Common Trust Funds

Common trust funds (CTFs) accept and aggregate funds from fiduciary clients of the bank. By aggregating fiduciary clients, the bank may lower the operational and administrative expenses associated with investing fiduciary client assets. The bank may take on substantial risk depending on the investment strategy of the fund and the bank’s ability to meet the investment objectives of the fund. For tax purposes, CTFs are governed by IRC Section 584, which immediately allows them partnership tax status. Accordingly, CTFs file Forms 1065 and issue Forms K-1 to participants. A unique aspect of IRC Section 584, however, is that this tax status is achieved so long as the CTF follows the regulations for collective investment funds issued by the U. S. Office of the Comptroller of the Currency (OCC), regardless of whether the bank as a whole is supervised by the OCC. CTFs typically are exempt from regulation under the Investment Company Act of 1940 under the provisions of 1940 Act Section 3(c)(3). Participating interests in a CTF are not insured by the FDIC and are not subject to potential claims by the bank’s creditors.

Employee-Benefit Collective Funds

Employee-benefit collective funds are created specifically for the purpose of aggregating money received from employee benefit and similar plans that are tax-exempt. Most participants in these funds are qualified under the Employee Retirement Income Security Act (ERISA). These funds are governed by IRC Section 501 and are categorically tax exempt so long as all participants in the fund meet the requirements of IRC Section 401(a) and Revenue Ruling 81-100. These funds may, but are not required to, file returns as “direct filing entities” (DFEs) with the IRS, which also constitute filings with the U.S. Department of Labor (DOL). (If the collective investment fund does not file, each participating plan is required to file financial information about the fund as part of its Form 5500 filing.) More information about DFEs is available in the AICPA Audit and Accounting Guide Employee Benefit Plans. Unlike IRC Section 584, this exemption does not require the funds to follow any banking regulation other than that otherwise governing the bank as a whole (that is, state-chartered banks are not required to follow OCC collective fund regulation, while nationally-chartered banks, which are directly supervised by the OCC, do follow that regulation). The funds are exempt from regulation under the Investment Company Act of 1940 under the provisions of 1940 Act Section 3(c)(11).

Because of the separate regulatory regime for employee-benefit collective funds, it is rare for employee benefit plan money to be commingled with other participants’ funds in a single fund, and many banks establish separate parallel funds using identical investment strategies for the two investing groups. Banks may consult counsel prior to commingling employee benefit plan money with other money in a CTF.

OCC Regulation

Because OCC regulation applies to all CTFs, as well as employee-benefit collective funds sponsored by banks supervised by the OCC, it is important for auditors to understand its major elements.

The principal OCC regulations are contained in Article 9.18 of the Code of Federal Regulations (12 CFR 9.18), which prescribes many fund operating practices and establishes certain requirements for fund financial statements. Some of the key components of Article 9.18 include the following:

•     Each participating account must have a proportionate interest in all the fund’s assets (9.18(b)(3)).

•     All readily marketable assets must be valued by persons independent of those with investment management responsibilities at least quarterly at mark-to-market value, unless such cannot reasonably be ascertained, in which case a fair value determined in good faith is used. Short-term investment fund assets may be valued at amortized cost but only under specified conditions which in some aspects resemble those enumerated in SEC Rule 2a-7 (9.18(b)(4)).

•     In the event there is a suspension or limitation of withdrawals and liquidation of the short term investment fund is as a result of redemptions, a determination must be made as to the extent of the difference between the amortized cost and fair value and if there is a material dilution or other unfair results to the participating accounts and procedures must be adopted to formally approve the liquidation of the short term investment fund and facilitate a fair and orderly liquidation of the short term investment fund SEC Rule 2a-7 (9.18(b)(4)).

•     Admission and withdrawal of assets may only be on the basis of the valuation described in the preceding text, based on a notice received on or before the valuation date. No requests or notices may be cancelled after the valuation date. A bank administering a fund invested in real estate or other assets that are not readily marketable may require a notice period not exceeding one year for withdrawals (9.18(b)(5)).

•     The collective investment fund is to be audited at least once every 12 months by auditors responsible only to the bank’s board of directors (9.18(b)(6)(i)).

•     At least annually, the fund is to prepare a financial report based on the audit. Fees and expenses are to be disclosed in a manner consistent with applicable law in the state the bank maintains the fund. The report must contain

—     a list of investments showing the cost and market value of each position and a statement covering the period after the previous report showing the following (organized by type of investment) (9.18(b)(6)(ii)).

—     appropriate notation of any investments in default.

—     a statement of income and disbursements.

—     a summary of purchases (with costs) and a summary of sales (with profit or loss and any other investment changes).

(Under OCC policy, an audit cannot be waived in the period that a fund is terminated; unless the termination occurs as of the annual audit date, an additional “stub period” audit is required to verify that all assets were distributed or accounted for.)

•     A copy of the report, or a notice that a copy of the report is available, must be provided without charge to each person who would normally receive an accounting with respect to a participating account. Additionally, the report must be made available to any person who requests it, but a “reasonable charge” may be levied (9.18(b)(6)(iv)).

•     A bank may charge a reasonable management fee if permitted under the law of the applicable state in which the fund was formed and the amount of the fee does not exceed the value of services that would not have been provided to participants had they not invested in the fund. Other reasonable expenses of operating the fund may also be charged to the fund, but the bank must absorb the expenses of establishing the fund (9.18(b)(9) and (10)). OCC policy does, however, permit different accounts to be charged different management fees commensurate with the amount and types of services provided to fund participants.

The OCC has published, as part of its “Comptroller’s Handbook” series, a guide titled “Asset Management—Collective Investment Funds,” most recently updated as of May 2014, which provides extensive guidance regarding internal controls, investment practices, risk management practices and regulation. It also elaborates on the provisions of Article 9.18 and provides OCC policies in addition to those noted in the preceding text. This guide is available on the OCC’s website at https://www.occ.treas.gov/publications/publications-by-type/comptrollers-handbook/am-cif.pdf.

Auditors of CCTs should consider any state banking regulations which may apply, as well as, for employee-benefit collective funds, ERISA requirements imposed by either the IRS or DOL.

Financial Reporting

Generally, CCTs follow the reporting practices of nonregistered investment companies described in chapter 7 of the guide, with the additional requirements provided under Article 9.18(b)(6) described in the previous section for funds regulated directly or indirectly by the OCC. Employee-benefit collective funds of state-chartered banks are not necessarily required to follow OCC practices.