Fed potentially broad authority to impose "prudential limitations" on FHC depository-affiliate relationships and transactions as long as the Fed finds it necessary to prevent evasions of law or significant risks to a DI or a federal insurance fund, or "other adverse effects," such as undue concentration of resources, unfair competition, conflicts of interest or unsound banking practices.


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7. Role as Supervisor, as well as Enforcer Sec. 113 (pp. 31-32)

The present BHC Act provides the Fed with general supervisory authority over BHCs, including the authority to receive reports, conduct examinations and approve applications. However, absent a violation of a specific law or regulation, the Fed must take action under its unsafe or unsound practices enforcement powers and procedures. Under the GLB Act, the Fed is granted specific new statutory authority to utilize significant remedial powers and to exercise a greater supervisory role, both formally and informally, without the use of its enforcement powers.

8. Informal Authority as "First Among Equals" Regulator

The Fed’s informal powers under the GLB Act are also likely to be significant, even in areas where the GLB Act would appear to limit its authority. As the direct regulator of the parent FHC, the Fed will have a lever to cause the FHC to affect the activities and operations of its operating subsidiaries. The GLB Act structure suggests that the Fed in practice is likely to be a "first among equals" regulator with an ability to invite itself to the table with other federal or state financial regulators whenever serious issues arise regarding the financial condition, management, activities, etc., of a FHC, its subsidiary banks or of any affiliate that has significant interaction with a bank affiliate. The very complexity of the GLB Act structure and its various provisions may provide opportunities for the Fed to assert its own role as particular cases develop. The practical result is that the Fed, as the umbrella supervisor of FHCs, should be able to play an influential role in shaping the regulatory response to any serious issues in a FHC group of companies.

C. Audits of the Federal Reserve Sec. 726 (p. 138)

Section 726 requires an independent accounting firm to perform an audit of the Federal Reserve Banks and the Federal Reserve Board annually.

D. GAO Conflicts of Interest Study Sec. 728 (pp. 138-139)

Section 728 requires the Comptroller General of the United States [the General Accounting Office ("GAO")] to study the conflict of interest faced by the Federal Reserve between its role as primary regulator of the banking industry and its role as a vendor of services. Specifically, the GAO should address the conflict between the Fed’s role as a regulator of the payment system and its role as a competitor with private sector providers of payment services, and how best to resolve any such conflict. A report on the study is to be submitted to Congress on or before November 12, 2000.


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VI. "FED LITE" REGULATION OF BHCs AND SUBSIDIARIES Sec. 111 (pp. 25-29)

In extended negotiations involving committee staff, the Fed, the SEC and, to a lesser extent, other "functional" regulators and industry groups, provisions concerning the manner in which the Fed exercises authority over a BHC and its subsidiaries had been negotiated. The purpose of these provisions was to streamline and focus the Fed's supervision of these entities. With respect to a BHC and its subsidiaries generally, the Fed retains general authority to supervise, examine and receive reports from BHCs, but is to rely as much as possible on the information-gathering and supervision activities of other financial regulators.

The GLB Act's effect on the direct supervisory role of the Fed and other AFBAs over "regulated" nonbank subsidiaries or affiliates of a BHC, a national or state bank, or a savings and loan holding company is discussed in the next section below.

A. BHC Reports Sec. 111 (pp. 25-26)

The Fed may require any BHC or its subsidiaries, to submit reports under oath informing the Fed of "its financial condition, systems for monitoring and controlling financial and operating risks," transactions with DI subsidiaries, and statutory compliance. However, "to the fullest extent possible," the Fed is required to use existing reports prepared for other regulators or self-regulatory organizations, publicly reported information, externally audited financial statements, and reports filed with other agencies. A BHC or its subsidiary is required to provide such reports if requested by the Fed.

B. BHC Examinations Sec. 111 (pp. 26-27)

The GLB Act permits the Fed to examine a BHC and its subsidiaries and provides guidance to the Fed concerning such examinations. To the extent possible, the Fed is required to use examination reports prepared by or for other banking and financial regulators. Examinations are to be used to inform the Fed of the state of a BHC and its subsidiaries with respect to its: (i) operational nature and financial condition and associated risks that "may pose a threat to the safety and soundness" of subsidiary DIs; (ii) systems for monitoring and controlling financial and operating risks; and (iii) statutory compliance.

Moreover, "to the fullest extent possible," the Fed is directed "to limit the focus and scope" of examinations: (i) to the BHC; and (ii) to subsidiaries that "could have a materially adverse effect on the safety and soundness" of any DI affiliate because of (1) the subsidiary's "size, condition, or activities," or (2) "the nature or size of transactions" between a subsidiary and its affiliated DIs.


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C. Prudential Safeguards for DIs Sec. 114 (pp. 32-34)

The GLB Act creates a freestanding provision of law that provides new express authority for the AFBAs to impose restrictions or requirements on DI transactions or relationships with affiliates. Section 114 addresses each AFBA individually and, in general, provides that they may impose certain "prudential safeguards," that is "restrictions or requirements on relationships or transactions" between a DI and its affiliates. Essentially, this provision acts to offset the extent of the relief provided under Fed Lite.

Such a restriction or requirement may be imposed by an AFBA or the Fed with respect to a BHC or FHC if it (1) is consistent with the purposes of certain referenced banking laws; and (2) avoids significant risk to the safety and soundness of DIs or the federal deposit insurance funds ("DIFs") or avoids other adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests, or unsound banking practices (that is, the current BHC Act Sections 4(c)(8) and 4(j) standard to engage in activities closely related to banking ). For Fed regulated entities, such action may also be taken to prevent an evasion of applicable federal banking laws. The AFBAs are required to regularly review any actions taken and to modify or eliminate obsolete restrictions or requirements.

D. Authorization to Release Reports Sec. 727 (p. 138)

Section 727 amends the Federal Reserve Act (12 U.S.C. § 326) to allow the Board of Governors of the Federal Reserve to provide examination reports or other confidential supervisory information regarding any State member bank or other (examined) entity under the authority of the Board to any State or Federal agency with authority over such an entity, to any officer or director of such an entity, and to any other person that the Board determines to be proper.

This section also adds the Commodity Futures Trading Commission ("CFTC") to the list of supervisory agencies under the definitions for the Right to Financial Privacy Act of 1978 (12 U.S.C. § 3401).

VII. SUPERVISION OF NONBANK REGULATED ENTITIES Secs. 111, 112, 113, 115 (pp. 25-35)

The GLB Act significantly curtails the Fed's and other AFBAs' existing supervisory authority over nonbank regulated entities that are (1) BHC subsidiaries or (2) affiliates or subsidiaries of DIs under other federal statutes. Several provisions in the GLB Act form the principal elements of this streamlined regulatory framework.

First, provisions in Sections 111 and 113 place restrictions on the authority of the Fed under the BHC Act with respect to a "functionally regulated subsidiary." Second, Section 112(a) places conditions on the Fed's use of source of strength actions against certain regulated nonbank affiliates. Finally, Section 112(b) extends these limitations to each of the AFBAs with respect to


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a DI's "functionally regulated affiliates," including DI subsidiaries, under all other statutory schemes, such as the National Bank Act (the "NB Act"), the FDI Act or the Home Owners’ Loan Act ("HOLA").

In general, these provisions preserve the roles of the agencies responsible for "regulated subsidiaries" and curtail the Fed's direct supervisory, examination, reporting and rulemaking authority over such entities. It bars the Fed and AFBAs from establishing capital requirements for such subsidiaries and, in the normal course, examining or taking an enforcement action against them or otherwise seeking to impose restraints on them or regulate their operations.

From a day-to-day operational perspective, the GLB Act seeks to eliminate the ability of the Fed and the AFBAs to engage in duplicative, overlapping or burdensome regulation of entities that are already subject to extensive regulation at the hands of their functional regulators under statutory schemes that are tailored to these industries. Most importantly, when taken together, the intent of these provisions is to prohibit the Fed and the AFBAs, in the normal course, from taking any bank-like general supervisory action under the banking laws against or with respect to otherwise supervised activities of a regulated nonbank subsidiary.

A. Definition of Functionally Regulated Subsidiary Sec. 113 (pp. 31-32)

For purposes of Sections 111 and 113, the term "functionally regulated subsidiary" means any company that is not a BHC or a DI; and is:

(i) a broker or dealer that is registered under the Securities Exchange Act of 1934 ("the Exchange Act"),

(ii) an investment adviser, properly registered by or on behalf of either the SEC or any State, with respect to the investment advisory activities of such investment adviser and activities incidental to such investment advisory activities;

(iii) an investment company that is registered under the 1940 Act;

(iv) an insurance company, with respect to insurance activities of the insurance company and activities incidental to such insurance activities, that is subject to supervision by a State insurance regulator; or

(v) an entity subject to regulation by the CFTC, with respect to the commodities activities of such entity and activities incidental to such commodities activities. Section 111; New BHC Act § 5(c)(5).

If any of these companies controls an insured bank, directly or indirectly, or is a DI that engages in these activities, it will not be eligible for treatment as a functionally regulated subsidiary.


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B. Restrictions on Reporting Requirements and Examinations Sec. 111 (pp. 25-29)

1. Limits on Reports Sec. 111 (pp. 25-26)

The Fed may require a special report directly from a functionally regulated subsidiary only after it has unsuccessfully requested that the subsidiary's functional regulator--be it federal or state--obtain the requested report. Even then, the Fed may obtain the report directly from the subsidiary only if the report is necessary to assess (i) a material risk to a BHC or its subsidiary DIs, (ii) compliance with the BHC Act or other federal law that the Fed has specific jurisdiction to enforce against such company or subsidiary, or (iii) its systems for monitoring and controlling financial and operational risks within the holding company system that may pose a threat to the safety and soundness of subsidiary DIs.

2. Limits on Examinations Sec. 111 (pp. 26-28)

The Fed may examine a functionally regulated subsidiary only if it "has reasonable cause to believe" that the institution (1) "is engaged in activities that pose a material risk to an affiliated [DI],"or (2)(i) "based on reports and other available information," is not "in compliance with" the BHC Act or other federal law that the Fed has specific jurisdiction to enforce against such subsidiary, including "provisions relating to transactions with" an affiliated DI; and (ii) the Fed cannot make such a determination through examination of the affiliated DI or BHC.

The Fed may also conduct an examination of such a subsidiary, if it "reasonably determines, after reviewing relevant reports," that it is necessary to inform the Fed of its systems for monitoring and controlling financial and operational risks within the holding company system that may pose a threat to the safety and soundness of subsidiary DIs.

3. SEC Examination of Investment Companies Sec. 115 (pp. 34-35)

Separately, except for a limited Federal Deposit Insurance Corporation ("FDIC") exemption, Section 115 of the GLB Act precludes the federal banking agencies from inspecting or examining any registered investment company that is not a BHC or savings and loan holding company. The SEC is required to provide these agencies with "the results of any examination, reports, records, or other information . . . to the extent necessary for the agency to carry out its statutory responsibilities." The FDIC may make an examination, "if necessary to determine the condition" of a DI "for insurance purposes," pursuant to its authority under section 10(b)(4) of the FDI Act, "as may be necessary to disclose fully the relationship between" the DI and the affiliate, and "the effect of such relationship" on the DI.


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C. Federal and State Interagency Consultation and Information Sharing Sec. 307 (pp. 78-80)

The Act includes a set of provisions that provides for information sharing among the Fed, the other banking regulators and insurance regulators. It begins with a statement of purpose that states the Congressional intention that the Fed as the umbrella supervisor for FHCs, the AFBAs (including the Fed) as the regulators of DIs, and the appropriate state insurance supervisor as the functional regulator of insurance companies work together on a confidential basis to share information, in order to improve the efficiency and the quality of supervision of FHCs that control both a DI and a state-regulated insurance entity.

It goes on to provide that, at the request of the appropriate federal or state regulator, the Fed, the federal banking agencies and the state regulators may share confidential information, including (i) examination reports, (ii) information on transactions and relationships between a regulated insurance company and any affiliated DI, and (iii) information regarding the financial condition, risk management policies and operations of any FHC that controls a company engaged in insurance activities under their respective jurisdictions. In addition, the Act provides that the Fed and AFBAs may share any other confidential information that the agency believes to be "necessary or appropriate to permit the State insurance regulator to administer and enforce applicable State insurance laws."

The AFBAs may not provide any information entitled to confidential treatment under federal regulations or other applicable law to a state insurance regulator unless the latter agrees (i) to keep the material confidential and (ii) to take "all reasonable steps" to oppose attempts to secure disclosure of the shared information. The AFBAs are also directed to treat any information obtained from a state insurance regulator in a reciprocal fashion. Any interagency sharing of information or material between the regulators shall not constitute a waiver of, or otherwise affect, any privilege to which such information is otherwise subject.

D. Capital Sec. 111 (p. 28)

Currently, despite a lack of explicit statutory authority, the Fed asserts that its general BHC Act supervisory authority provides it with broad discretion to establish capital adequacy rules or guidelines and source of strength requirements for BHCs and nonbank subsidiaries. Several provisions in the GLB Act appear to assume the existence of such Fed authority by placing specific limits on the Fed's ability to impose capital requirements or issue source of strength directives.

Section 111 of the GLB Act adds new BHC Act Section 5(c)(3) (amending 12 U.S.C. § 1844(c)) that prohibits the Fed from prescribing or imposing, by regulation, guideline, order, or otherwise, capital requirements or capital rules on a functionally regulated subsidiary of a BHC (i) that is not a DI and (ii) is in compliance with applicable capital requirements of a federal regulatory authority, including the SEC, or state insurance authority; (ii) with respect to


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investment advisory activities or activities incidental thereto, of a properly registered investment adviser under the Advisers Act or state law; or (iii) with respect to insurance agency activities or activities incidental thereto, of an insurance agent licensed by the appropriate State insurance authority.

The GLB Act further prohibits the Fed, in developing, establishing, or assessing BHC capital or capital rules, from considering "the activities, operations or investments of an affiliated investment company," provided that the investment company (i) is not a BHC, or (ii) if the investment company has a market value in excess of $1 million, the BHC (together with its affiliates) does not own 25% or more of the investment company's shares. New BHC Act Section 5(c)(3).

E. Limits on Fed's Supervisory Authority Sec. 113 (pp. 31-32)

Section 113 of the GLB Act establishes a new Section 10A of the BHC Act under which, except as discussed below, the Fed may not "prescribe regulations, issue or seek entry of orders, impose restraints, restrictions, guidelines, requirements, safeguards, or standards, or otherwise take action under or pursuant to any provision of [the BHC Act] or Section 8 of the [FDI Act] against or with respect to" a functionally regulated subsidiary of a BHC or FHC. New BHC Act Section 10A(a). The Fed also may not take indirect action to achieve results that it could not effect directly.

Under these standards, the Fed is prohibited from issuing regulations or other supervisory or examination guidance, such as policy statements or bulletins, that specify policies, procedures or guidelines for subsidiaries to engage in regulated activities such as insurance agency or securities underwriting activities. At the same time, Section 10A provides two potentially significant exceptions to these prohibitions.

1. Material Risk Exception Sec. 113 (p. 32)

The Fed may take a supervisory action that "is necessary to prevent or redress an unsafe or unsound practice or breach of fiduciary duty by such subsidiary that poses a material risk to--(A) the financial safety, soundness, or stability of an affiliated [DI]; or (B) the domestic or international payment system." New BHC Act Section 10A(a)(1). However, to take action, the Fed must also find that "it is not reasonably possible to protect effectively against the material risk at issue through action directed at or against" DIs generally. New BHC Act Section 10A(a)(2).

As provided in the 1999 House Banking Committee Report, the term "material risk" means a "risk of serious harm to the financial safety, soundness, or stability" of an affiliated DI or to the domestic or international payment system. 1999 House Banking Committee Report at 132. As discussed above, for functional regulation purposes, the material risk threshold is also used to place limits on the Fed's reporting and examination authority with respect to functionally regulated subsidiaries.


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2. Statutory Compliance Exception Sec. 113 (p. 32)

The Fed would not be prevented from taking a supervisory action "to enforce compliance by a functionally regulated subsidiary of a [BHC] with Federal law that the [Fed] has specific jurisdiction to enforce against such subsidiary." New BHC Act Section 10A(c). Accordingly, if a regulated subsidiary acquired control of a bank without Fed approval or violated a consumer lending statute that the Fed has "specific jurisdiction to enforce," the Fed could take action, as appropriate.

F. BHC Act -- Source of Strength Sec. 112 (pp. 29-31)

Under its existing Regulation Y, the Fed expects a BHC to "serve as a source of financial and managerial strength" to its affiliated DIs. 12 C.F.R. § 225.4(a). Under this policy, the Fed maintains that it may order a BHC, through a capital directive or by other means, such as the sale of a nonbank subsidiary, to provide funds to its subsidiary DIs. As a supervisory and applications matter, the Fed may look with disfavor on capital structures that inhibit a BHC's ability to raise funds. Also, the Fed may object to the issuance of capital or debt instruments to fund the expansion of nonbank operations, if in its opinion, such action may hamper a BHC's future ability to supply needed funds to a DI subsidiary.

The GLB Act provides that a Fed source of strength directive "to provide funds or other assets" to a DI may "not be effective nor enforceable" with respect to an insurance company, a broker or dealer, an investment company or an investment adviser. In this regard, the Fed is required to provide notice of such an action to state insurance or securities regulators or the SEC, as appropriate. The relevant regulator may prevent the Fed from issuing its proposed order, if the regulator represents that compliance with the directive "would have a material adverse effect on the financial condition" of the covered entity. New BHC Act Section 5(g)(1) and (2) (12 U.S.C. § 1844).

If the relevant regulator takes such action, the Fed may order the BHC to divest its DIs within 180 days (or a longer period if the Fed determines it to be consistent with the DIs' safe and sound operation). After the issuance of the source of strength order and before DI divestiture, if any, the Fed may impose any conditions or restrictions on ownership or operation by the BHC of the DI, including restricting or prohibiting transactions between the insured DI and any affiliate of the institution, as are appropriate under the circumstances. New BHC Section 5(g)(3) and (4) (12 U.S.C. § 1844).

G. FDI Act -- Source of Strength Sec. 730 (pp. 139-140)

Section 730 of the GLB Act adds a new Section 18(t) of the FDI Act which would strengthen the source of strength concept by protecting the AFBAs from certain covered claims by any person (i) "for the return of assets of an affiliate or controlling shareholder" of an insured DI that were "transferred to, or for the benefit of," the DI, or (ii) "for monetary damages or other


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legal or equitable relief in connection with such transfer," if, at the time of transfer, the DI was (i) subject to direction by an AFBA to increase its capital or (ii) was "undercapitalized", "significantly undercapitalized" or "critically undercapitalized" as defined in Section 38 of the FDI Act (12 U.S.C. § 1831o).

The covered claims are those based on the avoidance of preferential or fraudulent transfers or conveyances or similar remedies under applicable law but not based on actual intent to hinder, delay, or defraud. If a portion of the transfer was made by an entity that is protected under the source of strength provisions in new Section 5(g) of the BHC Act or new Section 45 of the FDI Act discussed above, the agency must have satisfied the requirements of those provisions to be protected. New Section 18(t) of the FDI Act (12 U.S.C. § 1828(f)).

H. Use of Insurance Funds Sec. 117 (pp. 35-36)

Section 117 of the GLB Act amends Section 11(a)(4)(B) of the FDI Act (12 U.S.C. § 1821(a)(4)(B)), which limits using DIFs in certain circumstances to benefit shareholders of DIs. This section is amended to expand the prohibition to include DI affiliates or their subsidiaries, other than a DI that receives assistance in accordance with the provisions of the FDI Act.

I. Application of Fed Prohibitions to AFBAs Sec. 112 (pp. 30-32)

Section 112(b) of the GLB Act adds a new Section 45 to the FDI Act to extend the limitations on the Fed's authority in Sections 111, 112(a) and 113 of the Act to the authority of the AFBAs with respect to DI "functionally regulated affiliates," including DI subsidiaries, under all other statutory schemes, such as the NB Act, the FDI Act or the HOLA. The general purpose of this Section is to limit the ability of all the federal bank regulatory agencies to take supervisory actions with respect to a functionally regulated nonbank entity that is affiliated with a bank or thrift. It is intended to apply the same reporting, examination, capital, source of strength and enforcement limits applicable to the Fed to any AFBA and to serve as an overriding limit on other authority an AFBA may have with respect to nonbanking entities that are DI affiliates or subsidiaries.

Section 45 of the FDI Act states that "Notwithstanding any other provision of law," the applicable provisions of new Sections 5(c), 5(g) and 10A of the BHC Act "shall also limit whatever authority that a Federal banking agency might otherwise have under any statute or regulation to require reports, make examinations, impose capital requirements, or take any other direct or indirect action with respect to any functionally regulated affiliate of a DI, subject to the same standards and requirements as are applicable" to the Fed under those provisions.

The term "functionally regulated affiliate" of a DI means any affiliate that is (1) not a DI holding company, that is, a BHC or savings and loan holding company; and (2) is a functionally regulated affiliate. The term "affiliate" in the FDI Act, 12 U.S.C. § 1813(w)(6), has the meaning


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given to the term in Section 1841(k) of the BHC Act, that is, "any company that controls, is controlled by, or is under common control with another company." 12 U.S.C. § 1841(k).

Section 45 of the FDI Act provides that the FDIC may make an examination of a functionally regulated affiliate, "if necessary to determine the condition" of a DI "for insurance purposes," pursuant to its authority under section 10(b)(4) of the FDI Act, "as may be necessary to disclose fully the relationship between" the DI and the affiliate, and "the effect of such relationship" on the DI.

VIII. SEC. 104: PREEMPTION OF STATE LAW Sec. 104 (pp. 15-22)

When Section 104 of the Act became law, it immediately made a wide range of state laws subject to federal preemption if they impede or disadvantage either the creation of affiliations with DIs or the activities of such affiliates. These provisions apply to any type of affiliation with any DI, not just the FHCs authorized in Section 103. Section 104 is multi-faceted and complex, and it assigns no single regulator primary responsibility for interpreting its provisions. Accordingly, it will take the actions of banking and insurance regulators and probably litigation to develop the meaning and effects of these preemption provisions.

Section 104 addresses a number of substantively and politically sensitive issues. Banks and diversified financial companies sought federal preemption of state laws intended to prevent bank-insurance affiliations or place burdens on sales and cross-marketing of insurance by DIs and their affiliates. Insurance commissioners and many insurance trade groups wanted to preserve state regulation of insurance. They further sought to limit the ability of the Comptroller of the Currency (“OCC”) to expand insurance activities of national banks and the judicial deference given OCC decisions when challenged in the courts. Insurance agent groups particularly wanted to preserve existing state insurance provisions regarded as favorable to independent agents. Extended negotiations produced the complicated Section 104 rules concerning preemption of state insurance provisions. The rules governing insurance marketing and sales are especially complex and apply different tests and standards to various parts of state law, depending upon the date of enactment and subject matter.

A. Overview Of Section 104

1. Already Effective

The Act specifies that Section 104 is effective on the date of enactment -- i.e., when signed by the President on November 12.

2. Broad Preemption to Allow Affiliations with Depository Institutions Sec. 104(c) (p. 15)

It uses broad preemptive language intended to override any state law that would stand in the way of the creation of any affiliation “permitted” by the new Act or any other


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provision of federal law, with particular provisions addressing state insurance law and state review of acquisitions of insurers.

3. Broad Definition of Depository Institution and Affiliated Persons Sec. 104(g) (p. 21)

It applies to affiliates of any bank or savings institution, or of any foreign bank with a U.S. branch, agency, or commercial lending company. An affiliate is any person or entity controlling, controlled by, or under common control with the institution. The affiliate preemption also reaches any entity or person “associated” with a DI.

4. Broad Definition of “Insurer” Sec. 104(g) (p. 21)

Its definition of “insurer” for purposes of the affiliations preemption is equally broad, including “any person engaged in the business of insurance,” i.e., underwriters, brokers, agents, or any other person engaged in insurance as defined under state or federal law, whether a business entity or an individual

5. Broad Nondiscrimination Tests Applicable to State Insurance Sales Laws

Sec. 104(e) (p. 20-21)

Subject to “old law” and “safe harbor” exceptions, state rules concerning the conduct of financial activities, including insurance sales and cross-marketing by any DI or any affiliate, will be preempted if they either “prevent or significantly restrict” such activities or are discriminatory under any one of four relatively stringent tests

6. Special Rule for Pre-9/3/98 State Sales Laws (“Old Law”) Sec. 104(d) (p. 19)

State insurance sales rules or actions as of September 3, 1998, are subject only to a “prevent or significantly restrict” test in accordance with the U. S. Supreme Court decision in the case of Barnett Bank v. Nelson (1996) (“Barnett”), with judicial deference to federal banking agency interpretations in any litigation.

7. Double-Edged “Safe Harbor” Tests Sec. 104(d) (pp. 16-19)

State insurance sales rules that fall into thirteen so-called “safe harbor” categories are not subject to either the “prevent or significantly restrict” test or the nondiscrimination tests, but only if they are “no more burdensome or restrictive” than what is expressly permitted in the Act.


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8. Barnett Preserved Sec. 104(d) (p. 16)

The effect of Barnett is expanded by allowing other banking regulators to apply its preemption standards and by applying it beyond the provision of the National Bank Act at issue in that case. The applicability of the Barnett decision itself to state law other than “safe harbor” provisions is preserved.

9. Broad Nondiscrimination Tests Applicable to State Insurance Nonsales Laws and Laws Affecting All Other Depository Affiliations

Sec. 104(d) (pp. 19-20)

The four nondiscrimination tests also apply to state rules or actions governing nonsales activities of insurance companies, other nonsales insurance activities, or any other activity of a DI or any affiliate.

10. Expedited Dispute Resolution Sec. 304 (pp. 72-73)

The expedited dispute resolution procedure in the federal courts set forth in Section 304 can be used by any state or federal regulator (but not a private party) that questions a preemption determination under Section 104, and (except in Old Law cases) the courts shall review regulatory preemption determinations “without unequal deference.”

B. McCarran-Ferguson Reaffirmed Sec. 104(a) and (b) (p. 15)

The Act generally and Section 104 specifically attempt to follow a “functional regulation” approach . The Act opens the way to full financial affiliations and affirms the roles of banking, insurance, and securities regulators in their respective spheres.

Accordingly, Section 104(a) states that the McCarran-Ferguson Act “remains the law of the United States.” Under that Act, the “business of insurance” is subject to state regulation, except to the extent that a federal statute (such as Section 104 of the Act) “specifically relates” to insurance. 15 U.S.C. § 1011 et seq. Section 104(b) provides that, subject to Section 104(c), (d) and (e), no person or entity may provide insurance as principal or agent in a state unless licensed “as required by the appropriate insurance regulator of such State in accordance with relevant State insurance laws.” These two brief provisions, originally added to Title III of the House bill (H.R. 10) by the House Commerce Committee in 1998 and moved to the beginning of Section 104 in the Senate bill (S. 900), respond to the insurance industry view that the Comptroller of the Currency had intruded into state regulation of insurance.

It should be noted that for purposes of Section 104 the term “insurer” means “any person engaged in the business of insurance” and “State” includes not only the fifty states and the District of Columbia, but also the U.S. territories -- Puerto Rico, Guam, the Virgin Islands, American Samoa, the Northern Mariana Islands, and the Pacific Island trust territory.


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C. Preemption of Restrictions on Affiliations Sec. 104(c) (pp. 15-16)

Section 104(c) of the Act generally preempts any state law restricting the establishment of affiliations with DIs. Although developed with a focus on insurance anti-affiliation laws, this provision is not limited to insurance, but by its terms reaches any state law that adversely affects affiliations with a DI.

1. Broad Preemption for Affiliations with Depository Institutions Sec. 104(c)(1) (p. 15)

In general, under Section 104(c)(1) “no state” may “prevent or restrict” the affiliations authorized or permitted by the Act, or any other provision of federal law. That any affiliation “permitted” under any federal law may be reached indicates the potential, if undefined, scope of this preemption. This preemption reaches all forms of state action, including any statute, regulation, order, interpretation or “other action” that would prevent or restrict directly or indirectly covered affiliations or associations.

The preemption provisions cover not only DIs in a FHC, but all insured DIs, foreign banks with a U.S. branch, agency, or commercial lending company, and all affiliations with DIs of the type permitted under the Act. It reaches persons or entities “associated” with a DI or FHC, but does not define “associate.” In context that term would appear to cover joint venture, contractual, or other relationships among individuals, companies, or other persons engaged in financial or other activities covered by this subsection. Any person or entity “engaged in the business of insurance” is an “insurer” for purposes of these affiliation provisions.

2. Exceptions for State Insurance Regulators

The authority of state insurance regulators to review and approve acquisitions of insurers and state laws protecting demutualized insurers are preserved from preemption as long as they are not discriminatory in practice.

a. State Review of Insurance Affiliations Sec. 104 (pp. 15-22)

Unlike the 1998 version of H.R. 10 which preempted the ability of a state insurance regulator to review or disapprove acquisition of an insurer by a depository organization, the Act adopts the Senate bill (S. 900) approach, permitting state review of such acquisitions on a non-discriminatory basis and subject to time limits. With respect to insurers domiciled in a state, Section 104(c)(2) states that paragraph (c)(1) does not prohibit that state from collecting, reviewing, and taking actions on required applications and other documents concerning acquisitions or changes in control. The final bill also preserves the ability of state insurance regulators to collect information concerning any acquisition or change in control of any insurer engaged in insurance in the state or regulated by the state. Both of these permitted


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state actions must take place during the 60-day period before the effective date of the proposed acquisition or change in control.

Such state action may not “have the effect of discriminating, intentionally or unintentionally, against a depository institution or an affiliate thereof, or against any other person based upon an association of such person with a depository institution.” This provision does not define or characterize discrimination that might invalidate otherwise protected state action. This broad language suggests that any state rule or action concerning a proposed affiliation with a DI that has a discriminatory effect, even if unintended, on a depository organization may be found preempted. (The breadth of this language may be contrasted with the four non-discrimination tests of Section 104(d)(4) and (e).) This potentially sweeping effects test suggests that any denial of an acquisition of an insurer by a depository organization may be litigated.

b. Preservation of State Laws Limiting Takeovers of Demutualized Insurers Sec. 104(c) (pp. 15-16)

Section 104(c)(2)(C) preserves state laws preventing the unfriendly takeover of insurers that have converted from mutual to stock form. It provides that a state may restrict a change in the stock ownership of an insurer, or of a company formed for the purpose of controlling an insurer, after the conversion of such company from mutual to stock form, “so long as such restriction does not have the effect of discriminating, intentionally or unintentionally, against a depository institution or an affiliate thereof, or against any other person based upon an association of such person with a depository institution.” As with the general protection for state approval of insurer acquisitions, this provision means that any state action having a discriminatory effect, even if unintended, may be challenged, and thus does not provide absolute protection for demutualized insurers. Although most state laws protect demutualized companies for a specified period of time (e.g., three years or five years), this federal provision includes no time limit.

A parallel provision is found in Section 306. It provides that no state, other than the insurer’s state of domicile, may prevent or significantly interfere with, or possess the authority to review, approve or disapprove an insurer’s reorganization from mutual to stock form, including as a subsidiary of a mutual insurance holding company.

c. Capital Requirements Sec. 104(c)(2)(B) (p. 15)

Under Section 104(c)(2)(B), the general (c)(2) preemption does not prevent a state from requiring an acquirer of an insurer to “maintain or restore the capital requirements” of the insurance business being acquired to the minimum level prescribed under capital regulations of “general applicability.” This minimum level is described as the level required to avoid having to file a capital restoration plan under state insurance law. The state must make a capital deficiency determination within 60 days from the time that the acquiring


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party files notice and accompanying information with the state insurance regulator, as required by state law preserved under Section 104(c)(2)(A).

3. Partial Preemption of State Laws Governing Affiliations and Investments by Insurers under Section 306 Sec. 306 (p. 78)

Section 306 also addresses the concerns of insurance companies, particularly mutual companies, that investment restrictions or other limits in state law may effectively prevent such a company from operating as a FHC. It provides in effect a minimal uniform federal standard by preempting state investment or other laws that might in practical effect prevent such an insurer from having a DI affiliate. This section is expressly made subject to Section 104(c)(2) and its broad nondiscrimination requirement.

In addition to the demutualization provision discussed above, Section 306 addresses:

a. Insurer-depository affiliations - no state may prevent or significantly interfere with the ability of any insurer or its affiliate to become a financial holding company or to acquire control of a DI.

b. Downstream investment in depository institutions - states are prevented from limiting the amount of an insurer’s assets that may be invested in the stock of a DI, except that the insurer’s state of domicile can limit such investments to not less than 5% of the insurer’s assets.

4. Insurer Redomestication Preemption Under Title III Sec. 312 (pp. 80-82)

The insurance mutual holding company redomestication provisions contained in Title III generally permit an insurer located in a state that as a practical matter does not permit a domiciled insurer to reorganize into a mutual holding company structure to relocate its state of domicile to a state that permits such a structure.

D. Overview of Federal Preemption of State Law Concerning Insurance and Other Activities Sec. 104(d) (pp 16-20)

Section 104(d) establishes a preemption framework governing state rules or actions affecting activities of DIs and their affiliates, including detailed provisions specifically addressing insurance sales and other insurance activities. These provisions will often require a multi-step analysis to determine the effect of state law.

At the threshold, Section 104(d)(1) appears to state a broad federal preemption rule, but as a practical matter it is superseded by the different tests set forth in paragraphs (d)(2) - (4) specifically applicable to insurance sales, insurance activities other than sales (i.e., underwriting and other insurance company activities), and all other activities of DI affiliates. On its face, the


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(d)(1) rule parallels the broad Section 104 (c)(1) language and reaches any state law or action that would “prevent or restrict” an insured DI, or affiliate thereof, from “engaging directly or indirectly, either by itself or in conjunction with an affiliate, or any other person” in any activity authorized or permitted under the Act or the amendments made by the Act. (Unlike (c)(1), this language reaches only all activities permitted under the Act; the (c)(1) preemption is broader, also reaching any affiliation permitted under any provision of federal law.) The net result is that the (d)(1) language appears to have no operative significance, except perhaps in connection with non-insurance law addressed in Section 104(d)(4).

The paragraph (d)(2) provisions governing insurance sales are especially complicated: they include a multi-part general rule and two significant exceptions. The general rule is that insurance sales rules and actions are subject to both a “prevent or significantly restrict” test “in accordance with” Barnett and a strong four-part nondiscrimination test (in Section 104(e)), with disputes litigated under the Section 304 procedures and the “without unequal deference” standard of review.

However, insurance groups were concerned that the new nondiscrimination test would invalidate existing laws that (they believed) could survive scrutiny under the Barnett case standards. The result was a compromise in which Old Law (statutes, rules, or actions in force on September 3, 1998) is made subject only to the “prevent or significantly restrict” test of the general rule, but not the subsection (e) nondiscrimination test, with the proviso that in cases involving Old Law the courts would continue to accord deference to the OCC and other federal banking agencies under the Barnett and Chevron v. Natural Resources Defense Council [467 U.S. 837 (1984)] cases. A second, so-called “safe harbor” exception was made for thirteen specified types of state rules that are protected from preemption under the general rule as long as they conform to detailed federal standards in Section 104 (d)(2)(B).

Under paragraph (d)(3), nonsales insurance provisions are also subjected to the subsection (e) nondiscrimination test. State law or actions concerning activities other than insurance are subject to a parallel four-part nondiscrimination test in paragraph (d)(4). Finally, under Section 104(f) state law concerning corporate governance, antitrust, and securities registration and antifraud enforcement are expressly protected from preemption under Section 104.

E. Insurance Sales Sec. 104(d)(2) (pp. 16-19)

State rules or actions concerning insurance sales, solicitation, or cross-marketing are subject to the detailed, and at times ambiguous, provisions of section 104(d)(2). These provisions evolved in 1998 in a series of negotiations between banking and insurance interests. For banks, the starting point was the preemption analysis followed by the U.S. Supreme Court in a series of cases over many decades, most recently the 1996 Barnett case. That case stated (1) that a state law would be preempted by the National Bank Act if it impeded, prevented, or significantly interfered with the conduct of activities permitted to national banks and (2) that


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under the standards of Chevron, the Court of Appeals had appropriately accorded deference to the interpretations by the OCC, the responsible federal administrative agency.

Insurance groups generally responded to Barnett by arguing that all insurance activities should be regulated under state law under the McCarran-Ferguson Act, and that the OCC should not be able to separately regulate insurance sales activities of national banks under Barnett. They also asserted that Chevron deference to the OCC gave national banks an unfair advantage in litigation challenging state rules regarding insurance activities of such banks and their affiliates. In addition, insurance agent groups sought to preserve state insurance laws governing insurance sales by bank affiliates, some of which were enacted in the wake of Barnett.

1. General rule Sec. 104(d)(2)(A) (p. 16)

Subparagraph (d)(2)(A) states that no state may “prevent or significantly interfere” with the ability of an insured DI, or affiliate thereof, to engage directly or indirectly, either by itself or in conjunction with an affiliate or any other entity or person in insurance sales, solicitation, or cross-marketing activities. This provision is to be interpreted “in accordance with” the legal standards for preemption set forth in the Barnett case. As long as an entity engaged in insurance sales has a DI affiliate, state rules applicable to the insurance sales activities of that entity “by itself” may be preempted under the paragraph (d)(2)(A) standard. This standard applies to state statutes, regulations, orders, interpretations, or other action regarding insurance sales, marketing, or cross-marketing, except those described in the Safe Harbor.

In addition, subject to the Old Law and Safe Harbor exceptions, state insurance sales rules and actions are subject to the four-part nondiscrimination test in Section 104(e), described below.

Disputes between regulators with respect to possible preemption of sales rules and actions (except for Old Law provisions) are governed by the expedited dispute resolution provisions in Section 304 ( discussed below). In brief, under that provision, a dispute between a state insurance regulator and a federal banking agency over an insurance-related issue is to be determined by the courts “without unequal deference.”

2. “Old Law” Sec. 104(d)(2)(C) (p. 19)

Section 104(d)(2)(C) embodies a compromise with respect to preemption standards applicable to Old Law -- a state insurance sales “statute, regulation, order, interpretation or other action . . . that was issued, adopted, or enacted before September 3,1998,” the date chosen when the insurance compromise was reached. It leaves Old Law subject to the (d)(2) “prevent or significantly interfere” test. However, it provides in clause (i) that any state insurance sales, solicitation or cross-marketing regulation adopted prior to September 3, 1998, and outside the Safe Harbor, will not be subject to the special “no unequal deference” rule of Section 304. This means that judicial deference to federal banking agency positions under


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Chevron is retained for Old Law cases. Clause (ii) states that Old Law will not be subject to the nondiscrimination standards set forth in Section 104(e).

The use of a “bright line” date to characterize Old Law may not be as clear as first it might appear. Questions may still be raised about whether a specific provision or action is subject to the general rule or the Old Law exception. For example, how are statutes or rules re-enacted or amended after this date to be treated, or interpretations or “other actions” issued after that date that are based upon prior interpretations but not identical.

3. Barnett preserved Sec. 104(d)(2)(C)

Further ambiguities may be presented by clause (iii)(I) of Section 104(d)(2)(C), which expressly preserves the Barnett case. It states that “[n]othing in this paragraph [(d)(2)]shall be construed . . . to limit the applicability” of the Barnett decision to any state statute, regulation, order, interpretation, or other action not described in the Safe Harbor. This may be read to suggest that because the Barnett case concerned the interpretation of the National Bank Act that this provision applies only in cases involving interpretation of that Act. It should be remembered that the general (d)(2) standard, which applies to all insurance sales activities of DI affiliates, is by its terms to be applied “in accordance with” Barnett’s legal standards for preemption.

4. “Safe Harbor” Sec. 104(d)(2)(B) (pp. 16-19)

Subparagraph (2)(B) provides a “safe harbor” that provides protection from potential federal preemption for thirteen specified types of state laws (whether adopted before or after September 3, 1998). However, at the same time, these provisions represent a federal standard against which state rules in these thirteen areas must be measured. Disputes between regulators over the application of the safe harbor are governed by the Section 304 procedures and standard of review.

The Section 104(d)(2)(B) “safe harbor” provisions allow states to impose restrictions that fall into thirteen enumerated categories so long as the restrictions “are substantially the same as but no more burdensome or restrictive” than the provisions of this paragraph. “Safe harbor” is thus at least a partial misnomer because state restrictions in these thirteen areas that are more burdensome or restrictive are not protected, and the specific terms of the thirteen enumerated items do not appear to leave much room for mischief. In addition, this paragraph does not include a severability clause, and the lack of such a clause should mean that those state rules or actions that exceed the bounds of a Safe Harbor provision may fail in their entirety, not just to the extent they exceed what is permissible under this paragraph.

• = Protection for unassociated insurance issuers or underwriters (i): If an insurance policy is required in connection with a loan or extension of credit, states may prevent insured DIs, or affiliates thereof, from rejecting a policy solely on


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the basis that a person not associated with that institution issued or had underwritten the policy.

• = One fee for insurance services (ii): When insurance is required in connection with a loan or extension of credit or other traditional banking product, states may prohibit insured DIs or affiliates thereof, from charging a “debtor, insurer, insurance agent or broker” a separate fee, unless such fee would be required when the institution or an affiliate serves as the insurance agent or broker providing the insurance.

• = Advertising restrictions (iii): States may restrict insured DIs, or affiliates thereof, from using any advertisements or distributing other “insurance promotional material” that would cause a reasonable person to believe mistakenly that a state or the Federal Government stands behind the credit of the institution or affiliate, is responsible for the insurance sales activities, guarantees any returns on insurance products or pays any insurance benefits.

• = State licensing requirements (iv): The state may require any person who receives any commission or brokerage fee for “services as an insurance agent or broker” to hold a valid state license for the applicable class of insurance, but such services do not include a referral by an unlicensed person that does not include a discussion of “specific insurance policy terms and conditions.”

• = Referral fee restrictions (v): States may prohibit insurance companies from paying referral fees “based on the purchase of insurance by the customer” for referrals by an unlicensed person to a licensed person of customers who seek to purchase, or who seek opinion or advice on, an insurance product.

• = Privacy requirements for policyholder information (vi) and (vii): States may prohibit the release of customer insurance information to persons other than an employee, agent or affiliate of a DI for the purpose of “soliciting or selling insurance” without the express consent of the customer. The information covered includes information about the policy itself, such as premiums, terms and the conditions of coverage and customer claims contained in the records of an insured DI or affiliate thereof. This restriction on information sharing does not apply to any officer, director, employee, agent, subsidiary or affiliate of an insured DI. States also cannot prohibit the provision of information (i) in connection with the transfer of insurance in force on existing insureds of an insured DI or affiliate thereof, to an unaffiliated insurance company, agent or broker, (ii) in connection with a merger with or acquisition of such an unaffiliated company, agent or broker, or (iii) where the release of information is authorized by state or federal law. States may prohibit the release of health information derived from a customer’s insurance records for any purpose other than for the activities of a licensed agent or broker, unless the insuring institution receives the customer’s


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permission. Title V, which was added subsequent to the Section 104 compromise, of course contains more detailed privacy provisions.

• = Separations between credit approval and insurance (viii) and (ix): States may prohibit the extension of credit or any equivalent product to a customer, or varying the consideration for any product, on “the condition or requirement that the customer obtain insurance” from an insured DI or affiliate thereof or any other particular insurer, agent, or broker, subject to exceptions noted below. Although such institutions may impose “reasonable requirements” on the credit-worthiness of any insurance provider or on the scope of coverage that a customer may choose, where insurance is offered or required in connection with a pending loan application, states can require that the customer be informed in writing that his or her “choice of an insurance provider” will not affect the credit decision or credit terms. States may not prohibit an insured DI or affiliate thereof, from informing a customer that obtaining a loan requires insurance, that approval is contingent on procuring acceptable insurance, or that the institution where they are applying for credit provides that insurance. Nor may states prohibit any insured DI or affiliate from engaging in any activity permissible under the antitying provisions of the Bank Holding Company (“BHC”) Act Amendments of 1970.

• = Disclosure of insurance risks (x): When a customer buys an insurance policy from an insured DI or an affiliate, states may require the bank to clearly and conspicuously disclose, in writing “when practicable,” to its customer that the policy is not a deposit, is not insured by the FDIC, is not guaranteed by the institution (or any affiliate or person soliciting or selling insurance on the premises thereof) and “where appropriate, involves investment risk, including potential loss of principal.” The federal consumer protection rules required under Section 305 also require this disclosure.

• = Separation of credit and insurance transactions (xi) and (xii): States may require an insured DI or an affiliate thereof, or any person soliciting the purchase of or selling insurance on the premises of these institutions, to use separate credit and insurance transaction documents (other than for credit or flood insurance). States may also prevent insured DIs, or subsidiaries or affiliates thereof, or any person soliciting the purchase of or selling insurance on the premises thereof, from including customers insurance premiums (other than for credit or flood insurance) in the primary credit transaction without the express written consent of the customer.

• = Requirement of maintaining separate books for insurance transactions (xiii): Banking institutions may be required to maintain “separate and distinct books and records relating to insurance transactions,” including customer complaints. Such books and records may be required to be made available for inspection by the state insurance regulator.


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5. “No Inferences” Sec. 104(d)(2) (p. 19)

Clause (iii)(II) provides that nothing in paragraph (d)(2) “shall be construed . . . to create any inference” with respect to any state provision or action not referred to or described in that paragraph.

6. Nondiscrimination Sec. 104(e) (pp. 20-21)

Under Section 104(e), nondiscrimination standards apply to any state law or action applicable to the insurance activities of any affiliate of a DI, whether structured as a FHC, a savings and loan holding company, a free-standing bank or thrift with an affiliated insurance agency, or a third-party sales or marketing arrangement. These nondiscrimination standards apply to all state insurance regulations except for sales regulations that were enacted prior to September 3, 1998, or that are within the Section 104 “safe harbor.” There are four separate nondiscrimination tests.

Under these provisions, no state may regulate the insurance activities permitted under this Act or “any other provision of Federal law” of insured DIs or affiliates thereof to the extent that such rule or action:

a. “distinguishes by its terms” between such institutions or affiliated entities and other persons or entities engaged in insurance activities “in a manner that is in any way adverse” to such DI or affiliated entity;

b. “as interpreted or applied, has or will have an impact” on such DIs and affiliated entities that is “substantially more adverse” than its impact on other persons or entities (that are not such DIs or affiliated entities) providing the same products and services or engaged in the same activities;

c. “effectively prevents” such a DI or affiliated entity from engaging in any insurance activity permitted by this Act or any other provision of federal law; or

d. “conflicts with the intent of this Act” and the amendments made by this Act to allow affiliations permitted by this Act or other federal law.

A state insurance sales law, except for Old Law and Safe Harbor provisions, found wanting under any of these tests is preempted.

F. State Law Governing Insurance Activities Other than Sales Sec. 104(d)(3) (p. 19)

Section 104 (d)(3) provides the preemption rule for state insurance laws governing all insurance activities other than sales, solicitation and cross-marketing, such as underwriting, investment and other activities of insurance companies. It uses a double-negative construction that supersedes not only the (d)(1) “prevent or restrict” language, but also the (d)(2)(A) “prevent


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or significantly restrict” test. The net effect of this provision is to preserve state regulation of insurance underwriters and other providers of insurance as long as state regulation is nondiscriminatory under the standards of Section 104(e).

The paragraph (d)(3) language specifically provides that state statutes, regulations, interpretations, orders or other actions shall not be preempted to the extent that they meet four tests. To be protected from preemption, a state law or action must be--

• = “insurance” regulation--it must “relate to,” or be enacted “for the purpose of regulating the business of insurance” in accordance with the McCarran-Ferguson Act ;

• = not apply to a DI--it may apply only to persons or entities that are not insured DIs, but are directly engaged in the business of insurance (including subsidiaries or affiliates of DIs and the savings bank life insurance underwriting activities of banks);

• = not regulate sales--it must not relate to or directly or indirectly regulate insurance sales, solicitations or cross-marketing activities (which are addressed in Section 104(d)(2)); and

• = not be discriminatory--it must not be prohibited under the nondiscrimination standards of Section 104(e).

Taken together, these provisions mean that any person or entity (other than a DI) engaged in the “business of insurance” other than insurance sales, solicitation or cross-marketing will be subject to any state law that meets the nondiscrimination test. Insurance subsidiaries or affiliates of DIs thus are subject to the same rules as all other insurance providers. The exception for insurance activities conducted directly by DIs is relatively narrow because banks have generally not been authorized to engage directly in nonsales “insurance” activities; state banks have been limited since 1991 under Section 24 of the Federal Deposit Insurance Act, and Title III of the Act expressly bars new insurance activities as principal by national banks.

G. State Law Governing Activities Other Than Insurance Sec. 104(d)(4) (p. 20)

Parallel to paragraph (d)(3), Section 104(d)(4) addresses state laws or actions that regulate activities other than insurance. This provision subjects any state statute, regulation, order, interpretation or “other action” affecting any DI or any affiliate thereof to several nondiscrimination tests. Because of the breadth of this preemption provision, the subsection (f) exclusion for certain state corporate, antitrust, and securities provisions was added. This exclusion serves to underscore the broad range of state laws that remain subject to review under these (d)(4) standards.


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Paragraph (d)(4) employs the same double negative structure as the paragraph (d)(3) provisions and similarly applies nondiscrimination tests to other state laws that may adversely affect DIs or any affiliate.

This provision first excludes state law addressed elsewhere in Section 104: insurance sales, solicitations or cross-marketing activities covered under paragraph (d)(2); insurance activities other than sales, solicitations, or cross marketing activities, covered under paragraph (d)(3); or securities investigations or enforcement actions referred to in paragraph (f)(1).

State laws and actions not subject to these exclusions must meet four nondiscrimination tests to avoid preemption. The effect of this subparagraph is to preserve a state law or action that may prevent or restrict an activity (other than insurance) of a DI, or any affiliate, if it meets all four of the nondiscrimination tests.

The (d)(4) nondiscrimination tests are substantively the same as the ones in subsection (e). Such “other” state law is subject to preemption to the extent that it:

1. “distinguishes by its terms” between such institutions or affiliated entities and other persons or entities engaged in the activity at issue and other persons engaged in that activity “in a manner that is in any way adverse” to such DI or affiliated entity;

2. “as interpreted or applied, has or will have an impact” on such DIs and affiliated entities that is “substantially more adverse” than its impact on other persons or entities (that are not such DIs or affiliated entities) providing the same products and services or engaged in the same activities;

3. “effectively prevents” such a DI or affiliated entity from engaging in any activity permitted by this Act or any other provision of federal law; or

4. “conflicts with the intent of this Act” to allow affiliations permitted by this Act or other federal law.

H. Preservation of State Securities, Corporate Governance, and Antitrust Laws Sec. 104(f) (p. 21)

An across-the-board exemption from Section 104 preemption is provided for certain state laws to avoid unintended consequences.


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1. Jurisdiction of State Securities Regulators to Enforce State Antifraud Laws Sec. 104(f)(1) (p. 21)

Section 104(f)(1) provides that subsections 104(c) and (d) shall not be construed to affect the jurisdiction of the securities commission (or any agency or office performing like functions) of any state, under the laws of such state, to investigate and bring enforcement actions, consistent with Section 18(c) of the Securities Act of 1933, with respect to fraud or deceit or unlawful conduct by any person in connection with securities or securities transactions. State laws governing registration of broker-dealers, investment advisers, or associated persons (that are consistent with the federal securities laws) are also preserved.

2. Corporate Governance and Antitrust Laws Sec. 104(f)(2) (p. 21)

In response to the concern that provisions of state corporate or antitrust laws might be found to “prevent or restrict” affiliations among financial firms, Section 104 includes express protection for such state laws. Section 104(f)(2) states that Section 104(c) and (d) are not to be construed to affect state laws, regulations, orders, interpretations or other actions of general applicability relating to the governance of corporations, partnerships, limited liability companies or other business associations incorporated or formed under the state’s laws or domiciled in that state provided they are “not inconsistent with the purposes of this Act” to permit financial affiliations.

This provision also preserves the applicability of the antitrust laws of any state or any state law that is similar to antitrust laws. Section 104(g)(2) defines “antitrust laws” to have the same meaning as in Section 1(a) of the Clayton Act (15 U.S.C. § 12), and Section 5 of the Federal Trade Commission Act (15 U.S.C. § 45) to the extent that the latter relates to unfair methods of competition.

I. Expedited Dispute Resolution Sec. 304 (pp. 72-73)

The Section 104 provisions are free-standing and do not amend any existing federal banking or other statute. In addition, no administrative agency is given regulatory authority to administer or interpret Section 104. This structure means that in the first instance state insurance regulators and the federal banking agencies each might interpret Section 104, but it also means that the courts will be called upon to provide more definitive interpretation. The expedited dispute resolution procedure of Section 304 can be used by any state or federal regulator that questions a preemption determination under Section 104. However, nothing in Section 304 indicates that any of its provisions apply to private party litigation in which Section 104 preemption issues may rise. (See the discussion of Section 304 on page 53-54)


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IX. BANK-INSURANCE ISSUES--BACKGROUND

Until the last few years, insurance companies and agent groups generally opposed affiliations between banks and insurance agencies or companies, and sought to limit banking company expansion into insurance activities. During the 1970s particularly, insurance agent groups succeeded in amending the laws of perhaps half the states to limit the ability of banks to sell insurance or have insurance brokerage or agency affiliates. Some of these laws also specifically barred affiliations of banks and insurance companies, while others indirectly had that effect.

The pre-GLB Act federal statutory framework was established in 1982, in Title VI of the Garn-St Germain Act, when insurance interests succeeded in amending the BHC Act to limit strictly the insurance affiliations permitted to a BHC and the ability of BHCs to expand their insurance sales capacity. An effort by banking organizations subsequently to use state bank affiliates as a platform for broader insurance affiliations was largely cut off in the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA").

In the 1980s, banking organizations increasingly focused on the provision of the NB Act authorizing national banks to operate insurance agencies in towns with 5,000 or fewer inhabitants. They also explored the ability of a national bank, or a bank subsidiary, to offer annuities or other insurance-type products under the "incidental to banking" powers of the NB Act. Two unanimous U.S. Supreme Court cases upheld these initiatives and dramatically changed the politics and nature of the bank-insurance issues.

In 1995, in Nations Bank v. Variable Annuity Life Ins. Co. ("VALIC"), 513 U.S. 251 (1995), the Supreme Court unanimously upheld the determination of the OCC that annuities are financial products that can be sold by a national bank throughout the country, and are not "insurance." The VALIC opinion endorsed a broad view of the OCC’s power to determine the scope of the language in the NB Act authorizing national banks to exercise "all such incidental powers as shall be necessary to conduct the business of banking," citing Chevron U.S.A. Inc. v. Natural Resources Defense Council ("Chevron"), 467 U.S. 837 (1984). In early 1996, in Barnett Bank v. Nelson ("Barnett"), 517 U.S. 25 (1996), the Supreme Court again unanimously upheld the OCC in its determination that the NB Act provides express authority for a national bank to acquire and operate an insurance agency in a town-of-5000, and thus preempts a state law that on its face prohibited such an affiliation. In both of these cases, the Court considered and rejected the argument that the OCC’s determinations were contrary to the McCarran-Ferguson Act (15 U.S.C. §§ 1101 et seq.).

These cases opened the door to a potentially broad expansion of national bank insurance activities by affirming the federal law authority of national banks to engage in insurance activities. The belief within the insurance industry that the competitive positions of insurance agents and companies was effectively protected from bank competition by Title VI or state laws protected from preemption under the McCarran-Ferguson Act.


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The GLB Act effectively reverses Title VI and permits bank-insurance and other "financial" affiliations, but preserves the substance of state regulation of insurance. It addresses the issue of state regulation of insurance, the extent of federal preemption, the insurance activities of national banks and their subsidiaries, and the deference to be given to the OCC by the courts. As discussed below, the Act limits the ability of national banks to expand into any new activity that would be regarded as functionally insurance underwriting.

X. INSURANCE ACTIVITIES OF NATIONAL BANKS

A. Overview

The compromise regarding the insurance activities of national banks is contained in Title III and consists of the following core elements: (i) national banks and their subsidiaries are precluded from all insurance underwriting except for products authorized prior to January 1, 1999, and certain enumerated products that include "an insurance component"; (ii) for products first offered after January 1, 1999, state insurance regulators have the authority to determine which products constitute insurance; (iii) in categorizing new products, "insurance" is defined with specific reference to existing state insurance law and to provisions of the federal tax code providing special treatment to certain insurance and annuity products, and with express exclusions for specified bank products; (iv) national banks generally may not underwrite or sell title insurance; and (v) disputes between a federal banking regulator and a state insurance regulator are subject to expedited review by a U.S. Court of Appeals in a procedure that does not afford federal banking agencies their customary deference under the Chevron case. The provisions of S. 900 and H.R. 10 as passed by the Senate and House organized these provisions somewhat differently, but were substantively quite similar. The Act largely adopts the H.R. 10 structure and language.

B. Functional Regulation of Insurance Sec. 301 (p. 70)

Section 301 states that the insurance activities of "any person," including a national bank engaging in insurance sales under the "town-of-5000" provisions, "shall be functionally regulated by the States," subject to the preemption provisions of Section 104.

C. National Bank Insurance Activities

1. Scope of Principal Activities Sec. 302(a) and (b) (p. 70)

In general, except for "authorized product," national banks may provide "insurance" as principal only to the limited extent permitted to subsidiaries under Section 121 of the Act, which adds new Section 5136A of the Revised Statutes. A product is authorized if: (i) as of January 1, 1999, the OCC had determined in writing that national banks may provide such product, or national banks in fact were providing it as principal; (ii) no court in writing had overturned an authorizing OCC determination; and (iii) the product is neither title insurance nor


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an annuity contract subject to tax treatment under I.R.C. § 72. Title insurance activities of national banks are addressed under Section 303.

2. Definition of "Insurance" Sec. 302(c) (pp. 70-71)

The Act includes a three-part definition of insurance. "Insurance" is--

• = "any product regulated as insurance as of January 1, 1999, in accordance with the relevant State insurance law, in the State in which the product is provided";

• = any product first offered after January 1, 1999, that a state insurance regulator determines to be insurance because it insures, guarantees, or indemnifies against liability, loss of life, loss of health, or loss through damage to or destruction of property, including, but not limited to, surety bonds, life insurance, health insurance, title insurance, and property and casualty insurance (such as private passenger or commercial automobile, homeowners, mortgage, commercial multiperil, general liability, professional liability, workers' compensation, fire and allied lines, farm owners multiperil, aircraft, fidelity, surety, medical malpractice, ocean marine, inland marine, and boiler and machinery insurance), and that does not qualify for the bank products exception (described below); or

• = any annuity contract subject to tax treatment under I.R.C. § 72 (this provision reverses the portion of the VALIC case that found that annuities were not "insurance.")

3. Bank Products Exception Sec. 302(c)(2)(B) (p. 71)

The bank products exception excludes from the definition of insurance any bank product or service that is (i) a deposit product; (ii) a loan, discount, letter of credit, or other extension of credit; (iii) a trust or other fiduciary service; (iv) a qualified financial contract, as defined in FDI Act Section 11(e)(8)(D)(i) (12 U.S.C. § 1821(e)(8)(D)(i)); or (v) a financial guaranty.

This exception does not apply to certain products that include an "insurance component" such that, if offered by the bank as principal, would qualify: (i) as an insurance contract under I.R.C. § 7702; or (ii) for treatment of losses under I.R.C. § 832(b)(5) if the product is not a letter of credit "or other similar extension of credit," a qualified financial contract or a financial guaranty.

4. Offshore Insurance Activities Sec. 302(d) (p. 71)

In Conference, a rule of construction was added stating that insurance or reinsurance provided outside of the United States that insures, guarantees, or indemnifies an


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insurance company for products provided in this country shall be regarded as providing insurance as principal in the states where the insurance is provided.

5. Title Insurance Sec. 303 (pp. 71-72)

The Act generally prohibits any national bank from engaging in "any activity involving the underwriting or sale of title insurance." In a state that permits state banks to engage in title insurance sales as agent, a national bank or its subsidiary may also sell title insurance in the state on the same basis and in the same manner as state banks. The Act further specifies that state "wild card" statutes may not authorize title insurance activity.

A grandfather is provided for title insurance activities "actively and lawfully" conducted prior to enactment by a national bank or one of its subsidiaries. However, if a national bank has an affiliate (that is not also a subsidiary) that provides insurance as principal, neither the bank nor any subsidiary may engage in the underwriting of title insurance." If a subsidiary of a national bank provides insurance as principal (but no non-subsidiary affiliate does), the bank may not engage in "any activity involving" title insurance underwriting.

The 1999 House Banking Committee Report states that this provision "should not be construed" as limiting the ability of any national bank located and doing business in a town of 5,000 or less to sell title insurance, even if it is not doing so on date of enactment. However, in a further provision, subsection 303(e) states that nothing in this Act or in federal law preempts any state law in effect prior to the date of enactment of this Act that prohibits the offer, provision, or sale of title insurance, or the underwriting of title insurance on any real property in the state, by "any person whatsoever." The Report also states that neither section 104 of H.R. 10 nor current section 92 of the NB Act (the town-of-5000 provision) shall be construed to preempt such an existing state prohibition on the sale of title insurance. 1999 House Banking Committee Report at 160.

D. Disputes Over New Insurance Products Sec. 304 (pp. 72-73)

Insurance interests reacting to the VALIC and Barnett cases concluded that national banks would have an unfair advantage in litigation concerning the scope of bank insurance activities or the applicability of state law to federally insured DIs because of judicial deference to the interpretations of the OCC or other federal agencies. Banking interests countered that under the Chevron case the OCC’s interpretations of the NB Act are entitled to the same deference as paid by the courts to other federal agencies interpreting the statutes given such agencies to administer. Although this debate was important and sensitive politically, it largely missed the legal point that under current law, no federal agency including the OCC should receive federal judicial deference in a case involving an activity that is the "business of insurance" committed to the states under the McCarran-Ferguson Act (15 U.S.C. § 1101 et seq.), unless a federal statute expressly covered the insurance activity at issue and thus provides for federal agency jurisdiction. The VALIC case won by the OCC turned on court's determination that the OCC could reasonably conclude that


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annuities were investment products under the NB Act, not "insurance," while the Barnett "town-of-5000" case dealt with a federal statute specifically addressing insurance.

Against this background, insurance interests sought a statutory provision that would ensure that in litigation concerning bank-insurance issues, state insurance regulators and the OCC or other federal agencies would be on the same footing before the court. Section 304 creates a special dispute-resolution process that responds to insurance industry concerns.

1. Appellate Review Sec. 304 (p. 73)

In Section 304, the Act addresses the concern that Chevron deference unfairly advantaged the OCC and banking groups in litigation over determinations by the OCC that national banks could engage in insurance sales activities despite a state law that would appear to restrict such activity. Section 304 provides expedited and equalized judicial review by a U.S. Court of Appeals of disputes between a federal banking regulator and a state insurance regulator regarding insurance issues, including whether federal law preempts a state insurance provision. Such disputes may involve the Fed, OCC, OTS or FDIC with respect to any insured bank or thrift. In such a case, the court must render its judgment within 60 days of the filing of the petition for review, unless the parties agree to an extension. Supreme Court review of such a decision shall be sought “as soon as practicable” after the Appeals Court judgment is issued.

2. Deference Sec. 304(e) (p. 73)

This section also specifies a standard of judicial review for any case filed under this provision. It states that the court shall make its decision “based on its review on the merits of all questions presented under State and Federal law, including the nature of the product or activity and the history and purpose of its regulation under State and Federal law, without unequal deference.” The deference issue was highly controversial and symbolic among banking and insurance organizations and this compromise was important to the legislative process. However, the Act generally implements a functional regulation approach to banking and insurance activities, reaffirming the McCarran-Ferguson policy committing regulation of the “business of insurance” to the states. Accordingly, state action within the McCarran delegation and federal banking agency interpretations of banking laws should each be given weight by federal courts under any standard of review. It thus remains to be seen whether the inclusion of the Section 304 “without unequal deference” standard will prove to have been more important for its symbolism than its practical effect. Moreover, because Section 304 by its terms applies only to cases brought by a regulator, it does not address the standard of review a court would apply in a case brought by private litigants in which a regulatory determination is at issue.

3. Statute of Limitations Sec. 304(d) (p. 73)

Consistent with expedited review and a desire for resolution of issues, the Act contains a relatively short statute of limitations provision. No action under this provision may be filed after


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the later of the end of (i) the 12-month period dating from the first public notice of the final form of the order, ruling, or determination, or (ii) six months from the effective date of such regulatory action.

XI. SUBSIDIARIES OF BANKS

A. Background

1. The 1996 OCC Part 5 Rule

Under longstanding OCC regulations, an operating subsidiary of a national bank may engage in activities that are "part of, or incidental to, the business of banking." Over the years, the OCC has gradually expanded the scope of activities permissible for subsidiaries of national banks on a case-by-case basis. In the VALIC case, the ability of an operating subsidiary to sell annuities was upheld by the Supreme Court. The VALIC opinion suggested that the OCC might have significant latitude in determining that financial activities might be "incidental to banking" under the NB Act.

In 1996, the OCC published a revised operating subsidiary regulation as part of a general update of 12 C.F.R. Part 5 ("Part 5"). That regulation included a provision allowing the OCC to approve an application by a national bank for an operating subsidiary to engage in an "incidental to banking" activity that might not have been permissible for the national bank itself to engage in. For example, an operating subsidiary might engage in securities underwriting consistent with Section 20 of the Glass-Steagall Act, but barred for the bank itself under Sections 16 and 21 of that statute.

The publication of Part 5 engendered considerable controversy. Critics charged that the OCC was going beyond its statutory authority. The securities and insurance industries expressed particular concern that the OCC was dismantling Glass-Steagall restrictions and opening the door for banks to engage in securities and insurance activities without affording those industries the benefit of a two-way street.

The Treasury Department's 1997 financial modernization bill would have codified Part 5 and permitted operating subsidiaries of national banks to engage in the same financial activities as affiliates of BHCs subject to the same affiliate transaction rules, and would also have permitted insurance underwriting to be conducted in an operating subsidiary. It would not, however, have permitted real estate development activities.

2. Background Concerning Subsidiaries of State Banks

It should be noted that this controversy over subsidiaries of banks focused on national banks. Since 1991, activities of state banks and their subsidiaries have been subject to Section 24 of the FDI Act (12 U.S.C. § 1831a), which in general provides that neither a state bank nor one of its subsidiaries may engage in any activity as principal unless the activity is permissible for a national bank, or unless the FDIC permits it based upon a determination that the activity poses no significant risk to the DIF and the bank is in compliance with applicable


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capital standards. Further, all but a few states have so-called "wild card" statutes that provide a state law basis for state banks to engage in activities authorized or permitted for national banks. Any expanding national bank subsidiary activities as principal is likely to open the way for a similar expansion for state banks. (But note that Section 305 of H.R. 10 specifically limits the use of state "wild card" authority to engage in title insurance activities.)

The GLB Act adds a new Section 46 to the FDI Act that largely confirms the existing federal-state framework for state banks. Expansion of state bank subsidiaries into new financial activities as principal are likely to be reviewed on an activity by activity basis by the FDIC to determine whether the new activity is governed by Section 24 of the new Act.

3. The Operating Subsidiary Controversy

The issue of whether national banks should be able to engage in wide ranging financial activities in subsidiaries, or whether the expanded financial activities provided in the pending proposals should be conducted only in a FHC structure proved controversial throughout the debate on S. 900 and H.R. 10. It raised important issues about the scope and flexibility of the national bank charter and the role of the OCC, the Treasury, and the Administration in the development of financial services policy. In both 1998 and 1999, the Administration stated in strong terms its intention to veto S. 900/H.R. 10 if it contained provisions limiting national bank operating subsidiaries to only financial agency activities or of a financial nature.

Chairman Greenspan and the Fed took the position that operating subsidiary powers must be limited due to economic distortion resulting from the subsidy the Fed asserts bank subsidiaries receive from the federal deposit insurance and other safety net benefits provided to the bank. The Fed also argued that the ability of national banks to choose whether to engage in financial activities through a subsidiary or a holding company affiliate might tend to undermine the role of the BHC and thus the supervisory role of the Fed in the evolution of the banking and financial system. The OCC and the Administration countered that neither national banks nor their subsidiaries in fact benefit from any subsidy and that they have no intent to undercut the present holding company system. They also expressed concern that the future of the national bank charter would be imperiled if subsidiaries of national banks could not engage in the same activities as their affiliates. They further stressed that subsidiaries with the ability to engage in a wide range of financial activities would tend to promote safety and soundness by diversifying the sources of income to the bank.

The steadfastness of the Administration's veto threat encouraged compromise efforts. The 1997 House Banking Committee bill had provided operating subsidiaries with financial activities parallel to those authorized for FHCs (except for insurance underwriting, merchant banking, and real estate development). This year, H.R. 10 was again amended in the House Banking Committee to include a broad operating subsidiary provision acceptable to the Administration (again excluding insurance and real estate development activities).

Further, the 1999 House Banking Committee Report supported the Administration’s policy analysis:


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With regard to the subsidy issue, the Committee concluded that while there was a degree of validity to the Federal Reserve's concerns, the issue was economically de minimis. Given the stipulation of Chairman Greenspan that the cost of regulation exceeded the cost of funds advantage a federally insured institution enjoys, and given the marginality of the case, if one exists, that the cost of funds for affiliates might be higher than costs for operating subsidiaries, the Committee opted for greater financial institution flexibility, with the understanding that it was important to ensure maintenance of the dual banking system rather than instill that system with disincentives for an institution to charter as a national bank.

1999 House Banking Committee Report at 100.

4. The Final House and Senate Bills

The House Banking Committee this year expanded the financial activities of operating subsidiaries in H.R. 10 and largely restored the approach it had taken in 1997. As a result, H.R. 10 authorized a national bank to have a subsidiary engaged in financial activities (a "financial subsidiary") in a set of provisions that substantially parallel the provisions of new BHC Act Section 6 of the BHC Act for financial subsidiaries of holding companies. New Revised Statutes Section 5136A.

S. 900 by contrast allowed only free standing national banks with assets up to $ 1 billion to have a subsidiary that may engage in financial activities as principal. All national banks in a holding company and free standing banks above that asset ceiling would be limited to subsidiaries engaged in only financial agency activities.

B. The Conference Compromise

The GLB Act includes a set of provisions concerning subsidiaries of national banks that was worked out during the Conference between representatives of the Treasury/OCC and the Fed. It brought to rest one of the most contentious issues throughout the H.R. 10/S. 900 process. These provisions permit national banks to engage in most financial activities through a subsidiary, but they supersede the existing OCC Part 5 rules and effectively limit the ability of the OCC to determine the scope of activities of subsidiaries of national banks under the NB Act. Indeed, the authority to determine what additional activities may be permitted to a financial subsidiary is not given to the OCC, but jointly to the Treasury and the Fed.

It is also possible that these amendments to the NB Act may be read to place an outer limit on the range of activities that may be conducted in the national bank itself. Under the VALIC case and Part 5, it would be possible for the "business of banking" to be construed broadly to include a range of nontraditional financial activities. The enactment of a separate provision addressing "financial" activities of bank subsidiaries, plus the provisions limiting both insurance and securities activities of national banks under Titles II and III, together may mean that "banking" will have a less expansive reach than the OCC may have thought possible under pre-GLB Act law. There is no small irony in the fact that while the original Glass-Steagall Act limited bank securities activities without limiting the scope of the NB Act itself, this 1999


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"financial modernization" legislation fundamentally changes, and potentially narrows, that landmark 1863 banking legislation.

C. National Bank Financial Subsidiaries

A new Section 5136A, “Financial Subsidiaries of National Banks,” is added to the National Bank Act (Revised Statutes). It does not directly amend any existing provision of the NB Act and thus on its face does not affect the powers and activities of national banks. The Conference Report, however, states the intent of the Conferees that this new section, and regulations thereunder, supersede and replace the OCC’s Part 5 regulations on operating subsidiaries. Conference Report at 7. The OCC is directed to adopt regulations implementing new Section 5136A within 270 days of enactment, or by August 12, 2000.

1. Financial Activities, With Exceptions Sec. 121 (p. 36)

A national bank may control or hold an interest in a “financial subsidiary,” subject to a number of conditions and limitations. A financial subsidiary is defined as any company controlled by one or more insured banks other than a subsidiary that "engages solely" in activities permissible for national banks to engage in directly.

A financial subsidiary may engage in any activity that is financial in nature or incidental to a financial activity as well as any activity authorized for national banks directly (subject to the same terms and conditions applicable to the bank). Subject to certain exclusions, a national bank financial subsidiary may engage in the same activities as a FHC subsidiary. The statute specifically excludes the following activities:

• = underwriting insurance or annuities, except to the extent permitted in sections 302 or 303(c) the insurance activities permitted to national banks under Title III (see above).

• = real estate investment or development, except as may be otherwise expressly authorized by law; or

• = activities permitted through insurance investments or merchant banking, as described in new BHC Act section 4(k)(4)(H) or (I). Section 122, however, provides that in five years (November 12, 2004) the Treasury and Fed may determine whether to authorize merchant banking activities.

Financial activities include all activities permitted under new Section 4(k) of the BHC Act or permitted by regulations adopted by the Secretary of the Treasury, under procedures parallel to the one provided for expansion of financial activities for FHCs. This procedure allows the Fed to block any determination that an activity is “financial” or “incidental to financial” for a national bank subsidiary.


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2. Qualification Requirements Sec. 121 (pp. 36-43)

The OCC must approve an application by a national bank for a financial subsidiary "based solely upon the factors" set forth in Section 5136A.

a. "Well-Capitalized" (After Deduction) and "Well-Managed"

A national bank seeking to have a financial subsidiary, and each of its DI affiliates, must meet “well-capitalized” and “well-managed” tests. These terms are defined to parallel the definitions of these terms for FHCs.

The Act specifies that a national bank shall exclude from its assets and equity all equity investments, including retained earnings, in a financial subsidiary. The assets and liabilities of the subsidiary shall not be consolidated with the bank’s assets. This deduction must be disclosed and separately presented in the preparation of the bank's GAAP financial statements.

b. Size Limit Sec. 121 (p. 37)

The aggregate consolidated total assets of all financial subsidiaries of a national bank may not exceed the lesser of 45% of the bank’s total assets, or $50 billion. This $50 billion limit shall be adjusted according to an "indexing mechanism" to be jointly established by the Treasury and the Fed.

c. Rated Subordinated Debt for the Largest National Banks Sec. 121 (pp. 37-40)

An additional qualification requirement is imposed on the largest national banks. If a bank is among the 50 largest insured banks (based on consolidated total assets as of the end of the previous year), it must have an issue of subordinated debt rated in one of the top three investment grade categories by a nationally recognized rating agency. To be eligible for meeting this requirement, the debt must be unsecured, long-term and not supported by any guaranty, letter of credit or other credit enhancement. In addition, it must not be held in any significant amount by any affiliate, officer, director, principal shareholder, employee, or any person acting on behalf of the bank or any affiliate with the bank or affiliate's funds.

If a national bank is among the next 50 largest banks, it must meet either this subordinated debt requirement or other criteria set jointly by the Treasury and the Fed. If other criteria are adopted, they must be "comparable and consistent" with the purposes for which the rating requirement is established. Such a rating requirement does not apply to a national bank not among the 100 largest or to any national bank engaging only in agency activities that are financial in nature.

Under new Section 5136A(f), if a national bank subject to a rated subordinated debt requirement fails to meet this requirement after establishing a financial


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subsidiary, it is barred from making further equity or debt investment in any financial subsidiary until it again meets this requirement.

d. CRA Compliance Sec. 121 (p. 37)

The CRA qualification criteria applicable to FHCs under new BHC Act section 4(l)(2) are expressly applied to national banks with a financial subsidiary. That provision expressly requires such a national bank, and all its affiliated DIs, to have a "satisfactory" CRA rating before establishing a financial subsidiary or engaging in expanded financial subsidiary activities. New Revised Statutes Section 5136A(a)(7) specifically cross-references this requirement.

3. Expansion Of Financial Activities By Rulemaking Sec. 121 (p. 38)

The GLB Act allows the Treasury, in consultation with the Fed, to determine the scope of "financial" and "incidental to financial" activities for national bank operating subsidiaries. This provision is a mirror-image of the one that gives the Fed authority to expand the list of "financial" or "incidental" activities for FHCs, in consultation with the Treasury.

The Act requires the Treasury to notify and consult with Fed concerning any "request, proposal or application" under new Section 5136A for a determination whether an activity is financial in nature or incidental to a financial activity. The Treasury may not make such an affirmative determination if Fed states in writing its belief to the contrary within 30 days (unless the Treasury agrees to extend the time for Fed's response). Conversely, the Fed may recommend that the Treasury find an activity to be financial in nature or incidental to a financial activity. Within 30 days of the recommendation or such longer time as the Treasury and Fed agree to, the Treasury must notify the Fed in writing whether it will initiate a public rulemaking to deem the activity to be financial or the reasons for not taking such action.

4. Factors To Be Considered Sec. 121 (pp. 38-39)

Section 5136A again parallels new section 4(k)(3) with respect to the factors to be considered in determining whether a new activity should be found to be "financial."

In making such "financial" determinations, the Fed and Treasury are directed to "take into account" the following: (i) the purposes of the BHC Act and the GLB Act; (ii) changes, or reasonably expected changes, in the financial services marketplace, or in the technology for delivering financial services; and (iii) whether the activity is "necessary or appropriate" to allow BHCs and their affiliates (1) to compete effectively with other companies seeking to provide financial services in this country, (2) efficiently deliver information and services that are financial in nature through the use of technological means, including any application necessary to protect the security of or efficacy of systems for the transmission of data or financial transactions, or (3) to offer to customers available or emerging technological means for using financial services.


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5. Additional Financial Activities Sec. 121 (p. 39)

The GLB Act directs the Treasury to define by regulation or order, "consistent with the purposes of this Act," the following activities as financial in nature and to determine the extent to which they are financial in nature or incidental to activities that are financial in nature:

a. Lending, trust and other banking activities--lending, exchanging, transferring, investing for others, or safeguarding financial assets other than money or securities;

b. Financial transfers--providing any device or other instrumentality for transferring money or other financial assets; and

c. Third-party financial transactions--arranging, effecting or facilitating financial transactions for the account of third parties.

This provision parallels section 4(k)(5).

6. Risk Management And Corporate Separation Sec. 121 (p. 41)

A national bank that has a financial subsidiary shall maintain procedures for identifying and managing any financial or operational risks posed by that subsidiary. In additional, the bank will follow policies and procedures to preserve the separate corporate identity and legal status of the bank and the financial subsidiary. Each AFBA shall examine whether such policies and procedures are being followed.

7. Affiliate Transactions Sec. 121 (p. 41)

The Act makes transactions between a national bank and a financial subsidiary subject to the Section 23A and 23B affiliate transaction rules. A financial subsidiary is deemed an "affiliate" not a "subsidiary" for purposes of these sections. The Act also includes anti-evasion language authorizing the Fed to deem an investment in, or an extension of credit by, an affiliate in a financial subsidiary of a bank to be regarded as an investment or extension of credit by the bank parent of the financial subsidiary.

8. Antitying Sec. 121 (p. 43)

The Act also provides that a financial subsidiary of a national bank shall be deemed an affiliate of a bank holding company for purposes of the antitying provisions of BHC Act Section 106.


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9. Failure to Continue to Meet Qualifying Requirements Sec. 121 (p. 42)

If a national bank with a financial subsidiary, or any DI affiliate, ceases to meet the capital or managerial qualifying requirements for that status or to maintain risk controls and corporate separation as required, it will be so notified by the OCC. The national bank then has 45 days (unless extended by the OCC) in which to execute a corrective agreement with the OCC. The OCC may, at its discretion and subject to such terms and conditions as the OCC may impose and to such extension of time as the OCC may allow, require the bank to cease or limit its activities as the OCC deems appropriate in the circumstances. The banking agencies with jurisdiction over depository affiliates of the bank may also take similar actions. If the qualifying requirements are not again met within 180 days of receipt of the notice, the OCC may order divestiture of the financial subsidiary.

Failure of a bank to maintain a satisfactory or better CRA rating is not a basis for the OCC to take remedial action under this provision. Nevertheless, a bank with a financial subsidiary that does not maintain a satisfactory CRA rating will not be permitted to expand into new financial activities as long as such noncompliance continues. An unsatisfactory CRA rating triggers an automatic statutory bar on new financial activities or investments for the bank, and that bar can be removed only at the next CRA examination. Although not specifically referenced in this provision, a failure of CRA compliance may have longer-term consequences than capital or management deficiencies provided the OCC is satisfied with the bank's planned action to remedy a capital or management problem.

Overall, the effect of the noncompliance provisions creates a significant need for consolidated monitoring of the status of all affiliated DIs system to ensure that pending proposals to engage in financial activities or to acquire financial companies are not disrupted by a DI receiving an unsatisfactory CRA rating or becoming not well-capitalized or well-managed.

D. Subsidiaries of State Banks Sec. 121 (p. 43)

The GLB Act adds a new section 46 to the FDI Act providing "safety and soundness firewalls" for financial subsidiaries of insured state banks. This provision states that a state bank may control or hold an interest in a subsidiary that engages in “activities as principal that would only be permissible” for a national bank to conduct in a financial subsidiary if the following requirements applicable to national banks are met:

• = the bank and its depository affiliates must be well-capitalized (after the required capital deduction);

• = the bank makes the same capital deduction and related disclosure;

• = the state bank complies with the same risk management and corporate separation standards; and


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• = the bank's financial subsidiary is treated as an affiliate, not a subsidiary, for purposes of Sections 23A and 23B

The Act expressly preserves the ability of a state bank to retain all existing subsidiaries. It also expressly provides that this new provision shall not be construed to supersede the authority of the FDIC to review activities under existing Section 24 of the FDI Act. These provisions are not entirely clear on their face whether they apply to every subsidiary of a state bank engaging in financial activities or only to a financial subsidiary that the FDIC could not permit under the existing Section 24. In view of the fact that the Act expressly preserves FDIC authority under Section 24 and nowhere expresses an intention that new Section 46 supersede Section 24, the latter reading seems the better one. We understand that the FDIC legal staff is disposed to take the latter view, although it has not expressed any official view on the issue. The FDIC of course has the task of harmonizing Sections 24 and 46 of the FDI Act.

XII. NEW REVENUE BOND ACTIVITIES OF NATIONAL BANKS Sec. 151 (p. 47)

Under pre-Act law, a national bank may not underwrite or deal in revenue bonds, which are state or local bonds that are not backed by the full faith or credit of the state or local government. A national bank may underwrite or deal only in obligations of the United States, general obligation state and municipal bonds, specified quasi-government guaranteed obligations and certain other government-related obligations. A national bank may purchase for its own account certain types of investment securities that the OCC has specified and limited by regulation.

The Act amends 12 U.S.C. § 24(Seventh) to expressly authorize national banks to underwrite, deal in and purchase for their own account state and municipal revenue bonds, limited obligation bonds, and other obligations that satisfy the requirements of Section 142(b)(1) of the Internal Revenue Code.

XIII. CEBA BANKS Sec. 107 (pp. 22-24 )

Prior to 1987, the BHC Act defined a "bank" as an institution that both accepted demand deposits and engaged in commercial lending (with specified exceptions, including savings associations). This definition meant that a company could control a FDIC-insured bank that either took demand deposits or made commercial loans, not be a BHC and engage in activities not permissible for BHCs. A number of commercial, insurance, securities and diversified financial companies acquired such so-called "nonbank banks" in the mid-1980s. The Competitive Equality Banking Act of 1987 ("CEBA") changed this structure by including all insured banks in the BHC Act definition of "bank," while allowing these companies to keep control of their insured bank subsidiaries and not be treated as BHCs. To retain this grandfather status, these companies became subject to limits on additional investments in insured DIs, and their bank subsidiaries were subjected to asset growth, new activities, cross-marketing and affiliate daylight overdraft restrictions. (These grandfathered banks herein are called "CEBA


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banks.") The growth limit was effectively repealed under the Economic Growth and Regulatory Paperwork Reduction Act of 1996.

CEBA states that these restrictions are intended to be temporary "until such time as the Congress has enacted proposals to allow, with appropriate safeguards, all banks or bank holding companies to compete on a more equal basis." 12 U.S.C. § 1843(f)(3)(A). The GLB Act does enact such proposals and also rewrites these CEBA grandfather restrictions to put these banks back into substantially the same position they were in before CEBA was enacted.

A. Cross Marketing Restrictions Sec. 107(c) (pp. 22-23)

The Act repeals this provision.

B. Activities Sec. 107(d) (p. 23)

As amended by the Act, Section 4(f) of the BHC Act will allow a CEBA bank to engage in any permissible activity, except that it may not both (i) accept demand deposits/checking accounts and (ii) make commercial loans, "other than loans made in the ordinary course of a credit card operation." It thus allows a CEBA bank to freely choose its configuration--a bank that previously had accepted demand deposits but not made commercial loans now may forego demand deposits and begin to make commercial loans, or vice versa.

The Act further specifies that "for purposes of this [provision], loans made in the ordinary course of a credit card operation shall not be treated as commercial loans." In context, this language appears to mean that a loan to a business or for a commercial purpose is not to be treated as a "commercial loan" for purposes of the continuing CEBA bank activities limit, provided such loans are made "in the ordinary course of a credit card operation." The term "credit card operation" is not defined, but it would appear that an account having the characteristics of a typical credit card would be covered, e.g., an account with a revolving line of credit for which a plastic card is issued, but which also may be accessed by checks to third parties. The Fed, which has been historically hostile to CEBA banks, has jurisdiction to interpret this language.

C. Asset Acquisition Sec. 107(d) (p. 23)

At present, companies that control CEBA banks may not acquire control of more than 5% of the shares or assets of an additional bank or thrift. The Act partially relaxes this restriction by allowing such a company to acquire without limit assets that are derived from, or are incidental to, activities which are permitted for credit card banks or industrial loan companies ("ILCs") under Section 2(c)(2)(F) or (H) of the BHC Act, 12 U.S.C. § 1841(c)(2). This amendment substantially repeals this limit because ILCs (e.g., Utah-chartered ILCs) may engage in a full range of banking activities and hold assets derived from such activities.


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D. Daylight Overdrafts Sec. 107(c) (pp. 22-23)

CEBA bars grandfathered banks from incurring daylight overdrafts on behalf of any affiliate unless the overdraft was (1) due to an inadvertent accounting or computer error beyond the control of the bank or affiliate or (2) is on behalf of a registered primary dealer affiliate and is fully secured. The Act retains this limit on daylight overdrafts on behalf of an affiliate, but adds an exception for an affiliate in connection with activities that are financial or incidental to financial and does not cause a violation of the Section 23A or 23B affiliate transaction rules.

A further parallel exception is added for ILCs, allowing such institutions to incur the same types of affiliate overdrafts permissible for a CEBA bank.

E. Divestiture Sec. 107(e) (pp. 23-24)

The Act amends CEBA language that might be interpreted to require immediate divestiture of the CEBA bank if a grandfathered company or its CEBA bank failed to observe each of the CEBA grandfather restrictions. It adopts language from S. 900 that would allow such a company either to cure a compliance deficiency within a 180-day period or to submit a plan to the Fed for approval to cease the activity or correct the condition in a "timely manner" (up to one year). The bank must also implement procedures to prevent recurrence of the problem.

F. Foreign Bank Subsidiaries of a Credit Card Bank Sec. 107(f) (p. 24)

The Act adds a new provision to BHC Act section 4(f) applicable only to credit card banks, which are restricted under BHC Act section 2(c)(2)(F) to engaging only in credit card operations and may not accept retail deposits or make commercial loans. This amendment allows such a bank nevertheless to control a foreign bank that engages in lawful activities under its home country law, as long as the investment of the credit card bank meets the requirements of the Edge Act and the foreign bank does not offer any product in the United States.

XIV. FOREIGN BANKS

Under the International Banking Act of 1978 (the "IB Act"), a foreign bank with a branch, agency or commercial lending company in the United States is today subject to the BHC Act. 12 U.S.C. § 3106(a). Under the BHC Act, a foreign bank that controls a U.S. insured bank also becomes a BHC subject to the BHC Act. Under the GLB Act, a foreign bank with a U.S. branch, agency, or commercial lending company, even if it has a U.S. bank subsidiary, will be subject to a "well-capitalized" and "well-managed" requirement to become a FHC, although the Fed may temper these requirements consistent with considerations of national treatment or competitive equity.

The GLB Act does not impose these requirements on a foreign bank that has a U.S. bank subsidiary, but no U.S. branch, agency, or commercial lending company. In this case, the


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foreign bank is treated as a BHC and its U.S. bank subsidiary must comply with the "well-capitalized," "well managed," and CRA requirements. The Act does not impose a CRA requirement on a foreign bank and maintains current practice that CRA is not applicable to the uninsured operations of foreign banks in the United States. Further, it does not require a foreign bank that wishes to become a FHC to "roll-up" its U.S. branches and other banking operations into a U.S. bank subsidiary.

A. Qualification to be a Financial Holding Company Sec. 103 (p. 10)

New Section 4(l)(3) of the BHC Act states that for purposes of the FHC qualifying requirements the Fed is required to apply "comparable" capital and management standards to a foreign bank with a branch (insured or uninsured), agency or commercial lending company in the United States, "giving due regard to the principle of national treatment and equality of competitive opportunity." This provision by its terms does not apply to a foreign bank that has only one or more U.S. bank subsidiaries but not a U.S. branch, agency, or commercial lending company.

The nature of this capital requirement departs from existing practices under the BHC Act and the IB Act with respect to a foreign bank engaging in nonbanking activities in the United States and raises potentially significant national treatment and extraterritoriality issues. This is so because the GLB Act provides that for a BHC to engage in expanded nonbanking financial activities all of its bank subsidiaries must be “well capitalized” and “well managed.” No new capital or other requirements are imposed on U.S. BHCs in connection with their ability to engage in such new nonbanking activities.

Thus, if a BHC is not well-capitalized or well-managed, it nonetheless is eligible to declare itself a FHC and engage in new financial activities (as long as its DI subsidiaries meet these tests). Also, it would not be subject to the remedial provisions that the Fed may apply to a BHC if its subsidiary DIs are not “well capitalized” and “well managed.” In contrast, new capital and managerial standards are imposed on a foreign bank with a U.S. branch, agency or commercial lending company seeking to become a FHC and to engage in new nonbanking activities.

This framework raises several related concerns. The differential treatment of a BHC and a foreign bank for nonbanking purposes is a significant departure from the long-standing U.S. practice in the treatment of foreign banks. In particular, it contradicts current U.S. principles of national treatment to apply to a foreign bank a specific capital requirement that is above the Basle Accord minimums and does not apply to a BHC itself. Under this framework, a foreign bank meeting both BHC and home country standards and otherwise operating in a sound manner nevertheless might fail the "well capitalized" test to become or remain qualified as a FHC-- especially during an economic downturn.

The failure to continue to meet these requirements is also significant because the Fed is required to address noncompliance and is given very broad powers to do so, including requiring divestitures or taking action directly against the foreign bank. While the Fed should be expected


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to use its discretion to avoid divestiture in an inappropriate case, the triggering of a statutorily imposed remedial scheme is automatic. In short, a foreign bank, even one with a U.S. bank subsidiary that is well-capitalized and well-managed, would be subject to a more rigid, more intrusive and potentially more rigorous regime than domestic BHCs.

Moreover, as a consequence of this change, the Fed, in practice, would be provided with a direct supervisory and enforcement role vis-á-vis the home country operations of a foreign bank. In particular, the application of the well-managed test in this manner further broadens the Fed's responsibilities for assessing the operations of foreign banks outside the United States. These provisions export U.S. statutory rules and effectively override both the home country supervisor and the Basle Accords. How the Fed addresses these and other issues will determine whether the GLB Act provides substantive parity of treatment for domestic BHCs and foreign banks.

B. Venture Capital/Merchant Banking

Currently, like a BHC, a foreign bank may engage in U.S. merchant banking/venture capital activities in a highly restricted manner, mostly through BHC Act Section 4(c)(6) or a Small Business Investment Company ("SBIC"). Section 4(c)(6) permits a BHC to make a "passive," investment of up to 4.9% of any class of voting securities of a U.S. investment company plus a nonvoting equity investment that when combined with the voting investment does not exceed 24.9% of the company's equity. Subject to certain requirements, a BHC - owned SBIC may acquire up to 49.9% of the equity securities of a designated "small business," depending on the number of other shareholders in the company and the size of their holdings relative to that of the BHC.

Further, under Section 2(h)(2) of the IB Act and Section 4(c)(9) of the BHC Act and their implementing Regulation K, a foreign bank that is a "qualified foreign banking organization" ("QFBO") may under 12 C.F.R. 211.23(f) of Regulation K:

a. engage in any activities outside the United States provided any related U.S. activities, if any, are incidental to those non-U.S. activities;

b. own or control voting shares of a non-U.S. company provided that its U.S. activities, if any, are only incidental to its non-U.S. business;

c. own or control less than 25% of the voting shares of a non-U.S. company that is not a subsidiary of the foreign bank and that engages in U.S. activities, provided that more than 50% of its consolidated assets and revenues are located or derived from outside the United States, respectively (certain other restrictions apply if the company is engaged in U.S. securities activities, although these may be changed on account of the GLB Act); and

d. own or control 25% or more of the voting shares of a non-U.S. operating, commercial company that engages in the same kind or related activities in the United States, including through a U.S. subsidiary, provided that more than 50%


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of the company's consolidated assets and revenues are located or derived from outside the United States, respectively.

In addition to the above items, the GLB Act permits the following merchant banking/venture capital investments for a foreign bank.

1. Passive Control of Companies Through Merchant Banking Investments

Sec. 102 (p. 7-8)

As noted above, in general, under the GLB Act, a FHC may have operational "control" only over entities that are engaged in activities that are financial in nature or incidental to financial activities. However, the GLB Act permits a foreign bank that becomes a FHC to hold controlling shares of a company as long as the investment is made in the ordinary course of business and the overall relationship is sufficiently passive to be properly regarded as an investment relationship, not the actual operation of another company.

To conduct merchant banking activities, a FHC must have a "securities affiliate" or an affiliate of an insurance company that provides investment advice to an insurance company and is an investment adviser registered under the Advisers Act. Such an affiliate (or any affiliate of the securities affiliate) may acquire or control, as principal or on behalf of one or more entities, shares, assets or interests in a company or other entity, whether or not constituting control, if:

• = the shares, assets or ownership interests are not acquired or held by a DI or a subsidiary of a DI;

• = the shares, assets or ownership interests are held for a period of time that will permit their sale or disposition on a reasonable basis consistent with the financial viability of the activities; and

• = during the period the shares, assets or ownership interests are held, the BHC does not “routinely manage or operate” the company or entity except as necessary to achieve a reasonable return on the investment.

The Fed and Treasury are specifically authorized to issue regulations governing merchant banking activities, including rules governing transactions with controlled companies, if they jointly deem such rules appropriate to implement the purpose of the GLB Act and prevent evasions.

The general bar against engaging in new financial activities or acquiring financial companies if a BHC's subsidiary DI has an unsatisfactory CRA rating does not apply to the acquisition of shares under the above merchant banking or insurance company investments Sections of the GLB Act "by an affiliate already engaged in" such activities.


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2. Nonqualifying Foreign Banks Sec. 102 (pp. 4-5)

Section 102 of the GLB Act amends Section 4(c)(8) of the BHC Act to provide that a BHC or foreign bank may engage in any activity that the Fed has previously determined by regulation or order to be closely related to banking prior to enactment of the Act. Thus, a foreign bank must qualify to be a FHC to engage in any new nonbanking activities. At the same time, existing Section 20 securities activities or other Section 4(c)(8) activities are grandfathered, subject to such terms and conditions contained in the regulation or order that authorized the activity, unless modified by the Fed.

3. Noncompliant Foreign Bank FHCs Sec. 102 (pp. 4-5)

A foreign bank that initially qualifies as a FHC but subsequently fails to meet the FHC requirements may cure this noncompliance under the same rules as domestic FHCs. During the period of noncompliance, a FHC or foreign bank is not required automatically to cease its financial activities that were not previously deemed closely related to banking under Section 4(c)(8). The Fed, however, may impose such affirmative limitations as it deems appropriate on the conduct or activities of the company or any of its affiliates. See discussion above.

C. Expanded Fed "Prudential" Regulatory Authority Over Foreign Banks and Their U.S. Affiliates Sec. 114 (pp. 33-34)

Under Section 114(b)(3) and (4) of the GLB Act, the Fed, by regulation or order, is authorized to impose additional restrictions or requirements on relationships or transactions between a U.S. branch, agency or commercial lending company of a foreign bank and its U.S. affiliates. The Fed may impose these restrictions if it finds them consistent with (i) the GLB Act, the BHC Act, the FR Act, or "other federal law applicable to foreign banks and their affiliates in the United States" and (ii) it is appropriate to prevent an evasion of one of these laws or to avoid any significant risk to the safety and soundness of a DI or an insurance fund, or other adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests, or unsound banking practices -- that is, the current BHC Act Section 4(c)(8) and 4(j) standards to engage in activities closely related to banking.

This provision responded to foreign bank concerns that, under prior versions of the legislation, the Fed's authority would have extended extraterritorially to transactions between the foreign bank itself and its U.S. affiliates. The prior versions would have possibly allowed the Fed to apply restrictions on transactions between "a foreign bank" and any U.S. affiliate.


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D. IB Act Grandfather Rights Sec. 141 (pp. 46-47)

Section 141 of the GLB Act amends Section 8(c) of the IB Act, 12 U.S.C. § 3106(c), such that, if a foreign bank elects to be a FHC, its IB Act grandfather rights are terminated with respect to financial activities--but not commercial activities. In addition, if a grandfathered foreign bank does not become a FHC within two years after enactment of the GLB Act, the Fed, giving due regard to the principle of national treatment and equality of competitive opportunity, may impose the same restrictions and requirements on the conduct of financial activities of such foreign banks as are applied to FHCs. Included within these restrictions and requirements are those "prudential" safeguards adopted for FHCs under Section 114 of the Act. See above for corresponding foreign bank provision under Section 114.

E. Subsidiaries as Representative Offices Sec. 142 (p. 47)

Section 142 of the GLB Act amends Section 1(b)(15) of the IB Act, 12 U.S.C. § 3101(15), to remove from the definition of "representative office" an exclusion for a subsidiary of a foreign bank. Thus, in appropriate circumstances, the establishment of a subsidiary of a foreign bank could be regarded as requiring the Fed’s prior approval to establish a representative office.

F. Examination of Nonbank Affiliates Sec. 142 (p. 47)

Section 142 of the GLB Act also amends Section 10(c) of the IB Act, 12 U.S.C. § 3107(c), to authorize the Fed to examine "any affiliate of a foreign bank conducting business in any State" in order to determine and enforce compliance with this Act, the BHC Act, or "other applicable Federal banking law."

G. Interstate Branches and Agencies of Foreign Banks Sec. 732 (p. 141)

Section 732 of the GLB Act, amending Section 5(a)(7) of the IB Act (12 U.S.C. § 3103(a)(7)), permits a foreign bank to establish an agency or branch located outside its home state provided that: (1) it obtains the approval of the Fed and either the Comptroller of the Currency or the appropriate state supervisor in the case of a federal or state branch or agency, respectively; (2) the relevant state permits the establishment and operation of such a branch or agency; and (3) if a branch, it only receives deposits permitted to Edge Act corporations.

Further, with the appropriate approval as above, a foreign bank may upgrade an existing agency or limited branch located outside a foreign bank's home state to a branch -- provided that: (1) the establishment and operation of the branch is permitted by state law; and (2) such agency or limited branch was operating in that state as of September 28, 1994, or has satisfied any state law minimum age requirement under Section 44(a)(5) of the FDI Act, 12 U.S.C. § 1831u(44)(a)(5). This section limits such state age limits to a maximum of five years.


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XV. CONSUMER PROTECTION RULES FOR SALES OF INSURANCE PRODUCTS THROUGH BANKS Sec. 305 (pp. 73-78)

The Act adds a new customer protection section to be codified as new FDI Act Section 47. (12 U.S.C. §§ 1811 et seq.) It specifies a number of elements that the banking agencies must include in customer protection regulations regarding sales of insurance by DIs or DI offices – to be codified as new FDI Act Section 47. These sales are to be published in final form within one year of enactment (November 12, 2000). New FDI Act Section 47 parallels in many respects the existing Interagency Statement on Retail Sales of Nondeposit Investment Products. These existing guidelines were developed by the banking agencies based upon standards largely developed by banking trade associations. In contrast, this provision establishes new FDI statutory standards and mandates the adoption of rules regarding insurance sales by depository organizations.

The rules to be adopted under this provision will represent a floor standard for institutions’ conduct and will not automatically preempt conflicting or more demanding state customer or consumer protection laws or the federal securities laws, unless the federal banking agencies jointly determine that the federal rules provide greater protection. This provision does not cross-reference the federal preemption provisions of Section 104, and thus the Act does not expressly reconcile the general protection for state law under this new FDI Act section with the specific preemption rules of Section 104 regarding state insurance law. The better reading would subject state insurance laws that may be regarded as referenced in new FDI Act Section 47 to the framework for preemption regarding insurance activities under Section 104.

A. Federal Agency Rulemaking

1. Anti-coercion Rules Sec. 305 (pp. 73-74)

The regulations shall prohibit an insured DI from engaging in any practice that would lead a customer to believe that an extension of credit, in violation of the anti-tying provisions of the BHC Act, is conditioned upon (i) the purchase of an insurance product from the DI or its affiliates, or (ii) a consumer not obtaining such a product from an unaffiliated entity. FDI Act Section 47(b).

According to the 1999 House Banking Committee Report on H.R. 10, the anti-coercion rules are intended to be consistent with anti-tying provisions in Section 106(b) of the BHC Act Amendments of 1970, and interpretations thereunder. That report states that "[t]his section is not intended to prohibit the offering of products or services permitted under section 106(b)", but the agencies are directed to adopt rules prohibiting an insured DI from using any sales practices "that would lead a consumer to believe that as extension of credit is conditional on the purchase of a nondeposit product from the institution (or its affiliates or subsidiaries), or an agreement by the consumer not to obtain a nondeposit product from an unaffiliated entity, in violation of the anti-tying rules contained in section 106(b) of the BHC Act Amendment of 1970." 1999 House Banking Committee Report at 143.


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2. Consumer Protection Rulemaking Sec. 305 (p. 73)

The rules shall be jointly adopted by the banking agencies after consultation with state insurance regulators and apply to retail sales practices, solicitation, advertising, or offers of any insurance product by a DI or any person engaged in such activities at the office of a DI or on its behalf. These rules are to be consistent with the requirements of the Act and provide "additional protection" for customers to whom such marketing is directed. These protections will be extended to subsidiaries of DIs, if deemed necessary to ensure that the consumer protections are provided. (It should be noted that Section 47 appears to use the term "consumer" and "customer" interchangeably.)

3. Disclosure and Advertising Sec. 305 (p. 74)

The Act provides that when a consumer opens an account for the purchase of an insurance product, or makes an initial purchase, oral and written disclosures must be made before completion of the initial sale stating:

• = that nondeposit products are not FDIC or U.S. Government insured;

• = for investment products such as variable annuities, that investment risk is associated with the product, including possible loss of principal; and

• = that an approval of an extension of credit may not be conditioned on the purchase of a nondeposit product from the DI or its affiliates, or a consumer not obtaining such a product from an unaffiliated entity (these disclosures are also required at the time of the loan application).

All of the disclosures must be made in a "conspicuous, simple, direct and readily understandable" manner using such words as: NOT FDIC-INSURED, NOT GUARANTEED BY THE BANK, MAY GO DOWN IN VALUE, or "NOT INSURED BY ANY GOVERNMENT AGENCY." FDI Act Section 47(c)(1)(A) and (B). These disclosures are not required in a general advertisement or listing of product offerings. A disclosure will not be considered as meaningfully provided if disclosure materials are available but not actually provided and orally disclosed to the customer. FDI Act Section 47(c)(1)(A).

4. Adjustments Sec. 305 (p. 75)

The rules may take into account the nature of the contact with customers, e.g., by telephone or electronic media, or in person, when addressing the most appropriate form of disclosure and customer acknowledgment. FDI Act Section 47(c)(1)(E).


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5. Consumer Acknowledgment Sec. 305 (p. 75)

At the time the customer receives the disclosures or at the time of the nondeposit product's initial purchase, the customer must sign and date a statement acknowledging receipt of the disclosures. FDI Act Section 47(c)(1)(F).

6. Prohibition on Misrepresentation Sec. 305 (p. 75)

The rules shall prohibit any practice or advertising, at a DI office, or on behalf of the DI or subsidiary, which could mislead a person or cause a reasonable person to reach an erroneous belief about (i) the uninsured nature of a product or, (ii) in the case of an annuity or other insurance product involving investment risk, the investment risk associated with such product. It further provides that the approval of a credit extension may not be conditioned on the purchase of an insurance product and that the customer is free to buy such product at another institution. FDI Act Section 47(c)(2).

7. Physical Segregation Sec. 305 (p. 75-76)

The Act further calls for the adoption of regulations to ensure that routine deposit activities are kept physically segregated "to the extent practicable" from insurance product activity. The rules shall require:

(1) a separate setting and circumstances under which transactions involving insurance products shall be conducted, including a location physically segregated from the area where deposits are routinely accepted;

(2) standards permitting a person in a public area where deposit activity occurs to refer a customer seeking insurance to a qualified sales person, only if the person making the referral receives no more than a one-time nominal fee of a fixed dollar amount for each referral that does not depend on whether or not the referral results in a transaction; and

(3) standards prohibiting an insured DI from permitting any person to sell insurance unless the person is appropriately qualified and licensed.

FDI Act Section 47(d).


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B. Domestic Violence Discrimination Sec. 305 (p. 76)

The Act includes the H.R. 10 provision prohibiting discrimination against victims of domestic violence and providers of services to victims of domestic violence, either as applicants for insurance or as insureds, by any insurance principal agent or broker, or on behalf of any insured DI.

C. AFBA Consumer Grievance Process Sec. 305 (p. 76)

The AFBAs jointly are required to establish a consumer complaint mechanism for receiving and expeditiously addressing complaints of alleged violations of these regulations. The AFBAs must: (i) establish a group to receive complaints, (ii) develop procedures for investigating complaints, (iii) develop procedures to inform consumers of their rights in the complaint process, and (iv) develop procedures for addressing complaints, including the recovery of losses.

D. Effect on Other Federal and State Consumer Protection Rules Sec. 305 (p. 76-77)

The Act expressly addresses the relationship of these new consumer protection provisions to existing securities and insurance provisions. It provides that in general the new FDI Act section does not supersede these existing provisions, except in circumstances when it would provide greater protection to consumers than state insurance laws. FDI Act Section 47(g).

1. General Standard Sec. 305 (p. 77)

The Act provides that no provision of new FDI Act section 47 shall be construed as granting, limiting, or otherwise affecting any authority of the SEC, self-regulatory organizations, the Municipal Securities Rulemaking Board, or the Treasury under any federal securities law or, except as specifically provided, any authority of any state insurance commissioner under state law.

2. Coordination with Insurance Law Sec. 305 (p. 77)

The required implementing regulations shall not apply to retail sales, solicitations, advertising or offers of any insurance product by or on behalf of an insured DI in any state having laws, regulations, orders, or interpretations that are inconsistent with or contrary to such regulations, unless the federal banking agencies jointly determine that a specific provision of these federal regulations provide consumers greater protection than the comparable state provision. Although this provision does not expressly cross-reference the Section 104 preemption provisions, the nondiscrimination standards of the latter should apply to state consumer protection laws affecting activities of DIs and their affiliates as provided in Section 104.


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3. Preemption Sec. 305 (p. 77)

If the Fed, OCC, and FDIC jointly determine that the protection afforded by the federal customer protection regulation provides greater protection than the comparable rules in any state, the appropriate state regulator will be notified. After considering comments from state regulators, the federal agencies may jointly determine that the federal rules provide greater protection. If so, the appropriate state regulator shall be notified that the state rule will be preempted unless the state adopts legislation to override the preemption within 3 years of the date of the enactment.

4. Nondiscrimination Against Non-affiliated Agents Sec. 305 (p. 77-78)

The federal banking agencies "shall ensure" that the federal customer protection regulations do not have the practical effect of discriminating, intentionally or unintentionally, against any person engaged in insurance sales that is not affiliated with an insured DI.

XVI. PRIVACY PROVISIONS Secs. 501-527 (pp. 99-113)

The privacy protections afforded to consumers proved to be one of the most controversial issues to emerge in the course of the debate on financial modernization in 1999. While the issue was briefly debated in the Senate, and many Senators, most notably Banking Committee ranking member Paul Sarbanes (D-MD), had wanted to include more extensive privacy provisions, Banking Committee Chairman Phil Gramm (R-TX) resisted the idea of privacy provisions or of the more extensive provisions until the House-Senate Conference.

A. Legislative Background 1. House Bill

The outlines of the privacy provisions that were ultimately included in the legislation emerged in the House Commerce Committee as Article V of H.R. 10. The centerpiece of these provisions was a consumer notice and "opt-out" provision that requires that consumers be notified of their right to prevent their information from being shared with third parties.

These provisions were vigorously debated on the House floor. Industry representatives objected to efforts to require an opt-out for information-sharing among affiliates on the grounds that it would undermine the efficiency of the affiliate structure. On the other hand, consumer groups argued that the potential for abuse within the holding company called for the broader opt-out protection. After considerable debate, a compromise amendment, which did not include restrictions on information sharing among affiliates, sponsored by Reps. Michael G. Oxley (R-OH), Deborah Pryce (R-OH), and Marge Roukema (R-NJ) was finally approved on a vote of 427-1. Instead of restricting information sharing among affiliates, the House-passed bill mandated a study of information sharing among affiliates to be undertaken by Treasury with the


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bank regulators and the FTC, and "in conjunction with" the National Association of Insurance Commissioners ("NAIC"), the financial services industry, consumer organizations and privacy groups. This controversial determination to exclude affiliate sharing was challenged in Conference, but it was not changed.

2. Conference

In Subtitle A of Title V of the GLB Act, the Senate receded to the House with a multi-provision amendment that largely preserved the basic compromise reached on the House floor.

The House-Senate Conference amendment largely preserved the House bill with a few notable exceptions. The more significant change was an amendment offered by Senator Paul Sarbanes, which many characterized as a "reverse preemption provision." It states that Title V is not intended to preempt either the Fair Credit Reporting Act, nor state laws unless those laws are inconsistent with the federal law. However, the provision also explicitly states that state law will not be considered to be inconsistent with federal law for these purposes if "the protection such statute, regulation, order, or interpretation affords any person is greater than the protection provided under this subtitle . . . as determined by the Federal Trade Commission, after consultation with the agency or authority with jurisdiction under section 505(a) of either the person that initiated the complaint or that is the subject of the complaint, on its own motion or upon the petition of any interested party.” Sec. 507(b). (This language parallels the provisions of Section 305(g).)

Other changes adopted in Conference include:

• = A clarification stating that the FTC has authority to enforce the title’s provisions against non-financial institutions;

• = An exemption for persons or entities subject to the jurisdiction of the Commodity Futures Trading Commission, the Federal Agricultural Mortgage Corporation, and Freddie Mac and Fannie Mae, to the extent they do not sell or transfer nonpublic personal information to a non affiliated third party;

• = An expansion of the annual disclosure requirements applicable to financial institutions to require that privacy policies regarding sharing of personal information among affiliates be disclosed in addition to policies applicable to the sharing of nonpublic personal information with third parties;

• = An expansion of the authority of the functional regulators to prescribe exceptions to the opt-out provisions of the law, authorizing the agencies to prescribe exceptions to the limits on reuse of information and the limitations on the sharing of account number information; and

• = An amendment clarifying that the disclosure of non public personal information" contained in a consumer report issued by a consumer reporting agency does not


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fall within the opt-out notice requirement, and a clarification that the term “nonpublic personal information" does not encompass lists or descriptions derived without using any nonpublic personal information.

Smaller financial institutions fought hard in Conference for the expansion of the notice and opt-out requirements to include affiliates of financial institutions as well as third parties, arguing that permitting information to be freely shared among affiliates places them at a competitive disadvantage. Although they were supported in this effort by consumer groups, privacy advocacy groups and initially, the Administration, the compromise ultimately did not expand upon the structure agreed to in the House. The result of their effort is hortatory language in the Conference Report urging that “agencies and authorities described in section 504(a)(1) should take into consideration any adverse competitive effects on small commercial banks, thrifts and credit unions.”

As an accommodation to certain software manufacturers, the GLB Act also includes hortatory language allowing that agencies and Departments may permit by regulation disclosures in an “encrypted, scrambled, or similarly coded form”.

B. Overview

The Title V privacy provisions of the GLB Act now include the following:

• = A new "affirmative and continuing" obligation to safeguard privacy applicable to all firms that engage in financial services (not just banks or traditional finance service providers), as well as to firms engaged in activities "incidental" to financial activities.

• = A requirement that each financial regulator establish "standards" to implement this privacy obligation.

• = A general privacy disclosure to consumers about the institution's privacy policy, including its policies concerning information sharing with affiliates and third parties, which is required upon opening an account or beginning a relationship and reiterated not less than annually. A separate opt-out disclaimer with respect to the transfer of information to unaffiliated third parties also upon the opening of an account [or beginning of a relationship] and not less than annually thereafter.

• = A prohibition against transfers of "nonpublic personal information" to unaffiliated third parties, unless the possibility of such transfers and the option to opt-out are disclosed and the customer has been given the opportunity to "opt-out".

• = Numerous specific exceptions that permit disclosures to third parties without providing notice or opportunity to opt-out.

• = A mandate that the bank regulators, the NCUA, the Treasury and the SEC, in consultation with the FTC and representatives of state insurance regulators,


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engage in separate "coordinated" rule-makings to detail how the two disclosures should be provided and what they should include.

• = A requirement that the Treasury Department study information sharing practices among financial institutions and their affiliates.

• = A prohibition against the practice of "pretext calling" that includes criminal sanctions.

C. Duty to Protect Consumer Information Sec. 501 (pp. 99-100)

The privacy provisions of the GLB Act impose on each "financial institution" an “affirmative and continuing obligation to respect the privacy of its customers and to protect the security and confidentiality of those customers' nonpublic personal information.” Section 501(a). To accomplish this goal, the GLB Act requires each functional regulator to issue "appropriate standards for the financial institutions subject to their jurisdiction" to insure “the security and confidentiality of customer records and information;" to protect against “any anticipated threats or hazards to the security or integrity of such records;” and "to protect against unauthorized access to or use of such records or information which could result in substantial harm or inconvenience to any customer."

This is a broad mandate that each functional regulator will have to interpret, and the Act provides no means for ensuring consistent interpretations. Moreover, it is not clear whether the term "standards" necessarily requires rulemaking. It is quite possible that a regulator could issue a loose directive to protect the security and confidentiality of customer records, while another could issue detailed regulations covering a wide range of activity.

The term "consumer" is defined as "an individual who obtains, from a financial institution, financial products or services which are to be used primarily for personal, family, or household purposes, and also means the legal representative of such an individual."

D. Opt-Out for Third-Party Sharing Sec. 502 (pp. 100-102); Sec. 509(5) (p. 107-108)

As noted above, the most publicized and controversial part of the privacy provisions of the GLB Act is its requirement that financial institutions may not disclosure "nonpublic personal information" to nonaffiliated third parties unless they provide a specific opt-out notice to consumers and the opportunity to opt-out prior to such third party sharing. The Act provides that such notice must be provided “clearly and conspicuously,” in “writing or in electronic form or other form permitted by regulation.” The notice must provide consumers with an explanation of how to direct that their information not be disclosed, and an opportunity to exercise this option prior to disclosure to an affiliated third party.

"Nonaffiliated third party" is defined to mean any entity that is not an affiliate of, or related by common ownership or affiliated by corporate control with, the financial institution.


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1. General Exception for Marketing and Servicing Sec. 502(b)(2) (p. 100)

The GLB Act provides a general exception for providing nonpublic personal information to third parties to perform services or functions on behalf of the financial institution intended to cover transfers necessary for joint marketing arrangements, or to facilitate a third party servicing of consumer accounts. However, these transfers must be fully disclosed to consumers, and financial institutions must enter into contractual agreements with the third parties that require the third parties to "maintain the confidentiality of such information."

2. Specific Exceptions Sec. 502(e) (p. 101), Sec. 509(7) (p. 107)

The GLB Act further provides a number of specific exceptions for circumstances that do not require that any notice be given to consumers prior to disclosure of nonpublic personal data to some third parties. However, if any third party disclosure does not fall completely within one or more of these exceptions, then the notice and opportunity to opt-out must be provided. These include the following circumstances:

• = Transfers "as necessary to effect, administer, or enforce a transaction requested or authorized by the consumer" in connection with servicing or processing a financial product or service, maintaining or servicing the consumer’s account, or a proposed or actual securitization, secondary market sale or similar transaction. ("As necessary to effect, administer, or enforce the transaction" is defined in detail in Section 509(7).)

• = Transfers made with the consent or at the direction of the consumer.

• = Transfers made to protect the confidentiality or security of a consumer’s records, to protect against fraud, unauthorized transactions, for required institutional risk control or other liability, or for resolving customer disputes or inquiries.

• = Transfers to persons holding a beneficial interest relating to the consumer, or to persons acting in a fiduciary or representative capacity on behalf of the consumer.

• = Transfers to provide information to an insurance rate advisory organization, guaranty fund or agency, a credit rating agency, and to permit the assessment of the financial institution's compliance with industry standards.

• = Transfers to the financial institution’s attorneys, accountants and auditors.

• = Transfers permitted or required under other laws and in accordance with the Right to Financial Privacy Act of 1978, to law enforcement agencies (including federal functional regulators; the secretary of the Treasury with respect to the Bank Secrecy Act, state insurance authorities or the Federal Trade Commission), self-


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regulatory organizations, or for an investigation on a matter related to public safety.

• = Transfers to a consumer reporting agency, and transfers from a consumer report produced by a consumer reporting agency in compliance with the Fair Credit Reporting Act, in accordance with interpretations of such Act by the Board of Governors of the Federal Reserve System or the Federal Trade Commission.

• = Transfers in connection with a sale, merger, transfer, or exchange of all or a portion of the business or operating unit of the financial institution if the disclosure concerns only customers of that business or unit.

• = To comply with federal, state, or local laws, rules, and to comply with civil, criminal, or regulatory investigations, federal, state or local summons or subpoenas or to respond to judicial process of government authorities with jurisdiction over the financial institution under these authorities.

3. Limits on Reuse of Information Sec. 502(c) (p. 100)

Unaffiliated third parties that receive nonpublic personal information from a financial institution for any purpose (including pursuant to the exceptions set forth above) may only disclose such information if "such disclosure would be lawful if made directly to such other person by the financial institution." This effectively makes third parties that receive nonpublic personal information from financial institutions subject to the these provisions of the law.

4. Prohibition on Sale of Account Information for Telemarketing Sec. 502(d) (pp. 100-101)

The GLB Act includes a provision to address the kinds of abuses involving the sale of customer account information to third party telemarketers that have recently received so much publicity. Disclosures of account numbers or similar access numbers or credit card numbers or access codes information to third parties for use in telemarketing, direct mail marketing or other marketing through electronic mail is expressly prohibited.

E. Disclosure of Privacy Policy and Procedure Sec. 503 (p. 102)

Each financial institution is required by the GLB Act to make certain required disclosures of its privacy policies to each consumer, both at the time of establishing a customer relationship and then “not less than annually" during the continuation of the relationship. These disclosures, which must be clear and conspicuous, may be made either in writing or in electronic form or other form authorized by regulation, must set forth the institution’s privacy policies and practices and must include:


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• = The policies and practices with respect to disclosures to affiliates and to nonaffiliated third parties including the categories of persons to whom information may be disclosed.

• = The institution's policies with respect to disclosures of nonpublic information related to former customers.

• = General policies for protecting the confidentiality and security of nonpublic personal information of consumers.

• = The categories of nonpublic personal information that the institution collects.

• = Disclosures required, if any, under section 603(d)(2)(A)(iii) of the Fair Credit Reporting Act.

While this disclosure requirement is independent of the opt-out disclosure requirement in Section 502, it appears that these disclosures could be combined, if the combined notice complies with the requirement that notice be provided when the customer relationship is established (and then not less than annually) and provides sufficient opportunity for customers to opt-out.

F. Rulemakings to Develop Federal Privacy Standards Sec. 504 (pp. 102-103)

The GLB Act directs the federal bank regulators, the NCUA, the Treasury, the SEC, and the FTC, after consultation with representatives of the State insurance authorities designated by the NAIC, each to prescribe regulations to carry out the privacy provisions. This broad authorization to promulgate “such regulations as may be necessary to carry out the purposes of this subtitle” could encompass additional details about disclosures and notice to consumers, as well as elaboration on any of the exceptions to the third-party opt-out requirement. The GLB Act specifically authorizes the creation of additional exceptions to the notice and opt-out provisions in the rulemaking "as are deemed consistent with the purposes of this subtitle." It specifies that these rulemakings be undertaken in accordance with the Administrative Procedures Act, and that they be issued in final form not less than six months after the date of enactment.

The Act also requires that the several agencies and departments engaging in rulemaking "consult and coordinate" with each other to assure "to the extent possible, that the regulations prescribed by each such agency and authority are consistent and comparable with the regulations prescribed by other agencies and authorities."

G. Enforcement Sec. 505 (pp. 103-104), Sec. 506 (pp. 104-105)

The GLB Act provides that the privacy provisions of the Act will be enforced by the Federal functional regulators, the state insurance authorities, and the FTC with respect to financial institutions and "other persons" subject to their jurisdiction. It also amends the FCR


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Act to clarify that the federal banking agencies have the authority to issue regulations “as necessary" to detect and enforce privacy violations that may occur during the transfer of, and process of correcting information given by banks to reporting agencies.

H. Relation to State Privacy Laws Sec. 507 (p. 105)

The GLB Act provides that the privacy provisions of the Act shall not preempt, alter or affect any state law or regulation, except to the extent such laws or regulations are inconsistent with the provisions of the Act and then only to the extent of the inconsistency.

Section 507 (b) further explicitly states that state law will not be considered to be inconsistent with federal law for these purposes if the protection such state –

"statute, regulation, order, or interpretation affords any person is greater than the protection provided under this subtitle...as determined by the Federal Trade Commission, after consultation with the agency or authority with jurisdiction under section 505(a) of either the person that initiated the complaint or that is the subject of the complaint, on its own motion or upon the petition of any interested party."

This provision was adopted in Conference with the support of consumer groups and privacy advocates. It may effectively undermine the force of Title V as a national standard, and cause the privacy debate to resume in various state capitals. This was the stated intention of its supporters, and state attorney generals may examine ways to correct what they perceive as the inadequacies of the federal law.

However, an obscure provision of the Fair Credit Reporting Act ("FCR Act")could prove to be an obstacle to state action on the privacy issue with respect to information sharing among affiliated institutions. Section 1681 of the FCR Act states " no requirement or prohibition may be imposed under the laws of any State with respect to the exchange of information among persons affiliated by common ownership or common corporate control." It is not clear whether this provision, which has not been tested in court, will impede efforts by the states to legislate in this area.

I. Study of Information Sharing Among Financial Affiliates Sec. 508 (pp. 105-106)

In lieu of any restrictions on information sharing among affiliates of FHCs, the GLB Act directs the Treasury, in conjunction with the federal functional financial regulatory agencies and the FTC, to conduct a comprehensive study of current information sharing practices among financial institutions and their affiliates and unaffiliated third parties, and to report to Congress with its findings and recommendations for legislative or administrative action by January 1, 2002. In conducting this study, the Treasury is directed to consult with representatives of the state insurance authorities, etc. However, in his statement at the signing of the bill, President Clinton announced that he was directing the National Economic Council to work with Treasury and Office of Management and Budget to complete the study and recommendations next year.


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J. Definitions Sec. 509 (pp. 106-108)

1. "Financial Institution"

The definitions make clear that these provisions are intended to be applied to all institutions participating in the delivery of financial services to customers. The term “financial institution” is defined to be “any institution the business of which is engaging in financial activities as described in new Section 4(k) of the Bank Holding Company Act of 1956." Specifically excluded from the definition of "financial institution" are persons or entities subject to the jurisdiction of the CFTC, the Federal Agricultural Mortgage Corporation or any entity chartered and operating under the Farm Credit Act of 1971.

2. "Consumer"

It defines a "consumer" as "an individual who obtains, from a financial institution, financial products or services which are to be used primarily for personal, family, or household purposes, and also means the legal representative of such an individual." The definition makes explicit that Section 502 and 503 privacy notice provisions apply only to retail transactions with individuals, and do not apply to corporate or business data or business customers.

K. Pretext Calling Sec. 521-527 (pp. 109-113)

Subtitle B of Title V incorporates the provisions protecting consumers from the "identity fraud" that had been added to the Senate bill by Senator Sarbanes. The Act provides civil and criminal penalties for those who obtain personal information by fraud or deception from either an individual or a financial institution. The Act also grants new enforcement authority to the FTC.

The Act specifically prohibits any person from obtaining or attempting to obtain customer information relating to another person by making a "false, fictitious, or fraudulent statement or representation" to an employee or agent of a financial institution, a customer of an institution, or through the use of a forged or false document to such an institution. Moreover, requesting another person to obtain personal financial information in a manner that violates this section is also a violation under the Act. The Act excepts law enforcement agencies and insurance institutions investigating insurance fraud from the reach of these provisions, and provides exceptions for financial institutions in certain circumstances including testing security procedures, investigating allegations of misconduct on the part of an employee and recovering customer information of the institution which was obtained or received by another person.

The Act provides that the identity fraud provisions will be enforced by the FTC "in the same manner and with the same power and authority as the Commission has under the Fair Debt Collection Practices Act." Sec. 522(a) The federal banking regulators are also authorized to enforce compliance by institutions under their respective jurisdictions.


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Section 523 of the Act provides for criminal penalties for knowing and intentional violations, and permits authorities to double fines for violations involving more than $100,000 in a twelve-month period.

Like the other privacy provisions in Title V, the pretext calling provisions in Section 524 will be preempted by state laws that afford greater protection as determined by the FTC and the agency with jurisdiction over the complaint.

Each federal financial institution regulator is required to review its regulations and guidelines to determine whether revisions are necessary to protect against identity theft. Moreover, the Act requires the GAO, in consultation with the federal financial service regulators to report to Congress within 18 months of the date of enactment on the efficacy and adequacy of the remedies provided, including recommendations for change. Each of the federal financial service regulators must also report to Congress annually on the number and disposition of all enforcement actions related to identity theft.

L. Effective Date Sec. 504(a)(3) (p. 103), Sec. 510 (p. 108)

The Act specifies that final rules must be issued no later than six months following enactment (May 12, 2000). The privacy provisions of this GLB Act take effect six months after the date that the federal functional regulators, the Treasury and the FTC promulgate the rules required under Section 504(b).

XVII. COMMUNITY REINVESTMENT ACT

The CRA provisions of the Act were the most contentious and were the last major provision to be agreed to. The CRA issues ad been highly contentious since 1998. Senator Phil Gramm blocked the passage on the Senate floor of H.R. 10 because of his objections to provisions that he believed expanded the reach of CRA. (Gramm did not become Chairman of the Senate Banking Committee until January 1999). On the other side of the aisle, the Administration and Congressional Democrats and various community groups vowed to defeat any bill that "rolled back" CRA.

A. Overview The CRA provisions ultimately agreed to include four key features:

• = CRA compliance as a prerequisite for financial affiliations. The final bill dropped a requirement in the House bill that FHC's "maintain" a satisfactory CRA rating to remain a FHC.

• = CRA sunshine provisions. The Act requires full disclosure of certain "CRA agreements" between a nongovernmental person or entity and an insured DI. It further imposes detailed annual reporting requirements concerning funds received in connection with such agreements.


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• = Lengthened CRA exam intervals for certain DIs with assets of $250 million or less. DIs in this size category will be examined every five years if their last CRA exam rating was "outstanding," every four years if their last exam rating was "satisfactory," and as "deemed necessary" if their last rating was less than satisfactory.

• = Reports on CRA lending. The Act calls for two separate reports, one by the Fed on CRA lending, and one by Treasury assessing the adequacy of services provided.

B. CRA Compliance as a Prerequisite for Financial Affiliations Sec. 103(a) (pp. 9 - 10)

The Act requires that each affiliated DI of a FHC or national bank have at least a "satisfactory" CRA rating before a company can become a FHC, before a FHC can enter into new financial activities, or before a national bank can engage in financial activities in a subsidiary. However, an earlier requirement that such DIs both "have and maintain" a satisfactory CRA rating as a condition of engaging in new financial activities was not included in the Act. Moreover, the conference report explicitly states that the bank regulators may not limit or sanction a FHC if the ratings of its DI affiliates fall below satisfactory, nor can they require divestiture.

Failure to maintain a satisfactory or better CRA rating is not a basis for the Fed to take action under this provision. A FHC with a subsidiary that does not maintain a satisfactory CRA rating, however, will not be permitted to expand into new financial activities as long as such noncompliance continues. Ironically, depending on the severity of action proposed by the Fed under these provisions, an unsatisfactory CRA rating for a DI may have a substantially greater negative affect on the FHC than the Fed remedial action if the DI is not well-capitalized or well-managed. This is so because the unsatisfactory CRA rating triggers an automatic statutory bar on new financial activities or investments for the FHC. In contrast, when a DI is not well-capitalized or well-managed, the Act provides an administrative process based upon the FHC's planned action to remedy the problem. This process will not inhibit the new financial activities or investments unless the Fed so requires.

C. CRA Sunshine Requirements Sec. 711 (pp. 128 - 132)

The CRA requires banking regulators to consider CRA performance by the parties to a DI merger or acquisition transaction and allows public comment. Community groups have regularly used that opportunity to question the CRA performance of an acquiring banking organization and has often negotiated lending and other commitments with the acquirer. Throughout the deliberations on financial modernization this year, Chairman Gramm criticized this practice of DIs entering into agreements with community groups to provide loans or other resources for persons--in low or moderate-income areas.


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To address this issue, the Act requires both full disclosure of these types of CRA agreements, and detailed annual reporting by recipients of funds or resources under such agreements. Agreements covered by the Act include any written agreement between a DI or an affiliate providing for cash payment by the DI in excess of $10,000, or loan commitments exceeding $50,000 annually in connection with CRA compliance by the institution. The Act specifically exempts agreements relating to (i) "any individual mortgage loan"; (ii) any agreement concerning a loan or credit commitment "at rates not substantially below market rates", where there is no agreement to relend the funds; and (iii) any agreement with a party that "has not commented on, testified about, or discussed with the institution or otherwise contacted the institution" about CRA. (Sec. 711(e)).

Both parties to covered agreements are also subject to annual reporting requirements. Such reports, which will be submitted to the AFBA, shall include information concerning payments, fees, or loans, aggregate data on loans, investments and services made pursuant to such agreements and "other pertinent matters as determined by regulations by the appropriate Federal banking agency". Sec. 711(b). The Act permits a nongovernmental entity or person subject to the Act to comply with this requirement by transmitting its report to the DI party to its agreement. The reports must include "detailed, itemized list of the uses to which such funds have been made." (Sec. 711(c)).

The Act requires the AFBA to prescribe regulations to implement the disclosure and reporting requirements. In so doing, the Act instructs the agencies to "ensure that the regulations prescribed by the agency do not impose an undue burden on the parties and that the proprietary and confidential information is protected." The banking agencies are also instructed to "consult and coordinate" with each other to assure that regulations are "consistent and comparable." Finally, the Fed is empowered to provide further exemptions from the reporting requirements. (Sec. 711(h)).

D. Small Bank CRA Examinations Sec. 712 (p. 132)

The Act diminishes the frequency of CRA examinations for DIs with assets of $250 million or less. Such institutions will be examined as follows: (i) if an institution received an "outstanding" rating at its last examination, it will not be examined again for at least five years; (ii) if it received a "satisfactory" rating at its last examination it will not be examined again for at least four years; and (iii) an institution with a rating below satisfactory will be examined "as deemed necessary by the appropriate Federal financial supervisory agency." The banking agencies are authorized to subject such institutions to "more frequent or less frequent examinations for reasonable cause." (Sec. 712(c)). Moreover, the Act specifically provides that CRA examinations will continue to take place in connection with an application for a deposit facility.


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E. Federal Reserve and Treasury Reports on CRA Lending Sec. 713 & 715 (pp. 132 - 133)

The Act calls for two separate reports on CRA lending. The Fed, in consultation with the Chairmen of the House and Senate Banking Committees, is directed to conduct a comprehensive study of CRA lending, focusing on default rates, delinquency rates, and profitability. The report is due March 15, 2000.

The Act directs the Treasury, in consultation with the federal banking agencies, to conduct a study of the adequacy of services being provided as intended by the Community Reinvestment Act of 1977. A "baseline" report is due by March 15, 2000 with a final report to be submitted to Congress on or before November 12, 2001. The report shall address the extent to which adequate services are being provided and must include services to low and moderate income neighborhoods and for persons of modest means.

XVIII. ATM FEE REFORM Secs. 701-705 (pp. 126-128)

The ATM Fee Reform Act of 1999, as this subtitle is cited, amends the Electronic Funds Transfer Act ("EFTA") to require any operator of an ATM (other than a financial institution which holds the account of the consumer using the machine) to notify consumers using such machine that the operator imposes a fee, as well as the amount of such fee (Amending EFTA Section 904(d) (15 U.S.C. § 1693b(d)). The required notice must be posted in a "prominent and conspicuous" location on the machine, as well as shown on the screen, or a paper notice must be dispensed before the consumer is irrevocably committed to completing the transaction. Accordingly, ATM fees may only be imposed if the required notice is given and the consumer continues with the transaction after receipt of the notice. In the event that a third person removes, damages or alters any notice posted on a machine by an ATM operator, the operator will be exempt from liability under Section 910 of the EFTA. (Amending EFTA Section 910 (15 U.S.C. § 1693h).

The Act also imposes a separate notice requirement at the time an ATM card is issued. Consumers receiving an ATM card must be notified that a fee may be imposed by an ATM operator other than the card issuer, and by any national, regional or local network over which an ATM transaction is conducted. (Amending EFTA Section 905(a) (15 U.S.C. § 1693c(a)).

The Act directs the GAO to study the feasibility of enhancing the notice provided to ATM consumers to clearly state the total amount of all fees to be imposed by: the machine operator, the consumer's financial institution, any network over which the transaction will be conducted and any other party involved in the transaction. Among the factors to be considered in the study are the availability of the necessary technology, implementation and operating costs, the competitive impacts on different sizes and types of institutions, the time required to implement such a requirement and the benefits likely to accrue to consumers. The GAO is to submit a report of findings, conclusions and recommendations to Congress by May 12, 2000.


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XIX. OTHER CONSUMER PROVISIONS

A. Study of the Effect of Financial Modernization Legislation on the Accessibility of Small Business and Farm Loans Sec. 109 (p. 25)

To assess the effect of the Act on the provision of credit to small businesses and farms, Section 109 requires the Secretary of the Treasury, in consultation with federal banking agencies, to conduct a study on the extent to which credit is being provided to and for small business and farms, as a result of this Act. A report on the study, including any recommendations, must be submitted to Congress within 5 years of the date of enactment of this Act.

B. Fair Treatment of Women by Financial Advisers Sec. 733 (p. 141)

Section 733 sets forth the sense of the Congress that individuals offering financial advice or products should do so in a non-discriminatory or non-gender biased manner.

C. Provision of Technical Assistance to Microenterprises Sec. 725 (pp. 134-138)

This provision establishes a grant program to fund technical assistance and capacity building microenterprise development programs, or other organizations engaged in (1) providing training and technical assistance to low income and disadvantaged entrepreneurs; (2) enlarging the capacity of programs or organizations that serve low income and disadvantaged entrepreneurs; and (3) providing research and development for the purposes of identifying and promoting the best practices with regards to training and technical assistance programs that serve low income and disadvantaged entrepreneurs.

XX. SECURITIES LAW AMENDMENTS

The effort to determine appropriate “functional regulation” of bank securities activities proved difficult and contentious throughout the process leading up to passage of the Act as the SEC sought jurisdiction over all bank “securities” activities and banks sought to retain the ability to continue to engage in a range of financial and investment-related activities within the bank without SEC supervision. The Act does provide for “functional regulation” by replacing the blanket exemption for banks from registration as broker-dealers under the Securities Exchange Act of 1934 (the "Exchange Act") with a list of exceptions. Accordingly, banks will need to determine if their current or future planned activities fit within the statutory exceptions from broker-dealer registrations. If not, they will need to allow sufficient time to register a separate subsidiary or affiliate as a broker-dealer under both federal (SEC) and state law. In addition, a broker-dealer must become a member of the National Association of Securities Dealers and its employees must be appropriately licensed, which requires qualification exams. In the case of bank employees engaging in only private replacements, Section 203 of the Act requires the NASD to create a limited qualification category. Nevertheless, the regulation of broker-dealers


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by all these regulators is extensive and requires the establishment of an effective compliance program. The effective date of the broker-dealer provision is May 12, 2001.

The Act also amends the Investment Company Act of 1940 (the "1940 Act") with respect to bank common trust fund and mutual fund activities and amends the Advisers Act to require banks that act as investment advisers for registered investment companies (i.e. mutual funds and unit investment trusts) must register under the Advisers Act. While less extensive than the Exchange Act, the Advisers Act is a regulatory statute which covers such matters as advertising, performance and referral fees, personal trading and books and records. It also requires the establishment of an effective compliance program. The Act permits banks to register their in-house investment advisory business as "separately identified departments or divisions" rather than requiring a subsidiary or affiliate to register under the Advisers Act. Accordingly, each bank that acts as an investment adviser for registered investment companies must consider which structure will work best for it and must prepare for the new regulatory scheme. The effective date of these provisions also is May 12, 2001.

A. Banks Acting as Brokers and Dealers

The Act brings bank broker-dealer activity under the general authority of the Exchange Act. It does so by replacing the current blanket exclusion of banks from the definition of "broker" with a series of exceptions for banks dealing or engaging in specific products and activities.

1. Identified Bank Products Sec. 206 (pp. 56-57)

The Act expressly permits a bank to effect transactions in the following "identified banking products":

• = a deposit account, savings account, certificate of deposit or other deposit instrument issued by a bank;

• = a banker's acceptance;

• = a letter of credit issued by a bank;

• = a debit account at a bank arising from a credit card or similar arrangement;

• = a participation in a loan, in which the bank or an affiliate of the bank (other than a broker or dealer) participates, sold to a qualified investor or other sophisticated person; and

• = a swap agreement, including a credit or equity swap, if the swap is sold only to a qualified investor (i.e., retail equity swaps are excluded).


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2. Definition of "Broker" Sec. 201 (pp. 48-53)

In addition to the "identified banking products" listed above, the Act lists the following products and services a bank may offer and sell without broker-dealer registration:

• = third-party brokerage arrangement, subject to certain conditions which closely resemble the requirements in the Interagency Statement on Retail Sales of Nondeposit Investment Products;

• = trust activities, subject to restrictions on advertising and fees;

• = exempted securities;

• = stock purchase plans, subject to restrictions on solicitation and netting of buy and sell orders;

• = sweep accounts;

• = affiliate transactions;

• = private placements, but only if, one year after enactment, the bank is not affiliated with a broker-dealer that engages in underwriting, dealing or market-making and the dollar value of any private placement does not exceed 25% of the bank's capital;

• = municipal securities;

• = de minimus transactions (no more than 500 transactions in securities in a calendar year; and

• = safe keeping and custody activities.

Under the exception for trust activities and stock purchase plans, any brokerage transaction must be through a registered broker-dealer, which could be an affiliate, unless it is a cross-trade or conducted in a manner permitted under SEC rules.

3. Definition of "Dealer" Sec. 202 (pp. 53-54)

The Act similarly removes the blanket exclusion of banks from the definition of "dealer" in Section 3(a)(5) of the Exchange Act and replaces it with a series of exemptions for particular activities undertaken by banks. In addition to the "identified bank products" listed above, exempted activities include:


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• = exempted securities;

• = securitization;

• = derivatives; and

• = investment, trustee or fiduciary transactions.

4. "New Hybrid Products" Sec. 205 (pp. 54-56)

In the words of Banking Committee staff, the Act creates a “jump ball” rulemaking and decision-making process with respect to “new hybrid products” -- products that are not “securities” under the current federal securities laws, nor “identified banking products” under the Act. Under the procedures established by the Act, if the SEC determines that a new hybrid product should be regarded as a “security,” it will initiate a rulemaking to effect that determination. The SEC must consult with the Fed prior to the rulemaking and “shall consider” the latter's views, including the Fed's views with respect to the nature of the product and the appropriateness of its regulation as a security, and the implications of that determination for the banking industry. A “new hybrid product” rule adopted by the SEC may be challenged by the Fed in the U.S. Court of Appeals for the D.C. Circuit, and the SEC's rule is stayed until the dispute is resolved. Neither the Fed’s nor the SEC’s views are to be given deference by the court. Other "aggrieved" parties may also file suit, but the SEC's rule will not be stayed.

B. Investment Company Act and Advisers Act Amendments

The Act permits a BHC, through a subsidiary of a bank or through a non-bank subsidiary, to underwrite and distribute mutual funds. In addition, as noted above, Section 101(b) repeals Section 32 of the Glass-Steagall Act, thus permitting common officers, directors and employees between a bank and a registered investment company.

Title II - Subtitle B of the Act amends the 1940 Act and the Advisers Act in several ways to bring about functional regulation of bank investment advisory services to mutual funds and to address potential conflicts of interest raised by bank involvement in the mutual fund business. Significantly, banks performing service as an "investment adviser" to an investment company will no longer be excepted from the requirements set forth in the Advisers Act. Highlights of the provisions follow.

1. Banks as Investment Advisers Sec. 217 (pp. 62-63)

The exclusion for banks and BHCs from the definition of "investment adviser" in Section 202(a)(11) of the Advisers Act is removed for BHCs and banks that advise investment companies. Accordingly, banks performing this service would be required to register with the SEC under the Advisers Act, or to register a separately identifiable department or division


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performing these functions. Under the Act, the SEC and the AFBAs are directed to share examination results of banks and BHCs that are registered as investment advisers.

2. Investment Company Custodians Sec. 211 (p. 59)

The practice of a bank serving as custodian of an affiliated management investment company or as a trustee of an affiliated unit investment trust is currently relatively unregulated. The Act gives the SEC authority under Sections 17(f) and 26 of the 1940 Act to adopt regulations governing those practices, but requires it to consult with and take into consideration the views of the federal banking agencies.

3. Loans to Investment Companies Sec. 212 (pp. 59-60)

Current restrictions under Section 17 of the 1940 Act, regarding loans to investment companies, do not apply to loans from a bank, even if the bank is an affiliate of the investment company. The Act amends Section 17(a) to authorize the SEC to regulate the practice of investment company affiliates making loans to an affiliated investment company, but also requires it to consult with and take into consideration the views of the federal banking agencies.

4. Independent Directors Sec. 213 (pp. 60-61)

Current law prohibits an investment company from having a majority of its directors be persons who are officers, directors, or employees of one bank. The Act amends Section 10(c) of the 1940 Act to extend that restriction to cover any one bank and its subsidiaries or any one BHC and its affiliates.

5. Interested Persons Sec. 213 (pp. 60-61)

Section 2(a)(19)(A) of the 1940 Act is amended to expand the definition of "interested person" of an investment company to include any person or affiliate of a person that during the preceding six-month period executed any portfolio transaction for, engaged in any principal transaction with, distributed shares of or loaned any money to the investment company, another investment company having the same adviser, or an account over which the investment company's adviser has brokerage placement discretion; similar changes are made to the definition in Section 2(a)(19)(B) of the 1940 Act of "interested person" of an investment adviser and principal underwriter.

6. Bank Common Trust Funds Sec. 221 (p. 64)

Section 3(c)(3) of the 1940 Act currently exempts bank common trust funds from the definition of "investment company." The Act expands this exemption to include common


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and collective pooled funds offered by thrift institutions. It also codifies the SEC's interpretation that the exemption is available only for a fund that is used solely as an aid to the administration of trusts, estates or other accounts maintained by the bank for a fiduciary purpose. Thus, common trust funds could not be generally advertised or marketed. In addition, it makes technical amendments to Section 3(a)(2) of the Securities Act of 1933 and Section 3(a)(12)(A)(iii) of the Exchange Act to key the exemptions for bank common trust funds under those statutes to the exemption under the 1940 Act.

7. Disclosure re Bank Mutual Funds Sec. 214 (pp. 61-62)

The Act also provides that it shall be unlawful for any person selling a security of a registered investment company to represent or imply that the security is guaranteed, recommended, etc by the United States or any instrumentality of the United States, has been insured by the FDIC or guaranteed by or otherwise an obligation of any bank. Further, the Act requires prominent disclosure of the fact that the FDIC or any other government agency does NOT insure the securities of a registered investment company. If the SEC adopts rules under this section, it must consult with, and take into consideration the review of, the federal banking agencies.

C. SEC Supervision of Investment Banking Holding Companies Sec. 231 (pp. 65-70)

Under current law, securities firms seeking to control a bank in another country have had to use a limited purpose New York banking company (under Article XII of the New York Banking Law) as an intermediate shell holding company. Foreign banking regulators have allowed such use of article XII companies so that the New York Banking Department can serve as the consolidated banking supervisor as required by those regulators (and, in parallel fashion, by U.S. law for foreign banks in this country).

The Act permits the SEC to be such a regulator for a new entity, an Investment Banking Holding Company ("IBHC"). An IBHC is defined as any non-natural person owning or controlling one or more brokers or dealers, as well as any persons directly or indirectly controlling, controlled by, or under common control with an IBHC. The Act permits an IBHC to elect or withdraw from SEC supervision. However, the elective provisions only apply to IBHCs that are not affiliated with any insured bank (other than a trust company, credit card bank, Edge Act or Agreement corporation), any foreign bank or company described in Section 8(a) of the IB Act (12 U.S.C. § 3106(a)), or any foreign bank that directly or indirectly controls an Edge or Agreement corporation chartered under Section 25A of the FR Act (12 U.S.C. § 611 et seq.).

D. Reporting of Bank--Loan Loss Reserves Sec. 241 (p. 70)

The GLB Act requires the SEC to consult and coordinate with the AFBA before taking action with respect to the reporting of loan loss reserves in financial statements by any insured DI or holding company.


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XXI. FEDERAL HOME LOAN BANK SYSTEM AMENDMENTS

Title VI of the Act extensively revises the structure and operation of the Federal Home Loan Bank System. The final provisions draw heavily from legislation introduced early in 1999 by Senators Chuck Hagel (R-Nebraska) and Evan Bayh (D-Indiana) in their freestanding bill -- the Federal Home Loan Bank System Modernization Act of 1999 (S. 458) and by Representatives Richard Baker (R-Louisiana) and Paul Kanjorski (D-Pennsylvania) in their similar bill the Federal Home Loan Bank System Modernization Act of 1999(H.R. 822). The new law effectively expands the mission of the System by expanding the authority of FHLBs to extend advances to small banks and thrifts with assets of $500 million or less to fund loans to small businesses, small farms and small agri-busineses. Earlier versions of the legislation would have added rural and community development lending to this list, but these were dropped in conference. The Act also imposes new, tougher, risk-based capital standards for the FHLBs. Finally, the Act includes a new corporate governance scheme for the FHLBs and enhanced enforcement powers for the FHFB.

A. System Membership

1. Voluntary Savings Association Membership Secs. 603 &608(d) (pp. 113-114 & 124)

The GLB Act amends the HOLA to permit savings associations to become voluntary members of the FHLB System beginning May 2000, in accordance with the Federal Home Loan Bank Act (the "FHLBA"). Section 603 amending 12 U.S.C. § 1464(f). At present, all federal savings associations are required to be members of the FHLB System. The Act does not, however, permit members to withdraw from the system unless their FHLB determines that withdrawal will not undermine its ability to meet its new REFcorp obligation. Section 608(d); amending 12 U.S.C. § 1426(e).

2. Community Financial Institutions Secs. 602 & 605 (pp. 113 & 115)

The Act creates a category of community financial institutions ("CFIs"). CFIs are FHLB System member institutions that have assets of less than $500 million (or such amount as adjusted annually for inflation by the Federal Housing Finance Board ("FHFB")) based on a three-year moving average of total assets, and whose deposits are insured under the FDI Act. Section 602; amending 12 U.S.C. § 1422. CFIs may be eligible for System membership without regard to the usual requirement that at least 10 % of total assets be in residential mortgage loans. Section 605; amending 12 U.S.C. § 1424(a).


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B. Advances to Member Borrowers Sec. 604 (pp. 114-115)

The Act amends Section 10(a) of the FHLBA to expand the purposes for which FHLBanks may make secured advances to member institutions, as well as the types of collateral which may be used to secure such advances. Section 604; amending 12 U.S.C. § 1430(a). Under the Bill, in addition to providing funds for residential housing finance, FHLBanks may make advances to any CFI for the purpose of funding small business, agriculture, and “small agribusinesses.” Moreover, the Bill allows CFIs to use secured loans for small business, agriculture, and small agribusinesses, or securities backed by these assets, as collateral for those advances.

C. Qualified Thrift Lender Provisions Sec. 604 (pp. 114-115)

The Act eliminates a number of statutory preferences for QTL-members. QTL members no longer receive priority for FHLB advances, and the 30% System-wide cap on advances to non-QTL members is repealed by the Act. Additionally, non-QTL members are no longer subject to the advance-based stock purchase requirement (which had required them to purchase more FHLB stock when they made use of advances) or the requirement that their advances be housing-related. These changes are effective upon the implementation of the new capital provisions.

D. REFCorp Bond Payments by FHLBanks Sec. 607 (pp. 118-119)

The FHLBanks are required to contribute to paying off the REFCorp bonds, a contribution which currently totals approximately $300 million per year. Under the Act, the shortfall allocation provision of Section 21B(f)(2)(C) of the FHLBA is modified to provide that each FHLBank will pay to the Funding Corporation in each calendar year, 20.00% of its net earnings (after deducting Affordable Housing Program and operating expenses). If this amount is less than $300 million, the payment period will be lengthened. The effective date for these REFCorp changes is January 1, 2000. Section 607; amending 12 U.S.C. § 1441b(f)(2)(C).

E. Management of the Banks Sec. 606 (pp. 115-118)

Responding to criticisms that the FHFB is currently overly involved in the day-to-day management of the FHLBanks, the Act transfers authority over many operational areas from the FHFB to the individual FHLBanks. These functions include purchasing or constructing buildings, hiring and fixing compensation levels for officers employees, attorneys and agents, setting the form of member applications for FHLB advances, interest rates on advances, the sale or participation of advances with another FHLB, and paying dividends out of retained earnings.

The Act sets the terms for both elected and appointed directors of the FHLBs at 3 years (staggered with approximately one-third of the terms expiring each year). Each board’s


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Chairperson and Vice Chairperson will be elected by a majority vote of the board and will serve two year terms. The Act caps annual salaries of the FHLB directors at $25,000 for the Chairperson, $20,000 for the Vice Chairperson and $15,000 for other directors. The Act permits directors to reside outside the FHLB district if they are an officer or director of a member institution located in the district. Section 606(a); amending 12 U.S.C. § 1427(d).

F. Federal Housing Finance Board Enforcement Authority Sec. 606(e) (p. 117)

While the Act curtails the governance authority of the FHFB over the FHLB’s in many respects, it enhances FHFB enforcement authority. It enables the FHFB to exercise the same powers that the AFBAs may when acting affirmatively to correct conditions resulting from violations or practices, and to limit the activities of any FHLBank or director or officer thereof. Moreover, the Act gives the FHFB the same powers, rights and duties to enforce the FHLBA as the Office of Federal Housing Enterprise Oversight ("OFHEO") has to enforce statutes under its purview, and provides that the FHFB may sue or be sued. The Act also authorizes the FHFB to "address any insufficiencies in capital levels" of the FHLBanks resulting from the conversion to a voluntary membership System. Section 606(e)(1); amending 12 U.S.C. § 1422b(a).

G. Capital Structure of Federal Home Loan Banks Sec. 608 (pp. 119-126)

The Act revises the capital structure of the FHLB System and creates a system of

permanent capital. While the Act directs the FHFB to promulgate regulations in accordance with the statute within one year of enactment, the FHFB has already announced its intention to issue draft regulations by May 2000. The FHFB regulations must set forth both a leverage requirement and risk-based capital requirements, and provide a minimum investment required of members.

The Act authorizes each FHLB to issue two classes of stock: Class A stock, which would be redeemable with six months prior written notice; and Class B stock, which would be redeemable with five years prior written notice. The Act requires the FHFB to adopt a leverage capital requirement in which total capital must equal 5% of aggregate on-balance sheet assets. However, for purposes of this calculation, the value of retained earnings and the paid-in value of Class B stock will be multiplied by 1.5. All banks must have a leverage ratio of at least four-percent of total capital to assets without regard to the multiplier. The Act also instructs the FHFB to include in its regulations a risk-based requirement for the FHLBs in which permanent capital is sufficient to meet the bank's credit risk and market risk (including interest rate risk). In promulgating the risk-based capital rule, the Finance Board must "take due consideration" of OFHEO's risk-based capital rule "with such modifications" as are deemed appropriate.

Each bank's Board of Directors must approve a capital plan within 270 days after the publication of the Finance Board’s capital regulations. Each plan shall adopt a capital structure "best suited for the condition and operation of the bank and the interests of the members of the


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bank" that meets the minimum leverage and risk-based requirements. Each plan shall provide for minimum investments by bank members.

The terms for stock redemptions and for withdrawals and removals from the system are also addressed. Members may withdraw voluntarily from the System by providing written notice. Members will be required to wait the period of time applicable to the classes of stock held. At the end of the period, the stock will be surrendered in return for cash equal to the par value of the stock. During the waiting period, the member could benefit from all membership rights, including dividends.

The Act provides that in the event of termination of membership by the Finance Board, the applicable waiting periods would still apply. However, in this case the rights of membership are not available to the member during the waiting period, except for dividend rights. At the end of the waiting period, terminated members would receive par value for its stock.

The Bill would provide that no FHLB may redeem or repurchase any applicable capital stock if, following the redemption, the FHLB would fail to satisfy any minimum capital requirement.

XXII. DEPOSIT INSURANCE FUNDS: ELIMINATION OF THE SAIF AND DIF RESERVES Sec. 736 (p. 142)

Section 736 of the GLB Act eliminates the SAIF and DIF "special reserve" funds established under Sections 2704 of the Deposit Insurance Funds Act, as enacted in September 1996 (P.L. No. 104-208). As required by that law, the FDIC established the special reserve accounts as of January 1, 1999 to hold any amounts in the SAIF and DIF in excess of the statutorily prescribed reserve ratios. This provision is effective on the enactment date of the Act, November 12, 1999.

XXIII. UNITARY SAVINGS AND LOAN HOLDING COMPANIES

A. Background

Under Section 10(c) of the HOLA, a Unitary is a company that controls only one insured savings association (not counting an insured savings association acquired by the company in a supervisory transaction). A Unitary may engage in any type of financial or nonfinancial activity if each of its thrift subsidiaries meets the requirements of the QTL asset test. Nevertheless, the overwhelming number of S&LHCs that satisfy the requirements to qualify as a Unitary do not engage in any nontraditional activities.

The thrift provisions were a controversial part of H.R. 10 and S. 900 throughout the process. Although even the largest thrifts engage almost exclusively in consumer and housing-related activities and derive no more than 2%-5% of their assets or revenues from business customers, the Unitary structure has been criticized because it permits common ownership of "banking" and "commercial" companies. Until the thrift provisions were drastically changed in


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the House Rules Committee in mid-1998, H.R. 10 made wholesale changes in laws governing thrifts. When passed by the House in 1998, H.R. 10 barred a company from becoming a Unitary by chartering a new savings association. At the same time, it would have permitted any existing Unitary to continue to operate as under present law and to transfer its savings association to any other company, which would then succeed to Unitary status. The Senate Banking Committee in 1998 amended H.R. 10 to bar a grandfathered Unitary from selling its thrift to any company engaged in any activity that is not "financial," other than another grandfathered Unitary.

Since mid-1998, the debate over the Unitary focused on the extent to which existing Unitaries may transfer unitary status to an acquiring company that was not a Unitary (or had an application pending to become one) on the specified grandfather date.

1. Bar to New Unitaries Sec. 401(a) (pp. 97-98)

The Act adds a new paragraphs (9) (A) and (B) to HOLA Section 10(c) stating that no company may acquire through any type of business combination control of an insured savings association after May 4, 1999, unless (i) it engages, and continues to engage, only in the activities permissible for a FHC under the BHC Act as amended or to a multiple S&LHC under Section 10(c)(1)(C) or 10(c)(2), or (ii) unless it is grandfathered as a Unitary.

2. Unitary Grandfather Sec. 401(a) (p. 98)

The Act further provides that the new paragraph (9) restrictions "do not apply" to any company that was a Unitary on May 4, 1999 (or becomes a Unitary pursuant to an application pending on that date). Such a company may continue to operate under present law as long as the company continues to meet the Unitary tests in existing Section 10(c)(3): it can control only one savings institution, excluding supervisory acquisitions, and each such institution must meet the QTL test. A grandfathered Unitary also must continue to control at least one savings association, or a successor institution, that it controlled on May 4, 1999.

This language is from the Johnson Amendment to S. 900. The corresponding H.R. 10 provision was similar, but left the door open for the creation of new unitaries engaging in limited nonfinancial activities. Section 401 of H.R. 10 was amended by the House floor to provide that a company that engages in activities that are not financial in nature may apply to the Fed for approval to continue to engage in such activities after acquiring control of a savings association.

The Act also includes a provision from S. 900 to allow certain family trusts that acquire control of a federal association under an application filed before May 4, 1999 to engage in nonfinancial activities. A "rule of construction" is provided in Section 401(c) allowing a company that had a subsidiary that submitted an application on September 2, 1998, to file to convert a state-chartered trust company controlled on May 4, 1999, to a savings association.


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3. Multiple S&LHCs Sec. 401(a) (p. 98)

The Act permits multiple S&LHCs also to engage in any BHC Act Section 4(k) financial activity. New Section 10(c)(9)(B) provides that "no savings and loan holding company may engage directly or indirectly (including through a subsidiary other than a savings association) in any activity" other than those already permitted under 10(c)(1)(C) or 10(c)(2) or as now permitted under BHC Act Section 4(k).

4. Corporate Reorganizations Sec. 401(a) (p. 98)

Under new Section 10(c)(9)(D), corporate reorganizations involving a S&LHC and a company under common control with that holding company are expressly permitted.

5. OTS Authority to Issue Interpretations and Prevent Evasions Sec. 401(a) (p. 98)

Under new Section 10(c)(9)(E), the OTS is given express authority to prevent evasions of this limitation on the creation of new Unitaries, including the authority to determine that, notwithstanding the form of the transaction, the transaction would permit an acquisition of control prohibited under HOLA. Since this paragraph expands the activities of all S&LHCs, in addition to limiting the creation of new Unitaries, this provision may allow OTS to address the financial activities of savings organizations in the regulatory process.

It should be noted that the Act also allows OTS to issue interpretations, regulations, or orders that the Director determines are necessary "to administer and carry out the purpose . . . of this paragraph."

6. Mutual Holding Companies Sec. 401(b) (p.99)

The Act amends Section 10(o) of HOLA to provide that mutual savings and loan holding companies chartered by the OTS may engage in the same financial activities authorized for financial holding companies under new BHC Act Section 4(k). It also repeals the limitation that a mutual holding company may not engage in insurance agency and escrow activities.

7. Optional Conversion to Bank of Federal Savings Association Sec. 723 (p. 134)

The Act provides that any federal savings association converting to either a national or state bank charter after the date of enactment may retain the word "Federal" in its name, provided the institution remains an insured DI.


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XXIV. MUTUAL BANK HOLDING COMPANY Sec. 105 (p. 22)

The GLB Act permits any BHC to be organized in mutual form and to be regulated on terms and conditions comparable to stock BHCs. While not clearly drafted, this provision appears to apply both to mutual holding companies created by mutual savings banks and referenced in BHC Act Section 3(g)(2), and to other mutual companies that become BHCs.

XXV. REDOMESTICATION OF MUTUAL INSURERS Secs. 311-316 (pp. 80-85).

Not all states currently allow a mutual insurance company to reorganize as a mutual insurance holding company and thus to have a nonoperating company as a FHC, as stock companies typically will. As passed by the House in 1998, H.R. 10 provided federal law authority for insurers in these states to redomesticate to a state in 1998 that allows such a holding company reorganization, and preempts state laws that would impede such a move. The Senate Banking Committee deleted the entire set of redomestication provisions. The GLB Act, however, resurrected the House provisions.

A. Redomestication Sec. 312 (pp. 80-82).

The GLB Act permits a mutual insurer to transfer its domicile from one state to another as part of a reorganization plan to become a stock insurer as a direct or indirect subsidiary of a mutual holding company. Redomestication under these provisions is conditioned upon a determination by the state insurance regulator of the transferee state that the reorganization plan satisfies the following procedural requirements:

• = Board and policyholder approval. At least a majority of both the mutual insurer's board of directors and its policyholders must approve the reorganization as dictated by the notice, disclosure and voting requirements approved by the state insurance regulator of the transferee state;

• = Continued voting control. Policyholders must have the same voting rights with respect to the mutual insurer after the consummation of the reorganization as they held prior thereto;

• = IPOs. Any initial public offering of stock under the reorganization must comply with applicable securities laws and must transpire in a fashion approved by the state insurance regulator of the transferee state;

• = Stock and options grants to officers and directors. During an applicable period provided under the state law of the transferee's domicile or for six months following an initial public offering, elected officers or directors of a mutual holding company, stock holding company or the converted insurer may not be given grants of stock or stock options by the stock holding company or the


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converted insurer, except those grants such a person is entitled to receive as a policyholder and as approved by the state insurance regulator of the transferee state;

• = Preservation of policyholder rights. The contractual rights of policyholders must be preserved following the reorganization into a mutual holding company; and

• = Fair and equitable treatment. The state insurance regulator of the transferee state must approve the reorganization as fair and equitable to policyholders.

Other provisions of the Act also (i) preserve the insurer's licenses and similar items, if the insurer remains duly qualified to transact the insurance business in a state; (ii) retain all policies and contracts in full force and effect, although a state insurance regulator may require that policies of individuals residing in that state be endorsed; and (iii) require that notice of the transfer and any proper amendments to corporate documents be provided to the insurance regulator of each licensed state.

B. Preemption Sec. 313 (pp. 82-83)

The GLB Act broadly preempts state laws that conflict with the purposes and intent of the Act's mutual insurer redomestication provisions. Among the laws preempted are those that, because of the redomestication, improperly (i) impede the activities of the insurer or its customers, agents or other intermediaries (but then only to the extent a conflicting law would discriminate against an insured licensee or other intermediary procuring or placing insurance through a non-redomesticated entity), or (ii) terminate licenses, approvals, or similar items of the insurer. Further, state laws (other than a law of the transferee state) are preempted if they discriminate against a redomesticated insurer as compared to a non-redomesticated insurer, including provisions concerning certificates of authority.

Under the Act, however, a licensing state may require a redomesticated insurer to comply with laws concerning (i) unfair claim settlement practices, (ii) application premiums or other taxes, (iii) service of process registration, (iv) examination requirements if the insurance regulator in the state of redomestication has not begun an examination or scheduled one to begin within one year of the date of redomestication, (v) orders that address certain delinquency proceedings or voluntary dissolutions, (vi) deceptive, false or fraudulent acts or practices, (vii) court injunctions regarding hazardous or impaired financial conditions, (viii) participation in any insurance insolvency guaranty association on a non-discriminatory basis, and (ix) the licensing of persons acting or offering to act as an insured licensee for an insurer on a non-discriminatory basis.

For redomestication purposes, the term "state" comprises any state, the District of Columbia, any territory of the United States, American Samoa, Guam, Puerto Rico, the Trust Territories of the Pacific Islands, the U.S. Virgin Islands, and the Northern Mariana Islands.


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XXVI. UNIFORM MULTISTATE LICENSING OF STATE LICENSED INSURANCE AGENTS AND BROKERS

A. Uniform Licensing Reforms Secs. 321-336 (pp. 85-97)

Subtitle C, Title III of the GLB Act establishes the National Association of Registered Agents and Brokers (the "NARAB"), a nonprofit corporation subject to the provisions of the District of Columbia Nonprofit Corporation Act. The NARAB is to be a mechanism through which uniform licensing, continuing education and other insurance producer sales qualification requirements and conditions may be adopted and applied on a multistate basis. However, this Subtitle preserves the right of states to license, supervise and discipline insurance producers and to enforce laws and regulations governing insurance-related consumer protection and unfair trade practices. The NARAB is subject to supervision and oversight by the NAIC, and is not established as an agency of the Federal Government. This proposal has been in circulation for several years and seeks to create greater uniformity in the standards and laws governing insurance sales practices consistent with the existing framework of state regulation of insurance.

B. Delayed Effective Date Sec. 321 (pp. 85-87)

Subtitle C will only become effective if, at the end of 3-years after enactment of the GLB Act, a majority of the states have not enacted (i) uniform multistate laws and regulations governing the licensing of individuals and entities authorized to sell and solicit the purchase of insurance, or (ii) reciprocity laws and regulations governing the licensing of nonresident individuals and entities authorized to sell and solicit insurance. The NAIC, in consultation with the state regulators, shall determine at the end of the 3-year period if the majority of the states have adopted a uniform set of laws and regulations that conform to the uniformity and reciprocity requirements set forth in this Subtitle. A United States district court shall have exclusive jurisdiction over any challenge to such determination.

If at any time the uniformity or reciprocity required above cease to exist, the provisions of this Subtitle will take effect within two years unless the provisions are again satisfied before the end of those two years. States shall not be required to adopt new or additional licensing requirements to achieve uniformity, but states must change laws and regulations to correct any inconsistencies with specific provisions of this Subtitle.

C. Standards for State Compliance Sec. 321 (pp. 85-86)

States shall be deemed to have met the statutory requirements for uniformity in licensing insurance producers if they have established --

• = uniform criteria regarding integrity, personal qualifications, education, training and experience;


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• = uniform criteria for continuing education requirements;

• = uniform ethics course requirements;

• = uniform criteria to ensure the suitability and appropriateness of insurance products for consumers based on the financial information disclosed thereby; and

• = no licensing or other qualification requirements that limit or condition the activities of insurance producers on the basis of their residence or place of operations.

The states shall be deemed to have established the required reciprocity if at least a majority of them have reciprocal administrative licensing procedures, reciprocal satisfaction of continuing education requirements, no limiting nonresident requirements, and reciprocal reciprocity with each other.

D. Association Operations Secs. 325-336 (pp. 87-97)

Other provisions in Title III, Subtitle C, of the Act address the legal and administrative operations of the NARAB, its relationship to the NAIC and its interaction with state insurance regulators. Major provisions in this Subtitle governing the workings of the NARAB are summarized below.

• = Membership. Membership in the NARAB is based on the premise that any state-licensed insurance producer shall be eligible for membership, unless the producers’ license has been suspended or revoked during the 3-year period proceeding the membership application. The NARAB is authorized to establish various classes and/or categories of membership as well as membership criteria, to inspect and examine the records and offices of members to determine compliance with such criteria, and to suspend or revoke the membership of those who either fail to comply or have been disciplined pursuant to a final state regulatory adjudication. Membership entitles the member to licensure in each state for which the member pays the requisite fees. The NARAB is required to establish an office of consumer complaints with a toll-free hotline to receive and investigate complaints relating to its members both from consumers and state insurance regulators. Such office will recommend disciplinary action to the NARAB and refer complaints to state insurance regulators when appropriate. Section 325.

• = Board of Directors. The NARAB Board of Directors is to comprise seven directors appointed by the NAIC for three-year terms. If the NAIC has not appointed the initial board within two years, the initial board of directors will consist of the seven state insurance regulators of the seven largest states in terms of the total dollar amount of commercial-line insurance placements. The board


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shall have such powers and authority as may be specified in the bylaws of the NARAB. The officers shall be elected or appointed for terms not exceeding three years. The chairperson of the board of directors must be a member of the NAIC. Sections 326-327.

• = Bylaws, Rules, and Disciplinary Action. The NAIC is to review and approve the NARAB’s by-laws and rules as specified in the Act. Proposed by-laws or amendments thereby will generally take effect unless the NAIC disapproves them as contrary to the public interest or the purposes of the Act. Conversely, the NAIC must affirmatively find proposed rules consistent with the public interest and the Act. Procedural requirements for disciplinary actions by the NARAB and the NAIC review of such actions are also provided. Section 328.

• = Assessment fees. The NARAB is authorized to establish any nondiscriminatory application and membership fees necessary to cover operational costs and assessments, but such fees may not discriminate against smaller insurance producers. The NAIC is also permitted to assess the NARAB for costs incurred with respect to the NARAB. Section 329.

• = Functions of NAIC. The NAIC is authorized to examine, inspect, and require reports from the NARAB. The NAIC is required to review the NARAB’s annual report, including financial statements, and forward it to Congress and the President. Section 330.

• = Liability of the NARAB and of its directors, officers, and employees. The NARAB will not be deemed to be an insurer or insurance producer for purposes of any state law or regulation. This section insulates the NARAB, its directors, officers and employees from any liability for any actions taken or omitted in good faith under or in connection with any matter subject to this subtitle. Section 331.

• = Elimination of NAIC oversight. The President of the United States, with the advice and consent of the Senate, will establish the NARAB without the NAIC oversight if, after two years from the date, this Subtitle takes effect: (i) at least a majority of the states representing at least 50 % of the total U.S. commercial-lines insurance premiums have not satisfied the uniformity or reciprocity requirements set forth in Section 321; and (ii) the NAIC has not approved NARAB’s by-laws, cannot operate the NARAB, or does not conduct its activities as required under this Subtitle. In such case, the NARAB will be subject to suspension and oversight by the President. Section 332.

• = State law preemption. This Subtitle preempts state laws, regulations, provisions or other actions that discriminate against an insurance producer or its affiliates because of the producer’s NARAB membership or residency. Any state laws that impose any licensing, appointment, integrity, personal or corporate qualifications, education, training, experience, residency, or continuing education requirement


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upon a NARAB member which is different from the NARAB’s membership or renewal requirements are also preempted, except for counter-signature requirements imposed on non-resident producers. Except as provided elsewhere in this Subtitle, no provision of this section alters or affects the effectiveness of any state law or regulation purporting to regulate insurance producers, including those which regulate unfair trade practices or establish consumer protection including countersignature laws. Section 333.

• = Coordination with other regulators. The NARAB has the authority to (i) issue uniform insurance producer licensing and renewal applications, while preserving a state’s right to impose conditions consistent with Section 333, (ii) establish a central clearinghouse for license applications and renewals, and (iii) establish a national database for regulatory information concerning insurance producer activities. The NARAB is also directed to coordinate with the NASD to ease the administrative burdens on dual members. Section 334.

• = Judicial review. Exclusive jurisdiction over litigation involving the NARAB is granted to the federal courts. Aggrieved persons must exhaust all administrative remedies before the NARAB and the NAIC prior to seeking judicial review. Section 335.

• = Definitions. Section 336 sets forth the definitions for home state, insurance, insurance producer, state, and state law for the purposes of Subtitle C.

XXVII. MISCELLANEOUS

A. Repeal of Stock Loan Limit Sec. 735 (p. 142)

The GLB Act eliminates Section 11(m) of the FR Act which limited (i) the percentage of individual bank capital and surplus which was represented by loans secured by stock or bond collateral made by a member bank, and (ii) the amount of such loans (amending 12 U.S.C. § 248(m)).

B. Report on Online Banking and Lending Requirements Sec. 729 (p.139)

Section 729 of the Act requires the federal banking agencies, as defined in FDI Act Section 3(z) (12 U.S.C. § 1813(z)), to conduct a study of banking regulations governing the delivery of financial services, including regulations relating to person-to-person contacts in financial services transactions. The federal banking agencies are to submit a report to Congress on the results of the study, with recommendations on how to adapt existing regulatory requirements on such transactions to online banking and lending. The report should be submitted within two years of enactment of the GLB Act and should contain any recommendations for legislative or regulatory action that the agencies deem appropriate.


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C. Expanded Small Bank Access to S Corporation Treatment Sec. 721 (pp. 133-134)

Section 721 of the Act requires the Comptroller General to conduct a study on possible revisions to rules governing S corporations, including increasing the permissible number of shareholders, permitting shares to be held in individual retirement accounts, clarifying the treatment of interest on investments held for safety, soundness, and liquidity purposes, and improving Federal tax treatment of bad debt and interest deductions among other things. The Comptroller General shall submit a report on the study to Congress not later than 6 months after the date of enactment of this Act. This study was included in response to the urging of S corporation representatives who sought actual changes to achieve these ends.

D. Plain Language Requirement Sec. 722 (p. 134)

Section 722 of the Act directs Federal banking agencies to use plain language in all proposed and final rulemakings published in the Federal Register after January 1, 2000. It also requires the Federal banking agencies to report to Congress no later than March 1, 2001 regarding compliance with the plain language requirement.

E. Bank Officers and Directors as Officers and Directors of Public Utilities

Sec. 737 (p. 142)

Currently, the Federal Power Act prohibits any person from serving concurrently as (i) an officer or director of a public utility and (ii) an officer or director of, among other entities, any bank, trust company, banking association or firm authorized to underwrite or participate in the marketing of public utility securities, without authorization by order of the Federal Power Commission. Federal Power Act § 305(b); 16 U.S.C. § 825d(b).

Section 737 of the Act, however, relaxes this restriction against these director and officer interlocks. A person would be allowed to serve concurrently as an officer or director of both a public utility (for purposes of this section, the "Utility") and one of the foregoing institutions (for purposes of this section, the "Related Financial Institution") in the following circumstances:

• = The officer or director does not participate in any deliberations or decisions involving the selection of any bank, trust company, banking association or securities underwriting/marketing firm if the Related Financial Institution is one of the firms under consideration;

• = The Related Financial Institution does not underwrite or participate in the marketing of the Utility's securities;

• = The Utility selects underwriters through "competitive procedures;" or


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• = The issuance of securities by the Utility has been approved by all federal and state regulators having jurisdiction over the issuance of such securities.

F. Interstate Branches: Interest Rates and Other Charges Sec. 731 (pp. 140-141)

Under Section 85 of the NB Act (12 U.S.C. § 85), as confirmed by the United States Supreme Court in Marquette National Bank v. First of Omaha Service Corp., 439 U.S. 299 (1978), national banks are permitted to "export" to customers in other states interest rates and other loan-related fees authorized under the laws of its home state. State banks have parallel authority under section 25 of the FDI Act (12 U.S.C. § 1831d).

Section 731 provides for "loan pricing parity" among insured DIs. It permits an in-state insured DI whose home state law sets a specific loan fee limit on rates that can be charged by in-state DIs to charge the same fees on loans that are charged by out-of-state branches located in such a state. This Section applies to any state with a lawful maximum annual loan interest rate of 5% above the 90-day commercial paper discount rate in effect at the relevant Federal Reserve bank. Conference Report at 30. In a colloquy between Senators Gramm and Grams on the Senate floor, Senator Gramm stated that it is his understanding that (i) this Section is not intended to affect DIs whose home office and authorized branch offices are not located in a state with such an interest rate ceiling; (ii) national banks are in "all events" authorized to export interest rates of their home state; and (iii) national banks are also entitled to charge the rates of the host state of an interstate branch, as authorized by the OCC, "where there is a nexus between the host state and the loan."

G. Control of Bankers' Banks Sec. 724 (p.142)

Section 724 of the Act amends Section 2(a)(5)(E)(i) of the BHC Act to clarify that a company may own or control a state-chartered bank or trust company engaged in circumscribed deposit-taking activities without being deemed a BHC for purposes of the BHC Act if the subsidiary bank or trust company is wholly-owned by "one or more" thrift institutions or savings banks. As under current law, the subsidiary bank's or trust company's deposit-taking must be limited to accepting deposits from thrifts or savings banks, deposits arising out of the corporate business of its thrift or savings bank owners, or deposits of public funds.

H. Approval for Purchases of Securities Sec. 738 (p.143)

Section 23B of the FR Act generally prohibits banks and their subsidiaries from purchasing or acquiring securities from an underwriting or selling syndicate for which an affiliate serves as a principal underwriter (FR Act § 23B(b)(1)(B); 12 U.S.C. § 371c-1(b)(1)(B)). However, the FR Act excepts from this prohibition the purchase or acquisition of securities from such a syndicate where a majority of the bank's directors who are not officers or employees of the bank (or its affiliates) approves the transaction before the securities are initially offered to the public (FR Act § 23B(b)(2); 12 U.S.C. § 371c-1(b)(2)). Section 738 of the Act extends this


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exception to any purchase or sale of securities where a majority of all directors (i.e., not necessarily a majority of the independent directors) approved the transaction (i) before such securities were initially offered to the public and (ii) after determining that the securities represented a sound investment for the bank (disregarding the fact that an affiliate was a principal underwriter for the securities).

I. Membership of Loan Guarantee Boards Sec. 734 (pp. 141-142)

Section 734 amends the Emergency Steel Loan Guarantee Act of 1999 to permit either a member of the Board Governors of the Federal Reserve or a SEC Commissioner to serve on the Emergency Steel Loan Guarantee Board in place of the Federal Reserve Chairman and the SEC Chairman.

J. Grand Jury proceedings Sec. 740 (pp. 143-144)

Section 740 permits state bank regulators the same access to grand jury information that is currently provided for federal regulators. (Amending 18 U.S.C. 3322(b)).

K. Rental Car Agency Insurance Activities Sec. 341 (p. 97)

During the three year period beginning on the date of enactment, section 341 provides for a federal presumption that no state law imposes a licensing requirement on any person who solicits the purchase of, or sells, insurance in connection with the rental or lease of an automobile for a period of 90 days or less.

The Washington Report on Financial Institutions is a publication of Gibson, Dunn & Crutcher LLP (the "Firm") and is prepared by members of the Financial Institutions Group in the Firm's Washington, D.C. office. It should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general informational purposes only.

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