4000 - Advisory Opinions
Request for Interpretation of General Counsel's Opinion No. 6--"Soft-Dollar" Arrangements and Commission Splitting on Brokered Transactions Involving Trust Accounts
October 13, 1983
Pamela E. F. LeCren, Senior Attorney
The following is in response to your July 14, 1983 request that the Legal Division provide further clarification on General Counsel's Opinion No. 6 which discusses the legality of discount brokerage services when offered by insured nonmember banks. Your request asks that the FDIC address two specific questions involving brokerage services and bank trust departments: (1) whether or not an insured nonmember bank may share in commissions generated by brokered transactions involving revocable trust accounts where (a) the settlor of the trust has consented by separate trust instrument to the bank trustee sharing commissions with the discount broker or (b) the trust instrument permits, or has been amended to permit, such commission sharing; and (2) what is the interrelationship of the use of "soft dollars" by a bank trustee to obtain research services and General Counsel's Opinion No. 6. Your questions are answered separately below.
Commission Splitting/Revocable Trusts
General Counsel's Opinion No. 6 discusses at length the legality under the Glass-Steagall Act of a contractual arrangement whereby an insured nonmember bank utilizes the discount brokerage services of a particular broker/dealer and the bank shares in the commissions generated by the brokered transactions. The opinion goes beyond a straight Glass-Steagall Act analysis, however, and states in part that,
if the bank intends to utilize the contractual arrangement with the broker/dealer for transactions executed in connection with trust department accounts, the bank should not receive any additional compensation with regard to those transactions from the broker/dealer, i.e., the bank's trust department should not share in any commission associated with the transaction. To do so would raise possibilities of a breach of fiduciary obligation toward the bank's trust department customers.
Your letter in essence asks the FDIC to reconsider this apparent total prohibition on commission splitting where any trust department account is involved.
As shown by the above language, FDIC's concern is centered on a possible breach of fiduciary obligation if the bank, as trustee, shares in commissions generated by transactions effected on behalf of trust department accounts. Whether or not a particular act on the part of a trustee will give rise to a breach of fiduciary obligation depends upon the circumstances in any particular case (for example, whether the trust is directed or undirected) and will vary from state to state depending upon local. Even in the case of a trust department account for which the bank does not act as trustee (for example, managed agency accounts) the bank may have certain performance obligations with respect to the account even though its obligations do not rise to the level of a fiduciary obligation. While we do agree with your statement that, as a general principle of law, a trustee if expressly authorized by the trust instrument may do or take acts which in the absence of authorization would give rise to a breach of fiduciary obligation, we are aware that some state statutes prohibit a bank trustee from sharing in any commissions generated by securities transactions effected on behalf of trust department accounts. We are also aware that a court of law, depending upon the facts in any particular instance, may order rescission of the commission despite the authorization.
In the absence of a statutory prohibition, however, and assuming no unusual facts, it would appear that where (1) a revocable trust instrument expressly authorizes the bank trustee to share in commissions generated by securities transactions effected on behalf of the account, and (2) the settlor of the trust entered into the authorization after full disclosure of the facts the sharing of the commission would not itself give rise to a breach of fiduciary obligation.1 This is not to say, however, that the administration of that trust account could not give rise to a breach of obligation or not be subject to criticism. For example, it is possible that the bank trustee by committing its brokerage business to one broker/dealer may not meet its best execution obligations. If the bank trustee has discretion over the account and the commission splitting arrangement is dependent upon the volume of trades, the bank may be open to a charge of "churning" accounts to generate fees. A proper accounting must also be kept for each account, other records maintained, and all necessary disclosures made in accordance with applicable law. If the broker/dealer is a related company of the bank and that fact is not properly disclosed, a breach of fiduciary obligation could be found.
As any number of particulars can vary concerning the manner in which an account is administered and the nature of the bank's obligation can vary as to the particular type of trust department account, we cannot be any more specific in responding to the initial portion of your request. In short, although given the proper circumstances the bank's trust department could split commissions, a bank would be advised to obtain the opinion of counsel before doing so.
Soft Dollar Arrangements
"Soft dollars" is a term typically used to describe an arrangement whereby a bank purchases products or services and pays for them with brokerage commissions arising from securities transactions. Section 28(e) of the Securities and Exchange Act of 1934 (15 U.S.C. 78bb) established a so-called "safe harbor" for bank trustees that cause trust accounts to pay a broker/dealer a commission for brokerage transactions that is higher than another broker would charge. Where the bank trustee determines in good faith that the commission is reasonable in relation to the value of the brokerage and research services provided by the broker, the trustee will not be said to have breached his/her fiduciary obligation.2 In essence, section 28(e) overrides preexisting concepts of fiduciary obligation and states that under appropriate circumstances it does not give rise to a breach of fiduciary obligation for a trustee to cause a trust account to incur a greater expense than otherwise might be incurred.
Your letter requests that the FDIC comment upon the interrelationship of General Counsel's Opinion No. 6 and section 28(e).3 Presumably, you read the above passage quoted from General Counsel's Opinion No. 6 as limiting, or somehow affecting, the reach of section 28(e). In response to your inquiry, we can only say that General Counsel's Opinion No. 6 does not address section 28(e) nor do we see any correlation between a "soft dollar" arrangement and a situation where a bank shares commissions with a discount broker. A discount broker by definition does not "provide" research services. Although under section 28(e) the broker to whom commissions are paid need not produce the research services in-house, according to the Securities and Exchange Commission the broker is not "providing" services within the meaning of section 28(e) where the broker is merely paying the obligation of the bank to a third party. (See Securities and Exchange Release No. 16679, March 19, 1980). Such would seem to be the case if a bank that shares in commissions with a discount broker has the discount broker remit the portion of the commission that would be otherwise retained by the bank to a research service.
1 Although you have not expressly indicated, we assume that "revocable trust" refers to a trust where the settlor of the trust is also the beneficiary. If there is more than one beneficial interest involved, the consent of all beneficiaries would need to be obtained. This in essence may preclude the commission split for trusts where the beneficial interests are not easily ascertained or where the beneficiary is a minor. Additionally, any securities transactions involving court supervised accounts would need court approval. Go back to Text
2 Section 28(e) provides in relevant part as follows: (e)(1) No person using the mails, or any means or instrumentality of interstate commerce, in the exercise of investment discretion with respect to an account shall be deemed to have acted unlawfully or to have breached a fiduciary duty under State or Federal law unless expressly provided to the contrary by a law enacted by the Congress or any State subsequent to the date of enactment of the Securities Act Amendments in 1975 solely by reason of his having caused the account to pay a member of an exchange, broker, or dealer an amount of commission for effecting a securities transaction in excess of the amount of commission another member of an exchange, broker, or dealer would have charged for effecting that transaction, if such person determined in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided by such member, broker, or dealer, viewed in terms of either that particular transaction or his overall responsibility with respect to the accounts with which he exercises investment discretion. Go back to Text
3 A portion of your letter describes a program your client is considering entering into relating to the use of soft-dollars by the bank as trustee to obtain research services. You conclude that the arrangement would be protected by section 28(e). The protection of that section is available only under "limited circumstances" (See Office of the Comptroller of the Currency, Trust Department Circular No. 17, March 1980). We cannot comment on whether or not the program under consideration falls within the protections of section 28(e) as we do not have sufficient information. Go back to Text