6 frb of chicago banking and commerce cmuckenfuss by Katherine Foote

GIBSON, DUNN~CRUTCHER LLP

THE ILC DEBATE AND THE SEPARATION OF BANKING AND COMMERCE: A WORK STILL IN PROGRESS~

Prepared for: Federal Reserve Bank of Chicago

Annual Conference on Banking Structure May 17, 2007

Cantwell F. Muckenfuss III Robert C. Eager Gibson, Dunn & Crutcher, LLP Washington, D.C.

www.gibsondunn.com

TABLE OF CONTENTS Page i.

INTRODUCTION

II.

IS PAST PROLOGUE?

III.

Historical Perspective

Overview of the Core Arguents

An Aside - Roads Not Taken in the 1990s

CURNT EFFORTS TO RESTRICT ILCs

Prelude to Federal Efforts: 2002 Californa Legislation

Federal Legislative Efforts, 2003-2006

IV. THE GRAM-LEACH-BLILEY ACT FRAEWORK

Overview of GLB Act

Banking and Commerce Opportunities Under the GLB Act Framework

INUSTRIAL LOAN COMPANS: AN OVERVĂŚW

ILC Industry Growth in the Context of the Baning Industry as a Whole

Curent ILC Companies

Supervision of ILC Companies by the FDIC

Utah ILC Framework

GAO Report Criticism of

FDIC

VI. HOLDING COMPAN SUPERVISION BY THE FED, OTS, AND EU

GAO Report Concerning Consolidated Supervision

Federal Supervision of

c. D.

Nontraditional FHCs

Fed Implementation of Consolidated Supervision for Non-US Banking Organizations OTS Supervision of

Unitary Savings & Loan Holding Companies

57 58

Page E.

Consolidated Supervision as Implemented by the European Union

VII. HOLDING COMPAN SUPERVISION: EMPIRICAL RESULTS A.

Failures of ILCs Controlled by Nonbaning Companies

Failures of

Failures of Banks in Bank Holding Companies

60 62 62

Thrfts Controlled by Nonfinancial Companies

65 65

Overview 68

VIII. Debate and Commentary on "Baning and Commerce" 1980-2006: An Eclectic

the Federal Reserve Bank of Minneapolis, "Are Bans Special?" (1982)

Amicus Brief filed by Sears, Dimension v. Board of Governors case (1985)

Paul V olcker, Chairman ofthe Federal Reserve, Testimony (1986)

Appendix A to V olcker Testimony (M. Fein and M. Faber Memorandum

E. Gerald Corrgan, President of

on the History of

Banng and Commerce), Federal

the Separation of

Reserve Board (1986)

"The Union of to Testimony of

Baning and Commerce in American History" - Appendix Hans Angermueller, Citicorp (1986)

Carer Golembe, The Golembe Report (1986)

Gerald Corrgan, President of

70 71

the Federal Reserve Ban of

New York,

"Financial Market Structure: A Longer View" (1987)

Department of the Treasury, Financial Modernization Proposal (1991)

C. Felsenfeld, "The Bank Holding Company Act: Has It Lived Its Life?," 38 Vill. L. Rev. 2, 86 (1993)

Banking: II," The Golembe

Carer Golembe, "The Troublesome Myths of

Report (1995)

the Treasury, Testimony on H.R. 10

John D. Hawke, Under Secretary of

(1997) L.

Alan Greenspan, Chairman of

the Federal Reserve, Testimony on H.R. 10 77

(June 17, 1998)

Page M.

Robert E. Rubin, Secretary of

the Treasury, Testimony on H.R. 10

(June 17, 1998)

on, "The Gramm-Leach-Bliley Act Eliminated the Separation Baning and Commerce - How This Wil Affect the Future ofthe Safety Net" (2000)

Gray Davis, Governor of California, Statement Regarding Assembly Bil 551 (Sept. 30,2002)

the Federal Deposit Insurance Corporation, Speech to the American Baners Association (Oct. 8,2002)

Peter Wallis of

Donald E. Powell, Chairman of

Financial Institutions

G. Edward Leary, Utah Commissioner of

John D. Hawke, Jr., Former U.S. Comptroller ofthe Curency, Remarks to

the 16th Special Seminar on International Finance of the Japan Financial News Co., Ltd. (Nov. 16,2005)

Alan Greenspan, Chairman ofthe Federal Reserve, Letter to Rep. James A. Leach (Jan. 20, 2006)

James A. Leach, U.S. Representative, Press Release (Jan. 25, 2006)

Ben S. Bernanke, Chairman ofthe Federal Reserve, Letter to Rep. Brad Sherman (Mar. 21, 2006)

James A. Leach, U.S. Representative, Letter to Acting Chairman Gruenberg (Mar. 27, 2006)

Stephanie Tubbs Jones, U.S. Representative, Statement to the FDIC (Apr. 10, 2006)

the American Baners

Arhur Johnson, Speaking on Behalf of

Association, Oral Testimony to the FDIC (Apr. 10,2006)

Tom Stevens, Speaking on Behalf ofthe National Association of

84 Realtors,

Oral Testimony to the FDIC (Apr. 10, 2006)

the American Financial Services Association, Oral Testimony to the FDIC (Apr. 10, 2006)

AA.

Peter Wallison, Oral Testimony to the FDIC (Apr. 11,2006)

BB.

Barey Fran, U.S. Representative, Letter to Acting Commissioner

Bob McKew, Speaking on Behalf of

Gruenberg (Apr. 19,2006)

Page CC. Statement of

Comptroller of

the Currency John C. Dugan Regarding the

ILC Moratorium Extension (Januar 31, 2007) 86

DD. Testimony of

25, 2007) 87

Vice Chairman Kohn, Board of

Reserve System (April

EE. Testimony of

Governors of

Robert Colby, Deputy Director Division of

Regulation, U.S. Securities and Exchange (April

FF. Testimony of

Utah Commissioner G. Edward Leary (April

the Federal

Market

25, 2007) 88 25, 2007) 88 the American Financial

GG. Testimony of John L. Douglas on behalf of

Services Association ("AFSA")(ApriI25, 2007) 88 Chairman Frank at Mark-Up ofH.R. 698, May 2,2007 (as

reported by the American Banker) 89

HH. Comments of

Exhibit A

Exhibit B

Exhibit C

100

GIBSON, DUN & CRUTCHER LLP

THE ILC DEBATE AND THE SEPARTION OF BANKING AND COMMERCE: A WORK STILL IN PROGRESS Cantwell F. Muckenfuss III Robert C. Eager Gibson, Dunn & Crutcher, LLP Washington, D.C.

ww.gibsondun.com

I. INTRODUCTION baning and commerce" has been a

A. The controversy over "separation of

legislative and regulatory fault line for much ofthe last half-century, even though what it actually means is far from self-evident. It begs the questions of what exactly are "banng" and "commerce" and whether "separation" refers to permissible activities or permissible affliations. These ambiguities may help us understand why this phrase draws deeply on economic theology, myth, politics, and regulatory turf (as well as the roles of some living legends). The current relationship between "banking" and "commerce" was addressed in the GrammLeach-Bliley ("GLB") Act, and the debate over that relationship was central to the nearly 20 year process leading up to the GLB Act. i

As discussed in these materials, the long-runng debate over "bankg-and-commerce" - what companies and activities are permssible for an organiation controlling a commercial bank - has for several years focused on the last remainig option for a nonfinancial company to acquire a robust insured bank charter, an ILC. (Even though the applicable state laws now denomiate them as "industrial banks," the Utah institutions were originally called "industrial loan companies," or ILCs, and ILC has become the shortand reference to the entie

industr. Accordingly, we have used ILC in this generic way.) Federal and state legislative proposals are on the table that would significantly restrct, and potentially even elimiate, that option. Indeed, the pressure for action on ILC affiliations has intensified in recent months, with a one-year FDIC moratorium on action on any ILC application involving commercial affliation, and the passage by the House Financial Services Commttee on May 1 of a bil to bar such affliations; how the Senate wil deal with these issues is unclear. Given the uncertain outcome of

these processes, the materials that follow, like the debate itself, are a work in

progress. They attempt to captue the curent state of play and the content of the debate. We intend to continue

to update and amplify the discussion and analysis in these materials. We welcome your comments, criticisms, corrections, or rebuttals, and to point out thngs we may have missed. We also have compiled a compendium of

writings and statements on bankng-and-commerce that we can provide. Contact us at cmuckenfuss(ÂŁgibsondunn.com or reager~gibsondun.com.

GIBSON, DUN & CRUTCHER LLP B. The GLB Act is neither modern nor comprehensive. Rather, it is an extremely complicated treaty which created neither a coherent financial structure nor a rationalized structure of regulation and supervision. The treaty reflects compromises among competing governental bodies and private interests who in the end could live with an outcome on the subject of banking and commerce (as well as other subjects of contention) that met immediate and perceived competitive and policy interests. Some have suggested that, as with a long war, the fighting stopped because the participants were worn down and tired of the battle. In any event, the result was legislation which was complex, left open major policy issues, and rolled back certain significant competitive options. C. A recitation of pertinent provisions highlights this point. The GLB Act did draw a brighter line between companies limited to banking and financial activities and companies not subject to that limit. At the same time the legislation included extensive grandfathering for existing relationships, which were not subjected to the new limitations. The pertinent GLB provisions include: 1. Expansion of the Ban Holding Company ("BHC") Act framework by

authorizing creation of financial holding companies ("FHCs") that can engage in "financial," "incidental to financial" and "complementary" activities, as well as investment baning, insurance, and merchant

baning. 2. Termination ofthe "Unitary" savings and loan holding company

("Unitary") option under the Savings & Loan Holding Company ("S&LHC") Act, with a grandfather for all existing unitares; the FHC financial activities framework applies to new S&L holding companies going forward. 3. Retention of grandfathered Competitive Equality Baning Act ("CEBA")

banks (so-called "nonban bans"), with a further relaxation of grandfather limitations. 4. Retention ofthe Ban Holding Company ("BHC") Act exceptions for

ILCs, credit card bans and trst bans. 5. Retention of existing statutory authority on the powers of national and

state banks, but addition of restrictions on ban insurance underwriting and financial subsidiares, and "push-out" of

ban securities activities.

D. After the GLB Act, the ILC charer remained the only charer option for companies that could not or did not wish to be subject to the strictures of

the Ban

or Financial Holding Company Acts as well as regulation and supervision by the Federal Reserve. It is, therefore, not surrising that opponents of affliations between commercial firms and insured depositories would seek to eliminate the option.

GIBSON, DUN & CRUTCHER LLP

The May 2,2007, mark-up in the House Financial Services Committee of

the

proposal imposes restrctions on ILC-commercial affiiations going forward. It is also a graphic, almost comical, example of the legislative process -- devolving into a free for all of grandfathers and exemptions. The latest step in that effort further casts doubt that there is a sound economic and policy basis for continuing to erect barrers to baning-commerce affliations. That mark-up agreed that all ILC-commercial affliations existing before October 2003 would be fully grandfathered, including the control ofILCs by GM, BMW, and Volkswagen. The question of whether to make an exception to the general restriction on new ILC-commercial affiliations so that other automobile companies could establish ILC affliations was raised (Ford and Daimler Chrsler have filed applications). Although Chairman Fran deferred that question until a possible House-Senate conference on a final bil, he stated that a care-out might be appropriate so that a means for automobile and other companies to provide "self-financing" for their products might be permitted. E. More generally, the GLB Act left in place a bifucated structue that distinguishes the U.S. The GLB Act did enact long-needed and salutar expansion ofBHC activities. Nevertheless, the GLB Act as a whole is perhaps most notable for the extent to which it embodies the views of the Fed, confirms and strengthens its authority over baning organizations, and thus culminates its 60 years of advocacy in favor of a "separation of baning and commerce." The U.S. still has two worlds of finance.

路 One is a world with legally defined outer limits on permissible activities. Companies within these boundaries are regulated under a super ban holding company act under the umbrella supervision and regulation of

the Fed. This

world includes Citigroup, JPMorgan-Chase, MetLife, Charles Schwab, and Countryide, as well as a number of foreign bans that have insurance and securities affliates in their home countres. Several financial companies, notably Friedman Billings Ramsey and Manulife/John Hancock briefly entered these confines as financial holding companies, but rather quickly sold or converted their bans and exited. This experience underscores the emptiness of the catchphrases used by many including Chairman Greenspan, durng the process leading up to the GLB Act that it would be a "two-way street," and that this "modernization" legislation would create a "level playing field. "

路 The rest of the world is outside that framework. It includes a large number of companies with robust grandfathered bans and thrfts and has no outer limits

or legal boundaries (other than the restriction on acquiring control of a BHC Act "ban" or a thrft by new entrants; grandfathered companies can grow

their institutions by ban mergers or asset acquisitions). Companies in this realm have no constraints on affliation and can control an insured depository institution without Fed umbrella supervision (although subject to a varety of

GIBSON, DUN & CRUTCHER LLP state and federal legal requirements as parents or affliates of a depository institution). The list of financial and commercial companies that control a bank or thrft in this other world is very long. It includes almost every major insurance and securities firm in the countr, as well as commercial companies such as General Electrc, General Motors, Toyota, Target, Nordstrom, and BMW. Home Depot is seeking to join these rans. Many of

these companies,

notably American Express, Merrll Lynch, Morgan Stanley and GE, have controlled an insured depository institution for two decades and have been leaders in financial innovation for consumers and businesses. Indeed, many control multiple charters, including the ones that permit a virtually complete range of banking products and services - grandfathered CEBA bans, grandfathered thrfts, and ILCs. There also is no restrction on acquisitions of credit card bans, nondeposit trst companies, mortgage companies, or commercial or consumer finance companies. the world does inform corporate strategy. Before 1999, it was widely - and probably reliablyrumored that both Citicorp and Wells Fargo actively considered becoming Unitares in order to escape the BHC Act restrictions. It is notable that some of the staunchest supporters of the GLB process, such as Merrll Lynch and Morgan Stanley, have remained outside the BHC Act boundares that were expanded, but

F. The contrast between the limited BHC Act world and the rest of

retained, in 1999. Since 1999, fewer than five nonbanng financial companies have acquired a bank and thus accepted the confines (albeit expanded) of the

BHC Act (notably, Friedman Billings Ramsey and Manulife each entered and subsequently exited the BHC Act regime).

G. The existence of this financial services realm outside the BHC Act boundares and the embedded grandfathering enjoyed by all the major players plainly call into question the oft repeated statements that the GLB Act extended a long-standing "policy" of separating "banng" and "commerce." Whle the GLB Act did limit entry of nonfinancial companies into baning affliations by barng new nonfinancial Unitary thrft holding companies, the GLB Act at the same time the expansive non-BHC Act realm in confirmed the existence and vitality of which commercial and diversified financial companies wil continue to control bans and engage freely in financial and commercial activities as their business plans dictate.

H. It is striking that the GLB Act took the form it did because alternatives that were at least as credible - and more coherent and appropriate for the 21 st centur were available.2 The Republican Treasury Deparment in 1991 had advanced a

Attached as Exhbit 1 is another example of what a comprehensive supervisory framework might look like, one

that also does not include any bankng-and-commerce activities limitation. We developed ths approach in 1997 (Footnote continued on next page)

GIBSON, DUN & CRUTCHER LLP proposal allowing ban-commercial affiliations, which passed the House Banking Committee chaired by Democrat Henry Gonzalez that year. For a number of the Baning Committees, including Senator, later

years, senior members of

Chairman, D'Amato, offered a proposal allowing any qualified company to control a ban under a new "diversified financial holding company structure." In

1997, the Administration supported a FHC structure with a generous commercial the existing Unitar structure so that there would be a clear means for a nonfinancial company to be able to have an insured depository affiiation. (In 1998, as GLB neared final enactment, the affliation basket or, alternatively, retention of

Administration ceased to support this alternativei

I. Not surrisingly, the most steadfast and consistent paricipant in the political and

legislative process over more than 60 years has tended to prevaiL. And, if the curent effort to eliminate the ILC option for commercial companies is successful, what was neither traditional nor historical wil have become reality. From our

perspective, this has been unfortunate for the financial system, for its customers and ultimately for the Fed itself. This outline, we believe, demonstrates the dearth of factual, legal, and policy substance in the arguments in favor of restrctions on baning-commercial affliations, whether involving ILCs or major commercial bans. More importantly, the obsession with a myth has prevented the development ofa framework of regulation and supervision of the financial services industr that is truly modern and comprehensive - one that both addresses the reality of the marketplace AN assures the Fed of its overarching goal of maintaining systemic health.

In the outline that follows, we wil:

(Footnote contiued from previous page)

for a diversified financial company client that wished to determe what credible alternatives to the Leach bil

might be feasible.

It is interesting that during this legislative process, the Fed did acknowledge that globalization, business inovation, and technology had combined to blur the lines between "bankng," "fmance," and "commerce, II but

did not countenance a strctue permttg bankng-nonfinancial affliations as long as the Fed had commensurate broader authority. In the 1997, Chairn Greenspan did address such developments as follows:

"The world is changing rapidly and it may well become increasingly diffcult to distinguish between bankng

bankng and commerce would be a profound and surely ireversible strctual change in the American economy. We should, as a result, be careful to assure ourselves that whatever changes are made in our financial system do not distort our continued evolution to the most effcient fmancial system. In earlier testimony, I suggested that we would have to review and aspects of commerce. However, the free and open legal association of

carefully the kinds of combinations that could occur with a permssible basket for nonfinancial fir. As we

have done so, the problems exposed have led us to a more cautious position. More generally, the subsidy transfer concerns and our uncertainty about the ultimate impact of free affliation between bankng and commerce on our financial system suggest to the Board that at least any wider authorization of

commerce should be postponed while we focus on financial modernation." htt://ww.federalreserve.gov/boarddocs/testimonv/1997/l9970522.htm

baning and

GIBSON, DUN & CRUTCHER LLP historical perspective oflegislation addressing baning-and-

· provide a brief

commerce;

· briefly sumarze and rebut the principal points made by the Fed and others in supporting the separation of

baning and commerce;

pending legislation affecting ILCs, notably H.R. 698, the "Industrial Ban Holding Company Act of2007," which would establish an "industral ban holding company" ("IBHC") as a new type of regulated holding company and exclude "commercial firms" from taking control of an ILC;

. give a brief overview of

· sumarze the FDIC actions in 2006-07 implementing a moratorium on new commercial firm- ILC affliations;

· layout the legal framework for affiiations of depository institutions in the GLB Act and the opportunities for engaging and controlling an insured depository institution and engaging in nonfinancial activities after the GLB Act;

· provide an overview ofthe ILC industry as it stands today and elaborate on the FDIC and Utah provisions that make up the legal framework governing operation of ILCs and their affiliates; · summarze the recent focus on supervision of companies that control depository

institutions;

· look at the evidence concerning failures of ILCs, banks in ban holding companies, and thrfts in diversified Unitar savings and loan holding companies - to shed empirical light on the assertion of the greater systemic protections provided by the BHC Act's consolidated holding company supervisory model; and,

· reprise the debate over baning-and-commerce by providing an eclectic selection of excerpts from paricipants in the debate from 1982 to the present.

II. IS PAST PROLOGUE?

A. Historical Perspective The legislative chronology concerning bank-nonbank affliations evidences the path from a world in which there were no federal legal restrctions on nonbank affliations for bans to the enactment of the GLB Act. Legislative proposals to add further limits on affiliations have been passed by the House of Representatives, but not been taken up in the Senate.

1. The Baning Act of 1933, which included the Glass-Steagall Act, the first

restrction on baning affiiations (investment baning).

GIBSON, DUN & CRUTCHER LLP 2. The Ban Holding Company ("BHC") Act of 1956, which imposed

nonbanking activities restrictions on multiban holding companies. 3. The 1966 amendments to the BHC Act, which amended the BHC Act

"bank" definition. 4. The Savings and Loan Holding Company ("S&LHC") Act, which

restrcted multiple thrft holding companies. 5. The 1970 amendments to the BHC Act, which imposed activities limits on all BHCs and expanded a BHC "ban" definition to read institutions that both take demand deposits and make commercial loans. 6. The Gar-St. German Act of 1982, which restricted BHC insurance

activities, and in response to the emerging thrft crisis expanded thrft powers and allowed waiver of conflicting laws to facilitate supervisory acquisitions of failing thrfts. 7. The Competitive Equality Baning Act of 1987 which redefined BHC "banks" to include all insured banks (except ILCs, credit card banks, trst

bans), grandfathered "nonbank bans" (with severe restrctions), and

added the qualified thrft lender ("QTL") requirement for Unitaries. 8. The 1991

legislation that began as the Administration's proposal to authorize ban-commercial affliations and ended as the re-regulatory Federal Deposit Insurance Corporation ("FDIC") Improvement Act ("FDICIA"), which restrcted state bans to the activities permissible for national banks.

9. The GLB Act of 1999. 10. Next step? The present FDIC moratorium on approving new affiiations between an ILC and a commercial firm rus until Januar 31,2008, for

the stated reason to provide Congress an opportity to address the issues involved.4 While the proposals on the table in 2003-2006 primarily focused on making the ILC option less attractive to commercial firms, the bil just adopted in the House Financial Services Committee would foreclose that option.5 However, there is no proposal to revisit the GLB Act framework, to reconsider what "comprehensive modernization" might

htt://ww .fdic. gov /regulations/la ws/federal/2007 /07noticeilcext.htm htt://ww. house. gov/apps/list/press/fmancialsvcs demlpress050207.shtm

GIBSON, DUN & CRUTCHER LLP entail, or to address the needs of the financial systems, and the consumers, businesses, and institutions who use it in the coming years and decades. B. Overview of the Core Arguments6 baning and commerce." The

The Fed has largely shaped the debate over the "mixing of

1982 essay, "Are Bans Special?" by Gerald Corrigan, then President ofthe Federal Reserve Ban of

then Fed Chairman Paul Volcker7 have

Minneapolis, and the mid-1980s testimony of

the federal law framework that has always allowed some degree of banking-commercial affliations. In addition to the Fed, the most prominent critics in recent years have included former Rep. Jim Leach, the General Accountability Offce ("GAO"),8 the Independent Community Baners Association ("ICBA") proved seminal and provided arguents used by the critics of

the core

and the American Baners Association ("ABA"). This section provides an overview of

arguments advanced by the opponents of baning-commercial affliations (herein, the Critics) with our comment on these criticisms. Subsequent sections of this paper address these points in greater detaiL. The most recent testimony is by Federal Reserve Vice Chairman Donald Kohn, the ICBA, and ABA before Chairman Frank's Committee on April 25, 2007,9 concerning the proposed legislation to prevent new ILC-commercial firm affliations (even while grandfathering existing affliations). As noted above, the critics' arguents have evolved and changed over time, and the most recent testimony reflects such changes.10 It is noteworthy that this Kohn testimony does not actually state a Fed position on many issues listed below, but instead asserts that "Congress" has expressed or adopted certain policies or decisions.

6 Statement of

Donald L. Kohn Vice Chairn Board of

Commttee on Financial Services House of

the Federal Reserve System before the

Govemors of Representatives April

25, 2007,

htt://ww.house.gov/apps/list/earing/financialsvcs dem/tkohn042507.pdf; see also Testimony of McVicker on Behalf of

the American Bankers Association before the Commttee on Financial Services of

United States House of

Representatives April

Earl D. the

25, 2007

htt://ww .house. gov /apps/list/earing/financialsvcs dem/trcvicker0425 07. pdf

"Are Banks Special?" and Chairn Volcker's 1986 testimony are excerpted in Part VII, below.

All GAG statements in this section are from its July 12, 2006 testimony, uness otherwise specified: htt://financialservices.house. gov/media/vdfl071206ijh.pdf 9

Unless otherwise specified, statements by Kohn, the ICBA, and ABA are from this hearing: htt://ww.house. gov /apps/list/earig/financialsvcs dem/tkohn04 2507 .pdf:

htt://financialservices.house. gov /pdf/Ghiglieri. pdf; htt://ww.house. gOV /apps/list/earing/financialsvcs dem/trcvicker0425 07. pdf.

to As noted below, the most recent Fed approach has modulated the "historical tradition" of separating bankng

and commerce and the concern about conflcts of interests. It is wort comparing these curent Fed arguments with previous ones, e.g., the Corrigan 1982 essay, "Are Banks Special?," Chairn Volcker's 1986 testimony, and Chairn Greenspan's 1998 testimony (see excerpts in Part VII, below).

GIBSON, DUN & CRUTCHER LLP Banking and Commerce

1. The "Historic" Separation of

CRITICS: Volcker in 1986: "The United States has had a long tradition baning and commerce" and attached a lengthy staff study as an appendix to support his assertion. In his final statement on this subject, an attachment to a letter to Rep Leach dated Jan. 20, 2006, oflegislative separation of

outgoing Chairman Greenspan stated: "The United States has a tradition

of separating baning and commerce." (at p. 3) ABA: "The separation of U.S. law." ICBA:

baning and commerce has long been a featue of

"The ILC specter continues to loom over the nation's financial system. The ILC charter continues to threaten our nation's historic separation of banking and commerce and undermine our system of holding company supervision, harming consumers and threatening financial stability." Kohn: "If left unchecked, this recent and potential future growth of firms operating under the (ILC) exception threatens to undermine the decisions baning and

that Congress has made concernng the separation of

commerce in the American economy. . ." and "For many years, Congress baning and commerce in

has sought to maintain the general separation of

the United States and has acted affrmatively to close loopholes that create significant breaches in the wall between baning and commerce."

COMMENT: In the sweep of American history, the concern with affliations that mix "banng-and-commerce" is a relatively recent phenomenon. While the debate over baning-securities affiiations early in the 1930s may have been a forerunner, it appears that the Fed first advocated a baning-commerce separation before Congress in the late 1930s. The historical facts are quite clear, as the study prepared by Thomas Huertas in response to the 1986 Fed appendix demonstrates. i i There is no tradition of

preventing bans from having non-financial

affliations. Indeed, the original 1956 BHC Act only restricted the nonbaning activities of multiple-bank holding companies; only in the

1970 amendments were companes that controlled a single "ban" (that engaged in both commercial lending and taking demand deposits) limited to activities deemed by the Fed to be closely related to baning. The lack of historical basis for the Fed's frequent invocation of a "tradition" of separation with respect to affliations is amply demonstrated in the appendix to the Angermueller testimony, the Sears brief, the Golembe and Felsenfeld materials excerpted in Part VIII below.

11 (Huertas,) "The Union of

Banking and Commerce in American History" - Appendix to Testimony of

Angermueller, Citicorp (1986)

Hans

GIBSON, DUN & CRUTCHER LLP the actual involvement of "banks" in "commerce" is far less uniform than the repeated Fed assertions would suggest. Throughout the 19th century and even up to the 1930s in this country, when the legal distinctions between entities engaging in commercial Moreover, the history of

banking, merchant baning, private baning, and investment banking,

especially under state laws, were far less clear than they have become since the 1930s, it seems that "baning" institutions were very much involved in "commerce" as investors, financiers, deal-makers and owners. bans themselves the actual

Thus, even with respect to the activities of

history is far less tidy than political rhetoric (and policy advocacy) would suggest. 2. Extension of tbe Federal Banking Safety Net and Increased Systemic

Risk12

CRITICS: GAO: "The federal governent provides a safety net to the banng system that includes federal deposit insurance, access to the

Federal Reserve's discount window, and final riskless settlement of payment system transactions." AN "The system of federal deposit insurance can also create incentives for commercial firms affiliated with insured bans to shift risk from commercial entities that are not covered

by federal deposit insurance to their FDIC-insured baning affiiates. As a result, mixing banng and commerce may increase the risk of extending the safety net, and any associated subsidy, may be transferred to commercial entities. This risk, however, may be mitigated by statutory and regulatory safeguards between the ban and their commercial affliates such as requirements for ars-length transactions and restrctions

on the size of affliate transactions under section 23A and 23B of the Federal Reserve Act. However, during times of stress, these safeguards may not work effectively - especially if managers are determined to evade them." ICBA: "Baners who have provided bilions of dollars to capitalize the Deposit Insurance Fund have a strong interest in maintaining its strength. Allowing commercial firms to own federally insured ILCs add tremendous new risks to the DIP." Kobo: "(A)llowing the mixing of baning and commerce might, in effect, lead to an extension of the federal safety net to commercial affliates and make insured bans susceptible to

the reputational, operational and financial risks of their commercial affiiates. "

12 The critics have advanced a cluster of arguments suggesting that commercial affiiations necessarily increase systemic risk. These arguments tend to be broadly stated and rest on assumptions that commercial firms tend to manage their businesses with less care for legal compliance and sound management principles than do their counterparts in organiations engaged only in financial activities.

GIBSON, DUN & CRUTCHER LLP COMMENT: Critics ofILC organizations have repeatedly asserted that somehow recent ILC applications pose new and special risks and challenges. Nothing could be fuher from the truth. There is an extensive record of ownership of insured depositories by commercial firms or entities which own commercial firms. Review of this record demonstrates a number of important points: depository institutions owned by or affliated with commercial enterprises have rarely posed significant supervisory problems; the record of safe and sound operations compares favorably with other categories of insured depositories; commercial firms were an important source of capital and stability to the thrft industry during the depths of the thrft crisis and could again be an important source of capital in future times of need; and commercial firms have understood their stewardship as owners and respected the rules concerning serving as a source of financial and managerial strength, affiliate transactions and tying; There is simply no evidence that there are greater systemic risks or any extension of the federal safety net when an ILC or any depository institution may have a commercial owner or affliates or that any risks that may exist are any different from the risks from bank affliations with securties firms or insurance companies, as authorized by the GLB Act.

Indeed, the evidence of problems demonstrates that there is less risk with commercial affiliations. The existing panoply of federal (and state) rules governng affliate transactions, the applications process for new entrants and the use of conditions to ensure the integrty, independence and separateness of

the ban within its corporate family, and the ongoing

supervision of ILCs and their affliates amply address such concerns and insulate the ban. History suggests that the greater concerns arse from financial affliations - when securities and insurance affliations with bans were restricted by federal law, the baning agencies addressed potential customer confusion and spilover risks when bans were

involved in the sales on non-deposit investment products in a joint policy statement discussing best practices.

Moreover, there is no evidence that nonfinancial activities of an affiiate pose paricular risks that would jeopardize its ban affliate. The FDIC in paricular has thoughtfully and thoroughly studied these issues for more than two decades and has consistently concluded that "commercial"-ban affliations pose no special risks and can be effectively supervised under existing law and supervisory programs. 13

13 The comprehensive analysis set fort in Mandate for Change (Mandate For Change: Restrcturing the Banking Industr (FDIC: 1987) ("Mandate for Change")), came to this conclusion: "As a rule, . . . it likely wil (Footnote continued on next page)

GIBSON, DUN & CRUTCHER LLP Indeed, the evidence supplied by more than 20 years of experience demonstrates that nonfinancial affiiates of insured depository institutions have been good stewards and have been a consistent source of financial and managerial strength for the depository institution, whether unitary

S&LHCs or affliates of nonban bans or ILCs. As has been the practice of all the baning agencies, supervision should continue to be tailored to the particular characteristics and business plan ofthe depository institution and the risks (if any) posed by its parent and affiliates, whether commercial or financial in nature. 3. Lack of Consolidated Supervision

CRITICS: Kohn: "Congress established a consolidated supervisory framework for ban holding companies that includes the Federal Reserve as supervisor of

the parent holding company and its nonbank subsidiares

in addition to having a federal supervisor for the insured depository institution itself. This framework allows the Federal Reserve to understand the financial and managerial strengths and risks within the consolidated organization as a whole and gives the supervisor the authority and ability to identify and resolve significant management, operational, capital or other deficiencies within the overall organization before they pose a danger to the organization's subsidiary insured bans.

These benefits help explain why many developed countries, including those of the European Union, have adopted consolidated supervision frameworks and why it is becoming the preferred approach to supervision worldwide." and "History demonstrates that financial trouble in one part of a business organization can spread, and spread rapidly, to other parts of the organization."

COMMENT: Risk arses from the natue of a business plan and the conduct of activities, and supervision is a means for assessing risk management and not a distinct source of risk. The nature of federal baning supervision in this countr is in itself not a source of risk

(although insuffcient supervision can allow institutions risks to go

(Footnote continued from previous page) be diffcult to generalize about the relative riskiness of different activities for banks. In particular it is apparent that commercial and financial activities wil not be distiguishable on the basis of any inherent differences in risk." ยกd. at 63. Two decades after the nonbank bank debate focused attention on theses issues at the FDIC, the analysis of the FDIC was the same: "We at the FDIC must all be vigilant in our supervisory role. But I will reiterate: The FDIC believes the ILC charter, per se, poses no greater safety and soundness risk than other

charter tyes." CSBS Remarks, supra.

GIBSON, DUN & CRUTCHER LLP unanaged).14 Congress has established three statutory approaches to

providing full and effective supervision of depository institutions and their affiliates (and the SEC now does so as well under its distinct regime). Under existing statutes, every depository organzation wil be subject to a supervisory regime that is comprehensive and fully effective, whether the supervisor is the Fed, OTS, or the FDIC. Questions about the FDIC's authority to supervise ILC companies have been raised by the GAO, the Fed and others. The fact is that the FDIC has the same broad supervisory, regulatory and enforcement authority over industrial bans that it has over other non-member insured state bans

under its jurisdiction. is In addition, the FDIC has substantial statutory authority to examine and take enforcement and remedial action against affliates, as may be necessary to protect an industrial ban from adverse affliate actions. 1 6

In Exhibit 3 we review the detailed existing FDIC examination policies for supervising affliates of insured bans, including ILCs, both under its general examination regime and the LilI Program. 1 7 This appendix then

reviews the standards concerning consolidated supervision under the EU Conglomerates Directive and the standards ofthe Fed when it makes

14 The experience of

the

the bankng agencies in the 1980s is instrctive. See Fed. Deposit Ins. Corp., 1 History of

the Eighties") at 38-79.

Eighties - Lessonsfor the Future (December 1997) ("History of

15 12 D.S.C. ยง 1820(b)(2). The FDIC has addressed in detail the effectiveness of

its supervision of

industral

bank and in 2004, adopted modifications to improve supervision. See Mindy West, The FDIC's Supervision of

Industrial Loan Companies: A Historical Perspective, htt:ww.fdic. gov/regulations/ examiations/supervisory/insights/ sisum04/ sim04. pdf. 16 12 D.S.C. ยง 1820(b). The FDIC has express power "to mae such examinations of

the affairs of

an affliate ofa

depository institution as may be necessary to disclose fully. . . (i) the relationship between such depository institution in any such affliate; and (ii) the effect of such relationship on the depository institution." 12 US.C. ยง 1820(b)(4)(A) (emphasis added). The FDIC can use its cease and desist authority to prevent or stop unsafe and unsound practices, including practices by an affliate, and has express authority to require affliates to change their conduct to protect the bank. It can impose temporary or permnent cease-and-desist orders against the bank and its affliates, civil money penalties against the bank and its affliates, involuntary termnation of insurance, or divestitue. The FDIC has parallel express statutory authority to require that banks adhere to the specific conditions of approval orders. 12 U.S.c. ยง 1818(b), (c), (d), (e) and (j). These express powers are reinorced and expanded by the FDIC's incidental powers under 12 U.S.C. ยง 1819(a) Seventh.

17 This program is actively used in Utah, as Commssioner Leary recently noted: "Utah is participating with the FDIC in the Large Bank Supervision Program for four industrial banks. The supervision of

these large banks is

coordinated by a fulltime relationship manager for the State as well as the FDIC. These examiners coordinate the implementation of the supervisory plan for each bank. This plan generally involves three targeted reviews that roll-up to an annual Examiation Report that is reviewed with management and the board." htt://ww.dfi. utah.gov/PDFiles/IB%20Speech%202006.pdf.

GIBSON, DUN & CRUTCHER LLP determinations whether non-U.S. baning organizations should be viewed

as having home country consolidated supervision. This review ofthe EU and Fed standards demonstrates that the existing examination and supervision program implements standards and policies are robust by any standard and substantially parallel to those in the EU Directive for nonmember insured bans under its jursdiction, including ILCs and their affliates. We believe that the materials set forth in Exhibit 3 demonstrate that the FDIC both has the authority to provide the equivalent of consolidated supervision over ILC organzations and has in place a supervisory program that provides that comprehensiveness of supervision for existing ILC organizations whose size and complexity call for such treatment. Critics that suggest that the FDIC has inadequate authority to supervise ILC organizations involving commercial affliates are simply wrong they read the FDI Act in an unduly narow way, ignore the FDIC's discretion to implement and apply its statute, and take no account ofthe express statutory authority ofthe FDIC to use its "incidental" powers under 12 U.S.C. ยง 1819 to supplement its other powers in order to achieve insured bans and to

its mandate to ensure the safety-and-soundness of

protect the FDIC fund. the FDIC's long track record of successful supervision ofILC organizations, it should be immaterial whether a "consolidated" or "bancentric" label is applied. In short, the FDIC has all necessary authority and has in place supervisory programs that provide comprehensive and

In view of

effective supervision of ILC organzations. The fact that the FDIC is

supporting H.R. 698 and would accept fuher enhancement of its explicit statutory authority (what agency ever rejects statutory enhancements?) does not undercut the point that FDIC has demonstrated that it is an effective supervisor ofILC organzations under existing law, and, as former FDIC General Counsel John Douglas has testified, that its existing powers are indeed suffcient to be fully effective. 4. Preferential Credit and Conflcts of Interest

bankng and commerce could also add to the potential for increased conflcts of interest and raise the risk that insured institutions may engage in anticompetitive or unsound practices. For example, some have stated that, to foster the prospects of their commercial affliates, banks may restrct credit to their affliates' competitors, or tie the provision of credit to the sale of products by their commercial affliates. Commercially affiliated banks may also extend credit to their commercial affiliates or affliate parters, . . ." ieBA: "The mixing of baning and commerce presented would undermine the imparial allocation of credit." Kohn: "Congress also expressed concern CRITICS: GAO: "The mixing of

GIBSON, DUN & CRUTCHER LLP that banks affliated with commercial firms may be less willing to provide credit to the competitors of their commercial affliates or may provide credit to their commercial affliates at preferential rates or on favorable terms. " COMMENT: Critics ignore the long history of regulatory experience with affiliations between nonfinancial companies and insured depository

institutions (e.g., nonban bans and unitary S&LHCs), a history that

shows no evidence of greater likelihood of conflicts of interest or tying involving such types of firms. 18 In the 1980s and 1990s, there was extensive consideration by the regulatory agencies, in the academic community and in Congress of the potential for conflcts of interests and tying if a ban were permitted to be affliated with a nonbank financial firm such as an investment bank, broker-dealer, or insurance company, which were regarded as "commercial" entities prior to enactment ofthe GLB Act. i 9 Rules and guidance (e.g., regarding Section 20 affliates, guidelines for retail sales of nondeposit products by bans, sales of

insurance products by depository institutions and affliates) were developed to address these concerns and have helped to inform best practices in parallel contexts.20

18 The CSBS Remarks (See Donald E. Powell, "The ILC Debate: Regulatory And Supervisory Issues," Remarks

State Bank Supervisors, May 30,2003 (PR-52-2003) ("CSBS Remarks")) note not both existing law and FDIC supervisory practices, but also the fact that the FDIC has "found parent companies ofILCs to be acutely conscious of their responsibilities with respect to their ILC subsidiaries and the consequences of violating applicable laws and regulations." These observations are consistent with the analysis of the Mandatefor Change study, which addressed six tyes of potential conflcts of interest and concluded: "Despite the widespread potential for abuse, there is little to suggest that conflct-ofinterest abuse in the U.S. economy is at an unacceptable leveL. Those who make such claims bear the burden of proof, but they have presented no such proof. . .. Without evidence to the contrary, one must conclude that existing controls are adequate to prevent excessive conflct-of interest abuse. Nowhere is this more tre than in Before The Conference of

only the effectiveness of

the bankg industr." !d. at 46. The findings and recommendations of both the 1991 Treasur Report, at

XVII - 29-36 (Modernizing the Financial System: u.s. Department of the Treasury Recommendations for

Safer, More Competitive Banks (February 1991), and the 2005 Restrctug Report (see Rose Marie Kushmeider, "The U.S. Federal Financial Regulatory System: Restrctung Federal Bank Regulation," 17

FDIC Banking Review (December 2005), are consistent with the Mandate analysis.

19 See, e.g., 1991 Treasur Report at XVII-29-31. 20 Agency Transaction Services for Customer Investments (Securities Brokerage), BHC Supervision Manual

Section 3230.0; Underwiting and Dealing in U.S. Obligations, Muncipal Securities, and Money Market Non deposit

Instrents BHC Supervision Manual Section 3240.0; Interagency Statement On Retail Sales Of Investment Products, adopted by each of

the four bankng agencies. See OCC Bankng Circular 274 (July 19,

1993), FDIC Supervisory Statement FIL-71-93 (October 8, 1993), former Federal Reserve letters SR-93-35 (June 17, 1993) and SR-91-14 (June 6, 1991), and OTS Thrift Bulletin 23-1 (Sept. 7, 1993).;12 C.F.R. Part 343 - Consumer Protection In Sales OfInsurance, implementing 12 V.S.C. 1831x.

GIBSON, DUN & CRUTCHER LLP There is no factual basis to support the view that conflicts of interest are more likely with nonfinancial affiiates. Indeed, the types of examples often cited involve conflicts involving financial affliates, that is, affiliations permitted under the GLB Act. For example, the 2005 Baning-Commerce study refers to the possibility that if a ban borrower

jeopardized its ability to repay loans, the parent would have an incentive to have its underwting affliate help issue bonds for the

were in distress that

the loan. Another example

customer so that the proceeds could pay off

cited was the 2003 enforcement actions brought by the SEC against investment baning firms that were promoting securities of firms that their research deparents knew were in trouble.21 This study concludes: "On

examination, the principal potential conflcts that are offered as a rationale for separating baning and commerce seem unlikely to pose significant

risks to the safety and soundness of the ban or to the federal safety net. . .. In short, . . . most conflict situations affecting bans can be controlled through the supervisory process and enforcement of the

appropriate firewalls and need not pose excessive risk to banks or the baning system. ,,22

Moreover, the legal safeguards against affiliate abuse apply across the board to all insured bans and thrfts - Sections 23A and 23B, the antitying rules and the insider lending rules. Sections 23A and 23B and existing anti tying rules, supplemented by the examination process, have proven effective. In view of the lack of actual problems over many years oflLC and nonban ban affiliations with "commercial" firms, and the the examination process combined with the potential of the agencies' enforcement tools, critics should have the burden of demonstrating that the safeguards are inadequate. rigor of

5. Concentration of Economic Power

CRITICS: GAO: "Some have also stated that mixing banking and commerce could promote the formation of very large conglomerate enterprises with substantial amounts of economic power. If these institutions were able to dominate some markets, such as the baning market in a particular local area, they could impact the access to ban

services and credit for customers in those markets." Kobn: "Congress

21 2005 Bankg-Commerce Study (See Christine E. Blair, "The Futue of

Bankng in America-The Mixing of

Banking and Commerce: Current Policy Issues," 16 FDIC Banking Review,

htt://ww.fdic.gov/bankanalytcal/ankng/2005ian/artcle3.htr(..2005Banking-CommerceStudy..).This study cites no example of conflicts of interest that are unque to bank-commercial affliations.

22 /d. at 7.

GIBSON, DUN & CRUTCHER LLP expressed concern that allowing bans and commercial firms to affiliate with each other could lead to the concentration of economic power in a few very large conglomerates."

COMMENT: This concern has often been expressed by reference to the old zaibatsu system in Japan in which bans within interrelated families of other financial companies and commercial enterprises operated on a preferential basis as a cartel capable of exercising substantial influence in the economy as a whole. Although there may have been a time when holdings by the Rockefellers, Mellons or the Transamerica company might have provided a basis for such concerns, the zaibatsu fear has little, if any, or grounding in the structure and dynamics ofthe post-1950 U.S. economy in American law, especially the U.S. tradition of vigorous enforcement of antitrust laws. This arguent also seems paricularly misplaced in the context of today's

the U.S. baning system has

American economy. The consolidation of produced a number of

banng and financial companies with total assets in

the $500 bilion to $l trllon range. In addition, and even more pertinent, are the unquestionably pro-competitive effects ofthe financial subsidiares ofGE, GM and other of the largest U.S. commercial companies. Moreover, even a liberal Democrat such as former Clinton Administration Secretary of Labor Robert Reich has recognized that the competition provided by the entrance of major nonfinancial companes into banng and financial services would be beneficial for American consumers,

paricularly those underserved by existing banng organizations. 6. Unfair Competition

CRITICS: Kohn: "The exception in curent law creates an unlevel playing field among organizations that control a ban because it allows the

corporate owners of ILCs to operate under a substantially different framework than the owners of other insured bans. H.R. 698 would perpetuate these competitive imbalances by continuing to grant firms that acquire an ILC significant advantages not available to the owners of other insured bans, such as the authority to engage in commercial activities and

the ability to escape the CRA, capital and managerial requirements that apply to financial holding companies. GAO: "(T)he potential risks that may result from greater mixing of baning and commerce include. . . increased economic power exercised by large conglomerate enterprises." ICBA: "Some commercial firms that have applied for an ILC have "the size and resources to engage in predatory pricing for as long as it takes to drive local competitors out of the market - not only community bans, but other locally owned small businesses as well. A community bank is only as strong as the community it serves. If our small business customers are drven out of business and our communities are damaged, our deposit base 17

GIBSON, DUN & CRUTCHER LLP wil suffer, our earing assets wil decline, and the level of resources

available for capital development and community lending wil deteriorate." AN "Community baners not only welcome competition, we thrve on it. Healthy and fair competition stimulates the development of new product and service lines that not only help our bottom line, but create real value for our customers. To suggest that community bankers are afraid of competition is uninformed, unwaranted, and only diverts

attention away from the real policy issues."

COMMENT: "Fair competition" has been advanced recently by ILC critics as a reason for limiting commercial-ILC affliations, but again is an arguent with no meaningful factual basis.23 Indeed, this criticism is

ironic because competitive inequalities are inherent in the bifucated strctue that the critics wish to reinforce. Whether publicly stated or not,

the Fed and large baning

this position reflects the unhappiness of

organizations with the fact that the major financial organizations that do not have a major ban as their primary entity have not chosen to the GLB

Act financial holding company status and Fed supervision. This criticism also tends to downplay or ignore the benefits that the ban or financial holding companes derives from having an insured bank as its primary subsidiar and from Fed regulation.

Properly ru bans of all types have thrved durng the last 15 years, a time of monumental change in baning and financial services. It is true that the number and sizes of ILCs have grown over this period, but as set forth below, they represent only about 1.5% of all baning assets and can hardly be viewed, in general, as a competitive threat to any ban, large or smalL.

Moreover, the most significant competitive changes since 1990 have occured as a result of the enactment ofthe historic and far-reaching banks to

Riegle-Neal interstate branching statute in 1994 and the ability of

enter new interstate geographic markets. A parallel development has been the adoption of more detailed and explicit rules for national bans (and

federal thrfts) with respect to the preemption of state law by these federal institutions. Simultaneously, the effects of computer technology, telecommunications, and the Internet have made fundamental changes in how financial business is conducted. Each ofthese changes is

23 As a former community banker, Chairn Powell commented on competitive concerns: "Many worry about

competition in the futue that may come from new entrants into the ILC environment. I understand these fears. After all, I was a communty banker once and I know all too well the pressures these institutions feel every day. * * * (W)hile I understand the aniety some people have on this issue, fear of competition should not be the compelling argument in formulating good public policy." CSBS Remarks, supra.

GIBSON, DUN & CRUTCHER LLP unprecedented and in many respects revolutionary. Cumulatively, they have been transformational- and make trivial the issues related to ILCs.

During this period of revolutionar change, the banking industry as a whole, and soundly managed bans of all sizes, have demonstrated that competition in baning is vigorous and good for them and their customers. In light ofthese developments and this history, the call for "fair competition" with respect to ILC organization seems makeweight and is certainly ironic in light ofthe arguent that lasted for more than 20 years preceding the enactment ofthe GLB Act. We believe that when viewed objectively, the call for "fair competition" seems to be little more than a mask for protectionism. 7. "Dramatic" Growth of

the ILC Industry in Recent Years

CRITICS: Kohn: "(D)ramatic changes have occurred with ILCs in recent years that have made ILCs virtally indistinguishable from other commercial bans. . .. As a result of these and other changes, the aggregate amount of assets and deposits held by all ILCs operating under this exception increased substantially just in the nine years between 1997 and 2006, with assets increasing by more than 750 percent (from $25.1 bilion to $212.8 billion) and deposits increasing by more than 1000 percent (from $11.7 bilion to $146.7 bilion). In fact, in 2006 alone, the assets and deposits ofILCs increased by $62.7 bilion and $38.8 billon, respectively. The number of Utah-charered ILCs also has doubled since 1997, while declining in the few other states permitted to charer exempt

ILCs. ABA: "Between 1987 and 2006, aggregate ILC assets grew more than 5,500 percent, from $3.8 bilion to almost $213 bilion, with the

average ILC holding close to $3.7 billon in assets." GAO: "The natue and size of individual ILCs and their parent companies also has changed dramatically in recent years. While the largest ILC in 1987 had assets of approximately $410 million, the largest ILC today has more than $67 bilion in assets and more than $54 billon in deposits, making it among the twenty largest insured bans in the United States in terms of deposits. An additional twelve ILCs each have more than $1 billon in deposits. And, far from being locally owned and focused on small-dollar consumer loans, many today are controlled by large, internationally active companies and are used to support varous aspects of these organizations' complex business plans and operations." COMMENT: The growth of the ILC industry in absolute terms in undeniable, but the use of percentages as a basis to assert dramatic change is a distortion. ILC industry growth is tiny in the context of the baning industry as a whole and, if anything, reflects the attractiveness of the charer to the financial companies that have accounted for almost all of the growth. In the context of

the baning industry as a whole, the growth of

GIBSON, DUN & CRUTCHER LLP ILCs, whether measured in deposits, assets, or number of applications filed, is insignificant. At the end of 2005, ILCs accounted for only 1.5% of the total assets of all insured bans.24 Their relatively small size also indicates that the risk posed by ILC growth almost certainly is less than the risk posed by the growth of

insured bans generally. The relative

insignificance of the growth in ILCs is most graphically demonstrated by comparson with the largest baning organizations, each of which grew more over the last two years than all ILCs combined grew during the past 20 years. The statistics about growth in the baning industr as a whole

and of ILCs demonstrate how the growth of ILCs is unremarkable. C. An Aside - Roads Not Taken in the 1990s

Durng the 1990s, a number of modernization bils were advanced that provided a strcture in which baning and commercial affliations could exist while incorporating safeguards addressing both maintenance of

ban safety-and-soundness and potential systemic

risk. 1. Cranston-D'Amato-Barnard Bils

Beginnng in 1987, Senators Alan Cranston and Alfonse D'Amato introduced modernization legislation that would permit baning-commercial affiiations in a "diversified financial holding company" ("DFHC") structue. Rep. Doug Barnard sponsored a parallel bil in the House. This proposal would not amend the BHC Act, but provided a new alternative

strcture in which any company could acquire control of a full-service ban as long as certain capital and "safety and soundness" standards were maintained. It did repeal Section 20 and 32 of the Glass-Steagall Act. It provided no holding company regulation, but created a new National Financial Services Oversight Committee made up ofthe Secretary ofthe Treasury, federal

baning agency heads, SEC chairman and CFTC chairman to provide oversight and financial services policy development. As late as 1995, when House Baning Chairman Leach initiated his efforts to expand permissible activities under the BHC Act, Senate baning Committee Chairman D'Amato had a bil that would provide a new federal supervisory framework under which any company could control a commercial ban and engage in financial or nonfinancial activities. 2. Treasury and House Bils in 1991

In 1991, the Bush Administration issued a wide-ranging report Modernizing the Financial System, which included proposals for interstate branching, deposit insurance reform and a two-tier holding company structue that would allow ban holding companies to expand into companies controlling baning, securties and insurance affliates, allow other financial 24 See htt://financialservices.house.gov/media/pdf/071206gel.pdf; see also

htt://www.federalreserve.gov/pubs/bulletin/2006/bankcondition!default.htm.

GIBSON, DUN & CRUTCHER LLP companies to control a ban, and allow any company to control such a financial holding company if it met a series of qualifications and subject to umbrella oversight. The Treasury restrcturing proposal was substantially included in legislation that was adopted by the House Baning Committee under Chairman Gonzalez (D- TX). The baning-commerce and branching modernzation proposals, however, were not agreed to in the Senate and were not included in what became the Federal Deposit Insurance Corporation Improvement Act of 1991.

3. A "Commercial Basket" for Financial Holding Companies The question of whether to allow FHCs to engage to a limited extent in nonfinancial activities was contentious throughout much of the financial modernization debate, but it became clear early in 1999 that no nonfinancial "basket" would be included in this legislation. The 1997 House Banking Committee version ofH.R. 10 broke new ground by permitting a FHC to derive up to 15% of its domestic revenues from domestic commercial affliates, for example, through the ownership of commercial, retail, manufactung or industrial enterprises, but could acquire an existing company only if the target had less than $750,000,000 in consolidated assets. This prohibition was designed to prevent a FHC from affiiating with any ofthe 1,000 largest U.S.

commercial companes in consolidated assets. In 1997 testimony, the Treasury was supportive

this approach. This commercial "basket" was reduced in the House Commerce Committee and then eliminated on the House floor in 1998, except for a 10- to 15- year grandfather provision for nonbanng companes that become FHCs. of

III. CURRNT EFFORTS TO RESTRICT ILCs Parallel to the political reaction to the establishment of a baning affliate by Sears in the

1980s, the potential entrance of such major retailers as W ai-Mar and Home Depot energized their opponents and led to efforts to address the ability of commercial firms to have ILC affliations.

A. Prelude to Federal Efforts: 2002 California Legislation In 2000, California completely revised its industral ban statutes so that, like Utah, a California industral bank could exercise all powers authorized for a commercial ban chartered in California except for accepting demand deposits that the depositor may withdraw by check or similar means for payment to third paries. Nevertheless, out of concern that a major nonfinancial company might acquire a California ILC, in 2002, the California Legislature passed AB 551. That bill amended state law to prohibit any person from acquiring "control of an industrial ban, as defined in Section 105.5, unless the person is engaged only in the activities permitted for financial holding companies, as provided in Section 103 of the federal GramLeach-Bliley Act (12 U.S.C. Sec. 1843(k)(I)), or is a credit union, as defined in Section 134.5, or a credit union service organization, as defined in Section 14651 or Section 108(7)(1) ofthe Federal Credit Union Act (12 U.S.c. Sec. 1757(7)(1))." Governor Gray Davis signed this bil into law on September 30, 2002.

GIBSON, DUN & CRUTCHER LLP B. Federal Legislative Efforts, 2003-2006

Between 2003 and 2006, legislative proposals that would benefit insured banks generally, and thus ILCs as well, provided the principal vehicle for the ILC debate, as ILC opponents questioned any enhancement of

the ILC charter. These bils proposed to authorize de novo

interstate branching for insured bans and to pay interest on business checking accounts. ILC opponents sought to exclude ILCs from getting the benefit ofthese changes. At the same time,

former Chairman Leach and a report prepared by the General Accountability Offce (GAO) (the "2005 GAO Report") at his request sought to broaden the debate to the question the rationale for the ILC exception in the BHC Act enacted in 1987. In the end, when Congress did enact regulatory relief legislation in late 2006, it omitted the controversial ILC provisions. 1. Interstate Branching'in the House Regulatory Relief Bil (H.R.3505)

Section 401 ofH.R. 3505 proposed to amend the Riegle-Neal Interstate Banking and Branching Effciency Act to authorize insured bans to establish de novo interstate branches under federal law, subject to certain requirements and limitations on ILCs. Under the GilmorFran amendment to this bil, an ILC would not be able to establish any interstate branches if it was acquired or established after October 1, 2003, and is controlled directly or indirectly by a "commercial firm," which is defined as one that derives at least 15% or more of its anual

consolidated gross revenues from nonfinancial activities. The Gillmor-Frank language would roll back existing law and deny covered ILCs any interstate branching. H.R. 3505 has been passed by the House. A parallel bil adopted in 2006 by the Senate Baning Committee and then passed by the Senate omitted any interstate branching amendment and was thus silent on this bil was subsequently enacted.

ILC issue. This relatively narrow Senate regulatory relief

2. Interest on Business Checking Legislation (H.R. 1224)

Depository institutions would be allowed to offer interest-bearing business demand deposit accounts under H.R. 1224. This proposal was amended to parallel the Gillmor-Fran limitation in H.R. 3505 and would not apply to non-qualified industrial loan companies, that is, financial institutions controlled by commercial firms. Commercial firms were defined as firms that have at least 15 percent of anual gross revenues derived from activities that are not

financial in nature in at least 3 of the previous 4 calendar quarers. That bil was passed by the House, but was not acted on by the Senate. 3. Leach Bil to Subject ILCs to the BHC Act

In September 2005, Rep. Leach introduced the Financial Safety and Equity Act to eliminate the curent ILC exception in the BHC Act. It would treat an ILC as a BHC Act "ban" and thus require any nonbaning company controllng an ILC to become a financial holding company and thus become subject to, and comply with, all ofthe conditions, requirements, restrictions and limitations that apply to a financial holding company under the BHC Act. This bil did not include any grandfathering and thus could have affected the status of financial companies such as Merrll Lynch and Morgan Stanley that control Utah ILCs, as well as

GIBSON, DUN & CRUTCHER LLP nonfinancial companies such as GE or Toyota. The ILCs controlled by these companies (and particularly Merrll Lynch) have largely spurred the growth in total Utah ILC assets since 1987. 4. The 2007 Gilmor-Frank Bil: H.R. 698, the "Industrial Bank

Holding Company Act of 2007" a. As Proposed

In January 2007, Chairman Fran and senior Republican member Gilmor of the House Financial Services Committee introduced H.R. 698 to establish a new type of regulated holding company - an IBHC - and exclude "commercial firms" from taking control of an industrial bank

loan company ("ILC"). A general grandfather is provided for commercial firmsILC affiiations approved prior to October 1, 2003. A further grandfather is provided for ILCcommercial firm affiliations originating between October 1,2003 and January 28,2007, but that provision also imposes significant restrctions on the banng activities of affected companies. or industral

(1) IBHC Framework

The bil amends the FDI Act to establish an explicit overall supervisory framework including registration, reporting, examination and enforcement provisions for IBHCs. It generally parallels the framework for companies currently regulated as a depository holding company under federal (or state) law, although the specific IBHC provisions are not identical to the existing law for either a ban holding company or savings and loan holding company ("S&LHC"). (2) FDIC Supervision In view of

the FDIC to get reports and information

the very broad existing authority of

from, examine, and take enforcement against existing companies that control an insured ban,

including an ILC, it may well be that the bil serves primarly to codify and make that ability explicit, rather than actually to expand the FDIC's effective authority over such companies. Even the new registration requirement appears to add little in view of the FDIC's ability to gather information sufficient to permit it to make an exhaustive review of any organization seeking to acquire control of an ILC or seek deposit insurance for a de novo ILC. In this light, the registration requirement would appear largely duplicative. Nevertheless, implicitly responding to comments of the General Accountability Offce (GAO) and others, the bil does makes the FDIC's authority explicit within an overall holding company regulatory framework for IBHCs. It should be noted that in her testimony at the April 25 hearng on H.R. 698, Chairman Bar expressed FDIC support for the enhancements to its authority in the bil. At the same time she stopped short of saying that the FDIC actually needs this additional explicit authority to be an effective regulator. She testified as follows:25

25 htt://www .fdic. gov/news/news/soeeches/ chairn! spaor25 07 .htr

GIBSON, DUN & CRUTCHER LLP The primary difference in the supervisory strctues of ILCs and other

insured depository institutions is the type of authority that can be exerted over a company that controls the institution. The FRB and the OTS have explicit supervisory authority over bank and thrft holding companies, including some holding companies that currently own ILCs. The FDIC has the authority to examine the affairs of any affiiate of an ILC, including a parent company and any of its subsidiares, as may be necessary to disclose fully the relationship between the ILC and the affliate, and the effect of any such relationship on the ILC. However, as a practical matter, where the parent of an ILC is supervised by the FRB or OTS, the FDIC routinely coordinates with these agencies in obtaining such information regarding affiiates. In the case of an affliate that is

regulated by the Securties and Exchange Commission (SEC) or a state insurance commissioner (fuctional regulators), the FDIC and the fuctional regulator share information.

FDIC supervisory policies regarding any depository institution, including an ILC, are concerned with organizational relationships, paricularly

compliance with the rules and regulations intended to prevent potentially abusive practices. The scope and depth of review vary depending upon the natue and extent of intercompany relationships and the degree of risk

posed to the depository institution. The FDIC's overall examination experience with ILCs has been similar to the larger population of insured institutions, and the causes and patterns displayed by problem ILCs have been like those of other institutions. . . .

The FDIC strongly supports efforts to provide statutory guidance on the key issues regarding the ILC charer, especially the issue of commercial ownership. As I discussed earlier in my testimony, many of the issues surounding ILC ownership involve important public policy considerations that should be resolved by Congress. Although the FDIC is not endorsing any paricular legislative approach to resolving ILC issues, H.R. 698, the Industrial Bank Holding Company Act of 2007 provides a workable framework for the supervision of ILCs and their holding companies. . . .

H.R. 698 would expressly provide the FDIC with several important supervisory authorities with respect to ILC holding companies. . . . With the addition of authority to impose consolidated capital requirements and other authorities of the Ban Holding Company Act, H.R. 698 would provide the FDIC with supervisory powers over ILC holding companies that are comparable to the FRB's powers over ban holding companies.

This improved statutory framework should provide the FDIC with the tools to effectively supervise ILC holding companies.

GIBSON, DUN & CRUTCHER LLP

(3) Commercial Firm Grandfathering

The bil provides a general grandfather for commercial firm-ILC affliations approved by the FDIC prior to Oct. 1, 2003, the date when former Rep. Jim Leach first introduced a bil to restrict such affiliations. This grandfather parallels the effectively unestricted grandfather provided unitary S&LHCs under the 1999 Gramm-Leach-Bliley ("GLB") legislation. A restricted grandfather is provided for such affliations established between that date and Jan. 28, 2007, when the FDIC adopted a one-year extension of its moratorium on approvals of new commercial firm-ILC affiiations. For the latter companies, this grandfathering bill entails signficant restrictions: (1) the grandfathered company may not take control of any other depository institution, (2) the ILC is subject to restrictions on new activities and (3) the ILC is restrcted in providing interstate baning services. These provisions are reminiscent of the conditional grandfathering provided "nonban bans" under the Competitive Equality Baning Act of 1987 ("CEBA") and markedly contrast with the GLB grandfather. b. Bil as Amended in Mark-Up and Adopted

the grandfathering and exceptions the bil would provide for firms not subject to Fed or OTS supervision. Before the mark-up, a managers' amendment was agreed to that would regard companies subject to SEC supervision as satisfying the "consolidated" supervision standards in A focus of

the May 2 mark-up ofH.R. 698 was the nature and scope of

the bil- thus ensurng that companies such as UBS and Goldman Sachs would not be materially

affected by it. Durng the mark-up efforts were made to provide a fuher exception for ILCs affliated with automobile companies. GM, BMW, and Volkswagen have pre-October 2003 ILC affiliates; Toyota has a 2004 ILC; and Ford and Daimler Chrsler fied applications in 2006. While substantial sentiment in favor of accommodating such companies and providing an opportity for new entrants was expressed, action was deferred. Chairman Fran suggested that

an arangement could be worked out before any final bil would be passed by Congress to permit new ILC affliations so that certain types of commercial firms can "self-finance" their products.26 It is expected that the report on this bil will be filed the week of be brought to the House floor as early as the week of

May 14 and that it could May 21. This action wil put pressure on

the Senate to act, but what may happen is uncertain. 5. The FDIC Moratorium

In August 2006, following the confirmation of Sheila Bair as the new FDIC Chairman, the FDIC initiated a series of actions that culminated in a moratorium until Januar 31,2008, on

FDIC action of any applications or notices that would entail a new affliation between an insured

26 In view of

the fact that there have been vociferous protests to the Home Depot application to acquire an ILC affiiate that would extend credit to builders who could shop at Home Depot, ths "self-finance" concept may represent an interesting slippery slope - and fuher indicates that the "bankng-and-commerce" issue is often driven by competitive positioning rather than public policy.

GIBSON, DUN & CRUTCHER LLP ILC and a commercial firm (as defined).27 The stated purose for the moratorium until 2008 is to provide Congress time to consider these issues. Even though we believe the FDIC has a duty to make timely decisions on pending applications, the 2006 Moratorium and the accompanying Request for Comments did, nevertheless, provide the FDIC a timely opportunity for a rigorous, comprehensive and thoughtful review and discussion of the regulation and supervision of ILCs and their parents. The record developed by the FDIC through that request and in its prior hearing

and acceptance of comments on pending applications is a very thorough one that demonstrates beyond question the lack of merit in the many assertions made about ILC-commercial affliations, the mixing of banking and commerce, and the ability of the FDIC and state regulators to provide effective and comprehensive supervision of such organizations.28 a. 2006 Moratorium and Request for Comments

On August 1, 2006, the FDIC adopted a general moratorium on all ILC applications and notices for the establishment or acquisition of ILCs for six months. See Moratorium on Certain Industrial Loan Company Applications and Notices, 71 Fed. Reg. 43842-44 (Aug. 1,2006) (the "Moratorium"). Subsequently, it sought comments of a wide range ofILC-related issues,

baning-commerce affliations.

including those raised by the 2005 GAO Report and critics of

See Notice and Request for Comment concerning Industral Loan Companies and Industrial Banks, 71 Fed. Register 49456-49459 (August 23, 2006)(the "FDIC Comment Request"). Our response to the questions posed by the FDIC is at Exhibit 1. b. Moratorium Extension to 2008 After receiving these comments (and with the Democrats in control of

Congress), the new commercial

FDIC determined on January 31,2007, to extend the moratorium for any

affiiation for an ILC and to propose rules establishing a more explicit regulatory framework for all insured ILCs. See 72 Fed. Reg. 5217-28 (Proposed Rule), 5290-5294 (Moratorium Extension) (February 5,2007). That FDIC release noted that eight ILC deposit insurance applications and two change in control notices for the acquisition of industrial bans were

the potential parent companies would be subject to "Federal Consolidated Ban Supervision," that is, by the Fed or OTS, and that several ofthese companies engaged in activities that are considered commercial in natue. The release stated:

pending before the FDIC and that none of

"Many of

the statutory and regulatory tools available to Federal Consolidated Ban Supervisors

can substantially restrct the extent to which such companies may engage in commercial activities or affliate with commercial companies. Moreover, the examination, reporting, and monitoring systems of

Federal Consolidated Ban Supervisors can be effective tools in

preventing an affliate's activities from causing a safety and soundness risk to the ban. Finally, holding companies that are expected to serve as a source of strength to their subsidiar insured 27 Recent FDIC actions are discussed in recent testimony by Chairn Bair, htt://ww .house. gov/apps/Iist/earing/financialsvcs dem/tbair04 2507. pdf

28 See comments and submissions on the FDIC website. htt://ww.fdic.gov/reg.

GIBSON, DUN & CRUTCHER LLP depository institutions provide an important resource for an insured bank in need of additional capital. "

In its moratorium release, the FDIC recognized that existing ILC-commercial affliations would not be affected by the extended moratorium, with the result that pending commercial applicants would receive disparate treatment from those commercial companies already controllng ILCs. The release concludes: "(T)he FDIC has considered the potential impact of the extended moratorium on individual applicants and proponents, including commercial companies, and because the issues raised by such ownership have the potential for broad and substantial impact on the entire baning system and, potentially, the nation's economy, the FDIC believes that Congressional resolution ofthese issues may be appropriate. .. While to date,

the concerns that have been expressed and the recent trend of increased ownership of industrial bans by commercial entities, the FDIC wil continue to monitor closely existing industrial bans that curently are controlled by commercial companies." commercially owned industral bans have not resulted in serious problems, in light of

Against this backdrop, the FDIC proposed rule specifically considered, "Non-FCBS29

Financial" companes (including those subject to state insurance commissions or the SEC), as distinguished from FCBS financial companies that are subject to Fed and OTS supervision. Because "Non-FCBS Financial" affliations may present some ofthe same supervisory issues as commercial affliations, the FDIC did not include them in the extended moratorium, but did address them specifically in its proposed rule to ensure there are safeguards providing adequate protections for the safety and soundness of the ILC and for the protection of the Deposit Insurance Fund. c. Comptroller Dugan's Position Comptroller John Dugan, a member ofthe FDIC Board, supported the extension of the moratorium and proposed ILC rulemaking. He found it appropriate for Congress to consider the varous policy issues raised by critics of commercial-ILC affliations. At the same time, he expressed clear views on the ability of commercial firms to control ILCs under present law and the ability of the FDIC to serve as an effective regulator of such enterprises under existing law

and practices. He stated at the FDIC Board meeting:

In short, denying an ILC application for deposit insurance based merely on commercial affiliation would be fudamentally inconsistent with first, the express congressional exemption of ILCs from the Bank Holding Company Act's restriction on commercial affliation, and second, the FDIC's track record in addressing risks raised by such affliations durng the last 20 years. The continued ability of commercial firms to own ILCs will undoubtedly be a close and diffcult policy decision for Congress, but

29 FCBS - Federal Consolidated Bankng Supervision

GIBSON, DUN & CRUTCHER LLP it is not a close decision for me as a legal determination to be made by this agency. As a result, if Congress fails to change the law permitting

the moratorium, and if a deposit insurance application is submitted thereafter by an ILC with commercial affliations, I wil not vote to deny the application merely because of that affliation. In the meantime, I strongly urge Congress to address this issue. commercial ownership ofILCs durng the extension of

http://ww .occ. treas. gOV /ft/release/2007-9a.pdf. New Non-FCBS Financial

d. Conditional Approvals of

Company-ILC Affiiations Since extending the moratorium, the FDIC has conditionally approved three applications for deposit insurance for de novo ILCs with financial affiiates not subject to any federal banng supervision:

. CapitalSource Bank, a subsidiar of CapitalSource, Inc., a publicly traded commercial finance company with a national network of offices and employees and a

commercial loan portfolio totaling $7.3 bilion. . Fifth Street Ban, a subsidiar of Securty National Master Holding Company, LLC,

a closely-held private company that owns subsidiares involved in the purchase, management, and collection of distressed real estate loans and properties. . Marlin Business Ban, a subsidiar of Marlin Business Services Corporation, a

publicly traded company with an existing primar operating subsidiar that provides

nationwide equipment leasing primarly to the small-ticket segment ofthe market. These approvals included substantially more extensive and explicit conditions than the FDIC typically had imposed in prior similar applications. These conditions address concerns expressed by ILC critics and included in the rulemaking proposal in conjunction with the extended moratorium. See Exhibit 3, below. 6. State Efforts to Limit ILCs As of

March 2007, Iowa, Maryland, Virginia, Missour and Oklahoma had enacted bils

intended to restrct or block activities in the state of any commercially owned ILC, including

branching into the state on the property of a commercial affliate. Bils to restrict such activities had been introduced in 10 other state legislatures. While some of these bills would prevent an ILC from any other state ILC from branching in the state (whether commercially affliated or not), others would bar ILCs from doing any business in their states.

GIBSON, DUN & CRUTCHER LLP iv. THE GRAM-LEACH-BLILEY ACT FRAEWORK The GLB Act broadened the BHC Act to permit qualified FHCs to engage in "financial" the ability of commercial firms to acquire an insured thrft going forward, and retained the BHC Act exceptions for the several "limited purpose" institutions established in 1987 - ILCs, CEBA bans, trust companies, and credit card bans. For ILC's "limited purose" is a mischaracterization because they can have full baning powers except for certain types of checking accounts. The Fed position that federal law should separate baning and commerce was advanced in the GLB Act, even while specific opportunities for nonfinancial firms to control insured depository institutions were retained. Except for ILCs, the ability to and related activities, cut off

control a robust banng charer under the GLB Act is subject to grandfathering, either as a

company.

grandfathered CEBA ban company or a grandfathered Unitary S&L holding

A. Overview of GLB Act The centerpiece of the GLB Act is Title I, which revises and expands the existing Bank Holding Company Act of 1956 (the "BHC Act") framework by adding a new Section 4(k) to permit a holding company system to engage in a full range of financial activities. The GLB Act also made a fundamental change in the S&LHC Act to limit new S&LHCs to "financial" activities. The new law left in place a series of exceptions adopted in 1987 allowing "limited purose" baning institutions - grandfathered "nonban bans," credit card bans, insured trst bans, and industral bans - to be affliated with nonfinancial companes.

1. "Financial Activities" This term is broadly defined to include not only baning, insurance, and securities

activities, but also merchant baning for a holding company with a securities affiliate and additional activities that the Fed, in consultation with the Secretar ofthe Treasury, determines

to be "financial in natue," "incidental to such financial activities," or "complementary to a financial activity" as long as such an activity does not "pose a substantial risk to the safety and soundness of depository institutions or the financial system generally." The Act's list of "financial activities" includes:

Lending, trust and other banking activities - lending, exchanging, transferrng, investing for others, or safeguarding money or securities. insuring, guaranteeing or indemnifying against loss, harm, damage, ilness, disability or death, or

Insurance activities - acting as principal, agent or broker for the purposes of

providing and issuing anuities.

Financial or economic advice or services - providing financial, investment or economic advisory services, including advising an investment company (as defined by Section 3 of the Investment Company Act of 1940 (the "1940 Act") (15 U.S.C. ยง 80a-3)).

Pooled investments - issuing or selling instrents representing interests in pools of assets permissible for a ban to hold directly.

GIBSON, DUN & CRUTCHER LLP Securities underwriting and dealing - underwting, dealing in or making a market in

securities.

Existing BHC activities - engaging in any activity that the Fed has, by regulation or order, determined to be permissible for a BHC under Section 4(c)(8) of the BHC Act (12 U.S.C. ยง 1843(c)(8)) as in effect the day before enactment of the Act. Regulation K activities - engaging in any activity in the United States that is permissible for a BHC to engage in outside the United States and, under Section 4( c )(13) ofthe BHC Act (12 U.S.C. ยง 1843(c)(13)), was determined to be usual in connection with the transaction of

baning or other financial operations abroad, including, for example,

management consulting and data processing services. 2. "Complementary Activities"

New Subsection 4(k)(1) also gives the Fed authority to allow a FHC to engage in any activity that is "complementary" to a financial activity and does not "pose a substantial risk to the safety and soundness of depository institutions or the financial system generally." Although this provision is now structued to include such complementary activities as par ofthe basic FHC

activities language, it is not self-executing and must be specifically implemented by the Fed. 3. Merchant Banking The Board and the Secretary of the Treasury (the "Secretary") jointly adopted final regulations governng the FHC merchant baning activities; the rules became effective on

February 15, 2001. In the rulemakng, the Board and the Secretar stated that they "believe that the rule permits a 'two-way' street between securties firms and banking organizations while, at

the same time, giving effect to the statutory framework adopted by Congress to help maintain the separation of

banng and commerce and ensure the safety and soundness of depository

institutions. " 4. Insurance Company Investments

Parallel to the merchant baning provisions, the Act permits insurance or anuity companies in a FHC to invest in or control a company, as permitted to insurance companies under state insurance law. Such investments must be made in the ordinary course of business of an insurance company, as determined by insurance regulators in the company's state of domicile, and the insurance company may not "routinely manage or operate" the company or entity except as necessary to achieve a reasonable retur on the investment. In par, BHC Act ยง 4(k)( 4)(1), provides: (iii) such shares, assets, or ownership interests represent an investment

business of such insurance company in accordance with relevant State law governing such investments; and

made in the ordinary course of

GIBSON, DUN & CRUTCHER LLP

(iv) during the period such shares, assets, or ownership interests are

held, the ban holding company does not routinely manage or operate such company except as may be necessary or required to obtain a reasonable return on investment. Although this language seems intended to permit an insurer to have all the affliations and investments permitted it under its state charer, the language of clause (iv) parallels language concerning merchant baning investments, and thus includes an embedded issue about how this provision would work in practice. a. The Lessons of the Manulife Entry and Exit The most tellng example ofthe limits of

the GLB Act framework, even in its own terms

baning, securties,

as a framework for permitting a "two-way street" for combinations of

insurance and other "financial" activities, is the short-lived status ofthe Manulife Financial Corp. as a FHC as a result of its acquisition of John Hancock and its grandfathered "nonban" ban (First Signatue Ban). The GLB Act was popularly understood to permit "any" insurance

company to become affiliated with a BHC Act "ban" as an FHC, and to continue to engage in all the activities and investments permitted it as a state-chartered insurer. The Manulife example indicates, however, that this is not an unestricted two-way street. b. The Fed's Manulife Approval Order The Fed's Manulife order, dated April

5, 2004, makes no reference to the Section

4(k)( 4)(1) provision, but treats certain unspecified "real estate investment, development, and

the fact that it is typical for insurance companies to invest in real estate as part of their insurance investment activities, it seems reasonable to assume that at least some ofthe activities questioned by the Fed were "an investment made in the ordinary course of business of such insurance company in accordance with relevant State law governing such investments" as provided in the GLB Act provision. Nevertheless, the Fed order requires Manulife to conform these activities, which "have not been approved under the BHC Act" within two years. Rather than conform to these limitations, Manulife sold First Signatue in 2005 and has exited the FHC system. management activities" as not permissible. In view of

B. Banking and Commerce Opportunities Under the GLB Act Framework

The GLB Act framework includes both the expanded scope of the BHC Act and the varous exceptions that permit companies to have nonfinancial affliations as a company that does not control a "bank" but only one or more of the many exceptions included in the GLB Act framework - notably ILCs, grandfathered CEBA bans and grandfathered Unitar thrfts. This

GIBSON, DUN & CRUTCHER LLP section wil review these options and the outer edges ofthe framework for BHCs and banks, as it was set out in the wake of enactment ofthe GLB Act.3o 1. In a FHC or Financial Subsidiaries of a Bank

a. FHC Affiliates (1) Scope of Financial Activities The GLB Act provides that the Fed and Treasury may expand the list of permissible financial activities with reference to developments in technology and competition. It thus gives them power to redraw the "financial-nonfinancial" boundary line to move presently "nonfinancial" activities into the "financial" category. The statute states that the agencies should take into account:

路 the puroses ofthe BHC Act and the GLB Act;

路 changes or reasonably expected changes in the financial services marketplace or in the technology for delivering financial services; and

路 whether such activity is "necessar and appropriate" for a FHC (i) to compete effectively with other companes to provide financial services, (ii) to efficiently deliver information or services that are financial in natue through the use of

technological means, including any application necessary to protect the security of or effcacy of systems for the transmission of data or financial transactions, and (iii) to offer customers any available technological means for using financial services or for the document imaging of data. (2) Fed Implementation (i) "Finder" Activities

The Fed, with Treasury concurence, adopted a rule allowing a FHC to engage in "finder"

activities. It defines the activities of a finder as bringing buyers and sellers together for transactions that the parties themselves negotiate and consumate. The rule lists examples of specific services that a FHC could provide as a finder and includes limitations designed to ensure that a FHC does not use finder authority to engage in commercial activities. (65 Fed. Reg. 80735 (Dec. 22, 2000)). In discussing this proposal, Fed staff made the following points:

30 Most of

the material in this section was prepared in late 2002; in view of the focus of these materials on ILCs and "bankg-and-commerce" we have not attempted to update these materials concernng regulatory

developments elaborating the options listed below.

GIBSON, DUN & CRUTCHER LLP · Banng organizations, which in the past largely have served as a finder by providing statement stuffers and other marketing materials of sellers of varous products and services or by helping to identify service providers as an accommodation to customers, have begun to explore the opportunity to act as a finder electronically on a broader scale.

· Commenters asserted that acting as a finder electronically offers increased opportties for FHCs to cross sell financial products and services or to enhance the attractiveness to customers of the FHC's own web site and would facilitate competition between FHCs and nonbanking companies.

· "A hallmark of finder services is that the finder does not maintain an inventory of goods or take title to or assume responsibility for the storage, delivery, or quality of the goods sold, or directly provide the underlying products or services obtained by the buyer. . . . As a result, the finder does not take on the risk of a principal in the underlying transaction." · "(S)taffbelieves that a FHC's involvement in negotiating and binding, or in any

activity prohibited by the limitations (in the rule), could involve a FHC in commercial activities and increase the exposure of the finder to the risks associated with the underlying transaction." (ii) Data Processing and Electronic Activities

The Fed proposed to allow financial holding companes as a complementary activity to own companies engaged in data storage, Internet and portal hosting activities and broad advisory activities involving data processing activities so long as the investment involves the provision of financial products and services. It also proposed to permit ban holding companies to conduct a greater amount of nonfinancial data processing in connection with processing financial data. In addition, the Fed sought comment generally on whether it should permit FHCs to invest in companies that develop new technologies that might support the sale and availability of financial products and services, companes that provide communcation links for the delivery of financial products and services and/or companies that engage in the electronic sale and delivery of products and services (including, but not limited to, financial products and services). (65 Fed. Reg. 80384 (Dec. 21, 2000)). In discussing this activity, the Fed staff noted the following:

· The new "financial in nature" test was intended to allow activities to be authorized in response to technological and other developments that more broadly affect the market for financial products and services.

· To be "complementary to a financial activity," the activity must in some way complement or enhance a financial activity, or a relationship or connection must exist between the complementary activity and a financial activity. · "The authority to engage in complementary activities was included as a mechanism for allowing some amount of commercial or nonfinancial activities so long as there is 33

GIBSON, DUN & CRUTCHER LLP a connection between the complementary activity and a financial activity conducted by the FHC and the activity does not pose unacceptable risks to the safety and soundness ofthe FHC, its bans or the baning system. At the same time, Congress

rejected the invitation to allow depository institutions to affliate in an unrestrcted

manner with commercial companies and determined not to permit FHCs to engage in a basket of purely commercial activities that have no connection to financial activities. " . Proponents pointed out that the investments covered in the rulemaking were similar to

investments that could be made under the merchant baning authority granted to FHCs, but that cross marketing between the depository institutions owned by the FHC and the portfolio company is not permitted under that authority. "(I)t is precisely this cross-marketing opportnity that motivates many ofthe requested investments. " (ii) Implementation of Section 4(k)(5)

The GLB Act directs the Fed to define by regulation or order, "consistent with the puroses of this Act," the following activities as financial in natue and to determine the extent to which they are financial in nature or incidental to activities that are financial in natue:

. Lending, trust and other banng activities - lending, exchanging, transferrng, investing for others, or safeguarding financial assets other than money or securties; . Financial transfers - providing any device or other instrentality for transferrng

money or other financial assets; and

. Third-pary financial transactions - aranging, effecting or facilitating financial transactions for the account of third paries.

The Fed has adopted an interim rule and requested comments on these provisions. (Dec. 19, 2000 release) (66 Fed. Reg. 257 (Jan. 3,2001)). (iv) Real Estate Brokerage Proposal

In response to requests made by the American Bar Association, Financial Services Roundtable and other groups, in December 2000, the Fed proposed to designate real estate brokerage and real estate management as activities that are financial in nature or incidental to a financial activity and, consequently, permissible for FHCs. (66 Fed. Reg. 307 (Jan. 3,2001)). The proposal would not authorize FHCs to engage in real estate investment or development. This proposal provoked a powerful political response from realtor groups, congressional hearngs and legislative proposals designed to prevent Fed action. In support ofthe proposal, Fed staff made the following points: . thrfts and certain state bans already engage in general real estate brokerage and

management activities;

GIBSON, DUN & CRUTCHER LLP · for decades ban trust departments have been involved in brokering and managing

real estate assets in trust estates;

· BHCs engage in a wide varety of other real-estate related activities; · brokerage is a "natual extension" of the finder activities permissible for national bans and FHCs;

· brokerage is related to existing BHC authority to assist third parties in obtaining commercial real estate equity financing; bans and BHCs are functionally and operationally similar to some real estate management services;

· payment, disbursement, and accounting activities of

· "allowing FHCs to engage in real estate brokerage and management may help FHCs to compete effectively with other financial service providers in the United States that offer such services - one of the factors that the GLB Act requires the Board to consider when determining whether an activity is financial in natue;"

· real estate brokerage and management do not raise significant safety and soundness issues. Since this proposal was released, opponents have been successful in raising congressional roadblocks, and that stalemate continues. b. Financial Subsidiaries of a Bank

(1) National Bank

the Curency ("OCC") regulations, an

Under longstanding Office ofthe Comptroller of

operating subsidiary of a national ban may engage in activities that are "part of, or incidental to, the business of

baning. " Over the years, the OCC has gradually expanded the scope of

activities permissible for subsidiares of

national bans on a case-by-case basis. In the VALlC

case, the ability of an operating subsidiary to sell annuities was upheld by the Supreme Court. The VALlC opinion suggested that the OCC might have significant latitude in determining that financial activities might be "incidental to banking" under the NB Act. In 1996, the OCC published a revised operating subsidiar regulation as par of a general update of 12 C.F.R. Par 5 ("Par 5"). That regulation included a provision allowing the OCC to

approve an application by a national ban for an operating subsidiary to engage in an "incidental to baning" activity that might not have been permissible for the national ban itself to engage in. For example, an operating subsidiary might engage in securities underwriting consistent with Section 20 of the Glass-Steagall Act, but barred for the ban itself under Sections 16 and 21 of that statute.

GIBSON, DUN & CRUTCHER LLP The GLB Act includes a set of provisions concerning subsidiares of national bans that

the Treasur/OCC and the

was worked out during the Conference between representatives of

Fed. These provisions permit national bans to engage in most financial activities through a

subsidiar, but with limits on insurance underwting, real estate development, and merchant banking (for at least five years). These provisions supersede the existing OCC Part 5 rules and effectively limit the ability of the OCC to determine the scope of activities of subsidiaries of national banks under the NB Act. Indeed, the authority to determine what additional activities may be permitted to a financial subsidiar is not given to the OCC, but jointly to the Treasur and the Fed. (OCC Rules, 65 Fed. Reg. 12905 (Mar. 10,2000)). (2) State Banks

The GLB Act adds a new section 46 to the Federal Deposit Insurance ("FDI") Act providing "safety and soundness firewalls" for financial subsidiares of insured state bans. This

provision states that a state ban may control or hold an interest in a subsidiar that engages in "activities as principal that would only be permissible" for a national ban to conduct in a

various requirements applicable to national banks are met.

financial subsidiary if

The Act expressly preserves the ability of a state ban to retain all existing subsidiares. It also expressly provides that this new provision shall not be construed to supersede the authority ofthe FDIC to review activities under existing Section 24 ofthe FDI Act. 2. Within a Bank a. National Banks

For a number of years, the OCC has taken the position that the provisions of Section 24 Seventh of

the national ban statute that allow national bans to engage in baning and activities

"incidental" to baning provide flexibility to offer financial and related products and services in response to changing market conditions and customer needs. Although the GLB Act did specifically address insurance and securities activities of national bans and the activities of national ban subsidiares, it made no changes in the core powers language in Section 24 Seventh. Exemplar of

the OCC approach in the post-GLB Act environment is its recent

rulemaking concerning electronic baning.

The rulemaking created new Par 7.5000 et seq. as a comprehensive codification of its determinations on a range of

technology related matters. (67 Fed. Reg. 34992 (May 17, 2002)).

The rule encompasses electronic activities that are incidental to the business of

baning;

fuishing products and services by electronic means; sale of excess electronic capacity and byproducts; digital certification authority; data processing; correspondent services; shared electronic services. It also addresses the "location" of national ban electronic and Internet activities. Noteworthy features ofthis rulemaking include:

GIBSON, DUN & CRUTCHER LLP

. It incorporates the OCC's "transparency doctrine." Rather than looking separately at

the electronic means of delivery, the OCC wil look through the transmission system to determine whether the underlying product is one that national bans can offer. . It requires national bans that share electronic space (such as web pages or web sites)

with other businesses to "take reasonable steps to clearly, conspicuously, and understandably distinguish between products and services offered by the bank and those offered by the other business." . It updates the OCC's longstanding rule authorizing national bans to act as finders as

baning, and includes examples that illustrate the range of finder activities that the OCC has authorized without regard to the technology used.

par ofthe business of

It notes that the OCC has allowed national bans to use finder authority to operate "virtal malls" on the Internet.

. The rule also addresses national ban preemption in the age of the Internet and

electronic baning. The OCC release quotes OCC Chief Counsel Julie Williams: "When you are offering financial products electronically, your customers may come from all over the countr. The application of multiple state standards to an activity conducted via the Internet can, in itself, be an obstacle to national banks engaging in permissible activities through electronic means. Uniform standards of operation benefit both national bans and their customers through increased effciency." . The rule provides that a national ban wil not be considered "located" in a state

simply because it maintains a technology-based facility, such as an automated loan center or a network server, in that state or because customers in that state electronically access a bank's products and services.31

b. State Banks

Under provisions enacted in 1991, a state ban may engage in any activity as principal in which a national ban may engage, unless the FDIC determines that permitted under state law but not for national bans would "pose no significant risk" to the deposit insurance fund. The FDIC has adopted Par 362 of its rules to implement these provisions and permitted a large number of state bans to engage in activities permitted by their state charers but not for national

bans. In addition, the Conference of State Ban Supervisors has been promoting greater uniformity and coordination among state ban supervisors to facilitate the ability of state banks to engage in activities on a multi-state basis.

31 See also the OCC rulemakings concerng debt cancellation contracts (67 Fed. Reg. 58962 (Sept. 19,2002)

(fmal rule)) and fiduciary activities (67 Fed. Reg. 54528 (Aug. 22,2002)).

GIBSON, DUN & CRUTCHER LLP 3. For Grandfathered UnItaries

a. Background As developed in the 1950s and 1960s, the S&LHC Act paralleled the BHC Act (as then in effect) by imposing holding company regulation on companies controllng more than one insured savings association ("multiple savings and loan holding companies"), which were limited to specified activities and to controlling thrfts in one state. A company that controlled a single insured savings association, a "Unitary," however, was not subject to any limit on its activities. Amended in the 1980s by the imposition of a "qualified thrft lender" ("QTL") requirement on Unitares, this framework has stood as a foil to the BHC Act strcture. An unsuccessful effort was made in the House in 1995 (and again in the 1997 House Banng Committee version of the Bils) to require all thrfts to convert into bans and their holding companies to become BHCs and thus to terminate the Unitar structue.

the Home Owners' Loan Act ("HOLA"), prior to the GLB Act, a Unitary was defined as a company that controls only one insured savings association (not counting an insured savings association acquired by the company in a supervisory transaction). A Unitary may engage in any type of financial or nonfinancial activity if each of its thrft subsidiares meets the requirements ofthe QTL asset test. Under Section 10(c) of

The thrft provisions were a controversial part ofH.R. 10 and S. 900 throughout the process. Although even the largest thrfts engage almost exclusively in consumer and housingrelated activities and derive no more than 2%-5% of their assets or revenues from business customers, the Unitary structue has been criticized because it permits common ownership of "banking" and "commercial" companies. b. Bar to New Unitaries

The GLB Act adds new paragraphs (9) (A) and (B) to HOLA Section 10(c) stating that business combination control of an insured savings association after May 4, 1999, unless (i) it engages, and continues to engage, only in the activities permissible for a FHC under the BHC Act as amended or to a multiple S&LHC under Section 10(c)(1)(C) or 1O(c)(2), or (ii) unless it is grandfathered as a Unitar. The choice of the May 4 date, and its retention in the final legislation, had the effect of cutting off pending applications. no company may acquire through any type of

c. Unitary Grandfather

The Act fuher provides that the new paragraph (9) restrictions "do not apply" to any company that was a Unitar on May 4, 1999 (or becomes a Unitary pursuant to an application pending on that date). Such a company may continue to operate under present law as long as the company continues to meet the Unitary tests in existing Section 1O(c)(3): it can control only one savings institution, excluding supervisory acquisitions, and each such institution must meet the QTL test. A grandfathered Unitar also must continue to control at least one savings association, or a successor institution, that it controlled on May 4, 1999.

GIBSON, DUN & CRUTCHER LLP Because the new restrctions "do not apply" to any SHLC that controlled only one QTL thrft on the grandfather date, any grandfathered Unitares have the legal ability to acquire any other type of company, including one engaged in commerce. A grandfathered Unitary need not have had any nonfinancial affiliation before enactment ofthe GLB Act in order to be eligible to make a nonfinancial acquisition under the grandfather. A reference point for the scope ofthis grandfather may be the Fed order that permitted Dean Witter, Discover to retain its CEBA ban grandfather in its "merger of equals" transaction with Morgan Stanley & Co. 4. For Grandfathered CEBA Bank Companies

a. Background Prior to 1987, the BHC Act defined a "ban" as an institution that both accepted demand deposits and engaged in commercial lending (with specified exceptions, including savings associations). This definition meant that a company could control a FDIC-insured bank that either took demand deposits or made commercial loans, not be a BHC and engage in activities not permissible for BHCs. A number of commercial, insurance, securties and diversified financial companies acquired such so-called "nonban bans" in the mid-1980s. CEBA changed this strcture by including all insured bans in the BHC Act definition of "ban," while allowing these companes to keep control of their insured ban subsidiares and not be treated as BHCs. To retain this grandfather status, these companies became subject to limits on additional investments in insured DIs, and CEBA ban subsidiares were subjected to asset growth, new activities, cross-marketing and affiliate daylight overdraft restrctions. In the years between 1987 and enactment ofthe GLB Act, the grandfathered CEBA companes waged an effective campaign to remove many of the original grandfather limitations. b. Growth Limit

The growth limit was effectively repealed under the Economic Growth and Regulatory Paperwork Reduction Act of 1996. c. Cross Marketing Restrictions

The GLB Act repealed this provision. d. Activities

As amended by the GLB Act, Section 4(f) ofthe BHC Act wil allow a CEBA ban to engage in any permissible activity, except that it may not both (i) accept demand deposits/checking accounts and (ii) make commercial loans, "other than loans made in the ordinary course ofa credit card operation." It thus allows a CEBA ban to freely choose its configuration - a ban that previously had accepted demand deposits but not made commercial loans now may forego demand deposits and begin to make commercial loans, or vice versa. The Act fuher specifies that "for purposes of this (provision), loans made in the ordinary course of a credit card operation shall not be treated as commercial loans." Although many of the CEBA

GIBSON, DUN & CRUTCHER LLP bans have been sold, closed or converted, the ones controlled by Morgan Stanley Dean Witter,

American Express, and Merrll Lynch remain significant. 5. Through Mfiiated Trust Companies

Historically, the scope of permissible fiduciary activities in each state was in large part determined on a state-by-state basis for all providers, both state and federal, wherever based. Over the last decade, this balkanized, 50-state legal framework has been substantially transformed, first by the federal baning agencies, the OCC and Offce of Thrft Supervision ("OTS ") and more recently by state regulators. The OCC has charered uninsured national trst

companies that can be controlled by any type of company entirely outside the BHC Act framework, parallel to the uninsured state trust charers that have been available in many states and that were used in the 1980s and early 1990s by many securities firms. To date, the OTS has offered only an insured federal thrft with trst powers, which until the GLB Act could be controlled by a type of company through the Unitary holding company. Typically, these trust thrfts were acquired by insurance and securities firms, often by conversion of an existing uninsured state trst company. In the mid-1990s, the federal thrft charter was thus the preferred trust vehicle for organizations outside the baning industry. Before the GLB Act, an uninsured national trust ban charer was unavailable to most

nonban financial companies because of Sections 20 and 32 of the Glass-Steagall Act that restricted affliations between national bans and entities engaged in securties underwting and distrbution, including mutual fuds. (These provisions, however, were not a bar to the

Dreyfus by Mellon Ban.) The GLB Act repealed these affiliation provisions, and since then Goldman-Sachs and a number of other securties/financial organizations have received

acquisition of

charters for uninsured national trust bans.

CEBA had amended the BHC Act to provide for a trst company that is not a BHCA "ban" as long as it fuctions "solely in a bona fide trst or fiduciary capacity" and meets a restrictions with respect to deposits, cross-marketing, offer of demand deposits, and these restrictions placed on these trst vehicles and the availability of alternatives, this option has been largely unused.

number of

availability of

Fed payments or discount window services. Because of

6. Through Credit Card Banks

CEBA also amended the BHC Act to permit any type of company to control a credit card ban. A large number of retailers and other nonfinancial companies have established credit card bans (although some, such as Nordstrom, subsequently converted that bank to a federal thrft before 1999).

In order to qualify for exclusion from the ban definition, a credit card bank must: . "engage only in credit card operations;"

. "not accept demand deposits or deposits that the depositor may withdraw by check or

similar means for payment to third paries or others;"

GIBSON, DUN & CRUTCHER LLP 路 "not accept any savings or time deposit ofless than $100,000;" 路 "maintain only one offce;" and

loans. "

. "not engage in the business of making commercial

The CEBA legislative history states that the term "engage only in credit card operations" means that "the institution may engage only in the business of issuing and processing credit cards for individuals and in transactions that are incident to that business." Moreover, a credit card ban must have only one office "that accepts deposits." This makes clear that the original restrction on only one offce was intended only "to prohibit it from having deposit-taking offces

throughout a state or nationally" and that "a credit card ban could maintain additional offices that engage in back room activities typically associated with a credit card operation." 7. Through Industrial Loan Companies

the GLB Act, the ILC has been

Between 1987 and about 1996, and since enactment of

the principal avenue for nonbaning institutions to control an insured institution with broad retail and wholesale banng powers. Under CEBA, an ILC controlled by a non-BHC firm can engage in all deposit, lending and other banng activities as authorized in its charer, but may "not

accept demand deposits that the depositor may withdraw by check or similar means for payment to third paries. " In view of the GLB Act restrictions on new nonfinancial companies as Unitares, the ILC is now the only entr vehicle available. Under CEBA, only ILCs in states that had such a charer in 1987 could qualify for the exception from BHC Act "bank" status. Beginning in 1987, Utah has led the way in the development of an attactive ILC charter and regulatory environment. In the late 1990s, Nevada and Californa sought to provide a comparable opportity. ILC charters have also been available in Colorado and Hawaii.

In 2002, the effort to restrict ILC acquisitions began in California, with the enactment of AB 551 to bar nonfinancial companies from acquiring a California ILC. Since then, two bils passed by the House would deny new powers to nonfinancial-affiliated ILCs. The bils would permit de novo interstate branching for all insured bans and allow bans to pay interest on

business checking accounts, but would prevent non-grandfathered commercial companies controlling an ILC from getting the benefit of these changes. a. CEBA Provision

The ILC exception was originated in the Senate Baning Committee mark-up ofCEBA California and supported by Sen. Jake Gar Utah. As enacted, section 2(c)(2)(H) ofthe BHC Act, provides that a BHC Act "ban" does

in an amendment proposed by Sen. Alan Cranston of of

not include:

(H) An industral loan company, industral ban, or other similar institution which is - (i) an institution organzed under the laws of a State

GIBSON, DUN & CRUTCHER LLP which, on March 5, 1987, had in effect or had under consideration in such State's legislature a statute which required or would require such institution to obtain insurance under the Federal Deposit Insurance Act(I) which does not accept demand deposits that the depositor may withdraw by check or similar means for payment to third parties; (II) which has total assets of less than $100,000,000; or (III) the control of which is not acquired by any company after the date of the enactment of the Competitive Equality Amendments of 1987 (enacted Aug. 10, 1987); or (ii) an institution which does not, directly, indirectly, or through an affiiate, engage in any activity in which it was not lawfully engaged as of March 5, 1987, except that this subparagraph shall cease to apply to any institution which permits any overdraft (including any intraday overdraft), or which incurs any such overdraft in such institution's account at a Federal Reserve ban, on behalf of an affiliate if such overdraft is not the result of an inadvertent computer or accounting error that is beyond the control of both the institution and the affliate.

b. GLB Act Amendment At the same time the GLB Act restrcted the creation of new commercial firm-S&L affiliations, it both retained the original CEBA provision permitting any type of company to control an ILC that does not take demand deposits and added a minor liberalizing amendment concernng daylight overdrafts.32 And it did so two years after Utah has amended its law to permit the charering of new ILCs with broader powers33 and after a signficant number of major diversified financial and nonfinancial companes had acquired Utah ILCs. This action necessarily leads to the conclusion that Congress did not intend to sweep industrial banks into any general "separation of

baning and commerce" and specifically reaffrmed the existing

opportity for any type of company to control an ILC.

V. INDUSTRIAL LOAN COMPANIES: AN OVERVIEW The following review of federal law allowing ILC-commercial affliations and their supervision by the FDIC and state authorities demonstrates that they have been a means for nonfinancial companies to offer new, and often innovative, financial products beneficial to consumers and that ILC organizations have operated soundly under existing supervisory programs.

32 See Section lO7(c) of

841(c)(2)(H).

the GLB Act, amending 12 V.S.C. ยง 1

33 As the Fed noted in its July 2006 Hearing testimony: "For example, in 1997, Utah lifted its moratorium on the chartering of new ILCs, allowed ILCs to call themselves banks, and authoried ILCs to exercise virally all of

the powers of state-chartered commercial banks. In addition, Utah and certain other grandfathered states recently began to charter new ILCs and to promote them as a method for companies to acquire a federally insured bank while avoiding the requirements of the BHC Act."

GIBSON, DUN & CRUTCHER LLP Since 1987 (except for the period from about 1996 to 2000 when thrfts were the charter

of choice), the ILC has been the principal avenue for nonbaning institutions to control an insured institution with broad retail and wholesale baning powers.34 Under the Competitive

Equality Baning Act of 1987 ("CEBA") (as discussed more fully in Par II), an ILC controlled by a non-BHC firm can engage in all deposit, lending and other banking activities as authorized in its charer, but may "not accept demand deposits that the depositor may withdraw by check or similar means for payment to third paries." Post-GLB Act, with the entry restrictions on nonfinancial companies as Unitaries, the ILC is now the only robust depository institution charter available to such companies. Under CEBA, only ILCs in states that had such a charer in 1987 could qualify for the exception from BHC Act "ban" status. Beginnng in 1987, Utah has led the way in the development of

attractive ILC charer and regulatory environment. In the late 1990s, Nevada and California sought to provide a comparable opportunity; ILC charers have also been available in Colorado and Hawaii (primarly a limited purose lending company, without general baning powers).

A. ILC Industry Growth in the Context of the Banking Industry as a Whole ILC critics have pointed to the percentage rate of growth of ILCs since 1987 to suggest that this growth is a source of new risks or problems that must be addressed. That concern seems misplaced. Indeed ILC growth is insignificant in the context of growth and changes in the banking industry as a whole over the last two decades. It is indisputable that the total assets held by ILCs have grown significantly in percentage terms over the last 20 years, but this gain is largely explained by the fact that ILC assets were miniscule in 1987. Indeed, assets of

industral banks totaled only about $155 bilion as of

all ILCs in Utah amounted to only $94.5 billion at year-end 2005. The bulk ofthis growth has occured in the subsidiares of a handful oflarge well-regarded companies: the five largest ILCs have combined total assets of about $110 billion and total deposits of $84 bilion.35

March 31,2006, of

which $127 billion are in Utah institutions. Total deposits of

In the context of the baning industry as a whole, the growth of ILCs, whether measured in deposits, assets, or number of applications fied, is insignificant. At the end of 2005, ILCs

34 It should be noted that a number of

major companies have both an insured thift and an ILC, including Merril Lynch, Morgan Stanley, American Express and GE.

35 Based on FDIC figures. Utah Commssioner Leary recently provided an overview of

the industr: "Industrial the 61 existing industrial banks, 43 are either independently owned or affliated with a parent company whose business is primarily financial in

banks are owned by a diverse group of

financial and commercial firms. Of

the industr's assets and deposits. The remainig 18 are associated with parent companies that can be considered nonfnanciaL. They account for approximtely ten percent of industrial bank assets and deposits." htt://www.dfi.utah.gov/PDFiles/IB%20Soeech%202006.pdf.

natue. These 43 comprise approximately 90 percent of

GIBSON, DUN & CRUTCHER LLP the total assets of all insured bans.36 Their relatively small size also indicates that the risk posed by ILC growth almost certainly is less than the risk posed by the accounted for only 1.5% of

growth of insured bans generally. The relative insignficance ofthe growth in ILCs is most which graphically demonstrated by comparson with the largest baning organizations, each of grew more over the last two years than all ILCs combined grew durng the past 20 years. The statistics about growth in the banking industry as a whole and of ILCs demonstrate how the growth of ILCs is unemarkable

1. Deposits A table published by the American Banker in May 2006 sureyed the growth in deposits

held by the bans in the largest bank and thrft holding companies as measured at year-end 20022005.37 In that survey, the total aggregate deposits of the bans in the four largest BHCs (Ban of America, Citigroup, JPMorganChase and Wachovia) increased in 2004-2005 as follows: B of A by $221 bilion (53%); Citi by $119 bilion (25%); Chase by $229 bilion (70%); Wachovia by $101 bilion (45%). Thus, aggregate ban deposits for each of these companies grew during two years by more than deposits grew at all the Utah ILCs combined over almost two decades. Together, the top five insured banng organzations experienced total deposit growth during the

past four years (2002-2005) of$891 bilion. The growth durng the past four years is more than 925% of total Utah ILC deposit growth over almost two decades.38 A comparson with the growth in deposits of the largest ILCs as provided in their Call Reports over the same four-year period is also strking. As of year-end 2002, Merrll Lynch Ban USA ($55,689,434,000); American Express Centuon Ban ($7,487,901,000 (including

gross foreign and domestic deposits)); and Morgan Stanley Ban ($1,994,159,000) had total deposits of$65,171,494,000. By the end of2005, these three ILCs had a total of $63,970,762,000 in deposits (Merrll Lynch Ban USA ($52,724,538,000); American Express Centuon Ban ($5,586,791,000); and Morgan Stanley Ban ($5,659,433,000)) - an overall decline of 1.8%.39

2. Assets the ten largest ban holding companies increased by $5.4 trllon, or more than 250%, from $3.3 trillon to a combined total of$8.7 Between 2000 and 2006, the total assets of

36 See htt://fmancialservices.house.gov/media/pdf/07l206gel.odf; see also

htt://ww. federalreserve. gov/oubs/bulletin2006/ban condition! default.htr. 37 Bank and Thrift Holding Companies with the Most Deposits, 2002-2005 (Year-end totals, May 19,2006) htt://ww.americanbanker.comlrankings.htr?rankngchart/BTHC/Deoosits/051906R TBSuppBHCMostDep osits5- Years.htr. 38 ยกd. 39 Based on FDIC Report of Condition filings as of

December 31, 2002, and December 31,2005.

GIBSON, DUN & CRUTCHER LLP trillon. Between 1990 and 2006, total assets of the top ten ban holding companies grew by more than 925%. During this same period, the total assets of the largest bank holding company, Citigroup (Citicorp in 1990), increased by more than 725%, from $216 bilion in 1990 to $1.58 trillon in early 2006. The second largest BHC, Ban of America, experienced even greater growth: it grew by over 1000%, from total assets of $11 0 billion at the end of 1990 to total assets of almost $1.4 trillion as of March 31, 2006.40 By comparison, the $155 bilion growth in total ILC assets between 1987 and 2005 is insignificant. 3. Applications

The 2006 FDIC OIG Report reports that durng the five years ending December 2005, the which 19 were for ILCs.41

FDIC approved deposit insurance applications for 780 institutions, of

B. Current ILC Companies 1. Acquisitions and Growth of ILCs a. Utah entrants durng the 1987-97 period included Advanta,

American Express, AT&T, Franlin Templeton, GMAC, GE, Merrll Lynch, Morgan Stanley, Pitney Bowes, USAA and Wright Express. b. Utah entrants since the GLB Act through 2005 have included

BMW, CMS Energy, Flying J, Goldman Sachs, Lehman Brothers, Medallon Cab, Salle Mae, Target, Tyco, UBS, Volkswagen, Volvo. c. The most entrants have included Capital Source, Capmark (from

GMAC), Marlin Business Services Corporation, Securty National Master Holding Company, LLC, and proposed entrants in 2006 included Wal-Mar, Home Depot, Comdata, Daimler Chrsler, American Pioneer, Blue Cross/Blue Shield, Berkshire Hathaway. d. Nevada - 6 ILC charers, including Harley-Davidson, Toyota, and

USAA.

e. Colorado - First Data (total assets under $50 milion) 40 Sources, American Banker:

htt://ww.americanbanker.comJrankngs.htm?rankingchart/BTHC/Assets/072006BTHCAssets.htm; htt://ww.americanbanker.comJrankings.htm?rankingchart/BTHC/ Assets/Top 1 000 12000html; Ranking the Banks, 1991, American Banker archive.

41 See FDIC Offce ofInspector General (OIG), The FDIC's Industrial Loan Company Deposit Insurance

Application Process, Report No. 06-014, July 2006 ("2006 FDIC OIG Report") at 4 and Appendix XI (p. 48).

GIBSON, DUN & CRUTCHER LLP f. California - 15 ILC charters total; total industry assets of $15.7

bilion, none owned by nonbanking companies, although many owned by individuals who also engage in other nonbanking businesses. Largest has $11.3 billion in assets; 2nd largest has assets of $1.2 bilion; eight have assets under $200 milion.

Tables 1 and 2, prepared by the FDIC for its April 2007 testimony, provide an overview the ILC industry today.

TABLE 1.

27374

10/31/1988

57565 27471

9/15/2003 3/20/1989

32992 57803 25653

5/25/1990 8/2/2004 9/24/1984

MERRILL LYNCH BANK USA UBS BANK USA AMERICAN EXPRESS CENTURION BANK MORGAN STANLEY BANK

67,234.7

54,805.3

22,009.1 21,096.8

19,269.6 4,446.2

UBS AG

American Express

21,019.8 19,937.0

Morgan Stanley

Cerberus/GMAC

FREMONT INVESTMENT &

12,915.1

16,555.4 9,910.4 10,089.5

GMAC BANK

LOAN

57485

7/6/2004

34351 57529

9/27/1996 4/1/2003

58009

8/24/2005

GOLDMAN SACHS BANK USA USM SAVINGS BANK CAP

Merril Lynch

Fremont General

Corporation 12,648.9

11,019.6

5,825.6 3,773.9

314.2 2,880.3

USM Life Company

3,224.7

2,633.5

2,829.5 2,219.8

2,312.1 1,591.0

Capmark Financial Group / GMAC Lehman Brothers Holdings Inc. CIT Group

BMW Group

MARK BANK

LEHMAN BRO.

COMMERCIAL BANK

Goldman Sachs

35575

1 0/20/2000

CIT BANK

35141

11/12/1999

BMW BANK OF NORTH AMERICA

33778

2/12/1993

GE CAPITAL FINANCIAL INC

1,991.8

218.3

GE (General Electric)

33535 57833

12/16/1991 8/2/2004

ADVANTA BANK CORP

1,958.2 1,916.2

1,374.3 81.6

Advanta

BEAL SAVINGS BANK

Beal Financial

Corporation

25667 34519 34697

10/5/1984 9/22/1997 6/1/1998

32707

11/3/1989

FIRESIDE BANK MERRICK BANK WRIGHT EXPRESS FINL

1,382.4 1,032.4 815.6

1,162.7 813.3 622.0

761.8

621.5

SERVICES

25158 57225 34599 33493

6/4/1984 1/10/2002 1/16/1998 8/29/1991

CENTENNIAL BANK FINANCE FACTORS, L TO VOLKSWAGEN BANK USA PITNEY BOWES BANK INC TAMALPAIS BANK

672.9 665.3 644.0 501.8

487.4 488.4 516.6 369.8

Unitrin, Inc.

CardWorks, LP

Wright Express

UT UT

Land America

Financial Group Finance Enterprises Volkswagen Pitney Bowes Epic Bancorporation

GIBSON, DUN & CRUTCHER LLP

34781

10/1/1998

58001

58177 35260 57408 26363

9/29/2005 11/28/2005 11/12/1999 7/21/2003 9/10/1985

27330 57449 34820

8/26/1988 12/22/2003 4/3/2000

TRANSPORTATION ALLIANCE BK

483.2

406.8

MAGNET BANK

458.7 438.9 437.5 391.3 343.3

406.3 293.3 378.3 295.7 227.0

336.4 309.5 278.8

207.0 258.3 172.2

204.3 193.4

131.0 123.9

175.6

SALLIE MAE BANK REPUBLIC BANK INC

EXANTE BANK COMMUNITY COMMERCE BANK

SILVERGATE BANK MEDALLION BANK

SECURITY SAVINGS

1/22/1990 12/1/2003

57542

8/16/2004

26704

7/3/1986

91005

11/5/1985

26271

6/3/1985

90017 57293 27539

7/21/1987 6/3/2002 6/28/1989

26615 25870

2/25/1986 12/17/1984

25803 57056 32908

12/17/1984 3/1/2001 2/16/1990

CIRCLE BANK WORLD FINANCIAL CAPITAL BANK TOYOTA FINANCIAL SAVINGS BANK BALBOA THRIFT & LOAN ASSN 5 STAR BANK

3/23/1990

90040

9/28/1987

HOME BANK OF CALIFORNIA FIRST FINANCIAL BANK

ENERBANK FIRST SECURITY THRIFT CO GOLDEN SECURITY BANK FINANCE & THRIFT CO

8/1/2005

No affilation Sallie Mae

No affiliation

UnitedHealth Group TELACU

Silvergate Capital

Medallon Financial

Stampede Capital LLC

CA UT

New West Bancshares Alliance Data Systems

27.6

Toyota

173.4

155.5

Hafif Bancorporation

165.7

130.6

Armed Forces Benefit

164.6

110.6

La Jolla Savers and Mortgage Fund

148.0 147.3 140.7

31.2 126.2 78.8

CO UT

First Data Corp. CMS Energy

First American Corp

134.0 119.0

109.2 95.6

No affiliation

F& T Financial

Services, Inc.

RANCHO SANTA FE TH & L ASSN

99.1

CELTIC BANK

95.5 56.4

77.6 45.9

55.4

41.5

53.9

43.2

38.3

30.6

69.1

Semperverde Holding

Company

TUSTIN COMMUNITY

THE MORRIS PLAN COMPANY HOME LOAN INDUSTRIAL BANK

57962

Association

BANK

32907

Flying J, Inc.

BANK

32743 57570

ALLEGIANCE DIRECT BANK

Celtic Investment, Inc. No affiliation

First Financial Corporation Home Loan Investment Company

Leavitt Group Enterprises, Inc.

35228

11/3/1999

ESCROW BANK USA

34.9

1.0

26755

8/7/1986

MINNESOTA 1ST CREDIT & SVG INC EAGLEMARK SAVINGS

25.6

18.8

Minnesota Thrift

Company Harley-Davidson

34313

8/25/1997

24.5

BANK

1.5

Capmark Financial Group / GMAC

GIBSON, DUN & CRUTCHER LLP

58148

1/26/2006

34404 35533 57769 34549 35400

5/15/1997 10/5/2000 9/27/2004 9/22/1997 1/12/2001

LCA BANK CORPORATION

18.5

13.1

Lease Corporation of

America WEB

15.9 14.2 14.2 3.9

BANK

FIRST ELECTRONIC BANK

TARGET BANK AMERICAN SAVINGS INC TRUST INDUSTRIAL BANK

2.7

7.6 8.2 8.4 1.8 0.6

Steel Partners 1/, LP

Fry's Electronics

Target Corporation

Waseca Bancshares

FISERV

http://ww.house.gov/apps/list/hearinglfinancialsvcs dem/htbair042507.pdf at 17

TABLE 2 - lLC Growth

ASSETS OF 58 CURRENT FDlC-lNSURED IlCs, 1986 _ 2006 A:~-u (s:ei&:')

~¡-

i~e

OAt Oltl (3,. Cn",rle;.¡ . Cornmerci-=l Owher~ (15 :Ch;itiet,:~ . F=ìl\hi:í..l Ser...c.eg ON-h.et~ re- C1,;rier;J ill!!

~I!

l 4 1 2 3..' I 2 i 4 1 23 4 1 2 ~ 4 1 2 3 ~ 1 2 3.4 1 i 3 . t ~ I ~. , 2;¡ 4 t 2 J' 41 Z 3 4 t 2 $,4 1 Z 3 4 t 2 S 41 2 a ~ f 2..3 4 1 2 i 4 t 2 3- 4 1 2 S 4 1 i 3 4

j9i7 t~e U~9 1,g., 1591 1.i~ tSS'3 199+ 1!o5 1SSi 1~'7 19.9B 1m ~sr'l ZØQ1 :i,~ ::vu .:1' ~5 1.t.'\

http://www .house. gov /apps/list/hearinglfnancialsvcs dem/htbair0425 07. pdf at 18

GIBSON, DUN & CRUTCHER LLP 2. Holding Company Supervision of Utah ILCs

nature of

In his April 2007 House committee testimony, Utah Commissioner Leary discussed the the federal holding company supervision of the Utah ILC companies: The ban holding company model works well for companies whose

principal business is limited to baning - it was devised at a time when ban holding companies were permitted to do nothing else. The existing industrial ban supervisory process works well. Utah believes it is the "superior" model for holding companies whose principal business may not

be baning. What has received no coverage in the curent debate is the fact that industral bank oversight by the states and the FDIC is supplemented by holding company oversight by federal financial regulators other than the Federal Reserve. The Offce of Thrft Supervision (OTS) and Securities and Exchange Commission (SEC) have regulatory oversight over many holding companies with Utah industral ban subsidiares.

As previously stated, the OTS has supervisory responsibilities in five Utah

industrial ban holding companes whose industral bans collectively constitute 63% of all Utah industrial ban assets. The OTS has holding company jursdiction because of affiiated federal savings bans to the

Utah industrial bans. The SEC has Consolidated Federal Supervisory responsibility over Goldman Sachs Ban's holding company whose industral ban holds approximately 7% oftotal Utah industrial ban assets. The SEC has dual consolidated supervision authority with the OTS over three additional Utah industral bans in total representing 56% of

Utah assets.

The Federal Reserve has holding company supervision ofUBS Bank's parent company which holds approximately 12% oftotal Utah industral ban assets because UBS's parent filed as a Financial Holding Company with the Federal Reserve. The federal agency oversight listed above constitutes approximately 80% of all Utah industrial ban assets as of December 31, 2006. This is not a parallel regulatory strcture when

federal agencies have holding company authority over 80% of all Utah industrial ban assets.

Not included in the federal agency oversight totals above but consideration should be given to three additional Utah industrial bans: Advanta Ban with $2.0 bilion in total assets, Target Ban with $14 milion, and World Financial Capital Ban with $193 million in total assets, all of which have the Comptroller of sister national bans charered by the Offce of the Curency (OCC).

GIBSON, DUN & CRUTCHER LLP Again, trying to keep this discussion in perspective, the entire industrial ban industry, even with its growth during the last twenty years,

U.S. baning assets. The parent

represents only approximately 1.8% of

Utah industrial bank assets are engaged exclusively or predominantly in financial services activities. These include: Advanta, American Express, Citigroup, Merrll Lynch, Morgan companies ofthe vast majority of

Stanley

and UBS. Other industral bans are owned by diversified

companes, such as General Electric and GMAC which engage in both financial and non-financial activities. Some are controlled by companies primarly engaged in commercial or industral activities, such as BMW and Volkswagen. However, both BMW and Volkswagen have extensive baning operations in Europe. While not subject to regulation as ban holding companies, industrial ban

owners are subject to many ofthe same requirements as bank holding companies. As a result, safeguards already exist to protect these depository institutions against abuses by the companies that control them or activities of affliates that might jeopardize the safety and soundness of the institutions or endanger the deposit insurance system.

Utah struggles to understand why Congress would want to keep out wellcapitalized innovative entrants to the market? Whle the baning system is

becoming concentrated in the hands of a few large institutions with huge market power and system risk, I understand that the five largest banks are trllion dollar entities. These entities control a third of industry assets and

deposits, and a fourh of all ban branches.42 C. Supervision of ILC Companies by the FDIC

As set forth more fully in Exhibit 3, the FDIC has developed a comprehensive and effective supervisory program for industral banks controlled by nonbanng companies that parallels the supervision provided to other non-member insured state bans by the FDIC and

provided by the Fed and OTS for organizations within their jursdiction.43

42 htt://ww.house. gOV /apps/list/earing/fnancialsvcs dem/tleary042507. pdf 43

12 U.S,C ยง 1820(b)(2). The FDIC has addressed in detail the effectiveness of its supervision of industrial banks and in 2004, adopted modifications to improve supervision. Mindy West, "The FDIC's Supervision of Industrial Loan Companies: A Historical Perspective," in Supervisory Insights at 9-10 (Summer 2004).

GIBSON, DUN & CRUTCHER LLP 1. Supervisory Authority

The FDIC has substantial statutory authority to examine and take enforcement and remedial action against affliates. Under the FDI Act the FDIC has broad supervisory powers to address risk. The FDIC has express power "to make such examinations of the affairs of an affliate of a depository institution as may be necessar to disclose fully. . . (i) the relationship between such depository institution in any such affliate; and (ii) the effect of such relationship on the depository institution." 12 U.S.C. ยง1820(b)(4)(A) (emphasis added). These broad express powers are further expanded by the statutory grant to the FDIC to "exercise by its Board of Directors, or duly authorized offcers or agents, all powers specifically granted by the provisions of this Act, and such incidental powers as shall be necessar to cary out the powers

the broad scope the Supreme Cour has the statute that the given to "incidental powers" in a baning context,44 it is plain on the face of FDIC has plenary powers. Accordingly, the FDIC can gather all pertinent information concerning any risks raised for the baning system from an ILC's relationship with its affiliates and can take appropriate follow-up action. so granted." 12 U.S.c. 1819(a) Seventh. In view of

2. Enforcement Authority

The FDIC can use its cease and desist authority to prevent or stop unsafe and unsound practices, including practices by an affiliate, and has express authority to require affiiates to change their conduct to protect the bank. It can impose temporary or permanent cease-and-desist orders against the ban and its affliates, civil money penalties against the ban and its affliates, involuntar termination of insurance, or divestiture. The FDIC has parallel express statutory authority to require that bans adhere to the specific conditions of approval orders.45 3. Conditional Approval of Applications

The business plan of each new entrant is subjected to close scrutiny by the FDIC and state agency and wil not be permitted to go forward if it presents unacceptable and unanageable risks.46 The agencies are well equipped to assess the risks entailed, both for new

entrants and on an ongoing basis.

44 See NationsBank v. Variable Annuity Corp, 513 U.S. 251 (1995). 45

12 V.S.C. ยง 1818(b), (c), (d), (e) and (j).

46 The consistency of

the FDIC's experience and analysis over more than two decades is particularly noteworty. See generally Mandate for Change, esp. at 15 (commercial affliates of "nonbank banks" in 1987), 63, 74-75 (in general, "commercial" activities no riskier than financial activities). The CSBS Remarks, supra, reflect two decades of FDIC experience and state that the present ILC strctue poses no greater safety-and-soundness risks than do strctues involving other tyes of

banks or thfts: "It is important to note here that risk posed by any

depository institution depends on the appropriateness of the institution's business plan and model, management's competency to ru the bank, the quality of the institution's risk-management processes, and, of course, the institution's level of capitaL. . .. Furer, the firewalls and systems of governance safeguarding ILCs from (Footnote contiued on next page)

GIBSON, DUN & CRUTCHER LLP The FDIC routinely imposes conditions on applications (including ILC applications) that provide the FDIC with ongoing supervisory tools and authorities tailored to each application. On March 12,2004, the Division of Supervision and Consumer Protection issued a memorandum Prudential Conditions in Approvals of Applications for Deposit entitled "Imposition of Insurance." That memorandum states: "Applicants should also understand that certain prudential conditions may be imposed well beyond the institution's initial three-year period of this authority in the extensive operation." The FDIC has demonstrated the robustness of conditions attached to the ILC applications approved in 2007 involving affiiations with otherwise unegulated financial firms. See Exhibit 4. 4. Existing FDIC Program for Supervising Large or Complex ILC

Organizations The FDIC has developed a comprehensive program for examining and supervising large and complex insured banking organizations, including ILCs and their affiliates. This Large Insured Depository Institution (LilI) program incorporates the goals, standards, and methods comparable in terms of comprehensiveness and effectiveness to those deemed appropriate by the European Union (ED) and the Fed when determining whether international baning

organizations as subject to "consolidated home countr supervision." The Fed standards closely parallel the EU and international standards applied to U.S. organizations.47 See Exhibit 4. Financial Institutions and the FDIC San Francisco Region has resulted in a series of signficant internal controls, standards and procedures, including requirements for local management, boards of directors and files, as well as definitive business plans for Utah-based industrial bans.48 Long-established cooperation between the Utah Deparment of

(Footnote contiued from previous page)

bank the ILC charter in recent years is attibutable to a contiually evolving supervisory approach that considers each institution's purose and placement within the

misuse by their parent companies are, in many cases, more strgent than what exists in many affiiates of holding companies. In part, the generally positive experience of

organiational strctue." 47 The U.S. and EU standards and programs also reflect the work of

the Basel Commttee on Bankng Supervision

the Bank for International Settlements, including the Concordat on "Minmum standards for the supervision of international bankng groups and their cross-border establishments" (July 1992) ("Basel Commttee Cross-Border Bankng Report Documents") htt://ww.bis.org/oubllcbsc3l4.odf; The Supervision of (October 1996) htt://www.bis.org/publlcbs27.odf; and High-level priciples for the cross-border of

implementation of

the New Accord (August 2003), htt://www.bis.org/publlcbs100.odf.

48 See Regional Director memo, transmittal number 2004-001, "Imposition of

Prudential Conditions in Approvals

of Applications for Deposit Insurance" for conditions that may be imposed by the FDIC when approving a deposit insurance application.

GIBSON, DUN & CRUTCHER LLP D. Utah ILC Framework The Utah Departent of Financial Institutions ("DFI") has robust, plenary authority over both its ILCs and companies that control them.49 As set forth more fully in Exhibit 3, the Commissioner of the DFI has broad supervisory regulatory and enforcement authority over Utah ILCs that is parallel to the FDIC's authority. Such authority includes the right to examine the

ILC and to take enforcement and remedial actions against the ban and its affliates. See, e.g.,

Utah Code An. §§ 7-1-307, 7-1-308, 7-1-313, 7-1-314, 7-1-501, 7-1-510 and 7-2-1. Enforcement powers include the right to issue cease and desist orders, remove directors and offcers, take possession of the institution, and enforce supervisory acquisitions and mergers. See, e.g., Utah Code An. §§ 7-1-307, 7-1-308, 7-1-313 and 7-2-1. The Commissioner has authority to impose any conditions and limitations on an application for authority, as necessary to protect depositors, creditors and customers. Utah Code An. § 7-1-704. Furhermore, corporations and other business entities that control an ILC, as well as the subsidiaries and affiiates of such entities, are subject to Utah Code An. § 7-1-501. The Commissioner thus has direct supervisory authority over all ILC holding companes, and may take enforcement and remedial actions directly against the holding company and its affliates as necessary. See, e.g., Utah Code An. §§ 7-1-307, 7-1-308, 7-1-313, 7-1-314, 7-1-501, 7-1-510 and 7-2-1. The Commissioner may also adopt rules with respect to ILC holding companies to protect depositors, the public and the financial system of the state. Utah Code An. § 7-1-301.

E. GAO Report Criticism of FDIC In September 2005, the Governent Accountability Office ("GAO") issued report on ILCs pursuant to a request by Rep. Leach, who had posed questions intended to contrast the supervision oflLCs with the "consolidated supervision" approach ofthe Fed. This report

followed, and drew substantially on, a September 2004 report on ILCs issued by the FDIC's Inspector General ("IG"). Although the GAO report is in many respects detailed and comprehensive, and provides accounts ofthe views of proponents of the existing ILC structure, its conclusions support the position of Rep. Leach and the Fed. Rep. Leach intended this report to be a significant document in his ongoing campaign to advance the Fed's views on baningand-commerce. In view of the scope and intent of the GAO report, we have reproduced significant portions of it in this and subsequent sections. 1. Overview and GAO Conclusions The following excerpts are ilustrative of

the GAO report:

· Industry Overview - "ILCs have significantly evolved from the small, limited purose institutions that existed in the early 1900s. In paricular, the ILC industr has grown rapidly since 1999 and, in 2004, six ILCs were among the 180 largest financial 49 See generally htt://www.dfi.utah.govIPDFiles/IB%20Soeech%202006.pdf.

GIBSON, DUN & CRUTCHER LLP institutions with $3 billion or more in total assets, and one institution had over $66 bilion in assets. " . Assessment of FDIC and Utah supervision - "The vast majority ofILCs have corporate holding companies and affiliates and, as a result, are subject to similar risks from holding company and affliate operations as bans and thrfts and their holding companies. However, unlike ban and thrft holding companies, most ILC holding companies are not subject to federal supervision on a consolidated basis. Although FDIC has supervisory authority over an insured ILC, it does not have the same authority to supervise ILC holding companies and affiiates as a consolidated supervisor. 路 Banking and commerce - "(W)e were unable to identify any conclusive empirical

evidence that documented operational efficiencies from mixing baning and commerce, and the views of

ban regulators and practitioners were mixed. . . .

However, the potential risks from combining baning and commercial operations the federal safety net provided for bans

remain, including the potential expansion of

to their commercial entities, increased conflcts of interest within a mixed baning and commercial conglomerate, and increased economic power exercised by large conglomerate enterprises."

路 GAO Recommendations to Congress - "To better ensure that supervisors of institutions with similar risks have similar authorities, Congress should consider varous options such as eliminating the curent exclusion for ILCs and their holding

companies from consolidated supervision, granting FDIC similar examination and enforcement authority as a consolidated supervisor, or leaving the oversight responsibility of small, less complex ILCs with the FDIC, and transferrng oversight

of large, more complex ILCs to a consolidated supervisor.

"Congress should more broadly consider the advantages and disadvantages of mixing baning and commerce to determine whether continuing to allow ILC holding companies to engage in this activity more than the holding companies of other types of financial institutions is waranted or whether other financial or ban holding companies should be permitted to engage in this level of activity. ,,50

2. Fed Critique of the FDIC

The GAO report incorporates a critique by the Fed intended to advance the Fed's position concerning consolidated supervision. This critique tends to take a "glass half empty" approach, that is, to construe narowly (and thus we believe, incorrectly) the scope of FDIC authority. It 50 U.S. Gov't Accountability Offce, GAO-05-621, Industrial Loan Corporations, Recent Asset Growth and Commercial Interest HigWight Differences in Regulatory Authority (2005).

GIBSON, DUN & CRUTCHER LLP the FDIC to Directors, or duly authorized officers or agents, all powers specifically granted by the provisions ofthis Act, and such incidental powers as shall be necessary to cary out the powers so granted." (12 U.S.c. ยง 1819(a)(seventh)). In view ofthe scope of "incidental" powers upheld by the Supreme Court in recent years, this FDIC authority provides further statutory support for the FDIC's capacity to be a robust and effective supervisor on a par with its sister agencies. should be noted that the GAO Report omits reference to the express power of "exercise by its Board of

The 2005 GAO Report on ILCs sumarzes the Fed's critique ofthe FDIC's supervisory authority as follows:

Board officials told us that the ban-centric approach alone is not suffcient to assess all the risks that a holding company and affliates can pose to an insured financial institution. Board offcials also stated that consolidated supervision has a long, successful history of assessing the potential risks that holding company and affiliate organzations may pose to insured depository institutions. According to Board offcials, in order to understand the risks within a holding company strctue and how they are dispersed, ban supervisors must assess risks across business lines, by

legal entity, and on a consolidated basis. Board offcials note that consolidated supervision provides its examiners with both the ability to understand the financial strength and risks of the overall holding company - especially operations and reputation risk - and the authority to address significant management, operations, capital, and other deficiencies throughout the organzation before these deficiencies pose a danger to

affliate insured bans and the ban insurance fud. Furher, Board offcials stated that focusing supervisory efforts on transactions covered by sections 23A and 23B will not cover the full range of risks that insured institutions are exposed to from holding companies and their subsidiares. Board offcials told us that sections 23A and 23B violations most often occur in smaller organizations, and the risks posed by large organizations are more often related to other issues such as internal controls and computer systems problems. These offcials stated

that FDIC would likely not be able to detect these problems in a large holding company unless it was able to supervise the entire organization on a consolidated basis.

VI. HOLDING COMPANY SUPERVISION BY THE FED, OTS, AND EU By its terms, federal law embodies multiple approaches to baning safety-and-soundness the BHC Act, the FDI Act, and the S&LHC Act leads to the conclusion that Congress has accepted the effcacy of and does not prefer BHC Act consolidated supervision. The history of

multiple models of

ban-affliate-holding company supervision and has not endorsed anyone as

the preferred modeL. These models take into account the varous structues for insured depository institution-holding company affliation and provide correspondingly varying

GIBSON, DUN & CRUTCHER LLP

supervisory methods for protecting the FDIC fud and ensurng the soundness of

the baning

system. For 25 years, non-financial companes have controlled FDIC insured bans under FDIC

supervision and outside the BHC Act consolidated supervision framework. In 1987, 1989, 1991,

1994, and 1999, Congress enacted major banng legislation that addressed bannon-ban affiiations and the regulatory tools for managing risk and advancing safety and soundness in banng. Throughout this period, the FDIC has effectively exercised the powers given it by

institutions controlled by non-BHC companies, and the legislation enacted during this period, notably FDICIA in 1991, facilitated and enhanced the FDIC's approach.

statute for the supervision of

Below, we sumarize the GAO Report's discussion, which advocates "consolidated supervision" without giving adequate attention to differences in how the OTS and Fed exercise their responsibilities. Indeed, in light of the over 100 diversified financial and nonfinancial companes that the OTS currently supervises, the GAO discussion of consolidated supervision

implicitly undercuts its conclusion that the Fed approach is preferable. The OTS track record is a strong one.

A. GAO Report Concerning Consolidated Supervision the

The GAO Report includes a table intended to compare the supervisory authority of

FDIC, Fed, and OTS. As suggested above, the Report gives an unduly narow constrction of

FDIC authority:

Figure 4: Comparison of ExpllcltSupevlsory Authorities of the FDIC, Board, and OTS

FDIC.

llo'iplon.I exioil s.peNl..ry ..th..il

Bord ors

~ Colllthe J.~ren1 and affilia&.to ptovíde- vaÎ:ue reports such a. rêp:ta of cp~raìons. financiAl conition. and sYSIélna for rnonìting flak.

.' .' .0 .' .' .' ,-.' 0 --.. '" .' .' .' .' .' .' .' .'

! Impoe cOMQlida:bad or pø~nt~niy capial requir& on tM p6re a.nd fQqlJir that it.rve M a. source of strêngth tothê ¡Miired

;. ,

Examino lte r..labnahips, in.4ig sps.,ih:"ians.,1is, ìi any. l;lWon tho ínslld insiiuUon and it p""", or oIiai.. beyond apeific trensactbM when necllsearyt\3 díæbs th. natur end efct of 1he rela1iomhp ~tv.."" thil mured inlitJb.ion perentöralfilele, the plU'eri or

err., aflíate of an insured intikin. inludìnQ 8. parent Of"alfi!ìate 1hetdl)s rot ha\'& 8l' l'eetìshi¡: wid the Nuri&d

orO:D:ernín9 ~~~rs that go beyond the SCOpê of arr .tlJh rebtìonhipa and their eff O? the depooìtoiy instiution.

i Take enfoicel't actPnaoiìnstth. paf'lnt of en ìnsured ìnstitti(ln, ¡

¡ Ta "" .nfo",,,1T Betons 6ginot oIllatE 01 tho inolld ínotion thai pattlple in the "ond u: of sf", ot or.oi .. Bgent for. lhe I iO$ Înstrt1Ìon. ¡

¡ Take GlOOrc10mJ acton &çiainat any afffa1e of thtl insured instib.Jlion. e'sn it the affliate doe not act ae agent fa~ (:" parti-¡i-'Ete in the L~iduct

¡ of, the affehs. oHM ineur6d iMlÍtÎon. t",.,,,.."",,....,,,,....""..,._,,,""..,..,,..,,,,,.,,..,,..,,..,.,,..,.,,-...,....,,..,,...."~...."".."".".."_..__...........""....".."..'_Wo''''_._..,,...,,_,_,,,,y.....,,,,''.."""...."_...._",,,_v ¡

f.-".--,---,---- -,---,,-J dtpoitor mmutìon. !

i Correl tl~ parent 10 dìwt of an efHate posin Q $iOUG nskto the æfety and SQundneSG of1he insured instítion.

~,.~~",,~, ,,,,',~yy,,,,~

.. .

. . . .

~~""-, "--...

. Explíoit $uthait

..- L9SS extensve Quthoiit o No ButOlit

~ C'~ lnll)ls.li (l ~&lMKlr'. llJlti or in roc, ~rd. .ndOTS. 'FDIC may 9Xamine an insured inst~utiQn forinlQ tailiate ~alisai;iÇls at any lim.. and tan ..mine1he affliate whcm I1cessary todisdoSQ the trasaction and ~s effct on the insured inSliiution.

GIBSON, DUN & CRUTCHER LLP Nontraditional FHCs

B. Federal Supervision of

In August 2000, the Fed released a detailed supervisory document, "Framework for Financial Holding Company Supervision" (SR 00-13(SUP), Aug. 15,2000), in which it discussed the new task of supervising a more diverse universe of financial organizations than the ban holding companies that it has historically regulated. The Fed described its approach to FHC supervision in the following way: Most of the concepts discussed in this framework are already being applied by the Federal Reserve in the context ofthe consolidated supervision ofBHCs. Examples include greater reliance on risk-focused supervision; strengthening relationships with senior management; improving coordination with other federal, state and international regulatory and supervisory authorities; greater reliance on specialty teams, sound practices papers and public disclosures; and simplification ofthe applications process.

Stil, supervision of

more diversified FHCs presents new challenges. To

address these challenges, the Federal Reserve wil continue its efforts to strengthen (i) cooperative arangements with ban and thrft regulators, the SEC, CFTC, state insurance and securties regulators, and foreign supervisors; (ii) relationships with FHC management and personnel responsible for significant risk management fuctions and, where

the organzation's nonban subsidiaries; (iii) information flows that provide supervisors with relevant, up-to-date information without imposing unwarranted burden on financial necessary, the management of

organzations; (iv) technques for evaluating capital adequacy for FHCs engaged in an expanded range of nonbank financial activities; (v) public disclosures and market discipline; (vi) technques for assessing the overall risk profile of FHCs and the implications for affliated depository institutions; and (vii) incentives for FHCs to continually review and improve their risk management processes, internal controls, and audit practices.

C. Fed Implementation of

Consolidated Supervision for Non-US Banking

Organizations The Fed has established parallel standards for determining when a non-U.S. bank is subject to consolidated home country supervision. The Fed's rule on this subject also focuses on the ability of the foreign country supervisor to achieve the results of consolidated supervision and not on the specific means adopted.

GIBSON, DUN & CRUTCHER LLP The Fed ruleS! provides: (ii) Basis for determining comprehensive consolidated supervision. In

determining whether a foreign ban and any parent foreign ban is

subject to comprehensive consolidated supervision, the Board shall determine whether the foreign bank is supervised or regulated in such a manner that its home country supervisor receives sufficient information on the worldwide operations of the foreign ban (including the relationships ofthe ban to any affiliate) to assess the foreign ban's overall financial condition and compliance with

law and regulation. In makng such a determination, the Board shall assess, among other factors, the extent to which the home country supervisor:

(A) Ensures that the foreign ban has adequate procedures for monitoring and controllng its activities worldwide; (B) Obtains information on the condition ofthe foreign ban

and its subsidiares and offces outside the home country

through regular reports of examination, audit reports, or otherwise; (C) Obtains information on the dealings and relationship

between the foreign ban and its affliates, both foreign and domestic;

(D) Receives from the foreign ban financial reports that are consolidated on a worldwide basis, or comparable information that permits analysis of the foreign bank's financial condition on a worldwide, consolidated basis; (E) Evaluates prudential standards, such as capital adequacy

and risk asset exposure, on a worldwide basis.

Like the EU, the Fed recognizes that "consolidated supervision" is not a single supervisory template.

D. OTS Supervision of Unitary Savings & Loan Holding Companies The influx of over 100 new, diverse, and often diversified S&LHCs in the late 1990s, and the enactment ofthe GLB Act have led the OTS to reconsider its approaches to S&LHC supervision. As reflected in statements by successive OTS Directors and recent releases, this 51 See 12 C.F.R. ยง 211.24(c)(ii).

GIBSON, DUN & CRUTCHER LLP process is ongoing. From the agency's perspective, new tools and methods are regularly

considered to deal with potential risks. At a minimum, these developments suggest the possibility of a somewhat more Fed-like view of its role as a supervisor of S&LHCs, even while OTS recognizes the importance of retaining its traditional attraction to companies based on a clear distinction between OTS and Fed holding company regulation. There remain clear

the OTS and the Fed.

differences in the supervisory approaches of

In several speeches in 2000-2001, then OTS Director Ellen Seidman has discussed her the speeches reflect the agency's search for the right approach. The OTS continually addresses the issue of how to appropriately supervise S&LHCs and these issues continue to receive agency attention. views on the need for enhanced S&LHC supervision, but the varng pariculars and tone of

In a January 2001 speech, then Director Seidman summarzed the task as follows: A five-part comprehensive strategy all guided in intensity by the combined risk profile, financial health and stability of the consolidated entity, and the degree of interdependence between the thrft and its affliates. The

strategy consists of: enhanced off-site monitoring; strengthened coordination with fuctional regulators; refined risk-focused examination procedures; improved holding company financial analysis; and enhanced communcations. Some of these elements are curently in place while 52

others are in the process of

being developed.

In a November 2005 speech before the EUIUS Retail Baning Foru in Brussels, curent

Director James Reich addressed the issue ofOTS supervision: (U)nique among U.S. supervisors, the OTS has strong statutory authority over the companies that own or control institutions it charers. Any company that owns or controls a thrft is subject to OTS supervision up to and including the top-tier parent company. holding companies as well as

We regularly conduct onsite examinations of

the thrfts themselves. And our statutory enforcement authority allows us

the latitude to ensure these holding companies strcture and conduct their activities in a way that does not imperil or otherwise threaten the depository institution portion oftheir business. . . . Many of(the companies we supervise) are also subject to the recently implemented EU Financial Conglomerates Directive. We have worked hard over the past several years to improve and enhance our coordination

52 Remarks of Ellen Seidman, Director of

the Offce of

Thrift Supervision, to the Exchequer Club of

DC (Jan. 17, 2001), available at htt://www.ots. treas. gOV / docs/7 /77 103 .htm.

Washington,

GIBSON, DUN & CRUTCHER LLP and communication with the global supervisory community - and this wil remain a priority for our organization. . . . refining our examination processes. In my view, we must continue to sharen our focus on capital adequacy, good (T)here is the question of

corporate governance and sound risk management. The trend in examination practice has been toward a more risk-focused approach and this trend must continue. This is especially tre in large complex organizations. We canot be everywhere - nor do we want to be. The responsibility lies with baners to ru their businesses responsibly and treat their customers fairly. And we must be positioned as supervisors to use our limited resources to perform a fair and thorough evaluation of this.

(W)e must check our urge to control. We must recognze the value of

the

market in driving the future of retail banng. There is an almost

irresistible temptation on the par of supervisors to manage the evolution of the industr by skewing incentives, controllng products and affiiations, and imposing burdensome regulations. History is not kind to this sort of heavy-handed governent intervention - whether in the United States or elsewhere. Customer choice, as expressed in the marketplace,

should drve the industry forward. We supervisors must work to ensure this evolution occurs with a strong underpinnng of capital, within a framework of effective managerial control, and while protecting the 53 customer from abusive practices.

E. Consolidated Supervision as Implemented by the European Union

Consolidated supervision is an important concept in baning supervision around the

world and in the United States, the EU, and other countries around the world, baning organzations must be found to be subject to consolidated home country supervision before being

54 Over the last decade financial regulatory

allowed to do banking business in other countres.

authorities in Europe and the United States paricularly have given substantial attention to the concept and implementation of consolidated supervision of financial conglomerates. During the last five years, as the European Union has implemented its Conglomerates Directive, which is based on the concept of consolidated supervision oflarge complex operations, the U.S. financial agencies, with the cooperation of the Treasury Deparment, have dealt with the subject of supervision and regulation of enterprises which have baning components but which are not

traditional banng organizations supervised by the Fed. The SEC has been accepted as a 53 Speech by John Reich, Director of

the Offce of Thrft Supervision, Before the EUfUS Retail Bankng Foru (Nov. 14, 2005), available at htt://www.ots.treas.gov/docs/8/8711O.pdf.

See Basel Commttee Documents, supra.

GIBSON, DUN & CRUTCHER LLP

consolidated supervisor of

Merrll Lynch and Morgan Stanley and the OTS as consolidated

supervisor of the financial and baning activities of General Electric.

In releasing its Conglomerates Directive in 2001, the EU indicated that it had three principal objectives: . To ensure that the financial conglomerate has adequate capitaL. In paricular the

proposed rules would prevent the same capital being counted twice over and so used simultaneously as a buffer against risk in different entities in the same financial conglomerate ('multiple gearng'). The proposal would also prevent "downstreaming" by parent companies whereby they issue debt and then use the proceeds as equity for their regulated subsidiares ("excessive leveraging");

. To introduce methods for calculating a conglomerate's overall solvency position; and . To deal with the issues of intra-group transactions, exposure to risk and the suitability

and professionalism of management at financial conglomerate leveL. 55

In 2004, the European Financial Conglomerates Committee and the EU Banking Advisory Committee jointly prepared a "general guidance" addressing "the extent to which the supervisory regime in the United States of America is likely to meet the objectives of consolidated supervision.,,56 The guidance took account of the roles of the four federal banng agencies, the state baning agencies, the SEC, state securties agencies and the securties selfInsurance Commissioners

regulatory organzations, and the roles ofthe National Association of

55 European Commssion, "Financial services: Commssion proposes Directive on prudential supervision of

financial conglomerates," Press release IP/0l/609 (Brussels, 26 Apri12001).The FDIC examination and supervision program described above satisfies the EU criteria.

56 EFCC/BAC general guidance - USA supervision, Final 06.07.2004, at htt:// ec.europa.eu/internal marketffmancial-conglomerates/ docs/ guidance-usa- final -060704 en. pdf.

57 ยกd. at 3. 58

"The OTS does not have a uniform approach to capital requirements at the holding company leveL. We understand the thiing behind ths approach, given the diversity of organiations which have a thft-holding

company. However, this does mean that EU supervisors must ensure that they fully understand the way in (Footnote continued on next page)

GIBSON, DUN & CRUTCHER LLP the supervisory regimes for financial groups had been recently adopted and implemented, the guidance indicates that the practices followed by the agencies should be reviewed in 2006. No fuher assessment has to date been released. undertaking a form of consolidated supervision for the first time.59 Noting that several of

VII. HOLDING COMPANY SUPERVISION: EMPIRICAL RESULTS The GAO Report addressed two instances of ILC failures as a proxy for assessing the effectiveness of FDIC supervision and uses these examples to suggest shortcomings in the FDIC's authority and approach. It also addresses the failure ofthe parent of an ILC. Taking a cue from this report, this section sets forth the facts with respect to the instances of ILC failure and then broadens the inquiry to consider evidence of failures of thrfts owned by Unitary S&L holding companies and the failures of

bans in ban holding companies, based upon reports and

analysis by authoritative persons and agencies. This record shows that the most costly baning failures took place in multiban holding companies in the late 1980s and early 1990s, a period when the Fed had essentially the same powers over holding companies as it does today. The facts of the examples below at a minimum support the conclusion that if there is any correlation between diversified nonbaning control of a ban and failure, it is a strongly positive one: the

evidence indicates that such failures have been very rare and the FDIC has not experienced losses when they have occured (note the Conseco, Pinnacle West and Baldwin United examples below). In contrast, the ban holding company ban failures at a minimum support the

conclusion that the Fed's consolidated supervision authority is not inherently superior: the Fed's role and authority in these cases did not serve to prevent or mitigate these costly failures. These examples together suggest that given the substantial and parallel authorities of

the federal

banng agencies, any effort to link supervisory authority to failures is unduly simplistic and perhaps misleading.

A. Failures of ILCs Controlled by Nonbanking Companies

The GAO Report discusses two ILC failures since 1999. These examples repeat the those failures in California that resulted in losses to the FDIC fud. The third example, Conseco, was not considered by the FDIC IG; it involved the failure of the parent of a solvent Utah ILC and resulted in no loss to the FDIC fund. assessment made by the FDIC IG of

(Footnote contiued from previous page)

which capital requirements are applied to a particular group, and be satisfied that this delivers an outcome that is consistent with the objectives of consolidated or supplementary supervision." !d. at 4. 59

the SEC's CSEI regime that ED supervisors must take into account. In reliance by groups on the inclusion of un subordinated long-term debt in capital for a transitional period, and consider whether this poses a problem. The CSE regime wil apply Basel-like standards for capital calculation at the holding company leveL. Given the way in which these groups have evolved, EU supervisors must consider whether there is enough mobile capital in the group to "There are some important aspects of

partcular, EU supervisors must consider the extent of

cover the risks arising from the activities of

unegulated entities. Such consideration must also take into

account the application to any regulated US broker-dealers in the group of capital standards that are more onerous than the Basel standards." ยกd. at 5.

GIBSON, DUN & CRUTCHER LLP 1. Pacifc Thrift & Loan, Woodland Hils, CA (1999) 路 Total assets: $117.6 milion at closing; amount of loss to the FDIC

01/01/02)

fud: $42 millon (as of

. Causes of failure:

* Poor corporate governance;

* Poor risk management;

* Lack of risk diversification; * Anual financial statement audit did not identify the actual the bank;

financial condition of

* Inappropriate accounting for estimated future revenue from high risk assets;

* Auditors did not provide a written report of internal control weakesses to the ban audit committee and examiners; * Auditors did not provide examiners access to workpapers and

supporting documentation; (Source: GAO Report, Table 5) 2. Southern Pacifc Bank, Torrance, CA (2003)

路 Total assets: $1.1 bilion at closing; amount ofloss to the fud: $63.4 milion; (as of 12/31/04)

. Causes of failure:

* Poor corporate governance;

* Poor risk management;

* Lack of risk diversification; * Anual financial statement audit did not identify the actual the bank;

financial condition of

* Auditors did not provide a written report of internal control weakesses to the ban audit committee and examiners;

(Source: GAO Report, Table 5)

GIBSON, DUN & CRUTCHER LLP 3. The Example of Conseco

The following is the FDIC sumar ofthis failure:

The bankptcy of the corporate owner of an ILC - Conseco Inc. - but not of

the ILC itself

ilustrates how the ban-up approach can effectively

protect the insured entity without there being a BHC-like regulation ofthe parent organization. . .. Conseco Inc. expanded its operations throughout the 1980s and 1990s by acquiring other insurance operations in the life, health, and property and casualty areas. Conseco Inc. was primarly an insurance company until its 1998 acquisition of Green Tree Financial Services. . .. Included in the acquisition were two insured depository charers held by Green Tree Financial Services - a small credit-card bank

chartered in South Dakota and an ILC chartered in Utah. . .. The ILC . . . Conseco Ban was operated profitably in every year except the year of its

inception, and grew its equity capital from its initial $10 milion in 1997 to just over $300 milion in 2003. Over the same period, its assets ballooned from $10 milion to $3 billion. Conseco Bank was supervised by both the Utah Deparment of Financial Institutions and the FDIC. Despite the financial troubles of its parent and the parent's subsequent banptcy (fied on December 18, 2002), Conseco Ban's corporate firewalls and the regulatory supervision provided by Utah and the FDIC proved adequate in ensurng the ban's safety

the $1.04 bilion dollars

and soundness. In fact, $323 milion of

received in the bankptcy sale of Conseco Finance was in payment for the insured ILC - Conseco Ban, renamed Mil Creek Ban - which was purchased by GE CapitaL. As a testament to the Conseco Ban's financial health at the time of sale, the $323 milion was equal to the book value of the ban at year-end 2002. Thus, the case of Conseco serves as an example ofthe ability of

the ban-up aPPoroach to ensure that the safety

and soundness of the bank is preserved. 0

60 See The Example of Conseco, available at htt://www.fdic.gov/bankanalvtcallanking/2005ian/artcle3.htm. For the GAO Report's discussion ofConseco, see p. 58. We would note that in the early 1980's, another insurance holding company with commercial affiiates and a bank affiiate, Baldwin-United, failed and went into an insurance insolvency proceeding. Despite ths failure, the insured bank controlled by Baldwin-United

was not adversely affected and was sold intact without any loss to the FDIC fud.

GIBSON, DUN & CRUTCHER LLP B. Failures of Thrifs Controlled by Nonfinancial Companies 6i

The S&L debacle of the 1980's entailed a total cost of approximately $150-175 bilion.

The Report ofthe National Commission on Financial Institution Reform, Recovery and this wave of failures included, inter alia, cyclical and sectional economic problems, gross and extensive mismanagement by S&L executives, supervisory and regulatory failures by state and federal agencies, and accounting failures.62 This report makes no mention of holding company supervision or abuse by holding companies as a source or cause of problems in the S&L industr during this period. Enforcement ("NCFIR") found that the causes of

The FDIC's History of the Eighties - Lessons for the Future (December 1997), voL. 1,

chapter 4, also discuses the S&L collapse, without any reference to holding company structure or relationships. It makes no suggestion that diversified control of thrfts or weakesses in the

supervision ofS&L holding companes by the Federal Home Loan Ban Board ("FHLBB") in any way contrbuted to the S&L debacle. A member of the FHLBB durng late 1980s, Lawrence White, now a professor at NY, examined the crisis after he left offce. In discussing S&L holding companies durng the crisis, he notes that the FHLBB typically received a net worth maintenance agreements from such companies and that in the case of what may be the only notable failure by a thrft controlled by a nonfinancial company, the parent company, Pinnacle West (also parent of a major public power utility company) paid the FSLIC $400 milion when its S&L subsidiary, Meraban, failed. White concludes: "The experience ofthrft holding companies is instrctive. The presence of companies involved in markets as diverse as autos, steel, wood products, retailing, public utilities, insurance and securities as holding company owners of thrfts has not created problems; the same would surely

be true if

these, or similar, companies had owned banks.

,,63

C. Failures of Banks in Bank Holding Companies To assess and lear from the wave of

ban failures in the late 1980s and early 1990s, the

the Eighties - Lessons for the Future (December 1997), voL. 1. The following paragraphs are excerpts from that study, and provide facts on the ban failures during this period. FDIC Research Division conducted an in-depth studied published as The History of

61 Origins and Causes of

the S&L Debacle: A Blueprintfor Reform: A Report to the President and Congress of

the United States, Washigton, DC: National Commssion on Financial Institution Reform, Recovery and

Enforcement (1993) at 4.

62 /d. at 5-10. 63 See L. Whte, The S&L Debacle: Public Policy Lessons for Bank and Thrif Regulation, (New York: Oxford Univ. Press, 1991) 216 n.17, 228 n.27, 240-43.

GIBSON, DUN & CRUTCHER LLP 1. Overview of Costlest Bank Failures

resolving Continental

As of 1997, the estimated cost to the FDIC of

(Ilinois Ban) is approximately $1.1 billon. . .. Although many criticized the Continental resolution, the FDIC's estimated cost was considerably smaller than the costs for First Republic ban Corp. ($3.77 bilion) and MCorp-Dallas ($2.85 bilion). Moreover, if one considers estimated losses as a percentage of assets, Continental (3.27 percent) rans behind Texas American Bancshares (22.67 percent), MCorp (18.12 percent), First Republic (11.69 percent), First City Bancorporation (its 1988 failure) (9.55 percent), New Hampshire Savings Ban (9.55 percent),

Goldome Federal Savings Ban (9.24 percent), CrossLand Federal Savings (7.50 percent), and Ban of New England Corp. (3.40 percent). These percentages are calculated using asset size either at the time of closure or at the time ofthe assistance transaction, whichever is applicable.64 2. Continental Ilinois A staff

report of

the House Baning Subcommittee in 1985 expressed

reservations about both the OCC's and the Federal Reserve's supervision

of ContinentaL. Among its criticisms, the report found that the OCC failed to take decisive action. To slow the ban's growth or increase its equity-

to-assets ratio before 1983 and failed to require Continental to remedy known problems in its loan management system before 1982. The report also held that despite the OCC's awareness of Continental's growing concentrations in oil and gas, the agency did not consistently and forcefully point out potential dangers to management, and that OCC examination reports in general were too ambiguous to provide a clear message to the ban about its problems. . . .

The report criticized the Federal Reserve on the grounds that although its supervision of the holding company identified potential risks from the reliance on volatile fuding, the agency did not communicate these warings consistently over time. The report also noted that the Federal Reserve's continuing approval ofthe holding company's applications to expand its activities, despite numerous examinations containing critiques of the ban's capitalization, asset quality, and fuding may have conveyed to CIC and the public that the Federal Reserve basically approved ofthe

64 History of

the Eighties, at 245, n. 37.

GIBSON, DUN & CRUTCHER LLP both the holding company and

operating and financial characteristics of

the ban.65 3. Bank of

New England (BNE) Corp.

Despite the efforts of a new management team to improve performance, BNE lost another $80 milion in the first half of 1990; and by year-end 1990, $3.2 bilion, or 20 percent, ofBNEC's loans were nonperforming. On January 4, 1991, after BNEC anounced that it expected a $450 milion fourth-quarer loss that would render both the holding company and BNE technically insolvent, depositors mobbed BNE's branches and withdrew $1 billion. On Sunday, January 6, 1991, the OCC formally declared BNEC's three major baning units, BNE, CBT, and MN, insolvent and appointed the FDIC as receiver.66 4. Texas Bank Holding Companies Of

the total failure - resolution costs borne by the FDIC from 1986 to

1994, half ($ 1 5.3 billion) was accounted for by southwestern ban

failures. (This included losses of nearly $6.3 billon in 1988 and $5.1 total FDIC

bilion in 1989,91.1 percent and 82 percent, respectively, of

failure-resolution costs for those two years.) From 1987 through 1989, 71 percent of the bans that failed in the United States were southwestern bans (491 out of689), and so were some ofthe most significant failures, such as bans within the First City Bancorporation, First RepublicBank Corporation, and MCorp holding companes. . .. The banng collapse in

the Southwest was especially devastating to the Texas baning industry. From 1980 through 1989,425 Texas commercial bans failed, including 9 67

of the state's 10 largest ban holding companes.

5. Nonfinancial Investment

Although capital from nonfinancial sources was substantial in the resolution of thrft failures durng the 1980s, the FDIC study notes one such instance in a ban failure: On April 22, 1991, the FDIC anounced that the three (BNEC) bridge bans would be acquired by Fleet/Norstar Financial Group, Inc., of

Providence and investment managers Kohlberg, Kravis, Roberts & Co.

65 /d. at 245-46. 66 ยกd. at 375-76.

67 /d. at 291.

GIBSON, DUN & CRUTCHER LLP (KK). Fleet agreed to raise $683 milion in capital for the bans within three months; KK would provide $283 milion, and the ban planed to

raise the remaining $400 millon in stocks and bonds. The paricipation of KK as a parner with Fleet/orstar in the acquisition of the three bridge bans was the first time that a nonban financial buyer participated in the

purchase of a failed commercial ban. KK's involvement not only allowed capital to enter the baning industr from nonbaning sources but was also expected to increase the number of potential bidders in future 68 ban failures.

VIII. Debate and Commentary on "Banking and Commerce" 1980-2006: An Eclectic Overview The debate over baning and commerce has lasted for decades. Following are a series of quoted excerpts from signficant documents and commentators.69 It is a selective and obviously incomplete overview that hopes to captue the flavor and major concepts ofthe debate. (We

would welcome receiving copies of any signficant - or interesting or amusing - documents that are left out.) Although we could begin with Fed statements as far back as the 1930s, the "modern" debate began with Gerald Corrgan's 1982 essay. A. E. Gerald Corrigan, President of the Federal Reserve Bank of Minneapolis,

"Are Banks Special?" (1982) The recent evolution ofthe financial strctue in the United States has

view regarding the proper direction for

produced two competing points of

fuher change. On the one hand, there is the view that the "financial services industry" - encompassing bans, thrfts, brokers, investment bans, and insurance companies - should be looked at as a single entity.

According to this view, efforts to distinguish among kinds of institutions are both futile and unecessar. This view ofthe financial services industry is based on the belief that many financial services offered by varous classes of institutions are so complementary to (or such close

substitutes for) one another that institutional distinctions are rendered useless. Implicit in this view is the assumption that bans are not speciaL. The competing, if not opposing, view is that banks are indeed speciaL. This view holds that specialization of financial institutions has worked well and, at least in some cases, specialization may still be more effcient

68 ยกd. at 375-76.

69 Like many of the quotes included thoughout this outline, these excerpts are taken from various portions of documents, letters, speeches, essays, briefs, etc., and do not represent complete quotations from any given source.

GIBSON, DUN & CRUTCHER LLP and also better serve the public interest. This view is associated with the historical separation of baning from commerce and from investment baning. In general, this "separation doctrne" in baning grew out of concerns about concentration of financial power, possible conflicts of interest, and the appropriate scope of risks bans should incur in the face of the special trusteeship falling on institutions that engage in the lending of depositors' money. In a shorthand way, as pertains to bans and the

banking system, these concerns are typically captured by the phrase, "safety and soundness."

B. Amicus Brief fied by Sears, Dimension v. Board of Governors case (1985) In fact, however, Congress never intended to establish, and has not established, a national policy of separating baning and commerce.

Since at least 1943, the Board has regularly urged Congress to "separate banng and commerce" by restrcting, and authorizing the Board to

regulate, the activities of organizations that own or control all depository institutions. Despite the Board's repeated requests, Congress has consistently refused to draw a line between banng and commerce;

instead, the actions of Congress have been far more limited, reflecting almost entirely a desire to constrain the economic power of commercial

bans. When Congress has acted, it has addressed specific manfestations ofthis power as they arose, going no further than necessary to achieve its limited objectives. Its actions have reflected a careful balancing of

the Board's

requests for sweeping authority to separate banng and commerce with a sensitive concern for maintaining competition and flexibility in the economy. C. Paul Volcker, Chairman of

the Federal Reserve, Testimony (1986)

The United States has had a long tradition of legislative separation of banking and commerce (See Appendix A). The Congresses that enacted holding company legislation, beginnng in 1933, continuing in 1956, and again in 1970, built on this tradition. They were essentially concerned about potential threats to the critical role that bans play in the economy

and to safety and soundness. In the face of a new thrst toward linking baning with commercial activities made possible by the ban holding company, they foresaw the possibility that credit would be abused for the benefit of the owners and they were concerned about possible discrimination in the allocation of credit to the benefit of other parts of the holding company.

GIBSON, DUN & CRUTCHER LLP D. Appendix A to V olcker Testimony (M. Fein and M. Faber Memorandum on

the History of the Separation of Banking and Commerce), Federal Reserve Board (1986)

Beginning with its 1927 Anual Report to Congress, the Federal Reserve Board expressed concern about the use of holding companies to evade state branching laws and the lack of supervision or regular examination by state or federal authorities over such companies. In 1930, a staff study by the Federal Reserve Committee on Branch, Group, and Chain Baning concluded that "(t)he chief weakess of the holding company device as an instrent for strengthening the banng strcture lies in its manpulative

possibilities, and the diffculties of adequate supervision." The study did not indicate ban holding company involvement in nonbaning activities to any substantial extent.

Signficant combinations of

banng and industral or manufacturng

sectors generally did not occur until later in the 20th Centu. Concerns

over the development of a conglomerate system thus were not voiced until later and - other than with respect to securities activities - the nonbanking activities of ban holding companies were not restricted until the 1956 Ban Holding Company Act and its 1970 Amendments. Ban holding companes as a percentage of total commercial baning resources was somewhat modest prior to enactment of the Ban Holding Company Act. In 1955, information provided by the Federal Reserve

Board to the House Baning and Curency Committee reported the existence of 114 ban holding companies controlling 452 bans, total commercial ban deposits. Forty-six of these companies were subject to regulation under the Bank Holding Company Act of 1956; only five were affected by the divestiture requirements. representing 5.87% of

ban holding companies, the

Despite the relatively modest growth of

potential of the holding company device to undermine the historic separation of baning and commerce and result in a concentrated banking system was of such concern to the Congress that the restrictions of the Ban Holding Company Act were deemed necessary. E. "The Union of Banking and Commerce in American History" - Appendix to

Testimony of Hans AngermueIler, Citicorp (1986) As evidence for his assertion that there exists a long tradition of legislative separation of

baning and commerce Chairman Volcker referred to an

banking and commerce has been a prevailing principle applied to commercial banks in appended staff study, which asserts that "the separation of

American since colonial times."

GIBSON, DUN & CRUTCHER LLP However, that "principle" and, indeed, the staff study itself, are so imprecise as to be practically irrelevant to the current debate concerning baning and commerce. The staff study predominantly

the union of concerns itself

with what a bank may do, while the current debate is bans, not bans themselves. Most

focused primarily on the owners of

recent proposals for broader products and services for "bans" have in fact ban holding companies to own

been proposals to expand the authority of

non-baning enterprises, such as securities or insurance firms. Similarly, most of

the recent controversy about non-ban banks revolves around the

question of

non-ban

who may own a bank and whether the owners of

regulation as that imposed on

bans should be subject to the same type of

ban holding companes.

In fact, whatever restrictions may have been placed on banks, owners of business activities throughout

bans have in fact engaged in all types of

American history. Existing restrictions on what the owner of a ban may

relatively recent vintage, and even these restrctions do not apply bans. Thus, if history provides any guide at all to the question of whether banks should be affliated with non-banng firms, history points in the direction of allowing such affliations. do are of

to all owners of

F. Carter Golembe, The Golembe Report (1986) Even if we concede that bans are "special" - a favorite term of several Federal Reserve offcials - it does not necessarly follow that a business

organization which happens to number a ban among its subsidiaries also

becomes, or should become, "speciaL." Of course the Federal Reserve Board looks at bank holding companies differently - as banking organizations which happen to number among their subsidiaries some non-baning firms. This difference in viewpoint accounts for a great deal of the controversy that has gone on over the years, and continues to exist, over the nature and appropriateness of Federal Reserve Board regulation of

bank holding companes.

In any event, given what we think was the F&F* objective, the paper is done quite well. They marshal skilfully the evidence in support of a paricular thesis. As it happens, we think the thesis is wrong - we think that the weight of the evidence strongly suggests that there is no historical tradition separating baning from commerce, at least of the kind that F &F seem to have in mind.

its source and because of the use that may be made of it by others. It is, after all, a Federal Reserve Board staff paper. While such papers may not be holy wrt, nonetheless The F&F paper bothers us basically because of

they usually cary considerably more weight with the Congress than the

scribblings of academics and consultants. Thus we would have liked the

GIBSON, DUN & CRUTCHER LLP paper that was balanced in its presentation. Even if it had come out with the conclusion reached by F&F, Congress would have been aware that there is at least some doubt, together with evidence to support that doubt, that for 200 Federal Reserve Board to have commissioned a staff

years American Governents have sought to narowly constrain the banng business. Put another way, we would have expected more from

the Board of Governors on the historical underpinnings of an issue so crucial to bankng and to the economy. (* Fein and Faber) G. Gerald Corrigan, President of

New York,

the Federal Reserve Bank of

"Financial Market Structure: A Longer View" (1987) Thus, it is important to consider what options and alternatives may be available in seeking to fashion a more evenly competitive and, most of all, a more stable financial system. In the broadest sense, there would seem to be only four alternatives available. First, to resist, and indeed to seek to reverse, the forces of market change and innovation, thereby forcing practices and institutions back into the legal and regulatory framework of the past. Second, to stay on the present course of piecemeal change -

some by regulation and judicial proceedings, a little by legislation, but much by a helter-skelter of events in the marketplace in the hopes that somehow that curious combination of forces wil produce a result that makes sense from a public policy perspective and does not yield so many casualties along the way so as to undermine public confidence in the system as a whole. A third alternative would entail wholesale deregulation including, among other things, the systematic relaxation of baning and commerce, the

(or elimination of) the separation of

dismantling or scaling back of the public safety net associated with banking and a wilingness to allow market forces, and market forces alone,

to ru their course at any, or virtally any, cost. Finally, the fourth broad

alternative would entail moving in the direction of a more uniform and integrated approach to the operation and supervision of

the banking and

financial system while still preserving the distinction between "banking" and the remainder of

H. Department of

the economy.

the Treasury, Financial Modernization Proposal (1991)

VII. Modernized Financial Services Regulation - List of

Recommendations

A. Permit Well-Capitalized Bans to Have Financial Affliates 1. Includes Securities, Mutual Funds, and Insurance

GIBSON, DUN & CRUTCHER LLP 2. Allow Financial Companies to Own Well-Capitalized

Bans Financial Services Holding Companies

B. Commercial Ownership of

C. Safeguards 1. Only for Well-Capitalized Bans 2. Safety Net Confined to Bank 3. Strict Regulation Focused on Ban 4. Financial Affiliates Separately Capitalized

5. Functional Regulation of Affliates

6. Funding and Disclosure Firewalls a. State law standard for insurance sales

b. Consumer disclosure firewalls

7. Umbrella Oversight

The time has come for change. Laws must be adapted to permit banks to reclaim the profit opportities they have lost to changing markets.

Where baning organizations have natual expertise in other lines of

business, they should be allowed to provide it for the benefit of the consumer. Likewise, where other financial companies have natural synergies with baning, they should be allowed to invest in bans. New sources of capital must be tapped.

Put another way, protecting the taxpayer demands a well-capitalized banking system. But a baning organzation must be competitive to build,

attract, and maintain capital in its bans. Simply piling on restrctions in the name of safety and soundness wil not achieve this end. Adapting to

market innovation is criticaL.

Accordingly, as set forth below, the Administration proposes to allow bans to affliate with a broad range of financial firms through the financial services holding companies (FSHCs). Commercial formation of companies would in tur be permitted to own these new FSHCs (see Figure 11). This proposed structure would create a level playing field that

GIBSON, DUN & CRUTCHER LLP permits baning, financial, and commercial companies to affliate with each other on fair terms. I. C. Felsenfeld, "The Bank Holding Company Act: Has It Lived Its Life?," 38 Vil. L. Rev. 2, 86 (1993)

Although the evidence is less than conclusive, it is fair to say that the United States has a tradition that bans themselves should not be in commerce. As to bank holding companies and the relationship oftheir ban and nonban subsidiaries, it is diffcult to conclude that such a

tradition exists. Ban holding companies were not introduced in any number until the twentieth centu, and at least some ofthe early holding companies were engaged in commerce. When federal bank holding company legislation was first considered in 1931, four bils were introduced. None ofthem suggested that holding companies should be separated from commerce. Situations existing today combine commerce both with banks and with bans. These are

other institutions that are almost carbon copies of

generally small organizations, which supports the conclusion that Congress' tre concern is with undue size - not with the combination of bankng and commerce. As noted earlier, commerce in a ban holding company is separated from baning. History ilustrates that within the U.S. tradition this degree of separation is sufficient.

Whether baning and commerce should be separate but related through the holding company structue and, if so, under what conditions of separation, can best be described as a continuing issue, not a debate that history has settled. The Treasur Deparent has taken one side; the Congress, led by the Federal Reserve Board, has most recently taken the other. There should be an ongoing open dialogue on whether the BHCA serves a public purpose in sustaining the separation. J. Carter Golembe, "The Troublesome Myths of Banking: II," The Golembe Report (1995) The belief

that there is a centures-old principle holding that serious

problems await any financial system permitting an intermixing of

baning

and commerce is more diffcult to deal with than was the "Glass-Steagall myth," discussed in my last report. The latter can be described crisply and in straightforward terms: early in the present centur commercial bans

became involved in investment baning; they did bad things and as a result bad things happened to the baning system and to the economy. Governent then responded by separating deposit baning and investment

baning.

GIBSON, DUN & CRUTCHER LLP Matters are not quite so clear when it comes to the "baning and commerce myth." Largely because of a lack of clarty as to what is meant by "baning" and by "commerce," there is not one but several collective beliefs, confusingly intermixed and diffcult to disentangle. And the legislation intended to settle matters, the Bank Holding Company Act (BHCA), came at the baning and commerce issue obliquely because it bans, and also because

did not deal with bans but with the owners of

drafters ofthat Act and of its subsequent amendments had other things on their minds than the evils of mixing "banng and commerce." Only in recent years have there been efforts to burish the BHCA's "baning and commerce" origins. . .. The proposition that I will be examining in this report can be stated, I think fairly, as follows:

From the time baning began in this nation until the present day, or for slightly more than two centuries, public policy as manifested by legislatures and the cours has provided for the separation of banng and commerce. Despite occasional and costly deparures from adherence to this policy, it continues to be the proper course, and one against which any proposed important change in baning laws must be measured.

Is this proposition, paricularly its first sentence, fact or fiction? History or myth? Is it tre, for example, that "The United States has had a long tradition of legislative separation of baning and commerce" as a former Federal Reserve Board Chairman told the Congress, or was a previous General Counsel to the Treasury Deparment (and later counsel to President Reagan) correct when he said: "There never has been a national policy of separating baning and commerce"? (Felsenfeld, p. 36). The answer possibly depends on what each meant by "baning" and by

"commerce. "

In this report I argue that in its pure form the proposition is a myth and, indeed, a most troublesome myth. It is the product of, and at the same time the creator of, a variety of belies and ideas about U.S. baning, some of which are wrong and others of which are quite sensible. But at center it is a vision of an idealized bankng system that possibly existed somewhere, and most certainly existed in the minds of some prominent political scientists who wrote about baning, but which never existed in

the United States.

GIBSON, DUN & CRUTCHER LLP K John D. Hawke, Under Secretary of the Treasury, Testimony on H.R. 10 (1997)

A major question that Congress wil face in considering broader activities for ban holding companies is the extent to which they should be permitted - if at all - to engage in nonfinancial activities. Let me say at the outset that we have not proposed to eliminate all the barers that separate baning from purely commercial or industrial activity. Our baning system has never been characterized by such a

mixing of enterprises, and we see no pressures from the marketplace demanding such a permissive rule. Our objective is far more modest: to provide a framework for bringing the various segments of

the financial

boundares - to allow insurance and securties firms to enter the banng business, just as baning services industr within a common set of

organizations are expanding their insurance and securties activities, and if possible, to eliminate the disparties between the regulation of banks and the fact

thrfts. To accomplish thee objectives, we need to take account of

that most insurance and securties firms have some degree - generally nonfinancial activity, as well as the fact that "Unitary" quite modest - of thrft holding companes - those ownng only one thrft - have no limits at all on their permissible activities.

Our proposal sets forth two possible models that Congress might draw upon if it shares our view that it is desirable to provide such a common set of

boundares. We would support either approach.

The first is a "basket" concept, which the Banng Committee has adopted. Under this approach, a company could qualify to own a bank

only if it derived the predominant percentage of its domestic gross revenues - the Baning Committee bil fixed on 85 percent - from financial institutions and other financial activities. If

this eligibility

threshold were met, the QBHC could derive the remainder of its revenues from nonfinancial activities. However, in order to assure that very large financial firms owning bans could not use the nonfinancial "basket" to acquire very large commercial or industral companies, we would prohibit, as does the Baning Committee bil, a QBHC from acquiring any nonfinancial company with total assets in excess of &750 milion - a number that approximates the 1,000 largest nonfinancial companies in the United States. We would also prohibit bans from making any loans to or

investments in their nonfinancial affliates. If such a "basket" approach were adopted, it would provide a framework for merging the bank and thrft charers and bringing Unitary thrft holding

companies under a common regulatory umbrella with baning organizations. It would also provided a "two-way street" that would make 76

GIBSON, DUN & CRUTCHER LLP it possible for securties and insurance companies and other diversified financial services firms that may have some modest percentage of nonfinancial revenue, to own an insured ban.

On the other hand, if Congress chose not to permit any level of nonfinancial activity for companies owning bans, many securties,

insurance, and diversified financial services firms would be precluded from owing bans. Under the circumstances, the ownership of a thrft institution may well be the only means such firms would have to achieve competitive equity with baning organizations having broad financial powers. Accordingly, if such a "financial-only" alternative were chosen, we believe the existing thrft holding company framework should remain unchanged, which would allow financial services firms whose nonfinancial affiiations would otherwise preclude them from owing an insured ban to affliate with an insured depository institution. bans to engage in

Neither model would permit subsidiares of

commercial activities, but each model would permit the financial bans to engage in a broad

subsidiares and holding company affliates of

new range of financial activities. L. Alan Greenspan, Chairman of the Federal Reserve, Testimony on H.R. 10 (June 17, 1998)

A consensus has also developed that banng and commerce should not be mixed at this time beyond the limited level needed to allow a realistic twoway street for financial firms that are predominantly securities and insurance companies to acquire bans. There is also agreement that the

new law must provide regulators with adequate means to protect the consumer and assure that consumers are carefully informed about the differences between products that are backed by federal deposit insurance and those that are not.

Last year, the Board, in testimony before the House Baning and Commerce Committees, recommended caution about authorizing banking and commerce affliations. We noted that technology was already in the process of eroding any bright line between commerce and baning. Nonetheless, we concluded that the free and open legal association of baning and commerce would be a profound and surely irreversible strctural change that should best wait while we absorbed the significant

changes called for by financial modernization. . . .

In light ofthe dangers of mixing banking and commerce, the Board supports elimination of the Unitary thrft loophole, which curently allows

GIBSON, DUN & CRUTCHER LLP any type of commercial firm to control a federally insured depository institution. Failure to close this loophole now would allow the conflicts inherent in baning and commerce combinations to fuher develop in our economy and complicate efforts to create a fair and level playing field for all financial service providers.

M. Robert E. Rubin, Secretary of the Treasury, Testimony on H.R. 10 (June 17, 1998)

With these safeguards in place, there is zero difference between conducting an activity in a subsidiar and in an affiiate with respect to safety and soundness or competitive advantage from any ban fuding subsidy that may exist. That is why the FDIC has consistently concluded that the subsidiar structue poses no threat to safety and soundness. In fact, as to safety and soundness, under the Edge Act, many U.S. bans have long engaged overseas in investment and merchant bankng through subsidiaries - some of

them very large - and Edge Act subsidiares are

charered and regulated by the Federal Reserve Board. Furthermore, for the reasons already discussed, the subsidiar is actually stronger than an affliate from a safety and soundness perspective. Our final objection to the bil is that the elected Administration is accountable for economic policy - and ban policy is a key component of economic policy. Under H.R. 10, bans would gravitate away from the

national baning system, and the elected Administration would lose its nexus with the baning system, thereby losing its capacity to affect ban policy. N. Peter Wallson, "The Gramm-Leach-Bliey Act Eliminated the Separation of

Banking and Commerce - How This Wil Affect the Future of the Safety Net" (2000)

The Gram-Leach-Bliley Act, despite Congress's stated intentions, must be deemed to have eliminated the policy basis for separating baning and

commerce. This conclusion ultimately reflects an unstated Congressional judgment that bans should no longer be treated differently from other

financial institutions. Without this element of uniqueness, the basis for protecting bans through a governent-supported safety net is called into question.

The governent's responsibility for the safety net has already been significantly reduced. The safety net has three elements: (i) deposit insurance, (ii) the Fed's role as lender oflast resort, and (iii) the Fed's role in the payment system. Since FDICIA, deposit insurance is no longer a governent liability; the Fed's lender of last resort activity has recently been and can remain focused on the stability ofthe financial markets, not

GIBSON, DUN & CRUTCHER LLP on individual bans; and the Fed's role in the large dollar payment system can easily be supplanted by a private system, as shown by CHIPS.

The eventual elimination ofthe ban safety net - and the intensive regulation it is used to justify - wil eventually be seen to have its roots in the Gramm-Leach-Bliley Act. o. Gray Davis, Governor of California, Statement Regarding Assembly Bil 551

(Sept. 30, 2002) To the Members of

the California State Assembly:

I am signing AB 551 in accordance with the federal prohibition against mixing baning and commerce, as intended by the seminal 1999 law, Gram-Leach-Bliley (GLB). Before GLB, the U.S. Congress spent several years considering what the national policy should be regarding relationships between commercial companes and financial institutions. The U.S. Congress determined that affiliations between banks and nonfinancial, commercial companes pose great risks to the safety and soundness of our financial system, can distort credit decisions, and can lead to an aggregation of economic power that can be injurous to consumers. Both Alan Greenspan, curent Chairman ofthe Federal

Reserve, and Paul Volcker, former Chairman ofthe Federal Reserve, shared that view. The authors ofGLB, U.S. Representatives Jim Leach and Tom Bliley, and the curent chairman of the U.S. Senate Baning and Commerce Committee, Senator Paul Sarbanes, weighed in with our State Assembly's Committee on Banking and Finance when they were considering AB 551. These Congressional leaders made clear that their intent in passing GLB was to foreclose the mixing of baning and commerce. The senior Counsel for the U.S. Senate Baning and Commerce Committee stipulated to my office that AB 551 is not only consistent with GLB, but more this important law.

importantly, fuhers the underlying objectives of

Given the recent spate of accounting and balance sheet irregularities in the corporate world, such as Enron, W orldCom, Tyco, the separation between banking and commerce, now more than ever, is criticaL. In keeping with the intent and objectives ofthe important national law, Gramm-LeachBliley, I am signing AB 551.

the Federal Deposit Insurance Corporation, Speech to the American Bankers Association (Oct. 8, 2002)

P. Donald E. Powell, Chairman of

We all know we are ultimately going to have to deal with the question of baning and commerce - even though the governor of California has taken

GIBSON, DUN & CRUTCHER LLP the issue offthe table for the time-being. We have heard from very experienced and thoughtful people about the hazards of this model, but it is worth noting the FDIC has not traditionally been as opposed as some to the question of

ban ownership by commercial firms.

this modeL. Those criticisms include questions about conflcts of interest, about expanding the federal safetynet to the broader marketplace, and about concentrations of economic power. These are all important and we should be thoughtful about how we proceed. But the very same questions can, in many respects, be raised There are valid criticisms of

about the financial holding company model curently enshrned in law and

moving toward predominance in the marketplace.

In our view, Congress has given us good tools to manage the relationship between parents and insured subsidiares. These are a great help in preventing the problems that have been identified with this sort of business arangement - indeed the FDIC manages these relationships

every day in the industrial loan company model with little or no risk to the deposit insurance fuds :- and no subsidy transferred to the nonban parent.

I realize this issue worres many communty baners. In response, I would simply say that baners must be nimble, they must innovate, and they must embrace the possibilities of emerging markets and strctues. Those

who put these values into practice wil be the surivors in the baning the future - not necessarily those who "Just Say No."

marketplace of

Q. G. Edward Leary, Utah Commissioner of Financial Institutions 1. Remarks to the Utah Association of Financial Services (Aug. 27, 2004)

DO INUSTRIL BANKS REPRESENT AN INAPPROPRITE MIXING OF BANING AN COMMERCE?

No! Some observers argue that they are already mixed. The Gram Leach Bliley Act in 1999 endorsed insurance and securties firms as being "financial in nature" to merge with baning but drew a distinction with "commercial" firms and said that was not okay.

As we all know business combinations between banks and commercial firms exist today.

In its simplest terms, I believe, one can think of mixing baning and commerce as: bans are sources of fuds and all other enterprises including commercial firms are users of fuds. Those entities that supply

fuds should not be connected to those entities that use the fuds. Some

GIBSON, DUN & CRUTCHER LLP

believed that the root cause of

the Great Depression of

the 1930's was the

keeping baning and commerce separate exists today, even though in the rest of the world the mixing is very prevalent. mixing of

baning and commerce. Therefore the desirability of

After Congress passed the Gram-Leach-Bliley Act of 1999, where essentially they endorsed mixing banng and commerce, it is permissible for bans to be affliated with securities firms and insurance companies -

on the theory that all are involved in what is loosely called "financial activities" and not in what might be called "commerce."

2. Remarks to the Utah Association of Financial Services (Aug. 26, 2005) CEBA also carved out some important exceptions to the definition of the term "ban," including an exception for industral banks. I want to emphasize the point; this exemption is NOT a LOOPHOLE but a SPECIFIC GRAT OF EXEMPTION in federal law.

In considering and passing the Gram-Leach-Bailey Act of 1999, Congress did not repeal the exemption granted industral bans in the

1987 CEBA Act while they did remove the exemption for others. R. John D. Hawke, Jr., Former U.S. Comptroller of the Currency, Remarks to the 16th Special Seminar on International Finance of

the Japan Financial

News Co., Ltd. (Nov. 16,2005) Let me state my personal view right at the outset: Conglomerate ownership of baning institutions - paricularly ownership by financial conglomerates - properly managed and appropriately regulated and supervised - can provide opportities for greater profitability, can offer consumers significant advantages, and can add strength to the financial system. Moreover, I do not share the view that there must be rigid walls between baning and "commerce." Not only is there a virtually total lack

of evidence in the U.S. that affliations between banks and non-ban firms present serious threats to the banng system, but those who argue against

such affliations are very frequently motivated less by philosophy than by a desire to segment markets in order to diminish competition.

S. Alan Greenspan, Chairman of the Federal Reserve, Letter to Rep. James A. Leach (Jan. 20, 2006) In 1999, Congress also reaffirmed the longstanding separation of

and commerce.

baning

GIBSON, DUN & CRUTCHER LLP

The character, powers and ownership oflLCs have changed materially since Congress first enacted the ILC exemption. These changes are undermining the prudential framework that Congress has carefully crafted and developed for the corporate owners of other full-service bans. Importantly, these changes also threaten to remove Congress' ability to determine the direction of our nation's financial system with regard to the mixing of banking and commerce and the appropriate framework of prudential supervision. These are crucial decisions . . . they should not be made through the expansion and exploitation of a loophole that is available to only one type of institution charered in a handful of states.

The federal Bank Holding Company Act (BHC Act), originally enacted in 1956, establishes a comprehensive prudential framework for the regulation and supervision of companes that own a ban (referrng to as "bank holding companies"). This framework, which includes supervisory requirements and restrctions on the permissible activities of bank holding company, is designed to help protect a ban from the risks posed by the activities or condition of

its parent company (and the parent's nonban baning and

subsidiaries) and maintain the general separation of

commerce in the American economy.

The United States has a tradition of

maintaining the separation of

baning

and commerce. In the Graham-Leach-Bliley Act (GLB Act) of 1999, Congress reaffrmed this policy by closing the Unitar thrft loophole, which previously allowed commercial firms to control an FDIC-insured savings association, and by authorizing financial holding companies as a general matter to affliate only with companes that are engaged in activities determined (by Congress and the Board, in consultation with the Treasury Departent) to be financial and nature or incidental to financial activities. (Footnote omitted.)

T. James A. Leach, U.S. Representative, Press Release (Jan. 25, 2006) "The construct of the financial modernization act known as Gramcommerce and baning,"

Leach-Bliley is that there be no merging of

Leach said. "The bizare loophole that allows commercial companies to

breach the separation of commerce and baning through a statute limited to a handful of states creates inequities in industry regulation and state authority. It is an anomaly that deserves review by Congress," Leach added.

GIBSON, DUN & CRUTCHER LLP the Federal Reserve, Letter to Rep. Brad

U. Ben S. Bernanke, Chairman of

Sherman (Mar. 21, 2006) reasons, Congress has sought to maintain the separation of baning and commerce in the United States. Congress reaffirmed its desire to keep baning and commerce separate in 1999 when it passed the Gram-Leach-Bliley Act (GLB Act). That act closed the Unitary thrft loophole, which previously allowed commercial firms to acquire a savings association, and authorized financial holding companies as a general matter to affliate only with companies that are engaged in activities that have been determined to be financial in nature or incidental to financial For a varety of

activities. The GLB Act also placed limits on "financial subsidiares" of member bans. These limits, among other things, allow financial subsidiaries of member bans to engage only in activities that its parent ban may conduct directly or that have been determined to be financial in natue or incidental to financial activities by the Treasur Deparment in

consultation with the Board. v. James A. Leach, U.S. Representative, Letter to Acting Chairman Gruenb~rg

(Mar. 27,2006) In the development of GLB, some parties advocated mixing baning and commerce. Congress carefully considered this issue and chose not to endorse such an approach, thereby sticking with clear legislative precedent. Congress has explicitly forbidden bans from engaging in commercial endeavors. Implicitly, it is irrational to think that a commercial company, by buying or establishing a baning institution such as an Industrial Loan Company (ILC), should be able to do what Congress prohibited in reverse. What was prohibited in one direction should not be sanctioned in another. There were four broad intents in the GLB financial modernization legislation: (1) to enhance three-way competition between the banking, securties and insurance industres; (2) to create functional regulation by

category of activity; (3) to establish a principal umbrella regulator to ensure that regulatory cracks are filled; and (4) to curail regulatory arbitrage at the federal leveL.

w. Stephanie Tubbs Jones, U.S. Representative, Statement to the FDIC (Apr. 10, 2006)

In 1956, Congress enacted the Ban Holding Company Act to insulate bans from activities of a parent or subsidiary company. The separation of baning and commerce and the stability and transparency of our baning system have provided a stable framework for the growth of our

GIBSON, DUN & CRUTCHER LLP economy. Congress most recently upheld that policy in the Gramm-

Leach-Bliley Act of 1999. This policy is essential to maintaining the integrty and competitiveness of the financial system and protecting communities and consumers. x. Arthur Johnson, Speaking on Behalf of the American Bankers Association,

Oral Testimony to the FDIC (Apr. 10,2006) ILCs may be owned by nonfinancial commercial firms. This ability of nonfinancial commercial firms to engage in banking rus counter to our nation's historical separation of

baning from nonfinancial commerce.

Congress consistently has acted to close avenues through which nonfinancial commercial entities could own depository institutions.

Curently in Congress, there are bils addressing ILCs and they continue to reflect a heightened interest in preserving the separation between banking and nonfinancial commerce.

Y. Tom Stevens, Speaking on Behalf of the National Association of Realtors, Oral Testimony to the FDIC (Apr. 10,2006) The purose of our testimony today is to add our voices to those who seek to maintain and strengthen our national policy against mixing banking and commerce. When baning and commerce are permitted to mix, it brings

with it inherent conflicts of interest, har to the competitive landscape and risk to the financial system.

z. Bob McKew, Speaking on Behalf ofthe American Financial Services Association, Oral Testimony to the FDIC (Apr. 10,2006) Let me turn to the issue of

banng and commerce. Federal law has

baning and commerce although you wil I am sure you wil hear arguents to the contrary. The Ban Holding always allowed the mixing of

Company Act did not restrict a commercial company from ownng a bank until 1970 and even then there was signficant grandfathering provisions and multiple exceptions. These institutions have evolved and thrved even today.

In 1987, Congress expressly created the credit card ban charer that could be owned by commercial entities and required industrial bans to have federal deposit insurance. The law today allows ban affiiates to engage

in complex derivatives activities and underwte disaster insurance. Opponents of the industral ban seem to suggest that somehow these activities are less risky endeavors than selling consumer products like sweaters and house wares.

GIBSON, DUN & CRUTCHER LLP AA. Peter Wallson, Oral Testimony to the FDIC (Apr. 11,2006) The point I want to make today is that if there ever was such a policy, it was abandoned when Congress adopted the Gramm-Leach-Bliley Act in 1999.

The Gram-Leach-Bliley Act broadened the range of activities with which banks could be associated, permitting affiiation with securities firms and insurance companies and any other firm engaged solely in financial activities. This, however, was not a minor change. When considered in light of

the policy reasons for separating baning and

commerce, there is no significant difference between a ban's affiiating with a firm solely engaged in financial activities or affliating with a purely commercial firm. . . .

If every abuse or potential abuse that is supposed to provide the basis for separating baning and commerce could occur if bans were affiliated with securties firms, which Congress permitted under that act, what basis would there be for prohibiting affliations with retailers? In effect, the Gramm-Leach-Bliey Act was a statement by Congress that there was no longer any basis for believing that affliations between suppliers of credit and users of credit represent a danger either to the ban or to the economy generally.

It's time people realized that there is no public policy involved in the separation of banng and commerce. It is only the protection of various industries against unwanted competition.

(Material from the FDIC Hearng Q&A)

(T)he whole idea of separating banng and commerce is not some sort of

immutable, eternal principle that has always been applied in our economy.

It actually arose, as far as my research indicates, in 1938 in a statement that the Federal Reserve made to Congress that somehow there ought to be a separation between baning and commerce. That idea did catch on in Congress and became very popular and was, I think, one ofthe underlying reasons for the adoption of the Ban Holding Company Act in 1956.

GIBSON, DUN & CRUTCHER LLP

When Congress adopted the Gram-Leach-Bliley Act in 1999, essentially they were helping the Fed maintain its power for another few years, but they did not provide the Fed with any way of making a judgment between what is a financial activity and what isn't a financial activity. So the congressmen can assert that there was an effort to separate commercial activities from banng, but that isn't actually what Congress did when it permitted banks to be affiiated with securties firms and

. .

insurance companies.

BB. Barney Frank, U.S. Representative, Letter to Acting Commissioner Gruenberg (Apr. 19, 2006) I believe that the best solution would be for the. . . (FDIC) to approve no more industral loan company (ILC) applications that do not meet the requirements established by Rep. Gillmor and myself in our provisions passed by the House as par ofH.R. 1224 and H.R. 3505. Those provisions prohibit. . . (branching by) an ILC ifmore than 15 percent of the anual gross revenues of the ILC and all its affliates were derived from activities that are not financial in natue or incidental to a financial

activity, i.e., 85 percent ofthe revenues ofthe entity as a whole must come from activities that are financiaL. I believe this is necessary because of the keeping the separation of banng and commerce, including industrial, commercial and retail activities. I think the best policy is to say no to anymore ILC applications that do not meet the 85/15 test as contained in the Gilmor-Fran provisions.7o importance of

CC. Statement of Comptroller of the Currency John C. Dugan Regarding the ILC Moratorium Extension (January 31, 2007) Instead, our sole statutory concern in this context is in essence the risk to the fud presented by commercial affliations of industrial loan companies. As a general matter, I believe Congress has directly spoken to and addressed this issue by exempting ILCs from the Ban Holding Company Act's restrctions. But even if one were to ignore that fact -

which we canot - the record before us simply does not establish that commercial affliations present an undue risk to the fund. While the

70 Note that the words "branchig by" included above were added via a April 26, 2006, letter from Rep. Frank to Acting Chairan Gruenberg correctig an error in the earlier letter. The April 26 letter concluded: "I believe that the revenue test is sound policy and should be extended to all pending and new ILC applications for the reasons stated in my April 19 letter."

GIBSON, DUN & CRUTCHER LLP Board may take into account potential or hypothetical risk, as discussed in the text of the moratorium, it seems to me that the very best evidence of risk in this area is the FDIC's own 20-year experience in supervising ILCs owned by commercial companies. Here I quite agree with the Chairman's statement about the strong track record ofthe FDIC in supervising such ILCs - though I am very disappointed that the moratorium itself makes no reference to that track record. As staffhas told me expressly, there have indeed been some unique safety and soundness issues raised by commercial ownership of ILCs. But in every such case over these last 20 years, FDIC supervision has more than adequately addressed those risks, and no commercially owned ILC has caused a single dollar of loss to the deposit insurance fud. Likewise, the comments we received during the

last six months have provided virtally no empirical evidence to support the proposition that commercially owned ILCs are more risky than noncommercially owned ILCs.

http://ww .occ. treas. gov/ft/release/2007 -9a.odf.

DD. Testimony of Vice Chairman Kohn, Board of Governors of the Federal Reserve System (April 25, 2007) We believe it is critical for Congress to consider and address the important public policy implications raised by the ILC exception, paricularly in light of

the dramatic recent growth and potential futue expansion of

bans

operating under this special exception. If left unchecked, this recent and potential futue growth of firms operating under the exception threatens to

undermine the decisions that Congress has made concernng the separation of banking and commerce in the American economy and the proper supervisory framework for companes that own a federally insured ban.

The ILC exception also creates an unlevel competitive playing field by allowing both financial and commercial firms to own an insured ban but avoid the prudential limitations, supervisory framework and restrctions on affiiations that apply to corporate owners of other insured bans. * * *

This type of coordinated solution - closing the loophole and "grandfathering" existing owners - is precisely the type of approach that Congress took in 1970, 1987 and 1999 in closing previous exceptions in the baning laws that were undermining the separation of banking and commerce and other important public policy objectives. It also is the right approach to fix the ILC loophole.

http://ww .house. gov / aoos/list/hearnglfinancialsvcs demltkohn042507.

GIBSON, DUN & CRUTCHER LLP EE. Testimony of Robert Colby, Deputy Director Division of Market Regulation, U.S. Securities and Exchange (April 25, 2007) (W)hile we generally support the goals ofthe H.R. 698, the bil as

introduced would subject the CSEs that already are highly regulated under the Commission's consolidated supervision program to an additional layer of duplicative and burdensome holding company oversight. The bil should be amended to recognize the unique ability of

the Commission to

comprehensively supervise the consolidated groups that are overwhelmingly in the securties business, especially given the heightened focus on these issues in an era of increased global competitiveness. Because the Commission has established a successful consolidated supervision program based on its unque expertise in overseeing the securities businesses, the Commission's program should be cared out of this legislation in the same way as are the holding companies supervised by the Federal Reserve and OTS.

http://ww .house. gov /apps/list/hearng/financialsvcs dem/tcolby042507 .pdf FF. Testimony of Utah Commissioner G. Edward Leary (April 25, 2007)

It is truly ironic that I am here today because ofthe success ofthe the failure ofthat modeL. Utah in parership with the FDIC has built a regulatory model to which the regulatory model not because of

financial services markets have reacted favorably. This regulatory model is not a system of lax supervision and inadequate enforcement. Utah industral bans are safe, sound and appropriately regulated by both the

state which charters them and the FDIC which is the relevant federal regulator and deposit insurance provider. I am told the ariculated threat ofthe industry which warrants passage of this bil is a "potential" threat of misuse ofthe charer by holding companes which are "non-fnancially" oriented. This bill removes a "potential" threat even before the threat has materialized or has manifested itself. We should all be clear on the relative size of of

the industr. The industrial ban industr constitutes 1.8%

total baning assets. This is not a systemic crisis that threatens

baning. http://ww .house. gov / apps/list/hearng/financialsvcs dem/tleary042507 .

GG. Testimony of John L. Douglas on behalf of the American Financial Services Association ("AFSA")(April25, 2007) the FDIC with respect to industrial bans, similar to the experience ofthe OTS with respect to diversified owners of savings (T)he experience of

GIBSON, DUN & CRUTCHER LLP associations, belies any fudamental concerns over threats to the banking system or our economy that might arise from commercial ownership. This is a well capitalized, well managed segment of the industry, making important contributions to consumers and small businesses by making credit available to meet demands. There have only been two failures of FDIC-insured industral bans owned by holding companies.71 These

holding companies were not commercial enterprises, they were solely engaged in financial activities. These two failures cost the FDIC roughly $100 milion. Both failed not as a result of any self dealing, conflcts of interest or impropriety by their corporate owners; rather, they failed the "old fashioned way" - poor risk diversification, imprudent lending and poor controls. These two failures stand in shar contrast to the hundreds of ban failures operating in holding company strctures, many of which cost the FDIC bilions of dollars. The list is long and soberingContinental Ilinois, First Republic, First City, MCorp, Ban of New England, and so on - many of which were subject to the much-vaunted "consolidated supervision" by the Federal Reserve as the holding company regulator that is offered as a cure for something that hasn't proven to be a problem.

HH. Comments of Chairman Frank at Mark-Up of H.R. 698, May 2, 2007 (as reported by the American Banker)

House Financial Services Chairman Barney Fran, D-Mass., who cosponsored the bil with Rep. Paul Gillmor, R-Ohio, said making exceptions for ILCs that focus solely on vehicle financing is "a very reasonable arguent."

But he persuaded Rep. John Campbell, R-Calif., to withdraw an amendment that would have created a care out for the auto industr, arguing that introducing exceptions would be more suitable for conference negotiations with the Senate.

The two institutions were Pacific Thrift and Loan (see htt://www.fdic.gov/news/news/press/1999/pr9971.htr) and Southern Pacific Bank (see htt://ww.fdic.gov/news/news/press/2003/prl 103.htr). There were a series

of small industral bank failures between 1986 and 1996. All of these institutions had less than $60 millon in assets and were essentially operated as fmance companies. None had "commercial" parents or were part of holding company strctues. Most were located in Californa and could not withstand the bankng crisis of the late 1980's and early 1990's. They failed, according to the FDIC, as a result of "ineffective risk management and poor credit quality." See FDIC "Supervisory Insights, The FDIC's Regulation of Industrial Loan Companies: A Historical Perspective," htt://ww . fdic. gov /regulations/ examinations/supervisory/insights/ sisum04/industrial-loans.htr.

GIBSON, DUN & CRUTCHER LLP we preserve this bil as is," Rep. "It is our view that we are best served if Frank said. "We believe that the Senate wil be amenable to a larger number of exceptions." A final bil would not simply exclude auto manufacturers from the ILC restrictions, but instead would create a focused outlet for automakers as well as other companies to offer loans for their products without allowing firms to engage in more general banng services, he said. "I am not anticipating that at the end of this process we wil have a care out for the auto industry," Rep. Fran said. "There will be a form for selffinancing of ... purchases. It won't be limited to the auto industry. It wil be for any industry that meets that an economic profie."

http://ww.americanbanker.com/article.html?id=20070502MH80T85U & from=washregu&email=y

GIBSON, DUN & CRUTCHER LLP

Exhibit A March 13, 1997

MEMORANDUM RE: New Financial Regulatory Framework FROM: C.F. Muckenfuss, III

I. INTRODUCTION Substantively and politically, perhaps the most diffcult remaining problem obstrcting financial modernization legislation is the role of the Federal Reserve and whether and for what puroses any federal financial agency wil have consolidated oversight over a company that owns a bank and other financial companies. the path of

As we know, Treasur is formulating its own comprehensive proposaL. It now appears that the Treasury wil permit affliation of commercial banks and any company that is predominantly a financial services company ( J the model reflected in the Roukema

bil. It is accepted that there must be a signficant role for the Fed in any new financial services holding company ("FSHC") framework. The discussion that follows outlines a framework which attempts to (1) respond to the Fed's concerns as articulated by Chairman Greenspan and other Fed offcials (and former offcials), (2) be acceptable to nonbaning

organizations ( J and (3) retain a significant Treasury role. The framework outlined below provides for a division and sharng of new responsibilities between a new National Financial Services Committee ("NFSC"), chaired by the Secretary of

the

Treasury, and the Federal Reserve Board. Whle the Fed would lose its role as regulator of holding companes, it would be charged with lead responsibility for consolidated risk

management and systemic risk oversight of FSHCs. Responsibilities of existing fuctional regulators would remain essentially the same, subject to coordination within the new NFSC and an enhanced focus on consolidated risk management. The approach suggested below reflects an effort to give the Fed a meaningful role that is responsive to its own stated concerns and at the same time is workable for companies, ( J, not now subject to the Ban Holding Company Act ("BHCA"). Whether something

along these lines is suggested to Treasury or not, it is probably strategically useful to discern whether there is any overarching Fed role that would be tolerable to ( J. Obviously,

the framework is intended to be suggestive and there is no magic to particular elements. For example, the Fed rather than Treasury could be made chair of the NFSC, or they could alternate or be co-chairs.

GIBSON, DUN & CRUTCHER LLP II. OVERVIEW OF THE NEW FRMEWORK A. Elimination of

the Ban Holding Company Model

As the D'Amato/Baker and Roukema bils propose, the Federal Reserve would no longer the activities of holding companies, whether for activities or

supervise or regulate all aspects of

prudential reasons. The proposal thus rejects the Leach model that gives the Federal Reserve

general regulatory authority with respect to the FSHC. Nor would a single overarching umbrella regulator replace the Fed. For example, there would be no holding company applications for

new nonbanking activities or holding company capital requirements. B. Primar Responsibilitv for Holding Company Regulation and Supervision Would

Lie with Functional Regulators In general, each fuctional regulator would be responsible for regulating and supervising

its particular regulated enterprise, as today, including the administration of capital requirements, change of control, etc. As in the Roukema and D'Amato/Baker bils, acquisition of insured bans would continue to be subject to the Change in Ban Control Act as at present. The

primary federal regulator ofthe ban would thus review a proposed ban acquisition under the existing statutory financial, managerial, competitive, and CRA factors. C. A National Financial Services Committee Would Administer the FSHC Act and

Provide a Forum for Coordination and Haronization Among Functional Regulators The new NFSC would be charged with interpreting and implementing the new Financial Services Holding Company Act, including the determination of what is "financial" and the implementation of the 75/25 FSHC test envisioned in the Roukema bil or whatever "basket" approach the Treasury chooses. The NFSC's responsibilities would include registration of FSHCs, coordination among fuctional regulators, resolution of disputes and the harmonization of policies and approaches to the maximum degree practicable.

the Treasur;* Vice the Federal Reserve Board; and Members: the Federal Reserve

The NFSC would have eight members: Chairman: Secretary of Chairman: Chairman of

Governor with responsibility for ban regulation, the Chairman ofthe FDIC, the Comptroller of the SEC, the Chairman of the CFTC, and a representative of the

the Curency, the Chairman of

National Association of Insurance Commissioners (NAIC). The NFSC Secretariat would be administered through the Treasury Deparment. The

would be included

existing Federal Financial Institutions Examination Council ("FFIEC") staff

As suggested above, the Fed could serve as chair or the chair could alternate. As a bureaucratic matter, such choices have substantive consequences since the staff and the biases of the agency or departent in the chair wil have disproportionate weight. A rotating chair would enhance the power of

the permanent Secretariat staff.

GIBSON, DUN & CRUTCHER LLP in the Secretariat, with the addition of experts in ban supervision, securities, commodities, and would draw upon staff of the existing functional regulatory agencies on the NFSC. As outlined below, two subcommittees within the NFSC, a Subcommittee on Consolidated Risk Management and a Systemic Risk Working Group, would be chaired by the Federal Reserve Board. insurance. To the maximum extent possible, the NFSC staff

D. Federal Reserve Would be Assigned New Responsibilities for Oversight of

Systemic Risk and Consolidated Risk Management

Unlike the D'Amato/Baker and Roukema bils, the Federal Reserve Board would be assigned new responsibilities in two critical areas - systemic risk and consolidated risk management - which call for consolidated oversight of diversified financial services companies. In both areas, the Fed would be given new authority and assigned lead responsibility within the NFSC. In these areas, great reliance would be placed on Fed staff and as a practical matter this would ease the personnel impact on the Fed flowing from loss of holding company responsibilities. E. Systemic Risk The Federal Reserve would chair a standing working group comprised of the members of the NFSC charged with financial crisis management when a (signficant) risk to the financial

system is present. This Working Group would formalize existing ad hoc practice in dealing with

financial crises such as the Drexel failure or the stock market collapse of 1987. Functional regulators would participate in the Working Group on an as needed basis in dealing with a paricular crisis. *

the Working Group, the Federal Reserve might be given a special overarching authority to take necessary actions upon a "determination of systemic risk" by the Board of Governors beyond its existing ability to jawbone and fund through the discount window (lender oflast resort). Protection against overzealousness of the Fed could be provided through an overrde by 2/3 ofthe non-Federal Reserve members of the NFSC. Alternatively, the Fed's authority could be triggered through a formal "determination of systemic risk" by a supermajority of the NFSC. In addition to its responsibilities as Chair of

the Fed, would take steps to

Additionally, the Working Group, under the leadership of

diminish overall system risk through:

It should be noted that Treasur Secretary Rubin now chairs a Workig Group on Financial Markets which includes as permnent members the Fed, the SEC and the CFTC. The New York Fed, the OCC, the FDIC, the OTS, the National Economic Council and the Council of Economic Advisors also participate on an informl basis. We understand that this group is perceived by the participants to be an effective forum for these puroses and, of course, permnent staffs of the agencies have institutional memory and do maintain effective relationships on an inorml basis. Nevertheless, this idea has logic and if assigned to the Fed does replace their loss of holding company authority and is directly responsive to their long-stated concerns.

GIBSON, DUN & CRUTCHER LLP . Recommendations to functional regulators, other governent agencies or the Congress aimed at diminishing overall systemic risk; . Creation of institutional memory and the education of new players with respect to

proven technques and tools;

. Contingency planing on a coordinated basis; and . Coordination by the Working Group, led by the Fed, with its foreign counterparts to

anticipate problems and reduce systemic risk on a global basis, as well as dealing with crises as they arise. F. Consolidated Risk Management

It is increasingly perceived, generally and within the Fed, that consolidated risk management oversight is a more appropriate form of prudential supervision than traditional bank examination and supervision. This is especially tre for complex diversified firms. The proposal would give the Federal Reserve the lead role in this area, as chair of an NFSC Subcommittee on Consolidated Risk Management. "Lead Agency." The Fed also would serve as "lead agency" for the purose of consolidated risk management oversight ofthe FSHCs that control the 25 largest bans. In

addition, companes otherwise subject to oversight by a different lead agency could voluntarly choose the Fed as its lead agency for risk management. (This would allow a quiet market mechanism to work and could be important to companies operating abroad.) For these "Designated FSHCs," the Federal Reserve would review and evaluate their consolidated Risk Management Plans and be able to paricipate in the examination of all the banks within that its leading financial business unit as designated by the FSHC at registration or as later changed by the company (subject to NFSC review). FSHC. For all other FSHCs, the "lead agency" in this regard would be the regulator of

Coordination Among Functional Regulators. The Subcommittee would develop policies, procedures, reporting requirements, and standards, where appropriate, with respect to consolidated risk management. The Subcommittee should seek to harmonize the efforts ofthe the enterprises subject to oversight.

different regulators while respecting the great diversity of

Implementation and enforcement would be the responsibility of the lead agency. The Subcommittee would consult and coordinate with foreign financial regulators to achieve haronization of oversight of multinational financial firms in this area. Development of Risk Management Plans. Each FSHC (smaller or simpler companies could be excluded) would be required to develop a Risk Management Plan (tailored to it own circumstances and addressing such matters as appropriate capital levels, allocation of capital, controls, and management adequacy and processes) and provide it to its "lead agency." These

plans would be reviewed by the lead agency and shared with other appropriate fuctional

regulators.

GIBSON, DUN & CRUTCHER LLP Federal Reserve Back-up Role. To assist in their evaluation ofFSHC Risk Management Plans, the Fed or other lead agency for risk management would be able to receive all periodic or examination reports prepared in the ordinary course by or for any entity controlled by an FSHC. Based on its review of these documents, the Fed or other lead agency could make recommendations to the functional regulators of the FSHC's subsidiares with respect to any supervisory or enforcement concerns. In the event the Fed (but not any other lead agency) determines that action is necessary to address (1) (signficant) systemic risk or (2) an issue that it is not practicable for the appropriate fuctional regulator to address, the Fed may take appropriate supervisory or enforcement action as circumstances warant. In either case,

the non-Federal Reserve

proposed Federal Reserve action could be blocked by a 2/3 vote of

members of the NFSC. G. International Responsibilities of

the Fed

The Fed would continue to have lead responsibility for oversight ofthe operations of foreign financial companies in the U.S. consistent with the new framework and would continue its principal role with foreign central bans. (The former role requires substantial rethinking in light of market changes and financial modernzation, but that is not the task at hand.)

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GIBSON, DUN & CRUTCHER LLP Exhibit B Legislative History of 12 v.s.e. ยง 1841(c)(2)(H).

In 1987, Congress extensively considered issues concerning the ability of commercial firms to control an FDIC-insured ban. The Competitive Equality Bankng Act of 1987 non

("CEBA") amended the federal BHC Act to restrict the abilty of

baning companies to own

an FDIC-insured ban. However, an amendment proposed by Sen. Alan Cranston provided an express basis in the BHC Act for any type of company to control an industrial ban. Prior to 1987, nonbaning companies including Sears, J.C. Penney, and American Express controlled FDIC-insured bans that did not accept demand deposits - so-called "nonban bans." Concerned with the implications of these affliations, Congress considered legislation that would bar such affiliations in the future. As stated in the Senate report on that legislation: "An unintended loophole in the Ban Holding Company Act has resulted in a situation in which any company can own a ban - a so-called nonban bank - thus breaking

down the banking/commerce separation that has served our nation so well." S. Rep. 100-19 at p.2. To prevent such affliations in the futue, the bil as proposed would amend the BHC Act to provide that an FDIC-insured ban would be a "bank" under the BHC Act and that any company that controlled such a "bank" would have to conform to the limitations on ban holding companies set forth in the BHC Act. ยกd. at p. 11.

Although this "nonban ban" proposed change was accepted, the Senate Baning Committee also adopted an express exception to this new definition ofthe term "ban" applicable to industrial loan companes and industral bans charered by states, such as California and Utah, that had authorizing statutes in 1987. Durng the Committee mark-up on March 10, 1987, that amendment was proposed by the ranng Democrat on that Committee, Sen. Alan Cranston, as "Cranston Amendment No.8," and adopted. That amendment, as subsequently modified by Sen. Jake Garn and adopted by the Senate, was codified at 12 U.S.C. ยง 1841(c)(2)(H). It provides that any type of company may control a industral ban chartered

by states then providing an ILC charter without falling under the BHC Act, as long as that institution does not "accept demand deposits that the depositor may withdraw by check or similar means for payment to third paries" ("demand deposits"). See S. Rep. 100-19 at p. 30. See also Congo Rec. - House H6889, 6890 (July 31, 1987). As enacted, section 2(c)(2)(H) of the BHC Act, provides that a BHC Act "ban" does not include: (H) An industrial loan company, industrial ban, or other similar

institution which is - (i) an institution organized under the laws of a State which, on March 5, 1987, had in effect or had under consideration in such State's legislature a statute which required or would require such institution to obtain insurance under the Federal Deposit Insurance Act(I) which does not accept demand deposits that the depositor may withdraw by check or similar means for payment to third paries;

(II) which has total assets ofless than $ 100,000,000; or (III) the control of the enactment of the Competitive Equality Amendments of 1987 (enacted Aug. 10, 1987); which is not acquired by any company after the date of

GIBSON, DUN & CRUTCHER LLP or (ii) an institution which does not, directly, indirectly, or through an affliate, engage in any activity in which it was not lawfully engaged as of March 5, 1987, except that this subparagraph shall cease to apply to any institution which permits any overdraft (including any intraday overdraft), or which incurs any such overdraft in such institution's account at a Federal Reserve ban, on behalf of an affliate if such overdraft is not the result of an inadvertent computer or accounting error that is beyond the control of both the institution and the affliate. 12 U.S.c. ยง 1841(c)(2)(H).

law and as such is an element of federal policy regarding the appropriate relationship between "banking" and "commerce." That federal policy plainly permits a commercial company to control a Utah industrial bank that does not accept demand deposits. This industral bank amendment to CEBA is par of federal

In 1995-1999, Congress again considered federal policy concerning affliations between insured depository institutions and nonbaning companes. Federal Reserve Chairman Greenspan and others did reiterate their position concerning a federal policy to separate "baning" and "nonfinancial" activities. In fuherance of such a policy the GLB Act in Title I did amend the BHC Act to permit "financial" affliations for bans and in Title IV amended the Savings and Loan Holding Company Act ("S&LHC Act") to restrct new affliations between "untar" S&LHCs engaged in nonfinancial activities and FDIC-insured savings associations. See 12 U.S.c. ยง 1467a(c)(9).

Nevertheless, at the same time the GLB Act made these changes, it both retained the original CEBA provision permitting any type of company to control an ILC that does not take demand deposits and added liberalizing language. See Section 107(c) of the GLB Act, amending 12 U.S.C. ยง 1841(c)(2)(H). And it did so two years after Utah has amended its law to permit the charering of

new ILCs with broader powers72 and after a significant number of

major diversified

financial and nonfinancial companies had acquired Utah ILCs. This action necessarily leads to the conclusion that Congress did not intend to sweep industral bans into any general "separation of

banking and commerce" and specifically reaffirmed the existing opportity for

any type of company to control an ILC.

As amended by the GLB Act, the BHC Act now provides (language added by the GLB Act is italicized): (H) An industrial loan company, industrial ban, or other similar

institution which is - (i) an institution organized under the laws of a State 72 As the Fed noted in its July 2006 Hearing testimony: "For example, in 1997, Utah lifted its moratorium on the chartering of new ILCs, allowed ILCs to call themselves banks, and authorized ILCs to exercise virally all of

(II) which has total assets ofless than $ 100,000,000; or (III) the control of the enactment of the Competitive Equality Amendments of 1987 (enacted Aug. 10, 1987); or (ii) an institution which does not, directly, indirectly, or through an affliate, engage in any activity in which it was not lawfully engaged as of March 5, 1987, except that this subparagraph shall cease to apply to any institution which permits any overdraft (including any intraday overdraft), or which incurs any such overdraft in such institution's account at a Federal Reserve ban, on behalf of an affiliate if such overdraft is not the result of an inadvertent computer or accounting error that is beyond the control of both the institution and the affiliate, or that is otherwise permissible for a bank controlled by a company described in section 4(/(1) (12 Us.e. ยง 1843(/(1)). which is not acquired by any company after the date of

GIBSON, DUN & CRUTCHER LLP Exhibit C The FDIC Supervisory Program for ILC Organizations Is Comprehensive and Is Equivalent in Comprehensiveness and Effectiveness to the Home Country Consolidated Supervision Standards Implemented by the EU for U.S. Organizations

and by the Fed for Non-U.S. Banking Organizations This Exhibit compares the principal elements ofthe FDIC's existing, comprehensive program for examining and supervising insured bans, including ILCs and their affliates, to the international standards used for determining when a baning supervisor may be deemed to provide a "consolidated home country supervision" for baning and financial organizations based in that home countr. The first section provides excerpts from the FDIC Exam Manual concerning the supervision of affliates and its LilI Program. The FDIC's success as a supervisor ofILC this program. The next sections organizations is based upon the scope and effectiveness of sumarze the ED's supervisory standards under its Conglomerates Directive and its application

the OTS, SEC, and New York ofthose standards to U.S. organizations under the jursdiction of Banng Deparent. The final section excerpts the Fed rule setting forth its standards for determining whether the home country supervisor of a non-U.S. bankng organization provides

"consolidated home countr supervision." These Fed standards closely parallel the EU and international standards applied to U.S. organizations.73

This review demonstrates that the FDIC's safety-and-soundness examination program is a comprehensive and effective supervision program that addresses ILC organizations of all sizes and degrees of complexity. The comparson with the EU and Fed standards for "consolidated supervision" further demonstrates that the FDIC program incorporates the goals, standards, and methods of consolidated supervision into its supervision of ILCs, their parents, and affiiates. Thus, whatever label is applied, the FDIC's program compares favorably in terms of comprehensiveness and effectiveness.

I. FDIC'S EXISTING SUPERVISION OF ILC ORGANIZATIONS This section reviews key elements of the FDIC's existing, comprehensive program for examining and supervising insured bans, including ILCs and their affliates. It presents excerpts from the Exam Manual and LilI Program guidance.

73 The U.S. and EU standards and programs also reflect the work of

the Basel Commttee on Bankng Supervision

of the Bank for International Settlements, including the Concordat on "Minmum standards for the supervision of international bankg groups and their cross-border establishments" (July 1992) Cross-Border Bankg Report (October 1996) the New

htt://ww.bis.org/pubJ/cbsc3l4.pdf; The Supervision of

htt://ww.bis.org/pubJ/cbs27.pdf; and High-level principles for the cross-border implementation of

Accord (August 2003), htt://ww.bis.org/pubJ/cbslOO.pdf.

100

GIBSON, DUN & CRUTCHER LLP A. FDIC Exam Manual Section 4.3 of the FDIC Exam Manual sets forth in detail the overall FDIC examination program with respect to affiliates of insured bans. A significant portion of this section addresses organizations that control an ILC but are not a BHC. It includes a section paricularly addressing "Unique Characteristics of Commercial Parent Companies," which provides:

Certain ban charers, such as ILCs, may have commercial parent

companies in place of a traditional bank holding company or financial institution holding company. As with ban holding companies, these commercial parents can be a source of strength for their subsidiary ban by providing access to the capital and debt markets, and affording the opportunity to use a varety oftechnical services not always available to

small or mid-size bans.

However, commercial parents also present different management challenges to the insured institution and different analytical challenges to examiners. Commercial parents may not be able to offer additional

management expertise directly relevant to financial institutions. In serving the specific financial needs of a commercial company, a niche ban may

be insuffciently diversified against credit or liquidity risks. Further a financial catastrophe at a parent or affiliate, unrelated to the business of the insured institution, could result in an unanticipated but immediate disruption to the earngs or operations ofthe insured entity.

Moreover, assessment of "extra-insured" risk factors canot be made with the comparatively straight-forward ratio analysis used for evaluating bank holding companes. Commercial firms present more vared revenue

streams and business risks. Furher, while a clearly identified weakess in the insured institution wil generally determine the need to conduct an assessment ofthe potential source of strength provided by the commercial parent, any determination of a "potential source of weakess" presented by a parent or affliate to an otherwise healthy insured entity will be far more

complex. Examiners should only undertake such an assessment following consultation and direction from the Regional Office.

For nonban holding companies or commercial parent entities, some possible sources for financial analysis include: parent entity quarerly or anual reports, Securties and Exchange Commission filings such as 10Ks, 10-Qs, etc., ban records on affliates, external industry analysis

sources (i.e. Moody's Standard and Poor's, etc.), internal and/or external audits, corporate press releases, newspaper aricles, etc.

Section 4.3 specifically addresses a range of issues and analytical methods for assessing the ability of the parent to serve as a source of financial strength to its ban affiliate:

101

GIBSON, DUN & CRUTCHER LLP The holding company structue can provide its subsidiar bank strong

financial support because of greater ability to attract and shift funds from excess capital areas to capital deficient areas. The financial support can take the form of equity capital injections and/or the funding of loans and investments. However, when the financial condition of the holding company or its nonbaning subsidiaries is tenuous, pressures can be exerted on the subsidiar bans. In order to service its debt or provide

support to another nonbank subsidiar, the holding company may place the

inordinate financial pressure on its subsidiar bans by any of

following methods: payment of excessive dividends; pressure subsidiar

bans to invest in high risk assets to increase asset yields; purchase and/or trade its high quality assets for the other affliate's lower quality assets; unecessar services from affliates; or payment of excessive management or other fees. . . . purchase of

Even when the holding company is financially sound, supervisory concerns may arse as the parent issues long term debt to fund equity capital in the subsidiares. Although this capital raising activity, known as "double leveraging," does increase equity capital in the subsidiar, too

much debt at the holding company level can generate pressure on the subsidiar to upstream additional dividends. . . . the subsidiar, or in the case of

The double leverage ratio is the equity of

multiple subsidiaries the combined equity of all the subsidiares; divided by the equity ofthe holding company. A holding company with a ratio of

100% or less, is not using double leverage. The amount of double leverage a holding company can comfortably car can depend on varous

factors; but analysis should center on the amount of earings or cash flow the lead ban generates most of the combined company's earngs, can upstream to the parent. Even which the subsidiaries, or the lead ban if

holding companies with comparatively modest double leverage ratios can negatively affect the ban if

the non-ban subsidiares produce negative

cash flow. Other leverage ratios which attempt to isolate or incorporate different segments of the holding company's capital strctue (preferred

stock or minority interests for example) can be useful for assessing more complex organzations.

Fixed charge coverage is a ratio that measures the ability of the parent company to cover its interest expense. . . . Cash flow match is a more severe test of parent cash availability to meet not only interest expenses, but also operating expenses, taxes, shareholder dividends, and debt maturties. . . .

the financial support a

These cash flow measures are the best indicators of

parent company can provide to a subsidiar ban. Asset size,

102

GIBSON, DUN & CRUTCHER LLP capitalization, revenue or profitability; even relative to the size of the insured institution, are imperfect measures for gauging potential support.74

B. LilI Program

In addition to the general approaches discussed in the Exam Manual, the FDIC has addressed paricular issues arsing from large organizations that include an ILC in its LilI Program. The LilI program builds on and parallels the Fed's LCBO program to look at the major baning organzations under their supervision on a consolidated basis.75 On March 12, 2004, the FDIC Division of Supervision and Consumer Protection ("DSCP") specifically expanded the LilI Program to include organizations not subject to the BHC Act, including ILC organizations. (Transmittal 2004-009).76 In that memorandum the Director ofDSCP stated:

The FDIC regulates these baning institutions (including ILCs) in the same maner as other state nonmember bans with respect to examination,

enforcement and other supervisory activities. However, there are the organzations that own these institutions since they are not depository institution holding companies differences regarding the oversight of

and therefore not subject to Federal Reserve supervision.

Case Managers and other Regional Offce supervisory staff are encouraged to review their portfolios of insured depository institutions with non-ban holding company ownership structures and determine if they should be added to the LilI program. Staff should include entities where the organzational strcture and strategic focus ofthe parent company present significant risks to the depository institution, even if the risks are currently well-controlled. As with any institution, our supervisory objective is to identify changes to the risk profie as early as possible. Review staff should pay paricular attention to the depository institution's relationship with its parents and other related organzations. In general, quarerly reviews ofthese entities should focus on such areas as controls and safeguards over conflicts of interest, controls over intercompany transactions, and the possible existence of abusive activities by related paries.

74 htt://ww.fdic,gov/regulations/safetv/manual/section4-3.htr#parent. The FDIC and DFI coordinate to

implement the UDI program for the major ILC organiations. See CSBS Remarks, supra, and Commssioner G. Edward Leary July 2006 House Subcommttee testimony: htt://ww.dfi. utah.gov/PDFiles/IB%20Congressional%20Testionv%20-%20ELeary.pdf. 75 The LIDI program is discussed in detail in chapter 11 of the FDIC Statement of

Policy on Applications for

Deposit Insurance; Case Manager Procedures ManuaL.

76 At present there are five ILC organiations supervised under ths program and one in the large bank dedicated examier program. See 2006 FDIC/DIG Report at Table 7, p. 27.

103

GIBSON, DUN & CRUTCHER LLP If added to the LilI program, staff should prepare a quarerly Executive Summary and assign an LilI offsite rating. (italics in original) As discussed in the CMPM, the LilI Program "provides timely, comprehensive, and forward-looking analyses of risk profies of companies with total assets of $1 0 billion or more, on a consolidated entity basis. Companies with consolidated total assets of at least $3 bilion but less than $10 bilion can be added to the LilI Program at the discretion ofthe Regional Director. Although LilI companies are primarily holding companies, the Program also includes unit bans and thrfts that meet their asset size thresholds. Timely and complete analysis ofthe risk

profiles of these companies provides a proactive approach aimed at identifying and monitoring the largest risks to the insurance fund. In order to quantify the analysis and facilitate overall trend analysis, an offsite rating and risk profie indicator are assigned to each company on a quarerly basis.,,77 As set forth in the CMPM, the LilI Program analyzes companies in four main areas:

路 The organizational strcture and strategic focus of the company 路 The overall risk profie and financial condition of the company 路 An identification and review of signficant issues, curent events, and challenges facing the company

路 The review and development of a suffcient supervisory program to address the risk issues facing the company78

The CMPM discussion ofthe LilI Program is lengthy and detailed and makes it plain that the quarerly analysis should consider all significant aspects ofthe organization's financial

risk. The LilI

condition, management and controls, business developments and sources of

Program demonstrates that the FDIC not only has the authority to address comprehensively the substance and dynamics of the relationships between ILCs and their affliates, but more importantly has a program in place that does just that and that is comparable to the parallel LCBO program implemented by the Fed. C. FDIC's Use Of Conditions

The FDIC has demonstrated the robustness ofthis authority in the extensive conditions attached to the ILC applications approved in 2007 involving affliations with otherwise unegulated financial firms. Among these conditions are the following: a. That the parent consents to examination by the FDIC of

it and each of

its

subsidiares to monitor compliance with the provisions ofthe Federal Deposit

77 CMPM at 11-1.

78 !d. at 11 - 1-2.

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GIBSON, DUN & CRUTCHER LLP Insurance Act or any other federal law that the FDIC has specific jurisdiction to enforce against such company or subsidiar and those governing transactions and relationships between any depository institution subsidiar and its affliates. b. That deposit insurance shall not become effective until the parent ceases to

engage in activities that are not financial activities and that the parent shall engage, directly or indirectly, only in financial activities. c. That the parent shall submit to the FDIC an anual report regarding its operations

and activities, in the form and maner prescribed by the FDIC, and such other reports as may be requested by the FDIC to keep the FDIC informed as to financial condition, systems for monitoring and controllng financial and operating risks, and transactions with the Ban; and compliance by the parent or its subsidiares with applicable provisions ofthe Federal Deposit Insurance Act or any other Federal laws that the FDIC has specific jurisdiction to enforce against such company or subsidiary. d. That the parent shall maintain such records as the FDIC may deem necessary to

assess the risks to the Bank or to the Deposit Insurance Fund. e. That the parent wil limit its representation, direct and indirect, on the board of directors of

the Bank to no more than 25 percent of

the members of

such board of

directors, in the aggregate. f. Prior to the effective date of deposit insurance, the Ban shall have appointed and

Directors who possess the knowledge, experience, and capability to carry out the responsibilities of the position in a safe shall thereafter maintain a Board of

and sound manner and independently ofthe activities of

the parent and its

affliated entities. g. The Ban shall obtain written approval from the FDIC prior to adding or replacing a member of the Ban's Board of Directors or any senior executive offcer during the first three years of operation. h. The Ban shall obtain wrtten approval from the FDIC prior to entering into any contract for essential services with the parent or any of its affiiated entities. 1. The Ban shall notify the FDIC of any material nonperformance under any contract for essential services with the parent or any of its affliated entities within 15 days

J. That durng the first three years of operation, the Ban shall obtain wrtten approval from the FDIC prior to consumating any proposed major deviation or material change from its business plan. k. That prior to the date of federal deposit insurance, the Bank and the parent enter

into a Capital Maintenance and Liquidity Agreement with the FDIC.

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GIBSON, DUN & CRUTCHER LLP II. CONSOLIDATED SUPERVISION AS IMPLEMENTED BY THE EUROPEAN UNION We recognize that consolidated supervision is an important concept in baning supervision around the world and that in the United States, the EU, and other countries around the world, baning organizations must be found to be subject to consolidated home country supervision before being allowed to do banking business in other countries.79 Over the last decade financial regulatory authorities in Europe and the United States paricularly have given substantial attention to the concept and implementation of consolidated supervision of financial conglomerates. During the last five years, as the European Union has implemented its Conglomerates Directive, which is based on the concept of consolidated supervision of large complex operations, the U.S. financial agencies, with the cooperation of the Treasury Deparent, have dealt with the subject of supervision and regulation of enterprises which have

banking components but which are not traditional banking organizations supervised by the Fed. Merrll Lynch and Morgan Stanley

The SEC has been accepted as a consolidated supervisor of

and the OTS as consolidated supervisor of the financial and baning activities of General

Electrc. In releasing its Conglomerates Directive in 2001, the EU indicated that it had three principal objectives:

. To ensure that the financial conglomerate has adequate capitaL. In paricular the

. To introduce methods for calculating a conglomerate's overall solvency position; and . To deal with the issues of

intra-group transactions, exposure to risk and the suitability

and professionalism of management at financial conglomerate leveL. so

In 2004, the European Financial Conglomerates Committee and the EU Banking Advisory Committee jointly prepared a "general guidance" addressing "the extent to which the supervisory regime in the United States of America is likely to meet the objectives of consolidated supervision."S! The guidance took account ofthe roles of the four federal baning agencies, the state baning agencies, the SEC, state securities agencies and the securties self-

79 See the Basel Commttee Documents, supra.

80 European Commssion, "Financial services: Commssion proposes Directive on prudential supervision of

2001).

financial conglomerates," Press release IP/OL/609 (Brussels, 26 April

81 EFCC/BAC general guidance - USA supervision, Final 06.07.2004, at htt:// ec.europa.eu/intemal market/fmancial-conglomerates/ docs/ guidance-usa- final-060704 en. pdf.

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GIBSON, DUN & CRUTCHER LLP regulatory

organizations, and the roles of

the National Association of

Insurance Commissioners

(NAIC) and state insurance commissioners. Based on this review it concluded: "The range of authorities involved means that reaching a single conclusion on whether the US supervisory regime as a whole achieves the objectives of consolidated and supplementary supervision is diffcult. Nonetheless, we are of the view that, on balance, there is broad equivalence in the US supervisory approaches, notwithstanding the caveats noted below. ,,82 The guidance then made specific comments on the use of supervisory agreements by the New York State Banking Deparment, the approach to capital adequacy by the OTS,83 and the fact that the SEC would be undertaking a form of consolidated supervision for the first time.84 Noting that several of the supervisory regimes for financial groups had been recently adopted and implemented, the guidance indicates that the practices followed by the agencies should be reviewed in 2006. No fuher assessment has to date been released. The FDIC examination and supervision program described above plainly satisfies the EU criteria.

III. FED's IMPLEMENTATION OF CONSOLIDATED SUPERVISION FOR NONU.S. BANKING ORGANIZATIONS This EU document does not discuss the Fed's approach to holding company supervision, presumably because of the Fed's long-established role as a consolidated supervisor of holding companies. The Fed has established parallel standards for determining when a non-U.S. ban is subject to consolidated home country supervision. The Fed's rule on this subject also focuses on the ability of the foreign countr supervisor to achieve the results of consolidated supervision and not on the specific means adopted. The Fed rule85 provides:

82 ยกd. at 3. 83

"The OTS does not have a uniform approach to capital requirements at the holding company leveL. We understand the thiing behind this approach, given the diversity of organiations which have a thrft-holding

company. However, ths does mean that EU supervisors must ensure that they fully understand the way in which capital requirements are applied to a partcular group, and be satisfied that this delivers an outcome that is consistent with the objectives of consolidated or supplementary supervision." ยกd. at 4. 84 "There are some important aspects of

the SEC's CSEI regime that EU supervisors must take into account. In reliance by groups on the inclusion of un subordinated long-term debt in capital for a transitional period, and consider whether this poses a problem. The CSE regime wil apply Basel-like standards for capital calculation at the holding company leveL. Given the way in which these groups have evolved, EU supervisors must consider whether there is enough mobile capital in the group to partcular, EU supervisors must consider the extent of

cover the risks arising from the activities of

unregulated entities. Such consideration must also take into

account the application to any regulated US broker-dealers in the group of capital standards that are more onerous than the Basel standards." ยกd. at 5.

85 See 12 C.F.R. ยง 211.24(c)(ii).

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GIBSON, DUN & CRUTCHER LLP (ii) Basis for determining comprehensive consolidated supervision. In

determining whether a foreign ban and any parent foreign bank is subject to comprehensive consolidated supervision, the Board shall determine whether the foreign ban is supervised or regulated in such a maner that its home country supervisor receives sufficient information on the worldwide operations ofthe foreign ban (including the relationships ofthe ban to any affliate) to assess

the foreign ban's overall financial condition and compliance with

law and regulation. In making such a determination, the Board shall assess, among other factors, the extent to which the home countr supervisor:

(A) Ensures that the foreign ban has adequate procedures for monitoring and controlling its activities worldwide; (B) Obtains information on the condition ofthe foreign ban

and its subsidiares and offces outside the home countr through regular reports of examination, audit reports, or otherwise; (C) Obtains information on the dealings and relationship

between the foreign ban and its affliates, both foreign and domestic;

(D) Receives from the foreign ban financial reports that are consolidated on a worldwide basis, or comparable information that permits analysis of

the foreign bank's

financial condition on a worldwide, consolidated basis; (E) Evaluates prudential standards, such as capital adequacy

and risk asset exposure, on a worldwide basis.

Like the EU, the Fed recognizes that "consolidated supervision" is not a single supervisory template.

iv. THE UTAH DFI'S DESCRIPTION OF THE POWERS AND SUPERVISORY

FRAEWORK FOR ILCS IN UTAH A. Overview On its website the Utah DFI describes its ILC regime as foiiows:86

86 See htt://ww.dfi.state.utah.us/whatisILC.htm.

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GIBSON, DUN & CRUTCHER LLP A Utah-chartered industrial bank (ILC) is an institution subject to the same regulatory oversight as a Utah-charered commercial ban. As of February 26, 1997, it may, but need not use the term "ban" or "savings ban" in its name. As of March 12, 1997, Utah law was amended to authorize the Department of Financial Institutions to charter new ILCs. As of March 17,2004, Utah law. . . was amended to rename the industry from Industral Loan Corporations (ILCs) to Industrial Bans. Generally, ILCs are authorized to make all kinds of consumer and commercial loans and to accept federally insured deposits, but not demand deposits ifthey have total assets greater than $100 milion. ILCs are subject to the same regulatory and supervisory oversight as commercial bans. In many respects, however, ILC activities and powers are not as restrcted as commercial bans.

Financial Institutions regulates all stateTitle 7 of the Utah Code Anotated 1953, as Amended, "FINANCIA INSTITUTIONS ACT." ILCs are authorized to engage in the "banking business" under the statutory framework of Title 7, FDIC rules and regulations that generally apply to commercial bans wil apply. In Utah, the Deparment of

chartered financial institutions pursuant to authority of

The flexibility of an ILC charer has made it an attractive vehicle for some large and well-known corporations. ILCs offer a versatile depository charer for companies that are not permitted to, or that choose not to, become subject to the limitations of the Ban Holding Company Act or the Glass Steagall Act. Most operating ILCs have taken advantage of Utah's Consumer Code and marketed specialized products or services nationwide. These companies have taken advantage of interest rates and other charges the exportation of

afforded national bans and federally insured state-charered financial

institutions. An ILC mainstay has been the issuance of credit cards to consumers and businesses nationally. Utah has established a reputation for a positive regulatory environment. The process of obtaining an ILC charter commences with an application to the Deparment of Financial Institutions under Sections 7-1-704 and 706 of the Utah Code and an application for insurance of deposits with the FDIC. Because the information requested in the FDIC application is similar to that requested in the State application, the FDIC application can be filed in lieu of the State application.

In reviewing an application and business plan for approval, the Deparment gives considerable weight to the following factors. Many other factors may also be considered in the ultimate approval process.

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GIBSON, DUN & CRUTCHER LLP the organizer(s).

1. The character, reputation and financial standing of

2. The organizers have the resources (source of capital) to support an ILC.

whom, must be outside, whom must be Utah residents.

3. Selection ofa Board of

Directors, the majority of

unaffliated individuals, some of

4. The establishment of a Utah organization where autonomous decision

making authority and responsibilities reside with the board and management such that they are in control ofthe ILC's activities and direction.

5. Utah-based management that has a track record, the knowledge, expertise and experience in operating a depository institution in a regulated environment.

6. Management that is independent ofthe parent; however, the goals and policies of

the parent may be cared out if defined in the ILC's business

plan. 7. A bona fide business plan and purose for the existence of an ILC, in

which deposit takng is an integral component, including three years pro forma proj ections and supporting detaiL. 8. FDIC deposit insurance. 9. All ILC lending and activities wil be reviewed in light of strct compliance with the spirit and letter of

Federal Reserve Regulations

Section 23 A and B, Restrictions on Transactions with Affliates and

Regulation O.

As with all depository institutions, ILCs are subject to safety and soundness examinations by the Deparent of Financial Institutions and the FDIC. ILC examinations are usually conducted jointly with the FDIC annually. An ILC is also subject to examinations under the Community Reinvestment Act and wil receive a compliance examination.

In a 2005 speech, the Commissioner of the Utah DFI discussed the scope and approach of his deparment as a supervisor of ILCs:

The department takes its supervisory role seriously. Weare an active paricipant with the FDIC in all industrial ban examinations and targeted reviews wherever they are conducted in the countr. Examiners are going regularly to New York, Chicago, Princeton, New Jersey, Phoenix, Jacksonville and Stamford, Conn. to conduct examinations. Our examiners are participating in large loan exams (reviewing loans and lines-of credit in the $1 OO's of millons), capital market examinations, trst

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GIBSON, DUN & CRUTCHER LLP exams, information system exams, consumer compliance and community reinvestment exams and ban secrecy act and anti-money laundering

exams. We believe we are full parners with FDIC examiners.8? B. Utah Authority over Parents of ILCs

The Utah DFI has broad supervisory regulatory and enforcement authority over Utah industrial bans that parallels to the FDIC's authority and broad express authority over the

parents of ILCs. Such authority includes the right to examine the institution and to take enforcement and remedial actions against the ban and its affiliates.88 Enforcement powers includes the right to issue cease and desist orders, remove directors and officers, take possession of the institution, and enforce supervisory acquisitions and mergers.89 The DFI can impose any conditions and limitations on an application for authority, as necessary to protect depositors, creditors and customers.90 Furhermore, all parent companies must register with the DFI as industral ban holding companies, and thereby fall within DFIjursdiction.9i The DFI thus has

direct supervisory authority over all industrial ban holding companies, and may take enforcement and remedial actions directly against the holding company and its affliates as necessary.92 The DFI also may adopt rules with respect to industrial ban holding companies, to protect depositors, the public and the financial system of

the State.93

v. GAO COMMENTARY ON FED. OTS AND FDIC SUPERVISION AT PRESENT The 2005 GAO Report includes the following commentar: As consolidated supervisors, the Board and OTS have authority to examine ban and thrft holding companes and their nonbank subsidiares in order to assess risks to the depository institutions that could arse because oftheir affliation with other entities in a consolidated strctue. The Board and OTS may examine holding companies and their nonbank subsidiares, subject to some limitations, to assess, among other things, the

87 G. Edward Lear, Utah Commssioner of Financial Institutions, Remaks to the Utah Association of

Services (Aug. 26, 2005)

Financial

88 See, e.g., Utah Code Ann. §§ 7-1-307, 7-1-308, 7-1-313, 7-1-314, 7-1-501, 7-1-510 and 7-2-1.

89 See, e.g., Utah Code Ann. §§ 7-1-307, 7-1-308, 7-1-313 and 7-2-1.

90 Utah Code An. § 7-1-704. 91 Utah Code Ann. § 7-8-16. 92 See 12 C.F.R. § 21 1.24(c)(ii); EFCC/BAC general guidance - USA supervision, Final 06.07.2004 at htt:// eC.europa.eu/intemal market/fmancial-conglomerates/ docs/ guidance-usa- final-060704 en. pdf

(commenting on the OTS, the SEC and the New York State Bankng Departent).

93 Utah Code Ann. § 7-1-301.

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GIBSON, DUN & CRUTCHER LLP nature of the operations and financial condition of the holding company and its subsidiares; the financial and operations risks within the holding company system that may pose a threat to the safety and soundness of any depository institution subsidiar of such a holding company; and the systems for monitoring and controlling such risks. The Board's examination authority is limited to certain circumstances, such as where the Board "has reasonable cause to believe that such subsidiary is engaged in activities that pose a material risk to an affiliated depository institution" or the Board has determined that examination ofthe subsidiary is necessary to inform the Board of the systems the company has to monitor and control the financial and operational risks within the holding company system that may threaten the safety and soundness of an affiiated depository institution. OTS's examination authority with respect to holding companes is subject to the same limitation. Also, the focus of Board and OTS examinations of all holding company nonban

subsidiaries must, to the fullest extent possible, be limited to subsidiares that could have a materially adverse effect on the safety and soundness of a depository institution affiliate due to either the size, condition, or activities of the subsidiar or the natue or size of transactions between the subsidiar and any affliated depository institution. FDIC examinations of affiliates having a relationship with an institution are not subject to the same limitations where the examination is to determine the condition of the institution for insurance puroses.

their authority, consolidated supervisors take a systemic approach to supervising depository institution holding companies and their

As a result of

nonban subsidiares. Consolidated supervisors may assess lines of

business, such as risk management, internal control, IT, and internal audit across the holding company structure in order to determine the risk these operations may pose to the insured institution. These authorities enable consolidated supervisors to determine whether holding companes that

own or control insured depository institutions, as well as holding company nonban subsidiaries, are operating in a safe and sound maner so that

their financial condition does not threaten the viability of their affliated depository institutions. Thus, consolidated supervisors can examine a holding company subsidiar to determine whether its size, condition, or activities could have a materially adverse effect on the safety and soundness of the ban even if there is no direct relationship between the two entities. Although the Board's and OTS' examination authorities are subject to some limitations, as previously noted, both the Board and OTS maintained that these limitations do not restrict the supervisors' ability to detect and assess risks to an insured depository institution's safety and soundness that could arse solely because of its affiiations within the holding company. The Board's and OTS' consolidated supervisory authorities also include the ability to require holding companies and their nonban subsidiares to

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GIBSON, DUN & CRUTCHER LLP provide reports in order to keep the agencies informed about matters that include the holding company's or affiiate's financial condition, systems for monitoring and controlling financial and operations risks, and transactions with affliated depository institutions. These authorities are subject to restrictions designed to encourage the agency to rely on reports made to other supervisors, publicly available information, and externally audited financial statements. The Board requires that ban holding companies provide anual reports of the company's operations for each year that it remains a ban holding company; OTS has the authority to

require an independent audit of, among other things, the financial statements of a holding company, at any time. According to Board's and OTS' examination manuals, examiners may also use additional reports of holding company and affiliate activities that are not publicly available, such as the holding company's financial statements, budgets and operation plans, varous risk management reports, and internal audit reports. In addition to examination authority, as consolidated supervisors, the Board and OTS have instituted standards designed to ensure that the holding company serves as a source of strength for its insured depository institution subsidiares. The Board's regulations for ban holding companies include consolidated capital requirements that, among other things, can help protect against a ban's exposure to risks associated with its membership in the holding company. The OTS does not impose consolidated regulatory capital requirements on thrft holding companies. Although there is no specific numerical requirement (ratio), OTS' policy is

that regulated holding companes should have an adequate level of capital to support their risk profile. OTS examiners are instructed to consider all aspects of an organzation's risk profile, on a case-by-case basis, to determine if capital is adequate with respect to both the holding company 94 and its affliate thrft.

IO0220501_2.DOC

94 U.S. Gov't Accountability Offce, GAO-05-621, Industrial Loan Corporations, Recent Asset Growth and Commercial Interest Highlight Differences in Regulatory Authority (2005) (Footnotes omitted).

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