We were pleased to read Charles W. Woodford's letter to the editor June 23, calling on bankers and consultants to remember that a trust business is grounded on a highly developed sense of fiduciary duty.

In the past, banks' fiduciary roles were straightforward, and compliance records were impressive. These days, the roles are changing and compliance is more difficult, yet it is nonetheless as necessary as before.

In our recent experience, some outside advisers and vendors, in apparent zeal to establish themselves in this competitive business, have by their actions, statements, and advice demonstrated a dangerous lapse of memory about what the banking business is all about.

In so doing, they have contributed to an environment which to observers may appear abusive, and may invite unwanted legislative and regulatory involvement.

Not Whether, But How

We want to encourage moderation and realism in the ongoing debate over these issues.

It is time to recognize that the important debate over bank securities activities is no longer whether banks can engage in such activities, but how they should conduct them in a manner that not only complies with legal and supervisory requirements, but also retains customers' confidence and trust.

Pricing is one issue that banks have been wrestling with. This is not an easy subject.

The pricing levels for many traditional fiduciary services and the methodology used in setting them have not been reexamined for a long time; bank trust customers are demanding easier access and more money management options, e.g., sweeps from deposit accounts into fiduciary accounts; and fiduciary accounts have been linked by the banks to other financial vehicles, e.g., mutual funds, which have a different regulatory scheme and separate fee structures and pricing methodology.

Fanning the Flames

In the midst of the uncertainty created by customer demands, technology, and new products, banks have sought guidance from their vendors and advisers and from the regulators. The regulators have provided guidance of a general nature, leaving the bank to consult its advisers on specific situations.

In August 1992, Mellon Bank suffered a federal court defeat in a class action lawsuit brought by trust customers challenging the bank's pricing practices for trust and related sweep account services.

Some commentators fanned the flames of panic, suggesting that this lawsuit would threaten the pricing practices of virtually all banks and set disastrous precedent for further limitations to be imposed on banks' pricing of their services. (This decision was appealed by the bank and the complaint dismissed on procedural grounds.)

A careful, informed reading of the allegations in the case, however, demonstrated that if fiduciary fees (particularly sweep account fees) are assessed and disclosed in a reasonable, fair, and orderly manner and the imposition of fees is permissible under state law or the governing trust instruments, the risk of legal action and liability can be significantly reduced.

Fortunately, the case never created any real problem for bank fiduciaries. Why then the flap? Was there a need to sound the alarm about a case which was so clearly off the mark from its inception?

There is not, and never was, a magic formula for avoiding the types of problems faced by the bank in this case.

But if banks set their fees for fiduciary service at a reasonable rate which is reflective of the value of the service actually rendered, and disclose those fees to their customers in a timely and meaningful manner, they probably can avoid serious problems.

Growing Preference

Meanwhile, more and more banks are becoming deeply involved in the offering of mutual funds to their customers, including fiduciary customers.

Customers increasingly express a preference for the investment of their fiduciary assets in mutual funds in order to derive the many benefits mutual funds offer: daily pricing listed in the newspaper, ease of redemption and flexibility of investment, just to name a few benefits.

In deciding to invest fiduciary assets in mutual funds, particularly mutual funds in which the bank receives fees from the fund or its distributor for services (e.g., sales agent, custodian, transfer agent, administrator, or investment adviser), the bank must confront and resolve its essential fiduciary duties of prudence and loyalty.

The Pricing Issue

Leaving aside for the purposes of this limited discussion the ticklish issue of whether a bank discharges its fiduciary obligations of prudence by investing discretionary fiduciary assets in a fund underperforming its peers but for which the bank receives economic or other benefits for the investment, the essential fiduciary pricing issue is simple: namely, can a bank receive fees from its fiduciary accounts for trust services, and from the fund for investment advisory or other services?

Again, the regulators have, when requested, offered guidance on this vexing subject, but the agencies by and large have left the banks to resolve for themselves the key fiduciary issues and to consult their own outside advisers on specific pricing schemes.

Bankers must resolve serious fiduciary obligations on the one hand, and conform to the requirements of a heavily regulated banking and securities business on the other hand, when they consider how to price their fiduciary and fund services to fiduciary customers.

|Double-Dipping' Fees

It is disturbing to hear that some outside vendors and advisers reportedly are suggesting to banks that they can "double-dip" their fees in the fiduciary account-mutual fund relationship.

Is there any banker who doubts the wisdom of avoiding even the appearance of a conflict of interest in this setting? Why would anyone adopt or counsel a course which experience has taught over and over will result in customer, regulatory, and congressional wrath?

Under certain well-defined conditions, a bank may legitimately and fairly receive more in fees from the fiduciary customer after linking the customer's fiduciary account to a mutual fund (which also provides the bank additional fee sources) than it did prior to the linkage, or receive fees from more than one source.

These conditions revolve around the premise that the linkage results in added services and value to the customer, increases the efficacy of services already provided, and that the fees are understood and agree to by the customer.

This is not "double-dipping," and is nothing more than using the criteria for pricing we set out earlier: the fees must be reasonable, reflective of the value of the products and services rendered, disclosed in a clear and meaningful manner, and consistent with applicable law and the governing account documents.

Mellon Bank and Boston Co.

On April 21, the Federal Reserve Board approved the acquisition of Boston Co., a major mutual fund advisory and service organization, by Mellon Bank Corp.

Like other board decisions in the bank powers area, the decision has prompted a good deal of debate in the press, Congress, the industry, and the banking bar as to what, if anything, the approval means for an expansion of bank securities powers.

In fact, however, this debate should not have occurred at all, as the denouement of the discussion clearly demonstrates.

Many in the Glass-Steagall bar, ourselves among them, were disappointed and concerned with the Mellon order.

These concerns arise from the shared belief that the order has the unfortunate potential for restricting bank mutual fund activities, rather than expanding them, by reviving affiliation and control issues long dealt with under the lore, not the law, of bank-mutual fund relationships.

Stoking the Embers

Still, other observers put a characteristic spin on this decision by highlighting their views of the potential waiting to be unlocked from the order, even to the point of suggesting that the order offered the potential for mutual fund sponsorship and distribution by bank holding companies.

These prognostications, however, threw kerosene on the smoldering embers of congressional disquietude over bank mutual fund activity.

Rep. John D. Dingell, D-Mich., staunch protector of the remnants of Glass-Steagall, wrote a pointed letter to the Federal Reserve Board threatening a broader congressional inquiry into the board's regulation of bank-mutual fund activities and demanding that it specifically confirm that the board did not intend to reject its prior interpretations and chart a new course that would effectively preempt Congress' perceived prerogatives in the Glass-Steagall reform area.

In reply, Fed Chairman Alan Greenspan rejected any notion of the abandonment of its longstanding precedent.

Worst of Both Worlds

The net effect? The Mellon order potentially leaves us with the worst of both worlds; one, a decision by a principal federal regulator which raises questions and reaches conclusions that may inhibit bank innovation in the mutual fund area, and two, a Fed position which effectively has eliminated whatever opportunity might have existed for the order to serve as a vehicle for expanded securities powers.

The progression of expanding bank securities activities has resulted largely from bold innovation, building carefully on precedent and evolving business and technological capabilities, not from major legislative overhaul of the Glass-Steagall Act.

Nor has it occurred as a result of a regulator's rejecting outright its prior policies and positions. Contrary to the beliefs of many in Congress and the securities industry, bank expansion in the securities area has been accomplished in a responsible manner which, time and again, has survived judicial challenges.

Political Pressure

Nonetheless, banks operate in an environment of renewed political stress surrounding their expansion into new products and services.

Therefore, banks not only would be well served to rely on judicious innovative techniques as they define future businesses and their roles in them, but also to be measured in the use of these techniques.

For veterans of the bank powers battles in Congress and the courts who have witnessed the chilling effect earlier congressional missives have had on the efforts of the regulatory agencies to bring the banking industry into the 21st century, the Dingell-Greenspan correspondence was an unfortunate and unhelpful return to the past.

Mutual Fund Regulation

Fearing that banks' involvement with mutual fund sales is running ahead of their ability to adequately regulate and supervise the activities, state securities commissioners have embarked, through the North American Securities Administrators' Association, on an effort to understand what the banks are doing and where additional regulation or supervision might be useful.

While this effort appears to be in its early stages, individual states have evidenced a predisposition toward stronger and more aggressive supervision, even to the extent of forcing actions by individual banks not specifically mandated by the states' black letter law or regulations.

Congressional pressure on the federal banking regulators to demonstrate that sufficient regulatory safeguards are in place to prevent abuses in mutual fund sales by banks has further raised concerns over the sufficiency of the regulatory scheme.

Several commentators, including a major securities trade association, have suggested that the federal banking regulators should take steps to institute a comprehensive scheme of uniform guidelines in this area.

This is apparently intended to both preempt the jurisdiction of them states and to forestall any continuing congressional demands for legislative action or pressure on the banking regulators.

The rush to develop a code of conduct suggests a fervor associated with the newly converted and therefore may be viewed by many as, on balance, more of a political, rather than a substantive, gesture.

Much of the impetus for this effort to come up with a comprehensive set of federal guidelines seems to emanate from the perceived need by some of the federal banking regulators to respond to the congressional pressure from those members of Congress who view expanded bank securities powers with suspicion.

Avoiding Overkill

While there is no doubt that more clarity and consistency in requirements, and more regulatory involvement in the supervision of these activities, would benefit all concerned (banks, mutual fund companies, regulators, and politicians), care must be taken to avoid "oversolving" what is now little more than a potential problem.

Over the last several years, billions of dollars of mutual fund shares have been sold through banks and there is little evidence of abuse in the process.

Some of the problems which may have emerged - e.g., bank tellers informing their retail customers that mutual funds are FDIC-insured - are clearly wrong and should be stopped, even though by all accounts these incidents are isolated and probably are more the result of ignorance than animus.

By and large, however, the bank mutual fund sales business has developed without any probative evidence of systemic abuse, and any problems should be resolvable or preventable through reasoned, temperate action by the regulatory agencies.

In this regard, the securities administrators association seems to be taking the right approach by first asking what is actually going on, before officially deciding how to deal with the situation.

Here, as in other areas, industry overreaction or regulatory overkill will benefit no one. The relationships, technology, marketing practices, and business objectives are just now in the process of evolving, and it remains unclear precisely how all these relationships will naturally sort out.

It would be most unfortunate if natural development were stifled by the imposition of overly restrictive regulatory requirements which would have the effect of defining how these critical relationships, and therefore the product itself, must be structured.

Steady Course

As the bank mutual fund business evolves, bankers, their vendors, advisers, and even their regulators must approach the issues that emerge in a forthright, balanced, and realistic manner.

Charting the course to the future of the banking business can be dangerous if we swing the helm wildly from the center of balance. At the core of the balance is the necessary sense of responsibility that must permeate banks' dealings with their customers.

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