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4000 - Advisory Opinions
Bank Transactions with Affiliated Securities
Companies
FDIC-88-39
May 23, 1988
Pamela E. F. LeCren, Senior Attorney
This is in response to your letter dated March 31, 1988 to Regional
Director Anthony Scalzi concerning the applicability of section 337.4
of the Federal Deposit Insurance Corporation's rules and regulations
(12 C.F.R. 337.4) to the contemplated formation of an investment
advisory subsidiary corporation by an unnamed insured state chartered
nonmember bank. Our comments, which follow, must be general as your
letter provides few if any details regarding the proposed subsidiary
and its operation.
According to your letter, it is the bank's intent to form a
subsidiary which will conduct business from the bank's lobby. The
subsidiary will be a registered investment adviser and will offer
financial planning and investment advisory services to the bank's
customers. Your letter indicates that the subsidiary will not offer
securities brokerage services either in the capacity of a broker-dealer
or an underwriter but will employ one or more registered
representatives of an unrelated broker-dealer who will sell securities
to the bank's customers. These sales will be made solely upon the order
and for the account of the bank's customers.
Section 337.4 of the FDIC's regulations requires that any subsidiary
of an insured nonmember bank that engages in activities not authorized
to a bank under section 16 of the Glass-Steagall Act (12 U.S.C. 24
(Seventh)) as made applicable to insured nonmember
{{4-28-89 p.4339}}banks by section 21 of the
Glass-Steagall Act (12 U.S.C. 378) must meet the definition of a bona
fide subsidiary contained in section 337.4(a)(2) of the FDIC's
regulations. Such a subsidiary is subject to a number of prescribed
restrictions and controls. In order to respond to your question we must
determine whether the activity as described in your letter is one in
which a bank could engage under the Glass-Steagall Act. If so, the
bank's subsidiary will not be required to meet the definition of a bona
fide subsidiary or be subject to the transaction restrictions or
disclosure requirements contained in section 337.4. Even if these
provisions of the regulation are not applicable, however, the bank must
still give the FDIC 60 days advance notice of the acquisition or the
establishment of the subsidiary as the notice requirements of the
regulation are broader than the remaining provisions of the regulation.
Analysis
Section 16 of the Glass-Steagall Act provides that:
The business of dealing in securities and stock by [a bank]
shall be limited to the purchasing and selling. . .of securities and
stock without recourse, solely upon the order, and for the account of
customers, and in no case for its own account, and the [bank] shall
not underwrite any issue of securities or stock.
Section 21 of the Glass-Steagall Act prohibits any company that
engages in the issuance, public sale, distribution or underwriting of
securities from also taking deposits. It excepts from its coverage,
however, securities activities otherwise permissible to national banks
under section 16. (Securities Industry Association v. Board of
Governors of the Federal Reserve System, 807 F.2d 1052 (1986),
cert. denied, 107 S.Ct. 3228 (1987) ("Bankers Trust"),
securities activities permissible under section 16 are not prohibited
under section 21.)
Neither section 16 nor section 21 on its face extends to the giving
of financial planning advice or investment advice. The Supreme Court
has indicated that the activities of an investment adviser are not
significantly different from the fiduciary activities traditionally
conducted by banks (Board of Governors v. Investment Company
Institute, 450 U.S. 46, 63 (1981), ("Board of Governors"))
and that the language in section 21 covering the issuance,
underwriting, sale, or distribution of securities is "hardly the
sort of language that would be used to describe an investment
adviser." (Board of Governors at 63, n.
32). 1
It is clear, therefore, that investment advisory services in and of
themselves are not encompassed by the
Act. 2
{{4-28-89 p.4340}}
Section 16 of the Glass-Steagall Act also does not prohibit retail
brokerage activities as such activities fall squarely within the
permissive language of that section, i.e., involve the
purchase and sale of securities upon the order and for the account of a
customer without recourse. Retail brokerage does not involve
underwriting or dealing (such transactions do not involve the purchase
and sale of particular securities as principal), does not contravene
the prohibition on the public sale of securities found in the
Glass-Steagall Act, and does not present the subtle hazards which were
identified by Congress as arising from the promotional pressures
associated with the buying and selling of securities for one's own
account. Securities Industry Association v. Comptroller of the
Currency, 577 F. Supp. 252 (D.D.C. 1983), aff'd. 758 F.
2d 739 (D.D. Cir. 1985), cert. denied, 106 S.Ct. 790 (1986);
Securities Industry Association v. Board of Governors of the
Federal Reserve System, 104 S.Ct. 3003 (1984) ("Schwab").
A recent opinion of the D.C. Circuit Court of Appeals held that
combining securities brokerage services with investment advice does not
contravene section 20 of the Glass-Steagall
Act. 3
(Securities Industry Association v. Board of Governors, 281
F.2d 810 (1987), cert. denied, 108 S.Ct. 697 (1988)
("Nat. West")). The Court reasoned upon reviewing Schwab
and Board of Governors that "The proposed
activities. . ., for purposes of determining the scope of the term
public sale', are simply undistinguishable from the activities
described in Schwab. The sole distinction cited by SIA is
that CSC will also provide investment advice [in addition to retail
brokerage]. We cannot understand, however, why this should transform
the proposed activities into the public sale of securities."
NatWest at 814. The Court went on to state that "The
addition of investment advice to brokerage activities does not
implicate any of the activities which the Schwab Court
described as traditionally associated with underwriting"
(NatWest at 814) an activity which gives rise to the subtle
hazards which can pose a threat to banks. Finally, although the Court
found it unnecessary to do a subtle hazards analysis as the activity in
question did not involve holding securities for investment or buying
and selling securities as principal (NatWest at 816) the
Court reviewed the facts and determined that (1) NatWest would have no
salesman's stake in any particular security, (2) Congress did not
intend the Glass-Steagall Act to address any concerns that may arise
from investment advisory activities, and (3) that in any event the
added provision of execution services would not increase those
concerns. 4
Conclusion
The combination of investment advice and brokerage services, if
offered by a bank, will not result in a violation of section 21 of the
Glass-Steagall Act provided that: (1) the bank buys and sells
securities solely upon the order, and for the account of, its customers
without recourse and not for its own account, (2) the bank has no
salesman's stake in the sale of particular securities, and (3) the bank
does not engage in the public offering of securities, does not purchase
securities for resale on its own behalf as principal, act as agent on
behalf
{{4-28-89 p.4341}}of an issuer to sell securities, or
otherwise underwrite or distribute securities. Such a subsidiary of an
FDIC-Insured state nonmember bank would not be required to meet the
bona fide requirements of section 337.4 nor would such a subsidiary be
bound by the transaction restrictions or disclosure requirements of
that section. As noted previously, however, even if these provisions do
not apply, the regulation still applies insofar as the 60-day advance
notice of the acquisition or establishment of the subsidiary is
concerned.
Inasmuch as your inquiry did not provide this office with details
regarding the proposed subsidiary and it will operate, we are
unfortunately unable to render a more specific opinion in response to
your inquiry. Should you wish to pursue this matter, please provide
this office with as much detail as possible concerning the subsidiary
and its proposed operation. We are specifically interested in the
following information: (1) what type of investments does the subsidiary
intend to recommend to the bank's customers, (2) how will the
subsidiary be compensated, (3) will the subsidiary be compensated
separately for the investment advice and the brokerage services, (4)
how will the registered representatives be compensated, (5) will the
subsidiary have any investment discretion with respect to any of the
purchases, (6) will the investment advice be general or specific as to
particular securities, (7) how many securities or types of investments
will be the subject of the subsidiary's recommendations, (8) what will
be the relationship, if any, between the bank and the subsidiary, (9)
will the advice be given to customers on the commercial side of the
bank, the trust side, or both, (10) what if any disclosures will the
subsidiary make concerning the extent to which the bank is responsible
for the advice and brokerage services, (11) will the bank finance
customer purchases, and (12) what will be the relationship between the
subsidiary and the unrelated broker-dealer with which the subsidiary's
registered representatives employees are to be registered. In addition,
we would also like any other information that is relevant to the issues
raised in the above discussion.
1 The Board of Governors case involved a challenge
by the Investment Company Institute to a Federal Reserve Board
regulation permitting bank holding companies and their nonbank
subsidiaries to act as investment advisers to closed end mutual funds.
The Institute claimed that the regulation was contrary to the Bank
Holding Company Act and the Glass-Steagall Act. The Supreme Court
upheld the Federal Reserve Board's regulation finding that the
activities in question were consistent with the Bank Holding Company
Act and were not prohibited by the Glass-Steagall Act. The Court
indicated that "To invalidate the Board's regulation [we would
have] to assume that the activity of managing investments for a
customer had been regarded by Congress as an aspect of investment
banking rather than an aspect of commercial banking. But the Congress
that enacted the Glass-Steagall Act did not take such an expansive view
of investment banking." Board of Governors, at 71. Go Back to Text
2 The Supreme Court also has observed that "none of [the]
more subtle hazards [associated with securities activities] would be
present were a bank to act as an investment adviser. . .subject to
the restrictions imposed by the Board." Board of Governors
at 67. Those restrictions were that neither the bank holding
company nor any of its bank or nonbank subsidiaries could: (1) purchase
for their own account, or for the account of a customer in the capacity
as fiduciary, securities issued by the investment company being
advised, (2) extend credit to such an investment company, (3) accept
securities issued by such an investment company as collateral on a loan
made for the purpose of acquiring the securities, and (4) directly or
indirectly engage in the distribution or sale of securities issued by
such an investment company. Restrictions were also set on the
distribution of prospectuses and sales literature through the bank
holding company and its bank and nonbank subsidiaries, referrals of
bank customers to the investment company, the expression of opinions by
bank officers or employees as to securities issued by the investment
company, the sharing of offices and/or a similar name by the bank and the investment company, and giving the
depositor list for any bank subsidiary of the holding company to the
investment company. The Court noted that these restrictions would
"preclude the promotional pressures that are inherent in the
investment banking business . . .[and]. . .would prevent to a
large extent the association in the public mind between the bank and
the investment company as well as the resulting connection between
public confidence in the bank and the fortunes of the investment
company." Board of Governors at 67. Go Back to Text
3 Section 20 of the Glass-Steagall Act (12 U.S.C. 377)
prohibits the affiliation of member banks of the Federal Reserve System
with companies engaged principally in the issuance, underwriting,
public sale, or distribution of securities. As both sections 21 and 20
cover the same type of activities (i.e. issuing,
underwriting, distribution, and public sale) cases construing the
operative language of section 20 are equally relevant in determining
the application of section 337.4 of the FDIC's regulations. Go Back to Text
4 "A contrary holding, that the potential for these hazards
[unsound loans to issuers of securities recommended to customers,
recommending securities issued by bank customers who have outstanding
bank loans, loss of bank's reputation for prudence if recommended
securities perform poorly] is sufficient to render an activity
unlawful, would render all investment advisory activities, including
those traditionally performed by trust departments, unlawful."
NatWest at 817. Go Back to Text
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