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4000 - Advisory Opinions

Application of § 344.4(a)(2) Which Establishes Recordkeeping and Confirmation Requirements for Securities Transactions


February 17, 1994

Gerald J. Gervino, Senior Attorney

You have asked whether a proposal set forth by counsel for *** ("Bank") conforms with the requirements of § 344.4(a)(2) of our regulations, which establishes recordkeeping and confirmation requirements for securities transactions.

The Bank has been cited by our examiners for an apparent violation of § 344.4(a)(2), because confirmations issued by mutual fund distributors to Bank customers who purchase mutual fund shares on the Bank's premises through the Bank's affiliated broker/dealer, *** ("Broker"), do not disclose the amount of remuneration that the Bank receives on the transaction. The examiners noted that Part 344 requires that the amount of remuneration received by the Bank must be disclosed on the confirmation or separately disclosed to the customer by the Bank, unless the remuneration is paid pursuant to a prior written agreement between the customer and the Bank.

The remuneration that the Bank receives is paid by the Broker out of the dealer concession that the Broker receives either directly from the particular mutual fund or from the mutual fund's principal underwriter or distributor. The amount of the dealer concession received by the Broker (as well as any other broker selling the fund) is disclosed in the fund's prospectus, which every Bank customer receives before he or she may purchase any fund shares. Out of its dealer concession, the Broker reallocates 70% to 85% to the Bank, with the actual amount being based upon the Bank's actual production. Because of this variable, the precise amount of the remuneration that the Bank receives cannot be calculated and disclosed to the customer.

The dealer concession received by the Bank on any particular transaction varies from fund to fund and, even within a particular fund, from transaction to transaction. Mutual funds or their service providers furnish the confirmations and are not inclined to customize confirmations sent to Bank customers, who in most instances comprise a relatively inconsequential portion of the mutual fund's sales. Disclosure on the confirmation is not a viable alternative.

In the interest of establishing systems and procedures that will assure continuing compliance with Part 344, the Bank and the Broker propose the following regulation. The Broker presently requires each Bank customer to complete a mutual fund account application before he or she may invest in a new mutual fund. The Broker will add a statement to this application form that will disclose to the customer that his or her Bank will receive remuneration in an amount between 70% and 85% of the dealer concessions applicable to his or her mutual fund transactions, as disclosed in the mutual fund prospectus. This statement will be preceded by an open box to be checked by the customer to indicate that the customer has read the disclosure and agrees with the remuneration agreement. This acknowledgement will follow the customer's immediately preceding acknowledgement that the customer has received and read the prospectus for the mutual fund in which he or she is investing.

Counsel for the Bank has furnished you, and you have enclosed, a copy of the Broker's current mutual fund customer account application, on which he has marked the location where he proposes to insert a disclosure statement. Counsel has also indicated on the enclosed mutual fund customer account application, the change that the Broker plans to make in its standard, uninsured product legend included at the top of the form.

Counsel's clients contend that the Bank customer's acknowledgement and consent to this arrangement constitute "a prior written agreement between the Bank and the customer" (within the meaning of 12 CFR 344.4(a)(2)) with respect to the particular mutual fund to which the account application relates. Counsel feels that the Bank should have no continuing obligation to disclose to the customer the amount of remuneration received by the Bank on subsequent transactions for the benefit of the customer in shares of the particular mutual fund.

Counsel sees the proposal as falling short of enabling the customer to ascertain the precise amount of remuneration received by the Bank, even though the disclosure is as precise as the Bank can be. Based upon historical experience, the 75% to 85% range, on a gross dollar basis, equates to an average of $39.36. During the first eleven months of 1993, dealer concessions averaged 2.60% or $262.44 on an average transaction size of $10,093.82. The Bank could have been allocated from $183.71 to $223.07, the above indicated range of $39.36. Counsel's clients believe that advance disclosure of the amount of remuneration to be received by the Bank within this range of specificity serves to achieve the underlying purpose of the regulation. In their view, that purpose is to allow the customer to determine the level of the economic incentive that the Bank has in recommending the customer's purchase of uninsured investment securities.

Counsel asks that we concur with his opinion that the foregoing proposal of the Bank and the Broker will satisfactorily resolve the FDIC criticism of the Bank's investment securities activities.

The new language would be inserted in a column headed "Disclosures" and otherwise indicating by separate checkmark that the investor understands certain dangers and has received important disclosures, including the mutual fund prospectus and the fact that mutual fund shares are not deposits or other obligations of the Bank. It would read as follows:

I/we understand that my/our--Bank will receive remuneration in connection with this and future purchases of mutual fund shares by me/us which will be within a range of 70% to 85% of the fee received by--Broker on the transaction, as disclosed in the mutual fund prospectus.

Section 344.4(a) provides a partial exception for the disclosure of remuneration received by the bank from other sources, where:

the remuneration is . . . determined pursuant to a prior written agreement between the bank and the customer. . . .

The suggested remedy refers to an agreement between the Bank and the customer. The above language in the application discloses Bank remuneration, but does not include any specific language expressly indicating an agreement between the parties. For purposes of construing an exemption, we believe the existence of an agreement cannot be left to implication. As currently drafted, we would not consider the above language adequate to qualify for an exemption under § 344.4(a)(2).

Since it would seem possible to alter the language used in order to meet that objection, we will consider the proposal on the assumption that language expressly requiring agreement were substituted. Bank Counsel has represented, as highlighted above, that the remuneration cannot be calculated and disclosed and that the disclosure of a range of percentages is as precise as the Bank can be. Under the circumstances and in view of Counsel's representations, we would concur in Counsel's opinion, with respect to Part 344, if the disclosure were phrased as to indicate an express agreement between Counsel's clients and their customers. If not yet done, Counsel should be made aware of our soon to be published guidelines on mutual fund sales by banks.

If you have any further questions, please write or call me at (202) 898-3723. My Fax number is (202) 898-3715.

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