Bank Corporate and Municipal Bond Trustee, Registrar, and Stock Transfer Agent Fiduciary Duty Litigation
The author, renowned nationwide expert witness Don Coker, explains some of the important nuances of banking litigation involving bank trust departments acting in various capacities for several different types of securities.
Many banks that have a Trust Department, and have therefore been granted Trust Powers (a separate charter from that of a bank) serve in a myriad of Corporate Trustee and Agency capacities, such as:
● Corporate Bond Trustee
● Municipal Bond Trustee
● Bond Registrar
● Bond Paying (or Fiscal) Agent
● Stock Transfer Agent
● Stock Registrar
● Successor Trustee
● Mutual Fund Transfer Agent
● Registered Transfer Agent
● Dividend Reinvestment Agent
● Other Corporate Trustee Roles
Basic Structure of a Bond Trustee Arrangement
Bonds may be used to fund the operations of a corporation, governmental entities such as a state, county, or city, public authorities such as a water or sewage district, school districts, hospital districts, special districts of all types, churches, or any other incorporated or public entity.
Bonds may be secured by some collateral such as real estate or a stream of income payments from some specific source such as a bridge or tunnel or a special tax, or the bonds may be unsecured in which case they are usually called debentures.
Asset-backed securities, such as residential mortgage-backed securities, commercial mortgage-backed securities, real estate mortgage investment conduits, and other forms of collateralized mortgage obligations are secured by a pool of mortgages.
A corporate trust arrangement is created through a document called an indenture (sometimes called by another name such as a trust indenture, trust agreement, or simply the agreement) that defines the general responsibilities of the parties to the agreement.
The trustee has a duty to perform the various functions specified by the indenture agreement. These functions vary from agreement to agreement but can include the following:
• The actual printing, issuance, and distribution of the bonds
• Maintaining required records and documentation
• Paying principal and interest
• If a collateralized bond, holding title to the collateral
• Prudently investing any idle cash
• Ensuring compliance with legal and regulatory requirements
• Monitoring for defaults under the indenture
• Acting to protect the interests of all bondholders in the event of a default
Corporate or Municipal Bond Trustee
A corporate bond trustee has a fiduciary duty and responsibility to represent the interests of all of the bondholders. A corporate bond trustee’s responsibilities can include the actual issuance of bonds, the maintenance of bondholder ownership records, transfer of recorded ownership from a seller to a buyer, the scheduled payment of principal and interest due to the bond owners, and the payment of remaining principal that is due to the bond owners upon the maturity of the bonds.
Bonds may be structured in many different formats such as in single or serial maturities, fixed or floating interest rates, sinking funds provisions to facilitate the repayment of principal, various call provisions, convertibility into other forms of securities, and many other innovative structures, all requiring specialized handling tailored to the specific security.
Bonds initially may be sold in various ways such as to the general public, an investment group of limited size, a governmental agency, or a single investor such as an insurance company or Warren Buffett.
It is more likely that bonds today are issued in registered form rather than in bearer form, as was common years ago. This is why the registrar of the bond issue must keep up with the ownership of each particular bond. Likewise, most bonds are issued in book entry form where no actual physical bond document is send to an investor. The investor’s evidence of their ownership of the bond is their trade confirmation where they bought the bond and their monthly investment statements.
A bond issue indenture typically covers:
• Description of the debt and the use of the funds
• Features of the bonds
• Details of the payment of interest
• Repayment of principal
• Relationships between the borrower (or obligor), the bank as trustee or agent, and the bondholders
• Duties of each party to the indenture
• Description of the collateral, if any
• Events of default and actions to be taken in the event of a default
The corporate bond trustee or bond registrar normally performs the function of making sure that sold bonds are cancelled and new bonds issued in a corresponding amount so that the authorized amount of bonds remains as it should be.
An indenture covering a secured bond transaction will be accompanied by some type of security instrument such as a mortgage, trust mortgage, deed of trust, collateral trust, equipment trust, or possibly some other security instrument depending on the type of collateral securing the bonds.
The bond registrar usually performs the duties of both the bond transfer agent and the bond registrar. This procedure is not written in stone, and there may be a separate bond registrar that keeps up with the registration issues and a bond transfer agent that handles the ownership transfer functions.
At one time, corporate, government bonds, and other debt securities were issued primarily in bearer form. Unlike stock issues, which were in registered form, the issuer did not know who held the bonds. The bondholder "clipped" interest coupons attached to the bond and sent them to the trustee or paying agent as interest became due. Eventually, the bond itself matured or was called prior to maturity, and was sent to the trustee for payment.
Today, however, most bond issues are registered for both principal and interest. Under Section 149 of the Internal Revenue Code, in order to qualify for the Federal tax exemption for interest with respect to state, county, and municipal bonds, such bonds must be in registered form. A transfer agent is, therefore, needed to maintain records of ownership. Since bond issues often have a 20 or 30 year maturity, some bearer bonds, (and associated coupons) may still be encountered by examiners.
For bond issues, the entity that performs transfer agent services is termed the bond registrar. A bond registrar performs all of the functions of the stock transfer agent and the stock registrar.
While unusual, banks are sometimes appointed solely as registrar of a bond issue, without the associated bond trustee duties.
Stock Transfer Agent
The functions of a stock transfer agent are similar to those just described for a corporate bond trustee in that the stock transfer agent usually issues stock certificates, maintain ownership records identifying the owners of each share of stock, and they handle sales of stock by cancelling stock certificates for sold stock and issuing new stock certificates to the new stock owners. Again, as with bonds, the vast majority of stock ownership is reflected in book entry ownership as opposed to paper certificates.
Incoming certificates are checked to verify their authenticity, and the transfer agent then sends both the canceled certificates and the newly issued certificates to the stock registrar for verification. A bank may serve as both the transfer agent and the stock registrar which means that the documents are handled internally.
A stock registrar’s job is to make sure that the correct number of shares is outstanding at all times. This job begins with verifying the original stock issuance and checks each transfer that is made by the stock transfer agent. This includes checking the genuineness of the certificates that are presented for transfer in order to make sure that the old certificates have been properly canceled. If a variance in the number of shares is discovered, it is referred to as an over or under issuance, out-of-balance condition, out-of-proof condition, a record difference, or some similar term New York Stock Exchange rules permit one institution to act as both transfer agent and registrar for listed securities other than its own.
Much less frequently, banks may be appointed solely as the outside registrar of a stock issue, without the more typical dual appointment as transfer agent and registrar.
Bank trust departments often provide successor trustee services for existing bond issues, both pre and post default. These successor trustee engagements can be challenging since they usually arise due to some problem that has made it necessary or advisable to replace the original trustee. In these successor trustee situations, the bank has all of the responsibilities it would have had it been the original trustee.
Paying Agent and Registrar
When there is no bond trustee for an issue, such as for a school district, a bank trust department can act as paying agent and registrar with carefully defined duties, including:
• Making required payments of principal and interest to bondholders
• Maintaining accurate bond ownership records
• Filing all necessary forms with the taxing authorities
• Registering bonds when they are issued
• Transferring bonds to new owners and destroying the old certificates
When a bank trust department performs these functions for a bond issue, it may be referred to as a disbursing agent, coupon paying agent, bond paying agent, fiscal agent, or some similar descriptive title.
A bank trust department can perform this same function for a stock issue in which case they may be called a dividend disbursing agent, dividend paying agent, or some similar descriptive title.
Mutual Fund Transfer Agent
Bank trust departments also serve as a mutual fund transfer agent that performs the functions of both the stock transfer agent and the stock registrar. In these functions, the bank trust department maintains ownership records for each share of mutual fund stock, destroys shares that are sold, transfers shares that are purchased, and verifies that the number of shares is accurate.
Mutual fund share transfer agent operations are different from stock or bond transfer agent operations in that mutual funds are almost always on a book entry basis as opposed to a paper certificate. Some mutual funds will allow a paper certificate to be issued in certain instances such as if a share owner wants to pledge the mutual fund shares as collateral for a loan.
Mutual fund registrars face a moving target situation when they are serving in this capacity for an open-end mutual fund which means that the total number of shares issued and outstanding varies based upon the volume of share purchases or redemptions (sales). Most mutual funds are open-end.
In order for a bank trust department (or any other entity) to serve as a mutual fund transfer agent, the entity must be a registered transfer agent under federal securities laws, specifically Section 17A of the Securities and Exchange Act of 1934 and Part 341 of the FDIC Rules and Regulations. Each registering entity is assigned a FINS (Financial Industry Numbering System) Number.
Operations of mutual funds are subject to the Investment Company Act of 1940.
Registered Transfer Agents
Likewise, bank trust departments that transfer securities that are either listed on a national stock exchange or registered under Federal securities laws must register as a registered transfer agent. This includes bank trust departments and state banks that are not members of the Federal Reserve System and that are a transfer agent for securities of their own institution, its holding company, or other affiliates whether or not the bank has been granted trust powers. If a bank trust department outsources its transfer agent responsibilities in what is referred to as a private label arrangement, then the institution still must register.
If a bank is required to become a registered transfer agent, it is required that all bond, stock, and other securities issues be processed according to the SEC's guidelines and regulations for registered transfer agents. One twist that is important to note is that whereas municipal, industrial revenue, and development bonds normally are not subject to securities registration, they must be registered if they are transferred by a registered transfer agent.
Corporate bond issues that are listed on a national securities exchange and mutual funds where the bank has been named as a transfer agent also require a bank trust department or other transfer agent entity to register as a transfer agent.
Dividend Reinvestment Agent
Bank trust departments can act as a dividend reinvestment agent, typically for a corporation where the bank is serving as the transfer agent. Dividend reinvestment plans usually operate on a book entry basis.
Other Securities Capabilities of Bank Trust Departments
● Conversion Agent
Bank trust departments sometimes serve as a conversion agent in situations where debt securities are issued and are capable of being converted into common or preferred stocks or other equity securities.
● Exchange Agent
Exchange agent functions include matters such as exchanging of one class of securities for another class, or the exchange of bearer bonds for registered bonds, or any other type of exchange of one security for another.
● Subscription Agent
A subscription agent subscribes, i.e., sells, a new flotation of stocks, bonds, or other securities.
● Authenticating Agent
A bank trust department may establish an authenticating agent relationship with a company when the indenture trustee is located in a small city away from money market banks.
● The documents that establish the relationship between a bank and the entity that is issuing the bonds, stock, or mutual funds tend to be quite similar, but they must be read carefully in order to determine the responsibilities of the various parties.
● It is a nationwide fundamental industry standard practice and procedure that the Trustee has a fiduciary duty to represent the interests of all of the bondholders.
● The registration function primarily involves keeping up with who owns which bonds or shares and that the correct number of bonds or shares is outstanding.
● The transfer function primarily involves canceling certificates that represent sold securities and issuing new certificates that represent purchased securities, understanding that the vast majority of this work is on a book entry basis.
ABOUT THE AUTHOR: Banking Consultant and Expert Witness Don Coker
Expert witness and consulting services. Over 500 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ.
Clients have included numerous individuals, 75 banks, and governmental clients such as the IRS, FDIC. Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator.
B.A. degree from the University of Alabama. Completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School. Called on by clients in 31 countries for work involving 61 countries. Widely published, often called on by the media.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.