stated there is no statutory basis for allowing conflicts of interest
in connection with exempted activities even if banking entities provide
disclosure or establish information barriers, and the rule should
prohibit banking entities from engaging in permitted activities if
material conflicts of interest exist.\1557\ One commenter believed the
definition did not appear to address issues of customer favoritism, in
which a bank is financially incentivized to treat one customer more
favorably than another (typically less sophisticated) customer.\1558\
Some commenters believed that the proposed definition of material
conflict of interest was too vague or narrow and suggested it should be
strengthened by either expanding the types of transactions that may
result in

a material conflict of interest or by imposing additional limitations
or restrictions on transactions.\1559\ For instance, one commenter
suggested the final rule consider depositors of a banking entity to be
``customers'' for the purpose of this provision, impose a fiduciary
duty on any banking entity conducting an exempt activity pursuant to
section 13(d)(1) of the BHC Act, and impose size restrictions on any
banking entity engaging in proprietary trading under an exemption. This
commenter also stated that a banking entity inherently has a material
conflict of interest with its customer when it takes the opposite side
of a transaction and, therefore, that the final rule should require a
banking entity to disgorge all principal gains from transactions
conducted pursuant to any exemption under section 13(d)(1) of the BHC
Act, including market-making, trading in U.S. government obligations,
insurance company activities and other exempt activities.\1560\ In
addition, a few commenters stated that, if disclosure or information
barriers were permitted to mitigates conflicts under the final rule,
clients of the banking entity must be required to acknowledge in
writing that they understand the potential conflicts of interest
present in order for any disclosure to be effective in mitigating a
conflict of interest.\1561\
---------------------------------------------------------------------------

    \1557\ See Public Citizen; Sens. Merkley & Levin; Occupy; AFR et
al. (Feb. 2012).
    \1558\ See Public Citizen.
    \1559\ See, e.g., Occupy; AFR et al. (Feb. 2012); Sens. Merkley
& Levin (Feb. 2012).
    \1560\ See Occupy.
    \1561\ See, e.g., Lynda Aiman-Smith; AFR et al. (Feb. 2012);
Sens. Merkley & Levin (Feb. 2012).
---------------------------------------------------------------------------

    Some commenters believed that the Agencies should consider issuing
additional guidance regarding the definition of material conflicts of
interest, high-risk assets, and high-risk trading strategies.\1562\ One
commenter stated that the final rule should limit the extraterritorial
impact of section 13 by only applying the restrictions of section
13(d)(2) of the BHC Act to the U.S. operations or activities of foreign
banking entities and that the regulation of safety and soundness of the
foreign operations and activities of foreign banking entities should be
left to the home country regulator or supervisor of a foreign banking
entity.\1563\
---------------------------------------------------------------------------

    \1562\ See Rep. Blumenauer et al.; Sens. Merkley & Levin (Feb.
2012).
    \1563\ See IIB/EBF; EBF.
---------------------------------------------------------------------------

    Some commenters provided general suggestions on enhancing
compliance with the prohibition on material conflicts of interest. A
common suggestion among industry participants was to implement the
prohibition on material conflicts of interest under these rules in a
manner consistent with the implementation of section 621 of Dodd-
Frank.\1564\ One commenter suggested that trading in government
obligations should not be subject to the material conflict of interest
provision because government obligations are broadly traded and do not
present the types of conflicts addressed by the proposed rule.\1565\ In
contrast, one commenter stated banking entities should be required to
receive pre-trade clearance from the Federal Reserve for trading in
certain government obligations like municipal bonds and mortgage-backed
securities, due to their role in the 2008 financial crisis.\1566\
---------------------------------------------------------------------------

    \1564\ See ASF (Conflicts) (Feb. 2012); SIFMA et al. (Prop.
Trading) (Feb. 2012); SIFMA (Securitization) (Feb. 2012); LSTA (Feb.
2012); Sens. Merkley & Levin (Feb. 2012).
    \1565\ See BDA (Feb. 2012).
    \1566\ See Occupy.
---------------------------------------------------------------------------

a. Disclosure
    Some commenters expressed concern about potential difficulties
associated with the proposed disclosure provision and provided
suggestions to address these difficulties. For example, a few
commenters noted the difficulty in determining what constitutes
effective disclosure,\1567\ especially in relation to the volume of
disclosure or the impact of information asymmetry in illiquid
markets.\1568\ One commenter stated that unless the rule requires full
disclosure of a banking entity's trading strategy and the rationale
behind it, allowing disclosure will permit the banking entity to
protect itself without adequately mitigating the harm of the conflict.
This commenter also noted the practical difficulties associated with
disclosing anticipated future conflicts and conflicts in the context of
block trading.\1569\ Another commenter stated market participants
understand inherent conflicts of interest and believed disclosure in
such situations would be burdensome and unnecessary.\1570\ One
commenter stated that the rule should require a banking entity to
negate, not just permit the client, customer, or counterparty to
substantially mitigate, the materially adverse effect of the
conflict.\1571\
---------------------------------------------------------------------------

    \1567\ See Occupy; ISDA (Apr. 2012); Better Markets (Feb. 2012);
SIFMA et al. (Prop. Trading) (Feb. 2012); ICFR.
    \1568\ See Occupy.
    \1569\ See Public Citizen; See also AFR et al. (Feb. 2012).
    \1570\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \1571\ See Occupy.
---------------------------------------------------------------------------

    A few commenters disagreed with the disclosure provision, noting
that Congress specifically considered and rejected disclosure as a
mitigation method for purposes of section 621 of the Dodd-Frank Act and
that this indicates the Agencies should not permit a material conflict
of interest to be mitigated through disclosure for purposes of section
13 of the BHC Act.\1572\
---------------------------------------------------------------------------

    \1572\ See, e.g, Occupy.
---------------------------------------------------------------------------

    Commenters were in disagreement as to the extent and timing of
disclosure that should be required under the rule. Some commenters
stated the disclosure provisions would slow trading, and suggested the
rule require only one-time disclosure at the inception of the business
relationship\1573 \ or periodic disclosures to address ongoing
conflicts.\1574\ One of these commenters noted that extensive trade-by-
trade disclosure requirements create the risk of unintended breaches of
confidentiality.\1575\ Other commenters requested the Agencies provide
additional guidance, such as when transaction-specific disclosure is
necessary,\1576\ whether disclosure should be written,\1577\ and what
constitutes ``reasonable detail.'' \1578\
---------------------------------------------------------------------------

    \1573\ See ISDA (Apr. 2012); Arnold & Porter.
    \1574\ See SIFMA et al. (Prop. Trading) (Feb. 2012); ISDA (Apr.
2012).
    \1575\ See ISDA (Apr. 2012).
    \1576\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \1577\ See Sens. Merkley & Levin (Feb. 2012); ICFR (questioning
the effectiveness of enforcement mechanisms if oral disclosure
permitted under the rule); Occupy.
    \1578\ See ICFR.
---------------------------------------------------------------------------

    In addition, some commenters provided suggestions on whether
parties should be required to acknowledge receipt of disclosures \1579\
or affirmatively consent to the conflict.\1580\ One commenter proposed
allowing a majority of a committee of independent board members to
approve consent to waivers of conflicts of interest.\1581\ One
commenter believed disclosure and consent by a sophisticated investor
ought to be sufficient to serve as a waiver to most types of conflict
of interest.\1582\ In contrast, another commenter asserted general
disclosure or waivers of conflicts should never be allowed, and the
Agencies should not provide any additional guidance as to the extent,
timing, frequency, or scope of disclosure appropriate in any given
situation.\1583\ Similarly, one commenter asserted the Agencies should
not provide guidance on what issues can be addressed by disclosure, as
such guidance would be ``dangerously

prescriptive and would introduce moral hazards.'' \1584\
---------------------------------------------------------------------------

    \1579\ See, e.g., Arnold & Porter; Sens. Merkley & Levin (Feb.
2012); Better Markets (Feb. 2012); Public Citizen; AFR et al. (Feb.
2012); Lynda Aiman-Smith.
    \1580\ See Public Citizen; Sens. Merkley & Levin (Feb. 2012);
Better Markets (Feb. 2012).
    \1581\ See Arnold & Porter.
    \1582\ See Arnold & Porter.
    \1583\ See Alfred Brock (stating there is no such thing as a
``sophisticated party'').
    \1584\ See ICFR.
---------------------------------------------------------------------------

Information Barriers
    A few commenters addressed the information barriers provision of
the proposed rule. One commenter expressed support for the proposed
approach,\1585\ while three commenters stated this provision was
ineffective.\1586\ A few commenters opposed the information barriers
provision because they believed information barriers would make
conflict mitigation more difficult \1587\ or would effectively mandate
that no single officer be aware of a banking entity's collective
operations.\1588\
---------------------------------------------------------------------------

    \1585\ See Alfred Brock.
    \1586\ See Better Markets (Feb. 2012); Occupy; Public Citizen.
    \1587\ See Occupy.
    \1588\ See Public Citizen (contending that this would undermine
the Dodd-Frank Act's requirement to promote sound management, ensure
financial stability, and reduce systemic risk).
---------------------------------------------------------------------------

    A few commenters also requested the Agencies provide guidance
regarding the use of information barriers. One commenter requested the
Agencies specify the type and nature of information barriers and where
they are practical to implement.\1589\ Another commenter believed that
the Agencies should view information barriers favorably. This commenter
stated that information barriers should be permitted for addressing
conflicts of interest unless the banking entity knows, or should
reasonably know, that the information barrier would not be effective in
restricting the spread of information that could lead to the
conflict.\1590\ To provide greater clarity, another commenter
recommended the Agencies provide guidance on certain elements that may
be used to determine the reasonableness of information barriers, such
as memorialization of procedures and documentation of actions taken
pursuant to such procedures.\1591\
---------------------------------------------------------------------------

    \1589\ See AFR et al. (Feb. 2012).
    \1590\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \1591\ See ISDA (Apr. 2012) (arguing that its suggested guidance
was derived from prior SEC and self-regulatory organization guidance
on information barriers).
---------------------------------------------------------------------------

3. Final Rule
    After considering carefully comments received on the proposal as
well as the purpose and language of section 13 of the BHC Act, the
Agencies have adopted the final rule largely as proposed. Under the
final rule, a banking entity that 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 the transaction,
class of transactions, or activity, must address and mitigate the
conflict of interest, where possible, through either timely and
effective disclosure or informational barriers.\1592\ This requirement
is in addition to, and does not supplant, any limitations or
prohibitions contained in other laws. For example, a material
misrepresentation by a banking entity to its client, customer, or
counterparty in connection with market-making activities may involve
fraud and is generally illegal under a variety of Federal and State
regulatory schemes (e.g., the Federal securities laws) \1593\ as well
as being prohibited under section 13 of the BHC Act.
---------------------------------------------------------------------------

    \1592\ The Agencies note that the definition of material
conflict of interest and the disclosure provisions related to that
definition apply solely for purposes of the 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).
    \1593\ See 12 U.S.C. 1851(g)(3).
---------------------------------------------------------------------------

    The Agencies believe that certain of commenters' suggested
modifications to the proposed rule are outside the scope of the
Agencies' statutory authority. For example, the Agencies do not believe
section 13 of the BHC Act provides statutory authority to directly
impose limits on the size of banking entities \1594\ or to implement
specific fiduciary standards on banking entities.\1595\ In addition,
the Agencies do not believe it is appropriate to expand the definition
of ``customer'' to include individuals and entities that solely make
use of the bank's traditional banking services because section 13 is
focused on the trading activities and investment in which banking
entities may be involved.\1596\
---------------------------------------------------------------------------

    \1594\ See Occupy.
    \1595\ See Occupy.
    \1596\ See Occupy.
---------------------------------------------------------------------------

    The final rule recognizes that a banking entity may address or
substantially mitigate a potential conflict of interest by making
adequate disclosures or creating and enforcing informational barriers.
Some commenters argued that the legislative history of the Dodd-Frank
Act suggests that disclosure or informational barriers are not adequate
to address a material conflict of interest.\1597\ However, section 13
of the BHC Act directs the Agencies to define ``material conflict of
interest'' and gives the Agencies discretion to determine how to define
this term for purposes of the rule. Under the final rule, a material
conflict of interest exists when the banking entity engages in
transactions or activities that cause its interests to be materially
adverse to the interests of its client, customer, or counterparty. At
the same time, the final rule provides banking entities the opportunity
to take certain actions to address the conflict, such that the conflict
does not have a materially adverse effect on that client, customer, or
counterparty. Under the final rule, a banking entity may address a
conflict by establishing, maintaining, and enforcing information
barriers reasonably designed to avoid a conflict's materially adverse
effect, or by disclosing the conflict in a manner that allows the
client, customer, or counterparty to substantially mitigate or negate
any materially adverse effect created by the conflict of interest. The
Agencies believe that, to the extent the materially adverse effect of a
conflict has been substantially mitigated, negated, or avoided, it is
appropriate to allow the transaction, class of transaction, or activity
under the final rule. Continuing to view the conflict as a material
conflict of interest under these circumstances would not appear to
benefit the banking entity's client, customer, or counterparty. The
disclosure standard under the final rule requires clear and meaningful
information be provided to the client, customer, or counterparty in a
manner that provides such party the opportunity to negate or
substantially mitigate, any materially adverse effects on such party
created by the conflict.
---------------------------------------------------------------------------

    \1597\ See Public Citizen; Sens. Merkley & Levin (Feb. 2012);
Occupy; AFR et al. (Feb. 2012).
---------------------------------------------------------------------------

    Some commenters suggested that obtaining consent to or waiver of
disclosed conflicts should be sufficient to comply with the rule.\1598\
The Agencies do not believe that consent or waivers alone are
sufficient to address material conflicts of interest, and continue to
believe that any banking entity using disclosure to address a conflict
of interest should be required to provide any client, customer, or
counterparty with whom the banking entity has a conflict with the
opportunity to negate or substantially mitigate the materially adverse
effect of the conflict on the client, customer, or counterparty. The
Agencies believe this approach, which applies equally to all

types of clients, customers, or counterparties, will reduce the
potential for unintended or differing impacts on certain types of
clients, customers, or counterparties. In response to one commenter's
suggestion that the final rules require full negation of the materially
adverse effect on the client, customer, or counterparty, the Agencies
continue to believe it is appropriate to allow a transaction or
activity to continue if the client, customer, or counterparty is
provided an opportunity to substantially mitigate the materially
adverse effect.\1599\ The Agencies are concerned that requiring the
conflict's impact to be fully negated under all circumstances could
prevent a banking entity from providing a service to a particular
customer despite that customer's knowledge of the conflict and ability
to substantially reduce the effect of the conflict on that customer.
---------------------------------------------------------------------------

    \1598\ See, e.g., Arnold & Porter.
    \1599\ See Occupy.
---------------------------------------------------------------------------

    With regards to commenters' statements that information barriers
and disclosure will not work to address the harm caused by conflicts,
the Agencies emphasize that under the final rule, like the proposed
rule, a banking entity may use disclosure or information barriers to
address a conflict only in those instances where the disclosure
provides the client, customer, or counterparty with the opportunity to
negate or substantially mitigate any materially adverse effect of the
conflict on that entity or the information barriers are reasonably
designed to prevent the conflict of interest from involving or
resulting in a materially adverse effect on a client, customer, or
counterparty. If the banking entity is unable to effectively use
disclosure or information barriers in a way that meets the rule's
requirements, then the banking entity is prohibited from engaging in
the conflicted transaction, class of transaction, or activity.
Additionally, the Agencies note that the material conflict of interest
provisions in the final rule do not preempt any duties owed to parties
outside the transaction, including any duty of confidentiality.\1600\
---------------------------------------------------------------------------

    \1600\ See ISDA (Apr. 2012).
---------------------------------------------------------------------------

    In response to commenters' statements that the volume of
information included in a disclosure or the manner in which the
disclosure is presented may make it difficult for a customer to
identify and understand the relevant information regarding the
conflict,\1601\ the Agencies note that the final rule requires
disclosure of the conflict or potential conflict be clear, timely, and
effective and that the disclosure includes any other necessary
information. Disclosure is also required 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.\1602\ Thus, disclosure that is only general or generic, 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, or that is hidden in a large volume of needless
information would not meet this standard. The Agencies believe these
provisions of the final rule are designed to ensure that customers
receive sufficient information about the conflict of interest so that
they are well informed and, as required by the rule, able to negate or
substantially mitigate any materially adverse effect of the conflict.
---------------------------------------------------------------------------

    \1601\ See Better Markets (Feb. 2012) (suggesting that a
disclosure regime can facilitate abuse by enabling market
participants to point to obscure and meaningless disclosure as a
shield against liability); Occupy (arguing that a large volume of
disclosed information can be difficult to understand or can serve to
hide relevant information).
    \1602\ See final rule Sec.  ----.7(b)(1)(i) and final rule Sec.
----.16(b)(1)(i).
---------------------------------------------------------------------------

    In addition to requiring that customers are provided with detailed
information about the conflict, the final rule, like the proposal,
requires that disclosure is made prior to effecting the specific
transaction or class or type of transactions, or engaging in the
specific activity, for which a conflict may arise and is otherwise
timely. As a result, under Sec.  ----.7(b)(2)(i), disclosure must 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 take steps that would negate or substantially
mitigate the conflict. This approach is similar to the approach
permitted by a variety of consumer protection statutes and regulations
for addressing potential conflicts of interest in consumer
transactions.\1603\
---------------------------------------------------------------------------

    \1603\ See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I)-(IV) (finding
that disclosure and physical separation of personnel and activities
addresses the potential that consumers might be misled by the
broker-dealer activities of banks); 15 U.S.C. 80b-6(3) (``It shall
be unlawful for any investment adviser, by use of the mails or any
means or instrumentality of interstate commerce, directly or
indirectly . . . acting as principal for his own account, knowingly
to sell any security to or purchase any security from a client, or
acting as broker for a person other than such client, knowingly to
effect any sale or purchase of any security for the account of such
client, without disclosing to such client in writing before the
completion of such transaction the capacity in which he is acting
and obtaining the consent of the client to such transaction.''). See
also Form ADV, the form used by investment advisers to register with
the Securities and Exchange Commission and state securities
authorities, and, in particular, Form ADV Part 2: Uniform
Requirements for the Investment Adviser Brochure and Brochure
Supplements. A registered investment adviser generally must deliver
the Form ADV brochure, which contains disclosure about conflicts of
interest, to its prospective and existing clients. See 17 CFR
275.204-3; Amendments to Form ADV, Investment Advisers Act Release
No. 3060 (July 28, 2010), 75 FR 49234 (Aug. 12, 2010) (``We are
adopting a requirement that investment advisers registered with us
provide prospective and existing clients with a narrative brochure
written in plain English . . . We believe these amendments will
greatly improve the ability of clients and prospective clients to
evaluate firms offering advisory services and the firms' personnel,
and to understand relevant conflicts of interest that the firms and
their personnel face and their potential effect on the firms'
services.'').
---------------------------------------------------------------------------

    Some commenters requested that the final rule permit a conflict to
be negated or substantially mitigated through generic or periodic
disclosures, such as at the beginning of a trading relationship or on
an annual basis. Other commenters stated that some conflicts, such as
anticipated future conflicts or those that arise in the context of
block trading, may require the banking entity to provide disclosure in
advance of the actual conflict in order to allow the client, customer,
or counterparty the opportunity to mitigate the materially adverse
effect.\1604\ The Agencies emphasize, however, that disclosure provided
far in advance of a particular transaction, such that the client,
customer, or counterparty is unlikely to take that disclosure into
account when evaluating the transaction, would not suffice. At the same
time, 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 be permissible disclosure under the final rules. The Agencies
believe that, in considering the effectiveness of disclosures, the
type, timing and frequency of disclosures depends significantly on the
customer relationship, the type of transaction, and the matter that
creates the potential conflict. Therefore, while written disclosures
may be appropriate in certain circumstances, the Agencies are not
requiring banking entities to provide written disclosure,\1605\ or
obtain documentation showing that disclosure was received,\1606\
because the Agencies believe it is more important that disclosure is
timely than documented. For example, if disclosure were required

to be in writing, this might slow a banking entity's ability to provide
the disclosure to the relevant customer, which could impede the
customer's ability to consider the disclosed information and take steps
to negate or substantially mitigate the conflict's effect on the
customer. The Agencies further note that the final rule does 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.
---------------------------------------------------------------------------

    \1604\ See Public Citizen; See also AFR et al. (Feb. 2012).
    \1605\ See Sens. Merkley & Levin (Feb. 2012); ICFR; Occupy;
Alfred Brock.
    \1606\ See, e.g., Arnold & Porter; Sens. Merkley & Levin (Feb.
2012); Better Markets (Feb. 2012); Public Citizen; AFR et al. (Feb.
2012); Lynda Aiman-Smith.
---------------------------------------------------------------------------

    As noted above, one commenter expressed concern about the burdens
of disclosing inherent conflicts and stated such disclosure is
unnecessary because market participants understand inherent conflicts
of interest.\1607\ As noted in the proposal, certain inherent
conflicts, such as 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
permitted activities.\1608\
---------------------------------------------------------------------------

    \1607\ See SIFMA et al. (Prop. Trading) (Feb. 2012); but See
Occupy.
    \1608\ See Joint Proposal, 76 FR 68,893. Thus, the Agencies are
not adopting one commenter's suggestion that the final rule consider
all transactions by a banking entity to involve a material conflict
of interest because the banking entity is necessarily on the
opposite side of a transaction with its client, customer, or
counterparty. See Occupy.
---------------------------------------------------------------------------

    The Agencies continue to believe that information barriers can be
an effective means of addressing conflicts of interest that may arise
through, for example, the spread of information among trading desks
engaged in different trading activities that may result in potentially
inappropriate informational advantage. The Agencies are not adopting
one commenter's suggestion that the final rule specify the particular
types of scenarios where information barriers may be effective \1609\
because, as discussed below, the Agencies believe banking entities are
better positioned to determine when information barriers may be
effective given their trading activities and business structure.\1610\
In response to one commenter's concern that information barriers may
result in the banking entity's management not being aware of the firm's
collective operations,\1611\ the Agencies note that information
barriers do not require this result. Rather, information barriers would
be established between relevant personnel or functions while other
personnel, including senior managers, internal auditors, and compliance
personnel, would have access to each group separated by the barrier.
---------------------------------------------------------------------------

    \1609\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \1610\ The Agencies note examples of information barriers that
may address or substantially mitigate a material conflict of
interest include restrictions on information sharing, limits on
types of trading, prohibitions on common officers or employees
between functions. Such information barriers have been recognized in
Federal securities laws as a means to address or mitigate potential
conflicts of interest or other inappropriate activities. See, e.g.,
17 U.S.C. 78o(g).
    \1611\ See Public Citizen.
---------------------------------------------------------------------------

    The final rule continues to recognize that a banking entity may
address or substantially mitigate a conflict of interest through use of
information barriers. In order to address and mitigate a conflict of
interest through the use of the information barriers, a banking entity
is 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.\1612\ Importantly, the final 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 complied with the requirements of Sec.  --
--.7(b)(2)(i).\1613\
---------------------------------------------------------------------------

    \1612\ The Agencies note that a banking entity subject to
Appendix B of the final rule 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. 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. See Part IV.C.2.e., infra.
    \1613\ 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.
---------------------------------------------------------------------------

    While some commenters requested that the final rule include
additional limitations as part of implementing the material conflict of
interest provisions in section 13(d)(2), the Agencies do not believe
additional restrictions are appropriate at this time. 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.\1614\ In all cases, the question
of whether a material conflict of interest exists will depend on an
evaluation of the specific facts and circumstances. For example,
certain simple transactions may implicate conflicts of interest that
cannot be mitigated by disclosure or restricted by information
barriers. On the other hand, certain highly structured and complex
transactions may involve conflicts of interest that can be mitigated by
disclosure or restricted by information barriers.
---------------------------------------------------------------------------

    \1614\ 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.
---------------------------------------------------------------------------

    The Agencies believe that conflicts of interest must be determined
and addressed in accordance with the specific facts and circumstances
presented. One commenter suggested that the proposed rule be modified
so that a banking entity could conclusively rely on information
barriers unless it knows or has reason to know that policies,
procedures, and controls establishing barriers would not be effective
in restricting the spread of information.\1615\ By focusing on whether
a banking entity knows or has reason to know that its policies and
procedures would not be effective, rather than on what the banking
entity knows or should reasonably know about a conflict of interest
that may involve or result in a material adverse effect on a client,
customer, or counterparty, the commenter's suggestion has the potential
to allow a banking entity to engage in transactions that involve a
material conflict of interest. Therefore, the Agencies have determined
not to

adopt the commenter's suggested approach. Similarly, the Agencies are
rejecting some commenters' suggestions that the final rule prescribe
the method, scope, or specific content of disclosures.\1616\ The
Agencies believe that specific guidance on disclosure may provide an
incentive for banking entities to consider the form of disclosure
provided, rather than whether disclosure can address the substance of
the conflict as determined by the specific facts and circumstances at
hand. Moreover, the Agencies believe banking entities are in the best
position to identify and evaluate the conflicts present in their
business as well as the most effective method of disclosing such
conflicts. Banking entities must tailor their compliance programs to
identify, monitor, and evaluate potential conflicts based on their
business structure and specific activities and customer
relationships.\1617\
---------------------------------------------------------------------------

    \1615\ See SIFMA et al. (Prop. Trading) (Feb. 2012).
    \1616\ See Occupy; ISDA (Apr. 2012); Better Markets (Feb. 2012);
SIFMA et al. (Prop. Trading) (Feb. 2012); ICFR; Alfred Brock; Public
Citizen; AFR et al. (Feb. 2012); Arnold & Porter; Sens. Merkley &
Levin (Feb. 2012).
    \1617\ For a full discussion of the final rule's compliance
requirements, including a discussion of the specific compliance
requirements applicable to different banking entities, See Part
IV.C. of this SUPPLEMENTARY INFORMATION, infra.
---------------------------------------------------------------------------

    Finally, some commenters requested that the final rule specifically
address the conflict of interest provisions related to asset-backed
securitizations contained in section 621 of the Dodd-Frank Act. As
explained below in Part IV.B.1., some securitizations are subject to
the final rule, and others such as securitizations of loans are not
subject to section 13 of the BHC Act. For any securitization that meets
the definition of covered fund under the final rule, relationships with
and transactions by a banking entity involving those securitizations
remain subject to the requirements of section 13, including the
requirements of section 13(d)(2). In addition, the banking entity would
be subject to the limitations contained in section 621 of the Dodd-
Frank Act and any rules regarding conflicts of interest relating to
securitizations implemented under that section. The final rule in no
way limits the application of section 621 of that Act with respect to
an asset-backed security that is subject to that section.
b. Definition of ``High-Risk Asset'' and ``High-Risk Trading Strategy''
1. Proposed Rule
    Section ----.8(c) of the proposed rule defined ``high-risk asset''
and ``high-risk trading strategy'' for purposes of the proposed
limitations on permitted trading activities. Proposed Sec.  --
--.8(c)(1) defined 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. Proposed Sec.  ----.8(c)(2) defined 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.\1618\
---------------------------------------------------------------------------

    \1618\ See Joint Proposal, 76 FR 68,894. The Agencies noted 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). See Joint
Proposal, 76 FR 68,894 n.215.
---------------------------------------------------------------------------

2. Comments on Proposed Limitations on High-Risk Assets and Trading
Strategies
    With respect to the prohibition on transactions or activities that
expose banking entities to high-risk assets or high-risk trading
strategies, one commenter stated the provisions were effective,\1619\
while other commenters stated the proposed rule was too vague \1620\
and implied that banking entities may be required to exit positions in
periods of market stress, further reducing liquidity.\1621\ A few
commenters suggested the Agencies identify and prohibit certain types
of high-risk assets or high-risk trading strategies under the
rule.\1622\ In contrast, one commenter asserted the Agencies should not
specify certain classes of assets or trading strategies as ``high
risk.'' \1623\ A few commenters requested greater clarity on the
proposed definitions and suggested the Agencies provide additional
guidance.\1624\ One of these commenters suggested the Agencies simplify
compliance by establishing safe harbors, setting pre-determined risk
limits within risk-based approaches, or allowing individual banking
entities to set practical risk-based standards that the Agencies can
review.\1625\
---------------------------------------------------------------------------

    \1619\ See Alfred Brock.
    \1620\ See AFR et al. (Feb. 2012); Japanese Bankers Ass'n.;
Investure; AllianceBernstein; Comm. on Capital Markets Regulation.
    \1621\ See Obaid Syed.
    \1622\ See Sens. Merkley & Levin (Feb. 2012); Johnson & Prof.
Stiglitz; Occupy.
    \1623\ See Alfred Brock.
    \1624\ See Japanese Bankers Ass'n.; Sens. Merkley & Levin (Feb.
2012); Occupy; Public Citizen.
    \1625\ See Japanese Bankers Ass'n.
---------------------------------------------------------------------------

    One commenter suggested integrating the ban on high-risk activities
throughout the rule and stated that, given the evolving nature of
financial markets, regulators should have the flexibility to update
criteria for identifying high-risk assets or high-risk trading
strategies.\1626\ This commenter stated the definition of high-risk
trading strategies was appropriately broad and flexible, but suggested
improving the rule by encompassing trading strategies that are so
complex the risk or value thereof cannot be reliably and objectively
determined.\1627\ The commenter also suggested that the quantitative
measurements collected under proposed Appendix A could be utilized to
help inform whether a high-risk asset or trading strategy exists.\1628\
---------------------------------------------------------------------------

    \1626\ See Sens. Merkley & Levin (Feb. 2012).
    \1627\ See Sens. Merkley & Levin (Feb. 2012).
    \1628\ See Sens. Merkley & Levin (Feb. 2012).
---------------------------------------------------------------------------

    One commenter stated that in large concentrations, all assets can
be high risk. This commenter suggested evaluating transactions on a
case-by-case basis and believed all activity exempted under section
13(d)(1) of the BHC Act should be viewed as ``high-risk'' absent prior
regulatory approval. This commenter further suggested that high-risk
assets or trading strategies be defined to include any asset or trading
strategy that would have forced a banking entity to exit the market
during the 2008 financial crisis, and that leverage, rehypothecation,
concentration limits, and high frequency trading should be viewed as
indicia of high-risk trading strategies. Finally, this commenter
suggested the Agencies require banking entity CEOs to certify that
their institution's activities do not result in a material exposure to
high-risk assets or high-risk trading strategies.\1629\
---------------------------------------------------------------------------

    \1629\ See Occupy.
---------------------------------------------------------------------------

3. Final Rule
    After considering carefully the comments received, the Agencies
have modified the final rule to provide that a high-risk asset means an
asset or group of assets that would, if held by a banking entity,
significantly increase the likelihood that the banking entity would
incur a substantial financial loss or would pose a threat to the
financial stability of the United States. Similarly, the final rule
defines high-risk trading strategy to include any strategy that would,
if engaged in by a banking entity, significantly increase the
likelihood that the banking entity would incur a substantial financial
loss or would pose a threat to the financial stability of the United
States.
    Importantly, under the final rule, banking entities that engage in
activities

pursuant to an exemption must have a reasonably designed compliance
program in place to monitor and understand whether it is exposed to
high-risk assets or trading strategies. For instance, any banking
entity engaged in activity pursuant to the market-making exemption in
Sec.  ----.4(b) must, as part of its compliance program, have
reasonably designed written policies and procedures, internal controls,
analysis and independent testing regarding the limits for each trading
desk, including limits on the level of exposures to relevant risk
factors that the trading desk may incur. These policies and procedure
and any activity conducted pursuant to the final rule will be evaluated
by the Agencies, as appropriate, as part of ensuring the safety and
soundness of banking entities and monitoring for exposures to high-risk
activities or assets.
    While some commenters stated that the definition of high risk asset
or trading strategy should be more clearly defined, the Agencies
believe that it is appropriate to include a broad definition of these
terms that accounts for different facts and circumstances that may
impact whether a particular asset or trading strategy is high-risk with
respect to a banking entity. As stated by commenters, this framework is
effective and flexible enough to be utilized by the Agencies in a
variety of contexts. For instance, a trading strategy or asset may be
high-risk to one banking entity but not another, or may be high-risk to
a banking entity under some market conditions but not others. As part
of evaluating whether a banking entity is exposed to a high-risk asset
or trading strategy, the Agencies expect that a variety of factors will
be considered, such as the presence of excess leverage, rehypothecation
or excessively high concentration of assets, or unsafe and unsound
trading strategies.
    We believe an approach limiting this provision's applicability to
certain permitted activities or creating a safe harbor for certain
assets or trading strategies would be inconsistent with the statutory
language, which prohibits any permitted activity that involves or
results in a material exposure to a high-risk asset or high-risk
trading strategy.\1630\ In addition, the Agencies decline to identify
any particular assets or trading strategies as per se high-risk because
a determination of the specific risk posed to a banking entity depends
on the facts and circumstances.\1631\ Certain facts and circumstances
may include, but are not limited to, the amount of capital at risk in a
transaction, whether or not the transaction can be hedged, the amount
of leverage present in the transaction, and the general financial
condition of the banking entity engaging in the transaction. In
response to one commenter's recommendation that the Agencies adopt a
CEO certification requirement specific to the high-risk
provisions,\1632\ the Agencies believe such a requirement is
unnecessary in light of the required management framework in the
compliance program provision of Sec.  ----.20 of the final rule, as
well as the CEO certification requirement included in the final
rule.\1633\
---------------------------------------------------------------------------

    \1630\ See BDA (Feb. 2012); Japanese Bankers Ass'n.
    \1631\ See Occupy.
    \1632\ See Occupy.
    \1633\ See Sec.  ----.20 and Appendix B of the final rule, also
discussed in Part IV.C., infra.
---------------------------------------------------------------------------

c. Limitations on Permitted Activities That Pose a Threat to Safety and
Soundness of the Banking Entity or the Financial Stability of the
United States
    Finally, as the Agencies did not receive any comments on the
proposed rule's limitations on permitted activities that pose a threat
to the safety and soundness of the banking entity or to the financial
stability of the United States and the proposed approach mirrored the
statutory language, the Agencies have determined no changes to final
rule are necessary.

B. Subpart C--Covered Fund Activities and Investments

    As noted above and except as otherwise permitted, section
13(a)(1)(B) of the BHC Act generally prohibits a banking entity from
acquiring or retaining any ownership in, or acting as sponsor to, a
covered fund.\1634\ Section 13(d) of the BHC Act contains certain
exemptions to this prohibition. Subpart C of the final rule implements
these and other provisions of section 13 related to covered funds.
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
final rule, as well as Appendix B, to the extent applicable.
---------------------------------------------------------------------------

    \1634\ See 12 U.S.C. 1851(a)(1)(B).
---------------------------------------------------------------------------

1. Section ----.10: Prohibition on Acquisition or Retention of
Ownership Interests in, and Certain Relationships With, a Covered Fund
    Section ----.10 of the final rule defines the scope of the
prohibition on the acquisition and retention of ownership interests in,
and certain relationships with, a covered fund. It also defines a
number of key terms, including the definition of covered fund.
    The term ``covered fund'' specifies the types 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 final rule.\1635\ The final rule modifies
the proposed definition of covered fund in a number of key aspects. The
Agencies have defined the term ``covered fund'' with reference to
sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940
(``Investment Company Act'') with some additions and subject to a
number of exclusions, several of which have been modified from
permitted activity exemptions included in the proposal.
---------------------------------------------------------------------------

    \1635\ See final rule Sec. Sec.  ----.10(b)-(c). The term
banking entity is defined in final rule Sec.  ----.2(c).
---------------------------------------------------------------------------

    The Agencies have tailored the final definition to include entities
of the type that the Agencies believe Congress intended to capture in
its definition of private equity fund and hedge fund in section
13(h)(2) of the BHC Act by reference to section 3(c)(1) and 3(c)(7) of
the Investment Company Act. Thus, the final definition focuses on the
types of entities formed for the purpose of investing in securities or
derivatives for resale or otherwise trading in securities or
derivatives, and that are offered and sold in offerings that do not
involve a public offering, but typically involve offerings to
institutional investors and high-net worth individuals (rather than to
retail investors). These types of funds are not subject to all of the
securities law protections applicable with respect to funds that are
registered with the SEC as investment companies, and the Agencies
therefore believe that these types of entities may be more likely to
engage in risky investment strategies. At the same time, the Agencies
have tailored the definition to exclude entities that have more general
corporate purposes and do not present the same risks for banking
entities as those associated with the funds described above, as well as
certain other entities as further discussed below.
    The final rule also contains a revised version of the proposal's
treatment of certain foreign funds as covered funds, which has been
modified from the proposal and tailored to include only the types of
foreign funds that the Agencies believe are intended to be the focus of
the statute, such as certain foreign funds that are established by

U.S. banking entities and not otherwise subject to the Investment
Company Act.
    The Agencies have not included all commodity pools within the
definition of covered fund as proposed. Instead, and as discussed in
more detail below, the Agencies have included only commodity pools for
which the commodity pool operator has claimed exempt pool status under
section 4.7 of the CFTC's regulations or that could qualify as exempt
pools and which have not been publicly offered \1636\ to persons who
are not qualified eligible persons under section 4.7 of the CFTC's
regulations.\1637\ Qualified eligible persons are typically
institutional investors, banking entities and high net worth
individuals (rather than retail investors). This more tailored
approach, together with the various exclusions from the covered fund
definition in the final rule, is designed to include as covered funds
those commodity pools that are similar to funds that rely on section
3(c)(1) or 3(c)(7) while not also including as covered funds entities,
like commercial end-users or registered investment companies, whose
activities do not implicate the concerns that section 13 was designed
to address.
---------------------------------------------------------------------------

    \1636\ See infra note 1721 and accompanying text regarding the
meaning of the term ``offer'' as used in the final rule's inclusion
of certain commodity pools as covered funds.
    \1637\ See final rule Sec.  ----.10(b)(1)(ii).
---------------------------------------------------------------------------

    Finally, other related terms, including ``ownership interest,''
``resident of the United States,'' ``sponsor,'' and ``trustee,'' are
also defined in Sec.  ----.10(d) of the final rule.\1638\ As explained
below, these terms are largely defined in the same manner as in the
proposal although with certain changes, including changes to help
clarify the scope of these definitions as requested by commenters. Some
of these terms and related provisions also have been reorganized to
improve clarity. As explained in more detail below, the Agencies
received a number of comments relating to some of the terms defined in
Sec.  ----.10. Some comments directly relate to the scope of the
proposed rule and the economic effects associated with the prohibitions
on covered funds activities and investments, some of which commenters
argued did not further the purposes of section 13.\1639\ The Agencies
have carefully considered these and other comments when defining the
key terms used in the statute and in providing certain exclusions to
the definition of the term covered fund. The Agencies also have sought
to provide guidance below, where appropriate, on how these key terms
would operate in order to better enable banking entities to understand
their obligations under section 13 and the final rule.
---------------------------------------------------------------------------

    \1638\ See final rule Sec.  ----.10(d)(6), (8), (9), and (10).
    \1639\ See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); BoA;
Goldman (Covered Funds); Rep. Himes; SVB; Scale.
---------------------------------------------------------------------------

a. Prohibition Regarding Covered Fund Activities and Investments
    Section ----.10(a) of the final rule implements section 13(a)(1)(B)
of the BHC Act and prohibits a banking entity from, directly or
indirectly, acquiring or retaining as principal an equity, partnership,
or other ownership interest in, or acting as sponsor to, a covered
fund, unless otherwise permitted under subpart C of the final
rule.\1640\ This provision of the rule reflects the statutory
prohibition.
---------------------------------------------------------------------------

    \1640\ See final rule Sec.  ----.10(a).
---------------------------------------------------------------------------

    The general prohibition in Sec.  ----.10(a) of the proposed rule
applied solely to the acquisition or retention of an ownership interest
in, or acting as sponsor to, a covered fund, ``as principal.'' \1641\
Commenters generally supported this approach, arguing that applying the
prohibition related to covered fund activities and investments by a
banking entity only to instances where the banking entity acts as
principal is consistent with the statutory focus on principal
activity.\1642\ The final rule takes this approach as discussed below.
---------------------------------------------------------------------------

    \1641\ See proposed rule Sec.  ----.10(a); See also Joint
Proposal, 76 FR 68,896.
    \1642\ See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012);
SIFMA et al. (Mar. 2012).
---------------------------------------------------------------------------

    The proposed rule and preamble accompanying it described potential
exemptions from the definition of ownership interest for a variety of
interests, including interests related to employee benefit plans,
interests held in the ordinary course of collecting a debt previously
contracted, positions as trustee, or interests acquired as agent,
broker or custodian. Commenters provided information on each of these
types of ownership interests, and generally supported excluding each of
these from the section's prohibition on acquiring or retaining an
ownership interest in a covered fund.
    A significant number of commenters focused on employee benefit
plans. Commenters generally argued that the prohibition in section
13(a) of the BHC Act did not encompass interests held on behalf of
employees through an employee benefit plan. While the proposed rule did
not explicitly cover certain ``qualified plans'' under the Internal
Revenue Code, a number of commenters argued that the prohibition should
not cover activity or investments related to other types of employee
benefit plans that are not a ``qualified plan'' under the Internal
Revenue Code.\1643\ A significant number of commenters urged exclusion
of interests in and relationships with foreign employee benefit
plans.\1644\ Commenters argued that the risks of investments made
through employee benefit plans are borne by the employee beneficiaries
of these plans, and any decision to cover employee benefit plans or
investments made by these plans under the prohibitions in section 13 of
the BHC Act would eliminate or severely restrict the availability of
employee programs that are widely offered, regulated and endorsed under
a system of Federal, state and foreign laws.\1645\
---------------------------------------------------------------------------

    \1643\ See Credit Suisse (Williams); Arnold & Porter; UBS; Hong
Kong Inv. Funds Ass'n.
    \1644\ See, e.g., Credit Suisse (Williams); Arnold & Porter;
UBS; NAB; Hong Kong Inv. Funds Ass'n; Australian Bankers Ass'n.
(Feb. 2012).
    \1645\ See, e.g., Arnold & Porter.
---------------------------------------------------------------------------

    Commenters also supported the exemption under the proposed rule for
holdings in satisfaction of a debt previously contracted in good
faith.\1646\ This provision of the proposal recognized that banking
entities may acquire an ownership interest in or relationship with a
covered fund as a result of a counterparty's failure to repay a bona
fide debt and without an intent to engage in those activities as
principal.\1647\
---------------------------------------------------------------------------

    \1646\ See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); LSTA
(Feb. 2012).
    \1647\ See proposed rule Sec.  ----.14(b).
---------------------------------------------------------------------------

    Several commenters urged revision to the proposal to add a specific
exclusion for investments held by a banking entity in the capacity of
trustee (including as trustee for a charitable trust).\1648\ These
commenters argued that failing to recognize and exempt these types of
activities in the final rule would prevent banking entities that act as
trustees from effectively meeting their trust and fiduciary obligations
and from providing these services to customers. Commenters also argued
that the exemption for trust activities should not be dependent on the
duration of the trust because the law governing the duration of trusts
is changing and varies across jurisdictions.\1649\
---------------------------------------------------------------------------

    \1648\ See, e.g., ABA (Keating).
    \1649\ See, e.g., ABA (Keating); Arnold & Porter; NAB.
---------------------------------------------------------------------------

    As with the proposed rule, the prohibition in Sec.  ----.10(a) of
the final rule applies only to the acquisition or retention of an
ownership interest in, or sponsorship of, a covered fund as

principal. The Agencies continue to believe section 13 of the BHC Act
was designed to address the risks attendant to principal activity and
not those that are borne by customers of the banking entity or for
which the banking entity lacks design or intent to take a proprietary
interest as principal.
    In order to address commenter concerns regarding the types of
activity that are subject to the prohibition, the Agencies have
modified and reorganized the final rule to make the scope of acting
``as principal'' clear and more consistent with the proprietary trading
restrictions under the final rule.\1650\ The final rule provides that
the prohibition does not include acquiring or retaining an ownership
interest in a covered fund by a banking entity: (1) Acting solely as
agent, broker, or custodian, so long as the activity is conducted for
the account of, or on behalf of, a customer, and the banking entity and
its affiliates do not have or retain beneficial ownership of the
ownership interest;\1651\ (2) through a deferred compensation, stock-
bonus, profit-sharing, or pension plan of the banking entity (or an
affiliate thereof) that is established and administered in accordance
with the law of the United States or a foreign sovereign, if the
ownership interest is held or controlled directly or indirectly by a
banking entity as trustee for the benefit of people who are or were
employees of the banking entity (or an affiliate thereof); \1652\ (3)
in the ordinary course of collecting a debt previously contracted in
good faith, provided that the banking entity divests the ownership
interest as soon as practicable, and in no event may the banking entity
retain such instrument for longer than such period permitted by the
appropriate agency; or (4) on behalf of customers as trustee or in a
similar fiduciary capacity for a customer that is not a covered fund,
so long as the activity is conducted for the account of, or on behalf
of, the customer, and the banking entity and its affiliates do not have
or retain beneficial ownership of such ownership interest.\1653\
---------------------------------------------------------------------------

    \1650\ See final rule Sec.  ----.3(d)(7) (9).
    \1651\ A banking entity acting as agent, broker, or custodian is
not acting ``as principal'' under the final rule so long as the
activity is conducted for the account of, or on behalf of, a
customer and the banking entity does not have or retain beneficial
ownership of such ownership interest, as noted above. This provision
is consistent with the final rule's treatment of banking entities
acting on behalf of customers as trustee or in a fiduciary capacity.
    \1652\ The Agencies note that this provision does not permit
joint investments between the banking entity and its employees.
Rather, this provision is intended to enable banking entities to
maintain deferred compensation and other similar plans formed for
the benefit of employees. The Agencies recognize that, since it is
possible an employee may forfeit its interest in such a plan, the
banking entity may have a residual or reversionary interest in the
assets referenced under the plan. However, other than such residual
or reversionary interests, a banking entity may not rely on this
provision to invest in a covered fund.
    \1653\ See final rule Sec.  ----.10(a)(2). For instance, as part
of engaging in its traditional trust company functions, a bank or
savings association typically may act through an entity that is
excluded from the definition of investment company under section
3(c)(3) or 3(c)(11). This would be included within the scope of
acting on behalf of customers as trustee or in a similar fiduciary
capacity, provided that it meets the applicable requirements of the
exclusion under the final rule.
---------------------------------------------------------------------------

    Because these activities do not involve the banking entity engaging
in an activity intended or designed to take ownership interests in a
covered fund as principal, they do not appear to be the types of
activities that section 13 of the BHC Act was designed to address.
However, the Agencies note that in order to prevent a banking entity
from evading the requirements of section 13 and the final rule, the
exclusions for these activities do not permit a banking entity to
engage in establishing, organizing and offering, or acting as sponsor
to a covered fund in a manner other than as permitted elsewhere in the
final rule. The Agencies intend to monitor these activities and
investments for efforts to evade the restrictions in section 13 of the
BHC Act and the final rule on banking entities' investments in and
relationships with covered funds.
b. ``Covered Fund'' Definition
    Section 13(h)(2) of the BHC Act defines hedge fund and private
equity fund to mean an issuer that would be an investment company, but
for section 3(c)(1) or 3(c)(7) of the Investment Company Act, or ``such
similar funds'' as the Agencies determine by rule.\1654\ Given that the
statute defines ``hedge fund'' and ``private equity fund'' without
differentiation, the proposed rule and the final rule combine the terms
into the definition of a ``covered fund.'' Sections 3(c)(1) and 3(c)(7)
of the Investment Company Act are exclusions 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.\1655\ The
proposal included as a covered fund any entity that would be an
investment company but for the exclusion from that definition contained
in section 3(c)(1) or 3(c)(7) of the Investment Company Act, any
foreign entity that would also be an investment company but for those
same exclusions were the foreign entity to be organized or offered in
the United States, and a commodity pool as defined in section 1a(10) of
the Commodity Exchange Act.\1656\ The preamble to the proposal
recognized that this definition was broad and specifically requested
comment on whether and how the definition of covered fund should be
modified for purposes of the final rule.
---------------------------------------------------------------------------

    \1654\ See 12 U.S.C. 1851(h)(2).
    \1655\ 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: (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 propose to make a public
offering of such securities. See 15 U.S.C. 80a-3(c)(1) and (c)(7).
    \1656\ See proposed rule Sec.  ----.10(b)(1).
---------------------------------------------------------------------------

    Commenters contended that the definition of covered fund should not
focus exclusively on whether an entity relies on section 3(c)(1) or
3(c)(7) of the Investment Company Act. Commenters argued that sections
3(c)(1) and 3(c)(7) of the Investment Company Act are exclusions
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. Under the Investment Company Act, any entity that holds
investment securities (i.e., generally all securities other than U.S.
government securities) representing at least 40 percent of the entity's
total assets would be an investment company.\1657\ According to
commenters, this definition and the accompanying exclusions are part of
a securities law and regulatory framework designed for purposes
different than the prudential purpose that underlies section 13 of the
BHC Act.\1658\
---------------------------------------------------------------------------

    \1657\ 15 U.S.C. 80a-3(a)(1)(A) & (C). The definition of
securities is very broad under the Investment Company Act and has
been interpreted to include instruments such as loans, that would
not be regarded as securities under the Securities Act of 1933 and
the Securities Exchange Act of 1934. In addition, the determination
of what constitutes an ``investment security'' under the Investment
Company Act requires complex analysis and consideration of a broad
set of facts and circumstances.
    \1658\ See, e.g., NVCA.
---------------------------------------------------------------------------

    A number of comments received on the proposal argued that the
proposed definition of covered fund was overly broad and would lead to
anomalous results inconsistent with the words, structure, and purpose
of section 13.\1659\ For instance, many commenters asserted that the
proposed rule's definition of covered fund would cause a number of
commonly used corporate entities that are not traditionally thought of
as hedge

funds or private equity funds, such as wholly-owned subsidiaries, joint
ventures, and acquisition vehicles, to be subject to the covered fund
restrictions of section 13. These commenters argued that this
interpretation of section 13 would cause a disruption to the operations
of banking entities and their closely related affiliates that does not
relate to the intent of section 13 and therefore cause an unnecessary
burden on banking entities. Commenters argued that the words, structure
and purpose of section 13 allow the Agencies to adopt a more tailored
definition of covered fund that focuses on vehicles used for investment
purposes that were the target of section 13's restrictions.
---------------------------------------------------------------------------

    \1659\ See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012);
BlackRock; AHIC; Sen. Carper et al.; Rep. Garrett et al.
---------------------------------------------------------------------------

    In particular, commenters requested that the final rule exclude at
least the following from the definition of covered fund: U.S.
registered investment companies (including mutual funds); the foreign
equivalent of U.S. registered investment companies; business
development companies; wholly-owned subsidiaries; joint ventures;
acquisition vehicles; financial market utilities; foreign pension or
retirement funds; insurance company separate accounts; loan
securitizations, including asset-backed commercial paper conduits; cash
management vehicles or cash collateral pools; credit funds; real estate
investment trusts; various securitization vehicles; tender option bond
programs; and venture capital funds.\1660\ Commenters requested some of
these exclusions in order to mitigate the impact of the proposal's
inclusion of commodity pools as part of the definition of covered
fund.\1661\
---------------------------------------------------------------------------

    \1660\ See ABA (Keating); ABA (Abernathy); SIFMA et al. (Covered
Funds) (Feb. 2012); Allen & Overy (on behalf of Foreign Bank Group);
Allen & Overy (on behalf of Canadian Banks); Deutsche Bank
(Repackaging Transactions); ICI (Feb. 2012); Putnam; JPMC; GE (Feb.
2012); Chamber (Feb. 2012); Rep. Himes; BOK; Ass'n. of Institutional
Investors (Feb. 2012); Wells Fargo (Covered Funds); BoA; NAIB et
al.; PNC; SunTrust; Nationwide; STANY; BNY Mellon et al.; RMA;
Goldman (Covered Funds); Japanese Bankers Ass'n; IRSG; ISDA (Feb.
2012); IIB/EBF; Citigroup (Jan. 2012); SSgA (Feb. 2012); State
Street (Feb. 2012); Eaton Vance; Fidelity; SBIA; River Cities;
Ashurst; Sen. Hagan; Sen. Bennet.
    \1661\ As discussed below, the Agencies have modified the final
rule to include only certain commodity pools within the definition
of covered fund.
---------------------------------------------------------------------------

    Some commenters argued that the proposal failed to distinguish
between different types of investment funds.\1662\ These commenters
expressed the view that the statute provides the Agencies with the
discretion to distinguish between investment funds generally and a
subset of funds--hedge funds and private equity funds--that may engage
in particularly risky trading and investment activities. For example,
several commenters argued that the proposed rule's restrictions on
covered fund investments should not cover venture capital funds that
provide investment capital to new businesses.\1663\ Others argued for
an exclusion for securitization vehicles such as securitizations that
are backed, in whole or in part, by assets that are not loans,
including corporate debt repackagings,\1664\ CLOs,\1665\ ABCP
conduits,\1666\ insurance-linked securities,\1667\ and synthetic
securitizations backed by derivatives.\1668\
---------------------------------------------------------------------------

    \1662\ See NVCA; See also SIFMA et al. (Covered Funds) (Feb.
2012); ABA (Keating).
    \1663\ See, e.g., ABA (Keating); ABA (Abernathy); Canaan
(Young); Canaan (Ahrens); Canaan (Kamra); Growth Managers; River
Cities; SVB; EVCA.
    \1664\ See AFME et al.; Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Cleary Gottlieb; Deutsche Bank (Repackaging
Transactions); SIFMA (Securitization) (Feb. 2012).
    \1665\ See SIFMA (Securitization) (Feb. 2012); Allen & Overy (on
behalf of Foreign Bank Group); ASF (Feb. 2012); Cleary Gottlieb;
Credit Suisse (Williams); JPMC; LSTA (Feb. 2012).
    \1666\ See Allen & Overy (on behalf of Foreign Bank Group); ASF
(Feb. 2012); Credit Suisse (Williams); Eaton Vance; Fidelity; GE
(Feb. 2012); GE (Aug. 2012); ICI (Feb. 2012); IIB/EBF; JPMC; PNC;
RBC; SIFMA (Securitization) (Feb. 2012); AFME et al.
    \1667\ See AFME et al.; SIFMA (Securitization) (Feb. 2012).
    \1668\ See AFME et al.; ASF (Feb. 2012); Cleary Gottlieb; Credit
Suisse (Williams); SIFMA (Securitization) (Feb. 2012); ABA
(Keating).
---------------------------------------------------------------------------

    As a potential solution to some of these concerns, a number of
commenters argued that the Agencies should define covered fund by
reference to characteristics that are designed to distinguish hedge
funds and private equity funds from other types of entities that rely
on section 3(c)(1) or 3(c)(7) of the Investment Company Act.\1669\
Commenters believed this approach would help exclude some of the
corporate vehicles and funds mentioned above that they did not believe
were intended by Congress to be included as hedge funds and private
equity funds and therefore reduce costs that, in the commenters' view,
did not further the purposes of section 13.\1670\
---------------------------------------------------------------------------

    \1669\ See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012);
BlackRock; Credit Suisse (Williams); SSgA (Feb. 2012); State Street
(Feb. 2012); Deutsche Bank (Repackaging Transactions); Allen & Overy
(on behalf of Foreign Bank Group).
    \1670\ See SIFMA et al. (Covered Funds) (Feb. 2012); AFME et al;
Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012);
Ashurst; Barclays; BDA (Feb. 2012); Credit Suisse (Williams);
Commercial Real Estate Fin. Council; Fidelity; ICI (Feb. 2012); ISDA
(Feb. 2012); JPMC; Nuveen Asset Mgmt.; PNC; RBC; SIFMA et al.
(Covered Funds) (Feb. 2012); SIFMA (Municipal Securities) (Feb.
2012); SSgA (Feb. 2012); State Street (Feb. 2012); Vanguard; Wells
Fargo (Covered Funds).
---------------------------------------------------------------------------

    These commenters proposed a number of different potential types of
characteristics for defining hedge fund and private equity fund. Some
commenters focused on certain structural or investment characteristics
found in traditional private equity funds and hedge funds, such as
investor redemption rights, performance compensation fees, leverage and
the use of short-selling.\1671\ Another commenter argued that the
characteristics used to define a covered fund should focus on the types
of speculative behavior that the statute was intended to address,
citing characteristics such as volatility of asset performance and high
leverage.\1672\
---------------------------------------------------------------------------

    \1671\ See Ass'n. of Institutional Investors (Feb. 2012);
Barclays; JPMC; SIFMA et al. (Covered Funds) (Feb. 2012); See also
FSOC study at 62-63 (suggesting a characteristics-based approach
considering compensation structure; trading/investment strategy; use
of leverage; investor composition); ABA (Keating); BNY Mellon et
al.; Northern Trust, SSgA (Feb. 2012); State Street (Feb. 2012);
Deutsche Bank (Repackaging Transactions); T. Rowe Price; RMA
(suggesting use of characteristics derived from the SEC's Form PF
for registration of investment advisers of private funds).
    \1672\ See RBC (citing FSOC study).
---------------------------------------------------------------------------

    In contrast to the majority of the commenters, one commenter urged
that characteristics be used to expand the proposed definition to
include any issuer that exhibits characteristics of proprietary trading
that the statute prohibits to be done by a banking entity.\1673\
According to this commenter, any fund engaging in more than minimal
proprietary trading should be a covered fund and subject to the
requirements of section 13.
---------------------------------------------------------------------------

    \1673\ See Occupy.
---------------------------------------------------------------------------

    However, not all commenters supported a characteristics-based
definition. One commenter opposed a characteristics-based definition,
suggesting that the final rule rely only on the statutory reference to
the Investment Company Act, and arguing that using characteristics to
define a covered fund (e.g., leverage) could create opportunities for
circumvention of the rule.\1674\ Commenters that generally supported
the proposed definition argued that its broad scope prevented
circumvention.\1675\
---------------------------------------------------------------------------

    \1674\ See AFR et al. (Feb. 2012).
    \1675\ See Sens. Merkley & Levin (Feb. 2012); AFR et al. (Feb.
2012); Alfred Brock.
---------------------------------------------------------------------------

    One commenter argued in favor of broadening the definition of
covered fund to include entities that rely on an exclusion from the
definition of investment company other than those contained in section
3(c)(1) and 3(c)(7), such as section 3(c)(2) (which provides an
exclusion for underwriters and brokers) or 3(c)(6) (which provides an
exclusion for entities engaged in a business other than investing in

securities).\1676\ By contrast, other commenters argued that an entity
should not be considered a covered fund if the entity relies on an
exclusion or exemption contained in the Investment Company Act other
than an exclusion contained in section 3(c)(1) or 3(c)(7) under that
Act, such as the exclusion contained in section 3(c)(3) for bank
collective investment funds.\1677\
---------------------------------------------------------------------------

    \1676\ See Occupy (also arguing in favor of including entities
that rely on rule 3a-1 (which provides an exemption for issuers that
hold less than 45% of their assets in securities excluding
government securities) or 3a-6 (which provides an exemption for
foreign banks and insurance companies) to avoid being regulated as
investment companies under the Investment Company Act).
    \1677\ See, e.g., ABA (Keating).
---------------------------------------------------------------------------

    The Agencies have carefully considered all of the comments related
to the definition of covered fund. While the Agencies believe that the
proposal reflected a reasonable interpretation of the statutory
provision, on further review and in light of the comments the Agencies
have determined to adopt a different approach. The Agencies have
revised the final rule to address many of the concerns raised by
commenters regarding the scope of the original proposal in a manner the
Agencies believe is a better reading of the statutory provision because
it is both consistent with the language, purpose and structure of
section 13 and avoids unintended consequences of the less precise
definitional approach of the proposal.
    In the final rule, the Agencies have joined the definitions of
``hedge fund'' and ``private equity fund'' into a single definition
``covered fund'' (as in the statute) and have defined this term as 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 with a
number of express exclusions and additions (explained below) as
determined by the Agencies. Thus, for example, an entity that invests
in securities and relies on any exclusion or exemption from the
definition of ``investment company'' under the Investment Company Act
other than the exclusion contained in section 3(c)(1) or 3(c)(7) of
that Act would not be considered a covered fund so long as it satisfies
the conditions of another Investment Company Act exclusion or
exemption.\1678\ Such an entity would not be an investment company but
for section 3(c)(1) or 3(c)(7), and the Agencies have modified the
final rule to explicitly exclude such an entity.\1679\
---------------------------------------------------------------------------

    \1678\ For instance, bank common trust and collective funds that
qualify for the exclusion from the definition of investment company
pursuant to section 3(c)(3) or 3(c)(11) of the Investment Company
Act are not covered funds. See 15 U.S.C. 78a-3(c)(3) and (c)(11).
These funds are subject to supervision and regulation by a Federal
banking agency, thus helping to distinguish them from traditional
hedge funds and private equity funds which are generally not
themselves subject to such supervision or regulation.
    \1679\ See final rule Sec.  ----.10(c)(12).
---------------------------------------------------------------------------

    The Agencies believe this definition is consistent with the words,
structure, purpose and legislative history of section 13 of the BHC
Act. As noted above, section 13(h)(2) provides that:

The terms ``hedge fund'' and ``private equity fund'' mean an issuer
that would be an investment company as defined in the [Investment
Company Act] (15 U.S.C. 80a-1 et seq.), but for section 3(c)(1) or
3(c)(7) of that Act, or such similar funds as the [Agencies] may, by
rule, as provided in subsection (b)(2), determine.\1680\
---------------------------------------------------------------------------

    \1680\ See 12 U.S.C. 1851(h)(2) (emphasis added).

    The statutory provision contains two parts: a first part that
refers to any issuer that is ``an investment company, as defined in the
Investment Company Act, but for section 3(c)(1) and 3(c)(7) of the
Act''; and a second part that covers ``such similar funds as the
[Agencies] may, by rule . . . determine.'' The proposed rule offered a
reading of this provision as a simple concurrent definition with two
self-contained, supplementary parts. Under this approach, all entities
covered by part one of the definition would be included in the
definitions of ``hedge fund'' and ``private equity fund,'' and the role
of the Agencies under the second part was limited to considering
whether and how to augment the scope of the primary statutory
definition.
    As noted above, commenters argued that this interpretation led to
unintended consequences that were not consistent with other provisions
of section 13 or the purposes of section 13, and that other
interpretations of the definition of covered fund were consistent with
both the words and the purpose of the statute. Also as explained above,
commenters offered multiple alternative interpretations of the
definition of, the scope of the prohibition on ownership interests in,
and relationships with, a covered fund.\1681\
---------------------------------------------------------------------------

    \1681\ In addition to the readings described above, one
commenter argued that the section could be read to provide that both
the reference to issuers covered by section 3(c)(1) or 3(c)(7) of
the Investment Company Act in the first part of section 13(h)(2) and
the reference to similar funds in the second part of the section
should be read as qualified by the clause ``as the Agencies may by
rule . . . determine.'' Under this reading, Congress granted the
Agencies authority to determine by rule whether an entity described
by the first part would be covered and whether an issuer would be
deemed to be a similar fund under the second part. See SIFMA et al.
(Covered Funds) (Feb. 2012).
---------------------------------------------------------------------------

    The Agencies believe that the language of section 13(h)(2) can best
be interpreted to provide two alternative definitions of the entities
to be covered by the statutory terms ``hedge fund'' and ``private
equity fund.'' Under this reading, the first part of section 13(h)(2)
contains a base definition that references the noted exclusions under
the Investment Company Act (the ``default definition''), while the
second part grants the Agencies the authority to adopt an alternate
definition that is triggered by agency action (the ``tailored
definition''). Thus, if the Agencies do not act by rule, the definition
is set by reference to the Investment Company Act and the relevant
exclusions alone; if the Agencies act by rule, the definitions are set
by the Agencies under that rule. As noted above, the Agencies have
determined to exercise the authority under the second part of the
statute to define ``hedge fund'' and ``private equity fund'' in the
final rule.
    Relying on the Agencies' authority to adopt an alternative,
tailored definition of ``hedge fund'' and ``private equity fund,'' the
final rule references funds that are similar to the funds in the base
alternative provided in the first alternative definition--that is, an
issuer that would be an investment company under the Investment Company
Act but for section 3(c)(1) or 3(c)(7) of that Act. The additions and
exclusions from that definition represent further determinations by the
Agencies regarding the scope of that definition that were made in the
course of a rulemaking conducted in accordance with section 13(b)(2) of
the BHC Act.
    The Agencies believe that this reading of the statutory provision
is consistent with the purpose of section 13. That purpose appears to
be to limit the involvement of banking entities in high-risk
proprietary trading, as well as their investment in, sponsorship of,
and other connections with, entities that engage in investment
activities for the benefit of banking entities, institutional investors
and high-net worth individuals.\1682\ Further, the Agencies believe
that the provision permits them to tailor the scope of the definition
to funds that engage in the investment activities contemplated by
section 13 (as opposed, for example, to vehicles that merely serve to
facilitate corporate structures); doing so allows the Agencies to avoid
the unintended results, some of which commenters identified, that might

follow from a definition that is inappropriately imprecise.\1683\
---------------------------------------------------------------------------

    \1682\ See 156 Cong. Reg. S.5894-5895 (daily ed. July 15, 2010)
(statement of Sen. Merkley).
    \1683\ The Agencies believe that the choice of the tailored
definition is supported by the legislative history that suggests
that Congress may have foreSeen that its base definition could lead
to unintended results and might be overly broad, too narrow, or
otherwise off the mark. Part two of the statutory definition was not
originally included in the bill reported by the Senate Committee on
April 30, 2010. While the addition of part two did not receive
specific comment, Rep. Frank, a co-sponsor and principal architect
of the Dodd-Frank Act, noted that the default definition ``could
technically apply to lots of corporate structures, and not just the
hedge funds and private equity funds'' and confirmed that ``[w]e do
not want these overdone.'' See 156 Cong. Rec. H5226 (daily ed. June
30, 2010) (statement of Reps. Himes and Frank) (noting intent that
subsidiaries or joint ventures not be included within the definition
of covered fund); 156 Cong. Rec. S5904-05 (daily ed. July 15, 2010)
(statement of Sens. Boxer and Dodd) (noting broad definition of
hedge fund and private equity fund and recommending that the
Agencies take steps to ensure definition is reasonably tailored).
---------------------------------------------------------------------------

    The Agencies also note that nothing in the structure or history of
the Dodd-Frank Act suggests that the definition of hedge fund and
private equity fund was intended to necessitate a fundamental
restructuring of banking entities by disallowing investments in common
corporate vehicles such as intermediate holding companies, joint
operating companies, acquisition vehicles and similar entities that do
not engage in the types of investment activities contemplated by
section 13. Moreover, other provisions of the Dodd-Frank Act and
existing banking laws and regulations would be undermined or vitiated
by a reading that restricts investments in these types of corporate
vehicles and structures.\1684\
---------------------------------------------------------------------------

    \1684\ For example, the Dodd-Frank Act requires banking entities
to serve as a source of financial strength to their insured
depository institutions and requires certain banking entities to
form intermediate holding companies to separate their financial and
non-financial activities. See Sections 167, 616(d) & 626 of the
Dodd-Frank Act. These provisions would be severely undermined if the
prohibitions on investments and activities contained in section 13
were applied to ownership of intermediate holding companies. For
instance, a bank holding company would not be able to serve as a
source of strength to an intermediate holding company (or any
subsidiary thereof) that is a covered fund due to the transaction
restrictions contained in section 13(f). See 12 U.S.C. 1851(f). As
another example, the Agencies have made certain modifications to the
final rule to make clear that it will not affect the resolution
authority of the Federal Deposit Insurance Corporation, including by
excluding from the covered fund definition issuers formed by or on
behalf of the Corporation for the purpose of facilitating the
disposal of assets acquired in the Corporation's capacity as
conservator or receiver. See Sec.  ----.10(c)(13).
---------------------------------------------------------------------------

    Based on the interpretive and policy considerations raised by
commenters, the language of section 13(h)(2), and the language,
structure, and purpose of the Dodd-Frank Act, the Agencies have adopted
a tailored definition of covered fund in the final rule that covers
issuers of the type that would be investment companies but for section
3(c)(1) or 3(c)(7) of the Investment Company Act with exclusions for
certain specific types of issuers in order to focus the covered fund
definition on vehicles used for the investment purposes that were the
target of section 13. The definition of covered fund under the final
rule also includes certain funds organized and offered outside of the
United States in order to address foreign fund structures and certain
commodity pools that might otherwise allow circumvention of the
restrictions of section 13. The Agencies also expect to exercise the
statutory anti-evasion authority provided in section 13(e) of the BHC
Act and other prudential authorities in order to address instances of
evasion.\1685\
---------------------------------------------------------------------------

    \1685\ As discussed in Part IV.C.1 of this SUPPLEMENTARY
INFORMATION regarding the compliance program requirements of the
final rule, the Agencies will consider information maintained and
provided by banking entities under the compliance program mandate to
help monitor potential evasions of the prohibitions and restrictions
of section 13. Additionally and consistent with the statute, the
final rule permits the Agencies to jointly determine to include
within the definition of covered fund any fund excluded from that
definition. The Agencies expect that this authority may be used to
help address situations of evasion.
---------------------------------------------------------------------------

    As discussed above, an alternative approach to defining a covered
fund would be to reference fund characteristics. Commenters arguing for
a characteristics-based approach stated that it would more precisely
tailor the final rule to the intent of section 13 and limit the
potential for undue burden on banking entities. A characteristics-based
definition, however, could be less effective than the approach taken in
the final rule as a means to prohibit banking entities, either directly
or indirectly, from engaging in the covered fund activities limited or
proscribed by section 13. A characteristics-based approach also could
require more analysis by banking entities to apply those
characteristics to every potential covered fund on a case-by-case
basis, and create greater opportunity for evasion. As discussed below,
the Agencies have sought to address some of the concerns raised by
commenters suggesting a characteristics-based approach by tailoring the
definition of covered fund to provide exclusions for certain entities
that rely on section 3(c)(1) or 3(c)(7) of the Investment Company Act
and otherwise would be treated as covered funds.
    Some commenters discussed the potential cost to banking entities to
analyze the covered fund status of certain entities if the Agencies
were to define the term covered fund by reference to sections 3(c)(1)
and 3(c)(7), arguing that this analysis would be costly.\1686\ A
characteristics-based approach could mitigate the costs associated with
an investment company analysis but, depending on the characteristics,
could result in additional compliance costs in some cases to the extent
banking entities would be required to implement policies and procedures
to prevent potential covered funds from having characteristics that
would bring them within the covered fund definition. Furthermore,
banking entities may currently rely on section 3(c)(1) and 3(c)(7) of
the Investment Company Act to avoid registering various entities under
the Investment Company Act, and the costs to analyze the status of
these entities under a statutory-based definition of covered fund are
generally already included as part of the fund formation process and
the costs of determining covered fund status may thus be mitigated,
especially given the exclusions provided in the final rule.
---------------------------------------------------------------------------

    \1686\ See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012).
---------------------------------------------------------------------------

    The entities excluded from the definition of covered fund are
described in detail in section (c) below.
1. Foreign Covered Funds
    In order to prevent evasion of the prohibition and purposes of
section 13, the proposal included within the definition of covered fund
any issuer organized or offered outside of the United States (``foreign
covered fund'') that would be a covered fund were it organized or
offered in the United States.\1687\
---------------------------------------------------------------------------

    \1687\ See proposed rule Sec.  ----.10(b)(1)(iii).
---------------------------------------------------------------------------

    Commenters expressed concern that the proposed treatment of foreign
covered funds was overly broad, exceeded the Agencies' statutory
authority, was not consistent with principles of national treatment,
and violated international treaties.\1688\ Commenters expressed concern
about the difficulties of applying Investment Company Act concepts to
foreign funds that are structured to comply with

regulatory schemes under local laws outside the United States. They
also argued that it would be burdensome and costly to require foreign
banking entities to interpret and apply U.S. securities laws to foreign
structures that are designed primarily to be offered and sold outside
the United States.\1689\ Commenters also contended that foreign mutual
fund equivalents, such as retail Undertakings for Collective
Investments in Transferable Securities (``UCITS''),\1690\ would be
treated as covered funds under the proposal even though they generally
are similar to U.S. registered investment companies, which are not
covered funds, meaning that under the proposal the scope of foreign
funds captured was broader than the scope of domestic funds.\1691\
These commenters argued that a foreign fund organized and offered
outside of the United States should not be treated as a covered fund
simply because the foreign fund may (or could) rely on the exclusion
under section 3(c)(1) or 3(c)(7) of the Investment Company Act were it
to be offered in the United States.\1692\
---------------------------------------------------------------------------

    \1688\ See SIFMA et al. (Covered Funds) (Feb. 2012); BNY Mellon
et al.; BlackRock; ABA (Keating); AFTI; AFG; ICI Global; Ass'n. of
Institutional Investors (Feb. 2012); ICI (Feb. 2012); SSgA (Feb.
2012); State Street (Feb. 2012); JPMC; BoA; Goldman (Covered Funds);
Bank of Montreal et al. (Jan. 2012); AGC; Cadwalader (on behalf of
Thai Banks); ALFI; BVI; EBF; British Bankers Ass'n.; French ACP;
AFME et al.; F&C IIF; ICSA; IMA; EFAMA; UKRCBC; AIMA; AFMA;
Australian Bankers Ass'n. (Feb. 2012); Allen & Overy (on behalf of
Foreign Bank Group); IFIC; Allen & Overy (on behalf of Canadian
Banks); RBC; French Treasury et al.; Hong Kong Inv. Funds Ass'n.;
TCW; Govt. of Japan/Bank of Japan.
    \1689\ See JPMC; See also Cadwalader (on behalf of Thai Banks);
Cadwalader (on behalf of Singapore Banks); Ass'n. of Banks in
Malaysia; Govt. of Japan/Bank of Japan.
    \1690\ UCITS are public limited companies that, under a series
of directives issued by the EU Commission, coordinate distribution
and management of unit trusts or collective investment schemes in
financial instruments on a cross-border basis throughout the
European Union on the basis of the authorization of a single member
state.
    \1691\ See Allen & Overy (on behalf of Foreign Bank Group); ABA
(Keating); AFG; AFTI; BoA; French Banking Fed'n.; SIFMA et al.
(Covered Funds) (Feb. 2012); See also BNY Mellon et al.; BlackRock;
ICI Global; Ass'n. of Institutional Investors (Feb. 2012); ICI (Feb.
2012); SSgA (Feb. 2012); State Street (Feb. 2012); JPMC; BoA;
Goldman (Covered Funds); Bank of Montreal et al. (Jan. 2012); AGC;
Cadwalader (on behalf of Thai Banks); ALFI; BVI; EBF; British
Bankers Ass'n.; French ACP; AFME et al.; F&C IIF; ICSA; IMA; EFAMA;
UKRCBC; AIMA; AFMA; Australian Bankers Ass'n. (Feb. 2012); Allen &
Overy (on behalf of Foreign Bank Group); IFIC; Allen & Overy (on
behalf of Canadian Banks); RBC; French Treasury et al.; Hong Kong
Inv. Funds Ass'n.; HSBC Life; ICSA Ass'n. of Banks in Malaysia
(arguing that foreign banking organization would have to determine
how a fund would be regulated under U.S. law before making
investments in funds in their home markets).
    \1692\ See Allen & Overy (on behalf of Foreign Bank Group); ABA
(Keating); SSgA (Feb. 2012); BoA; Goldman (Covered Funds).
---------------------------------------------------------------------------

    Some commenters argued that the proposal did not clearly identify
which foreign funds would be covered, thereby creating uncertainty
about the scope of funds to which section 13 would apply.\1693\ Several
commenters argued that the proposal's foreign covered fund definition
could be read to include a foreign fund, even if its securities were
never offered and sold to U.S. persons, because the fund could
theoretically be offered in the United States in reliance on section
3(c)(1) or 3(c)(7).\1694\ Commenters argued that the definition of
foreign covered fund should be tailored.\1695\ Some commenters argued
that foreign funds that are not made available for sale in the U.S. or
actively marketed to U.S. investors should be specifically excluded
from the definition of covered fund.\1696\ Several other commenters
supported narrowing the definition of foreign covered fund to those
foreign funds with characteristics similar to domestic hedge funds or
private equity funds.\1697\
---------------------------------------------------------------------------

    \1693\ See Australian Bankers Ass'n. (Feb. 2012); BlackRock.
    \1694\ See BlackRock; SIFMA et al. (Covered Funds) (Feb. 2012);
JPMC; ABA (Keating); IIB/EBF. These commenters argued that the
proposed definition of a covered fund could result in virtually
every foreign fund being considered a covered fund, regardless of
whether the fund is similar to a hedge fund or private equity fund.
    \1695\ See, e.g., AGC; Ass'n. of Institutional Investors (Feb.
2012); ABA (Keating); Goldman (Covered Funds); BoA; GE (Feb. 2012);
Japanese Bankers Ass'n.; EBF.
    \1696\ See Australian Bankers Ass'n. (Feb. 2012); AFG; BNY
Mellon et al.; BlackRock; Goldman (Covered Funds); IIB/EBF.
    \1697\ See SIFMA et al. (Covered Funds) (Feb. 2012); JPMC;
Goldman (Covered Funds); Credit Suisse (Williams); ABA (Keating);
IIB/EBF; Barclays; BoA; GE (Feb. 2012) (discussing the uncertainty
with respect to foreign-based loan and securitization programs and
whether they would be deemed covered funds).
---------------------------------------------------------------------------

    After considering the comments in light of the statutory provisions
and purpose of section 13, the Agencies have modified the final rule to
more effectively tailor the scope of foreign funds that would be
covered funds under the rule and better implement the language and
purpose of section 13. As noted above, section 13 of the BHC Act
applies to the global operations of U.S. banking entities, and one of
the purposes of section 13 is to reduce the risk to the U.S. financial
system of activities with and investments in covered funds. The
Agencies proposed to include foreign funds within the definition of
covered fund in order to more effectively accomplish the purpose of
section 13. In particular, the Agencies were concerned that a
definition of covered fund that did not include foreign funds would
allow U.S. banking entities to be exposed to risks and engage in
covered fund activities outside the United States that are specifically
prohibited in the United States. This result would undermine section 13
and pose risks to U.S. banking entities and the stability of the U.S.
financial system that section 13 was designed to prevent.
    At the same time, section 13 includes other provisions that
explicitly limit its extra-territorial application to the activities of
foreign banks outside the United States. As explained below, section 13
specifically exempts certain activities in covered funds conducted by
foreign banking entities solely outside of the United States.
    Based on these considerations and the information provided by
commenters, the Agencies have revised the definition of covered fund in
the final rule to include certain foreign funds under certain
circumstances. The final rule provides that a foreign fund is included
within the definition of covered fund only for any banking entity that
is, or is controlled directly or indirectly by a banking entity that
is, located in or organized or established under the laws of the United
States or of any State. Under this definition a foreign fund becomes a
covered fund only with respect to the U.S. banking entity (or foreign
affiliate of a U.S. banking entity) that acts as a sponsor to the
foreign fund or has an ownership interest in the foreign fund. Under
the rule, a foreign fund is any entity that: (i) is organized or
established outside the United States and the ownership interests of
which are offered and sold solely outside the United States; (ii) is,
or holds itself out as being, an entity or arrangement that raises
money from investors primarily for the purpose of investing in
securities for resale or other disposition or otherwise trading in
securities; and (iii) has as its sponsor the U.S. banking entity (or an
affiliate thereof) or has issued an ownership interest that is owned
directly or indirectly by the U.S. banking entity (or an affiliate
thereof).\1698\ A foreign fund therefore may be a covered fund with
respect to the U.S. banking entity that sponsors the fund, but not be a
covered fund with respect to a foreign bank that invests in the fund
solely outside the United States.
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    \1698\ See final rule Sec.  ----.10(b)(1)(iii).
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    This approach is designed to include within the definition of
covered fund only foreign entities that would pose risks to U.S.
banking entities of the type section 13 was designed to address. The
Agencies note that any foreign fund, including a foreign fund sponsored
or owned by a foreign banking entity, that is offered or sold in the
United States in reliance on the exclusions in section 3(c)(1) or
3(c)(7) of the Investment Company Act would be included in the
definition of covered fund under Sec.  ----.10(b)(1)(i) of the final
rule unless it meets the requirements of an exclusion from that
definition as discussed below.\1699\ Thus, the rule is

designed to provide parity--and no competitive advantages or
disadvantages--between U.S. and non-U.S. funds sold within the United
States.
---------------------------------------------------------------------------

    \1699\ See also Goodwin, Procter & Hoar LLP, SEC Staff No-Action
Letter (Feb. 28, 1997); Touche Remnant & Co., SEC Staff No-Action
Letter (Aug. 27, 1984).
---------------------------------------------------------------------------

    To further ensure that this approach to foreign funds is consistent
with the scope of coverage applied within the United States, the final
rule excludes from the definition of covered fund any foreign issuer
that, were it subject to U.S. securities laws, would be able to rely on
an exclusion or exemption from the definition of investment company
other than the exclusions contained in section 3(c)(1) or 3(c)(7) of
the Investment Company Act.\1700\
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    \1700\ See final rule Sec.  ----.10(b)(2). Because any issuer
that offers its securities under the U.S. securities laws that may
rely on an exclusion or exemption from the definition of investment
company other than the exclusions contained in section 3(c)(1) or
3(c)(7) of the Investment Company Act would not be a covered fund,
this exclusion is designed to provide equivalent treatment for
foreign covered funds.
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    As explained below, the final rule also contains an exclusion for
foreign public funds.\1701\ This is designed to prevent the extension
of the definition of covered fund from including foreign funds that are
similar to U.S. registered investment companies, which are by statute
not covered by section 13.
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    \1701\ See Sec.  ----.10(c)(1).
---------------------------------------------------------------------------

2. Commodity Pools
    Under the proposal, the Agencies proposed to use their authority to
expand the definition of covered fund to include a commodity pool as
defined in section 1a(10) of the Commodity Exchange Act.\1702\ A
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.\1703\ The Agencies
proposed to include commodity pools in the definition of covered fund
because some commodity pools are managed and structured in a manner
similar to a covered fund.
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    \1702\ See proposal rule Sec.  ----.10(b)(1)(ii).
    \1703\ Commodity interests include: (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)
leveraged transaction authorized under section 23 of the Commodity
Exchange Act. See Joint Proposal, 76 FR 68,897 n.224 and
accompanying text.
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    Some commenters objected to this expansion of the definition of
covered fund as beyond the scope of section 13. Commenters argued that
covering commodity pools would extend section 13 of the BHC Act to any
entity that engages in a single commodity, futures or swap transaction,
including entities that share few, if any, of the characteristics or
risk associated with private equity funds or hedge funds.\1704\ For
example, some commenters argued that many non-bank businesses that are
not investment companies but that hedge risks using commodity interests
would be treated as covered funds if all commodity pools were
covered.\1705\ In addition, registered mutual funds, pension funds, and
many investment companies that rely on exclusions or exceptions other
than section 3(c)(1) or 3(c)(7) of the Investment Company Act would be
covered as commodity pools. Commenters argued that the CFTC has ample
authority to regulate the activities of commodity pools and commodity
pool operators, and nothing in section 13 indicates that Congress
intended section 13 to govern commodity pool activities or investments
in commodity pools.\1706\ Commenters also argued that expanding the
definition of covered fund to include commodity pools would have the
unintended consequence of limiting all covered transactions between a
banking entity sponsor or investor in a commodity pool and the
commodity pool itself.\1707\ If a commercial end user is a commodity
pool for example, this restriction could limit access to credit for
that entity.
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    \1704\ See, e.g., ABA (Keating) (citing See, e.g., CFTC
Interpretative Letter No. 86-22, Comm. Fut. L. Rep. (CCH) ] 23,280
(Sept. 19, 1986)); SIFMA et al. (Covered Funds) (Feb. 2012); ICI
(Feb. 2012); BlackRock; Goldman (Covered Funds); Wells Fargo
(Covered Funds); BoA; EFAMA; TCW; ISDA (Feb. 2012); Arnold & Porter;
BNY Mellon et al.; SSgA (Feb. 2012); State Street (Feb. 2012);
Credit Suisse (Williams); RMA; IIB/EBF.
    \1705\ See Goldman (Covered Funds); TCW; IIB/EBF.
    \1706\ See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); ICI
(Feb. 2012); BlackRock.
    \1707\ See, e.g., BoA.
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    Commenters that opposed the proposal's inclusion of commodity pools
generally asserted that, if commodity pools were nonetheless included
as covered funds under the final rule, the definition of commodity pool
should be modified so that it would include only those pools that
engage ``primarily'' or ``principally'' in commodities trading and
exhibit characteristics similar to those of conventional hedge funds
and private equity funds.\1708\ Other commenters urged the Agencies to
incorporate the exemptions from the commodity pool operator
registration requirements under the Commodity Exchange Act (such as
rule 4.13(a)(4)).\1709\
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    \1708\ See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012);
Goldman (Covered Funds); BlackRock; Wells Fargo (Covered Funds); BNY
Mellon, et al.; SSgA (Feb. 2012); State Street (Feb. 2012); Credit
Suisse (Williams); ABA (Keating); FIA; IIB/EBF; BoA.
    \1709\ See Credit Suisse (Williams).
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    Some commenters supported including commodity pools within the
definition of covered fund,\1710\ with some suggesting that this
approach would be consistent with the goals of the statute.\1711\ One
commenter asserted that including commodity pools would be necessary to
prevent banking entities from indirectly engaging in prohibited
proprietary trading through commodity pools.\1712\ Another commenter
asserted that the inclusion of commodity pools was advisable because
the CFTC has in the past viewed many commodity pools as similar to
hedge funds.\1713\
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    \1710\ See AFR et al. (Feb. 2012); Alfred Brock; Occupy; Sens.
Merkley & Levin (Feb. 2012).
    \1711\ See Sens. Merkley & Levin (Feb. 2012); Occupy; AFR et al.
(Feb. 2012); Alfred Brock.
    \1712\ See Sens. Merkley & Levin (Feb. 2012).
    \1713\ See Occupy.
---------------------------------------------------------------------------

    After carefully considering these comments, the Agencies have
determined not to include all commodity pools as covered funds as
proposed. Instead, and taking into account commenters' concerns, the
Agencies have taken a more tailored approach that is designed to more
accurately identify those commodity pools that are similar to issuers
that would be investment companies as defined the Investment Company
Act of 1940 but for section 3(c)(1) or 3(c)(7) of that Act, consistent
with section 13(h)(2) of the BHC Act.
    Under the final rule, as a threshold matter, a collective
investment vehicle must determine whether it is a ``commodity pool'' as
that term is defined in section 1a(10) of the Commodity Exchange
Act.\1714\ The Agencies note that collective investment vehicles need
to make this determination for purposes of complying with the Commodity
Exchange Act regardless of whether commodity pools are covered funds.
Under section 1a(10), a commodity pool is ``any investment trust,
syndicate, or similar form of enterprise operated for the purpose of
trading commodity interests.'' \1715\ If a collective investment

vehicle meets that definition, the commodity pool would be considered a
covered fund provided it meets one of two alternative tests and does
not also qualify for an exclusion from the covered fund definition
(e.g., the exclusion for registered investment companies).
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    \1714\ See 7 U.S.C. 1a(10).
    \1715\ Id. The CFTC and its divisions have provided
interpretative guidance with respect to the meaning of the
definition of commodity pool. See, e.g., 46 FR 26004, 26005 (May 8,
1981) (adopting the CFTC's regulatory definition of commodity pool
in 17 CFR 4.10(d), which is substantively identical to the
definition in section 1a(10) of the Commodity Exchange Act); 77 FR
11252, 11258 (Feb. 24, 2012) (explaining the need for swaps to be
included in the de minimis exclusion and exemption in 17 CFR 4.5 and
4.13); CFTC Staff Letter 12-13 (Oct. 11, 2012) (providing
interpretative guidance to equity real estate investment trusts);
and CFTC Staff Letters Nos. 12-14 (Oct. 11, 2012) and 12-45 (Dec. 7,
2012) (providing interpretative relief that certain securitization
vehicles are not commodity pools).
---------------------------------------------------------------------------

    First, a commodity pool will be a covered fund if it is an ``exempt
pool'' under section 4.7(a)(1)(iii) of the CFTC's regulations,\1716\
meaning that it is a commodity pool for which a registered commodity
pool operator has elected to claim the exemption provided by section
4.7 of the CFTC's regulations. The Agencies believe that such commodity
pools are appropriately considered covered funds because, like funds
that rely on section 3(c)(1) or 3(c)(7), these commodity pools sell
their participation units in restricted offerings that are not
registered under the Securities Act of 1933 and are offered only to
investors who meet certain heightened qualification standards, as
discussed above.\1717\ The Agencies therefore have determined that they
properly are considered ``such similar funds'' as specified in section
13(h)(2) of the BHC Act.
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    \1716\ 17 CFR 4.7(a)(1)(iii).
    \1717\ Although section 3(c)(1) itself does not limit the types
of investors who may invest in a fund relying on that exclusion,
section 3(c)(1) provides that the fund may not conduct a public
offering. A fund relying on section 3(c)(1) therefore must offer and
sell its interests in offerings that are not registered under the
Securities Act of 1933, which offerings generally are limited to
persons who meet certain qualification standards.
---------------------------------------------------------------------------

    Alternatively, a commodity pool for which exempt pool status under
section 4.7 of the CFTC's regulations has not been elected may also be
a covered fund if the pool features certain elements that make the pool
substantively similar to exempt pools under section 4.7. The Agencies
are including the alternative definition of commodity pools that are
covered funds because, if the Agencies had included only pools for
which exempt pool status had been elected, covered fund status for
pools in which banking entities are invested could easily be avoided
merely by not electing exempt pool status under section 4.7. The
following is a description of the elements of a pool that would cause a
pool that is not an exempt pool under section 4.7 to be a covered fund.
    The first element is that a commodity pool operator for the pool is
registered pursuant to the Commodity Exchange Act in connection with
the operation of that commodity pool. This element is present for all
pools that are exempt pools under section 4.7 because exempt pool
status can only be elected by registered commodity pool operators. This
element excludes from the definition of covered fund an entity that is
a commodity pool, but for which the pool operator has been either
exempted from registration as a commodity pool operator or excluded
from the definition of commodity pool operator under the CFTC's
regulations or pursuant to a no-action letter issued by CFTC
staff.\1718\
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    \1718\ See, e.g., CFTC regulations 3.10(c) and 4.13 and CFTC
Staff Letters Nos. 12-37 (Nov. 29, 2012) (relief from registration
for operators of certain types of family office pools), 12-40 (Dec.
4, 2012) (relief from registration for operators of business
development companies that meet certain conditions) and 12-44 (Dec.
7, 2012) (relief from registration for operators of mortgage real
estate investment trusts that meet certain conditions). See also
supra note 1715.
---------------------------------------------------------------------------

    The second element under the alternative definition is that
substantially all of the commodity pool's participation units are owned
only by qualified eligible persons under section 4.7(a)(2) and
(a)(3).\1719\ This element is consistent with the requirement under
section 4.7 that exempt pool status can only be claimed if the
participation units in the pool are only offered or sold to qualified
eligible persons.\1720\ Moreover, the inclusion of this element aligns
the elements of the alternative test with features that define funds
that rely on sections 3(c)(1) and 3(c)(7) of the Investment Company Act
of 1940.
---------------------------------------------------------------------------

    \1719\ 17 CFR 4.7(a)(2) and (a)(3).
    \1720\ Although section 4.7 requires that all participation
units be owned by qualified eligible persons, this element of the
final rule has been modified to include pools for which
``substantially all'' participation units are owned by qualified
eligible persons to prevent avoidance of covered fund status by
distributing a small number of participation units to persons who
are not qualified eligible persons.
---------------------------------------------------------------------------

    The assessment as to whether the commodity pool in question
satisfies this condition must be made at the time that the banking
entity is required to make the following determinations: Whether it can
obtain new participation units in the commodity pool, whether it can
retain previously purchased participation units in the commodity pool,
and whether it can act as the commodity pool's sponsor. The Agencies
believe this to be appropriate because it would require the banking
entity to consider current information regarding the commodity pool and
its participants rather than assess the composition of the pool's
participants over time even though its investments in or relationships
with the pool do not change, which could be difficult depending upon
the length of time that the pool has been in operation and the records
available at the time of determination.
    Finally, the third element under the alternative definition is that
the commodity pool participation units have not been publicly offered
to persons other than qualified eligible persons. Consistent with CFTC
regulations addressing the meaning of ``offer'' in the context of the
CFTC's regulations, the term ``offer'' as used in Sec.  --
--.10(b)(1)(ii)(B) ``has the same meaning as in contract law, such
that, if accepted the terms of the offer would form a binding
contract.'' \1721\ This aspect of the alternative definition is
intended to limit the ability for commodity pools to avoid
classification as covered funds through an offer, either in the past or
currently ongoing, to non-qualified eligible persons ``in name only''
where there is no actual offer to non-qualified eligible persons.
---------------------------------------------------------------------------

    \1721\ See 77 FR 9734, 9741 (Feb. 17, 2012) (describing the
meaning of the term ``offer'' in the context of the business conduct
standards for swap dealers and major swap participants with
counterparties adopted by the CFTC). The term ``offered'' as used in
this section of the final rule is not intended to denote an
``offer'' for purposes of the Securities Act of 1933.
---------------------------------------------------------------------------

    Accordingly, unless the pool operator can show that the pool's
participation units have been actively and publicly offered to non-
affiliated parties that are not qualified eligible persons whereby such
non-qualified eligible persons could in fact purchase a participation
unit in the commodity pool, a pool that features the other elements
listed in the alternative definition would be a covered fund. Such a
showing will not turn solely on whether the commodity pool has filed a
registration statement to offer its participation units under the
Securities Act of 1933 or whether the commodity pool operator has
prepared a disclosure document consistent with the provisions of
section 4.24 of the CFTC's regulations.\1722\ Rather, the pool operator
would need to show that a reasonably active effort, based on the facts
and circumstances, has been undertaken by brokers and other sales