Collective Investment Funds

Internal Controls

CIF Operations

Effective operational controls should be in place to ensure that the bank, either directly or through its ongoing oversight of a third party:

Values CIF interests at intervals specified in the plan, and prices fund assets to support such valuations.
Executes admissions and withdrawals on a timely basis, as specified by the terms of the plan.
Monitors admissions and withdrawals to ensure that there are no opportunities to engage in “late trading”^[3] of a fund.
Monitors compliance with plan provisions regarding “market timing”^[4] activities.
Takes fees/expenses appropriately from each fund. Significant expenses, such as audit fees, are generally accrued and expensed throughout the year to spread these costs across all participating accounts.
Monitors and resolves CIF account overdrafts.
Arranges for an adequate audit annually.

Fund Administration

CIF administrative controls should be adequate to ensure that the bank:

Establishes and maintains funds in accordance with a written plan.
Maintains CIF documents in a central repository.
Has a formal process through the board of directors of the bank, or a committee appointed by the board, to approve or terminate CIFs.
Uses qualified counsel.
Evaluates fees to ensure they are reasonable.
Maintains adequate board/committee oversight.

The bank is expected to have sound controls over fund plans, third-party contracts, and other original documents that provide the bank with authority to invest assets in a CIF. The controls should ensure that original documents are properly authenticated and preserved for future accountings. Copies may be retained in fund files, but original documentation should be maintained in a centrally controlled location. Original board and committee minutes, with attachments noting approvals and actions taken, should receive the same level of safeguarding.

National banks should have internal policies that outline the bank’s position for voting proxies and for handling related social or controversial issues. These policies should include a provision that the bank maintain a record of how proxies are voted and, when a decision is made not to vote a proxy, the reasons why that decision was made.

In addition to the mandatory financial report disclosures set forth in 12 CFR 9.18(b)(6), which are described in the “Audits and Financial Reports” section of appendix B, a national bank should consider making available to interested persons the bank’s proxy voting policy and CIF proxy voting record. A bank should ensure that any such disclosures are consistent with its fiduciary obligations to its customers as well as the affected CIF. In most cases, the bank, as trustee of a CIF, will be the owner of any security acquired by that CIF for which there is a proxy issue. Accordingly, there is no regulatory requirement that a bank or its CIFs disclose to bank customers or to the public the bank’s proxy voting record. A bank may choose to make this information available as part of its 9.18(b)(6) annual disclosures, through periodic communications provided to plan participants, or through other methods of communication.

“Late trading” is a participant placing an order to add to or withdraw from a CIF at that day’s price after the CIF has closed its books for the day. For most CIFs that are valued daily, the fund’s unit or net asset value is determined at 4:00 p.m. Eastern time. Late trading enables the participant to profit from market events that occur after 4:00 p.m. that are not reflected in that day’s fund price. In order to prevent late trading, orders received after a day’s cut-off must be processed using the next day’s price. When a bank uses third parties, particularly electronic trading platforms, to accept participant orders or to maintain fund records, the bank must ensure that each third party has ironclad procedures in place that ensure that orders are assigned the appropriate price based upon when they were received.

The SEC has defined “market timing” in the mutual fund context to include: “(a) frequent buying and selling of shares of the same mutual fund, or (b) buying or selling mutual fund shares in order to exploit inefficiencies in mutual fund pricing. Market timing, while not illegal per se, can harm other mutual fund shareholders because it can dilute the value of their shares if the market timer is exploiting pricing inefficiencies, disrupt the management of the mutual fund’s investment portfolio, and can cause the targeted mutual fund to incur costs borne by other shareholders to accommodate frequent buying and selling of shares by the market timer.” In the Matter of Brean Murray & Co., Inc. (February 17, 2005). These practices may also be used to “market time” a CIF. Historically, the opportunities for market timing have been most available in international equity funds and funds holding thinly traded securities.

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