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4000 - Advisory Opinions
Insured Nonmember Bank May Participate in Brokerage Networking
Program Without Violating Glass-Steagall Act
FDIC-92-48
July 16, 1992
Pamela E.F. LeCren, Counsel
The following is in response to your request that the FDIC
"approve" nonmember bank participation in the brokerage
networking program [X] which is made available by ***.
The FDIC has had occasion to review a number of securities brokerage
networking programs primarily for the purpose of determining whether or
not the participation of an insured nonmember bank in such an
arrangement would cause the participating bank to be in violation of
§ 21 of the Glass-Steagall Act (12 U.S.C. 378). The first such
program reviewed by the FDIC was a program known as INVEST which is
offered by ISFA Corporation. (See FDIC staff opinion letter FDIC
83--21, December 9, 1983). Upon reviewing that program, it was the
FDIC's conclusion that participation by an insured nonmember bank in
the INVEST program would not cause the bank to be in
violation of the Glass-Steagall Act. The FDIC specifically
declined, however, to endorse the program. What is more, despite the
fact that our letter indicated that "the FDIC does not at this time
perceive any excessive or undue risk arising from nonmember bank
participation in Invest", the review undertaken by the FDIC at that
time did not constitute a complete safety and soundness review.
When subsequently asked to review securities brokerage networking
programs, the FDIC has for the most part confined itself to a
determination of whether the program would involve a violation of the
Glass-Steagall Act. If a program is found to be substantially similar
to INVEST, the conclusion necessarily follows that the program would
not involve a participating bank in a violation of the Glass-Steagall
Act.
We have on occasion commented on one particular aspect or another
regarding a program under review if something about the program
appeared to be problematical or potentially so. In that vein, FDIC
staff opinion letter FDIC 86--18, June 12, 1986, raised the possibility
that compensating bank employees who act as registered representatives
on
{{10-30-92 p.4652}}the basis of the volume of the business
generated by the representative could lead to a conflict of interest
that may be the basis for criticism by the FDIC. It was also
noted that a conflict of interest could arise if a participating bank
receives bonuses based upon the volume of business generated under the
program. Again, it was noted that this could be the basis of criticism
by the FDIC. Lastly, the same letter indicates that use by a
participating bank of the program to accomplish trades on behalf of
fiduciary accounts could raise questions as to a possible breach of
fiduciary obligation and questions of whether the bank met its best
execution obligations. The opinion raised these issues for the sole
purpose of reinforcing to the requestor that the FDIC was not endorsing
the program but was specifically reserving the right to object in the
future to the program and/or how it is operated if the circumstances so
warranted.
According to your letter, "In most material respects, the [X]
program resembles the INVEST program in its methods of operation and
respective responsibilities of [X] and the [participating] bank"
with the exception of the following:
1. Unlike INVEST, [X] shoulders the business risk that it may
incur losses as a result of customers failing to meet their
obligations;
2. A participating bank will indemnify [X] against any
liabilities [X] incurs as a result of a failure by the bank, or any
of the bank's employees who are not registered representatives, to
comply with the contract;
3. [X] will effect transactions for fiduciary accounts of a
participating bank (the bank does not receive any payment in connection
with such transactions);
4. [X] purchases bonds into inventory which are sold at a net
price if ordered by customers (this represents a very small percentage
of [X]'s business);
5. Registered representatives may recommend securities not on the
approved list if they obtain the approval of a principal in [X]'s
home office;
6. Customers are assigned to investor classes by the individual
registered representatives who are responsible for making a suitability
determination before recommending any securities (all transactions are
reviewed by a principal in [X]'s home office);
7. Registered representatives may receive cash, checks and
securities from customers for forwarding to [X] (if representatives
are not available, tellers may, where permitted by regulators, receive
and safeguard funds and securities for subsequent delivery to a
representative);
8. [X]'s contract does not require more than one registered
representative to be present at a service location; and
9. Transaction-related compensation is not prohibited under the
contract.
Based upon our review of your letter, the contracts and the
Procedures and Policy Guidelines made available to this office, we
concur with your opinion that in most respects the [X] program is
similar to the INVEST program. We concur as well with your description
of the areas in which the two programs differ. We do not find the
differences to be material in terms of deciding whether participation
in the program would involve an insured nonmember bank in a violation
of the Glass-Steagall Act. 1
We renew our comments, however, that transaction-based compensation may
be the source of criticism and that use of the program to effect trades
for the bank's fiduciary accounts may likewise be the source of
criticism. In addition, it is likely that the FDIC would find receipt
by a bank teller of cash or checks intended for a [X] registered
representative to be objectionable in view of section 328.2(c) of the
FDIC's regulations (12 C.F.R. § 328.2(c)) which prohibits an insured
bank from receiving deposits at a teller window where any uninsured
institution receives deposits or similar
liabilities. 2
You should note that FDIC examination reports are
{{2-29-00 p.4653}}the property of the FDIC and that an
insured nonmember bank may not disclose such reports, or any
information derived therefrom, without first obtaining the FDIC's
consent. You should also note that insured nonmember banks are subject
to Part 344 of the FDIC's regulations (12 C.F.R. 344) which makes the
bank responsible for recordkeeping and confirmations with respect to
securities transactions it effects. A participant bank will be expected
to comply with any applicable provisions of Part 344. Finally, you
should be aware that to the extent [X] effects deposit transactions
the operation of its program may be subject to the FDIC's rule on
brokered deposits (12 C.F.R. 337.6) which implements § 29 and § 29a
of the FDI Act.
Please be advised that, as in the similar cases in which the FDIC
has reviewed networking programs, this review does not constitute a
full safety and soundness review of the [X] program and is not an
"approval" or endorsement. What is more, our comments are based
solely upon the facts as we understand them to be based upon your June
3, 1992 correspondence. The failure or omission of this letter to raise
or comment upon any safety and soundness issue, conflict of interest,
or other such issue should not be read to constitute a conclusion on
the part of the FDIC that no such issue exists.
Finally, effective December 19, 1992 no insured state bank may
engage as principal in any activity that is not permissible for a
national bank without obtaining the FDIC's consent. Consent can only be
granted if the bank meets its capital requirements and the FDIC
determines that conducting the activity will not pose a significant
risk to the insurance fund of which the bank is a member. (See
§ 24(a) of the FDI Act (12 U.S.C. 1831(a)) as added by the Federal
Deposit Insurance Corporation Improvement Act of 1992, "FDICIA").
If a national bank would be permitted by the Office of the Comptroller
of the Currency ("OCC") to enter into the [X] arrangement, then
an insured state bank may do so without the FDIC's consent under § 24
of the FDI Act.
This office is of the opinion that it would be inappropriate for the
FDIC to determine on its own whether a national bank may enter into the
subject contract. We therefore advise you to seek an opinion from the
OCC. We will note in passing that the OCC has had occasion to review
the INVEST and other similar programs (copies of relevant opinions
enclosed) and has found several such programs to be permissible for a
national bank. [X] does appear to differ, however, in some respects
from the programs OCC has reviewed. Those differences may or may not be
material to the OCC.
We are unable to definitively comment at this time on whether the
FDIC would find participation in the [X] program to present a
significant risk to the fund. The issue of what constitutes a
significant risk to the fund is itself unsettled at this
time. 3
Until such time as that issue is resolved and the Board of Directors
delegates the power to make determinations under § 24, only the Board
of Directors has the authority to do so. Staff hopes to have a
regulation in place prior to December 19, 1992 that will, at a minimum,
resolve issues such as how to determine what is and is not permissible
for a national bank and which may establish an application procedure by
which banks may obtain the FDIC's consent to initiate or continue to
conduct activities that are impermissible for national banks. In the
meantime, you may take some comfort from the fact that to date the FDIC
has not to my knowledge prohibited insured nonmember banks from
participating in brokerage networking programs.
If you have any further question, please do not hesitate to contact
me at (202) 898-3730.
{{2-29-00 p.4654}}
1We note that [X] will buy and sell bonds for its own
account. Even assuming that the bonds are not of a type that could be
underwritten or distributed by a bank, [X] and not the participating
bank will be buying and selling the bonds for its own account. Go Back to Text
2We recognize that § 328.2(c) does not by its terms apply to
the instant situation. The practice your letter describes, however,
raises similar concerns of engendering depositor confusion. What is
more, the practice of allowing a teller to receive funds could raise a
question of whether the funds so received are deposits for purposes of
the Federal Deposit Insurance Act in which case the bank would be
required to pay assessments on the funds. Go Back to Text
3The FDIC recently published for comment a proposed amendment
to the FDIC's regulations (proposed Part 362) that would implement the
equity investment restrictions of § 24. That proposal, among other
things, proposes to define the phrase "significant risk to the
fund''. Go Back to Text
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