The Financial Institutions Bureau has observed instances where state-chartered banks paid management and other fees to shareholders or insider-related organizations which bear no relationship to the type, level, quality or value of goods and services received. These practices include, but are not limited to: (1) excessive salaries; (2) excessive director fees; (3) fees paid where there is no corresponding benefit to the bank; (4) prepayment of fees for services not yet received; (5) fees to subsidize unprofitable holding company operations, and (6) fees established solely to meet a shareholder or insider-related organization s need for funds.

As a general rule, we view this practice as an unsafe and unsound activity which results in a dissipation of profits and capital. Additionally, there is a possibility that tax audits may result and all or a portion of these fees may be declared preferential dividends and disallowed as tax deductible expenses or, in the case of affiliated organizations, income and expenses might be reallocated. In either event, the bank may become directly or indirectly liable for additional income taxes.

Management and other fees paid by state-chartered banks should have a direct relationship to and be based solely upon the fair value of goods and services received, and only compensate the servicer for providing goods and services which meet the legitimate needs of the bank. Moreover, the recipient of the fees must have the expertise necessary to provide such services.

Being mindful of the factors which may influence the mechanism to establish a proper relationship between fees paid and services rendered, it is our policy to be sufficiently flexible or permit reasonable fees based upon cost, cost plus a reasonable profit, or current fair market value. Additionally, where the servicer incurs overhead expenses, recovery of those costs is acceptable to the extent they represent a legitimate and integral part of the service provided. Overhead may be defined as including salaries and wages, occupancy cost, utilities, payroll taxes, supplies and advertising. Debt service requirements of shareholders or other insider-related organizations are not considered legitimate overhead expenses which may be allocated or imposed upon a state-chartered bank.

Bank examiners are instructed to review all fees paid to shareholders or other insider-related organizations for the purpose of detecting instances where such fees are not justified, appear excessive, do not serve the legitimate needs of the bank, or otherwise constitute unsafe and unsound banking practices. It will not be the examiners' intent or responsibility to establish the pricing criteria for goods and services rendered; nevertheless, they are instructed to be alert to situations which indicate arbitrary inflation of cost, inefficiencies which result in inflation of cost, or where fees exceed the opportunity cost of seeking services elsewhere. State-chartered banks which elect to pay management or other fees to shareholders or other insider organizations will be expected to retain satisfactory records which represent the bank s Board of Directors and examiners the fair value of goods and services received, their benefit to the bank, and the cost efficiency of the fees paid.

Where the payment of excessive management and other fees to shareholders or other insider-related organizations is established, corrective action, including restitution, shall be the responsibility of the Board of Directors. Additionally, in those instances where the payment of excessive fees results in the levy of additional income taxes, we are of the opinion that the burden of those taxes should be borne by the recipient and/or possibly the Board of Directors responsible for approving the fees.

We are aware of the cash flow requirements of shareholders and insider-related organizations necessary to meet debt service requirements or pay dividends. It is our position that these costs should be accommodated through prudent dividend policies of the bank.

If there are cases where fees appear not to be in compliance with this bulletin, we recommend that you review your program with the Bank and Trust Division before you implement it.

Signed:	Richard J. Francis, Commissioner
	Gifford Knudsen, Director, Bank & Trust Division
Dated:	March 19, 1979