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F E D E R A L R ES ERVE B A N K OF D A L L A S DALLAS. TEXAS 75222 C i r c u l a r No. 78-38 A pril 6, 1978 MISUSE OF INSIDE INVESTMENT INFORMATION TO ALL STATE MEMBER BANKS IN THE ELEVENTH FEDERAL RESERVE DISTRICT: T h e Board of G o v e r n o r s of th e F e d e ra l R e s e r v e System has is s u e d a policy statem ent c o n c e r n i n g the u s e of in s id e information by a State m ember b a n k in connection with a n y d e c isio n o r recom m endation to p u r c h a s e o r sell s e c u r i t i e s . It is th e B o a r d 's ju d g m e n t that th e u s e of s u c h information c o n s titu te s an u n s a f e o r u n s o u n d b a n k in g p r a c t i c e . Enclosed is a copy of th e p r e s s r e l e a s e a n d FEDERAL REGISTER d ocu m ent. Sincerely yo u rs , R o b e r t H . Boykin F irs t Vice President E n c lo s u re This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) coy*.- FEDERAL p r e s s FOR IMMEDIATE RELEASE RESERVE r e l e a s e March 20, 1978 T h e B oard of G o v e r n o r s of th e F e de ra l R e s e rv e Syste m today is s u e d a policy s tatem e nt a l e r t i n g State m em ber b a n k s to p e n a ltie s that may a r i s e from the m is u s e of in s id e in v e s tm e n t info rm ation, a n d p r o v i d i n g ex am ples of s tep s that could be ta k e n to avoid violation of F e d e ra l law in th is fie ld . T h e B oard said th e policy sta te m e n t—w hic h is effective immediately— reflects th e j u d g m e n t of th e B oard th a t m is u s e of material in s id e information in connection with s e c u r i t i e s t r a n s a c t i o n s , o r re c om m e n dations a b o u t s u c h t r a n s a c t i o n s , c o n stitu te s an u n safe a n d u n s o u n d b a n k in g p r a c t i c e . A c c o r d i n g l y , th e statem e nt s a i d , the B oard " e x p e c ts each State m ember b a n k e x e r c i s i n g in v e stm e n t d is c r e t io n for the a c c o u n ts of o t h e r s to a d o p t w ritt e n policies a n d p r o c e d u r e s . . .to e n s u r e th a t material in s id e information in its p o s s e s s io n is not m i s u s e d . " T h e policy statem e n t, affecting chiefly the o p e ra tio n s of t r u s t d e p a r tm e n ts of State m em ber b a n k s , noted th a t F e d e ra l law g e n e r a l l y p r o h ib i ts the p u r c h a s e or sale of s e c u r i t i e s b y p e r s o n s p o s s e s s i n g m aterial in s id e information abou t the s e c u r it ie s until the inform ation th e y h a v e is d i s c l o s e d to th e p u b l i c . If the information c a n n o t be d is clo se d p u b l i c l y b e c a u s e it w a s o b ta in e d in c o n fid e n ce , h o l d e r s of the information must a b s ta in from t r a n s a c t i o n s o r reco m m end ations c o n c e r n i n g the s e c u r i t y involved until the informa tion is d i v u l g e d . Violations of t h e s e la w s, th e statem ent no te d, could e x p o s e b a n k s to s e v e r e financial p e n a l tie s a n d to c rim in a l c h a r g e s . Information w a s d e fin e d a s b e in g " m aterial" w hen t h e r e is a su b sta n tia l likeli hood th a t a r e a s o n a b l e in v e s t o r would c o n s i d e r it im portant in d e c id in g w h e th e r to b u y , s e l l , o r hold s e c u r i t i e s . T h e B oard said th a t in its o p in io n , the p r e v e n t i v e policies a n d p r o c e d u r e s b a n k s s h o u ld a d o p t s h o u ld limit a c tiv itie s th a t a r e likely to r e s u l t in an im p r o p e r i n t e r c h a n g e of material inform ation. T h e y sh o u ld a lso p r o v id e the b a n k with w ays to deal af firm a tiv e ly w ith s u c h information w h e n it comes into the p o s s e s s io n of b a n k p e rs o n n e l who make in v e stm e n t d e c i s io n s for th e a c c o u n t of o t h e r s . T h e Board u r g e d each State member b a n k to r e v ie w its policies a n d p r o c e d u r e s to make s u r e th e y would accom p lish th e se p u r p o s e s , in th e p a r t i c u l a r c i r c u m s t a n c e s of the b a n k . T h e B oard set fo rth the following ex am ples of p o s s ib le a p p r o a c h e s to th e d e v e l o p ment of w r itt e n p o lic ie s a n d p r o c e d u r e s to a v o id the m is u se of m aterial in s id e information: - 2 - 1. Denial of a c c e s s b y t r u s t p e r s o n n e l to commercial c r e d i t file s , g o v e r n m e n t, a g e n c y , a n d municipal s e c u r i t i e s u n d e r w r i t i n g file s , and o t h e r p e r t i n e n t files. 2. A p ro h ib itio n a g a i n s t a tte n d a n c e b y t r u s t p e r s o n n e l a t p r i v a t e meet ings with b a n k lending or u n d e r w r i t i n g p e r s o n n e l , e x c e p t w h e r e the meeting is held solely to s e e k a new c u s t o m e r re la tio n s h ip . 3. A p ro h ib itio n a g a i n s t p e r s o n n e l s e r v i n g sim u lta n e o u sly on a committee a u th o r iz e d to make specific in v e stm en t d e c is io n s o r recom m endations a n d a committee r e s p o n s i b l e for commercial le n d in g o r u n d e r w r i t i n g of g o v e r n m e n t is s u e s . 4. A r e q u i r e m e n t for a p ro m p t r e p o r t to m anagem en t by a n y t r u s t d e p a r t ment, o r t r u s t d e p a r tm e n t e m ployee, of the r e c e i p t of in side information they sh ould not h a v e , a n d , if m anagem ent d e te r m in e s th a t the informa tion is m a te ria l, p ro m p t o r d e r s to: —Halt all b a n k tr a d in g of the in dicated s e c u r i t y , o r b a n k recom mendations c o n c e r n in g it; — Determine w h e t h e r th e information is va lid a n d h a s not been made public ; —R e q u e s t the i s s u e r or o t h e r a p p r o p r i a t e p a r t i e s to make p e r t i n e n t information public; —Seek legal a d v ic e , if th e information is not p u b lic ly d is c l o s e d , as to w h a t e lse sh o u ld be do n e b e fore t r a d i n g in the s e c u r i t y , or recom m endations c o n c e r n i n g it, a r e r e s u m e d . 5. T h e p ro v is io n for e v e r y a c c o u n t, of a copy of the b a n k 's policies a nd p r o c e d u r e s to the p e r s o n h a v in g p o w e r to te rm in a te th e b a n k ' s d i s c r e t i o n a r y inve stm en t a u th o r ity o v e r the a c c o u n t, o r to the p e r s o n to whom a n a c c o u n tin g would o r d i n a r i l y b e r e n d e r e d . 6. Physical s e p a r a tio n of t r u s t a n d commercial b a n k len ding a n d i n v e s t ing p e r s o n n e l , a s c ir c u m s ta n c e s allow. A copy of the B o a r d 's policy statem e nt is a tta c h e d . - 0- [6 2 1 0 -0 1 ] [D ocket No. R 0148] Policy S M m m i H C o n c a m in g U u o f In tid * In fo rm a tio n E x tra c t From FEDERAL REGISTER, VOL. 43, NO. 59, M onday, March 27, 1978 p p . 12755 - 12756 AGENCY: Board of Governors of the Federal Reserve System. ACTION: Policy statement. SUMMARY: This policy statement re flects the judgment of the Board of Governors of the Federal Reserve System that the use of material inside information by any State member bank in connection with any decision or recommendation to purchase or sell securities constitutes an unsafe and unsound banking practice. Notifica tion is given that the Board of Gover nors expects each State member bank exercising investment discretion for the accounts of others to adopt writ ten policies and procedures suitable to its particular circumstances to ensure that such information in its possession is not misused. Guidelines are pro vided to aid State member banks in the development of such policies and procedures. EFFECTIVE DATE: March 17. 1978. FOR FURTHER INFORMATION CONTACT: Robert S. Plotkin, Assistant Direc tor. 202-452-2782, or Robert A. Wallgren, Chief, Trust Activities Pro gram. 202-452-2717, Division of Banking Supervision and Regula tion, Board of Governors of the Fed eral Reserve System, Washington, D.C. 20551. SUPPLEMENTARY INFORMATION: This policy statem ent is issued pursu ant to the board's supervisory author ity over State member banks con tained in section 9 (12 U.S.C. 321) and section 11 (12 U.S.C. 248(a)) of the Federal Reserve Act and the Financial Institutions Supervisory Act of 1966 (12 U.S.C. 1818(b)) and related provi sions of law. S t a t e m e n t o f P o l i c y C o n c e r n i n g U se o f In s i d e In f o r m a t i o n Commercial banks may receive infor mation about their customers that is not otherwise available to the public. In many cases, customers about which the bank possesses confidential infor mation are firms whose securities are publicly traded. Full-service commer cial banks, being institutions that pro vide a diversity of services, may, at the same time such confidential informa tion is in their possession, be effecting purchases or sales of such securities for trust customers and others and ad vising customers as to the purchase or sale of such securities. Where confidential information in the possession of a person is “materi al” (i.e.. is of such nature that there is a substantial likelihood that a reason able investor would consider it impor tant in deciding whether to buy. sell, or hold securities). Federal securities law generally prohibits the purchase or sale of pertinent securities by such person until the information is dis seminated to the public. A person in possession of such material inside in formation must, before effecting transactions in the affected security, disclose to the public such information or, if unable to do so (e.g., in order to protect a corporate confidence), must abstain from trading in or recommend ing such securities until the informa tion is disclosed. Similarly, divulging confidential material inside informa tion only to one's customers who then act on the basis of the information vio lates Federal securities law. For a bank to purchase or sell, or recommend the purchase or sale of, se curities on the basis of material inside information in the bank’s possession subjects the bank not only to injunc tive suits and criminal proceedings, but also to civil damage suits by per sons on the other side of the transac tions. In such cases, liability may not be limited to the persons on the other side of the transactions, but conceiv ably could extend to all persons who effected transactions in the securities before the information became public; thus potential liability could be sub stantial in terms of the amount of damages that may be awarded. Accordingly, the Board of Governors will view the use of material inside in formation in connection with any deci sion or recommendation to purchase or sell securities as an unsafe and un sound banking practice. Furthermore, the Board expects each State member bank exercising investment discretion for the accounts of others to adopt written policies and procedures, suit able to its particular circumstances, to ensure that such information in its possession is not misused. Because the size and organizational structure of individual banks that engage in investment activities vary widely, the Board does not believe that it should, at this time, mandate the specific content of policies and procedures to be adopted. The Board believes, however, that in general such policies and procedures should limit those types of activity that are likely to give rise to an improper interchange of material inside information and es tablish a course of action for the bank to deal affirmatively with such infor mation that may come into the posses sion of personnel engaged in invest ment decision making for the accounts of others. In this connection, the Board urges each State member bank to review its organizational structure and methods of operation to ensure that its policies and procedures are ap propriately tailored to its circum stances. System trust examiners will be instructed to evaluate regularly the adequacy of policies and procedures adopted by individual banks. Set forth below are examples of spe cific approaches to dealing with inside information that State member banks may wish to consider in the develop ment of policies and procedures for their own use. Although more general ly applicable to larger banks, (i.e.. those managing assets for the ac counts of others with a market value over $100 million), they may prove useful to smaller banks as well. E xamples (1) Trust personnel (i.e., bank em ployees whose duties include the making of investment decisions or rec ommendations for fiduciary or agency accounts) should not have access to commercial credit files, government, agency, and municipal securities un derwriting files or such other files that the bank can reasonably deter mine may contain material inside in formation; (2) Trust personnel should not attend private meetings between or among personnel engaged in commer cial lending activities or in underwrit ing government, agency, and munici pal securities, on the one hand, and bank customers on the other, except where the sole purpose of the meeting is to seek a new customer relationship; (3) Officers, directors, or employees of the bank should not serve simulta neously on any committee having re sponsibility for the making of invest ment decisions or recommendations with respect to specific transactions and any committee having responsibil ity for commercial lending or govern ment, agency, and municipal securities underwriting activities, unless neces sary to the circumstances of the indi vidual bank; (4) All trust department employees should be advised to report promptly to the management of the trust de partment suspected material inside in formation and, upon a determination by that management that the infor mation is material, management should promptly (a) Halt all trading by the bank in the security or securities of the perti nent issuer and all recommendations thereof; (b) Ascertain the validity and non public nature of the information with the issuer of the securities; (c) Request the issuer or other ap propriate parties to disseminate the information promptly to the public, if the information is valid and non public; (d) In the event the information is not publicly disseminated, notify the bank's legal counsel and request advice as to what further steps should be taken, including possible publication by the bank of the information, before transactions or recommendations in the securities are resumed. (5) A copy of the bank's policies and procedures should be furnished for each fiduciary or agency account for which the bank exercises investment discretion to the person having the power to terminate the account or, if there is no such person, to the persons to whom an accounting would ordi narily be rendered. (6) Trust personnel should be sepa rated physically from commercial lending personnel and government, agency, and municipal securities un derwriting personnel to the extent ap propriate to the circumstances of the individual bank. Board of Governors of the Federal Reserve System, March 17, 1978. T heodore E . A l l is o n , Secretary of the Board. [ F R D oc. 78-7952 F ile d 3-24-7 8 ; 8:45 a m ]
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