2. Do automatic investment service plans involve a pooling or investment company equivalent which is required to be registered under the Investment Company Act of 1940?

3. What protections under the securities laws and regulations: (a) are currently available to participants in such plans?

(b) are not available as a result of the bank exemption from the securities laws and should be?

4. Do banks operate their brokerage services through their trust departments? Is the authority to execute stock transactions derived from the agency power of 12 U.S.C. 24 given to all national and Federal Reserve member banks or from the fiduciary powers codified in 12 U.S.C. 92a?

5. Is there any evidence in past administrative rulings or the legislative history of the banking laws to suggest that Congress intended to restrict traditional bank brokerage powers in a manner to support the following arguments which have been made in opposition to automatic investment service plans?

(a) such brokerage services must only be an accommodation? (b) banks can offer service only to existing customers?

(c) banks cannot advertise service to the general public?

(d) banks cannot realize a profit from the brokerage transac⚫tion?

6. Assuming the legality of the basic brokerage functions performed in connection with an automatic investment service plan is established under the Glass-Steagall Act, do the promotional activities surrounding these activities challenge that validity?

7. Does the automatic investment service plan compete with brokerdealers and investment companies, or does it serve as an alternate арproach to investment services?

8. Securities and Exchange Commission Chairman Ray Garrett had identified ten specific concerns about automatic investment services, 15

(a) participants in automatic investment services do not have the benefit of Securities and Exchange Commission regulations applicable to non-bank securities entities, including regulated brokers, investment companies and investment advisers;

(b) substantial cash contributions by a large number of participants in an automatic investment service plan could result in an increase in concentrated purchases and the likelihood that such purchases may disrupt trading in a security or otherwise dominate the market;

(c) if a plan allows a bank to vote fractional shares or vote proxies that are not returned by the participants, the resultant concentration of voting power in the bank could create a significant regulatory problem;

(d) the bank could charge unreasonable fees for the service due to lack of Securities and Exchange Commission supervision; (e) conflicts of interest can be a problem because of a bank's many different roles and obligations;

15 Hearings on the Credit Crunch and Reform of Financial Institutions Before the House Comm. on Banking and Currency, 93d Cong., 1st Sess, Part 2, 520-25 (1973).

(f) banks are not subject to securities law rules which require brokers to make certain a purchase is "suitable" for an investor; (g) inappropriate advertising material by the banks is not covered by the securities laws unless fraudulent;

(h) since banks are unregulated entities when engaging in the business of buying and selling securities as agent for customers, the customers have no assurance that the bank is getting the best price possible under the prevailing market conditions;

(i) participants may not receive adequate confirmations showing the particulars of the purchase;

(j) securities left with a bank are not accorded insurance protection under the Federal Deposit Insurance Corporation, in contrast to coverage under the Securities Investor Protection Act. Each of these points should be analyzed to determine:

(a) their validity;

(b) the existence of bank regulations which provide investors equivalent necessary protections;

(c) whether statutory revisions are necessary to assure that automatic investment service participants receive an appropriate level of investor protection.

SECTION III-INDIVIDUAL PORTFOLIO MANAGEMENT SERVICES

A. DESCRIPTION

16

With this service, a number of banks are offering portfolio management services to investors with accounts as small as $10,000 which is generally the smallest amount accepted. There is no pooling of the assets in the accounts of individual investment portfolio account customers and in most programs, the transactions are executed by brokers selected ultimately by the customer.

Investment advice to small investors typically is on a nondiscretionary basis, meaning that purchases and sales are not made by the bank without prior approval by the customer. In some cases formal procedures for obtaining approval of customers have been established. Recommendations are sent by the bank directly to the customer on a form which he must then sign and mail to his broker with appropriate instructions indicating his approval of the bank manager's recommendation or indicating appropriate changes in the event he disapproves.

In addition to entering the field of small account investment advisory services, banks are aggressively offering expanded investment management services to more affluent individuals and institutions.17

B. SECURITIES LAWS

The position of the SEC is that certain ways of operating portfolio management services raise several questions under the federal securities laws including (1) whether managing a number of discretionary accounts in the same manner involves the issuance of securities re

16 See footnote, 5 supra.

17 See, Fiske, "The Banks Fight Back," Institutional Investor (April, 1972).

quired to be registered under the Securities Act of 1933, and (2) whether such an operation involves the creation of an investment company required to be registered under the Investment Company Act of

1940.18

The manner in which banks offer investment portfolio management services has been greatly influenced by three documents of the 1970's: (1) the terms of a consent decree agreed to by First National City Bank in 1971; 19 (2) limitations on bank securities activities as a result of the Supreme Court's 1971 decision in Investment Company Institute v. Camp, discussed in Section VIB of thi outline; 20 and (3) recommendations in the 1973 Report of the SEC's Advisory Committee on Investment Management Services for Individual Investors.21

The consent decree settled a lawsuit brought by the Securities and Exchange Commission against First National City Bank after it began offering customers a Special Investment Advisory Service ("SIAS") whereby participants invested at least $25,000 and signed a power of attorney giving the bank discretion to purchase and sell securities for the participant's account through Merrill Lynch, Pierce, Fenner & Smith, Inc. Although advertisements made it appear clients would receive individualized investment services, Merrill Lynch had agreed with First National City Bank to make investments in all SIAS accounts as directed by the bank in a virtually identical manner. The Commission sought an injunction against First National City Bank, Merrill Lynch, and SIAS, alleging that the defendants were operating an unregistered investment company in violation of the Investment Company Act of 1940 and selling securities in violation of the registration requirements of the Securities Act of 1933.

Without admitting the allegations, the defendants consented to the entry of an order requiring among other things, that they cease operating SIAS and not engage in similar activities except in compliance with the registration requirements of the Securities Act and the Investment Company Act. Shortly after the settlement, the SEC staff agreed to permit First National City Bank to offer a small account portfolio management service without registration so long as the bank does not have investment discretion, the clients receive individual services, and the clients can choose among a number of brokers.

The Advisory Committee's Report on Investment Management Services for Individual Investors in January 1973, reviewed the status of individual portfolio management services under the securities laws and recommended, among other things, that the Commission clarify and revise its position. Following release of the Report, the SEC indicated that it intended to publish for comment certain proposed positions with respect to the issues raised generally by the offering of such services and the recommendations of its Advisory Committee. However, so far the SEC has not published anything further on there rec

18 See SEC. v. First National City Bank and Merrill Lynch Pierce Fenner & Smith, [1969– 70 Transfer Binder] CCH Fed. Sec. L. Rep.¶ 92.592 (S.D. N.Y. 1970), S.E.C. Lit. Rel. No. 4534 (Feb. 6, 1970); see also, O'Brien Sherwood Associates, Inc. (1973 Transfer Binder] CCH Fed. Sec. L. Rep. ¶ 79.339 (avail. April 2, 1973).

19 Id.

20 401 U.S. 617 (1971).

1 Small Account Investment Management Services Report of the SEC Advisory Committee on Investment Management Services for Individual Investors, (SEC, January,

ommendations except for its request for comments on bank approved investment services.22

C. BANKING LAWS AND REGULATIONS

Bank regulatory agencies view these types of portfolio management services as being an extension of a traditional banking service and permissible under the banking laws.

D. QUESTIONS AND ISSUES

1. Would the application of the Investment Advisers Act of 1940 to banks provide any additional meaningful protections to investors? 2. Should bank trust department money management activities be subject to the Investment Advisers Act of 1940?

3. Could the operation of a small account portfolio management service by a bank have a serious adverse effect on customer attitudes towards the bank's commercial banking activities in the event investment performance expectations are not met?

4. To what extent can and do commercial banks offset advisory fees with charges for commercial banking services? If this practice is followed is it in the public interest for banks to be able to use this method to compete with other persons in the securities business?

SECTION IV-ADVISORY SERVICES FOR INVESTMENT COMPANIES AND REAL ESTATE INVESTMENT TRUSTS

Investment companies are pools of capital formed to provide a large number of investors of mostly moderate means with a convenient and efficient vehicle for investing in securities. A real estate investment trust ("REIT") is formed in the same way as an investment company, although the legal form often differs. However, the REIT invests in real estate and interests in real estate rather than stocks and debt securities.

It should be noted that the investment company and REIT industries are unlike others in the country in that investment management, administrative, record keeping and similar corporate housekeeping services usually are performed externally by a management company. In addition, an affiliated commercial bank or brokerage firm often serves the investment company or REIT as transfer agent, shareholder servicing agent and custodian or regular broker and can set up a dividend reinvestment plan for the investment company or REIT. Because of this unusual structure, conflict of interest problems in these two industries are more prevalent than in most others. Although conflict of interest transactions involving registered investment companies are regulated by the SEC under the Investment Company Act of 1940, there is no comparable statute covering REITs.

Banks have used two different means for serving as investment advisers to investment companies. In a few cases the bank itself, which is

22 See footnote 5, supra.

exempt from the Investment Advisers Act of 1940, serves as investment adviser. However, in most cases, bank holding companies form separate investment advisory subsidiaries, which are required to register with the Commission under the Investment Advisers Act of 1940. Bank holding companies have also aggressively entered the real estate investment trust ("REIT") business. A REIT investment management company usually is established by a bank holding company as a wholly owned subsidiary, which then organizes a REIT as a separate company. Shares of the REIT are then offered to the public by an unaffiliated investment banking firm and the REIT investment manager invests the proceeds.

Brokerage firms have been active participants in the investment company industry ever since the 1920's, when the first mutual funds were organized and the investment company concept first began to gain popularity. Investment companies have been found to be an ideal way for both brokerage firms and investment counselling firms to provide investment advisory and brokerage services to small investors who do not have large enough amounts to invest to justify setting up an individual account. In some cases they serve directly as investment adviser, and in others manage the investment company through a subsidiary. Although a few banking institutions have been affiliated with investment companies for a number of years, it has only been recently that large commercial banks and bank holding company affiliates have entered the investment company industry in a significant way.

B. SECURITIES LAWS

The federal securities laws place no restrictions on banks serving as investment advisers to investment companies or real estate investment

trusts.

As can be seen from Appendix C, banks are exempt from the definitions of broker and dealer in all of the federal securities laws and from the definition of investment adviser contained in the Investment Advisers Act of 1940. However, banks are not exempt from the Investment Company Act of 1940 provisions applicable to investment advisers of registered investment companies.

Although the Securities and Exchange Commission staff in the past has raised a number of conflict of interest problems when banks serve as custodian and transfer agent for closed-end investment companies they also sponsor and manage, the Securities and Exchange Commission has not taken action against any bank serving an investment company in more than one capacity.

24

C. BANKING LAWS AND REGULATIONS

In 1971, the Board of Governors of the Federal Reserve Board announced a proposal to amend its Regulation Y to authorize bank

24 See United States Trust Co. of New York; Central Securities Corp. [1972-73 Transfer Binder] CCH Fed. Sec. L. Rep. 78.814 (avail. May 12, 1972; Viking Growth Fund, Inc. (1973 Transfer Binder] CCH Fed. Sec. L. Rep. 179,348 (avail. Apr. 14, 1973); see also Notice of Proposal to Amend Rule 17d-1 Under the Investment Company Act of 1940 to Provide an Exemption From the Rule for Affiliated Persons With Respect to Certain Service Agreements With Investment Companies, Inv. Co. Act Rel. No. 8245 (Feb. 25, 1975), Sec. File No. S7-513.