Lawrence A. Knecht
Senior Vice President
and Legal Counsel
July 17, 2001
VIA FEDERAL EXPRESS
Jonathan G. Katz
Securities and Exchange Commission
450 5th Street, NW
Washington, D.C. 20549-0609
RE: Interim Final Rules for Banks, Savings Associations and Savings Banks under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934 (the "Exchange Act"), Release File No. S7-12-01 ("Interim Final Rules")
Dear Mr. Katz:
I am writing on behalf of UMB Bank, n.a. and its affiliated and subsidiary companies ("UMB"). We appreciate the opportunity to offer comments on the Interim Final Rules published by the Securities and Exchange Commission (the "Commission" or "SEC").
We believe the Interim Final Rules will impose on banks a number of burdensome and unworkable requirements, add substantial additional costs, limit banks in their ability to serve their customers, and force certain segments of their traditional trust and fiduciary business out of the bank. This is contrary to Congressional intent that banks be permitted to continue providing trust, fiduciary and custodial services to meet the financial needs of their customers. In its Report concerning the Trust and Fiduciary Exception in the Gramm-Leach-Bliley Act (the "GLB Act") the Conference Committee expressed its expectation that "the SEC will not disturb traditional bank trust activities under this provision."1 Similarly, the Senate Banking Committee stated:
"The Committee does not believe that an extensive 'push-out' of or restrictions on the conduct of traditional banking services is warranted. Banks have historically provided securities services largely through their trust departments, or as an accommodation to certain customers. Banks are uniquely qualified to provide these services and have done so without any problems for years. Banks provided trust services under the strict mandates of State trust and fiduciary law without problems long before Glass-Steagall was enacted; there is no compelling policy reason for changing Federal regulation of bank trust departments, solely because Glass-Steagall is being modified."2
In our opinion, the Interim Final Rules are incompatible with Congressional intent. They would establish expensive, impractical conditions not found in the GLB Act, effectively negating the availability of many of the push-out exceptions contained in the statute. If trust activities are forced out of the bank, UMB's customers would be negatively impacted as a result of fragmented relationships with the bank and a broker-dealer, and disruption of their traditional trust relationships. In our experience, our customers prefer entrusting their fiduciary business to banks rather than brokers.
Our primary concerns with specific sections of the Interim Final Rules are set forth below.
A. "Chiefly Compensated" Calculations. One of the GLB Act's conditions to the Trust and Fiduciary Activities Exception is that a bank must be "chiefly compensated" for securities transactions that it effects for trust and fiduciary customers on the basis of (a) an administration or annual fee, (b) a percentage of assets under management, or (c) a flat or capped per order processing fee equal to not more than the cost incurred by the bank in connection with executing securities transactions for trustee and fiduciary customers, or any combination of such fees.
We have serious concerns about the manner in which the SEC intends to implement the "chiefly compensated" standard as set forth in the Interim Final Rules.
1. Account-by-Account Calculation of Compensation. The Commission states that the "chiefly compensated" requirement will be applied to each trust and fiduciary account maintained by the bank, rather than to the bank's trust and fiduciary activities as a whole. We believe that the express language of the GLB Act only requires that a bank be chiefly compensated by permissible fees from all of its trust and fiduciary customers. This reading is also consistent with the purpose of the exception - that banks be prevented from conducting a "full-scale brokerage operation" through its trust department.
The requirement that the chiefly compensated calculations be done on an account-by-account basis would be very costly and burdensome for UMB. The calculations would first of all be very complex, as evidenced by the lengthy explanation of these calculations in the Adopting Release. UMB does not currently have systems in place to do this sort of tracking. We estimate that it would take 18 to 24 months to develop and install the necessary software and train associates to do the required calculations, at a cost of roughly $1 to $2 million to the bank.
This requirement would also be unworkable in the context of multiple-party accounts such as 401(k) accounts. Under the Interim Final Rules, it is unclear whether the compensation calculations would have to be tracked at the employer level, the participant level, or both. The computational difficulties would be increased exponentially if this requirement were imposed at both the employer and participant levels.
As a more workable alternative, UMB suggests that the calculations be based on the aggregate revenues that a bank receives each year from all trust and fiduciary accounts for which it effects securities transactions during the year.
This alternative would be consistent with the methodology currently employed in implementing FASB, including FASB 91, which does not force banks to do an account-by-account analysis but instead allows banks to assess the impact in the aggregate based on materiality.
2. Relationship, Sales and Unrelated Compensation. The Interim Final Rules provide that the compensation received by a bank for administering trust and fiduciary accounts be divided into three categories - Relationship Compensation, Sales Compensation and Unrelated Compensation. To pass the "chiefly compensated" test, Relationship Compensation on an account must exceed Sales Compensation each year. The Rules state that Relationship Compensation must be received directly from the customer or directly from the assets in the account and does not include payments received from other persons, such as mutual funds. In addition, the Rules define Sales Compensation as including 12b-1 fees and service fees paid by mutual funds.
First of all, we would note that the GLB Act does not limit the source of payment for the statutorily permissible fees, so we do not understand the reason for this limitation in the Interim Final Rules. The requirement that Relationship Compensation must be received directly from the customer or from the assets in the account unfairly limits the ability of a bank and its customers to tailor compensation arrangements, including having fees paid from a single account or from someone other than the account holder or beneficiary. In addition, we question how this requirement could be implemented in the case of multi-participant 401(k) accounts.
Secondly, we have very serious concerns about the Commission's position on 12b-1 and service fees. Defining these fees as Sales Compensation would cause UMB's Employee Benefit Department to have to be restructured at a substantial cost to the bank, and ultimately to UMB's customers.
By way of background, UMB administers 401(k) accounts for over 100,000 participants. A very significant percentage of the revenue from these plans comes from 12b-1 and mutual fund service fees. Implementation of the compensation provisions of the Interim Final Rules would cause UMB to change its entire method of charging fees and/or move these accounts to a broker-dealer. Similar consequences would ensue in connection with many Individual Retirement Accounts administered by UMB's trust department.
UMB does not believe that either 12b-1 or service fees are sales fees. Nor do we believe that these fees present the potential abuses about which the Commission has expressed concern when a bank or its employees have a "salesman's stake" in securities offered to trust customers. At UMB, there is no solicitation or "sale" of the mutual funds that are offered to the employer/sponsor of a 401(k) account or to the grantor of an IRA. Instead, the employer or customer selects the funds from a wide array of choices made available by the bank.
Although UMB provides general investment education to 401(k) participants, the bank does not offer investment advice. Currently, no unregistered bank employee of UMB receives any bonus or incentive compensation when a mutual fund is selected by the employer or customer or when 12b-1 dollars or service fees are received by the bank. In addition, UMB has procedures requiring that 12b-1 and service fees received by the bank be fully disclosed and acknowledged in writing by an independent fiduciary (typically the plan sponsor of a 401(k) account or the grantor of an IRA).
Furthermore, a key point is that the 401(k) customer can choose to pay trustee's fees to the bank in the form of hard dollars (defined by the Commission as permissible compensation) or to have these fees offset by 12b-1 or service fees (treated by the Commission as impermissible compensation).
In view of the foregoing, we do not believe that either 12b-1 fees or service fees should be treated as "Sales Compensation" that would trigger a wholesale restructuring of an entire line of business for the bank. If the Interim Final Rules are implemented, UMB would incur a significant increase in its costs, including registration, supervision, compliance, training, audit and reporting. Ultimately, these costs would have to be passed on to the customer.
We suggest that 12b-1 fees and service fees should be treated as Relationship Compensation. Alternatively, we would propose that the Commission exempt ERISA accounts and self-directed IRA's in its treatment of 12b-1 fees and service fees as Sales Compensation.
Finally, apart from 12b-1 fees, we see no rationale for treating service fees as Sales Compensation. Service fees paid by mutual funds are clearly administrative in nature and are not distribution - or sales-related. In addition, service fees have no direct impact on shareholder returns because these fees are paid out of the investment company's management fees.
3. "Per Order Processing Fee". Under the GLB Act, one type of permissible compensation is "a flat or capped per order processing fee equal to no more than the cost incurred by the bank in connection with executing such securities transactions". A per order processing fee may be treated as permissible Relationship Compensation under the Interim Final Rules only if the fee does not exceed (a) the amount charged by the broker-dealer for executing the transaction, plus (b) the costs of any resources the bank exclusively dedicates to the execution and settlement of securities transactions for trust and fiduciary customers.
We believe this interpretation is unduly restrictive and burdensome, and has no statutory basis. We do not understand why a bank's costs must arise exclusively from resources that a bank has dedicated solely to executing and settling trust securities transactions, when the GLB Act contains no such limitation. Implementation of this restriction would create problems for UMB because the employees who handle trust trades at the bank have other administrative responsibilities. This portion of the Rules would prevent banks from fully recouping the costs incurred by them which are properly allocable to shared resources.
In addition, we believe that it would be unfair to exclude the entire amount of the per order processing fee if only a portion exceeds the bank's costs.
As a solution, we suggest that a bank be permitted to treat as permissible Relationship Compensation the cost of any resources, including shared resources, that a bank can prove are allocated to executing and settling securities transactions on behalf of trust and fiduciary accounts.
4. Rule 3a4-2--SEC-Granted Exemption from Account-by-Account Calculation. The Interim Final Rules contain a "safe harbor" that will permit banks that are compensated almost entirely by Relationship Compensation to avoid making calculations on an account-by-account basis. However, in order to fit within the safe harbor, a bank must demonstrate that Sales Compensation received during the immediately preceding year for all of the bank's trust and fiduciary activities is less than 10 percent of the total Relationship Compensation received for all of its trust and fiduciary activities. In addition, in order to qualify for the safe harbor, the bank must maintain procedures reasonably designed to ensure compliance with the "chiefly compensated" test as to each trust or fiduciary account, when the account is opened and at various times during the administration of the account.
While we appreciate the Commission's attempt to grant some relief from the account-by-account calculation requirements, we believe that this Exemption will have limited usefulness to banks. First of all, this Exemption will not relieve banks from the requirement that account-by-account calculations be undertaken at various points during the administration of an account. This could be particularly troublesome in connection with certain types of accounts, such as 401(k) accounts. Secondly, we believe that the 10 percent limitation is too restrictive.
As mentioned above, we would suggest that the chiefly compensated test be implemented on the basis of all trust and fiduciary accounts administered by a bank. If the Commission does not adopt this proposal, then we believe that the Rule 3a4-2 safe harbor be increased from 10 percent to 50 percent.
5. Definition of Trustee and Fiduciary Capacity. The GLB Act states that a bank may avail itself of the Trust and Fiduciary Exception for securities transactions that it affects "in a trustee capacity... or in a fiduciary capacity."
In the Interim Final Rules, the Commission goes beyond the statute by limiting this exception to "bona fide" trustees and by requiring that the trustee have investment discretion over the account.
We believe that the SEC has added ambiguity to a requirement that was otherwise very clear in the statute itself. The GLB Act's definition of the term "fiduciary capacity" is taken from Part 9 of the OCC's Regulations governing the fiduciary activities of national banks, which has stood the test of time as a clear set of guidelines in this area.
In addition, the Commission creates specific exemptions from the "bona fide" requirements for Indenture Trustees, ERISA Trustees and IRA Trustees. By providing special treatment for these three categories of trustees, uncertainty is cast over other trust arrangements where investment discretion is reserved to the grantor or lodged with a third party, including various types of self-directed grantor trusts, charitable trusts, and certain corporate trusts.
We believe that the Commission should give effect to the plain meaning of the terms "trustee capacity" and "fiduciary capacity" that are found in the GLB Act.
6. Restrictions on Investment Advisory Activities. The GLB Act provides that a bank acts in a "fiduciary capacity" when it serves "as an investment adviser if the bank receives a fee for its investment advice." The Interim Final Rules, however, state that a bank will deemed to be acting in an investment advisory capacity for purposes of the Trust and Fiduciary Exception only if the bank -
(a) provides continuous and regular investment advice to the customer's account that is based upon the individual needs of the customer; and
(b) owes a duty of loyalty to the customer (arising out of state or federal law, contract, or customer agreement).
The "continuous and regular" investment advice requirement is overly broad and difficult to understand, and does not appear in either the GLB Act or in Part 9 of the OCC's Regulations. We suggest that the only requirement should be that a bank receives a fee for the investment advice it provides to the customer.
7. Bank Departments that are Regularly Examined for Fiduciary Principles. The Adopting Release to the Interim Final Rules states that "all aspects" of the securities transactions conducted by a bank for its trust and fiduciary customers must be conducted in a part of the bank that is regularly examined by bank examiners for compliance with fiduciary principles and standards. We are concerned that the phrase "all aspects" is overly broad and could unduly restrict new business and cross-selling efforts by commercial new business officers and other non-trust department associates.
8. Advertising Restrictions. One of the conditions to the Trust and Fiduciary Activities Exception contained in the GLB Act is that the bank may not publicly solicit brokerage business, other than by advertising that it effects securities transactions in conjunction with advertising its other trust activities.
We believe that this limitation should be clarified, particularly in regard to the types of informational materials that can be placed on a bank's web site in connection with a bank's proprietary mutual funds and other types of securities.
B. Safekeeping and Custody Activities Exception. The GLB Act expressly permits banks to undertake a variety of custodial-related activities without being considered a broker, including "providing safekeeping or custody services with respect to securities" and "serving as a custodian or provider of other related administrative services to any IRA, pension, retirement, profit sharing, bonus, thrift savings, incentive, or other similar benefit plan." On the other hand, the Commission through its Interim Final Rules states that this statutory exception does not allow banks to accept securities orders for their custodial IRA customers, for certain 401(k) and other benefit plans, or as an accommodation to custodial customers.
Like most banks, order-taking for securities transactions has long been part of UMB's traditional custody services, both in the personal and corporate trust departments. On the personal trust side, order-taking is offered as an accommodation to customers and is provided on an infrequent basis. However, UMB feels that it is important to offer this service to its customers so that customers may avoid the additional time and expense of going through a broker-dealer for occasional trades. Eliminating the ability of banks to accept securities orders from customers would be very disruptive to UMB's IRA custody business and would cause many IRA accounts to have to be moved out to a broker-dealer. In addition, the extra time, expense and paperwork to effect occasional trades through broker-dealers would be burdensome to customers and may cause many of them to move their traditional custody accounts out of the bank.
The Rule 3a4-5 Exemption would not be helpful to UMB because it would prohibit UMB from receiving any compensation for effecting trades. In effect, this could require the bank to provide certain aspects of its custodial services at a loss. This is not consistent with the customary banking activities that Congress sought to protect. Furthermore, the requirement contained in this Exemption that banks offer similar proprietary and non-proprietary mutual funds to custody customers has no basis in the GLB Act and is inappropriate in the context of custody account where the bank provides no investment advice.
C. Rule 3a4-6 - Exemption to Permit Execution of Investment Company Securities through NSCC's Mutual Fund Services. The GLB Act requires banks to execute through a registered broker-dealer securities transactions effected pursuant to the Trust and Fiduciary Activities Exception and the Safekeeping and Custody Exception. The SEC has provided through Rule 3a4-6 an exemption for mutual fund trades through NSCC's Mutual Funds Service, including Fund/SERV.
While UMB appreciates this safe harbor exemption, we would point out that many mutual funds do not currently utilize Fund/SERV. Consequently, UMB places many of its mutual fund orders directly through the mutual fund itself, either by telephone or through an electronic order placement system. In some cases, the orders are placed through a transfer agent for the fund that is not a registered broker-dealer. To require that these orders go through a broker-dealer would drive up costs. Therefore, we would suggest that the safe harbor exemption be broadened to include mutual fund orders placed directly through the mutual fund.
D. Statutory Exception for Third Party Brokerage Arrangements. The GLB Act provides that a bank will not be required to register as a broker as long as it complies with the networking limitations contained in the statute. Among these requirements is that unregistered bank employees may not receive incentive compensation for brokerage transactions, except that bank employees may receive compensation for referrals "if the compensation is a nominal one-time cash fee of a fixed dollar amount and the payment of the fee is not contingent on whether the referral results in a transaction."
In its Interim Final Rules, the Commission has interpreted the term "nominal one-time cash fee of a fixed dollar amount" to be limited to either -
(a) a payment that does not exceed one hour of the gross cash wages of the employee making the referral; or
(b) a payment in the form of points in a program that covers "a range of bank products and non-securities related services, where the points count toward a bonus that is cash or non-cash if the points awarded for referrals involving securities are not greater than the points awarded for products or services not involving securities."
In addition, the SEC indicates that banks may have bonus programs based on the overall profitability of "the bank" in addition to the point system for referrals; however, bonuses paid in addition to the point system may not be based strictly on brokerage referrals.
First of all, we believe that limiting a cash referral fee to the hourly wage of the referring associate places unnecessary burdens on banks that are not found in the statute and are inconsistent with previous SEC precedents, including the no-action letter to Chubb Securities Corporation. Differing referral fees could lead to a loss of a team approach in promoting referrals to a broker-dealer. In addition, separate calculations of the referring associate's referral fee will drive up bank costs. On the other hand, we are concerned that if the bank chooses an across-the-board referral fee, the bank may be required to utilize the lowest wage employee's hourly rate.
We also have concerns about the Commission's Rules regarding a referral points program. Not all products are the same in terms of profitability for the bank. We would question, for example, why a safe deposit referral should be worth the same number of points as a brokerage referral. There is no justification for this requirement in the statute, as long as the monetary value of the point is "nominal".
Significantly, we note the recurring concern expressed by the SEC about bank associates having a "salesman's stake" in effecting securities transactions. We believe that the referral process is not the same as the sales process and that the "salesman's stake" is encountered primarily at the sales associate level, not at the referring associate level. The sales associate is fully licensed and is subject to the full array of NASD and SEC review and enforcement procedures.
Finally, we believe that company-wide bonus programs are not within the scope of what Congress intended to cover in the GLB Act. The statute speaks only to incentive compensation for securities transactions. Therefore, company-wide bonus programs should be beyond the purview of the Commission. At the very least, the reference in the Interim Final Rules to bonuses based on the overall profitability of "the bank" should be eliminated in favor of a reference to the overall profitability of the holding company and its affiliated and subsidiary companies, in the case of banks that are part of a holding company.
E. Cure Period. Banks may not know if they have engaged in an inadvertent violation of the GLB Act until the end of the year, since the chiefly compensated calculations will not be done until that time. Therefore, we suggest that the Commission provide:
(a) a cure period for inadvertent violations; and
(b) a safe harbor for banks that operate in good faith and have in place policies and procedures reasonably designed to result in compliance with the exceptions contained in the statute.
F. Effective Date. UMB needs an extension of time well beyond the October 1, 2001, and January 1, 2002, effective dates to comply with the "chiefly compensated" and other requirements contained in the GLB Act and the Interim Final Rules. We have estimated that it will take 18 to 24 months to put systems in place to do the chiefly compensated calculations. Accordingly, we would suggest that the effective date be pushed out a minimum of an additional 18 to 24 months.
Again, we appreciate the opportunity to offer comments concerning the Interim Final Rules. We believe that the Rules impose a number of expensive and unworkable requirements on banks that will create inconvenience for customers, disrupt existing customer relationships, and force many traditional lines of business out of the bank and into a broker-dealer, a result that we believe Congress expressly sought to avoid. We appreciate the SEC's consideration of our comments and we respectfully request that the Commission withdraw the Interim Final Rules and develop rules that address the concerns of UMB and others within the banking industry.
Lawrence A. Knecht
Senior Vice President
and Legal Counsel
|1||See H. R. Conf. Rep. No. 106-434 at 164 (1999).|
|2||S. Rep. No. 106-44 at 10 (1999).|