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4000 - Advisory Opinions
Insured Nonmember Bank May Participate in Investment
Services Program Without Violating the Glass-Steagall Act
FDIC-83-21
December 9, 1983
Pamela E. F. LeCren, Senior Attorney
The following is in response to your request that the FDIC review
and comment upon an investment services program offered by your client,
* * *. * * * is a registered securities broker and registered
investment adviser that presently offers investment services through
"subscribing" 1
savings and loan institutions and mutual savings banks. * * * would
like to offer the services, known as "Invest", through insured
nonmember banks and is hereby seeking FDIC's approval of nonmember bank
participation in the Invest program.
According to the documents submitted to this office, * * * is a
wholly-owned subsidiary of * * *, which is in turn owned by
approximately 30 savings and loan associations and a
{{4-28-89 p.4140}}number of mutual savings banks. The
Federal Home Loan Bank Board on May 6, 1982 approved the formation of
the holding company and its subsidiary after finding, among other
things, that the services to be offered by ISFA through its subsidiary
were not in violation of the Glass-Steagall
Act. 2
Those services and the manner in which a "subscribing"
institution participates are more fully set forth
below. 3
Background:
As stated above, * * * is a registered broker/dealer and adviser
and as such offers investment advice to, and executes securities
transactions for, its customers. Customers are serviced at Invest
Service Centers which are established on the premises of subscribing
institutions. At present, Invest Service Centers only purchase and sell
equity securities, debt securities, municipal securities, and mutual
fund shares. Invest Service Centers will not effect commodity futures
or commodity option transactions for customers; will not effect
transactions for fiduciary accounts of subscribing institutions; nor
handle discretionary accounts. * * * does not purchase securities for
its own account nor does it engage in any underwriting activities.
Investment advice is standardized, i.e., is formulated by
* * * main office personnel. Invest Service Center employees are not
authorized to offer investment advice which differs from that generated
by the main office. Investment recommendations will vary according to
"classes" of customers. A customer is assigned to a class by main
office personnel. * * * will, at the customer's request, effect
transactions not recommended for the customer's "class" but will
make clear that such transactions have not been approved for that
customer. Portfolio evaluations are made by main office personnel.
Each Invest Service Center is clearly identified as such and is
located in an area of the subscribing institution that is readily
distinguishable from the areas in which the banking business of the
subscribing institution is conducted. All Invest advertisements and
promotional material disseminated by the institution must be approved
in advance by * * * and must clearly state that the investment and
advisory services are being provided by * * * and not by the
subscribing institution. Each Invest customer is given a notice that
he/she must sign which indicates that the securities services are being
offered by, and are the sole responsibility of, * * * and * * *
clearing broker. Monthly account statements, which are received by each
Invest customer from * * * clearing broker, make clear that
securities services are furnished by * * *.
Invest Service Centers do not carry customer accounts nor hold funds
or securities for customers. Whenever a customer wishes to purchase
securities, the customer will send the funds directly to the clearing
broker who will forward the securities directly to the
customer
{{4-28-89 p.4141}}or the customer's designated
depository. Conversely, whenever a customer wishes to sell securities,
the customer places those securities in a "mailer" for shipment
to the clearing broker. The broker again sends the proceeds of the sale
directly to the customer.
Each Invest Service Center is staffed by at least two * * *
registered representatives who will be dual employees of the
subscribing institution. These individuals must enter into an
employment agreement with * * * specifying, among other things, that
* * * will have exclusive control over that employee's * * *
related securities activities and that the dual employee will strictly
adhere to * * * Compliance and Procedure Manuals. Additionally, the
Subscribers Contract (article 10, paragraph (d)) indicates that the
subscribing institution shall strictly honor * * * control
relationship with the dual employee and shall not have any involvement
whatsoever in any of the securities brokerage and investment advisory
services performed by the dual employee. Although the Subscribers
Contract (article 10, paragraph (e)) provides that the subscribing
institution is required to report to * * * any violation of law,
rule, or regulation or any violation of * * * standards of conduct on
the part of the dual employee of which the subscribing institution has
knowledge, the contract provides that the institution has no obligation
to monitor the dual employee's conduct or to cause such employee to
comply with * * * Compliance and Procedure Manuals.
The dual employee is compensated by the subscribing institution
"which payment may be subject to partial or complete reimbursement
by * * * ". (See article 10, paragraph (a) of Subscribers
Contract). The subscribing institution is liable for all the dual
employee's fringe benefits. Neither * * * nor the subscribing
institution may compensate any dual employee, either directly or
indirectly, based upon the volume of securities transactions, the
amount of commissions, or the amount of revenue sharing payments
generated by the dual employee. (See article 10, paragraph (a) of
Subscribers Contract.) The contract also contains an indemnification
clause which provides that * * * will indemnify the subscribing
institution against all losses, claims, damages, liabilities, etc. that
arise from any act of a dual employee while acting as a registered
representative of Invest.
* * * will make monthly Revenue Sharing Payments to the
subscribing institution. Revenue Sharing Payments represent
reimbursement for compensation of the dual employees and payment for
the use of the facilities and equipment of the subscribing institution
that are necessary for the operation of the Invest Service Center.
* * * reserves the right under the Subscribers Contract (article 9,
paragraph (b)(ii)) to deduct from Revenue Sharing Payments a portion of
all losses, cost and expenses, if any, incurred directly or indirectly
by * * * as a result of the failure of any Invest customer to meet
any obligation to deliver funds or securities or to meet any margin
call. The institution's portion of any loss "shall be equal to the
percentage of Revenue Sharing Payments payable to [the institution] .
. . on the date of the event giving rise to such loss . . . [but]
shall in no event exceed the amount of payments payable . . . to the
[institution] with respect to securities transactions occurring after
* * * shall have incurred the
loss." 4
The * * * compliance manual directs that non-dual employees of the
subscribing institution must not proffer or otherwise disseminate
investment recommendations to customers or other persons nor engage in
any conversations with customers or other persons that might be
construed as a securities sales conversation. Non-dual employees may
distribute, upon request, informational literature regarding the Invest
program and may inform customers and other persons that Invest is
available on the premises of the institution. Non-dual employees must
not recommend or insist that any person open an
{{4-28-89 p.4142}}account with Invest nor suggest or
imply that the Invest Program will meet any person's investment
objectives or imply that the subscribing institution has any role at
all in the provision of, or any responsibility for, the securities
services offered by * * *. The compliance manual also directs the
subscribing institution to insure that its books and records are kept
separate and distinct from all books and records of * * * maintained
on the premises of the subscribing institution.
The subscribing institution is to designate an officer to review
each new recommended securities list generated by the * * * Research
Department to determine whether there is any security on that list
issued by a company with which the subscribing institution has
established a business relationship. If such is the case, and that
relationship has resulted in, or might in the future result in, the
subscribing institution acquiring material inside information regarding
the company, * * * will make arrangements to have that security
deleted from the recommended securities list utilized by the dual
employee on the premises of that subscribing institution. The
designated officer must also immediately notify * * * should the
subscribing institution establish such a business relationship with a
company subsequent to a security being placed on the recommended
securities list.
Discussion:
We have carefully considered the question of whether or not a
nonmember bank may participate in Invest as a subscribing institution
without violating the Glass-Steagall Act and have concluded that a
nonmember bank may do so. Sections 32 and 20 of the Glass-Steagall Act
(12 U.S.C. sections 78, 377) which respectively prohibit an affiliation
between a bank and a securities firm and prohibit dual employment
between a bank and a securities firm are not contravened as under the
express language of the statute neither provision applies to a
nonmember bank. Even if section 20 applied to a nonmember bank, * * *
would not be an affiliate of the subscribing institution within the
meaning of section 20. 5
We also find that section 21 of the Glass-Steagall Act (12 U.S.C.
section 378) which prohibits a nonmember bank from selling,
distributing, underwriting, or issuing any securities other than as
provided in section 16 of the Glass-Steagall Act (12 U.S.C. 24 (7th)),
would not be violated. A nonmember bank as a subscribing institution
would not appear to be engaged in selling, distributing, underwriting,
or issuing securities within the meaning of section 21 as a result of
its contractual arrangement with * * *. Even if we were to assume
that the activities in question could not lawfully be conducted by a
bank, under the circumstances as described at length above, it is and
not the bank that is buying and selling securities. The fact that a
dual employee of the bank is staffing the Invest Service Center would
not appear, under the closely defined roles established by contract and
otherwise, to cause the bank to be buying and selling
securities nor cause the bank to be in the business of
giving investment advice. Neither the bank nor any of its employees are
responsible for the development of the investment advice nor does the
bank or any of its employees represent that the bank is recommending
any investment decision. On the contrary, stringent measures are
prescribed to make Invest customers aware that * * * and not the
bank, is conducting, and is responsible for, the securities activities.
Although we feel, as indicated above, that the Glass-Steagall Act is
not a bar to nonmember bank participation in Invest, we wish to make
clear that our failure to take present objection to the Invest Program
does not constitute an endorsement. We make this statement even though
the FDIC does not at this time perceive any excessive or undue risk
arising from nonmember bank participation in Invest. That assessment,
however, could change in the future. We also reserve the right to take
issue with the manner in which any particular nonmember bank
administers the Invest program depending upon the facts in any
particular instance. Lastly, we stress that our comments are limited to
the facts as we
{{4-28-89 p.4143}}understand them to be. Should the facts
differ from that which we have described, or circumstances change in
the future, the opinions set out in this letter are subject to change.
1 A "subscribing" institution is one that has a
contractual relationship with * * * but does not have any ownership
interest in the company. Go Back to Text
2 The Federal Home Loan Bank Board's action is the subject of a
legal challenge brought by the Securities Industry Association
("SIA") in Federal District Court for the District of Columbia
(SIA v. Federal Home Loan Bank Board, Civil
Action No. 82-1920, D.D.C. July 12, 1982). SIA alleges in its complaint
that the Federal Home Loan Bank Board's decision to approve the
application was arbitrary and capricious; that the brokerage and
investment services provided by * * * are activities not permitted to
savings and loan association service corporations under the Home Owners
Loan Act; and that * * * brokerage and investment activities are
contrary to section 21 of the Glass-Steagall Act. Summary judgment
motions are presently before the Court. We reserve the right to amend
our comments should SIA's legal challenge be upheld and if the basis
for the Court's opinion has any material effect on the substance of
this opinion. Go Back to Text
3 In addition to your letters of August 15, 1983 and August 18,
1983, your office submitted the following documents for our review: The
Federal Home Loan Board's May 6, 1982 Order; a legal opinion of the
Federal Home Loan Bank Board's General Counsel concerning the
application; the July 8, 1982 no action letter from the Securities and
Exchange Commission; a November 2, 1982 memorandum submitted to the
Securities and Exchange Commission re: the need for the owner savings
and loan associations to register as broker/dealers; the * * *
Employment Agreement; the Invest Subscribers Contract; a number of
* * * promotional materials; and the final draft of a legal
memorandum prepared by counsel representing * * * before the Federal
Home Loan Board discussing the Invest services in the context of the
Home Owners Loan Act, the Securities laws, and the Glass-Steagall Act.
The representations contained in these documents serve as the basis for
our description of * * * and the Invest Program as well as the basis
for our comments which follow. Go Back to Text
4 We wish to mention in passing that the provision for
reduction of Revenue Sharing Payments was carefully reviewed in light
of Part 332 of FDIC's regulations which prohibits a nonmember bank from
guaranteeing the obligations of others. We are satisfied, however, that
even though the bank shares in any losses, costs, or expenses * * *
incurs as a result of a customer's failure to deliver funds or
securities, the bank is not "guaranteeing" the obligation of the
customer. The bank's portion of the loss under the contract can be
construed as a cost of doing business especially as its liability is
limited to the amount of revenue due it from transactions occurring
subsequent to the loss. In short, the bank's future income is reduced
but no assets of the bank are subject to any claim by * * *. Go Back to Text
5 "Affiliate" for the purposes of section 20 of the
Glass-Steagall Act is defined as set out in 12 U.S.C. 221a(b). That
provision contains several alternative ways in which a company can be
considered an affiliate of a bank all of which require some percentage
of stock ownership or the ability to control in any manner the election
of a majority of a company's directors none of which are present
here. Go Back to Text
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