
|
Trust Examination Manual
Section 10- Other Trust Matters
Table of Contents
This section contains an overview of
Federal regulations and other matters related to fiduciary activities.
back to top
A.
Trust Powers
Trust powers are granted
to state-chartered banks under state
law, which is usually administered through a bank's
chartering authority. It
is state law, therefore, which defines activities
constituting fiduciary or trust powers. The FDIC always defers to state law in these
matters.
State statutes and Corporation regulations
do not always uniformly identify what functions constitute "fiduciary"
activities requiring trust powers. Some state statutes define "trust
activity" as serving in a (state's) legally defined capacities of trustee,
executor or administrator of estates, or guardian of the estate of a minor or
incompetent. However, the term "trust activity" is not as clear when a
bank is performing an agency function which may, or may not, require trust
powers. Some banks administer "managed agency accounts" wherein there is
no "trust" relationship, yet the bank often assumes full control of cash and
assets, including investment discretion. In these cases, the bank's
responsibilities exceed those exercised in passive, or directed personal trust
accounts, or in court directed estates and guardianships. While a bank
may claim it is not acting in a "trust" capacity for such accounts, its
activities may require trust powers under state law.
The term "fiduciary capacity" is neither
universally defined, nor does it have identical meaning among the states in
setting their requirements for trust powers. The term "fiduciary" is
broadly defined. It can be almost any party performing a financial or other
service for another party. For example, some banks operate corporate
trust departments in which they do not serve as "trustee" for any account, but
perform extensive financial services which require trust powers. Some
states distinguish between "court" and "private" accounts, and require such
things as a faithful performance bond or uninvested cash pledge for designated
court accounts. Furthermore, the term "trustee" per se, is not always a
determinative, since banks have been authorized to serve as "trustee" over
certain types of accounts (IRA's) without having been granted trust powers.
It is also necessary to clarify the types
of "agency functions" which are considered "trust activities" requiring state
authorization. Many commercial banks are permitted to provide escrow,
safekeeping, custodian, or similar directed-agency services, without having a
trust department or regulatory authorization to perform trust powers.
This may include physical custody of assets, record keeping, collecting and
remitting income, performing some administrative actions (as in escrow
services), or similar activities. Whether any such activities are
permitted without "trust powers" is wholly dependent upon state
law.
back to top
B. FDIC Consent to exercise trust powers
In 1958, the Corporation articulated its
basis for requiring consent to exercise trust powers (refer to Appendix C,
FDIC Memorandums Regarding Consent to Exercise Trust Powers, dated
June 30, 1958), and established conditions for grandfathering consent. Banks
granted trust powers by State statute or charter prior to December 1, 1950,
regardless of whether or not such powers have ever been exercised, are not
required to file an application with the Corporation for consent to exercise
trust powers. Such consent is grandfathered with the approval for
Federal deposit insurance. Banks approved for Federal deposit
insurance after December 1, 1950, are required to file an application to
exercise trust powers, unless such filing was made simultaneously with the
application for Federal deposit insurance.
B.1.
FDIC Part 333 Consent Requirement
The Corporation does not grant trust
powers, but only gives its consent to exercise such powers as granted by state
authorities. Section 333.2 of the FDIC Rules and Regulations prohibits an
insured state nonmember bank from changing the general character of its
business without the Corporation's prior written consent. The test to
determine when a change in character of business has occurred is left to the
discretion of the Corporation. For trust powers, this normally occurs
when a fiduciary relationship is created under the laws of the governing state
authority. Therefore, it is general policy that unless a bank is exempted
through the circumstances described in the background section above, it must
file a formal application with the Corporation to obtain prior written consent
before it may exercise trust powers.
It should also be noted that the statute
applies only to banks. Separately chartered and capitalized uninsured
trust company subsidiaries of banks need not apply for FDIC consent to exercise
trust powers. Also, state nonmember institutions that acquire or start
registered investment adviser subsidiaries do not have to apply for FDIC
consent to exercise trust powers under Section 24 of the FDI Act or Part 362 of
the FDIC Rules and Regulations.
B.2.
FDIC Part 303 Applications for Consent
Part
303 of the FDIC Rules and Regulations governs the administrative
handling of applications for consent to exercise
trust powers. Application
procedures are set forth in Part 303, the Manual
of Examination Policies (Manual), and the Case Managers Procedures
Manual (CM Manual). Banks eligible for expedited processing under
Part 303 (as defined therein) may file an abbreviated application. Application
forms for both expedited and non-expedited processing
can be downloaded or requested from an FDIC Regional Office .
Applications are reviewed in
the context of the financial institution's ability to satisfactorily
perform trust activities. In reviewing any such application, the statutory
factors set forth in Section 6 of the Federal Deposit Insurance Act
are considered along with the factors discussed in the Manual of Examination
Policies and CM Manual applications sections.
B.3. Unauthorized Trust
Activities
Commercial banks may be found performing
fiduciary services without having obtained full or limited trust powers,
or the Corporation's consent to exercise such powers. In these
cases, the examiner should determine what services are being performed,
and review all written customer agreements. If a bank is acting
in any capacity requiring trust powers, the examiner should:
- Cite an apparent violation
of state law for performing fiduciary services
without trust powers (if applicable);
- Cite an apparent violation
of FDIC Section 333.2 for changing the character
of its business without the Corporation's prior
written consent; and,
- Advise management of the
following:
- that it must discontinue
accepting any additional appointments;
- that it should
(upon advice of counsel) discontinue performing
fiduciary services, if it can do so without
jeopardizing its accounts or incurring additional
liability upon itself;
- that it must apply
to its state authority for trust powers (if
applicable); and
- that it must also
apply to the Corporation for consent to exercise
the powers.
Refer to the applications
section of the Manual of Examination Policies for further information.
back to top
C.
Mergers, acquisitions, and transfers
of fiduciary business
Purchases,
sales, or transfers of fiduciary business between banks and other
entities can involve complex legal
issues. Several statutes may govern such transactions, depending on
individual case-specific circumstances. Mergers, acquisitions, and
transfers are predominantly a safety and soundness issue and inquiries from
bank management and examiners on this subject should generally be referred to
the applicable FDIC Regional Office. The five items discussed below are
intended to provide an appreciation of the regulations and risk management
process that management should follow in mergers, acquisitions, or transfers of
a "fiduciary book of business".
C.1.
Federal Deposit Insurance Act Section 18(c)(1)
Section 18(c)(1) of the Federal Deposit
Insurance Act is sometimes referred to as the
Bank Merger Act (BMA). In general, the BMA is applicable whenever
insured deposits are involved in a "merger" transaction. However, in
instances where a trust department, or fiduciary "book of business", is
"purchased" outright and is not involved in a "merger" transaction, it is not
clear whether the Act is applicable. A critical determinant may be
whether "deposits," as defined in Section 3 of the FDI Act, are part of an
assumption or merger transaction. The Corporation's
"Statement of Policy; Bank Merger Transactions" should be
reviewed in determining BMA applicability. Where applicable, the BMA
requires the prior written approval of the FDIC for any merger, consolidation,
or purchase and assumption transaction. Refer to the
Manual, Applications for Mergers, for further discussion of the
application process.
C.2.
Affiliates - Federal Reserve Act Sections 23A and 23B
Sections 23A and 23B of the Federal Reserve
Act are made applicable to the activities of insured state nonmember banks by
Section 18(j) of the FDI Act. These statutes are primarily directed
toward the prevention of abusive relationships between banks and their
affiliates in the area of commercial banking. These sections do, however, have
applicability to purchases and sales of trust departments between affiliated
entities .
Careful review of the definition of
"affiliate" in each section, and the differences in the definition between the
two sections, is necessary when reviewing trust related transactions. Section
23B specifically excludes banks from its definition of affiliates.
The term "bank" is defined in both sections 23A and 23B to include trust
companies. Thus, bank-to-bank transactions and bank-to-trust company
transactions are outside the scope of Section 23B.
-
Applicability to Purchases and Sales of Trust
Departments between a Bank and its Affiliates
In transactions where
assets are purchased from an affiliate, Section 23A(a)(4) applies.
It requires the transaction to be on terms and conditions consistent with safe
and sound banking practices. Such provisions are designed to ensure
inter-affiliate transactions occur on a commercially reasonable basis; and that
compensation between the parties, where warranted, is reasonable.
In transactions where assets are sold to an
affiliate, Section 23B applies in some cases. This Section requires the
transaction to occur on terms, and under circumstances, such as those
prevailing for non-affiliated entities. As previously noted, bank-to-bank
and bank-to-trust company transactions are not covered by Section 23B.
It is important to note that, in
transactions where a trust department or fiduciary business is purchased or
sold, the "asset" involved is an intangible expected future flow of fee income
arising from the underlying trust accounts. Incidental assets, such as
premises and equipment used to conduct business, may also be involved in such
transactions.
The following chart illustrates the
applicability of Federal Reserve Act Section 23B to several types of
transactions involving purchases or sales of fiduciary activities:
Application of FRB Section 23B [Re: Compensation]
on the Purchase (or sale) of a trust department to (or From)
Another Institution:
|
FROM:
|
TO:
|
N/A
|
No
|
No
|
YES
|
No
|
No
|
No
|
No
|
No
|
YES
|
No
|
No
|
YES
|
YES
|
YES
|
No
|
No
|
No
|
No
|
No
|
No
|
No
|
No
|
No
|
Expanded discussions of Federal Reserve Act Sections
23A and 23B are provided in Section
8.E.4 Conflicts of Interest and
Section 4.3 of the Manual of Examination Policies.
C.3.
Applicable State Law
State nonmember banks, and other companies,
must obtain authority to exercise trust powers from the applicable state in
which they operate. Applicable state law may also address certain types
of transactions involving consolidations of trust business. These
provisions, if any, will ordinarily be found under a state's organization and
merger statutes. State law will also typically address transfers, or
substitutions, of fiduciaries. In some jurisdictions, and with some types
of accounts, court approval may be required. Provisions related to this
will usually be found in state statutes dealing with trusts. Where
questions arise, the Regional Office or appropriate state authority should be
contacted for guidance.
C.4.
FDIC Consent
As discussed at the beginning
of this section, if the acquiring or resulting entity
is a state nonmember bank,
application to the Corporation for consent
to exercise trust powers may be necessary in merger
or other acquisition transactions. FDIC consent is
nontransferable. Therefore, the act of purchasing a trust department from
a bank which has such consent does not convey that consent to the
purchaser. Consent must be applied for unless the acquiring bank
already has such consent. In all instances where the acquiring entity
is a state
nonmember bank, examiners should ensure the
transaction was in compliance with FDIC Parts 303 and 333.
C.5.
Nonstatutory Considerations
In addition to adherence to various
Federal and state statutes, a host of other concerns attend the
purchase, sale, or
transfer of trust activities or accounts from
one fiduciary to another.
While several of these issues are discussed in depth elsewhere in this manual,
they are listed here to facilitate a review of transactions involving
institutional transfers of trust business. These issues necessarily
emphasize the impact such transactions have
on the safety and soundness of the institutions involved:
-
Compensation
The valuation
of trust departments for purposes of a sale is not a well-defined process. Conventional
business valuation methods may employ the use of average gross income generated
by the activity, times some multiple, to arrive at a price or value.
Present value analysis of expected cash flows from fees may also be used. In
analyzing either a purchase or sale, the examiner should request and
evaluate documentation of the basis for
the sales price and terms. In some instances, no compensation may be
warranted. In other instances, the lack of adequate compensation could
be a Federal Reserve Act 23A or
23B issue (for non-exempt parties) or a general safety and soundness concern.
-
Written Agreement
Trust transfers and sales should
be subject to a written agreement. The agreements should address:
-
the effective date of the transaction;
-
indemnification between the parties relevant to
fiduciary actions, and in the event of future contingencies;
-
provision allowing a due diligence process;
-
division of fees between buyer and seller during
transition;
-
compensation, or a sales price, as discussed above;
-
specific identification of accounts to be transferred;
-
duties and responsibilities of each party in effecting
the transfer of accounts and records;
-
duties and responsibilities of each party in effecting
the transfer of underlying assets;
-
termination and modification provisions; and
-
escape clauses, as necessary, to address such
contingencies as failure to obtain regulatory approval.
-
Capabilities of the Fiduciary
The entity acquiring the trust business
should be legally qualified to do so. State authority and FDIC consent to
exercise the types of powers associated with the acquired business should be in
place. Moreover, management should possess the skills necessary to
administer the new accounts. Management should have evaluated the need
for additional trust personnel, data processing capabilities, bank premises,
and other facilities to accommodate the new business well in advance of the
acquisition.
-
Resultant Earnings
Depending on the circumstances, pro forma
projections of earnings may be requested as part of the FDIC application
process. Regardless, management is expected to have evaluated the impact
of such transfers on the bank's earnings. Economies of scale are often
cited as a reason for acquiring or selling trust departments. While this
is a legitimate factor, such economies are not guaranteed and may not
materialize in every consolidation. Moreover, they do not always
translate into improved bank earnings.
-
Capital Adequacy and Accounting
Considerations
Engaging in fiduciary activities subjects
an institution's capital to additional risk. Capital adequacy can be
adversely affected by the acquisition of significant new accounts or new
business lines if not properly managed. Related deposit growth from the
acquisition may also place strains on capital.
Trust activities may be referred to as "off
balance sheet" activities, in as much as there typically is no book value
assigned to the business. In instances where a bank purchases or sells a
group of trust accounts from another entity for some value, the bank will need
to properly account for the transaction on its books. Where the bank
purchases only fiduciary activities, the purchase price should normally be
recorded on its statement of condition as "goodwill" or "trust department
intangibles." This value: (1) should be amortized in accordance with
generally accepted accounting principles, but (2) it should not be included in
Tier 1 capital computations. In some instances, the purchase may also
involve tangibles, such as fixed assets in which trust activities are
conducted. Those assets should be accounted for in the usual
fashion. In all cases, underlying trust account assets continue to be the
property of the respective trusts. As such, they are not subject to
purchase or sale between the buying and selling institutions. Where a
bank sells its trust business, it will typically not have a basis, or book
value, for the business. Consequently, the entire price it receives
should be reported on its income statement as a nonrecurring income item and
under "other operating income" on the Call Report.
-
Notification to Account Parties
Written notification to the respective
account parties on each account transferred is mandatory from a prudence
standpoint. In some states, state law may require such notification or
otherwise address this issue.
-
Successor Fiduciary Issues
To the extent that the purchasing entity
becomes a successor fiduciary of the acquired trust accounts, several
well-recognized duties accrue. These are discussed both in
Compliance - Personal and Charitable Accounts, and
Compliance - Employee Benefit Accounts, Fiduciary Responsibilities.
In addition to ensuring the prompt and
orderly transfer of assets held in trust between fiduciaries, and ensuring the
uninterrupted administration of the accounts, successors are obliged under
general common law tenets to scrutinize the acts of their predecessors.
Successor fiduciaries should seek redress for any wrongs committed by previous
fiduciaries. This is considered an essential due diligence
procedure. In doing so, successor fiduciaries should: (1) obtain and
review an accounting from the previous fiduciary for each account acquired, and
(2) request an indemnification from the prior fiduciary for all actions taken
during its administration of an account.
-
Fidelity and Indemnity Coverage
Purchasing entities should alert their
carriers early to the acquisition of new business. Bank management should
ensure that coverage is afforded, including coverage for acts of all prior
fiduciaries "discovered" following their acquisition of an account.
D. Methods used to deliver fiduciary services
The trust department, as a separate and
visibly distinct department of the bank, remains the most prevalent method for
banks to deliver fiduciary services. However, the recent trend toward
consolidation within the financial services sector has led to diverse
restructuring and merger activity. In some instances, banks previously
lacking trust product lines may have acquired them through mergers. In
other cases, the "trust" line of business may have been purchased or sold by a
bank. In some cases, trust services being provided by several individual
banks owned by the same holding company may have been consolidated within one
bank, or within a separately chartered trust company. In still other
instances, a bank may have contracted with an unrelated outside party, to
provide such services on-premises. Conversely, the bank under examination
may provide such services to other banks. To effectively assess the risk
such relationships pose to the institution, the examiner may find it helpful to
understand the organization, the legal structure of the delivery system, the
reasonableness of the relationship, and the reasonableness of the compensation
to the bank.
D.1.
Trust Branches and Trust Service Offices
In some instances banks may wish to
establish "branch" offices of their trust departments. Where the trust
branch is to be located within an existing intrastate branch of the
bank, there are usually no legal barriers and no further legal hurdles.
When a trust branch office is proposed at a location where the institution does
not have an existing branch , the procedure is more complex.
If a trust branch (or "trust service
office"), in the course of conducting its business, is an office where
"deposits are received, or checks paid, or money lent" - (1) such office is
considered by the FDIC as a "domestic branch" under Section 3 of the FDI Act,
and (2) the bank must apply to the FDIC (and state) for permission to establish
and operate a new branch.
This is due largely to the statutory
definition of the term "deposit". Section 3(l) of the FDI Act defines the
term deposit to include trust funds, whether held in the trust
department, or held or deposited in any other department of the bank or savings
association. The broad inclusion (within the statutory term "deposit") of
virtually all trust monies which may be on hand anywhere in the bank, in any
form, has implications. It will generally mean that the conduct of trust
activities which involve accepting funds will also be considered to be branch
banking or accepting deposits. This necessitates that banks either
conduct trust activities in existing branches, or that they apply for a branch,
if they intend to accept funds (other than non-cash assets) at the "trust
branch" or "trust service office."
D.2. Interstate Trust Branch Offices
State nonmember banks, and other companies,
must obtain authority to exercise trust powers from the applicable state in
which they operate. States may limit the authority of out-of-state
entities to engage in fiduciary activities within their borders.
Therefore, banks or other state-chartered entities which legally offer trust
services in one state, typically need to obtain separate approval from another
state before conducting trust business there.
In contrast with the foregoing, both the
OCC and OTS have issued similar opinions effectively permitting national banks
and federal savings associations to operate trust businesses on an interstate
basis. A national bank with trust powers (under 12 USC 92a) may engage in
trust activities to the same extent that state banks, trust companies, or other
corporations in competition with national banks, are permitted to engage
in. If a state permits the foregoing state licensed entities to compete
with national banks in trust activities, but prohibits out-of-state companies
from doing so, Section 92a may be used to preempt state law. This
effectively permits national banks to engage in trust activities in any state
in which its branches are located.
In 1996, the Conference of State Bank
Supervisors (CSBS), the FDIC, and the Federal Reserve Board signed an
interstate banking and branching agreement for state-chartered banks.
This agreement, revised in December 1997, allows states to adopt laws
permitting interstate operation of trust businesses. This permits state
chartered entities to be competitive, and complement the interstate activities
in the commercial banking arena.
CSBS assisted in the drafting of the
"Nationwide Cooperative Agreement for Supervision and Examination of
Multi-State Trust Institutions" that was executed in June 1999. To date,
42 states have signed the agreement, which lays out the framework for the
supervision and regulation of multi-state trust institutions. The
agreement is on CSBS's web site at
http://www.csbs.org/government/agreements/agreements.asp .
D.3. Trust Companies
Trust Companies
The term "trust company" can be misleading. In
some states, a bank must have trust powers in order to have "trust" in its
name. In other instances, banks have incorporated the term into their name,
even when the bank does not have trust powers. Thus, the term may simply
denote an insured bank.
In other instances, trust activities may be conducted
from a separate corporate entity, or "trust company". In many cases,
trust companies are subsidiaries of bank holding companies, but there are a few
that are direct subsidiaries of insured banks. In other cases, the trust
company may be owned by the parent company or it may be a truly independent
"stand alone" trust company and have no parent organization.
FDIC-Insured Trust Companies
Trust companies may be an insured bank which does almost
all of its business as a trust institution. They qualify for deposit
insurance under 12 C.F.R. §
303.14, which states that a single non-trust deposit of at least
$500,000 would meet the statutory standard of Section 3(a)(2)(A) of the
Federal Deposit Insurance Act. An institution with a single
non-trust deposit of at least $500,000 will be considered "... in the
business of receiving deposits, other than trust funds ..." and, thus,
qualifies for Federal deposit insurance. These institutions may receive a
bank charter from the state or the OCC, or a federal savings bank charter from
the OTS. These insured trust banks are examined the same as other insured
banks.
Non-FDIC-Insured Trust Companies
Most trust companies are not insured by the FDIC.
These companies are chartered and regulated by the state or by the OCC.
Trust companies which are owned by a bank holding company are also subject to
supervision by the Federal Reserve Board. Trust companies that are owned
by banks are subject to examination and supervision by the parent bank's
primary regulator.
A trust company that is a direct subsidiary of an
FDIC-supervised bank is viewed as a separately-chartered and
separately-capitalized entity. As such, its trust powers are granted
solely by the chartering agency, and the trust company is not required to seek
the FDIC's consent to exercise trust powers. In like manner, the trust
company's parent bank is not required to have the FDIC's consent to exercise
trust powers if all of its trust activities are conducted by the
separately-chartered subsidiary trust company.
Instructions for Call Report Schedule RC-T states that
the schedule should be completed on a fully consolidated basis, i.e., including
any trust company subsidiary (or subsidiaries) of the reporting
institution.
As noted under Section E.
Examination Authority, trust companies that are direct
subsidiaries of FDIC-supervised banks may be examined by the FDIC.
However, such examinations are not required under GM-1 requirements.
However, they may be examined if the supervisory Regional Office determines
that their activities have a material and substantive impact on the parent
bank. Also, refer to coverage of the Gramm-Leach-Bliley
Act (GLBA) concerning examinations of affiliates. Examination
reports furnished by the trust company's primary regulatory agency may also be
reviewed for normal monitoring of the trust company's
activities.
If an examination of a trust company that is a
direct subsidiary of an FDIC-supervised bank is performed, examiners should
determine that its activities are generally consistent with the Statement of
Principles of Trust Department Management. If examiners suspect that the
uninsured trust company is being utilized to generate deposits for the parent
bank in an unauthorized fashion, the activity should be investigated and
compared with the
Section 3(o) of the FDI Act definition of a domestic branch and
applicable State Law. Consult with the respective Regional Office, if
corrective action is needed.
D.4. Trust Referral Arrangements
Some institutions ("host banks") have
entered into third-party agreements with unaffiliated trust institutions
and registered investment advisers for the offering of fiduciary services to
"host bank" customers. The "host bank" does not need trust powers because
the fiduciary relationship is between the client and the third party and
typically receives a one time or annual referral fee based on the assets of the
referred clients. While the "host bank" does not have any investment or
fiduciary powers, it may retain administrative responsibilities and
receive administration fees in addition to the referral fee. All trust
referral arrangements, regardless of whether the bank retains any
administrative duties, should be governed by a written agreement that outlines
the responsibilities of all parties.
Additionally, the client should be
sufficiently informed of the general terms of this relationship with reasonable
and meaningful disclosures. For example, disclosures should be given upon
the establishment of an account and periodically (but not less frequently than
annually) thereafter. The disclosures should be sufficient to identify to
the client the party that is administering the client's account. If the
third-party is responsible for making such disclosures, the host bank should
ensure that the disclosures are provided, and, if appropriate disclosures have
not been made, should take the necessary actions to provide the disclosures.
Some banks have entered into arrangements
whereby customers are referred to third-parties who are not located on bank
premises. Such arrangements can include referrals by trust department
personnel that may involve the sale of non-deposit products (NDPs). The
bank may receive a fee or other monetary benefit for making such
referrals.
The
Interagency Statement on Retail Sales of Nondeposit Investment Products
applies to trust activity under the following two circumstances:
-
When non-institutional customers direct
investments for their fiduciary accounts, such as self-directed IRA and KEOGH
plans in trustee or custodial accounts. For such accounts, the three
minimum disclosures from the Interagency Statement apply.
-
When the customer has sole investment
discretion for an agency account. For such accounts, the entire statement
would be applicable.
The above two circumstances were outlined
in Regional Director Memorandum "Nondeposit Investment Products (NDIP) and
Recordkeeping Requirements Questions and Answers, issued June 23, 1998.
The memorandum states that self-directed employee benefit accounts such as
401(k) accounts are not subject to the Interagency Statement, as ERISA laws
considers them to be fiduciary accounts. The Statement also does not
apply to custodial accounts (other than self-directed retirement accounts)
where the institution is performing ministerial acts such as collecting
interest and dividend payments for securities held in the accounts and handling
the delivery or collection of securities or funds in connection with a
transaction.
Determining whether a bank offering such
trust products on the premises of another bank is in fact, operating a
"domestic branch" can be difficult. One critical determinant may be
whether the bank offering trust products is "receiving deposits." A
variety of contractual provisions may also impact the final determination,
including the use of the host-bank as a "correspondent bank" to accept trust
customer deposits. In some instances, it has been held that banks may
contract with other banks to act as their agent in conducting certain limited
activities, including the taking of deposits, without being deemed to be
operating a branch. Refer to
FDIC Advisory Opinions 93-57 and 95-22 for additional information.
But, the process of "offering trust
services" goes beyond the receipt of deposits. In the absence of
established examination policies, examiners should ascertain the facts,
document the contractual provisions and practical operation of the arrangement,
and forward the information to the Regional Office for its determination.
D.5. Private Banking Services
The USA PATRIOT
Act, Section 312, provides the following definition of a "private banking
account" as it applies to the Act.
- The term 'private
banking account' means an account (or any combination of accounts) that--(i)
requires a minimum aggregate deposit of funds or other assets of not less
than $1,000,000; (ii) is established on behalf of 1 or more individuals who
have a direct or beneficial ownership interest in the account; and (iii) is
assigned to, or is administered or managed by, in whole or in part, an
officer, employee, or agent of a financial institution acting as a liaison
between the financial institution and the direct or beneficial owner of the
account.
Generally, a bank might offer "private
banking" services to a select group of its more wealthy customers - high net
worth individuals and their corporate interests. Such services will
usually provide the customer with all conventional banking products at one
location and through one bank officer, or a team of such officers, thus
eliminating the need for the customer to physically visit several separate
departments. Typically, a private banking department will provide an
array of personal and financial services, including estate and financial
planning, trust and investment advisory services, personal loans, and
maintenance of deposit relationships. Many private banking clients choose
this method of financial management for the personalized service and
confidentiality provided.
Private banking services have increased in
popularity in recent years as more banks have begun to rely on the income
generated by this service. The structure and sophistication of private
banking services varies by bank size and business structure. Examiners
are also reminded that smaller institutions may offer similar services to
certain customers while not designating it as private banking. Without
the implementation of appropriate oversight, policies, and risk management
systems, management may expose itself to increased reputational and legal risks
inherent in this business.
D.5.a. Management Oversight - Private
Banking
As with all significant business lines,
senior management has a responsibility to formulate a sound risk management and
control environment. A business plan outlining the targeted client base,
range of services provided, and financial risk objectives and tolerance levels
should be implemented. The scope and depth of coverage typically vary
depending upon the size and complexity of services offered. However,
management has a responsibility to define acceptable targets and review for
compliance with such targets.
D.5.b. Policies - Private
Banking
As with other areas of the bank, suitable
written policies provide a basis upon which to operate. If appropriate
policies and internal controls have not been implemented, there may be cause
for concern. Management may expose the institution to reputational and
legal risks, if compliance with USA PATRIOT Act and Anti-Money Laundering
regulations are lacking. A sound private banking operation will typically
have written customer due diligence guidelines to assist in the prevention of
illicit acts.
Some standard customer due diligence
guidance includes:
-
obtaining identification and basic
background information on clients,
-
describing the clients' source of wealth
and lines of businesses,
-
requesting references and handling
referrals, and
-
identifying suspicious transactions.
The USA PATRIOT Act requirements for a
customer identification program promotes a risk-focused approach {Section
1.H.2 USA Patriot Act Compliance}.
For example, Section 312 of the Act
requires private banking accounts involving foreign persons to be considered
for enhanced due diligence.
-
Section
312(a)(i)(1): IN GENERAL- Each financial institution that establishes,
maintains, administers, or manages a private banking account or a correspondent
account in the United States for a non-United States person, including a
foreign individual visiting the United States, or a representative of a
non-United States person shall establish appropriate, specific, and, where
necessary, enhanced, due diligence policies, procedures, and controls that are
reasonably designed to detect and report instances of money laundering through
those accounts.
-
Section
312(a)(i)(3): Minimum Standards For Private Banking Accounts- If a
private banking account is requested or maintained by, or on behalf of, a
non-United States person, then the due diligence policies, procedures, and
controls required under paragraph (1) shall, at a minimum, ensure that the
financial institution takes reasonable steps--`(A) to ascertain the identity of
the nominal and beneficial owners of, and the source of funds deposited into,
such account as needed to guard against money laundering and report any
suspicious transactions under subsection (g); and `(B) to conduct enhanced
scrutiny of any such account that is requested or maintained by, or on behalf
of, a senior foreign political figure, or any immediate family member or close
associate of a senior foreign political figure that is reasonably designed to
detect and report transactions that may involve the proceeds of foreign
corruption.
D.5.c. Risk Management -
Private Banking
Management should be able to identify,
measure, monitor and control the reputational, fiduciary, legal, credit and
operational risks inherent in private banking. This should include
relationship documentation and due diligence standards, controls over the flow
of client funds , adequate management
information systems, and procedures to identify and report suspicious activity.
State law in most cases continues to
require that a separate set of books and records for trust services be
maintained. (This is required by the Statement of Principles of Trust
Department Management, also.) This will hold even though they may be
located in several areas of the bank, and not integrated with the records of
the trust department. Examiners will thus need to ascertain the
particulars of recordkeeping for all trust activities in banks under
examination. Examiners should also ensure that the fiduciary assets of
private banking activities are reported in the bank's Call Report Schedule
RC-T.
D.5.d. Segregation of
Duties, Compliance and Audit - Private Banking
Many successful private banking operations
employ the principle of segregation of duties in order to maintain an effective
internal control environment. The effective segregation of duties
enhances compliance with policies and procedures by facilitating the
identification and correction of errors and the detection and investigation of
irregularities. The compliance program should be independent of
management to enhance its effectiveness. Reviewing for compliance with
customer due diligence guidelines, bank policies, and other laws and
regulations is an essential part of a compliance program. Lastly, an
effective independent audit function can provide assurance that the internal
control structure of the private banking function is being maintained and
operated adequately.
back to top
E.
Examination authority of subsidiaries and affiliates
An expanded discussion of the Corporation's
authority to conduct examinations of affiliates is contained in Section 4.3 of
the Manual of Examination Policies (Manual)
and the Case Manager's Procedures Manual (CM Manual). Relevant statutory provisions are discussed below.
E.1. FDI Act Section 10 and the Gramm-Leach-Bliley Act
Section 10(b) of the FDI Act empowers
examiners to make a thorough examination of insured institutions and their
affiliates, while Section 10(c) of the Act gives the Corporation limited
authority to examine other entities which may not be affiliated with the
financial institution in question. An assessment of whether a review of
affiliated entities is needed should be determined during the pre-examination
risk-scoping process. Examiners must support the need for affiliate
examinations and must undertake no affiliate examination without prior approval
from the Regional Office.
Prior to initiating formal procedures
seeking to exercise statutory authority to examine third parties, it is
expected that informal, voluntary avenues (simply asking the bank to request
the third party to provide data) will have been exhausted. In all cases,
the examiner should consult with the Regional Office on such matters.
The enactment of the Gramm-Leach-Bliley Act
(GLBA) provides additional guidance on the review of affiliates. The GLBA
reserves the FDIC's authority under Section 10 of the FDI Act to examine
affiliates and subsidiaries of insured depository institutions to the extent it
is necessary for the FDIC to determine the relationship between the institution
and the affiliate and the effect the relationship has on the depository
institution. However, before conducting an examination, visitation, or
investigation of a functionally regulated subsidiary or an affiliate of a bank,
the examiner should communicate with the functional regulator. Examiners
should determine whether a review of an affiliate's activities is necessary
during the pre-examination risk-scoping process. Contact with the
functional regulator should be made in accordance with Regional Office
guidance.
E.2. Bank Service
Corporation Act
Section 7 of the Bank Service Corporation Act provides statutory
authorization for primary federal regulators of the banks which are principal
investors of the service corporation to examine service corporations. To
the extent that an entity is definable as a bank service corporation, the
statute provides that the entity may be examined, not only by regulators of
banks owning the entity, but also by regulators of non-shareholder banks
serviced by the entity. The Act can be referenced at www.fdic.gov under
Miscellaneous Statutes and Regulations. While the Act has specific
applicability to corporations providing data processing services for banks, it
may also apply when other types of services, such as fiduciary, are being
provided. However, the narrow definition of bank service corporation
(especially in regard to ownership) serves to substantially limit the Act's
scope. back
to top
F. Gramm-Leach-Bliley Act
(GLBA) - Securities-Related Activities
F.1. SEC Registration Requirements The passing of the GLBA in 1999 permits
institutions to adopt a financial holding company structure, wherein financial
institutions are permitted to conduct securities and insurance activities
through affiliated entities.
The GLBA rules also affect
various securities activities which may be present in a bank or bank
trust department. If bank's activities do not meet specified
exemptions or exceptions from the definition of "broker," the
bank must register as a broker or dealer with the Securities and Exchange
Commission (SEC) and would be subject to applicable SEC regulations. The
exemption and exceptions and possible registration for banks as 'broker',
'dealer', and 'investment adviser' are discussed
below and in Appendix
D. If the bank is claiming an exemption or exception under
the broker or dealer designations, recordkeeping
requirements established by the Federal
bank regulaory agencies must be met. These recordkeeping rules
are expected to be finalized in late 2008.
Appendix
D - Securities Law contains further examination guidance, statutory
excerpts, and SEC rules related to bank securities activities.
F.1.a. Registered Broker
Section 201 of the GLBA repealed the
blanket exemption of banks from the definition
of "broker" under the Securities
Exchange Act of 1934 and replaced it with
11 specific exceptions from the Exchange Act definition
of "broker." Under
the statute, banks that engage in securities
activities must either satisfy the conditions
for one of the specific GLBA exceptions or other
exemptions provided by Regulatin R (discussed below)
or conduct those activities through a registered
broker-dealer subsidiary or affiliate. For this reason, the broker
exceptions are referred to as the "push-out" rules,
since an institution that can not qualify for an
exception or exemption must "push-out" its securities
activities to a registered entity. The exception-related
activities are detailed GLBA and can be found
in Appendix
D, Bank as Broker.
On October 13,
2006, the Financial Services Regulatory Relief
Act of 2006 (FSRRA) was signed into law. Among
other things, the FSRRA required the Federal
Reserve and the SEC to jointly issue a regulation
implementing the GLBA broker exception rules.
In doing so, the Federal Reserve was
required to consult FDIC, OCC, and OTS. In addition
to implementing certain of the GLBA exceptions
from the definition of "broker," which
required further guidance, the joint rule, designated
as Regulation R, provided additional administrative
exemptions from the definition
of the term "broker" as defined in the Exchange Act. The
joint FRB/SEC
final Regulation R was published in
the Federal Register on October 3, 2007. See
Exchange Act Release No. 34-566501:File
No. S7-22-06 (353KB PDF file - PDF
Help)
F.1.a.1.
Regulation R
Regulation R details the requirements
for a bank to qualify for a number of the GLBA exceptions and other
administrative
exemptions from the definition of "broker," including
the trust & fiduciary exception; the custody and safekeeping
exemption; the networking exception; and the
sweep accounts exception. Other administrative exemptions provided
in Regulation R include
exemptions for transactions in Regulation S securities,
non-custodial securities lending activities, referrals of high
net worth/institutional
clients under a third-party networking arrangement,
as well as certain exemptions from the Exchange Act's Section 3(a)(4)(C)(i)
trade execution requirements. These are discussed
in greater detail
below.
F.1.a.1.a.
Trust & Fiduciary Exception
The Trust & Fiduciary
exception allows a bank, in its capacity as trustee or fiduciary,
to
effect securities transactions for the accounts
it administers if the following conditions
are satisfied:
- Transactions are effected in the bank's trust department or
other department that is regularly examined
for compliance with fiduciary principles and
standards;
- The bank does not publicly solicit brokerage business;
- The bank is "chiefly compensated" for its trust and fiduciary
activities on the basis of:
- An administrative or annual fee; or
- A percentage of assets under management; or
- A flat or capped per order processing fee equal to not
more than the cost incurred; or
- A combination of the above; and .
- Trades are effected in compliance with Exchange Act Section
3(a)(4)(C), which requires trades to be effected:
- By a registered broker-dealer; or
- Via a cross trade or substantially similar trade
either within the bank or between the bank
and an affiliated fiduciary in a manner
that is not contrary to fiduciary principles;
or
- In some other manner that the SEC permits.
Fiduciary capacity, for the purposes of Regulation R, is defined
by the Office of the Comptroller's Part 9.
Fiduciary capacity includes acting as trustee,
executor, administrator, registrar of stocks
and bonds, transfer agent, guardian, assignee,
receiver, or custodian under a uniform gift to
minors act, or as an investment adviser if the
bank receives a fee for its investment advice,
or in any capacity in which the bank possesses
investment discretion on behalf of another.
The prohibition on solicitation of brokerage business restricts
the extent to which a bank can advertise that
it effects securities transactions. In its advertisements,
a bank may only indicate that it effects securities
transactions in connection with its trust and
fiduciary services. The fact that a bank effects
securities transactions cannot be made more prominent
that the material advertising the bank's provision
of trust and fiduciary services.
F.1.a.1.a.1 Chiefly Compensated
Regulation R defines
what it means to be "chiefly compensated"
for trust and fiduciary services on the basis
of an annual/administrative fee, a percentage
of assets under management, a flat or capped
per order processing fee equal to no more than
the cost of executive, or a combination of
these. Whether a bank satisfies the chiefly
compensated requirement depends on the amount
of "relationship" compensation in relation
to total compensation. Thus, the ratio of relationship
compensation, discussed below, to total compensation,
either for each trust and fiduciary account
or on a bank-wide basis, must equal or exceed
a specific percentage. The chiefly compensation
ratio calculation is discussed in more detail
below.
Chiefly Compensated Test
The chiefly compensated test consists of
calculating the ratio of relationship compensation to total
compensation
for the preceding year and the year preceding
that year. The ratio for each year is expressed as a percentage
and the percentages
for the two years are averaged. Thus, whether
a bank satisfies the chiefly compensated test is determined
by calculating the
moving average of the relationship compensation
to total compensation percentages for the two immediately
preceding years. Banks
may use either a calendar or fiscal year
as the basis for the yearly percentages to be calculated.
The two year moving average
must be computed within 60 days following
the end of that year. Since the compliance period begins
in the first fiscal year
commencing after September 30, 2008, the
first calculation of chiefly compensated test will occur
by March, 2011, for
banks using a calendar year. While the
calculation is only required within the two months following
the end of the year,
banks are encouraged to monitor the percentage
throughout the year in order to be able to identify and address
any problems
that might emerge.
Banks have two options regarding the basis
on which the chiefly compensated test is
calculated. The test may be determined
on an account-by-account basis. Under the account-by-account
methodology, the bank would determine the
ratio of relationship compensation to
total trust and fiduciary
compensation attributable
to each account for each trust and fiduciary
account, except for those accounts that
Regulation R requires or allows to be
excluded from the test. The bank meets
the chiefly compensated test if the chiefly compensated percentage
for each account is
greater than 50%.
The second option allows a bank to determine
compliance with the chiefly compensated
test on a bank-wide basis. Under the
bank-wide methodology, the
bank would calculate a single
percentage for each year. The single
percentage would include total relationship compensation
from all trust and fiduciary
accounts required to be included in the
computation and the total compensation
received by the bank in connection
with its provision
of trust and fiduciary services. Under
this method, the bank satisfies the chiefly
compensated test if
the percentage is greater
than or equal to 70%. Relationship and
total compensation are addressed below.
Relationship Compensation
Relationship compensation is any compensation a bank receives
that is attributable to a trust or fiduciary
account, or to trust and fiduciary activities
if calculated on a bank-wide basis, that consists
of:
- Annual or administrative fees, including, but not limited
to, fees:
- For personal services, tax preparation,
or real estate settlement services;
or
- For disbursing funds from, or for
recording receipt of payments to,
a trust or fiduciary account;
or
- In connection with securities lending
or borrowing transactions; or
- For custody fees.
Administrative fees also include various fees in connection
with investments in mutual funds. The fees
do not have to be paid to the bank by the mutual fund,
but can be paid by a third-party, such as the
fund's distributor, transfer agent, administrator
or an advisor to the fund. Such fees include:
- Fees for personal services;
- Fees for the maintenance of shareholder accounts;
- Fees based on a percentage of assets under management
for the following services:
- Transfer or sub-transfer agent services;
- Aggregating and processing purchase and redemption
orders;
- Providing account statements to beneficial owners;
- Processing dividend payments;
- Providing sub-accounting services;
- Forwarding communications to beneficial owners; and
- Receiving, tabulating, and transmitting proxies.
12b-1 fees are considered relationship compensation
since they comprise fees that are based on
a percentage of assets under management. The receipt
of
12b-1 fees, like the receipt of all compensation
related to securities transactions, must be
consistent with the fiduciary principles and
standards governing the bank's trust and fiduciary
accounts.
Finally, flat or capped per order processing fees that
do not exceed the cost incurred in effecting
securities transactions qualify as relationship
compensation. These fees may include the fee
charged by the executing broker-dealer and
the addition of the fixed or variable cost
incurred by the bank in effecting the transaction.
Banks, however, may not include a profit margin
to the cost charged to the customer and still
have the fees qualify as relationship
compensation. Banks, therefore, are expected
to document any fixed or variable costs allocated
to transactions in order to support that such
allocations include only the actual cost incurred
by the bank in effecting the transaction.
It is important to note that relationship compensation
is not limited to compensation received by
the bank for securities-related transactions,
but include all forms of compensation related
to the administration of trust and fiduciary
accounts, regardless of whether the amounts
are paid by the trust or fiduciary account
or by a third party.
Total Compensation
The ratio of relationship compensation
to total compensation determines whether a bank satsifies
the "chiefly
compensated" requirement for the Trust & Fiduciary
exception from the definition of broker in
the Exchange Act. Total compensation encompasses
all compensation attributable to a trust or
fiduciary account or to the trust and fiduciary
business of a bank if the determination is
made on a bank-wide basis. However, as discussed
below, some forms of compensation are specifically
excluded by Regulation R. Total compensation
does not include any revenues that are not
derived from the provision of trust or fiduciary
services. Examples of compensation that should
not be included as either relationship compensation
or total compensation are:
-
Providing bank-office services to third parties;
-
The sale of an office or assets of the trust
department;
-
Internal credits, such as a credit for deposits
of trust funds in the commercial bank; or
-
"Soft Dollar" credits.
Excluded Compensation
Regulation R provides for the exclusion
of various revenues from both relationship compensation
and total
compensation. Of particular importance is the
exclusion of any compensation that is received
in connection with a transaction for
which the bank is relying on an exception
or exemption other than the Trust & Fiduciary
exception. For example, Regulation S provides
an exemption for transactions in securities
issued in an offshore transaction under SEC
Regulation S. A bank purchasing Regulation
S securities and relying on the Regulation
S exemption could not include compensation
from those transactions in calculating the "chiefly
compensated" ratio.
Similarly, revenues derived from trust and fiduciary accounts
held at a foreign branch are excluded if:
-
Held at a non-shell foreign branch; and
-
The bank has a reasonable cause to believe that
the trust and fiduciary accounts of the foreign
branch that are held by or for the benefit
of U.S. persons constitute less than 10%
of the foreign branch's trust and fiduciary
accounts.
A non-shell foreign branch is one that is located outside
the U.S.; provides services to residents of
the foreign jurisdiction where it is located;
and the day-to-day decision-making is not done
by an office or branch in the U.S. A bank would
have a reasonable cause to believe that an
accountholder is not a U.S. person if the person's
principal mailing address is outside the U.S.
or the foreign branch's records indicate that
the accountholder is a non-U.S. person. The
exclusion of revenues from accounts held at
a foreign branch only applies if the bank utilizes
the bank-wide method for calculating the ratio
of relationship compensation to total compensation.
Under both the account-by-account and bank-wide methods,
compensation from short-term accounts, i.e.
those open for less than three months in the
relevant year, is not included in total compensation.
Compensation from acquired accounts, i.e. accounts
that the bank acquired from another entity
as part of a merger, consolidation, acquisition,
purchase of assets or similar transaction,
can be excluded for the first twelve months.
Regulation R also provides for a De Minimis Exclusion
where those banks using the account-by-account
method can exclude the revenues from the
lesser of 1% or 500 accounts in determining
compliance with the chiefly compensated requirement.
In order to do so, the bank must maintain records
demonstrating that the securities transactions
by or on behalf of the account were undertaken
in the exercise of its trust or fiduciary duties
and the bank must not have used the exclusion
in the preceding year.
Finally, a transferred account will not cause a bank
to fail the chiefly compensated test if the
account or its securities are transferred to
a registered broker dealer or an unaffiliated
entity that is not required to be registered
as a broker within three months following the
end of the relevant year.
F.1.a.1.a.2 Trade Execution Requirements
The Trust & Fiduciary
exception, as well as the other GLBA/Regulation
R exceptions and exemptions, require that
securities transactions be executed in accordance
with the Exchange Act's execution requirements,
which generally require securities transactions
to be executed by a registered broker-dealer
or in a cross trade. Regulation R, however,
provides several exemptions from the Exchange
Act's trade execution requirement. Regulation
R permits banks to effect certain transactions
directly through the NSCC, the issuer's transfer
agent, or an insurance company, if certain
requirements are met.
Regulation R permits transactions in "covered securities" to
be effected through the NSCC, directly with
the transfer agent, or with an insurance company
or separate account that is excluded from the
definition of transfer agent in the Exchange
Act. A "covered security" is a registered mutual
fund or a variable insurance contract funded
by a separate account that is registered. The
following two requirements must be satisfied:
- The security is not traded on a national securities
exchange or through the facilities of a
national securities association or an interdealer quotation
system; and
- The security is distributed by a registered broker-dealer,
or the sales charge is no more than the
amount permissible for a security sold by a registered
broker-dealer under Investment Company
Act of 1940 rules.
Regulation R also provides an exemption whereby transactions
in employer securities for employee benefit
plans can be effected directly with the transfer
agent provided that:
- Providing safekeeping and custody services
to customers with regard to securities, including
the exercise of warrants and other rights
on behalf of bank customers;
- Facilitating the transfer of funds or securities
as a custodian or clearing agent in connection
with the clearance and settlement of its
customers' transactions in securities;
- Facilitating lending or financing transactions
or investing cash in connection with its
safekeeping, custody, and securities transfer
services;
- Holding securities pledged by a customer
to another person or securities subject to
repurchase agreements involving a customer,
or facilitating the pledging or transfer
of such securities by book entry or as otherwise
provided by law, provided that the bank maintains
records separately identifying the securities
and the customer; or
- Serving as a custodian or provider of other
related administrative services to any individual
retirement account, pension, retirement,
profit sharing, bonus, thrift savings, incentive,
or other similar benefit plan.
In addition to the statutory exception, Regulation
R provides two exemptions whereby a bank can
take orders for the purchase or sale of securities
from custody account customers. One exemption
allows a bank, as part of its customary banking
activities, to accept orders for securities
transactions from employee benefit plan accounts,
individual retirement accounts, and similar
accounts. The second exemption allows a bank
to accept orders for securities transactions
from custody account customers on an accommodation
basis.
The exemptions discussed below apply to accounts
for which the bank acts as a custodian. Regulation
R defines an account for which a bank acts
as a custodian as an account that is:
- An employee benefit account;
- An individual retirement account or similar
account;
- An account established by a written agreement
between the bank and the customer that sets
forth the terms that will govern the fees
payable to, and rights and obligations of,
the bank regarding the safekeeping or custody
of securities; or
- An account for which the bank acts as a
directed trustee.
Whether a bank serves as custodian for securities
or other assets of an account depends on the
services the bank provides to the account,
rather than the label used to identify the
account. Thus, a bank that acts as
an escrow agent or paying agent and that provides
custody and safekeeping services to the account
is considered an account for which the bank
acts as custodian, notwithstanding the fact
that the account is not called a custody or
safekeeping account.
F.1.a.1.b.1.
Exemption for EB, IRA, and Similar Accounts
A bank may accept orders for securities transaction
from custody accounts for employee benefit
plans, individual retirement plans and similar
accounts provided that:
- The bank does not advertise that it accepts
orders, except as part of advertising
its other custody and safekeeping services;
- No bank employee is compensated based
on whether a securities transaction is
executed
or on the quantity, price, or type of
security involved;
- The bank is not a trustee or fiduciary,
other than a directed trustee;
- The bank is not acting as a carrying
broker; and
- The bank complies with the trade execution
requirements in Exchange Act Section
3(a)(4)(C)(i).
Banks may not advertise that custody accounts
are securities brokerage accounts or are a
substitute for a brokerage account. While
the bank cannot be a trustee or fiduciary and
still rely on the custody
exemption, there is an exception made for banks
that serve as directed trustees. A bank that
serves as a directed trustee is eligible for
the custody exemption provided it complies
with the other requirements of the exemption.
A directed trustee is a trustee that does not
hold any investment discretion over an account.
Within common securities industry usage,
the terms "carrying broker" and "clearing
broker"
are virtually identical and often are used
interchangeably. In certain instances, the
terms mean a broker that, as part of an arrangement
with a second broker (an "introducing" or "corresponding"
broker), allows the second broker to be subject
to lesser regulatory requirements (e.g. under
the net capital provisions of Exchange Act
Rule 15c3-1 and the customer protection provisions
of Exchange Act Rule 15c3-3). Technically,
however, a "carrying broker" is a
broker that holds funds and securities on behalf
of customers,
whether its own customers or customers introduced
by another broker-dealer, and a "clearing
broker" is a member of a registered clearing
agency.
The preamble to the final Regulation R discusses
factors that
the
SEC would
consider
in determining
if a bank were acting as a carrying broker.
The SEC indicated that it would consider
the existence of shared clients between a
broker-dealer
and
bank
and
the reason why clients of the broker-dealer
have established custody accounts at a bank.
The existence of shared customers where the
broker-dealer causes its customers to establish
custody accounts at a bank could result in
a determination that the bank was acting
as a carrying broker for the broker-dealer.
If,
however, the clients of the broker-dealer
independently decide to open a custody account
at a bank,
then the bank would likely not be viewed
as acting as a carrying broker for the broker-dealer.
Banks may share systems and platforms with
a broker-dealer, for example an affiliated
broker-dealer with which a common BSA/AML
compliance
system is used. Other examples of permissible
arrangements include legal and compliance
functions, accounting and finance functions
(such as payroll
and expense account reporting), and administrative
functions (such as human resources and internal
audit). Moreover, banks may perform limited
back office functions
for
a
broker-dealer
without being deemed as acting as a carrying
broker. A broker-dealer cannot delegate to
a bank functions that require registration
with a self-regulatory organization (SRO)
and the broker-dealer must retain control
of its
property,
cash, and securities.
In addition to bank custodians, non-custodial,
non-fiduciary third-party administrators and
record keepers for employee benefit plans may
rely on the EB/IRA custody exemption provided
that:
- Both the custodian bank and the third-party
administrator/record keeper comply with
the requirements of the exemption; and
- The administrator/record keeper does
not execute cross trades other than:
- Crossing or netting open-end mutual
funds not traded on an
exchange; or
- Crossing or netting orders for
accounts held at the custodian bank
that
contracted with the third-party
administrator/record keeper.
F.1.a.1.b.2.
Exemption for Accommodation Trades
For custody accounts that are not maintained
by an employee benefit plan, individual retirement
accounts, or other similar accounts, a bank
may accept orders for securities transactions
as an accommodation to the customer provided:
- Any fee charged or received by the bank
does not vary based on:
- Whether the bank accepted the order;
or
- The quantity or price of the securities
bought or sold.
- Advertisements do not state that the bank
accepts orders for securities transactions;
- Sales literature does not state that the
bank accepts orders, except as part of describing
other aspects of its custodial and safekeeping
services;
- The bank does not provide investment advice
or research, make recommendations, or solicit
transactions. However, the bank may:
- Advertise or provide sales literature
as allowed in the exemption;
- Respond to customer inquiries about
custody and safekeeping services by providing
-
- Advertisements and sales literature;
- Prospectus or sales literature
prepared by a registered investment
company; or
- Materials based on the above.
- The bank complies with the compensation
and trade execution requirements of the EB/IRA
exemption.
The requirement that the bank not provide
investment advice or research, make recommendations,
or solicit transactions does not prohibit a
bank from cross-marketing its trust and fiduciary
services to custody account customers. Banks
may cross-market investment advisory services
to custody customers by:
- Providing non-account specific information
via newsletters, websites, etc.;
- Providing examples of research, including
stock specific research that the bank provides
to other persons for marketing purposes.
A bank, however, may not provide personalized
investment research regarding securities held
in a custody account. Lists and menus of securities
that can be purchased or sold are not considered
investment advice.
If a customer has both a trust or fiduciary
account and a custody account at the bank,
the bank
may provide investment advice and research
to the customer in connection with the trust
or fiduciary account. The bank is not responsible
for how the trust or fiduciary accountholder
uses such advice or research.
F.1.a.1.b.3.
Subcustodians
A bank that acts as a subcustodian for an
account for which another bank acts as custodian
may rely on either the EB/IRA exemption or
the Accommodation Trade exemption, depending
on the type of account at the custodial bank,
provided that:
- Both the subcustodian and the custodian
bank comply with the requirements of the
respective exemption; and
- The subcustodian does not execute cross
trades, other than -
- Crossing or netting open-end mutual
funds not traded on an exchange; or
- Crossing or netting orders for accounts
of the custodian.
F.1.a.1.c.
Networking Exception
The networking exception
permits non-licensed employees to receive compensation
for the referral of a retail customer to a
registered broker-dealer without causing the
bank to be considered a broker-dealer under
the Exchange Act. Regulation R defines "referral"
as "an action taken by one or more bank
employees to direct a customer of the bank
to a broker-dealer
for the purchase or sale of securities for
the customer's account." Normally, a non-licensed
individual is not allowed to
receive
incentive
compensation in connection with a securities
transaction. The networking exception allows
non-licensed
bank employees to receive a referral fee, which
will not be considered incentive compensation,
provided that the fee received is
a nominal, one-time cash fee of a fixed dollar
amount and the payment is not contingent
on whether the referral results in a transaction.
In addition to limiting referral fees to a
nominal amount, the regulation also addresses
bank bonus plans and the circumstances under
which such plans can include securities-related
activities without being considered incentive
compensation for purposes of the Exchange Act.
Referral fees and bonus programs are discussed
in detail below.
F.1.a.1.c.1.
Referral Fees
Nominal
Regulation R defines the term
nominal referral fee as a payment to a bank
employee personally involved in making the
referral that does not exceed:
- Twice the average of the minimum and
maximum hourly wage established by the
bank for the
current or prior year for the job family
that includes the employee; or
- 1/1000th of the average of the minimum
and maximum annual salary established
by the
bank for
the current or prior year for the job
family that includes the employee; or
- Twice the actual
hourly wage established by the bank for
the current or prior year for the job
family
that includes the employee; or
- 1/1000th of the actual
annual salary established by the bank
for the current or prior year for the
job family
that includes the employee; or
- $25
Banks are not limited to using a single
definition for determining whether a referral
fee is nominal. Banks may
use different methodologies for different lines
of business or operating units. Banks may also
change the methodologies used within a given
year. An employee's "job family" means a group
of jobs or positions involving similar responsibilities,
or requiring similar skills, education, or
training, that a bank, ...uses...for purposes
of hiring, promotion, and compensation. Examiners
should review these job families in order to
ensure that they are not being used to evade
the "nominal referral fee" requirement.
The $25 definition of "nominal" will
be adjusted for inflation beginning on
April 1, 2012 and every 5 years thereafter.
Non-Contingent
A fee is non-contingent if it does not depend on whether:
- The referral results in the purchase
or sale of a security; or
- The referral results in an account
being opened with a broker-dealer; or
- The referral results in multiple transactions.
A referral fee can, however, be contingent
on whether the customer:
- Keeps an appointment
with the broker-dealer; or
- Meets base-line qualification criteria
for referral, such as minimum net worth,
etc.
F.1.a.1.c.2.
Bonus Programs
Incentive compensation is compensation intended
to encourage a bank employee to refer customers
to a broker-dealer or give a bank employee
an interest in the success of a securities
transaction at a broker dealer. Regulation
R provides, however, that incentive compensation
does not include a bonus or similar plan that
is:
- Paid on a discretionary basis. A bonus
plan is discretionary if the amounts paid
are not fixed in advanced and employees do
not have an enforceable right to the bonus
before it is declared by the board;
- Based on multiple factors or variables;
- Include multiple significant factors or
variables that are not related to securities
transactions at a broker-dealer;
- Referrals by employees are not a factor;
and
- Referrals by any other person are not a
factor.
Bonus programs can also be based on the overall profitability
or revenue of:
- The bank, on a stand-alone or consolidated basis;
- An affiliate or operating unit of a bank, if they do not
predominately engage in making referrals
to a broker-dealer; or
- A broker-dealer, if:
- Overall profitability or revenue is only one of multiple
factors or variables used to determine
compensation;
- Referrals are not a factor; and
- Referrals by other employees is not a factor.
In assessing bonus programs for compliance with Regulation R,
examiners will consider the following factors:
- Whether the factors and variables of the bonus plan relate
to activities actually being conducted;
- The resources being devoted to the activities being
conducted; and
- Whether the business lines or activities materially contribute
to the amount of bonus payments.
Over time, it is expected that factors and variables related
to securities transactions will not predominate
the determination of the amount of bonus payments
awarded.
F.1.a.1.d.
Exemption for Referral of High Net Worth/Institutional
Customers
Regulation R provides an additional exemption for referrals
by non-licensed bank employees of high net
worth (HNW) or institutional customers to a
third-party broker-dealer. Unlike referrals
of retail customers, payments can be more than
nominal in amount and may be contingent in
nature. To receive payments under this exemption
bank employees must meet the following requirements:
- Not be licensed;
- Be predominately engaged in banking activities other
than making referrals to broker-dealers;
- Not be subject to any statutory disqualification; and
- Encounter customers in the ordinary course of the employee's
duties.
Regulation R defines a HNW customer as either:
- A natural person who, either individually or jointly with
a spouse, has a net worth of at least $5
million, excluding equity in his/her primary residence;
or
- Any revocable, living trust, where the settlor is a
natural person meeting the $5 million net
worth requirement.
For purposes of determining whether a natural person
meets the $5 million net worth test, the assets of
a person include: (1) any assets held individually;
(2) if the person is acting
jointly with his or her spouse, any assets
of the person’s
spouse (whether not such assets are held jointly);
and (3) if the person is not acting jointly
with his or her spouse,
fifty percent of any assets held jointly with
such person’s
spouse and any assets in which such person
shares with such person’s spouse a community property
or similar shared ownership interest.
Regulation R defines an institutional customer as a corporation,
partnership, limited liability company, trust,
or other non-natural person with at least:
- $10 million in investments; or
- $20 million in revnues; or
- $15 million in revenues if the referral is for investment
banking services.
The final rule defines “investment banking
services” to include, without limitation,
acting as an underwriter in an offering for
an issuer, acting as a financial adviser in
a merger, acquisition, tender-offer or similar
transaction, providing venture capital, equity
lines of credit, private investment-private
equity transactions or similar investments,
serving as placement agent for an issuer, and
engaging in similar activities. The phrase “other
similar services” would include, for
example, acting as an underwriter in a secondary
offering of securities and acting as a financial
adviser in a divestiture.
The dollar thresholds detailed above will
be adjusted for inflation beginning on April
1, 2012 and every 5 years thereafter.
When making a referral of a HNW/Institutional customer the bank
must disclose the following:
- The name of the broker-dealer; and
- The fact that the bank employee participates in an
incentive program where the employee may
receive a fee of more than a nominal amount
that may be contingent on whether the referral
results in a transaction.
The disclosures must be provided either:
- In writing prior to or at the time of the referral; or
- Orally prior to or at the time of referral, provided
that the bank provides the required information
in writing within 3 days of the referral.
Banks may, however, contract with the broker-dealer to provide
the required disclosures, provided the agreement
is in writing. When provided by the broker-dealer,
the disclosures must be provided:
- Prior to or at the time the customer begins the process
of opening an account; or
- If the customer already has an account at the broker-dealer,
prior to the time the customer places an
order.
The bank must have a reasonable basis for believing that the
customer is a HNW or institutional customer
at the time of the referral for natural persons
or before the referral is paid to the employee
for a non-natural person.
The exemption imposes the following obligations
on the broker-dealer with which the bank contracts
for third-party brokerage services:
- Determine whether the referring bank employee is subject
to a statutory disqualification;
- Have a reasonable basis to believe that the customer
referred is a HNW/institutional customer;
- If the referral fee is contingent, perform a suitability
analysis of the transaction before execution;
- If the referral fee is non-contingent, determine that
the customer:
- Has the capability to evaluate investment risk and
make independent decisions; and
- Is exercising independent judgment based on individual
assessment; or
- Perform a suitability analysis of all transactions
requested by the customer contemporaneously
with the referral.
The broker-dealer is required to determine whether the referring
employee is subject to a statutory disqualification
prior to paying the first referral and once
a year thereafter as long as the employee remains
eligible to receive such referral fees. The
rule requires that, before a higher-than-nominal
referral fee is paid to a bank employee under
the HNW/institutional customer exemption, the
bank provide the broker-dealer the name of
the employee and such other identifying information
that the broker-dealer may need to determine
whether the employee is subject to statutory
disqualification. The bank should provide at
least annually its broker-dealer partner any
changes to the identifying information initially
provided.
A bank or broker-dealer would have a “reasonable basis
to believe” that a customer is a high net worth customer
or institutional customer if, for example,
the bank or broker-dealer obtains a signed
acknowledgment from the customer (or, in the
case of an institutional customer, from an
appropriate representative of the customer)
that the customer meets the applicable standards
to be considered a high net worth customer
or an institutional customer, and the bank
employee making the referral or the broker-dealer
dealing with the referred customer does not
have information that would cause them
to believe that
the information provided by the customer (or
representative)
is false.
The broker-dealer is required to inform the customer if the
customer does not meet the suitability criteria.
The broker-dealer must also notify the bank
if it determines that the customer is not a
HNW or institutional customer and if it determines
that a referring employee is subject to a statutory
disqualification.
For purposes of the HNW/Institutional Customer exemption
the term "referral fee" is defined as a predetermined
dollar amount, or a dollar amount determined
by a predetermined formula that does not vary
based on:
- The revenue generated by or the profitability of the securities
transactions of customers; or
- The quantity, price, or identity of the securities
transactions conducted over time by the customer;
or
- The number of customer referrals made.
A referral fee, however, can be based on a fixed percentage
of the revenues received by a broker-dealer
for investment banking services provided to
the customer.
The exemption provides that a bank that acts in good
faith and that has reasonable policies and procedures
in place to comply with the requirements
of the exemption will not be considered
a “broker” under Section 3(a)(4) of the Exchange
Act solely because the bank fails, in a particular
instance, to determine that a customer is
an institutional or high net
worth customer; provide the customer the
required disclosures; or provide the broker-dealer
the required information concerning
the bank employee receiving the referral
fee within the time periods prescribed. If
the bank is seeking to comply and takes
reasonable and prompt steps to remedy the
error, such as by promptly making the required
determination or promptly providing the broker-dealer
the required information, the bank will not
lose the exemption from registration in these
circumstances. Following any required remedial
action, the bank must make reasonable efforts
to reclaim the portion of the referral fee
paid to the bank employee for a referral
that does not, following any required remedial
actions, meet the requirements of the exemption
and that exceeds the amount
the bank otherwise would be permitted to
pay.
F.1.a.1.e. Sweep Account Exception/Money Market Fund
Exemption
The Sweep Account Exception allows a bank to effect transactions
as part of a program for the investment or
reinvestment of deposit funds in a no-load
money market fund. Regulation R defines a
no-load fund as a fund that does not charge
an upfront sales load or a deferred sales load,
and where total charges against the net assets
for sales, sales promotion, personal services
or the maintenance of shareholder accounts does not
exceed 25 basis points. Under the statutory
exception, a bank may also sweep deposit funds on behalf
of another bank into a no-load money market
fund. Regulation R provides an exemption under
which a bank may, on behalf of both bank customers
or other banks,
invest or reinvest funds in a money market
fund that is not a no-load fund, as defined
in the regulation.
In order to effect transactions
in a money market fund that is not a no-load
fund the bank must:
- Provide the customer, directly or indirectly, another
product or service that would not cause
the bank to register as a broker dealer;
- Provide the customer with a prospectus for the fund
not later than at the time the customer authorizes
the transactions; and
- Not refer to or characterize the fund as a no-load
fund
F.1.a.1.f. Exemption
for Transactions in Regulation S Securities
Regulation S is an SEC regulation that governs the conditions
under which securities offered to investors
outside the U.S. are exempt from registration
under the Securities Act of 1933. A Regulation
S security is an equity security issued by
a public company located in the U.S. to non-U.S.
persons in an offshore transaction.
Regulation R exempts a bank effecting transactions in Regulation
S securities from the definition of broker
to the extent that the bank, acting as an agent:
- Effects a sale of an eligible security to a purchaser
who is not in the U.S.; or
- Effects, by or on behalf of a person who is not
a U.S. person, a resale of an eligible security
after its initial sale with a reasonable
belief that the security was sold outside
the U.S. to a purchaser who is not in the
U.S. or a broker-dealer. If the resale is
made prior to any applicable distribution
compliance period under Rule 903(b)(2) or
(b)(3) of Regulation S, the resale must comply
with Rule 904 of Regulation S; or
- Effects, by or on behalf of a registered broker-dealer,
a resale of an eligible security after its
initial sale with a reasonable belief that
the eligible security was initially sold
outside the U.S. to a purchaser who is not
in the U.S. If the resale is
made prior to any applicable distribution
compliance period under Rule 903(b)(2) or
(b)(3) of Regulation S, the resale must comply
with Rule 904 of Regulation S
An eligible security is a security that:
- Is not being sold from the inventory of
the bank or an affiliate of the bank; and
- Is not being underwritten by the bank or
an affiliate of the bank on a firm commitment
basis, unless the bank acquired the security
from an unaffiliated distributor that did
not purchase the security from the bank or
an affiliate of the bank.
A purchaser is a person who purchases an eligible
security and who is not a U.S. person.
F.1.a.1.g.
Exemption for Securities Lending Transactions
Regulation R provides an exemption from the
definition of broker for banks that, as an
agent, engage in securities lending transactions
or securities lending services. A bank may
engage is these activities with or on behalf
of persons the bank reasonably believes to
be:
- A qualified investor as defined in the
Securities Exchange Act of 1934; or
- An employee benefit plan that owns or invests
on a discretionary basis not less than $25
million in investments.
A "securities lending transaction" is
a transaction in which the owner of a security
lends the
security temporarily to another party pursuant
to a written securities lending agreement under
which the lender retains the economic interests
of an owner and has the right to terminate
the transaction and recall the loaned securities
on terms agreed by the parties.
Regulation R defines "securities lending services" as:
- Selecting and negotiating with a borrower
and executing, or directing the execution
of the loan with the borrowers:
- Receiving, delivering, or directing the
receipt or delivery of loaned securities;
- Receiving, delivering, or directing the
receipt or delivery of collateral;
- Providing mark-to-market, corporate action,
recordkeeping or other services incidental
to the administration of the securities lending
activity;
- Investing, or directing the investment
of, cash collateral; or
- Indemnifying the lender of securities with
respect to various matters.
F.1.a.2 Other GLBA Exceptions
F.1.a.2.a. Permissible Securities Transactions
Permissible securities transactions are transactions
in specific types of securities and instruments that banks commonly
engage in. The types of transactions covered by this exception
are:
- Commercial paper, bankers acceptances, or commercial
bills;
- Exempted securities, e.g. U.S. government securities;
- Qualified Canadian government obligations;
and
- Any standardized credit enhanced debt
security issued by a foreign government
pursuant to the March 1989 plan of then Secretary
of the Treasury Brady, used by such
foreign government to retire outstanding commercial
bank loans, i.e. Brady bonds.
For purposes of this exception, municipal securities are not
treated as exempted securities. Transactions in municipal securities
are covered by a separate exception in GLBA.
F.1.a.2.b.
Stock Purchase Plans
A bank, acting as transfer agent, may effect transactions
in the securities of an issuer as part of any pension, retirement,
profit sharing, bonus, thrift, savings, incentive, or other similar
benefit plan for the employees of the issuer, or affiliates thereof.
The bank, however, may not solicit transactions nor provide investment
advice with respect to such securities in connection with the
plan.
A bank, acting as transfer agent, may also rely on this exception
to effect transactions as part of an issuer’s dividend
reinvestment plan, if:
- The bank does not solicit transactions or provide
investment advice with respect to the purchase
or sale of securities in
connection with the plan; and
- The bank does not net shareholders’ buy and sell orders,
other than for programs for odd-lot holders
or plans registered with the SEC.
Similarly, a bank, acting as transfer agent may effect transactions
in the securities of an issuer as part of a plan or program for
the purchase or sale of such issuer’s share, if:
- The bank does not solicit transactions or provide
investment advice with respect to the purchase
or sale of securities in
connection with the plan; and
- The bank does not net shareholders’ buy and sell
orders, other than for programs for odd-lot
holders or plans registered
with the SEC.
A bank may deliver written or electronic plan
materials to the employees of the issuer,
shareholders of the issuers, or members of affinity groups
of the issuer, provided
the materials are comparable in scope or
nature to that permitted by the SEC as of the date of
enactment of GLBA or are otherwise
permitted by the SEC.
F.1.a.2.c.
Private Securities Offerings
A bank may effect
sales of a primary offering of securities
not involving a public offering, provided that the
bank is not affiliated with a broker or
dealer and any one private placement
offering in which
the bank is involved does not exceed
25% of the bank’s capital. Private placements of government
and municipal securities are not subject
to the 25% of capital limitation.
F.1.a.2.d.
Municipal Securities
GLBA provides for an exception for a bank acting
as a broker in municipal securities transactions.
F.1.a.2.e.
Affiliate Transactions
A bank may effect transactions for the account
of any affiliate of the bank, provided that the affiliate is
neither a registered broker-dealer nor engaged in merchant
banking activities. For this exception, affiliate is as defined
in the Bank Holding Company Act of 1956. Similarly, the term
merchant banking is as described in Section 4(k)(4)(H) of the
same act.
F.1.a.2.f. Identified Banking Products
Banks may effect
transactions in “identified
banking products.” Identified banking products are
products that have not traditionally been considered securities
and include
deposit accounts, certificates of deposit,
loans, and loan participations. The loan participation exception,
however, is qualified by the
requirement that it must be a participation
which the bank, or an affiliate of the bank, participates
in or owns and that is
sold to either qualified investors or persons
having the opportunity to review and capability of assessing
material information concerning
the loan participation. One further requirement
governing the sale of loans or loan participations requires
that such loans
or participations not be deemed securities
under the Securities Exchange Act of 1934. Swap agreements,
including all credit and
equity swaps, other than equity swaps with
retail customers, are considered identified banking products.
F.1.a.2.g.
De Minimis Transactions
GLBA provides for a de minimis exception for
banks that effect up to 500 securities transactions
a year. The de minimis exception, however,
can not be used for transactions
effected by dual employees. It should also
be noted that the up to 500 transactions threshold
pertains to the total of both
broker transactions and dealer riskless principal
transactions, so that the combined securities
transactions governed by the
broker De Minimis and dealer Riskless Principal
exceptions must total less than 500 per year.
F.1.b. Registered Dealer
Bank Dealer Exceptions
to Registration with the SEC for Certain Securities Activities
Section 202 of the GLBA amended the
definition of "dealer" by repealing the Securities Exchange Act exclusion for
banks from dealer registration and regulation.
The SEC has issued a final rule
concerning the bank dealer exceptions to the Securities Exchange Act of 1934
("Exchange Act"), as amended in Section 202 of the GLBA. See 68 Federal
Register 8686 (February 24, 2003). Also refer to
Appendix D, Bank as Dealer. The compliance date of the rule is
September 30, 2003. Exchange Act section 3(a)(5) defines a "dealer" as a
person that is "engaged in the business of buying and selling securities" for
its own account through a broker or otherwise, and exempts persons, whether
banks or non-banks, who do not buy or sell securities "as part of a regular
business". Banks do not need to register with the SEC and the National
Association of Securities Dealers unless they act as dealers and do not qualify
under any of the exceptions under Section 202 of GLBA. The SEC has
recently issued a
Staff Compliance Guide to Bank on Dealer Statutory Exceptions and Rules,
which is available on the SEC Division of Market Regulation's website and in
Appendix D of this manual.
GLBA replaced the former uniform bank
exception for securities dealer registration under the Exchange Act with four
specific exceptions. These statutory exceptions are:
-
Investment transactions:
permits banks to buy and sell securities for investment purposes for the bank
and in its customers' trustee and fiduciary accounts.
- Permissible securities
transactions: permits banks to buy and sell exempted
securities, certain Canadian government obligations, and Brady bonds.
- Identified banking products:
permits banks to buy and sell certain "identified banking products," as defined
in Section 206 of GLBA.
- Asset-backed
transactions: permits banks through a grantor trust or other
separate entity to issue and sell to qualified investors certain asset-backed
securities representing obligations predominately originated by a bank, an
affiliate of a bank other than a broker-dealer, or a syndicate in which the
bank is a member for some types of products.
The SEC's bank dealer
rule addresses certain interpretive issues arising from these statutory
exceptions for bank dealer activities. In addition, it addresses certain
additional exemptions that involve bank dealer activities that also could be
covered as broker activities. These additional exemptions provided under
the SEC's bank dealer rule include:
Riskless principal
transactions. This exemption permits banks to engage in a
limited number (up to 500) of "riskless principal" transactions per calendar
year without registering with the SEC as dealers. A "riskless principal"
transaction is one in which, after having received an order to buy from a
customer, a bank purchases the security from another person to offset that
contemporaneous sale. Alternatively, a riskless principal transaction is
one in which after having received an order to sell from a customer, a bank
sells the security to another person to offset that contemporaneous purchase.
- How to count transactions for
purposes of this exemption: Transactions
with two customers where the bank acts as a riskless principal between them
count as one transaction. However, if a bank acts as a riskless principal
between one counterparty and multiple counterparties by arranging multiple
transactions, each of the transactions on the side that involves the largest
number of transactions would count as separate transactions against the annual
transaction-limit.
- How counting will be affected
by banks' brokerage activities:
The Exchange Act also permits banks to engage in certain "broker" activities
without registering with the Commission. At the time the "dealer"
provisions become effective, however, the "broker" provisions still will be
subject to a Commission order delaying their effectiveness. One of the
"broker" exceptions - known as the de minimis exception - permits banks to
engage in no more than 500 brokerage transactions per year that are not
otherwise exempt without registering with the Commission. When banks
utilize this exception after the compliance date is set for the broker rules,
banks' riskless principal transactions and
brokerage transactions effected under the de minimis exception will count
toward the same 500-transaction limit. In other words, banks may be able
to engage in any combination of brokerage transactions under the de minimis
exception and riskless principal transactions under Rule 3a5-1, so long as the
total number of these transactions does not exceed 500 per year. Until
the broker rules are effective, however, banks may use the entire
500-transaction limit for riskless principal transactions.
Securities lending
transactions. This exemption permits banks to engage in, or
effect, securities lending transactions with certain counterparties. A
"securities lending transaction" is a transaction in which the owner of a
security lends the security temporarily to another party under a written
securities lending agreement. Through this agreement, the lender retains
the economic interests of an owner of the securities. Subject to the
terms agreed upon by the parties, including an agreement to loan the securities
for a fixed term, the lender also has the right to terminate the transaction
and to recall the loaned securities.
F.1.c.
Investment Advisers
Section 217 of the GLBA amends
certain sections of the Investment Advisers Act of 1940
(Advisers Act) to require any
bank or bank holding company which serves
as an investment adviser to a registered investment company
(i.e. open-end mutual fund) to register under the
Advisers Act. A bank or bank holding company can also register
a separately identifiable department or division (SIDD). Under
the GLBA, regulatory agencies and the Commission are required to provide
each other with
the results of any examinations or inspections
conducted with respect to the investment advisory activities. Refer
to Appendix D, Bank
as Investment Advisor, for additional information.
F.2. Privacy Issues Faced by the
Fiduciary
Privacy applies to all financial
institutions. It is an emerging area of concern, therefore, rules and
regulations applicable to financial institutions are continuing to evolve and
will for some time. In order to assess privacy issues in the context of
fiduciary activity, a few fundamental concepts and terms/definitions are
necessary.
Part 332 of the FDIC's Rules and Regulations is the privacy regulation
applicable to state nonmember banks. The regulation contains extensive
definitions of terms, and numerous examples to illustrate the definition. Some
of the defined terms include:
-
A "financial institution" is any
institution the business of which is to engage in financial activities as
described in section 4(k) of the Bank Holding Company Act of 1956.
Industry publications have stated this, in general terms, means "any
institution the business of which is engaged in financial services". The
definition includes providing investment advisory services and issuing and
selling of interests in pooled assets.
-
Privacy rules pertain to "nonpublic
personal information" which is defined as personally identifiable financial
information. It includes information provided by the consumer to obtain a
product or a service and/or information gleaned from transactions with the
consumer or performed for the consumer. It excludes "publicly available"
information. Information is "publicly available" if a financial
institution has a reasonable basis to believe that the information is lawfully
made available to the general public from one of the categories of sources
listed in
Part 332.
-
It only covers "personal"
information. Therefore, it only applies to consumers, not to business or
institutional customers.
-
A consumer is defined as an individual, who
obtains from a financial institution, financial products or services used
primarily for personal, family, or household purposes. The definition
also includes the legal representatives of such an individual.
-
Federal banking authorities have excluded
beneficiaries of trusts and participants of employee benefit plans that the
bank either sponsors, or for which it acts as trustee or fiduciary. The
rationale is that the trust/plan itself is the customer and not an individual,
and therefore the rules do not apply.
-
An investment management agency
relationship with a business or a trust would not fall under this regulation.
-
However, in the case of an individual who
selects a financial institution as custodian of securities or assets, as in an
IRA, the individual is viewed as a consumer. Another example is an
investment management agency with an individual(s).
-
Refer to
Section 332.3(e) for the complete definition of "consumer" and
Section 332.3(i) for the complete definition of "customer
relationship."
-
A financial institution is prohibited from
disclosing "nonpublic personal information" about a consumer to nonaffiliated
third parties unless the institution satisfies various notice and opt-out
requirements, and the consumer has not elected to opt-out. A
nonaffiliated third party means any person except: (i) a bank affiliate; or
(ii) a person employed jointly by the bank and any company that is not a bank
affiliate. The company the person works for is considered a nonaffiliated
third party. Also, an affiliate that is an affiliate solely by virtue of
its direct or indirect ownership in an entity conducting merchant banking or
insurance company activities (as defined in Section 4(k) of the Bank Holding
Company Act of 1956) is considered a nonaffiliated third party.
- A
financial institution is required to disclose to all of its customers
the institution's privacy policies and
practices with respect to information
sharing with both affiliates and nonaffiliated third parties. This
is discussed below in item F.2.b.
- ederal privacy guidelines do not supersede
more stringent State regulations. Nor do they preempt the Fair
Credit Reporting Act.
F.2.a.
Applicability to Trust Operations
A financial institution is required to
develop guidelines for the safeguarding of customer information. The
guidelines are applicable to trust operations. These guidelines pertain
to the administration and physical safeguarding of customer records and
information. There are three elements to consider when establishing
policies and procedures with regard to privacy. First, the fiduciary is
to insure the security and confidentiality of customer records. Second,
the fiduciary is to protect against any anticipated threats or hazards
to the security or integrity of such records. Third, the fiduciary is to
protect against unauthorized access to, or use of, such records or information
that could result in substantial harm or inconvenience to any customer.
This includes: the fiduciary's use of information; the re-disclosure and reuse
of information (Section
332.11); and the use of information by contractually obligated third
party service providers (Section
332.13). The guidelines will be unique to each institution and
dependent upon the size and complexity of the operation. To develop an
effective risk management program to govern privacy, the following will be
required:
-
Identification and assessment of risk;
-
Development of written plans and procedures
to manage the risk;
-
Implementation and testing of compliance
with established policies; and
-
Adjustments to the policies, as needed,
based upon findings and changes in the operating environment.
The Board of Directors should approve the
written policies and periodically receive reports on the implementation and
effectiveness of the policies. Management should continually evaluate the
operating environment to determine needed changes to, and monitor compliance
with, the policies.
F.2.b. Applicability to Fiduciary
Customers/Consumers
The privacy regulation contains customer
and consumer disclosure requirements. There is no preset method for
disclosure. However, alternative methods are available to satisfy
disclosure requirements, including the use of short-form initial disclosures;
toll-free telephone numbers, hand-delivered disclosures, etc. The
disclosures may be provided in paper or electronic format. The only
requirement is that "each consumer should reasonably be expected to receive the
notice". Verbal notification is prohibited. However,
regardless of the method used, detailed guidelines govern the type of
information to be contained in disclosures, as summarized below:
-
Typically, a fiduciary must disclose the
privacy policy at the initiation of the relationship and annually
thereafter. However, Sections
332.14 and
332.15 identify exceptions to this rule. Annually has been defined to
mean at least once in any 12 consecutive months during which the relationship
exists. A fiduciary may define any 12-consecutive-month period so long as
it is applied consistently.
-
Disclosures are to be "clear
and conspicuous."
Section 332.3(b) provides a detailed definition of "clear and
conspicuous". There is also guidance for web site notices. There
is no predefined disclosure language or form.
-
There are minimum requirements (Section
332.6) governing the content of annual and periodic disclosure
statements. In general, the disclosure statement includes the following
information: categories of nonpublic information that are collected; the
categories of information that are disclosed; the categories of affiliated and
nonaffiliated third parties to whom the information is disclosed; and the
categories of information disclosed about former customers. A statement
of the categories of information disclosed, and to whom it is disclosed, is
also required if "nonpublic personal information" is disclosed to nonaffiliated
third parties. At this point, the consumer's right to "opt-out" must also
be disclosed. Finally, all statements must also include the fiduciary's
policy and practices with respect to protecting the confidentiality and
security of "nonpublic personal information."
-
The "opt-out" information must also be
"clear and conspicuous". In general, the notice must include language to
the effect that the fiduciary reserves the right to disclose nonpublic personal
information to nonaffiliated third parties, that the consumer has the right to
opt-out of the disclosure, and a "reasonable" means by which the customer may
opt-out. Significantly, the "opt-out" requirement typically does not
pertain to the disclosure of nonpublic personal information to a nonaffiliated
third party that performs services or functions on behalf of the
fiduciary. Instead, at a minimum, the contractual agreement with the
third party should prohibit the third party from disclosing, or using the
information, other than to carry out its duties.
back to top
G.
Outside Contracting for fiduciary services
Increasingly,
financial institutions are contracting with affiliates and third parties
to
facilitate the offering of
trust services to their customers. These contracts can be for services
ranging from trust data processing, custody, investment management, and
complete fiduciary services. Many small trust departments have
historically outsourced data processing, tax preparation,
and certain specialized asset management tasks.
Outsourcing is one method for obtaining
expertise not internally available, improving services, and managing
costs. However, outsourcing may also expose the department to additional
risk. This includes security of customer information, and the
availability of information and management reporting systems. Management
should identify the key risks associated with outsourcing arrangements, and
implement appropriate oversight programs to monitor each service provider's
controls, performance, and financial condition on a continuing basis.
Today, it may be possible for banks to
delegate virtually the entire process of providing and administering trust
services, while retaining the appearance of, and some of the income from,
providing such services. The Corporation neither endorses nor prohibits
an institution's full delegation of services and duties to outside service
providers. Rather, this practice is considered a business risk decision.
In doing so, bank management is expected to fully investigate and document
beforehand the inherent challenges and legal obstacles to providing
fiduciary services in this manner. Bank management is also expected to demonstrate
its continuous monitoring of service provider activities, the
quality of services provided its customers, and any associated business or
legal risk. The Corporation's approach in evaluating business plans to
extend trust services in this manner is to consider the merits of each business
plan on a case-by-case basis.
Once a decision has been made to employ an
outside service provider, the selection process itself must be prudent.
Before selecting an agent, the board and senior management should first
investigate and acquire a suitable working knowledge of the business or service
to be contracted. Management should then perform and document its
due-diligence review of prospective agents. These activities may later
aid the bank in demonstrating that care and prudence were exercised in
selecting an agent to assist in, or perform, fiduciary duties.
Significantly, although fiduciaries may be permitted under law to delegate
duties to agents, they retain responsibility for the careful selection of
such agents (refer to section
9 of the Uniform Prudent Investor Act). And while the initial
selection process is important, management has a continuing responsibility to
ensure the service provider's suitability after the relationship has been
established.
States still operating under the Prudent
Man Rule may prohibit the out-outsourcing of account administrations, fiduciary
and/or investment management responsibilities. Refer to
Prudent Man Rule in Appendix C.
G.1. Applicable Regulations
When establishing a relationship with a
third party or affiliate, management must be conversant with all applicable
regulations. For relationships with affiliates, Section 23A and 23B of
the Federal Reserve Act may apply. Section 23B requires all transactions
between a financial institution and a non-bank affiliate to be conducted on a
basis comparable to that of similar transactions between nonaffiliated
entities. Management must also ensure that state law permits the
delegation of services to third parties. For those states that have enacted the
Prudent Investor Act, management is typically granted broad delegation
power. This power is further addressed below. In all instances, contracts
between the bank and third parties should meet the requirements of Section 30
of the FDI Act; namely, that the contract does not adversely affect the safety
and soundness of the institution.
G.2. Due Diligence Reviews
Prior to designating a servicing agent for
its fiduciary activities, the serviced institution should document its exercise
of reasonable caution in selecting agents. Compatibility and performance
should be considered in conjunction with the cost of the services to be
provided. The scope of the due diligence may depend upon the type and
significance of outsourcing activity. However, detailed below are common
considerations in any due diligence review. The listing does not
supersede provisions of law or regulation, nor does it preclude additional
concerns which may occur in some situations.
-
An assessment should be made of the
servicing organization's ability to handle the volume and nature of trust
accounts and assets to be serviced. Obtaining a list of servicer
references and contact names is a common practice.
-
The financial strength and viability of the
servicing organization should be considered. In this regard, the strength
provided by a parent holding company or similar organization may also be
considered. This would entail a review of financial statements and audit
reports, and a search of pending or threatened financial or legal claims.
-
If investment management is being
outsourced, then a review of the servicer's investment performance (over a
minimum of 5 to 10 years, or several investment cycles) should be
reviewed. SEC advisers Form ADV, if required, may provide some insight on
the registered investment advisers investment philosophy.
-
Audit or supervisory evaluations of the
servicing organization, if available. Depending upon the outsourced
function, management may obtain AICPA Statement of Auditing Standards
SAS 70 Reports, if conducted, or other available reports.
-
A review of certain policies, procedures,
and controls of the servicing organization should be made. Knowledge of a
service provider's business strategies, privacy policies, service philosophies,
and quality control initiatives may be beneficial in choosing a firm whose
standards correspond to the bank's standards.
-
Evidence supporting the maintenance of
fidelity insurance coverage by the servicing organization should be obtained.
G.3. Written Agreements
With Agents
Once a service provider is chosen, a
written agreement should be drafted that governs the arrangement. The
institution's legal counsel should be involved in the drafting and/or review of
the contract when critical functions are being outsourced. The contract
should be flexible, yet clearly outline the expectations and responsibilities
of all parties. The contract should specify the scope and risks of the
outsourced activity, all relevant terms, conditions and responsibilities, and
the liabilities of each party. The minimum provisions which should be
included are:
Institutions should be strongly encouraged
to include the following in written servicing agreements:
-
Minimum service levels, dispute resolution
procedures ,
termination clauses - It is prudent
for the contract to include bankruptcy clauses, and warranties allowing for
termination for cause without penalty by the serviced institution.
Examiners should be alert for contracts with extended termination dates between
the bank and affiliated entities which may be used to create "value" on the
books of the affiliate. Contracts should be reasonable in length, given
services performed.
-
Documentation Standards
- The files and computer records
relating to the serviced bank should be identified as accounts of the serviced
bank, and not that of the servicer, to facilitate audits, examinations,
preparation required regulatory reports (e.g. Call Report Schedule RC-T), and
any similar reporting requirements. Additionally, the confidentiality of
shared information and client data should be addressed.
-
Audit Provisions
- The contract should include the
right of the serviced entity to obtain SAS 70 Reports, or other third-party
reviews and audits. Or, the contract may allow for the serviced entity to
conduct audits of the service provider's operations. Some contracts may
also allow for receipt of the servicing entities audit reports, or those
sections of audits which apply to the serviced institution.
-
Supervisory Access
- The rights of the institution's supervisory authorities to access
information of the institution and the operations of the servicer.
-
File Recovery at Termination
- Clauses in the contract should address the return of hardcopy and
electronic files to the serviced institution, or its designee.
-
Liability Clauses
- An indemnity provision in the
agreement should set forth the liability of each party.
-
Insurance Coverage
- There should be a provision requiring sufficient fidelity and liability
insurance coverage on the activity by both parties.
In all
instances, contracts between the bank and third parties should meet the
requirements of Section 30 of the Federal Deposit Insurance Act; namely,
contracts must not adversely affect the safety and soundness of the
institution.
G.4.
Periodic Monitoring of Agent's Condition and Performance
In addition to performing an initial review
of the servicing agent, management has a responsibility to monitor and
periodically update its documentation on the condition and activities of the
servicing organization, while ensuring that the provisions of the agreement are
being met. At a minimum, the institution's monitoring program should
incorporate:
-
Conducting, or reviewing results of,
independent audits of the service provider's operation;
-
Verifying and reviewing the adequacy of the
service provider's contingency plans; and
-
Developing contingency plans in the event
of deteriorating performance or other problems encountered with the service
provider.
-
Monitoring the investment performance of
the servicer, if the servicer provides investment management services.
G.5.
Client Disclosures
Since it is possible for an institution to
delegate virtually the entire process of providing and administering trust
services, the question arises as to how much disclosure should be made to
clients regarding such arrangements. An institution that delegates
virtually all of its responsibilities would be expected to disclose more than
those which only outsource ancillary services. Regardless, disclosures
should provide clients with sufficient information to make informed decisions,
and to maintain a rapport commensurate with the fiduciary relationship
itself. State laws may also dictate the extent of disclosures made to
clients.
G.6.
Delegation of Investment Management Services
Some departments do not have the expertise
or staffing resources to provide investment management services. These
institutions either do not offer investment management services to their
clients, or have delegated this function to a third party. To some
degree, the legality of delegating fiduciary investment management authority is
dependent on state law. FDIC-supervised financial institutions located in
states in which fiduciary investments are governed by the
Prudent Man Rule or by a Legal List, may not delegate the
servicing of their fiduciary accounts to another institution, unless state law
explicitly provides for such a delegation. FDIC-supervised financial
institutions located in states in which fiduciary investments are governed by
the Prudent
Investor Act, may delegate the servicing of their
fiduciary accounts to another trust department or other entity.
Those firms that have delegated investment
management responsibilities to others may use Registered Investment Advisers as
defined under the Investment Advisers Act of 1940. Registered Investment
Advisers are paid to provide investment advice, and generally must register
with the SEC or the state securities agency where their principal place of
business is located. Generally, those who manage client assets of $25
million or more must register with the SEC, while all others register with
their respective state agency.
The SEC adopted a rule amendment
under the Investment Advisors Act of 1940 to exempt
certain investment advisers that
provide advisory services through the Internet
from the prohibition on Commission registration.
The rule amendments permit these advisers, whose
businesses are not connected to any particular
state, to register with the Commission instead of
with state securities authorities. The final rule (Release
No. IA-2091 www.sec.gov) became effective January 20, 2003.
All registered advisers are required to
file a "Form ADV," which is an application to apply for registration or amend
registration. Form ADV consists of two parts. Part I contains
general and personal information about the applicant. Part II contains
information on the nature of the applicant's business, including: operations,
services offered, fees charged, type of clients advised, educational and
business backgrounds of associated persons, and other business activities of
the applicant. The ADV is a public document, and registered investment
advisers should provide a copy of the form to their clients. Therefore,
if the department utilizes the services of a registered adviser, management
should have a copy of the most recent Form ADV on hand. Additionally,
management should have a contract with the adviser outlining the
responsibilities of both parties. The receipt and periodic review of such
documents is an integral task of the due diligence process.
G.7.
Use of a Registered Securities Broker as Custodian
Increasingly, departments are utilizing the
services of registered securities brokers as custodian for the assets of trust
department accounts. While this practice was previously prohibited under
Corporation guidelines and long-standing precedents of the OCC, the revised OCC
Regulation 9 no longer contains such prohibitions. As such, other
regulatory agencies have reportedly permitted institutions to utilize similar
arrangements. If such an arrangement is encountered, the examiner should
expect to see an appropriate due diligence program to manage associated
risks. Bank management has the responsibility to ensure that the legal
agreement with the broker offers sufficient protections to the bank and its
trust beneficiaries. Please refer to
Section 2.J. Use of Broker Dealer for Securities Safekeeping for more
information.
back to top
H. Servicing Contract
Accounts
The trust department may engage in
contracts to provide services for outside companies,
such as accepting a role (agent, custodian, trustee, etc.) from outside
organizations marketing employee
benefit plans, IRAs, investment plans, trusteeship
of prototype trusts, and other similar products. Since these types of arrangements inherently
contain additional risk exposure, management should ensure that they are
fulfilling all their responsibilities under written agreements and fiduciary
laws. Many of the same due diligence efforts discussed above would
be applicable to the institution providing such services.
I.
Enforcement Actions
Trust
department activities are subject to supervisory enforcement
actions just as any other activity or department of the
bank. The underlying rationale for all "enforcement actions" or
supervisory initiatives is to obtain correction or improvement of a perceived
problem, condition, or weakness. The examiner's careful selection
and judicious recommendation for the use of such actions continues to
be paramount
in preserving the effectiveness of these tools.
I.1. Types of Enforcement
Actions
I.1.a.
Informal Actions
Informal actions include: memorandums of
understanding, board resolutions, written agreements, and capital
directives. Examiners should consider an informal action for those
departments exhibiting supervisory concern, but where the problems do not pose
a threat to trust beneficiaries or the safety and soundness of the
institution. An informal administrative action should be considered, but
is not mandatory, for any department rated a
composite "3". The relative significance of weaknesses,
management's recognition of the weaknesses and its willingness to take
corrective measures, together with the extent of corrections made during the
course of an examination, should be all evaluated when considering an informal
action. However, at a minimum, an informal action may be necessary where
significant weaknesses remain uncorrected from prior examinations.
I.1.b. Formal Actions
Section 8 of the FDI Act gives the FDIC
Board of Directors broad enforcement powers including: Termination of Insurance
Actions (Section 8(a)), Cease and Desist Actions (Sections 8(b) and 8(c)), and
Suspension and Removal procedures (Section 8(e)). Problem trust
departments are those which are assigned a
composite rating of "4" or
"5" under the Uniform
Interagency Trust Rating System. It is expected that such
departments will normally be subject to some type of formal enforcement action
designed to return the department to an acceptable condition. If a formal
action is not undertaken, examiner comments should describe alternative actions
taken and justify their reasonableness.
I.2.
Enforcement Action Resources
There are various resources available to
the examiner if the examination findings indicate some type of enforcement
action may be necessary. Examiners are reminded that they should be in
contact with the Regional Office when considering such action. Detailed
below are some resources available for review.
-
Manual of Examination Policies
(Manual) - Section 13 provides expanded guidance on the use of
informal and formal enforcement actions.
- Formal and Informal
Action Procedures Manual (FIAP
Manual) - Contains procedural guidance when departmental
conditions indicate some type of enforcement action is warranted.
- Case Manager Procedures
Manual (CM Manual)
- For use at the Regional Office; it contains procedures to guide in the
review and processing of enforcement actions.
I.3.
Civil Money Penalties
In connection with examinations of
fiduciary activities, infractions of certain laws may be detected for which the
assessment of civil money penalties (CMPs) is authorized. A full
discussion of criteria and procedures for recommending such penalties is
provided in Section 14 of the
Manual. In addition, further guidance, as well as the scoring
matrix to be used in CMP decisions, is provided in the Formal and Informal
Action Procedures Manual (FIAP Manual).
back to top
J. Criminal Activities
The
examination of trust activities within a financial
institution may disclose apparent
violations of criminal law, or
suspicious activities related to money laundering
and the Bank Secrecy Act. When such conduct involves the institution,
either as a victim or potential victim, or where the
bank is used to facilitate criminal activity, it
is the examiner's responsibility to ensure that proper
action is taken and that reporting procedures are
followed. The
prescribed action and reporting procedures are set forth
in Section 9.2 of the Manual of Examination
Policies. In addition,
FDIC Part 353: Suspicious Activity Reports sets forth reporting
procedures for FDIC-supervised banks with respect
to known, attempted, or suspected crimes.
back to top
K. Insurance of fiduciary activities
Insurance is a fundamental part of a
department's risk management program. Once management has identified and
analyzed potential risk areas, and reviewed its internal control structure, it
may determine the appropriate method to deal with particular risks. The
transfer of risk through insurance is one method commonly used. The
specific needs of a department will dictate the type of coverage that should be
obtained, as well as the level of such coverage. Examiners should
refer to Section
4.4 of the Manual of Examination Policies for a general discussion
of insurance management. In addition to coverage of trust activities
under the bank's blanket bond and excess coverage, the following types
of insurance
are sometimes obtained by trust departments:
K.1.
Errors and Omissions (Trust Department Surcharge Liability)
This form of coverage usually covers
four types of losses:
-
Loss from a claim made against the insured by reason of
any alleged negligent act, error, or omission while discharging duties
enumerated in the policy. These duties generally consist of administering
estates or trusts; managing real and personal property; acting as a custodian;
rendering investment advice; or acting as stock transfer agent, registrar,
dividend disbursing agent, escrow agent, or trustee under a bond indenture.
-
Loss from any claim made against the insured arising
out of any alleged failure to act prudently under the Employee Retirement
Income Security Act of 1974, or in an insured capacity as a fiduciary for any
employee benefit account. It is important to note that for employee
benefit accounts to be covered, specific language indicating their inclusion
must be present in either the policy or a rider.
-
Expenses incurred in the defense of any claim, as long
as the coverage for that claim exists under the policy.
-
Payments made to reimburse any officer, director, or
employee for reasonable expenses and attorney fees incurred defending any
claims as an individual. Insurance policies normally will provide for bank
reimbursement only if the bank has indemnified the individual. In cases
where the bank does not indemnify the director, officer, or employee, there is
generally no coverage for the costs incurred by that individual.
K.2.
Real Estate and Mortgages
Blanket real estate insurance covers all
real estate owned by trust accounts, and real estate pledged on mortgages held
by the department. This coverage can be less expensive than purchasing
individual policies when numerous parcels are held. The blanket policy
covering mortgaged real estate usually provides coverage where the mortgagee
fails to keep the property insured. During the examination, there is no
need to check individual insurance policies for mortgaged real estate loans
where a blanket policy covering losses arising out of mortgaged real estate is
in force in an adequate amount. However, examiners should check
compliance with any covenants of the policy requiring the bank to perform
duties to keep the protection effective.
K.3. Other Desirable Insurance
Although insurance is not the only
consideration, thought should be given to exposure arising from employment of
agents by the department. In dealing with a variety of assets and
accounts, the department often employs others to perform tasks critical to
proper account administration. These agents may not be covered by the
bank's insurance policies. Therefore, the department should be certain
that both account beneficiaries and itself are properly protected by
appropriate third party bonding.
back
to top
L. Deposit insurance of trust funds
Deposit insurance regulations
are contained in Part
330 of FDIC Rules and Regulations. The publication "The Financial
Institution Employee's Guide to Deposit Insurance" (http://www.fdic.gov/deposit/deposits/financial/index.html),
provides another reference source. Questions arising during examinations
regarding specific circumstances, may be referred
to the FDIC Call Center at 1-877-ASKFDIC (877-275-3342).
For TDD the toll free phone number is 1-800-925-4618.
The hours of operation of the FDIC Call Center are
Monday thru Friday from 8 a.m. to 8 p.m. Eastern
Time.
From the examiner's perspective,
questions concerning deposit insurance generally arise
in connection with deposits held
as trust account assets. It is generally accepted that, to the extent
trust monies are invested in bank deposits, they
should be kept within insurance limits. Fundamental principles of
deposit insurance for certain types of accounts are
provided below, but examiners are cautioned that
the complexities of the subject preclude exhaustive coverage
here. Bank
management and clients should consult with their
attorneys, tax advisers, or other private professional
advisers, as appropriate, to determine the coverage
of their trust accounts under the deposit insurance
regulations.
Deposit insurance is based on
ownership rights and capacities, as disclosed in the records of the insured depository
institution. The precise documentation of account ownership in the
records of the depository institution is critical. Deposit records
include, but are not limited to, signature cards,
passbooks, and account ledgers and
computer records that relate to the bank's deposit
taking function.
With the exception of deposit accounts in the certain
retirement accounts ownership category, the maximum
coverage is $100,000 per depositor. For
those employee benefit accounts and trust
accounts that qualify for pass-through deposit
insurance, $100,000 per employee benefit plan
participant or trust beneficiary. The maximum
coverage for deposit accounts of certain retirement
accounts is $250,000. Coverage
is per institution: the deposits in each individually-insure
bank or savings institution are separately
insured, even if the institutions are affiliated
through common ownership by a bank holding
company. However, deposits
at separate branch offices operated under a single
charter are not separately
insured.
Various types of deposits are
eligible for coverage, such as savings accounts, certificates
of deposit, checking accounts, money market accounts,
retirement accounts, official checks, outstanding
drafts, etc. For
purposes of deposit insurance coverage, deposits
are categorized according to eight ownership
categories: Single Ownership Accounts; Joint Ownership Accounts;
Revocable Trust Accounts; Irrevocable Trust Accounts;
Accounts of a Corporation, Partnership, or Unincorporated
Association; Certain Retirement Accounts and
Employee Benefit Plan Accounts;
and Government Accounts. The discussion below
centers on those account ownership categories typically
encountered in a trust examination.
L.1. Deposits of Revocable
Trusts
On
January 13, 2004, the FDIC adopted new rules for the insurance
coverage of revocable trust accounts, also referred to as
living trusts. (See FDIC
Rules and Regulations Section 330.10, "Revocable Accounts.")
The new rules took effect on April 1, 2004. The owner, i.e. the grantor,
of a revocable
trust
will be insured up to $100,000 per beneficiary if all the following requirements
are
met:
- The beneficiary is the grantor’s spouse, child, grandchild,
parent, or sibling. Stepparents, stepchildren,
adopted children and similar relationships also qualify. Beneficiaries
that are in-laws,
cousins, nieces and nephews, and charitable
organizations do not qualify;
- The beneficiary’s interest in the trust vests upon the
death of the grantor of the trust; and
- The deposit account must be titled at the bank
in a manner that indicates that the deposit
account is held by a trust.
The amount of coverge is based on the actual interest of each qualifying
beneficiary. Unless the trust states otherwise, the FDIC will assume
that each beneficiary, including beneficiaries with a life estate, has
an equal interest in the trust.
The new rules differ from the old rules in that the FDIC will ignore
conditions that may limit a beneficiary’s right to his/her interest
in the trust. Prior to the new rule, beneficiaries with contingent interests
in a trust were not eligible for per-beneficary coverage. Also, the
new rule elimiated the requirement that the bank maintain account records
of the names of the trust beneficiaries. Now, the bank need only indicate
in the title of the deposit account that it is held by a trust. The
rule for payable on death (POD) accounts, however, still requires that
the names of the beneficiaries of a POD account be identified in the
bank ’s records.
If the trust has more than one grantor, deposit insurance coverage
would be up to $100,000 for each qualifying beneficiary for each grantor,
provided that the beneficiary’s interest in the trust vests upon
the death of the last surviving grantor.
The trust interest of a non-qualifying beneficiary is insured as the
grantor’s single ownership funds. In the case of single ownership
funds, the grantor’s funds would be added to any other single
ownership funds of the grantor, with the total amount of single ownership
funds insured up to $100,000.
L.2. Deposits of Estates
Deposits
of an estate (made by an executor or administrator) are considered to
fall in the "single ownership" category
of deposits. (See FDIC Rules and Regulations Section
330.6, "Single
Ownership Accounts.") These deposits are separately
insured to the decedent, but would be added to
any other deposits denominated in the name
of the deceased which have not yet been
marshaled by the executor. The
decedent's funds are, of course, separately
insured from any funds owned and deposited
in the same insured institution by the estate's
executors or administrators, or the estate's
beneficiaries. The
fiduciary capacity of the executor or administrator
must be disclosed on the institution's records.
L.3. Deposits of Irrevocable
Trust Accounts
The interests of a beneficiary in all deposit accounts established by the same
grantor and held at the same insured bank under an irrevocable trust are added
together and insured up to $100,000, if all of the following requirements are
met:
- The insured bank’s deposit account records disclose the
existence of the trust relationship;
- The beneficiaries and their interests in the
trust must be identifiable from the bank deposit
account records or from the trust’s records;
- Each beneficiary’s interest in the trust must be non-contingent,
as defined in Section
330.1 of the FDIC’s Rules and Regulations;
and
- The trust must be valid under state law.
Section
330.1 defines a non-contingent trust interest as a trust interest
capable of determination without evaluation of contingencies except
for those covered by the present worth tables and rules of calculation
for their use set forth in § 20.2031--7 of the Federal Estate Tax
Regulations (26 CFR 20.2031--7) or any similar present worth or life
expectancy tables which may be adopted by the Internal Revenue Service.
Note that, unlike the rules covering revocable trusts, the beneficiary
of an irrevocable trust does not have to be related to the grantor.
If the grantor retains an interest in the trust, the amount of the
grantor’s retained interest would be added to any single ownership
accounts owned by the grantor at the same bank
and the total insured up to $100,000. For such a situation to exist,
the grantor of the trust
must still be alive.
The following are situations where an irrevocable trust would not be
insured on a per beneficiary basis, in which case the deposits of the
trust as a whole would only be insured up to $100,000.
- The trust agreement does not name the beneficiaries or provide
any means of identifying the beneficiaries;
- The trust agreement provides that a beneficiary
will receive no assets unless certain conditions
are satisfied;
- The trust agreement provides
that a trustee may invade the principal of
the trust, with the result that the assets available
for other beneficiaries may be reduced
or eliminated; or
- The trust agreement provides that the trustee
or a particular beneficiary may exercise
discretion in allocating assets among the beneficiaries,
with the result that the future distribution
to each beneficiary is impossible to determine.
L.4. Deposits of Accounts
Held by an Agent, Nominee, Guardian, Custodian,
or Conservator
Funds
held in the name of an agent, nominee, custodian, guardian
or conservator on behalf of
a principal are insured as the funds of the
principal. The
funds are added together with any other
funds the principal owns in the same right
and capacity at the insured institution,
either directly or through an agent, and
insured to the same extent as if the
funds had been deposited directly by
the principal.
Funds held by an agent, nominee, guardian,
custodian, conservator or loan servicer on behalf
of two or more persons jointly, shall be treated
as a joint ownership accounts. See Section
330.9,
"Joint Ownership Accounts," for details on coverage
of joint ownership accounts.
L.5. Deposits of Employee
Benefit Accounts
Employee
benefit plan account deposits are deposits of a pension plan,
profit sharing plan or
other employee benefit plan described in Section
3(3) of the Employee Retirement Income Security Act (ERISA). Deposits
of employee benefit plans are insured to a maximum of $100,000
for each participant's non-contingent interest
in
the plan, provided that the recognition of deposit
ownership requirements of Section
330.5 are satisfied.
(See FDIC Rules and Regulations Section
330.14, "Retirement and Other Employee Benefit Plan
Accounts") This
coverage is known as "pass-through" insurance
because the insurance coverage passes through
the plan administrator, who for purposes of Section
330.14 is the "depositor" with respect to these
accounts, to each participant's interest. Coverage
for a plan's deposits is not based on the number
of participants, but rather on each participant's
share of the plan.
The value of a participant's non-contingent
interest in the deposit of a defined contribution employee
benefit plan is the employee's account balance as of
the date of default of the insured depository institution,
regardless of whether the amount was derived, in whole
or in part, from contributions of the employee and/or
the employer to the account. The value of a participant's
non-contingent interest in a defined benefit employee
benefit plan is the present value of the employee's
interest in the plan, evaluated in accordance with
the method of calculation ordinarily used under such
plan, as of the date of default of the insured depository
institution. In the case of an overfunded plan, an
employee benefit plan's deposits that can not be attributed
to the interests of the plan's participants will be
aggregated and insured up to a maximum of $100,000.
Similarly, desposits of an employee benefit plan that
represent contingent interests will be aggregated and
insured to a maximum of $100,000. A non-contingent
interest is an interest capable of determination
without evaluation of contingencies except
for those covered by the present worth tables and
rules of calculation for their use set forth in § 20.2031--7
of the Federal Estate Tax Regulations (26 CFR 20.2031--7)
or any similar present worth or life expectancy tables
which may be adopted
by the Internal Revenue Service.
L.6.
Deposits of Certain Retirement Accounts
Deposits of certain retirement
accounts are deposits owned by one person and titled
in the name of that person's retirement account.
See Section
330.14, "Retirement and Other Employee
Benefit Plan Accounts." The following types
of retirement plan deposits qualify for coverage
as
certain retirement
accounts:
- All types of IRAs including
traditional IRAs, Roth IRAs, Simplified Employee
Pension (SEP) IRAs, and Savings Incentive Match
Plans for Employees (SIMPLE) IRAs;
- All Section 457 deferred
compensation plan accounts, such as eligible deferred
compensation plans of state and local governments,
regardless of whether they are self-directed;
- Self-directed defined contribution
plan accounts, such as self-directed 401(k) plans,
self-directed SIMPLE IRAs held in the form of 401(k)
plans, self-directed defined contribution money
purchase plans, and self-directed defined contribution
profit-sharing plans; and
- Self-directed Keogh plan accounts
(or H.R. 10 plan accounts) designed for self-employed
individuals.
The above listed retirement accounts
owned by the same person in the same FDIC-insured
bank are added together and the total is insured
up to a maximum of $250,000.
For deposit insurance purposes, a "self-directed"
account means that plan participants have the right
to direct how the assets of their account are invested,
including the right to invest funds in deposits of
an FDIC-insured bank. If a plan has as its default
investment option deposit accounts at a particular
FDIC-insured institution, the FDIC considers such
a plan to be self-directed for deposit insurance
purposes. If a plan's only investment vehicle
is a deposit account(s) of a particular bank so
that the participants have no choice as to how to
invest the assets in their account, such a plan would
not be considered self-directed. However, if a plan
is a single employer/employee plan, then the fact
that there is only a single investment option, e.g.
a deposit in an FDIC-insured institution, would not
cause the deposits on such a plan to not be insured.
Coverdell Education Savings Accounts
(formerly known as Education IRAs), Health Savings
Accounts, and Medical Savings Accounts are not included
in the Certain Retirement Accounts ownership category.
Nor are 403(b) plans (annuity contracts for certain
employees of public Schools, tax-exempt organizations
and ministers) included in the Certain Retirement
Accounts ownership category.
back to top
M. Applicability of consumer
regulations to fiduciary activities
Unless
specifically exempted, the activities of trust accounts are subject
to compliance with applicable
laws. Consumer law is one category of such laws. Thus, a particular
trust account which engages in a regulated activity, such as lending, may be
required to comply with consumer lending laws. Responsibility for
compliance will generally rest with the financial
institution, or other party, acting in the capacity of trustee.
Primary regulatory responsibility for
reviewing the institution's compliance with these laws (both for its own
account, as well as in its role as trustee) rests with Division of Supervision
and Consumer Protection (DSC). Examiners may review the activity to
determine: (a) if particular statutes are applicable to specific accounts under
review and, (b) if so, that basic procedures are in place to effect
compliance. If performed, the scope of the review should allow an
assessment of whether any contingent liability attaches. Where significant
activity or problems are encountered, the matter should also be referred to DSC
- Consumer Protection and Compliance.
Foremost among these regulations will be
the Federal Reserve Board's Regulation Z (Truth in Lending) at 12 CFR
226. The regulation may apply if a trust account meets the definition of
a creditor, as noted at Section 226.2(a)(17) of the regulation. The
fundamental provisions of the definition require that the creditor regularly
(more than 25 times per year, or five times if secured by dwellings) extends
consumer credit (for personal, family, or household purposes) that is subject
to a finance charge, and payable in more than four installments. As noted
in the Official Staff Commentary for Section 226.2(a)(17)(i), item 7, each
trust is considered a separate entity for purposes of applying criteria in the
definition.
Activities of trusts can also fall within
the purview of other consumer regulations, such as Equal Credit Opportunity,
FRB Regulation B. For an overview of compliance regulations and statutes, refer
to the Compliance
Examination Handbook .
In some instances, personal, charitable, or
corporate trust accounts may be found to be subject to the above
regulations. More frequently, applicability will occur with employee
benefit plans. A discussion of compliance issues in employee benefit
plans may also be found in subsection
H.9.g.(4). Consumer Protection Laws and Loans to Plan Participants, located in
Section 5.
back to top
|
|
|