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Changes in Fed Rules Create Significant New Opportunities for Financial Holding Companies

January 2001
By Carlos Loumiet, Carl Fornaris and Gerald Duty, Greenberg Traurig, Miami Office

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Two final rules and two proposed rules issued by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) in December 2000 and January 2001 open new doors for domestic bank holding companies and foreign banking organizations that have qualified with the Federal Reserve to become financial holding companies (“FHCs”). These changes permit FHCs to take advantage of certain business models and activities that previously have been closed to them. These changes also give FHCs more freedom and independence in developing new delivery systems for financial products that fit the specific FHC’s needs.

By way of background, the Gramm-Leach-Bliley Act of 1999 permits the formation of FHCs, which are bank holding companies with substantially expanded powers. A bank holding company may elect to become an FHC by filing a written declaration with the Federal Reserve. In order to become an FHC, all of the bank and thrift subsidiaries of the proposed FHC must be well capitalized and well managed, and the proposed FHC must satisfy certain Community Reinvestment Act requirements. (See our January 2000 GT Alert.)

The new Federal Reserve rules allow, or, in the case of the proposed rules, would allow, FHCs to: (1) act as “finders,” which broadly encompasses bringing parties together to negotiate transactions between themselves and serving as an information conduit between the parties; (2) engage more liberally in so-called merchant banking (or venture capital) activities; (3) engage in real estate brokerage and real estate management activities; and (4) own companies engaged in data storage, Internet and portal hosting activities.

In some cases, two or more of the rules may overlap, each providing independent authority for the proposed FHC activity.

1. Final Rule: “Finder” Activities

On December 22, 2000, the Federal Reserve issued a final rule authorizing FHCs to act as “finders.” This rule became effective January 22, 2001. Under the rule, finders bring together one or more buyers and sellers of any product or service, whether financial or non-financial, for transactions that the parties themselves negotiate and consummate. These activities include not only locating and matching third parties that are interested in engaging in a business transaction between themselves, but also acting as a conduit for transaction-related information between the parties. Examples of finder activities include:

  • hosting an electronic marketplace Internet web site that provides hypertext or similar links to the web sites of third party buyers or sellers;
  • operating an Internet web site that allows multiple buyers and sellers to exchange information concerning the products and services that they are willing to purchase or sell, locate potential counterparties for transactions, aggregate orders for goods or services with those made by other parties, and enter into transactions between themselves;
  • operating a telephone call center that provides permissible finder services; and
  • hosting an Internet web site for a buyer (or seller) that provides information concerning the buyer (or seller) and the products or services it seeks to buy (or sell) and allows sellers (or buyers) to submit expressions of interest, bids, offers, orders, and confirmations relating to such products or services.

Importantly, finder activities may be exercised through any means or type of media and any type of information may be transmitted so long as it is related to a proposed transaction. The requirement that transmitted information be related to a proposed transaction satisfies the policy of not expanding permitted activities to those which are nonfinancial in nature, such as the simple dissemination of information.

FHCs are required to refrain from becoming principals in a transaction, taking title to or providing distribution services for goods and services which are the subject of a transaction or negotiating for, or binding, third parties to a transaction.

2. Final Rule: Merchant Banking (i.e., Venture Capital) Activities

On January 10, 2001, the Federal Reserve and the Secretary of the Treasury announced a joint final rule governing merchant banking activities of FHCs. This merchant banking rule which becomes effective February 15, 2001 has come to be referred to in the industry as the “venture capital” rule. According to the final rule, an FHC may directly or indirectly acquire or control any amount of shares, assets, or ownership interests of almost any company or other entity, including non-banking and non-financial companies, that is engaged in an activity that is not otherwise authorized for the FHC under the Bank Holding Company Act of 1956, as amended. This rule, together with other rules, allows FHCs, without prior approval in most cases, to acquire ownership interests in any type of non-depository company. Although the final rule maintains a prohibition on routine operation and management of the FHC’s portfolio companies, the rule does not prohibit an FHC from routinely managing or operating a private equity fund.

In order to make merchant banking investments, an FHC must provide notice to the Federal Reserve within thirty days after commencing merchant banking activities and must either (1) control a “securities affiliate” or (2) control both an insurance underwriter affiliate and an investment advisor affiliate registered under the Investment Advisers Act of 1940, as amended. The final rule amends an interim rule issued in March 2000 which defined “securities affiliate” to include any broker or dealer registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. The final rule expands the interim rule to include a registered municipal securities dealer, including a separately identifiable division or department of a bank that is registered as a municipal securities dealer under the Exchange Act. Significantly, the final rule also lowers the amount of capital that an FHC is required to hold per dollar invested. An FHC must hold between 8 cents and 25 cents for every dollar of equity investment, depending on the percentage of Tier 1 capital invested. These capital requirements are substantially lower than the general 50 cents-per-dollar capital standard which had been imposed under the much-criticized interim rule.

3. Proposed Rule: Real Estate Brokerage and Management Activities

On December 13, 2000, the Federal Reserve proposed an amendment to Regulation Y which would add real estate brokerage and real estate management to the list of permissible activities for FHCs. Real estate brokerage activities would include acting as agent for a party to a real estate transaction; listing and advertising real estate; locating buyers, sellers, lessors and lessees interested in engaging in real estate transactions among themselves; conveying information between the parties to a potential real estate transaction; and administering the closing to a real estate transaction. The amendment would specifically prohibit FHCs from investing in or developing real estate or taking title to or holding an ownership interest in any real estate that is the subject of the company’s real estate brokerage services.

With regard to real estate management services, the limit of permissible activities will be determined by taking into account the Federal Reserve’s concern that certain real estate management activities may more closely resemble routine operations of a commercial enterprise, as opposed to the acting as an intermediary between the owners and users of real estate. As such, among other activities, the amendment would not allow an FHC that provides real estate management services to itself to repair or maintain the managed real estate.

Comments to this proposed rule are due March 2, 2001. A final rule is expected to be adopted sometime in the Spring of 2001.

4. Proposed Rule: Equity Stakes in E-commerce Companies

On December 21, 2000, the Federal Reserve proposed a new rule that would authorize FHCs to: (1) derive up to 49% of their revenues from non-financial data processing activities; and (2) invest up to an aggregate of 5% of the FHC’s Tier 1 capital in: (a) companies that act as custodians of files containing either financial or non-financial data if the custodian also provides the same services for financial data; (b) companies that provide general data processing and data transmission services, if at least 20% of the total revenues of the company conducting these activities are derived from either providing data processing services to depository institutions and their affiliates, processing financial data, or the sale of other financial products and services; and (c) companies that provide or facilitate information search, exchange, consolidation, screening, filtering or aggregation services over electrical networks. FHCs could market and provide financial products and services through these companies.

Financial institutions argued that the development of systems for the delivery of financial products has changed dramatically from the paradigm of the past, where delivery systems were designed under separate contract to banking organizations. Today, technology is designed for use by multiple partners in various industries, and is therefore not specifically limited to the needs of specific banking organizations. The proposed rule is meant to rectify this situation, giving individual FHCs more power in determining how their financial products will be delivered in a changing economy.

In addition, it was argued that in the past banking organizations could hire a non-financial firm to market financial products. Today, many innovative marketing methods are conducted over the Internet by companies that seek equity investments rather than contractual arrangements. The Federal Reserve’s proposed rule allows FHCs to take advantage of this new environment.

Comments to this proposed rule are due February 16, 2001. A final rule is expected to be adopted sometime in the Spring of 2001.


© 2000 Greenberg Traurig

Additional Information:

For more information, please review our Financial Institutions Practice description, or feel free to contact one of our attorneys.

This GT ALERT is issued for general purposes only and is not intended to be construed or used as legal advice.Greenberg Traurig attorneys provide practical,result-oriented strategies and solutions tailored to meet our clients ’individual legal needs.The Firm ’s responsive approach to client service often cuts across legal subject matter,applying the right experience and resources from more than 750 attorneys in 18 offices.