4000 - Advisory Opinions
Insured Nonmember Bank May Participate in Brokerage Networking Program Without Violating Glass-Steagall Act
July 16, 1992
Pamela E.F. LeCren, Counsel
The following is in response to your request that the FDIC "approve" nonmember bank participation in the brokerage networking program [X] which is made available by ***.
The FDIC has had occasion to review a number of securities brokerage networking programs primarily for the purpose of determining whether or not the participation of an insured nonmember bank in such an arrangement would cause the participating bank to be in violation of § 21 of the Glass-Steagall Act (12 U.S.C. 378). The first such program reviewed by the FDIC was a program known as INVEST which is offered by ISFA Corporation. (See FDIC staff opinion letter FDIC 83--21, December 9, 1983). Upon reviewing that program, it was the FDIC's conclusion that participation by an insured nonmember bank in the INVEST program would not cause the bank to be in violation of the Glass-Steagall Act. The FDIC specifically declined, however, to endorse the program. What is more, despite the fact that our letter indicated that "the FDIC does not at this time perceive any excessive or undue risk arising from nonmember bank participation in Invest", the review undertaken by the FDIC at that time did not constitute a complete safety and soundness review.
When subsequently asked to review securities brokerage networking programs, the FDIC has for the most part confined itself to a determination of whether the program would involve a violation of the Glass-Steagall Act. If a program is found to be substantially similar to INVEST, the conclusion necessarily follows that the program would not involve a participating bank in a violation of the Glass-Steagall Act.
We have on occasion commented on one particular aspect or another regarding a program under review if something about the program appeared to be problematical or potentially so. In that vein, FDIC staff opinion letter FDIC 86--18, June 12, 1986, raised the possibility that compensating bank employees who act as registered representatives on the basis of the volume of the business generated by the representative could lead to a conflict of interest that may be the basis for criticism by the FDIC. It was also noted that a conflict of interest could arise if a participating bank receives bonuses based upon the volume of business generated under the program. Again, it was noted that this could be the basis of criticism by the FDIC. Lastly, the same letter indicates that use by a participating bank of the program to accomplish trades on behalf of fiduciary accounts could raise questions as to a possible breach of fiduciary obligation and questions of whether the bank met its best execution obligations. The opinion raised these issues for the sole purpose of reinforcing to the requestor that the FDIC was not endorsing the program but was specifically reserving the right to object in the future to the program and/or how it is operated if the circumstances so warranted.
According to your letter, "In most material respects, the [X] program resembles the INVEST program in its methods of operation and respective responsibilities of [X] and the [participating] bank" with the exception of the following:
1. Unlike INVEST, [X] shoulders the business risk that it may incur losses as a result of customers failing to meet their obligations;
2. A participating bank will indemnify [X] against any liabilities [X] incurs as a result of a failure by the bank, or any of the bank's employees who are not registered representatives, to comply with the contract;
3. [X] will effect transactions for fiduciary accounts of a participating bank (the bank does not receive any payment in connection with such transactions);
4. [X] purchases bonds into inventory which are sold at a net price if ordered by customers (this represents a very small percentage of [X]'s business);
5. Registered representatives may recommend securities not on the approved list if they obtain the approval of a principal in [X]'s home office;
6. Customers are assigned to investor classes by the individual registered representatives who are responsible for making a suitability determination before recommending any securities (all transactions are reviewed by a principal in [X]'s home office);
7. Registered representatives may receive cash, checks and securities from customers for forwarding to [X] (if representatives are not available, tellers may, where permitted by regulators, receive and safeguard funds and securities for subsequent delivery to a representative);
8. [X]'s contract does not require more than one registered representative to be present at a service location; and
9. Transaction-related compensation is not prohibited under the contract.
Based upon our review of your letter, the contracts and the Procedures and Policy Guidelines made available to this office, we concur with your opinion that in most respects the [X] program is similar to the INVEST program. We concur as well with your description of the areas in which the two programs differ. We do not find the differences to be material in terms of deciding whether participation in the program would involve an insured nonmember bank in a violation of the Glass-Steagall Act.1 We renew our comments, however, that transaction-based compensation may be the source of criticism and that use of the program to effect trades for the bank's fiduciary accounts may likewise be the source of criticism. In addition, it is likely that the FDIC would find receipt by a bank teller of cash or checks intended for a [X] registered representative to be objectionable in view of section 328.2(c) of the FDIC's regulations (12 C.F.R. § 328.2(c)) which prohibits an insured bank from receiving deposits at a teller window where any uninsured institution receives deposits or similar liabilities.2 You should note that FDIC examination reports are the property of the FDIC and that an insured nonmember bank may not disclose such reports, or any information derived therefrom, without first obtaining the FDIC's consent. You should also note that insured nonmember banks are subject to Part 344 of the FDIC's regulations (12 C.F.R. 344) which makes the bank responsible for recordkeeping and confirmations with respect to securities transactions it effects. A participant bank will be expected to comply with any applicable provisions of Part 344. Finally, you should be aware that to the extent [X] effects deposit transactions the operation of its program may be subject to the FDIC's rule on brokered deposits (12 C.F.R. 337.6) which implements § 29 and § 29a of the FDI Act.
Please be advised that, as in the similar cases in which the FDIC has reviewed networking programs, this review does not constitute a full safety and soundness review of the [X] program and is not an "approval" or endorsement. What is more, our comments are based solely upon the facts as we understand them to be based upon your June 3, 1992 correspondence. The failure or omission of this letter to raise or comment upon any safety and soundness issue, conflict of interest, or other such issue should not be read to constitute a conclusion on the part of the FDIC that no such issue exists.
Finally, effective December 19, 1992 no insured state bank may engage as principal in any activity that is not permissible for a national bank without obtaining the FDIC's consent. Consent can only be granted if the bank meets its capital requirements and the FDIC determines that conducting the activity will not pose a significant risk to the insurance fund of which the bank is a member. (See § 24(a) of the FDI Act (12 U.S.C. 1831(a)) as added by the Federal Deposit Insurance Corporation Improvement Act of 1992, "FDICIA"). If a national bank would be permitted by the Office of the Comptroller of the Currency ("OCC") to enter into the [X] arrangement, then an insured state bank may do so without the FDIC's consent under § 24 of the FDI Act.
This office is of the opinion that it would be inappropriate for the FDIC to determine on its own whether a national bank may enter into the subject contract. We therefore advise you to seek an opinion from the OCC. We will note in passing that the OCC has had occasion to review the INVEST and other similar programs (copies of relevant opinions enclosed) and has found several such programs to be permissible for a national bank. [X] does appear to differ, however, in some respects from the programs OCC has reviewed. Those differences may or may not be material to the OCC.
We are unable to definitively comment at this time on whether the FDIC would find participation in the [X] program to present a significant risk to the fund. The issue of what constitutes a significant risk to the fund is itself unsettled at this time.3 Until such time as that issue is resolved and the Board of Directors delegates the power to make determinations under § 24, only the Board of Directors has the authority to do so. Staff hopes to have a regulation in place prior to December 19, 1992 that will, at a minimum, resolve issues such as how to determine what is and is not permissible for a national bank and which may establish an application procedure by which banks may obtain the FDIC's consent to initiate or continue to conduct activities that are impermissible for national banks. In the meantime, you may take some comfort from the fact that to date the FDIC has not to my knowledge prohibited insured nonmember banks from participating in brokerage networking programs.
1We note that [X] will buy and sell bonds for its own account. Even assuming that the bonds are not of a type that could be underwritten or distributed by a bank, [X] and not the participating bank will be buying and selling the bonds for its own account. Go back to Text
2We recognize that § 328.2(c) does not by its terms apply to the instant situation. The practice your letter describes, however, raises similar concerns of engendering depositor confusion. What is more, the practice of allowing a teller to receive funds could raise a question of whether the funds so received are deposits for purposes of the Federal Deposit Insurance Act in which case the bank would be required to pay assessments on the funds. Go back to Text
3The FDIC recently published for comment a proposed amendment to the FDIC's regulations (proposed Part 362) that would implement the equity investment restrictions of § 24. That proposal, among other things, proposes to define the phrase "significant risk to the fund''. Go back to Text