4000 - Advisory Opinions
Whether Bank May Act as Agent for Sale of Fixed Rate Annuities and Permit Sale of Mutual Funds on Its Premises Through "Dual Employees" and Registered Broker-Dealer
October 29, 1992
Pamela E.F. LeCren, Counsel
Your letter to Alfred J. T. Byrne, General Counsel, Federal Deposit Insurance Corporation, requesting an opinion on whether your client bank may act as agent for the sale of fixed rate annuities and whether the bank may permit the sale of mutual funds on its premises through "dual employees" of the bank and a registered broker-dealer was forwarded to me for response.
Initially let me point out that the question of whether a bank is authorized to enter into the type of arrangements described in your letter is a matter of state law. Of course, as you no doubt are aware, even if state law allows for the relationships to be established, federal statute or regulation may prohibit or restrict the bank from doing so.
Securities Brokerage Networking Arrangements
The FDIC has had occasion from time to time to review a number of securities brokerage networking programs primarily for the purpose of determining whether or not the participation of an insured nonmember bank in such an arrangement would cause the participating bank to be in violation of § 21 of the Glass-Steagall Act (12 U.S.C. 378). The first such program reviewed by the FDIC was a program known as INVEST which is offered by ISFA Corporation (see FDIC advisory opinion 83--21). Upon reviewing that program, it was the FDIC's conclusion that participation by an insured nonmember bank in the INVEST program would not cause the bank to be in violation of the Glass-Steagall Act. The FDIC specifically declined, however, to endorse the program. What is more, despite the fact that our letter indicated that "the FDIC does not at this time perceive any excessive or undue risk arising from nonmember bank participation in INVEST", the review undertaken by the FDIC at that time did not constitute a complete safety and soundness review.
When subsequently asked to review securities brokerage networking programs, the FDIC has for the most part confined itself to a determination of whether the program would involve a violation of the Glass-Steagall Act. If a program is found to be substantially similar to INVEST, the conclusion necessarily follows that the program would not involve a participating bank in a violation of the Glass-Steagall Act.
We have on occasion commented on one particular aspect or another regarding a program under review if something about the program appeared to be problematical or potentially so. In that vein, FDIC advisory opinion 86--18 raised the possibility that compensating bank employees who act as registered representatives on the basis of the volume of the business generated by the representative could lead to a conflict of interest that may be the basis for criticism by the FDIC. It was also noted that a conflict of interest could arise if a participating bank receives bonuses based upon the volume of business generated under the program. Again, it was noted that this could be the basis of criticism by the FDIC. Lastly, the same letter indicates that use by a participating bank of the program to accomplish trades on behalf of fiduciary accounts could raise questions as to a possible breach of fiduciary obligation and questions of whether the bank met its best execution obligations. The opinion raised these issues for the sole purpose of reinforcing to the requestor that the FDIC was not endorsing the program but was specifically reserving the right to object in the future to the program and/or how it is operated if the circumstances so warranted.1
We think that the referenced letters should provide you with sufficient guidance on the Glass-Steagall Act issue as well as other aspects of securities brokerage networking arrangements that may give rise to adverse comment by the FDIC during an examination. Please note also that it is the FDIC's posture that networking arrangements of this type trigger the applicability of Part 344 of the FDIC's regulations (12 C.F.R. 344) which makes a bank responsible for record keeping and confirmations with respect to securities transactions.2 As a practical matter, in most such arrangements that we have seen, the registered broker-dealer keeps records regarding the transactions, sends out confirmations to customers, etc. so the only outstanding obligation a participating bank may have to itself perform under Part 344 would be to disclose to customers the remuneration it receives in connection with the transactions. Even that obligation may in some instances be discharged by the broker-dealer if the confirmation contains the relevant information.
All of the letters referenced above, with the exception of our July 16, 1992 unpublished opinion, were written prior to the enactment of § 24 of the Federal Deposit Insurance Act ("FDI Act'', 12 U.S.C. 1831a). Under that provision of law, after December 19, 1992, no insured state bank may engage as principal in any activity that is not permissible for a national bank without obtaining the FDIC's consent. Consent can only be granted if the bank meets its capital requirements and the FDIC determines that conducting the activity will not pose a significant risk to the deposit insurance fund of which the bank is a member. The statute does not define the phrase "as principal" nor has the FDIC yet promulgated regulations doing so. It is staff's initial opinion at this point, however, that any bank that enters into a contract with another party should be considered to be acting as principal with respect to that contract. Therefore, if a national bank could not enter into the arrangement you have described, your client bank could not do so without the FDIC's consent.3
The FDIC recently added Part 362 to the FDIC's regulations. Part 362 implements § 24 of the FDI Act in so far as equity investments of insured state banks are concerned. It is expected that the FDIC will propose an amendment to Part 362 in the near future that will address the conduct by an insured state bank or its subsidiaries as principal of activities that are not permissible for a national bank. Among the definitions contained in Part 362 is a definition of the phrase "significant risk to the insurance fund". As defined therein, a significant risk to the insurance fund will be considered to be present whenever there is a high probability that any insurance fund administered by the FDIC may suffer a loss. Although that definition was adopted in the context of equity investments, we do not anticipate that the FDIC will propose to change that definition when it considers amendments to Part 362.
Until such time as there may be a delegation of the authority to make significant risk determinations with respect to the direct and indirect activities of insured state banks, only the Board of Directors can make those determinations. Staff is working on regulations that should help resolve such questions as how one determines if an activity is permissible for a national bank and which may establish application procedures for banks that wish to obtain consent. Even if one were to assume that your client bank would need to obtain the FDIC's consent to enter into the contract at hand, you may draw some comfort, from the fact that to date the FDIC has not to our knowledge prohibited any insured nonmember bank from participating in securities brokerage networking programs.
Acting as Agent for Sale of Fixed Rate Annuities
In much the same way as the preceding discussion, the question of whether an insured state bank may act as agent for the sale of fixed rate annuities without the FDIC's consent under § 24 of the FDI Act depends upon whether acting as agent is an "as principal'' activity and whether a national bank could engage in the sale of fixed rated annuities. As indicated above, the FDIC has not yet determined the meaning of "as principal" for the purpose of § 24. Even assuming, however, that acting as agent for the sale of fixed rate annuities is an "as principal" activity, an insured state bank could so engage without the FDIC's consent under § 24 as the Office of the Comptroller of the Currency has determined that a national bank may do so. (CCH Fed. Banking L. Rep. Par. 85,501).
The inquiry does not necessarily end there, however. Although the FDIC does not have any regulations that require a bank to obtain the FDIC's consent before conducting such activities, and the FDIC does not have any regulations that would prohibit an insured state bank from conducting such activities, acting as agent for the sale of annuities can raise safety and soundness concerns.
One of the overriding concerns is that the individual's to whom annuities are sold should be made aware that the annuities are not insured deposits and that they are not obligations of the bank. Additionally, the sales should be accomplished in such a manner as to reduce to the fullest extent possible any customer confusion about what is being purchased. For example, if the bank targets customers with maturing certificates of deposits and informs them that their funds can be put into a fixed rate annuity that the bank makes available, there is a high probability that at least some of the customers will think that they have simply rolled over their certificate of deposit. Not only may a customer confuse the annuity with an insured deposit, if bank employees recommend the purchase of the annuities or make any representations about the safety of the annuities or their value as an investment, customer confidence could be adversely affected if the company that issues the annuities defaults on its obligations. In that event, the customers may seek redress from the bank. (We note that the bank plans to inform customers in writing that the annuities are not insured deposits. We also note that the bank will not recommend the annuities, that the bank will make clear that the bank is not warranting the value of the annuity, and that the customers will be informed that they have no recourse against the bank with respect to the annuities.) Lastly, if bank employees are compensated on a volume basis, certain conflicts of interest can arise that may be the subject of criticism.
The above discussion is by no means intended to be a complete review of all the possible safety and soundness and conflicts of interest issues that can arise. It should serve, rather, as a reminder that the FDIC will carefully scrutinize the conduct of such activity if it is undertaken.
I hope that the above has been responsive to your inquiry. If you have any further questions, please feel free to contact me at (202) 898-3730. Finally, in closing I would like to apologize for the delay in responding to your inquiry. I sincerely hope that the delay has not caused your client any inconvenience.
1See also, FDIC advisory opinion 86--32. We are enclosing another more recent letter for your information which to the best of our knowledge has not to this point been published by the FDIC. Go back to Text
2It is our opinion that for the purposes of Part 344 of the FDIC's regulations, the participating bank would be "effecting" securities transactions. Go back to Text
3The Office of the Comptroller of the Currency has had occasion to review the INVEST program and other similar arrangements and has found several such programs to be permissible for national banks. We are enclosing copies of those opinions for your information. Go back to Text