and their trust customers to evaluate the bank's own research potential. It would also make customers aware of the amount they had to spend over and above the trust commission for outside research.

Once bank regulatory agency policy with respect to research has been established, examination procedures should scrutinize the banks' "wall" practices to insure that the trust department trader will not know which broker's research services are purchased. The trust examiner again may educate a bank trust department about the "wall" policies adopted by other banks in his examination region.

Finally, the trust examiner and bank regulatory agencies should encourage bank trust department officials to develop a comprehensive definition of best execution. However, the quantity of securities transactions executed by banks would make it impossible for the trust examiner to scrutinize each transaction for best execution. Gross comparisons to the execution patterns of other institutional investors are not useful in determining a standard for best execution because other investors have very different purposes and characteristics." But the trust examiner should be more sensitive to consistent patterns of avoidance of particular markets or brokers by traders when he reviews

76. Some mutual fund boards of directors have appointed committees of independent directors to develop a comprehensive definition for best execution for the mutual fund's traders to follow. Nutt, A Study of Mutual Fund Independent Directors, 120 U. Pa. L. Rev. 179, 257 (1971). In the case of trust departments the regulatory agencies could, of course, preempt the bank's business judgments and formulate a best execution definition of their own. Considering the philosophy expressed by Dean Miller, Deputy Comptroller of the Currency for Trust, however, it is not likely that this will happen. See p. 979 supra. To acquire better trading advantages and enhance the aggregation or bunching of trading should be encouraged. Since bunching is difficult to accomplish at the trading stage, procedures should be adopted by banks to increase the awareness of various account managers within the bank to the possibility of bunching orders or executing in-house crosses. See BANK RESEARCH, supra note 62, at 23.

77. Bank trust examiners could compare aggregate mutual fund statistics and aggregate bank execution choices for certain trust accounts. Such a comparison would theoretically focus on the relative avoidance or use of specific markets as between the two financial institutions, and thus provide the examiner with gross execution comparisons. However, the overall pattern of mutual fund portfolio securities executions may not be sufficiently comparable to those of certain bank trust departinent accounts to provide such a "model." Banks historically have traded in greater quantities of se curities and in smaller share orders sizes than mutual funds. IIS REPORT, supra note 2, pt. 4, at 2169 (Table XIII-7). On the other hand, mutual fund advisors have historically used brokerage allocations in part as a reward for brokerage house mutual fund sales efforts. Glazer, A Study of Mutual Fund Complexes, 119 U. PA. L. Rev. 205, 232-59 (1970). Also, some mutual funds have created affiliated regional stock exchange broker-dealer subsidiaries to recapture brokerage commission dollars. Id., at 247-50; Nutt, A Study of Mutual Fund Independent Directors, supra note 76. Finally, banks execute securities transactions which terminate a trust's existence in contemplation of final distribution and apparently engage in more in-house crosses than mutual tund complexes. Compare, 12 C.F.R. § 9.12(d) (1972), with 17 C.F.R. § 270.17a-7 (1972). However, at some future point, gross execution comparisons between financial institutions may be possible. Compare Rule 19b-2, 185 BNA SEC. REG. & L. REP. at F-1 et seq. (Jan. 17, 1973) and SEC Statement on the Adoption of Rule 19b-2 Governing the Utilization of Exchange Mcm. bership for Public Purposes, 185 BNA (part ii) (Jan. 17, 1973) with FUTURE STRUCTURE STATEMENT, supra note 68, at 7.

37-733 74 pt. 3 32

monthly transaction reports from traders categorizing all securities transactions by broker, exchange, cost, and type of commission (fixed or negotiated).

E. Advising Multiple Clients

Since bank trust departments render investment advisory services to a variety of clients, there is a distinct danger that they will favor some accounts over others in information and trading allocation. For example, because a corporation's selection of a bank as trustee for its employee benefit plan funds is revocable," and because the corporation can be expected to monitor the fund's performance carefully, a bank may pay more attention to its account than to the typical estate or personal trust.80 Furthermore, banks in major money centers have begun to offer the investment advisory services of their trust departments to other banks-correspondent banks of their commercial departments and non-competing "country" banks, i.e., those outside central financial areas. They have also begun making available such services-through subsidiaries or holding companies-to the general public, and open- or closed-end investment companies.83 Since the sale of investment advisory services to outsiders generates additional income, trust department personnel may feel some pressure to attract more external customers by favoring them over trust accounts in allocating information and trading opportunities. None of the trust ex

82

78. For a discussion of the variety of clients a bank trust department may have, sce IIS REPORT, supra note 2, pt. 2, at 420-38.

79. Some corporations designate a bank as trustee but give the investment responsibilities to an outside investment adviser.

80. Corporations establishing employee benefit plans generally give the bank sole investment discretion, IIS REPORT, supra note 2, pt. 2, at 432 (Table V-7), sole voting authority, id., pt. 2. at 438 (Table V-13), and do not designate brokerage, id., pl. 2. at 437 (Table V-12). Of the forty-nine banks in the IIS Report survey, sixty-five percent of their employee benefit plan accounts are less than $50,000 in value. On the other hand, thirty percent of their employee benefit plan accounts exceed $500,000.

81. See E. Herman & C. Safada. Bank Trust Department Investment Services for Correspondent Banks and Other Subscribers, July 1972 (unpublished paper on file at the Yale Law School Library). Generally, correspondent banks are banks located in different money centers which provide services for each other. Country banks are non-money center banks which may utilize the services of money-center banks.

82. Some of the nation's leading financial institutions, including Chase Manhattan Bank, Bankers' Trust Co., First National City Bank, and Bank of America are adopting this practice. See, e.g., Fiske. The Banks Fight Back, INST. Inv., April, 1972, at 41 [hereinafter cited as FISKE]; Chase Manhattan Corp. Plans Unit to Handle its Trust Management, Wall St. J., April 20, 1972, at 15, col. 2. Bankers' Trust Plans to Set Up Investment Advisory Unit in Florida, Wall St. J., Sept. 25, 1972, at 6, col. 1; Advertisement of BA Investment Management Corporation, Wall St. J., Oct. 2, 1972. at 21, col. 2.

83. On January 24, 1972, the Board of Governors of the Federal Reserve System amended its Regulation Y, 12 U.S.C. § 225.4(a), effective February 1, 1972, to allow bank holding companies to act under certain circumstances as investment advisors to investment companies, including mutual funds. [1971-1972 Transfer Binder] CCH FED. SEC. L. REP. 78,503, at 81,091 (1972).

amination forms or manuals used by trust examiners deals with the conflict of interest problems raised by the rendering of investment advisory services to multiple clients.84

One prime occasion for favoritism among clients is the division of opportunities to purchase or sell "scarce" securities among trust accounts. For example, several account managers may desire a particularly attractive new issue for their trust accounts, but the trust department trader may only be able to get commitments for thirty percent of that amount from the new issue underwriting syndicate. Or several account managers may want to sell a specific security at the same time, but the trader may only be able to get block positioners or third market-makers to accept sixty percent of the shares being offered. Whether the security scarcity arises from market illiquidity, new offerings, or block transactions, fair allocation of investment opportunities among all clients requires the establishment and disclosure of trading allocation formulas. 85 The bank trust examiner could check adherence to this policy by spotchecking allocations.

86

Another prime occasion for account favoritism is the allocation of investment information in the form of internal and external research, or market information. The selection, sequence, and timing of allocation are critical to clients. While certain kinds of unequal allocation are common, securities law does not clearly state a duty to make information equally available. Preferential disclosure to a few clients by

84. The Comptroller's Manual advises its trust examiners that the sale of investment advisory services means the bank is acting in a fiduciary capacity with respect to its subscribers, and thus may be performed only by banks with trust powers. Comptroller's MANUAL, supra note 16, at D1. Interviews with bank regulatory 'officials revealed that trust examiners generally review the investment advisory service package materials only for improper inclusion of sensitive or confidential data.

85. A fiduciary may act simultaneously in one transaction as the agent for several clients if all of the parties understand the situation to be so and if the agent subsequently deals fairly with those clients. RESTATEMENT (SECOND) OF AGENCY $$ 390-94 (1958). Either full disclosure or custom can provide the "understanding" as among the various clients. Henderson, Conflicts of Interest for the Money Manager, THIRD ANNUAL INSTITUTE, supra note 56, at 293. The SEC may believe an allocation policy is essential: item 1.33 of Form N-1R which must be submitted by mutual funds to the SEC asks the investment advisor of an investment company to state its trading allocation policy. 3 CCH FED. SEC. L. Rer. 51,963, at 39,852-53. For a description of the allocation formulas used in some mutual fund complexes, see GLAZER, supra note 76, at 237-41.

86. The best Wall Street research has long gone first and sometimes exclusively to large institutional investors. For example, Merrill Lynch gives expanded research information, technical market memos, market information, etc., first to institutional investors. In some branches, Merrill Lynch keeps all rescarch for institutional use for two weeks, then gives it to the registered representative in the branch. Loomis, The Merrill Lynch Bull is Loose on Wall Street, FORTUNE, May, 1972, at 174.

87. Some commentators believe that the custom of preferential information allocation is legal because that is the reasonable expectation of the customers. FIRST ANNUAL INSTITUTE, supra note 19, at 333 (remarks of Arthur Fleischer, Jr. & Leonard Leiman); THIRD ANNUAL INSTITUTE, supra note 56, at 307-12 (remarks of Gordon Henderson). For a contrary view, see Third Annual Institute, supra note 56, at 310 (remarks of Meyer Eisenberg).

し

a broker prior to publishing a market letter has been condemned by the New York" and American Stock Exchanges, and the SEC.** Similarly, preferential disclosure of material changes from prior investment advice arising from research has been disapproved. Yet courts have not yet defined a general standard for information allocation." Preferential allocation might be upheld on a rationale of customer consent implied from prior bank disclosure or custom. But analogies from securities law suggest a better guideline: substantial equality, at least within classes among clients.

Under such a standard banks would be expected to make information available to all clients of the same class at the same time and in identical form, to the extent practicable. As a minimum, each bank should require banks to establish a fair and equitable formula for allocation, combined with detailed disclosure thereof to all customers.95 Banks should also obtain written acknowledgment that customers understand and agree to the formula. A bank trust examiner could then spot check for bank adherence to its information allocation policy.

88. NYSE, M.F. Circular No. 170. Nov. 16, 1962; NYSE, Guidelines for Member Firm Communications with the Public 5 (1970).

89. ASE, Info. Circular No. 51-71, April 30, 1971.

90. FIN. ANAL. Fed., Corporate DISCLOSURE AND INSIDER INFORMATION 15 (1968) (remarks of Commissioner Philip A. Loomis, Jr.).

91. See FUTURE STRUCTURE STATEMENT, supra note 68, at 6; and Butcher & Sherrerd, SEC Securities Exchange Act Release No. 9894 (Dec. 11, 1972) (Findings and Order Imposing Remedial Sanctions) [1971-1972 Transfer Binder] CCH FED. SEC. L. REP. ¶ 79,135, at 82.460 (1972). See Butcher & Sherrerd Penalized on Tips on Penn Central, Wall St. J., Dec. 13, 1972, at 2, col. 2. For a contrary view that the Butcher & Sherrerd case if applied universally is "beyond current expectations and standards," see THIRD ANNUAL INSTITUTE, supra note 56, at 308 n.25 (remarks of Gordon Henderson).

92. In Securities and Exchange Commission v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963), the Supreme Court held that the SEC may obtain an injunction compelling a registered investment advisor to disclose its practice of purchasing for its own account just prior to publishing a market letter recommending the investment and then immediately selling its shares upon the rise in the market price following the recommendation.

93. THIRD ANNUAL Institute, supra note 56, at 305 (remarks of Commissioner Philip A. Loomis, Jr.).

94. For a discussion of different types of policies used by mutual fund complexes and investment advisers for information allocation, see GLAZER, supra note 76, at 219-26; THIRD ANNUAL INSTITUTE, supra note 56, at 301 (remarks of Gordon Henderson).

95. Where soft brokerage dollars are used to acquire Wall Street research, conceptually the bank has an asset (e.g., the research) which "belongs" to all of its trust accounts for which it has executed securities transactions. Since tracing the research asset purchased back to individual accounts is virtually impossible, it may be regarded as an indivisible asset belonging to all the accounts. If the trust department sells externally created, undigested Wall Street research bought with brokerage commission dollars, the trust accounts would have a good case for recapturing the research sale proceeds on the ground that the trust department was illegally selling trust assets in breach of its fiduciary duties. 2 SCOTT, supra note 15, at $ 170.17. See also Provident Management Corp., SEC Securities Exchange Act Release No. 9028 (Dec. 1, 1970), [1970-1971 Transfer Binder] CCH FED. SEC. L. REP. 77,937. at 80,083 (1970). (Officers and directors of an investment adviser entered into reciprocal agreements to recapture and retain commissions from the mutual fund's portfolio transactions; this was held to be a breach of fiduciary duty and antifraud provisions of the securities laws.)

F. Size of Holdings and Concentration Limitations

As a result of sizeable bank trust department holdings in a single security, a bank may acquire potential control over major corporations." Representative Wright Patman, Chairman of the House Committee on Banking and Currency, has proposed a ten percent absolute limitation on a bank's trust department's holdings in a publicly held corporation." However, the wisdom of this limit has been questioned, and Patman's ten percent limitation seems arbitrary and unwise for several reasons. First, liquidity considerations generally are not served by a limit allowing such large holdings; a much lower level is already observed by most banks. Second, the Patman limit fails to take account of investment discretion, which is essential to banks' potential influence on portfolio companies. An accurate indicia of the bank's power over a portfolio corporation is thus not necessarily the total amount of its holdings, but the amount over which it has discretion. Third, banks often receive trusts, some restricted, with large holdings of a particular security; if an absolute ceiling were im

96. PATMAN REPORT, supra note 2, pt. 1, at 9.

97. H.R. 5700, 92d Cong., 1st Sess., § 13(2) (1971). The securities laws do not constrain aggregate investment in one security. Section 13(d)(1) of the Securities Exchange Act of 1934, 15 U.S.C. § 78 m(d)(1) (1971) requires the disclosure by a "group," when the members of the group acquire shareholdings in a corporation of five percent or more. How. ever, except to the extent a bank trust department constitutes a "person" under sections 78(d) and 79(d), because bank trust departments do not have beneficial ownership of the shares which they hold in trust, they are not subject to the disclosure provisions even though their securities holdings in the aggregate greatly exceed the triggering level. Unless the trust accounts were aggregated to constitute a "group" for purposes of these sections, no disclosure would be required.

98. Hearings on H.R. 5700 Before the House Committee on Banking and Currency, 92d Cong., 1st Sess., pt. 1, at 117 (1971) (remarks of Richard B. Smith, then Commissioner, Securities and Exchange Commission), at 129 (remarks of William B. Camp, Comptroller of the Currency). See also C. GOLEMBE, L. DEMBITZ and G. FISCHER, THE ECONOMIC POWER OF COMMERCIAL BANKS 155-58 (1969).

99. Furthermore, the larger the aggregate position taken by the bank in a portfolio company, the greater is the discount taken when the block is sold, and the more dif ficult it is for the bank to turn a profit. Such a discount is called an illiquidity discount. C. ELLIS, INSTITUTIONAL INVESTING 85 (1971). Bleakley, Illiquidity: Is It Becoming a Problem Again?, INST. INV., Sept., 1972, at 42. In disclosing First National City Bank's 1971 investment performance record, Executive Vice President Thomas C. Theobald was questioned on the fact that none of FNCB's largest stock holdings exceeded five percent of the issuer's common stock. Responding to the implication that five percent was a limit chosen by FNCB to avoid any disclosure problems, Mr. Theobald stated: "[T]hat certainly wasn't our primary reason. If we hold more than five percent of a company's stock, we'd be concerned that we could become locked in; that five percent limit is our working rule for good market liquidity." The Money Men, FORBES, April 15, 1972, at 44. Of course, the liquidity problem is only a real threat to accounts with large blocks over which the trust department has discretion. Large blocks held by the bank without investment discretion make up part of the aggregate total holdings, but are irrelevant to the liquidity question because the bank is not responsible for the timing of the sell decision, only for best execution by the trader when the moment comes. Thus, when discretionary and non-discretionary blocks are aggregated for purposes of calculating constraints, the total holdings may well exceed the constraints, while those accounts over which the bank exercises control are comfortably within any disclosure or liquidity needs.