November 14, 1994
TO: BANK INVESTMENT MANAGEMENT MEMBERS NO. 32-94
BOARD OF GOVERNORS NO. 117-94
RE: FEDERAL RESERVE LETTER ON BANK INVESTMENT ADVISER
ACTIVITIES
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The Federal Reserve Board recently sent the attached letter to
the supervisory officers at each Federal Reserve Bank. The letter
states that some bank holding companies recently have provided
financial support to money market funds advised by their
subsidiaries. The letter also notes that a few state member banks
have taken similar action with respect to their common investment
funds.
The letter states that banks should have policies and
procedures concerning their investment adviser activities that
assure that the adviser is aware of the risks associated with the
investment it recommends to its client funds, particularly with
respect to derivatives. These policies and procedures should
address "the possible exposure associated with providing direct
financial support to advised funds."
The letter also states that management's failure to understand
the risks in complex derivative products can constitute an unsafe
and unsound practice. According to the letter, Federal Reserve
Bank examiners should determine whether an adviser has policies and
procedures to ensure that its fund portfolios "are operated in a
manner fully consistent with the funds' objectives or, if
applicable, SEC requirements." Investment advisers should
periodically subject their funds to "stress testing" or contingency
planning to determine if the investments will continue to conform
to the funds' objectives in periods of market uncertainty and
volatility.
We will keep you advised of further developments in this
regard.
Paul Schott Stevens
General Counsel
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