[Code of Federal Regulations]
[Title 12, Volume 3]
[Revised as of January 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 12CFR250.412]

[Page 694-696]
 
                       TITLE 12--BANKS AND BANKING
 
                   CHAPTER II--FEDERAL RESERVE SYSTEM
 
PART 250--MISCELLANEOUS INTERPRETATIONS--Table of Contents
 
Sec. 250.412  Interlocking relationships between member bank and insurance company-mutual fund complex.

    (a) The Board has been asked whether section 32 of the Banking Act 
of 1933 and this part prohibited interlocking service between member 
banks and (1) the advisory board of a newly organized open-end 
investment company (mutual fund), (2) the fund's incorporated investment 
manager-advisor, (3) the insurance company sponsoring and apparently 
controlling the fund.
    (b) X Fund, Inc. (``Fund''), the mutual fund, was closely related to 
X Life Insurance Company (``Insurance Company''), as well as to the 
incorporated manager and investment advisor to Fund (``Advisors''), and 
the corporation

[[Page 695]]

serving as underwriter for Fund (``Underwriters''). The same persons 
served as principal officers and directors of Insurance Company, Fund, 
Advisors, and Underwriters. In addition, several directors of member 
banks served as directors of Insurance Company and of Advisors and as 
members of the Advisory Board of Fund, and additional directors of 
member banks had been named only as members of the Advisory Board. All 
outstanding shares of Advisors and of Underwriters were apparently owned 
by Insurance Company.
    (c) Section 32 provides in relevant part that:

    No officer, director, or employee of any corporation * * * primarily 
engaged in the issue, flotation, underwriting, public sale, or 
distribution at wholesale or retail, or through syndicate participation, 
of stocks, bonds, or other similar securities, shall serve [at] the same 
time as an officer, director, or employee of any member bank * * *.

    (d) The Board of Governors reaffirmed its earlier position that an 
open-end investment company is ``primarily engaged'' in activities 
described in section 32 ``even though the shares are sold to the public 
through independent organizations with the result that the investment 
company does not derive any direct profit from the sales.'' (1951 
Federal Reserve Bulletin 654, Sec. 218.101.) Accordingly, the Board 
concluded that Fund must be regarded as so engaged, even though its 
shares were underwritten and distributed by Underwriters.
    (e) As directors of the member banks involved in the inquiry were 
not officers, directors, or employees of either Fund or Underwriters, 
the relevant questions were whether--(1) Advisors, and (2) Insurance 
Company, should be regarded as being functionally and structurally so 
closely allied with Fund that they should be treated as one with it in 
determining the applicability of section 32. An additional question was 
whether members of the Advisory Board are ``officers, directors, or 
employees'' of Fund within the prohibition of the statute.
    (f) Interlocking service with Advisory Board: The function of the 
Advisory Board was merely to make suggestions and to counsel with Fund's 
Board of Directors in regard to investment policy. The Advisory Board 
had no authority to make binding recommendations in any area, and it did 
not serve in any sense as a check on the authority of the Board of 
Directors. Indeed, the Fund's bylaws provided that the Advisory Board 
``shall have no power or authority to make any contract or incur any 
liability whatever or to take any action binding upon the Corporation, 
the Officers, the Board of Directors or the Stockholders.'' Members of 
the Advisory Board were appointed by the Board of Directors of Fund, 
which could remove any member of the Advisory Board at any time. None of 
the principal officers of Fund or of Underwriters were members of the 
Advisory Board; and the compensation of its members was expected to be 
nominal.
    (g) The Board of Governors concluded that members of the Advisory 
Board need not be regarded as ``officers, directors, or employees'' of 
Fund or of Underwriters for purposes of section 32, and that the 
statute, therefore, did not prohibit officers, directors, or employees 
of member banks from serving as members of the Advisory Board.
    (h) Interlocking service with Advisors: The principal officers and 
several of the directors of Advisors were identical with both those of 
Fund and of Underwriters. Entire management and investment 
responsibility for Fund had been placed, by contract, with Advisors, 
subject only to a review authority in the Board of Directors of Fund. 
Advisors also supplied office space for the conduct of Fund's affairs, 
and compensated members of the Advisory Board who are also officers or 
directors of Advisors. Moreover, it appeared that Advisors was created 
for the sole purpose of servicing Fund, and its activities were to be 
limited to that function.
    (i) In the view of the Board of Governors, the structural and 
functional identity of Fund and Advisors was such that they were to be 
regarded as a single entity for purposes of section 32, and, 
accordingly, officers, directors, and employees of member banks were 
prohibited by section 32 from serving in any such capacity with such 
entity.

[[Page 696]]

    (j) Interlocking service with Insurance Company: It was clear that 
Insurance Company was not as yet ``primarily engaged'' in business of a 
kind described in section 32 with respect to the shares of the newly 
created Fund sponsored by Insurance Company, since the issue and sale of 
such shares had not yet commenced. Nor did it appear that Insurance 
Company would be so engaged in the preliminary stages of Fund's 
existence, when the disproportion between the insurance business of 
Insurance Company and the sale of Fund shares would be very great. 
However, it was also clear that if Fund was successfully launched, its 
activities would rather quickly reach a stage where a serious question 
would arise as to the applicability of the section 32 prohibition.
    (k) An estimate supplied to the Board indicated that 100,000 shares 
of Fund might be sold annually to produce, based on then current values, 
annual gross sales receipts of over $1 million. Insurance Company's 
total gross income for its last fiscal year was almost $10 million. On 
this basis, about one-tenth of the annual gross income of the Insurance 
Company-Fund complex (more than one-tenth, if income from investments of 
Insurance Company was eliminated) would be derived from sales of Fund 
shares. Although total sales of shares of Fund during the first year 
might not approximate expectations, it was assumed that if the estimate 
or projection was correct, the annual rate of sale might well rise to 
that level before the end of the first year of operation.
    (l) It appeared that net income of Insurance Company from Fund's 
operations would be minimal for the foreseeable future. However, it was 
understood that Insurance Company's chief reason for launching Fund was 
to provide salesmen for Insurance Company (who were to be the only 
sellers of shares of Fund, and most of whom, Insurance Company hoped, 
would qualify to sell those shares), with a ``package'' of mutual fund 
shares and life insurance policies that would provide increased 
competitive strength in a highly competitive field.
    (m) The Board concluded that Insurance Company would be ``primarily 
engaged'' in issuing or distributing shares of Fund within the meaning 
of section 32 by not later than the time of realization of the 
aforementioned estimated annual rate of sale, and possibly before. As 
indicated in Board of Governors v. Agnew, 329 U.S. 441 at 446, the 
prohibition of the statute applies if the section 32 business involved 
is a ``substantial'' activity of the company.
    (n) This, the Board observed, was not to suggest that officers, 
directors, or employees of Insurance Company who are also directors of 
member banks would be likely, as individuals, to use their positions 
with the banks to further sales of Fund's shares. However, as the 
Supreme Court pointed out in the Agnew case, section 32 is a 
``preventive or prophylactic measure.'' The fact that the individuals 
involved ``have been scrupulous in their relationships'' to the banks in 
question ``is immaterial.''

(12 U.S.C. 248(i))

[33 FR 13001, Sept. 14, 1968. Redesignated at 61 FR 57289, Nov. 6, 1996]