Trust Examination Manual
Section 6- Account Administration Corporate Trust Accounts
Table of Contents
B. Types of accounts
c. Duties of Trustee
Registrar (Transfer Agent for Registered Bonds)
Fund Transfer Agent
or Paying Agent
a. Secondary Market Disclosures for Municipal Issues
b. Defeasement Activities With Municipal Bonds
13. Trust Preferred Securities - Trustees
C. Account administration and controls
b. Operational Issues
c. Bond Trusteeships
e. Corporate Agencies
D. Complinace with the trust indenture act
a. Trustee Appointment Requirements
b. Conflicts of Interest
c. Trustee Administration of Issue
d. Administrative Filings With Trustee by Issuer
e. Actions in the Event of Default
E. Other compliance
Stolen and Counterfeit Securities
a. Legal Background
b. Escheatment Litigation
Laws and Regulations
Corporate trust and
agencies are accounts where the bank
serves as trustee, agent, or global custodian.
Corporate trust and agency services normally concern services performed in
the issuance, redemption, transfer, or recordkeeping for debt or equity
Trustee under a bond indenture or trustee for an issue of trust preferred
securities are typically the only trust relationships
administered by a corporate trust department. For example, under a bond indenture, one
trustee is appointed for a given bond issue, but several agents or co-agents may
provide various related services to
the same issue.
It is not uncommon for a single indenture to name both the trustee for the
issue and the related corporate
agents, such as a paying agent for the issue.
The most common corporate agency activities include
stock or bond transfer agent,
stock or bond issues,
paying agent for bond interest or stock dividends,
dividend reinvestment agent, and escrow agent.
Unlike personal and employee benefit
accounts, where the interest of the beneficiary is the primary concern, banks
serving in a corporate trust capacity serve two different constituencies. On
the one hand, the issue of the security covered under the indenture hires
the indenture trustee and pays the trustee's fees. The indenture
trustee and other agents owe the issuer of the security effective and
efficient administration of the duties assigned under the indenture.
On the other hand, a fundamental duty of the indenture trustee is to monitor
the issuer's compliance with the terms of the indenture and to take all
necessary actions to protect the interests of the bondholders. In
fact, the principal reason for appointing a trustee under a bond indenture
is for the protection of those purchasing the securities issued under the
B. Types of Accounts
B.1. Corporate Trustee
Departments that serve as corporate trustee assume
the greatest amount of responsibility and potential risk among the various types of corporate
trust and agency accounts discussed in this chapter. The responsibilities of the trustee may include
some or all of the following: the issuance of bonds, the maintenance of bondholder records,
transfer of recorded ownership, the payment of principal and interest, and payment
of remaining principal at maturity.
The issuer could be a corporation, state,
municipality, quasi-public authority, school, church, or any incorporated
organization, which chooses to finance its needs through the issuance of
bonds. Bonds may also be distinguished by whether they are secured or
unsecured. Examples of secured bonds include mortgage bonds, secured notes
and equipment trust certificates. More complex types of issues are
securitized or asset-backed securities which are discussed in the section
Debt Issues. Unsecured bonds are called debentures. Some bond issues are subject to
the Trust Indenture Act of 1939 (amended by the Trust Indenture Reform Act of 1990) and
others are not. Refer to
Sub-section D, Compliance with the Trust
Indenture Act of 1939 for additional information on the Trust Indenture Act.
Bonds issued may be sold to the general public, a
limited investor group, or a single investor such as an insurance company or governmental
agency. Bonds are now typically issued in registered, as opposed to bearer, form. They come
in a wide variety of other distinguishing features, such as single or
serial maturities; fixed or floating rates of interest; call provisions; convertibility into
other types of securities; and sinking fund provisions for payment of
The document creating the corporate trust is
called a trust indenture, a trust agreement, an indenture, or simply
an agreement. The indenture defines the:
- Purpose(s) and/or nature of the debt to be created,
- Nature and description of the bonds to be issued,
- Parameters of administration during the life of the bonds,
- Nature, method, and place of repayment of principal and interest,
- Relationship between the corporation (borrower or obligor), the bank
(trustee and/or agent) and lender(s) (bondholder(s)),
- Duties of the respective parties to the indenture,
- Description of the collateral (if any),
- Events of default,
- Actions to be taken in the event of default.
Indentures tend o be of uniform construction
and design, but may be tailored to include unique provisions. Associated
with the indenture is the instrument that perfects a lien on collateral, if any,
securing the bonds. These instruments are
called the trust mortgage, deed of trust, collateral trust, equipment trust, etc.,
depending on the type of collateral.
B.1.c. Duties of Trustee
The primary duty of the trustee under the indenture is
to perform the duties specified by the indenture. These normally include the following:
- Arranging for the printing and issuance of the bonds,
- Maintaining required records, accounts and documentation,
- Paying principal and interest,
- Holding beneficial title to collateral (if any),
- Safeguarding and appraising collateral (if any),
- Investing idle cash (if permitted or directed under the indenture),
- Ensuring the issue is in compliance with legal requirements,
- Monitoring for events of default under the indenture during the life of the bonds,
- Protecting the interests of bondholders in the event of
B.2. Stock Transfer Agent
Transfer agents usually perform three functions.
First, they issue stock certificates, which constitute an increase in shares
outstanding (e.g., original issues, stock dividends and splits, etc.). Second, they
maintain records identifying the owners of the shares of stock, how many shares are owned, and
which certificates are owned. Third, they cancel and reissue certificates to
reflect changes in ownership.
In connection with the latter, certificates and
accompanying documents are checked for authenticity and appropriateness; canceled;
and replaced by new certificates. The transfer agent sends both the canceled
certificates and the newly issued certificates to the
for verification. This involves only an in-house transmittal when the institution acts
as transfer agent and registrar. After registration, the newly issued certificates are
sent to the registered owners or their representatives and appropriate disposition
(destruction, return of canceled certificates to the issuer, or cancellation and retention
in a safeguarded area) is made of the canceled certificates.
Refer also to the discussion on
registered transfer agents.
B.3. Stock Registrar
A stock registrar performs the critical duty of guarding
against the over- or under-issuance of a security, sometimes referred to as a
out-of-proof or out-of-balance condition. In addition to checking original issues, the
registrar checks each transfer made by the transfer agent: to ensure the genuineness of
the certificates presented for transfer; to make certain that the old certificates have
been canceled; and to ensure that the number of shares represented by the new certificates
does not exceed the number of shares represented by the old (canceled) certificates. In
the case of bonds, the indenture trustee normally performs this function. New York Stock
Exchange rules permit one institution to act as both transfer agent and registrar for
listed securities other than its own.
Much less frequently, banks may be appointed
solely as the outside registrar of a stock issue, without the more typical
dual appointment as transfer agent and registrar.
Refer also to the discussion on
registered transfer agents.
B.4. Bond Registrar (Transfer Agent for
In the case of bonds, the bond registrar
usually performs the duties of both transfer agent and registrar.
usually, the indenture trustee performs the function of bond registrar.
On rare occasions, however, there may be a separate bond registrar for an
At one time, corporate, government bonds, and other debt
securities were issued primarily in bearer form. Unlike stock issues, which were in
registered form, the issuer did not know who held the bonds. The bondholder
"clipped" interest coupons attached to the bond and sent them to the trustee or
paying agent as interest became due. Eventually, the bond itself matured or was called
prior to maturity, and was sent to the trustee for payment.
Today, however, most bond issues are registered for both
principal and interest. Under Section 149 of the Internal Revenue Code, in order to
qualify for the Federal tax exemption for interest with respect to state,
county, and municipal bonds, such bonds must be in registered form. A transfer agent is,
therefore, needed to maintain records of ownership. Since bond issues often have a
or 30 year maturity, some bearer bonds, (and associated coupons) may still be
encountered by examiners.
For bond issues, the entity that performs transfer agent
services is termed the bond registrar. A bond registrar performs all of the
functions of the stock transfer agent and the stock registrar.
While unusual, banks are sometimes appointed solely
as registrar of a bond issue, without the associated bond trustee duties.
Also refer to the discussion of
registered transfer agents.
B.5. Mutual Fund Transfer Agent
Two characteristics of mutual fund transfer operations
are very different from stock or bond transfers. Mutual funds normally do not issue
certificates to evidence ownership. Instead, entries on the books of the mutual fund or
its transfer agent identify the owners and record the number of shares owned. In addition,
open-end mutual funds do not have a limit on the number of shares issued and outstanding.
Therefore, the "registrar function" faces a situation where the total number of
shares outstanding is constantly changing (increasing or decreasing, depending upon the
volume of purchases or redemptions).
A mutual fund transfer agent performs the functions of both
the stock transfer agent and stock registrar. It maintains ownership
records, transfers shares, and ensures the number of shares is kept in balance. A mutual
fund's transfer agent is identified in the mutual fund's prospectus.
Despite the general statements in the above paragraph,
there are exceptions to both. Some mutual funds allow the issuance of share certificates
on special request, such as when a customer wants to pledge fund shares as collateral for
a loan. While most mutual funds are open-end, with no set number of shares issued and
outstanding, "closed-end" mutual funds do have such limits. There are,
however, fewer closed-end mutual funds than open-end funds.
Every mutual fund transfer agent must be a registered
transfer agent. In addition, operations of mutual funds are subject to the
Company Act of 1940.
B.6. Registered Transfer Agents
Some institutions transfer securities, which are either
listed on a national stock exchange or, more commonly, are registered under Federal
securities laws. Section 17A of the Securities and Exchange Act of 1934 and Part 341 of
the FDIC Rules and Regulations, require FDIC-supervised institutions that transfer these
types of securities (including securities of a parent company or an affiliate) to register
with the Corporation as a transfer agent. State nonmember banks serving solely as transfer
agent for their own registered stock must also register as a transfer agent, whether or
not the bank exercises trust powers and regardless of which department performs the
transfer function. Registration as a transfer agent is also required when the institution
is merely named as transfer agent for these securities, but has contracted with a
third-party organization to actually perform all of the transfer processing and recordkeeping, a situation referred to as a private label arrangement.
As part of the registration process, each
institution must obtain a FINS (Financial Industry Numbering System)
Number from the Depository Trust Company in New York City. The FINS
Number is a standardized numbering system used to identify each
institutional party (banks, broker-dealers, transfer agents, etc.)
to a securities transaction.
As of November 30, 2003, 92 FDIC-supervised institutions
were registered as transfer agents. The FDIC utilizes a separate examination report for
registered transfer agents and the Registered Transfer Agent Examination Report of
Examination is completed for all such banks.
Examiners should note that, if a bank is a registered
transfer agent, all bond and stock issues (regardless of which
department of the bank transfers the securities) must b processed according to
the SEC's operational regulations for registered transfer agents. This
includes municipal and industrial revenue/development bond issues (which are
not subject to securities registration and, were it not for the bank's
registration as a transfer agent, would not otherwise be subject to
securities transfer regulations).
Stocks must be registered under Federal securities laws,
if they meet one of the following two criteria:
As of January 1, 1998, equity securities must be registered under Section
12(g) of the Securities and Exchange Act of 1934 and SEC regulation 17 C.F.R. Section
240.12g when an issuer has (i) $10 million or more in total assets and (ii) more than 500
shareholders. Refer to 12 C.F.R. Part 335 of the FDIC Rules and Regulations.
Prior to January 1, 1998, the applicable exemption threshold governing
the registration of equity securities is (i) less than $1 million in total assets and (ii)
500 or fewer shareholders.
Less frequently, examiners will encounter corporate bond
issues listed on a national securities exchange or mutual funds where the bank has been
named a transfer agent. These also require registration as a transfer agent.
B.7. Fiscal or Paying Agent
As the fiscal agent for a corporation or a municipality,
an institution makes interest payments on coupon bonds (often referred to as bearer bonds)
as the coupons are presented; redeems maturing bonds; or prepares and mails interest
checks for registered bonds, or dividend checks for stock issues. A fiscal agent may also
be called a dividend disbursing agent, coupon and bond paying agent, or some similar name
indicative of its duties.
B.8. Dividend Reinvestment
Some corporations offer their stockholders the option of
participating in dividend reinvestment programs, wherein dividends are automatically
applied to the purchase of additional shares of the corporation's stock, either on the
open market or directly from the corporation. On the dividend payment date, dividend
payments are transferred by the dividend disbursing agent to the dividend reinvestment
agent (often the same institution) who purchases shares of the corporation's stock. It may
also be possible for stockholders to purchase additional shares through their dividend
reinvestment agent. The dividend reinvestment agent usually holds the shares purchased
until the participating stockholder requests physical delivery.
B.9. Other Corporate Agencies
An institution may also serve s an escrow agent or
depository in connection with: defaults, mergers, consolidations, reorganizations,
initial public offerings, tender offers, or other transactions requiring
securities or funds be deposited with a responsible third-party. The depository may
also receive and record the claims of creditors.
Banks are often appointed as:
Conversion agent (where debt securities are
"converted" into equity securities),
Exchange agent (involving exchange of one class
of securities for another, or exchange of bearer bonds for registered
Subscription agent (usually involving an
invitation to equity security holders to subscribe to a new issuance of
additional debt or equity), and
Authenticating agent (commonly used when the
indenture trustee is not located in a major money market city -- the bond
registrar is also able to exercise limited authority to authenticate bonds
on exchange or transfer).
Lesser-known services are offered to corporations in
connection with the voluntary or involuntary liquidation of business enterprises. A
business concern, which finds itself in financial difficulties but is not insolvent, may
turn over its assets to a trust institution as assignee for the benefit of creditors.
A business in financial difficulties, which can not reschedule its payments owed to
creditors, may have a court appointed receiver operate the business until such time
as the assets can be liquidated or it becomes evident that bankruptcy can be averted. The
duty of a trustee in bankruptcy is to realize as much cash as possible from the
sale of the assets of a bankrupt business and, under the supervision of the court, to
apply the amount realized to the claims of creditors. Few institutions accept trusteeships
in bankruptcy because of the undesirable and unprofitable nature of this type of business.
B.10. Asset-backed/Securitized Debt Issues
In recent years, it has become more common for debt
securities to be secured by various types of self-liquidating collateral. These
asset-backed or securitized debt issues may be secured by a variety of assets, including
commercial loans, second mortgage loans, automobile loans, and credit card receivables.
The trustee must ensure that the collateral, a pool of loans for example, is properly
serviced, payments are properly allocated to principal and interest, and delinquencies are identified and resolved.
Accepting such responsibilities is a
major undertaking involving considerable potential risk. The pre-acceptance review of such
appointments is crucial: to identify the quality of the loans involved; to ensure the
bank's ability to monitor the loans and servicer; to evaluate the complexity of the deal
structure; and, if necessary, to arrange for back-up services.
Servicing of the loan pool cannot be delayed. There
have been instances where major problems have arisen when the loan servicer went out of business
or was otherwise unable to properly service the underlying loans. In such cases, the
bank trustee must promptly ensure continued servicing, which may involve considerable
unanticipated, and perhaps unreimbursed, costs.
The trustee is responsible for ensuring that adequate
backup arrangements exist to handle such a situation if it should arise. The trustee
itself can arrange to be the backup servicer, or it can use a third party servicer.
Considerations for selecting a backup data processing and/or loan servicer are similar to those used
to select other third party data processing servicers.
Either a "hot site" or a "cold site" can serve as
backup. A "hot site" is dedicated exclusively to servicing the
collateral; no other work is performed. The advantage is instant
availability. Maintaining such a site, however, which may
never be used, is extremely expensive. A "cold site" performs other
work (such as the bank's own data processing center). Costs are much
lower, but a cold site's capacity to service additional loans must
In each case, the trustee must ensure that the backup
- Has hardware and software compatible with that used by the original
- Has adequate capacity to continue with its own work as well as
service the loan portfolio.
As in any data processing servicing arrangement, a written contract
should be in place. Further guidance on considerations in selecting a data
processing servicer is
contained in the Serviced Institution Control Guidelines chapter of the FFIEC
IT Examination Handbook.
B.11. Municipal Trustee Issues
B.11.a. Secondary Market Disclosures for Municipal Issues
In 1995, the SEC Rule 15c2-12 [17 CFR 240.15c2-12] significantly
changed the requirements governing the public disclosure and availability of financial information related to
issuers of municipal debt securities. The rule was designed to prevent fraudulent,
deceptive or manipulative acts or practices in connection with the underwriting of
municipal securities by brokers, municipal securities dealers, and "participating
underwriters". With some limited exemptions, it applies to the underwriting of
municipal securities with an aggregate principal amount of $1,000,000 or more. The disclosure and financial requirements of "participating underwriters" are contained in Section 15c-2-12(b). A
"participating underwriter" is prohibited from purchasing or selling municipal
securities in connection with an offering, unless there is a written agreement or contract
for the benefit of holders of these securities to provide directly, or "indirectly
through an indenture trustee or a designated agent" required information. [Section
15c2-12(b)(5)]. Therefore, as indenture trustee for a municipal issue, a bank may be responsible for
providing the required financial information, if the indenture trustee has
entered into a contract to provide the required information for an issuer or
required information that must be provided to each nationally recognized municipal
securities information repository (NRMSIR), and to the appropriate state information
depository, if an, includes the following:
(1) annual financial information for each
obligated person for whom this information is presented in the final
official statement issued in conjunction with the underwriting of the issue.
(2) notice of any of the following events with respect
to securities in the offering, if material:
principal and interest delinquencies
non-payment related defaults
unscheduled draws on debt service reserves
reflecting financial difficulties
substitution of credit or liquidity providers, or
their failure to perform
adverse tax opinions or events affecting the
tax-exempt status of the security
modifications of the rights of security holders
release, substitution, or sale of property securing
repayment of the securities
(3) notice of the failure of any person required to
provide annual financial information by the date specified in the written agreement or
contract in a timely manner
Notification to the Municipal Securities Rulemaking
Board may be substituted for the requirements to notify the NRMSIR's for items (2) and (3)
In addition, SEC Rule 15c2-12(b)(5)(i) requires the
written contract for the benefit of holders of securities to indicate those to whom annual
financial information and notices of material events will be provided. The written
contract also must cover the following: (1) the type of financial information and
operating data to be provided annually; (2) the accounting principles used to complete the
financial statements, including any requirement for audited statements; (3) the date on
which annual financial information will be provided and to whom.
The NRMSIR's, are private information vendors. As of
June 21, 2004, there were four NRMSIR's and three state information depositories. The
NRMSIR's were the following: Bloomberg Municipal Repositories, DPC Data, Inc.,
Data and Standard & Poor's Securities Evaluations, Inc.. The
State Information Depositories (SID's) have been established for Texas,
Michigan, and Ohio, are In addition, the Municipal
Securities Rule Board (MSRB) also operates the Municipal Securities Information Library
and Continuing Disclosure Information systems, which provide similar information.
For those concerned with disclosure obligations for
municipal securities, the "preliminary note" to SEC Rule 15-c2-12 refers the
reader to the following: Securities Act Release No. 7049 and Securities Exchange Act
Release No. 33741, FR-42 (March 9, 1994). SEC Rule 15-c2-12 replaces the voluntary
industry standards promulgated by the American Bankers Association's Corporate Trust
Committee, which were known as Disclosure Guidelines for Corporate Trustees.
B.11.b. Defeasement Activities With
A defeasement is a type of
municipal debt financing which enables the issuing government entity to reduce the amount
of interest it pays on outstanding bonds. For example, an entity that has outstanding
bonds carrying high interest rates issues new debt at a lower (current) rate. The proceeds
are used to buy State and Local Government Series U.S. Treasury securities (SLGS), which pay enough interest to pay the interest on the old
outstanding bonds. SLGS are offered for sale to issuers of state and local
government tax-exempt debt to assist in complying with yield restrictions or
arbitrage rebate provisions of the Internal Revenue Code. The SLGS
program was established in 1972 and approximately eight percent of municipal
securities are subject to advance refunding, according to the July 1, 2004,
"Report on Transactions in Municipal Securities" by the SEC. The securities can be sold, but typically mature when the old bonds
reach their call date, providing a steady source of funds to retire the old debt. This
process allows municipalities to pay less on a current basis. SLGS cannot be
transferred by sale, exchange, assignment, pledge or otherwise.
Defeasement financings are also referred to as
arbitrage bonds. The use of arbitrage for new bond issues was limited by the Tax
Reform Act of 1986. Under the Act, annual calculations must be made of all earnings to
report income in excess of allowable yields. Earnings of impermissible arbitrage must be
placed in a rebate fund for payment to the IRS every five years. Failure to comply can
cause an otherwise tax-exempt municipal bond issue to become taxable retroactively to the
date of issuance
Although compliance with the requirements for
defeasement financing under the Tax Reform Act of 1986 is generally the responsibility of
the issuer, the trustee is often responsible for establishing and maintaining the rebate
fund. While other parties should make the rebate calculations, the trustee is responsible
for ensuring that the proper actions are taken to protect the interests of the
B.12. Global Custody
Global custody refers to the cross-border safeguarding,
settlement, servicing, and reporting of investor securities on a worldwide basis. This
line of business has experienced significant growth over the last 20 years as a result of
the continuing expansion of the international flow of capital and investment. The
customers of global custody services are holders of large pools of investment assets,
mainly securities. These customers include institutional investors, insurance companies,
public entities, mutual funds, banks and trust organizations.
The main services provided by global custodians are:
The safekeeping of cash and securities
The settlement of securities trades
The servicing of securities held in custody
Accurate and timely reconciliation of customer cash and
securities positions is essential to maintaining control over customer assets. Effective
reconciliation procedures and timely follow-up of open items are essential for the proper
management of safekeeping services.
Securities trades are normally processed through a
broker, who in turn, notifies the global custodian of the details of a trade. The
settlement process is more complicated than the normal process in the United States due to
Servicing of securities in global custody involves the
following functions: (1) collection of income; (2) monitoring and processing corporate
actions; (3) proxy voting; (4) processing tax reclamations; (5) foreign currency exchange;
(6) cash management; and (7) international securities lending. The first three functions
are similar to those performed in domestic custody accounts. The last four functions
involve other risks due to the additional aspects of international income tax collections,
which may vary, and the risks associated with currency fluctuations.
Subcustodians often are used by the global custodian to
provide local securities safekeeping services, to act as local settlement agents and to
provide related services in local overseas markets. Subcustodians provide the local
operational, regulatory and legal expertise applicable to their particular region.
Due to the key role of subcustodians in the global custody business, effective management of
the subcustodian network is essential for successful management of global custody.
The selection and oversight of subcustodians is crucial
to a well-managed global custody operation. Before selecting a subcustodian, the global
custodian should perform a due diligence review of the credit-worthiness and operational
and informational systems capabilities of the subcustodians available in a given regional
market. In addition to a rigorous initial screening of subcustodians, the global custodian
should monitor the performance and credit quality of each of its subcustodians on an
ongoing basis including periodic on-site visits to the subcustodian. The use of technology
and telecommunications is also a very important element of an effective subcustodian
network. Building a technological bridge between the clients, their global custodian, and
the subcustodian network is a key component of a prudently managed global custody program.
Trust Preferred Securities - Trustees
Trust preferred securities represent
preferred stock issued by a trust, usually a Delaware statutory trust,
created for the sole purpose of investing the proceeds from the sale of
preferred stock and common stock in a subordinated bond or debenture.
The trust created is a subsidiary that invests in the subordinated debt of
the trust's parent company. The parent will purchase the common stock
issued by the trust, usually representing at least 3% of the trust.
The only asset of the trust is the subordinated bond or debenture from the
parent and the only income received is the interest payments received on the
subordinated debt, which is used to pay dividends on the preferred stock issued by
Under the Trust Indenture Act of 1939, the
sale of subordinated debt in conjunction with the issuance of preferred
securities requires the appointment of an indenture trustee. The
duties of the indenture trustee for the subordinated debt do not differ from
the duties of other indenture trustees. The trust formed to
issue the preferred and common stock usually requires a Delaware trustee, in
the case of a Delaware trust, and the appointment of a property trustee.
The property trustee is the holder of record, for the benefit of the holders
of the preferred securities, of the subordinated debt. In the event of
default, the property trustee, whose duties are essentially those of an
indenture trustee, acts to protect the interests of the holders of the
preferred stock. A property trustee is required to exercise the care,
skill of a prudent person. In addition, the trust agreement provides that
the property trustee is a trustee for the purposes of the Trust Indenture
The parent normally will issue a guarantee
for the benefit of those holding the preferred securities. There will
be a preferred security guarantee trustee, usually the same as the indenture
trustee, to enforce the guarantee if necessary. The parent's
guarantee, however, is unsecured and subordinated to other creditors with
respect to existing and future senior debt. In contrast to many bond
indentures that contain restrictions on the issuance of senior debt or
requirements to maintain minimum liquidity levels, the indenture governing
the issuance of preferred stock and the related trust agreement contain no
or very few restrictions on the parent company's financial activities.
C. Account Administration and Controls
The administration of corporate trusteeships and
agencies generally requires fewer discretionary decisions and actions than do personal or
employee benefit trust accounts. However, they do require a higher level of documentation,
automated services, and an in-depth knowledge of securities, security-related laws,
industry practices, etc. Duties and actions are specified in the indenture and the
corporate trustee/agent is limited to the provisions of the indenture. It assumes or
performs additional duties and functions at its own risk.
As in all areas of fiduciary administration, the bank
should have adequate written policies and procedures governing account acceptance
conflicts of interest, internal operations, auditing, and profitability.
C.1. Pre-Acceptance Reviews
One of the most important aspects of good corporate
trust administration occurs before accounts are accepted. This is the decision-making
process of whether or not to accept a corporate trusteeship or agency account. Many
financings are driven by timing considerations, often the result of perceived market
windows or regulatory deadlines. Nonetheless, the due diligence review must not be
neglected. Factors to be considered include:
- the financial strength of the obligor, both currently and anticipated
over the life of the bond issue;
- the size and character of the issue;
- the integrity of the issuer;
- the existence of, and potential for, conflicts of interest;
- the environmental liability potential;
- the capacity and capability of the corporate trust department to perform
its duties and fulfill all responsibilities based on a thorough analysis of the
requirements of the indenture;
- the probability of profitable administration to the department. In regard
to profitability, the "cash float" of principal, interest, or dividends held as
bank deposits was often an integral consideration in past fee structures. With greater
emphasis on cash management, this is less of a factor today; and
- operational considerations, such as the capability of the information systems to
properly handle the administrative requirements of an issue.
C.2. Appointment Documentation
Complete documentation for each trust indenture is of
utmost importance. In this regard, a listing of documentation items is included on the
Corporate Trust Line Sheet, included in
Appendix B - Examination Aids. In general, banks should not accept accounts without
obtaining the necessary appointment documentation.
Some of the same types of documentation required for a
commercial loan should be maintained in conjunction with the administration of a corporate
trust, for example, a corporate resolution authorizing the debt, in this case a security.
In corporate trust appointments, the absence of required documentation may seem
inconsequential, but could have a major impact at a later date.
Appointment documentation is governed by the type of
appointment being accepted (bond trustee, transfer agent, paying agent, etc.), the
characteristics of the securities issue (bonds, stocks, convertible
securities, etc.), and the issuing organization
(corporations, local government agency, state government agency, etc). Some issuers are from regulated industries, such as
banking, broadcasting, utilities, or communications, where regulators may impose
C.3. Conflicts of Interest
The trustee must also exercise prudent judgment and
avoid potential conflicts of interest that might prevent it from acting
under the duty of
loyalty. For issues subject to the
Trust Indenture Act of
1939, prohibited conflicts must be identified in the indenture. Section 310(b) of the Trust
Indenture Act (15 U.S.C. Section 77jjj(b)) establishes procedures for the
disqualification of an indenture trustee in instances involving conflicts of
interest. Section 311 of the Act (15
U.S.C. Section 77kkk) addresses situations in which the indenture trustee is a creditor of
the issuer of the securities. For securities not subject to the Trust
Indenture Act, the existence of conflicts of interest is an equally
important consideration. Indenture trustees have been held liable for
losses suffered by bondholders in cases where it was determined that the
indenture trustee acted in a way that placed its own interest ahead of that of the bondholders.
A bank should avoid accepting an appointment
as indenture trustee for a securities issue of a corporation with which it
also has a creditor relationship. In such cases, when an obligor defaults under an indenture where a bank is both a creditor and
the indenture trustee, doubts may arise concerning whether the bank placed
its own interests (by attempting to improve the bank's credit position or chances of repayment)
ahead of its responsibility to protect the interests of all bondholders. Similarly,
when a bank acts as trustee for more than one debt issue
(or more than one debt tranche) of an issuer, questions about the indenture
trustee's impartiality may also arise.
Conflicts of interest are permissible for issues subject to
the Trust Indenture Act of 1939, provided the issue is not in default. Once default
occurs, however, unless a "curing" of the default occurs within the
period set in Section 310(b) of
the Trust Indenture Act, the trustee is required to resign. Refer to
- Compliance with the Trust Indenture Act of 1939 for a
more detailed discussion of
conflicts of interest.
Generally, conflicts of interest place the bank in a
position of increased risk, especially when a default occurs. Therefore,
potential and actual conflicts of interest should be identified and resolved prior to acceptance, and
monitored for the length of time the security remains outstanding. Some banks make prior arrangements to resign
in favor of another trustee in the event of default. Often, the successor trustee requires
indemnification for the original trustee's acts.
C.4. Environmental Liability
Trust departments that serve as trustee for bond issues
secured by real estate should have policies addressing the environmental risks related to real
estate. These policies should cover the types of environmental audits and other procedures
to be followed in order to ascertain whether any proposed real estate collateral for
corporate trust issues is contaminated. Prior to beginning the foreclosure
process on real estate, a determination
should be made, through an environmental audit or otherwise, that
the property subject to foreclosure is free of environmental contamination.
Failure to take reasonable precautions before taking title to potentially
contaminated real estate could subject the trustee to considerable
liability. Refer to
F.7.b in Section 3, Environmental Liability, for more information about
C.5. Administration and Controls
The bank's corporate trust department is frequently
operated separately from the personal trust department, often maintaining
separate books and records. The corporate trust function may be located in a different
area than the rest of the trust department. It is not uncommon for personal and employee
benefit accounts to use one data processing system, while corporate trust activities use
another. Examiners should review the organization, including recordkeeping systems, of
corporate trust services during the pre-examination planning process.
C.5.b. Operational Issues
appropriate processes, procedures and controls differ somewhat between bond
trusteeships and corporate agency appointments, the following operational
considerations apply to most appointments
Corporate trust administration, in the
absence of default, involves various administrative and operational duties that
are periodic and time sensitive, such as monitoring compliance with bond
covenants, paying interest and principal, and administering funds and
Ticklers, whether manual or automated, should be set up for all periodic events to ensure that all
administrative and compliance responsibilities are completed within required
timeframes. The tickler system should identify items that are
past due, such as the
failure to pay interest and principle, the failure to obtain annual
certificates of compliance, failure to obtain insurance certificates, etc.
Such events may, depending upon the terms of the indenture, call for
acceleration of the payments due, and should be closely by senior
management. Senior management is responsible for determining how the trustee
should proceed in instances of delinquent compliance with bond covenants.
Unissued and Cancelled Securities
Appropriate inventory controls should be
placed on supplies of blank certificates. The supply of blank certificates
should be limited to the quantity needed, to be issued as part of the
original distribution of the securities or as replacement certificates for
loss, missing or stolen securities. Access to the certificates should be
limited to appropriate personnel. A listing of the certificate numbers
should be kept and periodically reconciled to the certificates held in
inventory. Any breaks in inventory should be reported and investigated.
The trustee should also have appropriate
controls over cancelled securities certificates. The fraudulent use of
cancelled securities certificates presents significant problems and
potential cost to investors, creditors and broker-dealers. Securities
certificates that have not been properly cancelled can be used to defraud
the public and financial institutions. Stolen certificates that were not
properly cancelled have been subsequently sold to investors and used as
collateral for loans. Pursuant to SEC Rule 17AD-19, written procedures for
the cancellation, storage, transportation, destruction, or other disposition
of certificates should provide for the following:
- Controlling access to any cancelled certificate
- Physically marking certificates with the word
"cancelled" in a clear and conspicuous manner, unless the transfer agent's
procedures require the certificate to be destroyed within 3 business days
of cancellation. Tiny perforations that do not deface the
certificates are not consistent with the rule.
- Maintaining a secure storage area for cancelled
- Maintaining a retrievable database of all of its
cancelled, destroyed, or otherwise disposed of certificates. The
information required to be maintained includes the CUSIP number,
certificate number, denomination, registration, issue date, and
- Requiring that the physical transportation of cancelled
certificates be conducted in a secure manner and that a record of the
certificate transported be
maintained. When cancelled certificates are transported, the trustee
should receive notice that the certificates were delivered. In the case
of non-delivery, the trustee should investigate the circumstances
regarding the non-delivery. If the non-delivery is not resolved, the
certificates transported should be reported to the Securities Information
Center (SIC) as lost, missing, or stolen securities, as required by SEC
Rule 17f-1, which is applicable to all banks (not just trust departments)
that accept or handle certificates.
- Requiring that authorized personnel of the transfer
agent, supervise, witness and document the destruction of
When performing the bond registrar
function, the trustee, or outside registrar if one has been appointed,
should ensure that proper controls are in place to prevent physical under-
or over-issuances of securities. A trustee, or outside registrar,
responsible for a physical over-issuance of securities, may be required to
buy-in the excess securities issued. If the bank is a registered transfer
agent, the registrar function must comply with the SEC operational
requirements of 17 C.F.R. Section 240.17Ad.
Administration of Funds
Most corporate rust appointments,
whether as trustee under a bond indenture or under a corporate agency
agreement, involve the disbursement of funds for principal, interest, or
dividends. In addition, the corporate trustee or agent may have to
administering various related funds, such as sinking and reserve funds.
Banks should have processes and procedures for independently
validating the accuracy of funds held for interest, principal and other
disbursements. Procedures should provide for the validation of principal,
interest and dividend payments for outstanding, as well as called or matured
issues. In large departments, such validation normally would be
accomplished by separating the administrative function from the operational
function. The administrative review should act as a check on operations, by
verifying the accounting records relating to an issue. In smaller
departments the audit function can validate the accounting records relating
to corporate trust appointments. Out-of-balance issues should be
identified, reported to management, and receive prompt attention until
For all issues, records should
accurately indicate the amount of principal, interest and dividend payments
that are due and have not been paid. Funds held for the payment of interest
or dividends (payable on different coupon or dividend dates) should be
segregated Payments may be segregated by
establishing separate control accounts for each payment, increases control
over funds held for distribution and facilitates the reconciliation and
escheatment of unclaimed funds. The maintenance of separate payment
accounts prevents for interest and
dividends also prevents payment errors.
should review the trust department's reconciliation procedures.
Disbursement accounts should be reconciled after each payment date. The
standard bond printout, listing the current principal outstanding,
outstanding bonds that are due but not presented, and the amount of cash on
hand held for mature but not presented bonds, should be periodically
reconciled to the departments operational records. Principal outstanding
can be validated by comparing the department's automated records with the
issue's legal documents. The trustee's records can also be compared to the
obligor's records. The obligor of an issue also tracks the principal amount
outstanding and few obligors will transfer funds to the trustee in excess of
what the issuer owes for interest or principal.
Controls over returned mail should
ensure that returned interest, dividend and principal payments are properly
accounted for and protected from theft, misuse or misapplication. Unless
allowed by state law, issuers are not entitled to a return of unclaimed
interest and dividend payments. Instead, unclaimed funds are subject to
state escheat and unclaimed property laws. Without appropriate processes
and procedures to govern the administration and disbursement of funds,
corporate trustees and agents face the risk of violating state
escheat and unclaimed property laws. Without proper accounting controls,
escheatable funds can not be identified and may be misused to
cover unrelated operational losses or reported as miscellaneous income.
subsection E2.b - Escheatment Litigation for a discussion of cases
involving the failure to escheat funds to the proper authorities.
C.5.c. Bond Trusteeships
When an institution is appointed bond trustee,
it normally also serves as bond registrar (transfer agent) and
paying agent. Refer to the material under those captions, as well as
to material under the Corporate Agencies caption that follows this
Proper administration of the underlying collateral
is vital, including the identification and control of environmental risk where real
property is concerned. Extreme care must be taken by the trustee regarding the timing of
collateral foreclosure so that the interests of all parties to the indenture are fairly served.
A trustee's failure to appropriately protect the interests of bondholders
before, and subsequent, to default, can result in liability and loss to the trustee.
Proper maintenance of the collateral, including periodic verification or continuance of
Uniform Commercial Code (UCC) filings, is required. The trustee should ensure
that the initial filings were in the appropriate jurisdiction and should
verify that a continuance is filed, if under UCC Article 9. Should the trustee prematurely foreclose
on collateral, the obligor may incur liability. If foreclosure is inordinately delayed,
bondholder interests may suffer severe loss of value.
Many bond trusteeships involve the maintenance of
separate funds, used for sinking funds, construction, building maintenance, etc. The
assets of these funds are invested according to the provisions of the bond indenture. The
bank trustee usually has little or no discretion in such investments. Proper separation of
the various funds, investment of their assets, and administration of these funds are
The trustee must not only provide reports and recordkeeping for the
issuer, but also must protect the interests of the bondholders. The
reporting of distributions, and interest and dividend payments, to both tax authorities
and security holders is also required of the trustee. These responsibilities are important
since the trustee can be held liable if the bonds default and subsequent loss is
attributable to the trustee's negligence. The acts of omission as well as commission by
the trustee are critical in the event of default.
Many bond issues are complex
and impose numerous duties on the indenture trustee. For instance, credit
enhancements such as letters of credit and municipal bond insurance may have their own
requirements which the trustee must monitor. The risks of managing such issues must be
adequately addressed by the bank and reviewed by the examiner. For example, letters of
credit may be issued for a 10-year period covering a bond with a 30-year maturity. The
indenture may provide for mandatory early redemption, if no letter of credit covers the issue, or
if the creditworthiness of the letter of credit issuer drops below a certain quality.
The trustee must monitor the status of the letter of credit and its issuer to ensure
compliance with the indenture.
In recent years, bond issues have become more
complex. Moreover, interest rates, for instance, may be indexed to other indices. Derivative
securities have also become common. These increasingly complex securities present new
types of risks to bond trustees, who must know their responsibilities and have adequate
policies and procedures in place to manage the risks.
C.5.d. Default Administration
In the case of a default, the indenture trustee is
responsible for protecting the interests of the bondholders. There are
two types of default: technical and substantive.
Technical default occurs when the issuer does
not comply with specific covenants in the agreement. However,
the failure to comply, in and of itself, does not cause nonperformance.
Examples of technical default include failure to: provide periodic
financial statements, provide audited financial statements, demonstrate
compliance with specific provisions of the indenture, etc.
However, the manner in which the indenture trustee responds is important.
Unlike many large corporate issuers that have sophisticated compliance
systems to ensure that bond covenant requirements are satisfied, smaller,
less sophisticated issues may often fall into technical default. In
such cases the trustee must act in a timely manner to bring the issuer back
into compliance wit the bond covenants. The trustee should promptly
inform the issuer of the noncompliance and give the issuer a deadline for
curing the technical default, for example 30 to 90 days, or more if
circumstances make a longer deadline reasonable. In the event that the
issuer fails to cure the technical default by the deadline given, the
trustee should notify the issuer that a default will be declared if the
issuer does not cure the technical default by a certain date, for example
within 30 days. If the issuer still has not cured the technical
default by the given deadline, the trustee should declare a default and
consult the bondholders to determine whether to waive the default or
accelerate the payment of principal. Trustees that fail to act in an
appropriate and timely manner when technical defaults occur risk being held
liable for inaction or negligence, in the event of a subsequent substantive
defaultIn contrast to technical defaults, substantive events of default include the
failure to make required interest, principal or sinking fund payments; the
bankruptcy or insolvency of the obligor; or a cross default on other
obligations, such as loans or other bonds. The trustee should take timely and appropriate actions to ensure
that bondholders realize the maximum amount of repayment of principal and
interest due. Failure on the part of the trustee to act on the
bondholder's behalf, could
result in bondholder claims that the trustee, through negligence,
caused monetary losses and seek reimbursement of those losses.
In administering defaulted bonds, the trustee
should employ legal counsel and
request bondholder involvement. Bondholders should be
promptly informed of substantive default events. The trustee should
communicate with any bondholder committee nominated by all the bondholders
and seek direction from the that committee.
Within reason, when principal is at risk, trustees should defer to the
bondholders of the defaulted issue. Any modification in the bond indenture
and other governing documents should not be made without the consent of
bondholders. A decision to waive the default should be made by the
The trustee must act quickly
to secure any collateral, if the defaulted issue is secured. Securing
the collateral, however, might entail complications if the collateral is
a business or some other facility requiring professional management
or contaminated real estate. The trustee is not required to seek
all remedies or pay out of its own funds the expenses related to those remedies.
In most cases, the trustee should obtain an indemnification agreement from
the bondholders before pursuing certain remedies, along with a commitment
that it will be reimbursed for expenses incurred.
C.5.e. Corporate Agencies
The administration of corporate agencies does not
involve discretionary actions, but does require accurate recordkeeping, prompt posting of
accounting records, timely reporting, and a staff thoroughly trained in related laws,
regulations, and standard industry practices. The performance of agencies requires
technical expertise, open communication between interested parties, and an efficient
operating system. As in all other aspects of fiduciary operations, the corporate agency
function should be fully covered by written policies approved by the trust committee and
board of directors.
Unlike the long-term relationships of bond trusteeships,
corporate agency accounts are often moved to another institution: if the bank does not
perform to the expectations of the securities issuer, if the bank's performance
results in investor complaints to the issuer, or if the bank does not offer the full range
of services expected by the issuer. The importance of pre-acceptance reviews is just as
valid for corporate agencies as it is for bond trusteeships.
When the bank is serving as a paying agent, the obligor
deposits the necessary funds with the bank, which prepares and issues checks in payment of
the interest, dividends or bonds. When bonds are fully registered, an interest check is
sent to the holder of record. In the case of coupon bonds, the coupons must be presented
for payment. Coupons are received in several ways, but normally flow through the banking
system and the related clearinghouse process.
Many stock transfer appointments also involve the
administration of dividend reinvestment plans and/or stock purchase plans. The proper
administration of the funds received, accurate recordkeeping, the prompt execution of
orders, and the issuance of accurate investor statements are all important operational
imperatives. Section 344.6(f) of the FDIC Rules and Regulations requires that periodic
plans (such as stock purchase plans or dividend reinvestment plans) provide the customer
not less than once every three months a written statement showing: (1) the funds and
securities in the custody or possession of the bank, (2) all service charges and
commissions paid by the customer in connection with a transaction, and (3) all other
debits and credits of the customer's account involved in the transaction. If the
customer requests it, the bank must provide the information listed in Section 344.5 of the
FDIC's regulations, except in those cases where the customer does not remunerate the
As with bond trusteeships, the bank must not only
provide reports to the obligor, but also must provide investors with periodic statements
and provide tax authorities and security holders with reports of interest and dividend
D. Compliance with the Trust Indenture Act of
Certain bond issues, and their administration, must
comply with the Trust
Indenture Act of 1939 (TIA) [15 USC 77aaa - bbbb], as amended.
Only bonds issued by corporations are potentially subject to the TIA; municipal bond
issues (including industrial development and industrial revenue issues) are not covered.
Bonds issued by banks are exempt from the TIA. All Trust Preferred
Securities are subject to the TIA.
The TIA requires the use of an independent trustee in
connection with the public offering of debt securities. The TIA generally provides that
debt securities may be issued only pursuant to a trust indenture governing the
responsibility and liability of the trustee.
The Trust Indenture Reform Act of 1990
[PL 101-550 Title IV, 104 Stat. 2721] simplified the information
required in an indenture. It also eliminated the automatic disqualification of banks as
indenture trustee when the bank has director interlocks with the issuer, or has served as
underwriter for the issuer. The 1990 law requires the trustee to resign in circumstances
when an issuer defaults and the trustee is a lender to the issuer.
The full text of the Trust Indenture Act and implementing SEC regulations appear in Appendix F of this Manual. Some
regulatory filings must be submitted electronically. Refer to
K.3. Electronic Submission of Forms and
Notices, located in
Exemptions for various types of securities are contained
in Section 304. In addition,
certain SEC rules issued provide further guidance concerning the exemptions in Section 304. Two important
- non-indenture securities totaling less than $5,000,000, when issued
within a consecutive twelve-month period (TIA Section 304 (a)(8) and 17 CFR
260.4a-1 of SEC Rules)
- securities that have been or will be issued under an indenture which
limits the aggregate principal outstanding at any one time to $10,000,000; the exemption
is limited to securities issued within a 36-month period by the same issuer (TIA Section 304 (a)(9) and 17 CFR
260.4a-3 of SEC Rules)
The exemptions described above are aggregate exemptions.
For example, an issue of $10 million or less would have to be qualified with the SEC if,
under the indenture, additional bonds aggregating more than $10 million may be issued for
public distribution. TIA Sections 304(a)
through (e), as well as the SEC Rules noted above, may be found in Appendix F.
The TIA imposes stringent duties on the issuer
and the trustee of indenture securities. The requirements for registration and exemption
under the Act are provided by Section 305,
as well as implementing regulations.
The TIA generally requires that the indenture include
certain provisions. For example, the issue must be administered according to its
indenture. Specific provisions regarding conflicts of interest are detailed in Section 310. An annual
report to bondholder is required by Section 313. Actions
required in the event of default are covered by Section 315.
Other important areas covered in the TIA include:
(1) the appointment of the bond trustee, (2) conflicts of interest, (3) the
administration of the issue, and (4) actions in the event of default. These are
briefly summarized below.
D.3.a. Trustee Appointment Requirements
- There must be one or more trustees, at least one of whom shall be a
corporation appropriately organized and subject to Federal or State supervision or
examination. [§ 310(a)(1)]
- The trustee must have at all times a combined capital and surplus of not
less than $150,000. [§ 310(a)(2)]
D.3.b. Conflicts of Interest
- The indenture must provide that, in the case of a event of default,
if a conflicts of interest exists, the trustee must eliminate the conflict of
interest within 90 days or resign. If the trustee fails to comply, it must (within 10
days after the expiration of the 90-day period) transmit notice of such failure to the
bondholders. [§ 310(b)(i)
- Section 310(b)
specifies in detail prohibited relationships between the trustee and either an obligor or
an underwriter, if:
- it acts as trustee under more than one indenture (not issue)
of the same obligor (with some exceptions) [§ 310(b)(1)];
- it, or any of its directors, or executive officers, is:
- an underwriter for the obligor with respect to the indenture securities [§ 310(b)(2)];
- a director, officer, partner, employee, appointee, or representative of
the obligor, or an underwriter for the obligor with respect to the indenture securities
(with exceptions) [§ 310(b)(4)];
- it directly or indirectly controls, or is directly or indirectly
controlled by, or is under direct or indirect common control with, an underwriter for the
obligor with respect to the indenture securities [§ 310(b)(3)];
- more than certain specified percentages of the trustee's voting
securities are beneficially owned by the obligors, underwriters, and their respective
officials [§ 310(b)(5)];
- an issue is in default and the trustee is the beneficial owner of, or
holds as collateral security, more than specified percentages -
- an issue is in default and the trustee holds, in specified fiduciary
capacities, 25 percent or more of the outstanding securities [described in item (5) above]
[§ 310(b)(9)]; or
- the bank-trustee is, or becomes, a creditor of the obligor (with
exceptions) [§ 310(b)(10)]
- If the trustee is (or becomes) a creditor of the obligor within three
months prior to default, it must set aside any repayment received during this period, or
after default, in a special account to be divided pro rata between the trustee bank and
the bondholders (with some exceptions) [§ 311]
D.3.c. Trustee Administration of Issue
- Bondholder annual reports. If certain events have occurred (primarily
involving the debt issue, but also including changes in the conflicts of interest
described above), the trustee must send a report to the bondholders at intervals of not
more than 12 months. If no changes have occurred, no report is required [§ 313(a)]
- Bondholder periodic reports. If: (1) changes have occurred in the
bond issue's collateral, or (2) the trustee claims large reimbursable advances, a
report must be sent to bondholders within 90 days of such occurrence [§ 313(b)]
D.3.d. Administrative Filings With Trustee
- The obligor must file with the trustee: (1) an annual certification as to
compliance with the indenture, (2) copies of annual reports, and (3) other information and
documents. These must also be filed with the SEC [§ 314(a)(1), (2),
and (4)]. The content of the various reports is specified by Sections 314(b)
- The obligor must provide the trustee with lists (names and addresses) of
the bondholders, and the trustee must maintain such lists [§ 312(a)]. The trustee
must provide such lists to any three or more bondholders upon written request [§ 312(b)].
D.3.e. Actions in the Event of Default
The indenture must contain provisions setting out the
duties and responsibilities of the trustee prior to, in case of, and after, default [§ 315].
E. Other Compliance
Laws and regulations in the corporate trust area are
technical and require a high level of knowledge and training. In addition to
Indenture Act of 1939, other laws and regulations exist that are
supplemented by standard industry practices and the specific rules established by the
various stock exchanges on which the securities are listed.
E.1. Lost, Stolen and Counterfeit Securities
Pursuant to SEC Rule 17f-1 [17 CFR 240.17f-1],
a central database for the collection and dissemination of information about
lost, stolen, and counterfeit securities has been established. In general, all insured banks and every
registered transfer agent must register with the Securities Information Center (SIC) as
either a direct or indirect inquirer. The rule also imposes certain reporting and inquiry
SEC Rule 17f-1, banks and registered
transfer agents must report to the SIC instances of missing, lost, stolen, or counterfeit
securities. Securities certificates that are subsequently recovered must also be reported.
The rule does not include securities that have been escheated, called for
redemption, subject to litigation, or when the issuer is in bankruptcy.
Bond coupons are also not considered securities certificates for this rule. Reports are required for all corporate securities having a CUSIP number, municipal
securities, and bearer U.S. Government securities. Reports must be confirmed in writing on
SEC Form X-17F-1A. >
In the corporate trust function, the most likely
application of this reporting requirement is when the bank, in its bond or stock transfer
- Is notified by a security holder of lost or stolen securities
certificates. This occurs when the security holder requests a replacement certificate.
Normally, the transfer agent creates an internal "stop transfer" order and
issues a replacement certificate. The security holder is usually required to furnish an
indemnification bond as a part of this process. The indemnification bond protects the bank
in the event a lost or stolen certificate received in good faith is presented for transfer
later and the bank is required to honor the certificate by purchasing replacement
securities in the open market.
- During the securities transfer process, the transfer agent identifies:
- counterfeit certificates, or
- valid certificates previously reported as lost or stolen, or
- valid certificates listed as paid or canceled on the transfer
- The bank determines that securities certificates are missing from the
bank's blank certificate inventory.
It is important to note that the rule was amended in 2004
and clarifies that the rule covers the life span of a certificate, from the
time it is printed to the time destroyed.
The bank should file a report with SIC in each of these
Section 353.3(d)(2) of the FDIC Rules and Regulations, the filing of
suspicious activity reports is not required for lost, missing, counterfeit or stolen
securities, if the bank files a report as required by the
reporting requirements of 17 CFR
Banks are required to make routine
inquiries of the SIC by the end of the fifth business day after a certificate comes
into its "possession or keeping". Furthermore, inquiries must be made
of the SIC before the certificate is sold, used as collateral, or sent to
another reporting institution. Normally,
the inquiry requirement does not apply to the corporate trust function. There are
provisions in the Rule governing situations where certificates are received from sources
other than customers. Refer to SEC Rule 17f-1(d)(1), which appears under the
Miscellaneous Statutes and Regulations tab in Volume III of FDIC's loose-leaf regulations
E.2. State Escheat Laws
While escheatment laws primarily involve
deposits, banks acting as bond trustee, securities transfer agent, and
paying agent must comply with state abandoned property laws for checks and
securities certificates which are undeliverable, as well as for book-entry
accounts for which the owner cannot be located. Funds on deposit to pay unclaimed dividends, bond
coupons not presented for payment, bonds not presented for payment, as well as funds in
suspense accounts, may be subject to state escheat laws. However,
institutions should establish and implement adequate procedures to ensure
compliance with the applicable law.
Administratively, each state has its own dormancy
period. Over the years, these have tended to become shorter. In addition, every state
establishes rules as to where abandoned property must be sent. States also set their own
publication and notification requirements, have their own individual forms to be
completed, and set their own dates for transmitting escheated funds.
Due to the different administrative and legal requirements of each state, it
has been difficult both for bank personnel and for examiners to verify
compliance with escheat laws
E.2.a. Legal Background
Escheat laws vary from state
to state and may not exist in some states. One state may claim that
its escheat laws apply to dormant funds which are concurrently claimed by
another state. One state might clam the property based on the
location of the trustee/transfer agent bank (or broker/dealer), while
another state might claim the same property based on the physical or legal
headquarters of the issuing organization. Yet another state might issue
rules based on the stock exchange where the security was traded. It was
possible for several states to claim the same funds. Bank trustees and transfer agents were often faced with
In Delaware v. New York, 113 S. Ct. 1550
(1993), the U.S. Supreme Court resolved the differences among state laws concerning the
right to receive unclaimed securities distributions. In that decision, the Court provided
the following rules for resolving such disputes:
therefore resolve disputes among States over the right to escheat
intangible personal property in the following three steps. First,
we must determine the precise debtor-creditor relationship as
defined by the law that creates the property at issue. Second,
because the property interest in any debt belongs to the creditor
rather than the debtor, the primary rule gives the first
opportunity to escheat to the state of "the creditor's last known
address as shown by the debtor's books and records." Finally, if
the primary rule fails because the debtor's records disclose no
address for a creditor or because the creditor's last known
address is in a state whose laws do not provide for escheat, the
secondary rule awards the right to escheat to the state in which
the debtor is incorporated. 113 S. Ct. at 1556
- For purposes of the second rule under the Delaware v. New York
standard, the Court held that "intermediaries" such as banks or securities firms
who hold unclaimed securities distributions in their own name on behalf of the beneficial
owners of such distributions are the relevant "debtors" with respect to the
application of state law. In reaching this conclusion, the Court stated:
From an issuer's perspective, the only creditors are
registered shareholders, those whose names appear on the issuer's records. Issuers
cannot be considered debtors once they pay dividends, interest, or other distributions to
record owners; payment to a record owner discharges all of an issuer's obligations.
113 S. Ct. at 1559.
E.2.b. Escheatment Litigation
Two high profile lawsuits occurred during the latter
part of the 1990's and resulted in significant media and regulatory attention
being placed on the escheatment practices of corporate trust departments. In 1995, a
former officer in the corporate trust department of the Bank of America, San Francisco,
California, filed a lawsuit against the bank. The state of California, the city and county
of San Francisco and 300 local governments later joined the suit in 1997. The plaintiffs
claimed that between 1977 and 1995, the bank or its predecessor, Security Pacific,
mismanaged the proceeds of several bond issues for which it was serving as paying agent.
The bank was accused of escheating insufficient amounts of unclaimed funds, charging
excessive fees on bond trust accounts and destroying or losing critical records. Other
allegations included claims that the bank mishandled payments for bonds that had been
called so that it could maximize the earnings realized on the float of such funds and that
it made unauthorized investments in order to generate higher fees. The case was settled
out of court for $187 million.
The second lawsuit began when New York State auditors
discovered in 1994 that the amount of unclaimed funds at Bankers Trust Corporation, New
York, New York, had declined significantly from the prior year. Auditors became suspicious
when bank employees thwarted their attempts to obtain records explaining the reduction in
the amount of unclaimed funds o the bank's books. The FBI, the Manhattan U.S.
Attorney's office and the Federal Reserve took over the investigation in November
1998. According to newspaper reports, three former executives were indicted on various
Federal charges that they systematically diverted $19.1 million of unclaimed
customer's funds to the bank's own accounts. The funds were used to bolster the
department's financial results, cover budget shortfalls, and even pay for the office
Christmas party. The bank settled with Federal and New York State authorities in March
1999 by paying $63.5 million in fines and returning the $19.1 million in unclaimed funds
that it acknowledged diverting to revenue.
E.3. Other Laws and Regulations
There are various other laws, regulations, rules and
practices that affect the administration of accounts in a corporate trust department, such
as bankruptcy laws, the rules and regulations of the various securities exchanges where
securities are listed, Municipal Securities Dealer Regulations (refer to the Corporation's
handbook covering municipal securities dealer activities) and the standardized
operating procedures within the securities industry.