With this study I will restate some of the applicable laws, rules and official reports that describe an area of private investment activity that is lawful and well regulated. This is being provided to show the evidence that is publicly available that defines an area of financial activity not open to “public participation” but is limited to entities or persons with substantial funds. Further that such activity, although somewhat similar in terminology, has no relationship to what is often been described in warnings as “Prime Bank Fraud”, The author does not offer these observations as legal advice; an attempt to gain clients; as proof of what specific private placement transaction a person or company could or should consider; or as proof that any given person or entity can qualify or be successful pursing this field of interest. Such choices can only be pursued by a qualified party with the assistance of their active, practicing attorney. Even then, that activity should be considered only if that person and attorney were experienced and knowledgeable in the accepted methods used to protect capital values from unprotected third party control during such transactions.
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Definitions
Debenture
A debt obligation not backed by assets; an “IOU”, as opposed to a collateralized debt in which the borrower provides an item of value to back up his promise to repay. If someone claims that one is trading “bank debentures,” such a phrase according to the authorities would be a tip off of a scam. It may also just mean a wrong choice of terms and the company is buying and/or selling “MTNs” (Medium Term Notes).
Debt Instrument
Any note indicating an indebtedness, to be repaid with interest over time. By contrast, an equity instrument provides rights of ownership. Bonds, short-term corporate notes, treasury bills, IOUs, and MTNs are all forms of debt instruments. Stocks are the typical form of an equity instrument.
Prime
As used by the regulatory authorities, “prime” is used to designate a type of bank or institution. The largest, most important banks are properly referred to as “money center” banks. These types of banks have not been typically referred to as “Prime Banks” since the early 90s when the term was used regularly to describe the standing of a particular institution. The term “Prime Bank” is another key word as to the existence of a scam since it indicates that the person using the term is not “up to date” in their terminology.
Trader
One who actually effects transactions in debt, equity and other financial instruments. Some documents refer to this individual as a broker, dealer or sponsor.
Riskless Principal
The term is defined in SEC-Reg FSLR 2705AA Reg 230.144A (often simply referred to as Rule 144A), in which a “riskless principal transaction” is defined as “a transaction in which a dealer buys a security from any entity and makes a simultaneous offsetting sale of such security to a qualified institutional buyer, including another dealer acting as a riskless principal for a qualified buyer”.
Qualified Institutional Buyer (QIB)
SEC-Reg FSLR 2705AA Reg 230.144A (Exhibit A) provides definitions for a “qualified institutional buyer” which includes banks, insurance companies, a dealer acting on behalf of individuals or institutions which have 100 million dollars, or a dealer acting on behalf of institutional buyers engaging in a simultaneous offsetting sale of such security to a qualified institutional buyer, including another dealer acting as a riskless principal for a qualified buyer.
Portal Security, Portal Market
A security subject to SEC Rule 144A. PORTAL securities are traded in the PORTAL market. A copy of the application requirements for designation as a PORTAL security can be viewed at the NASD website (Refer to rules 5321 and 5322 of the NASD Market Place Rules).
High Yield
A term generally indicating a return on principal greater that one would obtain through, for example, purchasing a CD at a bank. High Yield corporate bonds would generally provide an interest rate higher than a treasury bill of similar terms, since the risk of default on the corporate bond is presumed to be higher than a debt instrument issued by the US Government.
Regulations Concerning Private Trading Activities
All securities traded within the US must be either registered with the Securities and Exchange Commission, according to the Securities Act of 1933, or exempt from registration. There is a wide range of securities exempt from registration. Section 3(a)2 of the Securities Act of 1933 excludes instruments issued by banks. SEC-Reg, FSLR 2705AA, Reg230.144A (often simply referred to as Rule 144A) authorizes a special class of securities which, although registered, are not available to the public. It also permits the purchase and sale of these securities by broker/dealers on behalf of Qualified Institutional Buyers (QIBs), in the form of “riskless principal transactions”. The activities of banks are largely regulated by the Federal Reserve and not the SEC. Regulation Y is the most applicable to trading activities.
Truth versus Error - Private versus Secret
The FBI and other warning reports refer to schemes concerning trading in “bank debentures” and obscure financial instruments, and they flat out state that such trading doesn’t take place. Some promoters may claim that there is a “secret trading” market for various instruments, while the regulators claim that no “such secret” market exists.
First, let us examine the “private” as opposed to “secret” trading market. In fact, many types of both debt and equity securities are traded daily without being reported to the public. Such activity takes place in a “private” market. These include PORTAL securities, debt instruments generated by banks, and corporate debt instruments sold by private placement. SEC Rule 144A refers to the “Private Resale of Securities to Institutional Buyers”. In fact, this is an entire class of securities traded daily, which are unavailable to any except QIBs. Such securities are not traded on public exchanges. The National Association of Securities Dealers (NASD) has a website (http://www.nasd.com/) that indicates that under its subsidiary, The NASDAQ Stock Market, Inc., it has set up the PORTAL Market. On the web site, it is described as follows:
The Portal Market
“The PORTAL SM Market, an electronic screen-based system, facilitates trading of SEC Rule 144A private placements by qualified investors. PORTAL provides companies with increased flexibility in raising capital by creating a method for accessing a significant source of funds. It gives U.S. institutional investors another opportunity to diversify their portfolios by making certain foreign securities available for purchase inthe domestic market. PORTAL complements SEC Rule 144A, which provides safe-harbor protections by exempting the private placements of certain issuers from the SEC’s registration and disclosure requirements and by allowing eligible institutional investors to trade these securities freely among themselves without having to observe restrictions that, prior to the adoption of the rule, otherwise delayed the trading of these securities.”
These securities are unavailable to the general public, and can be traded as part of a “riskless principal” transaction, per Rule 144A. You can examine a full explanation on the web site http://www.sec.gov/.The Bond Market Association also has an interesting web site printing a letter written to the SEC that has an interesting comment about a third of the way down through the document.
“NASD will not disseminate trade report information for transactions involving Rule 144A eligible, privately places debt securities, including PORTAL designated and investment grade DTC eligible debt.”
So, although NASD may collect data on trading in these types of securities, they will not release that data to the public. On the Bond Market Association web site mentioned above, a paper, titled 3-C-7 policies.pdf, Recommended Policies and Procedures for Secondary Market Trading in Book-Entry Section 3©(7) Securities, dated October 1999, that provides information concerning dealing in these type of securities on behalf of QIB/Qualified Purchasers. Exhibit 2 is particularly enlightening, page E2-3 where names and account numbers of QIB/QPs can be listed to allow the broker/dealer to buy and sell securities on behalf of these account holders.
Both “Private” and “Secret” are terms that mean the same thing. Where public disclosure is not allowed, or made the use of “Private” may be acceptable while the use of “Secret” may just indicate the lack of familiarity with proper terminology.
Medium Term Notes (MTN)
Medium Term Notes (MTN) are debt instruments with a maturity greater than 270 days, and generally less than 30 years. Debt instruments with maturities less than 270 days are generally referred to as “commercial paper” and are exempt from registration with the SEC. Corporations and Bank holding companies can file a SEC Form S-3 shelf registration in which the company can issue debt or equity instruments periodically without each time filing a new registration filing (see website: http://www.sec.gov/divisions/corpfin/forms/s-3.htm). This allows the company to issue instruments over a two-year period without any additional public notification. The adoption of SEC Rule 144A in April 1990 effectively created an alternative market in which foreign corporations could gain access to U.S. investors without having to satisfy the disclosure requirements for public offerings. These offerings include MTNs.
The easiest way to become familiar with the Federal Reserve Board’s data and comments
on this subject is to review the FRB’s annual survey of U.S. corporate MTNs. The most interesting is the report for 1996, which is attached as Exhibit “D”. It is well worth reading as it is also a historical survey of the MTN market. The Board of Governors of the Federal Reserve System 1996 Survey of Corporate Medium Term Notes, April 16, 1997, includes the following statement:
“The Division of Research and Statistics of the Federal Reserve Board obtains this data from a survey of U.S. corporations that borrow in the public MTN market. The reported figures do not include borrowing in the “Euro” markets or the private placement market (both traditional issues and securities sold under SEC Rule 144A are excluded). Moreover, the survey does not include offerings by foreign corporations, sovereigns, supranationals or federal agencies. The figures include MTNs offered by bank holding companies but exclude deposit notes and bank notes offered by banks because these securities are exempt from SEC registration under section 3(a)2 of the Securities Act of 1933. The Federal Reserve collects this data to improve its estimates of new securities issues of U. S. corporations, as published in the Federal Reserve Bulletin, and to improve estimates of corporate securities outstanding as shown in the Federal Reserve’s flow of funds accounts. The Federal Reserve obtains information on new programs from announcements of SEC Rule 415 registrations and contacts with MTN agents. It regards as confidential the disaggregated information provided by individual companies.”
So MTNs, which are sold under private placements, and MTNs issued by banks, or governments are again not publicly reported. In summary, the Bond Market Association and the Federal Reserve Bank web sites both states that certain transactions in securities are not reported to the public. The activity within this market is private. Secret or Private, what’s the difference? Those web sites simply state:
“About Corporate Medium Term Notes - Since 1997 the Federal Reserve Board has been obtaining the data on the issuance of medium term notes (MTNS) from the Depository Trust Company (DTC), a national clearinghouse for the settlement of securities trades and a custodian for securities. The DTC performs these functions for almost all activity in the domestic market. Before 1997, the data were based on surveys of U. S. corporations that borrow in the MTN market. The MTN data does not include offering by foreign corporations, sovereigns or federal agencies. The data includes MTNs offered by bank holding companies but excludes deposit notes and bank notes offered by banks because these securities are exempt from SEC registration under section 3(a)2 of the Securities Act of 1933. The Federal Reserve collects this data to improve its estimates of new securities issues of U. S. corporations, as published in the Federal Reserve Bulletin, and to improve estimates of corporate securities outstanding as shown in the Federal Reserve’s flow of funds accounts. The Federal Reserve obtains information on new programs from announcements of SEC Rule 415 registrations and contacts with MTN agents. It regards as confidential the disaggregated information provided by individual firms.”
MTNs are issued by bank holding companies (often said as not happening). One must remember that domestic banks can get most of their funds for loans from the FED based upon a formula related to their assets. Raising such “off balance sheet funds” can still be beneficial to such entities and to their holding companies. Non US banks must borrow the funds required to carry out their lending activities and since the passage of SEC Rule 144A, can sell their MTNs to U. S. Qualified buyers to raise funds for that purpose. You can bet it is a big market with numerous non-U.S. banks searching for the U.S. dollars they require for lending as part of their normal banking business.
The news release that follows provides no explicit description of the “Cash Instruments” referred to, such as private placements or Rule 144A securities, but there is not reason to believe that the news report includes activities, which were excluded from older reports.
Bank Activities
Derivatives Volume Grows to $25 Trillion in 3rd Quarter; Quarterly Derivatives Revenue is Record $2.5 Billion
“Washington, D.C. - December 22, 1997 - The amount of derivatives activity at commercial banks increased by $1.7 trillion in the third quarter to a record $25 trillion, the Office of the Comptroller of the Currency (OCC) reported today. Since the beginning of 1997, the notional amount of derivatives activity has increased by 25 percent. In its quarterly report of derivatives activity, the OCC said third quarter revenues of commercial banks from cash instruments and off-balance sheet derivatives increasedto a record $2.5 billion - up $509 million or 26 percent from the second quarter. For the year, revenues from trading cash instruments, such as Treasury Bonds and off-balance sheet activities, such as swaps, futures, forwards and options stood at $6.8 billion. Cash instruments are traded along with derivatives and they are not separated in revenue reports.”
Regulation Y, issued by the Board of Governors of the Federal Reserve Board, lists “permissible non-banking activities”. The list shows everything banks derive real income from. Section III “retail banking” is basically what banks were allowed to do. Everything that has become their real business is merely “permissible”. In Sec. 225.28 of Reg. Y there is a list of permissible non-banking activities:
(7) “Agency transactional services for customer investments - (i) Securities brokerage. Providing securities brokerage services (including securities clearing and/or securities execution services on an exchange), whether alone or in combination with investment advisory services, and incidental activities (including related securities credit services and custodial services), if the securities brokerage services are restricted to buying and selling securities solely as agent for the account of customers and do not include securities underwriting or dealing. (ii) Riskless principal transactions. Buying and selling in the secondary market all types of securities on the order of customers as a “riskless principal” to the extent of engaging in a transaction in which the company, after receiving an order to buy (or sell) a security from a customer, purchases (or sells) the security for its own account to offset a contemporaneous sale to (of purchase from) the customer….”
So, according to this regulation, banks may act as agents for customers for the purchase and sale of securities, as long as they, themselves, do not underwrite those sales. The Federal Reserve Board understands riskless principal transactions and allows its banks to perform these services for its customers who may be QIBs or QPs (and of course receiving a fee for its efforts).
Item iii in Regulation Y is also illuminating:
“(iii) Private placement services, Acting as agent for the private placement of securities in accordance with the requirements of the Securities Act of 1933 (1933 Act) and the rules of the Securities and Exchange Commission, if the company engaged in the activity does not purchase or repurchase for its own account the securities being placed, or held in inventory unsold portions of issues of these securities.”
So, banks are clearly permitted to provide private placement services to their customer. That should not be a big surprise to anyone. Banks can act as agents for riskless principal transactions, private placements and these activities are not publicly reported. If a bank deals exclusively with Government and bank issued debt instruments, then those activities are not subject to the registration and reporting requirements of the 1933 Securities Act. The SEC can claim that they have no knowledge of the bank’s trading activities (since the SEC does not directly regulate bank activities). At the Credit Suisse web site (http://www.csfb.com/) it offers corporate clients the opportunity to obtain funding through private placement with the following statement:
“The Credit Suisse First Boston Private Placement team has the insights and relationships to deliver world-class private funding…with relationships with more than 3,000 potential investors globally.”
Why would a bank participate in such activities on behalf of their customer? Perhaps two reasons. First, there are various instruments that are classified as “bank ineligible” securities. The bank is not allowed to purchase and hold these securities itself. Through this regulation, however, it is allowed to buy and sell such securities on behalf of its customers. This then allows the bank to receive profit from buying and selling securities that, without the customer, it could not otherwise participate. The second is because the bank is unable to underwrite new security issues, in other words, participate in the primary market for a new security.
As I understand it, if First Union were to attempt to sell a new issue of its MTNs, Chase Manhattan couldn’t directly purchase that security for its own account, even with the intent of reselling it, since such an activity would essentially be underwriting the creation and sale of the security. It may, however, purchase the full issue of that security for a customer. This regulation would lead one to believe that there is a need for a group of investors (perhaps valued bank customers) to underwrite the issue of new bank-issued securities on behalf of and for the benefit of the bank. Once these customers have purchased the security, they may be free to resell it to another bank acting for its customer or for its own account, since the purchasing bank is now buying a debt instrument on the secondary market, rather than the initial or primary market. Again, the bank will receive a fee income for providing this service to its customers.
You can bet that the customers allowed to take part gain a substantial profit for such a service. Since it is “selective” you can also bet they don’t want such information published. Thus it is “private” (means the same as secret, but since “secret” markets do not exist we can just use “private”). The difference is between what is secret and what is private. Form FR Y-20 page 4 (Website: http://www.ny.frb.org/banking/regrept/y20_1297.pdf) is the method that bank holding companies report their commissions on securities transactions and fees for private placements to the Federal Reserve. It is also instructive to note entries on the form for securities purchased under agreements to resell and securities sold under repurchase agreements
Riskless Principal Transactions
According to Rule 144A Bankers may provide “riskless principal” services to their clients. The fundamental basis of a “riskless principal” transaction is that the broker/dealer already has the seller and purchaser of a particular security lined up prior to the transaction being made, so that he has knowledge as to the gross profit which will be received if the transaction is completed. Under this type of transaction protocol, if the final purchaser of the security drops out, he is under no obligation to purchase the security from the seller. Likewise, if the seller cannot sell the security at the pre-arranged price, the broker/dealer is under no obligation supply the final purchaser with an equivalent security.
An investor who participates in a Private Placement transaction that involves a “riskless principal” transaction may be exposed to the risk that no transactions will be successfully completed, thus he may receive no profit. His principal, however, is not exposed to the same market risk as if one were buying and selling stocks on the open market where the investor is exposed to the random movements of the free market. Risk free profit? No, but a totally different downside than trading in the public equities market (especially if a “zero depletion” account structure is used).
Zero Depletion Accounts (i.e. DvP)
The term, Zero Depletion Account, just describes a deposit account where a bank is instructed in writing, and it agrees in writing, that certain purchases and sale activity can take place using the value in the account, but the account cannot be allowed to have, at any given time, a balance/value below the deposit amount. Buying of MTNs or any other such investment grade debt instrument and sold to a prearranged buyer or “exit” buyer. So the owner of the deposit looks to the institution to protect the value of his funds. These “zero depletion accounts” work and are sure protection for funds being used for the purposes herein described as long as one is dealing with a major financial institution.
Clearing Corporations - The Size of the Unregistered Market To determine the amount of trading that occurs in the private versus the public market, it may be instructive to examine the relative level of trading activity in the debt and equity markets first. The volume of trades cleared in a market does not directly translate into the size of the market.
Whenever a trader is involved in buying and selling a security, a clearinghouse is responsible to ensure that the security gets to the purchaser, and the seller is properly compensated. For example, if a one million dollar corporate bond is traded ten times, then the clearing corporation records a volume of 10 million dollars worth of trades. In the U. S. equities traded on the New York Stock Exchange, as well as those traded on a number of other exchanges, are cleared through the National Securities Clearing Corporation, (web site: http://www.nscc.com/ ) a private company. In 1988 a press release stated: “Last year, NSCC cleared and settled transactions in excess of $44.6 trillion. NSCC is owned by the New York Stock Exchange, American Stock Exchange and the National Association of Securities Dealers, Inc.” New York, February 5, 2004 - The Depository Trust & Clearing Corporation (DTCC) processed a record 29 million transactions on January 29, surpassing by 11.6 % the previous record of 26 million transactions set on June 6, 2003. DTCC, through its National Securities Clearing Corporation (NSCC) subsidiary, provides clearance and settlement services of virtually all trades done on the New York Stock Exchange, NASDAQ, the American Stock Exchange and for all regional exchanges and electronic communications networks (ECNs) in the United States.
"…Hank Belusa, vice president, DTCC Product Marketing and Development … noted that average daily transaction volume for 2003 was 18.9 million transactions, but that in
the first month of this year, the average jumped to more than 24 million daily transactions. DTCC, in fact, surpassed the June 6, 2003 record on two other days in January, although only by small percentages.
"Once you reach a new industry-wide trading plateau, it's unlikely that the market will move back to the old level, and the above average transaction volumes soon become the norm," said Belusa.
For comparison the Depository Trust Corporation (which has changed its name to the Depository Trust & Clearing Corporation) in a press release issued March 22, 1999 (http://www.dtcc.com/PressRoom/1999/integrate.html) stated: “The Depository Trust Company (DTC) is the world’s largest securities depository, holding nearly $19 trillion in assets for its participants and their customers. DTC is a national clearinghouse for the settlement of trades in corporate and municipal securities and performs securities custody services for its participating banks and broker/dealers. Last year, DTC processed over 164 million book-entry deliveries valued at more than $77 trillion. Owned by members of the financial industry who are its users, DTC is a limited purpose trust company under New York Banking Law, a member of the Federal Reserve System and a registered clearing agency with the Securities and Exchange Commission.”
With the combination of the two organizations, it is now more difficult to determine the relative amount of corporate debt versus equity that is traded, but in 1998 debt trading was 73% greater than trading in equity.
Government issued securities are also traded, and those trades are cleared through the Fixed Income Clearing Corporation (a merger of Government Securities Clearing Corporation (GSCC) and MBS Clearing Corporation (MBSCC). FICC is divided into the Government Securities Division and the Mortgage-Backed Securities Division. These two divisions offer their own product-specific services to their own members, with each maintaining separate rules. All government securities are debt securities. In 1998, GSCC cleared $200 trillion in trades, or roughly 5 times what was cleared in the equities market. Their original website stated that: “Each day, GSCC ensures the safe and efficient settlement of government securities with and average total value of over $875 billion; this amounts to over $200 trillion in trades processed annually.”
Their current website (http://www.ficc.com/) shows that from Aug 03 to Jul 04 the value cleared in the 12 month period was $175 trillion with total value compared at $540 trillion. These clearing companies are, of course, not the only ones around as both are the two major clearing organizations in Europe. Their websites do not indicate the gross amounts cleared in either debt or equity trades. Claims as to their relative size and importance indicate that they probably clear a volume of trades comparable to DTC and NSCC. Euroclear (http://www.euroclear.com/wps/portal) states that in 2003 its turnover was 241.9 trillion Euros and included 114 million transactions.
Clearstream (http://www.clearstream.com/), formerly Cedel stated in their website, “As an integral part of the Deutsche Börse Group, Clearstream offers settlement and custody services to more than 2,500 customers world-wide, covering over 150,000 domestic and internationally traded bonds and equities. Clearstream's core business ensures that cash and securities are promptly and effectively delivered between parties, and that customers are always notified of the rights and obligations attached to the securities they keepunder our custody. Clearstream maintains strong links to counterparts in 39 domestic markets, ensuring the timely and secure transfer of securities ownership and matching payment. Backed by flexible securities lending and collateral management services, Clearstream offers one of the most comprehensive international securities services available, settling more than 500,000 transactions daily.”
The volume of trades cleared by these various institutions clearly show that there is much greater volume in trades in the debt market that in the equity market. The volume of trades would also provide justification for the position that trades in debt instruments take place in large units, such as one hundred million dollar lots (it take 2 million trades with each trade being $100,000,000 to add up to $200 trillion). Thus, a private investor with less than $100,000,000 would be unlikely to find access into this marketplace unless a financial relationship with an established QIB could be established.
QIB Requirements
SEC Rule 144A (Exhibit A) provides qualifications necessary to become a QIB (Qualified Institutional Buyer) or QP (Qualified Purchaser). There are many options open to a person or entity meeting the basic financial qualifications. Many “recent arrivals” chose to establish relationships with humanitarian or other type of charitable activities, foreign government supported projects, or what is approved by international supported projects. (See item I in Rule 144A).
It is a security attorney’s responsibility to obtain such a determination on behalf of a client who intends to take advantage of such a qualification of establishes a legal and financial association with a QIB. Legal specialists provide the documentation and wording for a “zero depletion” accounts so as to control the transactional risks of any given matter. Exhibit “A” shows the restrictions on sales for book entry securities to a designated QIB or QP. Take note, that the issuer, or an agent acting on an issuers behalf, must only have a “reasonable belief” that all holders of its outstanding securities are QPs. So, it is clear that to take part in this market one need only be a Qualified Purchaser besides having sufficient funds or capital. How to become a QIB or QP, or how to associate oneself with a QIB or QP so there can be some profit sharing from the use of one’s funds, is also the normal work of securities lawyers.
Attached are two forms that a securities lawyer should be prepared to have on hand related to his client’s financial qualifications under rule 144A, a bank’s “know your customer” (KYC) rules and the recent Patriot Act’s disclosure requirements. The first is titled “Certificate of Rule 144A Qualified Institution Buyer and is attached as Exhibit “E”, also refer to website http://www.convertbond.com/Member/Utils/qibform.pdf, and Section 3©(7) Qualified Purchaser. The second is a disclosure form that seems to have most of the information required to be disclosed to a financial institution’s compliance department if one wishes to do some business with that institution.
Putting Together The Pieces So, one might ask, what does this all mean and how does it relate to the cautions stated by the securities?
First:
Those who promise “Prime Bank” schemes are using outdated terminology and are apparently not is a position to know or verify truth from error. One would be well advised to steer clear of such individuals. On this I am completely in agreement with the regulatory authorities.
Second:
The words of caution stated by regulators that “…secret securities trading programs run by the world’s largest money-center banks. No such trading programs exist” has some very carefully chosen verbiage. Rule 144A allows for certain securities to be sold through private placements to QIBs and sale of such securities are not publicly reported. These securities are bought and sold through the PORTAL market system. Broker/dealers in this market can purchase and sell these securities on behalf of their clients (QIBs) in the form of “riskless principal” transactions. This is clearly explained by many sources but look again at the U. S. Federal Reserve Board Annual Survey (Exhibit D). The warnings are not “lies”, they just don’t properly inform.
The fundamental basis of a “riskless principal” transaction is that the broker/dealer already has the seller and purchaser of a particular security lined up prior to the transaction being made, so that he might have knowledge as to the gross profit which will be received if the transaction is completed. Under this type of transaction protocol, if the final purchaser of the security drops out, he is under no obligation to purchase the security from the seller. Likewise, if the seller cannot see the security at the pre-arranged price, the broker/dealer is under no obligation to supply the final purchaser with an equivalent security. By engaging is “riskless principal” transactions, the investor’s funds are never exposed to the risk of a defaulted transaction if he uses a properly worded “zero depletion” account instruction drafted by a competent attorney and accepted by the institution transacting the matter. Legally, that means that the value of the account cannot be reduced below the deposit amount while debt instruments move into and out of that account. The anticipated profit sharing is the subject of a “private agreement” among the parties and the subject of this article.
Of course, the average person has no idea of the distinction between “riskless principal” transactions and “risk free transactions”. Thus, those that claim an investment is “risk free” are in error. We agree there is no such thing as a “risk free” investment. Controlling risk so that it is at an acceptable level is the job of a well-trained and experienced attorney. Doing business so that an acceptable third party is assuming the risk is done by using “zero depletion” accounts and other methods.
Third:
The volume of trades in debt instruments cleared through the various clearing corporations indicate that the dollar volume of trades in debt instruments far exceeds trades in equity instruments. Why? Someone must be making a profit from all this trading activity; otherwise the initial purchaser of the debt instrument would just sit back and collect whatever interest the debt instrument was providing. Sometimes debt instruments might be sold (at a loss) because the instrument was in default, and the purchaser wanted to cut his losses. But that must be only a small fraction of the instruments traded; otherwise the purchaser would soon go broke. This also is contradicted by the fact that the greatest volume of trading takes place in government issued securities, those securities that are the most secure in their repayment promises. Clearly all of this trading activity is generating profit for someone.
Fourth:
Why would banks and corporations participate in selling their debt instruments through private placements, rather than selling them openly in the public marketplace? The MTN market provides corporations with the ability to raise funds discreetly because the issuer, the investor and the agent are the only market participants that have to know about a primary transaction. In contrast the investment community obtains information about underwritten bond offerings. Funds can also be raised as needed. Because there are less expense associated with selling debt instruments privately (reduced prospectus, etc.) and because information about its activities is less available to its competitors, a bank or corporation should be expected to pay a premium for these benefits.
Fifth:
Why would an investor participate in the private placement market, as opposed to the public market? There are reasons why an investor would not want to enter into this market.
The securities the investor purchases are more restricted than those on the public market. There is less disclosure to the investor that a publicly traded security. Also, there is less liquidity and greater risk. There, the only incentive to the investor must be greater potential profit to the investor, along with a lower downside risk if the investor is participating in “riskless principal” transactions. In order to encourage an investor to participate in the private placement market, one must conclude that the investor is able to achieve a return at least as good as, or better than, the public market. Therefore, since the yield is likely to be better than one receives through a bank CD, the return must be, by our earlier definition, “high yield”.
Sixth:
Why does a bank holding company sell (MTNs? It can use the funds to procure and to pay off its own liabilities (borrowed capital). This has an effect of clearing its debt instruments (assets) and borrowings (liabilities) off its balance sheet, in turn, improving its net worth ratio and other indicators for its financial health. This approach also helps cut its capital cost. Put simply, it allows more loans and, in the process, more profits. Money is created through debt. The following quotes were made during hearings of the House Committee on Banking and Currency, September 30, 1941. Members of the Federal Reserve Board call themselves “Governors”. Governor Eccles was Chairman of the Federal Reserve Board at the time of these hearings.
Congressman Patman, “How did you get the money to buy those two billion dollars worth of Government Securities in 1933?”
Governor Eccles, “out of the right to issue credit money.”
Patman, “And there is nothing behind it, is there, except our Government’s credit?”
Eccles, “That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.
Congressman Fletcher, “Chairman Eccles, when do you think there is a possibility of returning to a free and open market, instead of this pegged and artificially financial market we how have?”
Eccles, “Never, not in your lifetime or mine.”
So why do banks participate in this trading activity? Because it is one of the many ways
that they can increase their profit and the banks are currently relatively profitable.
So If It Exists, Then…
Private placements are by their own nature private. Financial Institutions or Bank Holding Companies do not release data on their activity because it is a matter between them and participants. Much of the activity takes place outside of the regulations of the SEC; therefore, the SEC can properly claim that they have no knowledge of such activity. The Federal Reserve Board is a quasi-governmental organization subject to the regulation by congress but actually owned by the member banks. The banks are not obligated to provide confidential data about their private placement activities to others not actually involved with banking or banking supervision.
There is, of course, a downside to those who have first hand knowledge of such trading activities. In order to keep a private placement private, the participant may have had to sign agreements to the effect that he cannot release any of the data that he has obtained by virtue of his participation. The penalties of disclosure might be assumed to be pretty stiff (those details would also be private). One can guess that it would include loss of any profits obtained as well as exclusion from any future participation. Thus non-professionals are left to speculate about the structure of the private placement, “riskless principal” marketplace from the outside without, necessarily, being able to talk to anyone who has been on the “inside”. By examining the supporting structure in terms of regulations, reports and other evidence, one can draw various conclusions about the existence, size, function and purpose of existing activity often claimed by some to be non-existent.
The situation here is analogous to the Governments position on Area 51. We may not be able to visit Area 51, but photographs of buildings and landing strips would lead one to believe that they are not simply herding sheep out there.
How Can A QIB Take Part Or Get A Legal Offer?
That is not an issue that is the subject of this article. Private placements depend on the establishment of an acceptable relationship between parties who have a well-defined goal. A QIB or QP will just have to make certain that they qualify for an offer of the desired type and then hope that the professionals assisting them can make that connection necessary to allow the details of any given matter to be considered. I can say that the first thing to look for is an offer with full institutional protection for the funds used with some form of “zero depletion” account. Then, and only then, there may be a chance.
How Could Large Profits Possibly Result From Such Little
Risk Exposure?
There really isn’t one single answer to that obvious question. That could only be explained after professional due diligence procedures were undertaken by a participant’s attorney for any given private placement transaction.
One can assume from the above materials that the “underwriter” desires to earn a discount amount for contracting to acquire all of an issue. The QIB or QP would earn that discount by taking delivery for immediate redelivery to its “exit” buyers (at a price closer to “market”) and for immediate payment. The contract is completed by repeating the process electronically, as many times as necessary. At the end of the process, using simple math, the “profit” percentage is computed by taking the total value of the discount as that sum relates to the total value of the capital used. In that way the profit could be a large percentage of the value of the original capital used from a small discount, but yet not represent a large discount in itself.
It would be an error to think that such matters are always available to qualified parties whenever they looked for one, but it would also be an error to think that such matters were never available.
Conclusions
Trading in the private placement market of securities exempt from SEC registration, or securities subject to Rule 144A, occurs daily without the public disclosure of those trades. It is not a secret market; it is a private market, which hides in plain sight. There are laws and policies in place that permit and supervise this trading activity. Qualified Buyers may participate in this market. Entry in this market is difficult since financial institutions cannot solicit, particularly for private placements. There’s a big difference between “we will make it as hard as possible to get in” and “it is illegal, or doesn’t exist”.
Most of the actions of the SEC, FBI, and State Securities departments are against groups of people who know a little about this market and have no motive other than using it as an excuse for gaining control over another’s funds. Such preventative efforts also involve attempts by groups of individuals to become QIBs, without observing the laws associated with such attempts. It is not illegal to attempt to participate in this market, provided that securities laws are observed that regulate such efforts. That is what securities lawyers are paid to do. It is easier for regulators to state that “no such trading programs exist” rather than to inform folks that such trading exists for “Qualified Institutional Buyers” or “Qualified Purchasers”, who have $100,000,000.00 in the bank.
There is clear evidence that the applicable rules and laws allow this type of activity to occur by those eligible to participate. The institutional structure is also in place to allow this type of trading. How much profit, which can be generated by this activity, is not available from the public record. If it wasn’t better than one could achieve by investing in a bank issued CD, then there would probably not be any point to the legal and institutional structure set up to support this type of activity. Therefore, it is logical to conclude that this type of activities could properly be defined as a “high yield” opportunity. Finally, remember that only a fool would consider putting funds under the discretionary control of anyone other than a properly licensed and regulated institution; and even then only in reliance upon some form of protection such as a properly drafted “zero depletion account” or “account resolution” confirmed by that institution.
Exhibit A
SEC-REG, FSLR 2705AA, Reg. 230.144A
Private Resale of Securities to Institutions
Preliminary Notes to Rule 144A
1. This section relates solely to the application of Section 5 of the Act and not to antifraud or other provisions of the federal securities laws.
2. Attempted compliance with this section does not act as an exclusive election; any seller hereunder may also claim the availability of any other applicable exemption from the registration requirements of the Act.
3. In view of the objective of this section and the policies underlying the Act, this section is not available with respect to any transaction or series of transactions that, although in technical compliance with this section, is part of a plan or scheme to evade the registration provisions of the Act. In such cases, registration under the Act is required.
4. Nothing in this section obviates the need for any issuer or any other person to comply with the securities registration or broker-dealer registration requirements of the Securities Exchange Act of 1934 (the “Exchange Act”), whenever such requirements are applicable.
5. Nothing in this section obviates the need for any person to comply with any applicable state law relating to the offer or sale of securities.
6. Securities acquired in a transaction made pursuant to the provisions of this section are deemed to be “restricted securities” within the meaning of §230.144(a)(3) of this chapter.
7. The fact that purchasers of securities from the issuer thereof may purchase such securities with a view to reselling such securities pursuant to this section will not affect the availability to such issuer of an exemption under Section 4(2) of the Act, or Regulation D under the Act, from the registration requirements of the Act. Reg. §230.144A. (a) Definitions
(1) For purposes of this section, “qualified institutional buyer” shall mean:
(i) Any of the following entities, acting for its own account or the accounts of other qualified institutional buyers that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity:
(A) Any insurance company as defined in Section 2(13) of the Act;
NOTE: A purchase by an insurance company for one or more of its separate accounts, as defined by section 2(a)(37) of the Investment Company Act of 1940 (the “Investment Company Act”), which are neither registered under section 8 of the Investment Company
Act nor required to be so registered, shall be deemed to be a purchase for the account of such insurance company. [Added in Release No. 33-6963 (¶85,052), effective October 28, 1992, 57 F.R. 48721.]
(B) Any investment company registered under the Investment Company Act or any business development company as defined in Section 2(a)(48) of that Act; [Amended in Release No. 33-6963 (¶85,052), effective October 28, 1992, 57 F.R. 48721.]
(C) Any Small Business Investment Company licensed by the U.S. Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958;
(D) Any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees;
(E) Any employee benefit plan within the meaning of Title I of the Employee Retirement Income Security Act of 1974;
(F) Any trust fund whose trustee is a bank or trust company and whose participants are exclusively plans of the types identified in paragraph (a)(1)(i)(D) or (E) of this section, except trust funds that include as participants individual retirement accounts on H.R. 10 plans. [Added in Release No. 33-6963 (¶85,052), effective October 28, 1992, 57 F.R. 48721.]
(G) Any business development company as defined in Section 202(a)(22) of the Investment Advisers Act of 1940;
(H) Any organization described in Section 501(c)(3) of the Internal Revenue Code, corporation (other than a bank as defined in Section 3(a)(2) of the Act or a savings and loan association or other institution referenced in Section 3(a)(5)(A) of the Act or a foreign bank or savings and loan association or equivalent institution), partnership, or Massachusetts or similar business trust; and
(I) Any investment adviser registered under the Investment Advisers Act.
(ii) Any dealer registered pursuant to Section 15 of the Exchange Act, acting for its own account or the accounts of other qualified institutional buyers, that in the aggregate owns and invests on a discretionary basis at least $10 million of securities of issuers that are not affiliated with the dealer, provided that securities constituting the whole or a part of an unsold allotment to or subscription by a dealer as a participant in a public offering shall not be deemed to be owned by such dealer;
(iii) Any dealer registered pursuant to Section 15 of the Exchange Act acting in a riskless principal transaction on behalf of a qualified institutional buyer;
NOTE: A registered dealer may act as agent, on a non-discretionary basis, in a transaction with a qualified institutional buyer without itself having to be a qualified institutional buyer.
(iv) Any investment company registered under the Investment Company Act, acting for its own account or for the accounts of other qualified institutional buyers, that is part of a family of investment companies which own in the aggregate at least $100 million in securities of issuers, other than issuers that are affiliated with the investment company or are part of such family of investment companies. “Family of investment companies” means any two or more investment companies registered under the Investment Company
Act, except for a unit investment trust whose assets consist solely of shares of one or more registered investment companies, that have the same investment adviser (or, in the case of unit investment trusts, the same depositor), provided that, for purposes of this section:
(A) each series of a series company (as defined in Rule 18f-2 under the Investment Company Act [17 CFR 270.18f-2]) shall be deemed to be a separate investment company; and
(B) investment companies shall be deemed to have the same adviser (or depositor) if their advisers (or depositors) are majority-owned subsidiaries of the same parent, or if one investment company’s adviser (or depositor) is a majority owned subsidiary of the other investment company’s adviser (or depositor);
(v) Any entity, all of the equity owners of which are qualified institutional buyers, acting for its own account or the accounts of other qualified institutional buyers; and (vi) Any bank as defined in Section 3(a)(2) of the Act, any savings and loan association or other institution as referenced in Section 3(a)(5)(A) of the Act, or any foreign bank or savings and loan association or equivalent institution, acting for its own account or the accounts of other qualified institutional buyers, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with it and that has an audited net worth of at least $25 million as demonstrated in its latest annual financial statements, as of a date not more than 16 months preceding the date of sale under the Rule in the case of a U.S. bank or savings and loan association, and not more than 18 months preceding such date of sale for a foreign bank or savings and loan association or equivalent institution.
(2) In determining the aggregate amount of securities owned and invested on a discretionary basis by an entity, the following instruments and interests shall be excluded: bank deposit notes and certificates of deposit; loan participations; repurchase agreements; securities owned but subject to a repurchase agreement; and currency, interest rate and commodity swaps. [Amended in Release No. 33-6963 (¶85,052), effective October 28, 1992, 57 F.R. 48721.]
(3) The aggregate value of securities owned and invested on a discretionary basis by an entity shall be the cost of such securities, except where the entity reports its securities holdings in its financial statements on the basis of their market value, and no current information with respect to the cost of those securities has been published. In the latter event, the securities may be valued at market for purposes of this section.
(4) In determining the aggregate amount of securities owned by an entity and invested on a discretionary basis, securities owned by subsidiaries of the entity that are consolidated with the entity in its financial statements prepared in accordance with generally accepted accounting principles may be included if the investments of such subsidiaries are managed under the direction of the entity, except that, unless the entity is a reporting company under Section 13 or 15(d) of the Exchange Act, securities owned by such subsidiaries may not be included if the entity itself is a majority-owned subsidiary that would be included in the consolidated financial statements of another enterprise.
(5) For purposes of this section, “riskless principal transaction” means a transaction in which a dealer buys a security from any person and makes a simultaneous offsetting sale of such security to a qualified institutional buyer, including another dealer acting as riskless principal for a qualified institutional buyer.
(6) For purposes of this section, “effective conversion premium” means the amount, expressed as a percentage of the security’s conversion value, by which the price at issuance of a convertible security exceeds its conversion value.
(7) For purposes of this section, “effective exercise premium” means the amount, expressed as a percentage of the warrant’s exercise value, by which the sum of the price at issuance and the exercise price of a warrant exceeds its exercise value.
(b) Sales by Persons other than Issuers or Dealers. Any person, other than the issuer or a dealer, who offers or sells securities in compliance with the conditions set forth in paragraph (d) of this section shall be deemed not to be engaged in a distribution of such securities and therefore not to be an underwriter of such securities within the meaning of Sections 2(11) and 4(1) of the Act.
(c) Sales by Dealers. Any dealer who offers or sells securities in compliance with the conditions set forth in paragraph (d) of this section shall be deemed not to be a participant
in a distribution of such securities within the meaning of Section 4(3)(C) of the Act and not to be an underwriter of such securities within the meaning of Section 2(11) of the Act, and such securities shall be deemed not to have been offered to the public within the meaning of Section 4(3)(A) of the Act.
(d) Conditions to be Met. To qualify for exemption under this section, an offer or sale must meet the following conditions:
(1) The securities are offered or sold only to a qualified institutional buyer or to an offeree or purchaser that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer. In determining whether a prospective purchaser is a qualified institutional buyer, the seller and any person acting on its behalf shall be entitled to rely upon the following non-exclusive methods of establishing the prospective purchaser’s ownership and discretionary investments of securities:
(i) The prospective purchaser’s most recent publicly available financial statements, provided that such statements present the information as of a date within 16 months preceding the date of sale of securities under this section in the case of a U.S. purchaser and within 18 months preceding such date of sale for a foreign purchaser;
(ii) The most recent publicly available information appearing in documents filed by the prospective purchaser with the Commission or another United States federal, state, or local governmental agency or self-regulatory organization, or with a foreign governmental agency or self-regulatory organization, provided that any such information is as of a date within 16 months preceding the date of sale of securities under this section in the case of a U.S. purchaser and within 18 months preceding such date of sale for a foreign purchaser;
(iii) The most recent publicly available information appearing in a recognized securities manual, provided that such information is as of a date within 16 months preceding the date of sale of securities under this section in the case of a U.S. purchaser and within 18 months preceding such date of sale for a foreign purchaser; or
(iv) A certification by the chief financial officer, a person fulfilling an equivalent function, or other executive officer of the purchaser, specifying the amount of securities owned and invested on a discretionary basis by the purchaser as of a specific date on or since the close of the purchaser’s most recent fiscal year, or, in the case of a purchaser that is a member of a family of investment companies, a certification by an executive officer of the investment adviser specifying the amount of securities owned by the family
of investment companies as of a specific date on or since the close of the purchaser’s most recent fiscal year;
(2) The seller and any person acting on its behalf takes reasonable steps to ensure that the purchaser is aware that the seller may rely on the exemption from the provisions of Section 5 of the Act provided by this section;
(3) The securities offered or sold:
(i) Were not, when issued, of the same class as securities listed on a national securities exchange registered under Section 6 of the Exchange Act or quoted in a U.S. automated inter-dealer quotation system; Provided, that securities that are convertible or exchangeable into securities so listed or quoted at the time of issuance and that had an effective conversion premium of less than 10 percent, shall be treated as securities of the class into which they are convertible or exchangeable; and that warrants that may be exercised for securities so listed or quoted at the time of issuance, for a period of less than 3 years from the date of issuance, or that had an effective exercise premium of less than 10 percent, shall be treated as securities of the class to be issued upon exercise; and provided further that the Commission may from time to time, taking into account then existing market practices, designate additional securities and classes of securities that will not be deemed of the same class as securities listed on a national securities exchange or quoted in a U.S. automated inter-dealer quotation system; and
(ii) Are not securities of an open-end investment company, unit investment trust or face-amount certificate company that is or is required to be registered under Section 8 of the Investment Company Act; and
(4)(i) In the case of securities of an issuer that is neither subject to Section 13 or 15(d) of the Exchange Act, nor exempt from reporting pursuant to Rule 12g3-2(b) (§240.12g3- 2(b) of this chapter) under the Exchange Act, nor a foreign government as defined in Rule 405 (§230.405 of this chapter) eligible to register securities under Schedule B of the
Act, the holder and a prospective purchaser designated by the holder have the right to obtain from the issuer, upon request of the holder, and the prospective purchaser has received from the issuer, the seller, or a person acting on either of their behalf, at or prior
to the time of sale, upon such prospective purchaser’s request to the holder or the issuer, the following information (which shall be reasonably current in relation to the date of resale under this section): a very brief statement of the nature of the business of the issuer
and the products and services it offers; and the issuer’s most recent balance sheet and profit and loss and retained earnings statements, and similar financial statements for such
part of the two preceding fiscal years as the issuer has been in operation (the financial statements should be audited to the extent reasonably available).
(ii) The requirement that the information be “reasonably current” will be presumed to be satisfied if:
(A) The balance sheet is as of a date less than 16 months before the date of resale, the statements of profit and loss and retained earnings are for the 12 months preceding the date of such balance sheet, and if such balance sheet is not as of a date less than 6 months before the date of resale, it shall be accompanied by additional statements of profit and loss and retained earnings for the period from the date of such balance sheet to a date less than 6 months before the date of resale; and
(B) The statement of the nature of the issuer’s business and its products and services offered is as of a date within 12 months prior to the date of resale; or
(C) With regard to foreign private issuers, the required information meets the timing requirements of the issuer’s home country or principal trading markets.
(e) Offers and sales of securities pursuant to this section shall be deemed not to affect the availability of any exemption or safe harbor relating to any previous or subsequent offer or sale of such securities by the issuer or any prior or subsequent holder thereof.
[Adopted in Release No. 33-6862 (¶84,523 ), effective April 30, 1990, 55 F.R. 17933; and amended in Release No. 33-6963 (¶85,052 ), effective October 28, 1992, 57 F.R.
48721.]
Exhibit B
The PORTAL Market
The NASDAQ Stock Market, Inc.® operates The PORTAL Market® which facilitates the listing of unregistered securities eligible to be resold pursuant to Securities and Exchange Commission (SEC) Rule 144A. Adopted under the Securities Act of 1933("Securities Act"), PORTAL provides regulatory review of securities in connection with the clearance and settlement thereof via the Depository Trust Company (DTC).
Equity, fixed income, and derivative securities, may all be made eligible as part of the PORTAL security authorization process.
PORTAL Rules And Requirements
An Issuer or Member of the NASD must file an Application for Designation as a PORTAL Security Supporting documentation must be submitted with regard to SEC Rule 144A Transfer Restrictions and Information Delivery _ Forward applications and offering memorandums via express or regular mail to: The NASDAQ Stock Market, Inc.9513 Key West Avenue Rockville, MD 20850Attn: PORTAL or _ Fax applications and e-mail offering memorandums to: Portal at (301) 978- 8429/portal@nasdaq.com _ The payment must be submitted at the time the application is filed unless the option to be invoiced is selected on the application. Information on determining the fees due can be found by accessing the PORTAL FEE SCHEDULE. Checks should be made payable to The NASDAQ Stock Market, Inc. The final Offering Memorandum or documentation should be sent to NASDAQ® when they become available. The processing time for an application is approximately one to three business days.
Exhibit C
Federal Reserve Board: Reg. Y
§ 225.1 Authority, purpose, and scope.
(a) Authority. This part 1 (Regulation Y) is issued by the Board of Governors of the Federal Reserve System (Board) under section 5(b) of the Bank Holding Company Act of
1956, as amended (12 U.S.C. 1844(b)) (BHC Act); sections 8 and 13(a) of the International Banking Act of 1978 (12 U.S.C. 3106 and 3108); section 7(j)(13) of the Federal Deposit Insurance Act, as amended by the Change in Bank Control Act of 1978 (12 U.S.C. 1817(j)(13)) (Bank Control Act); section 8(b) of the Federal Deposit Insurance Act (12 U.S.C. 1818(b)); section 914 of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (12 U.S.C. 1831i); section 106 of the Bank Holding Company Act Amendments of 1970 (12 U.S.C. 1972); and the International Lending Supervision Act of 1983 (Pub. L. 98-181, title IX). The BHC Act is codified at 12 U.S.C. 1841, et seq. 1Code of Federal Regulations, title 12, chapter II, part 225.
(b) Purpose. The principal purposes of this part are to:
(1) Regulate the acquisition of control of banks by companies and individuals;
(2) Define and regulate the nonbanking activities in which bank holding companies and foreign banking organizations with United States operations may engage; and
(3) Set forth the procedures for securing approval for these transactions and activities. (c) Scope-(1) Subpart A contains general provisions and definitions of terms used in this regulation.
(2) Subpart B governs acquisitions of bank or bank holding company securities and assets by bank holding companies or by any company that will become a bank holding company as a result of the acquisition.
(3) Subpart C defines and regulates the nonbanking activities in which bank holding companies and foreign banking organizations may engage directly or through a subsidiary. The Board's Regulation K governs certain nonbanking activities conducted by foreign banking organizations and certain foreign activities conducted by bank holding companies (12 CFR part 211, International Banking Operations).
(4) Subpart D specifies situations in which a company is presumed to control voting securities or to have the power to exercise a controlling influence over the management or policies of a bank or other company; sets forth the procedures for making a control determination; and provides rules governing the effectiveness of divestitures by bank holding companies.
(5) Subpart E governs changes in bank control resulting from the acquisition by individuals or companies (other than bank holding companies) of voting securities of a bank holding company or state member bank of the Federal Reserve System.
(6) Subpart F specifies the limitations that govern companies that control so-called nonbank banks and the activities of nonbank banks.
(7) Subpart G prescribes minimum standards that apply to the performance of real estate appraisals and identifies transactions that require state certified appraisers.
(8) Subpart H identifies the circumstances when written notice must be provided to the Board prior to the appointment of a director or senior officer of a bank holding company
and establishes procedures for obtaining the required Board approval.
(9) Subpart I establishes the procedure by which a bank holding company may elect to become a financial holding company, enumerates the consequences if a financial holding company ceases to meet a requirement applicable to a financial holding company, lists the activities in which a financial holding company may engage, establishes the procedure by which a person may request the Board to authorize additional activities as financial in nature or incidental thereto, and establishes the procedure by which a financial holding company may seek approval to engage in an activity that is complementary to a financial activity.
(10) Subpart J governs the conduct of merchant banking investment activities by financial holding companies as permitted under section 4(k)(4)(H) of the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(H)).
(11) Appendix A to the regulation contains the Board's Risk-Based Capital Adequacy Guidelines for bank holding companies.
(12) Appendix B contains the Board's Capital Adequacy Guidelines for measuring leverage for bank holding companies and state member banks.
(13) Appendix C contains the Board's policy statement governing small bank holding companies.
(14) Appendix D contains the Board's Capital Adequacy Guidelines for measuring tier 1 leverage for bank holding companies.
(15) Appendix E contains the Board's Capital Adequacy Guidelines for measuring market risk of bank holding companies.
(16) Appendix F contains the Interagency Guidelines Establishing Standards for Safeguarding Customer Information.
[Reg. Y, 62 FR 9319, Feb. 28, 1997, as amended at 65 FR 16472, Mar. 28, 2000; 66 FR 414, Jan. 3, 2001; 66 FR 8484, Jan. 31, 2001; 66 FR 8636, Feb. 1, 2001]
I. Background
1. What is Regulation Y?
Regulation Y governs the corporate practices of bank holding companies and certain practices of state-member banks. Regulation Y also describes transactions for which bank holding companies must seek and receive the Federal Reserve's approval. Common transactions requiring approval include: When a bank holding company acquires a bank or merges with another bank holding company; When a bank holding company engages in a nonbanking activity, either directly or through a subsidiary; When an individual (or group of individuals) acquires control of a bank holding company or state-member bank; When a bank holding company or state-member bank in troubled condition appoints a new senior officer or director.
2. Why did the Federal Reserve streamline Regulation Y?
The Federal Reserve amended Regulation Y as part of a broad effort to "risk-focus" the supervisory process and to reduce the regulatory burden on well-run organizations. The Federal Reserve emphasized two important principles in developing these amendments: First, burden and delay will be reduced for well-run bank holding companies that meet objective and verifiable standards; and Second, the applications process will focus exclusively on an analysis of the specific proposal and will no longer be used as a vehicle to comprehensively analyze supervisory and compliance issues not related to the transaction. The supervisory process, including on-site inspections, is a more appropriate forum for review of matters not directly related to a specific transaction.
3. What actual changes were made by the Board to streamline regulatory requirements?
The Board reduced the information necessary for the completion and filing of applications. Additionally, applications procedures were streamlined for well-managed institutions. In some cases, application requirements have been eliminated entirely. Many restrictions previously applicable to the conduct of non-banking activities were also removed.
II. New Procedures
4. How does the new expedited procedure for banking acquisitions work?
Under the new procedure, a qualifying bank holding company may publish the required newspaper notice up to 15 days in advance of submission of the formal notice to the Federal Reserve. The public comment period remains 30 days and, absent a substantive and timely protest, approval is anticipated within 3 to 5 business days after expiration of the comment period. In other words, the actual time the Reserve Bank takes to process the notice can be as short as 18 days (30 + 3 - 15). A notice submitted by a qualifying bank holding company is generally expected to be approved under the expedited procedure. If, however, a significant issue is identified, the Federal Reserve may review the issue in greater depth by redesignating the notice as an application. This type of action will only occur under limited circumstances, such as the receipt of a substantive and timely protest.
5. How does the new expedited procedure for non banking acquisitions work?
A qualifying bank holding company may immediately engage de novo in any nonbanking activity that the Board has determined to be permissible. Within ten days after commencing the activity, the qualifying bank holding company must notify the Reserve Bank. No prior approval or notice is required. For a qualifying bank holding company, an acquisition of an existing company engaged in a permissible activity may be consummated after providing a twelve day prior notice to the Reserve Bank. Other transactions, including those filed by non-qualifying organizations or involving activities that have not already been determined by the Board to be permissible, are subject to a thirty-day prior notice period.
6. Who can take advantage of the new, streamlined processing?
Well-managed organizations whose transactions meet guidelines with respect to size, competitive effects, community convenience and needs and legality. These items are discussed in more detail in numbers 7, 8, and 9 below.
7. What is a well-managed banking organization?
A well-managed organization meets well-capitalized standards, is satisfactorily rated, and is not, and has not recently been, the subject of a formal supervisory action. (To be satisfactorily rated both the composite and management ratings must be satisfactory, as well as the compliance rating if such a rating is assigned.)
8. In addition to being well-managed, what other criteria must be met in order for a bank transaction to qualify for expedited processing?
The other qualifying criteria for bank acquisitions are: Compliance with convenience and needs criteria, including satisfactory Community Reinvestment Act records; No substantive, timely and adverse public comments; Pro forma deposit market-share of less than 35 percent and no significant changes in market concentration; Target banking organization has total risk-weighted assets of less than $7.5 billion and, when combined with all other expedited transactions within the past year, comprises less than 35 percent of pro forma risk-weighted assets; (Note: The 35 percent size limitation does not apply if the acquiring bank holding company, following consummation of the transaction, would have consolidated risk-weighted assets of less than $300 million.) Compliance with interstate banking statutes; and In the case of a foreign bank, compliance with comprehensive home-country supervision requirements.
9. For well-managed bank holding companies, what are the other qualifying criteria for nonbank transactions?
The other qualifying criteria for nonbank transactions are: The activity has been previously determined by regulation or order to be permissible; In the case of an acquisition, a pro forma market share of less than 35 percent and no significant change in
market concentration; and Target company has total risk-weighted assets of less than $7.5 billion and, when combined with all other expedited transactions within the past year, comprises less than 35 percent of pro forma riskweighted assets; also, gross consideration paid must be less than 15 percent of the filer's Tier One capital. (Note: The 35 percent size limitation does not apply if the acquiring bank holding company, following consummation of the transaction, would have consolidated risk-weighted assets of less than $300 million.).
III. Other Information Regarding Regulation Y
10. What proportion of acquisitions actually meets the criteria for expedited processing?
We estimate that about half of the bank and nonblank acquisition proposals will qualify for expedited processing.
11. What if a transaction does not qualify for expedited processing?
Non-qualifying transactions typically require somewhat more in-depth review, but will also be processed more quickly and with reduced informational requirements than in the past. Specifically, the pre-acceptance review period (historically averaging 25 days) was eliminated. From the date of filing, an applicant can generally expect that any application will be acted upon within 30 to 60 days.
12. What other application and notice requirements have been simplified in the new regulation?
Requirements were reduced or eliminated for proposals to: Acquire control of a bank holding company or state member bank; Redeem shares of bank holding company stock; and Appoint directors and senior officers in new organizations and organizations that have recently undergone a change in control.
13. What is the effective date for all these changes?
April 21, 1997
14. Who can I contact for more information?
Phil Ryan, Director, Applications and Enforcement, at (415) 974-2911 or toll-free at (800) 227-4133, ext. 2911; orPatrick Weiss, Manager, Applications and Reports, at (415) 974-3013 or toll-free at (800) 227-4133, ext. 3013. For full information of the Act refer http://ecfr.gpoaccess.gov/cgi/t/text/textidx?c=ecfr&sid=635f26c4af3e2fe4327fd25ef4cb5638&tpl=/ecfrbrowse/Title12/12cfr225_main_02.tpl
Exhibit D
Board of Governors of the Federal Reserve System
1996 Survey of Corporate Medium-Term Notes
April 16, 1997
1996 Survey of Corporate Medium-Term Notes
U.S. corporations issued $93.7 billion of medium-term notes (MTNs) in 1996, down from
a record $98.9 billion in 1995 (table 1.A). The slower pace of issuance is entirely attributable to nonfinancial firms, which sold $11.7 billion in 1996, $7.8 billion less than in 1995. Issuance by financial firms raised $2.5 billion to $82.0 billion, a record for these firms. A total of 165 firms sold MTNs in 1996, the fewest since 1990 and 30 fewer than in 1995 (table 1.B). The number of nonfinancial issuers, which dropped by one-third, fully accounted for this decline; the number of financial issuers increased by 9 to 87.
Since 1983, when the Federal Reserve began collecting these data, 528 companies have raised funds in the MTN market, including 206 financial companies and 322 nonfinancial companies. During 1996, total MTNs outstanding raised $19.8 billion to $287.3 billion (tables 2.A and 3). As of year-end, 411 firms--126 financial and 285 nonfinancial—had MTNs outstanding (table 2.B).
The corporations that issued MTNs in 1996 continued to have high credit ratings (table 5). More than 99 percent of the MTNs issued last year had investment-grade ratings. Single-A-rated issuers were again most common and accounted for 65 percent of total issuance. Only four firms with speculative-grade ratings issued MTNs last year. Because the volume of speculative-grade issues has always been small, outstanding MTNs also have high credit ratings; 98 percent of outstanding MTNs were rated investment-grade at year-end 1996 (table 6).
The MTN market accounts for a sizable share of intermediate- and long-term borrowing by U.S. companies. One measure of the MTN market share is the volume of MTN issuance as a percentage of total public issuance of investment-grade debt (MTNs plus straight corporate bonds). As shown in table 7, MTNs were less important in 1996 than in 1995, as the issuance ratio dropped 4 percentage points, to 43 percent. The reduced importance of MTNs was particularly pronounced among nonfinancial companies, which reduced their relative usage of MTNs for long-term financing by 10 percentage points, to 16 percent. Given the reduced importance of MTN issuance, the ratio of MTNs outstanding to the amount of public long-term debt outstanding (MTNs plus public corporate bonds), another measure of the MTN market share, fell 1 percentage point, to 18 percent (table 8).
The Division of Research and Statistics of the Federal Reserve Board obtains these data from a survey of U.S. corporations that borrow in the public MTN market. The reported figures do not include borrowing in the "Euro" markets or the private placement market (both traditional issues and securities sold under SEC Rule 144a are excluded). Moreover, the survey does not include offerings by foreign corporations, sovereigns, supranationals, or federal agencies. The figures include MTNs offered by bank holding companies but exclude deposit notes and bank notes offered by banks because these securities are exempt from SEC registration under section 3(a)2 of the Securities Act of 1933. The Federal Reserve collects these data to improve its estimates of new securities issues of U.S. corporations, as published in the Federal Reserve Bulletin, and to improve estimates of corporate securities outstanding as shown in the Federal Reserve’s flow of funds accounts. The Federal Reserve obtains information on new programs from announcements of SEC Rule 415 registrations and contacts with MTN agents.
It regards as confidential the disaggregated information provided by individual companies. Refer to website: http://www.federalreserve.gov/releases/corpnote/survey.pdf to see all data regarding the survey.
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