|
[Main Tabs]
[Table of Contents - 5500]
[Index]
[Previous Page]
[Next Page]
[Search]
5500 - General Counsel's Opinions
THE LEGALITY OF DISCOUNT BROKERAGE SERVICES WHEN OFFERED BY
INSURED NONMEMBER BANKS
General Counsel's Opinion No. 6
The FDIC has received numerous inquiries from insured nonmember
banks and their counsel asking whether or not it is lawful for an
insured nonmember bank to offer discount brokerage services to its
customers. The inquiries primarily focus on the lawfulness of
contractual arrangements between banks and unrelated discount brokers
whereby the discount broker executes securities transactions for bank
customers and the bank shares in the commissions generated by the
transactions. A response to those questions necessarily involves an
inquiry into the permissible scope of an insured nonmember bank's
direct securities activities under the Banking Act of 1933 (popularly
known as the Glass-Steagall Act and codified in several sections of the
United States Code). The Glass-Steagall Act is
{{6-28-93 p.5523}}generally recognized as
separating the business of banking from that of investment banking
(i.e., the securities business). Most of what is the
Glass-Steagall Act applies solely to member banks of the Federal
Reserve System. (See section 20 (prohibiting the affiliation of
member banks and companies engaged principally in the issue,
floatation, underwriting, public sale, or distribution of stocks,
bonds, debentures, notes or other securities, 12 U.S.C. 377) and
section 32 (prohibiting officers, directors, or employees of companies
primarily engaged in the issue, floatation, underwriting, public sale,
or distribution of stocks, bonds, or similar securities, or partners or
employees of a partnership so engaged, from serving as directors,
officers, or employees of member banks, 12 U.S.C. 78)).
Section 21 of the Glass-Steagall Act (12 U.S.C. 378) is applicable,
however, to member and nonmember banks alike. Section 21 provides, in
part, that it shall be unlawful for, any person, firm, corporation,
association, business trust, or other similar organization, engaged in
the business of issuing, underwriting, selling, or distributing
*** stocks, bonds, debentures, notes or other securities,
to engage at the same time to any extent whatever in the business of
receiving deposits ***.
Section 21 further provides, however, that nothing therein should be
read to prohibit "*** State banks ***
whether or not members of the Federal Reserve System) ***
from dealing, underwriting, purchasing, and selling investment
securities to the extent permitted to national banking associations by
the provisions of section 24 of this title." Section 24(7th) of
title 12 of the United States Code (hereinafter referred to as section
16 of the Glass-Steagall Act) limits "the business of dealing in
securities and stock *** to purchasing and selling such
securities and stock without recourse, solely upon the order, and for
the account of, customers ***." Section 16 ends with
the proviso that a national banking association (and thus a nonmember
bank) may purchase certain listed investment securities for its own
account.
A nonmember bank may therefore, consistent with the Glass-Steagall
Act, purchase and sell securities for the account of a customer if it
is without recourse and solely upon the order of the customer. It is
the opinion of the Legal Division of the FDIC, after reviewing the
language of the statute, current case law interpreting the
Glass-Steagall Act, and the Act's legislative history, that
"discount brokerage" is a permissible activity falling within the
language of section 16. By the term "discount brokerage" we are
referring to the practice by a bank of executing securities
transactions solely at the direction of a bank customer but not
providing that customer with any investment advice.
As explained in the senate report accompanying the Glass-Steagall
Act, section 16 would permit national banks "to purchase and sell
investment securities for their customers to the same extent as
heretofore ***." S. Rep. No. 77, 73rd Cong., 1st Sess.
16 (1933). National banks were engaged in brokerage type activities
prior to the enactment of the Glass-Steagall Act and their involvement
in such activities had been judicially recognized. ( See Blakley
v. Brinson, 286 U.S. 254 (1932); McNair v. Davis, 68
F.2d 935 (5th Cir.), cert. denied 292 U.S. 647 (1934); and
Block v. Pennsylvania Exchange Bank, 253 N.Y. 227, 170 N.E.
900 (1930)). Bank trust departments also had traditionally performed
brokerage functions with regard to trust accounts administered by
banks. Therefore in our opinion both the legislative history of section
16 and the historical involvement of banks in brokerage activities
support the conclusion that a nonmember bank is not prohibited from
engaging in discount brokerage activities as defined above.
Further support for the opinion that discount brokerage activities
are a permissible activity for banks can be found in court decisions
construing the Glass-Steagall Act. As early as 1947 the Supreme Court,
in determining whether a securities firm was "primarily engaged"
in securities activities covered by section 32 of the Glass-Steagall
Act, did not give any weight to the firm's substantial brokerage
activities. Board of Governors of the Federal Reserve System v.
Agnew, 329 U.S. 441 (1947). Implicit in that decision, and the
later observations of the Court concerning section 16, is the premise
that the Glass-Steagall Act is not concerned with activities in which
banks traditionally engaged which do not raise the types of hazards
sought to be addressed by the Glass-Steagall Act.
{{6-28-93 p.5524}}
As recognized by the Supreme Court in Investment Company
Institute v. Camp, 401 U.S. 617, 630-634 (1971), the legislative
history of the Glass-Steagall Act reflects concern that a bank might be
harmed by its direct or indirect involvement in certain securities
activities. Those hazards included the possibility that: (1) The
association of the bank with a securities company affiliate could
impair public confidence in the bank if the latter performed poorly;
(2) the bank might be tempted to make unsound loans to its securities
affiliate or to companies whose securities the bank's affiliate was
underwriting; (3) bank customer goodwill could suffer if any customer
suffered losses after investing in a security associated with the bank;
(4) the bank may make unsound "purpose loans" (loans obtained for
the purpose of acquiring securities) in order to facilitate the sale of
securities in which the bank or its securities affiliate dealt; (5) the
bank's affiliate could dump poor issues into the bank's trust
department; and (6) the bank's promotional interest in the securities
would be in direct conflict with its obligation to render impartial
investment advice.
The above hazards have been found not to be present in the case of
discount brokerage. The U.S. District Court for the District of
Columbia, for example, found automatic investment services
("AIS") by banks not to violate the Glass-Steagall Act. New
York Stock Exchange v. Smith, 404 F. Supp. 1091 (D.D.C. 1975),
vacated on other grounds sub nom. New York Stock Exchange v.
Bloom, 562 F.2d 736 (D.C. Cir 1977) cert. denied, 435
U.S. 942 (1978). Under an AIS program, a bank periodically makes
purchases of equity stocks for bank customers from among a list of
corporations provided by the bank and debits the customer's account
accordingly, i.e., the service is essentially a discount
brokerage program. As stated by the lower court in New York Stock
Exchange v. Smith.
Banks offering AIS do not have a salesman's interest in the
securities performances. Since the banks do not manage the customers'
investments, they need not prove that they perform better than anyone
else. This is quite different from the situation in Investment
Company Institute, where banks were compelled to outperform mutual
funds. Under AIS, banks are in competition with investment brokers only
in terms of convenience, costs, and dependability. This sort of
competition does not engender the threat to banks' solvency which
concerned the drafters of the Glass-Steagall Act because it is
independent of any investment decision. 404 F. Supp. at 1099-1100.
Based on the foregoing, it is the opinion of the Legal Division
that discount brokerage services offered by a nonmember bank are
permissible under the Glass-Steagall Act. The legality of any
particular brokerage activity may, however, vary from circumstance to
circumstance. Discount brokerage can function in as many ways as there
are discount brokers or banks. A bank may merely introduce its
customers to the broker/dealer services of a discount broker with the
bank's subsequent involvement in any securities transaction being
limited to debiting or crediting the customer's bank account after each
securities transaction ( i.e., the customer directly
contacts the broker/dealer to initiate transactions and the
broker/dealer confirms all transactions directly with the customer). A
bank's involvement may typically increase along a continuum. For
example, the bank customer may contact the bank for price quotations,
for the placing of buy and sell orders, etc. The bank may act as a
conduit of information to the broker/dealer, with the bank confirming
transactions with the customer; the bank transmitting funds and
securities from the customer to the broker/dealer; and the bank
possibly acting as custodian for the customers' securities. In either
case the bank would receive a portion of the broker's commission
generated by each transactions.
While we obviously cannot comment on all discount brokerage programs
as the facts may vary in each, we will observe that generally speaking
the Legal Division would not cite as a violation of the Glass-Steagall
Act a program in which: (1) The bank clearly acted solely at the
customer's direction; (2) the transactions are for the account of the
customer and not the account of the bank; (3) the transactions are
without recourse; (4) the bank makes no warranty as to the performance
or quality of any security; and (5) the bank did not advise the
customer to make any particular investment decision. (Trust and agency
accounts with regard to which the bank has investment discretion are
not subject to this restriction.) Item (5) is in keeping with the
traditional role played by banks with respect to
{{2-28-95 p.5525}}investment advice. The Legal
Division is of the opinion that investment advice to bank customers is
appropriately confined to the administration of trust accounts and
should not be done on the commercial side of the bank. This separation
plays a significant role in avoiding conflicts of interest and avoiding
loss of confidence in the bank due to the performance of a particular
securities investment and thus is significant in determining that
discount brokerage services do not violate the Glass-Steagall Act.
It is further the Legal Division's opinion that the bank may
lawfully promote the discount brokerage service. The bank should assure
itself, however, that its promotional literature does not
mischaracterize the bank's role in providing the discount brokerage
service. This will serve to prevent public misconception about the
bank's function with regard to the securities investment. If the bank
intends to utilize the contractual arrangement with the broker/deal for
transactions executed in connection with trust department accounts, the
bank should not receive any additional compensation with regard to
those transactions from the broker/dealer, i.e., the bank
trust department should not share in any commission associated with the
transaction. To do so would raise possibilities of a breach of
fiduciary obligation toward the bank's trust account customers.
If a bank's discount brokerage activities are anything more involved
than merely introducing bank customers to a broker/dealer pursuant to a
contractual arrangement, the bank is advised to review and comply with
Part 344 of FDIC's regulations to the extent that they are applicable.
(12 CFR Part 344) Part 344
sets forth recordkeeping and confirmation requirements for securities
transactions. Nonmember banks are also reminded that any margin lending
engaged in with regard to the discount brokerage services must comply
with Part 221 of the Federal Reserve Board's regulations
(12 CFR Part 221) and should
fully comport with sound banking practices.
Lastly, we reiterate that while we are generally of the opinion that
discount brokerage comports with the Glass-Steagall Act whether or not
the broker/dealer through whom the transaction is executed is an
affiliate or a subsidiary of the bank, the FDIC will have to judge each
particular program on a case-by-case basis. Any discount brokerage
activities on the part of a nonmember bank must fully comport with
State law and be consistent with the powers and authorities of any
State nonmember bank as defined by State law. This opinion is not
intended to address the issue of whether or not discount brokerage
presents any conflicts of interests or any safety or soundness
concerns. That issue and others are presently being studied by the FDIC
in connection with the agency's proposed rulemaking concerning the
need, if any, to condition, restrict or prohibit securities activities
of subsidiaries of nonmember banks and the need for regulations to
govern the relationship between a nonmember bank and its securities
affiliates.
[Source: 48 Fed. Reg. 22989, May 23, 1983]
[The page following this is 5529.]
[Main Tabs]
[Table of Contents - 5500]
[Index]
[Previous Page]
[Next Page]
[Search]
|
