The creation of trusts to hold assets is a financial strategy commonly associated with great wealth. But trusts have many uses, and people of modest means often resort to them for reasons ranging from a desire for privacy to a need for professional money management.
Banks are happy to have this business. While not all banks have trust powers, most do, and for a fee they provide the management and take care of the paperwork.
Managing small amounts of money, however, is inefficient and potentially expensive. To enable them to offer trust services to relatively small customers, banks often form "common trust funds" in which assets from many small trusts are pooled and managed together.
State laws and federal regulation govern how these common trust funds are operated and marketed. And until recently these operations were little noticed outside the banking industry.
Now, however, a major regulatory and legislative brouhaha has erupted, pitting many of the nation's banks -- especially the big ones -- and their chief regulator, the Office of the Comptroller of the Currency, against the mutual fund industry, securities regulators, some state officials, some members of Congress and many small banks.
At issue are rule changes proposed by the comptroller's office that would allow banks operating common trust funds to advertise them to the public and in some cases pay for the advertising out of the fund's assets.
"This rule would transform common trust funds from administrative devices into what appear to be mutual funds," said Rep. Edward J. Markey (D-Mass.), chairman of the telecommunications and finance subcommittee of the House Energy and Commerce Committee.
Markey and others are worried that banks could become mass marketers of these services and that consumers could be misled into thinking that their investments were federally insured when they are not. And they are worried that in the absence of current banking rules and the full array of investor protection laws that has grown up around mutual funds over the years, investors could be charged excessive fees.
"Without such rules in place, at least some institutions would likely submit to the temptation to put their own pecuniary self-interest ahead of that of their trust customers," Markey said at a subcommittee hearing Thursday.
Securities and Exchange Commission Chairman Richard C. Breeden also expressed concern that banks would not be as tightly regulated as mutual funds. He said the SEC believes it can apply some securities law to common trust funds if they are marketed to the public. But he warned that even though the comptroller's office agrees on this, individual banks may not agree and could choose to challenge the SEC in court.
Breeden suggested that Congress review these exemptions, which he said have "outlived their usefulness," and amend the securities laws "right now."
Comptroller of the Currency Robert L. Clarke, backed by the American Bankers Association, told the panel that the changes are "in the public interest." He noted that trusts have typically been for the wealthy, but there is growing need for them among the less well-heeled and "the changes we have proposed would simply extend these opportunities to that population."
Clarke said the worries about consumer abuse will prove unfounded and suggested that opposition is being fueled by mutual funds anxious to exclude new competitors from the market.
"If these funds are legal, which they are, and if they benefit the customer, which they do, who would oppose banks advertising them?" Clarke asked. "Who wants to keep truthful and accurate information about bank common investment funds from the public? Financial service providers who offer similar products are the ones who want to do that -- in short, mutual funds."
On the other hand, Rep. Thomas J. Bliley Jr. (R-Va.) demanded to know if "the widow who has her money with the bank" trust department would benefit from the change.
Clarke at first replied that she is receiving a service, money management, and that a fee was appropriate. But Bliley noted that there is already a fee for that service, and pressed to know how she would benefit from the rule changes.
"She wouldn't," Clarke said.
"That's what I thought," Bliley shot back.
The ferocity of the debate, which perhaps seems out of proportion to the role played by common trust funds in banking and the economy, is due in part to the context in which it takes place. Banks have been actively seeking to break out of their Depression-era restrictions, pressing for new regulations, laws and even court decisions to assist them.
Industries from securities underwriting to insurance are fearful that banks will eventually gain entry into their fields and with their financial muscle take away business and profits from the present players. As this battle ebbs and flows, any gain or loss tends to be viewed as a major breakthrough.
Clarke noted that his office has not yet decided how or whether to proceed with changing the rules. And he noted that in many states, state-chartered banks already have all the powers he proposes to confer on national banks.
However, the hearing provided a warning for consumers. If you are contemplating setting up a small trust to be managed by a bank, make sure that you and/or your attorney are fully familiar with what state law permits and what the trust agreement permits.
The SEC's Breeden noted that certain transactions that are forbidden outright under securities law are permitted under banking regulation if they are disclosed. State law may forbid them, but if it does not, then the trust document governs.
These transactions include deals that present conflicts of interest between the bank and its trust customers, such as causing the trust to buy securities issued by the bank or an affiliated entity. Rep. C. Thomas McMillen (D-Md.) wondered if customers might face a variation on the Lincoln Savings & Loan case in which customers bought securities that they now say they thought were federally insured.
The vast majority of bank trust departments are highly reputable, and cases where the customers have lost money are rare. But the risks are real. Securities issued by the parent of National Bank of Washington ended up in trust accounts of the bank -- a situation now under investigation by the SEC.