ABA Comment Letter to OCC re ANPR on Fiduciary Capacity and Non-Fiduciary Custody Activities

Dear Sir or Madam:

The American Bankers Association(ABA) appreciates this opportunity to comment onthe Office of the Comptroller of the Currency’s (OCC) advanced notice of proposed rulemaking(ANPR) on fiduciary capacity and non-fiduciary custody activities. Representing institutions ofall sizes and business models that act in a fiduciary capacity for and provide non-fiduciarycustody services to personal and institutional clients, ABA has a great interest in any potentialamendments to 12 CFR Parts 9 and 150 on behalf of our national bank and Federal savingsassociation members, as well as state chartered institution members.

In recent years, ABA has made recommendations to the OCC to consider holisticamendments to Part 9 with an eye toward modernization and burden reduction. Hence, we havebeen generally supportive of amendments, such as those finalized in 1996 and 1998, thatacknowledge an evolving industry. However, after careful consideration of the issues andquestions raised in the ANPR, we do not believe there is any compelling reason for the OCC toinitiate rulemaking on fiduciary capacity and non-fiduciary custody activities, and instead weassert that such rulemaking would be counterproductive. Contrary to the amendments we have recently suggested, we believe the rulemaking contemplated in the ANPR would impose undueand conflicting regulatory burdens without reducing uncertainty or materially enhancing thesafety and soundness of the institutions engaged in those activities. We recommend that theOCC not proceed with the contemplated rulemaking

Summary of OCC ANPR

The OCC is considering two independent but related regulatory projects and invitespublic comments on the usefulness and appropriateness of these potential efforts. Afterreviewing public comments, the OCC may decide to proceed with rulemaking, in which case theOCC would make those proposals available for public comment in keeping with theAdministrative Procedure Act.

In the first half of the ANPR, the OCC contemplates revising the definition of “fiduciarycapacity” in 12 CFR 9.2 “to include any activity based on the authority a national bank orFederal savings association has with respect to a trust, such as the power to make discretionarydistributions, override the trustee, or select a new trustee.” The OCC refers to these rolesgenerally as “trust adviser activities.” The OCC states that such rulemaking would reduceambiguity and confusion for national banks and Federal savings associations that are consideringacting in these roles and provide for the uniform application of OCC regulations to trustactivities that State laws describe with different terminology. By lessening this ambiguity andconfusion, the OCC expects that institutions can better assess and manage litigation risk, as wellas understand regulator expectations for managing these accounts in a safe and sound manner.

In the second half of the ANPR, the OCC contemplates codifying into Title 12 of theCode of Federal Regulations (CFR) requirements governing non-fiduciary custody services.Although the elements of this rulemaking would be based on current OCC guidance found inhandbooks and bulletins, the OCC expects to “impose minimal new responsibilities on well-managed national banks or Federal savings associations.” The OCC states that bank custodybusiness is significant, approximately $41 trillion in assets held by OCC-regulated entities, and the lack of requirements “set out in regulation” may pose a risk to those institutions. Amongother things, the OCC also states that any such rulemaking would complement applicableregulations promulgated by other regulators, such as those of the Securities and ExchangeCommission, Commodities Futures Trading Commission, Internal Revenue Service, and theirnon-U.S. counterparts.

Comments on Fiduciary Capacity

For a number of reasons, we urge the OCC not to propose amendments to the definitionof “fiduciary capacity” in 12 CFR 9.2. As a general matter, the industry has not expressed anyambiguity or confusion about the scope and duties of these “trust adviser activities” that wouldwarrant amending the definition. Nor are we aware of any national bank or federal savingsassociation that has considered taking on these duties without also acting in some other capacitythat is clearly within the current definition of “fiduciary capacity” (e.g., trustee or investmentagent for trustee).

As explained below, broadening the scope of the definition to include any activity withrespect to a trust that is allowed under state law could lead to inconsistent application of afiduciary standard relative to what would apply to state-chartered institutions, as well as poseother conflicts with “applicable law.” States have taken a variety of approaches to “trustadvisers,” which are by no means uniform. The Uniform Law Commission’s Directed Trust Act,which has been enacted in nine states thus far, may lead to some uniformity, but certain statesthat have an established directed trust business may not follow suit. Furthermore, even amongthose states that have adopted the Uniform Act, there is variability in some of the provisions.Ultimately, we believe that adding these duties to the fiduciary capacity definition may have theopposite effect the OCC intends by increasing litigation risks and confusion, especially withregard to the application of other provisions in Part 9.

The OCC can, of course, offer appropriate guidance through revisions to the relevantAsset Management Handbooks, Bulletins, or in the case of a specific inquiry by a bank throughan Interpretive Letter.

OCC Revisions in 1996 Contemplated and Rejected Reference to State Law

The last time that the “fiduciary capacity” definition was revised, in 1996, the OCC wasgrappling with significant changes in the industry and considered expanding the list of“traditional” fiduciary capacities to include new roles in which bank were engaged. During thatrulemaking, the OCC contemplated and ultimately rejected looking through to state law todetermine fiduciary capacity for purposes of Part 9 and appropriately concluded that the testshould rest on whether the bank has investment discretion or provides investment advice for afee. In particular, the OCC noted—

"A majority of commenters who addressed this issue supported the proposeddefinition, which utilizes investment discretion as a test, and opposed thealternative approach on the grounds that it would lead to inconsistent treatment ofaccounts in a bank with multistate operations, and increase risk by creating unduecomplexity in fiduciary compliance. A few commenters voiced concerns with theproposed definition, and recommended that the OCC define ‘‘fiduciary capacity’’to include any capacity that is fiduciary under state law."

"The OCC believes that ‘‘fiduciary capacity’’ should be defined in a manner thatfosters consistent application of part 9 throughout the national banking system.Thus, the OCC is not defining ‘‘fiduciary capacity’’ exclusively with reference tostate law. Rather, the final rule retains the proposal’s approach and defines‘‘fiduciary capacity’’ by using investment discretion as a test for determiningwhether part 9 applies to certain activities."

Proposed Fiduciary Capacity Would Pose Potential Conflicts with “Applicable Law”

Throughout Part 9, the regulations repeatedly refer and defer to “applicable law,” definedas “law of a state or other jurisdiction governing a national bank’s fiduciary relationships, any applicable Federal law governing those relationships, the terms of the instrument governing a fiduciary relationship, or any court order pertaining to the relationship.” Expanding the named fiduciary capacities to include “trust adviser activities” could pose a conflict between the duties required in Part 9 with the applicable law of the state or the governing instrument. For example, Delaware law allows that the governing document “may provide that any such adviser (including a protector) shall act in a nonfiduciary capacity.” In Arizona, state law presumes trust directors are not fiduciaries unless so specified in the trust document. In other states, such as Wisconsin and South Dakota, not all powers of a trust protector are fiduciary. To the extent a national bank or Federal savings association were to engage in such a role and the trust document did not impose a fiduciary duty, the requirements of Part 9 could conflict with “applicable law.”

Both the national banks and the OCC would be required to make a broader range ofinterpretive decisions to resolve conflicts between state law, governing documents, and Part 9regarding “trust adviser” roles and whether they reflect a fiduciary capacity. These decisionswould further increase the risk of litigation and regulatory conflict. Moreover, a state-charteredinstitution engaged in this activity without being subject to a fiduciary duty could put OCC-regulated institutions (which would then be subject to a fiduciary duty in the conduct of thatactivity while their state counterparts would not) at a competitive disadvantage, as discussedmore fully below.

Amending Fiduciary Capacity Definition Raises Concerns with Other Sections in Part 9

The ANPR’s consideration of expanding the list of fiduciary capacities withoutaddressing holistically other aspects of its fiduciary regulations causes us concerns. If engaged ina named fiduciary capacity, a bank would be subject to other applicable requirements in Parts 9or 150. However, given the nature and scope of duties of a “trust adviser,” a number of these requirements would not seemingly be appropriate. For example, in the unlikely event that a bankwere to act solely as trust protector, a role that often involves removing and appointing a trustee,would that capacity require the bank to meet other Part 9 responsibilities, such as those in 9.13,Custody of Fiduciary Assets? Similarly, as required under 12 CFR 9.10, a bank as trust protectormay be obligated to set aside collateral for uninsured deposits of such a fiduciary account. Thisobligation may exist even while the bank has no investment discretion or say in the decision todeposit those funds.

Broadly Conceived Potential New Capacity May Have Unintended Consequences

We recognize that the ANPR does not include specific language amending the “fiduciarycapacity” definition, but the description in the release is very broad and, if drafted consistentwith the description, could lead to unintended consequences. The OCC contemplates adding tothe definition “any activity based on the authority a national bank or Federal savings association”[emphasis added] “has with respect to a trust.” Banks provide many services based on theirauthority with respect to a trust that are clearly not fiduciary and should not be treated as such.For example, banks provide deposit services, tax preparation services, tax planning advice, non-investment financial advisory or counseling activities, and non-fiduciary custody services amongother things. Some of these services are specifically excluded from fiduciary status in 12 CFR9.101 and are only provided under contractual arrangements that affirm that non-fiduciary status.Yet because these activities would be encompassed by “any activity based on the authority of anational bank or Federal savings association” provided to a trust, non-fiduciary bank servicescould be brought within the scope of Part 9. Furthermore, the potential imposition of co-fiduciaryliability with the named trustee would present a significant risk to the bank from a litigationperspective.

Unequal Treatment of State and Federally-Chartered Institutions

Expanding the definition of “fiduciary capacity” under Part 9, which applies to nationalbanks and Federal savings associations, would place federally-chartered institutions at acompetitive disadvantage vis-à-vis their state-chartered peers, which in many instances wouldnot be subject to fiduciary responsibilities while acting in a like capacity. If the expandeddefinition is amended, the requirements applicable to banks will vary depending on their charter, with OCC-regulated institutions being subject to increased administrative costs and burdensassociated with instituting policies and procedures to ensure compliance. Absent demonstrablebenefits arising from the expansion or material problems arising from the current definition, thedisadvantage to national banks weighs against such expansion.

National Bank Act and Existing Guidance Provide Sufficient Clarity on Authority to Act

Under the National Bank Act section 92a, a national bank may act in a number oftraditional fiduciary roles, as well as “any other fiduciary capacity in which State banks, trustcompanies, or other corporations which come into competition with national banks are permittedto act under the laws of the State in which the national bank is located.” In Interpretive Letter#695 (December 1995), the OCC confirmed the authority of national banks “to conduct fiduciarybusiness in a state on a parity with that state’s own state-chartered institutions” and that “Section92a preempts any state laws that deny or restrict the right of national banks to conduct fiduciarybusiness on this basis.” To the extent national banks may question their ability to conduct thoseactivities allowed under state law, the OCC position is clear without having to incorporateexplicitly those roles into Part 9. The Interpretive letter further states, “[a] national bank mayexercise any of the fiduciary powers granted in section 92a(a) in any state unless that state bothprohibits national banks and restricts its own state institutions from exercising that fiduciarypower.”

Comments on Non-Fiduciary Custody Activities

While we recognize the importance and considerable size of the custody business, theOCC’s contemplation of a new set of regulations governing non-fiduciary custody activities isnot only unnecessary, but could pose risks to affected banks and impede their ability to meetcompetitively the needs of their custody clients. As a result, we strongly urge the OCC not toinitiate rulemaking governing non-fiduciary custody activities. For years, these services haveoperated without undue risk to banks, their clients, or the financial system under common lawprinciples of a bailor-bailee relationship, state law, mutually agreed upon contractual terms, aswell as relevant federal laws and non-U.S. regulatory requirements.

In addition, the OCC has broad prudential authority to supervise, monitor, and takeenforcement actions against a bank from a safety and soundness perspective without the need to rely upon a specific set of non-fiduciary custody regulations. As noted below, the Comptroller’sHandbook on Custody Services has worked well in the industry since published in 2002. In lieuof codifying requirements, the OCC could revise the Handbook to address developments thathave arisen in the interim, such as the promulgation of Regulation R, and align it with other OCCguidance.

In the end, the ANPR prompts concerns about the potential creation of regulations thatare neither principles-based nor flexible enough to accommodate existing relationships, clientexpectations, developments in applicable law, opportunities provided by new technology, as wellas standardized and legacy contractual arrangements. Such a regulatory regime couldsubstantially increase the expense and risk of providing these services, thereby warranting areassessment of industry business models and affecting the competitive position of OCC-regulated institutions.

Existing Applicable Law and Guidance Appropriately Regulate the Business

The OCC has produced a significant amount of guidance in the form of Comptroller’sHandbooks and Bulletins addressing custody generally, as well as custody for certain types ofclients and assets. This cumulative guidance has provided appropriate guidelines for banks toapply across a diverse portfolio of custody services and has worked well with the contractualnature of these activities.

In addition to OCC guidance, other bodies of law and practice regulate custody activities.The ANPR identifies many of these regimes, including those of the Securities and ExchangeCommission, Commodities Futures Trading Commission, Internal Revenue Service, andothers. In addition to the “applicable law” governing custody relationships cited in the ANPR,there are a few other laws and regulations worth citing, as described below.

Under state law, Article 8 of the Uniform Commercial Code (UCC) governs custodyaccounts holding securities and applicable financial assets on behalf of “entitlement holders.”This Article, which details the duties of securities intermediaries such as banks, addresses some of the concerns raised by the ANPR, such as the lack of “OCC regulation that specificallyrequires a custodial bank or savings association to safeguard or segregate client assets.” Specifically, UCC section 8-503 provides that “all interests in that financial asset held by thesecurities intermediary are held by the securities intermediary for the entitlement holders, are notproperty of the securities intermediary, and are not subject to claims of creditors of the securitiesintermediary….” Additionally, UCC section 8-504 lays out a number of duties imposed onsecurities intermediaries, including the following:

1. A duty to “promptly obtain and thereafter maintain a financial asset in aquantity corresponding to the aggregate of all security entitlements it has establishedin favor of its entitlement holders with respect to that financial asset.”
2. “Except to the extent otherwise agreed by its entitlement holder, asecurities intermediary may not grant any security interests in a financial asset it isobligated to maintain” for the entitlement holder.

UCC section 8-504 articulates a clear standard of care, providing that either (1) thestandard may be set contractually by the parties; or (2) in the absence of agreement, the securitiesintermediary must exercise “due care in accordance with reasonable commercial standards” inobtaining and maintaining financial assets. This section highlights the non-fiduciary andcontractually-based character of the relationship by allowing the client and custodian to agreeupon the duties of the securities intermediaries or, in the absence of an agreement, how the UCCwould apply. Other sections of UCC Article 8 require the securities intermediary to obtain andhold payments or distributions from an issuer on behalf of the client, exercise rights withrespect to the financial asset as directed by the entitlement holder, and comply with directionsby the client or “appropriate person” that the intermediary determines are genuine and authorizedwithin a reasonable period.

With respect to retirement accounts, plan assets subject to the Employee RetirementIncome Security Act of 1974 (ERISA) “shall be held in trust by one or more trustees.” Although banks acting as trustee must “transmit and certify” certain required information to the plan administrator, banks that hold assets in a “custodial account” are required to provideinformation “only upon request of the plan administrator.” Moreover, in the case of a custodialaccount, the bank must provide only “such information as is contained within the ordinarybusiness records of the bank, trust company, or similar institution” and is needed to complete theplan’s annual report, Form 5500.

New Rules Could Impose Competitive Disadvantages and Limit Services Provided

The ANPR notes that “current OCC guidance appropriately identifies safe and sound riskmanagement practices for custodians,” but does not explain persuasively why this guidancetherefore must be set out in the CFR. Banks providing non-fiduciary custodial services requireflexibility in order to evolve to meet client needs, properly service emerging asset classes such ascrypto-currencies and the like, and address changing technologies. If the OCC were to establish aset of regulations that is not principles-based and imposes even minimal new responsibilities, theflexibility needed for OCC-regulated institutions to meet client needs and compete effectivelywould be impaired. The codification of new requirements may also lead to a breach of existingcontractual provisions or necessitate the repapering of those agreements, raising issues of safetyand soundness.

The following concerns highlight some of the potential competitive disadvantages andincreased risks to national banks and federal savings associations of a prescriptive set of rules:

• The ANPR suggests that the new rules would impose additional responsibilities beyondwhat the bank and client have negotiated or what is required under applicable law withrespect to due diligence on the selection and monitoring of subcustodians and theverification of assets held by them. In certain circumstances, for example in foreignmarkets, only a few subcustodians may be available to hold assets on behalf of the bank’sclients. If the subcustodian does not meet the requirements of any potential rulemaking,the OCC-regulated institution may not be able to offer access to that market. Thediligence expected under existing guidance is suitable to its purpose, and its expansionmay require a reassessment of the custody business model and related pricing.
• The ANPR suggests that it may be desirable to establish minimum safekeeping andsegregation standards, akin to what was established in Europe in directives relating toinvestment activity (MiFID), to investment funds offered to the public (UCITS), and toalternative investment funds (AIFMD). However, those directives impose prescriptiverequirements that impose a significant incremental obligation on the custodian and limitthe ability of the parties to agree to a scope of service that meets the needs of thecustodian’s clients. For example, certain types of investments, such as interests in privateequity funds or loan participations, are not practicable for a custodian to “control” in away that assures that it can act to prevent the loss of securities or their unauthorizedtransfer. Similarly, in the case of shares held in registered name on the books of a transferagent, the custodian may not be able to perform ongoing reconciliations between itsrecords and those of the transfer agent in a feasible or cost effective manner.21 U.S.custodians have typically negotiated service terms with their clients under which theywill offer a more limited range of services with respect to these investments, such asreporting, holding copies of documentation, receipt of income actually paid to thecustodian, and the like. Imposing regulatory minimum requirements with regard to theseservices, along the lines of what have recently been imposed on custodians of regulatedfunds in Europe, may adversely affect the cost of investors holding these types ofinvestments or the ability of the custodian to agree with its clients on an appropriate wayof servicing them.
• The ANPR asks whether the OCC should require dual controls over custody assets,similar to what is required of fiduciary accounts under 9.13 and 150.230. Dual control,although appropriate for many assets in fiduciary accounts, may not always be suitablefor non-fiduciary custody accounts. For example, dual control requirements do not alignwell with the process of settling custody trades, which is done at the instruction of anauthorized person under the custody agreement. In addition to the controls associatedwith contractual requirements, each bank has standard fraud controls as part of its riskmanagement program, which serve to ensure that trades are settled in accordance with client demands. The increased operational and compliance costs associated with dualcontrol outweigh the benefits of imposing additional responsibilities upon banksproviding non-fiduciary custodial services.
• The ANPR suggests that non-fiduciary custody services have expanded since thepromulgation of Part 9 and may now include roles such as fund accounting, fundadministration, and foreign exchange. Even though banks have offered these services forsome time, we note that fund accounting and fund administration are activities thatgenerally can be provided around the globe by unregulated entities. Imposing additionalregulatory requirements on OCC-regulated institutions would likely give a competitiveadvantage to non-banking entities in providing these services and would disrupt the trendamong fund sponsors to consolidate custody and fund administration activities with asingle provider.
• Custody agreements are a product of extensive arms-length negotiations with clients,which are typically sophisticated, institutional investors. Consistent with Article 8 of theUCC and market practice, these negotiated provisions routinely can include a definedstandard of care and the allocation of risk between parties. They can also articulate theobligations of custodians with respect to how certain assets under custody, both foreignand domestic, are held, transferred, and exchanged, as well as the provision of foreigncustody services. Industry standard terms embedded in custody contracts are constantlyevolving to meet the needs of clients and address technological changes in themarketplace. Current market practice, and related existing contractual terms, couldpotentially conflict with any prescriptive rules that the OCC puts into place. Ifprescriptive rules are enacted, OCC-regulated institutions would need to undertake acostly and time intensive review of all existing customer contracts for conflict, seek toremediate any such conflict for all affected customer contracts, and either cease providingany related services or modify services levels and reassess pricing structure, thereforeraising issues of safety, soundness, and customer dissatisfaction. If the OCC were torequire by regulation specific provisions in these agreements, the ability of the bank andclient to come to an agreement on the relationship and compensation for those servicesmight be impeded.
• Prescriptive rules could serve as barriers to the natural evolution of custodial servicesprovided to clients and inhibit client-beneficial changes to the industry to address newtypes of assets and technology. For example, with respect to the digital assets and morebroadly Distributed Ledger Technology (DLT), we are concerned that any new OCCregulation would pin itself to current uses and limitations of this fast changingtechnology. Prescriptive rules could hamper OCC-regulated institutions from evolving tomeet client demands and market practices. Although it would be helpful to have guidancefrom the OCC on its expectations with respect to such assets, we believe this guidance isbest provided in the form of a Bulletin or other non-CFR release, which could be updatedmore expeditiously than could amendments to the Regulation.
• The OCC states the desire to impose non-fiduciary custody regulations on fiduciaryaccounts in order to “provide a single consistent standard for safeguarding client assetsand clarify expectations for custody of both fiduciary and non-fiduciary account assets.”The ANPR also suggests that the bank could be obligated to disclose services provided ina principal capacity, such as deposit or foreign exchange services, even though therelationship is neither fiduciary nor subject to a duty to avoid a conflict of interest. Lastly,as noted above, the ANPR contemplates additional due diligence of subcustodians thatmay not be presently required under applicable law. Given these issues raised in theANPR, we are concerned that potential rulemaking may blur the line between fiduciaryand non-fiduciary activities, thereby imposing new risks on the custody business andforcing banks to reassess the pricing, structure, and management of that business andpotentially making the provision of custody services non-competitive.

Conclusion

ABA appreciates this opportunity to comment on the OCC’s ANPR on fiduciary capacityand non-fiduciary custody activities. After due consideration of the questions and ideas raised,we urge the OCC not to initiate rulemaking on either matter, because no compelling reason hasbeen asserted as to the need for regulation, and, as we relate, regulation would be counterproductive and lead to increased risks to OCC-regulated banks. If you have any questionsabout the points raised in this letter, please do not hesitate to contact the undersigned.

Sincerely,

Phoebe A. Papageorgiou
Vice President, Trust Policy