BHC Investment Advisory Activities

The Federal Reserve Board's Regulation Y includes investment advisory services in its "laundry list" of permissible nonbanking activities for bank holding companies. Until last year, Reg Y permitted holding companies to act as financial or investment adviser "to the extent of" certain specified activities. With the rapid evolution of the investment advisory industry, there sometimes was uncertainty as to whether new forms of this activity were permitted under Reg Y without the need for a separate order from the Fed. Reg Y also permitted bank holding companies to provide discretionary investment advisory services, but only to institutional clients.

As part of the Fed's overhaul of Reg Y (effective as of April 21, 1997), the definition of permissible investment advisory activities was changed to include "acting as investment or financial adviser to any person, including (without, in any way, limiting the foregoing)" various activities included as examples, rather than as limitations. A holding company now may provide investment advice relating to securities, real estate, derivatives and other assets virtually without limitation, and may exercise investment discretion for retail, as well as institutional customers.

One investment advisory activity specifically listed in amended Reg Y is "sponsoring, organizing and managing a closed-end investment company." The Fed long has recognized this as permissible under both the Glass-Steagall Act and Bank Holding Company Act. Holding companies should be aware, however, that this activity is subject to significant restrictions not specified in the newly expansive definition of permissible investment advisory activities.

The Fed has indicated that, if a bank holding company "controls" a publicly or privately offered closed-end fund, the fund will be treated as a "subsidiary" of the holding company for Bank Holding Company Act purposes. In such case, the fund will be subject to essentially the same limitations on investments and activities as apply to the holding company itself, regardless of whether the holding company has an equity ownership interest in the fund. Thus, for example, the fund must limit its investments to no more than five percent of the voting shares of any issuer. In addition, the Fed has taken the position that the assets and liabilities of such a fund must be consolidated with the holding company for capital adequacy purposes.

While the liberalization of investment advisory activities under Reg Y is a welcome development, advance planning remains necessary to address the ramifications of "controlling" an investment fund.