4000 - Advisory Opinions
"Continuous Operation" Provision of 12 CFR 337.4
March 16, 1988
Gerald J. Gervino, Senior Attorney
In your recent letter, you have requested our concurrence with your conclusion that *** Brokerage Services Company, a wholly-owned subsidiary of your client, *** *** ("Bank"), *** may act as distributor and that another wholly-owned subsidiary of the bank, *** Management Corporation (***), may act as administrator, for certain mutual funds pursuant to Section 337.4 of our regulations 12 C.F.R § 337.4 (1987) and Section 103 of the Competitive Equality Banking Act of 1987. Because certain provisions of the Competitive Equality Banking Act of 1987 have expired, you have withdrawn by telephone your request with respect to the 1987 Act. Thus, we will confine our response to your inquiry relative to Section 337.4 of our regulations.
Your question involves § 337.4(b)(2) of our regulations. This section requires a securities subsidiary to meet the definition of a "bona fide subsidiary", as defined in § 337.4(a)(2) and (b)(2). It allows a subsidiary of an insured nonmember bank to engage in underwriting activities provided that certain conditions are met, including the condition that the subsidiary has been in continuous operation for the five-year period preceeding notice to the FDIC. § 337.4(b)(2)(ii). Your question is whether a wholly-owned subsidiary of the bank, Brokerage Services, has been in continuous operation for the five year period preceeding the time when the bank provides notice to the FDIC. We will treat this as five years from today for purposes of discussion.
In March of 1984 the bank acquired the *** Group, Inc. ("*** Group"), a full service broker registered as a broker-dealer with NASD and the Securities and Exchange Commission. The *** Group was incorporated in 1970. The acquisition was effected by a merger of *** Group into Brokerage Services, with Brokerage Services being the surviving corporation. Brokerage Services registered as a broker-dealer with the Securities and Exchange Commission at the time of the merger. It has since continued the retail broker-dealer activities formerly performed by the *** Group and engaged in other securities activities. These activities include: (1) purchasing shares of the mutual funds on behalf of retail customers, for which no compensation is received from the mutual funds; (ii) acting as a retail broker-dealer in corporate equity securities in the over-the-counter market; (iii) acting as a retail broker-dealer of mutual funds such as the fidelity family of mutual funds, for which compensation is received; (iv) acting as a broker for municipal securities; and (v) acting as a broker of puts/calls and as an option writer. Neither Brokerage Services nor the *** Group, however, has acted as distributor of mutual funds.
You understand that Brokerage Services and ***, which acts as investment advisor to several funds, are both bona fide subsidiaries of the bank, and that the bank has complied with and will continue to comply with the restrictions of Section 337.4(e) of our regulations. You also assume that all offices of Brokerage Services who will have supervisory responsibility for distributing shares of the mutual funds meet the requirements of five years of experience in similar activities at NASD member securities firms, as required by § 337.4(b)(2)(vi).
You believe that Brokerage Services is qualified to distribute securities of the mutual funds in accordance with § 337.4(b)(2). Brokerage Services is a member in good standing of the NASD, and the requirements of §§ 337.4(b)(2)(iii), (iv) and (v) with respect to directors, officers, general partners, employees and the stockholders of Brokerage Services have been met. Section 337.4(b)(2)(ii) requires a subsidiary to have been in continuous operation for a five-year period prior to engaging in underwriting activities. Although Brokerage Services itself has not engaged in distributing activities for the preceding five years, you believe that the "continuous operation" of and the duration and extent of the securities activities conducted by the *** Group prior to the merger of the *** Group into Brokerage Services should by virtue of the merger, be considered as the existence and activities of Brokerage Services.
You state that the supervisory personnel and staff of the *** Group became employees of Brokerage Services upon the acquisition of the *** Group in March, 1984. One of the operations managers of the *** Group remained in a similar capacity with Brokerage Services until August, 1985. Another of the operations managers remained with Brokerage Services in a similar capacity until the end of 1986. Prior to the departure of these supervisory personnel, however, employees of Brokerage Services received training with respect to the securities activities formerly performed by the *** Group. Because Brokerage Services has continued those securities activities formerly performed by the *** Group, you believe that such a "tacking" is consistent with the purposes of 337.4(b)(ii). Thus, you believe that § 337.4(b)(2),'s requirement that a bank's subsidiary be in continuous operation for five years prior to engaging in the contemplated activities has been met.
You also believe that *** has qualified to act as administrator of the mutual funds under § 337.4(b)(1). *** engages in no underwriting activities, and is a bona fide subsidiary of the bank as required by § 337.4(b)(ii).
Based upon the foregoing, you feel that Brokerage Services may act as distributor, and that *** may act as administrator of the mutual funds consistent with section 337.4 of our regulations. Based upon the facts you have presented to us and current applicable law and regulations, we agree that our regulation does not appear to prohibit the activities of Brokerage Services of *** set forth above. Of course, different facts and circumstances or a change in law or regulation might lead to a different conclusion.