Table of Contents
to pooled investments
B. Common and collective
General Information on CIF's
Common Trust Fund and Employee Benefit Collective Fund
Importance of Tax-Exempt Status
Importance of Securities Law exemptions
"Bona Fide Fiduciary" Rule
OCC Regulation 9.18 Requirements
Basic Terms and Accounting Concepts
Benefits and Limitations of CIF's to Fund Participants and To The Bank
Typical Fund Categories
tax-exempt status - IRC section 584 and IRS revenue ruling 81-100
Revenue Code Section 584
2. IRS Revenue
under securities acts
Act of 1933
Investment Company Act of 1940
Section 9.18 Applicability to State Nonmember Banks
1997 Revision of Section 9.18
Section 9.18(b)(1) The Written Plan
Section 9.18(b)(2) Fund Management
Section 9.18(b)(4) Valuation
Section 9.18(b)(5) Admission and Withdrawal
Section 9.18(b)(6)(i) Annual Audit
Section 9.18(b)(6)(ii) Financial Report
Section 9.18(b)(7) Advertising of Collective Investment Funds
Section 9.18(b)(8) Self-Dealing and Conflicts of Interest
Section 9.18(b)(9) Management Fees
Section 9.18(b)(10) Expenses
Section 9.18(b)(11) and (12) Prohibition Against Certificates / Good Faith
Section 9.18(c) Other Collective Investments
Investment management issues
Use of Outside Investment Advisors
implications on CIF operations
ERISA 408(b)(8) Exemption
DOL PTE 91-38 Exemption
Trusts Usage of Collective Investment Funds
Account Usage of Collective Investment Funds
Plan Usage of Collective Investment Funds
in CIF's of other institutions
CIF's investing in CIF's within the same department
When Engaging in Mutual Fund Activity
of Bank Financial Activities Under the Gramm-Leach-Bliley Act of 1999
Company Act of 1940
of CIF's to mutual funds
Mutual fund and CIF merger rules
SEC Rule 17a-8
pooled investment vehicles
2. Wrap Accounts, Also Known as
Asset Allocation Programs
3. Private Equity Fund
Managed "Pooled Income Funds" Organized by Outside Organizations
5. Regulation D
Exempted Securities Offerings
Bank as investment adviser to CIF's and mutual funds
Interagency Policy Statement
of federal laws
Securities Act of 1933
SEC Rule 180
(Sophisticated Investor Rule) under the 1933 Act
Regulation D under the
Exchange Act of 1934
Investment Company Act of
Investment Advisors Act
Banking Act of 1933
Title 12 C.F.R. 9.18
Internal Revenue Code (IRC)
A. Introduction to Pooled Investments
Pooled investment vehicles include
common trust funds and employee benefit
collective funds (both generically referred to as collective investment
funds); proprietary mutual funds and other pooled investments. Because of
their similarities, reference to collective investment funds (CIF's) within
this manual will refer to both common trust funds and employee benefit
collective funds, unless otherwise noted. Unlike CIF's,
proprietary mutual funds are SEC registered
securities that can be distributed to a wider variety of investors.
Other pooled investments refers to less common
or emerging account types such as master deposit accounts and private equity
All pooled investment vehicles are
designed to facilitate investment by combining fiduciary funds of various
trust department accounts. Although the operation of CIF's runs counter to
the accepted common law duty of the trustee not to commingle trust funds,
legislation has been passed in every state authorizing banks to establish
and administer CIF's.
The administration of pooled
investment vehicles must follow principles of prudent management; comply
with applicable laws, regulations, and regulatory opinions; and maintain
proper documentation, recordkeeping, and accounting. For each type of
pooled investment vehicle,
proper management entails compliance with specific aspects of the laws and
implementing regulations promulgated by Internal
Revenue, Securities and Exchange Commission, Office of the Comptroller of the Currency (OCC),
Department of Labor (DOL), and ERISA .
Any apparent violations of applicable laws and regulations expose the
institution to a substantial risk of loss, due to the cost of corrective
action including possible regulatory sanctions and penalties. Inadequate
management of pooled investment vehicles could also harm the trust clients
and create potential liabilities to the trust department and the bank.
As with individual trust accounts,
bank management and the trust committee are required by the Statement of
Principles of Trust Department Management to provide adequate oversight of
pooled investments. At a minimum, management and the trust committee should
document the performance of an annual administrative and investment review -
including assuring that the funds are administered in accordance with
B. Common and
Collective Funds (CIF's)
B.1 General Information on CIF's
A CIF is a trust fund maintained by
a bank exclusively for the collective investment of assets from several trust
accounts administered by a trust department. They are not available to the
general investing public. CIF's are sometimes operated on a multiple-bank
basis within a bank holding company. In such cases, the largest trust
department in the holding company typically makes its CIF's available to
fiduciary accounts in smaller, affiliated trust departments (where permitted
by the trust instrument, terms of the account, and local law).
Before a particular account
purchases a participation in a CIF, it must be determined that the account's
governing agreement permits CIF's and that the particular CIF is a suitable
investment for the account. The trust committee, or
alternatively designated individual or committee, should direct the
account's participation in a common trust fund.
B.2. Common Trust Fund and Employee Benefit Collective Fund
CIF's are divided into two general
categories depending on the types of trust accounts qualified to invest in
the CIF and the source of their federal tax-exemption.
Common Trust Fund
A common trust fund is a
fund that is typically held by personal trust accounts. As these funds
obtain exemption from Federal tax under
IRC Section 584, they are also referred to as "IRC 584 funds".
Additionally, common trust funds are operated under
OCC Regulation 9.18(a)(1). For this reason, these funds are many
times also referred to as "(a)(1)" funds.
Employee benefit trust accounts
are not permitted to be commingled with personal trust accounts in a
common trust fund. However, a common trust fund may apply the tax-
exemption afforded by IRC Section 584 to the collective investment of
employee benefit trust accounts only. This is permissible only as long as
all of the accounts invested in the common trust fund are
employee benefit trust accounts. In this case, no employee benefit agency
accounts or personal trust accounts may be invested in the
common trust fund. Due to these restrictions, this application of IRC 584
The collective investment of charitable trust
accounts is discussed in
Subsection H.1, Charitable Trust Usage Of Collective Investment Funds.
Employee Benefit Collective Investment Fund
When not used generically, the
term collective investment fund is normally applied to funds
established for the collective investment of employee benefit trust and
agency accounts, as permitted under
OCC Regulation 9.18(a)(2). Consequently, employee benefit
collective investment funds are sometimes referred to as "(a)(2) funds".
These funds generally obtain exemption from Federal tax under
IRS Revenue Ruling 81-100, and are also referred
to as "RR 81-100 funds".
Under IRC Section 584, no agency
accounts, including employee benefit agency accounts, are allowed.
Therefore, RR 81-100 is the method employed by most banks operating
employee benefit collective investment funds.
Note that operating a CIF for the
purpose of managing employee benefit accounts is subject to ERISA
"party-in-interest" concerns - prohibited transactions. The Department of
Labor (DOL) has issued two class exemptions to address this issue. Refer
to Subsection G - ERISA Considerations
B.3. Importance of Tax-Exempt Status
If the CIF is operated in
conformance with applicable rules and regulations, the CIF qualifies for Federal income tax-exemption.
CIF's draw their tax-exempt
status from either
Section 584 of the Internal Revenue Code or IRS
Revenue Ruling (RR) 81-100. Each source of exemption imposes different
requirements on the fund, and it is essential that examiners understand the
requirements of each and their differences; and how they impact the
operations of a given fund.
may request a written opinion from the IRS on whether its CIF qualifies for
tax-exempt treatment under the Internal Revenue Code. As in the case
of employee benefit plans, there is no IRS requirement that banks apply for
a determination of the tax-exempt status of CIF's. However, obtaining this opinion provides assurance that the CIF was drafted
in compliance with Federal tax laws, and that it qualifies for tax-exempt treatment.
If a CIF was later found not to
qualify for tax-exempt treatment, all CIF capital gains and ordinary income
might become subject to taxation. With respect to personal trust accounts,
taxation might occur both at the CIF level and again at the participant
level (double taxation). Employee benefit accounts would only experience
taxation at the CIF level, since the participating employee benefit plans
are themselves exempt from taxation. The loss of favorable tax treatment
could cause the bank to incur a liability to the participants in a
collective investment fund, whose proportional interests in the fund are
directly impacted by any loss in value due to the loss of a fund's tax-exempt status.
IRC Section 584 and RR 81-100 are
discussed in Subsection C - CIF
Tax-Exempt Status - IRC Section 584 and IRS Revenue Ruling 81-100.
B.4. Importance of Securities Law Exemptions
CIF's are exempt from securities
registration and regulation as a security and as a mutual fund only when
operated in compliance with specific exemptions under Federal securities
laws. Funds operated without the benefit of these exemptions must
register under the Securities Act of 1933, and operate as
mutual funds, under the Investment Company Act of 1940. With the repeal of
Section 20 of the Banking Act of 1933, banks now have more flexibility in
underwriting and operating mutual funds. The increased flexibility comes
from the Gramm-Leach-Bliley Act of 1999, which is explained in
Subsection K - Proprietary Mutual
Funds. To understand the nuances of the exemption one must ensure that
the concept of "bona fide
fiduciary" as interpreted by the SEC is followed.
Subsection D -
Registration under Securities Acts provides more information.
B.5. "Bona Fide Fiduciary" Rule
CIF's are established by banks to
facilitate the administration of accounts held under "bona fide fiduciary"
appointments (as defined under Federal securities laws). CIF's operating
rules strictly limit fund participation to "bona fide fiduciary"
appointments, and employee benefit trust and agency accounts. A bank's CIF
investment expertise cannot be offered either to personal agency accounts or
to non-trust department customers.
"Bona fide fiduciary" appointments
have been interpreted by the SEC under Federal securities laws to
be limited to the traditional "personal trust" appointments of:
trustee, executor, administrator, guardian, and Custodian under a Uniform
Gift to Minors Act. The SEC holds that the exercise of trust powers must
involve duties beyond those that are merely incidental to money management.
Examples of accounts involving such incidental money management include
investment agency relationships, IRA accounts, and
mini-trusts. The absence of a genuine underlying fiduciary purpose has
consistently been interpreted, by the SEC, as falling outside the confines
of a trust relationship. Further, the staff of the SEC has repeatedly ruled
that so called mini-trusts established under standardized, revocable, or
minimum asset level contracts, constitute little more than investment
management agency accounts (refer to the
SEC interpretive letter in Appendix G). Therefore, these types of
accounts are not permitted to participate in a bank collective investment
The sole exception to the "bona
fide fiduciary" rule applies to CIF's operated for employee benefit
accounts. In these situations (discussed later in this section) banks are
permitted to invest funds held as trustee or agent in CIF's.
B.6. OCC Regulation 9.18 Requirements
OCC Regulation Section
9.18 provides the regulatory requirements
for the operation of common and collective investment funds. Refer to Subsection E - OCC
Regulation 9.18 and
Appendix G for further information. Although not an FDIC regulation, state nonmember banks
operating CIF's granted tax-exempt status pursuant to IRC Section 584, must
comply with Regulation 9.18, because Section 584 requires compliance with
this regulation. Compliance with Regulation 9.18 is not required for funds
operated by FDIC regulated state nonmember banks which do not rely on IRC
584 for tax-exemption (typically employee benefit collective investment
funds receiving tax-exemption under RR 81-100). However, State Law and
general standards of practice make OCC Regulation 9.18 or other similar
guidelines applicable to RR 81-100 funds as well. Many states have
promulgated laws regarding CIF's. Due primarily to the need to comply with
Federal securities and tax laws, State laws are generally similar to
OCC Regulation 9.18 covers the
written plan, fund management including use of outside adviser, fund
valuation, admission and withdrawal, audit and financial reports, and
self-dealing/ conflicts of interest among other things.
B.7. Basic Terms and Accounting Concepts
B.8. Benefits and Limitations of CIF's
To Fund Participants and To The Bank
Plan - The governing
instrument of a fund. This is in effect a trust agreement, and is often
entitled a declaration of trust or a group trust.
Units - Units represent
investments in a CIF and, like shares of a mutual fund, units represent a
proportional ownership interest in all the investments held by the fund.
Participants - Individual
accounts investing in the fund are called participants.
Valuation Date - The CIF
valuation date is set by the Plan. It can vary from daily to quarterly,
but it cannot be less frequently than quarterly (for CIF's maintained for
personal trust accounts). Participants may only gain admission to
(purchase units) and withdrawal (sell units) from a CIF on or before a
CIF's valuation date.
Principal value of a unit - This is the amount a participant pays
or receives when investing in or selling a unit of a CIF. The principal value of a unit is determined by
dividing the total number of CIF units into the CIF's total market value
on a valuation date.
Income value of a unit - This is the amount of income accrued by each
unit during a valuation period. Methods used for calculating both the
principal value and income value of each unit must be outlined in each
Fund and Participant
Accounting Systems - Trust departments operating CIF's must operate
two parallel accounting systems for each CIF. First, each CIF
portfolio must have an adequate "fund accounting system" operated on an
accrual method of accounting, reflecting the CIF's securities transactions
and income earned. Secondly, all participants in each CIF must have a
"participant accounting system" to reflect each participant's holdings in
the CIF, (including: the number of units bought and sold, original cost
per unit, all capital gains and losses per unit, balance of units held,
income earned and distributed per unit, etc.).
Benefits of CIF's to participants and bank include:
CIF's offer the advantage of investment diversification, which is often
difficult to achieve when investing small amounts of fiduciary
Smaller accounts benefit because
they are able to regularly invest in CIF units that typically do not
require large outlays of cash. This improves the diversification of their
account and reduces uninvested cash balances.
Given the size of the transactions, it is
more efficient for the trustee to make and supervise investments for CIF's.
CIF's allow management to
concentrate investment decision-making and research efforts by permitting
it to manage fewer, but larger, portfolios.
CIF securities transaction costs
and brokerage commissions are reduced, since larger purchases and sales
can be effected more economically. Also, to the extent a participant
invests in a CIF, securities commissions are eliminated, because no fees
or charges may be assessed on the purchase or sale of CIF units under OCC
Limitations of CIF's for the
Adverse tax consequences can arise when unrealized capital gains are
allowed to accumulate in the fund. New participants become subject to the
taxable treatment of unrealized gains when they enter the fund. All
capital gains are passed through for tax purposes to the participants in a
fund during the taxable period in which the gains are realized. The
pass-through applies to new participants, whether or not they experience
any appreciation in their units.
Participating accounts are faced with reduced liquidity. Since
participants may only withdraw from a fund as of a valuation date, this
could be as infrequent as monthly or quarterly, participants may
experience liquidity problems arising from the inability to
sell CIF units.
The inability to divest of CIF units except at valuation dates may
inadvertently "lock in" all participants during a period of falling
prices. The longer the interval between valuation dates, the greater the
potential impact on all participants.
Limitations of CIF's for the bank include:
Most of the costs involved in establishing a common trust fund must be
borne by the bank, including legal fees for drafting the original
agreement and any subsequent modifications, and any reorganization
Banks also experience greater pressure on fund performance, as the
CIF's performance results are easily compared with performance attained by
various industry benchmarks or outside mutual funds with
similar investment objectives.
B.9. Typical Fund Categories
CIF's must be maintained by the
type of qualifying accounts (personal trust
employee benefit trust and agency accounts), as well as for the fund
objective, such as fixed income or equity. The following
are the more common types of CIF's which may be found in a trust department:
Equity Fund - These funds usually consist primarily, or wholly, of
common stocks. They are designed to achieve market appreciation while
producing some current income.
Diversified or Balanced Fund - Typically, such funds have a balance
of equity and fixed income securities providing asset diversification by
asset type. Such funds seek capital appreciation with a regular stream of
Fixed Income Fund - Portfolios of these funds are composed
predominately, or wholly, of bonds, preferred stocks, mortgages, and other
assets from which the income return is fixed.
Municipal Bond or Tax-Exempt Bond Fund - These CIF's are comprised
of state and municipal obligations which provide income exempt from both
Federal and State taxes for residents of the state issuing the securities.
Real Estate Investment Fund - Portfolios of these funds are
invested primarily in real estate.
Mortgage Fund - These funds consist predominately of mortgages.
Investment Fund (STIF) - These funds are CIF equivalents to a
money market mutual fund. They are established for the temporary
investment of trust cash. Their primary objective is to provide high
liquidity and a continuous stream of income at current rates of return.
OCC Regulation 9.18(b)(4), "Valuation" in
subsection E.7, contains specific requirements for proper STIF
Covered Call Option Fund
- These funds permit the writing of covered call options. Refer to
subsection F.2. Specialty CIF's for
information on OCC guidance.
Securities Investment Fund - These CIF's are primarily composed of
foreign securities. They may consist predominately of equities or fixed
income investments, or may be structured as balanced funds.
Subsection F.2. Specialty CIF's
contains information on OCC regulatory requirements, including
interpretations regarding the use of Foreign Securities Investment Funds
by ERISA accounts.
Index Fund -
These funds are invested in securities tied to a particular securities
index, such as Standard & Poor's, the New York Stock Exchange Index, or
the Dow Jones Industrials. Refer to
subsection F.2. Specialty CIF's for investment related information in
operating this type of fund.
Guaranteed Investment Contract ("GIC") Fund - These
primarily, or fully, invested in GIC's, which are usually issued by
insurance companies. Refer to
F.2.e. for investment information and GIC valuation requirements.
C. CIF Tax-Exempt Status - IRC
Section 584 and IRS Revenue Ruling 81-100
Each CIF is considered a separate
tax entity, having its own tax identification number and administrative
requirements. To maintain its tax-exempt status, CIF's must be operated in
conformity with IRS regulations. The primary IRS regulations granting
tax-exempt status are
Internal Revenue Code Section 584 and
IRS Revenue Ruling 81-100, described separately below. Each imposes
different requirements that significantly affect both the CIF's operation
and which accounts are allowed to invest in the CIF. Nondeposit trust
companies are permitted to operate common trust funds under
IRC Section 581.
Additional information on IRC Section 581 is located in Appendix G.
Internal Revenue Code Section 584
IRC Section 584 primarily pertains
to the operation of common trust funds for personal accounts (personal
trusts, estates, guardianships, and accounts created under a Uniform Gifts
to Minor Act). There are four key points to consider when reviewing a fund
granted tax-exempt status under Section 584:
IRC Section 584 provides that any common trust fund that obtains its
tax-exempt status from this section of the Code must comply with
OCC Regulation 9.18.
Therefore, FDIC-supervised banks operating common trust funds drawing tax-exemption from Section 584 must comply with OCC Regulation 9.18.
There are no state or local laws exempting state banks from compliance
with this provision, as compliance is mandatory to achieve CIF tax-exemption under Section 584.
Personal agency accounts and IRAs may not participate in ANY common trust
fund, due to restrictions contained in
Federal securities laws.
Failure to comply with
IRC Section 584 requirements
jeopardizes the tax-exempt treatment afforded common trust funds. Therefore,
any loss of the fund's tax favored treatment could expose the bank to
liability. Tax liability could occur at the fund level and the participant
level. The latter would occur due to regulatory sanctions and
penalties and/or pending participant actions, such as lawsuits. The fund participants' proportional interest in the fund are directly
impacted by any loss in the fund's value. The bank may be responsible for
absorbing the tax consequences incurred by participants.
There are forms that must be filed
annually with the IRS. U.S. Treasury Regulation Section 1.6032.1 and IRC
Section 6032 require banks operating common trust funds to file annual
informational returns with the IRS for each fund established under IRC
Section 584. The IRS has not developed a specific form for this purpose.
However, Schedule K-1 of Form 1065 (Partner's Share of Income, Credits,
Deductions) is typically used to satisfy the reporting requirement. The
return must include, for each fund participant: the name; the address; and
the proportional share of taxable income or losses, and capital gains or
losses. This informational return is required, regardless of the taxable
income earned during the reporting period. The aforementioned Treasury
regulation requires banks to file a full copy of the common trust fund's
declaration of trust at least once with the return. If the plan
is amended, the bank must resubmit the plan and its amendments with the
As noted in the earlier discussion
of common trust funds, banks may in some
instances rely on the tax- exempt treatment afforded by IRC Section 584 when
establishing funds exclusively for employee benefit trusts and certain other
tax-exempt fiduciary accounts administered in the capacity of trustee. If
an IRC 584 fund is established for employee benefit trusts, the fund would
be required to comply with
OCC Regulation 9.18, and employee benefit trusts could not be commingled
with personal trust accounts in common trust fund. Reasons for this
distinction relate to SEC decisions regarding securities registration.
IRC Section 584 appears in its
entirety in Appendix G. Also, Subsection
P.3 - Federal Tax Laws contains additional information on IRC Section
IRS Revenue Ruling 81-100 applies to the collective investment of
employee benefit trust and agency accounts. The qualifying accounts are
from employee benefit plans which obtain their tax-exempt status from
Section 401 of the Internal Revenue Code. RR 81-100 also technically
permits IRA accounts which obtain their tax-exempt status from Section 408
of the Internal Revenue Code.
Federal securities laws,
bank CIF's must qualify for exemption from securities registration and
exemption from investment company registration (i.e., registration as a
mutual fund). Therefore, IRA accounts should not be allowed to
participate in any CIF. Examiners should note the differences in
purpose between IRC and SEC regulations and opinions. Federal tax laws do
permit IRAs to be invested in collective investment funds, see IRC
Sections 408(a)(5) and 408(e)(6). Due to the SEC's restrictive interpretation of: (1) an "exempted security"
under Section 3(a)(2) of the Securities Act of 1933, and (2) "investment
company" (mutual fund) exemptions under Sections 3(c)(1), (3), and (11) of
the Investment Company Act of 1940, IRAs are effectively barred from CIF's
and, for all practical purposes, may only be collectively invested in
mutual funds operated under the Investment Company Act of 1940.
Therefore, examiners should review collective investment funds that allow
the investment of funds held by IRA accounts, determine if the bank is
complying with securities law, and cite apparent violations where
applicable. Refer to
Subsection D -
Registration Under Securities Acts and the December 6, 1994, SEC ORDER
The Commercial Bank of Salem, Oregon in Appendix G for additional
banks have used exemptions afforded under Regulation D of the Securities
Act of 1933 to collectively
invest otherwise non-permissible accounts, such as IRAs, without
registration. Regulation D places restrictions on the number and
sophistication of investors. Refer to Subsection
N.5. Regulation D Exempted Securities Offerings for details.
For all practical purposes, only
employee benefit accounts whose tax-exemptions derive from IRC Section 401
may invest in
RR 81-100 funds. These funds are typically established in a form
identical to that outlined by OCC Regulation 9.18(a)(2), even though compliance
with OCC regulations is not mandatory. Therefore, no violation should be
cited unless local law requires state nonmember banks to comply with
9.18(a)(2). OCC Regulation 9.18, however, generally addresses items
considered as standard industry practice and, therefore, serves as a guide
to the prudent operation of employee benefit CIF's. The operation of such
funds under OCC guidelines, or guidelines substantially similar, should be
recommended. Refer to Subsection E -
Regulation 9.18 for more information.
RR 81-100 requires
Participating employee benefit
plans adopt the "group trust" as a part of the plan ("group trust" refers
to the collective investment fund declaration of trust discussed in
Subsection P.3 - Federal Tax Laws);
"Group trusts" prohibit
collective investment fund assets from being diverted to any purpose other
than the exclusive benefit of participating plan beneficiaries;
"Group trusts" prohibit the
assignment of any collective investment fund assets by any of the
participating plans; and
"Group trusts" must be
established and maintained as domestic U.S. trusts.
Failure to comply with RR 81-100
jeopardizes a collective investment fund's tax-exempt status. The loss
of favorable tax treatment could cause the bank to incur a liability to the
participants in a collective investment fund, whose proportional interests
in the fund are directly impacted by any loss in value due to the loss of a
fund's tax-exempt status.
No informational returns are
required for employee benefit collective investment funds operated in
RR 81-100, and that derive their tax-exemption under IRC Section
501(a). However, Department of Labor regulations define collective
investment funds used for the collective investment and reinvestment of
funds contributed to an employee benefit plan as
Direct Filing Entities (DFE). DFE's are required to file reports with the
Department of Labor. Refer to
Section 5.J.1 of this manual for more information concerning Department
of Labor reporting requirements.
Revenue Ruling 81-100 is reprinted
in its entirety in Appendix G. Also,
Subsection P.3 - Federal Tax Laws contains additional information on RR
Registration Under Securities Acts
CIF's maintained by banks are generally exempt from the requirements of the
Securities Act of 1933 (1933 Act) and the
Investment Company Act of 1940 (1940 Act). However, if a bank does not
strictly meet the exemption requirements, the bank would be required to
register the CIF as a security under the 1933 Act and as an investment
company (mutual fund) under the 1940 Act. Banks generally seek to avoid
registration of their CIF's, due to the additional regulatory requirements
imposed with registration.
The following items explain the exemption rules and how banks may violate
the acts depending on which types of participant accounts are allowed or if
different account types are commingled.
Securities Act of 1933 (1933 Act)
The 1933 Act provides for the
registration of securities sold in interstate commerce to the investing
public and requires issuers of such securities to make full and fair
disclosure in connection with the offering of such securities.
Exemptions under the 1933 Act:
Section 3(a)(2) of the 1933 Act exempts from the registration
requirements and other provisions of the act:
Any interest or participation in
any common trust fund or other similar fund that is excluded from the
definition of the term "investment company" under Section 3(c)(3) of the
Investment Company Act of 1940. This generally exempts any CIF maintained by a bank for
the collective investment and reinvestment of assets contributed by the
bank in its capacity as trustee, executor, administrator, or guardian.
Any interest or participation in
a single or collective trust fund maintained by a bank for stock bonus,
pension, or profit sharing plans which meet the requirements for
qualification under Section 401 of the Internal Revenue Code of 1954.
Any interest or participation in
a single or collective trust fund maintained by a bank for a governmental
plan as defined in section 414(d) of the Internal Revenue Code of 1954
within certain described parameters.
Implications of Admitting
Certain Participants Into a CIF - 1933 Act:
IRAs: Funds permitting participation by IRAs would not be exempt
under Section 3(a)(2), because IRAs qualify under Section 408 of the
Internal Revenue Code. The participation of IRAs in a CIF would therefore
trigger securities registration requirements under the 1933 Act. If
the CIF was not registered, the participation of IRA accounts would
constitute an apparent violation of the 1933 Act. See further
discussion of IRAs below under Investment Company Act of 1940 subheading.
Keogh Plans: The exemption provisions of 3(a)(2) do not cover
that allow participation by some or all employees who are categorized
under 401(c)(1) of the Internal Revenue Code pertaining to Keogh plans
(HR-10 Plans). Keogh plans may not normally be invested in CIF's
without the CIF having to register under Federal securities laws.
However, a small number of specialized Keogh accounts may qualify for a
limited exemption and therefore be able to invest in a bank CIF. To
qualify, the plan accounts and plan sponsor must comply with a narrowly
defined intrastate exemption or SEC Rule 180 "Sophisticated Investor
Rule". Refer to Section
H.2. Keogh Account Usage of Collective Investment Funds for details.
Government Plans: Various governmental organizations' plans
receive their tax-exempt status from different Internal Revenue Code
sections (such as IRC 401, 403, 457, and other sources). Plan
participation in employee benefit CIF's is generally permissible without
causing the bank's CIF to have to register under the 1933 Act. However
there are instances where examiners should inquire further about the
respective plan's qualifications. This includes state and local
government entities which may obtain their plan's tax-exempt status from
other sources and may not meet other 1933 Act
standards. Refer to information in
Section H.3 Government Plan
Usage of Collective Investment Funds to ensure that CIF registration
under the 1933 Act is not required.
Traditional Agency Accounts: Banks may never collectively
invest a traditional investment management agency account in a CIF.
See Subsection B.2 Common Trust Fund and
Subsection E.3. Regulation 9.18(a)(1)
for further explanation. However, agency accounts are permitted to invest
in mutual funds that are registered under the 1933 Act.
Employee Benefit Agency Accounts: Employee benefit agency accounts
are permitted in Regulation 9.18(a)(2), "RR 81-100" CIF's. See
Employee Benefit Collective Investment Fund for additional
Regulation D Exemption: Although difficult to apply, some banks
have used exemptions afforded under Regulation D to collectively invest
in otherwise non-permissible accounts, such as IRAs, without registration.
Regulation D places restrictions on the number and sophistication of
investors. Refer to Subsection N.5. Regulation D
Exempted Securities Offerings for details.
D.2. Investment Company Act of 1940 (1940 Act)
The Investment Company Act of 1940 (1940 Act) provides for the registration
and regulation of investment companies. Under the 1940 Act, an
investment company is an issuer, which holds itself out as
being primarily engaged in the business of investing, reinvesting, or
trading in securities. In assessing the extent to which the provisions of
the 1940 Act may have applicability to the trust activities of banks,
reference should be made to the following exemptions contained in the 1940
Exemptions under the 1940 Act:
Section 3(c)(3) of the 1940 Act does not apply to "any common trust fund or similar fund maintained by a
bank exclusively for the collective investment and reinvestment of moneys
contributed thereto by the bank in its capacity as a trustee, executor,
administrator, or guardian."
Section 3(c)(11) of the 1940 Act exempts from the definition of an
investment company: "employee's
stock bonus, pension, or profit-sharing trust which meets the requirements
for qualification under Section 401 of the Internal Revenue Code of 1986
governmental plan described in section 3(a)(2)(C) of the Securities Act of
1933; or any collective trust fund maintained by a bank consisting solely
of assets of such trusts or governmental plans".
Implications of Admitting Certain Participants Into a CIF -
IRAs: The bank CIF
exclusion under the 1940 Act does not include IRAs, which fall under
Section 408 of the Internal Revenue Code. Due to
the SEC's restrictive interpretation of an exempted security under Section
3(a)(2) of the Securities Act of 1933, and investment company exemptions
under Sections 3(c)(1), (3), and (11) of the 1940 Act; IRAs
are effectively barred from CIF's and, for all practical purposes, may
only be collectively invested in registered mutual funds operated under
the 1940 Act. Therefore, examiners should question any CIF that allows
the investment of funds held by IRA accounts and must determine if the
bank is violating both the 1933 Act and 1940 Act. Refer to the
December 6, 1994, SEC ORDER on
The Commercial Bank of Salem, Oregon in Appendix G for additional
Commingling of employee benefit and personal accounts: The SEC has
interpreted the phrase "common trust fund" as applying only to those
accounts administered by banks in their traditional capacity as trustee,
executor, administrator or guardian for individuals. Therefore, the
commingling of both employee benefit and personal accounts fails to
qualify under the 3(c)(3) exemption because employee benefit plans are by
definition not personal trust accounts. Furthermore, the commingling of
both employee benefit and personal trust accounts fails to qualify under
the 3(c)(11) exemption because personal trust accounts are not covered by
Section 401 of the Internal Revenue Code.
Examiners should ensure that
employee benefit and personal accounts are not invested in the same CIF,
due to the registration requirements that would result.
Failure to qualify under the above exemptions due to the
commingling of personal and employee benefit accounts in a CIF subjects
the CIF to registration and regulation as a mutual fund (investment
company) under the 1940 Act.
The SEC has taken the position
that employee benefit accounts administered in the capacity of trustee may
not be commingled in common trust funds established for personal trust
accounts. The SEC has consistently made a distinction between personal
trusts and employee benefit trusts under securities laws. Consequently, it
is irrelevant that both
OCC Regulation 9.18 and
IRC Section 584 appear to permit accounts administered in the capacity
of trustee to be commingled without reference to the type of accounts
being invested (personal vs. employee benefit plan). These accounts are
not permitted to be commingled in a CIF.
November 1, 1991,
No-Action Letter to Santa Barbara Bank and Trust found in Appendix G,
the SEC replied to an inquiry concerning Federal securities law
restrictions against commingling assets of employee benefit plans, IRAs,
and personal trust accounts. The SEC stated that this would require
registration of a CIF as a mutual fund under the 1940 Act, and that
interests in the CIF would then have to be registered as securities under
the Securities Act of 1933.
Appendix D provides additional information on the
of Federal Securities Law to Banks and Bank Sponsored Securities Activities,
including three separate sections on collective trust funds.
E. OCC Regulation 9.18
The complete text of
OCC Regulation 9 - Section 9.18, regarding the operation of collective
investment funds, can be found in Appendix G. The following is a
synopsis of significant parts of Section 9.18.
E.1. Section 9.18 Applicability to State Nonmember Banks
State nonmember banks need to
Section 9.18 for funds granted tax-exempt status pursuant to
IRC Section 584. Funds granted tax-exempt status pursuant to
Revenue Ruling 81-100, such as
employee benefit CIF's, are generally not subject to Section 9.18
requirements. However, state law often requires that all CIF's comply
with Section 9.18 or comply with a similarly written state provisions. Even
where not required by law, the standards set forth in Section 9.18 should be
followed by state nonmember banks as industry best-practices for all funds.
E.2. 1997 Revision of Section 9.18
The OCC revised its national bank
fiduciary regulations in 1997. At
the time, several OCC fiduciary precedents and trust interpretive letters
had been issued under the prior version of the regulation. The OCC opined that the precedents and interpretations
in these interpretation letters have become industry practice
or simply articulate sound fiduciary principals.
At the same time, the OCC opined
that whether a CIF plan needs to be amended to accommodate the changes in
the revised regulation, depends upon the language in the existing plan. If
the language specifically states the requirements of the old regulation,
management should continue to operate the plan in compliance with the
original plan - unless the plan is amended. If the plan's language merely
makes general reference to 12 CFR 9.18, an amendment may not be necessary.
However, banks operating short-term investment funds should amend their
plans to reflect the new valuation provision in the revised regulation. Any
amendment should be approved by the bank's board or its designee. Expenses
incurred in amending a plan are considered the cost of establishing or
organizing a CIF, and, therefore, may not be charged to the fund (Section
9.18(b)(10)). Refer to Appendix G for
OCC Bulletin 97-22 (Excerpts) for further information regarding the
implementation of the revised Section 9.18 to pre-existing CIF's.
E.3. Section 9.18(a)(1)
Section 9.18(a)(1) provides that banks may operate
a fund maintained exclusively for the collective investment of monies
contributed by the bank in its capacity as trustee. Section 9.18(a)(1)
funds are commonly referred to as common trust funds and are defined in
Subsection B.2. Common Trust Fund. In the
administration of funds created pursuant to Section 9.18(a)(1), bank
procedures should provide that no units of participation may be held by an
The 1997 revision to Section
9.18(a)(1) eliminated the 10% limit on a participant's interest in a common
trust fund, and the 10% limit on investment of a common trust fund in the
obligations of one issuer. The revised regulation also eliminated the
requirement that a bank maintain, in cash and readily marketable assets, a
percentage of common trust fund assets as necessary to provide for the
liquidity needs of the common trust funds.
E.4. Section 9.18(a)(2)
Section 9.18(a)(2) states the general permissibility of banks
to operate a fund consisting solely of assets of retirement, profit sharing,
stock bonus, or other trusts that are exempt from Federal income tax.
Section 9.18(a)(2) funds are often referred to as
Funds (as previously described in Subsection B.2.). In the
administration of funds created pursuant to Section 9.18(a)(2), bank
procedures should not allow participation by any trust accounts which are
subject to Federal income tax.
E.5. Section 9.18(b)(1) The Written Plan
A CIF must be established and
maintained in accordance with a written plan. The plan may cover multiple
funds. The plan must be approved by resolution of the bank's board of
directors or a committee authorized by the board. (Although not required by
9.18, it is recommended that legal counsel examine the plan.) A copy of the
plan must be made available to any person for inspection at the main office
of the bank during banking hours.
Section 9.18(b)(1) sets forth the
required minimum content of the written plan establishing a CIF:
Investment powers and policies with respect to the fund,
Allocation of income, profits, and losses,
Fees and expenses that will be charged to the fund and to participating
Terms and conditions governing the admission and withdrawal of
Audits of participating accounts,
Basis and method of valuing assets in the fund,
Expected frequency for income distribution to participating accounts,
Minimum frequency for valuation of fund assets,
Amount of time following a valuation date during which the valuation must
Bases upon which the bank may terminate the fund, and
Any other matters necessary to define clearly the rights of participating
Items (iii) and (vii) are 1997 additions to Section 9.18. Plans that
were approved and in operation prior to the 1997 revisions (unless the plan
is amended) are not required to maintain such provisions.
E.6. Section 9.18(b)(2) Fund Management
Section 9.18(b)(2), a bank administering a CIF shall have exclusive
management thereof, except as a prudent person might delegate
responsibilities to others. The ability of management to delegate certain
responsibilities to others under the prudent person standard was added in
1997. Management, however, is responsible for conducting a due diligence
review prior to delegation, having board or designee approval of the
delegation, ensuring an written agreement sets forth duties and
responsibilities, and closely monitoring the activities and performance of
the third party. In OCC Bulletin 97-22, the OCC recommended that a
bank review, with their attorney, the securities laws and tax implications prior to any delegation of investment responsibility.
Delegating investment advise is discussed in
Subsection F.1 - Use of
Outside Investment Advisers.
Section 9.18(b)(4) Valuation
9.18(b)(4) requires that the fund be valued at least once every three
months. Funds must be valued at market value or, if such valuation is not
readily ascertainable, at a fair value determined by the trustee.
The current regulation grants a
valuation frequency exception for
9.18(a)(2) funds (retirement, pension, profit sharing, stock bonus, or
other trusts exempt from Federal taxation) that invest primarily in real
estate or other assets that are not readily marketable. For these types of
funds, the bank is only required to determine the value of the fund's assets
at least once each year. Note: Section 9.18(b)(4),
"Valuation", is currently being revised to provide increased flexibility
when valuing assets that are illiquid, difficult to value, or not readily
marketable. The anticipated change will allow these assets to be valued
once per year within all funds (without the existing restrictions on fund
type). The valuation of the fund's readily marketable assets will still be
required to be valued at least once every three months. Refer to
www.occ.treas.gov for most current
regulatory information on this issue.
There are specific valuation
guidelines for Short-term Investment Funds (STIF's). The assets of a
STIF may be valued at cost (as opposed to fair market value), if the STIF
maintains a dollar weighted average portfolio maturity of 90 days or less,
the bank uses straight line accrual between the cost and anticipated
principal receipt on maturity, and the bank holds fund's assets until
maturity under usual circumstances [Section
9.18(b)(4)(ii)(B)]. Revisions to Section 9.18 made
substantial changes with respect to the operation of STIF's. One significant
change is the elimination of the requirement that a STIF invest at least 80%
of the STIF's assets in instruments payable on demand or that have a
maturity date not exceeding 91 days from date of purchase. The revised
regulation also eliminated the requirement that at least 20% of the fund's
assets must be cash, demand obligations, and assets that will mature at the
fund's next business day.
E.8. Section 9.18(b)(5) Admission and Withdrawal
9.18(b)(5), participants should be admitted to or
withdrawn from a fund only on the basis of the valuation described in
Section 9.18(b)(4), and on such valuation date. The admission or withdrawal
must be under prior request or notice on or before the valuation date. The
bank may require notice of up to one year for withdrawals from funds with
assets that are not readily marketable. No admission or withdrawal request
or notice can be canceled or countermanded after the valuation date.
Distributions to withdrawing participants may be made in cash, ratably in
kind, a combination of cash and ratably in kind, or in any other manner
consistent with the applicable state law.
OCC Interpretive Letters #920 and #936, the OCC stated that while
Section 9.18(b)(4) addresses the frequency of valuing a CIF, that
requirement does not mandate a similar frequency for admissions and
withdrawals. The confusion, the OCC writes, results from the fact that the
regulation provides that admissions and withdrawals may only be on the basis
of the valuation. The Interpretive Letters are located in Appendix G.
E.9. Section 9.18(b)(6)(i) Annual Audit
Section 9.18(b)(6)(i) requires that
each CIF be audited at least once during each 12-month period by auditors
responsible only to the bank's board of directors. [If permitted by
Section 9.18(b)(10) permits the plan to pay reasonable expenses incurred
to operate the fund. The regulation does not define reasonable or specify
which expenses may be paid. The OCC had interpreted the prior regulation to
permit the recapture of the audit costs associated with independent outside
auditors, but not internal audit costs.]
There are no regulatory
requirements as to the scope of the audit. Therefore, as long as the audit
appears reasonably complete, examiners should express no objection. As
mentioned previously, CIF's that obtain tax-exempt status under RR 81-100 are
not necessarily subject to Section 9.18 requirements except if required to
do so under state law or regulation. Nonetheless, audits are strongly
recommended by the Corporation, and examiners should criticize any CIF that
is not audited annually. When OCC Regulation 9.18 sets specific
requirements, a reasonable equivalent should be in place for a CIF subject
to RR 81-100.
Both internal and external audits
are acceptable, if the audit scope is adequate. Items typically addressed in a CIF audit:
Sufficient tests to permit the auditor to provide an opinion on financial
data required by
OCC Regulation 9.18(b)(6)(ii).
Confirmation or verification of the fund's assets, together with a
reconciliation of pending transactions.
Reconciliation of any cash positions in deposit or money-market funds.
General compliance with
OCC Regulation 9.18, especially as to: advertising restrictions [Section
9.18(b)(7)] and prohibited transactions regarding self-dealing and
conflicts of interest [Section
General compliance with any applicable state laws or regulations.
Conformance with the plan document, particularly as to: limitations on the
types of eligible participants and limitations on permissible investments.
Review of any transactions with bank insiders or investments in their
Review of any fees paid by the CIF to the bank, its insiders, and their
A test to ensure that income receivable from investments is posted to the
CIF, and that proper accruals are used in distributing net income.
E.10. Section 9.18(b)(6)(ii) Financial Report
Section 9.18(b)(6)(ii) requires
each CIF to issue an annual report that is intended both for the bank and
the beneficiaries of participating accounts. At least once during each 12
month period, a financial report of the fund based on the audit
(Section 9.18(b)(6)(i) above) must either be furnished, or made
available, at no charge to each person who would receive an accounting from
each participating trust account. It may also be provided to
The financial report must contain a
list of investments at both cost and current market value, a summary of
investment changes for the period reflecting purchases (with costs) and
sales (with profit or loss), income and disbursements since the last report,
and notation of any investments in default. The report may not
contain predictions of future fund performance, but may include historical
Additionally, Part 344 of the FDIC Rules and Regulations - Recordkeeping and
Confirmation Requirements For Securities Transactions requires an annual
financial report for all CIF's (even RR 81-100 Employee Benefit CIF's).
Part 344.6(e) states that for collective investment fund accounts: "The
bank shall at least annually give or send to the customer a copy of a
financial report of the fund, or provide notice that a copy of such report
is available and will be furnished upon request to each person to whom a
regular periodic accounting would ordinarily be rendered with respect to
each participating account. This report shall be based upon an audit made by
independent public accountants or internal auditors responsible only to the
board of directors of the bank."
E.11. Section 9.18(b)(7) Advertising of Collective Investment Funds
Advertising of common trust funds
established for personal trust accounts (9.18(a)(1)
funds) is prohibited under
OCC Section 9.18(b)(7), except in connection with the advertisement of
general fiduciary services. The advertising restrictions of this section do
not apply to employee benefit collective investment funds (9.18(a)(2)
funds) typically organized under RR 81-100. Be advised that advertising of any
collective investment fund may jeopardize its exemption from securities laws,
thereby requiring registration.
E.12. Section 9.18(b)(8) Self-Dealing and Conflicts of Interest
Section 9.18(b)(8) requires banks administering CIF's to comply with
Self-Dealing and Conflicts of Interest requirements. The following
is a summary of CIF self-dealing and conflict of interest rules (with links
to the specific Regulation 9 sections):
The bank may not have an interest in the CIF, except in its fiduciary
capacity. (This includes a prohibition on any creditor relationship
between the bank and the fund or its participants. This section has been
interpreted to extend to overdrafts.) [9.18(b)(8)(i)]
The bank may not make a loan on the security of the participant's interest
in the fund. [9.18(b)(8)(ii)]
The bank may not lend, sell, or otherwise transfer assets of a fiduciary
account to the bank, insiders, or affiliates. [
9.12(b) as referenced by Section 9.18(b)(8)]
Defaulted investment exception: A bank may purchase a defaulted fixed
income investment from a fund for its own account. If it does so, the
purchase price must be at the greater of: market value, or cost plus
accrued unpaid interest. [9.18(b)(8)(iii)]
No fund assets may be invested in
the bank's stock or obligations. [Section
9.12(a) as referenced by Section 9.18(b)(8)]
See entire text of Section
Section 9.12 in Appendix G for further information.
Own-Bank Deposits in a Short-Term Investment Fund (STIF):
OCC Interpretive Letter #969 states that a bank may use own-bank
deposits for fiduciary assets awaiting investment or distribution
collectively in a STIF administered by the bank. However, the activities
must comply with conditions set forth in the letter and Section 9.10 and
Section 9.12 of the regulation. The activity must be "lawfully authorized
by the instrument creating the relationship, or by court order or by local
law". Refer to Interpretive Letter #969 in Appendix G for further
Underperforming CIF's: In addition to the specific conflicts of
interest principles addressed in
Section 9.18, banks confront other conflicts of interest in the
administration of CIF's. One of the most difficult is management's continued
use of a CIF that consistently under-performs general market indices. The
costs of establishing and maintaining CIF's, together with marketing or
public relations, and potential litigation considerations, may influence
management's decision to continue to invest customer
assets in CIF's. Sound fiduciary investment practice, on the other hand,
might require that account assets invested in an underperforming CIF be sold
and investments made in more productive investment vehicles. CIF
performance must be evaluated in the same manner as other investments. CIF
performance should be compared with mutual fund performance indices and
overall market indices (S&P 500, Dow Jones Industrials, etc.). Examiners
should not recommend either the continuation or termination of a particular
fund. However, management's failure to routinely evaluate and
document fund performance should be criticized. Funds that have
underperformed general market indices should receive management's (including
the board of directors) close scrutiny, and be covered by a strategic plan
to improve performance.
E.13. Section 9.18(b)(9) Management Fees
Section 9.18(b)(9) permits a bank administering a CIF to charge a
reasonable fund management fee only if the fee is permitted under applicable
law (and complies with fee disclosure requirements, if any) in the state in
which the bank maintains the fund. The amount of the fee must be
commensurate with value of legitimate services of tangible benefit.
Through various interpretive
letters, the OCC has provided some clarification to Section 9.18(b)(9)
regarding what constitutes reasonable fees commensurate with the value of
OCC Interpretive Letter #829, responds
to a bank inquiry regarding applying different management fees to common
participants commensurate with the amount and type of participant services
provided. Interpretive Letter #829 addressed charging different fees to
various 401(k) employee benefit plans participating in the bank's CIF's based
on the complexity of the 401(k) plans' administrative characteristics.
E.14. Section 9.18(b)(10) Expenses
Section 9.18(b)(10) permits a bank administering a CIF to charge
reasonable expenses incurred in operating the CIF, to the extent not
prohibited by applicable state law. The section specifies that the bank
shall absorb the expenses of establishing or reorganizing a CIF.
OCC Interpretive Letter #919, located in Appendix G, provides guidance
for permissible expense recovery from participants in model-driven funds and
index funds. Model-driven funds are collective investment funds that seek
to outperform a specified index or benchmark based on a pre-determined
investment strategy. The Interpretive Letter indicated that model-driven
funds may charge participants the cost of entering or exiting a fund just as
index funds do, provided the fund's governing document authorizes such
E.15. Section 9.18(b)(11) and (12) Prohibition Against Certificates / Good
Sections of 9.18(b)(11) and
9.18(b)(12) prohibit issuing certificates or documents representing an
interest in the CIF and provide an opportunity for bank's to promptly
correct good faith mistakes, respectively.
E.16. Section 9.18(c) Other Collective Investments
Section 9.18(c) prescribes other permissible instances when banks may
collectively invest assets that it holds as fiduciary. Under certain
circumstances, 9.18(c) address commingling single loans or obligations,
variable amount notes (vans), mini-funds, trust funds of corporations and
closely-related settlors, and other, special exemption funds subject to OCC
F. Investment Management Issues
F.1. Use of Outside Investment Advisors
OCC Regulation 9.18(b)(2) requires that the bank hold exclusive
management over collective investment funds, except as a prudent person
might delegate responsibilities to others. However, if management delegates
investment responsibility, as allowed under the 1997 revised OCC regulation,
the CIF may lose its exemption from Federal securities law (Section
3(a)(2) of the 1933 Act) and exemption from Federal taxation (IRC
584, for common trust funds).
The OCC has stated that management
may delegate investment responsibility so long as it is done prudently. Per
the OCC, this includes conducting a due diligence review of the investment
advisor prior to delegation and closely monitoring the investment advisor's
performance after delegation. The Board or its designee should approve the
delegation and ensure that an agreement outlining each party's duties and
responsibilities is in place. Management should review the securities law
and tax law implications of the delegation with legal counsel prior to the
delegation of investment management responsibilities.
In the past, the OCC has
permitted the use of outside investment advisors if:
F.1.a. CIF's Tax-Exempt Under IRC
584 (Subject to OCC Regulation 9.18)
such delegation is proper under
governing law or if the surrender of control and management results in
strict liability of the trustee for the acts of its delegate,
the arrangement is governed by
a written agreement,
the adviser can perform only
the functions the bank could perform,
the CIF is subject to the
jurisdiction of the OCC (no definition of OCC jurisdiction over
state nonmember bank CIF's has been rendered),
the trustee bank establishes
specific investment guidelines to be followed by the investment advisor,
the trustee bank frequently
reviews the investment advisor's activities, and
the trustee bank can terminate
the contractual relationship at will.
CIF Tax-Exempt by Revenue Ruling 81-100
There is no explicit coverage of
outside investment advisors for CIF's that are tax-exempt subject to
RR 81-100. Examiners should look first to ERISA, as these funds are
restricted to tax-qualified employee benefit plans, and then to OCC
precedents. State law or regulations may also contain applicable
In general, ERISA would appear to permit the use of a
non-affiliated investment advisor, so long as the fees were
ERISA Section 406(b)(3), however, appears to prohibit the use
of an affiliated investment advisor for a fee in connection with
a transaction involving the assets of the plan. If the affiliated
investment advisor charged no fee, no violation would occur.
Prohibited Transaction Class
91-38 (located in Appendix E) do not address the use of
investment advisors for
RR 81-100 funds.
In the past, the OCC has issued
approval for the use of an outside investment advisor for an employee
benefit CIF consisting primarily of a diversified portfolio of
guaranteed investment contracts (GIC's). The approval was conditioned
upon a number of items.
Each participating account,
either in its governing instrument or in a separate authorization
agreement, specifically authorized the investment in the fund,
the employment of the advisor (outside investment advisor) by the
trustee of the unrelated fund, and the amount of fees to
be paid to the advisor for the GIC Fund.
Approval of this arrangement
also required that any investment advisor fee charged to the fund be
listed as a separate line item on participating account statements, and
in the annual financial statement of the fund.
F.2. Specialty CIF's
following subsections provide information for several types of special
investment funds. (This is not meant to be an all-inclusive list).
Investment Fund (STIF)
STIF's are the CIF equivalents to a money market mutual fund, typically
used for the temporary investment of trust cash. Their primary objective
is to provide high liquidity and a continuous stream of income at current
rates of return. Refer to OCC Regulation
9.18(b)(4) discussion in Subsection E.7 for STIF valuation and
F.2.b. Covered Call Option
The OCC requires that each participating account provide specific investment
authority regarding use of the bank's covered call option fund. However
if the fund was established under
Revenue Ruling 81-100, the incorporation may be by reference. The
fund should also provide a specific method for valuing options.
Securities Investment Fund
The OCC requires
that each participating account contain specific authority to invest in
the bank's Foreign Security Investment Funds, unless the funds are
established under Revenue Ruling 81-100, which requires incorporation by
reference. In prior statements, the OCC also indicated that where
custody of the securities is maintained outside the jurisdiction of the
District Court of the United States, the requirements of
Section 404(b)(l) of ERISA must be met (i.e., no fiduciary may
maintain the "indicia of ownership" of any assets of the plan outside of
the jurisdiction of District Courts of the United States). If the
securities are not held in foreign branches of U.S. chartered banks, the
bonding requirements of
ERISA 412 must also be met.
Collective Investment Fund
The assets of such funds are
structured to replicate the performance of a recognized financial index,
e.g., the S&P 500. The OCC indicates that the index
funds may not include own-bank securities or securities of an affiliated
holding company, even though the securities of such companies may be
included in the financial index.
Guaranteed Investment Contract (GIC) Fund
GIC funds are comprised primarily
of guaranteed investment contracts issued by insurance companies, as well
as equivalent bank products (refer to the Glossary Section of this
manual). Since GIC's are perceived to be guaranteed, they are extremely
popular with 401(k) plans and their participants, as they appear to
provide a no-risk investment. The only guaranteed portion of a GIC,
however, is its interest rate and other contractual provisions. Repayment
of the principal is dependent on the financial condition of the GIC's
issuer. The failure of several large insurance companies (which issued
GIC's), made it clear that there is credit risk in GIC's. In addition, the
value of any fixed-rate investment product is affected by changes in
prevailing interest rates.
OCC Regulation 9.18(b)(4) requires that CIF investments be valued at a
reasonable fair market value. If a market value is not readily
ascertainable, the investments should be valued at fair value determined
in good faith by the trustee. Determining a fair value for GIC's is
difficult because these investments are not actively traded on a secondary
market or exchange, and do not have quoted market values. The OCC,
however, has stated that the unsupported use of the contract price or book
value does not meet the requirements of Regulation 9.18. In the
December 21, 1995,
letter to the law firm of Mayer, Brown & Platt, the OCC gave
permission to value GIC's at contract/face value if (1) only defined
contribution plan assets are in the CIF, and (2) the CIF's assets
consist solely of: "benefit responsive" GIC's, short-term government
securities, and money market instruments. This position follows an
approach taken by AICPA Statement of Position ("SOP") #94-4. Examiners
should closely review the valuation methodology employed for any GIC or
similar investment vehicles used in CIF's.
G. ERISA Considerations
ERISA Section 406 prohibited transaction rules are applicable when
employee benefit plan assets are invested in CIF's. In addition,
DOL advisory opinion states that investment of plan assets in a CIF
maintained by a bank trustee causes the assets of the CIF to be treated as
assets of the plan. ERISA 408(b)(8) and PTE 91-38 (discussed below) provide
exemptions for certain ordinary activities and transactions.
G.1. ERISA 408(b)(8) Exemption
ERISA Section 408(b)(8) provides an exemption from the prohibitions
ERISA Section 406 for any transaction between an employee benefit plan
or its participating accounts and the bank CIF if:
the transaction is a sale or purchase of an interest in the fund,
the bank or trust company receives not more than reasonable compensation,
the transaction is expressly permitted by the instrument under which the
plan is maintained, or by a fiduciary (other than the bank or trust
company or affiliate thereof) who has authority to control and manage the
assets of the plan.
G.2. DOL PTE 91-38 Exemption
Transactions between a bank CIF that holds plan assets and plan related
parties (such as the bank or an affiliate) are subject to
ERISA Section 406 prohibitions and
Internal Revenue Code 4975; but Department of Labor (DOL)
PTE 91-38 provides an exemption under certain conditions.
In PTE 91-38, the DOL grants a
class exemption for bank-maintained CIF's, in which employee benefit plans
have an interest, to engage in certain transactions with plan-related
parties provided specified conditions are met. For example; to qualify for
the exemption under PTE 91-38, the plan must hold less than a 5 to 10%
interest in the total assets of the CIF.
The proper application of PTE 91-38 precludes a violation
of ERISA 406(a), transactions between plan and party in interest.
However, if the CIF enters into a transaction with the bank or affiliate
insider, there would be a violation of
ERISA 406(b)(1), transactions between plan and fiduciary (and thereby
triggering a violation of
IRC 4975 tax on prohibited transactions). There is no exemption from
this section of ERISA. For example, if the CIF purchased loans from the
bank, the CIF would be in violation of 406(b)(1) and could possibly be in
violation of 406(a) if the conditions for relying on PTE 91-38 were not met.
H. Other Participant Account Limitations
Charitable Trusts usage of Collective Investment Funds
Banks are appointed to manage charitable trusts established by associations
which qualify as tax-exempt charitable organizations under IRC Section
501(a), and Charitable Remainder Trusts created by individuals under IRC
Section 664. This is slightly different from bank managed "pooled income
funds" organized by outside organizations (discussed
separately under section N.4).
Issues to be considered when contemplating the collective
investment of charitable accounts:
Collective investment of charitable trusts must be
confined to CIF's whose tax-exempt status is derived from IRC Section
IRC Section 584 permits the collective investment of funds held by a
bank in the capacity of trustee for an individual, and
in the capacity of trustee for employee benefit
accounts. Charitable trusts fall outside the scope of
RR 81-100which are limited to participation in CIF's for employee benefit plans
administered by banks in the capacities of both trust or agency.
Charitable accounts for which a bank acts as
"agent" may not be invested in
collective funds of any type. Remember it is impermissible under
Federal securities laws to collectively invest personal
Collective investment of charitable trusts must comply
OCC Regulation 9.18. The Internal Revenue Code, by virtue of IRC
Section 584, requires CIF's obtaining tax-exempt status under that
section of the Code to comply with OCC Regulation 9.18.
In the past, the OCC opined that charitable trusts may be
collectively invested with other fiduciary accounts in CIF's operated in
accordance with either
Section 9.18(a)(1) or
Section 9.18(a)(2). The CIF operated for
the collective investment of charitable trusts must conform to
IRC Section 584 requirements. This includes
Section 9.18(a)(2) CIF's, which are normally operated in accordance
with RR 81-100. As a practical matter, Section 9.18(a)(2) CIF's are
confined to employee benefit plans and operated in accordance RR
81-100. It would therefore be unusual for charitable trusts to be
invested in a Section 9.18(a)(2) CIF.
The OCC also ruled, pursuant to
Section 9.18(c)(5), that it was permissible to collectively invest
funds in a CIF consisting solely of charitable trusts without the need
to comply with all of the requirements contained in
Section 9.18(b). This interpretation would not extend, however, to
CIF's whose participation included charitable trusts along with personal
trusts, executorships, guardianships, etc., because the collective
investment of these personal trusts would have to comply with OCC
Regulation 9.18 in its entirety.
Under the revised OCC
Regulation 9.18, banks establishing CIF's for charitable trusts and
Section 9.18 (c)(5) for exemption from the provisions of 9.18(b)
must submit a written plan to the OCC. The content of the written plan
is enumerated in the text of Regulation 9.18(c)(5). The OCC has opined
that state nonmember banks operating charitable collective funds are
also required to submit the fund's plan to the OCC to qualify for
special exemption under 9.18(c)(5).
H.2. Keogh Accounts Usage of Collective Investment Funds
Keogh plans, also referred to as
HR-10 plans, are self-employed retirement plans that are qualified under IRC
Section 401(c)(1). As with IRA accounts, owing to a narrow interpretation
Securities Act of 1933 (Act) by the SEC, Keogh plans may not normally
be invested in CIF's without the CIF having to register under Federal
It is possible, nevertheless,
through the careful application of either: (1) Section 3(a)(11) of the
Securities Act of 1933 - Intrastate Exemption, or (2) SEC Rule
180-Sophisticated Investor Exemption, to invest Keogh plans in CIF's without
registering either the Keogh plans, or the CIF's, as securities under Section
5 of the Act.
H.2.a. Intrastate Exemption
for Keogh Accounts
Section 3(a)(2)(C)(ii) exemption from registration, must also comply
with the requirements of Section 3(a)(11) ("intrastate exemption"
requiring all fund participants to reside in the same state as the fund's
Section 3(a)(11) of the Act
provides an intrastate exemption from registration for any security
which is offered and sold only to residents within a single state, and
where the securities issuer is also a resident, and doing business,
within the same state.
For the intrastate exemption to
be available: (a) all commingled fund participants (including all
beneficiaries of the Keogh plans) and (b) the bank operating the CIF,
must be intrastate.
While the foregoing suggests
that Keoghs may be commingled with other employee benefit plan
accounts, this is not the case. The commingling of
intrastate Keogh plans with interstate employee benefit plans precludes
the Section 3(a)(11) registration exemption for the Keogh
plans. On January 15, 1981, the SEC's Division of Corporation Finance
opined that intrastate Keogh plans may be commingled with other types of
interstate employee benefit plans (pension, profit sharing, etc.) without
the interests of the non-Keogh plans having to be registered under the
Act. However, the Keogh plans themselves would have to be registered
unless specifically exempted by statute, or by Commission rule, or order.
(SEC Release No. 33-6281, 17 C.F.R. 231.6281)
Examples of SEC
interpretations of the exemptions afforded by
Sections 3(a)(2) and 3(a)(11) of
the Act include:
National Bank of Fairfax, the bank wanted to invest
Keogh accounts of both resident and nonresident employers. The
National Bank of Fairfax Self-Employed Retirement Plan and Trust would
only have been available to self-employed individuals and their
employees. The Plan provided two methods for investing Keogh accounts
under its single "umbrella" plan:
If an employer was a resident
of Virginia, its plan would be collectively invested in the CIF. This
method would comport with the exemption requirements of Section
If an employer was not a
resident of Virginia, the CIF required funds relating to the
non-resident plan to be segregated into a separate trust account. The
separate trust account would be operated under the same terms and
conditions as the accounts maintained for Virginia residents. In doing
so, the bank sought to apply the registration exemption afforded by
In response to the bank's
inquiry, the SEC denied the issuance of a No-Action Letter, stating that it
was not the intent of Section 3(a)(2) to provide specific exemptions for
Keogh plans and, therefore, the Section 3(a)(2) exemption would not be
available for the creation of separate trust accounts for nonresident
accounts. The National Bank of Fairfax's December 29, 1976, request for
No-Action letter and the SEC's response appears in
The Citizens and Southern National Bank of Georgia also requested a
No-Action letter from the SEC to permit application of Section
3(a)(2) and 3(a)(11) registration exemptions for the commingling of two
employee benefit collective investment funds maintained by the bank.
The C&S Pooled Profit Sharing
and Pension Trust held only employee benefit accounts, exclusive of
Keogh accounts. These accounts were sponsored by both Georgia and
The Commingled Retirement
Trust Fund held funds of Keogh plans of Georgia residents.
The bank sought the SEC's
approval to commingle these two funds without registration based on SEC
The SEC replied that Release
33-6281 was intended to permit commingling without the corporate plans
losing their registration exemption under SEC Section 3(a)(2). However,
the exemption granted the Keogh accounts under Section 3(a)(11) would be
lost if the two funds were combined, requiring the interests of the
Keogh plans to be registered. The Citizens and Southern National Bank
of Georgia, September 25, 1981, request for a No-Action letter and the
SEC's response are included in
H.2.b. "Sophisticated Investor Rule"
Exemption for Keogh accounts
SEC Rule 180 (17CFR Section
230.180) provides what is often termed the "sophisticated investor rule"
exemption. Details on this exemption are discussed in the overview of
Section P.1.b. SEC Rule 180 (Sophisticated Investor Rule) and
in Appendix G,
17 C.F.R. Section 230.180 "Sophisticated Investor Rule".
H.3. Government Plan Usage of Collective Investment Funds
Government employee benefit plans
as defined in the Internal Revenue Code include plans of the government of
the United States, the government of any state or political subdivision, or
plans of any agency or instrumentality thereof. Many of these plans qualify
for tax-exemption under IRC Sections 401, 403, or 457. However, not all
government plans are qualified under these sections of the Code. Due to
the fact that some state and local plans cannot meet all the qualifications
for tax-exemption, particularly vesting requirements as embodied in Section
401, the Code was amended to provide special tax treatment for such plans by
adding Section 414(d). Further, under some local law restrictions, it is
not permissible for some government plans to be established under formal
Securities registration and
investment company exemptions for bank CIF's used to collectively invest
government plans are contained in: Section 3(a)(2)(C)
of the Securities Act of 1933, Section
3(a)(12)(C)(iii) of the
Securities and Exchange Act of 1934, and
Sections 3(c)(11)(A) and (B) of the
Investment Company Act of 1940. Therefore, ample securities law
exemptions exist for the collective investment of government plans.
SEC No-Action Letters, including those covering government plan
participation in CIF's, are located in Appendix G.
Regardless of the form of tax
qualification used, and regardless of the presence or absence of a
formalized trust agreement, government plans may be collectively invested by
banks consistent with the requirements of
OCC Regulation 9.18(a)(2) and
Revenue Ruling 81-100. Government plans may be invested in CIF's
together with corporate-sponsored employee benefit plans, or in CIF's
confined to government plans. Those plans not established under trusts
must, however, be held: (a) under some form of fiduciary arrangement and (b)
in the custody of the organization authorized under local law.
It should be noted that some
governmental plans do not obtain an exemption from Federal income taxation.
Instead, they rely on an "exclusion" from taxation allowed through the
concept of "intergovernmental constitutional immunity". If a governmental
plan has not obtained tax-exempt status by meeting the requirements of the
Internal Revenue Code, evidence must exist that the plan is appropriately
relying on the exclusion from taxes allowed though "intergovernmental
The following SEC No-Action Letters
permit the inclusion of government
plans (including IRC Section 457 qualified plans of state and local
government employees) with corporate employee benefit plans without
triggering registration under: the Securities Act of 1933, the Securities
Exchange Act of 1934, or the Investment Company Act of 1940:
The Provident Bank (1991),
The Idaho First National Bank (1988), and
Fidelity Management Trust Company (1989), all located in Appendix G.
I. Investing in CIF's of other institutions
I.1. Affiliated Institutions
When permitted in the governing
instrument and allowed by state law, banks may invest funds of fiduciary accounts
in affiliate bank CIF's. The OCC has permitted such investments in the
past. The SEC has also addressed this issue in a 1989 No-Action Letter to
Old Kent Financial Corporation (located in Appendix G). In
No-Action Letter, the SEC permitted banks under the holding company of Old
Kent Financial Corporation to use the common and collective funds of other
affiliated banks under the holding company.
When banks invest fiduciary funds
in affiliate institution CIF's, examiners should ensure that:
the CIF plan of operation or
governing document authorizes use of the CIF by accounts of affiliated
the board of the affiliated
bank has authorized the use of the originating bank's plan,
the affiliated bank maintains
documentation for all admission and withdrawal decisions for each
fiduciary account invested in the originating bank's fund,
the originating bank is
notified on or before the fund valuation date, and the appropriate
committee of the originating bank approves all affiliate bank admissions
and withdrawals in compliance with
12 C.F.R. 9.18(b)(5), and
the originating bank furnishes
the annual financial report, or notice of its availability, to each
fiduciary account invested in its CIF's).
I.2. Non-Affiliated Institutions
Examiners may also encounter
situations where banks wish to invest fiduciary funds in CIF's of
non-affiliated banks. In the past, the OCC permitted employee benefit CIF's (Section
9.18(a)(2) funds) maintained by a trustee in accordance with
RR 81-100 to be invested in a CIF maintained by an unrelated trustee.
However, the OCC staff indicated that personal trust CIF's (Section 9.18(a)(1)
funds) deriving tax- exemptions pursuant to
IRC 584 cannot accept participations from non-affiliated
Although the OCC has permitted the
investment of fiduciary funds in non-affiliated institution CIF's, the SEC
declined to issue a No-Action Letter to Northern Trust Corporation on this
same issue. Northern Trust Corporation had been seeking permission for
non-affiliated CIF's to invest in CIF's operated by Northern Trust Company (a
subsidiary bank). Northern Trust Corporation had previously applied for and
obtained OCC approval to conduct this activity. However, the SEC did not
concur that the activity would be permissible without registering the
Northern Trust CIF's as securities. The 1989 SEC No-Action letters to
Northern Trust Corporation (Northern
Trust I and
Northern Trust II) are located in Appendix G.
Consequently, even where
permissible under local law and the governing document, banks should not
invest customer funds in non-affiliated bank CIF's or accept investments from
non-affiliated bank CIF's. Banks wishing to do so should be advised to
first seek an SEC No-Action ruling on the proposed activity. Failure to
obtain such a ruling could result in an SEC enforcement action, fines, and
losses to the participating accounts, which would inevitably be borne by the
CIF's investing in CIF's within the same department
The OCC has permitted CIF's to be
invested in other CIF's operated by the same department. Investing equity or
fixed income fund cash awaiting permanent investment in a short term
investment fund (STIF) would be a practical use of this provision. This is
not the only application, and there is no limitation on which funds can take
advantage of the provision.
K. Proprietary Mutual Funds
K.1. Considerations When Engaging in Mutual Fund Activity
There are numerous regulatory and
costly administrative burdens associated with the operation of a proprietary
mutual fund. The operation of a mutual fund requires knowledge of SEC and
IRC rules and regulations. Furthermore, banks have the added burden of
complying with applicable banking laws. Strong management oversight is
required. Since a large volume of activity is required to effectively
operate a fund and there is the potential for the receipt of lucrative fees,
banks operating proprietary mutual funds must address a number of
potentially abusive conflicts of interest.
Examples of the general
considerations involved in operating a mutual fund:
Mutual funds must be registered with the SEC, as both a security under the
Securities Act of 1933, and as a mutual fund (mutual funds are investment
companies under Federal securities laws) under the Investment Company Act
To operate on a tax-exempt basis and pass all income and capital gains
through to investors, mutual funds must also comply with various tax laws,
including Subchapter M of the Internal Revenue Code.
The mutual fund would be organized under a trust and the bank (or related
organization) would be trustee.
State law would govern the establishment of trust.
To be economically viable, a mutual fund must obtain a critical mass of
assets to realize the necessary economies of scale.
To profitably offer such products, the mutual fund sponsors must be
compensated through a sufficient volume of business (generally portfolio
size rather than number of investors).
Banks may act in a number of
capacities for any mutual fund, including: custodian, transfer
agent, and, investment adviser or investment manager.
Each of these activities has its own unique risks and may expose the bank to
different conflicts of interest. Also, the Gramm-Leach-Bliley Act (GLBA) of 1999 permits banks to engage in previously prohibited securities
related activities, such as underwriting. A greater range of potential
activities also increases the potential for conflicts of interest.
Appendix D discussion of
Applicability of Federal Securities Laws to Banks and Bank Sponsored
Securities Activities for specific requirements that would be applicable
to proprietary mutual fund activities. Specific subsections include
Bank as Investment Advisor,
Bank as Investment Company, and
Collective Trust Funds. Non-bank subsidiaries must, however, register
with the SEC, if they engage in any of these activities.
State law may require registration
as a custodian, investment advisor, or any other securities activities.
FDIC regulated banks acting as mutual fund transfer agents must register and
Part 341 of the FDIC's Rules and Regulations.
Structure of Bank Financial Activities Under the Gramm-Leach-Bliley Act of
Effective March 12, 2000, the GLBA repealed Section 20 of the Banking Act of
1933. Banks may now underwrite and distribute proprietary and
third-party mutual funds. This activity must be done through one of the
Financial Holding Company (FHC). A FHC may engage in any activity
and may acquire and retain shares of any company engaged in any activity
that is determined by the Federal Reserve Board to be "financial in
nature" or "incidental" to such financial activity. Or, a FHC may engage
in an activity that is complementary to a financial activity and does not
pose a substantial risk to the soundness of the financial institution.
Activities that are financial in nature include providing financial,
investment and economic advisory services, including advising an
investment company. It also includes underwriting, dealing in, or making a
market in securities (Section
4(k)(4) of the Bank Holding Company Act of 1956).
A FHC that acquires any company
or commences any of the above activities shall provide to the Federal
Reserve Board written notice describing the activity conducted by the FHC.
Notice must be provided not later than 30 calendar days after
commencing the activity.
A "bank holding company" is also
allowed to engage in the "expanded financial activities" of a FHC.
However, there are minimum capital, management, and community reinvestment
standards that must be met. Also, this requires pre-notification
to the Federal Reserve Board. Specific details are found in
Section 4(l) of the Bank Holding Company Act. The entire
Holding Company Act text is located in the FDIC's Laws, Regulations
and Related Acts.
Financial Subsidiary. The
activities that may be conducted by a subsidiary of a national bank have
also been revised. A national bank may control a "financial subsidiary",
or hold an interest in one, only if the subsidiary engages in activities
that are financial in nature or incidental to a financial activity.
Activities that are financial in nature include those described in the FHC
The GLBA added
Section 46 to the Federal Deposit Insurance Act (FDI Act) to govern
financial subsidiaries of state banks. Under the final rule, the FDIC adopted a streamlined certification process for insured
state nonmember banks to follow before they may conduct activities as
principal through a financial subsidiary. State nonmember banks
self-certify that they meet the requirements for carrying out these
activities. The self-certification process allows banks to conduct the
new activities immediately. There is be no delay for administrative
approval or review, although the FDIC continues to evaluate these
activities as part of the normal supervisory process.
To commence financial subsidiary
Section 46(a), the insured state nonmember bank must certify that it is
well-managed; that it and all of its insured depository institution
affiliates are well-capitalized; and that the insured state nonmember bank
is in compliance with the capital deduction requirement. In addition, an
insured state nonmember bank may not commence any new activity under Section
46(a), or directly or indirectly acquire control of a company engaged in any
such activity, if the bank or any of its insured depository institution
affiliates received a rating of less than satisfactory in its most recent CRA examination. Any insured state nonmember bank controlling or holding an
interest in a financial subsidiary also must comply with Sections
23B of the Federal Reserve Act, as amended by the GLBA and meet the
financial and operational safeguards required by Section 5136A(d) of the
Revised Statutes of the United States (12 U.S.C. 24a(d)), unless otherwise
determined by the FDIC.
If the financial subsidiary of the
insured state nonmember bank engages in the public sale, distribution or
underwriting of stocks, bonds, debentures, notes, or other securities
activity of a type permissible for a national bank solely through a
financial subsidiary, the state nonmember bank and the financial subsidiary
must comply with certain provisions requiring the separation of the
financial subsidiary from the bank. These provisions require that the
financial subsidiary be physically separate and distinct in its operations
from the operations of the bank; that the financial subsidiary conduct its
securities business pursuant to independent policies and procedures designed
to inform customers and prospective customers of the financial subsidiary
that the financial subsidiary is a separate organization from the insured
state nonmember bank and that the insured state nonmember bank is not
responsible for and does not guarantee the obligations of the financial
subsidiary. In addition, the bank must adopt policies and procedures,
including appropriate limits on exposure, to govern its participation in
financing transactions underwritten by its financial subsidiary.
Further, the bank may not
express an opinion on the value or the advisability of the purchase or sale
of securities underwritten or dealt in by its financial subsidiary, unless
the bank notifies the customer that the entity underwriting, making a
market, distributing or dealing in the securities is a financial subsidiary
of the bank.
The mutual fund, as a registered
investment company under the Investment Company Act of 1940, would be under
the supervision of the SEC. The SEC is required to share its
supervisory findings with
Federal banking agencies, upon request, and does not limit the FDIC's
examining authority of affiliates as outline in
Section 10(b)(4) of the Federal Deposit Insurance Act.
K.3. Investment Company Act of 1940
Investment Company Act of 1940 (1940 Act) governs the activities of
companies principally engaged in the business of investing, reinvesting, and
trading securities, and whose own securities are held by the public. Mutual
funds and other registered investment companies are subject to SEC
operational regulations designed to protect the interests of investors and
the public. The Act prohibits such companies from changing the nature of
their business, or their investment policies, without the approval of their
Among the most significant
sections of the
Investment Company Act of 1940 are the following:
Section 9 bars persons convicted of securities fraud within the past
10 years from serving as officers or directors;
Section 10 prevents underwriters, investment bankers or brokers from
constituting more than a minority of such companies' board of directors;
Section 13 prohibits such companies from changing the nature of their
business or their investment policies without the approval of holders of a
majority of their voting securities;
Section 15 requires that management contracts (and material changes
thereto) be approved by a majority of the holders of outstanding voting
securities of such registered company;
Section 17 prohibits transactions between such registered companies
and their directors, officers, affiliated companies, principal
underwriters, and promoters, except where the SEC grants an exemption
based on a finding of the fairness of such transactions and no
overreaching by the parties. It also identifies a bank as one of the
acceptable custodians for a registered investment company. The GLBA
amended Section 17(a) to allow loans from
affiliates to mutual funds (effective May 12, 2001). The amendment is
especially important to banks offering proprietary mutual funds. The
original Section 17(a) prohibited affiliates from selling, purchasing, or
borrowing money or property from mutual funds, but did not cover loans
from affiliates to mutual funds. In addition, the SEC interpreted Section
18(f) of the 1940 Act to prohibit mutual funds from borrowing money except
from a bank. The borrowing limit is one-third of the assets of the fund.
Under the current regulations this could pose potential problems for banks
offering proprietary mutual funds. The GLBA amended Section 17(f),
custody of securities, to allow for a bank or its affiliates to serve as a
custodian for proprietary mutual funds (registered investment companies).
Section 18 prohibits registered "closed-end" investment companies from
issuing senior securities, except under conditions and terms specified in
that Section; and
Section 20 prohibits "circular ownership" of such investment companies
and "cross-ownership" of their securities under the terms listed in
Included among other provisions
of the Investment Company Act are sections involving sales and repurchases
of securities issued by investment companies (Section
22), periodic payment plans (Section 27),
and face-amount certificate companies (Section
28). Also, the GLBA allows a bank or its
affiliate to serve as a custodian for a proprietary "unit
investment trust" (Section
L. Conversion of CIF's to Mutual Funds
Competitive pressures and changing
securities laws contribute to banks converting CIF's into proprietary mutual
funds. The banking industry has long taken the position that mutual funds
offer greater advantages to both the bank and trust beneficiaries. But
there are also risks, such as abusive conflicts of interest and increased
One of the incentives for
converting a CIF to a proprietary mutual fund is purely financial.
There is a lucrative array of fees available under a mutual fund
arrangement that is not available from bank sponsored CIF's. However, the
desire for increased revenue must not take precedence over the fiduciary
responsibility of the bank. Such a conflict must be resolved in favor of
the account beneficiaries. If the desire for financial reward is
dominant, the conflict could become abusive.
One of the potential
disadvantages to a bank is the public availability of the proprietary
mutual fund's performance -
a factor not generally confronted with CIF's. If a proprietary mutual fund
performs poorly over an extended period of time, the bank's reputation may
be harmed, especially if the poor performance continues without
appropriate corrective action.
Conversions of existing CIF's to
mutual funds typically take one of two forms. In both cases, the CIF
terminates activity and is replaced by the mutual fund operation. The first
type involves the liquidation-to-cash of a CIF's assets, with a simultaneous
rollover of the cash proceeds into a mutual fund. The second type involves
a one-time "in-kind" transfer of assets at market value from a CIF to a
Mutual funds may be sponsored by a
non-bank affiliate of a state nonmember bank. However, they are currently
predominantly sponsored by a non-affiliated third party institution
(including mutual fund companies and brokerage houses). In either case, the
bank usually provides investment advisory, custodial, transfer agent, and
other fee related services to the fund.
L.2. Tax Considerations of Conversion
Common Trust Fund Conversions
Prior to 1996, the conversion of
common trust funds established for personal trust accounts was treated as
a taxable transaction under the IRC. Years of lobbying Congress to enable
a tax-free "in-kind" transfer were finally successful in August 1996, when
IRC Section 584 was amended by Section 1805 of the "Small Business Job
Protection Act of 1996". This legislation added new paragraph
IRC Section 584(h), which permits tax-free conversions of Personal
Trust CIF's (A-1 Funds). The conversion can be into one or more mutual
funds. The basis of the mutual fund shares distributed to participant
trusts must be equal to the basis of the common trust fund interests
exchanged. In the event that the conversion involves more than one mutual
fund, the basis of the common trust fund interests exchanged should be
allocated proportionately to the mutual fund shares received. The
amendment was effective for transfers after December 31, 1995.
This amendment makes the
conversion tax-free for Federal taxation purposes only. Therefore, there
may be remaining state income tax consequences. There are also accounting
and other tax issues related to the rebating of fees, the amortization of
bond premiums, and capital gain distributions, to name a few, that must be
considered in conjunction with the conversion decision.
A copy of the
1996 amendment to IRC Section 584 is located in Appendix G.
L.2.b. Collective Investment Fund
Conversions of collective
investment funds maintained for employee benefit accounts subject to ERISA
do not face the same tax problems as those faced by common trust funds.
Tax relief is granted because, although conversion is a taxable event, the
participants can only be tax-exempt entities and, therefore, no tax
liability is incurred.
Supervisory Concerns of Conversion
The board of directors should
specifically authorize or ratify the conversion of a CIF to a mutual fund.
The advice of qualified legal counsel experienced in securities laws and
fiduciary matters should be obtained to ensure that the conversion complies
with all applicable laws and fiduciary obligations. The qualifications of
the firms and individuals providing legal counsel should be documented and
retained to support the adequacy of the decision-making process. At a
minimum, the conversion decision-making process should address the following
The board's due diligence
process should include a review of (1) customers' needs and how the
conversion meets these needs, (2) any potential legal and other risks,
(3) a stated reason to support the conversion, and (4) a method for
obtaining customer approval (see points (c) and (d) below).
The bank should address all
related fiduciary issues in its written policies, including conflict of
interest issues concerning the need for, and prudence of, converting
CIF's into mutual funds, and the reasonableness of the ongoing
Internal policy should require
investments in proprietary funds to be evaluated on the same basis as
any other investment product and proprietary funds should meet a bank's
own minimum investment selection standards.
There is an additional concern
when banks operate both proprietary mutual funds and CIF's. The
investment of trust accounts in proprietary mutual funds that under
perform own bank CIF's is troubling, since banks that operate proprietary
mutual funds have additional monetary incentives (which are unavailable
in CIF's) to invest trust accounts in the funds. In such cases, the
fiduciary should document the rationale for investing trust accounts in
proprietary mutual funds when CIF's with similar or identical investment
objectives and strategies are available.
Even when permitted by statute,
these transactions should be made in good faith. The fact that such
investments are allowed (permissive authority) does not relieve the
fiduciary of its "duty of care and skill" in the investment selection
process. A failure to properly address all conflict of interest and
investment prudence issues casts doubt on whether the fiduciary has
satisfied the traditional fiduciary duty of undivided loyalty, and could
lead to litigation and loss.
When necessary under local law
or the governing instrument, banks should obtain the consent of CIF
participants to convert their CIF units into mutual funds. Under
IRC Section 584(h), "substantially all" (which was undefined at the
time of this writing) CIF assets must be transferred into the mutual
Accounts not participating in
the conversion due to customer non-consent, prohibition within governing
instruments, or prohibition under local law, should be provided
reasonable investment alternatives consistent with the governing account
Investment in the mutual fund
should also meet the tests of loyalty and prudent investment
One such test is to compare the
consistency of the mutual fund's investment objectives with the
governing instruments of the accounts converted. When converting from a
CIF to a mutual fund the investment objective could change, and what was
once a suitable investment for an account may become inappropriate.
Another consideration is when a proprietary mutual fund's performance
lags comparable, but unaffiliated, alternative investments.
Subsection F.4.a of Section 3 for additional guidance regarding proprietary mutual
Where required, the bank
should: (1) obtain the consent of its State regulatory supervisor to
convert CIF's into mutual funds, and/or (2) provide it formal
pre-conversion notification. At the time of this writing, institutions
supervised by the FDIC, FRB, and OCC were not required to obtain the
consent of state authorities or notify state authorities of planned CIF
The bank should comply with all
securities law requirements, including the registration of the mutual
fund. If a bank subsidiary is involved in operating a mutual fund, it
should also register as an investment adviser and, as needed, as a
broker/dealer, in addition to the mutual fund registration.
The bank should determine
whether it is permitted to receive both fiduciary fees and proprietary
mutual fund servicing fees under local law and the governing
instruments. Fiduciary fees and mutual fund servicing fees should be
reasonable, and consistent with local law and the governing instrument.
One of the more complex issues
involving the operation of proprietary mutual funds is the charging of
fees. Virtually all states have enacted statutes expressly authorizing
a bank fiduciary to invest trust assets in the shares of a mutual fund
for which the bank, or affiliate, performs services and receives
reasonable compensation. Some states require that the fiduciary offset
its mutual fund fee or its trust administration fees by an amount that
corresponds to the bank's compensation for performing investment
advisory and/or other services for the mutual fund. If permitted to
receive fees for both trust fiduciary services and for the services
performed for the proprietary mutual fund, all fees should be reasonable
and disclosed to the customer, especially upon the conversion of a
common trust fund to a mutual fund. There may also be other state
requirements regarding disclosures, as well as investment restrictions.
The bank should provide
participating accounts an initial prospectus of the mutual fund, and all
necessary disclosures under Federal and State securities and banking
laws. Participating accounts should continue to receive any prospectus
and other disclosures required under these laws.
L.4. ERISA Considerations of Conversion
The conversion of a CIF to a mutual
fund does cause ERISA concerns - in particular problems related to the
prohibited transactions restrictions in Section 406 of ERISA.
Section 406(a) of ERISA prohibits transactions between a plan and a
Section 406(b) prohibits transactions between a plan and a fiduciary
with respect to a plan. Therefore, whenever plan assets are transferred to
a mutual fund to which a fiduciary or party-in-interest provides services,
or whenever a fiduciary or party-in-interest receives compensation as a
result of a plan's investment in a mutual fund, the prohibited transaction
rules should be considered.
There are two outstanding ERISA
class exemptions to help guide such conversion activity.
Cash-to-Cash - Pursuant to
Section 408 of ERISA, the Department of Labor issued
Prohibited Transaction Class Exemption (PTE) 77-4 which provides an
exemption from the prohibited transaction rules of ERISA, and the Internal
Revenue Code, for the purchase of shares of a mutual fund for which the
bank or its affiliates act as investment advisor.
PTE 77-4, the DOL requires banks to: (1) obtain the approval of an
independent fiduciary, (2) provide disclosures to participating accounts,
(3) obtain written consent for the conversion, and (3) adjust fees to
ensure a double fee is not charged to accounts invested in proprietary
mutual funds. These are in addition to the
concerns addressed in Subsection L.3.
Opinion 94-35, the DOL interpreted class exemption PTE 77-4 to apply only
to "cash" (cash-to-cash) conversions which liquidate CIF assets and
purchase shares of the mutual fund with the proceeds from the
liquidation. In other words, the prohibited transaction exemption would
not be applicable to conversions of "in kind" (asset to asset) transfers.
In-kind - Pursuant to
Section 408 of ERISA, the Department of Labor issued
PTE 97-41, which permits an employee benefit plan (the Client
Plan) to purchase shares of a registered investment company (the Fund)
that also serves as a fiduciary of the Client Plan. The investment
advisor for the Fund may be a bank or plan advisor registered under the Investment Advisors Act of 1940. The
exemption pertains to the exchange for plan assets transferred in-kind to
the Fund from a CIF maintained by the Bank or
Plan Advisor. It involves a complete withdrawal of a Client Plan's
assets from the CIF.
PTE 97-41, the DOL requires banks to follow minimum guidelines.
Additional information is found in Section 5 of the manual,
Subsection H.7.f(10). These are in addition to the
concerns addressed in Subsection L.3.
The failure to convert the CIF
within the confines of the proper exemption generally results in the
purchase of proprietary mutual fund shares being considered a prohibited
Section 406 of ERISA.
M. Mutual Fund and CIF Merger Rules
Sections 17(a)(1) and (2) of the Investment Company Act of 1940 restrict
merger activities of registered mutual funds with affiliated funds
(registered mutual funds or unregistered CIF's). To provide guidance in this
area, the SEC issued
Rule 17a-8, Mergers of Affiliated Companies (17 CFR 270.17a-8).
M.1. SEC Rule
SEC Rule 17a-8, Mergers of Affiliated Companies permitted the merger of
affiliated funds, if the funds were affiliated solely because they had
common investment advisers, officers, and/or directors. However, the SEC
expanded Rule 17a-8 in 2002 to include all affiliated funds regardless of
the nature of their affiliation. In addition, the amended rule provides an
updated set of requirements that need to be met in order to qualify for
Sections 17(a)(1) and (2)exclusion. Mergers that do not meet Rule 17a-8
must be presented to the SEC for review on a case-by-case basis.
The purpose of the change
was to expand the scope of Rule 17a-8 to more funds and thereby reduce the
burden of obtaining Commission approval for mergers that presented little
risk of overreaching.
SEC Rule 17a-8 governs
mergers between affiliated mutual funds and also mergers between mutual
funds and unregistered bank CIF's. The updated rule provides the following:
Mutual fund boards
must thoroughly review merger transactions and their terms. Each mutual
fund's board - including a majority of disinterested directors - must
determine that the merger is in the best interests of the mutual fund and
will not dilute the interests of shareholders. Directors must request and
evaluate any information reasonably necessary to their determinations, and
give appropriate weight to all pertinent factors in making their findings
under the rule, and in fulfilling the overall duty of care they owe to the
fund's shareholders. According to the SEC, in making their determination,
boards should consider relevant factors including:
Any fees or expenses
that will be borne directly or indirectly by the fund in connection with
Any effect of the
merger on annual fund operating expenses and shareholder fees and
Any change in the
fund's investment objectives, restrictions, and policies that will result
from the merger; and
Any direct or indirect
federal income tax consequences of the merger to fund shareholders.
The acquired fund must have shareholder approval, if the merger materially
alters the investment held by the fund shareholders.
SEC Rule 17a-8 as
amended, requires a majority of the shareholders of the acquired fund to
approve the merger if:
Any policy of the
acquired fund that under Section 13 of the Exchange Act could not be changed
without a vote of a majority of its outstanding voting securities is
materially different from a policy of the acquiring fund;
The acquiring fund's
advisory contract is materially different from that of the acquired fund,
except for the identity of the funds as parties to the contract;
After the merger,
directors of the acquired fund who are not interested persons of the
acquired fund and who were elected by its shareholders will not comprise a
majority of the directors of the acquiring fund who are not interested
persons of the acquiring fund; or
merger, the acquiring fund will be authorized to pay charges under a plan
that provides for use of fund assets for distribution ("rule 12b-1 plan")
that are greater than charges authorized to be paid by the acquired fund
under such a plan.
was expanded to permit mutual funds to merge with affiliated CIF's, provided
that the survivor is a registered investment company. The SEC had written
no-action letters to mutual funds seeking to merge with CIF's.
When the SEC revised Rule 17a-8, it warned that mutual funds engaging in mergers on or after the compliance date of the final rule (October 25, 2002)
should not rely on the no-action letters, but must either comply with the final rule or obtain an exemption from the SEC.
The SEC also requires
that the board of directors of a mutual fund that merges with a CIF, in
making its determination that the interests of the fund's shareholders will
not be diluted as a result of the merger, approve the procedures for
valuation of the securities (or other assets) that the unregistered entity
will convey to the fund. These procedures must provide for the preparation
of a report by an independent evaluator that sets forth the fair market
value of the assets for which market quotations are not readily available.
The independent evaluator's report must be included in the records of the
Rule 17a-8 contains a requirement that each investment company that survives
the merger preserve written records that document the merger and its terms.
The records must include, among other things, the minute books setting forth
the determinations of the funds' boards and the bases for those
determinations, any supporting documents provided to the directors in
connection with the merger, and documentation of the prices at which
securities were transferred in the merger. The recordkeeping
requirement ensures that examiners have adequate information to assess the
merging funds' compliance with the rule.
N. Other Pooled Investment Vehicles
Below are examples of other types
of pooled investment vehicles. The information presented is generic, since
each institution can design the product to meet the needs of its clients.
N.1. Master Deposit Accounts
A master deposit account is a
single interest-bearing deposit account in which the temporary funds of
individual trust accounts are commingled. The master deposit account is
often a money market deposit account of the fiduciary institution. Only
deposits are involved, no other types of assets are held in a master deposit
account. The number of trust accounts invested in and the balance of the
master deposit account may vary from day-to-day. This is not a common or
collective investment fund. The concerns with a master deposit account
include, management's ability to:
identify the amount of funds
attributable to each trust account invested in the master deposit account,
ensure that the funds of each
trust account is not left in the master deposit account as a long term
FDIC insurance applies to the trust account invested in the master
deposit account, and
conflicts of interest.
N.2. Wrap Accounts, Also Known as Asset Allocation
This may be considered a pooled
investment vehicle, even though assets of individual accounts are not
necessarily pooled. By definition, these are accounts where a money manager
(trust department) invests and manages a group of investments for a set
annual fee. The term wrap comes from the idea that the customer pays a
single fee for services, rather than a fee for individual trades. The fee
may be a flat fee or based upon the market value of the individual account.
There are two general types of wrap accounts - "traditional", comprised of a
combination of securities in order to achieve a specific investment goal,
and "mutual fund", comprised of a combination of mutual funds in order to
achieve a specific investment goal. In a wrap account, a customer's funds
are invested according to pre-established guidelines, often in the form of
an asset allocation model.
For example, a client's objective
may be aggressive growth and the institution has developed an asset
allocation program using mutual funds or stocks to achieve this
objective. The model is periodically adjusted. When the model
is adjusted the client's holdings are automatically adjusted to match the
The pooling aspect occurs because
there are a number of accounts in the program. Since all of the accounts
invested in the program are adjusted at the same time, it may appear that
management has created a nonregistered mutual fund made up of
discretionary accounts. The appearance
is further enhanced if the customer does not have the ability to adjust the
investment mix, or if the wrap account
agreement delegates full investment authority to the fiduciary.
Many departments employ asset
allocation models to administer the majority of their discretionary trusts
in order to gain economies of scale in asset management. The mere
existence of asset allocation models does not indicate that the department
is offering wrap accounts and could therefore be operating a nonregistered
SEC regulation 270.3a-4 provides guidance on wrap accounts and a
"non-exclusive" safe harbor against inadvertently operating a nonregistered
Key provisions of the safe
provisions for individualized
management of client accounts
specific initial and ongoing
the ability of the client to
impose reasonable restrictions on investments
quarterly account statements
client retention of ownership of
If the provisions are met such
accounts offered by the department will not be deemed a mutual fund. There
are also exceptions if all provisions of the "non-exclusive" safe harbor are
N.3. Private Equity Fund of Funds
A private equity fund of funds
typically invests directly in private companies in one of several formats.
A fund of funds is a general partnership that aggregates investor capital
and provides professional selection and management of a portfolio of private
equity funds. The formats include venture capital, buyouts, and mezzanine
investments. Each fund will have its own investment objective, like a
mutual fund, and a fund manager. Individuals often choose these funds when
they want to passively invest in private equities.
Most private equity funds are not
registered with the SEC under the
Investment Company Act of 1940 (1940 Act). They are exempt from
registering under the 1940 Act provided they meet specific
restrictions. The exemptions from registration are found in Sections
3(c)(1) 100-Person Fund and 3(c)(7)-Qualified Purchaser Fund of the 1940
The 100-Person fund is limited to
100 or fewer beneficial owners (partners) and may not be made available to
the general public. One of the beneficial owners will be the general
partner, for example the bank, and the remaining will be limited
partners. It is also limited to "accredited investors". An "accredited
investors" is generally defined as a person having a net worth of at least
$1 million or income for two years of at least $200,000. Even though not
required to register under the 1940 Act, the private equity fund is still
subject to the Act's limitation on
performance-based compensation (fees) does apply.
The Qualified-Purchaser fund does
not have the 100-person limit, but may only be purchased by "qualified
purchasers" and may not be made available to the general public.
Generally, the term "qualified" means an individual or married couple
having at least $5 million in investments. Certain trusts, even with
smaller amounts under management, may also invest, provided that
investments are made by a "qualified purchaser" and the trust was not
formed for the purpose of participating in the fund. This fund type is
limited to 500 partners.
In 1999, the SEC issued guidance on a number of issues
involving Sections 3(c)(1), 3(c)(7), and 2(a)(51)(A) of the 1940 Act. The
Regarding Private Investment Companies
(Private Collective Funds) under ICA of 1940
is located in Appendix G.
Bank Managed "Pooled Income Funds" Organized by Outside Organizations
"Pooled Income Funds" are defined
under IRC Sections 642(c)(3) and 642(c)(5). These pooled funds consist of
charitable gifts from donors which are maintained in a commingled investment
fund by organizations described in IRC Section 170(b)(1)(A), including
churches, educational institutions, hospitals, etc. The securities law
exemptions for these funds are contained in: Section 3(a)(4) of the
Securities Act of 1933, Section 3(a)(12)(A)(v) of the
Securities Exchange Act of 1934, and Section 3(c)(10)(B) of the
Investment Company Act of 1940.
Banks may be appointed as
administrator or investment manager for these funds. The funds are not treated as bank CIF's under Federal tax and securities
laws, nor operated under CIF requirements. Banks
should not operate "Pooled Income Funds" as their own CIF's. To be operated
in compliance with, and fall under the exemptions of, Federal tax and
securities laws, these funds must be established, sponsored, and held in
trust by the outside organization under a written governing
instrument. Banks may, however, "manage" the portfolios of the pooled
funds for outside organizations in the capacities of administrator,
investment advisor, or investment manager.
An assessment of the management of
"Pooled Income Funds" typically includes a
determination of management's
familiarity with applicable laws,
review of the fund's governing
documents and management's conformance with applicable provisions,
review of documentation
attesting to the charitable organization's qualification under IRC
501(a) and/or its authority to offer the funds under IRC Section
review of the organization's
corporate authority, or bylaws, enabling it to establish such a fund.
Banks lacking such documentation,
or awareness of applicable laws, should be advised to obtain the
documentation and seek qualified counsel. As with all other fiduciary
matters, banks lacking expertise should be cautioned against continuing to
offer these services until they obtain ample working knowledge of the
N.5. Regulation D Exempted Securities
[Rules Governing the Offer and Sale
of Securities Without Registration Under the
Securities Act of 1933 (the Act)]
The SEC adopted Regulation D under
the Securities Act of 1933 (17
C.F.R. 230.501 to 508) to facilitate the application of both the
nonpublic offering exemption
under Section 4(2) of the Act, and the
"small offering" exemption under
Section 3(b) of the Act. Regulation D (described in
more detail below) is intended to be a basic element in a uniform system
of Federal and State limited offering exemptions consistent with the
provisions of Sections 18 and 19(c) of the Act (involving state jurisdiction
over securities transactions, and Federal and State coordinated
regulation). In those states that have adopted Regulation D, or any version
of it, compliance with state law is also required.
Regulation D affords banks the
opportunity to offer pooled investment funds without having to register the
funds as securities under the act. However, banks need to be aware
that the funds themselves (1) continue to be viewed as securities by the
SEC, and (2) may still come under the definition of a mutual fund
("investment company") under the Investment Company Act of 1940 (1940 Act).
The regulation provides an
exemption from the Act's Section 5 securities registration requirements
under very specialized circumstances.
The regulation exempts issuers
from registering certain securities offerings. It is available only to
the issuer of the securities. It is not available to any affiliate of the
issuer, or any other person engaged in selling of the securities.
Caution: The exemptions apply only to the transactions in which the
securities are offered or sold by the issuer, not to the securities
It prohibits the offer or sale of
these securities by means of any general solicitation or advertising.
It limits the resale of the
securities without registration. Use of the regulation is
not available to any issuer for any chain of transactions which,
although technically in compliance with the regulation, is viewed by the
SEC as a method or scheme for evading registration under the Act. Issuers
which continuously sell investment products under Regulation D, and which
establish a new investment product each time the current product reaches
regulatory limits, may be viewed by the SEC as evading securities
Securities offered and sold outside the U.S. in
accordance with Regulation S (17 C.F.R. 230.901 to 904
- rules governing securities transactions made outside the U.S.) do not
have to be registered under the Act. Transactions in accordance
with Regulation S, even where coincident with Regulation D transactions,
are not counted towards the number of purchasers under Regulation D.
Regulation D permits securities issuers (including
banks) to issue a security which:
does not have to be registered
under Federal securities laws, and
does not have to be established
and operated as a
Regulation 9.18 CIF.
Therefore, some banks have
used the exemptions afforded under Regulation D to collectively invest
accounts which would not otherwise be permissibly invested in Regulation
including, but not limited to, agency accounts and IRAs.
To avoid both securities
registration and mutual fund treatment under Federal securities laws,
Regulation D must be applied in concert with investment company exemptions
allowed under Section 3(c)(1) of the
For purposes of the exemption
categories in SEC Rule 505 (limited offers and sales of securities not
exceeding $5 million) and Rule 506 (limited offers and sales without
regard to the dollar amount of offering), Regulation D limits ownership to
35 investors plus an unlimited number of "Accredited Investors".
In addition to restrictions on the
number and sophistication of investors, Regulation D imposes numerous
restrictions and requirements upon the issuer. Fluency with: Federal
securities laws, current and past SEC positions on securities and mutual
fund exemptions, Internal Revenue Code exemptions relating to pooled funds,
trusts, and qualified employee benefit plans,
Regulation 9.18, and applicable local securities and tax laws, is of
paramount importance for any potential issuer of securities under these
The operation of such investment
products requires a high degree of technical sophistication. Consequently,
examiners encountering investment pools that have purportedly been
established under Regulation D should review the following:
Outstanding legal opinions. Prior
to establishing such funds, bank management should seek and obtain the
written advice of qualified securities counsel. Examiners should
recommend that management obtain a legal opinion from counsel familiar
with such matters before selling additional participations in existing
funds and before creating any additional funds.
Failure to comply with Federal
securities laws may result in fines and other enforcement action by the SEC.
Further, failure to qualify under both securities and tax laws could result
in significant monetary losses to the fund, its investors, and ultimately,
Bank as Investment Adviser to CIF's and Mutual Funds
font face="arial" size="2">A
bank may serve as the investment advisor for affiliated or non-affiliated
pooled investment vehicles (CIF's, mutual funds, or other pooled
investments). If a bank is advising registered mutual funds, the bank must register and comply with the
Investment Advisors Act of 1940. Additional information is provided in
Appendix D, Bank as Investment Adviser.
Interagency Policy Statement
Transactions between a bank and its advised funds are restricted by the
following regulations: 23A and 23B of the Federal Reserve Act, OCC
Regulation 9, the Investment Company Act of 1940, the Investment Advisors
Act of 1940, and ERISA. The regulatory restrictions and prohibited
transactions address conflict of interest and self-dealing.
January 5, 2004, The Federal Bank Regulatory Agencies issued a joint
Interagency Policy on Banks/Thrifts Providing Financial Support to Funds
Advised by the Banking Organization or its Affiliates. The purpose of
the Policy Statement was to alert bank directorate and management to the
safety and soundness implications and legal impediments to a bank providing
financial support to investment funds advised by the bank, its subsidiaries
or affiliates. The Policy Statement was issued in response to the elevated
market volatility risk, credit risk, and interest rate risk present in
advising money market mutual funds and other investment funds. The Policy
Statement, located in Appendix G, provides risk management policy and
procedural guidance for bank investment advisory activities.
P. Overview of Federal Laws
The operation of bank's pooled
investment vehicles is directly linked to Federal securities, internal
revenue, and banking laws. Failure to operate in conformity with the
laws may jeopardize or cause the loss of securities and/or tax-exemptions to
the collective fund or other pooled investment, its units of participation
and, ultimately, its investors (trust accounts). Any losses sustained by
investors by reason of a bank's failure to comply with these laws, whether
through negligence or incompetence, would be the responsibility of the bank,
both as a fiduciary, and as the issuer and operator of the pooled investment
vehicle. Excerpts and summaries of some of the major applicable Federal
securities and tax laws, regulations, and rulings follow.
P.1. Federal Securities Law
Federal securities laws empower the
SEC to investigate any person or institution, including banks, suspected of
violating Federal securities laws and SEC rules and regulations. The SEC has
the authority to issue cease and desist orders, bring action in Federal
courts to issue injunctions, impose monetary penalties on securities laws
violators, and to bar individuals from serving as officers or directors of
public companies. The SEC also has the authority to revoke licenses and
impose civil money penalties in administrative proceedings against
broker/dealers, municipal securities broker/dealers, government securities
broker/dealers, transfer agents, and clearing agencies. Failure to adhere
to Federal securities laws governing the operation of common trust funds,
and tax and banking laws tied to securities law compliance, may not only
result in the loss of a fund's exempt status under these laws, but also
fines and censures against banks and bank officers administering the funds.
P.1.a Securities Act of
1933 (1933 Act):
One of the primary purposes of the
Securities Act of 1933 (1933 Act) is the regulation of interstate
securities transactions. The 1933 Act accomplishes this by: defining what
constitutes a security; requiring the registration and regulation of
securities; and, regulating interstate securities transactions.
Unless a specific exemption is available, a "security" must be registered
under the 1933 Act. Among other types of investments, a mutual fund, or the
sale of participations in a pooled portfolio of investments, is regulated as
Section 3(a)(2) Exempted
[Common Trust Funds - 9.18(a)(1) Funds - Personal Trust Accounts]
Funds maintained by a bank for the investment of assets
contributed thereto by the bank in its capacity as trustee, executor,
administrator, or guardian.
[Collective Investment Funds - 9.18(a)(2) Funds - Employee Benefit
Funds maintained by a bank which interest is issued in
connection with a stock bonus, pension, or profit sharing plan, which
meets the requirements for qualification under Section 401 of the IRC.
[Collective Investment Funds - 9.18(a)(2) Funds - Keogh Plans]
Funds, exempted by the Commission, which interest is issued in
connection with a stock bonus, pension, or profit sharing plan which
covers employees who are employees within the meaning of Section
401(c) of the IRC.
Section 3(a)(4) Exempted Security
[Non-Bank-Operated Commingled Investment Funds]
"Pooled Income Funds" maintained by charitable organizations
operated in conformance with IRC Section 642(c)(5).
Section 3(a)(11) Intrastate
Funds - 9.18(a)(2) Funds - Keogh Plans]
Intrastate exemption for securities sold only to persons of a
single state by an issuer incorporated and doing business in the same
Section 3(b) Small
SEC jurisdiction for
ruling on securities registration exemptions for issues not exceeding
Section 4(2) Exempted
exemption for transactions by an issuer not involving any public
Registration requirement for
securities sold interstate.
Section 18 State
Jurisdiction Over Securities Transactions
Affirmation of state
jurisdiction over securities and persons involved in securities
transactions (preserving so-called "Blue Sky" laws supervising
securities broker/dealers, and securities transactions at the state
Coordination of Federal and State Securities Regulation
Declaration of policy to
cooperate and coordinate securities regulation with state authorities.
SEC Rule 180 (Sophisticated Investor Rule) under the 1933 Act :
17 C.F.R. 230.180 SEC
Rule 180 provides what is often termed the "sophisticated investor"
exemption for Keogh accounts. To qualify, the employer (plan sponsor):
must be a law firm, accounting
firm, investment banking firm, pension consulting firm, or investment
advisory firm, the nature of whose business requires a familiarity with
financial matters which would reasonably be expected to permit the
employer to adequately represent its employees, or
must obtain expert financial
advice before adopting the plan from an entity which is independent of the
bank operating the CIF.
In addition, to qualify for the
exemption, the Keogh plan must only cover employees of a single employer
or employees of interrelated partnerships. For more information, refer to
Keogh Account information in
Section H.2 and
17 C.F.R. Section 230.180- "Sophisticated Investor Rule".
P.1.c. Regulation D under
the 1933 Act:
230.501 to 508 : Regulation D
[Summary of Rules Governing the Offer and Sale of Securities Without
Registration Under the Securities Act of 1933]
The rule provides exemption from
Section 5 securities registration requirements for issuers of small
nonpublic offerings. It also prohibits the offer or sale of securities by
means of any general solicitation or advertising, and provides for limited
resale of the securities (by the issuers) without registration.
The securities themselves, while
exempt from securities registration when offered for sale by the issuer: (1)
continue to be viewed as securities by the SEC and (2) may still come under
the definition of a mutual fund ("investment company") under the Investment
Company Act of 1940 (1940 Act).
To avoid both securities
registration and mutual fund treatment under Federal securities laws,
Regulation D must be applied in concert with investment company exemptions
allowed under the 1940 Act (Section 3(c)(1) of the 1940 Act). More
information can on Regulation D can be found in
Subsection N.5. Regulation D Exempted Securities Offerings.
For purposes of the exemption
categories in SEC Rule 505 (limited offers and sales of securities not
exceeding $5 million) and Rule 506 (limited offers and sales without regard
to the dollar amount of offering), Regulation D limits ownership to 35
investors plus an unlimited number of "Accredited Investors". However,
Section 3(c)(1) of the 1940 Act limits ownership to 100 investors.
Therefore, banks wishing to avail themselves of these exemptions must limit
investors to no more than 100, with no more than 35 of that number being non
Exemption for Securities Offerings Not Exceeding $1 million
Section 230.505 Exemption
for Securities Offerings Not Exceeding $5 million
Section 230.506 Exemption
for Securities Offerings Without Regard to Dollar Amount of Offering
P.1.d. Securities and
Exchange Act of 1934:
Securities Exchange Act of 1934 (1934 Act) regulates the interstate
trading of securities in the marketplace. The 1934 Act also provides for
ongoing public dissemination of securities disclosures, the regulation and
supervision of securities exchanges and marketplaces, and the regulation and
supervision of securities brokers and dealers.
[Common Trust Funds - 9.18(a)(1) Funds - Personal
Funds maintained by a bank for the
investment of assets contributed thereto by the bank in its capacity
as trustee, executor, administrator, or guardian.
Section 3(a)(12)(A)(iv) and (C)(i)
[Collective Investment Funds - 9.18(a)(2) Funds -
Employee Benefit Plans]
Funds maintained by a bank which
interest is issued in connection with a stock bonus, pension, or
profit sharing plan which meets the requirements for qualification
under Section 401 of the IRC.
[Collective Investment Funds - 9.18(a)(2) Funds -
Funds maintained by a bank which
interest is issued in connection with a governmental plan as defined
in Section 414(d) the IRC.
[Collective Investment Funds - 9.18(a)(2) Funds -
Funds, exempted by the Commission,
which interest is issued in connection with a stock bonus, pension,
or profit sharing plan which covers employees who are employees
within the meaning of Section 401(c) of the IRC.
Section 3(a)(12)(A)(v) Exempted Security
[Non-Bank-Operated Commingled Investment Funds]
"Pooled Income Funds" maintained by
charitable organizations operated in conformance with IRC Section
Investment Company Act of 1940:
Investment Company Act of 1940 (1940 Act) provides for the regulation of
"investment companies," including mutual funds. Investment companies are
issuers of securities which are engaged in the business of investing,
trading, and holding securities. The sale of interests in a pool of
investments may, under the 1940 Act, require the registration and regulation
of the "investment company," or issuer of securities.
Investment Company Exemption
Any issuer whose outstanding securities are
beneficially owned by not more than 100 persons, and which refrains
from making a public offering of its securities.
[Common Trust Funds - 9.18(a)(1) Funds - Personal Trust
Any bank which maintains a common trust
fund for the investment of assets contributed thereto by the bank in
its capacity as trustee, executor, administrator, or guardian.
[Collective Investment Funds - 9.18(a)(2) Funds -
Employee Benefit Plans]
Any bank which maintains a collective
trust fund for the investment of assets which are derived solely from
a stock bonus, pension, or profit sharing plan which meets the
requirements for qualification under Section 401 of the IRC of 1986,
or any governmental plan described in Section 3(a)(2)(C) of the
Securities Act of 1933, or both.
[Collective Investment Funds - 9.18(a)(2) Funds -
Funds maintained by a bank which
interest is issued in connection with a governmental plan as exempted
from securities registration by Section 3(a)(2)(C) of the Securities
Act of 1933.
[Non-Bank-Operated Commingled Investment Funds]
"Pooled Income Funds" maintained by
charitable organizations operated in conformance with IRC Section
Investment Advisers Act of 1940:
Investment Advisers Act of 1940 (Advisers Act) requires the registration
and supervision of investment advisers, including those who advise
"investment companies" as defined in the Investment Company Act of 1940.
Prior to the passage of the Gramm-Leach-Bliley Act of 1999 (GLBA), banks
were expressly exempted from the Advisers Act. Refer to
Section 202 for the revised definitions in the Investment Advisors Act.
Section 202(a)(2) Definition
of a Bank
A bank is defined as a
banking institution organized under the laws of the United States, a
member of the Federal Reserve System, or any banking institution or
trust company doing business under the laws of any state or of the
United States, a substantial portion of its business consisting of
receiving deposits or exercising fiduciary powers similar to those
permitted to national banks.
Section 202(a)(11) Investment
Pre-GLBA, the definition
of investment adviser did not include a bank, or any holding company,
as defined in the Bank Holding Company Act of 1956, which is not an
Post-GLBA,, the revised definition of an investment
advisor now includes banks and bank holding companies that provide
investment advice to registered mutual funds. However, the bank
exemption allowing for investment advisory services to individuals and
those other than mutual funds (registered investment companies)
continues to be intact (no registration required).
Note: Per Office of Thrift Supervision (OTS), the bank
exemption of this particular section does not apply to thrifts.
Federal Banking Law
Banking Act of 1933:
The Banking Act of 1933 (codified
into various sections of Title 12 of the U.S. Code), commonly referred to as
the Glass-Steagall Act (Act), was intended to separate commercial banking
activities from investment banking and securities activities. It
generally prohibited banks from directly engaging in securities activities.
However with the passage of the GLBA many of the prohibitions have been removed.
Section 16 Codified
to 12 U.S.C. Section 24 Seventh
Prohibits a national bank
from underwriting, buying or selling securities for its own account.
National banks are permitted to invest in marketable debt obligations
for their own account, which are not in excess of 10% of its capital
This section is applicable to
state member banks by virtue of the Federal Reserve Act. State
nonmember banks are not subject to this section, but are subject to
similar restrictions under Section 21 of the Act.
Section 21 Codified
to 12 U.S.C. Section 378
This section is the only
provision of the Act that is directly applicable by its terms to state
It makes it unlawful for
organizations engaged in the issuing, underwriting, selling, or
distributing of securities to engage in the business of receiving
deposits. These restrictions also apply to banks. In Board of
Governors of the Federal Reserve System v. Investment Company
Institute, the Supreme Court ruled, however, that the restrictions
do not apply to non-banking affiliates of banks (450 U.S. 46, 58, 59
n.24 (1981)). This section allows state nonmember
banks to purchase or sell securities for their own accounts.
However, Section 24 of the Federal Deposit Insurance Act (12 U.S.C.
Section 1831a) made state nonmember banks generally subject to the
same limitations as apply to national banks, thereby limiting their
advantage over national and state member banks.
Section 32 Codified
to 12 U.S.C. Section 78
The Gramm-Leach-Bliley Act
repealed Section 20 of the Banking of Act of 1933. Refer to
Appendix D for additional details.
This section did not apply to state nonmember banks.
Title 12 C.F.R. 9.18
National Banks derive their powers from the National Bank Act, enacted in
1863. The trust powers of national banks are set forth in 12 U.S.C. Section
92a. Initially, national banks were conferred the authority to act in a
fiduciary capacity under Section 11(k) of the Federal Reserve Act of 1913.
As early as 1927, banks were sponsoring collective investment funds.
However, formal Federal bank regulation of bank-sponsored funds was not
introduced until the Federal Reserve Board issued Regulation F in 1937. The
modern equivalent of collective funds emerged a year earlier when
Congress amended Federal tax laws, first granting tax-exemption to the
funds. In 1956, the IRS extended the scope of CIF tax-exemption to include CIF's of retirement plans qualified under IRC Section 401.
Regulation 9.18 emerged as the successor to Regulation F, when the
Congress transferred CIF supervisory authority from the Federal Reserve
Board to the OCC in 1962. The operation of CIF's in state nonmember banks
IRC Section 584 to achieve tax-exemption and must comply with OCC
regulations. These CIF's are usually limited to personal trust CIF's, as
compliance with OCC regulations is not mandatory for state nonmember banks
operating employee benefit CIF's in compliance with
Federal Tax Laws
Internal Revenue Code (IRC)
IRC Section 581
Definition of "Bank"
Defines a "bank" for the
purposes of IRC Sections 582 and 584. By virtue of this section of
the IRC, both banks and nondeposit trust companies are permitted to
operate common trust funds.
IRC Section 584
Common Trust Funds
Describes requirements and
procedures for the operation of bank operated common trust funds.
This section primarily pertains to the operation of common trust funds
for personal accounts (personal trusts, estates, guardianships, and
accounts created under a Uniform Gifts to Minor Act).
Section 584 provides that any
CIF which obtains its tax-exempt status from that section of the Code
must comply with
OCC Regulation 9.18. As a result, FDIC-supervised banks operating
CIF's in accordance with the tax-exemption in IRC Section 584 must
comply with OCC Regulation 9.18. State or local laws do not exempt
state banks from compliance with this provision, as compliance is
mandatory to achieve CIF tax-exemption under Section 584.
Banks may also rely on the
tax-exempt treatment afforded CIF's by Section 584 when establishing
funds exclusively for employee benefit and certain other tax-exempt
fiduciary accounts administered in the capacity of trustee.
RR 81-100 Collective
This Revenue Ruling applies
to the collective investment of trust and agency accounts of
employee benefit plans which obtain their tax-exempt status from
Section 401 of the Internal Revenue Code, or IRA accounts which obtain
their tax-exempt status from Section 408 of the Internal Revenue Code.
IRAs are effectively barred
from CIF's and, for all practical purposes, may only be collectively
invested in registered mutual funds.
These CIF's are typically
established in a form identical to that outlined by
OCC Regulation 9.18(a)(2). However, unlike mandatory compliance
OCC Regulation 9.18(a)(1) with respect to personal trust CIF's (by
IRC Section 584), there exists no similar Federal requirement that
FDIC-supervised banks comply with OCC Regulation 9.18(a)(2). Unless
local law requires state nonmember banks to comply with 9.18(a)(2),
that regulation should be regarded as a prudent industry standard and
as guidance in the operation of employee benefit CIF's, but not
The Revenue Ruling requires:
each participating employee benefit plan to adopt the group trust (CIF
declaration of trust) itself as part of the plan; that the group trust
prohibit CIF assets from being diverted to any purposes other than the
exclusive benefit of participating plan beneficiaries; that the group
trust prohibit assignment of any CIF assets by any of the
participating plans; and that the group trust be established and
maintained as a domestic U.S. trust.
IRC Section 642(c) Pooled
Pooled funds comprise
charitable gifts from donors which are maintained in a commingled
investment fund by organizations described in IRC Section
170(b)(1)(A), including churches, educational institutions, and hospitals.
Securities law exemptions for
these funds are contained in: Section 3(a)(4) of the Securities Act of
1933; Section 3(a)(12)(A)(v) of the Securities Exchange Act of 1934;
and Section 3(c)(10)(B) of the Investment Company Act of 1940. Banks
may be appointed as administrator or investment manager of these
funds, which are not treated as bank CIF's under Federal tax and
IRC Section 761 Partnership
A partnership is defined to
include groups, pools, or other unincorporated organizations through
which a business is conducted, including investment activities (such
as bank operated CIF's).
IRC Section 6032 Tax Returns
for Bank Common Trust Funds
U.S. Treasury Regulation
Section 1.6032.1 and IRC Section 6032 require banks (as defined
IRC Section 581) operating CIF's to file annual informational
returns with the IRS for each fund established under
Section 584 of the IRC. No specific form has been created by
the IRS for this purpose. However, Schedule K-1 of Form 1065
(Partner's Share of Income, Credits, Deductions) is typically used to
satisfy the reporting requirement.
The return is required to
include for each fund participant: name, address, their
proportional share of taxable income or losses, and capital gains or
losses. This informational return is required, regardless of the
taxable income earned during the reporting period. The aforementioned
Treasury regulation also requires banks to file a full copy of the
CIF's declaration of trust, and any amendments thereto, at least once
with the return.
Employee benefit CIF's
operated in accordance with
RR 81-100, and which derive their tax-exemption under IRC Section
501(a), are not required to file any informational returns with the
IRS. However, collective investment funds maintained by a bank, trust
company, or similar institution, for the collective investment and
reinvestment of assets contributed thereto from employee benefit plans
maintained by more than one employer or controlled group of
corporations are defined by the Department of Labor as
Direct Filing Entities (DFE). Such collective investment funds
are required to file
DOL Form 5500. The DFE Form 5500 is also an integral part of the
annual report of each participating plan. As a result, the
administrator of a plan may be subject to penalties for failing to
file a complete annual report unless both the DFE Form 5500 and the
plan's Form 5500 are properly filed.
Subsection 5.I.2. for information regarding various reporting
Common law places restrictions on
commingling. All states and the District of Columbia now have enabling
legislation which permits operation of collective funds. In many states,
the Uniform Common Trust Fund Act is the basis of the enabling
legislation that authorizes the operation of CIF's. State law may also
include additional requirements, such as a requirement to furnish periodic
accountings to a particular court and/or the state supervisory authority.