[Federal Register Volume 61, Number 170 (Friday, August 30, 1996)]
[Rules and Regulations]
[Pages 45873-45875]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-22168]
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Rules and Regulations
Federal Register
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Federal Register / Vol. 61, No. 170 / Friday, August 30, 1996 / Rules
and Regulations
[[Page 45873]]
FEDERAL RESERVE SYSTEM
12 CFR Part 225
[Regulation Y; Docket No. R-0868]
Investment Adviser Activities
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule.
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SUMMARY: The Board is adopting a final rule amending its interpretive
rule regarding investment adviser activities of bank holding companies
to allow a bank holding company (and its bank and nonbank subsidiaries)
to purchase, in a fiduciary capacity, securities of an investment
company advised by the bank holding company if the purchase is
specifically authorized by the terms of the instrument creating the
fiduciary relationship, by court order, or by the law of the
jurisdiction under which the trust is administered. This amendment
would reflect changes that have occurred since the rule was adopted;
and would conform the Board's interpretive rule to rules applied to
banks by the Federal Deposit Insurance Corporation and the Office of
the Comptroller of the Currency, and the standard in section 23B of the
Federal Reserve Act for this type of activity.
EFFECTIVE DATE: September 30, 1996.
FOR FURTHER INFORMATION CONTACT: Thomas M. Corsi, Senior Attorney (202/
452-3275); or David S. Simon, Attorney (202/452-3611), Legal Division,
Board of Governors of the Federal Reserve System. For the hearing
impaired only, Telecommunication Device for the Deaf (TDD), Dorothea
Thompson (202/452-3544).
SUPPLEMENTARY INFORMATION:
Background
In 1972, the Board permitted bank holding companies to serve as
investment advisers to mutual funds and other registered investment
companies, and adopted an interpretive rule setting forth limitations
on this activity. Among the restrictions in the rule is a requirement
that a bank holding company not purchase in its sole discretion in a
fiduciary capacity any securities of an investment company advised by
the bank holding company. The Board adopted this restriction because of
concern that a bank holding company might use its position as a
fiduciary to support an investment company that the bank holding
company advises, increase the asset size of the investment company, or
increase advisory fees.
The Board has sought public comment on a proposal to relax this
restriction to permit a bank holding company to purchase in its sole
discretion in a fiduciary capacity securities of an investment company
advised by the bank holding company if the purchase is specifically
authorized by the terms of the instrument creating the fiduciary
relationship, by court order, or by the law of the jurisdiction under
which the trust is administered.1 This change would reflect
current practice in this area.2
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\1\ 59 FR 67,654 (December 30, 1994).
\2\ The Board's proposal was in response to requests by several
bank holding companies. These bank holding companies indicated that
a mutual fund advised by the holding company is often the most cost-
effective method of providing investment advice to customers and is
increasingly attractive to customers because a mutual fund provides
customers with a readily marketable and easily valued investment
product. See Letter dated August 12, 1994, from the American Bankers
Association to Chairman Greenspan.
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Since the Board adopted its investment advisory interpretive rule,
Congress enacted section 23B of the Federal Reserve Act, which permits
a bank or its subsidiary to purchase securities, as a fiduciary, from
an affiliate if such purchases are permitted by the instrument creating
the fiduciary relationship, by court order, or by the law of the
jurisdiction governing the fiduciary relationship.3 Both the
Office of the Comptroller of the Currency (OCC) and the Federal Deposit
Insurance Corporation (FDIC) recently permitted the banks that they
regulate to purchase, in a fiduciary capacity, securities of an
investment company advised by an affiliate of the bank if the purchase
is specifically authorized by the terms of the instrument creating the
fiduciary relationship, by court order, or by local law.4 In
addition, many states have amended their laws to permit a fiduciary to
purchase, on behalf of customer accounts, shares of an investment
company advised by the fiduciary or its affiliate.5 In an
analogous area, the Board has permitted fiduciary purchases of
securities that are underwritten by a section 20 affiliate if the
purchase is specifically authorized under the instrument creating the
fiduciary relationship, by court order, or by the law of the
jurisdiction under which the trust is administered.6
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\3\ 12 U.S.C. 371c-1(b)(1).
\4\ See OCC Trust Interpretation No. 234 (September 21, 1989);
12 CFR 9.12; and 12 CFR 337.4(e).
\5\ See, e.g., Mich. Comp. Laws Sec. 487.485 (1992) (amended in
1992); Md. Code Ann., Est. & Trusts Sec. 15-106 (1993) (amended in
1991); Ind. Code Ann. Sec. 28-1-12-3 (Burns 1993).
\6\ Citicorp, J.P. Morgan & Company Incorporated, and Bankers
Trust New York Corporation, 73 Federal Reserve Bulletin 473 (1987)
(Citicorp Order), aff'd sub nom. Securities Industry Association v.
Board of Governors of the Federal Reserve System, 839 F.2d 47 (2d
Cir. 1988), cert. denied, 486 U.S. 1059 (1988).
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The proposed amendment would have required that a bank holding
company disclose to its fiduciary customers in writing that the bank
holding company or its subsidiary serves as investment adviser to the
investment company whose shares are purchased in a fiduciary capacity.
The Board specifically requested public comment on whether the proposed
disclosure requirement is necessary. The Board also requested public
comment on whether the proposed disclosure requirement would be
adequate if given only at the time the fiduciary relationship is
created, or whether written disclosure should be given immediately
prior to each initial investment in an investment company advised by
the bank holding company.
Summary of Public Comments
The Board received 21 comments on its proposal.7 Overall, the
comments supported the Board's proposal. Regarding disclosures, twelve
commenters stated that the Board should not require any special
disclosure when a bank holding company purchases as fiduciary shares of
an investment company advised by the fiduciary or its affiliates.
Several commenters argued that special
[[Page 45874]]
disclosures are unnecessary in cases in which the purchase is permitted
by court order or by the instrument creating the fiduciary relationship
because the court or person creating the fiduciary relationship would
be aware of the potential conflicts of interest. Commenters also stated
that, in the case in which the purchase of shares is permitted by state
law, the timing and content of disclosures should be governed
exclusively by the laws of the state. These commenters generally
maintained that the proposed disclosure would unnecessarily interfere
with state law, could confuse fiduciary customers, and could be
expensive and cumbersome.8
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\7\ These commenters included 17 banking organizations, two
trade associations, one law firm, and one bank consulting firm.
\8\ One commenter argued that the proposed disclosure was
appropriate and should be required immediately prior to each initial
investment in an investment company advised by the bank holding
company, as well as at the time the fiduciary relationship is
created.
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Discussion
After further review, the Board has determined that it is
unnecessary to impose a general disclosure requirement when a bank
holding company purchases as fiduciary shares of an investment company
it advises. The Board believes that existing disclosure requirements
are generally sufficient to ensure that fiduciary customers are aware
of potential conflicts of interest that may arise from this activity.
As noted by commenters, the instrument or court order creating the
fiduciary relationship, or state law, often contains or requires the
disclosure of any potential conflict of interest. In addition, the
common law has addressed conflicts of interest, disclosures, and other
remedies in this area. Thus, any disclosure requirement adopted by the
Board may be duplicative or conflict with other disclosure
requirements.
In addition, other federal statutes require certain fiduciaries,
including nonbanking subsidiaries of bank holding companies, to
disclose potential conflicts of interest that may affect the
fiduciary's recommendations. For example, under the Investment Advisers
Act of 1940 (Advisers Act), an investment adviser has a fiduciary duty
to disclose to a client any compensation it receives that may affect
its recommendations.9 Thus, according to the Securities and
Exchange Commission (SEC), an investment adviser that receives fees
from an investment company in which the adviser places trust funds as
fiduciary must disclose to the trust customer the receipt of those fees
and the potential conflict of interest presented.10
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\9\ 15 U.S.C. Sec. 80b-6. See Hornor Townsend & Kent, Inc., SEC
No-Act. LEXIS 495 (April 4, 1995), citing SEC v. Capital Gains
Research Bureau, Inc., 375 U.S. 180, 194-95 (1963).
\10\ See Neuberger & Berman, SEC No-Act. LEXIS 1496 (May 29,
1984).
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Although banks, trust companies, and bank holding companies
themselves are exempt from the definition of investment adviser under
the Advisers Act, the Act covers the advisory activities of affiliates
of banks and bank holding companies.11 According to the SEC, a
nonbank subsidiary of a bank holding company--other than a trust
company--has an obligation under the Advisers Act to disclose to its
fiduciary customers that it may acquire for them shares of investment
companies from which the nonbank subsidiary or its affiliate receives
advisory fees.12
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\11\ See, e.g., First Commerce Investors, Inc., SEC No-Act.
LEXIS 221 (January 31, 1991) (* * * the Advisers Act does not
specifically except a subsidiary of a bank or a bank holding company
from the definition of investment adviser, unless that subsidiary is
itself a bank or bank holding company.); 15 U.S.C. Sec. 80b-1(11).
\12\ Bank holding companies acting as fiduciaries to employee
retirement plans also may be required to make disclosures under the
Employee Retirement Income Security Act (ERISA) and Department of
Labor Regulations. See 29 U.S.C. Secs. 1106 and 1108; Prohibited
Transaction Exception 77-4, 42 FR 18,732 (April 8, 1977).
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Neither the OCC nor the FDIC generally require a bank to
specifically disclose to its fiduciary customers that the bank serves
as investment adviser to an investment company whose shares the bank
purchases in a fiduciary capacity.13 The OCC recently indicated
that a national bank that invests fiduciary assets in mutual funds that
pay fees to the bank for services may, if the bank also receives fees
for acting as a fiduciary, do so only to the extent authorized under
state law, the trust instrument, or court order. The OCC further
indicated that a trustee's overall fees must be consistent with any
state law requirements that fees be reasonable, necessary, or
appropriate, and the fee arrangement must be disclosed pursuant to any
relevant state law disclosure requirements.14
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\13\ See 12 CFR 9.12 and 337.4(e). In addition, section 23B does
not require a bank or its subsidiary to disclose to its fiduciary
customers that it may purchase securities from an affiliate.
Moreover, the Citicorp Order does not require specific disclosure of
fiduciary purchases of securities underwritten by a section 20
affiliate.
\14\ See OCC Interpretive Letter No. 704, November 2, 1995.
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While the Board is not adopting a disclosure requirement, the Board
believes, as a general matter, that the disclosure of potential
conflicts of interest is consistent with sound fiduciary principles.
Accordingly, the Board encourages bank holding companies not already
required to disclose potential conflicts of interest (by the instrument
or court order creating the trust or by state or federal law) to make
such disclosures. Bank holding companies engaging in this activity
should recognize that their activities may be subject to disclosure
requirements under state and federal laws, and should engage in the
activities in a manner consistent with common law principles of trust
law.
Other Comments
Four commenters stated that the Board should seek public comment on
amending other restrictions contained in paragraph (g) of the
interpretive rule. In particular, these commenters suggested that the
Board reconsider the appropriateness of paragraphs (g) (1), (3) and (4)
of the interpretive rule, which prohibit a bank holding company and its
bank and nonbank subsidiaries from (i) purchasing for their own account
securities of any investment company for which the bank holding company
acts as investment adviser, (ii) extending credit to any such
investment company, or (iii) accepting securities of such investment
company as collateral for a loan which is for the purpose of purchasing
securities of the investment company. Two of these commenters stated
that national and state-member banks can engage in these activities
subject only to the limitations contained in sections 23A and 23B of
the Federal Reserve Act. Another commenter stated that these
prohibitions prevent bank holding companies from competing effectively
with other organizations because bank holding companies cannot provide
the initial seed or start-up capital for advised investment companies
or provide liquidity to such funds. One commenter also stated that the
restrictions of paragraph (g) should apply to investment companies
advised by subsidiary banks of bank holding companies.15 The Board
has decided to seek comment on amending other provisions of paragraph
(g) in a separate proceeding.
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\15\ The restrictions contained in paragraph (g) only apply to
investment companies advised by a bank holding company or its
nonbank subsidiaries. See Norwest Corporation, 76 Federal Reserve
Bulletin 79, 80 n.3 (1990).
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Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act (Pub.
L. 95-354, 5 U.S.C. 601 et seq.), the Board of Governors of the Federal
Reserve System certifies that adoption of this final rule would not
have a significant economic impact on a substantial number of small
entities that would be subject to the regulation.
[[Page 45875]]
This amendment will remove a restriction currently contained in the
Board's regulations that the Board believes is no longer necessary. The
amendment does not impose more burdensome requirements on bank holding
companies than are currently applicable.
Paperwork Reduction Act
In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3506; 5 CFR 1320 Appendix A.1), the Board reviewed the final rule under
the authority delegated to the Board by the Office of Management and
Budget. No collections of information pursuant to the Paperwork
Reduction Act are contained in the final rule.
List of Subjects in 12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
For the reasons set forth in the preamble, the Board amends 12 CFR
Part 225 as set forth below:
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for 12 CFR 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1831i, 1831p-1,
1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and
3909.
2. Section 225.125 is amended by revising paragraph (g) to read as
follows:
Sec. 225.125 Investment adviser activities.
* * * * *
(g) In view of the potential conflicts of interests that may exist,
a bank holding company and its bank and nonbank subsidiaries should
not:
(1) Purchase for their own account securities of any investment
company for which the bank holding company acts as investment adviser;
(2) Purchase in their sole discretion, any such securities in a
fiduciary capacity (including as managing agent) unless the purchase is
specifically authorized by the terms of the instrument creating the
fiduciary relationship, by court order, or by the law of the
jurisdiction under which the trust is administered;
(3) Extend credit to any such investment company; or
(4) Accept the securities of any such investment company as
collateral for a loan which is for the purpose of purchasing securities
of the investment company.
* * * * *
By order of the Board of Governors of the Federal Reserve
System, August 26, 1996.
William W. Wiles,
Secretary of the Board.
[FR Doc. 96-22168 Filed 8-29-96; 8:45 am]
BILLING CODE 6210-01-P
