Asset Custody from National Banks versus Brokerages

Choosing between asset custody services from national banks and brokerage firms is a crucial decision for investors. This analysis aims to provide a thorough and balanced view anchored in the law. The discussion focuses on two essential elements:

1. The statutory prohibition on the use of client trust and custodial assets by national banks in 12 U.S.C. 92a(d) of the National Bank Act.

2. The legal protection of a federal statutory lien that 12 U.S.C. 92a(e) of the National Bank Act affords to trust clients of national banks.

Regulatory Frameworks

National banks operate under the jurisdiction of the Office of the Comptroller of the Currency and adhere to the National Bank Act (12 U.S.C. 92a).

Brokerage firms are regulated by the Securities and Exchange Commission and must comply with the Securities Exchange Act of 1934 and the accompanying SEC Rules.

Asset Use and Security

National Banks
The National Bank Act, as outlined in 12 U.S.C. 92a(d), strictly prohibits national banks from using client trust and custodial assets for their own business activities.

Brokerage Firms

Brokerage firms offer both "margin" and "cash" accounts. The SEC's Hypothecation of Customers’ Securities Rule (Rule 8c-1) permits brokerage firms to use, pledge, and "hypothecate" client securities in margin accounts as collateral for loans.

Generally, the SEC's Hypothecation and Customer Protection Rules prevent the use or hypothecation of securities in client "cash" accounts, unless the client explicitly permits it. Cash brokerage accounts offer a level of asset protection closest to that of a fiduciary account at a national bank.

Customers in cash accounts may technically become unsecured creditors if the brokerage firm becomes insolvent. This risk is typically managed through Securities Investor Protection Corporation (SIPC) receivership, as outlined in the Securities Investor Protection Act (SIPA) of 1970. The SEC Customer Protection Rule (Rule 15c3-3 under the Securities Exchange Act of 1934) mitigates this risk by mandating the separation of client assets from the firm's assets.

Ownership and Creditor Claims

Both national banks and brokerage firms act as custodians but do not own the client's assets. The National Bank Act supports this principle for national banks, while the SEC Customer Protection Rule provides similar assurances for brokerage firms.

The Benefit of Federal Statutory Lien

Clients with trust and custodial accounts at national banks benefit from a federal statutory lien under 12 U.S.C. 92a(e). This lien elevates them to the status of secured creditors if the national bank undergoes acquisition or failure.

Although this lien may seem redundant—assets held in a fiduciary or custodial capacity always remain the property of the account owner—it adds an extra layer of security for national bank trust clients.

Implications of Institutional Failure

National Banks
If a national bank fails, trust and custodial client assets are not subject to the claims of the bank’s creditors and the status of these clients as secured creditors gives their assets an added layer of protection.

Brokerage Firms
In the event of a brokerage firm's insolvency, the SIPC oversees asset recovery. Yet, the SIPC's coverage has limitations, which investors should consider carefully, as they may experience losses that exceed these limits.

Cost Differences

Brokerage accounts are often free because brokerage firms can use the funds in certain types of accounts to offset the cost of providing custody services.

In contrast, national banks typically assess a service charge for their custodial services. These service charges arise because, under the National Bank Act, national banks do not have the right to use the client's assets for their own business activities. Investors could consider this modest additional cost as an insurance premium that provides greater peace of mind and asset security.

Conclusion and Recommendations

Both national banks and brokerage firms offer asset custody services, each with its own set of advantages and potential drawbacks. However, the regulatory safeguards under the National Bank Act offer a more robust level of asset protection for clients of national banks with trust and custodial accounts.

Investors should thoroughly investigate the regulatory framework, reputation, and financial stability of any institution before entrusting them with their assets.

Senior Vice President

Trust & Wealth
Department Manager

Vice President
Trust & Wealth
 Operations Manager 
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Trust & Wealth
Client Associate

Investment products and services are:

Not a Deposit  ●  Not FDIC Insured  ●  May Lose Value  ●  Not Bank Guaranteed  ●  Not Insured by any Federal Government Agency

Please Note: Investment products and services carry investment risks, including the potential loss of the principal amount invested. They are not FDIC Insured, bank guaranteed, or insured by any federal government agency.

Important: Chain Bridge Bank, N.A. does not provide tax, legal, or accounting advice. The information provided here should not serve as, nor be relied upon for, tax, legal, or accounting advice. We strongly recommend consulting your own tax, legal, and accounting advisors before engaging in any financial transaction.

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