12/16/2005 Privileged and Confidential
Attorney – Client Communication
Attorney Work Product
CONFLICTS REVIEW
This is an Example only. The Material is to provide suggestions for consideration and it does not represent any conclusions that are to be relied on for compliance with any law, rule, or regulation.
Risk ranking
1: High - broadly impacting business or firm
2. Medium - business-specific, moderate concern
3: Low - very limited scope
Mitigation
1: Satisfactory
2. Partially satisfactory, but needs some work
3. Needs work
CROSS-BUSINESS
Client vs. Firm
Conflicts Review
Perception on multiple roles / Even where BANK follows all of its conflict and Chinese wall procedures, there can be a negative perception where public investors have suffered losses and BANK or one of its affiliates have made money on a name. For example, when one looks at the history of a “fallen angel” BANK or another BANK affiliate may have made money taking the company public or selling its debt securities, hedged its loan exposure so that it made money when the company defaulted (or made money by trading distressed securities of the name) and acted as restructuring advisor. At the same time, the holder of the debt or equity securities may have suffered large losses. Note- that the number of possible conflicts have multiplied many fold in the last 20 years given both expanded bank powers and mergers in the financial services area.
Rate: / JPM Chinese Wall and Conflicts Policies and Procedures Note – Are proper policies in use in other BANK areas and affiliates.
Mitigation:
Gifts/Entertainment / Potential for the receipt of or the giving of gifts or expensive entertainment by employees from clients or covered companies that may create the appearance of impropriety.
Rate: / BANK follows its Code of Conduct with respect to the receipt and/or the giving of gifts to/from clients, vendor or mutual fund sponsors. In addition, BANK has adopted a Prohibited Practices Policy that contains the same prohibition. BANK Associates received mandatory training on the Prohibited Practices Policy _____. Each associate certified to compliance at that time. Need monitoring of compliance with policy and suggest comprehensive mandatory disclosure or record-keeping. Note – different affiliates may have specific regulatory requirements.
Mitigation:
CROSS-BUSINESS
Employee vs. Client
Conflicts Review
Business/Group/Topic / Issue / Mitigation /Personal Trading / Potential for firm employees to invest in securities based on confidential information.
Consultants and vendors retained by BANK may be privy to confidential information in connection with their work here, but are not subject to firm’s Personal Trading Policy.
Rate: / Employees in different areas or affiliates may be required to have different levels of restrictions. For example employees in certain broker/dealers, investment advisors and mutual funds might be required to pre-clear trades. While licensed representatives in a retail broker may be only required to send duplicate confirms to Broker’s Compliance. Non-Licensed BANK associates not privy to inside trading information may only be asked to report transactions exceeding sum dollar amount on a quarterly or other basis ( perhaps subject to exceptions including mutual funds).
Policies should address things like approved lists, trust/advisory portfolio models and mutual fund portfolio holdings as confidential information.
Suggest policies on:
Code of Conduct
Trading on Inside Information Policy
Prohibited Practices Policy
Reporting Personal Investment Transactions
Insider Information
Free-Riding
Investigate whether trading policies are covered in contracts with consultants or outsourcing vendors and if not, insert such provisions.
Brokers and other areas may have a policy requiring usage of selected brokers or requiring pre-clearance thus enhancing the ability of BANK to monitor employee trading on a proactive basis.
Mitigation:
CROSS-BUSINESS
Employee vs. Client/Firm
Conflicts Review
Business/Group/Topic / Issue / MitigationEmployee Performance Measurement and Compensation / Incentive compensation may encourage employees to execute or recommend transactions that generate fees or encourage sale of one product over another.
Incentive compensation for might be structured to favor affiliate products over non-affiliated products.
Rate: / Various ways to approach this. Could make compensation for similar products the same across the board. Could require specific documentation for choice of products. Provide that employees are not paid on commission and any discretionary bonuses take into consideration the best interests of the client and the firm. Investment.
Mitigation:
Fee discounts to officers and directors / The OCC requires that national banks grant fee discounts to officers and directors on a fair and equitable basis. If State bank check applicable local regulations.
Rate:
/ Trust Policy limits fee discounts to officers and directors up to and including [20]% from the published Personal Trust fee schedules for all personal trust accounts (irrevocable trusts, revocable trusts, guardianships, estates, agency, investment advisory, IRAs and personal custody accounts).Officer and director accounts are coded for review. Management must approve fee discounts.
Mitigation:
BANK associate serves as co-trustee or other fiduciary of client account / The OCC prohibits the receipt of fees for serving as co-trustee. This practice gives rise to conflicting fiduciary duties as well as legal risk to the Firm.
Rate:
/ Code of Conduct and BANK Prohibited Practices Policy prohibit this activity.Mitigation:
BANK associate serves on board of directors of closely-held company / An officer or employee of BANK may serve on the board of directors or governing body of a closely held entity held in a fiduciary account (or accounts) for which BANK has investment or other fiduciary responsibility.
Rate:
/ Code of Conduct or Policy requires prior approval of General Counsel and Senior Management.Director's fees paid for serving on a board (and any similar fees) shall be credited to the accounts holding the closely held entity proportionate to the total holdings of the asset within the chartered entity. The director's fee shall be made payable to BANK in its fiduciary capacity, rather than to the individual officer serving on the board.
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Mitigation:
CREDIT PORTFOLIO
Patricia McNutt/Jon Verity
Client vs. Firm
Conflicts Review
Business/Group/Topic / Issue / Mitigation /Credit
Advisory engagement where the Firm holds a position in the debt. / Example BANK in its individual capacity holds an part interest in property with third parties where an affiliate hired to sell foreclosed real estate assets
Rate: / Affiliate relationships and fees are disclosed to all interested parties.
Mitigation:
Credit
Lending to trusts / BANK makes secured loans to trusts for which it serves as a trustee. If there ever came a need to foreclose on the collateral, BANK would be both the representative of the debtor and a fiduciary, on the one hand, and foreclosing creditor, on the other hand.
Rate:
/ Trust Policy should address loans to trusts .The policy contains a request form and requires involvement of the Loan Committee and review for exception to self dealing prohibition.. The policy requires that the terms be consistent with other lending sources and that conflict be waived by Grantor or, all beneficiaries or in governing instrument. In rare cases, loans from other sources may not be available.Mitigation:
BANKMargin or Bank Lending against Securities Products / There is always a potential that the firm uses credit or provides leverage as an incentive to a client to purchase securities.
Rate:
/ BANK Policies govern loans secured with fiduciary assets and brokerage accounts.Credit policies, know your customer rules and regulatory safeguards and control should be developed to limit the potential for abuse and conflict. Lending values are not controlled by the investment professionals, but by corporate credit. May need confidentiality agreements for allowing credit officers direct access asset information if access can not be granted or limited to collateral account.
Always review for proper authority to pledge, especially with fiduciary assets. Use control agreement with assets in affiliate brokerage account. Careful review required of pledge/control agreement form third party.
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Policies should include training on Reg W, tying, and Reg U .
Strict review process is in place to review all marketing, presentations and new products.
Mitigation:
PERSONAL TRUST
Jon Verity/Bill Norris
Client vs. Firm
Conflicts Review
Topic / Issue / MitigationTrust
Proprietary Products - Distribution of products created or managed by other divisions or affiliates of the BANK / Because the BANK or an affiliate firm manufactures and distributes product it takes the complete compensation, as compared to a third party product where it only gets the distribution component of the fees. A bias is therefore created to sell proprietary products over third party. Potential pressure may be placed on BANK and employees to sell these products because of the greater firm revenues. Examples include: proprietary mutual funds and hedge funds; venture capital funds; annuities; loans to fiduciary accounts; underwritten bonds and notes; and structured products.
Investment in proprietary mutual funds
Purchase of derivatives sold by affiliates as the counter party
BANK fiduciary accounts purchase insurance through affiliates
BANK fiduciary accounts purchase bonds underwritten by BANK or affiliate or where they are a member of the selling group
BANK as fiduciary invests in loans originated by the Bank, e.g. asset securitization
BANK as fiduciary invests accounts in affiliated sponsored real estate syndication
BANK as fiduciary invests in time or savings deposits of BANK or affiliate
Investment of short-term cash for fiduciary accounts
Rate:
/ BANK has implemented a variety of policies and procedures to prevent this including: other business units are not allowed to contact marketers and clients directly, but must go through BANK New Product Committee and BANK Investment Risk Committee; new product Approval Process allows for scrutiny of deals by the BANK Risk and Credit Committee which is made up of all BANK control and business groups; documentation and booking is reviewed by Compliance and Legal; and most importantly risk disclosure of the compensation and revenue is required to be contained in the marketing and offering documents for BANK products.Trust Policy prohibits self-dealing unless authorized by statute, court order, governing instrument.
Trust Investment Policy prohibits self-dealing unless authorized by statute, court order, or governing instrument.
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Ohio has conflict waiver statute that enables fiduciary to engage in transactions with affiliates provided certain steps are taken and disclosures given. Other states like Florida, Indiana, Michigan and Kentucky may adopt similar provisions. Illinois has a virtual representation statute that allows trust beneficiaries to waive conflicts.
Trust Policy specifically governs use of affiliated mutual funds and requires letters, disclosures and prospectuses.
Trust Policy requires that the mutual fund prospectuses must be distributed to non-discretionary clients on an annual basis. All customers receive notice on periodic statements that prospectus is available.
Trust Policy requires that as part of account acceptance process, accounts investing in affiliated mutual funds need authorization letters.
Trust Policy requires that as part of the administrative account review, accounts be reviewed to insure that a mutual fund letter is on file.
Periodic client statements disclose affiliate relationship and fees and ability to get updated prospectus and/or fee disclosure.
Trust fee schedules distinguish between account assets invested in affiliated mutual funds and assets invested in individually managed securities or outline rebate policies. Fee schedules disclose that BANK affiliates receive fees for services to the affiliated mutual funds including investment advisory fees.
Complete a competitive fee analysis especially for accounts using affiliated mutual funds as opposed to individually managed securities or outside managers. Unbundled fee schedule is another option for providing a platform for allowing a thorough fee review by the customer .
Standard agreements have language permitting affiliate investments and fees.
Trust Policy 500.190 provides for non-brokerage fiduciary accounts to only invests fiduciary/agency clients in a certain approved class shares of the mutual fund shares where available ( for example – it might be shares with no 12b-1 fees or loads).
Trust Policy requires that the Board or Trust Review Committee approve the use of proprietary m/f's and review performance on a quarterly basis.
Such reviews might cover investment performance and other aspects- for example: (1) the applicable index's performance over some period; (2) the fee level charged for each Fund (3) a comparison of the average expense ratio for other mutual funds in the same fund category (4) other data complied by rating agencies for each fund, including its star rating, top portfolio ratings, and other return data (5) beta (volatility of fund versus market benchmark) (6) alpha (difference between a fund’s actual performance and its expected returns given its risk level as measured by its beta) (7) Sharpe Ratio (measure indicating how well a fund has been rewarded for the risk it has assumed) (8) R-Squared (measure of percentage of a fund’s movement explained by movements in the benchmark) (9) qualifications of the Investment Officers for Fixed Income and Equities and (10) changes in Fund managers and mgmt in the past year. Board minutes should document this review.
Methodology for reviewing proprietary fund performance and expense ratios is subject to constant regulatory scrutiny.
Trust Policy requires that special attention be given to investments in the High Yield Bond Fund and other more risky investments. Also there may be a need to review trust agreement for account investment restrictions.
Trust policy permits and outlines criteria for the usage of third party investment managers within the context of proper asset allocation considering the provisions of the governing document and the client's investment objectives, portfolio size, investment horizon, principal and income distribution needs, liquidity needs, tax consequences, state law, additional investment management fees, and overall risk profile, as well as the available in-house investment expertise; and for each third party manager, the policy requires approval of the national trust committee, Trust Investment Committee or other senior review.
If purchases of third party mutual funds are permitted in agency accounts and trust accounts, specify and provide that they are on the BANK approved third party fund list maintained by the BANK . If the BANK receives third party mutual funds that are not otherwise approved in a new account, policy should deal with elimination or retention of such funds, if under current BANK policy, third party mutual funds are not purchased for irrevocable trust accounts for which BANK has sole or shared authority.
Board or Trust Review Committee periodically reviews and approves affiliated mutual fund policies, including proxy policies.
BANK Marketing Policy requires certain disclosures as well as review by BANK Compliance.
If Revenue sharing occurs between affiliated mutual fund and BANK to reimburse BANK for transfer of investment management business to BANK, comply with Reg W. This is done under a written agreement.
The corporate governance and management-reporting structure of the BANK’s Trust Area, the Board of a Trust Company or a Trust Review Committee may create a potential conflict of interest. If these entities are comprised entirely of inside directors within the LOB. No rule violations but consider the value of getting outside review of things like trust investment performance and the use of affiliated mutual funds. .
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The BANK’s Derivatives Policy must be followed before executing any equity derivative transaction in an account for which BANK has any investment responsibility. BANK Derivative Guidelines defines strategies and sets forth approval process before presentation is made to client.
Assign review of suitability of strategy, analysis type of account and pricing to an oversight group of in-house investment professionals
Obtain competitive bids on transactions for trust accounts where BANK has investment authority. Competitive bids may not be required on investment agency transactions because of the ability to obtain consent of the principal after full disclosure. Question may be, how do you determine fair pricing without competitive bids?
Also does BANK violate its fiduciary duty if it only does derivative transactions with affiliates in waiver situations. What about accounts where BANK can't get waivers? If BANK expands the use of derivative transactions with independent counter parties to address issue, it will also make it easier to get competitive bids to check pricing on derivatives done with affiliates.
Prior to purchasing insurance from an affiliate for an account, the BANK must perform due diligence and obtain certain approvals. Pre-approved language can be available for new account documents. Trust Policy should address – Use of Insurance Products provided by Affiliates
To extent BANK fiduciary transactions go through an affiliated broker, all necessary steps must be taken because of the conflict, the trade confirm should disclose the affiliation.
Need Firewalls between retail, commercial and investment banking areas of BANK
Fixed Income Procedure – outlines specific scenarios where conflict in interest must be addressed and necessary resultant actions
BANK as fiduciary does not invest in loans originated by BANK or affiliates.
BANK as fiduciary does not invest in real estate syndicates involving affiliates.
BANK as fiduciary does not invest in time or savings deposits of BANK or its affiliates
Trust Policy on uninvested cash outlines controls and exceptions for uninvested cash but only if within reasonable management of account
Trust Policy on Fee Processing – outlines process and controls on various types of fees
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Mitigation: