4000 - Advisory Opinions
Interpretation of General Counsel Opinion Number 6
June 5, 1998
Douglas H. Jones, Deputy General Counsel
I have been requested by William F. Kroener, General Counsel, Federal Deposit Insurance Corporation (the "FDIC") to respond to your letter dated February 5, 1998, which requests the FDIC's interpretation regarding General Counsel's Opinion Number 6 ("Opinion No. 6") which was issued on May 17, 1983. Your letter presents the issue of whether the trust department of your client, which is a North Carolina-chartered, insured nonmember bank (the "Bank"), may (i) select an affiliated broker-dealer firm within a competitive bidding process for purposes of the purchase and sale of fixed income securities, and (ii) pay that affiliated firm a market-based commission for its brokerage services. In your letter, you requested the FDIC's view regarding whether the Bank's proposed competitive bidding process and brokerage arrangement would violate Opinion No. 6.
In our view, the Bank's proposed competitive bidding process and brokerage arrangement would not violate Opinion No. 6. Opinion No. 6 does not prevent your client from selecting an affiliated broker-dealer to execute securities transactions on behalf of the Bank's trust department or paying the broker-dealer a market-based commission. In pertinent part, Opinion No. 6 states that in its commercial relationship with broker-dealers, a bank trust department should not receive any additional compensation with respect to securities transactions conducted by the broker-dealer.1 However, note that the proposed competitive bidding process and brokerage arrangement must satisfy various standards under Federal and State securities and trust law, as explained below.
According to your letter, the affiliated broker-dealer is a subsidiary of the Bank's parent holding company. Under its competitive bidding process, the Bank's trust department would select from among three "qualified and reputable" broker-dealers. Should the affiliated broker-dealer be selected based on its past performance regarding timeliness of securities transactions and price, the contractual arrangement with that affiliated broker-dealer would be executed under the same terms and conditions that would apply to any successful bidder.2 In addition, you have represented to us that both the Bank and the affiliated broker-dealer have policies and procedures to ensure that there will be no insider manipulation, undue influence or other corruption of the bidding system and that affiliate transactions will be on an arm's length, marketplace basis in accordance with Section 23B of the Federal Reserve Act, 12 U.S.C. § 371c--1.
As described in your letter, the affiliated broker-dealer's commission would be consistent with relevant standards of the National Association of Securities Dealers ("NASD"), including its Rule 2430 regarding fees for brokerage services. Rule 2430 provides that "[c]harges, if any for services performed. . .shall be reasonable and not unfairly discriminatory between customers." In addition, it would be a violation of NASD Rule IM--2440 to "enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security or to charge a commission which is not reasonable." Standards related to "best execution" by broker-dealers in securities transactions on behalf of their retail customers are set forth in NASD Rule 2320.
Based on these safeguards, you have concluded that the proposed arrangement would likely satisfy (i) the prudent fiduciary standards under North Carolina trust statutes (N.C. Gen. Stat. § 36A-2 (1997)); and (ii) the relevant restrictions and prohibitions for trust department operations as contained in the Uniform Trusts Act, as incorporated into North Carolina statutes (N.C. Gen. Stat. § 36A-60 et seq. (1997)).3
The intent of Opinion No. 6 was not to require that securities transactions executed by a broker-dealer on behalf of a bank trust department be performed on a nonprofit basis. By issuing Opinion No. 6, the FDIC intended to prohibit compensation by bank trust departments that was in addition to the fees already charged trust customers. This situation would arise in the event that the trust department directed its securities transactions to a broker-dealer that rebated to the bank or its trust department any portion of the broker-dealer's commission for such transactions.
The prohibition in Opinion No. 6 regarding the payment to a bank trust depar;tment of "additional compensation" with respect to securities transactions conducted by a broker-dealer is consistent with fiduciary standards under Federal law. For example, Section 406(b)(3) of the Employee Retirement Income Security Act of 1974 ("ERISA") prohibits a fiduciary with respect to an ERISA-covered plan from receiving any consideration for its own account from any party dealing with the plan. In 1985, the U.S. Department of Labor issued an exemption from this prohibition to allow under certain circumstances, commercial relationships between fiduciaries for ERISA-covered plans and broker-dealers.4
If you have any questions regarding this letter, please contact Michael Phillips, Counsel, at (202) 898-3581.
1Opinion No. 6 primarily responded to certain inquiries concerning "discount" securities brokerage services that would be provided by nonaffiliated broker-dealers for banks. Opinion No. 6 concluded that subject to certain conditions, discount brokerage services would be permissible for a state nonmember bank under the Banking Act of 1933 (commonly known as the "Glass-Steagall Act"), especially with respect to Section 16 of the Act, 12 U.S.C. § 24 (Seventh). See 48 Fed. Reg. 22989, May 23, 1983. Go back to Text
2We assume that under the Bank's competitive bidding process, it will select the broker-dealer that has demonstrated that it would charge the lowest commissions for the anticipated securities transactions, in conjunction with providing "best execution" for those securities transactions. Go back to Text
3We offer no opinion regarding whether the Bank's proposed competitive bidding process and brokerage arrangement are consistent with North Carolina trust statutes. Go back to Text
4See PTE 86--128, as issued in 51 Fed. Reg. 41,686 (Nov. 18, 1986). In that PTE notice, the Department of Labor cautioned that "excessive trading in the account is one respect in which the fiduciary might breach the general fiduciary responsibilities, including that of prudence, imposed on him or her by section 404(a)(1) of ERISA." 51 Fed. Reg. 41,690. In addition, the PTE stated that "the Department could conclude that a fiduciary had violated ERISA's prudence requirement where an account had been churned', despite the fact that the resulting composition of the plan's portfolio, viewed by itself without regard to the impact of excessive transaction costs, was beyond challenge." Id. Go back to Text