[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]



 ========================================================================
 Rules and Regulations
                                                 Federal Register
 ________________________________________________________________________
 
 This section of the FEDERAL REGISTER contains regulatory documents 
 having general applicability and legal effect, most of which are keyed 
 to and codified in the Code of Federal Regulations, which is published 
 under 50 titles pursuant to 44 U.S.C. 1510.
 
 The Code of Federal Regulations is sold by the Superintendent of Documents. 
 Prices of new books are listed in the first FEDERAL REGISTER issue of each 
 week.
 
 ========================================================================
 

  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.

-----------------------------------------------------------------------

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
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

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