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Banking Agencies Propose Rules to Implement Key Provisions of Financial Services Modernization Law

January 2000
By Carlos E. Loumiet and Carl A. Fornaris, Greenberg Traurig, Miami Office

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On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act (or the "Act"). The Act is a major financial services modernization law that will, among other things, facilitate broad new affiliations among securities firms, insurance firms, and bank holding companies by repealing the 66-year old provisions of the Glass-Steagall Act. The major provisions of the Gramm-Leach-Bliley Act become effective March 11, 2000.

Most significantly, the Act permits the formation of financial holding companies ("FHCs") — i.e., bank holding companies with substantially expanded powers — under which affiliations among bank holding companies, securities firms and insurance firms may occur, subject to a blend of umbrella supervision and regulation of the newly formed consolidated entity by the Board of Governors of the Federal Reserve System (the "Federal Reserve"), oversight of the FHC’s bank and thrift subsidiaries by their primary federal and state banking regulators, and functional regulation of the FHC’s nonbank subsidiaries — such as broker-dealers and insurance affiliates — by their respective specialized regulators.

On January 19, 2000, the Federal Reserve released an interim rule that sets forth procedures for bank holding companies and foreign banks with United States offices to elect to be treated as FHCs. The deadline to submit comments to the Federal Reserve in response to the interim rule is March 27, 2000, and a final rule will become effective some time after that date. While the interim rule will not be effective until March 11, 2000, bank holding companies may begin filing FHC elections immediately with their appropriate Federal Reserve Bank. The Federal Reserve System will endeavor by March 13, 2000, which is the first business day following the effective date of the FHC provisions of the Act, to act on all FHC elections filed before February 15, 2000. The Federal Reserve System will act on FHC elections filed after that date as quickly as practicable. Any elections filed before March 11, 2000 would not become effective, in the absence of Federal Reserve action, until the 31st day after March 11 (i.e., April 11, 2000).

Another significant change provided by the Act is the permissibility of national banks to conduct certain previously impermissible non-banking financial activities through a "financial subsidiary." On January 20, 2000, the OCC released its proposed rule to implement the Act’s "financial subsidiary" provisions. The deadline to submit comments to the OCC regarding the proposed rule is February 14, 2000. Based on representations from the staff of the OCC, it is anticipated that a final rule will become effective March 11, 2000.

A summary of the major provisions of the Act and the Federal Reserve’s and the OCC’s proposed rules follows.

A. Financial Holding Companies

The Act adds a new subsection (k) to Section 4 of the Bank Holding Company Act of 1956, as amended (the "BHC Act"), which authorizes FHCs and establishes eligibility requirements for FHCs. The new Section 4(k) also identifies activities that are permissible for FHCs.

Generally, a FHC may engage in any activity, and acquire and retain the shares of any company engaged in any activity, which the Federal Reserve, after consultation with the Secretary of the Treasury, has determined by regulation or order to be: (i) "financial in nature or incidental to such financial activity"; or (ii) "complementary to a financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally." The Act specifically identifies the following activities as financial in nature (i.e., as activities that may be conducted without limitation through the affiliates of a FHC):

  • Underwriting or dealing in all types of securities free of the current 25% limitation on revenues which the Federal Reserve has applied to dealing and market-making activities of so-called "Section 20" subsidiaries);
  • acting as underwriter, agent, or broker of all forms of insurance and annuities;
  • lending, exchanging, transferring, investing for others, or safeguarding money or securities;
  • providing financial, investment or economic advisory services, including advising an investment company;
  • issuing or selling instruments representing interest in pools of assets permissible for a bank to hold directly;
  • engaging in any activity that the Federal Reserve has determined, by order or pursuant to Regulation Y as in effect on November 12, 1999, to be so closely related to banking or managing or controlling banks as to be a proper incident thereto;
  • engaging in the United States in any activity that a bank holding company may engage in outside the United States, and that the Federal Reserve has determined under Section 4(c)(13) of the BHC Act to be usual in connection with the transaction of banking or other financial operations abroad;
  • merchant banking activities; and
  • insurance portfolio investment activities.

Over the next several years, this list of activities is expected to expand to include other activities that the Federal Reserve determines by regulation or order to be financial in nature or complementary to a financial activity.

In order to become a FHC and engage in FHC activities like the ones enumerated above, or acquire a company engaged in FHC activities not permissible for an ordinary bank holding company, the following conditions must be met: (1) all of the bank and thrift subsidiaries of the proposed FHC must be well capitalized and well managed; (2) the proposed FHC must satisfy certain Community Reinvestment Act ("CRA") requirements described below; and (3) the proposed FHC must file with the Federal Reserve a written declaration that (x) the company elects to become a FHC, (y) provides the name and head office address of the company and of each of its bank and thrift subsidiaries, and (z) certifies that the company meets the capitalization, management and CRA conditions for FHC status. Under the Federal Reserve’s interim rule (discussed below), a bank holding company’s election to become a FHC will become effective, at the latest, on the 31st day after the FHC election is received by the appropriate Federal Reserve Bank.

Assuming the proposed FHC meets the capital, management and CRA conditions and has filed its FHC certification with the Federal Reserve, the company need only provide written notice to the Federal Reserve no later than 30 days after commencing an activity or consummating an acquisition permitted to FHCs but not to bank holding companies. However, a FHC may be required to provide prior written notice to the Federal Reserve before commencing such an activity or acquisition if it: (1) is acquiring a thrift; (2) is required to file a premerger notification with the Federal Trade Commission for certain acquisitions; or (3) intends to engage in activities that are "complementary in nature" to those activities deemed by the Act to be financial in nature.

Failure to Satisfy Capital and Management Requirements. If a FHC’s bank and thrift subsidiaries fail to meet the well capitalized and well managed criteria, the FHC must execute an agreement with the Federal Reserve to comply with the requirements applicable to a FHC, and until the FHC is in compliance, the Federal Reserve may impose limitations on the FHC. If the FHC fails to satisfy Federal Reserve-imposed limitations, the Federal Reserve may require that the FHC divest control of any of its bank or thrift subsidiaries, or the FHC may elect to cease engaging in FHC activities that are not permissible for a bank holding company. FHCs that do not comply with the CRA requirement are also not prohibited from making acquisitions or engaging in activities that meet the more narrow "closely related to banking" standard pursuant to Section 4(c)(8).

CRA Requirements. A FHC may not commence any new financial activity not permitted to ordinary bank holding companies or acquire control of a company engaged in such activities if any bank or thrift subsidiary of the FHC received a rating of less than satisfactory at its most recent CRA exam. This limitation does not apply to an investment acquired by an affiliate — including a "financial subsidiary" of a national bank — pursuant to the merchant banking or insurance portfolio investment authority if the affiliate was already engaged in such activities. The Federal Reserve may not require a FHC to execute an agreement, cease activities that are not permissible for a bank holding company, or divest of a bank or thrift subsidiary, solely because the bank or thrift subsidiary of the FHC fails to receive a satisfactory rating at its most recent CRA exam.

Interim Rule. In order to implement the provisions of the Act governing the creation and conduct of FHCs, on January 19, 2000, the Federal Reserve issued an interim rule that amends its Regulation Y by adding a Subpart I that (a) defines the term "financial holding company" and establishes procedures by which a bank holding company may become a FHC; (b) enumerates the criteria a bank holding company must meet in order for the Federal Reserve to determine that an election is effective and describes the period within which the Federal Reserve will act on an election; (c) sets forth the consequences if any bank or thrift subsidiary of a FHC fails to remain well capitalized and well managed, or if any bank or thrift subsidiary of a FHC fails to maintain at least a satisfactory CRA rating; (d) specifically addresses procedures and requirements applicable to foreign banking organizations that seek to be treated as FHCs; (e) describes circumstances under which the Act allows the Federal Reserve to exclude bank or thrift when reviewing whether a bank holding company meets the applicable CRA requirement for a FHC; and (f) provides that, as a general matter, an election by a bank holding company to become a FHC will be effective on the 31st day after the election was received by the appropriate Federal Reserve Bank, unless the Federal Reserve has notified the bank holding company prior to that date that its election is ineffective because an institution controlled by the company fails to meet an applicable requirement. FHC approval, however, is not a fait accompli. The interim rule contains broad language that permits the Federal Reserve to "restrict or limit the commencement or conduct of activities or acquisitions" of a FHC if the Federal Reserve concludes the FHC "lacks the financial or managerial strength to engage in new activities, make new acquisitions, or retain ownership of companies engaged in new activities."

Whether to Become a FHC.

1. Bank Holding Companies

Bank holding companies have an important head start relative to other financial services companies in the FHC race: bank holding companies are already experienced in dealing with the Federal Reserve as their umbrella regulator. Perhaps more importantly, many of the larger bank holding companies have in place the necessary legal, compliance and accounting infrastructure to function in a consolidated regulatory environment. Moreover, unlike non-bank firms that need to apply to become bank holding companies before becoming FHCs, bank holding companies need only file their FHC election with the Federal Reserve. However, a decision by a bank holding company to become a FHC is not without some potential detriment. As noted above, if any of a FHC’s bank or thrift subsidiaries cease to be well capitalized or well managed, the Federal Reserve has the authority to require the FHC to divest any of its bank or thrift subsidiaries.

2. Investment Banks/Broker-Dealers

The Act directly affects investment banks and broker-dealers only if they wish to affiliate with banks. In that case, they must become FHCs. Unlike bank holding companies, however, an investment bank or broker-dealer seeking to become a FHC must file a detailed application with the Federal Reserve requesting permission to become a bank holding company. Notwithstanding the time-consuming process of applying to become a bank holding company, the process for the non-bank acquiror can be expedited somewhat by filing the bank holding company application and the election for FHC status concurrently. "In that case," according to the Federal Reserve’s interim rule, "it is expected that the [Federal Reserve] System would act to make the [FHC] election effective at the time the System acts on the underlying bank holding company application. Consequently, the company becomes a bank holding company." In this regard, on January 13, 2000, Charles Schwab & Co., Inc., the nation’s leading discount brokerage firm, and wealth management firm U.S. Trust Corporation announced that they would merge in a $2.7 billion stock transaction. Schwab has stated that it plans to apply to become a FHC, evidently the first broker-dealer to apply for that status since enactment of the Act.

3. Insurance Companies

Insurance companies that do not acquire banks are largely unaffected by the Act. In this regard, the Act makes clear that the McCarran-Ferguson Act, which provides that insurance is regulated at the state, rather than the federal level, continues to apply. The Act only preempts state insurance laws if those laws prohibit or "significantly interfere" with banks conducting insurance activities. If an insurance company is considering affiliating with a bank, it will face the same issues and questions discussed above with respect to investment banks and broker-dealers.

B. Provisions Affecting National Banks

1. "Financial Subsidiaries" Can Engage in FHC-Type Activities

The Act authorizes the formation of "financial subsidiaries" of national banks and allows them to engage in the same types of activities permissible for nonbank subsidiaries of FHCs (including securities underwriting and dealing), with the exception of insurance underwriting, real estate investment and real estate development. These national bank "financial subsidiaries" also may engage in merchant banking, but only after a five-year waiting period and only if the Federal Reserve and the Secretary of the Treasury jointly agree that the activity is permissible. In addition, the following are some of the limitations that also apply to national bank "financial subsidiaries":

  • transactions between a national bank and its "financial subsidiary" are subject to all of the restrictions applicable to transactions (including extensions of credit) between a bank and its nonbank holding company subsidiary, including Section 23A of the Federal Reserve Act;
  • a national bank that is among the 50 largest U.S. banks must have an issue of unsecured long-term debt rated in one of the three highest rating categories by an independent rating agency;
  • total assets of all "financial subsidiaries" of a national bank are capped at the lesser of 45% of the parent bank’s consolidated assets or $50 billion; and
  • in calculating compliance with regulatory capital standards, the parent national bank must deduct its equity investment in its "financial subsidiaries" as well as the subsidiaries’ assets and liabilities.

On January 20, 2000, the OCC released a proposed rule that would implement the Act’s "financial subsidiary" provisions by providing a streamlined process for national banks seeking OCC approval to acquire control of, or hold an interest in, a "financial subsidiary," or to commence an expanded financial activity in an existing "financial subsidiary." These proposed rules are intended to accommodate individual national bank preferences by permitting two alternative procedures for obtaining OCC approval.

Under the first option, a national bank may file a "Financial Subsidiary Certification" with the OCC listing the bank’s depository institution affiliates and certifying that the bank and each of its affiliates are well capitalized and well managed. Thereafter, at such time as the bank seeks OCC approval to acquire control of, or hold an interest in, a new "financial subsidiary," or commence a new expanded financial activity authorized under the National Bank Act in a "financial subsidiary," the bank may file a written notice with the appropriate OCC District Office at the time of acquiring control of, or holding an interest in, the "financial subsidiary," or commencing a new expanded financial activity authorized pursuant to the National Bank Act of the Revised Statutes in an existing "financial subsidiary." The written notice must be labeled "Financial Subsidiary Notice," must state that the bank’s certification remains valid, and describe the activity or activities to be performed in the "financial subsidiary" as well as cite to the specific authority permitting the expanded financial activity to be conducted by the "financial subsidiary." (Where the authority relied on is a Federal Reserve order or interpretation under the BHC Act, a copy of the order or interpretation should be attached.) The written notice also must demonstrate that the aggregate consolidated total assets of all "financial subsidiaries" of the national bank do not exceed the lesser of 45% of the bank’s consolidated total assets or $50 billion, that the bank will remain well capitalized after making the necessary capital adjustments, and, if applicable, that the bank meets the eligible debt requirement.

Alternatively, a national bank may choose to seek approval by filing a combined certification and notification with the appropriate OCC District Office at least five business days prior to acquiring control of, or an interest in, a "financial subsidiary," or commencing a new expanded financial activity in an existing "financial subsidiary." This type of notice would combine the information from the certification and notice described above, and should be labeled "Financial Subsidiary Certification and Notice."

Because the Act specifically states that OCC approval shall be based solely upon specific statutory factors, the OCC believes its approval may occur upon a bank’s submission of information demonstrating satisfaction of these statutory criteria. Thus, under both of the proposed alternatives, OCC approval occurs upon filing the requisite information within the time frames provided.

2. National Banks May Now Underwrite Municipal Revenue Bonds

The Act also gives national banks new authority to underwrite municipal revenue bonds directly by providing that the limitations and restrictions regarding the authority of a national bank to deal in, underwrite, and purchase investment securities for the national bank’s own account will not apply to certain obligations issued by or on behalf of any state or political subdivision of a state or any public agency or authority of any state or political subdivision of a state. A national bank must be well-capitalized in order to engage in municipal revenue bond underwriting.

C. Provisions Affecting Thrifts

1. Unitary Thrift Exemption Terminated

The most significant implication of the Act with respect to thrifts is that it terminates the unitary thrift exemption. Before passage of the Act, this exemption permitted a nonfinancial company (e.g., a supermarket or a telephone company) to establish and operate a single thrift subsidiary without becoming subject to Office of Thrift Supervision regulation as a savings and loan holding company. Companies that currently operate unitary thrifts or that filed applications on or before May 4, 1999 for permission to organize or acquire control of such thrifts are grandfathered under the Act, but a grandfathered thrift subsidiary of a nonfinancial company cannot be transferred to other nonfinancial companies without losing the exemption.

2. Other Amendments Affecting Thrifts

The Act also amends section 5(i) of the Home Owners’ Loan Act to permit any federal savings association chartered and in operation before November 12, 1999, to convert, with the approval of the OCC or state bank supervisor, into one or more national or state banks. The Act requires that the converted national or state bank meet all financial, management, and capital requirements applicable to the resulting national or state bank. The Act also repeals section 3(f) of the BHC Act, which allowed certain state-chartered savings banks (as opposed to other financial institutions) to engage in the sale or underwriting of savings bank life insurance.

D. Functional Regulation, Broker/Dealers and Insurance Sales

1. Functional Regulation

Consistent with the Act’s commitment to functional regulation, the Act designates the Securities and Exchange Commission ("SEC") and the Commodities and Futures Trading Commission as the primary regulators of FHC and bank securities and commodities activities, respectively, while leaving the federal and state banking agencies to regulate banks’ banking activities. The Act does specify that the SEC must defer to the appropriate bank regulatory agency with regard to all interpretations of, and enforcement of, applicable banking laws relating to the activities, conduct, ownership, and operations of banks. In addition, the SEC also must defer to the appropriate state insurance regulators with regard to all interpretations of, and enforcement of, applicable state insurance laws relating to the activities, conduct, ownership, and operations of insurance companies and insurance agents.

2. Elimination of "Broker" and "Dealer" Exemptions for Banks

Significantly, the Act eliminates the long-standing blanket exemption of banks from the definitions of the terms "broker" and "dealer" under the Securities Exchange Act of 1934, as amended (the "1934 Act"). The effect of this amendment to the 1934 Act is to subject banks to the same regulation by securities regulators as other securities providers.

There are some exceptions. A bank will not be deemed to be a "broker" for certain defined "bank activities" that include: third party brokerage arrangements (i.e., registered broker-dealer activities on bank premises); activities in a trustee or related fiduciary capacity; transactions in commercial paper and related instruments, 1934 Act exempt securities (e.g., certain foreign and United States government securities and municipal securities), Brady bonds and certain Canadian government obligations; transactions as part of a transfer agency function in certain stock purchase plans including employee benefit plans, dividend reinvestment plans and issuer plans; certain sweep account transactions; transactions for bank affiliates (other than a registered broker-dealer or merchant banking affiliate); private placements of securities; safekeeping and custody activities; transactions in "identified banking products" as defined in the Act (e.g., deposit instruments, certificates of deposit, banker’s acceptances, letters of credit, credit card deposits, loan participations sold to certain persons, and swap agreements); and not more than 500 additional securities transactions (other than the foregoing) per calendar year, provided that the transactions are effected by an employee of the bank who is not also an employee of a broker or dealer.

Moreover, a bank will not be deemed to be a "dealer" with respect to: transactions in commercial paper and related instruments, 1934 Act-exempt securities (e.g., certain foreign and United States government securities and municipal securities), Brady bonds and certain Canadian government obligations; buying or selling securities for investment purposes for (i) the bank or (ii) for accounts held by the bank as a fiduciary; the issuance or sale to "qualified investors" of certain asset-backed securities; or buying or selling "identified banking products" as defined in the Act.

The adoption of these amendments to the terms "broker" and "dealer" should not impact banking groups with sizeable securities operations. These groups will most likely have previously-organized Section 20 broker/dealer-registered affiliates in which all or most of the group’s securities activities are conducted. Smaller banks that have been conducting brokerage activities through their own branches will need to (i) limit their securities activities to fit within the new more limited exceptions for banking activities, or (ii) establish a separate securities subsidiary of the bank or of a FHC that registers as a broker-dealer, or (iii) register the bank itself as a broker-dealer. As a practical matter, banks will probably not want to register as broker-dealers with the SEC and the National Association of Securities Dealers, given the nature of the required reporting and record keeping obligations, applicable net capital requirements and examination and licensing requirements for individual bank employees.

Banks have until May 12, 2001 to comply with these 1934 Act amendments.

3. Consumer Protection Regulations Applicable to Bank Sales of Insurance

Section 305 of the Act, titled "Insurance Customer Protections," requires the federal banking agencies to adopt extensive consumer protection regulations applicable to insurance no later than November 12, 2000. The consumer protection regulations to be adopted must cover retail sales practices, solicitations, advertising and offers of insurance. Further, the federal banking agencies may adopt additional consumer protection regulations they deem appropriate and that are consistent with the purposes of the Act. These regulations – when adopted – largely will serve to codify as formal regulations the already-existing consumer protection guidance established by the widely-relied on February 17, 1994 Interagency Statement on Retail Sales of Nondeposit Investment Products.

E. CRA Amendments

CRA amendments provided for in the Act are simple:

  • any FHC with a subsidiary bank or thrift with a less than satisfactory CRA rating would be barred from engaging in new activities or acquiring nonbank companies;
  • banks and thrifts with assets below $250 million and with (i) "outstanding" CRA ratings would be examined for CRA compliance only once every five years, (ii) "satisfactory" CRA ratings would be examined every four years, and (iii) "less than satisfactory" or "unsatisfactory" CRA ratings would be examined more frequently; and
  • community groups who enter into CRA agreements with banks would be required to publicly disclose any related grants or loans which the community groups received from banks.


© 2000 Greenberg Traurig

This GT ALERT is issued for informational purposes only and is not intended to be construed or used as general legal advice. Greenberg Traurig attorneys provide practical, result-oriented strategies and solutions tailored to meet our clients’ individual legal needs.