4000 - Advisory Opinions
Bank Transactions with Affiliated Securities Companies
May 23, 1988
Pamela E. F. LeCren, Senior Attorney
This is in response to your letter dated March 31, 1988 to Regional Director Anthony Scalzi concerning the applicability of section 337.4 of the Federal Deposit Insurance Corporation's rules and regulations (12 C.F.R. 337.4) to the contemplated formation of an investment advisory subsidiary corporation by an unnamed insured state chartered nonmember bank. Our comments, which follow, must be general as your letter provides few if any details regarding the proposed subsidiary and its operation.
According to your letter, it is the bank's intent to form a subsidiary which will conduct business from the bank's lobby. The subsidiary will be a registered investment adviser and will offer financial planning and investment advisory services to the bank's customers. Your letter indicates that the subsidiary will not offer securities brokerage services either in the capacity of a broker-dealer or an underwriter but will employ one or more registered representatives of an unrelated broker-dealer who will sell securities to the bank's customers. These sales will be made solely upon the order and for the account of the bank's customers.
Section 337.4 of the FDIC's regulations requires that any subsidiary of an insured nonmember bank that engages in activities not authorized to a bank under section 16 of the Glass-Steagall Act (12 U.S.C. 24 (Seventh)) as made applicable to insured nonmember banks by section 21 of the Glass-Steagall Act (12 U.S.C. 378) must meet the definition of a bona fide subsidiary contained in section 337.4(a)(2) of the FDIC's regulations. Such a subsidiary is subject to a number of prescribed restrictions and controls. In order to respond to your question we must determine whether the activity as described in your letter is one in which a bank could engage under the Glass-Steagall Act. If so, the bank's subsidiary will not be required to meet the definition of a bona fide subsidiary or be subject to the transaction restrictions or disclosure requirements contained in section 337.4. Even if these provisions of the regulation are not applicable, however, the bank must still give the FDIC 60 days advance notice of the acquisition or the establishment of the subsidiary as the notice requirements of the regulation are broader than the remaining provisions of the regulation.
Section 16 of the Glass-Steagall Act provides that:
The business of dealing in securities and stock by [a bank] shall be limited to the purchasing and selling. . .of securities and stock without recourse, solely upon the order, and for the account of customers, and in no case for its own account, and the [bank] shall not underwrite any issue of securities or stock.
Section 21 of the Glass-Steagall Act prohibits any company that engages in the issuance, public sale, distribution or underwriting of securities from also taking deposits. It excepts from its coverage, however, securities activities otherwise permissible to national banks under section 16. (Securities Industry Association v. Board of Governors of the Federal Reserve System, 807 F.2d 1052 (1986), cert. denied, 107 S.Ct. 3228 (1987) ("Bankers Trust"), securities activities permissible under section 16 are not prohibited under section 21.)
Neither section 16 nor section 21 on its face extends to the giving of financial planning advice or investment advice. The Supreme Court has indicated that the activities of an investment adviser are not significantly different from the fiduciary activities traditionally conducted by banks (Board of Governors v. Investment Company Institute, 450 U.S. 46, 63 (1981), ("Board of Governors")) and that the language in section 21 covering the issuance, underwriting, sale, or distribution of securities is "hardly the sort of language that would be used to describe an investment adviser." (Board of Governors at 63, n. 32).1 It is clear, therefore, that investment advisory services in and of themselves are not encompassed by the Act.2
Section 16 of the Glass-Steagall Act also does not prohibit retail brokerage activities as such activities fall squarely within the permissive language of that section, i.e., involve the purchase and sale of securities upon the order and for the account of a customer without recourse. Retail brokerage does not involve underwriting or dealing (such transactions do not involve the purchase and sale of particular securities as principal), does not contravene the prohibition on the public sale of securities found in the Glass-Steagall Act, and does not present the subtle hazards which were identified by Congress as arising from the promotional pressures associated with the buying and selling of securities for one's own account. Securities Industry Association v. Comptroller of the Currency, 577 F. Supp. 252 (D.D.C. 1983), aff'd. 758 F. 2d 739 (D.D. Cir. 1985), cert. denied, 106 S.Ct. 790 (1986); Securities Industry Association v. Board of Governors of the Federal Reserve System, 104 S.Ct. 3003 (1984) ("Schwab").
A recent opinion of the D.C. Circuit Court of Appeals held that combining securities brokerage services with investment advice does not contravene section 20 of the Glass-Steagall Act.3 (Securities Industry Association v. Board of Governors, 281 F.2d 810 (1987), cert. denied, 108 S.Ct. 697 (1988) ("Nat. West")). The Court reasoned upon reviewing Schwab and Board of Governors that "The proposed activities. . ., for purposes of determining the scope of the term public sale', are simply undistinguishable from the activities described in Schwab. The sole distinction cited by SIA is that CSC will also provide investment advice [in addition to retail brokerage]. We cannot understand, however, why this should transform the proposed activities into the public sale of securities." NatWest at 814. The Court went on to state that "The addition of investment advice to brokerage activities does not implicate any of the activities which the Schwab Court described as traditionally associated with underwriting" (NatWest at 814) an activity which gives rise to the subtle hazards which can pose a threat to banks. Finally, although the Court found it unnecessary to do a subtle hazards analysis as the activity in question did not involve holding securities for investment or buying and selling securities as principal (NatWest at 816) the Court reviewed the facts and determined that (1) NatWest would have no salesman's stake in any particular security, (2) Congress did not intend the Glass-Steagall Act to address any concerns that may arise from investment advisory activities, and (3) that in any event the added provision of execution services would not increase those concerns.4
The combination of investment advice and brokerage services, if offered by a bank, will not result in a violation of section 21 of the Glass-Steagall Act provided that: (1) the bank buys and sells securities solely upon the order, and for the account of, its customers without recourse and not for its own account, (2) the bank has no salesman's stake in the sale of particular securities, and (3) the bank does not engage in the public offering of securities, does not purchase securities for resale on its own behalf as principal, act as agent on behalf of an issuer to sell securities, or otherwise underwrite or distribute securities. Such a subsidiary of an FDIC-Insured state nonmember bank would not be required to meet the bona fide requirements of section 337.4 nor would such a subsidiary be bound by the transaction restrictions or disclosure requirements of that section. As noted previously, however, even if these provisions do not apply, the regulation still applies insofar as the 60-day advance notice of the acquisition or establishment of the subsidiary is concerned.
Inasmuch as your inquiry did not provide this office with details regarding the proposed subsidiary and it will operate, we are unfortunately unable to render a more specific opinion in response to your inquiry. Should you wish to pursue this matter, please provide this office with as much detail as possible concerning the subsidiary and its proposed operation. We are specifically interested in the following information: (1) what type of investments does the subsidiary intend to recommend to the bank's customers, (2) how will the subsidiary be compensated, (3) will the subsidiary be compensated separately for the investment advice and the brokerage services, (4) how will the registered representatives be compensated, (5) will the subsidiary have any investment discretion with respect to any of the purchases, (6) will the investment advice be general or specific as to particular securities, (7) how many securities or types of investments will be the subject of the subsidiary's recommendations, (8) what will be the relationship, if any, between the bank and the subsidiary, (9) will the advice be given to customers on the commercial side of the bank, the trust side, or both, (10) what if any disclosures will the subsidiary make concerning the extent to which the bank is responsible for the advice and brokerage services, (11) will the bank finance customer purchases, and (12) what will be the relationship between the subsidiary and the unrelated broker-dealer with which the subsidiary's registered representatives employees are to be registered. In addition, we would also like any other information that is relevant to the issues raised in the above discussion.
1 The Board of Governors case involved a challenge by the Investment Company Institute to a Federal Reserve Board regulation permitting bank holding companies and their nonbank subsidiaries to act as investment advisers to closed end mutual funds. The Institute claimed that the regulation was contrary to the Bank Holding Company Act and the Glass-Steagall Act. The Supreme Court upheld the Federal Reserve Board's regulation finding that the activities in question were consistent with the Bank Holding Company Act and were not prohibited by the Glass-Steagall Act. The Court indicated that "To invalidate the Board's regulation [we would have] to assume that the activity of managing investments for a customer had been regarded by Congress as an aspect of investment banking rather than an aspect of commercial banking. But the Congress that enacted the Glass-Steagall Act did not take such an expansive view of investment banking." Board of Governors, at 71. Go back to Text
2 The Supreme Court also has observed that "none of [the] more subtle hazards [associated with securities activities] would be present were a bank to act as an investment adviser. . .subject to the restrictions imposed by the Board." Board of Governors at 67. Those restrictions were that neither the bank holding company nor any of its bank or nonbank subsidiaries could: (1) purchase for their own account, or for the account of a customer in the capacity as fiduciary, securities issued by the investment company being advised, (2) extend credit to such an investment company, (3) accept securities issued by such an investment company as collateral on a loan made for the purpose of acquiring the securities, and (4) directly or indirectly engage in the distribution or sale of securities issued by such an investment company. Restrictions were also set on the distribution of prospectuses and sales literature through the bank holding company and its bank and nonbank subsidiaries, referrals of bank customers to the investment company, the expression of opinions by bank officers or employees as to securities issued by the investment company, the sharing of offices and/or a similar name by the bank and the investment company, and giving the depositor list for any bank subsidiary of the holding company to the investment company. The Court noted that these restrictions would "preclude the promotional pressures that are inherent in the investment banking business . . .[and]. . .would prevent to a large extent the association in the public mind between the bank and the investment company as well as the resulting connection between public confidence in the bank and the fortunes of the investment company." Board of Governors at 67. Go back to Text
3 Section 20 of the Glass-Steagall Act (12 U.S.C. 377) prohibits the affiliation of member banks of the Federal Reserve System with companies engaged principally in the issuance, underwriting, public sale, or distribution of securities. As both sections 21 and 20 cover the same type of activities (i.e. issuing, underwriting, distribution, and public sale) cases construing the operative language of section 20 are equally relevant in determining the application of section 337.4 of the FDIC's regulations. Go back to Text
4 "A contrary holding, that the potential for these hazards [unsound loans to issuers of securities recommended to customers, recommending securities issued by bank customers who have outstanding bank loans, loss of bank's reputation for prudence if recommended securities perform poorly] is sufficient to render an activity unlawful, would render all investment advisory activities, including those traditionally performed by trust departments, unlawful." NatWest at 817. Go back to Text