deemed to be guilty of violating the federal securities laws, a determination that, under
current law, is left to the SEC, the bank regulators would refer the case to the SEC's
enforcement division. In addition, the appropriate bank regulatory agency, under its
u Under separate cover, the ABA will provide, star? of the Subcommittee with a more detailed analysis
authority to ensure the safety and soundness of the bank, can also bring appropriate
enforcement actions, including seeking cease and desist orders or civil money penalties.
Establishing a duplicative antifraud provision under the federal banking laws could
potentially put banks in the position of having to comply with two antifraud statutes that
may, in practice, conflict with each other. Moreover, enactment of a statute that
duplicates one already on the books may have the unintentional effect of creating a
jurisdictional dispute between the appropriate agencies. Banks do not need to become
embroiled in any more "turf wars" between regulators.
Another danger in enacting legislation that duplicates existing regulation, as many
of the provisions in H.R 3306 do, is that the regulators may very well lose their current
flexibility to adjust regulatory rules to fit changing circumstances. For example, H.R.
3306 specifies the disclosures necessary to prevent customer confusion. By specifying the
disclosures required, H.R. 3306 arguably takes away the regulators' flexibility to amend
their joint agency statement to require new or revised disclosures depending on the then-
current circumstances, new investment products or other developments unforeseen by the
The ABA would like to take this opportunity to express its specific opposition to
one provision of H.R. 3306. Proposed new section 44(g) of the Federal Deposit
Insurance Act would prohibit any bank or affiliate from using the name, tide, or logo of
the bank which is the same as or similar to the name, title, or logo of any investment
company or any nondeposit investment product cither offered for sale by the bank or
affiliate or with respect to which the bank or affiliate gives investment advice. This
provision is obviously intended to get at those institutions that brand affiliated mutual
funds with names or logos similar to that employed by the bank. The provision also
would prohibit banks from marketing generic investment products under a similar name
With respect to the branding of affiliated mutual funds, the ABA believes that,
with certain precautions, these mutual funds should be allowed to share some similarities
in both name and logo. For example, Antarctica Bank advises the Antarctica Funds. The
fact that the bank advises the funds must be disclosed under the federal securities and
banking laws, as well as under the industry standards. What better way for a bank to
inform the public that it serves as adviser to the fund than to brand the fund with a
similar name or logo. This approach appears to have worked well for other financial
services providers that have chosen to brand their insured bank with a name similar to
that of their affiliated funds, eg, Merrill Lynch Bank and Trust and the Merrill Lynch
The ABA does believe, however, that when similar names and logos are used by
banks and affiliated funds, banks bear an obligation to make increased disclosures to their
customers to ensure that those customers understand that the fund is not FDIC-insured.
In the above example, the Antarctica Bank would have an obligation to make increased
disclosures concerning its funds. If Antarctica Bank did not adequately satisfy its
obligation to make increased disclosures, it would be liable under both the federal
securities and banking laws.
The ABA does not support, nor do the industry guidelines permit, banks and their
affiliated funds sharing identical names. Thus, it would be improper for The Antarctica
Funds to be called The Antarctica Bank Funds.
With respect to marketing generic investment products, this provision of H.R.
3306 effectively prohibits banks from offering investment type accounts, such as an asset
allocation account, or sweep services under a similar name or logo. For example, the
Antarctica Bank could not market its asset allocation account under the name the
Antarctica asset allocation account. That account might invest in an array of mutual
funds and other investment products. The mutual fund products may or may not include
affiliated funds. Under the current regulations and industry standards, Antarctica Bank
would have to disclose to its retail customers that the investment products arc not FDIC-
insured and bear some degree of risk. If the products offered under the asset allocation
account include affiliated mutual funds, Antarctica Bank would be required to make
increased disclosures. Despite these disclosures and all the other consumer protection
measures undertaken by the industry, this provision, if enacted, would prohibit Antarctica
Bank from marketing that account under the Antarctica name. Surely, such an
anticompetitive effect could not have been intended.
In closing, it has been a privilege to appear before this Subcommittee to discuss
the various consumer education initiatives that the industry and the ABA have undertaken
to date. The ABA pledges to continue those efforts and to further investor awareness
generally concerning the uninsured nature of all investments, no matter where those
investments are sold. We want to work with you, the regulators and others to take
whatever additional steps are necessary to assure that investors are informed about the
nature of mutual funds and other investment funds. The ABA does not believe, however,
that legislation restricting the retail sales of mutual funds by banks is necessary or
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THE WALL STREET JOURNAL.
THURSDAY. FEBRUARY 24. 1994
Prudential Has New Woe: Unlicensed Brokers
By Mn iiafl Sir oNoin
NEW rORK - Scorn of Prudential Se-
curities Inc. broken are selling mutual
'.wit and stocks without proper broken*?
'icenses in »inous sines, internal Pruden-
tial compliance documents snow
As a result Prudential ultimately could
face the possibility of rescinding, or can-
-fimf , trades executed by the unlicensed
brokers. retuUion say.
The brokerage arm of P rude stlal In-
mi-uk* Co. of America says tt has a
otal of about 50.000 broker registrations
or its roughly 8.000 brokers. "We've had
•ur snare of proble ms with registration,"
ays John P. Murray. Prudential s direc-
of of corporate-nsk manaffement. "We're
t the process of lightening up and fixing
: We're trying to make sure everybody in
if place is licensed. " he says, adding that
e duesn t believe the problem is wide
To be sure, many larfe Wall Street
rokence firms have a number of unli-
msed brokers at any given time Indeed.
* Securities and Exchange Commission
si year found that the U.S. units of
Japan s Bur Four brokerage houses had.
among other notations, unregistered bro-
kers. But Use issue is particularly prob-
lematic for Prudential, which Is operaanf
under intense regulatory scrutiny as a
result of Its limited partnership woes.
Prudential Insurance recently com-
missioned a study by the accounting firm
Coopers & Lybrand examining, among
other things, the registration department
xi Prudential Securities. As part of the
renew, independent accountants will
come in and study the firm's registration
effort. Prudential also hired a former
executive from rival Merrill Lynch k Co. fo
buttress Its registration controls.
But Prudential hasn't yet informed
regulators of the predicament, people fa-
miliar with the matter say instead, the
firm appears to have paid brokers who
improperly sold mutual funds without
proper licenses, according to an Internal
"I have been informed by Bruce Karp of
IPrudentiaisI Registration Department
thai trades will go through even If Use
(brokerl isn't property licensed." says an
Aug. 16. 1993. memo from Anita Wnelan.
Prudential's mutual fund compliance di-
rector. The memo, to Prank Giordano.
Prudential s mutual fund general counsel,
added that Mr. Karp informed Ms. Wnelan
that the unlicensed brokers "are getting
In her memo. Ms. Wnelan didn't urge
thai any steps be taken to correct the
situation. When asked yesterday whether
the practice of paying unlicensed brokers
for their trades ts a problem, she replied:
"That's a valid concern, but I don't handle
licensing." She declined to comment fur-
ther. Mr. Giordano didn't return a telep-
hone call seeking comment.
Prudential says It dismissed Mr. Karp
last year, after the memo was written, for
performance reasons. Mr. Karp couldn't
be reached for comment.
Prudential says the Wnelan memo
shows that the firm was concerned about
the practice. "We're not In the business of
paying commissions to people without li-
censes." said Mr. Murray. As for any
discussions with regulators. Mr. Murray
said: "1 don't know whether we go around
and make announcements to regulators
about this. We have started on the process
-oming up with a whole bunch of ways to
up the problems in registration. It isn't
a secret around here, by any stretch.''
Other documents show that some Pru-
dential mutual-fund shareholders have
been sold tax-free municipal bond funds
for their individual retirement accounts.
(Investors aren't taxed on UtA funds until
they start withdrawing money from such
accounts.) This practice raises questions
of investor suitability, the same Issue at
the heart of Prudentials limited-partner
ship debacle. As previously reported, fed-
eral and state regulators have accused
Prudential of improperly selling 0.1$ bil-
lion of partnerships in the twos
The internal do cum ents suggest that
ax oversight and compliance aren't con-
'ined to Prudentials highly pubiicixed
Brokers and others who sell securities
nust pass required tests before doing
Harness These include so-called Series (
ests for selling mutual funds and Series 7
ests for selling stocks. Besides these re-
luirements. broken must be registered In
sutes in which their clients live, or
they are doing business The internal
documents show that some Prudential bro-
kers are operating without passing thetr
required series tests, and others without
their proper state licensing.
Branch Manaxers Cautioned
At a meeting of branch managers In
New York late last year. Mr. Murray said
he told managers: Nobody should have a
latsset faire attitude toward licensing-ei-
ther you are or you re not. there's no
m oet ween
The Issue of unlicensed brokers doesn't
appear to be new at Prudential. A Feb. 22.
1990. memo entitled ■Registration. Etc.:
New Company Policy." told unlicensed
Prudential brokers they would get paid if
they arranged side deals with other bro-
kers. "If you do a trade In a state that you
are not registered in and turn the trade
over to another broker for commission
purposes, these commissions are nonre-
fundable. You can make a deal' with the
broker to pay the commissions in a per-
sonal check, but New York will not journal
the commissions over after you are ap-
proved in thai state."
Prudential said It isn't familiar with the
memo, which apparently was written by
an Atlanta sales nuusager. But It said that
practice wasn't company policy.
State securities regulators currently
are examining the allegations of unli-
censed Prudential brokers selling mutual
funds and are preparing requests for
document from Prudential on the matter,
people laminar with the Issue say.
Issue Is Viewed as Serious
Any failure to report problems of unli-
censed brokers typically ts viewed harshly
by regulators. Speaking generally. Nancy
Smith. New Mexico's securities director
said: If true, having unlicensed brokers
sell securities is a very significant (allure,
and if its cor n po u nded by a failure of the
supemsory system and the lack of report
i ng on those notations, then thai makes it
a failure of even greater dimensions."
Ms. Smith added: "When you have unli-
censed agents selling securities, one would
expect the firm to offer full rescission to
On the municipal -bond Issue. Pruden-
tial says it has taken steps to Inform
Investors of the problem. In an Aug. 4.
1993. memo. Ms. Wnelan. the fund compn
ance chief, said: "It has come to my
attention that there may be Instances
when Prudential mutual- fund sharehold-
ers are holding Prudential municipal bond
mutual funds in IRA accounts.
Prudential says it is looking Into the
matter. The firm has pre pa red a letter to
Investors saying that as IRAs "Include tax
deferment until withdrawals commence,
the choice of tax -free municipals are gen-
erally not aa beneficial as other members
of our mutual-fund family. In view of this.
you may wttta to consider taking advan-
tage of our free exchange privilege into
another member of our fund family."
An American Bankers Association
March 8, 1994
1 1 20 Connecticut Avenue, N. W.
Washington, D.C. 20036
Banks and Mutual Funds
An American Bankers Association Background Paper
Commercial banks have been involved with the mutual funds business since the inception of that
industry in the early 1920's. The roles that banks have played with respect to mutual funds have both
changed and grown over the years, paralleling the development and growth of the industry itself. That
industry has grown from 426 funds with total assets of $45.9 billion in 1975 to over 4,320 funds with
total assets in excess of $2 trillion in 1993. 1
Mutual Funds, in General
Most mutual funds are open-end management investment companies as denned under the Investment
Company Act of 1940 ("the '40 Act"). A mutual fund is organized for the purpose of buying, selling,
trading, and owning securities. The company can establish one or more portfolios, or scries of
portfolios, with different objectives to appeal to various investment needs.
Investors, in the form of shareholders of the company, arc sought to provide the cash to buy the
portfolio securities; they receive their pro rata portion of the income derived from the ownership of
securities as the return on their investment. Buying shares of a mutual fund is, therefore, just like
buying the stock of any company- -the "business" of the mutual fund just happens to be buying, selling,
and owning securities, rather than, for instance, manufacturing automobiles.
Unlike corporate securities, however, there is no secondary market for mutual fund shares.
Consequently, investors wishing to liquidate their investment in the mutual fund must request the fund
to redeem their shares. Both purchase and redemption prices are expressed in terms of the per share net
asset value ("NAV"), less any sales or redemption charges.
As a publicly registered company, the mutual fund has a board of directors (or a board of trustees,
depending upon the legal structure its organization takes) that is responsible to the shareholders for the
operation of the company. The board contracts with a number of specialists to provide the services
necessary to operate the company and to comply with regulatory requirements. Exhibit 1 is a
representation of the players involved in a mutual fund.
Registered investment companies are governed by the '40 Act. Although a mutual fund is established
under the corporate or trust laws of a particular state, its operation and maintenance are regulated by the
Securities and Exchange Commission (SEC) under the '40 Act. Mutual funds offer securities to the
investing public on a continuous basis. This continuous primary offering of securities is effected under
the Securities Act of 1933 ("the Securities Act"), which requires certain disclosures to be made through
SEC filings and in the prospectus and statement of additional information provided to shareholders and
prospective shareholders. Disclosures made under the Securities Act are intended to prevent fraud and
misrepresentation. Shares of mutual funds must also be registered for sale in the states in which
investors reside at the time of sale, under state securities or "blue sky" laws.
As with any other company, the board of directors has a fiduciary duty to operate the business for the
benefit of the shareholders. Directors are elected by the shareholders annually. The '40 Act requires
that at least 40 percent of the directors must be independent, or unaffiliated with the investment adviser,
distributor, or any other service provider.
Source: Investment Company Institute; Securities and Exchange Commission.
The Mutual Fund Players
1*1 1 lt«0
1 ««».«.»• ».
Board of Trustees..
. INVESTMENT COMPANY -. *^-J
•■ — - -' I .n1ili| '^tfVJ^i,y
The fund Board of Directors appoints officers of the company who are responsible to the Board for the
day-to-day operations of the company in accordance with the policies set by the Board. For ease of
operations, the officers are often employees of the administrator.
The investment company hires an investment adviser to make the decisions about what securities to buy
and sell, in accordance with the investment objectives established by the Board and the various
regulations that the fund is subject to, and based upon the investment adviser's expertise in the securities
markets. Generally, investment advisers to mutual funds arc required to be registered with the SEC
under the Investment Advisers Act of 1940 ("Investment Advisers Act" ). The investment adviser's
contract must be reviewed and renewed by the Board every year, although a change in the adviser to a
fund or an increase in the adviser's fees must be approved by a vote of the fund shareholders. The fees
for advising a mutual fund are usually based upon some percentage of the NAV of the fund.
Commercial banks and bank holding companies are legally permitted to serve as investment advisers to
mutual funds. 1 As investment advisers to mutual funds, commercial banks arc specifically exempt from
registration under the Investment Advisers Act. If, however, a commercial bank chooses to establish its
investment advisory unit as a separate bank or bank holding company subsidiary, that subsidiary would
be required to register with the SEC under the Investment Advisers Act.
It is not by sheer accident that banks have become investment advisers to mutual funds. Banks, typically
through their trust department, have managed money very successfully for many years. Managing a
mutual fund is not that much different that managing any other pool of funds. Consequently, many
banks have leveraged their investment management expertise to serve as the investment adviser to mutual
The investment company hires a custodian to settle the securities transactions, hold the securities, and
collect the income due. The custodian is responsible for the safekeeping of all the securities and cash
owned by the fund.
Historically, banks have acted as custodians for the securities held in their trust accounts. The daily
routine of trade clearance, securities safekeeping, income collection, and cash transaction processing for
trust operations personnel is similar to the duties required for a mutual fund custodial arrangement.
There are additional recordkeeping, regulatory, and specific procedural requirements of the mutual fund
custodian. Although these requirements and associate costs become further complicated and magnified
as the mutual fund expands its investments outside of the United States, the potential for fee income is
still attractive. Custodial fees are usually priced based upon the number of transactions and number of
shareholders per fund.
Commercial banks have always served as custodians to mutual funds. Indeed, Section 17(f) of the '40
Act and SEC Rule 17f-l seem to recognize the importance of commercial banks serving as fund
custodians. For those banks offering their own or proprietary funds, banks may, like non-bank affiliated
mutual funds, self-custody their own funds in accordance with the SEC's self-custody rule, Rule 17f-2.
The Federal Reserve Board ("FRB") has stated, however, that where a bank holding company and its
nonbank subsidiaries serve as both investment adviser and custodian or transfer agent (see discussion
below) to a fund, the holding company and/or subsidiary "should exercise care to maintain at a minimal
level demand deposit accounts of the investment company which are placed with a bank affiliate and
should not invest cash funds of the investment company in time deposit accounts (including certificates
of deposit) of any bank affiliate." 12 C.F.R. 225.125(i).
J National banks are permitted to serve as investment advisers under the National Bank Act. State-
chartered banks should look first to their state law to determine their authority. The Federal Deposit
Insurance Corporation ("FDIC") does, however, permit state-chartered banks to serve as investment
advisers to mutual funds. Finally, the Federal Reserve Board ("FRB") permits bank holding companies and
their nonbank subsidiaries to serve as investment advisers to mutual funds. The FRB has placed some
limitations on that activity, however. Specifically, the FRB has stated that "[i]n view of the potential
conflicts of interest that may exist, a bank holding company and . . . its . . . nonbank subsidiaries should not
(1) purchase for their own account securities of any investment company for which the bank holding
company acts as investment adviser; (2) purchase in their sole discretion, any such securities in a fiduciary
capacity (including as managing agent); (3) extend credit to any such investment company; or (4) accept the
securities of any such investment company as collateral for a loan which is for the purpose of purchasing
securities of the investment company. 12 C.F.R. 225.125(g).
The fund accountant keeps track of the assets held, determines the market value of the assets and
liabilities of the mutual fund, and calculates the NAV and certain per share data. The '40 Act requires
that the NAV be calculated at least once every business day. The per share NAV is the price at which
the fund will purchase from or sell shares to the fund's underwriter. When purchasing shares from the