On April 3, the Federal Reserve Board ("Board") published
a final rule ("Rule") specifying when a financial company that may be made
subject to systemic regulation under Title I of the Dodd-Frank Wall Street
Accountability and Consumer Protection Act ("Dodd-Frank Act") is "predominantly
engaged in financial activities" for purposes of being designated for systemic
regulation under the Dodd-Frank Act. The Rule is effective on May 6, 2013.
As discussed below, the net effect of the Rule would be
to expand the types of activities that might qualify as financial activities
for purposes of applying the "predominantly engaged" test, and thus broaden the
population of large nonbank firms that might be designated as systemically
important financial firms, under the Dodd-Frank Act. Accordingly, large nonbank
financial firms should pay close attention to the Rule's requirements and its
potential impact on them.
The authority of the Financial Stability Oversight
Council (the "Council") to designate a firm as systemically important is
limited to those firms that meet the definition of "nonbank financial company"
under section 102(a)(4) of the Dodd-Frank Act. The term is limited to any firm
"predominantly engaged in financial activities." In turn, section 102(b)
charges the Board with defining the term "predominantly engaged in financial
activities" through rulemaking, but is constrained by specific statutory
requirements. Under section 102(a)(6), financial activities are those that are
financial in nature under section 4(k) of the Bank Holding Company Act
("BHCA"). Under the same provision, a company is "predominantly" engaged in
financial activities if one of two conditions exists: either (i) the annual
gross revenues derived by the company and all of its subsidiaries from
financial activities, as well as from the ownership or control of an insured
depository institution, represent 85 percent or more of the consolidated annual
gross revenues of the company; or (ii) the consolidated assets of the
company and all of its subsidiaries related to financial activities, as well as
related to the ownership or control of an insured depository institution,
represent 85 percent or more of the consolidated assets of the company.
In February 2011, the Board proposed regulations ("First
NPR") that would apply both of the 85 percent tests to each of the past two
calendar years. An institution that met either test in either of the two years
would be regarded as being "predominantly" engaged in financial activities.
This proposal provided no further explanation of "financial activity."
In April 2012, the Board revised the February 2011
proposal to address "financial activities" in greater detail, in response to
several comments on the First NPR concerning the applicability of the BHCA
restrictions on the conduct of certain financial activities, particularly
investment-related activities, by bank holding companies. The principal thrust
of the Board's Second NPR was to define a financial activity as "any activity
referenced in [BHCA] section 4(k)...without regard to conditions that were
imposed on bank holding companies that do not define the activity itself."
Conditions not applicable to the definition of "predominantly engaged" include
those "that were imposed to ensure that the activity is conducted in a safe and
sound manner, to prevent a financial holding company from controlling a
commercial firm, or to comply with another provision of law." [footnotes
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Foerster LLP. Because of the
generality of this update, the information provided herein may not be
applicable in all situations and should not be acted upon without specific
legal advice based on particular situations.
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