PART 1500—MERCHANT BANKING INVESTMENTS Authority: 12 U.S.C. 1843(k). Source: Reg. Y, 66 FR 8489, Jan. 31, 2001, unless otherwise noted. § 1500.1 What type of investments are permitted by this part, and under what conditions may they be made? (a) What types of investments are permitted by this part? (b) Must the investment be a bona fide merchant banking investment? (c) What types of ownership interests may be acquired? (d) Where in a financial holding company may merchant banking investments be made? (e) May assets other than shares be held directly? (1) The assets are held by or promptly transferred to a portfolio company; (2) The portfolio company maintains policies, books and records, accounts, and other indicia of corporate, partnership or limited liability organization and operation that are separate from the financial holding company and limit the legal liability of the financial holding company for obligations of the portfolio company; and (3) The portfolio company has management that is separate from the financial holding company to the extent required by § 1500.2. (f) What type of affiliate is required for a financial holding company to make merchant banking investments? (1) Securities affiliate. (i) A broker or dealer; or (ii) A municipal securities dealer, including a separately identifiable department or division of a bank that is registered as a municipal securities dealer. (2) Insurance affiliate with an investment adviser affiliate. (i) An insurance company that is predominantly engaged in underwriting life, accident and health, or property and casualty insurance (other than credit-related insurance), or providing and issuing annuities; and (ii) A company that: (A) Is registered with the Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1 et seq. (B) Provides investment advice to an insurance company. § 1500.2 What are the limitations on managing or operating a portfolio company held as a merchant banking investment? (a) May a financial holding company routinely manage or operate a portfolio company? (b) When does a financial holding company routinely manage or operate a company? Examples of routine management or operation Executive officer interlocks at the portfolio company. (ii) Interlocks by executive officers of the financial holding company Prohibition. (B) Definition. ( 1 ( 2 ( 3 ( 4 ( 5 (iii) Covenants regarding ordinary course of business. (2) Presumptions of routine management or operation. (i) Any director, officer, or employee of the financial holding company serves as or has the responsibilities of an officer (other than an executive officer) or employee of the portfolio company; or (ii) Any officer or employee of the portfolio company is supervised by any director, officer, or employee of the financial holding company (other than in that individual's capacity as a director of the portfolio company). (c) How may a financial holding company rebut a presumption that it is routinely managing or operating a portfolio company? (d) What arrangements do not involve routinely managing or operating a portfolio company? Director representation at portfolio companies. (i) The portfolio company employs officers and employees responsible for routinely managing and operating the company; and (ii) The financial holding company does not routinely manage or operate the portfolio company, except as permitted in paragraph (e) of this section. (2) Covenants or other provisions regarding extraordinary events. (i) The acquisition of significant assets or control of another company by the portfolio company or any of its subsidiaries; (ii) Removal or selection of an independent accountant or auditor or investment banker by the portfolio company; (iii) Significant changes to the business plan or accounting methods or policies of the portfolio company; (iv) Removal or replacement of any or all of the executive officers of the portfolio company; (v) The redemption, authorization or issuance of any equity or debt securities (including options, warrants or convertible shares) of the portfolio company or any borrowing by the portfolio company outside of the ordinary course of business; (vi) The amendment of the articles of incorporation or by-laws (or similar governing documents) of the portfolio company; and (vii) The sale, merger, consolidation, spin-off, recapitalization, liquidation, dissolution or sale of substantially all of the assets of the portfolio company or any of its significant subsidiaries. (3) Providing advisory and underwriting services to, and having consultations with, a portfolio company. (i) Provide financial, investment and management consulting advice to a portfolio company in a manner consistent with and subject to any restrictions on such activities contained in § 225.28(b)(6) or § 225.86(b)(1) of the Board's Regulation Y (12 CFR 225.28(b)(6) and 225.86(b)(1)); (ii) Provide assistance to a portfolio company in connection with the underwriting or private placement of its securities, including acting as the underwriter or placement agent for such securities; and (iii) Meet with the officers or employees of a portfolio company to monitor or provide advice with respect to the portfolio company's performance or activities. (e) When may a financial holding company routinely manage or operate a portfolio company? Special circumstances required. (2) Duration Limited. (3) Notice required for extended involvement. (4) Documentation required. (f) May a depository institution or its subsidiary routinely manage or operate a portfolio company? In general. (2) Definition applying provisions governing routine management or operation. (3) Exception for certain subsidiaries of depository institutions. et seq. § 1500.3 What are the holding periods permitted for merchant banking investments? (a) Must investments be made for resale? (b) What period of time is generally permitted for holding merchant banking investments? In general. (2) Ownership interests acquired from or transferred to companies held under this part. (i) Acquired by a financial holding company from a company in which the financial holding company held an interest under this part will be considered to have been acquired by the financial holding company on the date that the share, asset or ownership interest was acquired by the company; and (ii) Acquired by a company from a financial holding company will be considered to have been acquired by the company on the date that the share, asset or ownership interest was acquired by the financial holding company if— (A) The financial holding company held the share, asset, or ownership interest under this part; and (B) The financial holding company holds an interest in the acquiring company under this part. (3) Interests previously held by a financial holding company under limited authority. (4) Approval required to hold interests held in excess of time limit. (i) Be submitted to the Board at least 90 days prior to the expiration of the applicable time period; (ii) Provide the reasons for the request, including information that addresses the factors in paragraph (b)(5) of this section; and (iii) Explain the financial holding company's plan for divesting the shares, assets or ownership interests. (5) Factors governing Board determinations. (i) The cost to the financial holding company of disposing of the investment within the applicable period; (ii) The total exposure of the financial holding company to the company and the risks that disposing of the investment may pose to the financial holding company; (iii) Market conditions; (iv) The nature of the portfolio company's business; (v) The extent and history of involvement by the financial holding company in the management and operations of the company; and (vi) The average holding period of the financial holding company's merchant banking investments. (6) Restrictions applicable to investments held beyond time period. (i) For purposes of determining the financial holding company's regulatory capital, apply to the financial holding company's adjusted carrying value of such shares, assets, or ownership interests a capital charge determined by the Board that must be: (A) Higher than the maximum marginal Tier 1 capital charge applicable under the Board's capital adequacy rules or guidelines ( see (B) In no event less than 25 percent of the adjusted carrying value of the investment; and (ii) Abide by any other restrictions that the Board may impose in connection with granting approval under paragraph (b)(4) of this section. § 1500.4 How are investments in private equity funds treated under this part? (a) What is a private equity fund? (1) Is formed for the purpose of and is engaged exclusively in the business of investing in shares, assets, and ownership interests of financial and nonfinancial companies for resale or other disposition; (2) Is not an operating company; (3) No more than 25 percent of the total equity of which is held, owned or controlled, directly or indirectly, by the financial holding company and its directors, officers, employees and principal shareholders; (4) Has a maximum term of not more than 15 years; and (5) Is not formed or operated for the purpose of making investments inconsistent with the authority granted under section 4(k)(4)(H) of the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(H)) or evading the limitations governing merchant banking investments contained in this part. (b) What form may a private equity fund take? (c) What is the holding period permitted for interests in private equity funds? In general. (2) Request to hold interest for longer period. (3) Application of rules. (d) How do the restrictions on routine management and operation apply to private equity funds and investments held through a private equity fund? (2) Private equity funds controlled by a financial holding company. (3) Private equity funds that are not controlled by a financial holding company. (4) When does a financial holding company control a private equity fund? (i) Serves as a general partner, managing member, or trustee of the private equity fund (or serves in a similar role with respect to the private equity fund); (ii) Owns or controls 25 percent or more of any class of voting shares or similar interests in the private equity fund; (iii) In any manner selects, controls or constitutes a majority of the directors, trustees or management of the private equity fund; or (iv) Owns or controls more than 5 percent of any class of voting shares or similar interests in the private equity fund and is the investment adviser to the fund. § 1500.5 What aggregate thresholds apply to merchant banking investments? (a) In general. (1) 30 percent of the Tier 1 capital of the financial holding company; or (2) After excluding interests in private equity funds, 20 percent of the Tier 1 capital of the financial holding company (b) How do these thresholds apply to a private equity fund? (c) How long do these thresholds remain in effect? § 1500.6 What risk management, record keeping and reporting policies are required to make merchant banking investments? (a) What internal controls and records are necessary? General. (i) Monitor and assess the carrying value, market value and performance of each investment and the aggregate portfolio; (ii) Identify and manage the market, credit, concentration and other risks associated with such investments; (iii) Identify, monitor and assess the terms, amounts and risks arising from transactions and relationships (including contingent fees or contingent interests) with each company in which the financial holding company holds an interest under this part; (iv) Ensure the maintenance of corporate separateness between the financial holding company and each company in which the financial holding company holds an interest under this part and protect the financial holding company and its depository institution subsidiaries from legal liability for the operations conducted and financial obligations of each such company; and (v) Ensure compliance with this part. (2) Availability of records. (b) Certain additional recordkeeping and reporting requirements for merchant banking investments are set forth in the Board's Regulation Y, 12 CFR 225.175. § 1500.7 How do the statutory cross marketing and sections 23A and B limitations apply to merchant banking investments? Certain cross-marketing limitations and limitations under sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c, 371c-1) applicable to merchant banking investments are set forth in the Board's Regulation Y, 12 CFR 225.176. § 1500.8 Definitions. (a) What do references to a financial holding company include? (2) Except as otherwise expressly provided, the term “financial holding company” does not include a depository institution or subsidiary of a depository institution or any portfolio company controlled directly or indirectly by the financial holding company. (b) What do references to a depository institution include? (c) What is a portfolio company? (1) That is engaged in any activity not authorized for the financial holding company under section 4 of the Bank Holding Company Act (12 U.S.C. 1843); and (2) Any shares, assets or ownership interests of which are held, owned or controlled directly or indirectly by the financial holding company pursuant to this part, including through a private equity fund that the financial holding company controls. (d) Who are the executive officers of a company? (2) The term “executive officer” does not include— (i) Any person, including a person with an official title, who may exercise a certain measure of discretion in the performance of his duties, including the discretion to make decisions in the ordinary course of the company's business, but who does not participate in the determination of major policies of the company and whose decisions are limited by policy standards fixed by senior management of the company; or (ii) Any person who is excluded from participating (other than in the capacity of a director) in major policymaking functions of the company by resolution of the board of directors or by the bylaws of the company and who does not in fact participate in such policymaking functions. (e) What is the Board? (f) How are other terms that are used in this part defined?