To: Eugene A. Ludwig, Comptroller of the Currency
From: Julie L. Williams, Chief Counsel
Date: November 18, 1996
Subject: Legal Authority for Revised Operating Subsidiary Regulation
Introduction and Summary Conclusion
The attached final rule includes changes to the OCC's operating subsidiary regulation that clarify, expand upon and restate the standard for determining the scope of permissible operating subsidiary activities. The standard provides that a national bank may apply to engage by means of an operating subsidiary in activities that are part of, or incidental to, the business of banking under 12 U.S.C. 24(Seventh), and other activities permitted for national banks or their subsidiaries under other statutory authority. The new rule also includes a notice and comment procedure and establishes special requirements for any operating subsidiary that desires to engage in an activity that could not be directly engaged in by the parent national bank. This makes explicit what has always been implicit, reflects the fact, as discussed below, that the OCC and the courts have occasionally permitted national banks to engage in activities through the use of subsidiary companies that the banks could not directly perform, and offers an improved mechanism for OCC initial decisionmaking with respect to and ongoing supervision of such activities.
This standard is fully consistent with the authority of national banks to own subsidiaries and the permissible activities of those subsidiaries. National banks may conduct the business of banking and activities incidental thereto through subsidiaries. This authority is derived from the powers sentence in 12 U.S.C. 24(Seventh). A national bank subsidiary too may engage in activities that are part of or incidental to the business of banking within the meaning of 12 U.S.C. 24(Seventh). In some instances, this may include an activity that its parent national bank cannot conduct directly, where limitations have been imposed on the parent bank's ability to conduct an activity that could otherwise qualify as part of the business of banking or incidental thereto and those limitations do not apply to the bank's subsidiary. This could be the case, for example, if the limitation itself and the reason or rationale for limiting the parent bank's ability to conduct the banking or incidental-to-banking activity does not apply to the subsidiary, and if the ability of the subsidiary to conduct the activity would not frustrate a Congressional purpose of preventing the activity from being undertaken by its parent bank.
Operating subsdiary applications involving a banking or incidental-to-banking activity that a national bank may not conduct directly therefore must be evaluated on a case-by-case basis. For each activity, the OCC must consider the particular activity at issue, and for that activity, the OCC must weigh 1) the form and specificity of the restriction applicable to the parent bank, 2) the reason why the restriction applies to the parent bank, and 3) whether it would frustrate the Congressional purpose underlying the restriction to permit the bank's subsidiary to engage in the particular activity. The existence of regulatory safeguards on operating subsidiaries, as well as tailored conditions imposed in connection with particular application approvals, are additional considerations that the OCC may properly take into account in weighing the foregoing factors.
Discussion
1. The Powers Sentence in Section 24(Seventh) Allows National Banks to Own Subsidiaries As An Incident to Being in Business.
It is common for businesses in the United States to deliver some of their products or services to customers by means of subsidiaries. There is no reason in law or policy to ban national banks from the enjoyment of this ordinary corporate flexibility in the conduct of their affairs.
The first sentence in 12 U.S.C. 24(Seventh) specifies the powers that a national bank may exercise. Aside from some clarifying changes in punctuation, it has not been changed from the time of its enactment as part of the National Bank Act in 1864 to today. It states that a national bank may exercise "all such incidental powers as shall be necessary to carry on the business of banking; by discounting and negotiating promissory notes, drafts, bills of exchange, and other evidences of debt; by receiving deposits; by buying and selling exchange, coin, and bullion; by loaning money on personal security; and by obtaining, issuing, and circulating notes according to the provisions of title 62 of the Revised Statutes."
This powers sentence can be broken conceptually into several components. A national bank is expressly authorized to carry on the business of banking, and to exercise "all such incidental powers as shall be necessary" to do banking. "Necessary" has been judicially construed to mean "convenient and useful", see Arnold Tours, Inc. v. Camp, 472 F.2d 427 (1st Cir. 1972). The sentence then gives five examples of the expressly-authorized business of banking.
In NationsBank of North Carolina, N.A. v. Variable Annuity Life Insurance Co., 115 S.Ct. 810, 130 L.Ed. 2d 740 (1995) ("VALIC"), the Supreme Court confirmed that a national bank's permissible activities are not limited to the five examples in the powers sentence and things incidental thereto. The Comptroller has discretion, within reasonable bounds, to permit banking activities beyond those the statute sets forth as exemplary, id. at 814, n.2. This interpretive approach applies both to the nature of the bank's products and services and to the manner of their delivery.
There are at least two broad categories of recognizable activities (exercises of powers), which are either part of or incidental to the conduct of the business of banking, even though they are not specifically listed in the powers sentence. The first identifiable category involves "banking" activities or activities "incidental" to the delivery of banking products or services. One of the examples in the powers sentence list is lending on personal security; it is clearly part of banking. Lending on bases other than "personal security" would be a banking activity of the same type, even though not expressed. It is not incidental to banking, but is a part of banking per se. In M & M Leasing Corp. v. Seattle First Nat'l Bank, 563 F.2d 1377 (9th Cir. 1977), cert. denied, 436 U.S. 956, the court upheld the OCC's determination that the bank's auto leasing activities amounted to a form of secured lending, and therefore permissible banking. One could break down the activity into component parts, and consider the bank's power to own automobiles as "incidental" to its conduct of the banking business, secured lending. When the transaction was viewed in its entirety, the bank was delivering a banking service. Countless examples of banking and incidental-to-banking activities could be recited, even though of course they are not listed in the powers sentence.
A second broad category of activities are incidental to the conduct of the banking business, and therefore permissible, even though they are not, substantively, banking activities. They are not incidental to the delivery of a banking product or service. Instead, they relate to the fact that the bank is in business, and can do things that a business does. Examples include such powers as having employees, issuing stock to raise capital, owning or renting equipment, and borrowing money for operations. These are all done, and are permissible powers, not because they relate to "banking" activities, but because they are necessary, or at least convenient and useful, components of conducting business. Congress in various federal banking statutes has repeatedly recognized and regulated such business activities of banks qua business, without deeming it necessary to authorize them. They are "authorized" by the powers sentence in section 24(Seventh). Thus, various statutes refer to duties of bank employees, and to things that can and cannot be done with bank stock, and place limits on the ownership of bank premises, assuming their existence in each case.
The final example offered -- bank borrowing -- is particularly instructive because it became the subject of a number of lawsuits in the late nineteenth and early twentieth centuries. Again, borrowing is not banking (or an incidental banking activity). Most of us borrow, and we are not bankers. It is an aspect of being in business, and needing to raise funds from time to time to conduct the business. From 1864 until its repeal in 1982, a section of the National Bank Act (12 U.S.C. 82) imposed a capital-based limitation on the amount a bank could borrow. It stated, "No association shall at any time be indebted, or in any way liable, to an amount exceeding" its capital, except on account of certain demands listed in the statute. The courts consistently upheld the authority of a national bank to borrow money, not by referring to this borrowing-limitations statute, 12 U.S.C. 82, but rather by deeming it to be an incident to the general conduct of the banking business under 12 U.S.C. 24(Seventh). See, e.g., Wyman v. Wallace, 201 U.S. 230 (1905) (Borrowing is authorized under the statute permitting a national bank to conduct a general banking business); Aldrich v. Chemical Nat'l Bank, 176 U.S. 618 (1900) (A national bank may borrow money when this is necessary for its banking business); see also Auten v. U.S. Nat'l Bank, 174 U.S. 125 (1899).
The power to own a subsidiary corporation, and through it to deliver some services to customers, falls within this same category of activities that are lawful for a bank by virtue of the bank's being in business. It is permissible because it is part of being in business, and such corporate flexibility should not be denied to national banks any more than it is denied to other business entities. There is a limitation that logically follows from the fact that the national bank ownership authority is an incidental power contained in the section 24(Seventh) powers sentence, however. Since that sentence limits the bank to the conduct of the banking business, and the exercise of powers incidental thereto, a logical boundary for the activities permissible for the bank's subsidiary are activities that are part of or incidental to the conduct of the banking business. Interpretation of the powers sentence in this manner preserves the overall scheme of Congressional regulation of the national banking system.
2. The Additions to Section 24(Seventh) by the 1927 and 1933 Acts Acknowledged, Rather than Eliminated, the Power of National Banks to Own Operating Subsidiaries.
One of the examples of banking listed in the powers sentence in section 24(Seventh) is the "discounting and negotiating", i.e., the buying and selling, of "promissory notes, drafts, bills of exchange, and other evidences of debt." The sentence does not limit national banks' authority to buy and sell debt. Thus, it does not matter whether the instrument in question is a promissory note characterized as a loan note, or is a note, bond, debenture or other evidence of indebtedness characterized as a security. It does not matter whether the bank's purchase and sale activity in connection with the instrument (loan note or debt security) is for the account of customers or for its own account, or whether it constitutes trading, dealing, or underwriting. Intermediation with respect to all instruments that evidence a financial obligation is permissible banking so far as the powers sentence is concerned.
But, Congress since 1864 has placed limits upon the national banks' authority to buy and sell debt securities within the bank. It has done so not by changing the powers sentence, but by adding additional sentences following it in section 24(Seventh), and by adding other statutes. This was done to a small extent by the Act of Feb. 25, 1927, popularly known as the McFadden Act, 44 Stat. 1224 et seq. ("1927 Act"), and more substantially by the Banking Act of 1933, 48 Stat. 162 et seq. ("1933 Act"). The securities-related provisions of the 1933 Act, contained in sections 5, 16, 20, 21, and 32, are commonly referred to as Glass-Steagall provisions, after the main sponsors, and will sometimes be so referred to in this opinion.
Although the 1927 Act and especially the 1933 Act limited national banks' direct performance of investment banking activities, i.e., buying and selling evidences of debt which are securities, both statutes also acknowledged as lawful and subjected to regulation national bank ownership of subsidiary companies, that ownership having its source of authority in the powers sentence in section 24(Seventh). In other words, the very laws which limited national banks' securities powers also reinforced the idea that the banks could continue to own and control affiliated companies that engage in the business of banking.
a. The Investment Securities and the Safe Deposit Business Provisos Added to Section 24(Seventh) by the 1927 Act Confirmed and Regulated National Banks' Purchase and Sale of Debt Securities and Ownership of Subsidiaries, Respectively, Both of Which Activities Were Being Done Under the Authority of the Powers Sentence.
In the 1927 Act, Congress gave its first careful attention to national banks' ownership of subsidiaries, and their purchase and sale activity with debt securities. Both the express terms and the legislative history of the statute demonstrate that the intention was to regulate these aspects of the banking business, conducted under the authority of the powers sentence.
The 1927 Act revised section 24(Seventh) by adding two provisos to follow the national bank powers sentence. The first one said that "the business of buying and selling investment securities shall hereafter be limited to buying and selling without recourse marketable obligations evidencing indebtedness" of any person or entity. The OCC could further define the term "investment securities" by regulation. The total amount of investment securities of any one obligor or maker held by the bank could not exceed 25 percent of the bank's capital, although this capital-based limitation did not apply to obligations of the United States, general obligations of state and local governments, and obligations issued under the authority of the Federal Farm Loan Act. The second proviso said: "And provided further, That in carrying on the business commonly known as the safe deposit business no such association [i.e., national bank] shall invest in the capital stock of a corporation organized under the law of any State to conduct a safe deposit business in an amount in excess of" 15 percent of the bank's capital. See 1927 Act, sec. 2(b), 44 Stat. 1226.
Two observations are relevant here. First, the safe deposit business proviso is a limitation, not an authorizing provision. Rather than enabling a national bank to own stock in such a corporation, it placed a capital-based limitation upon that ownership. The authority came from the pre-existing powers sentence in section 24(Seventh). It was incidental to the conduct of the banking business (which encompassed the safe deposit business) to deliver the services directly or through a corporation owned by the bank. This is identical to the situation addressed by the Supreme Court in VALIC, supra. The Court in VALIC observed that the second sentence in section 24(Seventh), by placing limitations on banks' dealing in securities, thereby "presupposes" that banks already possessed the authority under the powers sentence to deal in securities. "Congress' insertion of the limitation decades after the Act's initial adoption makes sense only if banks already had authority to deal in securities, authority presumably encompassed within the business of banking' language which dates from 1863." 115 S.Ct. 813.
Second, the business of buying and selling investment securities was similarly authorized by the pre-existing powers sentence in section 24(Seventh). The 1927 Act was regulating this business, again with a capital-based limit approach, and additionally by definitional and activity limitations. By statute the investment security was now required to be a "marketable obligation evidencing indebtedness", and the bank's selling must be "without recourse" to the bank. The 1927 Act by its terms assumes that the business of buying and selling investment securities is part of the business of banking, and is placing safety and soundness restrictions on it.
These points about national bank equity investment authority and permissible securities activities -- that the bank can choose to conduct its banking business directly or through a corporation owned by it, and that debt security purchase and sale powers are part of the business of banking -- are confirmed by the legislative history of the 1927 Act, which evolved over several years. For example, a 1924 bill, S. 3316, sec. 10, would have placed a capital-based, per-obligor limit on the holding of investment securities. It would have done this by amending the national bank lending limit statute, 12 U.S.C. 84 (Revised Statutes 5200), adding a new Exception 9 thereto, rather than by amending the powers statute, 12 U.S.C. 24(Seventh) (Revised Statutes 5136). There was no existing per-customer amount limitation in section 24(Seventh), and the OCC had concluded that 12 U.S.C. 84 did not apply to national bank purchases and holdings of investment security obligations. S. Rep. No. 666, 68th Cong, 1st Sess. 6 (1924) summarized the situation:
Exception No. 9 [to 12 U.S.C. 84] is new language. National banks at the present time are engaged to a greater or lesser extent in buying and selling investment securities. There is no express power given in the national banking laws authorizing the conduct of this character of business. Nevertheless this is a form of service demanded by banks and it has come to be recognized as a legitimate banking service.
Under section 5136, Revised Statutes [12 U.S.C. 24(Seventh)], a national bank is authorized to discount and negotiate promissory notes, drafts, bills of exchange "and other evidences of debt." The Comptroller of the Currency has considered these investment securities as "other evidences of debt" and, therefore, authorized under the national bank act. This business, however, has become too important to the banks to hang by such a slender thread of legal interpretation. This exception, therefore, in connection with the last section of the bill recognizes and legalizes this practice and limits the amount which any national bank can take of any one issue of securities to 25 percent of the capital and surplus of the bank. In other words, this exception properly considers a bond or debenture as an obligation which should be governed by the provisions of section 5200, Revised Statutes [12 U.S.C. 84].
In 1926 the Congress changed the placement of its proposed recognition and regulation of national banks' investment securities business. Instead of adding a new Exception to the lending limit statute, 12 U.S.C. 84, it decided to add an investment securities proviso to the bank powers statute, 12 U.S.C. 24(Seventh). The section 24(Seventh) addition now also included a second proviso, the one relating to the ownership of safe deposit corporations. The bill, H.R. 2, sec. 2(b) (containing the section 24(Seventh) provisos) was explained in H.R. Rep. No. 83, 69th Cong., 1st Sess. 3-4 (1926):
The first proviso referred to recognizes the right of national banks to continue to engage in the business of buying and selling investment securities but at the same time it makes a general definition of the term "investment securities" and gives the comptroller the authority to make a further definition by regulation. This would give the comptroller the authority to exclude by definition the right of a national bank to purchase undesirable or unsafe investment securities. This provision also limits the total amount which a national bank may take of any one issue of such securities to 25 percent of its capital and surplus. In this connection it may be noted that this is a business regularly carried on by State banks and trust companies and has been engaged in by national banks for a number of years. The national banks hold to-day in the neighborhood of $6,000,000,000 of investment securities. The effect of this provision, therefore, is primarily regulative.
The second proviso regulates the safe-deposit business of national banks and prohibits them from investing an amount in excess of 15 percent of capital and surplus in a corporation organized to conduct a safe-deposit business in connection with the bank. This is a business which is regularly carried on by national banks and the effect of this provision is also primarily regulative.
The same discussion relating to the proposed investment securities business and the safe deposit business provisos being added to section 24(Seventh) was repeated verbatim in a Mar. 25, 1926 report on the same bill, H.R. 2, sec. 2(b), see H.R. Rep. No. 473, 69th Cong., 1st Sess. 5-7, 11 (1926). Section 2(b) of H.R. 2, containing the provisos on national banks' conduct of the investment securities business and ownership of safe deposit corporations, was enacted without change as section 2(b) of the 1927 Act, 44 Stat. 1226.
Evidence that, after these 1927 amendments, Congress recognized and accepted that national banks owned subsidiary companies which engaged in activities incidental to the conduct of a banking business was the 1930 bill introduced by Senator Carter Glass (S. 4723, 71st Cong., 2d Sess.). This bill was intended, among other things, to regulate the transactions between national banks and their affiliates. Section 6 of the 1930 Glass bill defined "affiliate" to include "a finance company, securities company, investment trust, or other similar institution, or any other corporation, of which control is held, directly or indirectly, through stock ownership or in any other manner, by a national bank or by the shareholders thereof who own or control a majority of the stock of such bank." (emphasis added). Section 7 of the bill would have amended 12 U.S.C. 161 to require each affiliate of a national bank to regularly submit reports on its affairs to the parent bank, which in turn would submit the reports to the OCC. This provision was eventually enacted in section 27 of the 1933 Act.
b. Section 16 of the 1933 Act Further Revised the Investment Securities Powers of National Banks, Without Changing their Authority to Own Shares of Stock in a Corporation.
In 1933 Congress re-affirmed the authority of national banks to own subsidiaries. It specifically disclaimed any intention to either increase or decrease the banks' power to hold corporate stock.
Section 16 of the 1933 Act made extensive revisions to 12 U.S.C. 24(Seventh), following the powers sentence, which remained unchanged. In other words, the first sentence in section 24(Seventh) continued to authorize national banks to exercise all powers incidental to the business of banking, including the discounting and negotiating of notes and other evidences of debt. Beginning with the second sentence in section 24(Seventh), in pertinent part the national bank's securities powers were now set forth as follows:
The business of dealing in investment securities by the association shall be limited to purchasing and selling such securities without recourse, solely upon the order, and for the account of, customers, and in no case for its own account, and the association shall not underwrite any issue of securities: Provided, That the association may purchase for its own account investment securities under such limitations and restrictions as the Comptroller of the Currency may by regulation prescribe, [subject to a per-obligor or maker limit of 10 percent of bank capital].... As used in this section the term "investment securities" shall mean marketable obligations evidencing indebtedness of any person, ... or corporation in the form of bonds, notes and/or debentures commonly known as investment securities under such further definition [as the OCC prescribes by regulation].... Except as hereinafter provided or otherwise permitted by law, nothing herein contained shall authorize the purchase by the association of any shares of stock of any corporation. The limitations and restrictions herein contained as to dealing in, underwriting and purchasing for its own account, investment securities shall not apply to obligations of the United States, or general obligations [of state and local governments, or obligations issued under the Federal Farm Loan Act, or issued by Federal Home Loan Banks or the Home Owners' Loan Corporation]: Provided, That in carrying on the business commonly known as the safe-deposit business the association shall not invest in the capital stock of a corporation organized under the law of any State to conduct a safe-deposit business in an amount in excess of [15 percent of the bank's capital].
Comparing this with the 1927 version of section 24(Seventh), the following points are notable: The "business of buying and selling investment securities" has become the "business of dealing in investment securities." The concept of investment security being a "marketable obligation evidencing indebtedness" of a person or corporation is in both the 1927 and 1933 versions, although the latter statute goes on to say that such obligations are in the form of a bond, note or debenture. The 25 percent of bank capital limit per obligor or maker (1927) has been reduced to 10 percent of bank capital (1933). The 1933 Act goes into distinctions as to dealing in without recourse (i.e., securities brokerage for customers), purchasing for the bank's own account, and underwriting. The 1927 Act did not address this. The 1933 Act adds to the list of obligations which, although investment securities, could be held or underwritten without limitation by the bank. Finally, and very importantly, the 1933 Act inserts a new sentence, "Except as hereinafter provided or otherwise permitted by law, nothing herein contained shall authorize the purchase by the association of any shares of stock of any corporation."
It is important to recognize what this sentence is, and what it is not. It is not a bar on national bank ownership of corporate stock. Rather, it is a disclaimer which expresses three ideas. First, it says that "nothing herein contained", i.e., nothing in the amendments to section 24(Seventh) contained in section 16 of the 1933 Act, should be construed to increase the authority of a national bank to own stock. The second idea is that section 16 is not intended to decrease a national bank's stock-ownership authority either. If that ownership is "otherwise permitted by law", it remains permissible. This "law" includes the powers sentence in the beginning of section 24(Seventh), which was not being affected by the section 16 changes. If the bank by its counsel, or the OCC by interpretation, concluded that a particular stockholding by a national bank was a permissible incident to its conduct of the banking business, the 1933 Act would not change this. The "otherwise permitted by law" reference would also preserve authorities given in other federal banking laws. For example, prior to 1933 sections 25 and 25a of the Federal Reserve Act permitted a national bank to invest in Edge Act and Agreement corporations and in foreign banks, 12 U.S.C. 601, 611 et seq.
Thus, the first two ideas in the disclaimer sentence are that section 16 of Glass-Steagall is not intended to increase, or decrease, the existing authority of a national bank to own stock, unless -- this is the third idea -- the power is "hereinafter provided". In other words, section 16 is increasing a national bank's stock ownership power only to the extent of language being added to section 24(Seventh) after the disclaimer. In 1933, the only reference to stock ownership which follows this sentence, i.e., the only ownership authority which could be said to be "hereinafter provided" in section 24(Seventh), is the safe deposit business proviso. But this proviso has been merely carried forward verbatim from the 1927 version of section 24(Seventh). And we have already seen that the authority to own such stock was necessarily contained in the first, powers sentence in section 24(Seventh). It was incidental to the conduct of the banking business to deliver the permissible services through a corporation which the bank owned. So the safe deposit corporation stockholding is "otherwise permitted by law", in the words of the disclaimer sentence, as well as "hereinafter provided".
The "otherwise permitted by law", in sum, is a reference to the pre-existing, and unaffected, powers sentence in section 24(Seventh), as well as a reference to pre-existing permissions in other federal banking laws such as sections 25 and 25a of the Federal Reserve Act. This point is easily overlooked because in section 16 of the 1933 Act Congress has dropped the safe deposit business proviso below the disclaimer; a superficial reading, without considering the 1927 Act background and history, would lead to the conclusion that the bank's authority to own the safe deposit corporation is "hereinafter provided" by section 16 and otherwise would not exist in 12 U.S.C. 24(Seventh).
There is another reason for potential confusion concerning the meaning of the disclaimer sentence, relating to the way section 16 evolved in Congress. As section 16 was enacted in its final form, the "nothing herein contained" reference seems pointless because nothing is being added to section 24(Seventh) which could be interpreted as increasing a national bank's stock-ownership power. So why is this disclaimer expressed? The answer lies in the fact that, until the provision was deleted in conference, both the House bill and the Senate bill added at the end of the powers sentence in section 24(Seventh), separated by a semi-colon, an additional example of what would be a permissible conduct of the banking business:
and generally by engaging in all forms of banking business and undertaking all types of banking transactions that may, by the laws of the State in which such [national] bank is situated, be permitted to banks of deposit and discount organized and incorporated under the laws of such State, except insofar as they may be forbidden by the provisions of any Act of Congress.
See S. 1631, sec. 16, and S. Rep. No. 77, [To accompany S. 1631], dated May 15, 1933, 73d Cong., 1st Sess. at 16 (1933); H.R. 5661, sec. 14, and H.R. Rep. No. 150 [To accompany H.R. 5661], dated May 19, 1933, 73d Cong., 1st Sess. at 18 (1933). The state banking powers addition at the end of the powers sentence was then followed by three sentences: the "business of dealing in investment securities" ... sentence, with its long proviso on buying and selling investment securities for the bank's own account; the sentence defining "investment securities"; and the disclaimer sentence with its proviso on safe deposit corporations. Until the additional power for national banks to "engage in all forms of banking business" permitted to competing state banks under state law was deleted in conference, the disclaimer sentence in section 16 meant this: the additional powers "herein contained", i.e., the authority to do what state banks could do under state laws, should not be construed to add to a national bank's shareholding power, unless "hereinafter provided" in section 24(Seventh), or "otherwise permitted by [federal] law." With the state banking powers provision in section 16, adding to national banks' authority in the powers sentence, all three ideas in the disclaimer sentence were necessary and conveyed meaning. When the inclusion of new banking powers derived from state law was dropped just before passage of the 1933 Act, only the "hereinafter provided" and "otherwise permitted by law" ideas retained vitality. This legislative history adds force to the understanding that section 16 was intended to neither increase, nor decrease, a national bank's existing authority, in 1933, to own stock in a subsidiary corporation as an incident to its conduct of the banking business.
3. Several Sections of the 1933 Act Confirmed and Regulated the Ownership by National Banks of Subsidiaries (Affiliates).
In addition to section 16, several other sections of the 1933 Act confirmed that national banks could own subsidiaries, and regulated the dealings between the banks and their subsidiaries and other affiliates. In each instance, the legislation imposed controls, and assumed the lawfulness of the relationship. The ownership authority came from the pre-existing powers sentence in 12 U.S.C. 24(Seventh). Again, the Supreme Court's opinion in VALIC, supra, has direct significance in this context, by its recognition that when Congress places a limitation on a national bank's activity, it thereby "presupposes" the bank's authority to engage in the activity.
In 1932, while Congress was considering legislation to strengthen the banking system, and to deal with banks' involvements in the securities markets, Federal Reserve Board Chairman Eugene Meyer testified on the subject of companies which were either owned directly by national banks, or were otherwise affiliated with them. Operation of the National and Federal Reserve Banking Systems: Hearings on S. 4115 Before the Senate Comm. on Banking and Currency, 72d Cong., 1st Sess. 391-392 (1932). Senators Glass and Couzens both asked Meyer to identify affiliates not expressly authorized by law, and he replied:
Well, there are 15 different kinds of affiliates....
There are realty companies, holding companies, bank building companies, mortgage companies, liquidating companies, agricultural loan companies, personal or small loan companies, investment trusts, building and loan associations, insurance companies, and so on....
Meyer then submitted a chart entitled "Number of nonbanking subsidiaries of national banks". This chart listed 770 companies which were affiliates of national banks, under four different types of control: "Stock owned by bank" (98); "Stock trusteed" (245); "Stock owned by other affiliate" (81); and "Stock owned by bank stockholders" (346). National banks directly owned the stock of the following types of subsidiaries, listed on Meyer's chart in the following order: 4 securities companies, 4 realty companies, 4 holding companies, 42 bank building companies, 33 safe deposit companies, 2 mortgage companies, 1 personal loan company, 1 investment trust, 3 foreign banks, 1 title and mortgage company, and 3 companies described as "miscellaneous."
The next year Congress passed the 1933 Act, a comprehensive reform of the banking system. The preamble of the 1933 Act states that it is intended to provide for the "safer and more effective use" of bank assets, to "regulate" interbank control, to prevent the "undue diversion" of funds into "speculative operations", and for other purposes. It is important to note that the Act was not putting banks out of entire lines of business or relationships; rather it was more carefully regulating their activities performed either within the bank or through affiliated companies.
Section 2(b) of the 1933 Act specifically defined an "affiliate" for purposes of that Act "and any other law amended by" the 1933 Act as including a subsidiary in which a bank controlled at least 50 percent of the subsidiary's voting stock. The laws amended by the 1933 Act included both the Federal Reserve Act and the National Bank Act, and the term "affiliate" was used in contexts where it referred to affiliates of member banks (i.e., both national and state member banks) as well as to affiliates of national banks alone. Thus, Congress clearly presupposed that national banks could have "affiliates," including 50 percent owned subsidiaries, and sought to regulate aspects of the banks' relationships with those entities. Had Congress believed that the definition was inappropriate as applied to national banks, it could have crafted an alternative, specialized definition. It clearly knew how to do so, as reflected by the separate "holding company affiliate" definition that was also included in the 1933 Act. The fact that Congress did not do so reflected its understanding, further evidenced in various other sections of the 1933 Act, that national banks had authority to own subsidiaries.
In several sections of the 1933 Act new limitations were placed on national banks' ownership of and transactions with affiliates which confirm the authority of the banks to own or otherwise control the affiliates, and regulate the relationship. Section 13 of the 1933 Act added a new section 23A to the Federal Reserve Act (12 U.S.C. 371c), imposing qualitative standards and collateral requirements on member banks in connection with their investments in and dealings with affiliates. In particular, the new section 23A provided that no member bank shall "(2) invest any of its funds in the capital stock" or debt obligations of any affiliate in an amount exceeding ten percent of the bank's capital. The statute imposed an aggregate cap of twenty percent of bank capital on the bank's equity and debt investments in, and loans to, all of its affiliates combined. In addition, it required that the bank's loans to its affiliates be collateralized in such a way that it would be unlikely that the bank would suffer a loss on the transactions.
Section 14 of the 1933 Act added a new section 24A to the Federal Reserve Act (12 U.S.C. 371d), limiting the amount of investments and loans member banks could have with respect to a bank premises corporation. No national bank without the approval of the OCC, and no state member bank without the approval of the Fed, can invest in the stock of or make loans to a corporation which holds the premises of the bank if, in aggregate amount, the investments and loans would exceed 100 percent of the bank's capital. As in the case of the previously-discussed safe deposit business proviso, the 1933 Act section 14 provisions on bank premises corporations are not phrased in terms of authorizing national banks to own such companies as subsidiaries. In other words, the section does not say that a national bank may own a bank premises corporation. Instead, the legislation is regulatory in nature, assuming the lawfulness of such an investment, and imposing limitations on it. The national bank's authority to own a safe deposit company and a bank premises company comes from another, pre-existing source, namely the powers sentence in section 24(Seventh). The national bank is "otherwise permitted by law", the law being the first sentence in section 24(Seventh), to own stock in a safe deposit corporation and a bank premises corporation, subject in each instance to a capital-based limitation.
Like sections 13 and 14, section 20 of the 1933 Act also points to the section 24(Seventh) powers sentence as a source of authority for a national bank to own subsidiaries. Section 20 prohibits the bank from owning or otherwise being affiliated with the securities firm if that firm engages principally in the proscribed activity. This is regulatory legislation, which presupposes that the banks affected by it have the legal ability to own subsidiaries that could be subject to the limitations applied by section 20. In the case of national banks, that authority would spring from the powers sentence in section 24(Seventh).<NOTE: None of this was inadvertent on the part of Congress; sections 2(b), 5, 13, 14, 20 and 28(a) of the 1933 Act amounted to a comprehensive scheme of recognition and regulation of the ownership by national banks (and state member banks) of subsidiaries and other types of affiliates. Thus, section 5 gave state member banks the same power, but no more, to own corporate stock as was possessed by national banks under the authority of 12 U.S.C. 24(Seventh). Section 2(b) defined a member bank's "affiliate" to include a company owned by the bank as a subsidiary. Section 13 imposed capital-based limitations on the amount of stock a member bank could own in affiliates. Section 14 required a national bank to obtain the OCC's permission in order to invest more than 100 percent of its capital funds in the stock of a bank premises corporation. Section 20 allowed a member bank to own the stock of a securities affiliate so long as the company was not engaged principally in the issue, underwriting or distribution of securities. And section 28(a) added a new provision to 12 U.S.C. 481, authorizing the OCC to examine all of the affiliates of national banks. Collectively, these provisions clearly demonstrate that Congress found the "affiliate" definition appropriate in several respects, including a context (examinations) involving only national banks. Use of the "affiliate" definition in an exclusively national bank context reflects Congress' assumption that national banks did, or could, have "affiliates" of each type described in the definition.>
A final piece of evidence from the 1933 Act points to the section 24(Seventh) powers sentence as a source of authority for national banks to engage in the banking business by means of subsidiary companies. Section 13 (adding a new section 23A to the Federal Reserve Act), as mentioned, imposes qualitative limitations on national and state member banks' equity and debt investments in and loans to affiliates, as well as collateral requirements on the banks' loans to the affiliates. Section 23A as enacted exempted from the qualitative limitations and collateral requirements any affiliate of the bank meeting any of the following criteria: (1) a company engaged solely in holding bank premises; (2) a company engaged solely in conducting a safe deposit business or the business of an agricultural credit corporation or livestock loan company; (3) any investment authorized to national banks by section 25 of the Federal Reserve Act (i.e., Edge Act and Agreement corporations); (4) any company organized under section 25a of the Federal Reserve Act (i.e., foreign banks); and (5) any company engaged solely in holding specified obligations, such as obligations of the United States government. Congress exempted these types of bank subsidiaries (or companies affiliated by virtue of some other ownership structure) because it did not view the companies as a potential threat to the bank, or because the relationship was already regulated and limited in other statutes. What remains is the concept that any other type of subsidiary owned by a national bank, or state member bank, or any nonsubsidiary affiliate, is subject to the limitations in section 23A. The section does not say that a national bank may own a subsidiary. It assumes the authority exists, and controls its exercise.
4. Since 1933 Congress, the Courts, and the OCC Have Consistently Recognized that National Banks Can Conduct their Business Directly or By Means of Operating Subsidiaries.
Congress has never diminished the authority of national banks to own subsidiaries. Indeed, it has expanded that authority in several statutes enacted in recent decades. The OCC in the 1960s developed a comprehensive scheme for the regulation and supervision of national banks' operating subsidiaries, and has maintained it ever since. The federal courts, including the Supreme Court, have uniformly confirmed and acknowledged that national banks may engage in the business of banking by means of subsidiaries.
Since 1933, Congress has added several sentences granting express permissions for national bank shareholdings in section 24(Seventh). Thus, a national bank can own shares in a title 42 housing company (a corporation or partnership organized for the purpose of encouraging private investment in low or moderate income housing), a state housing corporation, an agricultural credit corporation, and a bankers' bank. Since a national bank cannot own more than 5 percent of the bankers' bank, such an entity could not be an "affiliate". In each instance, the new section 24(Seventh) permission sentence begins, "Notwithstanding any other provision of this paragraph, the association may purchase for its own account shares of stock ...". This shows the influence of the disclaimer sentence, put into section 24(Seventh) in 1933. The presence of this sentence discourages enactments which merely assume an ownership relation and regulate it. A few other statutes also authorize national bank shareholdings. See 12 U.S.C. 1861 et seq. (bank service corporations), 15 U.S.C. 682(b) (small business investment companies), and 12 U.S.C. 24(Eleventh) (community development corporations).
The OCC from time to time issued interpretive letters or rulings that allowed bank shareholdings under the section 24(Seventh) powers sentence authority. For example, rulings published in the Comptroller's Manual in the mid-1960s permitted national banks to own other banks, mortgage companies, and finance companies. A July 30, 1965 letter by Comptroller Saxon (unpublished) authorized the Atlantic National Bank of Jacksonville, Florida, to acquire all of the outstanding capital stock of the Atlantic Trust Company in the same city. Saxon reasoned that the disclaimer sentence in section 24(Seventh) did not prevent the Atlantic Bank from owning the stock of the trust company. The legislative history of the sentence and its relationship to other provisions of section 24(Seventh) demonstrated that it pertained only to a national bank engaging in the business of investing or dealing in securities, including corporate stocks, unrelated to its conduct of the business of banking. Saxon went on to review the case law; the 1927 Act and its legislative history relating to the investment securities and safe deposit business provisos; the legislative history of the 1933 Act amending section 24(Seventh); and the affiliate transactions and bank premises holding company sections of the 1933 Act (sections 13 and 14, discussed above). All of this evidence led Saxon to the conclusion that 12 U.S.C. 24(Seventh) allows national banks to "own corporate stock, or interests therein, when such ownership is a proper incident to banking." The letter was summarized in the National Banking Review, vol. 3, no. 2, at 268 (Dec. 1965).
In 1966, the OCC codified its evolving concept of an operating subsidiary in a lengthy analysis set forth in a new regulation, 12 C.F.R. 7.10, published in volume 39 of the Federal Register on August 31, 1966, at 11459. It began:
(a) The Comptroller of the Currency has confirmed his position that a national bank may acquire and hold the controlling stock in a subsidiary operations corporation. A subsidiary operations corporation is a corporation the functions or activities of which are limited to one or several of the functions or activities that a national bank is authorized to carry on. The controlling stock interest is ordinarily 51 percent or more of the voting stock issued by the corporation, but may be a lesser percentage of voting stock if, under appropriate circumstances, such lesser percentage constitutes effective working control of the corporation.
(b)(1) The Comptroller's position involves his interpretation of the sentence in 12 U.S.C. 24(7) which has been mistakenly characterized by some as a "stock-purchase prohibition." Such sentence reads as follows [quoting the disclaimer sentence]. This sentence is plainly not a prohibition against any form of acquisition and ownership by a national bank of stock in another corporation.
The discussion continues, in (b)(2), to conclude logically that the disclaimer sentence "refers only to the investment securities provisions of 12 U.S.C. 24(7) within which the disclaimer sentence appears." It does not refer back to the powers sentence at the beginning of section 24(Seventh), pursuant to which, for example, the courts had upheld national banks' holdings of stock acquired by virtue of debts previously contracted. "The purpose of the disclaimer sentence is to prevent a national bank from dealing in, underwriting, and otherwise speculatively investing in corporate stock in the same way as a national bank is empowered with respect to investment securities", id. (b)(3). The "otherwise permitted by law" portion of the disclaimer sentence is redundant with respect to statutes other than section 24(Seventh). And finally, the legislative histories of the 1933 Act and the Banking Act of 1935 indicated that Congress' concern with corporate affiliates of national banks was limited to holding company affiliates and affiliates engaged in speculative stock trading, underwriting, and investment activities", id. (b)(4). The powers sentence in section 24(Seventh) allows national banks to acquire and hold stock in corporations "as an incident to and to facilitate the banks' conduct of their banking business", id.
Later in the same year the OCC published an operating subsidiary ruling, which appeared as Paragraph 7376 in the Comptroller's Manual (Nov. 1966 ed.). The ruling contained another formulation of the activities allowed for operating subsidiaries:
7376. Indirect performance of banking functions
A national bank may engage in activities which are a part of the business of banking or incidental thereto through a department of the bank or through a subsidiary corporation, the controlling stock of which is owned by the bank. For example, through a bank department or a subsidiary corporation, a national bank may issue credit cards, service mortgages, lease property, offer travel services, or operate a credit bureau. See Regulation 7.10 (12 CFR 7.10)
Then, on August 13, 1968, the OCC circulated in draft form to the presidents of all national banks a revised version of Paragraph 7376. The new Paragraph 7376 was published in the January 1969 edition of the Comptroller's Manual for National Banks. Entitled "Operating subsidiaries", the ruling contained four sections: (a) general rule, (b) activities permitted, (c) transactions with parent bank, and (d) applicability of banking laws. The general rule provided that with OCC prior approval, a bank could engage in activities which are part of or incidental to the business of banking, by means of an operating subsidiary. The bank must own at least 80 percent of the subsidiary's voting stock. The "activities permitted" section said the subsidiary could perform any business function which the parent bank could perform. Section (c) subjected transactions between the bank and the subsidiary to 12 U.S.C. 371c, unless that statute contained an exemption. And section (d) provided that "except as otherwise permitted by statute or regulation, all provisions of Federal banking laws applicable to the operations of the parent bank shall be equally applicable to the operations of its operating subsidiaries." Pertinent book figures of the parent bank and its operating subsidiaries would ordinarily be consolidated for all banking law purposes, including statutory limitations imposed by 12 U.S.C. 56, 60, 82 (borrowing limits), 84, or 371d. Operating subsidiaries would be examined on the same basis as the parent bank (previously the OCC had seldom examined operating subsidiaries). And the bank needed to inform the OCC prior to disposing of the subsidiary. Although labeled an interpretive ruling, in fact Paragraph 7376 operated effectively as a regulation.
Paragraph 7376 on operating subsidiaries was now more comprehensive than the regulation on the same subject at 12 C.F.R. 7.10, so in 1971 the OCC rescinded the regulation. Paragraph 7376 became codified as Interpretive Ruling 7.7376, 12 C.F.R. 7.7376, and this in turn was incorporated into 12 C.F.R. 5.34 without substantive change in 1983.
Since section 5 of the 1933 Act (12 U.S.C. 335) grants state member banks the same power to own stock as is possessed by national banks in section 24(Seventh), the question naturally arose as to whether state member banks could own subsidiaries as a means of conducting some of their business. While initially the Fed expressed the view that state member banks could not own subsidiaries, 52 Fed. Res. Bull. 1151 (1966), two years later it changed its opinion. A week after the OCC circulated its draft revision of Paragraph 7376 in August 1968, the Fed published its own conclusion that state member banks could also own operating subsidiaries. 12 C.F.R. 250.141, miscellaneous interpretation entitled "Member bank purchase of stock of operations subsidiaries'", published in 33 Fed. Reg. 11813 (Aug. 21, 1968). A month later Fed Chairman William McChesney Martin, Jr., explained the agency's position at a Congressional hearing on the subject. Federal Reserve Rulings Regarding Loan Production Offices and Purchases of Operating Subsidiaries: Hearings Before the House Comm. on Banking and Currency, 90th Cong., 2d Sess. 27-35 (1968). In the Fed's view, the disclaimer sentence added to 12 U.S.C. 24(Seventh) in 1933 was not intended to override the incidental powers clause in the section 24(Seventh) powers sentence above it so as to preclude the ownership of operating subsidiaries. Congress merely intended in the 1933 Act to prevent the involvement of commercial banks in "speculation in corporate stocks", Fed Chairman Martin testified, and did not intend to "repeal national banks' authority to establish operating subsidiaries", id. at 28-30. Because state member banks are given the same stockholding power as national banks, the Fed had concluded that state member banks could, like national banks, own operating subsidiaries.
On a few other occasions Congress has addressed the subject of bank-owned affiliates (subsidiaries), always acknowledging the lawfulness of their existence. For example, the Banking Affiliates Act of 1982, Pub. L. No. 97-320, sec. 410, 96 Stat. 1515-1520, comprehensively revised section 23A of the Federal Reserve Act. In several provisions, the legislation gave subsidiaries of member banks special attention. As now amended, section 23A(a) subjected the transactions between the bank's subsidiaries and the other affiliates of the bank to the same controls that applied to direct dealings between the bank itself and those same affiliates. Section 23A(a)(3) prohibited a "member bank and its subsidiaries" from purchasing a low-quality asset from an affiliate except in certain specified circumstances. Section 23A(b)(E) excluded the subsidiary of the bank from the definition of "affiliate" unless in a particular case the Fed thought that the bank-subsidiary relationship would be a detrimental one. And section 23A(d) excepted from the controls ordinarily imposed on affiliate transactions the dealings between a member bank and a bank subsidiary, provided that the bank owned at least 80 percent of the voting shares of the subsidiary.
Similarly, in 1987 Congress added a new section 23B to the Federal Reserve Act, placing further restrictions on member bank transactions with their affiliates, Pub. L. No. 100-86, sec. 102(a), 101 Stat. 564-567. The member bank "and its subsidiaries", by virtue of section 23B(a), could henceforth engage in transactions with affiliates only on terms and under conditions that were at least as favorable "to such bank or its subsidiary" as those prevailing for comparable transactions in the marketplace or that would be offered to unaffiliated companies. This is broader than section 23A because it reaches all types of transactions with affiliates, not just those defined as "covered transactions" in section 23A. And section 23B(c) placed an advertising restriction on each "member bank or any subsidiary or affiliate...", essentially prohibiting any suggestion that the bank would be responsible for the obligations of such companies. These statutory enactments -- defining, regulating, and excepting from certain controls, transactions between member banks and their subsidiaries, or between the subsidiaries of the banks and other affiliates of the bank -- make sense only on the understanding that the disclaimer sentence in section 24(Seventh) does not prevent national and state member banks from lawfully owning subsidiaries.
The courts too have been consistent in their recognition that national banks can conduct their business either directly or through subsidiaries. See, e.g., VALIC, supra (a national bank and its operating subsidiary had asked the permission of the OCC to sell annuities, and the Supreme Court held that this would be lawful); Clarke v. Securities Industry Assn., 479 U.S. 388 (1989) (operating subsidiaries of national banks can engage in the securities brokerage business at various nonbank locations); American Ins. Ass'n v. Clarke, 865 F.2d 278 (D.C. Cir. 1987) (a national bank's operating subsidiary can be a municipal bond insurance company); Ind. Bankers Ass'n of Ga. v. Bd. Govs. FRS, 516 F.2d 1206 (D.C. Cir. 1975) (Citizens and Southern National Bank could lawfully own a holding company which in turn owned a majority interest in 8 banks and a minority interest in 27 other banks in Georgia).
5. An Operating Subsidiary May Engage in a Banking or Incidental-to-Banking Activity that its Parent National Bank Cannot Conduct Directly If the Reason or Rationale for the Prohibition Does Not Apply to the Subsidiary, and the Ability of the Subsidiary to Conduct the Activity Would Not Frustrate a Congressional Purpose to Prevent its Parent from Conducting the Activity.
The OCC, each of the other Federal banking agencies, and the courts, have recognized in various contexts that limitations that apply to a bank itself do not necessarily apply to affiliates, including subsidiaries, of the bank. The precedents reflect a consistent theme: The answer cannot be generalized but will hinge on the particular activity at issue, the form and specificity of the restriction applicable to the parent bank, why the particular restriction applies to the parent bank, <NOTE: The maxim is well established that when the reason for a rule ceases, the rule itself ceases. The maxim is: "Cessante ratione legis, cessat et ipsa lex." Lockhart v. Fretwell, 506 U.S. 364, 373 (1993). It has also been applied in its translated form. See, e.g., United States v. Mahoney, 712 F.2d 956, 960 (5th Cir. 1983), cert. denied, 486 U.S. 1220 (1984) and United States v. Williams, 622 F.2d 830, 847 (5th Cir. 1980), cert. denied, 449 U.S. 1127 (1981). Of course, the maxim does not obviate statutory law, Trans World Airlines, Inc. v. Franklin Mint Corp., 466 U.S. 243, 273 (1984) (Stevens, J., dissenting), but it may be used as a guide for statutory interpretation. See, e.g., Maislin Industries, U.S. v. Primary Steel, 497 U.S. 116, 150 (1990) (Stevens, J., dissenting); Orscheln Bros. Truck Lines, Inc. v. Zenith Electric Corp., 899 F.2d 642, 644-45 (7th Cir. 1990), vacated and remanded on other grounds, 498 U.S. 933 (1990); United States v. Dudley, 739 F.2d 175, 177 (4th Cir. 1984); Jones v. Schweiker, 668 F.2d 755, 761 (4th Cir. 1981), vacated and remanded on other grounds, 460 U.S. 1077 (1982); Petteys v. Butler, 367 F.2d 528, 536 (8th Cir. 1966), cert. denied, 385 U.S. 1006 (1967); Blau v. Lamb, 363 F.2d 507 (2d Cir. 1966), cert.denied, 385 U.S. 1002 (1967). > and whether it would frustrate a Congressional purpose underlying the restriction on the bank to permit the bank's affiliate or subsidiary to engage in the particular activity.
The application of section 32 of the 1933 Act (12 U.S.C. 78) by the Fed is a model of this approach. Section 32 expressly prohibits an officer, director or employee of a securities firm from serving as an officer, director or employee of a member bank. The Fed has interpreted this personnel interlock provision to apply to a member bank's affiliate in some instances, and not in other instances, depending upon the circumstances of each case. For example, a December 28, 1967 ruling, 1 F.R.R.S. at para. 3-889 (1994), permitted a partner of a securities company to serve on the board of directors of a member bank's parent holding company. The holding company owned seven subsidiaries in addition to its member bank subsidiary. Three of the member bank's thirteen directors were officers and directors of the holding company. In this situation, the Fed decided that the personnel interlock prohibition applicable to the member bank should not be extended to the bank's parent.
However, a January 3, 1969 ruling, 12 C.F.R. Part 218, Int. 218.114 (1994), did not allow a proposed personnel interlock between a securities firm and a member bank's parent holding company. In this case, the bank holding company was essentially a shell company established for "almost the sole" purpose of holding the stock of the bank. The Fed reasoned that the affairs of the member bank and the holding company would be "so closely identified and functionally related" that they should be treated in the same way under section 32. To "give cognizance to the separate corporate entities" in these circumstances would "partially frustrate Congressional purpose in enacting the statute." <NOTE: The Fed recently reversed this position, rescinding the 1969 ruling extending section 32 to the holding company. The agency stated that it had based its 1969 interpretation "not so much on the literal language of section 32", but on its belief that "where the ownership and control of member banks is the principal activity of a bank holding company" the same possibilities of abuse would be present at the holding company level. The Fed stated it "now believes" Congress did not intend to extend section 32 to holding companies and rescinding the interpretation would give some measure of regulation burden relief. The Fed noted that the section 32 prohibitions would continue to apply to member banks. 61 Federal Register 57287 (November 6, 1996).>
In Securities Industry Ass'n v. Fed. Home Loan Bank Bd., 588 F. Supp. 749 (D.D.C. 1984), the Federal Home Loan Bank Board ("Bank Board") had permitted several federal savings and loan associations to own service corporations which, in turn, owned out-of-state subsidiaries engaged in securities brokerage and investment advisory activities. These subsidiaries of the service corporations were partially owned by investors which were not S&Ls. The applicable statute, section 5(c)(4)(B) of the Home Owner's Loan Act ("HOLA"), permitted federal S&Ls to invest in service corporations, but required that the corporation be organized under the laws of the state in which the home office of the S&L is located, and that its stock be available for purchase only by S&Ls in that state. No mention of, or provison for, subsidiaries of service corporations was contained in the statute.
The parties to the lawsuit agreed as to the material facts, that the federal S&Ls in question could not themselves engage in the securities brokerage and investment advisory activities, nor could they directly own the out-of-state jointly-owned subsidiaries which were engaged in this business. The court nevertheless held that the federal S&Ls' service corporations could own these subsidiaries. It observed that "[e]xcept in unusual circumstances", courts will not disregard the separate identities of a parent and its subsidiary, even a wholly-owned subsidiary, id. at 754-55, citing Labadie Coal Co. v. Black, 672 F.2d 92, 96 (D.C. Cir. 1982); Quinn v. Butz, 510 F.2d 743, 759 (D.C. Cir. 1975). Such separate existence will not be disregarded "merely because the corporate arrangement allows an affiliate or subsidiary to engage in activities which an affiliated or parent corporation is statutorily prohibited from doing", id. at 755, citing Board of Governors, FRS v. Investment Company Inst., 450 U.S. 46 (1981).
The court accepted the Bank Board's ruling that the activities of the service corporations' subsidiaries were "reasonably related to the activities" of federal S&Ls, id. at 754. It also observed that the Board "must be permitted to adapt the regulatory structure of HOLA to the changing needs of the economy", citing M & M Leasing Corp. v. Seattle First National Bank, 563 F.2d 1377, 1382 (9th Cir. 1977), and that the Board's determination with respect to the S&Ls' service corporations was "consistent with HOLA", id. See also Rettig v. Arlington Hgts. Fed. Sav. & Loan Ass'n, 405 F. Supp. 819, 824 (N.D. Ill, E.D. 1975) (Subsidiaries of federal S&Ls can engage in the insurance agency business even though the parent S&Ls cannot engage in the business themselves).
In a case heavily relied on by SIA v. FHLBB, supra, namely Board of Governors, FRS v. Investment Company Inst., 450 U.S. 46, 60 (1981), the Supreme Court observed that "bank affiliates may be authorized to engage in certain activities that are prohibited to banks themselves", and upheld the Fed's determination that services performed by an investment adviser for a closed-end investment company owned by the same holding company as a bank, were "so closely related to banking ... as to be a proper incident thereto". The investment advisory services in question could be performed by the member bank's affiliate without regard to whether the services could be performed by the bank itself, id. at 58-64. See also SIA v. Board of Governors, Federal Reserve System, 839 F.2d 47 (2d Cir. 1988), cert. denied, 108 S.Ct. 2830; SIA v. Board of Governors, Federal Reserve System, 847 F.2d 890 (D.C. Cir. 1988) (both holding that a member bank's affiliate may engage in some securities activities that would be prohibited to the member bank itself).
Finally, Investment Co. Institute v. Fed. Deposit Ins. Corp., 606 F. Supp. 683 (D.D.C. 1985) upheld against challenge the regulation issued by the FDIC to "govern the manner in which non-member state banks can arrange to own subsidiaries and affiliates engaged in aspects of the securities business, particularly underwriting various types of securities", id. at 684. The case hinged on the scope of section 21 of the 1933 Act, which prohibits insured non-member state banks from engaging directly in the securities business. The plaintiffs argued that the restrictions of section 21 also included subsidiaries of a bank; that subsidiaries should be treated as "alter egos" of their parent bank. The court rejected the effort to include the subsidiary within the limitations applicable to its parent under section 21, however, finding no Congressional intent to apply that section to a bank and a separate entity, even one that the bank controlled. The court held that a non-member insured bank could own a securities firm subsidiary.
As a matter of policy, the OCC has generally taken the position that federal banking laws applicable to a national bank should also be applied to the operations of its subsidiary. See, e.g., 12 C.F.R. 5.34(d) Policy, subsection (2) Applicability of banking laws and regulations (1994). Nevertheless, over the years the agency has made exceptions to this policy when deemed appropriate in the circumstances, and therefore has allowed subsidiaries to engage in banking and incidental-to-banking activities even though their parent bank could not engage in those activities directly.
For example, a Deputy Comptroller DeShazo letter dated October 25, 1967, permitted a Pennsylvania national bank to acquire up to 100 percent of the common stock of a commercial finance company headquartered in New York City, where it conducted the bulk of its business. The approval was given under Paragraph 7376 of the Comptroller's rulings (the operating subsidiary ruling). Nothing was said about any geographical problem or branching issue under 12 U.S.C. 36, even though the bank could not be located in New York. The statement was made that "the operations of the finance company will in general be subject to the same laws and regulations as it is now after acquisition by the bank." (emphasis added). In addition, the finance company as an affiliate would be subject to the statutes and regulations governing transactions between national banks and affiliated companies as contained in 12 U.S.C. 221a, 371c, "and other provisions of law and regulation applicable to the affiliates of national banks."
A January 1968 letter signed by Deputy Comptroller Watson held a mortgage company subsidiary's borrowings would be treated as being independent from the parent national bank's borrowings. This avoided a problem under the then-applicable capital limitations imposed on national bank borrowings by 12 U.S.C. 82. The mortgage company also was allowed to buy real estate for its own future development purposes, and make loans to finance a development tract on terms that would be impossible for the parent national bank under 12 U.S.C. 84 and 371. The Watson letter explained why in this concluding statement:
A [controlled subsidiary corporation of a national bank] is a separate, legal entity, apart from its parent corporation, operating under its own charter and articles of incorporation with corporate power and authority to own property and to carry on its business. Accordingly, the Commerce Mortgage Company may pursue such activities which are consistent with its doing business as a mortgage servicing corporation.
More recently, operating subsidiaries have been permitted to act as a general partner in various types of business enterprises, despite the Supreme Court's holding in Merchants Nat'l Bank v. Wehrmann, 202 U.S. 295 (1906), that it is ultra vires for a national bank to take on the unlimited liability of a general partner in a partnership. See, e.g., Interpretive Letter No. 541, Feb. 6, 1991, reprinted in [1990-91 Transfer Binder] Fed. Banking L. Rep. (CCH) para. 83, 253 (affirming an earlier letter which permitted an operating subsidiary to act as general partner in a commodity pool); Interpretive Letter No. 423, April 11, 1988, reprinted in [1988-89 Transfer Binder] id. para. 85, 647 (operating subsidiary can act as managing general partner in a venture formed to invest in real estate mortgage-related assets); and Interpretive Letter No. 289, May 15, 1984, reprinted in [1983-84 Transfer Binder] id. para. 85, 453 (approving an operating subsidiary to act as general partner of a partnership formed to establish ATMs). The OCC reasoned in these cases that an operating subsidiary could lawfully be a general partner because the unlimited partner liability would be cut off at the level of the subsidiary and not flow through to the parent bank.
These precedents reflect that the OCC's prior characterization of operating subsidiaries as essentially a "department of the bank" represented a handy justification of the permissibility of operating subsidiaries, not a legal conclusion regarding the outer bounds of the activities they could conduct. Similarly, the OCC's statements that an operating subsidiary of a national bank may perform only activities permissible for its parent bank, see e.g., 31 Fed. Reg. 11459 (Aug. 31, 1966); 48 Fed. Reg. 1732 (Jan. 14, 1983) constituted conclusions about what the OCC would allow, not what the OCC could allow. The OCC did not address as an abstract proposition in its operating subsidiary regulation the question whether the subsidiary's activities had to be so limited. Moreover, the OCC's actions, described above, effectively demonstrate, from the earliest years of operating subsidiaries, that the answer to the question was that the subsidiary's activities did not have to be absolutely confined to the activities permissible for national banks. The final rule is consistent with these earlier opinions in recognizing that a national bank subsidiary need not be a carbon copy of its parent in every situation and regardless of circumstances.
The case law too has allowed national bank-owned subsidiaries to engage in activities which would be barred to the banks themselves. For example, in Ind. Bankers Ass'n Ga., supra, the D.C. Circuit Court of Appeals allowed the Citizens and Southern National Bank of Georgia ("Bank") to own a holding company, and through the holding company to own interests in 35 banks throughout the state. Including these indirectly-held affiliates, the Bank effectively controlled 23 percent of the bank deposits in Georgia, 516 F.2d at 1210. Footnote 8 in the case, id. at 1211-12, explained the background of the national bank's ownership of a multi-bank holding company, with both the Bank and its wholly-owned holding company being registered as bank holding companies with the Fed. The Bank had created the holding company in 1928, and from 1928 until 1965 all the stock of the holding company was held by the Bank as trustee for the Bank's shareholders. In 1965 the Bank, after receiving the approval of its shareholders, the OCC, and the Fed, transferred all of the shares of the holding company to the Bank. The plaintiff in the case, the Independent Bankers Association of Georgia, argued that this transfer violated 12 U.S.C. 24(Seventh) by being a "purchase for its own account of any shares of stock of any corporation". The Fed in its 1965 review had permitted the transaction under both the Bank Holding Company Act and section 24(Seventh), observing as to the latter that there was no "purchase" of stock involved. The court opined in the footnote that the Fed's legal conclusion seemed "sound".
The main plaintiff challenge, and the one which the D.C. Circuit remanded to the Fed for a hearing, was whether the holding company's proposal to establish a de novo mortgage banking subsidiary satisfied the Bank Holding Company Act sec. 4(c)(8) public interest test, and would not be in violation of Georgia's branching law. Given the existing, extensive two-tier, national bank-owned multi-bank holding company system, this would seem to be a small issue indeed. The pertinent point to observe here is the fact that the Bank was by means of its holding company subsidiary indirectly conducting banking operations at various locations around the state which would be barred to the Bank directly under the state's branching laws.
Conclusion
In sum, national banks may conduct the business of banking and activities incidental thereto through subsidiaries. This authority is derived from the powers sentence in 12 U.S.C. 24(Seventh). The subsidiary too may engage in activities that are part of or incidental to the business of banking within the meaning of 12 U.S.C. 24(Seventh). This may include in some instances an activity that its parent national bank cannot conduct directly, if the limitation imposed on the bank itself and the reason or rationale for restricting the parent bank's ability to conduct a banking or incidental-to-banking activity do not apply to the subsidiary, and if the ability of the subsidiary to conduct the activity would not frustrate a Congressional purpose of preventing the activity from being undertaken by its parent bank. The clarified, more detailed and restated scope of permissible activities for operating subsidiaries in the revised operating subsidiary regulation is fully consistent with this authority.
However, the OCC must evaluate operating subsdiary applications involving an activity that a national bank may not conduct directly on a case-by-case basis. For each activity, therefore, the OCC must consider the particular activity at issue, and weigh 1) the form and specificity of the restriction applicable to the parent bank, 2) why the restriction applies to the parent bank, and 3) whether it would frustrate the Congressional purpose underlying the restriction to permit a subsidiary of the bank to engage in the particular activity. The OCC's evaluation of all these factors may also take into account any regulatory safeguards that apply to the operating subsidiary or to the activity itself, as well as additional conditions that may be imposed in conjunction with an application approval, and any further undertakings by the bank or the operating subsidiary that address the foregoing factors.