2011-11-7 OCC-FRS-FDIC-SEC Prohibitions Restrictions on Proprietary Trading

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68846 Federal Register / Vol. 76, No. 215/ Monday, November 7, 2011/ Proposed Rules

DEPARTMENT OF THE TREASURY

Office of the Comptroller of theCurrency

12 CFR Part 44

[Docket No. OCC20110014]

RIN 1557AD44

BOARD OF GOVERNORS OF THEFEDERAL RESERVE SYSTEM

12 CFR Part 248

[Docket No. R1432]

RIN 7100 AD 82

FEDERAL DEPOSIT INSURANCECORPORATION

12 CFR Part 351

RIN 3064AD85

SECURITIES AND EXCHANGECOMMISSION

17 CFR Part 255

[Release No. 3465545; File No. S74111]

RIN 3235AL07

Prohibitions and Restrictions onProprietary Trading and CertainInterests in, and Relationships With,Hedge Funds and Private Equity Funds

AGENCY: Office of the Comptroller of theCurrency, Treasury (OCC); Board ofGovernors of the Federal ReserveSystem (Board); Federal DepositInsurance Corporation (FDIC); andSecurities and Exchange Commission(SEC).

ACTION: Notice of proposed rulemaking.

SUMMARY: The OCC, Board, FDIC, andSEC (individually, an Agency, andcollectively, the Agencies) arerequesting comment on a proposed rulethat would implement Section 619 ofthe Dodd-Frank Wall Street Reform andConsumer Protection Act (Dodd-FrankAct) which contains certainprohibitions and restrictions on the

ability of a banking entity and nonbankfinancial company supervised by theBoard to engage in proprietary tradingand have certain interests in, orrelationships with, a hedge fund orprivate equity fund.

DATES: Comments should be received onor before January 13, 2012.

ADDRESSES: Interested parties areencouraged to submit written commentsjointly to all of the Agencies.Commenters are encouraged to use thetitle Restrictions on Proprietary

Trading and Certain Interests in, andRelationships with, Hedge Funds andPrivate Equity Funds to facilitate theorganization and distribution ofcomments among the Agencies.Commenters are also encouraged toidentify the number of the specificquestion for comment to which they areresponding.

Office of the Comptroller of theCurrency: Because paper mail in theWashington, DC area and at the OCC issubject to delay, commenters areencouraged to submit comments by theFederal eRulemaking Portal or email, ifpossible. Please use the titleRestrictions on Proprietary Tradingand Certain Interests in andRelationships with Hedge Funds andPrivate Equity Funds to facilitate theorganization and distribution of thecomments. You may submit comments

by any of the following methods: Federal eRulemaking Portal

Regulations.gov: Go to http://www.regulations.gov.Select DocumentType of Proposed Rules, and in theEnter Keyword or ID Box, enterDocket ID OCC201114, and clickSearch. On View By Relevance tabat the bottom of screen, in the Agencycolumn, locate the Proposed Rule forthe OCC, in the Action column, clickon Submit a Comment or OpenDocket Folder to submit or view publiccomments and to view supporting andrelated materials for this rulemakingaction.

Click on the Help tab on theRegulations.gov home page to get

information on using Regulations.gov,including instructions for submitting orviewing public comments, viewingother supporting and related materials,and viewing the docket after the closeof the comment period.

Email:[email protected].

Mail: Office of the Comptroller ofthe Currency, 250 E Street SW., MailStop 23, Washington, DC 20219.

Fax: (202) 8745274. Hand Delivery/Courier: 250 E Street

SW., Mail Stop 23, Washington, DC20219.

Instructions: You must includeOCC as the agency name and DocketID OCC201114 in your comment. Ingeneral, OCC will enter all commentsreceived into the docket and publishthem on the Regulations.gov Web sitewithout change, including any businessor personal information that youprovide such as name and addressinformation, email addresses, or phonenumbers. Comments received, includingattachments and other supportingmaterials, are part of the public recordand subject to public disclosure. Do not

enclose any information in yourcomment or supporting materials thatyou consider confidential orinappropriate for public disclosure.

You may review comments and otherrelated materials that pertain to thisproposed rulemaking by any of thefollowing methods:

Viewing Comments Electronically:

Go to http://www.regulations.gov.SelectDocument Type of PublicSubmissions, and in the EnterKeyword or ID Box, enter Docket IDOCC201114, and click Search.Comments will be listed under ViewBy Relevance tab at the bottom ofscreen. If comments from more than oneagency are listed, the Agency columnwill indicate which comments werereceived by the OCC.

Viewing Comments Personally: Youmay personally inspect and photocopycomments at the OCC, 250 E Street SW.,Washington, DC 20219. For security

reasons, the OCC requires that visitorsmake an appointment to inspectcomments. You may do so by calling(202) 8744700. Upon arrival, visitorswill be required to present validgovernment-issued photo identificationand submit to security screening inorder to inspect and photocopycomments.

Docket: You may also view or requestavailable background documents andproject summaries using the methodsdescribed above.

Board of Governors of the FederalReserve System:

You may submit comments, identified

by Docket No. R1432 and RIN 7100 AD82, by any of the following methods:

Agency Web site: http://www.federalreserve.gov.Follow theinstructions for submitting comments athttp://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.

Federal eRulemaking Portal: http://www.regulations.gov.Follow theinstructions for submitting comments.

Email:[email protected] the docket number in thesubject line of the message.

Fax: (202) 4523819 or (202) 452

3102. Mail: Address to Jennifer J. Johnson,Secretary, Board of Governors of theFederal Reserve System, 20th Street andConstitution Avenue NW., Washington,DC 20551.

All public comments will be madeavailable on the Boards Web site athttp://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfmassubmitted, unless modified for technicalreasons. Accordingly, comments willnot be edited to remove any identifyingor contact information. Public

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68847Federal Register / Vol. 76, No. 215/ Monday, November 7, 2011/ Proposed Rules

1Dodd-Frank Wall Street Reform and ConsumerProtection Act, Public Law 111203, 124 Stat. 1376

(2010).2Application of the proposed rule to smaller,

less-complex banking entities is discussed below inPart II.F of this Supplemental Information.

3The term banking entity is defined in section13(h)(1) of the BHC Act, as amended by section 619of the Dodd-Frank Act. See 12 U.S.C. 1851(h)(1).The statutory definition includes any insureddepository institution (other than certain limitedpurpose trust institutions), any company thatcontrols an insured depository institution, anycompany that is treated as a bank holding companyfor purposes of section 8 of the InternationalBanking Act of 1978 (12 U.S.C. 3106), and anyaffiliate or subsidiary of any of the foregoing.Section 13 of the BHC Act defines the terms hedgefund and private equity fund as an issuer thatwould be an investment company, as defined underthe Investment Company Act of 1940 (15 U.S.C.

80a1 et seq.), but for section 3(c)(1) or 3(c)(7) ofthat Act, or any such similar funds as theappropriate Federal banking agencies (i.e., theBoard, OCC, and FDIC), the SEC, and the CFTCmay, by rule, determine should be treated as ahedge fund or private equity fund. See 12 U.S.C.1851(h)(2).

4See 12 U.S.C. 1851(a)(2) and (f)(4). A nonbankfinancial company supervised by the Board is anonbank financial company or other company thatthe Financial Stability Oversight Council(Council) has determined, under section 113 ofthe Dodd-Frank Act, shall be subject to supervisionby the Board and prudential standards. The Boardis not proposing at this time any additional capitalrequirements, quantitative limits, or other

Continued

comments may also be viewedelectronically or in paper in Room MP500 of the Boards Martin Building (20thand C Streets NW.,) between 9 a.m. and5 p.m. on weekdays.

Federal Deposit InsuranceCorporation: You may submitcomments, identified by RIN number,

by any of the following methods: Agency Web site: http://

www.fdic.gov/regulations/laws/federal/propose.html.Follow instructions forsubmitting comments on the AgencyWeb site.

Email: [email protected] RIN 3064AD85 on the subject lineof the message.

Mail: Robert E. Feldman, ExecutiveSecretary, Attention: Comments, FederalDeposit Insurance Corporation, 550 17thStreet NW., Washington, DC 20429.

Hand Delivery: Comments may behand delivered to the guard station atthe rear of the 550 17th Street Building

(located on F Street) on business daysbetween 7 a.m. and 5 p.m.Public Inspection: All comments

received must include the agency nameand RIN 3064AD85 for thisrulemaking. All comments received will

be posted without change to http://www.fdic.gov/regulations/laws/federal/

propose.html,including any personalinformation provided. Paper copies ofpublic comments may be ordered fromthe FDIC Public Information Center,3501 North Fairfax Drive, Room EI002,Arlington, VA 22226 by telephone at1 (877) 2753342 or 1 (703) 5622200.

Securities and Exchange Commission:

You may submit comments by thefollowing method:

Electronic Comments

Use the Commissions Internetcomment form (http://www.sec.gov/rules/proposed.shtml); or

Send an email to [email protected] include FileNumber S74111 on the subject line;or

Use the Federal eRulemaking Portal(http://www.regulations.gov). Follow theinstructions for submitting comments.

Paper Comments

Send paper comments in triplicateto Elizabeth M. Murphy, Secretary,Securities and Exchange Commission,100 F Street NE., Washington, DC205491090.

All submissions should refer to FileNumber S74111. This file numbershould be included on the subject lineif email is used. To help us process andreview your comments more efficiently,please use only one method. TheCommission will post all comments onthe Commissions Internet Web site

(http://www.sec.gov/rules/proposed.shtml). Comments are alsoavailable for Web site viewing andprinting in the Commissions PublicReference Room, 100 F Street NE.,Washington, DC 20549, on official

business days between the hours of10 a.m. and 3 p.m. All commentsreceived will be posted without change;

we do not edit personal identifyinginformation from submissions. Youshould submit only information thatyou wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:OCC: Deborah Katz, Assistant Director,or Ursula Pfeil, Counsel, Legislative andRegulatory Activities Division, (202)8745090; Roman Goldstein, SeniorAttorney, Securities and CorporatePractices Division, (202) 8745210; KurtWilhelm, Director for Financial MarketsGroup, (202) 8744660; StephanieBoccio, Technical Expert for AssetManagement Group, or Joel Miller,

Group Leader for Asset ManagementGroup, (202) 8744660, Office of theComptroller of the Currency, 250 EStreet SW., Washington, DC 20219.

Board:Jeremy R. Newell, Counsel,(202) 4523239, or Christopher M.Paridon, Counsel, Legal Division, (202)4523274; Sean D. Campbell, DeputyAssociate Director, Division of Researchand Statistics, (202) 4523760; DavidLynch, Manager, Division of BankSupervision and Regulation, (202) 4522081, Board of Governors of the FederalReserve System, 20th and C Streets,NW., Washington, DC 20551.

FDIC: Bobby R. Bean, ActingAssociate Director, Capital Markets(202) 8986705, or Karl R. Reitz, SeniorCapital Markets Specialist, (202) 8986775, Division of Risk ManagementSupervision; Michael B. Phillips,Counsel, (202) 8983581, or Gregory S.Feder, Counsel, (202) 8988724, LegalDivision, Federal Deposit InsuranceCorporation, 550 17th Street NW.,Washington, DC 204290002.

SEC:Josephine Tao, AssistantDirector, Elizabeth Sandoe, SeniorSpecial Counsel, David Bloom, BranchChief, Anthony Kelly, Special Counsel,

Angela Moudy, Attorney Advisor, orDaniel Staroselsky, Attorney Advisor,Office of Trading Practices, Division ofTrading and Markets, (202) 5515720;David Blass, Chief Counsel, or GreggBerman, Senior Advisor to the Director,Division of Trading and Markets; DanielS. Kahl, Assistant Director, Tram N.Nguyen, Branch Chief, Michael J. Spratt,Senior Counsel, or Parisa Haghshenas,Law Clerk, Office of Investment AdviserRegulation, Division of InvestmentManagement, (202) 5516787; DavidBeaning, Special Counsel, Office of

Structured Finance, Division ofCorporation Finance, (202) 5513850;

John Harrington, Special Counsel, Officeof Capital Market Trends, Division ofCorporation Finance, (202) 5513860;Richard Bookstaber, Senior PolicyAdvisor, or Jennifer Marietta-Westberg,Assistant Director, Office of the SellSide; or Adam Yonce, Financial

Economist, Division of Risk Strategyand Financial Innovation, (202) 5516600, U.S. Securities and ExchangeCommission, 100 F Street NE.,Washington, DC 20549.SUPPLEMENTARY INFORMATION:

I. Background

The Dodd-Frank Act was enacted onJuly 21, 2010.1 Section 619 of the Dodd-Frank Act added a new section 13 to theBank Holding Company Act of 1956(BHC Act) (to be codified at 12 U.S.C.1851) that generally prohibits any

banking entity 2 from engaging in

proprietary trading or from acquiring orretaining an ownership interest in,sponsoring, or having certainrelationships with a hedge fund orprivate equity fund (covered fund),subject to certain exemptions.3 Newsection 13 of the BHC Act also providesfor nonbank financial companiessupervised by the Board that engage insuch activities or have such interests orrelationships to be subject to additionalcapital requirements, quantitativelimits, or other restrictions.4

http://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlmailto:[email protected]://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.sec.gov/rules/proposed.shtmlhttp://www.sec.gov/rules/proposed.shtmlhttp://www.sec.gov/rules/proposed.shtmlmailto:[email protected]:[email protected]://www.regulations.gov/http://www.regulations.gov/http://www.sec.gov/rules/proposed.shtmlhttp://www.sec.gov/rules/proposed.shtmlhttp://www.sec.gov/rules/proposed.shtmlmailto:[email protected]:[email protected]:[email protected]://www.regulations.gov/http://www.sec.gov/rules/proposed.shtmlhttp://www.sec.gov/rules/proposed.shtmlhttp://www.sec.gov/rules/proposed.shtmlhttp://www.sec.gov/rules/proposed.shtmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.htmlhttp://www.fdic.gov/regulations/laws/federal/propose.html


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restrictions on nonbank financial companiespursuant to section 13 of the BHC Act, as it believesdoing so would be premature in light of the fact thatthe Council has not yet finalized the criteria fordesignation of, nor yet designated, any nonbankfinancial company.

5See Financial Stability Oversight Council, Studyand Recommendations on Prohibitions onProprietary Trading and Certain Relationships withHedge Funds and Private Equity Funds (Jan. 18,2011), available athttp://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdf. See 12 U.S.C. 1851(b)(1).Prior to publishing its study, the Council requestedpublic comment on a number of issues to assist theCouncil in conducting its study. See 75 FR 61,758(Oct. 6, 2010). Approximately 8,000 comments werereceived from the public, including from membersof Congress, trade associations, individual bankingentities, consumer groups, and individuals. Asnoted in the issuing release for the Council Study,these comments were carefully considered by theCouncil when drafting the Council study.

6See Council study at 56. The Agencies haveimplemented this recommendation through theproposed compliance program requirementscontained in Subpart D of this proposal withrespect to both proprietary trading and coveredfund activities and investments.

7The Agencies also received a number ofcomment letters concerning implementation ofsection 13 of the BHC Act in advance of thisproposal. The Agencies have carefully consideredthese comments in formulating this proposal.

8See 12 U.S.C. 1851(b)(2). Under section13(b)(2)(B) of the BHC Act, rules implementingsection 13s prohibitions and restrictions must beissued by: (i) The appropriate Federal bankingagencies (i.e., the Board, the OCC, and the FDIC),jointly, with respect to insured depositoryinstitutions; (ii) the Board, with respect to anycompany that controls an insured depositoryinstitution, or that is treated as a bank holdingcompany for purposes of section 8 of theInternational Banking Act, any nonbank financialcompany supervised by the Board, and anysubsidiary of any of the foregoing (other than asubsidiary for which an appropriate Federal

banking agency, the SEC, or the CFTC is theprimary financial regulatory agency); (iii) the CFTCwith respect to any entity for which it is theprimary financial regulatory agency, as defined insection 2 of the Dodd-Frank Act; and (iv) the SECwith respect to any entity for which it is theprimary financial regulatory agency, as defined insection 2 of the Dodd-Frank Act. See id.

9See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary ofthe Treasury, as Chairperson of the Council, isresponsible for coordinating the Agenciesrulemakings under section 13 of the BHC Act. Seeid.

10See id. at 1851(b)(2)(A).11See id. at 1851(c)(1).12See id. at 1851(c)(6).

13See Conformance Period for Entities Engaged inProhibited Proprietary Trading or Private EquityFund or Hedge Fund Activities, 76 FR 8265 (Feb.14, 2011).

14See id. (citing 156 Cong. Rec. S5898 (daily ed.July 15, 2010) (statement of Sen. Merkley)).

1512 U.S.C. 1851(a)(1)(A) and (B).16See id. at 1851(d)(1). As described in greater

detail in Part III.B.4 of this SupplementaryInformation, the proposed rule applies some ofthese statutory exemptions only to the proprietarytrading prohibition or the covered fund prohibitionsand restrictions, but not both, where it appearseither by plain language or by implication that theexemption was intended only to apply to one or theother.

A. Rulemaking Framework

Section 13 of the BHC Act requiresthat implementation of its provisionsoccur in several stages. First, theCouncil was required to conduct a study(Council study) and makerecommendations by January 21, 2011on the implementation of section 13 ofthe BHC Act. The Council study wasissued on January 18, 2011, andincluded a detailed discussion of keyissues related to implementation ofsection 13 and recommended that theAgencies consider taking a number ofspecified actions in issuing rules undersection 13 of the BHC Act.5 The Councilstudy also recommended that theAgencies adopt a four-partimplementation and supervisoryframework for identifying andpreventing prohibited proprietarytrading, which included a programmaticcompliance regime requirement for

banking entities, analysis and reporting

of quantitative metrics by bankingentities, supervisory review andoversight by the Agencies, andenforcement procedures for violations.6The Agencies have carefully consideredthe Council study and itsrecommendations, and have consultedwith staff of the Commodity FuturesTrading Commission (CFTC), informulating this proposal.7

Authority for developing andadopting regulations to implement theprohibitions and restrictions of section13 of the BHC Act is divided betweenthe Agencies in the manner provided in

section 13(b)(2) of the BHC Act.8 Thestatute also requires the Agencies, indeveloping and issuing implementingrules, to consult and coordinate witheach other, as appropriate, for thepurposes of assuring, to the extentpossible, that such rules are comparableand provide for consistent applicationand implementation of the applicable

provisions of section 13 of the BHCAct.9 Such coordination will assist inensuring that advantages are not undulyprovided to, and that disadvantages arenot unduly imposed upon, companiesaffected by section 13 of the BHC Actand that the safety and soundness of

banking entities and nonbank financialcompanies supervised by the Board areprotected. The statute requires theAgencies to implement rules undersection 13 not later than 9 months afterthe Council completes its study (i.e., notlater than October 18, 2011).10 Therestrictions and prohibitions of section

13 of the BHC Act become effective12 months after issuance of final rulesby the Agencies, or July 21, 2012,whichever is earlier.11

In addition, the statute required theBoard, acting alone, to adopt rules toimplement the provisions of section 13of the BHC Act that provide a bankingentity or a nonbank financial companysupervised by the Board a period of timeafterthe effective date of section 13 ofthe BHC Act to bring the activities,investments, and relationships of the

banking entity into compliance withthat section and the Agenciesimplementing regulations.12 The Board

issued its final conformance rule asrequired under section 13(c)(6) of theBHC Act on February 8, 2011 (Boards

Conformance Rule).13 As noted in theissuing release for the BoardsConformance Rule, this period isintended to give markets and firms anopportunity to adjust to section 13 ofthe BHC Act.14

B. Section 13 of the BHC Act

Section 13 of the BHC Act generally

prohibits banking entities from engagingin proprietary trading or from acquiringor retaining any ownership interest in,or sponsoring, a covered fund.15However, section 13(d)(1) of that Actexpressly includes exemptions fromthese prohibitions for certain permittedactivities, including:

Trading in certain governmentobligations;

Underwriting and market making-related activities;

Risk-mitigating hedging activity; Trading on behalf of customers; Investments in Small Business

Investment Companies (SBICs) andpublic interest investments;

Trading for the general account ofinsurance companies;

Organizing and offering a coveredfund (including limited investments insuch funds);

Foreign trading by non-U.S.banking entities; and

Foreign covered fund activities bynon-U.S. banking entities.16

For purposes of this SupplementaryInformation, trading activities subject tosection 13 of the BHC Act, includingthose permitted under a relevantexemption, are sometimes referred to as

covered trading activities. Similarly,activities and investments with respectto a covered fund that are subject tosection 13 of the BHC Act, includingthose permitted under a relevantexemption, are sometimes referred to ascovered fund activities orinvestments.

Additionally, section 13 of the BHCAct permits the Agencies to grant, byrule, other exemptions from theprohibitions on proprietary trading andacquiring or retaining an ownershipinterest in, or acting as sponsor to, acovered fund if the Agencies determine

http://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdfhttp://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdfhttp://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdfhttp://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdfhttp://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdfhttp://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdfhttp://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdfhttp://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011%20rg.pdf


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17 Id. at 1851(d)(1)(J).18See id. at 1851(d)(2).19See 12 U.S.C. 371c.2012 U.S.C. 1851(f).2112 U.S.C. 371c1.22See 12 U.S.C. 1851(a)(2), (d)(4).

23 In recognition of economic impacts that mayarise from the proposed rule and its implementationof section 13 of the BHC Act, the Agencies arerequesting comment on the relative costs andbenefits of the proposal in Part VII of thisSupplemental Information.

24Under this uniform approach, each Agency isproposing the same rule provisions under section13 of the BHC Act. Each Agencys proposed rulewould apply only to banking entities for which theAgency has regulatory authority under section13(b)(2)(B) of the BHC Act.

that the exemption would promote andprotect the safety and soundness of the

banking entity and the financial stabilityof the United States.17 Furthermore,under the statute, no banking entity mayengage in a permitted activity if thatactivity would (i) involve or result in amaterial conflict of interest or materialexposure of the banking entity to high-risk assets or high-risk trading strategies,or (ii) pose a threat to the safety andsoundness of the banking entity or tothe financial stability of the UnitedStates.18

Section 13(f) of the BHC Actseparately prohibits a banking entitythat serves, directly or indirectly, as theinvestment manager, investmentadviser, or sponsor to a covered fund,and any affiliate of such a bankingentity, from entering into anytransaction with the fund, or any othercovered fund controlled by such fund,

that would be a covered transactionas defined in section 23A of the FederalReserve Act (FR Act),19 as if such

banking entity or affiliate were amember bank and the covered fundwere an affiliate thereof, subject tocertain exceptions.20 Section 13(f) alsoprovides that a banking entity may enterinto certain prime brokeragetransactions with any covered fund inwhich a covered fund managed,sponsored, or advised by the bankingentity has taken an equity, partnership,or other ownership interest, but anysuch transaction (and any other

permitted transaction with such funds)must be on market terms in accordancewith the provisions of section 23B of theFR Act.21

Section 13 of the BHC Act does notprohibit a nonbank financial companysupervised by the Board from engagingin proprietary trading, or from havingthe types of ownership interests in orrelationships with a covered fund that a

banking entity is prohibited or restrictedfrom having under section 13 of theBHC Act. However, section 13 of theBHC Act provides for the Board or otherappropriate Agency to impose

additional capital charges, quantitativelimits, or other restrictions on anonbank financial company supervised

by the Board or their subsidiaries andaffiliates that are engaged in suchactivities or maintain suchrelationships.22

II. Overview of Proposed Rule

A. General Approach

In formulating the proposed rule, theAgencies have attempted to reflect thestructure of section 13 of the BHC Act,which is to prohibit a banking entityfrom engaging in proprietary trading oracquiring or retaining an ownership

interest in, or having certainrelationships with, a covered fund,while permitting such entities tocontinue to provide client-orientedfinancial services. However, thedelineation of what constitutes aprohibited or permitted activity undersection 13 of the BHC Act often involvessubtle distinctions that are difficult bothto describe comprehensively withinregulation and to evaluate in practice.The Agencies appreciate that while it iscrucial that rules under section 13 of theBHC Act clearly define and implementits requirements, any rule must alsopreserve the ability of a banking entityto continue to structure its businessesand manage its risks in a safe and soundmanner, as well as to effectively deliverto its clients the types of financialservices that section 13 expresslyprotects and permits. These client-oriented financial services, whichinclude underwriting, market making,and traditional asset managementservices, are important to the U.S.financial markets and the participants inthose markets, and the Agencies haveendeavored to develop a proposed rulethat does not unduly constrain bankingentities in their efforts to safely provide

such services. At the same time,providing appropriate latitude to

banking entities to provide such client-oriented services need not and shouldnot conflict with clear, robust, andeffective implementation of the statutesprohibitions and restrictions. Giventhese complexities, the Agencies requestcomment on the potential impacts theproposed approach may have on

banking entities and the businesses inwhich they engage. In particular, and asdiscussed further in Part VII of thisSupplemental Information, the Agenciesrecognize that there are economic

impacts that may arise from theproposed rule and its implementation ofsection 13 of the BHC Act, and theAgencies request comment on suchimpacts, including quantitative data,where possible.

In light of these larger challenges andgoals, the Agencies proposal takes amulti-faceted approach to implementingsection 13 of the BHC Act. In particular,the proposed rule includes a frameworkthat: (i) Clearly describes the keycharacteristics of both prohibited andpermitted activities; (ii) requires

banking entities to establish acomprehensive programmaticcompliance regime designed to ensurecompliance with the requirements of thestatute and rule in a way that takes intoaccount and reflects the unique natureof a banking entitys businesses; and (iii)with respect to proprietary trading,requires certain banking entities to

calculate and report meaningfulquantitative data that will assist both

banking entities and the Agencies inidentifying particular activity thatwarrants additional scrutiny todistinguish prohibited proprietarytrading from otherwise permissibleactivities. This multi-faceted approach,which is consistent with theimplementation and supervisoryframework recommended in the Councilstudy, is intended to strike anappropriate balance betweenaccommodating prudent riskmanagement and the continued

provision of client-oriented financialservices by banking entities whileensuring that such entities do notengage in prohibited proprietary tradingor restricted covered fund activities orinvestments.23

In addition, and consistent with thestatutory requirement that the Agenciesrules under section 13 of the BHC Act

be, to the extent possible, comparableand provide for consistent applicationand implementation, the Agencies haveproposed a common rule andappendices. This uniform approach toimplementation is intended to providethe maximum degree of clarity to

banking entities and market participantsand ensure that section 13sprohibitions and restrictions are appliedconsistently across different types ofregulated entities.24

As a matter of structure, the proposedrule is generally divided into foursubparts and contains three appendices,as follows:

Subpart A of the proposed ruledescribes the authority, scope, purpose,and relationship to other authorities ofthe rule and defines terms usedcommonly throughout the rule;

Subpart B of the proposed rule

prohibits proprietary trading, definesterms relevant to covered tradingactivity, establishes exemptions from



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25A banking entity must comply with proposedAppendix As reporting and recordkeepingrequirements only if it has, together with itsaffiliates and subsidiaries, trading assets andliabilities the average gross sum of which (on aworldwide consolidated basis) is, as measured as ofthe last day of each of the four prior calendarquarters, equal to or greater than $1 billion.

26 In particular, a banking entity must complywith the minimum standards specified in AppendixC of the proposed rule (i) with respect to its coveredtrading activities, if it engages in any coveredtrading activities and has, together with its affiliatesand subsidiaries, trading assets and liabilities theaverage gross sum of which (on a worldwide

consolidated basis), as measured as of the last dayof each of the four prior calendar quarters, (X) isequal to or greater than $1 billion or (Y) equals 10percent or more of its total assets; and (ii) withrespect to its covered fund activities andinvestments, if it engages in any covered fundactivities and investments and either (X) has,together with its affiliates and subsidiaries,aggregate investments in covered funds the averagevalue of which is, as measured as of the last dayof each of the four prior calendar quarters, equal toor greater than $1 billion or (Y) sponsors andadvises, together with its affiliates and subsidiaries,covered funds the average total assets of which are,as measured as of the last day of each of the fourprior calendar quarters, equal to or greater than $1billion.

27See proposed rule l.3(b)(1).28See proposed rule l.3(b)(2).29See proposed rule l.3(b)(2)(i)(A).30See 76 FR 1890 (Jan. 11, 2011).

31 In the context of regulation of governmentsecurities dealers under the Securities ExchangeAct of 1934 (Exchange Act), the term financialinstitution as defined in section 3(a)(46) of theExchange Act includes a bank (as defined in section3(a)(36) of the Exchange Act) and a foreign bank (asdefined in the International Banking Act of 1978).See 15 U.S.C. 78c(a)(46).

32See proposed rule l.3(b)(2)(i)(B).33See proposed rule l.3(b)(2)(iii).34See proposed rule l.3(b)(3).35See proposed rule l.4(a), (b).

the prohibition on proprietary tradingand limitations on those exemptions,and requires certain banking entities toreport quantitative measurements withrespect to their trading activities;

Subpart C of the proposed ruleprohibits or restricts acquiring orretaining an ownership interest in, andcertain relationships with, a covered

fund, defines terms relevant to coveredfund activities and investments, as wellas establishes exemptions from therestrictions on covered fund activitiesand investments and limitations onthose exemptions;

Subpart D of the proposed rulegenerally requires banking entities toestablish an enhanced complianceprogram regarding compliance withsection 13 of the BHC Act and theproposed rule, including writtenpolicies and procedures, internalcontrols, a management framework,independent testing of the complianceprogram, training, and recordkeeping;

Appendix A of the proposed ruledetails the quantitative measurementsthat certain banking entities may berequired to compute and report withrespect to their trading activities; 25

Appendix B of the proposed ruleprovides commentary regarding thefactors the Agencies propose to use tohelp distinguish permitted marketmaking-related activities fromprohibited proprietary trading; and

Appendix C of the proposed ruledetails the minimum requirements andstandards that certain banking entitiesmust meet with respect to their

compliance program, as required undersubpart D.26

In addition, the Boards proposed rulealso contains a subpart E, to which theprovisions of the Boards ConformanceRule under section 13 of the BHC Actwill be recodified from their currentlocation in the Boards Regulation Y.

B. Proprietary Trading Restrictions

Subpart B of the proposed rule

implements the statutory prohibition onproprietary trading and the variousexemptions to this prohibition includedin the statute. Sectionl.3 of theproposed rule contains the coreprohibition on proprietary trading anddefines a number of related terms,including proprietary trading andtrading account. The proposed rulesdefinition of proprietary tradinggenerally parallels the statutorydefinition, and includes engaging asprincipal for the trading account of a

banking entity in any transaction topurchase or sell certain types offinancial positions.27

The proposed rules definition oftrading account generally parallels thestatutory definition, and providesfurther guidance regarding thecircumstances in which a position will

be considered to have been takenprincipally for the purpose of short-termresale or benefiting from actual orexpected short-term price movements,recognizing the importance of providingas much clarity as possible regardingthis term, which ultimately defines thescope of accounts subject to theprohibition on proprietary trading.28 Inparticular, the proposed definition of

trading account identifies three classesof positions that would cause anaccount to be a trading account. First,the definition includes positions takenprincipally for the purpose of short-termresale, benefitting from short-term pricemovements, realizing short-termarbitrage profits, or hedging anothertrading account position.29 As describedin this notice, this language issubstantially similar to language for atrading position used in the Federal

banking agencies current market riskcapital rules, as proposed to be revised(Market Risk Capital Rules),30 and the

Agencies propose to interpret thislanguage in a similar manner. Second,with respect to a banking entity subjectto the Federal banking agencies MarketRisk Capital Rules, the definitionincludes all positions in financialinstruments subject to the prohibitionon proprietary trading that are treated ascovered positions under those capital

rules, other than certain foreignexchange and commodities positions.Third, the definition includes allpositions acquired or taken by certainregistered securities and derivativesdealers (or, in the case of financialinstitutions 31 that are governmentsecurities dealers, that have filed noticewith an appropriate regulatory agency)

in connection with their activities thatrequire such registration or notice.32The definition of trading account alsocontains clarifying exclusions forcertain positions that do not appear toinvolve the requisite short-term tradingintent, such as positions arising undercertain repurchase and reverserepurchase arrangements or securitieslending transactions, positions acquiredor taken for bona fide liquiditymanagement purposes, and certainpositions of derivatives clearingorganizations or clearing agencies.33

Sectionl.3 of the proposed rule also

defines a number of other relevantterms, including the term coveredfinancial position. This term is used todefine the scope of financialinstruments subject to the prohibitionon proprietary trading. Consistent withthe statutory language, such coveredfinancial positions include positions(including long, short, synthetic andother positions) in securities,derivatives, commodity futures, andoptions on such instruments, but do notinclude positions in loans, spot foreignexchange or spot commodities.34

Sectionl.4 of the proposed ruleimplements the statutory exemptions for

underwriting and market making-relatedactivities. For each of these permittedactivities, the proposed rule provides anumber of requirements that must bemet in order for a banking entity to relyon the applicable exemption. Theserequirements are generally designed toensure that the activities, revenues andother characteristics of the bankingentitys trading activity are consistentwith underwriting and market making-related activities, respectively, and notprohibited proprietary trading.35 Theserequirements are intended to supportand augment other parts of the proposed

rules approach to implementing theprohibition on proprietary trading,including the compliance program



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36See proposed rule l.5(b)(1), (2).37See proposed rule l.5(b)(3).38See proposed rule l.6(a).39See proposed rule l.6(b).

40See proposed rule l.6(c).41See proposed rule l.6(d).42See proposed rule l.7. 43See proposed rule l.8.

requirement and the reporting ofquantitative measurements, in order toassist banking entities and the Agenciesin identifying prohibited tradingactivities that may be conducted in thecontext of, or mischaracterized as,permitted underwriting or marketmaking-related activities.

Sectionl.5 of the proposed rule

implements the statutory exemption forrisk-mitigating hedging. As with theunderwriting and market-makingexemptions, proposed l.5 contains anumber of requirements that must bemet in order for a banking entity to relyon the exemption. These requirementsare generally designed to ensure that the

banking entitys trading activity is trulyrisk-mitigating hedging in purpose andeffect.36 Proposed l.5 also requires

banking entities to document, at thetime the transaction is executed, thehedging rationale for certaintransactions that present heightened

compliance risks.37

As with theexemptions for underwriting and marketmaking-related activity, theserequirements form part of a broaderimplementation approach that alsoincludes the compliance programrequirement and the reporting ofquantitative measurements.

Sectionl.6 of the proposed ruleimplements statutory exemptions fortrading in certain governmentobligations, trading on behalf ofcustomers, trading by a regulatedinsurance company, and trading bycertain foreign banking entities outsidethe United States. Sectionl.6(a) of the

proposed rule describes the governmentobligations in which a banking entitymay trade notwithstanding theprohibition on proprietary trading,which include U.S. government andagency obligations, obligations andother instruments of certain governmentsponsored entities, and State andmunicipal obligations.38 Sectionl.6(b)of the proposed rule describes permittedtrading on behalf of customers andidentifies three categories oftransactions that would qualify for theexemption.39 These categories include:(i) Transactions conducted by a banking

entity as investment adviser, commoditytrading advisor, trustee, or in a similarfiduciary capacity for the account of acustomer where the customer, and notthe banking entity, has beneficialownership of the related positions; (ii)riskless principal transactions; and (iii)transactions conducted by a bankingentity that is a regulated insurance

company for the separate account ofinsurance policyholders, subject tocertain conditions. Sectionl.6(c) of theproposed rule describes permittedtrading by a regulated insurancecompany for its general account, andgenerally parallels the statutorylanguage governing this exemption.40Finally, l.6(d) of the proposed rule

describes permitted trading outside ofthe United States by a foreign bankingentity.41 The proposed exemptionclarifies when a foreign banking entitywill be considered to engage in suchtrading pursuant to sections 4(c)(9) or4(c)(13) of the BHC Act, as required bythe statute, including with respect to aforeign banking entity not currentlysubject to section 4 of the BHC Act. Theexemption also clarifies when tradingwill be considered to have occurredsolely outside of the United States, asrequired by the statute, and provides anumber of specific criteria for

determining whether that standard ismet.Sectionl.7 of the proposed rule

requires certain banking entities withsignificant covered trading activities tocomply with the reporting andrecordkeeping requirements specified inAppendix A of the proposed rule. Inaddition, l.7 requires that a bankingentity comply with the recordkeepingrequirements in l.20 of the proposedrule, including, where applicable, therecordkeeping requirements inAppendix C of the proposed rule.Sectionl.7 of the proposed rule alsorequires a banking entity to comply with

any other reporting or recordkeepingrequirements that an Agency mayimpose to evaluate the banking entityscompliance with the proposed rule.42Proposed Appendix A requires those

banking entities with significantcovered trading activities to furnishperiodic reports to the relevant Agencyregarding a variety of quantitativemeasurements of its covered tradingactivities and maintain recordsdocumenting the preparation andcontent of these reports. These proposedreporting and recordkeepingrequirements vary depending on the

scope and size of covered tradingactivities, and a banking entity mustcomply with proposed Appendix Asreporting and recordkeepingrequirements only if it has, togetherwith its affiliates and subsidiaries,trading assets and liabilities the averagegross sum of which (on a worldwideconsolidated basis) is, as measured as ofthe last day of each of the four prior

calendar quarters, equal to or greaterthan $1 billion. These thresholds aredesigned to reduce the burden onsmaller, less complex banking entities,which generally engage in limitedmarket-making and other tradingactivities. Other provisions of theproposal, and in particular thecompliance program requirement in

l

.20 of the proposed rule, are likelyto be less burdensome and equallyeffective methods for ensuringcompliance with section 13 of the BHCAct by smaller, less complex bankingentities.

The quantitative measurements thatmust be furnished under the proposedrule are generally designed to reflect,and provide meaningful informationregarding, certain characteristics oftrading activities that appear to beparticularly useful to help differentiatepermitted market making-relatedactivities from prohibited proprietary

trading and to identify whether certaintrading activities result in a materialexposure to high-risk assets or high-risktrading strategies. In addition, proposedAppendix B contains a detailedcommentary regarding identification ofpermitted market making-relatedactivities and distinguishing suchactivities from trading activities thatconstitute prohibited proprietarytrading.

As described in Part II.B.5 of theSupplementary Information below, theAgencies expect to utilize theconformance period provided in section13(c)(2) of the BHC Act to further refine

and finalize the reporting requirements,reflecting the substantial publiccomment, practical experience, andrevision that will likely be required toensure appropriate, effective use ofreported quantitative data in practice.

Sectionl.8 of the proposed ruleprohibits a banking entity from relyingon any exemption to the prohibition onproprietary trading if the permittedactivity would involve or result in amaterial conflict of interest, result in amaterial exposure to high-risk assets orhigh-risk trading strategies, or pose athreat to the safety and soundness of the

banking entity or to the financialstability of the United States.43 Thissection also defines material conflict ofinterest, high-risk asset, and high-risktrading strategy for these purposes.

C. Covered Fund Activities andInvestments

Subpart C of the proposed ruleimplements the statutory prohibitionon, as principal, directly or indirectly,acquiring and retaining an ownership



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44See proposed rule l.10(b)(1).45See proposed rule l.10(b)(3).46See proposed rule l.10(b)(3)(ii).47See 156 Cong. Rec. S5889 (daily ed. July 15,

2010) (statement of Sen. Hagan).

48See proposed rule l.12.49See proposed rule l.12(a)(2).50See proposed rule l.12(b), (c), and (d).51See proposed rule l.13(a)(c).52See proposed rule l.13(a).

53See proposed rule l.13(b)(1).54See proposed rule l.13(b)(2)(ii)(C) and (D).55See proposed rule l.13(b)(3).56See 156 Cong. Rec. S5897 (daily ed. July 15,

2010) (statement of Sen. Merkley).57See 12 U.S.C. 1851(g)(2).

interest in, or having certainrelationships with, a covered fund, aswell as the various exemptions to thisprohibition included in the statute.Sectionl.10 of the proposed rulecontains the core prohibition on coveredfund activities and investments anddefines a number of related terms,including covered fund and

ownership interest. The proposedrules definition of covered fundgenerally parallels the statutorydefinition of hedge fund and privateequity fund, and explains the universeof entities that would be considered acovered fund (including those entitiesdetermined by the Agencies to be suchsimilar funds) and, thus, subject to thegeneral prohibition.44

The definition of ownershipinterest provides further guidanceregarding the types of interests thatwould be considered to be an ownershipinterest in a covered fund.45 As

described in this SupplementaryInformation, these interests may takevarious forms. The definition ofownership interest also explicitlyexcludes from the definition carriedinterest whereby a banking entity mayshare in the profits of the covered fundsolely as performance compensation forservices provided to the covered fund

by the banking entity (or an affiliate,subsidiary, or employee thereof).46

Sectionl.10 of the proposed rulealso defines a number of other relevantterms, including the terms prime

brokerage transaction, sponsor, andtrustee.

Sectionl

.11 of the proposed ruleimplements the exemption fororganizing and offering a covered fundprovided for under section 13(d)(1)(G)of the BHC Act. Sectionl.11(a) of theproposed rule outlines the conditionsthat must be met in order for a bankingentity to organize and offer a coveredfund under this authority. Theserequirements are contained in thestatute and are intended to allow a

banking entity to engage in certaintraditional asset management andadvisory businesses in compliance withsection 13 of the BHC Act.47 The

requirements are discussed in detail inPart III.C.2 of this SupplementaryInformation.

Sectionl.12 of the proposed rulepermits a banking entity to acquire andretain, as an investment in a coveredfund, an ownership interest in a coveredfund that the banking entity organizes

and offers under l.11.48 This sectionimplements section 13(d)(4) of the BHCAct and related provisions. Section13(d)(4) of the BHC Act permits a

banking entity to make an investment ina covered fund that the banking entityorganizes and offers pursuant to section13(d)(1)(G), or for which it acts assponsor, for the purposes of (i)

establishing the covered fund andproviding the fund with sufficientinitial equity for investment to permitthe fund to attract unaffiliated investors,or (ii) making a de minimis investmentin the covered fund in compliance withapplicable requirements. Sectionl.12of the proposed rule implements thisauthority and related limitations,including limitations regarding theamount and value of any individual per-fund investment and the aggregate valueof all such permitted investments.49Proposed l.12 also clarifies how a

banking entity must calculate its

compliance with these investmentlimitations (including by deductingsuch investments from applicablecapital, as relevant), as well as sets forthhow a banking entity may request anextension of the period of time withinwhich it must conform an investment ina single covered fund.50

Sectionl.13 of the proposed ruleimplements the statutory exemptionsdescribed in sections 13(d)(1)(C), (E),and (I) of the BHC Act that permit a

banking entity: (i) To acquire and retainan ownership interest in, or act assponsor to, one or more SBICs, a publicwelfare investment, or certain qualifiedrehabilitation expenditures; (ii) toacquire and retain an ownership interestin a covered fund as a risk-mitigatinghedging activity; and (iii) in the case ofa non-U.S. banking entity, to acquireand retain an ownership interest in, oract as sponsor to, a foreign coveredfund.51 Sectionl.13(a) of the proposedrule permits a banking entity to acquireand retain an ownership interest in, oract as sponsor to, an SBIC or certainpublic interest investments, withoutlimitation as to the amount ofownership interests it may own, hold, orcontrol with the power to vote.52

Sectionl

.13(b) of the proposed rulepermits a banking entity to use anownership interest in a covered fund tohedge, but only with respect toindividual or aggregated obligations orliabilities of a banking entity that arisefrom: (i) The banking entity acting asintermediary on behalf of a customer

that is not itself a banking entity tofacilitate the customers exposure to theprofits and losses of the covered fund(similar to acting as a risklessprincipal); or (ii) a compensationarrangement with an employee of the

banking entity that directly providesinvestment advisory or other services tothat fund.53 Additionally, l.13(b) of

the proposed rule requires that thehedge represent a substantially similaroffsetting exposure to the same coveredfund and in the same amount ofownership interest in the covered fundarising out of the transaction that theacquisition or retention of an ownershipinterest in the covered fund is intendedto hedge or otherwise mitigate.54Proposed l.13(b) also requires a

banking entity to document, at the timethe transaction is executed, the hedgingrationale for all hedging transactionsinvolving an ownership interest in acovered fund.55

Sectionl

.13(c) of the proposed ruleimplements section 13(d)(1)(I) of theBHC Act and permits certain foreign

banking entities to acquire or retain anownership interest in, or to act assponsor to, a covered fund so long assuch activity occurs solely outside ofthe United States and the entity meetsthe requirements of sections 4(c)(9) or4(c)(13) of the BHC Act. This statutoryexemption limits the extraterritorialapplication of the statutory restrictionson covered fund activities andinvestments to foreign firms that, in thecourse of operating outside of theUnited States, engage in activitiespermitted under relevant foreign lawoutside of the United States, whilepreserving national treatment andcompetitive equality among U.S. andforeign firms within the United States.56The proposed rule defines both the typeof foreign banking entities that areeligible for the exemption and thecircumstances in which covered fundactivities or investments by such anentity will be considered to haveoccurred solely outside of the UnitedStates (including clarifying when anownership interest will be considered tohave been offered for sale or sold to a

resident of the United States). Sectionl.13(d) of the proposed rule alsoimplements in part the rule ofconstruction contained in section13(g)(2) of the BHC Act, which permitsthe sale and securitization of loans.57Proposed l.13(d) clarifies that a



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58See proposed rule l.13(d).59Section 13(d)(1)(J) of the BHC Act provides the

Agencies discretion to determine that activities notspecifically identified by sections 13(d)(1)(A)(I) ofthe BHC Act are also exempted from the generalprohibitions contained in section 13(a) of that Act,and are thus permitted activities. In order to makesuch a determination, the Agencies must find thatsuch activity or activities promote and protect thesafety and soundness of banking entities, as well aspromote and protect the financial stability of theUnited States. See 12 U.S.C. 1851(d)(1)(J).

60See 12 U.S.C. 1851(d)(1)(J).61See proposed rule l.13(a)(1)(2).

62See proposed rule at l.14(b).63Section 13(e)(1) of the BHC Act requires the

Agencies to issue regulations regarding internalcontrols and recordkeeping to ensure compliancewith section 13. See 12 U.S.C. 1851(e)(1).

64See proposed rule l.15.65See proposed rule l.16.6612 U.S.C. 371c1.67See proposed rule l.17.

68See proposed rule l.20. If a banking entitydoes not engage in covered trading activities and/or covered fund activities and investments, it needonly ensure that its existing compliance policiesand procedures include measures that are designedto prevent the banking entity from becomingengaged in such activities and making suchinvestments, and which require the banking entityto develop and provide for the required complianceprogram prior to engaging in such activities ormaking such investments.

banking entity may acquire and retainan ownership interest in, or act assponsor to, a covered fund that is anissuer of asset-backed securities, theassets or holdings of which are solelycomprised of: (i) Loans; (ii) contractualrights or assets directly arising fromthose loans supporting the asset-backedsecurities; and (iii) a limited amount of

interest rate or foreign exchangederivatives that materially relate to suchloans and that are used for hedgingpurposes with respect to thesecuritization structure.58 The authoritycontained in this section of theproposed rule would therefore allow a

banking entity to acquire and retain anownership interest in a loansecuritization vehicle (which would bea covered fund for purposes of section13(h)(2) of the BHC Act and theproposed rule) that the banking entityorganizes and offers, or acts as sponsorto, in excess of the three percent limits

specified in section 13(d)(4) of the BHCAct and l.12 of the proposed rule.Sectionl.14 of the proposed rule

implements section 13(d)(1)(J) of theBHC Act59 and permits a banking entityto engage in any covered fund activityor investment that the Agenciesdetermine promotes and protects thesafety and soundness of banking entitiesand the financial stability of the UnitedStates.60 The Agencies have proposed topermit three activities at this time underthis authority. These activities involveacquiring and retaining an ownershipinterest in, or acting as sponsor to,certain bank owned life insurance

(BOLI) separate accounts, investmentsin and sponsoring of certain asset-

backed securitizations, and investmentsin and sponsoring of certain entities thatrely on the exclusion from the definitionof investment company in section3(c)(1) and/or 3(c)(7) of the InvestmentCompany Act of 1940 (15 U.S.C. 80a1et seq.) (Investment Company Act)

but that are, in fact, common corporateorganizational vehicles.61 Additionally,the Agencies have proposed to permit a

banking entity to acquire and retain anownership interest in, or act as sponsorto, a covered fund, if such acquisition or

retention is done (i) in the ordinary

course of collecting a debt previouslycontracted, or (ii) pursuant to and incompliance with the conformance orextended transition periodsimplemented under section 13(c)(6) ofthe BHC Act.62

Sectionl.15 of the proposed rule,which implements section 13(e)(1) ofthe BHC Act,63 requires a banking entity

engaged in covered fund activities andinvestments to comply with (i) theinternal controls, reporting, andrecordkeeping requirements requiredunder l.20 and Appendix C of theproposed rule, as applicable and (ii)such other reporting and recordkeepingrequirements as the relevant supervisoryAgency may deem necessary toappropriately evaluate the bankingentitys compliance with subpart C.64

Sectionl.16 of the proposed ruleimplements section 13(f) of the BHC Actand generally prohibits a banking entityfrom entering into certain transactionswith a covered fund that would be acovered transaction as defined insection 23A of the FR Act.65 Sectionl.16(a)(2) of the proposed rule clarifiesthat, for reasons explained in part III.C.7of this Supplementary Information,certain transactions between a bankingentity and a covered fund remainpermissible. Sectionl.16(b) of theproposed rule implements the statutesrequirement that any transactionpermitted under section 13(f) of theBHC Act (including a prime brokeragetransaction) between the banking entityand a covered fund is subject to section23B of the FR Act,66 which, in general,

requires that the transaction be onmarket terms or on terms at least asfavorable to the banking entity as acomparable transaction by the bankingentity with an unaffiliated third party.

Sectionl.17 of the proposed ruleprohibits a banking entity from relyingon any exemption to the prohibition onacquiring and retaining an ownershipinterest in, acting as sponsor to, orhaving certain relationships with, acovered fund, if the permitted activityor investment would involve or result ina material conflict of interest, result ina material exposure to high-risk assets

or high-risk trading strategies, or pose athreat to the safety and soundness of thebanking entity or to the financialstability of the United States.67 Thissection also defines material conflict of

interest, high-risk asset, and high-risktrading strategy for these purposes.

D. Compliance Program Requirement

Subpart D of the proposed rulerequires a banking entity engaged incovered trading activities or coveredfund activities to develop andimplement a program reasonably

designed to ensure and monitorcompliance with the prohibitions andrestrictions on covered trading activitiesand covered fund activities andinvestments set forth in section 13 of theBHC Act and the proposed rule.68Sectionl.20(b) of the proposed rulespecifies six elements that eachcompliance program established undersubpart D must, at a minimum, include:

Internal written policies andprocedures reasonably designed todocument, describe, and monitor thecovered trading activities and coveredfund activities and investments of the

banking entity to ensure that suchactivities comply with section 13 of theBHC Act and the proposed rule;

A system of internal controlsreasonably designed to monitor andidentify potential areas ofnoncompliance with section 13 of theBHC Act and the proposed rule in the

banking entitys covered trading andcovered fund activities and to preventthe occurrence of activities that areprohibited by section 13 of the BHC Actand the proposed rule;

A management framework thatclearly delineates responsibility and

accountability for compliance withsection 13 of the BHC Act and theproposed rule;

Independent testing for theeffectiveness of the complianceprogram, conducted by qualified

banking entity personnel or a qualifiedoutside party;

Training for trading personnel andmanagers, as well as other appropriatepersonnel, to effectively implement andenforce the compliance program; and

Making and keeping recordssufficient to demonstrate compliancewith section 13 of the BHC Act and theproposed rule, which a banking entitymust promptly provide to the relevantAgency upon request and retain for aperiod of no less than 5 years.



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69A banking entity must comply with theminimum standards specified in Appendix C of theproposed rule (i) with respect to its covered tradingactivities, if it engages in any covered tradingactivities and has, together with its affiliates andsubsidiaries, trading assets and liabilities theaverage gross sum of which (on a worldwideconsolidated basis), as measured as of the last day

of each of the four prior calendar quarters, (X) isequal to or greater than $1 billion or (Y) equals 10percent or more of its total assets; and (ii) withrespect to its covered fund activities andinvestment, if it engages in any covered fundactivities and investments and either (X) has,together with its affiliates and subsidiaries,aggregate investments in covered funds the averagevalue of which is, as measured as of the last dayof each of the four prior calendar quarters, equal toor greater than $1 billion or (Y) sponsors andadvises, together with its affiliates and subsidiaries,covered funds the average total assets of which are,as measured as of the last day of each of the fourprior calendar quarters, equal to or greater than $1billion.

70See 76 FR 8265 (Feb. 14, 2011).

71For purposes of the proposed rule, anysecuritization entity that meets the requirements foran exclusion under Rule 3a7 or section 3(c)(5) ofthe Investment Company Act, or any otherexclusion or exemption from the definition ofinvestment company under the InvestmentCompany Act (other than sections 3(c)(1) or 3(c)(7)of the Investment Company Act), would not be acovered fund under the proposed definition.Additionally, an issuer of asset-backed securitiesthat is subject to legal documents mandatingcompliance with the conditions of section 3(c)(1) of3(c)(7) of the Investment Company Act would notbe a covered fund if such issuer also can satisfy allthe conditions of an alternative exclusion orexemption for which it is eligible.

72For example, under the proposed rule, abanking entity would be able to acquire or retainan interest or security of an issuer of asset-backedsecurities that is a covered fund if: (i) The interestor security of the issuer does not qualify as anownership interest under l.10(b)(3) of theproposed rule; (ii) the issuer of asset-backedsecurities is comprised solely of loans, contractualrights or assets directly arising from those loans,and certain specified interest rate or foreignexchange derivatives used for hedging purposes, aspermitted under l.13(d) orl.14(a)(2)(v) of theproposed rule; (iii) the banking entity is asecuritizer or originator and acquires and

retains such interest in compliance with theminimum requirements of section 15G of theExchange Act and any implementing regulationsissued thereunder, as provided underl.14(a)(2)(iii) of the proposed rule; or (v) thebanking entity organizes and offers the issuer andthe ownership interest is a permitted investmentunder l.12 of the proposed rule. Thecircumstances where a banking entity may acquireor retain an ownership interest in a covered fundare discussed in detail in Part III.C of thisSupplemental Information.

73The definitions of affiliate and subsidiaryare discussed in detail in Part III.A.2 of thisSupplemental Information.

For a banking entity with significantcovered trading activities or coveredfund activities and investments, thecompliance program must also meet anumber of minimum standards that arespecified in Appendix C of the proposedrule.69 The application of detailedminimum standards for these types of

banking entities is intended to reflect

the heightened compliance risks of largecovered trading activities and coveredfund activities and investments and toprovide clear, specific guidance to such

banking entities regarding thecompliance measures that would berequired for purposes of the proposedrule. For banking entities with smaller,less complex covered trading activitiesand covered fund activities andinvestments, these detailed minimumstandards are not applicable, though theAgencies expect that such smallerentities will consider these minimumstandards as guidance in designing an

appropriate compliance program.E. Conformance Provisions

Subpart E of the Boards proposedrule incorporates, with minor technicaland conforming edits, the final rulewhich the Board, after soliciting andconsidering public comment, issuedregarding the conformance periods forentities engaged in prohibitedproprietary trading or covered fundactivities and investments.70 That ruleimplements the conformance period andextended transition period, asapplicable, during which a bankingentity and nonbank financial companysupervised by the Board must bring itsactivities, investments and relationshipsinto compliance with the prohibitionsand restrictions on proprietary tradingand acquiring an ownership interest in,or having certain relationships with, acovered fund.

F. Treatment of Smaller, Less-ComplexBanking Entities

In formulating the proposed rule, theAgencies have carefully considered andtaken into account the potential impactof the proposed rule on small bankingentities and banking entities that engagein little or no covered trading activities

or covered fund activities andinvestments, including the burden andcost that might be associated with such

banking entities compliance with theproposed rule. In particular, theAgencies have proposed to reduce theeffect of the proposed rule on such

banking entities by limiting theapplication of certain requirements,such as the reporting and recordkeepingrequirements of l.7 and Appendix Aof the proposed rule and the complianceprogram requirements contained insubpart D and Appendix C of theproposed rule, to those banking entities

that engage in little or no coveredtrading activities or covered fundactivities and investments. TheAgencies have also requested comment(i) throughout this SupplementaryInformation on a number of questionsrelated to the costs and burdensassociated with particular aspects of theproposal, as well as (ii) in Part VII.B ofthis Supplementary Information on anysignificant alternatives that wouldminimize the impact of the proposal onsmall banking entities.

G. Application of Section 13 of the BHCAct to Securitization Vehicles or Issuers

of Asset-Backed Securities

Many issuers of asset-backedsecurities may be included within thedefinition of covered fund since theywould be an investment company butfor the exclusions contained in section3(c)(1) or 3(c)(7) of the InvestmentCompany Act.71 If an issuer of asset-

backed securities is considered to be acovered fund, then a banking entitywould not be permitted to acquire orretain any ownership interest issued bysuch issuer except as otherwisepermitted under section 13 of the BHC

Act and the proposed rule.72 Separately,issuers of asset-backed securities may beincluded within the definition of

banking entity, as noted in Part III.A.2of this Supplementary information.Although the proposed definition of

banking entity would not include anyentity that is a covered fund, an issuerof asset-backed securities that is both (i)an affiliate or subsidiary of a bankingentity,73 and (ii) does not rely on anexclusion contained in section 3(c)(1) of3(c)(7) of the Investment Company Act,would be a banking entity and thussubject to the requirements of section 13of the BHC Act and the proposed rule,including: (i) The prohibition onproprietary trading; (ii) limitations oninvestments in and relationships with acovered fund; (iii) the establishment andimplementation of a complianceprogram as required under the proposedrule; and (iv) recordkeeping and

reporting requirements. Given thebreadth of the definition of affiliate,these requirements may apply to asignificant portion of the outstandingsecuritization market, including issuersof asset-backed securities that rely onrule 3a7 or section 3(c)(5) of theInvestment Company Act.

In recognition of these concerns, theAgencies have requested commentthroughout this SupplementaryInformation on the potential effects ofsection 13 of the BHC Act and theproposed rule on the securitizationindustry and issuers of asset-backedsecurities.



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74See proposed rule l.1(d).75See 12 U.S.C. 1851(c)(1).76See id. at 1851(c)(2)(6).77See proposed rule l.1.

78See proposed rule l.2(e). Sectionsl.2(a)and (bb) of the proposed rule clarify that the termsaffiliate and subsidiary have the same meaningas in sections 2(d) and (k) of the BHC Act (12 U.S.C.1841(d) and (k)).

79The Agencies note that since the proposed rule

implements section 13 of the BHC Act, itincorporates that Acts definition of affiliate andsubsidiary. See proposed rule l.2(a) and (bb).The terms affiliate and subsidiary are generallydefined in section 2 of the BHC Act according towhether such entity controls or is controlled byanother relevant entity. See 12 U.S.C. 1841(d), (k).The concept of control under the proposed rule, inturn, is as defined in section 2 of the BHC Act andas implemented by the Board. See 12 U.S.C.1841(a)(2); 12 CFR 225.2(e).

80Under section 2 of the BHC Act and the BoardsRegulation Y (12 CFR part 225), a banking entityacting as general partner or managing member ofanother company would be deemed to control thatcompany and, as such, the company would be both

Continued

III. Section by Section Summary ofProposed Rule

A. Subpart AAuthority andDefinitions

1. Sectionl.1: Authority, Purpose,Scope, and Relationship to OtherAuthorities

a. Authority and ScopeSectionl.1 of the proposed rule

describes the authority under whicheach Agency is issuing the proposedrule, the purpose of the proposed rule,and the banking entities to which eachAgencys rule applies. In addition,l.1(d) of the proposed ruleimplements section 13(g)(1) of the BHCAct, which provides that theprohibitions and restrictions of section13 apply to the activities of a bankingentity regardless of whether suchactivities are authorized for a bankingentity under other applicable provisions

of law.74

b. Effective Date

Section 13(c)(1) of the BHC Actprovides that section 13 shall take effecton the earlier of (i) 12 months after thedate of issuance of final rulesimplementing that section, or (ii) 2 yearsafter the date of enactment of section 13,which is July 21, 2012.75 Because theAgencies did not issue final rulesimplementing section 13 of the BHC Act

by July 21, 2011, l.1 of the proposedrule specifies that the effective date forits provisions will be July 21, 2012.

The Agencies note that the proposed

effective date will impact not only thedate on which the proposed rulesprohibitions and restrictions onproprietary trading and covered fundactivities and investments go into effect(subject to the conformance period orextended transition period provided bysection 13(c) of the BHC Act),76but alsothe date on which a banking entity mustcomply with (i) the reporting andrecordkeeping requirements of l.7and Appendix A of the proposed ruleand (ii) the compliance programmandate of l.20 and Appendix C ofthe proposed rule. As proposed, l.1

would require a banking entity subjectto either the reporting andrecordkeeping or compliance programrequirements to begin complying withthese requirements as of July 21, 2012.77With respect to the compliance programrequirement of the proposed rule, l.1would require a banking entity to havedeveloped and implemented the

required program by the proposedeffective date, though the Agencies notethat prohibited activities andinvestments may not be fully conformed

by that date. The Agencies expect abanking entity to fully conform allinvestments and activities to therequirements of the proposed rule assoon as practicable within the

conformance periods provided insection 13 of the BHC Act and theBoards rules thereunder, which definethe conformance periods. With respectto the reporting and recordkeepingrequirements of the proposed rule,l.1 of the proposed rule wouldrequire a banking entity to beginfurnishing these reports for all tradingunits or asset management units as ofthe effective date, though thequantitative measurements furnished forproprietary trading activities that areconducted in reliance on the authorityprovided by the conformance period

would not be used to identify prohibitedproprietary trading until such time asthe relevant trading activities must beconformed.

The Agencies expect that a bankingentity may need a period of time toprepare for effectiveness of the proposedrule and, in particular, to implement

both the compliance program and thereporting and recordkeepingrequirements provided under theproposed rule. Accordingly, in order tohelp assess the effects and impact of theproposed effective date and anyalternative compliance dates, the

Agencies request comment on thefollowing questions:Question 1. Does the proposed

effective date provide banking entitieswith sufficient time to prepare tocomply with the prohibitions andrestrictions on proprietary trading andcovered fund activities andinvestments? If not, what other period oftime is needed and why?

Question 2. Does the proposedeffective date provide banking entitieswith sufficient time to implement theproposals compliance programrequirement? If not, what are theimpediments to implementing specificelements of the compliance programand what would be a more effectivetime period for implementing eachelement and why?

Question 3. Does the proposedeffective date provide banking entitiessufficient time to implement theproposals reporting and recordkeepingrequirements? If not, what are theimpediments to implementing specificelements of the proposed reporting andrecordkeeping requirements and whatwould be a more effective time period

for implementing each element andwhy?

Question 4. Should the Agencies usea gradual, phased in approach toimplement the statute rather thanhaving the implementing rules becomeeffective at one time? If so, whatprohibitions and restrictions should beimplemented first? Please explain.

2. Sectionl

.2: Definitions

Sectionl.2 of the proposed ruledefines a variety of terms usedthroughout the proposed rule, includingbanking entity, which defines thescope of entities to which the proposedrule applies. Consistent with thestatutory definition of that term,l.2(e) of the proposed rule providesthat a banking entity includes: (i) Anyinsured depository institution; (ii) anycompany that controls an insureddepository institution; (iii) any companythat is treated as a bank holdingcompany for purposes of section 8 of theInternational Banking Act of 1978 (12U.S.C. 3106); and (iv) any affiliate orsubsidiary of any of the foregoing.78 Inaddition, in order to avoid applicationof section 13 of the BHC Act in a waythat appears unintended by the statuteand would create internalinconsistencies in the statutory scheme,the proposed rule also clarifies that theterm banking entity does not includeany affiliate or subsidiary of a bankingentity, if that affiliate or subsidiary is (i)a covered fund, or (ii) any entitycontrolled by such a covered fund.79This clarification is proposed because

the definition of affiliate andsubsidiary under the BHC Act is

broad, and could include a covered fundthat a banking entity has permissiblysponsored or made an investment in

because, for example, the banking entityacts as general partner or managingmember of the covered fund as part ofits permitted sponsorship activities.80 If



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an affiliate and subsidiary of the banking entityfor purposes of the BHC Act. See 12 U.S.C. 1841(d),(k).

81See, e.g., 12 U.S.C. 1483(c)(6), (c)(8), and (k); 12CFR 225.28(b)(6), 225.86(b)(3).

82See proposed rule l.2(g), (v); 15 U.S.C.78c(a)(13), (14).

83For purposes of this Supplemental Information,existing issuers of asset-backed securities means

issuers that issued asset-backed securities prior tothe effective date of the proposed rule.

84For purposes of this Supplemental Information,existing asset-backed securities means asset-backed securities that were issued prior to theeffective date of the proposed rule.

such a covered fund were considered abanking entity for purposes of theproposed rule, the fund itself would

become subject to all of the restrictionsand limitations of section 13 of the BHCAct and the proposed rule, which would

be inconsistent with the purpose andintent of the statute. For example, sucha covered fund would then generally be

prohibited from investing in othercovered funds, notwithstanding the factthat section 13(f)(3) of the BHC Actspecifically contemplates suchinvestments. Accordingly, the proposedrule would exclude from the definitionof banking entity any fund that a

banking entity may invest in or sponsoras permitted by the proposed rule.

An entity such as a mutual fundwould generally not be a subsidiary oraffiliate of a banking entity under thisdefinition if the banking entity onlyprovides advisory or administrativeservices to, has certain limitedinvestments in, or organizes, sponsors,and manages a mutual fund (whichincludes a registered investmentcompany) in accordance with BHC Actrules.81

Sectionl.2(j) of the proposed ruledefines the term covered bankingentity, which is used in each Agencysproposed rule to describe the specifictypes of banking entities to which thatAgencys rule applies. In addition, anumber of other definitions containedin l.2 are discussed in further detail

below in connection with the separatesections of the proposed rule in whichthey are used.

The proposed rule also defines theterms buy and purchase and sell andsale, which are used throughout theproposed rule to describe the scope oftransactions that are subject to subpartsB and C of the proposed rule. Thesedefinitions are substantially similar tothe definitions of the same terms underthe Exchange Act, except that theproposed definitions provide additionalclarity regarding the types oftransactions that would be consideredthe purchase or sale of a commodityfuture or derivative or ownershipinterest in a covered fund.82 Thesedefinitions are purposefully broad inscope, and are intended to include awide range of transaction types thatwould permit a banking entity to gain oreliminate, or increase or reduce,

exposure to a covered financial positionor ownership interest in a covered fund.

Request for Comment

The Agencies request comment on theproposed rules definition of bankingentity. In particular, the Agenciesrequest comment on the followingquestions:

Question 5. Is the proposed rulesdefinition of banking entity effective?What alternative definitions might bemore effective in light of the languageand purpose of the statute?

Question 6. Are there any entities thatshould not be included within thedefinition of banking entity since theirinclusion would not be consistent withthe language or purpose of the statute orcould otherwise produce unintendedresults? Should a registered investmentcompany be expressly excluded fromthe definition of banking entity? Why orwhy not?

Question 7. Is the proposed rulesexclusion of a covered fund that isorganized, offered and held by a

banking entity from the definition ofbanking entity effective? Should thedefinition of banking entity be modifiedto exclude any covered fund? Why orwhy not?

Question 8. Banking entitiescommonly structure their registeredinvestment company relationships andinvestments such that the registeredinvestment company is not consideredan affiliate or subsidiary of the bankingentity. Should a registered investmentcompany be expressly excluded from

the definition of banking entity? Why orwhy not? Are there circumstances inwhich such companies should betreated as banking entities subject tosection 13 of the BHC Act? How manysuch companies would be covered bythe proposed definition?

Question 9. Under the proposed rule,would issuers of asset-backed securities

be captured by the proposed definitionof banking entity? If so, are issuers ofasset-backed securities within certainasset classes particularly impacted? Areparticular types of securitizationvehicles (trusts, LLCs, etc.) more likely

than others to be included in thedefinition of banking entity? Shouldissuers of asset-backed securities beexcluded from the proposed definitionof banking entity, and if so, why?How would such an exclusion beconsistent with the language andpurpose of the statute?

Question 10. What would be thepotential impact of including existingissuers of asset-backed securities 83 in

the proposed definition of bankingentity on existing issuers of asset-

backed securities and the securitizationmarket generally? How many existingissuers of asset-backed securities might

be included in the proposed definitionof banking entity? Are there ways inwhich the proposed rule could beamended to mitigate or eliminate

potential impact, if any, on existingasset-backed securities 84 withoutcompromising the intent of the statute?

Question 11. What would be the legaland economic impact to an issuer ofasset-backed securities of beingconsidered a banking entity? Whatadditional costs would be incurred inthe establishment and implementationof a compliance program related to theprovisions of the proposed rule asrequired by l.20 of the proposed rule(including Appendix C, whereapplicable)? Who would pay thoseadditional costs?

Question 12. If the ownershiprequirement under the proposed rule forcredit risk retention (section 15G of theExchange Act) combined with thecontrol inherent in the position ofservicer or investment manager meansthat more securitization vehicles would

be considered affiliates of bankingentities, would fewer banking entities bewilling to (i) serve as the servicer orinvestment manager of securitizationtransactions and/or (ii) serve as theoriginator or securitizer (as defined insection 15G of the Exchange Act) ofsecuritization transactions? What otherimpact might the potential interplay

between these rules have on futuresecuritization transactions? Could there

be other potential unintendedconsequences?

Question 13. Are the proposed rulesdefinitions of buy and purchase and saleand sell appropriate? If not, whatalternative definitions would be moreappropriate? Should any other terms bedefined? If so, are there existingdefinitions in other rules or regulationsthat could be used in this context? Whywould the use of such other definitions

be appropriate?

B. Subpart BProprietary TradingRestrictions

1. Sectionl.3: Prohibitio