4000 - Advisory Opinions
Insured Nonmember Bank May Participate in Investment Services Program Without Violating the Glass-Steagall Act
December 9, 1983
Pamela E. F. LeCren, Senior Attorney
The following is in response to your request that the FDIC review and comment upon an investment services program offered by your client, * * *. * * * is a registered securities broker and registered investment adviser that presently offers investment services through "subscribing"1 savings and loan institutions and mutual savings banks. * * * would like to offer the services, known as "Invest", through insured nonmember banks and is hereby seeking FDIC's approval of nonmember bank participation in the Invest program.
According to the documents submitted to this office, * * * is a wholly-owned subsidiary of * * *, which is in turn owned by approximately 30 savings and loan associations and a number of mutual savings banks. The Federal Home Loan Bank Board on May 6, 1982 approved the formation of the holding company and its subsidiary after finding, among other things, that the services to be offered by ISFA through its subsidiary were not in violation of the Glass-Steagall Act.2 Those services and the manner in which a "subscribing" institution participates are more fully set forth below.3
As stated above, * * * is a registered broker/dealer and adviser and as such offers investment advice to, and executes securities transactions for, its customers. Customers are serviced at Invest Service Centers which are established on the premises of subscribing institutions. At present, Invest Service Centers only purchase and sell equity securities, debt securities, municipal securities, and mutual fund shares. Invest Service Centers will not effect commodity futures or commodity option transactions for customers; will not effect transactions for fiduciary accounts of subscribing institutions; nor handle discretionary accounts. * * * does not purchase securities for its own account nor does it engage in any underwriting activities. Investment advice is standardized, i.e., is formulated by * * * main office personnel. Invest Service Center employees are not authorized to offer investment advice which differs from that generated by the main office. Investment recommendations will vary according to "classes" of customers. A customer is assigned to a class by main office personnel. * * * will, at the customer's request, effect transactions not recommended for the customer's "class" but will make clear that such transactions have not been approved for that customer. Portfolio evaluations are made by main office personnel.
Each Invest Service Center is clearly identified as such and is located in an area of the subscribing institution that is readily distinguishable from the areas in which the banking business of the subscribing institution is conducted. All Invest advertisements and promotional material disseminated by the institution must be approved in advance by * * * and must clearly state that the investment and advisory services are being provided by * * * and not by the subscribing institution. Each Invest customer is given a notice that he/she must sign which indicates that the securities services are being offered by, and are the sole responsibility of, * * * and * * * clearing broker. Monthly account statements, which are received by each Invest customer from * * * clearing broker, make clear that securities services are furnished by * * *.
Invest Service Centers do not carry customer accounts nor hold funds or securities for customers. Whenever a customer wishes to purchase securities, the customer will send the funds directly to the clearing broker who will forward the securities directly to the customer or the customer's designated depository. Conversely, whenever a customer wishes to sell securities, the customer places those securities in a "mailer" for shipment to the clearing broker. The broker again sends the proceeds of the sale directly to the customer.
Each Invest Service Center is staffed by at least two * * * registered representatives who will be dual employees of the subscribing institution. These individuals must enter into an employment agreement with * * * specifying, among other things, that * * * will have exclusive control over that employee's * * * related securities activities and that the dual employee will strictly adhere to * * * Compliance and Procedure Manuals. Additionally, the Subscribers Contract (article 10, paragraph (d)) indicates that the subscribing institution shall strictly honor * * * control relationship with the dual employee and shall not have any involvement whatsoever in any of the securities brokerage and investment advisory services performed by the dual employee. Although the Subscribers Contract (article 10, paragraph (e)) provides that the subscribing institution is required to report to * * * any violation of law, rule, or regulation or any violation of * * * standards of conduct on the part of the dual employee of which the subscribing institution has knowledge, the contract provides that the institution has no obligation to monitor the dual employee's conduct or to cause such employee to comply with * * * Compliance and Procedure Manuals.
The dual employee is compensated by the subscribing institution "which payment may be subject to partial or complete reimbursement by * * * ". (See article 10, paragraph (a) of Subscribers Contract). The subscribing institution is liable for all the dual employee's fringe benefits. Neither * * * nor the subscribing institution may compensate any dual employee, either directly or indirectly, based upon the volume of securities transactions, the amount of commissions, or the amount of revenue sharing payments generated by the dual employee. (See article 10, paragraph (a) of Subscribers Contract.) The contract also contains an indemnification clause which provides that * * * will indemnify the subscribing institution against all losses, claims, damages, liabilities, etc. that arise from any act of a dual employee while acting as a registered representative of Invest.
* * * will make monthly Revenue Sharing Payments to the subscribing institution. Revenue Sharing Payments represent reimbursement for compensation of the dual employees and payment for the use of the facilities and equipment of the subscribing institution that are necessary for the operation of the Invest Service Center. * * * reserves the right under the Subscribers Contract (article 9, paragraph (b)(ii)) to deduct from Revenue Sharing Payments a portion of all losses, cost and expenses, if any, incurred directly or indirectly by * * * as a result of the failure of any Invest customer to meet any obligation to deliver funds or securities or to meet any margin call. The institution's portion of any loss "shall be equal to the percentage of Revenue Sharing Payments payable to [the institution] . . . on the date of the event giving rise to such loss . . . [but] shall in no event exceed the amount of payments payable . . . to the [institution] with respect to securities transactions occurring after * * * shall have incurred the loss."4
The * * * compliance manual directs that non-dual employees of the subscribing institution must not proffer or otherwise disseminate investment recommendations to customers or other persons nor engage in any conversations with customers or other persons that might be construed as a securities sales conversation. Non-dual employees may distribute, upon request, informational literature regarding the Invest program and may inform customers and other persons that Invest is available on the premises of the institution. Non-dual employees must not recommend or insist that any person open an account with Invest nor suggest or imply that the Invest Program will meet any person's investment objectives or imply that the subscribing institution has any role at all in the provision of, or any responsibility for, the securities services offered by * * *. The compliance manual also directs the subscribing institution to insure that its books and records are kept separate and distinct from all books and records of * * * maintained on the premises of the subscribing institution.
The subscribing institution is to designate an officer to review each new recommended securities list generated by the * * * Research Department to determine whether there is any security on that list issued by a company with which the subscribing institution has established a business relationship. If such is the case, and that relationship has resulted in, or might in the future result in, the subscribing institution acquiring material inside information regarding the company, * * * will make arrangements to have that security deleted from the recommended securities list utilized by the dual employee on the premises of that subscribing institution. The designated officer must also immediately notify * * * should the subscribing institution establish such a business relationship with a company subsequent to a security being placed on the recommended securities list.
We have carefully considered the question of whether or not a nonmember bank may participate in Invest as a subscribing institution without violating the Glass-Steagall Act and have concluded that a nonmember bank may do so. Sections 32 and 20 of the Glass-Steagall Act (12 U.S.C. sections 78, 377) which respectively prohibit an affiliation between a bank and a securities firm and prohibit dual employment between a bank and a securities firm are not contravened as under the express language of the statute neither provision applies to a nonmember bank. Even if section 20 applied to a nonmember bank, * * * would not be an affiliate of the subscribing institution within the meaning of section 20.5
We also find that section 21 of the Glass-Steagall Act (12 U.S.C. section 378) which prohibits a nonmember bank from selling, distributing, underwriting, or issuing any securities other than as provided in section 16 of the Glass-Steagall Act (12 U.S.C. 24 (7th)), would not be violated. A nonmember bank as a subscribing institution would not appear to be engaged in selling, distributing, underwriting, or issuing securities within the meaning of section 21 as a result of its contractual arrangement with * * *. Even if we were to assume that the activities in question could not lawfully be conducted by a bank, under the circumstances as described at length above, it is and not the bank that is buying and selling securities. The fact that a dual employee of the bank is staffing the Invest Service Center would not appear, under the closely defined roles established by contract and otherwise, to cause the bank to be buying and selling securities nor cause the bank to be in the business of giving investment advice. Neither the bank nor any of its employees are responsible for the development of the investment advice nor does the bank or any of its employees represent that the bank is recommending any investment decision. On the contrary, stringent measures are prescribed to make Invest customers aware that * * * and not the bank, is conducting, and is responsible for, the securities activities.
Although we feel, as indicated above, that the Glass-Steagall Act is not a bar to nonmember bank participation in Invest, we wish to make clear that our failure to take present objection to the Invest Program does not constitute an endorsement. We make this statement even though the FDIC does not at this time perceive any excessive or undue risk arising from nonmember bank participation in Invest. That assessment, however, could change in the future. We also reserve the right to take issue with the manner in which any particular nonmember bank administers the Invest program depending upon the facts in any particular instance. Lastly, we stress that our comments are limited to the facts as we understand them to be. Should the facts differ from that which we have described, or circumstances change in the future, the opinions set out in this letter are subject to change.
1 A "subscribing" institution is one that has a contractual relationship with * * * but does not have any ownership interest in the company. Go back to Text
2 The Federal Home Loan Bank Board's action is the subject of a legal challenge brought by the Securities Industry Association ("SIA") in Federal District Court for the District of Columbia (SIA v. Federal Home Loan Bank Board, Civil Action No. 82-1920, D.D.C. July 12, 1982). SIA alleges in its complaint that the Federal Home Loan Bank Board's decision to approve the application was arbitrary and capricious; that the brokerage and investment services provided by * * * are activities not permitted to savings and loan association service corporations under the Home Owners Loan Act; and that * * * brokerage and investment activities are contrary to section 21 of the Glass-Steagall Act. Summary judgment motions are presently before the Court. We reserve the right to amend our comments should SIA's legal challenge be upheld and if the basis for the Court's opinion has any material effect on the substance of this opinion. Go back to Text
3 In addition to your letters of August 15, 1983 and August 18, 1983, your office submitted the following documents for our review: The Federal Home Loan Board's May 6, 1982 Order; a legal opinion of the Federal Home Loan Bank Board's General Counsel concerning the application; the July 8, 1982 no action letter from the Securities and Exchange Commission; a November 2, 1982 memorandum submitted to the Securities and Exchange Commission re: the need for the owner savings and loan associations to register as broker/dealers; the * * * Employment Agreement; the Invest Subscribers Contract; a number of * * * promotional materials; and the final draft of a legal memorandum prepared by counsel representing * * * before the Federal Home Loan Board discussing the Invest services in the context of the Home Owners Loan Act, the Securities laws, and the Glass-Steagall Act. The representations contained in these documents serve as the basis for our description of * * * and the Invest Program as well as the basis for our comments which follow. Go back to Text
4 We wish to mention in passing that the provision for reduction of Revenue Sharing Payments was carefully reviewed in light of Part 332 of FDIC's regulations which prohibits a nonmember bank from guaranteeing the obligations of others. We are satisfied, however, that even though the bank shares in any losses, costs, or expenses * * * incurs as a result of a customer's failure to deliver funds or securities, the bank is not "guaranteeing" the obligation of the customer. The bank's portion of the loss under the contract can be construed as a cost of doing business especially as its liability is limited to the amount of revenue due it from transactions occurring subsequent to the loss. In short, the bank's future income is reduced but no assets of the bank are subject to any claim by * * *. Go back to Text
5 "Affiliate" for the purposes of section 20 of the Glass-Steagall Act is defined as set out in 12 U.S.C. 221a(b). That provision contains several alternative ways in which a company can be considered an affiliate of a bank all of which require some percentage of stock ownership or the ability to control in any manner the election of a majority of a company's directors none of which are present here. Go back to Text