[Federal Register Volume 76, Number 215 (Monday, November 7, 2011)]
[Proposed Rules]
[Pages 68846-68972]
[FR Doc No: 2011-27184]

Vol. 76

Monday,

No. 215

November 7, 2011

Part II

Department of the Treasury

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Office of the Comptroller of the Currency

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12 CFR Part 44

Board of Governors of the Federal Reserve System

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12 CFR Part 248

Federal Deposit Insurance Corporation

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12 CFR Part 351

Securities and Exchange Commission

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17 CFR 255

 Prohibitions and Restrictions on Proprietary Trading and Certain
Interests in, and Relationships With, Hedge Funds and Private Equity
Funds; Proposed Rule

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

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 44

[Docket No. OCC-2011-0014]
RIN 1557-AD44

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

12 CFR Part 248

[Docket No. R-1432]
RIN 7100 AD 82

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 351

RIN 3064-AD85

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 255

[Release No. 34-65545; File No. S7-41-11]
RIN 3235-AL07

Prohibitions and Restrictions on Proprietary Trading and Certain
Interests in, and Relationships With, Hedge Funds and Private Equity
Funds

AGENCY: Office of the Comptroller of the Currency, Treasury (``OCC'');
Board of Governors of the Federal Reserve System (``Board''); Federal
Deposit Insurance Corporation (``FDIC''); and Securities and Exchange
Commission (``SEC'').

ACTION: Notice of proposed rulemaking.

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SUMMARY: The OCC, Board, FDIC, and SEC (individually, an ``Agency,''
and collectively, ``the Agencies'') are requesting comment on a
proposed rule that would implement Section 619 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (``Dodd-Frank Act'') which
contains certain prohibitions and restrictions on the ability of a
banking entity and nonbank financial company supervised by the Board to
engage in proprietary trading and have certain interests in, or
relationships with, a hedge fund or private equity fund.

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

ADDRESSES: Interested parties are encouraged to submit written comments
jointly to all of the Agencies. Commenters are encouraged to use the
title ``Restrictions on Proprietary Trading and Certain Interests in,
and Relationships with, Hedge Funds and Private Equity Funds'' to
facilitate the organization and distribution of comments among the
Agencies. Commenters are also encouraged to identify the number of the
specific question for comment to which they are responding.
    Office of the Comptroller of the Currency: Because paper mail in
the Washington, DC area and at the OCC is subject to delay, commenters
are encouraged to submit comments by the Federal eRulemaking Portal or
email, if possible. Please use the title ``Restrictions on Proprietary
Trading and Certain Interests in and Relationships with Hedge Funds and
Private Equity Funds'' to facilitate the organization and distribution
of the comments. You may submit comments by any of the following
methods:
     Federal eRulemaking Portal--``Regulations.gov'': Go to
http://www.regulations.gov. Select ``Document Type'' of ``Proposed
Rules,'' and in the ``Enter Keyword or ID Box,'' enter Docket ID ``OCC-
2011-14,'' and click ``Search.'' On ``View By Relevance'' tab at the
bottom of screen, in the ``Agency'' column, locate the Proposed Rule
for the OCC, in the ``Action'' column, click on ``Submit a Comment'' or
``Open Docket Folder'' to submit or view public comments and to view
supporting and related materials for this rulemaking action.
     Click on the ``Help'' tab on the Regulations.gov home page
to get information on using Regulations.gov, including instructions for
submitting or viewing public comments, viewing other supporting and
related materials, and viewing the docket after the close of the
comment period.
     Email<EMAIL_ADDRESS>     Mail: Office of the Comptroller of the Currency, 250 E
Street SW., Mail Stop 2-3, Washington, DC 20219.
     Fax:<PHONE_NUMBER>.
     Hand Delivery/Courier: 250 E Street SW., Mail Stop 2-3,
Washington, DC 20219.
    Instructions: You must include ``OCC'' as the agency name and
``Docket ID OCC-2011-14'' in your comment. In general, OCC will enter
all comments received into the docket and publish them on the
Regulations.gov Web site without change, including any business or
personal information that you provide such as name and address
information, email addresses, or phone numbers. Comments received,
including attachments and other supporting materials, are part of the
public record and subject to public disclosure. Do not enclose any
information in your comment or supporting materials that you consider
confidential or inappropriate for public disclosure.
    You may review comments and other related materials that pertain to
this proposed rulemaking by any of the following methods:
     Viewing Comments Electronically: Go to http://www.regulations.gov. Select ``Document Type'' of ``Public
Submissions,'' and in the ``Enter Keyword or ID Box,'' enter Docket ID
``OCC-2011-14,'' and click ``Search.'' Comments will be listed under
``View By Relevance'' tab at the bottom of screen. If comments from
more than one agency are listed, the ``Agency'' column will indicate
which comments were received by the OCC.
     Viewing Comments Personally: You may personally inspect
and photocopy comments at the OCC, 250 E Street SW., Washington, DC
20219. For security reasons, the OCC requires that visitors make an
appointment to inspect comments. You may do so by calling (202) 874-
4700. Upon arrival, visitors will be required to present valid
government-issued photo identification and submit to security screening
in order to inspect and photocopy comments.
    Docket: You may also view or request available background documents
and project summaries using the methods described above.
    Board of Governors of the Federal Reserve System:
    You may submit comments, identified by Docket No. R-1432 and RIN
7100 AD 82, by any of the following methods:
     Agency Web site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
     Email<EMAIL_ADDRESS>Include the
docket number in the subject line of the message.
     Fax:<PHONE_NUMBER> or<PHONE_NUMBER>.
     Mail: Address to Jennifer J. Johnson, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue NW., Washington, DC 20551.
    All public comments will be made available on the Board's Web site
at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, comments
will not be edited to remove any identifying or contact information.
Public

comments may also be viewed electronically or in paper in Room MP-500
of the Board's Martin Building (20th and C Streets NW.,) between 9 a.m.
and 5 p.m. on weekdays.
    Federal Deposit Insurance Corporation: You may submit comments,
identified by RIN number, by any of the following methods:
     Agency Web site: http://www.fdic.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on
the Agency Web site.
     Email<EMAIL_ADDRESS>Include the RIN 3064-AD85 on the
subject line of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention:
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW.,
Washington, DC 20429.
     Hand Delivery: Comments may be hand delivered to the guard
station at the rear of the 550 17th Street Building (located on F
Street) on business days between 7 a.m. and 5 p.m.
    Public Inspection: All comments received must include the agency
name and RIN 3064-AD85 for this rulemaking. All comments received will
be posted without change to http://www.fdic.gov/regulations/laws/federal/propose.html, including any personal information provided.
Paper copies of public comments may be ordered from the FDIC Public
Information Center, 3501 North Fairfax Drive, Room E-I002, Arlington,
VA 22226 by telephone at 1<PHONE_NUMBER> or 1<PHONE_NUMBER>.
    Securities and Exchange Commission: You may submit comments by the
following method:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an email to<EMAIL_ADDRESS>Please include
File Number S7-41-11 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
    All submissions should refer to File Number S7-41-11. This file
number should be included on the subject line if email is used. To help
us process and review your comments more efficiently, please use only
one method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street NE., Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: OCC: Deborah Katz, Assistant Director,
or Ursula Pfeil, Counsel, Legislative and Regulatory Activities
Division,<PHONE_NUMBER>; Roman Goldstein, Senior Attorney, Securities
and Corporate Practices Division,<PHONE_NUMBER>; Kurt Wilhelm,
Director for Financial Markets Group,<PHONE_NUMBER>; Stephanie Boccio,
Technical Expert for Asset Management Group, or Joel Miller, Group
Leader for Asset Management Group,<PHONE_NUMBER>, Office of the
Comptroller of the Currency, 250 E Street SW., Washington, DC 20219.
    Board: Jeremy R. Newell, Counsel,<PHONE_NUMBER>, or Christopher M.
Paridon, Counsel, Legal Division,<PHONE_NUMBER>; Sean D. Campbell,
Deputy Associate Director, Division of Research and Statistics, (202)
452-3760; David Lynch, Manager, Division of Bank Supervision and
Regulation,<PHONE_NUMBER>, Board of Governors of the Federal Reserve
System, 20th and C Streets, NW., Washington, DC 20551.
    FDIC: Bobby R. Bean, Acting Associate Director, Capital Markets
(202) 898-6705, or Karl R. Reitz, Senior Capital Markets Specialist,
(202) 898-6775, Division of Risk Management Supervision; Michael B.
Phillips, Counsel,<PHONE_NUMBER>, or Gregory S. Feder, Counsel, (202)
898-8724, Legal Division, Federal Deposit Insurance Corporation, 550
17th Street NW., Washington, DC 20429-0002.
    SEC: Josephine Tao, Assistant Director, Elizabeth Sandoe, Senior
Special Counsel, David Bloom, Branch Chief, Anthony Kelly, Special
Counsel, Angela Moudy, Attorney Advisor, or Daniel Staroselsky,
Attorney Advisor, Office of Trading Practices, Division of Trading and
Markets,<PHONE_NUMBER>; David Blass, Chief Counsel, or Gregg Berman,
Senior Advisor to the Director, Division of Trading and Markets; Daniel
S. Kahl, Assistant Director, Tram N. Nguyen, Branch Chief, Michael J.
Spratt, Senior Counsel, or Parisa Haghshenas, Law Clerk, Office of
Investment Adviser Regulation, Division of Investment Management, (202)
551-6787; David Beaning, Special Counsel, Office of Structured Finance,
Division of Corporation Finance,<PHONE_NUMBER>; John Harrington,
Special Counsel, Office of Capital Market Trends, Division of
Corporation Finance,<PHONE_NUMBER>; Richard Bookstaber, Senior Policy
Advisor, or Jennifer Marietta-Westberg, Assistant Director, Office of
the Sell Side; or Adam Yonce, Financial Economist, Division of Risk
Strategy and Financial Innovation,<PHONE_NUMBER>, U.S. Securities and
Exchange Commission, 100 F Street NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Background

    The Dodd-Frank Act was enacted on July 21, 2010.\1\ Section 619 of
the Dodd-Frank Act added a new section 13 to the Bank 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 or retaining an ownership interest in,
sponsoring, or having certain relationships with a hedge fund or
private equity fund (``covered fund''), subject to certain
exemptions.\3\ New section 13 of the BHC Act also provides for nonbank
financial companies supervised by the Board that engage in such
activities or have such interests or relationships to be subject to
additional capital requirements, quantitative limits, or other
restrictions.\4\
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    \1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ Application of the proposed rule to smaller, less-complex
banking entities is discussed below in Part II.F of this
Supplemental Information.
    \3\ The term ``banking entity'' is defined in section 13(h)(1)
of the BHC Act, as amended by section 619 of the Dodd-Frank Act. See
12 U.S.C. 1851(h)(1). The statutory definition includes any insured
depository institution (other than certain limited purpose trust
institutions), any company that controls an insured depository
institution, any company that is treated as a bank holding company
for purposes of section 8 of the International Banking Act of 1978
(12 U.S.C. 3106), and any affiliate or subsidiary of any of the
foregoing. Section 13 of the BHC Act defines the terms ``hedge
fund'' and ``private equity fund'' as an issuer that would be an
investment company, as defined under the Investment Company Act of
1940 (15 U.S.C. 80a-1 et seq.), but for section 3(c)(1) or 3(c)(7)
of that Act, or any such similar funds as the appropriate Federal
banking agencies (i.e., the Board, OCC, and FDIC), the SEC, and the
CFTC may, by rule, determine should be treated as a hedge fund or
private equity fund. See 12 U.S.C. 1851(h)(2).
    \4\ See 12 U.S.C. 1851(a)(2) and (f)(4). A ``nonbank financial
company supervised by the Board'' is a nonbank financial company or
other company that the Financial Stability Oversight Council
(``Council'') has determined, under section 113 of the Dodd-Frank
Act, shall be subject to supervision by the Board and prudential
standards. The Board is not proposing at this time any additional
capital requirements, quantitative limits, or other restrictions on
nonbank financial companies pursuant to section 13 of the BHC Act,
as it believes doing so would be premature in light of the fact that
the Council has not yet finalized the criteria for designation of,
nor yet designated, any nonbank financial company.

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A. Rulemaking Framework

    Section 13 of the BHC Act requires that implementation of its
provisions occur in several stages. First, the Council was required to
conduct a study (``Council study'') and make recommendations by January
21, 2011 on the implementation of section 13 of the BHC Act. The
Council study was issued on January 18, 2011, and included a detailed
discussion of key issues related to implementation of section 13 and
recommended that the Agencies consider taking a number of specified
actions in issuing rules under section 13 of the BHC Act.\5\ The
Council study also recommended that the Agencies adopt a four-part
implementation and supervisory framework for identifying and preventing
prohibited proprietary trading, which included a programmatic
compliance regime requirement for banking entities, analysis and
reporting of quantitative metrics by banking entities, supervisory
review and oversight by the Agencies, and enforcement procedures for
violations.\6\ The Agencies have carefully considered the Council study
and its recommendations, and have consulted with staff of the Commodity
Futures Trading Commission (``CFTC''), in formulating this proposal.\7\
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    \5\ See Financial Stability Oversight Council, Study and
Recommendations on Prohibitions on Proprietary Trading and Certain
Relationships with Hedge Funds and Private Equity Funds (Jan. 18,
2011), available at http://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
requested public comment on a number of issues to assist the Council
in conducting its study. See 75 FR 61,758 (Oct. 6, 2010).
Approximately 8,000 comments were received from the public,
including from members of Congress, trade associations, individual
banking entities, consumer groups, and individuals. As noted in the
issuing release for the Council Study, these comments were carefully
considered by the Council when drafting the Council study.
    \6\ See Council study at 5-6. The Agencies have implemented this
recommendation through the proposed compliance program requirements
contained in Subpart D of this proposal with respect to both
proprietary trading and covered fund activities and investments.
    \7\ The Agencies also received a number of comment letters
concerning implementation of section 13 of the BHC Act in advance of
this proposal. The Agencies have carefully considered these comments
in formulating this proposal.
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    Authority for developing and adopting regulations to implement the
prohibitions and restrictions of section 13 of the BHC Act is divided
between the Agencies in the manner provided in section 13(b)(2) of the
BHC Act.\8\ The statute also requires the Agencies, in developing and
issuing implementing rules, to consult and coordinate with each other,
as appropriate, for the purposes of assuring, to the extent possible,
that such rules are comparable and provide for consistent application
and implementation of the applicable provisions of section 13 of the
BHC Act.\9\ Such coordination will assist in ensuring that advantages
are not unduly provided to, and that disadvantages are not unduly
imposed upon, companies affected by section 13 of the BHC Act and that
the safety and soundness of banking entities and nonbank financial
companies supervised by the Board are protected. The statute requires
the Agencies to implement rules under section 13 not later than 9
months after the Council completes its study (i.e., not later than
October 18, 2011).\10\ The restrictions and prohibitions of section 13
of the BHC Act become effective 12 months after issuance of final rules
by the Agencies, or July 21, 2012, whichever is earlier.\11\
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    \8\ See 12 U.S.C. 1851(b)(2). Under section 13(b)(2)(B) of the
BHC Act, rules implementing section 13's prohibitions and
restrictions must be issued by: (i) The appropriate Federal banking
agencies (i.e., the Board, the OCC, and the FDIC), jointly, with
respect to insured depository institutions; (ii) the Board, with
respect to any company that controls an insured depository
institution, or that is treated as a bank holding company for
purposes of section 8 of the International Banking Act, any nonbank
financial company supervised by the Board, and any subsidiary of any
of the foregoing (other than a subsidiary for which an appropriate
Federal banking agency, the SEC, or the CFTC is the primary
financial regulatory agency); (iii) the CFTC with respect to any
entity for which it is the primary financial regulatory agency, as
defined in section 2 of the Dodd-Frank Act; and (iv) the SEC with
respect to any entity for which it is the primary financial
regulatory agency, as defined in section 2 of the Dodd-Frank Act.
See id.
    \9\ See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary of the
Treasury, as Chairperson of the Council, is responsible for
coordinating the Agencies' rulemakings under section 13 of the BHC
Act. See id.
    \10\ See id. at 1851(b)(2)(A).
    \11\ See id. at 1851(c)(1).
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    In addition, the statute required the Board, acting alone, to adopt
rules to implement the provisions of section 13 of the BHC Act that
provide a banking entity or a nonbank financial company supervised by
the Board a period of time after the effective date of section 13 of
the BHC Act to bring the activities, investments, and relationships of
the banking entity into compliance with that section and the Agencies'
implementing regulations.\12\ The Board issued its final conformance
rule as required under section 13(c)(6) of the BHC Act on February 8,
2011 (``Board's Conformance Rule'').\13\ As noted in the issuing
release for the Board's Conformance Rule, this period is intended to
give markets and firms an opportunity to adjust to section 13 of the
BHC Act.\14\
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    \12\ See id. at 1851(c)(6).
    \13\ See Conformance Period for Entities Engaged in Prohibited
Proprietary Trading or Private Equity Fund or Hedge Fund Activities,
76 FR 8265 (Feb. 14, 2011).
    \14\ See id. (citing 156 Cong. Rec. S5898 (daily ed. July 15,
2010) (statement of Sen. Merkley)).
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B. Section 13 of the BHC Act

    Section 13 of the BHC Act generally prohibits banking entities from
engaging in proprietary trading or from acquiring or retaining any
ownership interest in, or sponsoring, a covered fund.\15\ However,
section 13(d)(1) of that Act expressly includes exemptions from these
prohibitions for certain permitted activities, including:
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    \15\ 12 U.S.C. 1851(a)(1)(A) and (B).
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     Trading in certain government obligations;
     Underwriting and market making-related activities;
     Risk-mitigating hedging activity;
     Trading on behalf of customers;
     Investments in Small Business Investment Companies
(``SBICs'') and public interest investments;
     Trading for the general account of insurance companies;
     Organizing and offering a covered fund (including limited
investments in such funds);
     Foreign trading by non-U.S. banking entities; and
     Foreign covered fund activities by non-U.S. banking
entities.\16\
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    \16\ See id. at 1851(d)(1). As described in greater detail in
Part III.B.4 of this Supplementary Information, the proposed rule
applies some of these statutory exemptions only to the proprietary
trading prohibition or the covered fund prohibitions and
restrictions, but not both, where it appears either by plain
language or by implication that the exemption was intended only to
apply to one or the other.
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    For purposes of this Supplementary Information, trading activities
subject to section 13 of the BHC Act, including those permitted under a
relevant exemption, are sometimes referred to as ``covered trading
activities.'' Similarly, activities and investments with respect to a
covered fund that are subject to section 13 of the BHC Act, including
those permitted under a relevant exemption, are sometimes referred to
as ``covered fund activities or investments.''
    Additionally, section 13 of the BHC Act permits the Agencies to
grant, by rule, other exemptions from the prohibitions on proprietary
trading and acquiring or retaining an ownership interest in, or acting
as sponsor to, a covered fund if the Agencies determine

that the exemption would promote and protect the safety and soundness
of the banking entity and the financial stability of the United
States.\17\ Furthermore, under the statute, no banking entity may
engage in a permitted activity if that activity would (i) involve or
result in a material conflict of interest or material exposure of the
banking entity to high-risk assets or high-risk trading strategies, or
(ii) pose a threat to the safety and soundness of the banking entity or
to the financial stability of the United States.\18\
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    \17\ Id. at 1851(d)(1)(J).
    \18\ See id. at 1851(d)(2).
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    Section 13(f) of the BHC Act separately prohibits a banking entity
that serves, directly or indirectly, as the investment manager,
investment adviser, or sponsor to a covered fund, and any affiliate of
such a banking entity, from entering into any transaction with the
fund, or any other covered fund controlled by such fund, that would be
a ``covered transaction'' as defined in section 23A of the Federal
Reserve Act (``FR Act''),\19\ as if such banking entity or affiliate
were a member bank and the covered fund were an affiliate thereof,
subject to certain exceptions.\20\ Section 13(f) also provides that a
banking entity may enter into certain prime brokerage transactions with
any covered fund in which a covered fund managed, sponsored, or advised
by the banking entity has taken an equity, partnership, or other
ownership interest, but any such transaction (and any other permitted
transaction with such funds) must be on market terms in accordance with
the provisions of section 23B of the FR Act.\21\
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    \19\ See 12 U.S.C. 371c.
    \20\ 12 U.S.C. 1851(f).
    \21\ 12 U.S.C. 371c-1.
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    Section 13 of the BHC Act does not prohibit a nonbank financial
company supervised by the Board from engaging in proprietary trading,
or from having the types of ownership interests in or relationships
with a covered fund that a banking entity is prohibited or restricted
from having under section 13 of the BHC Act. However, section 13 of the
BHC Act provides for the Board or other appropriate Agency to impose
additional capital charges, quantitative limits, or other restrictions
on a nonbank financial company supervised by the Board or their
subsidiaries and affiliates that are engaged in such activities or
maintain such relationships.\22\
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    \22\ See 12 U.S.C. 1851(a)(2), (d)(4).
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II. Overview of Proposed Rule

A. General Approach

    In formulating the proposed rule, the Agencies have attempted to
reflect the structure of section 13 of the BHC Act, which is to
prohibit a banking entity from engaging in proprietary trading or
acquiring or retaining an ownership interest in, or having certain
relationships with, a covered fund, while permitting such entities to
continue to provide client-oriented financial services. However, the
delineation of what constitutes a prohibited or permitted activity
under section 13 of the BHC Act often involves subtle distinctions that
are difficult both to describe comprehensively within regulation and to
evaluate in practice. The Agencies appreciate that while it is crucial
that rules under section 13 of the BHC Act clearly define and implement
its requirements, any rule must also preserve the ability of a banking
entity to continue to structure its businesses and manage its risks in
a safe and sound manner, as well as to effectively deliver to its
clients the types of financial services that section 13 expressly
protects and permits. These client-oriented financial services, which
include underwriting, market making, and traditional asset management
services, are important to the U.S. financial markets and the
participants in those markets, and the Agencies have endeavored to
develop a proposed rule that does not unduly constrain banking entities
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 should not conflict with clear,
robust, and effective implementation of the statute's prohibitions and
restrictions. Given these complexities, the Agencies request comment on
the potential impacts the proposed approach may have on banking
entities and the businesses in which they engage. In particular, and as
discussed further in Part VII of this Supplemental Information, the
Agencies recognize that there are economic impacts that may arise from
the proposed rule and its implementation of section 13 of the BHC Act,
and the Agencies request comment on such impacts, including
quantitative data, where possible.
    In light of these larger challenges and goals, the Agencies'
proposal takes a multi-faceted approach to implementing section 13 of
the BHC Act. In particular, the proposed rule includes a framework
that: (i) Clearly describes the key characteristics of both prohibited
and permitted activities; (ii) requires banking entities to establish a
comprehensive programmatic compliance regime designed to ensure
compliance with the requirements of the statute and rule in a way that
takes into account and reflects the unique nature of a banking entity's
businesses; and (iii) with respect to proprietary trading, requires
certain banking entities to calculate and report meaningful
quantitative data that will assist both banking entities and the
Agencies in identifying particular activity that warrants additional
scrutiny to distinguish prohibited proprietary trading from otherwise
permissible activities. This multi-faceted approach, which is
consistent with the implementation and supervisory framework
recommended in the Council study, is intended to strike an appropriate
balance between accommodating prudent risk management and the continued
provision of client-oriented financial services by banking entities
while ensuring that such entities do not engage in prohibited
proprietary trading or restricted covered fund activities or
investments.\23\
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    \23\ In recognition of economic impacts that may arise from the
proposed rule and its implementation of section 13 of the BHC Act,
the Agencies are requesting comment on the relative costs and
benefits of the proposal in Part VII of this Supplemental
Information.
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    In addition, and consistent with the statutory requirement that the
Agencies' rules under section 13 of the BHC Act be, to the extent
possible, comparable and provide for consistent application and
implementation, the Agencies have proposed a common rule and
appendices. This uniform approach to implementation is intended to
provide the maximum degree of clarity to banking entities and market
participants and ensure that section 13's prohibitions and restrictions
are applied consistently across different types of regulated
entities.\24\
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    \24\ Under this uniform approach, each Agency is proposing the
same rule provisions under section 13 of the BHC Act. Each Agency's
proposed rule would apply only to banking entities for which the
Agency has regulatory authority under section 13(b)(2)(B) of the BHC
Act.
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    As a matter of structure, the proposed rule is generally divided
into four subparts and contains three appendices, as follows:
     Subpart A of the proposed rule describes the authority,
scope, purpose, and relationship to other authorities of the rule and
defines terms used commonly throughout the rule;
     Subpart B of the proposed rule prohibits proprietary
trading, defines terms relevant to covered trading activity,
establishes exemptions from

the prohibition on proprietary trading and limitations on those
exemptions, and requires certain banking entities to report
quantitative measurements with respect to their trading activities;
     Subpart C of the proposed rule prohibits or restricts
acquiring or retaining an ownership interest in, and certain
relationships with, a covered fund, defines terms relevant to covered
fund activities and investments, as well as establishes exemptions from
the restrictions on covered fund activities and investments and
limitations on those exemptions;
     Subpart D of the proposed rule generally requires banking
entities to establish an enhanced compliance program regarding
compliance with section 13 of the BHC Act and the proposed rule,
including written policies and procedures, internal controls, a
management framework, independent testing of the compliance program,
training, and recordkeeping;
     Appendix A of the proposed rule details the quantitative
measurements that certain banking entities may be required to compute
and report with respect to their trading activities; \25\
---------------------------------------------------------------------------

    \25\ A banking entity must comply with proposed Appendix A's
reporting and recordkeeping requirements only if it has, together
with its affiliates and subsidiaries, trading assets and liabilities
the average gross sum of which (on a worldwide consolidated basis)
is, as measured as of the last day of each of the four prior
calendar quarters, equal to or greater than $1 billion.
---------------------------------------------------------------------------

     Appendix B of the proposed rule provides commentary
regarding the factors the Agencies propose to use to help distinguish
permitted market making-related activities from prohibited proprietary
trading; and
     Appendix C of the proposed rule details the minimum
requirements and standards that certain banking entities must meet with
respect to their compliance program, as required under subpart D.\26\
---------------------------------------------------------------------------

    \26\ In particular, a banking entity must comply with the
minimum standards specified in Appendix C of the proposed rule (i)
with respect to its covered trading activities, if it engages in any
covered trading activities and has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum
of which (on a worldwide consolidated basis), as measured as of the
last day of each of the four prior calendar quarters, (X) is equal
to or greater than $1 billion or (Y) equals 10 percent or more of
its total assets; and (ii) with respect to its covered fund
activities and investments, if it engages in any covered fund
activities and investments and either (X) has, together with its
affiliates and subsidiaries, aggregate investments in covered funds
the average value of which is, as measured as of the last day of
each of the four prior calendar quarters, equal to or greater than
$1 billion or (Y) sponsors and advises, 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 four prior
calendar quarters, equal to or greater than $1 billion.
---------------------------------------------------------------------------

    In addition, the Board's proposed rule also contains a subpart E,
to which the provisions of the Board's Conformance Rule under section
13 of the BHC Act will be recodified from their current location in the
Board's Regulation Y.

B. Proprietary Trading Restrictions

    Subpart B of the proposed rule implements the statutory prohibition
on proprietary trading and the various exemptions to this prohibition
included in the statute. Section --.3 of the proposed rule contains the
core prohibition on proprietary trading and defines a number of related
terms, including ``proprietary trading'' and ``trading account.'' The
proposed rule's definition of proprietary trading generally parallels
the statutory definition, and includes engaging as principal for the
trading account of a banking entity in any transaction to purchase or
sell certain types of financial positions.\27\
---------------------------------------------------------------------------

    \27\ See proposed rule Sec.  --.3(b)(1).
---------------------------------------------------------------------------

    The proposed rule's definition of trading account generally
parallels the statutory definition, and provides further guidance
regarding the circumstances in which a position will be considered to
have been taken principally for the purpose of short-term resale or
benefiting from actual or expected short-term price movements,
recognizing the importance of providing as much clarity as possible
regarding this term, which ultimately defines the scope of accounts
subject to the prohibition on proprietary trading.\28\ In particular,
the proposed definition of trading account identifies three classes of
positions that would cause an account to be a trading account. First,
the definition includes positions taken principally for the purpose of
short-term resale, benefitting from short-term price movements,
realizing short-term arbitrage profits, or hedging another trading
account position.\29\ As described in this notice, this language is
substantially similar to language for a ``trading position'' used in
the Federal banking agencies' current market risk capital rules, as
proposed to be revised (``Market Risk Capital Rules''),\30\ and the
Agencies propose to interpret this language in a similar manner.
Second, with respect to a banking entity subject to the Federal banking
agencies' Market Risk Capital Rules, the definition includes all
positions in financial instruments subject to the prohibition on
proprietary trading that are treated as ``covered positions'' under
those capital rules, other than certain foreign exchange and
commodities positions. Third, the definition includes all positions
acquired or taken by certain registered securities and derivatives
dealers (or, in the case of financial institutions \31\ that are
government securities dealers, that have filed notice with an
appropriate regulatory agency) in connection with their activities that
require such registration or notice.\32\ The definition of trading
account also contains clarifying exclusions for certain positions that
do not appear to involve the requisite short-term trading intent, such
as positions arising under certain repurchase and reverse repurchase
arrangements or securities lending transactions, positions acquired or
taken for bona fide liquidity management purposes, and certain
positions of derivatives clearing organizations or clearing
agencies.\33\
---------------------------------------------------------------------------

    \28\ See proposed rule Sec.  --.3(b)(2).
    \29\ See proposed rule Sec.  --.3(b)(2)(i)(A).
    \30\ See 76 FR 1890 (Jan. 11, 2011).
    \31\ In the context of regulation of government securities
dealers under the Securities Exchange Act of 1934 (``Exchange
Act''), the term ``financial institution'' as defined in section
3(a)(46) of the Exchange Act includes a bank (as defined in section
3(a)(36) of the Exchange Act) and a foreign bank (as defined in the
International Banking Act of 1978). See 15 U.S.C. 78c(a)(46).
    \32\ See proposed rule Sec.  --.3(b)(2)(i)(B).
    \33\ See proposed rule Sec.  --.3(b)(2)(iii).
---------------------------------------------------------------------------

    Section --.3 of the proposed rule also defines a number of other
relevant terms, including the term ``covered financial position.'' This
term is used to define the scope of financial instruments subject to
the prohibition on proprietary trading. Consistent with the statutory
language, such covered financial positions include positions (including
long, short, synthetic and other positions) in securities, derivatives,
commodity futures, and options on such instruments, but do not include
positions in loans, spot foreign exchange or spot commodities.\34\
---------------------------------------------------------------------------

    \34\ See proposed rule Sec.  --.3(b)(3).
---------------------------------------------------------------------------

    Section --.4 of the proposed rule implements the statutory
exemptions for underwriting and market making-related activities. For
each of these permitted activities, the proposed rule provides a number
of requirements that must be met in order for a banking entity to rely
on the applicable exemption. These requirements are generally designed
to ensure that the activities, revenues and other characteristics of
the banking entity's trading activity are consistent with underwriting
and market making-related activities, respectively, and not prohibited
proprietary trading.\35\ These requirements are intended to support and
augment other parts of the proposed rule's approach to implementing the
prohibition on proprietary trading, including the compliance program

requirement and the reporting of quantitative measurements, in order to
assist banking entities and the Agencies in identifying prohibited
trading activities that may be conducted in the context of, or
mischaracterized as, permitted underwriting or market making-related
activities.
---------------------------------------------------------------------------

    \35\ See proposed rule Sec.  --.4(a), (b).
---------------------------------------------------------------------------

    Section --.5 of the proposed rule implements the statutory
exemption for risk-mitigating hedging. As with the underwriting and
market-making exemptions, proposed Sec.  --.5 contains a number of
requirements that must be met in order for a banking entity to rely on
the exemption. These requirements are generally designed to ensure that
the banking entity's trading activity is truly risk-mitigating hedging
in purpose and effect.\36\ Proposed Sec.  --.5 also requires banking
entities to document, at the time the transaction is executed, the
hedging rationale for certain transactions that present heightened
compliance risks.\37\ As with the exemptions for underwriting and
market making-related activity, these requirements form part of a
broader implementation approach that also includes the compliance
program requirement and the reporting of quantitative measurements.
---------------------------------------------------------------------------

    \36\ See proposed rule Sec. Sec.  --.5(b)(1), (2).
    \37\ See proposed rule Sec.  --.5(b)(3).
---------------------------------------------------------------------------

    Section --.6 of the proposed rule implements statutory exemptions
for trading in certain government obligations, trading on behalf of
customers, trading by a regulated insurance company, and trading by
certain foreign banking entities outside the United States. Section
--.6(a) of the proposed rule describes the government obligations in
which a banking entity may trade notwithstanding the prohibition on
proprietary trading, which include U.S. government and agency
obligations, obligations and other instruments of certain government
sponsored entities, and State and municipal obligations.\38\ Section
--.6(b) of the proposed rule describes permitted trading on behalf of
customers and identifies three categories of transactions that would
qualify for the exemption.\39\ These categories include: (i)
Transactions conducted by a banking entity as investment adviser,
commodity trading advisor, trustee, or in a similar fiduciary capacity
for the account of a customer where the customer, and not the banking
entity, has beneficial ownership of the related positions; (ii)
riskless principal transactions; and (iii) transactions conducted by a
banking entity that is a regulated insurance company for the separate
account of insurance policyholders, subject to certain conditions.
Section --.6(c) of the proposed rule describes permitted trading by a
regulated insurance company for its general account, and generally
parallels the statutory language governing this exemption.\40\ Finally,
Sec.  --.6(d) of the proposed rule describes permitted trading outside
of the United States by a foreign banking entity.\41\ The proposed
exemption clarifies when a foreign banking entity will be considered to
engage in such trading pursuant to sections 4(c)(9) or 4(c)(13) of the
BHC Act, as required by the statute, including with respect to a
foreign banking entity not currently subject to section 4 of the BHC
Act. The exemption also clarifies when trading will be considered to
have occurred solely outside of the United States, as required by the
statute, and provides a number of specific criteria for determining
whether that standard is met.
---------------------------------------------------------------------------

    \38\ See proposed rule Sec.  --.6(a).
    \39\ See proposed rule Sec.  --.6(b).
    \40\ See proposed rule Sec.  --.6(c).
    \41\ See proposed rule Sec.  --.6(d).
---------------------------------------------------------------------------

    Section --.7 of the proposed rule requires certain banking entities
with significant covered trading activities to comply with the
reporting and recordkeeping requirements specified in Appendix A of the
proposed rule. In addition, Sec.  --.7 requires that a banking entity
comply with the recordkeeping requirements in Sec.  --.20 of the
proposed rule, including, where applicable, the recordkeeping
requirements in Appendix C of the proposed rule. Section --.7 of the
proposed rule also requires a banking entity to comply with any other
reporting or recordkeeping requirements that an Agency may impose to
evaluate the banking entity's compliance with the proposed rule.\42\
Proposed Appendix A requires those banking entities with significant
covered trading activities to furnish periodic reports to the relevant
Agency regarding a variety of quantitative measurements of its covered
trading activities and maintain records documenting the preparation and
content of these reports. These proposed reporting and recordkeeping
requirements vary depending on the scope and size of covered trading
activities, and a banking entity must comply with proposed Appendix A's
reporting and recordkeeping requirements only if it has, together with
its affiliates and subsidiaries, trading assets and liabilities the
average gross sum of which (on a worldwide consolidated basis) is, as
measured as of the last day of each of the four prior calendar
quarters, equal to or greater than $1 billion. These thresholds are
designed to reduce the burden on smaller, less complex banking
entities, which generally engage in limited market-making and other
trading activities. Other provisions of the proposal, and in particular
the compliance program requirement in Sec.  --.20 of the proposed rule,
are likely to be less burdensome and equally effective methods for
ensuring compliance with section 13 of the BHC Act by smaller, less
complex banking entities.
---------------------------------------------------------------------------

    \42\ See proposed rule Sec.  --.7.
---------------------------------------------------------------------------

    The quantitative measurements that must be furnished under the
proposed rule are generally designed to reflect, and provide meaningful
information regarding, certain characteristics of trading activities
that appear to be particularly useful to help differentiate permitted
market making-related activities from prohibited proprietary trading
and to identify whether certain trading activities result in a material
exposure to high-risk assets or high-risk trading strategies. In
addition, proposed Appendix B contains a detailed commentary regarding
identification of permitted market making-related activities and
distinguishing such activities from trading activities that constitute
prohibited proprietary trading.
    As described in Part II.B.5 of the Supplementary Information below,
the Agencies expect to utilize the conformance period provided in
section 13(c)(2) of the BHC Act to further refine and finalize the
reporting requirements, reflecting the substantial public comment,
practical experience, and revision that will likely be required to
ensure appropriate, effective use of reported quantitative data in
practice.
    Section --.8 of the proposed rule prohibits a banking entity from
relying on any exemption to the prohibition on proprietary trading if
the permitted activity would involve or result in a material conflict
of interest, result in a material exposure to high-risk assets or high-
risk trading strategies, or pose a threat to the safety and soundness
of the banking entity or to the financial stability of the United
States.\43\ This section also defines material conflict of interest,
high-risk asset, and high-risk trading strategy for these purposes.
---------------------------------------------------------------------------

    \43\ See proposed rule Sec.  --.8.
---------------------------------------------------------------------------

C. Covered Fund Activities and Investments

    Subpart C of the proposed rule implements the statutory prohibition
on, as principal, directly or indirectly, acquiring and retaining an
ownership

interest in, or having certain relationships with, a covered fund, as
well as the various exemptions to this prohibition included in the
statute. Section --.10 of the proposed rule contains the core
prohibition on covered fund activities and investments and defines a
number of related terms, including ``covered fund'' and ``ownership
interest.'' The proposed rule's definition of covered fund generally
parallels the statutory definition of ``hedge fund'' and ``private
equity fund,'' and explains the universe of entities that would be
considered a ``covered fund'' (including those entities determined by
the Agencies to be ``such similar funds'') and, thus, subject to the
general prohibition.\44\
---------------------------------------------------------------------------

    \44\ See proposed rule Sec.  --.10(b)(1).
---------------------------------------------------------------------------

    The definition of ``ownership interest'' provides further guidance
regarding the types of interests that would be considered to be an
ownership interest in a covered fund.\45\ As described in this
Supplementary Information, these interests may take various forms. The
definition of ownership interest also explicitly excludes from the
definition ``carried interest'' whereby a banking entity may share in
the profits of the covered fund solely as performance compensation for
services provided to the covered fund by the banking entity (or an
affiliate, subsidiary, or employee thereof).\46\
---------------------------------------------------------------------------

    \45\ See proposed rule Sec.  --.10(b)(3).
    \46\ See proposed rule Sec.  --.10(b)(3)(ii).
---------------------------------------------------------------------------

    Section --.10 of the proposed rule also defines a number of other
relevant terms, including the terms ``prime brokerage transaction,''
``sponsor,'' and ``trustee.''
    Section --.11 of the proposed rule implements the exemption for
organizing and offering a covered fund provided for under section
13(d)(1)(G) of the BHC Act. Section --.11(a) of the proposed rule
outlines the conditions that must be met in order for a banking entity
to organize and offer a covered fund under this authority. These
requirements are contained in the statute and are intended to allow a
banking entity to engage in certain traditional asset management and
advisory businesses in compliance with section 13 of the BHC Act.\47\
The requirements are discussed in detail in Part III.C.2 of this
Supplementary Information.
---------------------------------------------------------------------------

    \47\ See 156 Cong. Rec. S5889 (daily ed. July 15, 2010)
(statement of Sen. Hagan).
---------------------------------------------------------------------------

    Section --.12 of the proposed rule permits a banking entity to
acquire and retain, as an investment in a covered fund, an ownership
interest in a covered fund that the banking entity organizes and offers
under Sec.  --.11.\48\ This section implements section 13(d)(4) of the
BHC Act and related provisions. Section 13(d)(4) of the BHC Act permits
a banking entity to make an investment in a covered fund that the
banking entity organizes and offers pursuant to section 13(d)(1)(G), or
for which it acts as sponsor, for the purposes of (i) establishing the
covered fund and providing the fund with sufficient initial equity for
investment to permit the fund to attract unaffiliated investors, or
(ii) making a de minimis investment in the covered fund in compliance
with applicable requirements. Section --.12 of the proposed rule
implements this authority and related limitations, including
limitations regarding the amount and value of any individual per-fund
investment and the aggregate value of all such permitted
investments.\49\ Proposed Sec.  --.12 also clarifies how a banking
entity must calculate its compliance with these investment limitations
(including by deducting such investments from applicable capital, as
relevant), as well as sets forth how a banking entity may request an
extension of the period of time within which it must conform an
investment in a single covered fund.\50\
---------------------------------------------------------------------------

    \48\ See proposed rule Sec.  --.12.
    \49\ See proposed rule Sec.  --.12(a)(2).
    \50\ See proposed rule Sec. Sec.  --.12(b), (c), and (d).
---------------------------------------------------------------------------

    Section --.13 of the proposed rule implements the statutory
exemptions described in sections 13(d)(1)(C), (E), and (I) of the BHC
Act that permit a banking entity: (i) To acquire and retain an
ownership interest in, or act as sponsor to, one or more SBICs, a
public welfare investment, or certain qualified rehabilitation
expenditures; (ii) to acquire and retain an ownership interest in a
covered fund as a risk-mitigating hedging activity; and (iii) in the
case of a non-U.S. banking entity, to acquire and retain an ownership
interest in, or act as sponsor to, a foreign covered fund.\51\ Section
--.13(a) of the proposed rule permits a banking entity to acquire and
retain an ownership interest in, or act as sponsor to, an SBIC or
certain public interest investments, without limitation as to the
amount of ownership interests it may own, hold, or control with the
power to vote.\52\
---------------------------------------------------------------------------

    \51\ See proposed rule Sec.  --.13(a)--(c).
    \52\ See proposed rule Sec.  --.13(a).
---------------------------------------------------------------------------

    Section --.13(b) of the proposed rule permits a banking entity to
use an ownership interest in a covered fund to hedge, but only with
respect to individual or aggregated obligations or liabilities of a
banking entity that arise from: (i) The banking entity acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the customer's exposure to the profits and losses
of the covered fund (similar to acting as a ``riskless principal''); or
(ii) a compensation arrangement with an employee of the banking entity
that directly provides investment advisory or other services to that
fund.\53\ Additionally, Sec.  --.13(b) of the proposed rule requires
that the hedge represent a substantially similar offsetting exposure to
the same covered fund and in the same amount of ownership interest in
the covered fund arising out of the transaction that the acquisition or
retention of an ownership interest in the covered fund is intended to
hedge or otherwise mitigate.\54\ Proposed Sec.  --.13(b) also requires
a banking entity to document, at the time the transaction is executed,
the hedging rationale for all hedging transactions involving an
ownership interest in a covered fund.\55\
---------------------------------------------------------------------------

    \53\ See proposed rule Sec.  --.13(b)(1).
    \54\ See proposed rule Sec. Sec.  --.13(b)(2)(ii)(C) and (D).
    \55\ See proposed rule Sec.  --.13(b)(3).
---------------------------------------------------------------------------

    Section --.13(c) of the proposed rule implements section
13(d)(1)(I) of the BHC Act and permits certain foreign banking entities
to acquire or retain an ownership interest in, or to act as sponsor to,
a covered fund so long as such activity occurs solely outside of the
United States and the entity meets the requirements of sections 4(c)(9)
or 4(c)(13) of the BHC Act. This statutory exemption limits the
extraterritorial application of the statutory restrictions on covered
fund activities and investments to foreign firms that, in the course of
operating outside of the United States, engage in activities permitted
under relevant foreign law outside of the United States, while
preserving national treatment and competitive equality among U.S. and
foreign firms within the United States.\56\ The proposed rule defines
both the type of foreign banking entities that are eligible for the
exemption and the circumstances in which covered fund activities or
investments by such an entity will be considered to have occurred
solely outside of the United States (including clarifying when an
ownership interest will be considered to have been offered for sale or
sold to a resident of the United States). Section --.13(d) of the
proposed rule also implements in part the rule of construction
contained in section 13(g)(2) of the BHC Act, which permits the sale
and securitization of loans.\57\ Proposed Sec.  --.13(d) clarifies that
a

banking entity may acquire and retain an ownership interest in, or act
as sponsor to, a covered fund that is an issuer of asset-backed
securities, the assets or holdings of which are solely comprised of:
(i) Loans; (ii) contractual rights or assets directly arising from
those loans supporting the asset-backed securities; and (iii) a limited
amount of interest rate or foreign exchange derivatives that materially
relate to such loans and that are used for hedging purposes with
respect to the securitization structure.\58\ The authority contained in
this section of the proposed rule would therefore allow a banking
entity to acquire and retain an ownership interest in a loan
securitization vehicle (which would be a covered fund for purposes of
section 13(h)(2) of the BHC Act and the proposed rule) that the banking
entity organizes and offers, or acts as sponsor to, in excess of the
three percent limits specified in section 13(d)(4) of the BHC Act and
Sec.  --.12 of the proposed rule.
---------------------------------------------------------------------------

    \56\ See 156 Cong. Rec. S5897 (daily ed. July 15, 2010)
(statement of Sen. Merkley).
    \57\ See 12 U.S.C. 1851(g)(2).
    \58\ See proposed rule Sec.  --.13(d).
---------------------------------------------------------------------------

    Section --.14 of the proposed rule implements section 13(d)(1)(J)
of the BHC Act\59\ and permits a banking entity to engage in any
covered fund activity or investment that the Agencies determine
promotes and protects the safety and soundness of banking entities and
the financial stability of the United States.\60\ The Agencies have
proposed to permit three activities at this time under this authority.
These activities involve acquiring and retaining an ownership interest
in, or acting as sponsor to, certain bank owned life insurance
(``BOLI'') separate accounts, investments in and sponsoring of certain
asset-backed securitizations, and investments in and sponsoring of
certain entities that rely on the exclusion from the definition of
investment company in section 3(c)(1) and/or 3(c)(7) of the Investment
Company Act of 1940 (15 U.S.C. 80a-1 et seq.) (``Investment Company
Act'') but that are, in fact, common corporate organizational
vehicles.\61\ Additionally, the Agencies have proposed to permit a
banking entity to acquire and retain an ownership interest in, or act
as sponsor to, a covered fund, if such acquisition or retention is done
(i) in the ordinary course of collecting a debt previously contracted,
or (ii) pursuant to and in compliance with the conformance or extended
transition periods implemented under section 13(c)(6) of the BHC
Act.\62\
---------------------------------------------------------------------------

    \59\ Section 13(d)(1)(J) of the BHC Act provides the Agencies
discretion to determine that activities not specifically identified
by sections 13(d)(1)(A)-(I) of the BHC Act are also exempted from
the general prohibitions contained in section 13(a) of that Act, and
are thus permitted activities. In order to make such a
determination, the Agencies must find that such activity or
activities promote and protect the safety and soundness of banking
entities, as well as promote and protect the financial stability of
the United States. See 12 U.S.C. 1851(d)(1)(J).
    \60\ See 12 U.S.C. 1851(d)(1)(J).
    \61\ See proposed rule Sec.  --.13(a)(1)-(2).
    \62\ See proposed rule at Sec.  --.14(b).
---------------------------------------------------------------------------

    Section --.15 of the proposed rule, which implements section
13(e)(1) of the BHC Act,\63\ requires a banking entity engaged in
covered fund activities and investments to comply with (i) the internal
controls, reporting, and recordkeeping requirements required under
Sec.  --.20 and Appendix C of the proposed rule, as applicable and (ii)
such other reporting and recordkeeping requirements as the relevant
supervisory Agency may deem necessary to appropriately evaluate the
banking entity's compliance with subpart C.\64\
---------------------------------------------------------------------------

    \63\ Section 13(e)(1) of the BHC Act requires the Agencies to
issue regulations regarding internal controls and recordkeeping to
ensure compliance with section 13. See 12 U.S.C. 1851(e)(1).
    \64\ See proposed rule Sec.  --.15.
---------------------------------------------------------------------------

    Section --.16 of the proposed rule implements section 13(f) of the
BHC Act and generally prohibits a banking entity from entering into
certain transactions with a covered fund that would be a covered
transaction as defined in section 23A of the FR Act.\65\ Section
--.16(a)(2) of the proposed rule clarifies that, for reasons explained
in part III.C.7 of this Supplementary Information, certain transactions
between a banking entity and a covered fund remain permissible. Section
--.16(b) of the proposed rule implements the statute's requirement that
any transaction permitted under section 13(f) of the BHC Act (including
a prime brokerage transaction) between the banking entity and a covered
fund is subject to section 23B of the FR Act,\66\ which, in general,
requires that the transaction be on market terms or on terms at least
as favorable to the banking entity as a comparable transaction by the
banking entity with an unaffiliated third party.
---------------------------------------------------------------------------

    \65\ See proposed rule Sec.  --.16.
    \66\ 12 U.S.C. 371c-1.
---------------------------------------------------------------------------

    Section --.17 of the proposed rule prohibits a banking entity from
relying on any exemption to the prohibition on acquiring and retaining
an ownership interest in, acting as sponsor to, or having certain
relationships with, a covered fund, if the permitted activity or
investment would involve or result in a material conflict of interest,
result in a material exposure to high-risk assets or high-risk trading
strategies, or pose a threat to the safety and soundness of the banking
entity or to the financial stability of the United States.\67\ This
section also defines material conflict of interest, high-risk asset,
and high-risk trading strategy for these purposes.
---------------------------------------------------------------------------

    \67\ See proposed rule Sec.  --.17.
---------------------------------------------------------------------------

D. Compliance Program Requirement

    Subpart D of the proposed rule requires a banking entity engaged in
covered trading activities or covered fund activities to develop and
implement a program reasonably designed to ensure and monitor
compliance with the prohibitions and restrictions on covered trading
activities and covered fund activities and investments set forth in
section 13 of the BHC Act and the proposed rule.\68\ Section --.20(b)
of the proposed rule specifies six elements that each compliance
program established under subpart D must, at a minimum, include:
---------------------------------------------------------------------------

    \68\ See proposed rule Sec.  --.20. If a banking entity does not
engage in covered trading activities and/or covered fund activities
and investments, it need only ensure that its existing compliance
policies and procedures include measures that are designed to
prevent the banking entity from becoming engaged in such activities
and making such investments, and which require the banking entity to
develop and provide for the required compliance program prior to
engaging in such activities or making such investments.
---------------------------------------------------------------------------

     Internal written policies and procedures reasonably
designed to document, describe, and monitor the covered trading
activities and covered fund activities and investments of the banking
entity to ensure that such activities comply with section 13 of the BHC
Act and the proposed rule;
     A system of internal controls reasonably designed to
monitor and identify potential areas of noncompliance with section 13
of the BHC Act and the proposed rule in the banking entity's covered
trading and covered fund activities and to prevent the occurrence of
activities that are prohibited by section 13 of the BHC Act and the
proposed rule;
     A management framework that clearly delineates
responsibility and accountability for compliance with section 13 of the
BHC Act and the proposed rule;
     Independent testing for the effectiveness of the
compliance program, conducted by qualified banking entity personnel or
a qualified outside party;
     Training for trading personnel and managers, as well as
other appropriate personnel, to effectively implement and enforce the
compliance program; and
     Making and keeping records sufficient to demonstrate
compliance with section 13 of the BHC Act and the proposed rule, which
a banking entity must promptly provide to the relevant Agency upon
request and retain for a period of no less than 5 years.

    For a banking entity with significant covered trading activities or
covered fund activities and investments, the compliance program must
also meet a number of minimum standards that are specified in Appendix
C of the proposed rule.\69\ The application of detailed minimum
standards for these types of banking entities is intended to reflect
the heightened compliance risks of large covered trading activities and
covered fund activities and investments and to provide clear, specific
guidance to such banking entities regarding the compliance measures
that would be required for purposes of the proposed rule. For banking
entities with smaller, less complex covered trading activities and
covered fund activities and investments, these detailed minimum
standards are not applicable, though the Agencies expect that such
smaller entities will consider these minimum standards as guidance in
designing an appropriate compliance program.
---------------------------------------------------------------------------

    \69\ A banking entity must comply with the minimum standards
specified in Appendix C of the proposed rule (i) with respect to its
covered trading activities, if it engages in any covered trading
activities and has, together with its affiliates and subsidiaries,
trading assets and liabilities the average gross sum of which (on a
worldwide consolidated basis), as measured as of the last day of
each of the four prior calendar quarters, (X) is equal to or greater
than $1 billion or (Y) equals 10 percent or more of its total
assets; and (ii) with respect to its covered fund activities and
investment, if it engages in any covered fund activities and
investments and either (X) has, together with its affiliates and
subsidiaries, aggregate investments in covered funds the average
value of which is, as measured as of the last day of each of the
four prior calendar quarters, equal to or greater than $1 billion or
(Y) sponsors and advises, 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 four prior calendar
quarters, equal to or greater than $1 billion.
---------------------------------------------------------------------------

E. Conformance Provisions

    Subpart E of the Board's proposed rule incorporates, with minor
technical and conforming edits, the final rule which the Board, after
soliciting and considering public comment, issued regarding the
conformance periods for entities engaged in prohibited proprietary
trading or covered fund activities and investments.\70\ That rule
implements the conformance period and extended transition period, as
applicable, during which a banking entity and nonbank financial company
supervised by the Board must bring its activities, investments and
relationships into compliance with the prohibitions and restrictions on
proprietary trading and acquiring an ownership interest in, or having
certain relationships with, a covered fund.
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    \70\ See 76 FR 8265 (Feb. 14, 2011).
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F. Treatment of Smaller, Less-Complex Banking Entities

    In formulating the proposed rule, the Agencies have carefully
considered and taken into account the potential impact of the proposed
rule on small banking entities and banking entities that engage in
little or no covered trading activities or covered fund activities and
investments, including the burden and cost that might be associated
with such banking entities' compliance with the proposed rule. In
particular, the Agencies have proposed to reduce the effect of the
proposed rule on such banking entities by limiting the application of
certain requirements, such as the reporting and recordkeeping
requirements of Sec.  --.7 and Appendix A of the proposed rule and the
compliance program requirements contained in subpart D and Appendix C
of the proposed rule, to those banking entities that engage in little
or no covered trading activities or covered fund activities and
investments. The Agencies have also requested comment (i) throughout
this Supplementary Information on a number of questions related to the
costs and burdens associated with particular aspects of the proposal,
as well as (ii) in Part VII.B of this Supplementary Information on any
significant alternatives that would minimize the impact of the proposal
on small banking entities.

G. Application of Section 13 of the BHC Act to Securitization Vehicles
or Issuers of Asset-Backed Securities

    Many issuers of asset-backed securities may be included within the
definition of covered fund since they would be an investment company
but for the exclusions contained in section 3(c)(1) or 3(c)(7) of the
Investment Company Act.\71\ If an issuer of asset-backed securities is
considered to be a covered fund, then a banking entity would not be
permitted to acquire or retain any ownership interest issued by such
issuer except as otherwise permitted under section 13 of the BHC Act
and the proposed rule.\72\ Separately, issuers of asset-backed
securities may be included within the definition of banking entity, as
noted in Part III.A.2 of this Supplementary information. Although the
proposed definition of banking entity would not include any entity that
is a covered fund, an issuer of asset-backed securities that is both
(i) an affiliate or subsidiary of a banking entity,\73\ and (ii) does
not rely on an exclusion contained in section 3(c)(1) of 3(c)(7) of the
Investment Company Act, would be a banking entity and thus subject to
the requirements of section 13 of the BHC Act and the proposed rule,
including: (i) The prohibition on proprietary trading; (ii) limitations
on investments in and relationships with a covered fund; (iii) the
establishment and implementation of a compliance program as required
under the proposed rule; and (iv) recordkeeping and reporting
requirements. Given the breadth of the definition of ``affiliate,''
these requirements may apply to a significant portion of the
outstanding securitization market, including issuers of asset-backed
securities that rely on rule 3a-7 or section 3(c)(5) of the Investment
Company Act.
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    \71\ For purposes of the proposed rule, any securitization
entity that meets the requirements for an exclusion under Rule 3a-7
or section 3(c)(5) of the Investment Company Act, or any other
exclusion or exemption from the definition of ``investment company''
under the Investment Company Act (other than sections 3(c)(1) or
3(c)(7) of the Investment Company Act), would not be a covered fund
under the proposed definition. Additionally, an issuer of asset-
backed securities that is subject to legal documents mandating
compliance with the conditions of section 3(c)(1) of 3(c)(7) of the
Investment Company Act would not be a covered fund if such issuer
also can satisfy all the conditions of an alternative exclusion or
exemption for which it is eligible.
    \72\ For example, under the proposed rule, a banking entity
would be able to acquire or retain an interest or security of an
issuer of asset-backed securities that is a covered fund if: (i) The
interest or security of the issuer does not qualify as an
``ownership interest'' under Sec.  --.10(b)(3) of the proposed rule;
(ii) the issuer of asset-backed securities is comprised solely of
loans, contractual rights or assets directly arising from those
loans, and certain specified interest rate or foreign exchange
derivatives used for hedging purposes, as permitted under Sec.
--.13(d) or --.14(a)(2)(v) of the proposed rule; (iii) the banking
entity is a ``securitizer'' or ``originator'' and acquires and
retains such interest in compliance with the minimum requirements of
section 15G of the Exchange Act and any implementing regulations
issued thereunder, as provided under Sec.  --.14(a)(2)(iii) of the
proposed rule; or (v) the banking entity organizes and offers the
issuer and the ownership interest is a permitted investment under
Sec.  --.12 of the proposed rule. The circumstances where a banking
entity may acquire or retain an ownership interest in a covered fund
are discussed in detail in Part III.C of this Supplemental
Information.
    \73\ The definitions of ``affiliate'' and ``subsidiary'' are
discussed in detail in Part III.A.2 of this Supplemental
Information.
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    In recognition of these concerns, the Agencies have requested
comment throughout this Supplementary Information on the potential
effects of section 13 of the BHC Act and the proposed rule on the
securitization industry and issuers of asset-backed securities.

III. Section by Section Summary of Proposed Rule

A. Subpart A--Authority and Definitions

1. Section --.1: Authority, Purpose, Scope, and Relationship to Other
Authorities
a. Authority and Scope
    Section --.1 of the proposed rule describes the authority under
which each Agency is issuing the proposed rule, the purpose of the
proposed rule, and the banking entities to which each Agency's rule
applies. In addition, Sec.  --.1(d) of the proposed rule implements
section 13(g)(1) of the BHC Act, which provides that the prohibitions
and restrictions of section 13 apply to the activities of a banking
entity regardless of whether such activities are authorized for a
banking entity under other applicable provisions of law.\74\
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    \74\ See proposed rule Sec.  --.1(d).
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b. Effective Date
    Section 13(c)(1) of the BHC Act provides that section 13 shall take
effect on the earlier of (i) 12 months after the date of issuance of
final rules implementing that section, or (ii) 2 years after the date
of enactment of section 13, which is July 21, 2012.\75\ Because the
Agencies did not issue final rules implementing section 13 of the BHC
Act by July 21, 2011, Sec.  --.1 of the proposed rule specifies that
the effective date for its provisions will be July 21, 2012.
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    \75\ See 12 U.S.C. 1851(c)(1).
---------------------------------------------------------------------------

    The Agencies note that the proposed effective date will impact not
only the date on which the proposed rule's prohibitions and
restrictions on proprietary trading and covered fund activities and
investments go into effect (subject to the conformance period or
extended transition period provided by section 13(c) of the BHC
Act),\76\ but also the date on which a banking entity must comply with
(i) the reporting and recordkeeping requirements of Sec.  --.7 and
Appendix A of the proposed rule and (ii) the compliance program mandate
of Sec.  --.20 and Appendix C of the proposed rule. As proposed, Sec.
--.1 would require a banking entity subject to either the reporting and
recordkeeping or compliance program requirements to begin complying
with these requirements as of July 21, 2012.\77\ With respect to the
compliance program requirement of the proposed rule, Sec.  --.1 would
require a banking entity to have developed and implemented the required
program by the proposed effective date, though the Agencies note that
prohibited activities and investments may not be fully conformed by
that date. The Agencies expect a banking entity to fully conform all
investments and activities to the requirements of the proposed rule as
soon as practicable within the conformance periods provided in section
13 of the BHC Act and the Board's rules thereunder, which define the
conformance periods. With respect to the reporting and recordkeeping
requirements of the proposed rule, Sec.  --.1 of the proposed rule
would require a banking entity to begin furnishing these reports for
all trading units or asset management units as of the effective date,
though the quantitative measurements furnished for proprietary trading
activities that are conducted in reliance on the authority provided by
the conformance period would not be used to identify prohibited
proprietary trading until such time as the relevant trading activities
must be conformed.
---------------------------------------------------------------------------

    \76\ See id. at 1851(c)(2)-(6).
    \77\ See proposed rule Sec.  --.1.
---------------------------------------------------------------------------

    The Agencies expect that a banking entity may need a period of time
to prepare for effectiveness of the proposed rule and, in particular,
to implement both the compliance program and the reporting and
recordkeeping requirements provided under the proposed rule.
Accordingly, in order to help assess the effects and impact of the
proposed effective date and any alternative compliance dates, the
Agencies request comment on the following questions:
    Question 1. Does the proposed effective date provide banking
entities with sufficient time to prepare to comply with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments? If not, what other period of time is needed
and why?
    Question 2. Does the proposed effective date provide banking
entities with sufficient time to implement the proposal's compliance
program requirement? If not, what are the impediments to implementing
specific elements of the compliance program and what would be a more
effective time period for implementing each element and why?
    Question 3. Does the proposed effective date provide banking
entities sufficient time to implement the proposal's reporting and
recordkeeping requirements? If not, what are the impediments to
implementing specific elements of the proposed reporting and
recordkeeping requirements and what would be a more effective time
period for implementing each element and why?
    Question 4. Should the Agencies use a gradual, phased in approach
to implement the statute rather than having the implementing rules
become effective at one time? If so, what prohibitions and restrictions
should be implemented first? Please explain.
2. Section --.2: Definitions
    Section --.2 of the proposed rule defines a variety of terms used
throughout the proposed rule, including ``banking entity,'' which
defines the scope of entities to which the proposed rule applies.
Consistent with the statutory definition of that term, Sec.  --.2(e) of
the proposed rule provides that a ``banking entity'' includes: (i) Any
insured depository institution; (ii) any company that controls an
insured depository institution; (iii) any company that is treated as a
bank holding company for purposes of section 8 of the International
Banking Act of 1978 (12 U.S.C. 3106); and (iv) any affiliate or
subsidiary of any of the foregoing.\78\ In addition, in order to avoid
application of section 13 of the BHC Act in a way that appears
unintended by the statute and would create internal inconsistencies in
the statutory scheme, the proposed rule also clarifies that the term
``banking entity'' does not include any affiliate or subsidiary of a
banking entity, if that affiliate or subsidiary is (i) a covered fund,
or (ii) any entity controlled by such a covered fund.\79\ This
clarification is proposed because the definition of ``affiliate'' and
``subsidiary'' under the BHC Act is broad, and could include a covered
fund that a banking entity has permissibly sponsored or made an
investment in because, for example, the banking entity acts as general
partner or managing member of the covered fund as part of its permitted
sponsorship activities.\80\ If

such a covered fund were considered a ``banking entity'' for purposes
of the proposed rule, the fund itself would become subject to all of
the restrictions and limitations of section 13 of the BHC Act and the
proposed rule, which would be inconsistent with the purpose and intent
of the statute. For example, such a covered fund would then generally
be prohibited from investing in other covered funds, notwithstanding
the fact that section 13(f)(3) of the BHC Act specifically contemplates
such investments. Accordingly, the proposed rule would exclude from the
definition of banking entity any fund that a banking entity may invest
in or sponsor as permitted by the proposed rule.
---------------------------------------------------------------------------

    \78\ See proposed rule Sec.  --.2(e). Sections --.2(a) and (bb)
of the proposed rule clarify that the terms ``affiliate'' and
``subsidiary'' have the same meaning as in sections 2(d) and (k) of
the BHC Act (12 U.S.C. 1841(d) and (k)).
    \79\ The Agencies note that since the proposed rule implements
section 13 of the BHC Act, it incorporates that Act's definition of
``affiliate'' and ``subsidiary.'' See proposed rule Sec. Sec.
--.2(a) and (bb). The terms affiliate and subsidiary are generally
defined in section 2 of the BHC Act according to whether such entity
controls or is controlled by another relevant entity. See 12 U.S.C.
1841(d), (k). The concept of control under the proposed rule, in
turn, is as defined in section 2 of the BHC Act and as implemented
by the Board. See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
    \80\ Under section 2 of the BHC Act and the Board's Regulation Y
(12 CFR part 225), a banking entity acting as general partner or
managing member of another company would be deemed to control that
company and, as such, the company would be both an ``affiliate'' and
``subsidiary'' of the banking entity for purposes of the BHC Act.
See 12 U.S.C. 1841(d), (k).
---------------------------------------------------------------------------

    An entity such as a mutual fund would generally not be a subsidiary
or affiliate of a banking entity under this definition if the banking
entity only provides advisory or administrative services to, has
certain limited investments in, or organizes, sponsors, and manages a
mutual fund (which includes a registered investment company) in
accordance with BHC Act rules.\81\
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    \81\ See, e.g., 12 U.S.C. 1483(c)(6), (c)(8), and (k); 12 CFR
225.28(b)(6), 225.86(b)(3).
---------------------------------------------------------------------------

    Section --.2(j) of the proposed rule defines the term ``covered
banking entity,'' which is used in each Agency's proposed rule to
describe the specific types of banking entities to which that Agency's
rule applies. In addition, a number of other definitions contained in
Sec.  --.2 are discussed in further detail below in connection with the
separate sections of the proposed rule in which they are used.
    The proposed rule also defines the terms ``buy and purchase'' and
``sell and sale,'' which are used throughout the proposed rule to
describe the scope of transactions that are subject to subparts B and C
of the proposed rule. These definitions are substantially similar to
the definitions of the same terms under the Exchange Act, except that
the proposed definitions provide additional clarity regarding the types
of transactions that would be considered the purchase or sale of a
commodity future or derivative or ownership interest in a covered
fund.\82\ These definitions are purposefully broad in scope, and are
intended to include a wide range of transaction types that would permit
a banking entity to gain or eliminate, or increase or reduce, exposure
to a covered financial position or ownership interest in a covered
fund.
---------------------------------------------------------------------------

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

Request for Comment
    The Agencies request comment on the proposed rule's definition of
``banking entity.'' In particular, the Agencies request comment on the
following questions:
    Question 5. Is the proposed rule's definition of banking entity
effective? What alternative definitions might be more effective in
light of the language and purpose of the statute?
    Question 6. Are there any entities that should not be included
within the definition of banking entity since their inclusion would not
be consistent with the language or purpose of the statute or could
otherwise produce unintended results? Should a registered investment
company be expressly excluded from the definition of banking entity?
Why or why not?
    Question 7. Is the proposed rule's exclusion of a covered fund that
is organized, offered and held by a banking entity from the definition
of banking entity effective? Should the definition of banking entity be
modified to exclude any covered fund? Why or why not?
    Question 8. Banking entities commonly structure their registered
investment company relationships and investments such that the
registered investment company is not considered an affiliate or
subsidiary of the banking entity. Should a registered investment
company be expressly excluded from the definition of banking entity?
Why or why not? Are there circumstances in which such companies should
be treated as banking entities subject to section 13 of the BHC Act?
How many such companies would be covered by the proposed definition?
    Question 9. Under the proposed rule, would issuers of asset-backed
securities be captured by the proposed definition of ``banking
entity''? If so, are issuers of asset-backed securities within certain
asset classes particularly impacted? Are particular types of
securitization vehicles (trusts, LLCs, etc.) more likely than others to
be included in the definition of banking entity? Should issuers of
asset-backed securities be excluded from the proposed definition of
``banking entity,'' and if so, why? How would such an exclusion be
consistent with the language and purpose of the statute?
    Question 10. What would be the potential impact of including
existing issuers of asset-backed securities \83\ in the proposed
definition of ``banking entity'' on existing issuers of asset-backed
securities and the securitization market generally? How many existing
issuers of asset-backed securities might be included in the proposed
definition of ``banking entity''? Are there ways in which the proposed
rule could be amended to mitigate or eliminate potential impact, if
any, on existing asset-backed securities \84\ without compromising the
intent of the statute?
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    \83\ For purposes of this Supplemental Information, ``existing
issuers of asset-backed securities'' means issuers that issued
asset-backed securities prior to the effective date of the proposed
rule.
    \84\ For purposes of this Supplemental Information, ``existing
asset-backed securities'' means asset-backed securities that were
issued prior to the effective date of the proposed rule.
---------------------------------------------------------------------------

    Question 11. What would be the legal and economic impact to an
issuer of asset-backed securities of being considered a ``banking
entity''? What additional costs would be incurred in the establishment
and implementation of a compliance program related to the provisions of
the proposed rule as required by Sec.  --.20 of the proposed rule
(including Appendix C, where applicable)? Who would pay those
additional costs?
    Question 12. If the ownership requirement under the proposed rule
for credit risk retention (section 15G of the Exchange Act) combined
with the control inherent in the position of servicer or investment
manager means that more securitization vehicles would be considered
affiliates of banking entities, would fewer banking entities be willing
to (i) serve as the servicer or investment manager of securitization
transactions and/or (ii) serve as the originator or securitizer (as
defined in section 15G of the Exchange Act) of securitization
transactions? What other impact might the potential interplay between
these rules have on future securitization transactions? Could there be
other potential unintended consequences?
    Question 13. Are the proposed rule's definitions of buy and
purchase and sale and sell appropriate? If not, what alternative
definitions would be more appropriate? Should any other terms be
defined? If so, are there existing definitions in other rules or
regulations that could be used in this context? Why would the use of
such other definitions be appropriate?

B. Subpart B--Proprietary Trading Restrictions

1. Section --.3: Prohibition on Proprietary Trading
    Section --.3 of the proposed rule describes the scope of the
prohibition on proprietary trading and defines a

number of terms related to proprietary trading. The Agencies note that
the definition of ``proprietary trading'' in the statute and under the
proposed rule is broad. This definition must be viewed in light of the
exemptions described later in the proposed rule, which reflect
statutory provisions permitting a number of activities.
a. Prohibition on Proprietary Trading
    Section --.3(a) of the proposed rule implements section 13(a)(1)(A)
of the BHC Act and prohibits a banking entity from engaging in
proprietary trading unless otherwise permitted under Sec. Sec.  --.4
through --.6 of the proposed rule. Section --.3(b)(1) of the proposed
rule defines proprietary trading in accordance with section 13(h)(4) of
the BHC Act.\85\ This definition is a key element of the proposal
because, unless an activity covered by the definition is specifically
permitted under one of the exemptions contained in Sec. Sec.  --.4
through --.6 of the proposed rule, a banking entity is prohibited from
engaging in that activity. Specifically, the proposal largely restates
the statutory definition of proprietary trading, defining that term to
mean engaging in the purchase or sale of one or more covered financial
positions as principal for the trading account of the banking
entity.\86\ The terms ``trading account'' and ``covered financial
position'' are defined in Sec. Sec.  --.3(b)(2) and --.3(b)(3) of the
proposed rule, respectively. The proposed definition of proprietary
trading also clarifies that proprietary trading does not include acting
as agent, broker, or custodian for an unaffiliated third party, because
acting in these types of capacities does not involve trading as
principal, which is one of the requisite aspects of the statutory
definition.
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    \85\ See proposed rule Sec.  --.3(b)(1).
    \86\ See 12 U.S.C. 1851(h)(4); see also proposed rule Sec.
--.3(b)(1). Although the statutory definition refers to the
``purchase, sale, acquisition, or disposition of'' covered financial
positions, the proposed rule uses the simpler terms ``purchase'' and
``sale,'' which are defined broadly in Sec. Sec.  --.2(g) and (v) of
the proposed rule.
---------------------------------------------------------------------------

b. ``Trading Account''
i. Definition of ``Trading Account''
    Section 13(h)(6) of the BHC Act defines the term ``trading
account'' as ``any account used for acquiring or taking positions in
securities [or other enumerated instruments] principally for the
purpose of selling in the near-term (or otherwise with the intent to
resell in order to profit from short-term price movements),'' as well
as any such other accounts that the Agencies by rule determine.\87\ As
an initial matter, the Agencies note that it is often difficult to
clearly identify the purpose for which a position is acquired or taken
and whether that purpose is short-term in nature, particularly since
identification of that purpose generally depends on the intent with
which the position is acquired or taken. Moreover, the statute does not
define the terms ``near-term'' or ``short-term'' for these purposes.
---------------------------------------------------------------------------

    \87\ See 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------

    In implementing the statutory definition of trading account, the
proposed rule generally restates the statutory definition, with the
addition of certain details intended to provide banking entities with
greater clarity regarding the scope of positions that fall within the
definition of trading account.\88\ The proposed definition of trading
account has three prongs. First, under the proposed rule, a trading
account includes any account that is used by a banking entity to
acquire or take one or more covered financial positions for the purpose
of: (i) Short-term resale; (ii) benefitting from actual or expected
short-term price movements; (iii) realizing short-term arbitrage
profits; or (iv) hedging one or more such positions.\89\ Second, the
proposed definition of trading account also includes any account used
by a banking entity that is subject to the Market Risk Capital Rules to
acquire or take one or more covered financial positions that are
subject to those rules, other than certain foreign exchange and
commodity positions.\90\ Third, the proposed definition of trading
account also includes any account used by a banking entity that is a
securities dealer, swap dealer, or security-based swap dealer to
acquire or take positions in connection with its dealing
activities.\91\ To provide additional clarity and guidance regarding
the trading account definition, the proposed rule also includes a
rebuttable presumption that any account used to acquire or take a
covered financial position that is held for sixty days or less is a
trading account under the first prong, unless the banking entity can
demonstrate that the position was not acquired principally for short-
term trading purposes. The proposed definition also clarifies that no
account will be a trading account to the extent that it is used to
acquire or take certain positions under repurchase or reverse
repurchase arrangements or securities lending transactions, positions
for bona fide liquidity management purposes, or certain positions held
by derivatives clearing organizations or clearing agencies. Each of the
three definitional prongs is independent of the others--any one prong
would, if met, cause the relevant account to fall within the definition
of ``trading account.''
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    \88\ The Agencies note that the structure of the proposed
definition, which defines a trading account by reference to the
positions that the account is used to acquire or take, is consistent
with the structure of the statutory language used in section
13(h)(6) of the BHC Act.
    \89\ See proposed rule Sec.  ----.3(b)(2)(i)(A).
    \90\ See proposed rule Sec.  --.3(b)(2)(i)(B).
    \91\ See proposed rule Sec.  --.3(b)(2)(i)(C).
---------------------------------------------------------------------------

    The Agencies have drawn on existing rules, in particular the Market
Risk Capital Rules and various securities and commodities laws, in
identifying trading accounts and defining related terms in the
proposal.
ii. Positions Acquired or Taken for Short-Term Trading Purposes
    The first prong of the proposed trading account definition refers
to positions that a banking entity acquires or takes principally for
short-term purposes--that is, for one of the following enumerated
purposes described in Sec. Sec.  --.3(b)(2)(i)(A)(1) through (4) of the
proposed rule:
     Short-term resale;
     Benefitting from actual or expected short-term price
movements;
     Realizing short-term arbitrage profits; or
     Hedging one or more such positions.
    This prong reflects the statutory definition's reference to
positions acquired or taken ``principally for the purpose of selling in
the near-term (or otherwise with the intent to resell in order to
profit from short-term price movements).'' \92\
---------------------------------------------------------------------------

    \92\ See 12 U.S.C. 1851(h)(6); see also proposed rule Sec.
--.3(b)(2)(i).
---------------------------------------------------------------------------

    Section --.3(b)(2)(i)(A)(1) of the proposed rule's definition of
trading account includes covered financial positions acquired or taken
principally for the purpose of short-term resale.\93\ This part of the
trading account definition restates language contained in the statutory
definition of trading account and describes one class of positions that
are acquired or taken for short-term trading purposes.
---------------------------------------------------------------------------

    \93\ See proposed rule Sec.  --.3(b)(2)(i)(A)(1).
---------------------------------------------------------------------------

    Section --.3(b)(2)(i)(A)(2) of the proposed rule includes covered
financial positions acquired or taken principally for the purpose of
benefitting from actual or expected short-term price movements.\94\
This part of the trading account definition does not require the resale
of the position; rather, it requires only an intent to engage in any
form of transaction on a short-term basis (including a transaction

separate from, but related to, the initial acquisition of the position)
for the purpose of benefitting from a short-term movement in the price
of the underlying position. This part of the proposed definition would,
for example, include a derivative or other position where the banking
entity enters into (or intends to enter into) a subsequent transaction
in the near-term to simply offset or ``close out,'' rather than sell,
all or a portion of the risks of the initial position, in order to
benefit from a price movement occurring between the acquisition of the
underlying position and the subsequent offsetting transaction.
Similarly, it would also include a derivative, commodity future, or
other position that, regardless of the term of that position, is
subject to the exchange of short-term variation margin through which
the banking entity intends to benefit from short-term price movements.
The proposed definition would also capture the acquisition of a debt
instrument where the banking entity intends to enter into a short-term
transaction to simply offset, rather than sell, the credit, interest
rate and/or other material risk elements of the initial position so as
to benefit from a price movement occurring between acquisition of the
underlying position and the subsequent offsetting transaction.
---------------------------------------------------------------------------

    \94\ See proposed rule Sec.  --.3(b)(2)(i)(A)(2).
---------------------------------------------------------------------------

    Section --.3(b)(2)(i)(A)(3) of the proposed rule's definition of
trading account includes covered financial positions acquired or taken
principally to lock in short-term arbitrage profits.\95\ Although
similar to the positions described in Sec.  ----.3(b)(2)(i)(A)(2) of
the proposed definition (i.e., those acquired for the purpose of
benefitting from actual or expected short-term price movements), this
part of the definition focuses on short-term arbitrage profits more
generally, without regard to whether the transaction is predicated on
expected or actual movements in price. Rather, a position acquired to
lock in arbitrage profits would include positions acquired or taken
with the intent to benefit from differences in multiple market prices,
even in cases in which no movement in those prices is necessary to
realize the intended profit. Such arbitrage-based transactions might
involve profiting from the difference in the market price of multiple
related positions or assets, or might instead involve the difference in
market price for particular price or risk elements associated with
positions or assets. This would include, for example, arbitrage profits
resulting from the convergence or divergence in prices between
different positions held by a banking entity engaged in relative value
convergence arbitrage, which involves marrying a long and short
position to benefit from a convergence or divergence in price between
the two, or any similar strategy, because such convergence or
divergence could happen at any time (i.e., in one day, in sixty-one
days, or some other time period).
---------------------------------------------------------------------------

    \95\ See proposed rule Sec.  --.3(b)(2)(i)(A)(3).
---------------------------------------------------------------------------

    Section --.3(b)(2)(i)(A)(4) of the proposed rule's definition of
trading account includes covered financial positions acquired or taken
for the purpose of hedging another position that is itself held in a
trading account.\96\ In particular, the Agencies assume that, with
respect to any position the purpose of which is to hedge another
covered financial position in the trading account, the banking entity
generally intends to hold the hedging position, whatever its nominal
duration, for only so long as the underlying position is held.
Accordingly, the proposed rule makes clear that such hedging positions
fall within the definition of trading account.
---------------------------------------------------------------------------

    \96\ See proposed rule Sec.  --.3(b)(2)(i)(A)(4).
---------------------------------------------------------------------------

iii. Overview of Current Market Risk Capital Rules Approach to Short-
Term Trading Positions
    The first prong of the proposed trading account definition, which
references positions acquired principally for short-term trading
purposes, is, like the statutory definition it implements,
substantially similar to a key portion of the definition of a ``covered
position'' under the Market Risk Capital Rules.\97\ For the reasons
discussed below, the Agencies have taken this similarity into account
and propose to construe the first prong of the definition of trading
account under the proposed rule--and in particular its reference to
``short-term''--in a manner that is consistent with the Market Risk
Capital Rules' approach to identifying positions taken with short-term
trading intent.
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    \97\ The Federal banking agencies' current Market Risk Capital
Rules are located at 12 CFR Part 3, Appendix B (OCC), 12 CFR Part
208, Appendix E and 12 CFR Part 225, Appendix E (Board), and 12 CFR
Part 325, Appendix C (FDIC), and apply on a consolidated basis to
banks and bank holding companies with trading activity (on a
worldwide consolidated basis) that equals 10 percent or more of the
institution's total assets, or $1 billion or more. On January 11,
2011, the Federal banking agencies proposed revisions to the Market
Risk Capital Rules that include, inter alia, changes to the
definition of covered position. Proposed revisions to the Market
Risk Capital Rules include (i) changes to portions of the covered
position definition not relevant to the statutory definition of
trading account in section 13 of the BHC Act and (ii) the addition
of a requirement that any position in a trading account also be a
``trading position'' in order to be considered a covered position.
See 76 FR 1890 (Jan. 11, 2011). The revised definition of ``trading
position'' that has been proposed for those purposes is generally
identical to this proposed rule's definition of trading account
(i.e., a position acquired or taken: (i) For the purpose of short-
term resale; (ii) with the intent of benefitting from actual or
expected short-term price movements; (iii) to lock in short-term
arbitrage profits; or (iv) to hedge another trading position). The
Agencies also note that the first prong of the proposed rule's
trading account definition is also substantially similar to the
Basel Committee's definition of ``trading book.'' See Basel
Committee on Banking Supervision, Amendment to the Capital Accord to
Incorporate Market Risks, available at http://bis.org/publ/bcbs119.pdf.
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    The Market Risk Capital Rules define a covered position to include
all positions in a bank's ``trading account,'' as that term is defined,
in part, in the Report of Condition and Income that banks are required
to file periodically with respect to their financial condition (``Call
Report''). Under the Market Risk Capital Rules, a covered position is
one that is subject to a risk-based capital charge that is based, at
least in part, on the banking organization's internal risk management
models for purposes of calculating the banking organization's risk-
based capital requirement.\98\ In defining the term ``trading
account,'' the Call Report notes that trading activities typically
include, among other activities, ``acquiring or taking positions in
such items principally for the purpose of selling in the near-term or
otherwise with the intent to resell in order to profit from short-term
price movements.'' \99\ This language is substantially identical to the
statutory

definition of trading account in section 13 of the BHC Act in that it
refers to acquiring or taking positions (i) principally for the purpose
of selling in the near-term or (ii) otherwise with the intent to resell
in order to profit from short-term price movements.
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    \98\ The Agencies note that the Market Risk Capital Rules, both
in their current and proposed form, also (i) include within the
definition of covered position other positions not captured by the
reference to positions acquired for the purpose of short-term resale
or with the intent of benefitting from actual or expected short-term
price movements (e.g., all commodity and foreign exchange positions,
regardless of the intended holding period) and (ii) exclude from
that definition certain positions otherwise acquired with short-term
trading intent for a variety of policy reasons. The Agencies have
not proposed to incorporate such inclusions or exclusions for
purposes of the proposed rule's definition of trading account;
rather, the Market Risk Capital Rules and related concepts have been
referred to only to the extent that they pertain to positions
acquired for the purpose of short-term resale or with the intent of
benefitting from actual or expected short-term price movements.
    \99\ Report of Condition and Income at A78a (also including, in
the definition of ``trading account,'' ``regularly underwriting or
dealing in securities; interest rate, foreign exchange rate,
commodity, equity, and credit derivative contracts; other financial
instruments; and other assets for resale * * * and * * * acquiring
or taking positions in such items as an accommodation to customers
or for other trading purposes.''). Accordingly, given its broader
scope, the Call Report ``trading account'' includes trading
positions that fall outside the statutory ``trading account'' for
purposes of determining what is prohibited and permitted covered
trading activity under section 13 of the BHC Act.
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    In providing guidance regarding the application of ``trading
account,'' the Call Report also states that trading account positions
include any position that is classified as ``trading securities'' under
relevant U.S. Generally Accepted Accounting Principles (``GAAP'')
standards for accounting.\100\ Under the referenced accounting
standards, trading securities are defined as those ``that are bought
and held principally for the purpose of selling them in the near-term''
and ``generally used with the objective of generating profits on short-
term differences in price.'' \101\ The Agencies note that the
definition of a trading security under the relevant U.S. GAAP
accounting standards is similar to both (i) the financial positions
described in the second prong of the Call Report's definition of
trading account and (ii) the financial positions described in the
statutory definition of trading account under section 13 of the BHC
Act.
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    \100\ See Report of Condition and Income at A78a, referring to
ASC Topic 320, Investments--Debt and Equity Securities (formerly
FASB Statement of Financial Accounting Standards No. 115,
``Accounting for Certain Investments in Debt and Equity
Securities'').
    \101\ See id. In formulating the proposed rule, the Agencies
carefully considered whether to define trading account for purposes
of the proposed rule in a manner that formally incorporated the
accounting standards governing trading securities. The Agencies have
not proposed this approach because: (i) The statutory proprietary
trading prohibition under section 13 of the BHC Act applies to
financial instruments, such as derivatives, to which the trading
security accounting standards may not apply; (ii) these accounting
standards permit companies to classify, at their discretion, assets
as trading securities even where the assets would not otherwise meet
the definition of trading security; and (iii) these accounting
standards could change in the future without consideration of the
potential impact on section 13 of the BHC Act.
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    Although neither the Market Risk Capital Rules, the Call Report,
nor relevant accounting standards provide a precise definition of what
constitutes ``near-term'' or ``short-term'' for purposes of evaluating
whether a position is of the type held in a trading account or is a
trading security, guidance provided under relevant accounting standards
notes that ``near-term'' for purposes of classifying trading activities
is ``generally measured in hours and days rather than months or
years.'' \102\ The Agencies expect that the precise period of time that
may be considered near-term or short-term for purposes of evaluating
any particular covered financial position would depend on a variety of
factors, including the facts and circumstances of the covered financial
position's acquisition, the banking entity's trading and business
strategies, and the nature of the relevant markets. In considering the
purpose for which a covered financial position is acquired or taken and
evaluating whether such position is acquired or taken for short-term
purposes, the Agencies intend to rely on a variety of information,
including quantitative measurements of banking entities' covered
trading activities (as described below in Part II.B.5 of this
Supplementary Information), supervisory review of banking entities'
compliance practices and internal controls, and supervisory review of
individual transactions.
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    \102\ See FASB ASC Master Glossary definition of ``trading.''
Although Sec.  --.3(b)(2)(ii) of the proposed rule includes a
rebuttable presumption that an account used to acquire or take
certain covered financial positions that are held for 60 days or
less is a trading account, the Agencies note that U.S. GAAP does not
include a presumption that securities sold within 60 days of
acquisition were held for the purpose of selling them in the near
term.
---------------------------------------------------------------------------

    In order to better reinforce the general consistency between the
proposal's approach to defining a trading account and the ``trading
account'' concept embedded in the Market Risk Capital Rules, the second
prong of the proposed definition of trading account, contained in Sec.
--.3(b)(2)(i)(B) of the proposed rule, provides that a trading account
includes any account used to acquire or take one or more covered
financial positions, other than positions that are foreign exchange
derivatives, commodity derivatives, or contracts of sale of a commodity
for future delivery (unless the position is otherwise held with short-
term intent), that are also market risk capital rule covered positions,
if the banking entity, or any affiliate of the banking entity that is a
bank holding company, calculates risk-based capital ratios under the
Market Risk Capital Rules.\103\ For these purposes, a ``market risk
capital rule covered position'' is defined as any covered position as
that term is defined for purposes of (i) in the case of a banking
entity that is a bank holding company or insured depository
institution, the market risk capital rule that is applicable to the
banking entity, and (ii) in the case of a banking entity that is
affiliated with a bank holding company, other than a banking entity to
which a market risk capital rule is applicable, the market risk capital
rule that is applicable to the affiliated bank holding company.\104\ In
particular, for banking entities already subject to the Market Risk
Capital Rules, it appears that positions subject to trading account
treatment under those rules because they involve short-term trading
intent are generally the type of positions to which the proprietary
trading restrictions of section 13 of the BHC Act were intended to
apply. In addition, including all covered financial positions that
receive trading account treatment under the Market Risk Capital Rules
because they meet a nearly identical standard regarding short-term
trading intent would also eliminate the potential for inconsistency or
regulatory arbitrage in which a banking entity might characterize a
position as ``trading'' for capital purposes but not for purposes of
the proposed rule.
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    \103\ The Agencies have excluded positions that are foreign
exchange derivatives, commodity derivatives, or contracts of sale of
a commodity for future delivery from this prong of the proposed
trading account definition because all foreign exchange and
commodity positions are considered ``covered positions'' under the
Market Risk Capital Rules regardless of whether they involve the
short-term trading intent required under the statutory definition of
trading account in section 13(h)(6) of the BHC Act.
    \104\ See proposed rule Sec.  --.3(c)(8). Accordingly, in the
context of a subsidiary of a bank holding company (other than a
subsidiary, such as a bank, to which a market risk capital rule is
already directly applicable), if that bank holding company is
subject to a market risk capital rule, any position of that
subsidiary that meets the definition of a ``covered position'' under
the market risk capital rule applicable to the bank holding company
would be subject to Sec.  --.3(b)(2)(i)(B) of the proposed rule.
---------------------------------------------------------------------------

    The Agencies emphasize that this second prong of the trading
account definition is being proposed in contemplation of the proposed
revisions to the Market Risk Capital Rules and, in particular, the
proposed definition of ``covered position'' under those proposed
revisions. To the extent that those proposed revisions with respect to
the definition of ``covered position'' are not adopted, or adopted in a
form other than as proposed, the Agencies would expect to take that
into account in determining whether or how to include the proposed
second prong of the trading account definition for purposes of the
final rule to implement section 13 of the BHC Act.\105\
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    \105\ In particular, the Agencies note that under the proposed
revisions to the Market Risk Capital Rules, but not the existing
Market Risk Capital Rule, the term ``covered position'' expressly
includes, other than with respect to commodity and foreign exchange
positions, only positions taken with short-term trading intent. See
76 FR 1890 (Jan. 11, 2011). The Agencies do not intend to
incorporate ``covered positions'' under the Market Risk Capital
Rules in a way that includes positions lacking short-term trading
intent.
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iv. Positions Acquired or Taken by Securities Dealers, Swap Dealers,
and Security-Based Swap Dealers
    The third prong of the proposed definition of trading account is
contained in Sec.  --.3(b)(2)(i)(C) of the

proposed rule and provides that a trading account includes any account
used to acquire or take one or more covered financial positions by a
banking entity that is: (i) A SEC-registered securities or municipal
securities dealer; (ii) a government securities dealer that registered,
or that has filed notice, with an appropriate regulatory agency; \106\
(iii) a CFTC-registered swap dealer; or (iv) a SEC-registered security-
based swap dealer, in each case to the extent that the covered
financial position is acquired or taken in connection with the
activities that require the banking entity to be registered, or to file
notice, as such.\107\ Similarly included is any covered financial
position acquired or taken by a banking entity that is engaged in the
business of a dealer, swap dealer, or security-based swap dealer
outside of the United States, if such position is acquired or taken in
connection with the activities of such business.\108\ As a result of
this third prong, all covered financial positions acquired or taken by
a registered dealer, swap dealer or security-based swap dealer, a
government securities dealer that has filed notice with an appropriate
regulatory agency, or a banking entity engaged in the same type of
dealing activities outside the United States, are automatically
included within the scope of positions described in the trading account
definition, if they are acquired or taken in connection with the
activities that require the banking entity to be registered, or file
notice, as such (or, in the case of a banking entity engaged in the
business of a dealer, swap dealer, or security-based swap dealer
outside of the United States, in connection with the activities of such
business). As discussed below, the proposed rule contains exemptions
that permit a variety of covered trading activity in which these types
of entities typically engage, notwithstanding the inclusion of all
covered financial positions of such entities within the definition of
trading account.
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    \106\ See 15 U.S.C. 78c(a)(42)(E); 15 U.S.C. 78o5(a)(1)(B); 17
CFR 400.5(b); 17 CFR 449.1. Section 15C(a)(1)(A) of the Exchange Act
requires any government securities dealer, other than a registered
broker-dealer or a financial institution, to register with the SEC
pursuant to section 15C(a)(2). Registered broker-dealers and
financial institutions are required to file written notice with
their appropriate regulatory agency, as defined in section 3(a)(34)
of the Exchange Act, prior to acting as a government securities
dealer. See 15 U.S.C. 78o-5(a)(1)(B). The proposed definition of
trading account would cover positions of all three forms of
government securities dealers: (i) those registered with the SEC;
(ii) registered broker-dealers; and (iii) financial institutions
that have filed notice with an appropriate regulatory agency.
    \107\ See proposed rule Sec.  --.3(b)(2)(i)(C)(1)-(4). The
Agencies emphasize that this provision applies only to positions
taken in connection with the activities that require the banking
entity to be registered as one of the listed categories of dealer,
not to all of the activities of that banking entity. For example, an
insured depository institution may be registered as a swap dealer,
but only the swap dealing activities that require it to be so
registered would be covered by the second prong of the trading
account definition. A position taken in connection with other
activities of the insured depository institution that do not trigger
registration as a swap dealer, such as lending, deposit-taking, the
hedging of business risks, or other end-user activity, would only be
included within the trading account if the position met one of the
other prongs of the trading account definition (i.e., Sec. Sec.
--.3(b)(2)(i)(A) or (B) of the proposed rule).
    \108\ See proposed rule Sec.  --.3(b)(2)(i)(C)(5).
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    The Agencies have proposed this third prong of the trading account
definition because all assets or other positions held by firms that
register or file notice as securities or derivatives dealers as part of
their dealing activity are generally held for sale to customers upon
request or otherwise support the firm's trading activities (e.g., by
hedging its dealing positions), and so would appear to involve the
requisite short-term intent and be captured within the statutory
definition of trading account. To the extent that a covered financial
position is acquired or taken by such a banking entity outside the
scope of the dealing activities that require the banking entity to be
registered, or to file notice, as a dealer, swap dealer, or security-
based swap dealer, that position may still cause the relevant account
to be a trading account under the proposed rule if the account holding
such a position otherwise meets the terms of the first or second prong
of the trading account definition (i.e., positions acquired or taken
for short-term trading purposes or certain Market Risk Capital Rules
positions).
v. Rebuttable Presumption for Certain Positions
    In order to provide greater clarity and guidance on the application
of the trading account definition, and in particular for those banking
entities with no experience in evaluating short-term trading intent or
that are not subject to the Market Risk Capital Rules, the proposed
rule also includes a rebuttable presumption regarding certain positions
that, by reason of their holding period, are presumed to be trading