Press Releases II. Administrative Exemptions Related to Trust and Fiduciary Activities
A. Proposed Rule 242.721: Administrative Exemption Allowing Banks to Calculate their Compliance with the Chiefly Compensated Standard on a Bank-Wide or Business-Line Basis
Proposed Rule 242.721 provides an administrative exemption that would allow banks, subject to certain conditions, to calculate their compliance with the statute’s chiefly compensated standard on a bank-wide or business-line basis. As discussed above, we believe that the GLB Act itself permits banks to use a bank-wide approach in determining whether they meet the Act’s chiefly compensated standard without the need of an administrative exemption. Accordingly, we do not believe that Proposed Rule 242.721 is necessary if the statute itself is properly interpreted. We also believe that the conditions contained in Rule 242.721 are unduly restrictive and that, because of these restrictions, the Rule would not fully or adequately address the problems caused by the Commission’s interpretation of the statute’s chiefly compensated standard.
1. 11-Percent Limit.
Most importantly, Proposed Rule 242.721 would allow a bank to use a bank-wide or business-line approach in calculating its compliance with the statute’s chiefly compensated test only if, during the preceding year, the bank’s ratio of sales compensation to relationship compensation from the relevant accounts was no more than 1 to 9 (approximately 11 percent when stated in terms of a percentage). The Proposed Rule would allow this ratio to increase to 1 to 7 (approximately 13 percent), but only once every 5 years.
As an initial matter, we believe that any percentage threshold established by the Commission through an administrative exemption must reflect the language and intent of the GLB Act. Therefore, it must give life to the term “chiefly compensated.” Granting an exemption that essentially treats a bank as being "chiefly compensated" by sales compensation if the sales compensation the bank receives from its trust and fiduciary accounts exceeds 11 percent of the "relationship compensation" the bank receives from these accounts simply cannot be squared with the language or purposes of the GLB Act. In addition, any percentage threshold must be high enough to accommodate the diverse trust and fiduciary operations and business lines of the nation’s banking institutions, and provide banks with meaningful “headroom” so that the trust and fiduciary businesses of banks are not threatened by natural fluctuations and developments in the business. These considerations played a significant role in the development of the statutory Trust and Fiduciary Exception, which itself permits banks to derive up to 49 percent of their total trust and fiduciary income from fees that do not qualify as relationship compensation under the statute.
Moreover, if any percentage threshold established in the Proposed Rule does not meaningfully accommodate the full range of trust and fiduciary operations of banks, then additional administrative exemptions must be developed for the multitude of trust and fiduciary operations of banks that would be disrupted by the artificially low threshold established by the Commission. This approach, which is the approach followed in the Proposed Rules, creates an overly complex and burdensome regulatory regime for banks simply to continue their normal trust and fiduciary activities. The statutory Trust and Fiduciary Exception was structured to establish a straightforward chiefly compensated test that would work for the diverse nature of banks and their trust and fiduciary businesses, and a similar approach should guide the development of any administrative exemptions necessitated by the Commission’s unduly restrictive interpretation of the statute.
With this background, and based on discussions with the banking industry, we believe the percentage limits included in the Proposed Rule are far too low and would not meaningfully accommodate the diverse trust and fiduciary operations of banks or the natural development of these activities.25 The 11-percent threshold is well below the 49-percent level that the statute itself allows and that the Commission has determined applies if a bank seeks to comply with the chiefly compensated standard on an account-by-account basis. In addition, as the Commission appears to recognize, banks with significant corporate, municipal or employee benefit plan trust businesses likely could not operate within the percentage thresholds established by the Proposed Rules. Even if separate administrative exemptions were developed that fully accommodate these business lines, we understand that the percentage thresholds included in the Proposed Rules would not work for many banks, either on a bank-wide or a business-line basis. For these reasons, we believe any administrative exemption should allow banks to receive sales compensation up to the statutorily established limit (49 percent). A slightly lower percentage threshold could be established if the Commission determined that some “wiggle room” was needed to ensure banks did not exceed this statutory limit.
The percentage limit established by the Proposed Rule also is based on a comparison of sales compensation to relationship compensation. As discussed above, this type of comparison is unduly complex, conflicts with the type of straightforward comparison called for by the statute and, given the Commission’s definitions of these terms, would require banks to classify and track their fees according to three categories (relationship compensation, sales compensation and “other” compensation) which do not conform to the systems they currently use. Accordingly, any percentage threshold established by the Commission by administrative action should be based on a comparison of relationship compensation (or, alternatively, sales compensation) to the total compensation that the bank receives from the relevant accounts.
The Adopting Release requests that any bank seeking modifications to the percentage thresholds included in the Proposed Rule provide the Commission with specific information concerning the bank’s ratio of sales compensation to relationship compensation.26 As previously noted, banks currently are not required to classify and track the fees that they receive from their trust and fiduciary customers in the detailed and complex manner that would be required by the Proposed Rules. Accordingly, banks generally do not have the management information and other systems in place that would allow them to provide the Commission with specific and detailed information concerning their ratio of sales compensation to relationship compensation (as those terms are defined in the Proposed Rules).27 Thus, it likely will be difficult and expensive for many banks to provide the Commission with the specific information it has requested.
2. Exemption may force banks to use an account-by-account approach or nullify the effect of other exemptions.
The Proposed Rule permits a bank to use the exemption (i) “for all accounts for which the bank acts in a trustee or fiduciary capacity on a bank-wide basis” or, (ii) for “one or more individual lines of business provided that the sales compensation and relationship compensation from all accounts . . . within a particular line of business is used to determine whether the bank meets” the percentage limitations imposed by the Rule. Although the intended effect of this language is not entirely clear, it appears that these provisions essentially would force many banks to calculate their compliance with the statute’s chiefly compensated test on an account-by-account basis for a number of their accounts or nullify the benefits of other exemptions.
For example, as the Adopting Release appears to acknowledge, many banks may be forced to use the proposed exemptions for certain types of employee benefit plan accounts (Proposed Rule 242.770, the “Employee Benefit Plan Exemption”) because the 11-percent limit in Proposed Rule 242.721 would not accommodate the existing business relationships of banks and their customers in the employee benefit area.28 A bank that took advantage of the Employee Benefit Plan Exemption, however, would appear to be prohibited from using the bank-wide approach to calculate its compliance with the Proposed Rule’s 11-percent sales compensation limit for all of the bank’s other trust and fiduciary accounts not covered by that exemption. In addition, the Proposed Rule would appear to either—
(i) prohibit the bank from using a business-line approach to calculate its compliance with the Rule’s 11-percent limit for all of the bank’s employee benefit plan accounts that are not covered by Employee Benefit Plan Exemption;29or
(ii) require the bank, if it seeks to use the business-line approach to calculate its compliance with the 11-percent limit for the employee benefit plan accounts not covered by the Employee Benefit Plan Exemption, to include all of the sales compensation and relationship compensation that the bank receives from the accounts purportedly covered by the Employee Benefit Plan Exemption.
Similar results would appear to occur if the bank sought to use the proposed exemptions for indenture trustee relationships (Proposed Rule 242.723), for transactions involving money market mutual funds (Proposed Rule 242.776), or for certain living, testamentary and charitable accounts established before July 30, 2004 (Proposed Rule 242.720).
A bank should not be prevented from calculating its compliance with any given percentage limit on a bank-wide or business-line basis simply because the bank decides to avail itself of a separate administrative exemption granted by the Commission for a subset of the bank’s trust and fiduciary accounts. Restrictions that require banks to make such a choice would not only force many banks to comply with the statute’s chiefly compensated standard on an account-by-account basis (a result that is inconsistent with the GLB Act), but also would greatly increase the complexities and hardships that banks may face in attempting to comply with the Commission’s Proposed Rules.
In addition, if a bank decides to avail itself of a separate administrative exemption provided by the Commission for a subset of the bank’s trust and fiduciary accounts, the bank should not be forced to include the fees received from accounts covered by those exemptions for purposes of calculating its compliance with a percentage sales compensation limit. Such a requirement could negate the purpose of the targeted exemptions, i.e. to free these accounts from the Commission’s unduly restrictive chiefly compensated standard.
3. Proposed Rule continues to require account-by-account reviews.
Finally, the Rule would not entirely free banks from conducting account-by-account reviews of their individual trust and fiduciary accounts. In this regard, the Proposed Rule allows a bank to use a bank-wide or department-wide approach to compliance only if the bank maintains procedures that are reasonably designed to ensure that the bank reviews each trust and fiduciary account both before the account is opened, and whenever the bank individually negotiates with the accountholder or beneficiary of the account to increase the proportion of sales compensation to relationship compensation. After conducting these reviews, the bank must determine that the bank is likely to receive more relationship compensation than sales compensation from the individual account.30
Our Agencies continue to believe that the account-review procedures contained in the Proposed Rules are unnecessary and inappropriate. Banks that meet the chiefly compensated test on a bank-wide or business-line basis should not be required also to predict the level and types of fees they might receive from individual accounts.
B. Proposed Rule 242.770: Administrative Exemption for Certain Types of Employee Benefit Plan Accounts
Proposed Rule 242.770 would permit banks, subject to certain conditions, to purchase and sell mutual fund shares for employee benefit plans that are qualified under section 401(a) or described in sections 403(b) or 457 of the Internal Revenue Code (“eligible plans”) if the bank serves as trustee or custodian to the plan. In essence, the exemption would allow banks that act as a trustee, custodian or administrator for an eligible plan to buy and sell mutual fund shares for the plan without complying with the statute’s chiefly compensated requirement.31 There are several significant problems with this proposed exemption.
First, the exemption is available only for employee benefit plans that are qualified under section 401(a) or described in section 403(b) or 457 of the Internal Revenue Code (“Code”). Banks, however, currently act as trustee, fiduciary, administrator or custodian for a variety of other employee benefit plans, including Voluntary Employee Beneficiary Association Plans, governmental plans, church plans, multi-employer plans offered pursuant to a collective bargaining agreement, deferred compensation plans (including rabbi and secular trusts), supplemental or mirror plans, and supplemental unemployment benefit plans. The proposed administrative exemption would not allow banks to continue to provide securities transaction services to these types of customers. In addition, the proposed exemption would not cover other types of employee benefit plans that may be developed in the future in response to changes in the tax laws or developments in the marketplace and, thus, freezes the ability of banks to respond to the developing employee benefit plan needs of their customers.
Second, the Proposed Rule would allow banks to purchase and sell only shares of a registered mutual fund for an eligible plan. However, many benefit plans buy and sell, or allow their participants to buy and sell, other types of securities. For example, defined benefit plans frequently are invested in the securities of individual companies and employee stock option and employee stock ownership plans, of course, normally invest in the stock (or stock options) of the sponsoring company. Prohibiting banks from offering their employee benefit plan customers investment options other than mutual funds, therefore, is inconsistent with the current practice of banks and the nature of the employee benefit business.
Third, the Proposed Rule permits a bank to effect securities transactions for an eligible plan only if the bank “offsets or credits any compensation” that it receives from a mutual fund complex due to the investment of the plan’s assets against other fees and expenses that the plan owes to the bank.32 The Adopting Release indicates that this offset or credit requirement was based on information that some banks informally provided Commission staff concerning their current practice.33 The compensation restrictions contained in the Proposed Rule, however, are not consistent with banking industry practice and conflict with the requirements of the Employee Retirement Income Security Act (“ERISA”), as implemented by the Department of Labor.
In this regard, sections 406(b)(1) and (3) of ERISA generally prohibit a bank or other person that is a “fiduciary” with respect to a plan from (i) dealing with the assets of the plan in his or her own interest or for his or her own account, or (ii) receiving any consideration for his or her own account from any party dealing with the plan in connection with a transaction involving the assets of the plan.34 The Department of Labor has issued advisory opinions concerning when the receipt of Rule 12b-1, shareholder servicing and sub-transfer fees from a mutual fund by a bank or other entity providing services to an employee benefit plan may implicate these conflict-of-interest provisions.35
As a general matter, these opinions from the Department of Labor provide that a bank or other entity that exercises authority or control over the investment of a plan’s assets in a mutual fund may not receive Rule 12b-1, shareholder servicing or sub-transfer fees from the mutual fund unless the bank or other entity uses these fees as an offset or credit against the fees the plan would otherwise have to pay the bank or other entity. A bank, for example, would have to provide such an offset or credit if the bank acts as a trustee for a plan and, in this role, advises the plan sponsor concerning the mutual funds to be included as investment options in the plan.
However, the Department of Labor’s opinions do not require a bank to perform such an offset or credit where the bank does not exercise any authority or control to cause a plan to invest in the relevant mutual fund. Thus, for example, ERISA allows a bank that serves as directed trustee for an employee benefit plan to receive and retain fees from a mutual fund in which the plan is invested if another plan fiduciary (e.g. the plan sponsor), and not the bank, has the authority to determine the mutual funds in which the plan’s assets may be invested. Many banks that provide services to employee benefit plans currently receive and retain fees from mutual funds in accordance with these Department of Labor opinions. The compensation limitation contained in the Proposed Rule, however, would not allow this existing practice even where these relationships are structured to comply with the conflict-of-interest and other protections provided under ERISA.36
Moreover, ERISA already provides significant protections for employee benefit plans and their beneficiaries that apply equally to banks and other entities that provide services to employee benefit plans. For example, ERISA already requires the responsible fiduciary for a plan to determine that the compensation paid directly or indirectly by the plan to a service provider (including a bank) is reasonable in light of, among other things, the services provided to the plan and the other fees or compensation that the service provider may receive in connection with the investment of the plan’s assets. In addition, under ERISA, the responsible fiduciaries for a plan must (i) obtain sufficient information concerning the fees a service provider (including a bank) may receive from a mutual fund due the investment of the plan’s assets to determine that the entity’s compensation is reasonable, and (ii) monitor a service provider to ensure that, where the entity is required to provide the plan with fee offsets or credits, such offsets and credits are properly calculated and applied.37 Given all these existing safeguards, the need for the Commission to impose special compensation or disclosure requirements on banks in this area as a condition to their use of the bank exceptions in the GLB Act is not apparent.
Finally, the Proposed Rule would allow a bank to offer the participants in an eligible plan a participant-directed brokerage window only if each participant’s account is carried by a registered broker-dealer on a fully disclosed basis.38 Eligible plans often allow their participants the ability to purchase mutual funds or securities that are outside the normal investment options within the plan (i.e., those selected by the plan sponsor or other fiduciary). Many banks currently offer this service, which is commonly referred to as a participant-directed brokerage window, to their employee benefit plan customers and, indirectly, to the participants in these plans. However, the resulting participant accounts often are carried by the bank itself (and not a separate broker-dealer), in which case the bank transmits the orders from participants to a broker-dealer (or, in the case of mutual fund securities, to Fund/Serve or the fund’s transfer agent) on an omnibus basis. The “fully disclosed” requirement of the Proposed Rule conflicts with this practice and would require participants to move (or establish) their accounts at a broker-dealer. This, in turn, may result in higher fees for participants seeking this service.
C. Proposed Rule 242.720: Administrative exemption for certain living, testamentary and charitable trust accounts
Proposed Rule 242.720 would allow a bank, without complying with the statute’s chiefly compensated requirement, to buy and sell securities for any living, testamentary or charitable trust account that was opened or established before July 30, 2004, provided that the bank, among other things, does not “individually negotiate with the accountholder or beneficiary of [the] account to increase the proportion of sales compensation as compared to relationship compensation after July 30, 2004.”
We do not believe that this limited, administrative exemption would be necessary if the statute’s Trust and Fiduciary Exception was implemented properly. Moreover, the Trust and Fiduciary Exception in GLB Act was designed to ensure that banks could continue to engage in their normal trust and fiduciary activities without significant disruption. The Act was not intended to allow banks to retain only those trust and fiduciary accounts that existed on a given date. Accordingly, we do not believe that this exemption, which “grandfathers” only those living, testamentary or charitable accounts that were opened or established as of July 30, 2004, properly reflects the intent of Congress or provides meaningful relief from the hardships caused by the Commission’s unduly restrictive interpretation of the statute’s chiefly compensated test.
The proposed “grandfather” also does not cover the full range of personal trust and fiduciary accounts that banks establish for their customers.39 In addition, the exemption expires if a bank individually negotiates with the relevant accountholder or beneficiary in a manner that increases the proportion of sales compensation that the bank receives from a “grandfathered” account after July 30, 2004. These conditions would require banks to develop systems to identify and monitor their “grandfathered” personal trust accounts and handle accounts that lose their grandfathered status and, thus, increase the overall complexity and compliance burdens associated with the Proposed Rules. In addition, it is possible that an account would lose its “grandfathered” status if a bank, through negotiation or voluntarily, reduced the relationship compensation it received from a “grandfathered” account, thereby reducing the overall fees the customer or beneficiary had to pay for the bank’s services.
D. Proposed Rule 242.722: Administrative Exemption for Banks Using an Account-By-Account Approach to Compliance
Proposed Rule 242.722 seeks to provide banks that attempt to comply with the chiefly compensated test on an account-by-account basis a “safe harbor” in case certain accounts do not meet this test in any given year. Proposed Rule 242.722(b) generally would allow an individual trust or fiduciary account of a bank to fail the Commission’s chiefly compensated test in a given year if (i) no more than 10 percent of the bank’s total trust and fiduciary accounts failed the chiefly compensated test within that same year, and (ii) the individual account in question did not rely on the safe harbor in the Proposed Rule in any of the preceding 5 years.40 The Proposed Rule also appears to allow an individual trust or fiduciary account to fail the Commission’s chiefly compensated standard more than once every 5 years if (i) the bank documents the reasons why the account has not met the Commission’s chiefly compensated test and links that reason to the bank’s exercise of its fiduciary responsibilities, and (ii) no more than the lesser of 500 or 1 percent of the bank’s total trust and fiduciary accounts have failed to meet the Commission’s chiefly compensated test in more than one of the preceding 5 years.
As discussed earlier, we do not believe the statute’s chiefly compensated test was intended to be applied on an account-by-account basis. In addition, because banks generally do not have the systems to enable them to comply with the chiefly compensated test on an account-by-account basis, and likely would incur significant costs to develop these systems, we believe this administrative exemption is of limited benefit.
Furthermore, while we appreciate the Commission’s efforts to develop a “safe harbor” for banks that seek to comply with the Commission’s account-by-account interpretation of the statute, the terms of the exemption are unduly restrictive and very complex. These conditions likely would require banks to develop and maintain costly compliance systems in order to track over a moving 5-year period the number and identity of individual accounts that did not comply with the Commission’s interpretation of the statute’s chiefly compensated test.
Finally, we note that the exemption would strictly limit the number of individual trust and fiduciary accounts that could exceed the Commission’s chiefly compensated test in a given year even where the bank documents that this failure was caused by the bank’s exercise of its fiduciary responsibilities to its customers. There are certain times during the life of a trust or fiduciary account when the account may naturally have a large number of securities trades, but will still be a bona fide trust account. For example, in the exercise of a bank’s fiduciary duty, a bank may find it necessary to rebalance an account’s assets, such as immediately after the opening of an account or after major life events of either the settlor of a trust or the trust’s beneficiaries. This may result in a significant number of securities transactions and annual compensation for a given year that exceeds the chiefly compensated standard as interpreted by the Commission. However, when looked at over the life account, the annual relationship compensation received by the bank from the account clearly would regularly be greater than the sales compensation received. The Proposed Rules’ artificial numerical limits, however, may restrict banks from engaging in transactions dictated by their fiduciary duties. We do not believe it is appropriate to limit the number of trust and fiduciary accounts that may exceed the Commission’s chiefly compensated test due to the bank’s exercise of its fiduciary responsibilities to its customers.
25 We understand that the Commission developed the 11-percent limit based primarily on estimates that SEC staff obtained on an informal basis from a handful of banks concerning the overall ratio of sales compensation to relationship compensation that these banks receive on a bank-wide basis from their trust and fiduciary accounts. However, we understand that in preparing these estimates the banks (i) used definitions of “sales compensation” and “relationship compensation” that differ significantly from those included in the Proposed Rules, and (ii) excluded significant trust and fiduciary business lines from their calculations. Moreover, even these rough estimates were obtained from only a small number of banks. Accordingly, these estimates do not provide a sound basis for establishing a bank-wide or department-wide compensation threshold for the thousands of banks that engage in trust and fiduciary activities.
26See Adopting Release at 39,695.
27 This is especially true because there remains uncertainty in the banking industry as to how certain types of compensation should be classified under the Proposed Rules.
28See Adopting Release at 39,718.
29 As discussed in Part II.B below, the Employee Benefit Plan Exemption would not cover many types of employee benefit plans that currently obtain securities transaction services from banks. Most banks manage and operate all of their employee benefit plan accounts as a single, integrated line of business. Accordingly, it would be operationally infeasible for a bank to establish a separate “line of business” only for those employee benefit plan accounts not covered by the Employee Benefit Plan Exemption and, in any event, the Proposed Rules’ definition of a “line of business” may well prohibit a bank from doing so. See Proposed Rule 242.724(e).
30 Proposed Rule 242.721(a)(3) and (4).
31 Although the language of the Proposed Rule refers only to banks acting as a trustee or custodian, the Adopting Release indicates that the Rule also was intended to cover banks that act as a non-fiduciary administrator for an eligible plan. See Adopting Release at 39,718. The statute itself allows banks to effect transactions for benefit plans when acting as a custodian or administrator for the plan. See 15 U.S.C. § 78c(a)(4)(viii)(I)(ee). Accordingly, we have assumed that the Proposed Rule was intended to cover banks that provide administrative services to a plan in a non-fiduciary or non-custodial capacity.
32See Proposed Rule 242.770(a)(1).
33See Adopting Release at 39,718, n. 330.
34See 29 U.S.C. § 1106(b)(1) & (3). Under ERISA, a bank or other person is considered a “fiduciary” with respect to a plan to the extent that the bank or person (i) exercises any discretionary authority or control respecting management of the plan or any authority or control respecting management or disposition of its assets, (ii) renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of the plan, or has any authority or responsibility to do so, or (iii) has any discretionary authority or responsibility in the administration of the plan. See 29 U.S.C. § 1002(21)(A).
35See ERISA Advisory Opinion 97-15A and ERISA Advisory Opinion 97-16A. Because the Proposed Rule would require that a bank provide an offset or credit for “any compensation” that the bank receives from a mutual fund complex in which a plan’s assets are invested, the Proposed Rule’s compensation restriction could be read to cover other fees—such as investment advisory fees—that the bank receives from a mutual fund. We understand, however, that Rule’s reference to “compensation” was intended to refer only to the types of compensation discussed in the Department of Labor’s Advisory Opinions 97-15A and 97-16A.
36 The Proposed Rule also would require that a bank clearly and conspicuously disclose the fees its receives from a mutual fund to the sponsor of an eligible plan (or its designated fiduciary) in a manner that will allow the plan sponsor (or its designated fiduciary) to determine that the bank has credited or offset its fees in the manner required by the Rule. These disclosure requirements also are inconsistent with ERISA to the extent they would apply in situations where ERISA would not require a fee offset or credit.
37See ERISA Advisory Opinion 97-15A and ERISA Advisory Opinion 97-16A; see also 29 U.S.C. §§ 1104(a) and 1106(b). In the case of benefit plans that are not subject to ERISA, banks are subject to state laws that often impose requirements that are similar to those applicable under ERISA.
38See Proposed Rule 242.770(a)(3) and (b)(3).
39 For example, the exemption does not cover personal estates for which the bank acts as executor, administrator or representative; conservatorships or guardianships; or personal accounts to which a bank provides investment advice in a non-trustee capacity. In addition, as noted above, the exemption does not cover any personal account established after July 30, 2004.
40 Although paragraph (a) of Proposed Rule 242.722 also purports to provide banks an exemption from the Commission’s account-by-account chiefly compensated test, this paragraph appears to simply restate the Commission’s general interpretation of the chiefly compensated test while also imposing additional restrictions on banks that seek to
comply with the Commission’s account-by-account interpretation. Accordingly, paragraph (a) of the Proposed Rule does not appear to provide banks any exemptive relief.