Financial Services Alert

Developments of Note

FDIC Issues Guidance on Investments in Trust Preferred Securities

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The FDIC issued guidance on the treatment of insured state nonmember bank investments in trust preferred securities under the FDIC's recently revised activities regulations, which are discussed in detail in the February 9 Alert. The guidance confirmed that, because the OCC has permitted national banks to invest in trust preferred instruments as "Type III" securities, the activities regulations do not restrict an insured state bank's authority to invest in trust preferred instruments, provided the investment meets the investment quality and marketability requirements set forth in the OCC's rulings. The trust preferred investments are not subject to the 15% of capital limit imposed upon adjustable rate preferred stock and money market preferred stock by the revised regulations. Moreover, because, as discussed in the Alert, the revised activities regulations generally do not impose the quantitative investment limitations of the OCC regulations, insured state banks are not subject to the 10% per issuer diersity limit that applies to national bank investments in Type III securities, although state and federal bank examiners will evaluate these investments during safety and soundness examinations.

FFIEC Issues Year 2000 Customer Communication Outline

To assist financial institutions in providing information to their customers about the Year 2000 ("Y2K") problem, the FFIEC has issued a Y2K Customer Communication Outline that is intended to provide guidance about formulating public statements on Y2K readiness. The FFIEC suggests that an institution: (1) describe the Y2K issue, including what the Y2K issue is and how extensive it is; (2) address customer expectations by informing customers that maintaining their confidence is a top priority and that the institution and federal and state regulators are working to insure that customer service is not disrupted; (3) describe the institution's Y2K project plan, including remediation efforts, testing of internal and external systems, and the institution's progress in meeting its Y2K milestones; and (4) describe Y2K contingency plans, including resumption contingency planning to be used if a disruption occurs.

OCC Issues Ruling on Investment Adviser Activities

The OCC issued an interpretive letter (850) approving an arrangement whereby a national bank would receive a finder's fee for referring bank customers to an SEC-registered investment adviser and also permitted the investment adviser to enter into contracts with banks to act as subadviser in providing "private label" investment management services to bank fiduciary accounts. As to the referral arrangements, the OCC noted that the investment adviser will provide investment management services in its own name, directly to and under contract with bank customers; the bank's role would be merely facilitating contact and, in certain circumstances, providing administrative services; and the bank would not retain investment discretion over customer assets. The OCC declared that it has long recognized that the payment of reasonable finder's fees in connection with the marketing of advisory services is appropriate, so long as the fee is disclosed to bank customers. The OCC stated that a national bank need not obtain fiduciary powers to provide the referrals. As to the "private-label" subadviser arrangements, customers would have no contractual arrangement with the adviser and all written materials would identify the investment program as the bank's. As to the application of the Interagency Statement on Retail Sales of Nondeposit Investment Products to these arrangements, the OCC declared that the Interagency Statement would apply to the referral arrangement because of the finder's fee, but generally would not apply to the private-label arrangement.

NASD Issues Rulings on Rule 2420 and Other

The NASD issued interpretive orders regarding a variety of matters. With respect to NASD Rule 2420 (which addresses payment of fees or other compensation to non-member broker/dealers), the NASD ruled that an exception (the "Continuing Commissions Policy") from its standard policy which prohibits the payment of compensation to non-member broker/dealers was not intended to permit a corporate sale of brokers and customer accounts by a broker/dealer firm and the receipt by the selling broker/dealer of continuing and new commissions generated by the same brokers at the purchasing broker/dealer firm. Rather, the Continuing Commissions Policy was adopted principally to enable registered persons who are retiring from the business to continue to receive commissions. In another letter, a broker inquired whether Rule 2420 permits "override" payments to an insurance company that is not a registered broker/dealer, which payments would be calculated by multiplying the total dollar amount involved in the transactions during a fixed period by a percentage. While reiterating that Rule 2420 generally prohibits the payment of a fee or other compensation to non-member broker/dealers, the NASD stated that the company should first request interpretative advice from the SEC concerning the applicability of Section 15(a) of the Securities Exchange Act of 1934 (which sets forth the broker/dealer registration requirements) to an insurance company. Finally, in response to a request proposing that unregistered Customer Service Representatives be permitted to transcribe customer orders from taped lines during periods of peak telephone call volume, the NASD responded that the appropriate way to prepare for above-average call volume is to register additional personnel as Assistance Representatives for Order Processing (Series 11).

SEC Holds Roundtable on Role of Independent Mutual Fund Directors

The SEC held a two-day roundtable last week on the role of independent directors of mutual funds. At the roundtable, SEC Chairman Arthur Levitt said that he will ask the SEC to make mutual fund governance one of its top priorities. The SEC expects to use the roundtable as the basis for developing recommendations to enhance the effectiveness of independent directors. The SEC did not specify whether the recommendations would consist of legislative proposals, rulemaking proposals or SEC staff guidance. The roundtable included panel discussions that addressed the responsibilities of independent directors in the areas of mutual fund fees and expenses, distribution arrangements, portfolio brokerage and soft dollars, acquisitions of investment advisers and portfolio valuation.

A number of panelists spoke in favor of amending the Investment Company Act of 1940 to require that a majority of a fund's board of directors consist of independent directors. The 1940 Act currently requires that only 40% of a fund's board consist of independent directors (although funds with 12b-1 plans are required by the SEC to have a majority of independent directors). Several panelists also recommended that only independent directors be permitted to nominate other independent directors as is currently the requirement for funds with 12b-1 plans. Participants also urged the SEC staff to provide updated guidance to independent directors regarding the appropriate factors that directors should consider when evaluating 12b-1 plans. The roundtable included a discussion of bank-related funds. Bradley Skolnik, President-elect of the North American Securities Administration Association, distributed "best practices" guidelines for directors of bank-related mutual funds. The best practices include a recommendation that directors insist on effective compliance systems to prevent confusion and abuse in connection with the sale of fund products on bank premises.

Recommendations for Public Disclosure of Trading and Securities Activities of Banks and Securities Firms

The Basle Committee on Banking Supervision and the Technical Committee of the International Organization of Securities Commissions have made a joint proposal regarding the public disclosure of trading and derivative activities of banks and securities firms. The objective of the proposal is to promote the transparency of the trading and derivative activities. The proposal is that these institutions provide comprehensive information about their trading and derivative activities and how the activities contribute to their overall risk profile and profitability, as well as how well they manage the risks of these activities. More specifically, the information proposed has both qualitative and quantitative components about trading (for both derivative and cash instruments) and non-trading derivative activities (i.e., derivatives that are used for risk management purposes such as hedging). The proposal declares that credit risk, market risk, liquidity risk, operational risk, legal risk, and reputational risk all should be discussed with separate disclosures for trading and non-trading activities. The proposal also declares that institutions should provide detailed information on performance in managing these exposures, such as by describing their internal risk measurement and performance assessment systems. Comments on the proposal are due by May 31, 1999.

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