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4000 - Advisory Opinions
FDIC Insured Bank Acting for Purchase of Shares of
12b-1 Mutual Funds
FDIC-89-04
January 30, 1989
Pamela E. F. LeCren, Senior Attorney
Your correspondence with FDIC Regional Attorney Michael A. Tisci
inquiring as to whether Bank of *** may lawfully offer mutual funds to
its customers as "servicing agent" for the *** was forwarded to
the Washington, D.C. office of the FDIC's Legal Division for review.
According to the correspondence and agreements forwarded to this
office, Bank of *** has entered into a service agreement with ***
whereby the bank provides certain administrative services as
"servicing agent" for *** with respect to shares of any of the
*** mutual funds which the bank has purchased on behalf of its
customers at their direction. Based upon the facts and analysis as set
forth below, it is our conclusion that Bank of *** is not prohibited by
the Glass-Steagall Act from acting as servicing agent for ***.
According to the agreement forwarded to this office, acting as
"servicing agent" involves the bank in the following activities:
establishing and maintaining shareholder accounts and records on behalf
of its customers who become *** clients; assisting these customers
to
{{4-28-89 p.4389}}change their dividend options, account
designations, and addresses; processing purchase and redemption
transactions, providing periodic statements and reports showing
customer account balances; arranging for bank wires; providing
subaccounting; and providing such other information and services as ***
may request. The bank will provide the office space, equipment,
telephones, and personnel necessary to fulfill its responsibilities
under the agreement. The bank will act solely as agent on behalf of its
customers, without recourse, in entering into any purchase or sale
transaction and will not purchase any shares of the *** funds as
principal nor finance customer purchases. Transactions will be
confirmed in writing directly to the customer and securities will be
delivered directly from the transfer agent to the customer "unless
other arrangements are made by [the bank]."
The bank will deliver prospectuses to customers as well as other
materials (proxy solicitations, annual reports etc.) prepared by ***.
The bank will not make unsolicited mailings or distributions of
prospectuses, promotional materials, or sales literature and will not
give out information or materials other than those supplied by ***. The
bank will not give investment advice or do investment research and will
neither endorse nor recommend the purchase of any *** shares. The bank
will make no representations with respect to the funds other than those
set forth in prospectuses, promotions, and sales literature supplied by
***. The bank will disclose in writing to its customers prior to
entering into any purchase transactions on behalf of its customers that
the "[f]und shares are sold and distributed by ***, and made
available by the Bank of *** as service agent" and that "*** is
not a bank, and the mutual fund shares it distributes are not
obligations of or guaranteed by any bank, nor are they insured by the
FDIC." The bank will make a similar disclosure in all of its
marketing materials which advertise the availability of *** fund shares
through the bank.
The service agreement provides that the bank is not acting as agent
for any of the funds; that the agreement does not establish any
partnership or joint venture between *** and the bank for the sale and
distribution of shares in the funds; and that the agreement does not
constitute an exclusive arrangement. Under the agreement, if payment
for any purchase order is not received in accordance with the terms of
the applicable fund prospectus *** may cancel the sale and hold the
bank responsible for any loss *** sustains as a result
thereof. 1
The bank will be compensated by *** for the administrative services
the bank provides in accordance with the terms of each fund prospectus.
All of the funds are so-called 12b-1 funds as they are permitted under
Rule 12b-1 promulgated pursuant to section 12b of the Investment
Company Act of 1940 (15 U.S.C. § 80a-1) to use their assets to
compensate third parties for services in connection with the sale or
distribution of shares. The 12b-1 fees are based upon the average daily
net asset value of the customers' shares.
Section 21 of the Glass-Steagall Act (12 U.S.C. 378) provides in
relevant part that it shall be unlawful for:
[A]ny person, firm, corporation, association, business trust,
or other similar organization, engaged in the business of issuing,
underwriting, selling, or distributing, at wholesale or retail, or
through syndicate participation, stocks, bonds, debentures, notes or
other securities, to engage at the same time to any extent whatever in
the business of receiving deposits . . . Provided, that
the provisions of this paragraph shall not prohibit national banks or
state banks or trust companies (whether or not members of the Federal
Reserve System). . . from dealing in, underwriting, purchasing, and
selling investment securities to the extent permitted to national
banking associations by the provisions of Section 24 of this title
[Section 16 of the Glass-Steagall Act]. . .
Section 16 of the Glass-Steagall Act (12 U.S.C. 24 (seventh))
provides in relevant part that the business of dealing in securities
and stock by a national bank shall be limited to
{{4-28-89 p.4390}}purchasing and selling securities
without recourse solely upon the order and for the account of customers
and in no case for its own account and that such bank shall not
underwrite any issue of securities or stock except for certain listed
obligations. It has been held that securities activities permissible
under section 16 are not prohibited under section 21. 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 II").
The activities undertaken by Bank of *** pursuant to the service
agreement with *** seem to fall squarely within the literal language of
section 16. The bank undertakes to buy and redeem shares in the funds
solely as agent for its customers and not on behalf of the funds. The
bank acts at the direction of its customers and at their initiation.
The purchases and sales are without recourse. The bank does not commit
itself to sell shares in the funds on behalf of *** nor does it promote
the funds. (The bank's promotion efforts go to the availability of its
services as opposed to the promotion of the funds themselves.) In
short, the bank simply makes available to its customers a convenient
service whereby the bank essentially provides retail brokerage services
with respect to a certain family of mutual funds.
It is well established under the case law construing the
Glass-Steagall Act that retail brokerage activities are not prohibited
to banks as such activities are directly encompassed by section 16. It
has been further held that retail brokerage does not involve
underwriting or dealing in securities as such transactions do not
involve the purchase and sale of particular securities as principal.
Securities Industry Association v. Comptroller of the Currency
577 F. Supp. 252 (D.D.C. 1983), aff'd, 758 F.2d 739
(D.C.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").
The Supreme Court left open the possibility that agency transactions on
behalf of an issuer of securities might be considered underwriting for
the purposes of the Glass-Steagall Act. Schwab, at 3010 n.
17. As the bank does not act as agent on behalf of *** for the sale of
fund shares, however, there is no basis to consider the bank to be
engaged in underwriting activities.
It makes no difference under the analysis set forth in the case law
whether or not the bank holds itself out as ready to place orders in
one mutual fund, or family of funds, or in any mutual fund or other
security if requested to do so by a customer. (Nothing in the agreement
prevents the bank from placing buy and sell orders for customers in
mutual funds or other securities not underwritten or distributed by
***.) In either case, the bank's profits are based upon the volume of
transactions and not upon the value of any particular security which is
purchased or sold. None of the bank's assets are at risk because of the
transaction nor are any of its assets subject to the vagaries of the
securities markets. Although it might be arguable that the receipt of
fees from a 12b-1 mutual fund which are generated as a result of, or in
connection with, the sale and distribution of shares in the fund
involves the recipient in distribution activities, we do not feel that
the receipt by a bank of such fees necessarily causes the bank to be
involved in the distribution of securities provided that the fees
reflect the customary value of the bank's administrative services. In
short, if the bank neither promotes the fund, nor solicits purchasers
for the fund, and the bank's compensation can legitimately be said to
be for administrative services (i.e., the bank is not being
compensated for taking the sales risk of a distributor) then collecting
12b-1 fees should not involved the bank in distribution activities.
We recognize that agreements such as the one entered into by Bank of
*** can present certain conflicts or "subtle hazards". For
example, if bank employees receive "incentive awards" for
customer referrals which result in the placement of a purchase order
for fund shares 2
employees may solicit purchasers or recommend the purchase of shares in
the fund.
{{4-28-89 p.4391}}If customers are solicited and/or bank
employees make recommendations, the bank's reputation may suffer if the
investment goes sour. While we are not necessarily saying that a bank
cannot devise some sort of program to ensure the cooperation of its
employees in making the bank's customers aware of its services, we do
mean to emphasize that steps need to be taken to ensure that the bank
and its employees neither promote the funds nor recommend purchases.
Likewise, a bank that enters into this type of agreement with a 12b-1
fund may have an incentive to purchase shares in the fund on behalf of
its trust customers. 3
Such incentive should be minimal, however, since the bank's
compensation would be limited to the amount customary for the services
it performs and the basic principles of fiduciary obligation will
prevent self-dealing.
The potential for these conflicts, however, does not transform the
activity undertaken by the bank into one prohibited by the
Glass-Steagall Act. Although a subtle hazards analysis is typically
performed by the courts when construing any particular activity in
light of the Glass-Steagall Act, the existence of one or more of the
hazards sought to be prevented by the Glass-Steagall Act will not in
and of itself cause an activity to be prohibited by the Act.
Bankers Trust II, at 1069.
In closing we would like to remind you that the bank should
familiarize itself, and comply with, Part 344 of the FDIC's regulations
(12 C.F.R. 344) "Recordkeeping and Confirmation Requirements for
Securities Transactions". Although the notification requirements of
section 344.4 will be met if *** confirms directly to the customer and
the confirmation contains the information required by paragraph (a)(2)
of that section, technically speaking the bank is obligated under Part
344 to ensure that *** sends out the confirmation. Lastly, we suggest
that you make inquiry with the Securities and Exchange Commission in so
far as your question regarding whether the bank's employee who is
responsible for purchases, redemptions and all record keeping systems
is required to be a registered
representative.
1 It is our understanding based upon a telephone conversation
that the bank will only place orders for fund shares on a "cash
basis", i.e., the bank will either debit the accounts of
existing customers in the proper amount or will place a purchase order
paid for by check after the check has cleared. Customers are apprised
that if they pay by check their order will not be placed until the
funds clear. Go Back to Text
2 We note that the bank has established a program whereby 15%
of the compensation it receives from *** is set aside to divide among
employees "for referrals that they make which result in a purchase
or for simply assisting a customer who walks into the branch to inquire
about our mutual fund program." The bank's employees have been
divided into five pools or teams for the purpose of the incentive
program. "When a customer invests in a particular mutual fund, any
subsequent investments in that same fund (account) will be credited to the
pool of the employee who made the original referral." Go Back to Text
3 According to your correspondence, Bank of *** does not
operate a trust department. There is no concern, therefore, with regard
to Bank of *** making purchases of fund shares on behalf of fiduciary
account. Likewise, as Bank of *** will not make any purchases of the
funds for its own account in way of an investment, nor make loans to
its customers for the purpose of acquiring shares of the funds, there
is little risk that the bank will act imprudently in lending or
managing its investment portfolio in order to increase the service fees
it receives from ***. Likewise, there would seem to be little concern
that the bank would make imprudent investments in bonds and other
securities in which the funds invest, or make imprudent loans to
companies whose securities are held by the funds, in order to maintain
or improve the value of fund assets, and thus the funds, in order to
stimulate customer interest in purchases. Any trading or loan
activities on the part of the bank would be unlikely to affect the
value of any fund due to the large number of bonds and securities
typically invested in by a mutual fund. In any event, the cost to the
bank of such an action would not be justified by the bank's
remuneration for its administrative services. Go Back to Text
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