Source: https://www.sec.gov/rules/final/s71201/fein1.htm
Timestamp: 2019-04-23 18:23:23+00:00

Document:
This comment letter is filed on behalf of my client, Federated Investors, Inc., in response to the Commission's request for comment on the Interim Rules implementing the exemptions from broker-dealer regulation for banks in Title II of the Gramm-Leach-Bliley Act ("GLBA").
Federated is the sponsor and distributor of the Federated family of mutual funds registered under the Investment Company Act of 1940 with approximately $130 billion in total assets under management. Many of Federated's mutual funds are made available through bank trust departments acting in various fiduciary capacities, including as trustee and/or custodian for personal trust accounts, managed asset accounts, 401(k) plan and individual retirement accounts ("IRAs"), and trust indentures. Federated thus has a substantial interest in the applicability of the federal securities laws to such services offered by banks.
Federated appreciates this opportunity to address the specific issues on which the Commission has invited comment. In addition, we offer several suggestions for ways in which the Interim Rules might be clarified or modified to take into consideration the fiduciary context applicable to brokerage activities conducted by bank trust departments and the ways in which bank trustees are compensated for their services.
Federated believes that, on the whole, the Interim Rules provide useful guidance to banks as to the scope of the exemptions and afford meaningful relief in areas where investor protection concerns are minimal or are addressed under applicable fiduciary law. In particular, Federated supports the exemptions for indenture trustees, trustees of 401(k) plan accounts and individual retirement accounts, and investment advisory accounts. Federated requested relief in these three areas in letters addressed to the Commission's staff earlier this year and is pleased that the Commission acted quickly to provide exemptive relief. These exemptions will enable bank trust departments to continue to offer traditional banking services, avoid disrupting established fiduciary relationships consistent with the intent of Congress, and reduce uncertainty as to the scope of the trust exemption. Federated's letters are attached hereto for the record.
The Commission's approach of providing exemptive relief as opposed to interpretive guidance, however, has created some confusion as to whether certain trust activities that are not encompassed by the regulatory exemptions would require a separate exemption. To eliminate this confusion, we would urge the Commission to adopt a regulatory presumption that any activity performed by a bank in the capacity of "trustee" is covered by the trust exemption unless expressly found otherwise by the Commission.
In any case, we would urge the Commission to remain open-minded in continuing to work with the banking industry to clarify the scope of the GLBA exemptions. We urge the Commission to maintain a dialogue with individual banks and the industry as a whole in a progressive process aimed at maximizing compliance with the Interim Rules over time based on a mutual understanding as to how the investor protection concerns of the securities laws can best be effectuated in the banking context with minimal disruption to long-term fiduciary relationships and practices. In order to be effective, an ongoing compliance process will require a continuing dialogue with candor on both sides. We would hope that this process would include frequent communication with the federal banking regulators in developing a cooperative approach to ensuring compliance with the Interim Rules.
In interpreting the bank trust exemption, we urge the Commission take into consideration the fiduciary law context in which bank trust departments operate. Banks are subject to standards of prudence and a strict duty of loyalty under the Uniform Prudent Investor Act, which has been adopted by nearly all of the states. The few states that have not adopted the uniform Act have trust laws that impose similar fiduciary standards and duties upon trustees. In addition, banks that provide services to employee benefit plan accounts are subject to strict fiduciary duties under the Employee Retirement Income Security Act ("ERISA").
The applicable fiduciary law framework has resulted in a conservative investment culture that customers have come to rely on in seeking investment services from bank trust departments. Many bank customers have chosen bank trust departments rather than registered broker-dealers for investment services because of the fiduciary culture and their belief that trust law affords greater protection than the securities laws. Indeed, the investor protection scheme of the securities laws-based primarily on the principle of "disclosure" rather than substantive standards of prudence and reasonableness-is viewed by many bank customers as affording insubstantial protection. The system of banking supervision and regulation also provides a measure of security not available from broker-dealers and is an important factor in the selection of bank trust departments as money managers. Many bank trust customers would object to having their accounts transferred to a registered broker-dealer for these reasons, in addition to the fact that the fees charged by broker-dealers generally are higher than those charged by bank trust departments.
Federated's principal concern regarding the Commission's interpretation of the "chiefly compensated" test in the trust exemption under GLBA is the treatment of fees received by bank trust departments from mutual funds. Under the chiefly compensated test set forth in the Interim Rules, fees received by a bank from a mutual fund in which the bank invests fiduciary assets are treated either as "sales compensation" in the case of 12b-1 fees or "unrelated compensation" in the case of administrative or subaccounting fees. Such fees thus either are counted against a bank's qualifying "relationship compensation" or are neutral in calculating whether a bank trustee meets the "chiefly compensated" test.
Federated believes that the dichotomy between "relationship compensation" and "sales compensation" fails to take into consideration the fiduciary law context governing bank trustee compensation and penalizes legitimate compensation arrangements that are an integral part of the fiduciary services offered by bank trust departments.
As a mutual fund sponsor and administrator, Federated pays to bank trust departments fees for performing shareholder accounting and administrative services in connection with the investment of fiduciary assets in Federated's mutual funds. These fees have enabled bank trust departments to avoid increasing their account level fees and to offer fiduciary services at less cost than a customer would pay to a broker-dealer for the same services but without the fiduciary law protections that arise in a bank trust department setting.
Federated's arrangements with bank trust departments have been instituted after extensive review and analysis of applicable fiduciary law and relevant trust documents; amendment of trust law by state legislators to address such arrangements; issuance of supervisory guidance by federal banking regulators; adoption of policies and procedures designed to ensure that the fee arrangements are reasonable and otherwise comply with applicable trust law; amendment of trust instruments, fund prospectuses, and other documents; and disclosure to trust beneficiaries.
We are concerned that the Interim Rules will disrupt these carefully established fee arrangements. If bank trust departments cannot rely on fees paid by Federated as a source of qualifying compensation for the "chiefly compensated" test, they may be forced in many cases to restructure the pricing of their trust services by increasing their trustee fees. This result may occur in the case of certain 401(k) plan accounts, for example, where some bank trustees have chosen to not charge fees at the account level but receive all of their compensation in the form of mutual fund servicing fees. Federated also is considering whether it and/or the Federated Funds will need to establish new fee arrangements with banks and take other measures if the "chiefly compensated" test remains unchanged.
The treatment of mutual fund fees under the Interim Rules appears to be based on a misunderstanding of the law governing bank fiduciary compensation and a reading of the "chiefly compensated" test in the statute to suggest that bank trust departments are paid sales commissions. Under trust law, bank trustees are not permitted to receive sales commissions or other compensation for "selling" investments or other services to their trust accounts. State trust law specifically addresses the types of compensation that bank trustees may permissibly receive from mutual funds and does not permit bank trust departments to receive "sales commissions" or other rewards designed to compensate them for promoting particular products and services.
In nearly all of the states, trust law permits bank trustees to receive fees for the performance of services in connection with investments of fiduciary assets in mutual funds. The fees that Federated pays to bank trust departments are pursuant to service contracts designed to comply with state trust law. Federated has obtained legal opinions from local trust counsel in nearly every state addressing the permissibility of the fees it pays to bank trust departments and in each case local counsel has opined that the fees are permissible service fees-not sales compensation-under applicable trust law.
We thus would urge the Commission to reconsider the dichotomy it has drawn between "sales compensation" and "relationship compensation" in the Interim Rules and instead focus on the applicable fiduciary principles and standards that apply to fiduciary compensation. Only in cases where a bank trust department receives sales commissions for effecting securities transactions for trust accounts should the chiefly compensated test become an issue. In such a case, the trust department likely will be in violation of applicable trust law.
If the Commission retains its current test for applying the "chiefly compensated" language, Federated urges the Commission to allow the service fees it pays to bank trust departments to be counted as qualifying compensation. These fees are "consistent with fiduciary principles and standards" and are asset-based fees, in accordance with the statutory language of the trust exemption.
We note that the statute does not limit the sources of a bank's compensation for purposes of the "chiefly compensated" test, and the purposes of the "chiefly compensated" test can be met without limiting qualifying compensation to fees paid directly by trust accounts. Congress enacted the trust exemption to allow banks to continue traditional fiduciary activities and included the "chiefly compensated" test to discourage banks from using the exemption to engage in the sale of securities on commission in the manner of a retail brokerage business. As noted above, fiduciary law bars a trustee from receiving sales commissions and thus it is unlikely that a bank trust department would be engaged in a retail brokerage business. In any event, to the extent that shareholder servicing fees are paid out of mutual fund assets, they are a direct charge against the assets of fund shareholders, i.e., the trust beneficiaries whose assets are invested in the funds. In this sense, such fees are paid directly by trust beneficiaries and may properly be counted as qualifying compensation for purposes of the "chiefly compensated" test.
Federated supports the exemption for banks acting as trustees for 401(k) plan and IRA accounts as provided in the Interim Rules. We also believe that the exemption should encompass banks acting as custodial trustees for IRA accounts. While the language of the exemption appears to cover these custodial activities, the Federal Register notice states otherwise, creating confusion.
For the reasons stated in our letter to the Commission's staff dated March 13, 2001, Federated believes that a bank acting in the capacity of a trustee is entitled to the trust exemption under the express language of the Gramm-Leach-Bliley Act even if its fiduciary duties are limited. Particularly when a bank is designated as a "trustee" under federal law, such as under ERISA in the case of 401(k) plan accounts or the Internal Revenue Code in the case of individual retirement accounts ("IRAs"), Federated believes the Commission should honor the bank's trustee status and not deny the trust exemption, even when the bank's role is limited to that of a custodial trustee.
The absence of comprehensive fiduciary duties does not necessarily give rise to investor protection concerns. In the case of participant-directed 401(k) plan and IRA accounts, the bank's fiduciary duties are limited under federal law because the bank's role in effecting transactions for the investor is limited. The bank's role generally is limited to providing investment advice and custodial services and acting as an introducing broker. As noted in our March 13, 2001, letter, registered investment advisers who act as introducing brokers are not subject to broker-dealer regulation, and it would create a regulatory anomaly to subject banks to broker-dealer regulation for engaging in the same activities.
It is unclear what investor protection concerns would be addressed by broker-dealer regulation that are not be addressed under ERISA. We are unaware of any abuses in the offering of participant-directed 401(k) plan or IRA accounts by banks that would justify disregarding the trust exemption and subjecting banks to broker-dealer regulation. The abuses cited in the Commission's Federal Register notice accompanying the Interim Rules involved registered broker-dealers, not banks.
We urge the Commission to clarify that the exemption does apply to IRA custodians, as provided in the Interim Rules. Absent such a clarification, many banks may feel compelled to change their IRA agreements with customers to substitute trust agreements for custodial agreements, but without any change in the services they provide. Such an effort would be costly, disruptive and potentially confusing to customers, and would seem an unreasonable and unnecessary burden on bank trust departments attempting to comply with the terms of the trust exemption.
In any event, as noted below, we believe that banks offering custodial IRA accounts are covered by the GLBA exemption for custody activities.
Many of Federated's clients have expressed concern that it would be excessively burdensome to comply with the "chiefly compensated" test on an account-by-account basis as required by the Interim Rules. Although banks typically maintain fixed fee schedules, generally based on assets under management, many banks vary their prices by offering discounted fee arrangements on a customer-by-customer basis, resulting in a wide range of fee variations. Moreover, a single customer may maintain several accounts with a bank that are priced differently.
The task of evaluating thousands of accounts to ensure compliance with the "chiefly compensated" test would be especially burdensome given the broad definition of "sales compensation" included in the Interim Rules.
The Interim Rules do not address how such fee discounts, waivers, rebates, credits, or offsets are treated for purposes of the "chiefly compensated" test. In particular, the Rules do not indicate whether such fee concessions should be subtracted from a bank's compensation and, if so, whether the deduction should be made from "relationship compensation" or "sales compensation."
How a fee concession is characterized could determine whether a bank satisfies the chiefly compensated test or not. Assume, for example, that a bank receives $1000 in trustee fees from a trust account and $500 in 12b-1 service fees from a mutual fund in which the trust account has invested. Assume further that the bank credits the trust account with the $500 to offset the 12b-1 fees. If the definition of sales compensation in the Interim Rules remains unchanged, the bank will fail the chiefly compensated test because its relationship compensation will not exceed its "sales compensation." On the other hand, if the bank does not reduce its trust account fee but instead waives the $500 in 12b-1 fees, the bank will satisfy the "chiefly compensated" test because all of its compensation will be in the form of relationship compensation. In both cases, the bank is receiving, and the customer is paying, $1000 in fees.
This anomaly demonstrates the complexity of the chiefly compensated test and its uncertain implications for the structuring of trustee compensation arrangements. The chiefly compensated test should not become a determinative factor in how banks structure their trustee fees and we would urge the Commission to consider whether the chiefly compensated test in the Interim Rules can be revised to avoid this result.
Based on an informal survey of its bank clients, Federated believes that the 10 percent safe harbor concept in the Interim Rules would mitigate the compliance burden of the chiefly compensated test for many banks. Most of the banks Federated queried indicated that "sales compensation" represents less than 10 percent of their "relationship compensation" from fiduciary activities. Some of the banks indicated that they would feel more comfortable with a 15 percent safe harbor, however, in order to provide a larger margin for error due to uncertainty about the treatment of mutual fund fees for purposes of the chiefly compensated test.
Notwithstanding the benefits of the safe harbor, Federated is concerned that the procedural requirements of the safe harbor may substantially diminish its value as a relief measure. As we understand, the intent of the safe harbor is to eliminate the need for an account-by-account calculation to determine compliance with the chiefly compensated test. The procedural requirements, however, would require a bank to conduct such a calculation any time the bank changes its fees, which could be on an annual or more frequent basis. In addition, in applying the 10 percent test, a bank must review each account to exclude charges for non-securities transaction services, such as tax preparation, estate administration and other special services. The procedural requirements thus will result in a substantial compliance burden that may defeat the purpose for which the safe harbor was intended.
Accordingly, we would urge that the Interim Rules be amended to either eliminate the review procedures altogether or allow a bank to adopt an across-the-board fee increase without triggering the need for an account-by-account compliance review.
Under the Interim Rules, the trust exemption applies to an investment advisory account only if the bank provides "continuous and regular investment advice to the customer's account that is based on the individual needs of the customer" and the bank owes a duty of loyalty. As a preliminary matter, we note that this limitation on the exemption is not imposed by the statutory language of GLBA and may create uncertainty as to the scope of the exemption. Nevertheless, it appears to harmonize with past precedents of the Office of the Comptroller of the Currency describing the investment advisory activities of national banks7 and is consistent with Federated's understanding of how such activities are performed by bank trust departments.
Does not have discretionary authority, but provides the same allocation services and has ongoing responsibility to select or make recommendations, based on the needs of the client, as to specific securities or other investments the account may purchase and sell and, if such recommendations are accepted by the client, is responsible for arranging or effecting the purchase or sale.
Federated believes that this guidance is useful to the extent that it would appear to encompass within the trust exemption most asset allocation services provided by bank trust departments.
We note that the Form ADV instructions indicate that an adviser is deemed not to provide "continuous and regular" supervisory or management services if it makes an initial asset allocation without continuous and regular monitoring and reallocation. We assume that the periodic rebalancing of asset allocation models by banks would be viewed as providing "continuous and regular" investment advice for which a bank would retain the trust exemption. It would be helpful if the Commission clarified that this view is correct.
Federated does have some concern that the "continuous and regular" requirement may create undesirable pressure on banks to recommend more frequent transactions in a customer's investment account than otherwise would be appropriate under sound investment principles. Many bank customers invest for the long-term and follow a "buy and hold" investment strategy in accordance with advice given by their investment counselors (and innumerable investment newsletters). Most investors understand that it is unwise to make frequent changes in their holdings because of the transaction costs and the risks of chasing the market by "selling low and buying high." Indeed, broker-dealer regulation discourages frequent trading by prohibiting "churning" of customer accounts. The Commission ought not to adopt a regulation that encourages unnecessary trading in a customer's account.
To avoid this possibility, we would urge the Commission to consider adopting a safe harbor rule under which a bank would be deemed to satisfy the requirements of the exemption if it reviews a customer's investment advisory account at least annually to determine whether the customer's investments remain appropriate in light of the customer's investment objectives and financial needs.
The Gramm-Leach-Bliley Act requires the federal banking agencies, after consulting with the Commission, to adopt recordkeeping requirements to ensure compliance by banks relying on the exceptions from broker-dealer regulation. The banking agencies are required to make available compliance information to the Commission upon request.
In view of this statutory mandate, it seems evident that Congress intended the Commission to rely on the banking agencies to ensure compliance with the exemptions rather than adopt its own compliance requirements, consistent with the separate scheme of federal banking supervision and regulation. To the extent that a bank is exempt from broker-dealer registration, the bank is not within the Commission's jurisdiction. The adoption by the Commission of separate compliance requirements would represent a major shift of jurisdiction that we do not believe Congress intended. Congress directed the banking agencies to consider the Commission's views in adopting recordkeeping requirements, and we would encourage the Commission to work with the banking agencies in establishing appropriate requirements designed fulfill the statutory intent.
Banks frequently act as escrow agents for various business purposes. In this capacity, they act in a manner similar to that of an indenture trustee, holding and investing funds in no-load money market mutual funds according to the instructions of parties to a business transaction. In many cases, under a negotiated fee arrangement, the bank may rely on mutual fund fees rather than account fees as its primary compensation for performing escrow services, thus facing the same difficulty as indenture trustees in complying with the "chiefly compensated" test.
The Gramm-Leach-Bliley Act defines "fiduciary capacity" for purposes of the trust exemption to include "any other similar capacity" in addition to the fiduciary capacities specifically enumerated in the statute. A bank performing escrow services is acting in a "similar capacity" to an indenture trustee. Although the bank's role as escrow agent is primarily ministerial and its fiduciary duties are limited, the functions performed by the bank involve the same recordkeeping, custodial, and asset management functions of an indenture trustee. To the extent that the bank effects transactions in securities, such transactions are incidental to the bank's role as escrow agent. The typical escrow agreement is not entered into for the purpose of buying and selling securities but rather as a means of facilitating a business transaction through a trusted third party.
We do not believe that Congress intended to force banks to transfer their traditional escrow agent services to broker-dealer affiliates which, in many cases, lack familiarity with the types of business transactions that utilize escrow services and are ill-equipped to perform the duties of an escrow agent. Accordingly, we urge the Commission to adopt an exemption for escrow agent services similar to that for indenture trustees.
The exemption in the Gramm-Leach-Bliley Act for bank custodial activities specifically exempts a bank from broker-dealer registration when the bank "as part of customary banking activities . . . serves 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." The Commission has interpreted this exemption as not allowing a bank to effect securities transactions in its capacity as a custodial trustee for IRA accounts.
As noted above, we believe the trust exemption covers a bank when it acts as a custodial trustee for IRA accounts because the Internal Revenue Code deems the bank to be a "trustee." We also believe that the custody exemption covers a bank acting as a custodial trustee for IRA accounts.
The GLBA exemptions apply only if a bank is acting as a "broker." If the bank is not acting as a broker, the bank is not subject to broker-dealer registration and the exemptions are irrelevant to the bank's activities. The term "broker" is defined in the Securities Exchange Act of 1934 Act to mean "any person engaged in the business of effecting transactions in securities for the account of others."10 Accordingly, if a bank is not "effecting transactions in securities," the bank is not subject to broker-dealer registration and does not need an exemption. The GLBA exemptions-including the custody exemption-thus must be read as exempting activities that involve "effecting transactions in securities."
The custody exemption may be read as allowing only limited "effecting transactions in securities" in the case of certain custodial functions of banks, such as securities lending or borrowing, where the exemption includes limiting language. The custody exemption for IRA accounts, however, is not so limited.
It is highly unlikely that Congress would have provided an exemption allowing banks to act as custodians for IRA accounts without allowing them to effect transactions for such accounts. There simply is no market for an IRA account that does not allow the account holder to conduct transactions in the account. Such an IRA account does not exist.
Accordingly, we would urge the Commission to interpret the custody exemption to allow banks acting as custodial trustees for IRA accounts to effect transactions for such accounts.
The bank's payment of affiliated broker's fees for effecting brokerage transactions cover the cost of effecting the transaction and no more. Under no circumstances, unless authorized by applicable law, should the bank or its brokerage affiliate profit from a securities transaction effected for a fiduciary account.
The Interim Rules offer many accommodations to traditional banking activities while serving the investor protection objectives of the Securities Exchange Act of 1934, consistent with the intent of Congress in the Gramm-Leach-Bliley Act. We have commented on certain areas where we believe additional clarification or relief to bank trust departments is needed.
Federated appreciated this opportunity to comment on the Interim Rules and would be pleased to answer any questions or provide additional information on the issues we have addressed at your request.
cc: Eugene F. Maloney, Esq.
1 See, e.g., Department of Labor, Prohibited Transaction Class Exemption (PTCE) 77-4, 42 Fed. Reg. 18,732 (April 8, 1977), exempting the investment of ERISA plan assets in proprietary mutual funds subject to certain conditions, including that the plan not pay a sales commission in connection with the investment.
2 See 29 C.F.R. § 2509.75-8, D-3; 26 U.S.C. § 4975(e)(3).
3 66 Fed. Reg. at 27, 772.
4 26 U.S.C. § 408(h).
5 66 Fed. Reg. at 27,768 n. 83.
6 See, e.g., DOL Advisory Opinion 97-15A (Frost National Bank) (May 22, 1997).
7 See, e.g., OCC Fiduciary Precedent 9.2100 stating that a national bank's investment department "will make continuous reviews and recommendations as to the holdings in a customer's portfolio, and arrive at an investment and general policy to be applied to each account."
8 66 Fed. Reg. at 27,771.
9 15 U.S.C. § 80b-3a.
10 15 U.S.C. § 78c(a)(4)(A).
11 S. Rep. No. 106-44, 106th Cong., 1st Sess. 10 (1999).
12 66 Fed. Reg. at 27,774, n. 139, citing OCC Trust Interpretive Letter No. 273 (Sept. 23, 1992).
13 OCC Handbook on Conflicts of Interest (June 12, 2000) at 22.
On behalf of my client, Federated Investors, Inc., I hereby request an exemption pursuant to Section 15(a)(2) of the Securities Exchange Act of 1934 (the "Act") from the broker-dealer registration provisions of the Act with respect to the purchase by banks, acting solely at the direction of an issuer of indenture securities under the Trust Indenture Act of 1939, of shares of open-end investment companies registered under the Investment Company Act of 1940 and that hold themselves out as money market mutual funds ("money market mutual funds") and for which Federated acts as investment adviser, when the bank receives all of its compensation for acting as indenture trustee in the form of service fees paid by such funds and/or Federated.
As you know, for the reasons we have previously communicated to you, we believe that a bank in such circumstances is entitled to the bank trust exemption under Title II of the Gramm-Leach-Bliley Act. Nevertheless, we understand that the Staff may not agree with our view and would prefer to address this matter in the context of an exemption request under Section 15(a)(2) of the 1934 Act. Accordingly, we are hereby requesting such an exemption.
Since 1977, Federated has been instrumental in securing the passage of laws in all 50 states permitting an indenture trustee that is required to invest bond proceeds in U.S. government obligations to effectuate such instructions through the use of money market mutual funds which hold otherwise eligible securities. Federated also has been successful, through a combination of litigation, legislation and administrative determinations, in having distributions from its funds retain their character as U.S. government interest for state tax purposes.
At the present time, virtually every corporate trustee has elected to utilize eligible money market mutual funds in lieu of buying Treasury bills directly since, by doing so, all amounts they administer can be placed in an interest-earning vehicle and they are relieved of the time-consuming and expensive task of matching the maturity of an instrument with the often unpredictable draw schedule of the project the bond proceeds are to finance.
Corporate trust is a scale business and is intensely competitive. For over a decade, it has been customary for trustees to receive substantially all of their compensation for providing services to the issuer and bondholders in the form of fund level shareholder or administrative service fees rather than fees directly charged to the issuer or bondholders.
A bank acts in a fiduciary capacity when it serves as a trustee for an indenture under the Trust Indenture Act. Although the fiduciary obligations of the trustee generally are limited to the terms of the indenture and the trustee's role often is ministerial, the Trust Indenture Act and state trust laws impose standards of fiduciary conduct and responsibility on indenture trustees designed to protect and enforce the rights and interests of bondholders.
Many bond trusteeships involve the maintenance of separate funds, used for sinking funds, construction, building maintenance, etc. The assets of these funds are invested according to the provisions of the bond indenture. The bank trustee usually has little or no discretion in such investments. Proper separation of the various funds, investment of their assets, and administration of these funds is essential.
The trustee must not only provide reports and recordkeeping for the obligor, but must also protect the interests of the bondholders. Reporting of distributions, and interest and dividend payments, to both tax authorities and security holders is also required of the trustee. These responsibilities are important since the trustee can be held liable if the bonds default and subsequent loss is attributable to the trustee's negligence. The acts of omission as well as commission by the trustee are critical in the event of default.
The FDIC's Manual states that "[a]s in all areas of fiduciary administration, the bank should formulate and have adopted by the trust committee and board of directors written policies regarding account acceptability, conflicts of interest, internal operations, auditing, and profitability.4 The Manual provides guidance as to appropriate policies in this regard.
The exemption from broker-dealer registration for bank trust activities enacted in the Gramm-Leach-Bliley Act reflects a Congressional determination to allow banks to continue their traditional fiduciary activities without registering as broker-dealers.5 The Staff has indicated, however, that the trust exemption may not apply when a bank trustee receives more than 50 percent of its compensation from fund level fees as opposed to account level fees.
Without necessarily agreeing with the Staff's view, we are requesting an exemption under Section 15(a)(2) of the 1934 Act to remove any doubt that a bank would be required to register as a broker-dealer when purchasing shares of Federated's money market mutual funds in the bank's capacity as indenture trustee and receiving all of its compensation for acting as indenture trustee in the form of service fees paid by such funds and/or Federated.
Under Section 15(a)(2) of the 1934 Act, the Commission may exempt from broker-dealer registration any broker or dealer or class of brokers or dealers as it deems consistent with the public interest and the protection of investors. We believe that an exemption allowing banks to purchase money market mutual funds in their capacity as indenture trustees would be consistent with the public interest and the protection of investors.
Banks perform a valuable public service when acting as indenture trustees. The ability to utilize eligible money market mutual funds in lieu of buying Treasury bills directly is an important tool that enables bank trustees to administer indenture trust funds more efficiently consistent with the purposes of the Trust Indenture Act. As noted above, by placing funds in a managed investment vehicle with a stable net asset value such as a money market mutual fund, banks are relieved of the time-consuming and expensive task of matching the maturity of an instrument with the often unpredictable draw schedule of the project the bond proceeds are to finance. An exemption from broker-dealer registration would allow banks to continue their traditional role as indenture trustees without altering the form of compensation they receive in the form of fund level compensation rather than account level fees.
Investor protection concerns are not raised when banks purchase shares of mutual funds as indenture trustees because of the fiduciary context that governs the activities of banks under the Trust Indenture Act. Moreover, a bank acting as indenture trustee does not deal directly with individual investors, render investment advice to individual investors or handle any individual investor funds other than in connection with its duties under the trust indenture. The bank's employees do not receive any commissions or transaction-based compensation when acting in the bank's capacity as indenture trustee. Any securities transactions effected by the bank acting as indenture trustee arise not because a customer has come to the bank for brokerage or investment services, but because the bond issuer has selected the bank for its services as indenture trustee. The concerns that broker-dealer registration is intended to address are not present and no regulatory purpose would be served by requiring bank indenture trustees to register as broker-dealers when they invest funds held pursuant to a trust indenture in mutual funds.
We note that the Gramm-Leach-Bliley Act expressly exempted banks from broker-dealer registration when they offer sweep arrangements utilizing money market mutual funds.6 The exemption is limited to money market mutual funds presumably because of the nature of such funds as highly liquid cash substitutes. The exemption reflects a Congressional determination that such arrangements do not give rise to the concerns that broker-dealer regulation was intended to address.
Based on the foregoing, we respectfully request an exemption under Section 15(a)(2) of the Securities Exchange Act of 1934 to allow banks acting as indenture trustees pursuant to the Trust Indenture Act of 1939 to invest assets held under a trust indenture in money market mutual funds for which Federated acts as investment adviser notwithstanding that such banks receive all of their compensation for such services in the form of asset-based service fees paid by such mutual funds and/or Federated.
1 FDIC, Trust Examiners Manual § 6 at 1.
5 15 U.S.C. § 78c(a)(4)(ii), as amended by Title II of the Gramm-Leach-Bliley Act.
6 15 U.S.C. § 78c(a)(4)(v), as amended by Title II of the Gramm-Leach-Bliley Act.
7 15 U.S.C. § 78c(a)(4)(iii), as amended by Title II of the Gramm-Leach-Bliley Act.
8 See, e.g., OCC Circular 220 (Nov. 21, 1986) and 12 C.F.R. § 208.124, allowing banks to purchase for their own account mutual funds that invest in government securities, based on the authority of banks to invest directly in government securities under the Glass-Steagall Act.
On behalf of my client, Federated Investors, Inc. ("Federated"), I hereby request your confirmation that the Staff of the Division of Market Regulation concurs with our view that that a bank may act as trustee for participant-directed employee pension benefit plans pursuant to ERISA ("401(k) plan accounts") and as trustee/custodian for self-directed individual retirement accounts ("IRAs"), as described below, without registering as a broker-dealer under the Securities Exchange Act of 1934 (the "1934 Act").
Federated is the sponsor and distributor of the Federated family of investment companies registered under the Investment Company Act of 1940 ("mutual funds") with approximately $130 billion in total assets under management. Many of Federated's mutual funds are made available through 401(k) plan accounts and IRAs trusteed by banks. Federated thus has an interest in the applicability of federal securities to such services at banks. The legal basis for our request is set forth in the enclosed memorandum. We appreciate your consideration and attention to this matter.
Based on the following legal analysis, we believe that banks acting as directed trustees to self-directed 401(k) plans and individual retirement accounts (IRAs) are exempt from registration as broker-dealers under the Securities Exchange Act of 1934 ("1934 Act") in the circumstances described below.
The exception for trust activities does not apply unless (i) the bank directs trades in publicly traded securities to a registered broker-dealer for execution, (ii) the trade is a cross trade or other substantially similar trade of a security that is made by the bank or between the bank and an affiliated fiduciary, and is not in contravention of fiduciary principles established under applicable Federal or State law, or (iii) the trade is conducted in some other manner permitted under the SEC's rules and regulations.4 For purposes of this memorandum, we assume that these requirements are met by a bank that acts as directed trustee for participant-directed 401(k) plans and IRAs. We also assume that the bank will not publicly solicit brokerage business, other than by advertising that it effects transactions in securities in conjunction with advertising in other trust activities.
- maintaining custody of the plan's assets.
- providing investment education to plan participants.
A bank trustee offering such services generally will provide information to assist the employer that acts as the plan sponsor in developing a selection of mutual funds to be made available as investment options to the plan's participants. If the bank has its own family of mutual funds, the employer may include those funds among the fund options available to plan participants.
As a general matter, bank employees do not make investment recommendations or discuss the specific investments made by individual 401(k) plan participants other than to give account related information, take transaction orders, or provide investment education services of the type allowed under DOL guidelines. The activities of bank employees are restricted in order to limit the bank's liability in accordance with section 404(c) of ERISA. Under that section, a bank trustee is not liable for any loss that is the direct and necessary result of the plan participant's exercise of control of his or her own account. If the bank exercises discretion over plan investments or gives investment advice for a fee, however, the bank is not relieved of liability for 401(k) plan investment losses resulting from its breach of fiduciary duty. The incentive for a bank trustee of participant-directed 401(k) plan accounts thus is to avoid directing or controlling the plan's investments.
The only communication the bank trustee has with plan participants generally is for the purpose of enrolling participants and responding to telephone inquiries for current balance and account information, changes in investment elections, withdrawals and terminations. The bank also may mail periodic account statements and otherwise perform administrative functions necessary to administer the accounts as described above. In the case of a 401(k) plan where the participant may invest in individual securities, the bank may take purchase and sale orders from the participant to be executed through a broker-dealer.
Bank employees who deal with 401(k) plan accounts are compensated on a normal salary plus bonus basis and do not receive any transaction-based compensation. Accordingly, there is no incentive for bank employees to "churn" 401(k) plan accounts.
All prospectuses and other information relating to the mutual funds within the menu of funds available to 401(k) plan participants are prepared by a registered broker-dealer (typically an affiliate of the mutual fund sponsor) and are delivered to the plan sponsor to be distributed to the plan participants. In some cases, the plan sponsor may ask the broker-dealer or the bank trustee to mail the information directly to the plan participants.
Although the fee structures applicable to 401(k) plans may vary,6 a bank acting as a trustee to a participant-directed 401(k) plan generally is compensated by a fee calculated as a percentage of the participant's plan assets maintained by the bank. The fee may be charged to or debited from each plan participant's account or charged t the plan sponsor.
In addition, pursuant to the conditions described in DOL Advisory Opinions 97-15A and 97-16A,7 bank trustees that offer Federated mutual funds within the menu of funds available to 401(k) plan participants may receive fees from Federated for performing shareholder services in connection with investments in such funds by plan participants. Such services include recordkeeping and subaccounting services, processing of mutual fund purchase and redemption transactions, and providing mutual fund prospectuses and other enrollment materials to plan participants. Other mutual fund families pay similar shareholder service fees also.
Bank trust departments also act as trustees for self-directed IRA accounts. A bank trust department acting in such a capacity generally performs recordkeeping, accounting and safekeeping duties similar to those for 401(k) plan accounts, subject to fiduciary standards imposed under section 408 of the Internal Revenue Code ("IRC"). The trust department does not exercise investment discretion with respect to such accounts, but is responsible for implementing the investment instructions of the IRA customer and fulfilling the requirements of section 408 of the IRC.
Bank trustees may charge administrative fees to self-directed IRAs and receive shareholder service fees on a basis similar to that for 401(k) plan accounts. Bank employees who deal with IRA customers are compensated on a normal salary plus bonus basis and do not receive any transaction-based compensation.
For the following reasons, we believe that a bank acting as directed trustee to participant-directed 401(k) plan accounts and IRA accounts is acting in a fiduciary capacity and is entitled to rely on the trust exemption under the 1934 Act, as amended by GLBA.
ERISA contains prohibited transaction rules under which certain classes of transactions involving a "party in interest" or self-dealing or conflicts of interest are prohibited, even if they otherwise would be prudent and otherwise satisfy ERISA's fiduciary standards.12 A "party in interest" includes a plan fiduciary and persons who provide services to a plan, among others.
A directed trustee of a 401(k) plan thus is deemed to be a fiduciary for purposes of ERISA even if the trustee does not provide investment advice for a fee, lacks investment discretion, and the plan participant directs the trustee with respect to investments. In such a case, although a directed trustee is relieved of fiduciary liability for the direct consequences of a participant's exercise of control under section 404(c) of ERISA,14 the directed trustee is not relieved of its fiduciary status for other purposes under ERISA.
One of the requirements for an IRA is that the trustee be a bank or "such other person who demonstrates to the satisfaction of the Secretary that the manner in which such other person will administer the trust will be consistent with the requirements of this section."25 A registered broker-dealer is not eligible to serve as a trustee/custodian for IRA accounts, for example, unless it satisfies certain fiduciary requirements under regulations issued by the IRS pursuant to section 408. The fiduciary requirements applicable to nonbank IRA trustees demonstrate the extent to which the IRS views an IRA trustee which is a bank as exercising fiduciary obligations as part of its trustee role.
"The owners or directors of the applicant will be responsible for the proper exercise of fiduciary powers by the applicant." Rule 1.408-2(e)(5)(i)(A)(1).
"All employees taking part in the performance of the applicant's fiduciary duties will be adequately bonded." Rule 1.408-2(e)(5)(i)(B).
"The applicant will employ or retain legal counsel who will be readily available to pass upon fiduciary matters and to advise the applicant." Rule 1.408-2(e)(5)(i)(C).
"At least once during each period of 12 months, the applicant will cause detailed audits of the fiduciary books and records to be made by a qualified public accountant. At that time, the applicant will ascertain whether the fiduciary accounts have been administered in accordance with law, this paragraph, and sound fiduciary principles." Rule 1.408-2(e)(5)(iii)(A).
"Funds held in a fiduciary capacity by the applicant awaiting investment or distribution will not be held uninvested or undistributed any longer than is reasonable for the proper management of the account." Rule 1.408-2(e)(5)(iv).
"[T]he investments of each account will not be commingled with any other property." Rule 1.408-2(e)(5)(v).
"The applicant must keep its fiduciary records separate and distinct from other records." Rule 1.408-2(e)(5)(vii).
Connecticut law imposes upon the Trustee significant fiduciary duties and obligations, including the duty to obey the donor's instructions, to protect the fund, to exercise due diligence, to be completely loyal to the interests of the beneficiaries, and to avoid being influenced by any third-party or personal interest which may conflict with duties as Trustee.
In the case of both 401(k) plans and IRAs, a bank trustee qualifies for the trust exemption under the 1934 Act, as amended by the Gramm-Leach-Bliley Act.
In both cases, the bank "effects transactions in a trustee capacity, or effects transactions in a fiduciary capacity in its trust department or other department that is regularly examined by bank examiners for compliance with fiduciary principles and standards."
The term "fiduciary capacity" is defined in the 1934 Act, as amended by GLBA, and includes acting "in the capacity as trustee."35 The GLBA definition is identical to the definition of "fiduciary capacity" in the Comptroller of the Currency's trust regulations.
Whether acting as trustee for a self-directed 401(k) plan or an IRA, the bank is "chiefly compensated for such transactions, consistent with fiduciary principles and standards, on the basis of an administration or annual fee (payable on a monthly, quarterly, or other basis), a percentage of assets under management, or a flat or capped per order processing fee equal to not more than the cost incurred by the bank in connection with executing securities transactions for trustee and fiduciary customers, or any combination of such fees."
In neither case is there any danger of churning or other types of abuses at which broker-dealer regulation is aimed. Because the bank generally is compensated on the basis of a flat fee or percentage of assets fee and its employees receive no transaction-based compensation, the kind of salesman's stake that one might find in the sale of securities by a broker-dealer is absent. Moreover, as noted above, when a bank acts as trustee to a 401(k) plan or IRA, the bank is subject to fiduciary standards under ERISA and the Internal Revenue Code, as well as state trust law, that protect against conflicts of interest and self-dealing. To the extent that a bank receives compensation from a mutual fund in connection with fund investments by 401(k) plans and IRAs for which it acts as trustee, any such compensation must be in accordance with fiduciary standards under ERISA, the Internal Revenue Code, and state trust law.
Based on the foregoing, it is our view that a bank acting as trustee for a self-directed 401(k) plan or IRA is not subject to broker-dealer registration under the 1934 Act. The bank in both cases has the title of "trustee" and is acting in a fiduciary capacity subject to the fiduciary requirements and prohibitions of ERISA, the Internal Revenue Code, and state trust law. The bank thus is entitled to rely on the trust exemption from broker-dealer registration under the 1934 Act, as amended by the Gramm-Leach-Bliley Act.
1 15 U.S.C. § 78c(a)(4), as amended by Title II of the Gramm-Leach-Bliley Act.
2 15 U.S.C. § 78c(a)(4)(B)(ii).
3 15 U.S.C. § 78c(a)(4)(B)(ii).
4 15 U.S.C. § 78c(a)(4)(C).
5 Id. As noted in the DOL interpretive bulletin relating to participant investment education, the DOL's regulation relieving a plan fiduciary from liability in connection with participant directed-accounts is conditioned, in part, on the plan participants being provided with sufficient investment information regarding the investment alternatives available under the plan in order to make informed investment decisions. As the DOL stated, "[c]ompliance with this condition, however, does not require that participants and beneficiaries be offered or provided either investment advice or investment education."
6 See generally, Pension and Welfare Benefits Administration, Study of 401(k) Plan Fees and Expenses: Final Report (April 13, 1998), prepared for PWBA by Economic Systems, Inc.
7 DOL Advisory Opinion 97-15A (May 22, 1997) (Frost National Bank); DOL Advisory Opinion 97-16A (May 22, 1997) (Aetna Services, Inc.).
8 29 U.S.C. § 1103.
9 29 U.S.C. § 1002(21)(A).
10 See 29 C.F.R. § 2509.75-8, D-3.
11 29 U.S.C. § 1104(a).
12 29 U.S.C. § 1106.
13 See Martin v. National Bank of Alaska, 828 F. Supp. 1427 (D. Alaska 1992).
14 29 U.S.C. § 1104(c).
15 29 C.F.R. § 2550.404c-1(d).
16 29 C.F.R. § 2550.404c-1(f)(7).
18 DOL Opinion No. 97-15A (May 22, 1997) re Frost National Bank.
19 DOL Opinion No. 97-15A (May 22, 1997) re Frost National Bank ("The Department points out that the act of limiting or designating investment options which are intended to constitute all or part of the investment universe of an ERISA 404(c) plan is a fiduciary function which, whether achieved through fiduciary designation or express plan language, is not a direct or necessary result of any participant direction of such plan."). If the bank trustee does not make any recommendations concerning the selection of particular mutual funds but another plan fiduciary independently selects, from mutual fund families made available by the bank, particular funds to be made available for investment by plan participants, these duties will not arise if the bank gives notice to the plan sponsor before modifying the list of funds available for investment by plan participants. See DOL Advisory Opinion 97-16A (May 22, 1997). See also 29 C.F.R. § 2550.404c-1(f)(8).
20 26 U.S.C. § 408(a).
21 26 U.S.C. § 408(h).
22 See 29 C.F.R. § 2509.75-8, D-3; 26 U.S.C. § 4975(e)(3).
23 See 26 U.S.C. § 4975(d)(4).
24 See DOL Letter dated April 15, 1988 re Bank of Prattville, 1988 WL 192826 (E.R.I.S.A.).
25 26 U.S.C. § 408(a).
26 26 C.F.R. § 1.408-2(e)(2).
27 26 C.F.R. § 1.408-2(e)(2)(i).
28 26 C.F.R. § 1.408-2(e)(2)(iii).
30 26 C.F.R. § 1.408-2(e)(5).
31 26 C.F.R. § 1.408-2(e)(6).
32 See In re Sopkin, 57 B.R. 43 (Bkrtcy. D.S.C. 1985); First National Bank of Blue Island v. Estate of Philp, 436 N.E.2d 15 (Ill. 1982); In re Todd, 37 B.R. 836 (Bkrtcy. W.D.La. 1984).
33 Investment Co Institute v. Clarke, 630 F. Supp. 593, 597 (D.C. Conn.), aff'd 789 F.2d 175 (2d Cir.), cert. denied, 479 U.S. 940 (1986).
35 15 U.S.C. § 78c(a)(4)(D).
On behalf of my client, Federated Investors, Inc. ("Federated"), for the reasons indicated in the enclosed memorandum, I hereby request your confirmation that the Staff of the Division of Market Regulation concurs with our view that banks in their capacity as fiduciaries may offer managed asset services, as described in the enclosed memorandum, without registering as broker-dealers under the Securities Exchange Act of 1934 (the "1934 Act").
Federated is a sponsor and distributor of mutual funds with approximately $130 billion in total assets. Many of Federated's mutual fund products and services are made available through managed asset services offered by banks. Federated thus has an interest in the applicability of federal securities laws to such services. Given the approach of the May 12, 2001, effective date of Title II of the Gramm-Leach-Bliley Act, your timely attention to this matter is appreciated.
Federated believes that certain investment management services offered by bank trust departments in a fiduciary capacity, as described below, are covered by the trust exemption and requests the Staff's assurance that a bank may offer such programs without registering as a broker-dealer under the 1934 Act.
Managed asset services are an important part of the fiduciary services provided by bank trust departments to trust clients seeking asset allocation and investment management services. Such services involve the management of fiduciary assets in mutual funds through asset allocation models established by the bank's trust department based on investment advice and recommendations given to an individual client after a review of the client's specific financial situation, needs and objectives as reflected in an interview with the client and the client's responses to a questionnaire. Such services are offered subject to the standards of prudence, diversification and loyalty prescribed in the Uniform Prudent Investment Act as adopted by nearly all of the States.
In the typical managed asset relationship, if the trust department determines that the client's managed asset needs and objectives can best be met by investing in mutual funds, the trust department will recommend an allocation of the customer's assets among different mutual funds sponsored by Federated and/or other mutual fund sponsors based on an asset allocation model designed to meet the customer's particular profile. In the case of the Federated funds, customer assets are allocated among no-load funds with institutional or trust classes of fund shares.
If the client agrees with the trust department's recommendations, the trust department will invest the client's assets in accordance with the recommended asset management model. The trust department exercises discretion in selecting the asset management models and mutual funds that are recommended to clients and also may exercise discretion in making periodic adjustments in the asset allocation models to reflect changing market conditions and economic assumptions. The trust department generally has the discretion to substitute different mutual funds into the asset allocation formula.
Transactions in connection with the trust department's managed asset services are directed to the appropriate mutual fund transfer or servicing agent for execution. In the case of the Federated funds, purchase and redemption transactions generally are handled by Federated Securities Corp., a registered broker-dealer. No brokerage commission is charged for investments in the Federated no-load funds.
Trust clients who utilize the trust department's managed asset services generally are charged a fee, payable to the trust department, equal to a percentage of the client's assets that are invested through the program. Such fees may be in the range of 100-150 basis points and compensate the bank for providing investment advice and recommendations relating to the client's asset management needs, developing or selecting appropriate asset management models, making adjustments in the models as necessary, processing transactions, responding to the client's inquiries concerning its account, monitoring the client's account, and otherwise handling the client's account.
If permitted by applicable fiduciary law, the trust department also may receive compensation from Federated or the relevant mutual fund sponsor in the form of a shareholder servicing or administration fee generally in the amount of 25 basis points or less. This fee compensates the bank for performing recordkeeping and subaccounting services that the fund's administrator or transfer agent otherwise would need to provide. In the case of the Federated funds, the fee is not a 12b-1 fee charged to fund assets. Rather, it is paid directly by a Federated affiliate from the affiliate's own revenues.
Managed asset programs of the type described frequently are offered by community banks that do not have the resources to establish and maintain a broker-dealer affiliate. The customers of these banks are accustomed to obtaining investment advice and management services from the bank's trust department and may be uncomfortable transferring their accounts to an unaffiliated securities broker-dealer. Some bank customers might even object to doing business with an affiliated brokerage firm given the different sales culture of broker-dealers generally.
The trust exception afforded by GLBA was intended to allow bank trust departments to continue serving these customers. In some small communities, broker-dealer services might not be conveniently available and, if customers cannot obtain managed asset services from their local bank, they may be deprived of convenient access to such services altogether.
Managed asset programs offered by bank trust departments as described herein generally comply with the requirements as to compensation under the trust exception. Specifically, the trust department is "chiefly" compensated for such transactions in a manner consistent with fiduciary principles on the basis of an administration or annual fee or a percentage of assets under management. In the cases of which Federated is aware, more than 50 percent of the trust department's compensation from each account comes from a fee based on assets under administration. The shareholder servicing fee paid by Federated in no case exceeds fifty percent of the trust department's total compensation for asset allocation services for any single account, and is an asset based fee in any event.
In accordance with the trust exception under GLBA, bank trust departments that offer managed asset programs in reliance on the trust exception will comply with the provision in GLBA under which they may not "publicly solicit brokerage business other than by advertising that they effect transaction in securities in conjunction with advertising other trust services."
Accordingly, under the literal language of the 1934 Act, a bank trust department is not required to possess investment discretion when acting as an investment adviser in order to qualify for the trust exception. The statute does not state that the bank, when acting as an investment adviser, must possess discretion in order to be deemed to be acting in a fiduciary capacity. Investment discretion is required if a bank is relying on clause (ii) of the definition of "fiduciary capacity" but not clause (i). Under rules of statutory construction, the omission of any reference to investment discretion in clause (i) may be construed to mean that Congress intended to omit it. If an investment adviser were required to possess discretion in order to be deemed to be acting in a fiduciary capacity for purposes of the trust exception, then the reference to investment advisers in clause (i) would be redundant and have no meaning.
A contrary position would require thousands of investment advisers to register as broker-dealers and would undermine the scheme of separate regulation of investment advisers and broker-dealers enacted by Congress. An inequitable regulatory scheme would result if the SEC required banks but not investment advisers to register as broker-dealers when they provide asset allocation services.
Broker-dealers are required to register under the 1934 Act regardless of whether they exercise discretion. The definition of "broker" under the 1934 Act means "any person engaged in the business of effecting transactions in securities for the account of others" unless an exception applies.12 The exercise of investment discretion is not a criterion in the basic registration requirement for broker-dealers.
A position that banks must register as broker-dealers if their trust departments offer managed asset services would have the effect of subjecting bank investment advisory activities to SEC regulation under the Investment Advisers Act of 1940 ("Advisers Act"), contrary to the express statutory exemption for banks from such regulation. Although GLBA repealed the bank exemption from broker-dealer registration under the 1934 Act, it did not repeal the bank exemption from investment adviser registration under the Advisers Act.
Accordingly, while bank managed asset services are subject to neither the 1934 Act nor the Advisers Act under the Gramm-Leach-Bliley Act, they would become subject to both acts if the trust exception is interpreted by the Staff in such a way as to require such programs to be transferred to a registered broker-dealer that must also register as an investment adviser.
Bank trust departments are subject to strict standards of fiduciary conduct under state trust law when they provide managed asset services to fiduciary customers. In addition to standards of prudence under the Prudent Investor Rule, bank fiduciaries are subject to the duty of loyalty which requires a fiduciary to act solely in the interests of the beneficiary and to refrain from self-dealing.
These fiduciary standards applicable to bank trust departments include a duty to ensure that recommended investments are suitable for investment advisory customers. Although the SEC at one time proposed imposing a suitability standard on investment advisers registered under the Investment Advisers Act of 1940, the proposal never was adopted.16 Bank trust departments thus are subject to a higher standard of fiduciary conduct than an investment adviser.
While bank trust departments are exempt from broker-dealer and investment adviser registration, they are not exempt from the anti-fraud provisions applicable to broker-dealers and investment advisers under the federal securities laws. Moreover, to the extent that most trust department managed asset services involve investments in mutual funds, fiduciary clients benefit from all of the disclosure and other requirements that protect mutual fund shareholders under the Investment Company Act of 1940.
Accordingly, bank customers who avail themselves of managed asset services of bank trust departments are amply protected under the law and are not harmed or disadvantaged by the absence of broker-dealer or investment adviser regulation.
The SEC's own regulations and interpretations are inconsistent as to when an asset allocation program may be deemed to be discretionary or non-discretionary. The requirement for broker-dealer registration should not be based on such an unclear distinction.
Managed asset services of the type offered by many bank trust departments could be treated as non-discretionary for purposes of Form ADV required if they were offered by a registered investment adviser under the Investment Advisers Act of 1940.
Thus, the SEC's Form ADV recognizes that some asset allocation programs are discretionary and some are non-discretionary, even though both receive "continuous and regular supervisory or management services." While most managed asset services offered by bank trust departments likely would be considered discretionary for purposes of Form ADV, some such services might fall into the non-discretionary category.
The SEC addressed asset allocation programs similar to the managed asset services offered by bank trust departments when it adopted Rule 3a-4 under the Investment Company Act of 1940 in 1997.20 Rule 3a-4 provides a nonexclusive safe harbor from the definition of investment company for certain programs under which investment advisory services are provided on a discretionary basis to a large number of advisory clients having relatively small amounts to invest.
As a result of this guidance, it is unclear whether certain asset allocation programs may be deemed discretionary or non-discretionary. Under the Rule 3a-4 guidance, most managed asset services offered by bank trust departments would be discretionary to the extent that the customer generally accepts the bank's asset allocation recommendations and the bank exercises discretion in periodically adjusting the asset allocation models.
Under paragraph (B), a person could be deemed to exercise investment discretion if the person "indirectly" makes investment decisions without having actual discretionary authority. The Commission has not adopted a regulation pursuant to paragraph (C).
For the foregoing reasons, Federated believes that it would be contrary to the language and intent of the Gramm-Leach-Bliley Act for the Commission to subject managed asset services offered by bank trust departments to broker-dealer registration. Accordingly, we respectfully request the Staff to confirm that it agrees with this view and will not recommend enforcement action to the Commission if a bank trust department offers managed asset services of the type described herein.
3 15 U.S.C. § 78c(a)(4)(D) (emphasis added).
4 S. Rep. No. 106-44, 106th Cong., 1st Sess. 10 (1999).
5 H. Rep. No. 106, 434, 106th Cong., 1st Sess. 164 (1999).
6 12 C.F.R. § Pt. 9.
7 29 U.S.C. § 1002(21)(A).
8 DOL Advisory Opinion 97-15A (May 22, 1997) (Frost National Bank). In such cases, however, the bank trustee is relieved of responsibility for the plan participant's investment decisions, but is otherwise a fiduciary. Id. at n. 9, citing 57 Fed. Reg. 46,906, 46,924 n. 27 (1992).
9 SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191, 194 (1963).
10 59 Fed. Reg. 13,464, 13, 469 (1994) ("Investment advisers are fiduciaries . . .").
11 See Release No. IA-1000 (Dec. 5, 1985), 50 Fed. Reg. 49,835 49,839 (1985). An investment adviser thus may act in the role of an introducing broker without being required to register as a broker-dealer.
12 Securities Exchange Act 3(a)(4)(A), codified at 15 U.S.C. § 78c(a)(4)(A).
13 Investment Advisers Act § 202(a)(11)(c).
14 Investment Management & Research, Inc. (pub. avail. Jan. 27, 1977), cited in Townsend and Associates, Inc. (pub. avail. Sept. 21, 1994); Investment Advisers Act Release No. 471 (Aug. 20, 1975), cited in Townsend and Associates, Inc.
15 See Investment Advisers Act Release No. 1401 (Jan. 13, 1994); National Regulatory Services, Inc. (pub. avail. Dec. 2, 1992).
16 59 Fed. Reg. 13,464 (1994) (proposed rule).
17 Form ADV, Part I, Question 18.
18 Form ADV, Instructions to Schedule I of Form ADV, Instruction 7.
20 62 Fed. Reg. 15,098 (1997).
21 62 Fed. Reg. at 15,101.
22 62 Fed. Reg. at 15,101, n. 18.
23 Securities Exchange Act of 1934, § 4(a)(35).
24 This section is relevant for purposes of Section 11(a)(1) of the 1934 Act which states "It shall be unlawful for any member of a national securities exchange to effect any transaction on such exchange for its own account, the account of an associated person, or an account with respect to which it or an associated person thereof exercises investment discretion." Under section 23 of the 1934 Act, the federal banking agencies have rulemaking authority to implement section 11(a)(1).
25 DOL Advisory Opinion 97-15A (May 22, 1997) (Frost National Bank). In such cases, however, the bank trustee is relieved of responsibility for the plan participant's investment decisions, but is otherwise a fiduciary. Id. at n. 9, citing 57 Fed. Reg. 46,906, 46,924 n. 27 (1992).

References: § 2509
 § 4975
 § 408
 § 80
 § 78
 § 6
 § 78
 § 78
 § 78
 § 208
 § 78
 § 78
 § 78
 § 78
 § 1103
 § 1002
 § 2509
 § 1104
 § 1106
 v. 
 § 1104
 § 2550
 § 2550
 § 2550
 § 408
 § 408
 § 2509
 § 4975
 § 4975
 § 408
 § 1
 § 1
 § 1
 § 1
 § 1
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 v. 
 § 78
 § 78
 § 1002
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 § 78
 § 202
 § 4