Broker-Dealers as Custodians Get Qualified OK in Close NAIC Vote

September 18, 2003

In a 6-4 vote Sept. 17, the National Association of Insurance Commissioners (NAIC) top-level Financial Condition (E)Committee gave a tentative endorsement to allowing securities broker-dealers to function additionally as custodians of insurers’ portfolio assets.

The specter of the Frankel scandal was woven into extensive debate among regulators that preceded the close vote in the closing moments of the NAIC’s fal national meeting in Chicago. “Financier” Robert Frankel defrauded a number insurance companies through robbing their portfolios as he continued to issue fraudulent account statements to those companies.

The committee still wants criteria to be developed by which broker-dealers would qualify, and there was mention of using the NAIC’s Securities Valuation Office as the developer of a list of acceptable broker-dealers that could additionally perform the custodial function.

The proposal that broker-dealers be allowed also to act as custodians of insurers’ assets was initially deliberated in a subordinate NAIC committee, the Custodial Assets Working Group, chaired by New York regulator Mike Moriarty, which sent to the Financial Condition (E) Committee its report of consideration of the question. Fundamental in considering the question, which would result in banks and trust companies having a reduced role in custodial functions, is that there are economies in allowing broker-dealers to be custodians.

The tentative endorsement came in the form of adoption of the Custodial Assets Working Group’s report of its earlier deliberations and its conclusion that broker-dealers were sufficiently secure to function as custodians.

Financial Condition Committee vice-chair José Montemayor noted to the committee that Texas and Arkansas already allow insurers to use broker-dealers as custodians.

Virginia regulator Doug Stolte and Iowa regulator Jim Armstrong recommended against allowing broker-dealers to add the custodial function.

Doug Hartz, the NAIC staff’s expert on insolvency matters, discussing any distinction between broker-dealers and bank-trust entities with respect to security, said to the committee Tuesday, “the only thing any of these entities has custody of is bits and bytes.” He referred to the way the securities business is done in the age of electronic information sharing. He said additionally of the Frankel scandal that “The same could have been done by a bank or trust company,” noting that a stolen or misappropriated broker identity was involved in Frankel’s embezzlements.

On behalf of National Association of Mutual Insurance Companies member Cameron Mutual of Cameron, Missouri, its CFO Kent Osborn, a member of NAMIC’s State Affairs Committee, wrote to the Financial Condition Committee:

“Working with broker/dealers and transferring assets to a bank trust facility requires extra time, extra reporting, and is very expensive. … If this could be accomplished, the companies would be able to receive all their reporting and verification from one source.”

NAMIC’s Accounting Committee had earlier communicated to the Custodial Assets Working Group that it endorsed allowing broker dealers to function as custodians.

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