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II. Administrative Exemptions Related to Trust and Fiduciary Activities
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.
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.
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.
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.
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).
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.
34 See 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).
35 See 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.
37 See 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.
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.
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