97-14

June 30, 1997

Dear Ms. __________:

This relates to your letter of February 28, 1997, in which you took issue with our citing as a violation of Section 761 of the Financial Code the investment by _____________ (“Trust Co.”) in shares of a mutual fund known as __________ (the “______ Fund”). Details regarding the violation were set forth in our Report of Examination of Trust Co. as of October 28, 1996.

We acknowledge your position that Trust Co. has not owned the subject shares since 1993, and that it has corrected what you characterized as “bookkeeping misclassifications” which you state created the inaccurate impression that Trust Co. owned the shares at the time of our examination. Nevertheless, we wish to comment on your contention that the Fund would have been a lawful investment for Trust Co. had Trust Co., in fact, owned the shares in question.

You contend that ownership of Fund shares by Trust Co. should not be construed as a violation of Financial Code Section 761 because, (1) Financial Code Section 1338 provides broad authority for banks, including trust companies, to acquire mutual fund shares, and (2) ownership of shares of a mutual fund should be viewed as the legal equivalent of ownership of the funds underlying assets. We disagree on both counts.

Section 761 of the Financial Code provides that no bank shall purchase, acquire or hold the stock of any corporation except as expressly authorized in the Banking Law (Division 1 (commencing with Section 99) of the Financial Code). For purposes of Section 761, the term “bank” includes a trust company. See Financial Code Section 109. As discussed below, it is our view that Financial Code Section 761 prohibits a trust company from owning shares of a mutual fund except to the extent specifically permitted in Financial Code Sections 772 or 782.

You first contend that Trust Co.’s investment in the Fund is permissible under Financial Code Section 1338, which, you assert, creates an exception to the prohibition in Section 761. However, Section 1338, by its terms, applies only to commercial banks, and not to trust companies. It is true that Financial Code Section 109 provides that the term “bank” refers to both banks and trust companies unless the context otherwise requires. However, Section 103 of the Financial Code divides banks into two classes, namely commercial banks and trust companies. The reference in Section 1338 only to commercial banks creates a context in which it is clear that trust companies were intended to be excluded.

Furthermore, Section 1338 does not authorize even a commercial bank to acquire mutual fund shares for investment purposes. To the extent that it authorizes a commercial bank to underwrite securities of investment companies, Section 1338 may grant a commercial bank authority to purchase mutual fund shares for the limited purpose of effecting a redistribution of the shares. However, this limited authority may not be construed as a general authority to acquire mutual fund shares for investment purposes. No aspect of Section 1338 other than the authority to underwrite investment company shares expressly permits a commercial bank to or implies that a commercial bank may acquire or invest in shares of a mutual fund.

Secondly, you contend that for purposes of the Banking Law a mutual fund should be viewed as a conduit for the fund’s underlying investments and not as a separate investment with risks inherently different from the risks of the fund’s underlying assets. The Department has consistently rejected that position, as has the California Legislature. Indeed, Financial Code Section 782n1 was enacted for the purpose of allowing banks to invest in mutual funds comprised exclusively of certain investments and loans otherwise permitted for banks, notwithstanding the prohibition against investment in corporate stock implied in Financial Code Section 1335 (and stated explicitly in Financial Code Section 761). It therefore appears that for purposes of the Banking Law, the Legislature regarded an investment in a mutual fund as different from a direct investment in the fund’s assets.

– – – – – – – – – – – – – – – – – -Footnotes- – – – – – – – – – – – – – – – – –

n1 Section 782 provides in pertinent part: “Notwithstanding Section 1335, a bank may invest in shares of an investment company (1) registered with the Securities and Exchange Commission pursuant to the federal Investment Company Act of 1940, as amended (15 U.S.C. Sec. 80a-1 et seq.) and for which the shares are registered under the federal Securities Act of 1933, as amended (15 U.S.C. Sec. 77a et seq.), and (2) the portfolio of which consists solely of the following: . . . .”

– – – – – – – – – – – – – – – – -End Footnotes- – – – – – – – – – – – – – – – –

If we were to accept your argument that investment in a mutual fund is not an investment distinct from the funds underlying assets, Section 782 would become largely superfluous. To so interpret the statute would contradict the well-recognized principle which holds that effect must be given, if possible, to every word, clause, and sentence of a statute being construed, so that effect is given to all its provisions, so that no part will be inoperative or superfluous, void, or insignificant, and so that one section will not destroy another unless the provision is the result of obvious mistake or error. Rodriguez v. Superior Court, 14 Cal.App. 4th 1260, 1269 (1993).

We understand that the Fund is not comprised exclusively of the assets specified in Financial Code Section 782. Therefore, for the reasons discussed above, it is our view that Trust Co. is prohibited by Financial Code Section 761 from investing in shares of the Fund.

We note, however, that Section 772 of the Financial Code authorizes a bank, including a trust company, to invest corporate stock, including mutual funds, pursuant to such regulations as the Superintendent may prescribe. Pursuant to Section 772, the Superintendent has promulgated regulations (10 CRC § 10.19050, et seq.) which enable a trust company to obtain either a specific or general authorization to make such an investment. Trust Co. might consider seeking approval under these regulations if it wishes to acquire shares of the Fund.

If you have any questions, please feel free to contact me at (415) 263-8512.

Very truly yours,

CONRAD W. HEWITT
Superintendent of Banks

By

THOMAS M. LOUGHRAN
Senior Counsel

TML:arc