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Table of Contents
The operations section of a trust department provides support to the
administrative arm in much the same way as the operations division of a bank
supports its other functions. As such, it is the focal point for all actions
affecting customer accounts and the department itself. To be effective it must
provide management with accurate and reliable systems for documentation,
accounting and control. While the sophistication of the operational systems
employed is likely to vary with the size and complexity of the department, the
underlying principles involved are universal.
The trust function must have adequate facilities and equipment, as well as a
sufficient number of knowledgeable, trained and experienced staff, to
accomplish its tasks. Documentation substantiating appointments and actions
taken throughout the life of an account must be obtained, maintained and
preserved. Record keeping systems must provide a detailed picture of all funds
and other assets under the control of the fiduciary from an account's inception
to its closing. Procedures must be developed to process work in a uniform and
orderly manner and a practical system of checks and balances must be developed
to ensure the integrity of the work performed.
This section of the Manual is organized into the following
parts:
A. Trust
accounting
B. Property
ownership
C. Principal
and income
D. Carrying
values
E. Accounting
records
1. General
Ledger
2. Asset
Control Accounts
3. Subsidiary
Asset Controls
4. Subsidiary
Liability Controls
F. Trust records
1. Administrative
File
a. Legal
File
b. Digest
or Synopsis
c. Correspondence
File
d. Investment
Review File
e. Securities
Transaction File
f. Tax
File
2. Tickler
System
3. Other
Records
a. Securities
Transaction Register
b. Vault
Control Log
c. Broker
Statements
G. Account
documentation
1. Evidence
of Appointment
2. Supporting
Documentation
a. Trust
Committee Minutes
b. Approvals
c. Indemnification
d. Accountings
and Customers' Statements
e. Account
Reviews
f. Receipt
and Release
g. Other
Documents
H. Internal
Controls
1. Segregation
of Duties
2. Vacation
Policy
3. Reconcilements
4. Other
Elements of Control
5. Fraudulent
Acts
I. Nominees
J. Use
of broker-dealers for securities safekeeping/securities investor protection
corporation (SIPC)
K. Free
riding and daylight overdrafts
L. Facilities
M. Information
Technology
N. Business
Continuity Planning
O. Self-directed
IRA'S and keogh accounts
1. Direct
Arrangements
2. Arrangements
with Third Parties
P. Custodial
holdings of government securities: compliance with government securities act of
1986
1. Background
2. Applicability
a. To
broker-dealer activities
b. To
government securities repurchase transactions
c. To
custodial holdings of government securities for customers:
Q. Shareholder
Communications Act of 1985
1. Background
and Requirements
2. Applicability
to Trust Accounts
R. State escheat
laws
S. Audit
and accounting issues
1. Audit
Objectives
2. Audit
Program
3. Audit
Activities
4. Evaluation
of the Audit Function
5. Statement
on Accounting Standards (SAS #70)
6.
FAS 87
A. Trust accounting
While general accounting principles apply to trust
recordkeeping, significant differences exist between the accounting systems
employed by the trust department and the commercial department. Trust
departments are called upon to serve in various capacities. Aside from personal
and employee benefit trusts, the department may serve as corporate trustee for
bond issues or as a paying or escrow agent. Since each account must be
treated as an individual entity, the accounting system adopted will be required
to reflect individualized statements of holdings (or accountability), as well
as aggregate controls for the department. The specialization required by this
type of system, and the legal ramifications involved in handling fiduciary
matters, necessitate the adoption of a completely separate set of books and
records.
The fundamental principle behind general accounting
theory is expressed in the equation:
Assets = Liabilities
+ Capital
This principle does not apply to trust accounting, since
the fiduciary does not account for its own assets, but for the property of
others. As such, the fundamental principle behind trust accounting is expressed
as follows:
Assets = Accountability
(or Liabilities)
In this equation, assets such as securities, deposits,
or real property are liabilities for which the department is accountable, or
liable, to others. Expressed differently, the assets of trust accounts are also
the liabilities of the fiduciary. Normally, the only accounts holding cash or
assets not owed to fiduciary customers are "house accounts," which may include
undistributed profits and suspense items.
Note that the Call Report Instructions and Glossary
describing accounting standards and practices, and generally accepted
accounting principles, do not apply to trust accounting.
B. Property Ownership
The laws governing the ownership of property differ from
state to state. Therefore, examiners need some basic knowledge of the
property laws applicable within individual states. Trusts, in some form, are
permissible in all states. A trust occurs when the ownership of property is
separated as to title and equity. A trustee retains title to trust property
(corpus or principal), but has no beneficial or equitable interest in the
property. A trust cannot exist when the legal owner, or party holding title,
also holds the only beneficial interest in the property. Nevertheless, a
fiduciary does not necessarily have to hold title to property, such as in a
guardianship. Beneficiaries are divided into two classes: those holding a
current interest in the property of a trust, and those holding a remainder (or
future) interest. Since the first class of beneficiaries is entitled to the
current return generated from the property, while the latter is entitled to the
future value of the property at some specified future time, trustees must
maintain separate records to account for, and distinguish between, income and
principal.
In an agency capacity, ownership and, in general, title
to the assets, does not pass to the fiduciary, but remains with the principal.
The trust department's obligation is to act as the principal's agent and follow
the instructions stipulated in an agency agreement.
C. Principal and Income Allocations
The trustee is under a duty to deal impartially (remain
neutral) with beneficiaries, when there are at least two beneficiaries.
This rule applies when the beneficiaries' interests are concurrent or
successive. In personal fiduciary accounts, it is common for one set of
beneficiaries to be entitled to the income ("income beneficiaries"), while a
second set of beneficiaries is entitled to the principal ("remaindermen").
These classes of beneficiaries often have different, sometimes opposing, needs
and interests. While serving both classes of beneficiaries can often prove
difficult, the trustee must balance objectives and investments, so that one
class of beneficiary is not favored over the other.
While account agreements may outline permissible
investment products, the documents may not indicate treatment for
allocations between principal and income. For those circumstances where
principal and income are not defined, default allocations have been established
under the Uniform Principal and Income Act, with most states adopting the 1931
and the 1962 Revised Uniform Principal and Income Act. The Act was again
revised in 1997 to incorporate and be consistent with the concept of Prudent
Investor Act (modern portfolio theory and total return) and allow for
investment products not previously developed. A copy of the Act and
commentary are provided in Appendix C
Uniform
Principal and Income Act of 1997. Nearly all states have adopted
the Act in some form; however, examiners are reminded that states may modify
"uniform" Acts during the legislative process. According to the National
Conference of Commissioners on Uniform State Laws, the primary difference is
the ability to delegate investment decisions. Consequently, the law of
any state may depart in small or large measure from the "uniform" Act presented
in this manual. The text of these and other uniform acts is also
available at the Internet site of the National Conference of Commissioners
of Uniform State Laws,
https://www.uniformlaws.org
Although distinguishing between "principal" and "income"
appears relatively straightforward, there are many situations where it is much
more complicated. The following list summarizes allocations for various issues:
-
Discount Obligations - The entire increase in value of
these obligations is principal when the trustee receives the proceeds from the
disposition, unless the obligation, when acquired, has a maturity of less than
one year.
-
Capital Gains - Capital gain
dividend does not include any net short-term capital gain, and cash received by
a trust because of a net short-term capital gain is considered to be income.
-
Reinvested Dividends - If a
trustee elects or continues a course of action to reinvest dividends in shares
of stock of a distributing corporation or fund, the new shares would be
principal. However, if the trustee makes a decision, for example, to make
an investment without incurring brokerage fees, the trustee should transfer
cash from principal to income in an amount equal to the reinvested dividends.
-
Mineral rights - 90
percent of oil and gas receipts are considered principal, while the remaining
10 percent are income.
-
Timber, Christmas trees, and Plywood for Commercial Sale
or Use - If the timber cut and removed does not exceed the growth rate of
timber during the accounting periods in which a beneficiary has a mandatory
income interest, then net receipts are allocated to income. Any amount removed
in excess of the growth rate is considered principal. If the net receipts
are from the lease of timberland or from a contract to cut timber from land
owned by a trust, then net receipts may be allocated between income or
principal. In determining net receipts to be allocated, a trustee should
deduct and transfer to principal a reasonable amount for depletion.
-
Liquidating assets, such as leaseholds, patents,
copyrights, and royalty rights
- Property subject to depletion was revised to allocate 90 percent of the
amounts received to principal and the remainder to income.
-
Decedent's estate or terminating income interest
- An income beneficiary's estate will be entitled only to the net income
actually received by a trust prior to the beneficiary's death and not the
accrued income.
-
Derivatives (such as interest
rate swaps) and Options (not embedded) - If the department does not maintain
separate accounting records for these transactions, then the trustee shall
allocate to principal, receipts from and disbursements made in connection with
such transactions. A gain or loss that occurs because the trustee marks
securities to market or to another value during an accounting period is not a
transaction in a derivative financial instrument that is income or principal
under the Act. Only cash receipts and disbursements are included.
Options include an option to purchase real estate owned by the trustee and a
put option purchased by a trustee to guard against a drop in value of
marketable stock that must be liquidated to pay estate taxes. The
practice of selling call options on securities owned by the trust, if the terms
of the option require delivery of securities, is also included in this
definition. However, this does not apply if the consideration received or
given for an option is something other than cash or property, such as
cross-options granted in a buy-sell agreement between owners of an
entity.
-
Asset-backed securities, including real estate
mortgages, credit card receivables,
and
Auto Loans - If a
trust receives a payment, the trustee shall allocate to income the portion of
the payment which the payer identifies as being from interest and the balance
to principal. If a trust receives one or more payments in exchange for
the trust's entire interest in an asset-backed security in one accounting
period (defined as a calendar year or can be a 12-month period if selected by a
fiduciary), the trustee shall allocate the payments to principal. If a
payment is one in a series of payments that will result in the liquidation of
the trust's interest in the security over more than one accounting period, the
trustee shall allocate 10 percent of the payments to income, and 90 percent to
principal. An example of the final point is a busted
PAC tranche, where the class protection has been eliminated.
-
Inflation-indexed bonds
- Any increase in principal due to inflation after issuance is principal upon
redemption, if the bond matures more than one year after the trustee acquires
it; if it matures within one year, all of the increase is considered
income.
-
Deferred
compensation, annuities,
and
similar payments
- If no part of a payment is characterized as interest, dividend, or
equivalent, and all or part of the payment is required to be made, the trustee
should allocate to income 10 percent of the part that is required to be made
during the accounting period and the balance to principal. Payment is
defined to include a payment made in money or property from the payer's general
assets or from a separate fund created by the payer, including a private or
commercial annuity, an IRA, and a pension, profit-sharing, stock-bonus, or
stock-ownership plan. If no part of the payment is required to be made or
the payment received is the entire amount to which the trust is entitled, the
trustee shall allocate the entire payment to principal. A payment is not
"required to be made" is defined as to the extent that it is made because the
trustee exercises a right of withdrawal. To obtain an estate tax marital
deduction for a trust, the trustee should allocate more to income to obtain the
deduction.
-
Disbursements from income are
based on recurring items that are not specifically tied "To an"
asset. For example, trustees' fees can be charged against either principal or income or both,
while title insurance and real estate taxes must be assessed against
principal.
-
Generation-skipping transfer taxes
are payable from principal.
-
Disbursements made for environmental matters
- Includes reclamation, environmental assessments, remedy and removal of
environmental contamination, monitoring of remedial activities and the release
of substances, preventing future release of substances, collecting amounts from
persons liable or potentially liable, penalties imposed by law or regulation,
and defending claims based on environmental matters. All environmental
expenses are payable from principal, based on the assumption that the expenses
will be extraordinary in nature. However, if the trustee is carrying on a
business that uses or sells toxic substances, and cleanup costs would be a
normal cost of doing business, then the expenses could be allocated to
income.
-
Income tax obligations
resulting from the ownership of Subchapter s corporation stock and
interests in partnerships
- Income from a partnership is based on actual distributions from the
partnership, in the same manner as corporate distributions. Distributions
from corporations and partnerships that exceed 20 percent of the entity's gross
assets will be principal whether or not intended by the entity to be a partial
liquidation.
-
Income tax obligations are allocated based on the
source. If the tax is based on receipts allocated to income, the tax is paid from income. If
the tax is based on receipts allocated to principal, then the tax is paid from
principal.
-
The
power to make adjustments between principal and income to correct
inequities caused by tax elections or peculiarities in the way the
fiduciary income tax rules apply. This allows fiduciaries to make adjustments as necessary to
re-allocate principal and income to make taxes equitable, based on prior
tax elections. For example, individuals may elect to have taxes paid
annually or at maturity on the income from savings bonds, although the income
is not distributed, but added back to principal. In this situation, if
the tax election was to pay taxes annually, the income beneficiary may be
responsible for income tax on cash flows that the principal beneficiary may
enjoy in the future.
When dealing with principal and income, however, examiners should be
aware that the distinction between principal and income is not important for
personal agency and employee benefit trusts. As previously stated, the
trustee is under a duty to deal impartially with beneficiaries, when there are
at least two beneficiaries. For agency or employee benefit accounts, there is
one class of beneficiaries.
D. Carrying Values
Unlike commercial bank accounting, where assets and liabilities are
carried at cost or book value, there is no generally accepted system for
assigning carrying values to assets held by trust institutions. The examiner
may find that the assignment of carrying values will vary not only from
institution to institution, but also from one account to another within the
same trust department. This makes a meaningful analysis of trust department
statements of condition difficult, if not impossible, without knowing which
valuation methods are used to prepare the statements. One or several of the
following methods are generally used as asset carrying values in any given
institution:
-
Book or cost of the asset;
-
Tax cost or date of death valuation when acquired from a decedent's
estate;
-
Par value, the face value of property; or
-
Nominal value, assigning a nominal value to each item or interest of
ownership in an asset, or miscellaneous items such as insurance policies and
indentures. Stocks may also be carried at a nominal value for the number
of shares held, particularly in custody or safekeeping accounts.
For Call Report, Schedule T purposes, trust assets should be reported
at market value, where asset values can be determined by a market or trading,
or by other sources, such as appraisals. Nominal values are permitted as
described above.
E. Accounting Records
As mentioned earlier, the level of sophistication of trust
departments varies from institution to institution. Records will also vary
since, in addition to the differences relating to the size and character of the
accounts administered, trust accounting systems are not standardized. However,
the reporting requirements imposed on fiduciaries and the concepts involved
remain the same. Therefore, the overall framework of each accounting system
consists of the following:
E.1. General Ledger
The general ledger will comprise all control accounts of the
department. It includes both customer and internal accounts used by the
department to facilitate its operation. Many automated systems have subsidiary
control records but do not have the traditional "general ledger". The examiner
must exercise judgment in determining the sufficiency of the records
encountered.
E.2. Asset Control Accounts
These accounts should reflect the total holdings of the major asset
categories, such as stocks, bonds, or deposits.
E.3. Subsidiary Asset Controls
These accounts will reflect the total investments in specific issues
of stocks, bonds, etc.
E.4. Subsidiary Liability Controls
These records will reflect the total of cash and investment holdings
of each type of account administered. This category should be further
subdivided to allow for transactions to be posted to individual accounts. The
cash ledger should detail income and principal cash, and reflect transactions
in chronological sequence. The investment ledger should reflect each asset held
by a trust account. Purchases, sales, stock dividends and splits should be
recorded in chronological order. The examiner must bear in mind that some
indentures provide for the reinvestment of income cash, and that it is common
practice to invest "income" until it is distributed. In these situations, it
will be necessary to maintain separate ledgers to account for those assets
consisting of "invested income".
F. Trust Records
In addition to maintaining a reliable system of accounting, a trust
department needs other records to administer accounts in a timely and
cost-effective manner. The design and control of these support records can mean
the difference between a smoothly functioning department and one that may have
to search through unorganized records when an administrative action needs to be
taken. Moreover, departments with detailed and accurate records are less likely
to be adversely affected by personnel turnover, errors in judgment, or
contingent liabilities.
While some smaller, noncomplex trust departments may continue to
maintain trust records manually, most institutions now maintain trust records
electronically. Electronic recordkeeping systems are acceptable, provided
that the institution has implemented adequate internal controls and procedures
to ensure the integrity of trust department records. Two important records are
the Administrative File and the Tickler System.
F.1. Administrative File
The administrative file consists of interrelated records, which,
as a whole, represent the history of an account. The records of the
administrative file may be contained in a single file or in several files
within the department. These records consist of:
F.1.a. Legal File
Contains copies of all legal documents relevant to the account,
including the document creating the account, such as a will, a trust agreement,
or a court order.
F.1.b. Digest or Synopsis
Synoptic records provide a concise summary of the principal duties
and provisions of the legal documents governing the account, and may also
provide other important information, such as beneficiaries, remaindermen,
remittance instructions, and reporting requirements. Synoptic records are
especially valuable to trust department management and administrative
officers. This document may be a paper document maintained in the account
file or in an electronic format.
F.1.c. Correspondence File
Contains all correspondence related to the account.
F.1.d. Investment Review File
Contains asset reviews, which enable management to evaluate
investment performance.
F.1.e. Securities Transaction File
Contains broker confirmations and other data related to changes in
securities holdings during the life of the account.
F.1.f. Tax File
Contains tax-related documents and copies of tax returns filed for
the account.
F.2. Tickler System
A tickler system is a chronologically arranged system of
records, which reminds department employees to collect income, distribute
funds, calculate trust fees, etc. A tickler system can be maintained in
electronic or paper format. Though simple in design and concept, the
effective use of tickler systems can be critical for account administration.
F.3. Other Records
Other records which affect the operation of a department to a
significant degree and which an examiner will find useful in the examination
process are:
F.3.a. Securities Transaction Register
This record should list in chronological order all the securities
transactions effected by the department. This record will most likely be in
electronic format. The preparation and content of this document, as well
as other records pertaining to securities transactions, are subject to
Part 344 of the Corporation's Rules and Regulations.
F.3.b. Vault Control Log
This log is used to record the dates and identities of individuals
who access the department's vault. Records should also be maintained indicating
the items accessed and the reasons therefore.
F.3.c. Broker Statements
The statements reflect all transactions effected for the department
by brokers. These statements should be reviewed carefully by the staff and
reconciled to broker confirmations and the Securities Transaction Register.
G. Account Documentation
Documentation is as important as the administration itself, as
fiduciaries must account for their actions to others. Challenges to account
administration, resulting in complaints or litigation, may occur years after a
particular transaction has occurred. The failure to maintain documentation that
adequately supports the actions taken, including the rationale for such
actions, may result in court-imposed surcharges or negotiated loss settlements.
Examiners will encounter two basic types of documentation: documents evidencing
the fiduciary's appointment and the creation of the account, and documents
supporting the actions taken by the fiduciary during the term of the account.
G.1. Evidence of Appointment
In general, a fiduciary should refrain from taking any action until
it receives proper evidence of appointment and an original or authenticated
copy of the instrument creating the account. Valid evidences of appointment
depend upon the type of appointment. In the most basic appointment, such as a
personal agency, the department need only execute an agreement with its
customer. The same is true for a living trust. In accounts operating under
court jurisdiction, such as estates, trusts under will, and court-appointed
guardianships, the fiduciary will need to obtain a court order of appointment
in addition to the instrument creating the account. In estates where the
executor has been named in the will, the court appointment is called Letters
Testamentary. In estates where named executors cannot or do not accept the
appointment, a court will appoint an administrator for the estate under Letters
of Administration. Letters of Administration are also used to appoint an
administrator where no valid will exists or where the will does not nominate an
executor. Trustees named in a will serve under Letters of Trusteeship.
Guardians serving under court appointment are issued Letters of Guardianship.
In corporate appointments, the fiduciary should obtain a resolution for
appointment, as well as a copy of the instrument it will be serving under. In
accepting appointments to serve as successor to a prior trustee or executor,
the fiduciary should obtain:
-
Copies of the original court appointments (if applicable),
-
An authenticated copy of the instrument it will serve under,
-
An accounting of the estate, trust, or agency from inception to its
appointment, and
-
Any other documents substantiating its appointment, or indemnifying
it against the actions of others.
G.2. Supporting Documentation
During the term of an appointment, numerous actions may be taken to
serve the needs of the account and its beneficiaries. At times these actions
involve nothing more than processing an address change for an income
beneficiary. Others may involve actions having serious consequences for the
account, such as principal invasions or selling assets at a capital loss. A
fiduciary must be able to support its actions by demonstrating it had the
necessary legal authority and that it exercised sound judgment. The fiduciary's
legal authority will be found in common law, statutory law, and the underlying
indenture. The rationale for its actions may be more difficult to demonstrate;
therefore, it is essential that the fiduciary be able to justify its actions,
which requires adequate documentation. The types of documentation the fiduciary
should maintain are:
G.2.a. Trust Committee Minutes
Deliberation and action over matters affecting the account.
G.2.b. Approvals
Written approvals of discretionary actions are sometimes required by
indentures and, at other times, are merely prudent. Written approvals should
always be sought from co-fiduciaries. When extraordinary actions affect
individuals having a future interest in an account, the fiduciary should seek
written approvals from all remaindermen.
G.2.c. Indemnification
Certain discretionary actions may involve controversial matters, such
as purchasing own-bank or parent securities or performing duties not specified
in trust indentures, but requested by others, such as co-fiduciaries or
remaindermen. These actions require more formalized written approvals in the
form of agreements or court rulings indemnifying the fiduciary against loss.
G.2.d. Accountings and Customers' Statements
These are required for court-appointed accounts, but may be prepared
for other types of accounts. Essentially, the listing or statements reflect all
account transactions occurring during a specific period of time. Either the
court having jurisdiction, all interested parties, or both should approve
accountings.
Customer statements should be provided in compliance with the
governing agreement or at least annually. Most trust departments provide
at least quarterly statements.
G.2.e. Account Reviews
Periodic reviews performed by the trust committee.
G.2.f. Receipt and Release
This is a formal document acknowledging the receipt of cash or
assets. It is given by the recipient to the fiduciary, and releases the
fiduciary from any further obligation with respect to a bequest or other
distribution. This section applies to the physical transfer of assets and
not to book-entry transfers.
G.2.g. Other Documents
There are numerous documents a fiduciary will obtain during the
administration of an account. These might include property appraisals, lease
agreements, broker confirmations, receipts for contracted work, or investment
research. Each has its own significance, and depending on the nature of the
appointment, may serve to support and indemnify fiduciary actions.
H. Internal Controls
H.1. Segregation of Duties
One of the most fundamental methods of internal control is the
segregation of duties. One individual should not be capable of initiating,
authorizing, executing, and subsequently reviewing a transaction for
appropriateness. In a trust department, this concept begins by segregating
administrative from operational functions and continues by segregating duties
within the operating system itself.
Many
FDIC-supervised trust departments are relatively small in size and
the segregation of duties is often not economically practical. In
these cases, an institution should develop compensating controls.
One compensating control easily employed by smaller institutions is
the requirement that a second person be involved in executing a
transaction. This can be implemented by having a second individual
approve a transaction in writing. But it is effective only if the
second person reviews the supporting documentation and understands
the transaction being approved.
Management
is responsible for assessing the specific requirements of the
department and adopting an overall system of policies and
procedures. Examiners should evaluate the adequacy of these policies
and procedures, and determine compliance therewith.
H.2. Vacation Policy
Supervisory
agencies and auditors have long recommended the practice whereby
personnel are required to be continuously absent from their jobs or
duties for a given amount of time and their duties assumed by
another employee. During such an absence, the possibility of
detecting irregularities is much greater, as the employee who is
absent is unable to effectively control the situation. The FDIC has
encouraged an uninterrupted absence of at least two weeks. However,
compensating controls, such as the rotation of personnel among
different jobs and duties, can constitute an acceptable alternative
to a policy requiring a continuous two week absence.
H.3. Reconcilements
The
reconcilement of deposit accounts, suspense accounts, and securities
depository statements should be performed regularly by individuals
who are independent of these functions, i.e. individuals who do not
initiate, authorize or post such transactions to the recordkeeping
system. It is acceptable to have personnel in the commercial
department reconcile he aforementioned trust accounts to maintain
the separation of duties.
H.4. Other Elements of
Control
The
organizational structure of a trust department is another component
of overall control. Management must define functional lines of
responsibility and establish an organizational framework along those
lines. Work should flow in a logical manner. The
organizational structure should take into account the need for
checks and balances, as well as the need for an efficient, practical
system. Control systems should be reviewed regularly and updated as
necessary.
Examiners
should consider the extent to which the Board and management have
provided for the following:
- Adequate staffing to provide for efficient
and timely processing and appropriate separation of duties;
- Compensating controls where limited staff
precludes separation of duties;
- Clearly
defined responsibilities, duties, and lines of authority;
- Prompt
reporting and correction of internal control deficiencies;
- Adoption of a comprehensive operations
manual, which is updated to reflect changes as
needed.
Examiners
should assess the effectiveness of the department's internal control
practices in protecting and controlling trust assets. Controls
may include the following:
- Trust
assets are required to be separated from the assets owned by the
institution;
- More
than one employee should be present when assets are
received;
- Written
confirmations signed by beneficiaries or accountholders should be
maintained for all items distributed;
- Assets
held in the vault should be under dual control and verified
periodically;
- The
value of worthless assets should be determined and those assets
maintained on the department's books at nominal value;
- Hold
and return mail procedures should be established;
- Appropriate controls should be maintained
over unissued checks (or pre-printed check paper), including the
use of sequentially numbered documents;
- Signature controls should be established for
the disbursement of trust funds.
Examiners
should consider the extent to which the department's recordkeeping
systems provide for accurate and reliable recordkeeping and
reporting:
- Maintain records in sufficient detail to
properly reflect all trust department activities;
- Report
the assets of each trust account separately from the assets of
other accounts;
- Account
separately for principal and income according to the governing
agreement, or if the document is silent, the state principal and
income act;
- Process
trust department transactions in a timely and accurate
manner. This should include processing for securities income
and maturity through automated systems; securities pricing and
rating services; mutual fund and cash sweep transactions, and,
corporate actions that affect securities holdings.
Other
Internal Routine and Control Issues:
- Reconciliation of statements from securities
depositories, brokerage accounts, internal accounts (suspense and
own-bank), deposits at other institutions, mutual funds, and cash
management services should be performed by a person independent of
those preparing or authorizing entries or disbursements;
- Audit
trails for all accounting transactions should be maintained;
- The
effectiveness of internal controls should be assessed to ensure compliance with applicable laws and
regulations;
- Vault
control procedures should be established and
include recording access to the vault and transferring of
assets to/from the vault;
- All
assets should be verified periodically;
- Daily
proof of transactions (balancing and closing routines) should be
performed;
- Administrators should review and sign
transaction journals ;
- Management should provide for internal and/or
external audits;
- Accounting records should be maintained on a
current basis;
- Dual
signatures should be required for checks above a specified amount;
- Documentation should be required for asset
changes, cash distributions, and/or large overdrafts;
- Pre-numbered checks, in either manual or
electronic format, should be used in sequential order;
- Records
should be proofed by individuals not authorized to post them;
- Account
reviews should be performed by individuals other than the
administrator assigned to them;
- Investigation and resolution of stale
accounting items and out-of-proof conditions should be made in a
timely manner;
- Prompt
investigation and reporting of suspicious transactions and
activities, including the filing of suspicious activity reports,
should be made;
- Separate control over checks returned
undelivered should be established;
- Procedures for the reissuance of returned
checks should be established;
- An
adequate record retention policy should be
established.
Examiners
should realize that an effective system of internal controls
designed to establish dual control, separation of duties, and the
rotation of employees may be costly. Many trust departments are
unprofitable measured by any standard, and trust officers may resist
implementation of expensive control measures. Examiners need to
exercise judgment in assessing a department's control systems. One
or more basic points may have deficiencies, but the system may be
strengthened by bolstering others. Often this is accomplished by
reliance upon a strong audit, whether by an internal or external
auditor.
H.5. Fraudulent Acts
While the
discovery of fraudulent acts is not the primary objective of a trust
examination, the examiner should be alert to a culture that permits
such acts. The Board and senior management should establish a
corporate culture that encourages ethical behavior, and that belief
should be reflected in their own practices, as well as in the
corporate policies and procedures. However, fraudulent acts
occur, when there is a perception that management does not practice
what it preaches or when management is unconcerned with
deterrence. The Board and management can change this
perception by appointing a member of senior management to oversee a
fraud prevention program and that officer being accessible to and
having open, two-way communication with staff. One of the most
common methods of fraud detection is other employees telling a
member of management of activities witnessed.
However, deterrents are the major factor in fraud prevention.
strong internal controls and monitoring compliance with those
controls is a major deterrent to fraud. Therefore, management
should establish procedures for testing compliance with the
department's policies and procedures, in addition to implementing a
reasonably designed audit program. Employees are
less likely to attempt to defraud an entity, when deterrents are
visible to the employee.
The
following are areas that are particularly susceptible to
manipulation and abuse:
- Failure to record
the receipt of assets when accounts are opened. The
unwitnessed assembling of assets, particularly those of a
decedent's estate, is a dangerous practice. In such cases, the
detection of theft may be impossible since no record of a missing
asset exists.
- Unauthorized and
forged withdrawals of cash and securities from accounts. The
absence of effective dual control makes such actions easy for the
manipulator. One method is to transfer assets to an account under
an embezzler's control. Once the assets are in this account, the
individual is free to sell the assets for personal gain, use them
in market speculation, or pledge them for personal loans.
- Diversion of stale
outstanding checks, inactive trust deposits, and assets of dormant
trust accounts for personal gain. A combination of
independent and timely reconcilement procedures, together with the
periodic tracing of transactions from initiation to conclusion can
greatly reduce the likelihood of such diversions.
- Conversion of
payments received on securities believed to be worthless.
A trust department's policy guidelines
on worthless securities should include procedures to be followed
when determining an asset's worth. Requirements that all assets
deemed worthless be reported to the trust auditor or an
appropriate committee prior to being written off and the carrying
of worthless assets at a nominal value either in the respective
accounts or in controlled suspense accounts decrease the
susceptibility to manipulation. This also supports a continuous
audit trail of the asset from start to finish.
- Diversion of
income on assets received in either irregular amounts or at
irregular intervals. Such income is usually derived from
royalties, oil wells, and the like. Income from all investments
should be internally controlled and audited, with added attention
given to those situations where investments fail to produce
income. In this connection, several defalcations have occurred by
the diversion of payments of interest and principal on debt
obligations previously in default.
- Falsification of
expenses and misapplication of trust commissions and fees.
Expenses and recurring fees present possibilities for
manipulation. The adopted policy should require that expenses be
accompanied by appropriate documentation. The trust administrator
should not have control or access to expense checks. Similarly,
adequate internal safeguards should exist to assure the crediting
of trust commissions and fees to the appropriate income accounts.
- Manipulation of
payments received on rental properties, real estate, and real
estate mortgages. The administration of these trust
properties frequently involves handling cash payments received in
the department by personal deposit or through the mails. Unless
strong internal controls are in effect, defalcations through
overlapping or withholding of payments could occur.
- Improper use of
suspense accounts. Frequently, trust department suspense
accounts are not governed by good internal control procedures, and
unauthorized settlements or disbursements may easily occur.
- Improper
securities trading practices:
- Placing personal trades through bank
accounts, thereby obtaining the advantage of the bank's volume
discounts on commissions;
- Purchasing or selling an issue of
securities prior to executing bank or trust account trades which
could be expected to change the price of the security, thereby
obtaining a personal price advantage ("front-running");
- Purchasing and selling the same securities
issue on the same day, with the trader pocketing any price
increases and assigning transactions to trust accounts in the
event of any price decreases; and
- Buying or selling based on nonpublic
material inside information, which might affect the price of
securities, thereby enabling the trader to benefit personally
from the transaction.
- Misuse of
corporate bonds, notes, and stock certificates in the bank's
possession as corporate trustee or agent under indenture.
Inventories of unissued securities not under effective control
could be stolen and used as collateral for loans. Securities
remitted for payment or transfer not properly controlled could be
used for the same purpose.
I. Nominees
Most trust departments register securities in
a "nominee" name. Nominee registration simplifies the
transfer of stocks and bonds, and facilitates the collection
of dividends and interest. When a securities issuer pays interest
or declares a dividend, the bank receives a single dividend or
interest payment in the nominee name in which the security is
registered. The department subsequently credits the accounts
holding the particular security, typically using an automated
report called a "dividend map." Without the use of
nominee registration, separate dividend or interest payments
would be received for each account holding the security.
Nearly all states provide by statute that securities may be registered
in nominee form. Most governing trust instruments also authorize
the use of nominee registrations. "Nominees" are legal
partnerships comprising designated officers and/or employees of
the bank. The bank's board of directors should approve the execution
of the partnership agreement and, in most jurisdictions, register
the partnership with the state.
Examiners should determine that the bank's nominee partnership
agreements are reviewed periodically to ensure they are current,
and include only current authorized officers and/or employees in
the partnership agreement.
J. Use of Broker-Dealers
For Securities Safekeeping/Securities Investor Protection
Corporation (SIPC)
Financial
institution letter FIL-38-2002 was issued on April 25,
2002, and discusses credit risks arising from securities held at
broker-dealers and Securities Investor Protection Corporation (
SIPC ) coverage. A copy of the
financial institution letter may be found in Appendix C. SIPC covers most types of securities, such as
stock, bonds, and mutual funds. However SIPC does not protect
against declines in market value. Also, SIPC does not provide
protection for investment contracts that are not registered with the
SEC.
Another
coverage problem may occur when investors place cash or securities
in the possession of non-SIPC members. The trust
department may do business with a company that doesn't actually
execute buy and sell orders, but instead uses another firm, known as
a clearing firm, to process trades. Therefore, trust
management should make sure that the brokerage firm and its clearing
firm are both members of the SIPC.
In
general, during a liquidation of a broker-dealer, SIPC will request
the court to appoint a trustee which will (1) return property that
is registered in a specific customer name, (2) pay those customers
their pro rata share of "customer property", and (3) provide
customers (other than banks and broker-dealers for their own
accounts) SIPC advances up to the $500,000 limit. Customers not
subject to SIPC protection, such as banks, will receive a pro rata
distribution of "customer property." Therefore, banks and
trust departments must be able to differentiate between bank-owned
and bank customer-owned accounts and securities.
Furthermore, trust department management should exercise due
diligence when selecting broker-dealers and establishing a custodial
relationship. Thereafter, relationships with broker-dealers
selected should be periodically reviewed.
K. Free Riding and
Daylight Overdrafts
"Free
riding" occurs when customers buy and sell securities, usually on
the same day, in amounts greatly exceeding the amount allowed under
margin collateral requirements. The purchaser intends to pay
for the purchased securities with proceeds from the sale of the same
securities. The concept is similar to a check kiting
scheme. Since funds are not made available by the purchaser
prior to the purchase, it is a means whereby a bank, typically
through its trust department, may suffer losses. The Securities and
Exchange Commission has investigated and brought enforcement against
a number of firms or individuals for securities free
riding.
Free
riding often begins when a custodial account is opened with a trust
department. The customer also establishes brokerage accounts through
which the customer directs securities trades. The customer then
advises the broker-dealer that payment for such trades will be made
through the custodial account.
The
customer attempts to profit from short-term changes in market prices
of securities, without placing significant personal funds at risk.
Free-riders, anticipating a near-term price increase, frequently
place a buy order for securities with the intention of paying for
the securities with the proceeds from the sale of the same
securities.
Banks
permitting such transactions without requiring adequate margin
collateral face significant risks when customer accounts do not
contain sufficient funds to cover purchase orders or enough
securities to complete sell orders. These risks include:
(1) enforcement actions for violation of the Federal Reserve
Board's Regulation U (12 CFR 221) margin lending
standards, or for aiding and abetting violations of
Regulation X (12 CFR 224), or Regulation T
(12 CFR 220); and (2) losses caused by the need to
complete failed customer trades.
The
Federal Reserve has also taken the position that intraday or
"daylight overdrafts" relating to the purchase or sale of margin
stock is considered an extension of credit subject to Regulation U.
Violations of Regulation U may therefore be cited in situations
where intraday overdrafts occur due to the purchase or sale of
margin stock.
Policies
and procedures for accepting custodial accounts and for clearing
securities transactions should include measures to prevent free
riding. Such policies and procedures should:
- Set
standards for the acceptance of new custodial accounts, including
customer background and credit information.
- Determine whether the new customer intends to
use the account to obtain bank credit for transactions as if it
were a margin account at a broker-dealer, and if so, ensure that a
FR U-1 form is completed for compliance with Regulation U.
- Require
identification of broker-dealers sending securities to, and
receiving funds from, customer accounts, and establish systems to
track accounts involving numerous broker-dealers;
- Disaffirm customer trades where acceptance
would result in a violation of Regulation U; and
- Determine that each account has sufficient
funds to cover any trade or, if margin credit is extended, that
collateral requirements are met.
Financial
Institutions Letter FIL 76-93, dated November 4, 1993, provided
material on this subject, and may be found in Appendix C. Also, the
Federal Reserve Board issued a supervisory letter discussing the
Federal Reserve's margin lending requirements as they apply to free
riding (SR 93-13, dated March 16, 1993).
L. Facilities
A trust
department must have sufficient space and the necessary equipment to
accomplish its duties. It is desirable that the department be able
to conduct its activities in a segregated, or at least clearly
delineated, work space. The size and complexity of the assets under
management and the department's prospects for future growth form
much of the basis for determining premises and equipment needs. In
reviewing this factor, examiners should consider the department's
work flow, the appropriateness of safeguards over records, the
presence of negotiable assets and the ability to maintain effective
internal controls and segregation of duties.
M.
Information
Technology
Most trust
departments use automated trust accounting systems, with processing
performed either in-house or provided by a third-party
servicer. A review of Information Technology should be
performed by the Information Technology (IT) examiner, who will
determine the risk profile type and procedures to be performed by
completing the Technology Profile Script. The IT examiner
will review the agreements and disaster recovery program for content
at each IT examination. Therefore,
communication between the trust and IT examiners is essential for
coordinating the examination process and avoiding the duplication of
work. Significant deficiencies would normally be fully
presented in the IT examination report, with less detailed comments
in the trust examination report.
However,
the IT examination may not be performed during the same examination
cycle as the trust examination. Also, banks which have trust
subsidiaries may not have IT examinations of those
subsidiaries. In either circumstance, the trust examiner
should review the prior IT examination report for comments
pertaining to trust technology, if available. Once onsite, the
trust examiner should confirm that appropriate routine and controls
are in place. The following are examples of appropriate
routine and controls in an automated environment:
- System
access should be password restricted and passwords should be
changed frequently.
- Passwords should be set to a reasonable
minimum number of characters, symbols, and numbers. However,
words, proper names, or social security numbers should not be used
as passwords.
- Access
to records should be limited by the employees' position or
duties.
- Automated records should be reconciled and
any exceptions should be cleared in a timely manner.
- Suspense accounts should be monitored closely
and the individual who reconciles and monitors suspense accounts
and other automated records should not be the same person who
enters the data.
- Exception reports should be reviewed by trust
management.
- The
GLBA workprogram should be completed for the trust
department.
Trust
examiners should be aware that Section 7(c)(2) of the Bank
Service Corporation Act and FDIC Section 304.3(d) require that
the FDIC Regional Office be notified of the existence of the
servicing arrangement within 30 days of the contract or start of
service (Form 6120/06: Notification of Performance of Bank Service,
may be used). It may be possible for banks to submit this
information over FDICconnect webpage.
Trust
examiners should recommend that management obtain and review a copy
of the third party servicer's independent audit, known as the
Statement of Auditing Standards #70, or SAS
70. This
report should be reviewed by the trust, technology, and/or audit
committees prior to entering into a servicing contract and
periodically thereafter.
Electronic Banking
Electronic
banking applications have increased in the trust area, although the
level and sophistication of these applications vary widely.
Informational websites which advertise trust and other bank services
are the most basic. Transactional applications, which allow
customers to make changes to 401(k) plans and obtain current
portfolio valuations, are much more complex. While this
aspect should be incorporated into the IT examination, trust
examiners need to be aware of electronic banking applications and
their potential risks. Primary examination guidance and
information may be found in the FFIEC IT Examination Handbook and
Electronic Banking Workprogram.
The trust
examiner should notify the IT examiner when e-banking applications
are more than basic. The following is an overview of strategic
planning and goals, administrative controls, and information
security program assessments.
The Board
and senior management are responsible for developing the
institution's e-banking business strategy, which should include the
following:
- The
rationale and strategy for offering e-banking services, including
informational, transactional, or e-commerce support;
- A
cost-benefit analysis, risk assessment, and due diligence process
for evaluating e-banking processing alternatives, including third
party providers;
- Goals
and expectations that management can use to measure the e-banking
strategy's effectiveness; and,
- Accountability for the development and
maintenance of risk management policies and controls to manage
e-banking risks and for the audit of e-banking activities.
The Board
and senior management must provide effective oversight of
third-party vendors providing e-banking services and support.
Effective oversight requires that institutions ensure the following
practices are in place:
- Effective due diligence in the selection of
new service providers that considers financial condition,
experience, expertise, technological compatibility, and customer
satisfaction.
- Written
contracts with specific provisions protecting the privacy and
security of an institution's data, the institution's ownership of
data, the right to audit security and controls, and the ability to
monitor the quality of service, limit the institution's potential
liability for acts of the service provider, and terminate the
contract;
- Appropriate processes to monitor vendor's
ongoing performance, service quality, security controls, financial
condition, and contract compliance; and
- Monitoring reports and expectations including
incidence response and notification.
The Board
and senior management should ensure that the information security
program addresses these challenges and takes the appropriate
actions:
- Ensure
compliance with the "Guidelines Establishing Standards for
Safeguarding Customer Information" pursuant to section 501(b) of
the Gramm-Leach-Bliley Act of 1999 (GLBA).
- Ensure
the institution has the appropriate security expertise for its
e-banking platform.
- Implement security controls sufficient to
manage the unique security risks confronting the
institution. Control considerations should include the
following:
- On-going awareness of attack sources,
scenarios, and techniques;
- Up-to-date equipment inventories and
network maps;
- Rapid identification and mitigation of
vulnerabilities;
- Network access controls over external
connections
- Hardened systems with unnecessary or
vulnerable services or files disabled or removed;
- Use of intrusion detection tools and
intrusion response procedures;
- Physical security of all e-banking computer
equipment and media; and
- Baseline security settings and usage
policies for employees accessing the e-banking system or
communicating with customers.
- Use verification procedures sufficient to
adequately identify the individual asking to conduct business
with the institution.
- Use authentication methods sufficient to
verify individuals are authorized to use the institution's
systems based on the sensitivity of the data or connected
systems.
- Develop policies for notifying customers in
the event of a security breach effecting their confidential
information.
- Monitor and independently test the
effectiveness of the institutions security program.
N. Business Continuity
Planning
As part of
the Information Technology examination process, the entire bank, not
just the Information Technology of the Commercial Department, should
be reviewed. However, trust examiners need to be aware of the
general concepts of business continuity planning.
Business
continuity planning, also referred to as contingency planning,
encompasses various aspects of the continuation of the trust
business. In general, the planning process should incorporate
establishing strategies for alternate facilities, employee work
space, office equipment, files, etc. The goal is
provide at least a minimal level of service to maintain business
operations and retain customers. Therefore, the Board and
senior management should establish policies, procedures, and
responsibilities for the entire institution's continuity
planning. The written plan should address administrative
procedures, recovery items, list of contacts and locations for each
aspect of the trust department's business profile. However,
management should address the following:
- Backing
up all software and data files not covered by the IT Department.
- Maintaining adequate supply of pre-printed
forms and checks off-site
- Providing for duplicate corporate and notary
seals to be stored at a secure, off-site location
- A plan
to contact customers individually requires a list, which should
include customer names, addresses, and phone numbers.
- A plan
to contact customers via electronic means will require email
addresses or use of the bank's website.
Disaster
recovery is a subset of business continuity planning and is
primarily concerned with recovering critical data and item
processing, and communication networks. The three general
types of disasters are the following:
- Natural
- Weather-related, earthquakes, volcanic, wildfires
- Technical - Hardware or software failures or
crashes, explosions, hazardous material spills, fire, nuclear
power plant accidents, loss of electricity for extended periods of
time
- Civil -
Bomb threats, strikes, riots, criminal acts, sabotage,
terrorism,
O. Self-Directed IRA'S
and KEOGH Accounts
O.1. Directed
Arrangements
Section
333.101(b) of the FDIC Rules and Regulations permits banks to offer
self-directed IRA and Keogh accounts to customers without first
obtaining FDIC consent to exercise trust powers. Although banks are
permitted to offer these products without consent, the bank is
considered as trustee of the accounts, whether or not the bank
serves as custodian or trustee. The administration of IRA's
and Keogh accounts must comply with the requirements of the Internal
Revenue Code and applicable state laws. When self-directed accounts are offered
and booked as trust accounts, the accounts and related practices
should be reviewed during trust examinations. Regional
Director Memorandum 98-058, issued June 23, 1998, outlines
trust accounts subject to the Interagency Statement of Policy on
Nondeposit Investment Products. Those types of accounts and
applicable sections are summarized as:
- Self-Directed IRA and KEOGH Plans - Three
minimum disclosures from the Interagency Statement apply.
- Agency
accounts where the customer has sole investment discretion -
Interagency Statement applies in its entirety.
The three
minimum disclosures are the following: (a) Not insured by the
FDIC; (b) Not a deposit or other obligation of, or guaranteed by,
the depository institution, and (c) Subject to investment risks,
including possible loss of the principal amount invested.
If the
accounts are not trust accounts, then practices should be reviewed
as part of the Nondeposit Products review segment of the compliance
examination. Examination responsibility is discussed in an
Regional Director Memorandum 01-035 dated September 5, 2001.
The memorandum can be located on the Intranet. Additional
information and guidance are provided in the examination procedures
for Nondeposit Products.
The
following is a summary review of examination concerns in this area:
- Account
Documentation - The bank must have sufficient
documentation to adequately identify and support each account.
- Assets and Asset
Valuations - Appropriate methodology to determine
the market value of assets held in IRA and Keogh accounts should
be used. The valuation of unique and specialized assets such
as the securities of closely held businesses, mineral interests
and limited partnerships is difficult and often requires special
expertise. The assets of self-directed IRA and Keogh
accounts should be segregated from the bank's own assets, whether
kept in the bank's vault or at a correspondent bank.
- Accounting
Records - These should be separate from the bank's own
records, to properly reflect which assets belong to the bank's
customers.
- Investment
Advice - Investment advice must not be given to
self-directed accounts.
- Illegal
Investments - Although the customer directs the
investments in a self-directed account, the bank has a duty
(whether it is acting as trustee or custodian) to refuse to accept
illegal directions, either as to the type of asset held or as to a
prohibited transactions. For example, investments in
Subchapter S Corporations are prohibited, as are investments in
art, rugs, antiques, metals, gems, stamps, coins, or other items
of tangible personal property specified by the
IRS. (Note that certain coins, such as the American
Gold and Silver Eagles, are permissible IRA investments.) While
detailed analysis of each transaction is not required, the bank
does have a duty to refuse to execute illegal transactions.
Section 408(h) of the Internal Revenue Code treats custodians of
these accounts as trustees for tax purposes. Consequently, the
bank may incur liability for illegal acts within these accounts,
even though the accounts are self-directed.
- Recordkeeping - All investment
transactions for these types of accounts are subject to Part 344
of the FDIC Rules and Regulations.
- Audits/Independent
Review - An audit or independent review should be
performed for this activity. Coverage should include, at a
minimum, a proof of records, verification of assets,
reconciliation of any deposit and suspense accounts, a review of
the adequacy of internal controls, and compliance with law.
- Insurance -
The blanket bond insurance carrier should be notified.
- Assets and Asset
Valuations - Appropriate methodology to determine
the market value of assets held in IRA and Keogh accounts should
be used. The valuation of unique and specialized assets such
as the securities of closely held businesses, mineral interests
and limited partnerships is difficult and often requires special
expertise. The assets of self-directed IRA and Keogh
accounts should be segregated from the bank's own assets, whether
kept in the bank's vault or at a correspondent
bank.
O.2. Arrangements with Third Parties
The
popularity of self-directed IRA and Keogh accounts has prompted
nonbank financial service providers to offer these types of
accounts. The bank may act as agent between the nonbank
financial service provider and customers. When the bank or
trust department acts as agent only (the account is not accounted
for as a trust account or a commercial department account), these
accounts will be reviewed by Compliance Examiners, who will assess
compliance with the Interagency Statement of Policy governing
the sale of Nondeposit Investment Products.
P. Custodial Holdings of Government Securities:
Compliance With Government Securities Act of 1986
P.1.
Background
As a
result of several highly publicized failures of government
securities brokers and dealers and other improper practices,
Congress passed the Government Securities Act of 1986 (GSA). The
stated purpose of the GSA and its implementing Treasury regulations
is to enhance the protection of investors in government securities
by establishing and enforcing appropriate financial responsibility
and custodial standards. The GSA applies to (a) a bank which is a
government securities broker or dealer, (b) any bank which retains
custody of securities that are the subject of repurchase
transactions with its customers (hold-in-custody repurchase
transactions) and (c) any bank which holds government securities for
its customer. A customer, by definition, includes the counterparty
to a hold-in-custody repurchase transaction, but does not include a
broker or dealer that is registered as, or that has filed notice of,
its status as a government securities broker or dealer (§ 450.2(b)).
P.2.
Applicability
On
September 5, 2001, a Regional Director Memorandum was issued to
transfer supervisory responsibility from DOS to DCA for Nondeposit
Products, including insurance, retail sales of NDP, and Government
Securities Act of 1986. Review of the applicability of and
adherence to the Government Securities Act (GSA) should generally
occur during compliance examinations. The primary exception to
this transfer concerning GSA involves custodial holdings of
government securities in a trust department. That specific
activity should be reviewed during trust examinations.
Procedures
for conducting such examinations are contained in Regional Director
Memorandum 89-030, dated February 27, 1989. Treasury regulations
implementing the GSA are contained under the Miscellaneous Statutes
tab of the Prentice Hall service. In addition, several staff
interpretations by the Department of Treasury are included in the
Miscellaneous Statute tab of the FDIC Rules and Regulations.
P.2.a. With respect to broker-dealer
activities
If the
bank engages in broker-dealer activities related to government
securities, a separate examination report for such activities is
required. Pursuant to GSA Section 401.3(a)(2), the financial
institution must conduct at least 500 government securities
transactions, or does not have an arrangement with a registered
dealer to effect transactions in order to be subject to this
section.
P.2.b. With respect to government
securities repurchase transactions
Government Securities are defined to
include securities which are issued or guaranteed by corporations in
which the United States has a direct or indirect interest and which
are designated by the Secretary of Treasury for exemption as
necessary or appropriate in the public interest or for the
protection of investors. The following is a list of securities
that are considered to be government securities:
Commodity
Credit Corporation
Export-Import Bank
Farm
Credit Services including banks for cooperatives, intermediate
credit banks, and land banks
Federal
Home Loan Banks and Federal Home Loan Bank Board
Federal
Home Loan Mortgage Corp.
Federal
National Mortgage Association
Tennessee
Valley Authority
U. S.
Postal Service
Student
Loan Marketing Association
Federal
Housing Administration
General
Services Administration
Government
National Mortgage Association
Maritime
Administration
Washington
Metropolitan Area Transit Authority
Note: In general, if the title has the
word "development" or "development bank," it is not considered
a government security for this act.
- Where
the bank is the seller of the securities, i.e., borrower of funds,
and a trust account within the trust department of the same bank
is the purchaser of the securities, counterparty, or creditor, a
review of compliance with the GSA should generally occur at the
trust examination. In such situations, the buying of repurchase
agreements from the commercial side of the bank for trust accounts
will generally be regarded as a conflict of interest (refer also
to
Section 3, Asset Administration).
Where employee benefit plan monies are invested in own-bank
repurchase agreements, Prohibited Transaction Exemption
(PTE) 81-8 applies. PTEs are located in the
Appendix E.
- Where
an account administered by the trust department is the seller of
the security (i.e., borrower of funds), trust examiners
should review the administration as with any other account. In
particular, the circumstances leading to the transaction and the
borrowing (liability of the trust account to repurchase the
security) should be evaluated. If the counterparty is the
commercial department, consideration should be given as to whether
a conflict of interest is present. However, where the repurchase
agreement is between a trust account (i.e., the bank in its
fiduciary capacity) and an unrelated non-bank counterparty, there
is no need to review compliance with the GSA and implementing
regulations since Section 403.5(d) pertains only to repurchase
agreements between financial institutions (not financial
institutions as fiduciaries) and counterparties.
P.2.c. With regard
to custodial holdings of government securities for
customers:
- A
complete exemption from the GSA Section 450 is provided for
government securities held for customers by nonmember banks in a
fiduciary capacity. Fiduciary capacity, as defined in Section
450.2(d), includes: trustee, executor, administrator, registrar,
transfer agent, guardian, assignee, receiver, managing agent, and
any other similar capacity involving the sole or shared exercise
of discretion by a depository institution having fiduciary powers
that is supervised by a Federal or State financial institution
regulatory agency. This would normally exempt all activities
traditionally conducted in a trust department.
- Where
the bank is holding government securities for its customers (a
typical custodial arrangement) the activity is usually conducted
in conjunction with commercial bank customer services outside the
trust department. However, in some instances this activity may be
organized within the trust department. If so, trust examiners
should ensure that the provisions of the GSA are followed.
Examiners need to distinguish between the fiduciary capacities
described above, custodial arrangements involving only the
safekeeping of securities, and the performance of purely
ministerial acts as directed by the principal, but where no sole
or shared exercise of discretion exists. An exemption from Section
450 may also be available when customer securities are held
in a custodial capacity, if the nonmember bank adopts policies and
procedures that include all FDIC requirements applicable to
government securities held in a fiduciary capacity. These are
enumerated in the Regional Director Memorandum dated
February 27, 1989, on the GSA, and set forth as follows:
- The
nonmember bank adopts policies and procedures that apply all the
requirements of the FDIC that are applicable to government
securities held in a fiduciary capacity (listed in the following
section) to its custodial holdings, and
- These
custodial holdings are subject to examination by the FDIC for
compliance with FDIC fiduciary requirements. (All insured
nonmember banks would meet this requirement.)
FDIC
Fiduciary Requirements
- State
law regarding government securities held in a fiduciary capacity
must be followed.
- Government securities held in a fiduciary
capacity must be segregated from the bank's securities. Where
customer securities are held by a correspondent bank or outside
depository, such securities must be segregated in a separate
(separately identifiable) safekeeping account.
- No
liens, pledges, or any charges may be placed against government
securities held in a fiduciary capacity unless permitted by
written fiduciary contract or agreement. Customer government
securities may not be sold under agreement to repurchase, or
loaned to any party, unless specifically permitted by a written
agreement that is signed by the customer. No sales under
repurchase agreement or lending may be permitted unless
customers are adequately compensated monetarily, under written
agreement, nor shall they be permitted unless the securities are
adequately collateralized, preferably with securities of equal
quality, marketability, maturity, and interest rate. Customer
security interests in the collateral shall be perfected and held
by the bank or an independent third party.
- Records must clearly describe the fiduciary
capacity of the trustee and agreement with the customer.
- Records must clearly describe the
government securities, the customer's interests, all movements
of securities, and all transactions such as interest payments.
- A
safekeeping receipt or confirmation must be provided to the
customer.
- Adequate internal controls, such as
separation of duties, rotation of duties, dual control or joint
custody, must be in place.
- Adequate controls against external crime
must be in place.
- An
independent audit of assets and procedures must be conducted
yearly. In addition, safekeeping accounts shall be reconciled by
the bank at least monthly. Reconcilements shall be in written
form and available for review by Corporation examiners.
- The
fiduciary capacity must be adequately supervised.
Custodial
Requirements
If a
nonmember bank holds customer government securities in a custodial
capacity, and it does not qualify for the Section 450 exemption
described above, then the bank must comply with certain requirements
(largely paralleling the exemption provisions) set forth in the
regulation. Examiners should refer to the above-mentioned Regional
Director memorandum and the Department of Treasury regulations for
these requirements.
Q.
Shareholder Communications Act of 1985
Q.1. Background and
Requirements
The
Shareholders Communications Act of 1985 applies to all entities
exercising fiduciary powers. This includes trust departments holding
securities in nominee name or otherwise on behalf of beneficial
owners. The Act is implemented primarily by SEC Rule 14b-2. Essentially, the Rule
stipulates that banks must comply with certain requirements to
facilitate business communications between issuers of registered
securities ("registrants") and the holders of those securities
("beneficial owners"). The requirements address:
- Responding to inquiries for lists of
"beneficial owners,"
- Providing "beneficial owners" with proxy
materials (or requesting voting instructions), and
- Providing "beneficial owners" with annual
reports.
A
beneficial owner is any person who has, or shares the power to vote
pursuant to an agreement or otherwise, or directs the voting of, a
security. [SEC
Rule 14b-2(a)(2)]
While SEC Rule 14b-2 is the primary focus of
this material, the Rule makes numerous cross references to other SEC
regulations. SEC Rules 14a-1 and 14c-1 define relevant terms. Rules also
designate when and how materials are to be provided by the
securities issuer (SEC Rule 14a-13) and by broker-dealers
(SEC Rule 14b-1). SEC Rule 14c-7 defines how
materials are to be provided to investors. The text of these rules
appears in Appendix D.
Q.2. Applicability to Trust
Accounts
In general, all personal, employee benefit, and
corporate trusts which have investments in registered stock are
affected by these requirements.
- The requirements apply to all trust accounts
opened December 29, 1986 or later.
- The requirements do not apply to any trust
account opened on or before December 28, 1986 if either: (a) the
bank has a written affirmative request from "beneficial owners"
that information not be disclosed, or (b) the bank has made a
"good faith effort" [as defined by SEC Rule 14b-2(b)(5)] to obtain from beneficial owners their
consent to disclose such information.
R. State
Escheat Laws
Escheat is defined as a reversion of property
to the state in consequence of the lack of any individual qualified
to inherit the property. For trust departments, the issue will
generally arise concerning funds on deposit to pay unclaimed
dividends, bond coupons not presented for payment, bonds not
presented for payment and certain suspense accounts. Escheatment
laws primarily involve deposits. However, banks acting as bond
trustees, securities transfer agents, and paying agents must comply
with state abandoned property laws for: (1) checks and securities
certificates which are undeliverable, and (2) book-entry accounts
for which the owner cannot be located. Escheat laws vary from one
state to another. They will normally be found in state statutes
under titles such as "unclaimed property" or "abandoned property".
In some instances, one state may claim its escheat laws apply to
dormant funds also claimed by another state.
The trust operations area should have
procedures in place to ensure compliance with escheat laws.
Examiners should familiarize themselves with applicable state
escheat laws and be alert during examinations to stale items and
other instances where escheat laws might be applicable. Relevant
aspects of the escheat process are also discussed in
Section 5 (Employee Benefit
Accounts), and
Section 6 (Corporate Trust
Accounts).
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