As mutual funds become a standard banking product, banks are packaging them with other products and services to provide efficiencies and cost savings to customers.
Packaged arrangements involving mutual funds may raise issues under the anti-tying prohibitions of the Bank Holding Company Act, as well as federal and state antitrust laws, and must be carefully structured in order to comply with the law.
The anti-tying prohibitions of the Bank Holding Company Act are complex and their applicability in the context of bank mutual fund activities is uncertain. Little or no case law or guidance from the federal banking regulators exists.
Bank tying arrangements in other contexts recently have come under active scrutiny from Congress, the Department of Justice, and private litigants, and will be a focus in the mutual fund context as well.
The anti-tying rules apply differently depending upon which type of entity in a banking organization is providing mutual fund services -- whether it is the bank or an affiliate.
The decision as to which entity should serve as the investment adviser and which entity should serve as broker can significantly affect the marketing plans for mutual fund products.
Rule on Price-Cutting
The anti-tying prohibitions are broader than is commonly realized. The prohibit a bank or bank holding company subsidiary from requiring that a customer purchase some additional service in order to obtain a service. They also prohibit the bank or bank holding company subsidiary from lowering the price of the service if the customer purchases an additional service.
Banks also are prohibited from making the availability or price of products conditional on the customer obtaining a service from an affiliate.
An exemption is provided in certain cases for the tying of a loan, discount, deposit, or trust service. The "banking-product exception" applies only when both products are banking products and are offered by the same entity. The exception does no apply when one of the is offered by an affiliate.
Moreover, banks are prohibited from tying the availability or price of products on the condition that the customer not obtain some other product or service from a competitor of the bank or its bank holding company or a subsidiary of its bank holding company.
The applicability of the anti-tying laws to bank mutual fund activities is not clear. For example, is a mutual fund investment a service of the bank? Is it a service of an affiliate, or of some unrelated entity?
We would argue that the fund is not an entity of the type to which the anti-tying prohibitions are applicable, because it is neither a bank nor a subsidiary of a bank holding company.
But the bank nevertheless is performing a service when it sells mutual fund shares to customers. The service is probably a brokerage service. Is that a trust service for purposes of the banking product exemption?
We would argue yes, because brokerage is a type of service customarily performed by a bank trust department and is specifically authorized as an incidental power of national banks in the National Bank Act.
If a bank is the investment adviser to a mutual fund, it is deemed to be an affiliate of the bank for purposes of sections 23A and 23B of the Federal Reserve Act. In that case, is there a problem?
We would argue no, because the tying restrictions apply to the tying of a bank product to a service of a subsidiary of the same bank holding company, and a proprietary mutual fund is not a subsidiary.
But if the bank is the investment adviser, can't it be argued that the bank is providing a service? Yes, but the service being provided is the bank's investment advice on a collective basis; -- namely, a trust service -- and the banking product exemption should apply.
If an affiliate of the bank is the investment adviser, however, the banking product exemption would not apply.
None of these questions appears to have been addressed by the federal banking regulators, and thus there is little formal guidance at present. The uncertainty of the law in this area is particularly hazardous. The penalty for violating the anti-tying rules is severe.
In addition to the potential for civil enforcement actions by the federal banking agencies and criminal action by the Department of Justice, the anti-tying provisions establish a private right of action with a potential for treble damages.
In addition, certain forms of tying may violate state and federal antitrust laws which also provide private rights of action.
Guidance from federal banking regulators on the scope of the anti-tying rules thus is essential in order for banking organizations to offer packaged mutual fund services.
The packaging and discounting of mutual fund and bank products provides obvious benefits to consumers. Nonbank securities firms are permitted to package and offer discounts on their mutual fund and other securities products unfettered by the anti-tying prohibitions of the Bank Holding Company Act.
Similar arrangements by banks. should not be discouraged by an overly restrictive reading of the law by banking regulators.
The following examples illustrate how the anti-tying prohibitions might apply in practice to specific arrangements involving mutual funds.
* Suppose a bank offers free checking and discounts on loans to customers who invest in a mutual fund for which the bank acts as investment adviser. If the mutual fund is viewed as an unaffiliated entity, the arrangement would not be subject to the anti-tying provisions.
If the mutual fund investment is viewed as a service offered by the bank, it can be argued that the service is brokerage and/or investment advisory service, which falls into the category of trust services. If the service is not viewed as a trust service, the arrangement likely would violate the anti-tying rules.
* The situation is the same, but the mutual fund shares are sold by a brokerage subsidiary of the bank's holding company, rather than by the bank. The arrangement might be prohibited because the bank product exemption applies only when tied services are offered by same entity.
* Again, the situation is same, but the bank's own broker kerage subsidiary acts as the The arrangement probably is okay because the subsidiary likely would be treated as part of the bank.
* Same situation, but a kerage subsidiary of an affiliated bank acts as the broker. The arrangement would pose a problem because the banking product exemption applies only when the tied services are provided by the same bank, or by a direct subsidiary.
* Same situation, but the bank gives the customer the telephone number of the distributor to call to order fund shares. In that case, the bank might be viewed as not tying its own brokerage services and the tying restrictions should not apply.
* Suppose the mutual fund distributor reduces the sales load on the mutual fund if the customer maintains a checking account or loan with the bank that serves as the fund's adviser.
This arrangement should not be prohibited since the tying restrictions apply only to ties between banks and bank holding companies or their subsidiaries. Tying arrangements between a bank and other companies such as the distributor -- are not prohibited.
These are only a few examples of the many different ways in which the anti-tying prohibitions might apply to packaged bank mutual fund services.
Bank must carefully consider these laws in structuring their mutual fund activities in order to avoid potentially costly litigation. The law is complex, and guidance from bank counsel is essential.