and circumstances that the Agencies propose to consider be sufficient
to determine and verify that the banking entity is not engaged in
prohibited proprietary trading? If not, how should this issue be
addressed?
    Question 185. Are the facts and circumstances that would be used to
determine whether a banking entity's activities satisfy a certain
factor appropriate? If not, how should they be changed, and why? Should
any be eliminated or added? If so, which ones, and why?
    Question 186. Are the identified quantitative measurements that the
Agencies would use to help assess a particular factor appropriate? If
not, how should they be changed, and why? Should any be eliminated or
added? If so, which ones, and why?
f. Incorporation of Numerical Thresholds in the Commentary Regarding
Identification of Permitted Market Making-Related Activities
    As noted above, the Agencies are currently requesting comment on
whether to incorporate, as part of the proposed rule, numerical
thresholds for certain quantitative measurements, and if so, how to do
so. For example, the proposed rule could include one or more numerical
thresholds that, if met by a banking entity, would require the banking
entity to review its trading

activities for compliance and summarize that review to the relevant
Agency.
    The primary purpose of using some form of threshold would be to
provide banking entities with a clear standard regarding trading
activity that presented a quantitative profile sufficiently
questionable to warrant further review and explanation to the relevant
Agency. Such clarity would appear to provide significant benefits both
to banking entities in conducting their trading activities in
conformance with the proposed rule and to Agencies in monitoring
trading activities and obtaining additional, more detailed information
in circumstances warranting closer scrutiny. In addition to the
benefits of transparency, thresholds would also encourage consistent
review by banking entities and the Agencies of transactions, both
within a banking entity and across all banking entities. The purpose of
such thresholds would not be to serve as bounds of permitted conduct or
as a comprehensive, dispositive tool for determining whether prohibited
proprietary trading has occurred.
    Numerical thresholds have not been included in the proposed rule
because the Agencies believe that public comment and further review is
warranted before numerical thresholds and specific numerical amounts
may be proposed. Instead, the Agencies request comment on whether such
thresholds would be desirable and, if so, what particular form such
thresholds should take and what specific numerical thresholds would be
appropriate. To facilitate the comment process, this request for
comment includes a number of illustrative examples of numerical
thresholds on which specific comment is sought.
    In particular, the Agencies request comment on the following
questions:
    Question 187. What are the potential benefits and costs of
incorporating into the proposed rule one or more numerical thresholds
for certain quantitative measurements that, if reported by a banking
entity, would require the banking entity to review its trading
activities for compliance and summarize that review to the relevant
Agency? Would such thresholds provide useful clarity to banking
entities and/or market participants regarding the types of trading
activities that merit additional scrutiny? Should numerical thresholds
be used for any purposes other than highlighting trading activities
that should be reviewed, the results of which would be reported to the
relevant Agency? If so, for what purpose, and how and why?
    Question 188. For which of the relevant quantitative measurements
might it be appropriate and effective to include a numerical threshold
that would trigger banking entity review and explanation? How should a
numerical threshold be formulated, and why? Should a numerical
threshold for a single quantitative measurement be applied
individually, or should the threshold instead be triggered by exceeding
some combination of numerical thresholds for different measurements?
For any particular threshold, what numerical amount should be used, and
why? How would such numerical amount be consistent with a level at
which further review and explanation is warranted? Should the amount
vary by asset class or other characteristic? If so, how?
    Question 189. For each of the following illustrative examples of
potential thresholds, is the threshold formulated effectively? If not,
what alternative formulation would be more effective? Should the
threshold formulation vary by asset class or other characteristic? If
so, how and why? If the threshold was utilized, what actual numerical
amount should be specified, and why? How would such numerical amount be
consistent with a level at which further review and explanation is
warranted? Should the numerical amount vary by asset class or other
characteristic? If so, how and why?
     ``If a trading unit reports an increase in VaR, Stress
VaR, or Risk Factor Sensitivities greater than [--] over a period of
[--] months, or such other threshold as [Agency] may require, the
banking entity must (i) promptly review and investigate the trading
unit's activities to verify whether the trading unit is operating in
compliance with the proprietary trading restrictions and (ii) report to
[Agency] a summary of such review, including any explanatory
circumstances.''
     ``If a trading unit reports an average Comprehensive
Profit and Loss that is less than [--] times greater than the Portfolio
Profit and Loss, exclusive of Spread Profit and Loss, for [--]
consecutive months, or such other threshold as [Agency] may require,
the banking entity must (i) promptly review and investigate the trading
unit's activities to verify whether the trading unit is operating in
compliance with the proprietary trading restrictions and (ii) report to
[Agency] a summary of such review, including any explanatory
circumstances.''
     ``If a trading unit reports a Comprehensive Profit and
Loss to Volatility Ratio that is less than [--] times greater than that
trading desk's Portfolio Profit and Loss to Volatility Ratio over a
period of [--] months, or such other threshold as [Agency] may require,
the banking entity must (i) promptly review and investigate the trading
unit's activities to verify whether the trading unit is operating in
compliance with the proprietary trading restrictions and (ii) report to
[Agency] a summary of such review, including any explanatory
circumstances.''
     ``If a trading unit reports a number of Unprofitable
Trading Days Based on Portfolio Profit and Loss that is less than [--]
greater than the number of Unprofitable Trading Days Based on
Comprehensive Profit and Loss for [--] consecutive months, or such
other threshold as [Agency] may require, the banking entity must (i)
promptly review and investigate the trading unit's activities to verify
whether the trading unit is operating in compliance with the
proprietary trading restrictions and (ii) report to [Agency] a summary
of such review, including any explanatory circumstances.''
     ``If a trading unit reports a Pay-to-Receive Spread Ratio
that is less than [--] over a period of [--] months, or such other
threshold as [Agency] may require, the banking entity must (i) promptly
review and investigate the trading unit's activities to verify whether
the trading unit is operating in compliance with the proprietary
trading restrictions and (ii) report to [Agency] a summary of such
review, including any explanatory circumstances.''
6. Section --.8: Limitations on Permitted Trading Activities
    Section --.8 of the proposed rule implements section 13(d)(2) of
the BHC Act, which places certain limitations on the permitted trading
activities (e.g., permitted market making-related activities, risk-
mitigating hedging, etc.) in which a banking entity may engage.\203\
Consistent with the statute, Sec.  --.8(a) of the proposed rule
provides that no transaction, class of transactions, or activity is
permissible under Sec. Sec.  --.4 through --.6 of the proposed rule if
the transaction, class of transactions, or activity would:
---------------------------------------------------------------------------

    \203\ See 12 U.S.C. 1851(d)(2).
---------------------------------------------------------------------------

     Involve or result in a material conflict of interest
between the banking entity and its clients, customers, or
counterparties;
     Result, directly or indirectly, in a material exposure by
the banking entity to a high-risk asset or a high-risk trading
strategy; or
     Pose a threat to the safety and soundness of the banking
entity or U.S. financial stability.

    The proposed rule further defines ``material conflict of
interest,'' ``high-risk asset,'' and ``high-risk trading strategy'' for
these purposes.
a. Scope of ``Material Conflict of Interest''
    Section --.8(b) of the proposed rule defines the scope of material
conflicts of interest which, if arising in connection with a permitted
trading activity, are prohibited under the proposal.\204\ Conflicts of
interest may arise in a variety of circumstances related to permitted
trading activities. For example, a banking entity may acquire
substantial amounts of nonpublic information about the financial
condition of a particular company or issuer through its lending,
underwriting, investment advisory or other activities which, if
improperly transmitted to and used in trading operations, would permit
the banking entity to use such information to its customers', clients'
or counterparties' disadvantage. Similarly, a banking entity may
conduct a transaction that places the banking entity's own interests
ahead of its obligations to its customers, clients or counterparties,
or it may seek to gain by treating one customer involved in a
transaction more favorably than another customer involved in that
transaction. Concerns regarding conflicts of interest are likely to be
elevated when a transaction is complex, highly structured or opaque,
involves illiquid or hard-to-value instruments or assets, requires the
coordination of multiple internal groups (such as multiple trading
desks or affiliated entities), or involves a significant asymmetry of
information or transactional data among participants.\205\ In all
cases, the existence of a material conflict of interest depends on the
specific facts and circumstances.
---------------------------------------------------------------------------

    \204\ Section --.17(b) of the proposed rule defines the scope of
material conflicts of interest which, if arising in connection with
permitted covered fund activities, are prohibited.
    \205\ See, e.g., U.S. Senate Permanent Subcommittee on
Investigations, Wall Street and the Financial Crisis: Anatomy of a
Financial Collapse (Apr. 13, 2011), available at http://hsgac.senate.gov/public/_files/Financial_Crisis/FinancialCrisisReport.pdf.
---------------------------------------------------------------------------

    To address these types of material conflicts of interest, Sec.
--.8(b) of the proposed rule specifies that a material conflict of
interest between a banking entity and its clients, customers, or
counterparties exists if the banking entity engages in any transaction,
class of transactions, or activity that would involve or result in the
banking entity's interests being materially adverse to the interests of
its client, customer, or counterparty with respect to such transaction,
class of transactions, or activity, unless the banking entity has
appropriately addressed and mitigated the conflict of interest, where
possible, and subject to specific requirements provided in the
proposal, through either (i) timely and effective disclosure, or (ii)
informational barriers.\206\ Unless the conflict of interest is
addressed and mitigated in one of the two ways specified in the
proposal, the related transaction, class of transactions or activity
would be prohibited under the proposed rule, notwithstanding the fact
that it may be otherwise permitted under Sec. Sec.  --.4 through --.6
of the proposed rule.\207\
---------------------------------------------------------------------------

    \206\ See proposed rule Sec.  --.8(b)(1).
    \207\ The Agencies note that a banking entity subject to
Appendix C must implement a compliance program that includes, among
other things, policies and procedures that explain how the banking
entity monitors and prohibits conflicts of interest with clients,
customers, and counterparties. Further, as noted in the discussion
of the definition of ``material conflict of interest'' in Part
III.B.6 of this Supplemental Information, the discussion of that
definition is provided solely for purposes of the proposed rule's
definition of material conflict of interest, and does not affect the
scope of that term in other contexts or a banking entity's
obligation to comply with additional or different requirements with
respect to a conflict under applicable securities, banking, or other
laws (e.g., section 27B of the Securities Act, which governs
conflicts of interest relating to certain securitizations; section
206 of the Investment Advisers Act of 1940, which applies to
conflicts of interest between investment advisers and their clients;
or 12 CFR 9.12, which applies to conflicts of interest in the
context of a national bank's fiduciary activities).
---------------------------------------------------------------------------

    However, while these conflicts may be material for purposes of the
proposed rule, the mere fact that the buyer and seller are on opposite
sides of a transaction and have differing economic interests would not
be deemed a ``material'' conflict of interest with respect to
transactions related to bona fide underwriting, market making, risk-
mitigating hedging or other permitted activities, assuming the
activities are conducted in a manner that is consistent with the
proposed rule and securities and banking laws and regulations.
    Section --.8(b)(1) of the proposed rule describes the two
requirements that must be met in cases where a banking entity addresses
and mitigates a material conflict of interest through timely and
effective disclosure. First, Sec.  --.8(b)(1)(i) of the proposed rule
requires that the banking entity, prior to effecting the specific
transaction or class or type of transactions, or engaging in the
specific activity, for which a conflict may arise, make clear, timely,
and effective disclosure of the conflict or potential conflict of
interest, together with any other necessary information.\208\ This
would also require such disclosure to be provided in reasonable detail
and in a manner sufficient to permit a reasonable client, customer, or
counterparty to meaningfully understand the conflict of interest.\209\
Disclosure that is only general or generic, rather than specific to the
individual, class, or type of transaction or activity, or that omits
details or other information that would be necessary to a reasonable
client's, customer's, or counterparty's understanding of the conflict
of interest, would not meet this standard. Second, Sec.  --.8(b)(1)(ii)
of the proposed rule requires that the disclosure be made explicitly
and effectively, and in a manner that provides the client, customer, or
counterparty the opportunity to negate, or substantially mitigate, any
materially adverse effect on the client, customer, or counterparty that
was created or would be created by the conflict or potential
conflict.\210\
---------------------------------------------------------------------------

    \208\ See proposed rule Sec.  --.8(b)(1)(A).
    \209\ See id.
    \210\ See proposed rule Sec.  --.8(b)(1)(B).
---------------------------------------------------------------------------

    The Agencies note that, in order to provide the requisite
opportunity for the client, customer or counterparty to negate or
substantially mitigate the disadvantage created by the conflict, the
disclosure would need to be provided sufficiently close in time to the
client's, customer's, or counterparty's decision to engage in the
transaction or activity to give the client, customer, or counterparty
an opportunity to meaningfully evaluate and, if necessary, take steps
that would negate or substantially mitigate the conflict. Disclosure
provided far in advance of the individual, class, or type of
transaction, such that the client, customer, or counterparty is
unlikely to take that disclosure into account when evaluating a
transaction, would not suffice. Conversely, disclosure provided without
a sufficient period of time for the client, customer, or counterparty
to evaluate and act on the information it receives, or disclosure
provided after the fact, would also not suffice under the proposal. The
Agencies note that the proposed definition would not prevent or require
disclosure with respect to transactions or activities that align the
interests of the banking entity with its clients, customers, or
counterparties or that otherwise do not involve ``material'' conflicts
of interest as discussed above.
    The proposed disclosure standard reflects the fact that some types
of conflicts may be appropriately resolved through the disclosure of
clear and meaningful information to the client, customer, or
counterparty that provides such party with an informed opportunity to
consider and negate or substantially mitigate the conflict.

However, in the case of a conflict in which a client, customer, or
counterparty does not have sufficient information and opportunity to
negate or mitigate the materially adverse effect on the client,
customer, or counterparty created by the conflict, the existence of
that conflict of interest would prevent the banking entity from
availing itself of any exemption (e.g., the underwriting or market-
making exemptions) with respect to the relevant transaction, class of
transactions, or activity. The Agencies note that the proposed
disclosure provisions are provided solely for purposes of the proposed
rule's definition of material conflict of interest, and do not affect a
banking entity's obligation to comply with additional or different
disclosure or other requirements with respect to a conflict under
applicable securities, banking, or other laws (e.g., section 27B of the
Securities Act, which governs conflicts of interest relating to certain
securitizations; section 206 of the Investment Advisers Act of 1940,
which governs conflicts of interest between investment advisers and
their clients; or 12 CFR 9.12, which applies to conflicts of interest
in the context of a national bank's fiduciary activities).
    Section --.8(b)(2) of the proposed rule describes the requirements
that must be met in cases where a banking entity uses information
barriers that are reasonably designed to prevent a material conflict of
interest from having a materially adverse effect on a client, customer
or counterparty. Information barriers can be used to restrict the
dissemination of information within a complex organization and to
prevent material conflicts by limiting knowledge and coordination of
specific business activities among units of the entity. Examples of
information barriers include, but are not limited to, restrictions on
information sharing, limits on types of trading, and greater separation
between various functions of the firm. Information barriers may also
require that banking entity units or affiliates have no common officers
or employees. Such information barriers have been recognized in Federal
securities laws and rules as a means to address or mitigate potential
conflicts of interest or other inappropriate activities.\211\
---------------------------------------------------------------------------

    \211\ For example, information barriers have been used in
complying with the requirement in section 15(g) of the Exchange Act
that registered brokers and dealers establish, maintain and enforce
written policies and procedures reasonably designed, taking into
consideration the nature of such broker's or dealer's business, to
prevent the misuse of material, nonpublic information by such broker
or dealer or any person associated with such broker or dealer.
---------------------------------------------------------------------------

    In order to address and mitigate a conflict of interest through the
use of the information barriers pursuant to Sec.  --.8(b)(2) of the
proposed rule, a banking entity would be required to establish,
maintain, and enforce information barriers that are memorialized in
written policies and procedures, including physical separation of
personnel, functions, or limitations on types of activity, that are
reasonably designed, taking into consideration the nature of the
banking entity's business, to prevent the conflict of interest from
involving or resulting in a materially adverse effect on a client,
customer or counterparty.\212\ Importantly, the proposed rule also
provides that, notwithstanding a banking entity's establishment of such
information barriers, if the banking entity knows or should reasonably
know that a material conflict of interest arising out of a specific
transaction, class or type of transactions, or activity may involve or
result in a materially adverse effect on a client, customer, or
counterparty, the banking entity may not rely on those information
barriers to address and mitigate any conflict of interest. In such
cases, the transaction or activity would be prohibited, unless the
banking entity otherwise complies with the requirements of Sec.
--.8(b)(1).\213\ This aspect of the proposal is intended to make clear
that, in specific cases in which a banking entity has established an
information barrier but knows or should reasonably know that it has
failed or will fail to prevent a conflict of interest arising from a
specific transactions or activity that disadvantages a client,
customer, or counterparty, the information barrier is insufficient to
address that conflict and the transaction would be prohibited, unless
the banking entity is otherwise able to address and mitigate the
conflict through timely and effective disclosure under the
proposal.\214\
---------------------------------------------------------------------------

    \212\ See proposed rule Sec.  --.8(b)(2). As part of maintaining
and enforcing information barriers, a banking entity should have
processes to review, test, and modify information barriers on a
continuing basis. In addition, banking entities should have ongoing
monitoring to maintain and to enforce information barriers, for
example by identifying whether such barriers have not prevented
unauthorized information sharing and addressing instances in which
the barriers were not effective. This may require both remediating
any identified breach as well as updating the information barriers
to prevent further breaches, as necessary. Periodic assessment of
the effectiveness of information barriers and periodic review of the
written policies and procedures are also important to the
maintenance and enforcement of effective information barriers and
reasonably designed policies and procedures. Such assessments can be
done either (i) internally by a qualified employee or (ii)
externally by a qualified independent party.
    \213\ See proposed rule Sec.  --.8(b)(2).
    \214\ In addition, if a conflict occurs to the detriment of a
client, customer, or counterparty despite an information barrier,
the Agencies would also expect the banking entity to review the
effectiveness of its information barrier and make adjustments, as
necessary, to avoid future occurrences, or review whether such
information barrier is appropriate for that type of conflict.
---------------------------------------------------------------------------

    The Agencies note that the proposed definition of material conflict
of interest does not address instances in which a banking entity has
made a material misrepresentation to its client, customer, or
counterparty in connection with a transaction, class of transactions,
or activity, as such transactions or activity appears to involve fraud
rather than a conflict of interest. However, the Agencies note that
such misrepresentations are generally illegal under a variety of
Federal and State regulatory schemes (e.g., the Federal securities
laws). In addition, the Agencies note that any activity involving a
material misrepresentation to, or other fraudulent conduct with respect
to, a client, customer, or counterparty would not be permitted under
the proposed rule in the first instance. For example, a trading
activity involving a material misrepresentation to a client, customer,
or counterparty would fail, on its face, to satisfy the proposed terms
of the underwriting or market-making exemption.
b. Definition of ``High-Risk Asset'' and ``High-Risk Trading Strategy''
    Section --.8(c) of the proposed rule defines ``high-risk asset''
and ``high-risk trading strategy'' for proposes of Sec.  --.8's
proposed limitations on permitted trading activities. Section
--.8(c)(1) defines a ``high-risk asset'' as an asset or group of assets
that would, if held by the banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would fail. Section --.8(c)(2) defines a ``high-risk trading
strategy'' as a trading strategy that would, if engaged in by the
banking entity, significantly increase the likelihood that the banking
entity would incur a substantial financial loss or would fail.\215\
---------------------------------------------------------------------------

    \215\ The Agencies note that a banking entity subject to
proposed Appendix C must implement a compliance program that
includes, among other things, policies and procedures that explain
how the banking entity monitors and prohibits exposure to high-risk
assets and high-risk trading strategies, and identifies a variety of
assets and strategies (e.g., assets or strategies with significant
embedded leverage).
---------------------------------------------------------------------------

c. Request for Comment
    The Agencies request comment on the proposed limitations on
permitted trading activities. In particular, the

Agencies request comment on the following questions:
    Question 190. Is the manner in which the proposed rule implements
the limitations of section 13(d)(2) of the BHC Act effective and
sufficiently clear? If not, what alternative would be more effective
and/or clearer?
    Question 191. Is the proposed rule's definition of material
conflict of interest effective and sufficiently clear? If not, what
alternative would be more effective and/or clearer?
    Question 192. Is the proposed definition of material conflict of
interest over-or under-inclusive? If so, how should the definition be
broader or narrower? Is there an alternative definition that would be
appropriate? If so, what definition? Why would that alternative
definition better define material conflict of interest for purposes of
implementing section 13 of the BHC Act?
    Question 193. Would the proposed definition of material conflict of
interest have any unintended chilling effect on underwriting, market
making, risk-mitigating hedging or other permitted activities? If so,
what alternatives might limit such an effect?
    Question 194. Would the proposed definition of material conflict of
interest lead to unintended consequences? If so, what unintended
consequences and why? Please suggest modifications to the proposed
definition that would mitigate those consequences.
    Question 195. Is it likely that the proposed definition of material
conflict of interest would anticipate all future material conflicts of
interest, particularly as the financial markets evolve and change? If
not, what alternative definition would better anticipate future
material conflicts of interest?
    Question 196. Does the proposed rule provide sufficient guidance
for determining when a material conflict of interest exists? If not,
what additional detail should be provided? Should the Agencies adopt an
approach similar to that under the securities laws, in which a material
conflict of interest is not specifically defined?
    Question 197. Are there transactions, classes or types of
transactions, or activities inherent in underwriting, market-making,
risk-mitigating hedging or other permitted activities that should not
be prohibited but may be captured by the proposed definition of
material conflict of interest? If so, what transactions and activities?
Should they be permitted under the proposed rule? If so, why and under
what conditions, if any? Conversely, are there transactions or
activities that would be permitted under the proposed rule that should
be prohibited? If so, what transactions and activities? Why should they
be prohibited under the proposed rule?
    Question 198. Please discuss the inherent conflicts of interest
that arise from bona fide underwriting, market making-related activity,
risk-mitigating hedging, or any other permitted activity, and provide
specific examples of such inherent conflicts. Do you believe that such
conflicts ever result in a materially adverse interest between a
banking entity and a client, customer, or counterparty? How should the
proposal address inherent conflicts that result from otherwise-
permitted activities?
    Question 199. Is the manner in which the proposed rule permits the
use of disclosure in certain cases to address and mitigate conflicts of
interest appropriate? Why or why not? Should additional or alternative
requirements be placed on the use of disclosure to address and mitigate
conflicts? If so, what additional and alternative requirements, and
why? Is the level of detail and specificity required by the proposed
rule with respect to disclosure appropriate? If not, what alternative
level of detail and specificity would be more appropriate?
    Question 200. Should the proposed rule require written disclosure
to a client, customer, or counterparty regarding a material conflict of
interest? If so, please explain why written disclosure should be
required. Are there certain circumstances where written disclosure
should be required, but others where oral disclosure should be
sufficient? For example, should oral disclosure be permitted for
transactions in certain fast-moving markets or transactions with
sophisticated clients, customers, or counterparties? If oral disclosure
is permitted under certain circumstances, should subsequent written
disclosure be required? Please explain.
    Question 201. Should the proposed rule provide further detail
regarding the types of conflicts of interest that cannot be addressed
and mitigated through disclosure? If so, what type of additional detail
would be helpful, and why? Should the proposed rule enumerate an
exhaustive or non-exhaustive list of conflicts that cannot be addressed
and mitigated through disclosure? If so, what conflicts should that
list include, and why?
    Question 202. Should the proposed rule provide further detail
regarding the frequency at which disclosure must be made? Should
general disclosure be permitted for certain types of transactions,
classes of transactions, or activities? For example, should a banking
entity be permitted to make a one-time, written disclosure to a client,
customer, or counterparty prior to engaging in a certain type of
transaction or activity? Should general disclosure be permitted for
certain types of clients, customers, or counterparties (e.g., highly
sophisticated parties)? Please explain why specific disclosure (i.e.,
prior to each transaction, class of transaction, or activity) would not
be necessary under the identified circumstances. Are there any clients,
customers, or counterparties that should be able to waive a material
conflict of interest under certain circumstances? If so, under what
circumstances would a waiver approach be appropriate and consistent
with the statute? Please explain.
    Question 203. Should the proposed definition of material conflict
of interest deem certain potential conflicts of interest to not be
material conflicts of interest if a banking entity establishes,
maintains, and enforces policies and procedures (other than information
barriers) reasonably designed to prevent transactions, classes of
transactions, or activities that would involve or result in a material
conflict of interest? If so, for what types of potential conflicts?
What policies and procedures would be appropriate? How would this
approach be consistent with the purpose and language of the statute?
Should such policies and procedures only be considered effective if
they prevent the banking entity from receiving an advantage to the
disadvantage of the client, customer, or counterparty?
    Question 204. Are there any particular types of clients, customers,
or counterparties for whom disclosure of a material conflict of
interest should not be required under the proposal, consistent with the
statute? Please identify the types of clients, customers, or
counterparties for whom disclosure might not be necessary and explain.
Why might disclosures be useful for some clients, customers, or
counterparties, but not others? Please explain. What characteristics
should a firm use in determining whether or not a client, customer, or
counterparty needs a particular disclosure?
    Question 205. Are there additional steps that a banking entity that
seeks to manage conflicts of interest through the use of disclosure
should be required to take with regard to disclosure? If so, what
steps?
    Question 206. Are there circumstances in which disclosure might be
impracticable or ineffective? If so, what circumstances, and why?

    Question 207. Is the manner in which the proposed rule permits the
use of information barriers to address and mitigate conflicts of
interest appropriate? Why or why not? Should additional or alternative
requirements be placed on the use of information barriers to address
and mitigate conflicts? If so, what additional and alternative
requirements, and why?
    Question 208. Should the proposed rule mandate the use of other
means of managing potential conflicts of interest? If so, what specific
means should be considered? How effective are any such methods as
currently used? Can such methods be circumvented? If so, in what ways?
    Question 209. What burdens or costs might be associated with the
disclosure-related or information barrier-related requirements
contained in the proposed definition of material conflict of interest?
How might these burdens or costs be eliminated or reduced in a manner
consistent with the purpose and language of section 13 of the BHC Act?
    Question 210. Are there specific transactions, classes of
transactions or activities that should be managed through consent? If
so, what transactions or activities, and why? What form of consent
should be required? What level of detail should any such consent
include? Should consent only apply to certain conflicts and not others?
If so, which conflicts? Are there circumstances in which obtaining
consent might be impracticable or ineffective? Should consent be
limited to certain types of clients, customers, or counterparties? If
so, which clients, customers, or counterparties? Are there certain
types of clients, customers, or counterparties for whom consent would
never be sufficient? Are there additional steps that a banking entity
that seeks to manage conflicts of interest through the use of consent
should be required to take? Please specify such steps.
    Question 211. What is the potential relationship between, and
interplay of, the proposed rule and Section 621 of the Dodd-Frank Act
regarding conflicts of interest relating to certain securitizations
which contains a prohibition on material conflicts of interest?
    Question 212. Should the proposed rule provide for specific types
of procedures that would be more effective in managing and mitigating
conflicts of interest than others? Do banking entities currently use
certain procedures that effectively manage and mitigate material
conflicts of interest? If so, please describe such procedures and
explain why such procedures are effective. Is the proposed rule
consistent with such procedures? Why or why not? What are the costs and
benefits of modifying your current procedures in response to the
proposed rule?
    Question 213. Is the proposed rule's definition of a high-risk
asset effective and sufficiently clear? If not, what alternative would
be more effective and/or clearer? Should the proposed rule specify
particular assets that are deemed high-risk per se? If so, what assets
and why?
    Question 214. Is the proposed rule's definition of a high-risk
trading strategy effective and sufficiently clear? If not, what
alternative would be more effective and/or clearer? Should the proposed
rule specify particular trading strategies that are deemed high-risk
per se? If so, what trading strategies and why?

C. Subpart C--Covered Fund Activities and Investments

    As noted above, except as otherwise permitted, section 13(a)(1)(B)
of the BHC Act prohibits a banking entity from acquiring or retaining
any ownership in, or acting as sponsor to, a covered fund.\216\ Subpart
C of the proposed rule applies those portions of section 13 of the BHC
Act that operate as a prohibition or restriction on a banking entity's
ability, as principal, directly or indirectly, to acquire or retain an
ownership interest in, act as sponsor to, or have certain relationships
with, a covered fund. Subpart C also implements the permitted activity
and investment authorities provided for under section 13(d)(1) of the
BHC Act related to covered fund activities and investments, as well as
the rule of construction related to the sale and securitization of
loans under section 13(g)(2) of that Act. Additionally, subpart C
contains a discussion of the internal controls, reporting and
recordkeeping requirements applicable to covered fund activities and
investments, and incorporates by reference the minimum compliance
standards for banking entities contained in subpart D of the proposed
rule, as well as Appendix C, to the extent applicable.
---------------------------------------------------------------------------

    \216\ See 12 U.S.C. 1851(a)(1)(B).
---------------------------------------------------------------------------

1. Section --.10: Prohibition of Acquisition or Retention of Ownership
Interests in, and Certain Relationships With, a Covered Fund
    Section --.10 of the proposed rule defines the scope of the
prohibition on acquisition or retention of ownership interests in, and
certain relationships with, a covered fund, as well as defines a number
of key terms related to such prohibition.
a. Prohibition Regarding Covered Fund Activities and Investments
    Section --.10(a) of the proposed rule implements section
13(a)(1)(B) of the BHC Act and prohibits a banking entity from, as
principal, directly or indirectly, acquiring or retaining an equity,
partnership, or other ownership interest in, or acting as sponsor to, a
covered fund, unless otherwise permitted under subpart C of the
proposed rule.\217\ This prohibition reflects the statute's purpose and
effect of limiting a banking entity's ability to invest in or have
exposure to a covered fund.
---------------------------------------------------------------------------

    \217\ See proposed rule Sec.  --.10(a).
---------------------------------------------------------------------------

    The Agencies note that the general prohibition in Sec.  --.10(a) of
the proposed rule applies solely to a banking entity's acquisition or
retention of an ownership interest in or acting as sponsor to a covered
fund ``as principal, directly or indirectly.'' \218\ As such, the
proposed rule would not prohibit the acquisition or retention of an
ownership interest (including a general partner or membership interest)
in a covered fund: (i) By a banking entity in good faith in a fiduciary
capacity, except where such ownership interest is held under a trust
that constitutes a company as defined in section (2)(b) of the BHC Act;
(ii) by a banking entity in good faith in its capacity as a custodian,
broker, or agent for an unaffiliated third party; (iii) by a
``qualified plan,'' as that term is defined in section 401 of the
Internal Revenue Code of 1956 (26 U.S.C. 401), if the ownership
interest would be attributed to a banking entity solely by operation of
section 2(g)(2) of the BHC Act; or (iv) by a director or employee of a
banking entity who acquires the interest in his or her personal
capacity and who is directly engaged in providing advisory or other
services to the covered fund, unless the banking entity, directly or
indirectly, extended credit for the purpose of enabling the director or
employee to acquire the ownership interest in the fund and the credit
was used to acquire such ownership interest in the fund.
---------------------------------------------------------------------------

    \218\ The Agencies note that this language is intended to
prevent a banking entity from evading the restrictions contained in
section 13(a)(1)(B) of the BHC Act on acquiring or retaining an
ownership interest in a covered fund.
---------------------------------------------------------------------------

    Among other things, Sec.  --.10(b) of the proposed rule defines the
term ``covered fund.'' \219\ This definition explains the universe of
entities to which the

prohibition contained in Sec.  --.10(a) applies unless the activity is
specifically permitted under an available exemption contained in
subpart C of the proposed rule. Other related terms, including
``ownership interest,'' ``prime brokerage transaction,'' ``sponsor,''
and ``trustee,'' are in turn defined in Sec. Sec.  --.10(b)(2) through
--.10(b)(6) of the proposed rule.
---------------------------------------------------------------------------

    \219\ See proposed rule Sec.  --.10(b)(1). The term banking
entity, which is discussed above in Part III.A.2 of this
Supplementary Information, is defined in Sec.  --.2(e).
---------------------------------------------------------------------------

b. ``Covered Fund'' and Related Definitions
i. Definition of ``Covered Fund''
    Section 13(h)(2) of the BHC Act defines the terms ``hedge fund''
and ``private equity fund'' to mean ``any issuer that would be an
investment company, as defined in the [Investment Company Act], but for
section 3(c)(1) or 3(c)(7) of that Act,'' or such similar funds as the
Agencies may by rule determine.\220\ Given that the statute defines a
``hedge fund'' and ``private equity fund'' synonymously, the proposed
rule implements this statutory definition by combining the terms into
the definition of a ``covered fund.'' \221\
---------------------------------------------------------------------------

    \220\ 12 U.S.C. 1851(h)(2). Sections 3(c)(1) and 3(c)(7) of the
Investment Company Act, in relevant part, provide two exclusions
from the definition of ``investment company'' for, as appropriate,
(1) any issuer whose outstanding securities are beneficially owned
by not more than one hundred persons and which is not making and
does not presently propose to make a public offering of its
securities (other than short-term paper), or (2) any issuer, the
outstanding securities of which are owned exclusively by persons
who, at the time of acquisition of such securities, are qualified
purchasers, and which is not making and does not at that time
proposes to make a public offering of such securities. See 15 U.S.C.
80a-3(c)(1) and (c)(7).
    \221\ See proposed rule Sec.  --.10(b)(1).
---------------------------------------------------------------------------

    Sections 3(c)(1) and 3(c)(7) of the Investment Company Act are
exclusions from the definition of ``investment company'' in that Act
and are commonly relied on by a wide variety of entities that would
otherwise be covered by the broad definition of ``investment company''
contained in that Act. As a result, the statutory definition in section
13(h)(2) of the BHC Act could potentially include within its scope many
entities and corporate structures that would not usually be thought of
as a ``hedge fund'' or ``private equity fund.'' For instance, joint
ventures, acquisition vehicles, certain wholly-owned subsidiaries, and
other widely-utilized corporate structures typically rely on the
exclusion contained in section 3(c)(1) or 3(c)(7) of the Investment
Company Act. These types of entities are generally not used to engage
in investment or trading activities. Additionally, as noted in Part
II.G of this Supplementary Information, certain securitization vehicles
may be included in this definition.
    The proposed rule follows the scope of the statutory definition by
covering an issuer only if it would be an investment company, as
defined in the Investment Company Act, but for section 3(c)(1) or
3(c)(7) of that Act.\222\ Additionally, the proposed rule incorporates
the statutory application of the rule to ``such similar funds as the
Agencies may determine by rule as provided in section 13(b)(2) of the
BHC Act.'' \223\ The Agencies have proposed to include as ``similar
funds'' a commodity pool,\224\ as well as the foreign equivalent of any
entity identified as a ``covered fund.'' \225\ These entities have been
included in the proposed rule as ``similar funds'' given that they are
generally managed and structured similar to a covered fund, except that
they are not generally subject to the Federal securities laws due to
the instruments in which they invest or the fact that they are not
organized in the United States or one or more States.
---------------------------------------------------------------------------

    \222\ See proposed rule Sec.  --.10(b)(1)(i). Under the proposed
rule, if an issuer (including an issuer of asset-backed securities)
may rely on another exclusion or exemption from the definition of
``investment company'' under the Investment Company Act other than
the exclusions contained in section 3(c)(1) or 3(c)(7) of that Act,
it would not be considered a covered fund, as long as it can satisfy
all of the conditions of an alternative exclusion or exemption for
which it is eligible.
    \223\ 12 U.S.C. 1851(b)(2).
    \224\ ``Commodity pool'' is defined in the Commodity Exchange
Act to mean any investment trust, syndicate, or similar form of
enterprise operated for the purpose of trading in commodity
interests, including any: (i) Commodity for future delivery,
security futures product, or swap; (ii) agreement, contract, or
transaction described in section 2(c)(2)(C)(i) or 2(c)(2)(D)(i) of
the Commodity Exchange Act; (iii) commodity option authorized under
section 4c of the Commodity Exchange Act; or (iv) leverage
transaction authorized under section 23 of the Commodity Exchange
Act. See 7 U.S.C. 1a(10).
    \225\ See proposed rule Sec.  --.10(b)(1)(iii). The proposed
rule makes clear that any issuer, as defined in section 2(a)(22) of
the Investment Company Act, (15 U.S.C. 80a-2(a)(22)), that is
organized or offered outside of the United States, would qualify as
a covered fund if, were it organized or offered under the laws, or
offered for sale or sold to a resident, of the United States or of
one or more States, it would be either: (i) An investment company,
as defined in the Investment Company Act, but for section 3(c)(1) or
3(c)(7) of that Act; (ii) a commodity pool; or (iii) any such
similar fund as the appropriate Federal banking agencies, the SEC,
and the CFTC may determine, by rule, as provided in section 13(b)(2)
of the BHC Act.
---------------------------------------------------------------------------

ii. Definition of ``Ownership Interest''
    The proposed rule defines ``ownership interest'' in order to make
clear the scope of section 13(a)(1)(B) of the BHC Act and Sec.
--.10(a)'s prohibition on a banking entity acquiring or retaining any
equity, partnership, or other ownership interest in a covered fund. The
definition of ownership interest includes a description of what
interests constitute an ownership interest, as well as an exclusion
from the definition of ownership interest for carried interest.\226\
The proposed rule defines ownership interest to mean, with respect to a
covered fund, any equity, partnership, or other similar interest
(including, without limitation, a share, equity security, warrant,
option, general partnership interest, limited partnership interest,
membership interest, trust certificate, or other similar interest) in a
covered fund, whether voting or nonvoting, as well as any derivative of
such interest. This definition focuses on the attributes of the
interest and whether it provides a banking entity with economic
exposure to the profits and losses of the covered fund, rather than its
form. To the extent that a debt security or other interest of a covered
fund exhibits substantially the same characteristics as an equity or
other ownership interest (e.g., provides the holder with voting rights,
the right or ability to share in the covered fund's profits or losses,
or the ability, directly or pursuant to a contract or synthetic
interest, to earn a return based on the performance of the fund's
underlying holdings or investments), the Agencies could consider such
instrument an ownership interest as an ``other similar instrument.''
---------------------------------------------------------------------------

    \226\ See proposed rule Sec.  --.10(b)(3).
---------------------------------------------------------------------------

    Many banking entities that serve as investment adviser or commodity
trading advisor to a covered fund are compensated for services they
provide to the fund through receipt of so-called ``carried interest.''
In recognition of the manner in which such compensation is
traditionally provided, the proposed rule also clarifies that an
ownership interest with respect to a covered fund does not include an
interest held by a banking entity (or an affiliate, subsidiary or
employee thereof) in a covered fund for which the banking entity (or an
affiliate, subsidiary or employee thereof) serves as investment
manager, investment adviser or commodity trading advisor, so long as:
(i) The sole purpose and effect of the interest is to allow the banking
entity (or the affiliate, subsidiary or employee thereof) to share in
the profits of the covered fund as performance compensation for
services provided to the covered fund by the banking entity (or the
affiliate, subsidiary or employee thereof), provided that the banking
entity (or the affiliate, subsidiary or employee thereof) may be
obligated under the terms of such interest to return profits previously
received; (ii) all such profit, once allocated, is distributed to the
banking entity (or the affiliate, subsidiary or

employee thereof) promptly after being earned or, if not so
distributed, the reinvested profit of the banking entity (or the
affiliate, subsidiary or employee thereof) does not share in the
subsequent profits and losses of the covered fund; (iii) the banking
entity (or the affiliate, subsidiary or employee thereof) does not
provide funds to the covered fund in connection with acquiring or
retaining this carried interest; and (iv) the interest is not
transferable by the banking entity (or the affiliate, subsidiary or
employee thereof) except to an affiliate or subsidiary.\227\ The
proposed rule therefore permits a banking entity to receive an interest
as performance compensation for services provided by it or one of its
affiliates, subsidiaries, or employees to a covered fund, but only if
the enumerated conditions are met.
---------------------------------------------------------------------------

    \227\ See proposed rule Sec.  --.10(b)(3)(ii).
---------------------------------------------------------------------------

iii. Definition of ``Prime Brokerage Transaction''
    Section 13(f)(3) of the BHC Act permits a banking entity to enter
into a prime brokerage transaction with a covered fund in which a
covered fund managed, organized, or sponsored by such banking entity
(or an affiliate or subsidiary thereof) has taken an ownership
interest.\228\ However, section 13 of the BHC Act does not define what
qualifies as a prime brokerage transaction. In order to provide clarity
regarding the types of services and relationships that are permitted as
a prime brokerage transaction, the proposed rule defines a ``prime
brokerage transaction'' to mean one or more products or services
provided by a banking entity to a covered fund, such as custody,
clearance, securities borrowing or lending services, trade execution,
or financing, data, operational, and portfolio management support.\229\
---------------------------------------------------------------------------

    \228\ See 12 U.S.C. 1851(f)(3).
    \229\ See proposed rule Sec.  --.10(b)(4).
---------------------------------------------------------------------------

iv. Definition of ``Sponsor'' and ``Trustee''
    The proposed rule defines ``sponsor'' in the same manner as section
13(h)(5) of the BHC Act.\230\ Section --.10(b)(5) of the proposed rule
defines the term ``sponsor'' as an entity that: (i) Serves as a general
partner, managing member, trustee, or commodity pool operator of a
covered fund; (ii) in any manner selects or controls (or has employees,
officers, or directors, or agents who constitute) a majority of the
directors, trustees, or management of a covered fund; or (iii) shares
with a covered fund, for the corporate, marketing, promotional, or
other purposes, the same name or a variation of the same name.\231\
---------------------------------------------------------------------------

    \230\ See 12 U.S.C. 1851(h)(5).
    \231\ See proposed rule Sec.  --.10(b)(5).
---------------------------------------------------------------------------

    The definition of ``sponsor'' contained in section 13(h)(5) of the
BHC Act focuses on the ability to control the decision-making and
operational functions of the fund. In keeping with this focus, the
proposed rule defines the term ``trustee'' (which is a part of the
definition of ``sponsor'') to exclude trustee that does not exercise
investment discretion with respect to a covered fund, including a
directed trustee, as that term is used in section 403(a)(1) of the
Employee's Retirement Income Security Act (29 U.S.C. 1103(a)(1)). The
proposed rule provides that a ``trustee'' includes any banking entity
that directs a directed trustee, or any person who possesses authority
and discretion to manage and control the assets of the covered
fund.\232\
---------------------------------------------------------------------------

    \232\ See proposed rule Sec.  --.10(b)(6)(ii).
---------------------------------------------------------------------------

v. Request for Comment
    The Agencies request comment on the proposed rule's approach to
defining the terms covered fund, ownership interest, and other related
terms. In particular, the Agencies request comment on the following
questions:
    Question 215. Is the proposed rule's approach to applying section
13 of the BHC Act's restrictions related to covered fund activities and
investments to those instances where a banking entity acts ``as
principal or beneficial owner'' effective? If not, why? What
alternative approach might be more effective in light of the language
and purpose of the statute?
    Question 216. Does the proposed rule effectively address the
circumstances under which an investment by a director or employee of a
banking entity in a covered fund would be attributed to a banking
entity? If not, why? What alternative might be more effective?
    Question 217. Does the proposed rule's definition of ``covered
fund'' effectively implement the statute? What alternative definitions
might be more effective in light of the language and purpose of the
statute?
    Question 218. Is specific inclusion of commodity pools within the
definition of ``covered fund'' effective and consistent with the
language and purpose of the statute? Why or why not?
    Question 219. The proposed definition of ``sponsor'' focuses on
``the ability to control the decision-making and operational functions
of the fund.'' In the securitization context, is this an appropriate
manner to determine the identity of the sponsor? If not, what factors
should be used to determine the identity of the sponsor in the
securitization context for purposes of the proposed rule and why? Is
the definition of ``sponsor'' set forth in the SEC's Regulation AB
\233\ an appropriate party to treat as sponsor for purposes of the
proposed rule? Is additional guidance necessary with respect to how the
proposed definition of ``sponsor'' should be applied to a
securitization transaction?
---------------------------------------------------------------------------

    \233\ See 17 CFR 229.1101(l).
---------------------------------------------------------------------------

    Question 220. Should the application of the proposed definition of
``sponsor'' mean that the servicer or investment manager in a
securitization transaction would be considered the sponsor for purposes
of the proposed rule? What impact would this interpretation of the
proposed definition have on existing securitizations?
    Question 221. Should the definition of ``covered fund'' focus on
the characteristics of an entity rather than whether it would be an
investment company but for section 3(c)(1) or 3(c)(7) of the Investment
Company Act? If so, what characteristics should be considered and why?
Would a definition focusing on an entity's characteristics rather than
its form be consistent with the language and purpose of the statute?
    Question 222. Instead of adopting a unified definition of ``covered
fund'' for those entities included under section 13(h)(2) of the BHC
Act, should the Agencies consider having separate definitions for
``hedge fund'' and ``private equity fund''? If so, which definitions
and why?
    Question 223. Should the Agencies consider using the authority
provided under section 13(d)(1)(J) of the BHC Act to exempt the
acquisition or retention of an ownership interest in a covered fund
with certain attributes or characteristics, including, for example: (i)
A performance fee or allocation to an investment manager's equity
account calculated by taking into account income and realized and
unrealized gains; (ii) borrowing an amount in excess of one-half of its
total capital commitments or has gross notional exposure in excess of
twice its total capital commitments; (iii) sells securities or other
assets short; (iv) has restricted or limited investor redemption
rights; (v) invests in public and non-public companies through
privately negotiated transactions resulting in private ownership of the
business; (vi) acquires the unregistered equity or equity-like
securities of such companies that are illiquid as there is

no public market and third party valuations are not readily available;
(vii) requires holding those investments long-term; (viii) has a
limited duration of ten years or less; or (ix) returns on such
investments are realized and the proceeds of the investments are
distributed to investors before the anticipated expiration of the
fund's duration? Which, if any, of these characteristics are
appropriate to describe a hedge fund or private equity fund that should
be considered a covered fund for purposes of this rule? Are there any
other characteristics that would be more appropriate to describe a
covered fund? If so, which characteristics and why?
    Question 224. Is specific inclusion of certain non-U.S. entities as
a ``covered fund'' under Sec.  --.10(b)(1)(iii) of the proposed rule
necessary, or would such entities already be considered to be a
``covered fund'' under Sec.  --.10(b)(1)(i) of the proposed rule? If
so, why? Does the proposed rule's language on non-U.S. entities
correctly describe those non-U.S. entities, if any, that should be
included in the definition of ``covered fund''? Why or why not? What
alternative language would be more effective? Should we define non-U.S.
funds by reference to the following structural characteristics: whether
they are limited in the number or type of investors; whether they
operate without regard to statutory or regulatory requirements relating
to the types of instruments in which they may invest or the degree of
leverage they may incur? Why or why not?
    Question 225. Are there any entities that are captured by the
proposed rule's definition of ``covered fund,'' the inclusion of which
does not appear to be consistent with the language and purpose of the
statute? If so, which entities and why?
    Question 226. Are there any entities that are not captured by the
proposed rule's definition of ``covered fund,'' the exclusion of which
does not appear to be consistent with the language and purpose of the
statute? If so, which entities and why?
    Question 227. Do the proposed rule's definitions of ``covered
fund'' and/or ``ownership interest'' pose unique concerns or challenges
to issuers of asset-backed securities and/or securitization vehicles?
If so, why? Do certain types of securitization vehicles (trusts, LLCs,
etc.) typically issue asset-backed securities which would be included
in the proposed definition of ownership interest? What would be the
impact of the application of the proposed rules to these securitization
vehicles? Are certain asset classes (collateralized debt obligations,
future flows, corporate debt repackages, etc.) more likely to be
impacted by the proposed definition of ``covered fund'' because the
issuer cannot rely on an exemption other than 3(c)(1) or 3(c)(7) of the
Investment Company Act?
    Question 228. How many existing issuers of asset-backed securities
would be included in the proposed definition of ``covered fund?'' What
would be the legal and economic impact of the proposed rule on holders
of asset-backed securities issued by existing securitization vehicles
that would be included in the proposed definition of covered fund?
    Question 229. Are there entities that issue asset-backed securities
(as defined in Section 3(a) of the Exchange Act) that should be
exempted from the requirements of the proposed rule? How would such an
exemption promote and protect the safety and soundness of the banking
entity and the financial stability of the United States as required by
section 13(d)(1)(J) of the BHC Act?
    Question 230. Since certain existing asset-backed securities may
have a term that exceeds the conformance or extended transition periods
provided for under section 13(c) of the BHC Act, should the Agencies
consider using the authority contained in section 13(d)(1)(J) of that
Act to exclude those existing asset-backed securities from the proposed
definition of ``ownership interest'' and/or should the rule permit a
banking entity to acquire or retain an ownership interest in existing
asset-backed issuers? If so, how would either approach be consistent
with the language and purpose of the statute?
    Question 231. Many issuers of asset-backed securities have features
and structures that resemble some of the features of hedge funds and
private equity funds (e.g., CDOs are managed by an investment adviser
that has the discretion to choose investments, including investments in
securities). If the proposed definition of ``covered fund'' were to
exempt any entity issuing asset-backed securities, would this allow for
interests in hedge funds or private equity funds to be structured as
asset-backed securities and circumvent the proposed rule? If this
approach is taken, how should the proposal address this concern?
    Question 232. Are the structural similarities between an entity
that issues asset-backed securities and hedge funds and private equity
funds of sufficient concern that the Agencies should not exclude any
entity that issues asset-backed securities from the definition of
covered fund?
    Question 233. Should entities that rely on a separate exclusion
from the definition of investment company other than sections 3(c)(1)
or 3(c)(7) of the Investment Company Act be included in the definition
of ``covered fund''? Why or why not?
    Question 234. Do the proposed rule's definitions of ``ownership
interest'' and ``carried interest'' effectively implement the statute?
What alternative definitions might be more appropriate in light of the
language and purpose of the statute? Are there other types of
instruments that should be included or excluded from the definition of
``ownership interest''? Does the proposed definition of ownership
interest capture most interests that are typically viewed as ownership
interests? Is the proposed rule's exemption of carried interest from
the definition of ownership interest with respect to a covered fund
appropriate? Does the exemption adequately address existing
compensation arrangements and the way in which a banking entity becomes
entitled to carried interest? Is it consistent with the current tax
treatment of these arrangements?
    Question 235. In the context of asset-backed securities, the
distinction between debt and equity may be complicated (e.g., trust
certificates issued in a residential mortgage backed security
transaction) and the legal, accounting and tax treatment may differ for
the same instrument. Is guidance necessary with respect to the
application of the definition of ownership interest for asset-backed
securitization transactions?
    Question 236. In many securitization transactions, the residual
interest represents the ``equity'' in the transaction. As this often
constitutes the portion of the securitization transaction with the most
risk, because it may absorb any losses experienced by the underlying
assets before any other interests issued by the securitization vehicle,
should the Agencies instead use their authority under section
13(d)(1)(J) of the BHC Act to exempt the buying and selling of any
ownership interest in a securitization vehicle that is a covered fund
other than the residual interest?
    Question 237. For purposes of limiting either an exclusion for
issuers of asset-backed securities from the proposed definition of
``covered fund'' and/or an exclusion of asset-backed securities from
the proposed definition of ``ownership interest,'' what definition of
asset-backed security most effectively implements the language of
section 13 of the BHC Act? Section 3(a)(77) of the Exchange Act and the
SEC's Regulation

AB \234\ provide two possible definitions. Is either of these
definitions sufficient, and if so why? If one of the definitions is too
narrow, what additional entities/securities should be included and why?
If one of the definitions is too broad, what entities/securities should
be excluded and why? Would some other definition of asset-backed
security be more consistent with the language and purpose of section 13
of the BHC Act?
---------------------------------------------------------------------------

    \234\ See 17 CFR 229.1101(c).
---------------------------------------------------------------------------

    Question 238. Are there special concerns raised by not including as
an ownership interest the residual interests in a securitization
vehicle? Should the Agencies instead exempt the buying and selling of
any ownership interest in a securitization vehicle that is a covered
fund other than the residual interest?
    Question 239. Should the legal form of a beneficial interest be a
determining factor for deciding whether a beneficial interest is an
``ownership interest''? For example, should pass-through trust
certificates issued as part of a securitization transaction be excluded
from the definition of ``ownership interest''? Should the definition of
ownership interest explicitly include debt instruments with equity
features (e.g., voting rights, profit participations, etc.)?
    Question 240. How should the proposed rule address those instances
in which both debt and equity interests are issued, and the debt
interests receive all of the economic benefits and all of the control
rights? Should the debt interests (other than the residual interest) be
counted as ownership interests even though they are not legally
ownership and do not receive any profit participation? Should the
equity interests be counted as ownership interests even though the
holder does not receive economic benefits or have any control rights?
Should the residual interest be considered the only ``ownership
interest'' for purposes of the proposed rule? Should mezzanine
interests that lack both control rights and profit participation be
considered an ownership interest? If the mezzanine interests obtain
control rights (because more senior classes have been repaid), should
they become ``ownership interests'' at that time for purposes of the
proposed rule? If both debt and equity interests are counted as
ownership interests, how should percentages of ownership interests be
calculated when the units of measurement do not match (e.g., a single
trust certificate, a single residual certificate with no face value and
multiple classes of currency-denominated notes)?
    Question 241. Does the proposed rule's definition of ``prime
brokerage transaction'' effectively implement the statute? What other
types of transactions or services, if any, should be included in the
definition? Should any types of transactions or services be excluded
from the definition? Would an alternative definition be more effective,
and if so, why?
    Question 242. Do the proposed rule's definitions of ``sponsor'' and
``trustee'' effectively implement the statute? Is the exclusion of
``directed trustee'' from the definition of ``trustee'' appropriate?
    Question 243. Do the proposed rule's other definitions in Sec.
--.10(b) effectively implement the statute? What alternative
definitions might be more effective in light of the language and
purpose of the statute? Are additional definitions needed, and if so,
what definition(s)?
2. Section --.11: Permitted Organizing and Offering of a Covered Fund
    Section --.11 of the proposed rule implements section 13(d)(1)(G)
of the BHC Act and permits a banking entity to organize and offer a
covered fund, including acting as sponsor of the fund, if certain
criteria are met.\235\ This exemption is designed to permit a banking
entity to be able to engage in certain traditional asset management and
advisory businesses in compliance with section 13 of the BHC Act.\236\
---------------------------------------------------------------------------

    \235\ See proposed rule Sec.  --.11.
    \236\ 156 Cong. Rec. S5889 (daily ed. July 15, 2010) (statement
of Sen. Hagan).
---------------------------------------------------------------------------

a. Required Criteria for Permitted Organizing and Offering of Covered
Funds
    Section --.11 of the proposed rule provides for and describes the
conditions that must be met in order to enable a banking entity to
qualify for the exemption to organize and offer a covered fund.\237\
These conditions include: (i) The banking entity must provide bona fide
trust, fiduciary, investment advisory, or commodity trading advisory
services;\238\ (ii) the covered fund must be organized and offered only
in connection with the provision of bona fide trust, fiduciary,
investment advisory, or commodity trading advisory services and only to
persons that are customers of such services of the banking entity;
(iii) the banking entity may not acquire or retain an ownership
interest in the covered fund except as permitted under subpart C of the
proposed rule; (iv) the banking entity must comply with the
restrictions governing relationships with covered funds under Sec.
--.16 of the proposed rule; (v) the banking entity may not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of the covered fund or of any covered fund in which such
covered fund invests; (vi) the covered fund, for corporate, marketing,
promotional, or other purposes, (A) may not share the same name or a
variation of the same name with the banking entity(or an affiliate or
subsidiary thereof), and (B) may not use the word ``bank'' in its name;
(vii) no director or employee of the banking entity may take or retain
an ownership interest in the covered fund, except for any director or
employee of the banking entity who is directly engaged in providing
investment advisory or other services to the covered fund; and (viii)
the banking entity must (A) clearly and conspicuously disclose, in
writing, to any prospective and actual investor in the covered fund
(such as through disclosure in the covered fund's offering documents)
the enumerated disclosures contained in Sec.  --.11(h) of the proposed
rule, and (B) comply with any additional rules of the appropriate
Agency or Agencies, designed to ensure that losses in such covered fund
are borne solely by investors in the covered fund and not by the
banking entity.\239\ These requirements are explained in detail below.
---------------------------------------------------------------------------

    \237\ See proposed rule Sec. Sec.  --.11(a)-(h).
    \238\ While section 13(d)(1)(G) of the BHC Act does not
explicitly mention ``commodity trading advisory services,'' the
Agencies have proposed to include commodity pools within the
definition of ``covered fund'' and commodity trading advisory
services in the same way as investment advisory services because
commodity trading advisory services are the functional equivalent of
investment advisory services to commodity pools.
    \239\ See id. at Sec.  --.11(a)-(h). The Agencies are not
proposing any such additional rules at this time, although they may
do so in the future.
---------------------------------------------------------------------------

i. Bona Fide Services
    Section --.11(a) of the proposed rule requires that, in order to
qualify for the exemption related to organizing and offering a covered
fund, a banking entity provide bona fide trust, fiduciary, investment
advisory, or commodity trading advisory services.\240\ Banking entities
provide a wide range of customer-oriented services which may qualify as
bona fide trust, fiduciary, investment advisory, or commodity trading
advisory services.\241\ Additionally, depending on the type of banking
entity that conducts the activity or provides the service, variations
in the

precise services involved may occur. For example, a national bank and
an SEC-registered investment adviser may provide substantially similar
investment advisory services to clients, but be subject to different
statutory and regulatory requirements. In recognition of potential
variations in services and functional regulation, the proposed rule
does not specify what services would qualify as ``bona fide trust,
fiduciary, investment advisory, or commodity trading advisory
services'' under Sec.  --.11(a) of the proposed rule. Instead, the
proposed rule largely mirrors the statutory language of section
13(d)(1)(G)(i) of the BHC Act and reflects the intention that so long
as a banking entity provides trust, fiduciary, investment advisory, or
commodity trading advisory services in compliance with relevant
statutory and regulatory requirements, the requirement contained in
Sec.  --.11(a) of the proposed rule would generally be deemed to be
satisfied.
---------------------------------------------------------------------------

    \240\ See 12 U.S.C. 1851(d)(1)(G)(i); proposed rule Sec.
--.11(a).
    \241\ See, e.g., 12 U.S.C. 1843(c)(4), (c)(8), (k),12 CFR
225.28(b)(5) and (6), 12 CFR 225.86, 12 CFR 225.125 (with respect to
a bank holding company); 12 U.S.C. 24 (Seventh), 92a, 12 CFR Part 9
(with respect to a national bank); 12 U.S.C. 1831a, 12 CFR Part 362
(with respect to a state nonmember bank).
---------------------------------------------------------------------------

ii. ``Customers of Such Services'' Requirement
    Section 13(d)(1)(G)(ii) of the BHC Act requires that a banking
entity organize and offer a covered fund ``only in connection with''
the provision of qualified services to persons that are customers of
such services of the banking entity.\242\ Section --.11(b) of the
proposed rule implements the statute and reflects the statutory
requirement that there are two independent conditions contained in
section 13(d)(1)(G)(ii) of the BHC Act: (i) A covered fund must be
organized and offered in connection with bona fide trust, fiduciary,
investment advisory, or commodity trading advisory services, and (ii)
the banking entity providing those services may offer the covered fund
only to persons that are customers of those services of the banking
entity.\243\ Requiring a customer relationship in connection with
organizing and offering a covered fund helps to ensure that a banking
entity is engaging in the covered fund activity for others and not on
the banking entity's own behalf.\244\
---------------------------------------------------------------------------

    \242\ See 12 U.S.C. 1851(d)(1)(G)(ii).
    \243\ See proposed rule Sec.  --.11(b).
    \244\ See 156 Cong. Rec. at S5897 (daily ed. July 15, 2010)
(statement of Sen. Merkley).
---------------------------------------------------------------------------

    Section 13(d)(1)(G)(ii) of the BHC Act does not explicitly require
that the customer relationship be pre-existing. Accordingly, the
proposed rule provides that it may be established through or in
connection with the banking entity's organization and offering of a
covered fund, so long as that fund is a manifestation of the provision
by the banking entity of bona fide trust, fiduciary, investment
advisory or commodity trading advisory services to the customer. This
application of the customer requirements is consistent with the manner
in which trust, fiduciary, investment advisory, and commodity trading
advisory services are provided by banking entities. Historically,
banking entities have raised capital commitments for covered funds from
existing customers as well as individuals or entities that have no pre-
existing relationship with the banking entity.
    Banking entities commonly organize and offer funds to customers of
the banking entity's trust, fiduciary, and investment advisory or
commodity trading advisory services as a way of ensuring the efficient
and consistent provision of these services. For example, a person often
obtains the investment advisory services of the banking entity by
acquiring an interest in a fund organized and offered by the banking
entity. This is distinguished from a fund organized and offered by a
banking entity for the purpose of itself investing as principal,
indirectly through its investment in the fund, in assets held by the
fund. Under the proposed rule, a banking entity could, consistent with
past practice, provide a covered fund to persons that are customers of
such services for purposes of the exemption so long as the fund is
organized and offered as a means of providing bona fide trust,
fiduciary, investment advisory, or commodity trading advisory services
to customers. The banking entity may not organize and offer a covered
fund as a means of itself investing in the fund or assets held in the
fund.\245\
---------------------------------------------------------------------------

    \245\ The proposed rule does not change any requirement imposed
by separate statute, regulation, or other law, if applicable. For
instance, a banking entity that conducts a private placement of a
covered fund pursuant to the SEC's Regulation D pertaining to
private offerings would still be expected to comply with the
relevant requirements related to such offering, including the
limitations related to the manner in which and types of persons to
whom it may offer or sell interests in such fund. See 12 CFR 230.501
et seq.
---------------------------------------------------------------------------

    The Agencies note that a banking entity could, through organizing
and offering a covered fund pursuant to the authority contained in
Sec.  --.11 of the proposed rule that itself makes investments or
engages in trading activity, seek to evade the restrictions contained
in section 13 of the BHC Act and the proposed rule. In order to address
these concerns, the proposed rule provides that a banking entity
relying on the authority contained in Sec.  --.11 must organize and
offer a covered fund pursuant to a credible plan or similar
documentation outlining how the banking entity intends to provide
advisory or similar services to its customers through organizing and
offering such fund.
iii. Compliance With Investment Limitations
    Section 13(d)(1)(G)(iii) of the BHC Act limits the ability of a
banking entity that organizes and offers a covered fund to acquire or
retain an ownership interest in that covered fund.\246\ Separately,
other provisions of section 13 of the BHC Act provide independent
exemptions which permit a banking entity to acquire or retain an
ownership interest in a covered fund.\247\ Section --.11(c) of the
proposed rule incorporates these statutory provisions by prohibiting a
banking entity from acquiring or retaining an ownership interest in a
covered fund that it organizes and offers except as permitted under
subpart C of the proposed rule.\248\ The limits on a banking entity's
ability to invest in a covered fund that it organizes and offers are
described in Sec.  --.12 of the proposal.
---------------------------------------------------------------------------

    \246\ See 12 U.S.C. 1851(d)(1)(G)(iii).
    \247\ See, e.g., id. at 1851(d)(1)(C).
    \248\ See proposed rule Sec.  --.11(c).
---------------------------------------------------------------------------

iv. Compliance With Section 13(f) of the BHC Act
    Section --.11(d) of the proposed rule requires that the banking
entity comply with the limitations on certain relationships with
covered funds.\249\ These limitations apply in several contexts, and
are contained in Sec.  --.16 of the proposed rule, discussed in detail
below. In general, Sec.  --.16 of the proposed rule prohibits certain
transactions or relationships that would be covered by section 23A of
the FR Act, and provides that any permitted transaction is subject to
section 23B of the FR Act, in each instance as if such banking entity
were a member bank and such covered fund were an affiliate
thereof.\250\
---------------------------------------------------------------------------

    \249\ 12 U.S.C. 1851(d)(1)(G)(iv); proposed rule Sec.  --.11(d).
    \250\ See Supplementary Information, Part III.C.7.
---------------------------------------------------------------------------

v. No Guarantees or Insurance of Fund Performance
    Section --.11(e) of the proposed rule prohibits the banking entity
from, directly or indirectly, guaranteeing, assuming or otherwise
insuring the obligations or performance of the covered fund or any
covered fund in which such covered fund invests.\251\

This prong implements section 13(d)(1)(G)(iv) of the BHC Act and is
intended to prevent a banking entity from engaging in bailouts of a
covered fund in which it has an interest.\252\
---------------------------------------------------------------------------

    \251\ 12 U.S.C. 1851(d)(1)(G)(v); proposed rule Sec.  --.11(e).
    \252\ See 156 Cong. Rec. S5897 (daily ed. July 15, 2010)
(statement of Sen. Merkley).
---------------------------------------------------------------------------

vi. Limitation on Name Sharing With a Covered Fund
    Section --.11(f) of the proposed rule prohibits the covered fund
from sharing the same name or a variation of the same name with the
banking entity, for corporate, marketing, promotional, or other
purposes.\253\ This section implements section 13(d)(1)(G)(v) of the
BHC Act and addresses the concern that name-sharing could undermine
market discipline and encourage a banking entity to bail out a covered
fund it organizes and offers in order to preserve the entity's
reputation.\254\ Thus, under Sec.  --.11(f) of the proposed rule, a
covered fund would be prohibited from sharing the same name or
variation of the same name with a banking entity that organizes and
offers or serves as sponsor to that fund (or an affiliate or subsidiary
of such banking entity). A covered fund would also be prohibited under
the proposed rule from using the word ``bank'' in its name.\255\
---------------------------------------------------------------------------

    \253\ 12 U.S.C. 1851(d)(1)(G)(vi); proposed rule Sec.  --.11(f).
    \254\ 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (statement
of Sen. Merkley).
    \255\ Similar restrictions on a fund sharing the same name, or
variation of the same name, with an insured depository institution
or company that controls an insured depository institution or having
the word ``bank'' in its name, have been used previously in order to
prevent customer confusion regarding the relationship between such
companies and a fund. See, e.g., Bank of Ireland, 82 Fed. Res. Bull.
1129 (1996).
---------------------------------------------------------------------------

vii. Limitation on Ownership by Directors and Employees
    Section --.11(g) of the proposed rule implements section
13(d)(1)(G)(vii) of the BHC Act. The provision prohibits any director
or employee of the banking entity from acquiring or retaining an
ownership interest in the covered fund, except for any director or
employee of the banking entity who is directly engaged in providing
investment advisory or other services to the covered fund.\256\ This
allows an individual acting as fund manager or adviser and employed by
a banking entity to acquire or retain an ownership interest in a
covered fund that aligns the manager or adviser's incentives with those
of its customers by allowing the individual to have ``skin in the
game'' with respect to a covered fund for which that individual
provides management or advisory services (which customers or clients
often request).\257\
---------------------------------------------------------------------------

    \256\ See 12 U.S.C. 1851(d)(1)(G)(vii); proposed rule Sec.
--.11(g).
    \257\ See 156 Cong. Rec. S5897 (daily ed. July 15, 2010)
(statement of Sen. Merkley).
---------------------------------------------------------------------------

    The Agencies recognize that director or employee investments in a
covered fund may provide an opportunity for a banking entity to evade
the limitations regarding the amount or value of ownership interests a
banking entity may acquire or retain in a covered fund or funds
contained in section 13(d)(4) of the BHC Act and Sec.  --.12 of the
proposed rule. In order to address this concern, the proposed rule
would generally attribute an ownership interest in a covered fund
acquired or retained by a director or employee to such person's
employing banking entity, if the banking entity either extends credit
for the purpose of allowing the director or employee to acquire such
ownership interest, guarantees the director or employee's purchase, or
guarantees the director or employee against loss on the investment.
viii. Disclosure Requirements
    Section --.11(h) of the proposed rule requires that, in connection
with organizing and offering a covered fund, the banking entity (i)
clearly and conspicuously disclose, in writing, to prospective and
actual investors in the covered fund (such as through disclosure in the
covered fund's offering documents) that ``any losses in [such covered
fund] will be borne solely by investors in [the covered fund] and not
by [the banking entity and its affiliates or subsidiaries]; therefore,
[the banking entity's and its affiliates' or subsidiaries'] losses in
[such covered fund] will be limited to losses attributable to the
ownership interests in the covered fund held by [the banking entity and
its affiliates or subsidiaries] in their capacity as investors in [the
covered fund],'' and (ii) comply with any additional rules of the
appropriate Agency as provided in section 13(b)(2) of the BHC Act
designed to ensure that losses in any such covered fund are borne
solely by the investors in the covered fund and not by the banking
entity.\258\ The proposed rule also provides, as an additional
disclosure requirement related to organizing and offering a covered
fund, that a banking entity clearly and conspicuously disclose, in
writing, to any prospective and actual investor (such as through
disclosure in the covered fund's offering documents): (i) That such
investor should read the fund offering documents before investing in
the covered fund; (ii) that the ``ownership interests in the covered
fund are not insured by the FDIC, and are not deposits, obligations of,
or endorsed or guaranteed in any way, by any banking entity'' (unless
that happens to be the case); and (iii) the role of the banking entity
and its affiliates, subsidiaries, and employees in sponsoring or
providing any services to the covered fund. As noted above, the
proposed rule clarifies that a banking entity may satisfy the
requirements of this prong with respect to a covered fund by making the
required disclosures, in writing, in the covered fund's offering
documents.\259\
---------------------------------------------------------------------------

    \258\ 12 U.S.C. 1851(d)(1)(G)(viii); proposed rule Sec.
--.11(h).
    \259\ As contemplated in Sec.  --.11(a)(8)(ii) of the proposed
rule, to the extent that any additional rules are issued to ensure
that losses in a covered fund are borne solely by the investors in
the covered fund and not by the banking entity, a banking entity
would be required to comply with those as well in order to satisfy
the requirements of section 13(d)(1)(G)(viii) of the BHC Act.
---------------------------------------------------------------------------

ix. Request for Comment
    The Agencies request comment on the proposed rule's approach with
respect to implementing the exemption permitting banking entities to
organize and offer a covered fund. In particular, the Agencies request
comment on the following questions:
    Question 244. Is the proposed rule's approach to implementing the
exemption for organizing and offering a covered fund effective? If not,
what alternative approach would be more effective and why?
    Question 245. Should the approach include other elements? If so,
what elements and why? Should any of the proposed elements be revised
or eliminated? If so, why and how?
    Question 246. Is the proposed rule's approach to implementing the
scope of bona fide trust, fiduciary, investment advisory and commodity
trading advisory services consistent with the statute? If not, what
alternative approach would be more effective? Should the scope of such
services be broader or, in the alternative, more limited? Are there
specific services which should be included but which are not currently
under the proposed rule?
    Question 247. Does the proposed rule effectively implement the
``customers of such services'' requirement? If not, what alternative
approach would be more effective and why? Is the proposed rule's
approach consistent with the statute? Why or why not? How do banking
entities currently sell or provide interests in covered funds? Do
banking entities rely on a concept of ``customer'' by reference to
other laws or

regulations, and if so, what laws or regulations?
    Question 248. Does the proposed rule effectively and clearly
recognize the manner in which banking entities provide trust,
fiduciary, investment advisory, or commodity trading advisory services
to customers? If not, how should the proposed rule be modified to be
more effective or clearer?
    Question 249. Should the Agencies consider adopting a definition of
``customer of such services'' for purposes of implementing the
exemption related to organizing and offering a covered fund? If so,
what criteria should be included in such definition? For example,
should the customer requirement specify that the relationship be pre-
existing? Should the Agencies consider adopting an existing definition
related to ``customer'' and if so, what definitions (for instance, the
SEC's ``pre-existing, substantive relationship'' concept applicable to
private offerings under its Regulation D) would provide for effective
implementation of the customer requirement in section 13(d)(1)(G) of
the BHC Act? If so, why and how? How should the customer requirement be
applied in the context of non-U.S. covered funds? Is there an
equivalent concept used for such non-U.S. covered fund offerings?
    Question 250. Should the Agencies distinguish between direct and
indirect customer relationships for purposes of implementing section
13(d)(1)(G) of the BHC Act? Should the rule differentiate between a
customer relationship established by a customer as opposed to a banking
entity? If so, why?
    Question 251. Does the proposed rule effectively implement the
prohibition on a banking entity guaranteeing or insuring the
obligations or performance of certain covered funds? If not, what
alternative approach would be more effective, and why?
    Question 252. Does the proposed rule effectively implement the
requirement that a banking entity comply with the limitation on certain
relationships with a covered fund contained in Sec.  --.16 of the
proposed rule? If not, what alternative approach would be more
effective, and why?
    Question 253. Does the proposed rule effectively implement the
prohibition on a covered fund sharing the same name or variation of the
same name with a banking entity? If not, what alternative approach
would be more effective and why? Should the prohibition on a covered
fund sharing the same name be limited to specific types of banking
entities (e.g., insured depository institutions and bank holding
companies) or only to the banking entity that organizes and offers the
fund, and if so why?
    Question 254. Does the proposed rule effectively implement the
limitation on director or employee investments in a covered fund
organized and offered by a banking entity? If not, what alternative
approach would be more effective and why? Should the agencies provide
additional guidance on what ``other services'' should be included for
purposes of satisfying Sec.  --.11(g)? Why or why not?
    Question 255. Are the disclosure requirements related to organizing
and offering a covered fund appropriate? If not, what alternative
disclosure requirement(s) should the proposed rule include? Should the
Agencies consider adoption of a model disclosure form related to this
requirement? Does the timing of the proposed disclosure requirement
adequately address disclosure to secondary market purchasers?
3. Section --.12: Permitted Investment in a Covered Fund
    Section --.12 of the proposed rule describes the limited
circumstances under which a banking entity may acquire or retain, as an
investment, an ownership interest in a covered fund that the banking
entity or one of its subsidiaries or affiliates organizes and offers.
This section implements section 13(d)(4) of the BHC Act and related
provisions, and describes the statutory limits on both (i) the amount
and value of an investment by a banking entity in a covered fund, and
(ii) the aggregate value of all investments in all covered funds made
by the banking entity.
    As described below, a banking entity that makes or retains an
investment in a covered fund under Sec.  --.12 of the proposed rule is
generally subject to three principal limitations related to such
investment. First, the banking entity's investment in a covered fund
may not represent more than 3 percent of the total outstanding
ownership interests of such fund (after the expiration of any seeding
period provided under the rule). Second, the banking entity's
investment in a covered fund may not result in more than 3 percent of
the losses of the covered fund being allocable to the banking entity's
investment. Third, a banking entity may invest no more than 3 percent
of its tier 1 capital in covered funds.\260\
---------------------------------------------------------------------------

    \260\ See, e.g., proposed rule Sec. Sec.  --.12(b)(2), (c).
---------------------------------------------------------------------------

a. Authority and Limitations on Permitted Investments
    Section 13(d)(4) of the BHC Act permits a banking entity to acquire
and retain an ownership interest in a covered fund that the banking
entity organizes and offers pursuant to section 13(d)(1)(G), 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.\261\
Section --.12 of the proposed rule implements this authority and
related limitations.
---------------------------------------------------------------------------

    \261\ See 12 U.S.C. 1851(d)(4).
---------------------------------------------------------------------------

    Consistent with this statutory provision, the proposed rule
requires a banking entity to (i) actively seek unaffiliated investors
to ensure that the banking entity's investment conforms with the limits
of Sec.  --.12, and (ii) reduce through redemption, sale, dilution, or
other methods the aggregate amount and value of all ownership interests
of the banking entity in a single fund held under Sec.  --.12 to an
amount that does not exceed 3 percent of the total outstanding
ownership interests of the fund not later than 1 year after the date of
establishment of the fund (or such longer period as may be provided by
the Board pursuant to Sec.  --.12(e) of the proposed rule) (the ``per-
fund limitation''). Additionally, Sec.  --.12 of the proposed rule
implements the statutory requirement that the aggregate value of all
ownership interests of the banking entity in all covered funds held as
an investment not exceed 3 percent of the tier 1 capital of the banking
entity (the ``aggregate funds limitation'').\262\
---------------------------------------------------------------------------

    \262\ See proposed rule at Sec.  --.12(a)(2)(ii). The process
and manner in which a banking entity's 3 percent tier 1 capital
limit is determined for purposes of the proposed rule is discussed
in detail below in Part III.C.3 of this Supplementary Information.
---------------------------------------------------------------------------

b. Permitted Investment in a Single Covered Fund
    Section --.12(b) of the proposed rule describes the limitations and
restrictions on a banking entity's ability to make or retain an
investment in a single covered fund. This section implements the
requirements of section 13(d)(4) of the BHC Act.\263\
---------------------------------------------------------------------------

    \263\ See 12 U.S.C. 1851(d)(4)(B).
---------------------------------------------------------------------------

    Section --.12 of the proposed rule describes the manner in which
the limitations on the amount and value of ownership interests in a
covered fund must be calculated, in recognition of the fact that a
covered fund may have multiple classes of ownership interests which
possess different characteristics

or values that impact a person's ownership in that fund. A banking
entity must apply the limits to both the total value and amount of its
investment in a covered fund. For purposes of applying these limits,
the banking entity must calculate (without regard to committed funds
not yet called for investment): (i) The value of all investments or
capital contributions made with respect to any ownership interest by
the banking entity in a covered fund, divided by the value of all
investments or capital contributions made by all persons in that
covered fund, and (ii) the total number of ownership interests held as
an investment by the banking entity in a covered fund divided by the
total number of ownership interests held by all persons in that covered
fund.\264\ Therefore, under the proposed rule, such calculation would
include as the numerator the amount or value of a banking entity's
investment in a covered fund, and as the denominator the amount or
value (matched to the unit of measurement in the numerator) of all
classes of ownership interests held by all persons in that covered
fund. As noted above, the banking entity's investment in a covered fund
also may not result in more than 3 percent of the losses of the covered
fund being allocable to the banking entity's investment.\265\
---------------------------------------------------------------------------

    \264\ See proposed rule Sec.  --.12(b)(2).
    \265\ Under the proposed rule, a banking entity's investment in
a covered fund may not result in more than 3 percent of the losses
of the covered fund being allocable to the banking entity's
investment since the banking entity's permitted investment in a
covered fund may be no more than 3 percent of the value and amount
of such fund's total ownership interests, and the banking entity may
not, directly or indirectly, guarantee, assume, or otherwise insure
the obligations or performance of the covered fund. See 12 U.S.C.
1851(d)(1)(G)(v); proposed rule Sec.  --.11(e).
---------------------------------------------------------------------------

    In order to ensure that a banking entity calculates its investment
in a covered fund accurately and does not evade the per-fund investment
limitation, the proposed rule requires that the banking entity must
calculate its investment in the same manner and according to the same
standards utilized by the covered fund for determining the aggregate
value of the fund's assets and ownership interests in the covered
fund.\266\
---------------------------------------------------------------------------

    \266\ See proposed rule Sec.  --.12(b)(4).
---------------------------------------------------------------------------

    Under the proposed rule, the amount and value of a banking entity's
investment in any single covered fund is (i) the total amount or value
held by the banking entity directly and through any entity that is
controlled, directly or indirectly, by the banking entity,\267\ plus
(ii) the pro rata amount or value of any covered fund held by any
entity (other than certain operating entities noted below) that is not
controlled, directly or indirectly, by the banking entity but in which
the banking entity owns, controls, or holds with the power to vote more
than 5 percent of the voting shares.\268\
---------------------------------------------------------------------------

    \267\ See proposed rule Sec.  --.12(b)(1)(A).
    \268\ See proposed rule Sec.  --.12(b)(1)(B). As noted above,
whether or not an investment is controlled or noncontrolled will be
determined consistent with the BHC Act, as implemented by the Board.
See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
---------------------------------------------------------------------------

    Additionally, the proposed rule provides that, to the extent that a
banking entity is contractually obligated to directly invest in, or is
found to be acting in concert through knowing participation in a joint
activity or parallel action toward a common goal of investing in, one
or more investments with a covered fund that is organized and offered
by the banking entity (whether or not pursuant to an express
agreement), such investment shall be included in the calculation of a
banking entity's per-fund limitation.\269\ In this way, the proposed
rule prevents a banking entity from evading the limitations under Sec.
--.12 of the proposed rule through committed co-investments.
---------------------------------------------------------------------------

    \269\ See proposed rule Sec.  --.12(b)(2)(B).
---------------------------------------------------------------------------

    Section --.12(b)(3) of the proposed rule provides that the amount
and value of a banking entity's investment in a covered fund may at no
time exceed the 3 percent limits contained in Sec.  --.12(b) of the
proposed rule after the conclusion of any conformance period, if
applicable.\270\ In cases where a fund calculates its value or stands
ready to issue or redeem interests frequently (e.g., daily), a banking
entity must calculate its per-fund limitation no less frequently than
the fund performs such calculation or issues or redeems interests. In
recognition of the fact that not every covered fund may calculate or
determine its valuation daily (for instance, if it does not allow
redemptions except infrequently or invests principally in illiquid
assets for which no market price is readily available), the proposed
rule would not require a daily calculation of value for such fund
(unless a daily calculation is determined by the fund).\271\ In such
cases, the calculation of the amount and value of a banking entity's
per-fund limitation must be made no less frequently than at the end of
every quarter.\272\ Additionally, since a banking entity must organize
and offer any covered fund in which it invests, the Agencies expect
that such banking entity would closely and regularly monitor not only
the value of such fund's interests, but also any changes in the fund's
investors' relative ownership percentages.\273\
---------------------------------------------------------------------------

    \270\ See proposed rule Sec.  --.12(b)(3).
    \271\ With respect to an issuer of asset-backed securities,
depending on the transaction structure, such calculation may need to
be made each time a payment is made to any holder of the issuer's
asset-backed securities.
    \272\ The Agencies note that while calculation of a banking
entity's ownership interest in a covered fund must be determined no
less frequently than at the end of every quarter, it is possible
that no change in a banking entity's ownership interest (e.g., no
redemptions or other changes in investor composition) may occur
during every quarter.
    \273\ For instance, where a banking entity acts as sponsor to a
covered fund, in connection with the organizing and offering of that
fund it may include a requirement (such as a ``tag-along''
redemption right) in the fund's organizational documents in order to
assist the banking entity in complying with the per-fund investment
limitation.
---------------------------------------------------------------------------

c. Aggregate Permitted Investments in All Covered Funds and Calculation
of a Banking Entity's Tier 1 Capital
    In addition to a limit on investments in a single covered fund,
section 13(d)(4) of the BHC Act requires the banking entity to comply
with the aggregate funds limitation on investments in all covered
funds.\274\ As required under section 13(d)(4)(B)(ii)(II) of the BHC
Act, the proposed rule provides that the aggregate of a banking
entity's ownership interests in all covered funds that are held under
Sec.  --.12 of the proposed rule may not exceed 3 percent of the tier 1
capital of a banking entity.\275\ In order to maintain equality in
application of the aggregate funds limitation, the proposed rule
provides that, for purposes of determining compliance with Sec.  --.12
of the proposed rule, the aggregate of all of a banking entity's
investments in all covered funds under Sec.  --.12 of the proposed rule
must be valued pursuant to applicable accounting standards.\276\ This
value calculation is separate and in addition to the required
calculation of the value of a banking entity's investment in a covered
fund as part of determining compliance with the per-fund limitation.
---------------------------------------------------------------------------

    \274\ As noted in the discussion regarding the per-fund
limitation, the proposed rule provides that, for purposes of
determining compliance with Sec.  --.12, the banking entity's
permitted investment in a covered fund shall be calculated in the
same manner and according to the same standards utilized by the
covered fund for determining the aggregate value of the fund's
assets and ownership interests. However, the value of a banking
entity's aggregate permitted investments in all covered funds shall
be determined in accordance with applicable accounting standards.
See proposed rule Sec.  --.12(c)(1).
    \275\ See 12 U.S.C. 1851(d)(4)(B)(ii)(II); proposed rule Sec.
--.12(a)(2)(ii).
    \276\ See proposed rule Sec.  --.12(c)(1).
---------------------------------------------------------------------------

    Tier 1 capital is a banking law concept that, in the United States,
is

calculated and reported by certain depository institutions and bank
holding companies in order to determine their compliance with
regulatory capital standards. Accordingly, the proposed rule clarifies
that for purposes of the aggregate funds limitation in Sec.  --.12, a
banking entity that is a bank, a bank holding company, a company that
controls an insured depository institution that reports tier 1 capital,
or uninsured trust company that reports tier 1 capital (each a
``reporting banking entity'') must apply the reporting banking entity's
tier 1 capital as of the last day of the most recent calendar quarter
that has ended, as reported to the relevant Federal banking
agency.\277\
---------------------------------------------------------------------------

    \277\ See proposed rule Sec.  --.12(c)(1)(A).
---------------------------------------------------------------------------

    However, not all entities subject to section 13 of the BHC Act
calculate and report tier 1 capital. In order to provide a measure of
equality related to the aggregate funds limitation contained in section
13(d)(4)(B)(ii)(II) of the BHC Act and Sec.  --.12(c) of the proposed
rule, the proposed rule clarifies how the aggregate funds limitation
shall be calculated for entities that are not required to calculate and
report tier 1 capital in order to determine compliance with regulatory
capital standards. Under the proposed rule, with respect to any banking
entity that is not affiliated with a reporting banking entity and not
itself required to report capital in accordance with the risk-based
capital rules of a Federal banking agency, the banking entity's tier 1
capital for purposes of the aggregate funds limitation shall be the
total amount of shareholders' equity of the top-tier entity within such
organization as of the last day of the most recent calendar quarter
that has ended, as determined under applicable accounting
standards.\278\ For a banking entity that is not itself required to
report tier 1 capital but is a subsidiary of a reporting banking entity
that is a depository institution (e.g., a subsidiary of a national
bank), the aggregate funds limitation shall be the amount of tier 1
capital reported by such depository institution.\279\ For a banking
entity that is not itself required to report tier 1 capital but is a
subsidiary of a reporting banking entity that is not a depository
institution (e.g., a nonbank subsidiary of a bank holding company), the
aggregate funds limitation shall be the amount of tier 1 capital
reported by the top-tier affiliate of such banking entity that holds
and reports tier 1 capital.\280\ Thus, for purposes of calculating the
aggregate funds limitation under Sec.  --.12(c)(2) of the proposed
rule, the tier 1 capital for the different types of banking entities
would be as follows:
---------------------------------------------------------------------------

    \278\ See proposed rule Sec.  --.12(c)(2)(ii)(B)(2).
    \279\ See proposed rule Sec.  --.12(c)(2)(ii)(A).
    \280\ See proposed rule Sec.  --.12(c)(1)(B).

------------------------------------------------------------------------
                                          Tier 1 capital for purposes of
         Type of banking entity                    Sec.   --.12
------------------------------------------------------------------------
Depository institution that is a         Tier 1 capital of the
 reporting banking entity (or a           depository institution as of
 subsidiary thereof).                     the last day of the most
                                          recent calendar quarter that
                                          has ended, as reported to the
                                          relevant Federal banking
                                          agency.
Bank holding company or a subsidiary     Tier 1 capital of the bank
 thereof (other than a reporting          holding company as of the last
 banking entity).                         day of the most recent
                                          calendar quarter that has
                                          ended, as reported to the
                                          Board.
Company that controls an insured         Tier 1 capital of the top tier
 depository institution and that is a     entity within such
 reporting banking entity (or a           organization as of the last
 subsidiary thereof other than a          day of the most recent
 reporting banking entity).               calendar quarter that has
                                          ended, as reported to the
                                          Board.
Other banking entity (including an       Shareholders' equity of the top-
 industrial loan company holding          tier entity within such
 company, thrift holding company, or a    organization as of the last
 subsidiary thereof).                     day of the most recent
                                          calendar quarter that has
                                          ended, under applicable
                                          accounting standards.
------------------------------------------------------------------------

Additionally, in the case of a depository institution that is itself a
reporting banking entity and is also a subsidiary or affiliate of a
reporting banking entity, the aggregate of all investments in all
covered funds held by the depository institution (including investments
by its subsidiaries) may not exceed 3 percent of either the tier 1
capital of the depository institution or of the top-tier reporting
banking entity that controls such depository institution.\281\
---------------------------------------------------------------------------

    \281\ If the aggregate value of all investments in all covered
funds attributable to such a depository institution is less than 3
percent of its tier 1 capital, then that amount of capital which is
greater than the amount supporting the depository institution's
investments (or those held by its subsidiaries) in a covered fund,
but less than 3 percent of the depository institution's tier 1
capital, may be used to support an investment in a covered fund by
an affiliated banking entity that is not itself a depository
institution that holds and reports tier 1 capital or controlled,
directly or indirectly, by such a depository institution.
---------------------------------------------------------------------------

d. Deduction of an Investment in a Covered Fund From Tier 1 Capital
    Section 12(d) of the proposed rule also implements the provision
contained in section 13(d)(4)(b)(iii) of the BHC Act regarding the
deduction of a banking entity's aggregate investment in a covered fund
held under section 13(d)(4) of that Act from the assets and tangible
equity of the banking entity. The statute also provides that the amount
of the deduction must increase commensurate with the leverage of the
underlying fund.\282\
---------------------------------------------------------------------------

    \282\ See 12 U.S.C. 1851(d)(4)(B)(iii).
---------------------------------------------------------------------------

    Section --.12(d) of the proposal requires a banking entity to
deduct the aggregate value of its investments in covered funds from
tier 1 capital. Since Sec.  --.12 of the proposed rule implements the
authorities contained in section 13(d)(4) of the BHC Act related to an
investment in a fund organized and offered by the banking entity (or an
affiliate or subsidiary thereof), the deduction contained in Sec.
--.12(d) applies only to those ownership interests held as an
investment by a banking entity pursuant to Sec.  --.12 of the proposed
rule.\283\ For instance, a banking entity that acquires or retains an
ownership interest in a covered fund as a permitted risk-mitigating
hedge under Sec.  --.13(b) of the proposed rule, or that acquires or
retains an ownership interest in the course of collecting a debt
previously contracted in good faith, would not be required to deduct
the value of such ownership interest from its tier 1 capital.\284\ The
deduction required under Sec.  --.12(d) of the proposed rule must be
calculated consistent with other like deductions under the applicable
risk-based capital rules.\285\
---------------------------------------------------------------------------

    \283\ See proposed rule Sec.  --.12(d).
    \284\ The Agencies note that since this deduction from capital
implements Section 13(d)(4)(B)(iii) of the BHC Act, it is being
included in this proposed rule which deals with Section 13 of the
BHC Act. However, the Agencies may relocate this deduction as part
of any later revised capital rules if, in the future, it is
determined that inclusion in such rules is more appropriate.
    \285\ See 12 CFR part 208, Appendices A, E, and F (for a state
member bank); 12 CFR part 225, Appendices A, E, and G (for a bank
holding company); 12 CFR part 3, Appendices A, B, and C (for a
national bank); 12 CFR part 325, Appendices A, C, and D (for a state
nonmember bank); and 12 CFR part 167, Appendix C (for a federal
thrift).

---------------------------------------------------------------------------

e. Extension of Time To Divest an Ownership Interest in a Single
Covered Fund
    Section 13(d)(4)(C) of the BHC Act permits the Board, upon
application by a banking entity, to extend for up to 2 additional years
the period of time within which a banking entity must reduce its
attributable ownership interests in a covered fund to no more than 3
percent of such fund's total ownership interests.\286\ The statute
provides the possibility of an extension only with respect to the per-
fund limitation, and not to the aggregate funds limitation.\287\
Section --.12(e) of the proposed rule implements this provision of the
statute. In order to grant any extension, the Board must determine that
the extension would be consistent with safety and soundness and would
not be detrimental to the public interest.\288\
---------------------------------------------------------------------------

    \286\ 12 U.S.C. 1851(d)(4)(C).
    \287\ See id.
    \288\ As noted in Part III.C.2.a.ii of this Supplementary
Information, the Agencies recognize the potential for evasion of the
restrictions contained in section 13 of the BHC Act through
organizing and offering a covered fund pursuant to the authority
contained in Sec.  --.11 of the proposed rule. Therefore, in
addition to taking action against a banking entity that does not
actively seek unaffiliated investors to reduce or dilute the
investment of the banking entity as provided under Sec.  --.12(a)(2)
of the proposed rule, the Agencies expect that if a banking entity
is habitually or routinely seeking an extension of the one-year
period provided under Sec.  --.12(a)(2)(i)(B), this could be
evidence of seeking to evade the restrictions contained in the
proposed rule and, as appropriate, the Agencies may take action
against such banking entity.
---------------------------------------------------------------------------

    Section --.12(e) of the proposed rule requires any banking entity
that seeks an extension of this conformance period to submit a written
request to the Board. Under the proposal, any such request must: (i) Be
submitted in writing to the Board at least 90 days prior to the
expiration of the applicable time period; (ii) provide the reasons why
the banking entity believes the extension should be granted; and (iii)
provide a detailed explanation of the banking entity's plan for
reducing or conforming its investment(s).
    In addition, the proposed rule provides that any extension request
by a banking entity must address each of the following matters (to the
extent they are relevant): (i) Whether the investment would--(A)
involve or result in material conflicts of interest between the banking
entity and its clients, customers or counterparties; (B) result,
directly or indirectly, in a material exposure by the banking entity to
high-risk assets or high-risk trading strategies; (C) pose a threat to
the safety and soundness of the banking entity; or (D) pose a threat to
the financial stability of the United States; (ii) market conditions;
(iii) the contractual terms governing the banking entity's interest in
the covered fund; (iv) the date on which the covered fund is expected
to have attracted sufficient investments from investors unaffiliated
with the banking entity to enable the banking entity to comply with the
limitations in section 12(a)(2)(i)(B) of the proposed rule; (v) the
total exposure of the banking entity to the investment and the risks
that disposing of, or maintaining, the investment in the covered fund
may pose to the banking entity or the financial stability of the United
States; (vi) the cost to the banking entity of divesting or disposing
of the investment within the applicable period; (vii) whether the
divestiture or conformance of the investment would involve or result in
a material conflict of interest between the banking entity and
unaffiliated clients, customers or counterparties to which it owes a
duty; (viii) the banking entity's prior efforts to divest or sell
interests in the covered fund, including activities related to the
marketing of interests in such covered fund; and (ix) any other factor
that the Board believes appropriate.\289\ Under the proposed rule, the
Board would consider requests for an extension in light of all relevant
facts and circumstances, including the factors described above.
---------------------------------------------------------------------------

    \289\ See proposed rule Sec.  --.12(e)(1)(ii).
---------------------------------------------------------------------------

    Section --.12(e) of the proposed rule also would allow the Board to
impose conditions on any extension granted under the proposed rule if
the Board determines conditions are necessary or appropriate to protect
the safety and soundness of banking entities or the financial stability
of the United States, address material conflicts of interest or other
unsound practices, or otherwise further the purposes of section 13 of
the BHC Act and the proposed rule.\290\ In cases where the banking
entity is primarily supervised by another Agency, the Board would
consult with such Agency both in connection with its review of the
application and, if applicable, prior to imposing conditions in
connection with the approval of any request by the banking entity for
an extension of the conformance period under the proposed rule.\291\
---------------------------------------------------------------------------

    \290\ Nothing in section 13 of the BHC Act or the proposed rule
limits or otherwise affects the authority that the Board, the other
Federal banking agencies, the SEC, or the CFTC may have under other
provisions of law. In the case of the Board, these authorities
include, but are not limited to, section 8 of the Federal Deposit
Insurance Act and section 8 of the BHC Act. See 12 U.S.C. 1818,
1847.
    \291\ See proposed rule Sec. Sec.  --.12(e)(iii) and (iv).
---------------------------------------------------------------------------

f. Request for Comment
    The Agencies request comment on the proposed rule's approach to
implementing the exemption which allows a banking entity to make or
retain a permitted investment in a covered fund that it organizes and
offers. In particular, the Agencies request comment on the following
questions:
    Question 256. Is the proposed rule's approach to implementing the
exemption that allows a banking entity to make or retain a permitted
investment in a covered fund effective? If not, what alternative
approach would be more effective and why?
    Question 257. Should the approach include other elements? If so,
what elements and why? Should any of the proposed elements be revised
or eliminated? If so, why and how?
    Question 258. Should the proposed rule specify at what point a
covered fund will be considered to have been ``established'' for
purposes of commencing the period in which a banking entity may own
more than 3 percent of the total outstanding ownership interests in
such fund? If so, why and how?
    Question 259. Does the proposed rule effectively implement the
requirement that a banking entity comply with the limitations on an
investment in a single covered fund? If not, what alternative approach
would be more effective and why?
    Question 260. Does the proposed rule effectively implement the
requirement that a banking entity comply with the limitations on the
aggregate of all investments in all covered funds? If not, what
alternative approach would be more effective and why?
    Question 261. Is the proposed rule's approach to calculating a
banking entity's investment in a covered fund effective? Should the
per-fund calculation be based on committed capital, rather than
invested capital? Why or why not? Is the timing of the calculation of a
banking entity's ownership interest in a single covered fund